Nordstrom - 10-Q quarterly report FY

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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):

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Common stock outstanding as of December 1, 2006: 257,040 shares of common stock (in thousands).

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

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

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

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

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 fiscal year we will have an extra week – a 53^rd week that 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 the tax effects of a position be recognized only if it 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.

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (FAS 157). FAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FAS 157 is effective for fiscal years beginning after November 15, 2007. We are assessing the potential impact on our financial statements.

Also in September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (FAS 158). FAS 158 addresses the accounting for defined benefit pension plans and other postretirement benefit plans. It will require the recognition of a plan’s overfunded or underfunded status as an asset or liability in the balance sheet and the recognition of changes in that funded status in the year in which the changes occur through comprehensive income. FAS 158 also requires the measurement date for plan assets and liabilities to coincide with the plan sponsor’s fiscal year end. This statement is effective for fiscal years ending after December 15, 2006, except the change in measurement date provisions, which is effective for fiscal years ending after December 15, 2008. We have two benefit plans that are impacted by this standard: our Supplemental Executive Retirement Plan (SERP) and our retiree medical plan. Based on recent valuations and projections of the funded status of these plans, we expect that the effect of the adoption of FAS 158 will be to increase total liabilities and to reduce shareholders’ equity by approximately $14 million. The actual impact of adopting FAS 158 will depend on the valuation of our plan obligations as of our 2006 measurement date.

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 for 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. Following the adoption of SFAS No. 123(R), we recorded incremental stock-based compensation expense of $6,520, ($4,161 net of tax), or $0.01 per basic and diluted share for the quarter ended October 28, 2006 and $20,471 ($13,105 net of tax), or $0.04 per basic and diluted share for the nine months ended October 28, 2006. We expect to record $27,103 ($17,364 net of tax) 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 $25,384 for the nine months ended October 28, 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 in 2005:

In 2005, we used the Black-Scholes option valuation model to estimate the fair value of the stock options under SFAS No. 123. When we adopted SFAS No. 123(R), we elected to use the Binomial Lattice option valuation model. We believe that this model provides a better estimate of fair value than the Black-Scholes option valuation model, as it can accommodate variability in assumptions for expected volatility, dividends and risk-free interest rates. We used the following assumptions to estimate the fair value for stock options at grant date:

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 are comprised of our Nordstrom private label card receivables, which back the $100,000 variable funding note due in February 2007. 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 $300,000 for cash of variable funding notes at par; in September 2006, the VISA Trust issued $50,000 for cash of additional variable funding notes at par. 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 $350,000 reduction in our share of the principal balance of the underlying VISA credit card receivables since our last fiscal year end.

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 (7.70% at October 28, 2006). The fair value of our interest rate swap is as follows:

We retired the $300,000 Private Label Securitization debt when it matured in October 2006.

In October 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 $450,000 to $600,000. 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%. As of October 28, 2006, the facility’s interest rate was 5.41%. 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; in September 2006, the VISA Trust used this facility to issue an additional $50,000 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 $350,000 decrease in our share of the principal balance of VISA credit card receivables since our last fiscal year end.

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 October 28, 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 recipients with the opportunity for financial rewards when our stock price increases. The awards are determined based upon a percentage of the recipients’ 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 nine months ended October 28, 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 nine months ended October 28, 2006 and October 29, 2005 was $75,459 and $77,915. The total fair value of stock options vested during the nine months ended October 28, 2006 and October 29, 2005 was $30,087 and $26,519. As of October 28, 2006, the total unrecognized stock-based compensation expense related to nonvested stock options was $45,662, which is expected to be recognized over a weighted average period of 30 months. The aggregate intrinsic value of options outstanding as of October 28, 2006 was $357,713.

The following table summarizes information about stock options outstanding for the Nordstrom, Inc. Plans as of October 28, 2006:

We grant performance share units to align certain elements of our senior management compensation 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 October 28, 2006 and October 29, 2005, our liabilities included $9,314 and $11,716 for the units. For the nine months ended October 28, 2006 and October 29, 2005, stock-based compensation expense was $3,696 and $6,460. As of October 28, 2006, the remaining unrecognized stock-based compensation expense related to nonvested performance share units was $4,160, which is expected to be recognized over a weighted average period of 18 months. At January 28, 2006, 412,648 units were unvested. During the nine months ended October 28, 2006, 68,092 units were granted, 216,865 units vested and 8,396 units cancelled, resulting in an ending balance of 255,479 unvested units as of October 28, 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 unrestricted stock for a total expense of $169 in 2006. An additional 15 shares were deferred for a total expense of $514. As of October 28, 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. We record compensation expense over the purchase period at the fair value of the ESPP at the end of each reporting period.

We issued 446 shares under the ESPP during the nine months ended October 28, 2006. As of October 28, 2006 and October 29, 2005, we had current liabilities of $1,543 and $1,407 for future purchase of shares under the ESPP.

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

The segment information for the quarter and the nine months ended October 29, 2005 has been adjusted from our 2005 Form 10-Q 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. The results of these claims, proceedings and litigation cannot be predicted with certainty. However, 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 87 basis points for the nine months ended October 28, 2006 compared to the same periods last year. These results were driven by the combination of continued sales growth, merchandise margin rate expansion, stable selling cost rates, and leverage of general and administrative costs. Key highlights include:

Retail segment net sales for the quarter and nine month periods increased over the same periods in the prior year due to same-store sales increases and new stores. Since the third quarter of 2005, net sales have benefited from the opening of two Full-Line stores and the relocation and expansion of another Full-Line store. These three stores increased our retail square footage by 2.1% compared to last year.

All major merchandise categories achieved same-store sales growth above our overall sales plan. Key categories that performed ahead of plan were: Women’s Apparel, Accessories, and Designer merchandise across all categories. During the first and second quarter of this year our women’s apparel merchandise category had slight same-store sales decreases. In the third quarter, women’s apparel had a mid-single digit increase; same-store sales for the category were flat to last year for the nine months ended October 28, 2006.

For the quarter, our Direct segment had a 28.2% net sales increase and a 16.6% net sales increase for the nine months ended October 28, 2006. These increases were driven by continued growth in our online sales.

Compared to the same periods last year, our gross profit rate improved 156 basis points for the quarter and 71 basis points for the nine months ended October 28, 2006, driven primarily by improvements in our merchandise margin. All of our major merchandise categories delivered margin rate improvement for the quarter and all except one delivered rate improvement for the nine months ended October 28, 2006, as compared to the same periods last year. Additionally, for both periods, we experienced leverage on buying and occupancy expenses from better than planned sales.

Our buying and occupancy costs included $2.9 in the third quarter and $8.3 in the nine months ended October 28, 2006 for costs related to stock options awarded primarily to our merchant and product development groups. These costs impacted our gross profit rate by 16 basis points for the quarter and 14 basis points for the nine month period.

Our four-quarter average inventory turnover rate improved 4.6% in 2006, indicating that our merchandise planning and execution have continued to improve.

Compared to the same period last year, our SG&A rate improved 17 basis points for the quarter and 43 basis points for the nine months ended October 28, 2006. For both periods, the performance resulted primarily from sales growth leverage. Our variable expense rate, which consists primarily of selling labor and credit expenses, was slightly lower than last year, and we leveraged our general and administrative costs, including non-selling labor and advertising. In the third quarter, further rate improvement was held back by a rise in compensation costs linked to the price of our company’s stock, which appreciated 38.4% in the quarter. This cost increase impacted our SG&A rate by 64 basis points and diluted earnings per share by $0.03 for the quarter. This increase reverses the favorable impact on SG&A that these costs had in the second quarter (due to a decline in our stock price), and for the nine months ended October 28, 2006 compensation costs that are tied to our stock’s performance have decreased by $4.3 compared to the same period in the prior year.

SG&A included $3.6 in the third quarter and $12.2 in the nine months ended October 28, 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 19 basis points for the quarter and 20 basis points for the nine month period.

Interest expense, net increased by $1.2 to $11.4 for the quarter ended October 28, 2006 and $35.0 for the nine months ended October 28, 2006 compared to the same periods in 2005. We had an increase in our average interest rates and slightly lower interest income as we reduced our cash and short-term investment balances in 2006 as compared to 2005.

Other income including finance charges, net increased by $11.5 for the quarter and $38.5 for the nine months ended October 28, 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 October 28, 2006, we improved our ROIC to 19.5% compared to 15.7% for the 12 months ended October 29, 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 13.1% from 10.5% for the last 12 months ended October 28, 2006 compared to the 12 months ended October 29, 2005.

We define ROIC as follows: