Nordstrom - 10-Q quarterly report FY

 

 

(Exact name of Registrant as specified in its charter)

206-628-2111
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Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer þ      Accelerated filer o      Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

Common stock outstanding as of August 17, 2006: 256,621 shares of common stock (in thousands).

 

 

(Amounts in thousands except per share amounts and percentages)

(Unaudited)

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

(Amounts in thousands)

(Unaudited)

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

(Amounts in thousands except per share amounts)

(Unaudited)

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

(Amounts in thousands)

(Unaudited)

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

(Dollar and share amounts in thousands except per share and per option amounts)

(Unaudited)

The accompanying condensed consolidated financial statements should be read in conjunction with the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K for the fiscal year ended January 28, 2006. The same accounting policies are followed for preparing quarterly and annual financial information. All adjustments necessary for the fair presentation of the results of operations, financial position and cash flows have been included and are of a normal, recurring nature.

Our business, like that of other retailers, is subject to seasonal fluctuations. Our Anniversary Sale in July and the holidays in December typically result in higher sales in the second and fourth quarters of our fiscal years. Accordingly, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.

Similar to many retailers, this year we will have an extra week — a 53^rd week. This week will be reported in the fourth quarter, which will have 14 weeks instead of the normal 13 weeks.

The preparation of our financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. We base our estimates on historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. With the exception of our adoption of Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment” in the beginning of the first quarter of 2006, our accounting policies and methodologies in 2006 are consistent with those discussed in our Annual Report on Form 10-K for the fiscal year ended January 28, 2006.

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes.” FIN 48 requires that we recognize the impact of a tax position in our financial statements if that position is more likely than not to be sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. The provisions of FIN 48 are effective for us as of the beginning of our 2007 fiscal year. We are currently evaluating the impact of adopting FIN 48 on our financial statements.

Prior to the adoption of SFAS No. 123(R), we applied Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” to measure compensation costs for our stock-based compensation programs. Under APB No. 25, we recorded no compensation expense for stock options granted to employees and directors because the options’ strike price was equal to the closing market price of our common stock on the grant date. Also, through 2005 we recorded no compensation expense in connection with our Employee Stock Purchase Plan (ESPP). Through 2005, we presented the effect on net earnings and earnings per share of the fair value provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” in the Notes to Condensed Consolidated Financial Statements.

Effective January 29, 2006, we adopted SFAS No. 123(R), which requires us to measure the cost of employee and director services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The costs are recognized over the period during which an employee is required to provide services in exchange for the award.

We recognize stock-based compensation expense on a straight-line basis over the requisite service period. The following table summarizes our stock-based compensation expense (earnings):

The stock-based compensation expense before income tax benefit was recorded in our condensed consolidated statements of earnings as follows:

We adopted SFAS No. 123(R) using the modified prospective method. Under this transition method, the stock-based compensation expense recognized in the current period includes the expense for stock options granted after January 29, 2006. The stock-based compensation expense also includes the expense for options granted prior to, but not vested as of January 29, 2006 based on the grant-date fair value determined in accordance with the original provisions of SFAS No. 123. In addition, we recognized stock-based compensation expense related to our ESPP, as our 10% purchase discount exceeds the amount allowed under SFAS No. 123(R) for non-compensatory treatment. As provided for under the modified prospective method, we have not restated our results for prior periods. The incremental stock-based compensation expense upon adoption of SFAS No. 123(R) for the quarter ended July 29, 2006 was $6,823 ($4,365 net of tax), or $0.02 per basic share and $0.01 per diluted share. For the six months ended July 29, 2006, the incremental stock-based compensation expense was $13,951 ($8,933 net of tax), or $0.03 per basic and diluted share. We expect to record $26,960 in incremental stock-based compensation expense for the year ended February 3, 2007, representing approximately $0.06 per diluted share.

Prior to the adoption of SFAS No. 123(R), we presented all tax benefits resulting from the exercise of stock options and ESPP as operating cash inflows. SFAS No. 123(R) requires the benefits of tax deductions in excess of the compensation cost recognized for those awards to be classified as financing cash inflows rather than operating cash inflows, on a prospective basis. This amount is shown as “Excess tax benefit from stock-based payments” in the condensed consolidated statement of cash flows and was $15,109 for the six months ended July 29, 2006.

The following table illustrates the effect on net earnings and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” in 2005:

The weighted average fair value per option at the grant date was $16 and $10 in 2006 and 2005. The following describes the significant assumptions used to estimate the fair value of options granted:

The expense components of our Supplemental Executive Retirement Plan, which provides retirement benefits to certain officers and select employees, are as follows:

The computation of earnings per share is as follows:

The components of accounts receivable are as follows:

Our restricted trade receivables relate to our Nordstrom private label card, which back the $300,000 Class A notes due in October 2006. The unrestricted trade receivables consist primarily of our Façonnable trade receivables and accrued finance charges not yet allocated to customer accounts.

Other accounts receivable consist primarily of credit card receivables due from third-party financial institutions and vendor rebates, which are believed to be fully realizable as they are collected soon after they are earned.

Our investment in asset backed securities and the off-balance sheet financing are described in Notes 1 and 8 of our Annual Report on Form 10-K for the fiscal year ended January 28, 2006. The following table presents the co-branded Nordstrom VISA credit card balances and the estimated fair value of our investment in asset backed securities:

In July 2006, the VISA Trust issued for cash $300,000 of variable funding notes at par; these notes are referred to as the 2004-2 VFN. The proceeds received by the VISA Trust were then sent to us in exchange for a reduction in the Transferor Interest in the VISA Trust held by Nordstrom, Inc. The reduction in the Transferor Interest was equal to a $300,000 reduction in our share of the principal balance of the underlying VISA credit card receivables.

The following table presents the key assumptions we use to value the investment in asset backed securities:

The following table summarizes the income earned by the investment in asset backed securities that is included in other income including finance charges, net on the condensed consolidated statements of earnings:

To manage our interest rate risk, we have an interest rate swap outstanding recorded in other liabilities. Our swap has a $250,000 notional amount, expires in January 2009 and is designated as a fully effective fair value hedge. Under the agreement, we receive a fixed rate of 5.63% and pay a variable rate based on LIBOR plus a margin of 2.3% set at six-month intervals (7.85% at July 29, 2006). The fair value of our interest rate swap is as follows:

In the second quarter of 2006, we deposited $150,000 into a restricted pre-funding account. We will continue to deposit $50,000 of cash per month into the account to repay the $300,000 Private Label Securitization debt due in October 2006.

In June 2006, we amended our existing variable funding facility backed by Nordstrom private label card and VISA credit card receivables to increase the capacity of this facility from $150,000 to $450,000. Borrowings under the facility will incur interest based upon the actual cost of commercial paper plus specified fees ranging from 0.075% to 0.15% (5.43% as of July 29, 2006). We pay a commitment fee ranging from 0.125% to 0.15% for the note based on the amount of the commitment. Fee rates decrease if more than $50,000 is outstanding on the facility. The facility can be cancelled or not renewed if our debt ratings fall below Standard and Poor’s BB+ rating or Moody’s Ba1 rating. Our current rating by Standard and Poor’s is A, five grades above BB+, and by Moody’s is Baa1, three grades above Ba1.

In July 2006, the VISA Trust used this facility to issue $300,000 of Notes. As the VISA Trust is a statutory business trust and the VISA credit card receivables transferred to it are accounted for as a sale under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” the obligations of the VISA Trust are not recorded in our financial statements. The VISA Trust sent the proceeds from this note issuance to us in return for a reduction in our interest in the VISA Trust equal to a $300,000 decrease in our share of the principal balance of VISA credit card receivables.

In 2004, our shareholders approved the 2004 Equity Incentive Plan. We currently grant stock options, performance share units and common shares under this plan.

As of July 29, 2006, we have options outstanding under three stock option plans (collectively, the “Nordstrom, Inc. Plans”). Options vest over periods ranging from four to eight years, and expire ten years after the date of grant. A summary of stock option activity under the Nordstrom, Inc. Plans is presented below:

In 2005 and 2006, stock option awards to employees were approved by the Compensation Committee of the Company’s Board of Directors and their exercise price was set at the closing price of our common stock on the Committee meeting date. The stock option awards provide our leaders with the opportunity for financial rewards when our stock price increases. The awards are determined based upon a percentage of the leaders’ base salary and the fair value of the stock options, which was estimated using an option pricing model. The fair value per stock option was $16 in 2006 (using a Binomial Lattice option valuation model) and $10 in 2005 (using the Black-Scholes option valuation model). For the six months ended July 29, 2006, we awarded stock options to 1,235 employees compared to 1,207 employees in the same period in 2005.

The total intrinsic value of options exercised during the six months ended July 29, 2006 and July 30, 2005 was $46,016 and $66,890. The total fair value of stock options vested during the six months ended July 29, 2006 and July 30, 2005 was $30,068 and $26,403. As of July 29, 2006, the total unrecognized stock-based compensation expense related to nonvested stock options was $51,066, which is expected to be recognized over a weighted average period of 32 months. The aggregate intrinsic value of options outstanding as of July 29, 2006 was $226,268.

The following table summarizes information about stock options outstanding for the Nordstrom, Inc. Plans as of July 29, 2006:

We grant performance share units to align the performance of our senior management with our shareholder returns. Performance share units vest after a three-year performance period only when our total shareholder return (growth in stock price and reinvestment of dividends) is positive and outperforms companies in a defined peer group of direct competitors determined by the Compensation Committee of our Board of Directors. The percentage of units that vest depends on our relative position at the end of the performance period and can range from 0% to 125% of the number of units granted. As participants may elect to exchange each unit earned for one share of stock or the cash equivalent, these units are classified as a liability award.

At the end of each period, we record the performance share unit liability based on the vesting factors described above. At the end of July 29, 2006 and July 30, 2005, our liabilities included $4,903 and $11,825 for the units. For the six months ended July 29, 2006 and July 30, 2005, stock-based compensation (earnings) expense was $(715) and $6,570. As of July 29, 2006, the remaining unrecognized stock-based compensation expense related to nonvested performance share units was $2,329, which is expected to be recognized over a weighted average period of 15 months. At January 28, 2006, 412,648 units were unvested. During the six months ended July 29, 2006, 63,673 units were granted, 216,865 units vested and 991 units cancelled, resulting in an ending balance of 258,465 unvested units as of July 29, 2006.

The following table summarizes the information for performance share units that vested during the period:

The Nonemployee Director Stock Incentive Plan authorizes the grant of stock awards to our nonemployee directors. These awards may be deferred or issued in the form of restricted or unrestricted stock, nonqualified stock options or stock appreciation rights. We issued 5 shares of common stock for a total expense of $169 in 2006. An additional 15 shares were deferred for a total expense of $509. As of July 29, 2006, we had 755 remaining shares available for issuance.

We offer an Employee Stock Purchase Plan as a benefit to our employees. Employees may make payroll deductions of up to ten percent of their base and bonus compensation. At the end of each six-month offering period, participants may purchase shares of our common stock at 90% of the fair market value on the last day of each offer period. Beginning in 2006, we recognize stock-based compensation expense related to the ESPP, as our purchase discount exceeds the amount allowed under SFAS No. 123(R) for non-compensatory treatment. We record compensation expense over the purchase period at the fair value of the ESPP at the end of each reporting period.

We issued 237 shares under this plan in the first quarter of 2006. As of July 29, 2006 and July 30, 2005, we had current liabilities of $5,760 and $4,961 for the purchase of shares in the future.

The following tables set forth the information for our reportable segments and a reconciliation to the consolidated totals:

The segment information for 2005 has been adjusted from our previous disclosures as we now reflect Façonnable, Nordstrom Product Group and the distribution network in Other. Also, beginning in September 2005, we changed our internal method for recognizing returns of Direct sales at Retail Stores. Previously, these returns were recognized in the Direct segment and now they are recognized in the Retail Stores segment.

In July 2006, we received $5,586 of proceeds from the VISA Check/Master Money Antitrust Litigation. These proceeds were recorded as a gain in the second quarter of 2006 in other income including finance charges, net.

We are involved in routine claims, proceedings, and litigation arising from the normal course of our business. We do not believe any such claim, proceeding or litigation, either alone or in aggregate, will have a material impact on our results of operations, financial position, or liquidity.

The following discussion should be read in conjunction with the Management’s Discussion and Analysis section of our Annual Report on Form 10-K for the fiscal year ended January 28, 2006.

Net earnings as a percentage of net sales improved 80 basis points for the quarter and 90 basis points for the six months ended July 29, 2006 compared to the same periods last year. These results were driven by the combination of continued sales growth, moderate gross profit rate expansion, stable selling cost rates, and leverage of fixed costs. Key highlights include:

Total net sales for the quarter and six month periods increased over the same periods in the prior year due to new stores and same-store sales increases. Total net sales benefited from the four Full-Line stores opened since the second quarter of 2005. These four stores increased our retail square footage by 3% compared to last year.

Men’s apparel, cosmetics, accessories and intimate apparel were the key merchandise categories that experienced the largest same-store sales increases in the second quarter and for the six months ended July 29, 2006. During both periods, our women’s apparel merchandise category had slight same-store sales decreases.

Our second quarter sales are an important contributor to our annual results. We hold clearance sales in June with our Women’s & Kids’ and Men’s Half Yearly Events. In July, we conduct our Anniversary Sale, which is our biggest event of the year, offering new Fall-season merchandise priced at promotional discount prices before the season begins. Our highest sales volume days of the year occur during these three events. Each of these events delivered positive same-store sales increases in 2006. In addition, sales of regular-price merchandise increased in the second quarter.

Compared to the same period last year, our SG&A rate improved 64 basis points for the quarter and 57 basis points for the six months ended July 29, 2006. For both periods, the performance resulted primarily from leverage on better than planned sales. Our variable expense rate, which consists primarily of selling labor and credit expenses, was slightly lower than last year; and, we leveraged our fixed selling costs, including non-selling labor and advertising. SG&A include incentive and deferred compensation costs, which were impacted by fluctuations in our stock price and, to a lesser degree, overall market trends. We experienced favorability in our SG&A resulting from a decline in our stock price during both the quarter and six months ended July 29, 2006. However, our employee medical costs and information technology professional services increased in 2006.

SG&A included $4.2 in the second quarter and $8.6 in the six months ended July 29, 2006 for costs related to stock options awarded to employees in our store operations, business units and corporate service center. These costs impacted our SG&A rate by 18 basis points for the quarter and 21 basis points for the six month period.

Interest expense, net increased by $1.9 to $12.8 for the quarter ended July 29, 2006, compared to the same period in 2005. The increase was due to a slight increase in our average interest rates and lower interest income as we reduced our cash and short-term investment balances in 2006 as compared to 2005.

For the six months ended July 29, 2006, interest expense, net was $23.5, which was flat compared to the same period in 2005. During the first quarter of 2006, our interest income was higher than last year due to larger cash balances. During the second quarter, this was offset by an increase in interest expense as discussed above.

Other income including finance charges, net increased by $15.9 for the quarter and $27.0 for the six months ended July 29, 2006. For both periods, the increase was primarily due to growth in our co-branded Nordstrom VISA credit card program.

In July 2006, we received $5.6 of proceeds from the VISA Check/Master Money Antitrust Litigation. These proceeds were recorded as a gain in the second quarter of 2006 in other income including finance charges, net.

Our business, like that of other retailers, is subject to seasonal fluctuations. Our Anniversary Sale in July and the holidays in December typically result in higher sales in the second and fourth quarters of our fiscal years. Accordingly, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.

In the past two years, we have incorporated Return on Invested Capital (ROIC) into our key financial metrics, and since 2005 have used it as an executive incentive measure. Overall performance as measured by ROIC correlates directly to shareholders’ return over the long-term. For the 12 months ended July 29, 2006, we improved our ROIC to 18.5% compared to 14.7% for the 12 months ended July 30, 2005. Our ROIC improved primarily from increased earnings before interest and taxes. See our GAAP ROIC reconciliation below. The closest GAAP measure is return on assets, which improved to 12.5% from 9.9% for the last 12 months ended July 29, 2006 compared to the 12 months ended July 30, 2005.

We define ROIC as follows: