Nordstrom - 10-Q quarterly report FY

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.

Basis of Presentation
The accompanying condensed consolidated financial statements should be read in conjunction with the Notes to Consolidated Financial Statements contained in our 2006 Annual Report on Form 10-K. 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.

In May 2007, we increased our ownership in Jeffrey. As a result of the additional purchase, Jeffrey is now consolidated and included in our retail segment. This additional purchase included $29,436 of goodwill.

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.

Our accounting policies in 2007 are consistent with those discussed in our 2006 Annual Report on Form 10-K, with the exception of our adoption of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) in the beginning of the first quarter of 2007. Additionally, in the first quarter of 2007, we converted our Nordstrom private label card and co-branded Nordstrom VISA credit card receivables into one on-balance sheet securitization program, which is accounted for as a secured borrowing (on-balance sheet).

We report our Nordstrom private label card receivables and new co-branded Nordstrom VISA credit card receivables generated after May 1, 2007 at cost, net of an allowance for doubtful accounts. Our allowance for doubtful accounts represents our best estimate of the losses inherent in our customer accounts receivable based on several factors, including historical trends of aging of accounts, write-off experience and expectations of future performance.

Going forward, we expect that both our Nordstrom private label cards and co-branded Nordstrom VISA credit cards will be accounted for using the same on-balance sheet, historical cost method.

Substantially all of the Nordstrom private label receivables and 90% of the co-branded Nordstrom VISA credit card receivables are securitized. Under the securitization, the receivables are transferred to a third-party trust on a daily basis. The balance of the receivables transferred to the trust fluctuates as new receivables are generated and old receivables are retired (through payments received, charge-offs, or credits for merchandise returns). On May 1, 2007, the trust issued securities that are backed by the receivables. These combined receivables back the Series 2007-1 Notes, the Series 2007-2 Notes, and variable funding notes that are discussed in Note 5: Long-term debt.

Under the terms of the trust agreement, we may be required to fund certain amounts upon the occurrence of specific events. Our credit card securitization agreements set a maximum percentage of receivables that can be associated with various receivable categories, such as employee or foreign receivables. As of November 3, 2007, these maximums were not exceeded.

The cumulative effect of adopting FIN 48 has resulted in an increase to our liability for uncertain tax positions of $2,962, which reduced the beginning balance of retained earnings. Upon adoption we had approximately $20,899 of gross unrecognized tax benefits, of which $6,522 relates to deferred items which, if recognized, would not impact the effective tax rate. Interest and penalties related to income tax matters are classified as a component of income tax expense. The estimate for accrued interest and penalties upon adoption was $1,467. There were no material changes to these balances during the nine months ended November 3, 2007.

We file income tax returns in the U.S. federal and various state jurisdictions. We also file returns in France and several other foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 2002. Our U.S. federal filings for the years 2002 through 2005 are under routine examination and that process is anticipated to be completed before the end of 2008. Additionally, the U.S. federal tax returns for 2006 and 2007 are under concurrent year processing, and are expected to be complete in 2008. We currently have an active examination in France for the years 2001 through 2004. Certain state jurisdictions have active income tax examinations that include earlier years. These audits are not considered material.

Recent Accounting Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 will be effective at the beginning of our 2008 fiscal year. We are assessing the impact of the adoption of SFAS 157 and believe there will be no material impact on our results of operations, financial position or cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 will be effective at the beginning of our 2008 fiscal year. We are assessing the impact of the adoption of SFAS 159 and believe there will be no material impact on our results of operations, financial position or cash flows.

During the third quarter, we completed the sale of our Façonnable business to M1 Group in exchange for cash of $215,761, net of transaction costs. As part of this transaction, goodwill of $27,537 and acquired tradename of $84,000 were removed from our balance sheet and we recorded a gain of $33,925. Upon the closing of this transaction, we entered into a Transition Services Agreement with M1, whereby we will continue to provide certain back office functions related to the Façonnable U.S. wholesale business for a limited amount of time as part of a transition period. We additionally entered into a Minimum Purchase Agreement with the Façonnable U.S. wholesale business whereby we committed to purchase $246,000 of Façonnable inventory over the next three years.

The components of accounts receivable are as follows:

The following table summarizes the restricted trade receivables:

As of November 3, 2007, the restricted trade receivables relate to substantially all of our Nordstrom private label card receivables and 90% of the co-branded Nordstrom VISA credit card receivables. These restricted trade receivables back the Series 2007-1 Notes, the Series 2007-2 Notes, and the variable funding notes discussed in Note 5: Long-term debt. At February 3, 2007 and October 28, 2006, the restricted trade receivables related to our Nordstrom private label card backed our previously existing variable funding note.

The unrestricted trade receivables consist primarily of the remaining portion of our Nordstrom private label and co-branded Nordstrom VISA credit card 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.

Prior to the securitization transaction discussed in Note 1, our co-branded Nordstrom VISA credit card program was treated as an investment in asset backed securities. As previously discussed, as of November 3, 2007, our balance sheet does not include an investment in asset backed securities. The following table represents the components prior to the transaction:

The following table presents the key assumptions we used to value the investment in asset backed securities prior to the securitization transaction:

The following table summarizes the income earned by the investment in asset backed securities that is included in other income on the condensed consolidated statements of earnings prior to the transaction on May 1, 2007:

Our investment in asset backed securities and the off-balance sheet financing are described in Notes 1 and 3 of our 2006 Annual Report on Form 10-K.

We hold both secured and unsecured debt. The secured debts’ primary collateral are our Nordstrom private label cards and co-branded Nordstrom VISA credit card receivables. A summary of long-term debt is as follows:

In the first quarter of 2007, the Private Label Trust used our previously existing variable funding facility (2001-1 Variable Funding Note) to issue a total of $150,000 in Notes. On May 1, 2007, in connection with the issuance of the new Notes discussed below, we paid the outstanding balance and terminated this facility.

During the first quarter of 2007, we entered into an agreement for a new variable funding facility (2007-A Variable Funding Note) backed by substantially all of the Nordstrom private label card receivables and a 90% interest in the co-branded Nordstrom VISA credit card receivables with a commitment of $300,000. Borrowings under the facility incur interest based upon the cost of commercial paper issued by the third party bank conduit plus specified fees. During the third quarter of 2007, we used this facility to issue $220,000 in Notes. As of November 3, 2007, $200,000 in Notes were outstanding and the cost of commercial paper issued by the third party bank conduit was 5.71%. We pay a commitment fee for the note based on the size of the commitment and the amount of borrowings outstanding. 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-, four grades above BB+, and by Moody’s is Baa1, three grades above Ba1.

Both the Series 2007-1 Class A & B Notes and the Series 2007-2 Class A & B Notes are secured by substantially all of the Nordstrom private label card receivables and a 90% interest in the co-branded Nordstrom VISA credit card receivables.

Other debt consists primarily of capital lease obligations and liabilities related to the acquisition of Jeffrey.

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 (7.09% at November 3, 2007).

The Series 2007-1 Class A & B Notes increased our required principal payments due in fiscal 2010 by their combined notional amount of $350,000. The Series 2007-2 Class A & B Notes increased our required principal payments due after five years by their combined notional amount of $500,000.

During the third quarter of 2007, we entered into an agreement for a new variable funding facility backed by the remaining 10% interest in the co-branded Nordstrom VISA credit card receivables with a commitment of $100,000. As of November 3, 2007, no issuances have been made against this facility. Borrowings under the facility will incur interest based upon the cost of commercial paper issued by the third party bank conduit plus specified fees.

We maintain a $500,000 unsecured line of credit, which is available as liquidity support for our commercial paper program described below. We made no borrowings under this line of credit during the nine months ended November 3, 2007.

In October 2007, we entered into a new commercial paper dealer agreement, supported by our unsecured line of credit. Under this commercial paper program, we may issue commercial paper in an aggregate amount outstanding at any particular time not to exceed $500,000. This agreement allows us to use the proceeds to fund share repurchases as well as operating cash requirements. Under the terms of the commercial paper agreement, we pay a rate of interest based on, among other factors, the maturity of the issuance and market conditions. The issuance of commercial paper has the effect, while it is outstanding, of reducing our borrowing capacity under the line of credit by an amount equal to the principal amount of the commercial paper. As of November 3, 2007, we had $392,000 in outstanding issuances of commercial paper.

In December 2007, we issued $650,000 aggregate principal amount of 6.25% senior unsecured notes due 2018 and $350,000 aggregate principal amount of 7.00% senior unsecured notes due 2038. We have reclassified $301,500 of the commercial paper facility, which has been repaid by the proceeds of the debt offering. The remaining $90,500 of the commercial paper recorded in short-term debt was paid using operating cash flows.

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

In the first quarter of fiscal 2007, stock option awards to employees were approved by the Compensation Committee of our Board of Directors and their exercise price was set at the closing price of our common stock on March 1, 2007. 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 estimated fair value of the stock options, which was estimated using a Binomial Lattice option valuation model. During the nine months ended November 3, 2007, we awarded stock options to 1,195 employees compared to 1,235 employees in the same period in 2006.

We used the following assumptions to estimate the fair value of stock options at grant date:

The weighted average estimated fair value per option at the grant date was $20 and $16 in 2007 and 2006, respectively. The following describes the significant assumptions used to estimate the fair value of options granted:

Performance Share Units
We grant performance share units to align certain elements of our senior management compensation with our shareholder returns. Performance share units are payable in either cash or stock as elected by the employee; therefore they are classified as a liability award in accordance with Statement No. 123(R), Share-Based Payment (“SFAS 123(R)”). Performance share units vest after a three-year performance period only when our total shareholder return (reflecting daily stock price appreciation and compound 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.

We record the performance share unit liability based on the vesting factors described above. The liability is remeasured and the appropriate earnings adjustment is taken at each fiscal quarter-end during the vesting period. The price we use to remeasure the performance share units granted in 2005 is the closing market price of our common stock on the current quarter-end date. To remeasure the performance share units granted in 2006 and following, we use the 30-day average closing market price of our common stock leading up to the current quarter-end date. The price used to issue stock or cash for the performance share units upon vesting is the closing market price of our common stock on the vest date.

As of November 3, 2007, February 3, 2007 and October 28, 2006, our liabilities included $4,288, $12,653 and $9,314 for the performance share units. As of November 3, 2007, the remaining unrecognized stock-based compensation expense related to non-vested performance share units was approximately $1,000, which is expected to be recognized over a weighted average period of 12 months. At February 3, 2007, 255,467 units were unvested. During the nine months ended November 3, 2007, 50,070 units were granted, 112,496 units vested and no units cancelled, resulting in an ending balance of 193,041 unvested units as of November 3, 2007.

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

The computation of earnings per share, using the respective weighted average shares, is as follows:

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 nine months ended November 3, 2007 has been adjusted from our 2006 Form 10-Q disclosures to reflect the 2007 view of certain costs between our Credit, Other, and Retail Stores segments, but do not impact the condensed consolidated statement of earnings. These changes include expense related to our merchandise rewards certificate programs, intercompany merchant fee income and intercompany borrowings.

Additionally, in the second quarter of 2007, we increased our ownership in Jeffrey. As a result of the additional purchase, Jeffrey is now consolidated and included in our Retail segment.

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 cash flows.

In November 2007, our Board of Directors authorized an increase of $1,000,000 to our existing $1,500,000 share repurchase program. The existing share repurchase program, which was authorized by our Board of Directors in August 2007, had $751,400 of unused capacity as of November 3, 2007. Repurchases under the program may be made through the end of 2009. The actual amount and timing of share repurchases will be subject to market conditions and applicable Securities and Exchange Commission rules.

In December 2007, we issued $650,000 aggregate principal amount of 6.25% senior unsecured notes due 2018 and $350,000 aggregate principal amount of 7.00% senior unsecured notes due 2038. We have reclassified $301,500 of the commercial paper facility, which has been repaid by the proceeds of the debt offering. The remaining $90,500 of the commercial paper recorded in short-term debt was paid using operating cash flows.

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

Earnings per diluted share improved $0.16 for the quarter and $0.31 for the nine months ended November 3, 2007 due primarily to sales growth. Key highlights include:

Total net sales for the third quarter increased 5.3% for the quarter and 6.5% for the nine months ended November 3, 2007, compared to the same periods in the prior year due to same-store sales increases. All channels (full-line stores, Rack, and Direct) achieved positive same-store sales increases.

Designer apparel, women’s accessories, and men’s apparel were our merchandise categories with the largest full-line same-store sales increases for both the quarter and nine months ended November 3, 2007. Designer apparel offers fashion-forward and aspirational products, which drove the increase. Women’s accessories benefited from increases in sales of handbags and fashion jewelry. Additionally, the increase in men’s apparel was in part due to sales within our younger contemporary products.

Our Rack channel delivered 11.3% and 12.3% net sales increases in the quarter and nine months ended November 3, 2007, respectively. These results were driven by growth in accessories, men’s, women’s, and shoes merchandise categories.

Our Direct channel delivered 15.0% and 19.0% net sales increases in the quarter and nine months ended November 3, 2007, respectively. These results were led by growth in cosmetics, women’s accessories and men’s apparel.

In looking forward to the fourth quarter of 2007, we expect our same-store sales to be approximately flat.

Compared to the same period last year, our gross profit rate declined 38 basis points for the quarter and improved 22 basis points for the nine months ended November 3, 2007. For the quarter, our merchandise margin rate was unfavorably impacted by an increase in markdowns at our full-line stores. We entered the third quarter with inventory levels above plan and experienced higher markdowns during the quarter as we moved to re-align inventory levels with slower sales trends. Our merchandise margin rate decreased slightly in the nine months ended November 3, 2007. For both periods, merchandise margin performance was offset by a decrease in buying and occupancy expenses, partially from lower performance based incentives. Additionally, our buying and occupancy costs are mostly fixed, which created rate improvement when compared to the increased sales growth during the nine months ended November 3, 2007.

Our four-quarter average inventory turnover rate was 4.92 at the third quarter of 2007 compared to 4.73 at the third quarter of 2006, indicating continuous progress in improving merchandise planning and execution.

Total ending inventory per square foot at November 3, 2007 was flat compared to October 28, 2006. The current quarter end does not include inventory of Façonnable, which reduced our inventory per square foot by 2% and offset the remaining inventory increase. Part of the increase in our inventory supports the growth of our designer business in apparel, accessories and shoes. The remaining increase is due to merchandise levels in select divisions above our expectations. We believe inventory will be in line with plan by year-end.

The selling, general and administrative expense dollars increased for the quarter and nine months ended November 3, 2007 due to increased labor driven by our new stores and additional bad debt expense partially offset by incentive costs tied to company performance. The impact from bringing the co-branded Nordstrom VISA credit card receivables on-balance sheet increased our SG&A dollars by approximately $11 and $30 for the quarter and nine months ended November 3, 2007. In addition to the incremental bad debt expense related to accounting for the securitization transaction, we observed an increase in delinquency rates. Our write-off rates are consistent with where they were prior to the 2005 change in bankruptcy legislation. We anticipate bad debt to remain higher than last year due to the increase in our portfolio and delinquencies.

Our SG&A rate decreased by 70 basis points for the quarter. The rate improvement was driven by our expense growing at a slower rate than sales. Expenses decreased due to a reduction in performance based incentives, partially offset by higher bad debt expense.

For the nine months ended November 3, 2007, our SG&A rate increased 10 basis points. Bad debt expense was the primary driver of the rate deterioration, which was only partially offset by the reduction on our performance based incentives.

We closed the sale of the Façonnable business during the third quarter, and realized a gain on the sale of $33.9. The impact to reported earnings per diluted share was $0.09, net of tax of $13.1.

Net interest expense increased by $9.0 to $20.4 for the quarter primarily due to higher average debt levels resulting from the securitization transaction that occurred at the end of the first quarter (see Note 1). For the nine month period ended November 3, 2007, interest expense, net increased $9.5 to $44.4. Higher interest expense due to increased debt was partially offset by interest income on invested cash balances and a larger amount of capitalized interest in conjunction with our increased capital expenditures.

Other income, net increased by $10.0 to $68.8 for the quarter and by $21.4 to $194.9 for the nine months ended November 3, 2007. For both periods, the increase was primarily due to growth in our credit card programs, partially offset by securitization transaction costs.

Our business, similar to 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.

Return on Invested Capital (ROIC) (Non-GAAP financial measure)
We believe Return on Invested Capital (ROIC) is a key financial metric supporting long term shareholder value. As a result, we monitor it closely and use it as a senior executive incentive measure. Historically, overall performance as measured by ROIC correlates directly to shareholders’ return over the long-term. For the 12 months ended November 3, 2007, we improved our ROIC to 20.7% compared to 19.5% for the 12 months ended October 28, 2006. 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 14.0% from 13.1% for the last 12 months ended November 3, 2007 compared to the 12 months ended October 28, 2006.

We define ROIC as follows:

A reconciliation of our return on assets to ROIC is as follows: