ITEM 1. BUSINESS
Our Company
Founded over 100 years ago, we are one of the largest omni-channel luxury fashion retailers in the world, with approximately $4.7 billion in revenues for fiscal year 2017, of which approximately 31% were transacted online. Our Neiman Marcus, Bergdorf Goodman and MyTheresa brands represent fashion, luxury and style to our customers. We offer a distinctive selection of women’s and men’s apparel, handbags, shoes, cosmetics and precious and designer jewelry from premier luxury and fashion designers to our loyal and affluent customers “anytime, anywhere, any device.” We have a longstanding heritage of providing the highest level of personalized, concierge-style service to our customers through our experienced team of sales associates.
Under each of our primary brands, we offer our customers a curated and compelling assortment of narrowly distributed merchandise from luxury and fashion designers, including Chanel, Gucci, Brunello Cucinelli, Tom Ford, Christian Louboutin, Valentino, Saint Laurent, Prada, Akris, David Yurman, Ermenegildo Zegna, Loro Piana, Brioni, Louis Vuitton, Goyard and Van Cleef & Arpels. We believe we are the retail partner of choice to luxury designers because we offer distinctive distribution channels that access our loyal and affluent customers and adhere to strict presentation, marketing and promotional standards consistent with the luxury experience. We also have a long history of identifying, partnering with and nurturing emerging designers with the potential for rapid growth. The combined offering from established and emerging designers ensures our merchandise assortment remains unique, compelling and relevant as fashion trends evolve.
As a leader in omni-channel retailing, we provide our customers a deep assortment of luxury merchandise and a consistent, seamless shopping experience, whether our customers shop in our stores, on our websites or via e-mail, text or phone communications with our sales associates. Our comprehensive digital platform integrates and personalizes the online and in-store experience. We empower our sales associates with mobile devices and proprietary technology to improve their connection with our customers and we utilize advanced analytics to personalize merchandise presentations to our customers when they shop online. We believe that a significant portion of the total luxury spending of our customers is digitally influenced via purchases researched and/or transacted online.
We engage our customers primarily through three brands:
Neiman Marcus. Our Neiman Marcus brand caters to affluent luxury customers. We operate 42 full-line stores in marquee retail locations in major U.S. markets. Our stores are designed to provide a modern, luxurious ambiance by blending art, architecture and technology. In addition, we provide our customers access to our Neiman Marcus brand through our online platform, neimanmarcus.com, and our mobile app.
Bergdorf Goodman. Our Bergdorf Goodman brand caters to the most discerning luxury clientele. We operate two full-line stores that feature elegant shopping environments in landmark locations on Fifth Avenue in New York City and through our Bergdorf Goodman online platform, bergdorfgoodman.com.
MyTheresa. Our MyTheresa brand appeals to younger, fashion-forward, luxury customers, primarily from Europe, Asia and the Middle East. We operate mytheresa.com, our mobile app and the THERESA flagship store in Munich, Germany.
We conduct our specialty retail stores and online operations on an omni-channel basis. As our store and online operations have similar economic characteristics, products, services and customers, our operations constitute a single omni-channel reportable segment.
The Acquisition
On October 25, 2013, the Company merged with and into Mariposa Merger Sub LLC ("Mariposa") pursuant to an Agreement and Plan of Merger, dated September 9, 2013, by and among Neiman Marcus Group, Inc. ("Parent"), Mariposa and the Company, with the Company surviving the merger (the "Acquisition"). As a result of the Acquisition and the Conversion (as defined below), the Company is now a direct subsidiary of Mariposa Intermediate Holdings LLC ("Holdings"), which in turn is a direct subsidiary of Parent. Parent is owned by entities affiliated with Ares Management, L.P. and Canada Pension Plan Investment Board (together, the "Sponsors") and certain co-investors. Previously, the Company was a subsidiary of Newton Holding, LLC, which was controlled by investment funds affiliated with TPG Global, LLC (collectively with its affiliates, "TPG") and Warburg Pincus LLC (together with TPG, the "Former Sponsors"). On October 28, 2013, the Company and NMG (as defined below) each converted from a Delaware corporation to a Delaware limited liability company (the "Conversion"). References made to "we," "our" and "us" are used to refer to the Company and its subsidiaries, as appropriate to the context.
The Company's operations are conducted through its direct wholly owned subsidiary, The Neiman Marcus Group LLC ("NMG").
Certain financial information of the Company and its subsidiaries is presented on a consolidated basis and is presented as "Predecessor" or "Successor" to indicate whether it relates to the period preceding the Acquisition or the period succeeding the Acquisition, respectively. The Acquisition and the allocation of the purchase price were recorded for accounting purposes as of November 2, 2013, the end of our first quarter of fiscal year 2014. In connection with the Acquisition, the Company incurred substantial new indebtedness, in part in replacement of former indebtedness. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." In addition, the purchase price paid in connection with the Acquisition was allocated to state the acquired assets and liabilities at fair value. The purchase accounting adjustments increased the carrying value of our property and equipment and inventory, revalued our intangible assets related to our tradenames, customer lists and favorable lease commitments and revalued our long-term benefit plan obligations, among other things. As a result, the Successor financial information subsequent to the Acquisition is not necessarily comparable to the Predecessor financial information.
Our fiscal year ends on the Saturday closest to July 31. Like many other retailers, we follow a 4-5-4 reporting calendar, which means that each fiscal quarter consists of thirteen weeks divided into periods of four weeks, five weeks and four weeks. All references to (i) fiscal year 2017 relate to the fifty-two weeks ended July 29, 2017, (ii) fiscal year 2016 relate to the fifty-two weeks ended July 30, 2016 and (iii) fiscal year 2015 relate to the fifty-two weeks ended August 1, 2015. References to fiscal year 2014 and years preceding and fiscal year 2018 and years thereafter relate to our fiscal years for such periods.
Certain amounts presented in tables are subject to rounding adjustments and, as a result, the totals in such tables may not sum.
Our Customers
Our customers are educated, affluent and digitally connected. With respect to our U.S. operations, the average age of our customers is 51 and approximately 60% of our customers are 54 or younger. Approximately 79% of our customers are female, approximately 46% of our customers have an annual household income over $150,000 and approximately 30% of our customers have a household net worth greater than $1 million. Our customers are active on social media, and we engage them through an active presence on Facebook, Twitter, Instagram and Pinterest, our primary social media platforms.
Our InCircle loyalty program is designed to cultivate long-term relationships with our U.S. customers. This program includes marketing features, such as private in-store events, as well as the ability to accumulate points for qualifying purchases. Almost 40% of our total U.S. revenues in fiscal year 2017 were generated by our InCircle loyalty program members who achieved reward status. On a per customer basis, these customers spend approximately 11 times more with us than our other customers.
Our Brands
We operate three primary luxury brands-Neiman Marcus, Bergdorf Goodman and MyTheresa-which offer the highest level of personalized, concierge-style service and a distinctive selection of women’s and men’s apparel, handbags, shoes, cosmetics and precious and designer jewelry from premier luxury and fashion designers to our loyal and affluent customers “anytime, anywhere, any device.” Our luxury brands comprise a unique, omni-channel retailing model that enables us to leverage our relationships with luxury and fashion designers within each brand to optimize our merchandise allocations and assortments and to expand our customer base and brand awareness by exposing customers of each brand to our other brands through our online platforms and our multi-brand InCircle loyalty program.
We also operate Last Call, an off-price fashion brand catering to aspirational, price-sensitive yet fashion-minded customers, and Horchow, a luxury home furnishings and accessories brand. Our Last Call brand sources end-of-season and post-season clearance merchandise from our Neiman Marcus and Bergdorf Goodman brands and purchases other off-price merchandise directly from designers for resale, which enables us to effectively manage our inventory while expanding our brand awareness to aspirational, price-sensitive customers. Our Horchow brand also enhances our brand awareness to purchasers of luxury home furnishings and accessories who may not otherwise be customers of our luxury fashion retail brands.
Neiman Marcus. Neiman Marcus offers distinctive luxury merchandise, including women’s couture and designer apparel, contemporary sportswear, handbags, shoes, cosmetics, men’s clothing and accessories, precious and designer jewelry, decorative home accessories, fine china, crystal and silver, children’s apparel and gift items. Our customers access our Neiman Marcus brand and purchase merchandise through our 42 full-line Neiman Marcus stores located in 18 states and the District of Columbia, our print catalogs, our online platform, neimanmarcus.com, and our mobile app.
Our Neiman Marcus stores are located in marquee retail locations in major metropolitan markets across the United States and are organized as a collection of designer boutiques for established and emerging luxury and fashion designers, each of which is carefully curated by our Neiman Marcus merchandising team. Our Neiman Marcus stores are designed to provide a modern, luxurious ambiance by blending art, architecture and technology. We deliver exceptional customer service and a premier shopping experience through our knowledgeable, professional and well-trained sales associates, our loyalty program and our in-store dining experiences.
Our Neiman Marcus online platform and mobile app are organized by both product category and designer, and are curated to provide a highly personalized, boutique-like experience for our online customers by offering a wide selection of merchandise and around-the-clock customer assistance. Our web pages adjust to our customers’ preferences based on their prior visits and purchases, allowing customers to select their favorite items, see items new to the site since their last visit and request to be informed of new merchandise or events at their local Neiman Marcus store. Our “Product Configurator” allows customers to customize select items, including shoes and boots, with special colors, fabrics and monograms. Our personalization expertise extends beyond our online platform to our customers through advanced digital e-mail and advertising programs.
Bergdorf Goodman. Bergdorf Goodman is a premier retailer in New York City known for its high-luxury merchandise, which includes women’s couture and designer apparel, contemporary sportswear, handbags, shoes, cosmetics, men’s clothing and accessories, precious and designer jewelry, decorative home accessories, fine china, crystal and silver, children’s apparel and gift items. Our customers access our Bergdorf Goodman brand and purchase merchandise through our two Bergdorf Goodman stores, our print catalogs and our Bergdorf Goodman online platform, bergdorfgoodman.com.
Our two Bergdorf Goodman stores are landmark locations on iconic Fifth Avenue in New York City. The elegant, meticulously designed and decorated and visually stunning stores are tourist attractions and have been featured in numerous films and television shows. Like Neiman Marcus, they feature a collection of designer boutiques for established and emerging luxury and fashion designers, each of which is carefully curated by our Bergdorf Goodman merchandising team to include our narrowly distributed, highly differentiated and distinctive luxury merchandise. Bergdorf Goodman stores feature the same level of dedication to exceptional customer service as Neiman Marcus and often showcase innovative new customer service and marketing strategies, including promotional local same-day delivery and online social initiatives.
Our Bergdorf Goodman online platform, like Neiman Marcus, is organized by both product category and designer, and is curated to provide a boutique-like experience for our customers by offering personalized presentation of a wide selection of merchandise and around-the-clock customer assistance.
MyTheresa. In October 2014, we acquired MyTheresa, a luxury retailer headquartered in Munich, Germany. MyTheresa offers an assortment of merchandise focused on luxury, first-season fashion curated by the MyTheresa merchandising team. Customers access our MyTheresa brand through mytheresa.com, our mobile app and the THERESA flagship store in Munich, Germany. Our MyTheresa online platform offers a unique combination of editorial content on the latest trends and a broad offering of merchandise.
Last Call. Last Call is an off-price fashion goods retailer. Our customers purchase merchandise through our 38 Last Call stores and our online platform, lastcall.com. Merchandise offered under our Last Call brand includes, among other things, end-of-season and post-season clearance goods sourced directly from our Neiman Marcus and Bergdorf Goodman brands or other off-price merchandise purchased from designers for resale. During fiscal year 2017, we began a process to assess our Last Call footprint and closed four of our Last Call stores. On September 12, 2017, we announced that we will be closing ten additional Last Call stores in fiscal year 2018 in order to optimize our Last Call store portfolio. We will continue to evaluate our off-price business and seek to optimize the operations of Last Call in the future.
Horchow. We also operate the Horchow brand, which offers luxury home furnishings and accessories primarily through horchow.com and print catalogs.
Customer Service and Marketing
We have a longstanding heritage of providing the highest level of personalized, concierge-style service to our customers through our experienced team of sales associates and personal stylists. We believe our superior customer service enables us to cultivate long-term customer relationships and build strong loyalty to our brands. We are committed to providing our customers with a premier shopping experience at all of our brands, whether in-store or through our online platforms, through the following elements of our comprehensive customer service model:
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omni-channel marketing programs designed to promote customer awareness of our offerings of the latest fashion trends and services;
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our InCircle loyalty program designed to cultivate long-term relationships with our customers;
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our proprietary credit card program facilitating the extension of credit to our customers;
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knowledgeable, professional and well-trained sales associates; and
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customer-friendly websites.
We believe we offer our customers fair return policies consistent with the practices of other luxury and specialty retailers and generally more favorable than designer-owned boutiques and websites. We believe these policies help to cultivate long-term relationships with our customers.
Marketing Programs. We conduct a wide variety of omni-channel marketing programs that allow us to engage with our customers in multiple ways. We use our marketing programs to develop and maintain relationships with customers, communicate fashion trends and information and generate excitement about the designer brands we carry. The programs include in-store and online events, social promotions and targeted communications leveraging digital and traditional media.
We maintain an active calendar of events to promote our marketing programs. The events, many of which are connected to our InCircle loyalty program, include integrated in-store and online promotions of the merchandise of selected designers or merchandise categories. We also hold seasonal in-store and online trunk shows by leading designers featuring the newest fashions from the designer and participate in charitable functions and partnerships in each of our markets. Trunk shows and in-store promotions at our Neiman Marcus and Bergdorf Goodman stores feature a variety of national and international designers such as Chanel, Brunello Cucinelli, Tom Ford, David Yurman and Ermenegildo Zegna.
We maintain a social media presence for Neiman Marcus, Bergdorf Goodman and MyTheresa on blogs, Twitter, Instagram, Pinterest, Facebook and Snapchat. Social content includes insider fashion news, designer profiles, product promotion, customer service and event support. Posts and replies to customers are updated multiple times per day. Each platform is designed to reinforce our position as a fashion leader as well as to highlight the expertise and insider knowledge of our fashion directors and merchants.
Through our print media programs, we mail various publications to our customers communicating upcoming in-store events, new merchandise offerings and fashion trends. In connection with these programs, Neiman Marcus produces The Book approximately six to eight times each year. The Book is a high-quality shoppable magazine featuring the latest fashion trends that is mailed on a targeted basis to our customers. We also mail an annual Christmas Book known for both practical and lavish gift ideas as well as our over-the-top Fantasy Gifts that can only be found at Neiman Marcus. Our other print publications include the Bergdorf Goodman Magazine, the MyTheresa magazine, specialty catalogs and specific designer mailers.
In addition to print publications, we leverage our websites and online advertising through banner ads and paid searches to communicate and connect with customers seeking fashion information and products online. We believe that our online and print catalog operations complement our full-line retail stores and enable our customers to choose the channel that best fits their needs at any given time.
InCircle Loyalty Program. Our InCircle loyalty program is designed to cultivate long-term relationships with our U.S. customers. Our loyalty program focuses on our most active customers and includes marketing features such as private in-store events and the ability to accumulate points for qualifying purchases. Increased points are periodically offered in connection with promotional and other events. Upon attaining specified point levels, points are automatically redeemed for gift cards. Almost 40% of our total U.S. revenues in fiscal year 2017 were generated by our InCircle loyalty program members who achieved reward status. On a per customer basis, these customers spend approximately 11 times more with us than our other customers.
Proprietary Credit Card Program. We maintain a proprietary credit card program in the U.S. through which credit is extended to customers and have a related marketing and servicing alliance with affiliates of Capital One Financial Corporation ("Capital One"). Historically, our customers holding a proprietary credit card, all of whom are members of our InCircle loyalty program, have tended to shop more frequently and have a higher level of spending than customers paying with cash or third party credit cards. In fiscal years 2017 and 2016, approximately 42% of our U.S. revenues were transacted through our proprietary credit cards. We utilize data collected through our proprietary credit card program in connection with promotional events and customer relationship programs to target specific customers based upon their past spending patterns for certain designers, merchandise categories and store locations.
Pursuant to our agreement with Capital One (the "Program Agreement"), Capital One currently offers credit cards and non-card payment plans under both the "Neiman Marcus" and "Bergdorf Goodman" brand names. We receive payments from Capital One based on sales transacted on our proprietary credit cards. These payments are based on the profitability of the credit card portfolio as determined under the Program Agreement and are impacted by a number of factors including credit losses incurred and our allocable share of the profits generated by the credit card portfolio, which in turn may be impacted by credit ratings as determined by various rating agencies. These factors are more fully described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations-Key Factors Affecting Our Results-Income From Credit Card Program." In addition, we receive payments from Capital One for marketing and servicing activities we provide to Capital One.
In connection with the Program Agreement, we have changed and may continue to change the terms of credit offered to our customers. In addition, Capital One has discretion over certain policies and arrangements with credit card customers and may change these policies and arrangements in ways that affect our relationships with these customers. The Program Agreement terminates July 2020 (renewable thereafter for three-year terms), subject to early termination provisions.
Sales Associates. Our sales associates instill and reinforce a culture of relationship-based service valued by our customers. We compensate our sales associates primarily on a commission basis and provide them with training in the areas of customer service, selling skills and product knowledge. Our sales associates participate in active clienteling programs, utilizing both print and digital media, designed to maintain contact with our customers between store visits and to provide personalized updates on the latest merchandise offerings and fashion trends. We empower our sales associates to act as personal shoppers and, in many cases, as the personal style advisor to our customers. In our online operations, customers may interact with knowledgeable sales associates using online chat capabilities offered on our websites or by dialing a toll-free telephone number.
We have equipped our sales force with smartphones enabled with our proprietary mobile technology, which has enabled our sales associates to strengthen relationships with our customers through text messages and e-mails. The mobile apps available to our sales associates include our business dashboard, which shows a customer’s purchase history across channels, the customer’s alteration details and other service details. The sales associate is also given product recommendations and reasons to contact customers for events or offers.
Our sales associates are experienced. Sales associates who have been with us for longer than one year have an average tenure of approximately ten years and had a turnover rate in fiscal year 2017 of 26%. These tenured associates are highly productive, with more than 40% of them generating over $750,000 of revenues each in fiscal year 2017.
Customer-Friendly Online Platforms. We believe that we offer a high level of service to customers shopping online through user-friendly smartphone apps and websites, site speeds and functionality and many features such as personalized recommendations, runway videos of apparel, detailed product descriptions, sizing information, interviews with designers and multiple angle shots of merchandise. In addition, we place high importance on quick, accurate product delivery and offer customers a variety of options to take delivery of their purchases and make returns, including free shipping and returns, same-day delivery and buy online and pick up in store. We also offer customers an efficient and friendly call center.
Merchandise
We carry a broad selection of narrowly distributed, highly differentiated and distinctive luxury merchandise carefully curated by our highly skilled merchandising groups. We believe our merchandising experience and in-depth knowledge of our customers and the markets within which we operate allow us to select an appropriate merchandise assortment that is tailored to fully address our customers’ lifestyle needs.
Our experienced merchandising personnel determine the merchandise assortment and quantities to be purchased for each of our brands and the allocation of merchandise to each store. Our merchant and planning organizations for Neiman Marcus stores and Neiman Marcus online are combined to create an omni-channel team and align inventory in stores and online to deliver a superior shopping experience to our customers. As of October 3, 2017, we had approximately 400 merchandise buyers and merchandise planners.
Our percentages of revenues by major merchandise category for fiscal years 2017, 2016 and 2015 were as follows:
Substantially all of our merchandise is delivered to us by our designers as finished goods and is manufactured in numerous locations, including Europe and the United States and, to a lesser extent, China, Mexico and South America.
Our major merchandise categories are as follows:
Women’s Apparel. Women’s apparel consists of dresses, eveningwear, suits, coats and sportswear separates-skirts, pants, blouses, jackets and sweaters. We work with women’s apparel designers to present the merchandise and highlight the best of the designer's product. Our primary women’s apparel designers include Chanel, Brunello Cucinelli, Akris, Valentino, Dolce & Gabbana, Escada and The Row.
Women’s Shoes, Handbags and Accessories. Women’s accessories include belts, gloves, scarves, hats and sunglasses and complement our shoes and handbags assortments. Our primary designers in this category include Christian Louboutin, Chanel, Manolo Blahnik, Valentino, Saint Laurent, Jimmy Choo and Gucci in ladies' shoes and Chanel, Prada, Gucci, Bottega Veneta, Balenciaga, Saint Laurent, Louis Vuitton, Chloe and Celine in handbags.
Men’s Apparel and Shoes. Men’s apparel and shoes include suits, dress shirts and ties, sport coats, jackets, trousers, casual wear and eveningwear as well as business and casual footwear. Our primary designers in this category include Ermenegildo Zegna, Brioni, Brunello Cucinelli, Burberry and Tom Ford in men’s clothing and sportswear and Ermenegildo Zegna, Brioni, Salvatore Ferragamo, Gucci and Tom Ford in men’s accessories and shoes.
Cosmetics and Fragrances. Cosmetics and fragrances include facial and skin cosmetics, skin therapy and lotions, soaps, fragrances, candles and beauty accessories. Our primary designers of cosmetics and beauty products include La Mer, Chanel, Sisley, Creed, La Prairie, Estee Lauder, Dior and Tom Ford.
Designer and Precious Jewelry. Our designer and precious jewelry offering includes women’s necklaces, bracelets, rings, earrings and watches that are selected to complement our apparel merchandise offering. Our primary designers in this category include David Yurman, John Hardy and Ippolita in designer jewelry and Chanel and Van Cleef & Arpels in precious jewelry. We often sell precious jewelry that has been consigned to us from the designer.
Home Furnishings and Decor. Home furnishings and decor include linens, tabletop, kitchen accessories, furniture, rugs, decorative items (frames, candlesticks, vases and sculptures) and collectibles. Merchandise for the home complements our apparel offering in terms of quality and design. Our primary designers in this category include Jay Strongwater, MacKenzie-Childs and Baccarat.
Luxury and Fashion Designer Relationships
Our merchandise assortment consists of a broad selection of narrowly distributed, highly differentiated and distinctive luxury merchandise purchased from both well-known luxury designers and new and emerging fashion designers. We communicate with our designers frequently, providing feedback on current demand for their products, suggesting changes to specific product categories or items and gaining insight into their future fashion direction. Certain designers sell their merchandise or certain of their design collections exclusively to us and other designers sell to us pursuant to their limited distribution policies. Our relationships and purchasing power with designers allow us to obtain a broad selection of quality merchandise. Our women’s and men’s apparel and fashion accessories merchandise categories are especially dependent upon our relationships with designers. We monitor and evaluate the sales and profitability performance of each designer and adjust our future purchasing decisions from time to time based upon the results of this analysis. We have no guaranteed supply arrangements with our principal merchandising sources. In addition, our designer base is diverse, with only two designers representing more than 5% of our total revenues in fiscal year 2017. These designers represented 8.9% and 5.9% of our total revenues in fiscal year 2017. The breadth of our sourcing helps mitigate risks associated with a single brand or designer.
Consistent with industry business practice, we receive allowances from certain of our designers in support of the merchandise we purchase for resale. We also receive advertising allowances from certain of our designers, substantially all of which represent reimbursements of direct, specified and incremental costs we incur to promote the designers' merchandise. In addition, we receive allowances from certain merchandise designers in conjunction with compensation allowances for employees who sell the designers' merchandise. For more information related to allowances received from designers, see Note 1 of the Notes to Consolidated Financial Statements in Item 15.
To expand our product assortment, we offer certain merchandise, primarily precious jewelry, that has been consigned to us from the designer. As of July 29, 2017 and July 30, 2016, we held consigned inventories with a cost basis of approximately $393.1 million and $416.5 million, respectively. Consigned inventories are not reflected in our Consolidated Balance Sheets as we do not take title to consigned merchandise.
Inventory Management
We manage our inventory on an omni-channel basis, and our processes and facilities are designed to optimize merchandise productivity. In the first quarter of fiscal year 2017, we launched an integrated merchandising and distribution system, which we refer to as "NMG One". NMG One was designed to enable us to purchase, share, manage and sell our inventories across our omni-channel operations and brands more efficiently.
The majority of the merchandise we purchase is initially received at one of our centralized distribution facilities. We utilize distribution facilities in Longview, Texas, the Dallas-Fort Worth area, Pittston, Pennsylvania and Munich, Germany and three regional service centers in the United States. Our distribution facilities are linked electronically to our various merchandising teams to facilitate the distribution of goods to our stores.
We utilize electronic data interchange technology with certain of our designers, which is designed to move merchandise onto the selling floor quickly and cost-effectively by allowing designers to deliver floor-ready merchandise to the distribution facilities. In addition, we utilize high-speed automated conveyor systems capable of scanning the bar-coded labels on incoming cartons of merchandise and directing the cartons to the proper processing areas. Many types of merchandise are processed in the receiving area and immediately “cross docked” to the shipping dock for delivery to the stores. Certain processing areas are staffed with personnel equipped with hand-held radio frequency terminals that can scan a designer's bar
code and transmit the necessary information to a computer to record merchandise on hand. We utilize third party carriers to distribute our merchandise to individual stores.
We operate primarily on a pre-distribution model through which we allocate merchandise on our initial purchase orders to each store. This merchandise is shipped from our designers to our distribution facilities for delivery to designated stores. We closely monitor the inventory levels and assortments in our retail stores to facilitate reorder and replenishment decisions, satisfy customer demand and maximize sales.
We utilize a “locker stock” inventory management program to maintain a portion of our most in-demand and high fashion merchandise at our Longview and Pittston distribution facilities. Locker stock inventory can be shipped to the stores that demonstrate the highest customer demand or directly to our store and online customers. This program helps us to restock inventory at individual stores more efficiently, to maximize the opportunity for full-price selling and to minimize the potential risks related to excess inventories.
The two distribution centers in the Dallas-Fort Worth area support primarily our online operations in the United States, and our distribution center outside of Munich, Germany supports our MyTheresa operations. These distribution centers facilitate the receipt and storage of inventories from designers, fulfill customer orders on a timely and efficient basis and receive, research and process customer returns.
Capital Investments
We invest capital to support our long-term business goals and objectives with a goal of generating strong financial returns. We invest capital in the development and construction of new and existing stores, online platforms, distribution and support facilities and information technology. Since fiscal year 2013, we have made gross capital expenditures aggregating $1.1 billion related primarily to (i) enhancements to our merchandising and store systems; (ii) investments in our online platforms and technology and information systems; (iii) the construction of new stores in Garden City, New York (Long Island) (opened in fiscal year 2016) and in Fort Worth, Texas (opened in fiscal year 2017) and a distribution facility in Pittston, Pennsylvania; and (iv) the remodel of our Bergdorf Goodman women's and men’s stores in New York City and Neiman Marcus stores in the following cities:
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Bal Harbour, Florida;
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Chicago, Illinois;
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Oak Brook, Illinois;
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Beverly Hills, California; and
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Palo Alto, California.
In fiscal year 2017, we had gross capital expenditures of approximately $205 million. Net of developer contributions, capital expenditures for fiscal year 2017 were approximately $167 million. Currently, we project gross capital expenditures for fiscal year 2018 to be $208 to $218 million. Net of developer contributions, capital expenditures for fiscal year 2018 are projected to be $155 to $165 million.
We are focused on operating only in attractive markets that can profitably support our stores as well as maintaining the quality of our stores and online platforms and, consequently, our brands. We conduct extensive demographic, marketing and lifestyle research to identify attractive retail markets with a high concentration of our target customers prior to our decision to construct a new store. We typically receive cash allowances from developers related to the construction of our stores, thereby reducing our cash investment in these stores. We received construction allowances aggregating $37.4 million in fiscal year 2017, $38.3 million in fiscal year 2016 and $34.7 million in fiscal year 2015. Our recent and upcoming Neiman Marcus store openings significantly expand our presence in New York:
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Roosevelt Field: We opened a 111,000 square-foot full-line Neiman Marcus store in Garden City, New York in February of fiscal year 2016.
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Hudson Yards: We signed a lease to open a flagship full-line Neiman Marcus store on Manhattan’s flourishing west side at Hudson Yards, a new $25 billion, 28-acre mixed-use development project. The approximately 190,000 square-foot, multi-level store, which we currently expect to open in fiscal year 2019, marks the first full-line Neiman Marcus store in New York City and will anchor the one-million square-foot Shops at Hudson
Yards. This new store will offer Neiman Marcus’s signature mix of the world’s most exclusive luxury designers and superior customer service to New York residents and visitors.
In addition to the construction of new stores, we also invest in our existing stores to drive traffic, increase our selling opportunities and enhance customer service.
Competition
The luxury retail industry is highly competitive and fragmented. We compete for customers with luxury and premium multi-branded retailers, designer-owned proprietary boutiques, specialty retailers, national apparel chains, pure-play online retailers, individual specialty apparel stores and "flash sale" businesses that primarily sell out-of-season products. We compete for customers principally on the basis of quality and fashion, customer service, value, assortment and presentation of merchandise, marketing and customer loyalty programs and, in the case of Neiman Marcus and Bergdorf Goodman, store ambiance. Retailers that compete directly with us for distribution of luxury fashion brands include Saks Fifth Avenue, Barneys New York, Net-a-Porter, designer boutiques and other national, regional and local retailers. Nordstrom and Bloomingdale's feature a limited offering of luxury merchandise and compete with us to a lesser extent.
We believe we differ from other national retailers by:
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our approach to omni-channel retailing;
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distinctive merchandise assortments, which we believe are more upscale than other luxury and premium multi-branded retailers, and exclusive merchandise offerings that are only available in our stores;
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excellent customer service;
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prime real estate locations;
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premier online websites; and
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elegant shopping environments.
We believe we differentiate ourselves from regional and local luxury and premium retailers through:
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our omni-channel approach to business;
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strong national brands;
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diverse product selection;
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loyalty program;
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customer service;
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prime shopping locations; and
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strong designer relationships that allow us to offer the top merchandise from each designer.
Designer-owned proprietary boutiques and specialty stores carry a much smaller selection of designer brands and merchandise, lack the overall shopping experience we provide, have a limited number of retail locations and generally offer more restrictive return policies.
Employees
As of October 3, 2017, we had approximately 13,700 full-time employees. Our staffing requirements fluctuate during the year as a result of the seasonality of the retail industry. We hire additional temporary associates and increase the hours of part-time employees during seasonal peak selling periods. Except for certain employees of Bergdorf Goodman representing less than 1% of our total employees, none of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are good.
Seasonality
Our business, like that of most retailers, is affected by seasonal fluctuations in customer demand, product offerings and working capital expenditures. For additional information on seasonality, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Key Factors Affecting Our Results-Seasonality.”
Intellectual Property
We own certain tradenames and service marks, including the “Neiman Marcus,” “Bergdorf Goodman” and "mytheresa" marks, that are important to our overall business strategy. These marks are valuable assets that consumers associate with luxury goods.
Regulation
The credit card operations that are conducted under our arrangements with Capital One are subject to numerous federal and state laws that impose disclosure and other requirements upon the origination, servicing and enforcement of credit accounts and limitations on the maximum amount of finance charges that may be charged by a credit provider. In addition to our proprietary credit cards, credit to our customers is also provided primarily through third parties. Any regulation or change in the regulation of credit arrangements that would materially limit the availability of credit to our customer base could adversely affect our results of operations or financial condition.
Our practices, as well as those of our competitors, are subject to review in the ordinary course of business by the Federal Trade Commission and are subject to numerous federal and state laws. Additionally, we are subject to certain customs, anti-corruption laws, truth-in-advertising and other laws, including consumer protection regulations that regulate retailers generally and/or govern the importation, promotion and sale of merchandise. We undertake to monitor changes in these laws and believe that we are in material compliance with all applicable state and federal regulations with respect to such practices.
Additional Information
For more information about our business, financial condition and results of operations, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our Consolidated Financial Statements and the related notes thereto contained in Item 15.
We also make our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and related amendments, available free of charge through our website at www.neimanmarcusgroup.com as soon as reasonably practicable after we electronically file such material with (or furnish such material to) the Securities and Exchange Commission (the "SEC"). The information contained on our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered to be part of this Annual Report on Form 10-K.
Copies of the reports and other information we file with the SEC may also be examined by the public without charge at 100 F Street, N.E., Room 1580, Washington D.C., 20549, or on the internet at http://sec.gov. Copies of all or a portion of such materials can be obtained from the SEC upon payment of prescribed fees. Please call the SEC at 1-800-SEC-0330 for further information.
ITEM 1A.
ITEM 1A. RISK FACTORS
Risks Related to Our Business and Industry
Our success and results of operations depend heavily on our ability to maintain a relevant, enjoyable and reliable omni-channel experience for our customers and to anticipate and meet our customers’ evolving shopping preferences.
As an omni-channel retailer, we interact with our customers across a variety of different channels, including in-store, online, mobile devices, and social media, all in a rapidly evolving retail and shopping landscape. Our customers are increasingly using tablets and mobile phones to make purchases online and facilitate purchasing decisions when in our stores. Our customers also engage with us online by providing feedback and public commentary about all aspects of our business.
Omni-channel retailing is rapidly evolving and our success depends on our ability to differentiate our brand and product offerings by anticipating and implementing innovations in customer experience and logistics to appeal to customers
who increasingly rely on multiple channels to meet their shopping needs. To do so, we must make investments to keep up to date with competitive technology trends, including the proliferation of mobile usage, evolving creative user interfaces and other e-commerce marketing trends related to customer acquisition and engagement, among others, which may increase our costs and which may not succeed in increasing sales or attracting customers. Although we continually analyze trends in the way our customers shop and the relationships between our in-store and online offerings in an effort to maximize incremental sales, we may not gather accurate and relevant data or effectively utilize that data to accurately predict our customers' shopping preferences, which may impact our strategic planning and decision making.
If for any reason we are not successful at developing and implementing omni-channel initiatives to provide a convenient, consistent and enjoyable shopping experience for our customers across all channels and to provide our customers the products they want, when and where they want them, our financial performance and brands could be adversely affected.
Economic conditions may negatively impact consumer spending and demand for our merchandise.
We sell luxury retail merchandise. Purchases of merchandise by our customers are discretionary, and therefore highly dependent upon the level of consumer spending, particularly among affluent customers. A number of factors affect the level of consumer spending on our merchandise, and in turn our revenues and comparable revenues, including:
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general economic and industry conditions, including inflation, deflation, changes related to interest rates and foreign currency exchange rates, rates of economic growth, current and expected unemployment levels and government fiscal and monetary policies;
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the performance of the financial, equity and credit markets;
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consumer disposable income levels, consumer confidence levels, the availability, cost and level of consumer debt and consumer behaviors towards incurring and paying debt;
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national and global geo-political uncertainty;
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the strength of the U.S. dollar against international currencies, most notably the Euro and British pound, and a resulting impact on tourism and spending by international customers in the U.S.;
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a significant and sustained decline in the global price of crude oil and the resulting impact on stakeholders in the oil and gas industries, particularly in the Texas markets in which we have a significant presence;
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changes in prices for commodities and energy, including fuel; and
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current and expected tax rates and policies.
We believe that the factors identified in the list above are constraining customers' willingness to shop with us and causing some of those who do shop to limit the dollar amounts or quantities of their purchases. This has caused our operating results to decline. As a consequence, we recorded significant impairment charges in fiscal years 2017 and 2016 related to certain of our tradenames, goodwill and long-lived assets. Additionally, past deteriorations in domestic and global economic conditions, such as the downturn in calendar years 2008 and 2009, have had a significant adverse impact on our business by causing reductions in customer spending. If the current difficult economic conditions and their effect on customer spending on luxury goods continue, we could experience further material and adverse effects on our business, financial condition and results of operations.
The luxury retail industry is highly competitive and our failure to compete effectively with other retailers could negatively impact our results of operations and our customers' perceptions of us.
The luxury retail industry is highly competitive and fragmented. We compete for customers with luxury and premium multi-branded retailers, designer-owned proprietary boutiques, specialty retailers, national apparel chains, pure-play online retailers, individual specialty apparel stores and "flash sale" businesses that primarily sell out-of-season products. Many of our competitors have greater financial, marketing or operational resources than we do.
We face strong competition to attract and retain new customers, maintain relationships with existing customers and obtain merchandise from key designers. We compete for customers principally on the basis of quality and fashion, customer service, value, assortment and presentation of merchandise, marketing and customer loyalty programs, store ambiance, availability of in-store services and online experience and accessibility. The availability of in-store service and experience offerings, such as dining, beauty and salon services and special events is another dimension of competition as retailers seek to
draw customers to their stores. We believe our success in continuing to offer customers desirable in-store experiences and identifying and executing on new opportunities in this area is an important component of our competitive positioning.
Our failure to compete successfully based on these and other factors may have an adverse effect on our results of operations and cause us to lose market share to our competitors.
The continuing migration to online shopping and increasing availability of luxury merchandise online has diverted sales from physical stores and increased the intensity of in-store and online price competition among retailers. In the current business environment, many retailers are engaging in aggressive pricing competition strategies, including significant discounting of merchandise and the discounting or elimination of costs for services such as alterations or shipping. We may be required to engage in similar practices to compete with such retailers and attempt to preserve or increase market share, which could negatively impact our revenues, margins and reputation as a luxury retailer.
A number of other competitive factors could have an adverse effect on our business, financial condition and results of operations, including:
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expansion of product or service offerings by existing competitors;
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entry by new competitors into markets and channels in which we currently operate;
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alteration of the distribution channels used by designers for the sale of their goods to consumers; and
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adoption by existing competitors of innovative retail sales methods.
Our failure to compete successfully with our existing or new competitors may have a material adverse effect on our business, financial condition and results of operations.
If we fail to anticipate and identify merchandise fashion trends and accurately forecast demand, our business, financial condition and results of operations may be adversely affected.
We make decisions regarding the purchase of our merchandise inventory well in advance of the season in which it will be sold. For example, women’s apparel, men’s apparel, shoes and handbags are typically ordered six to nine months in advance of the date the merchandise will be offered for sale, while jewelry and other categories are typically ordered three to six months in advance of such date. Meanwhile, the increasing use of digital and social media by consumers as a driver of fashion demand has contributed to consumers’ anticipation and expectation that particular items of merchandise be available within a very short timeframe from their introduction.
If our sales during any season or for any particular merchandise product category are significantly lower than we anticipated, we may not be able to adjust our expenditures for inventory and other expenses in a timely fashion and may be left with significant amounts of unsold inventory. If that occurs, we may be forced to rely on markdowns or promotional sales to dispose of excess or slow-selling inventory, which may negatively impact our gross margins, results of operations and cash flows. Conversely, if we fail to purchase a sufficient quantity of in-demand merchandise items, we may be unable to meet consumer demand, lose sales opportunities or adversely affect our customer relationships and reputation as a premier luxury retailer. Any failure on our part to anticipate, identify and respond effectively to fashion trends and merchandise demand could adversely affect our business, financial condition and results of operations.
We focus on providing a seamless, cohesive and high-quality experience through our omni-channel retail model, which adds complexities to our business that create additional risk.
With the expansion of the integrated omni-channel retail model, including through the implementation of NMG One, we believe our overall business has become and will continue to become more complex. These changes require us to develop new expertise in response to the new challenges, risks and uncertainties inherent in the delivery and execution of an integrated omni-channel retailing model. For example, issues related to the implementation of NMG One, which we launched in the first quarter of fiscal year 2017, resulted in disruptions to our business and adversely affected our results of operations during fiscal year 2017. While we believe substantially all the issues related to the implementation of that project have been remediated, future omni-channel initiatives could cause additional disruptions to our business. As we continue to execute our plans and evolve and transform our omni-channel strategy, we may not adequately manage the related organizational or technological changes to align with our strategy, make investments at the right time or pace or in the right manner, or appropriately implement, monitor, report or communicate the changes in an effective manner.
We are also vulnerable to certain additional risks and uncertainties associated with our e-commerce websites, including changes in required technology interfaces, website downtime and other technical failures, internet connectivity issues, costs and technical issues as we upgrade our website software, computer viruses, changes in applicable federal and state regulations, security breaches and consumer privacy concerns. Our failure to successfully respond to these risks and uncertainties, properly allocate our capital between the store and online environment, make the appropriate level of investments in customer-facing technology, or adapt our store operations to the integrated omni-channel retail model could adversely affect our revenues or margins as well as damage our reputation, brands and competitive position.
We depend on the success of our advertising and marketing programs.
Our business depends on attracting a high volume of customers who are likely to purchase our merchandise. We have a significant number of marketing initiatives and regularly fine-tune our approach and adopt new ones, including continuing efforts to ensure our marketing activities are aligned with all of the different ways in which customers currently shop. However, there can be no assurance that we will be able to effectively execute our advertising and marketing programs in the future, and any failure to do so could adversely affect our business, financial condition and results of operations.
In particular, our InCircle loyalty program is designed to cultivate long-term relationships with our customers and enhance the quality of service we provide to our customers. We must constantly monitor and update the terms of this loyalty program so that it continues to meet the demands and needs of our customers and remain competitive with loyalty programs offered by other luxury and premium multi-branded retailers. Almost 40% of our total U.S. revenues in fiscal year 2017 were generated by our InCircle loyalty program members who achieved reward status. If our InCircle loyalty program were to fail to provide competitive rewards and quality service to our customers, our business and results of operations could be adversely affected.
Our business depends significantly on our ability to drive customer traffic to our retail stores, and such efforts can be costly and are subject to numerous operational and other risks.
In-store sales constitute a majority of our revenues and such sales rely on customer traffic. We believe customer traffic at our stores is driven by a number of Company-specific factors including location, store ambiance, the availability of in-store service and experience offerings, such as dining, beauty and salon services and special events, as well as customer traffic at surrounding stores and business. Many of our stores are located in desirable locations within shopping malls and benefit from the abilities that we and other anchor tenants have to generate consumer traffic. A substantial decline in mall traffic, the development of new shopping malls, the availability of locations within existing or new shopping malls, the success of individual shopping malls and the success of other anchor tenants may negatively impact our ability to maintain or grow our sales in existing stores, as well as our ability to open new stores, which could have an adverse effect on our financial condition or results of operations. In addition, increased availability of online shopping has contributed to a reduction of customer traffic at many other retailers which can lead to financial difficulties of shopping center tenants and, in turn, potential shopping center vacancies, all of which can further reduce customer traffic at these locations. Any of these factors may affect our stores. Certain of our stores may be impacted by other location-specific issues.
We routinely evaluate potential expansions and/or remodels of our existing stores to enhance the customer experience in an effort to increase sales. Store expansions or remodels often involve significant up-front costs, disruptions to the customer experience that can reduce traffic and sales and, in some cases, timing uncertainties. In undertaking store expansions or remodels, we must complete the expansion or remodel in a timely, cost-effective manner, minimize disruptions to our existing operations and succeed in creating an improved shopping environment that increases customer traffic and revenues. Our ability to complete expansions and remodels is also subject to our ability to fund them through cash flows from operations or indebtedness.
We believe our customer traffic and in-store revenue results are strongly dependent on our success in continuing to offer customers desirable in-store experiences through remodels and other service offerings. Our failure to provide a desirable in-store customer experience, as well as other customer traffic trends or declines that may be outside of our control, could adversely affect our revenues and results of operations.
Our expansion and growth through the opening of new retail stores is subject to numerous risks, some of which are beyond our control.
The success of our business is dependent on our ability to develop and execute our growth strategies. Our continued growth depends, in part, on our successful development, opening and operation of new stores. Successful execution of this strategy depends upon a number of factors, including our ability to identify suitable sites for new stores, negotiate and execute
leases on acceptable terms, construct, furnish and supply a store in a timely and cost effective manner, accurately assess the demographic or retail environment at a given location, hire and train qualified personnel, obtain necessary permits and zoning approvals, obtain commitments from a core group of vendors to supply a new store, integrate a new store into our distribution network and build customer awareness and loyalty. Our new stores are typically large-scale construction projects that are subject to numerous risks. Construction costs may exceed our original estimates due to increases in materials, labor or other costs, and we may experience permitting or construction delays, which may further increase project costs and delay projected sales. These risks may be exacerbated to the extent we engage third party developers or contractors in connection with such projects or are subject to approvals of regulatory bodies to complete the projects. For example, the Shops at Hudson Yards project is a significant, multi-year development project managed by a third party and we cannot assure you that the project, including the full-line Neiman Marcus store, will be completed within the timeframe or budget that we currently contemplate. As each new store represents a significant investment of capital, time and other resources, delays or failures in opening new stores, or achieving lower than expected sales in new stores, could materially and adversely affect our growth. In addition, new store openings involve the risks described under "Our performance and results of operations may be adversely affected by the significant costs associated with our expansion and growth strategies."
Our growth strategies may also lead us to expand into additional geographical markets in the future, either by opening new stores or through acquisitions. These markets may have different competitive conditions, consumer trends and discretionary spending patterns than our existing markets, which may cause our operations in these markets to be less successful than in our existing markets.
Failure to execute on these or other aspects of our growth strategies in a cost-effective manner could adversely affect our revenues and results of operations.
Our performance and results of operations may be adversely affected by the significant costs associated with our expansion and growth strategies.
We have made and intend to continue making significant ongoing investments to support our expansion and growth strategies. For example, we make capital investments in our new and existing stores, websites, omni-channel model and distribution and support facilities, as well as in information technology, and incur expenses for headcount, advertising and marketing, professional fees and other costs in support of our growth initiatives. The amounts of such investments, expenses and costs are often difficult to predict because they require us to anticipate our customers’ needs, our needs as we grow, trends within our industry and our competitors’ actions. If we fail to accurately predict the amounts of or returns on these investments, expenses and costs, our results of operations could be adversely affected.
Investments and partnerships in new business strategies and acquisitions could impact our business, financial performance and results of operations.
We may, from time to time, acquire other businesses, such as our acquisition of MyTheresa in October 2014, or make other investments in businesses or partnerships. Such acquisitions or investments would subject us to additional associated risks, including the integration of operations and personnel, the achievement of any expected operational, branding and other synergies and strategic benefits, and the diversion of management resources to effect and implement acquisitions. These acquisitions and investments may not perform as expected or cause us to assume liabilities unrecognized or underestimated in due diligence. In addition, we may be unable to retain key employees in any business we acquire, we may experience difficulty integrating any businesses we acquire, and any such acquisitions may result in the diversion of our capital and our management’s attention from other business issues and opportunities, any of which could harm our business, financial performance and results of operations.
A significant portion of our revenue is from our stores in four states, which exposes us to economic circumstances unique to or catastrophic occurrences affecting those states.
Our stores located in California, Florida, New York and Texas together represented approximately 50% of our revenues in fiscal year 2017. As a result, we are more vulnerable to economic and other conditions in those states, particularly the major metropolitan areas in those states, than our more geographically diversified competitors. Any events or circumstances that negatively affect those states could materially adversely affect our revenues and profitability.
The sustained reduction in oil prices that began in early calendar year 2014 has caused particular stress to the Texas economy, including in the major metropolitan areas where our seven Texas stores are located. We believe that this stress has negatively impacted the performance of our Texas stores, as a significant number of those stores' customers are employed or invested in, or otherwise affected by, the energy sector and are reducing their discretionary spending on items such as our
luxury merchandise. The trajectory of energy prices is uncertain and our Texas stores' performance may continue to be impacted by the performance of companies in the energy sector.
Additionally, our stores in California, Florida and New York are located in cities that host a large number of international travelers to the United States. We believe that the current relative strength of the dollar against other international currencies, including the Euro, is affecting the willingness of tourists and other non-U.S. customers to buy luxury merchandise from our stores in those states as the strength of the dollar relative to their home currencies makes our merchandise more expensive to them on a relative basis. Recent developments such as the United Kingdom's initiation of negotiations to leave the European Union and subsequent related developments, including the possibility of similar initiatives by other European countries, may lead to additional global economic uncertainty that could cause the dollar to remain strong relative to the Euro and the British pound, which could continue to affect the performance of our California, Florida and New York stores.
Other factors that may affect the results of operations of our stores located in those states include, among other things, changes in demographics, population and employee bases, wage increases, future changes in economic conditions, severe weather conditions such as Hurricane Harvey and Hurricane Irma, which significantly impacted and required temporary closure of our stores in Houston, Texas and in Florida when they made landfall during the first quarter of fiscal year 2018, and other catastrophic occurrences. Such conditions may result in reduced customer traffic and spending in our stores, physical damage to our stores, loss of inventory, closure of one or more of our stores, inadequate work force in our markets, temporary disruption in the supply of merchandise, delays in the delivery of merchandise to our stores and a reduction in the availability of merchandise in our stores. Any of these factors may disrupt our business and materially adversely affect our business, financial condition and results of operations.
We are dependent on our relationships with certain designers, vendors and other sources of merchandise.
Our relationships with established and emerging designers are a key factor in our success as a luxury merchandise retailer because sales of designer merchandise represent a substantial portion of our revenues. Many of our key vendors limit the number of retail channels they use to sell their merchandise and we have no guaranteed supply arrangements with our principal sources of merchandise. In addition, nearly all of our top designer brands are sold by competing retailers and have their own proprietary retail stores and/or websites. Accordingly, there can be no assurance that any of such sources or designers will continue to sell to us or meet our quality, style and volume requirements.
If one or more of our top designers were to (i) limit the supply of merchandise made available to us for resale on a wholesale basis or otherwise, (ii) increase the supply of merchandise made available to our competitors, (iii) increase the supply of merchandise made available to their own proprietary retail stores and websites or significantly increase the number of their proprietary retail stores, (iv) convert the distribution of merchandise made available to us from a wholesale arrangement to a concession arrangement (whereby the designer merchandises its boutique within our store and pays us a pre-determined percentage of the revenues derived from the sale of such merchandise), which certain of our key vendors have done, or (v) cease the wholesale distribution of their merchandise to retailers, our business could be adversely affected. Any decline in the quality or popularity of our top designer brands could also adversely affect our business.
During periods of adverse change in general economic, industry or competitive conditions, some of our designers and vendors may experience cash flow issues, reductions in available credit from banks, factors or other financial institutions, or increases in the cost of capital. In response to those conditions or to concerns about our financial condition, such designers and vendors may attempt to increase their prices, alter historical credit and payment terms available to us or take other actions. Any of these actions could have an adverse impact on our relationships with such designers or vendors, or constrain the amounts or timing of our purchases from such designers or vendors, and, ultimately, have an adverse effect on our revenues, results of operations and liquidity.
A material disruption in our information systems could adversely affect our business or results of operations.
We rely on our information systems to process transactions, summarize our results of operations and manage our business. The reliability and capacity of our information systems is critical to our operations and the implementation of our growth initiatives. Our information systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, cyber-attack or other security breaches and catastrophic events such as fires, floods, earthquakes, tornadoes, hurricanes, acts of war or terrorism and usage errors by our employees. If our information systems are damaged or cease to function properly, we may have to make a significant investment to fix or replace them, and we may suffer losses of critical data and/or interruptions or delays in our operations.
Additionally, our websites or mobile e-commerce platforms may suffer future outages or instability despite our efforts and investments and such outages may cause us to lose sales or lead us to offer promotions that could negatively impact our margins. To keep pace with changing technology, we must continuously implement new information technology systems as well as enhance our existing systems. Moreover, the successful execution of some of our growth strategies, in particular the expansion of our omni-channel and online capabilities, is dependent on the design and implementation of new systems and technologies and/or the enhancement of existing systems. Issues related to the implementation of NMG One, which we launched in the first quarter of fiscal year 2017, resulted in disruptions to our business and adversely affected our results of operations during fiscal year 2017. While we believe substantially all the issues related to the implementation of that project have been remediated, future omni-channel initiatives could cause additional disruptions to our business. Additionally, we are developing and implementing a process of updating our data storage center, which may involve outsourcing one or more of our data center functions to a third-party provider, migrating functions to the cloud or physically relocating all or some of our own data storage hardware to a new location. This process is in the very early stages, and it is possible that we may experience interruption to our operations in the course of completing this complex but necessary information technology initiative.
Any material disruption in our information systems, or delays or difficulties in implementing or integrating new systems or enhancing or expanding current systems, could have an adverse effect on our business, in particular our online operations, and results of operations.
An impairment of the carrying value of goodwill or other indefinite-lived intangible assets has negatively affected and may in the future negatively affect our financial results and net worth.
Indefinite-lived intangible assets, such as our Neiman Marcus, Bergdorf Goodman and MyTheresa tradenames and goodwill, are not subject to amortization but are tested for impairment in the fourth quarter of each fiscal year and upon the occurrence of certain events. We test indefinite-lived intangible assets by comparing the fair value of the assets to their estimated fair values. Similarly, we test goodwill at the reporting unit level by comparing the carrying value of the net assets of the reporting unit, including goodwill, to the unit's fair value. If the carrying values of indefinite-lived intangible assets or goodwill exceed their estimated fair value, an impairment charge is recorded to write down the intangible asset or goodwill to its estimated fair value. Factors that could result in an impairment include economic conditions, future business conditions and trends, projected revenues, earnings and cash flows as well as other market factors such as the weighted average cost of capital and valuation multiples. Based upon the review of our indefinite-lived intangible assets and our goodwill, we recorded impairment charges to our indefinite-lived intangible assets aggregating $309.7 million in fiscal year 2017 and $228.9 million in fiscal year 2016 and to our goodwill balances aggregating $196.2 million in fiscal year 2017 and $199.2 million in fiscal year 2016. Future impairment charges could be required if we do not achieve our current cash flow, revenue and profitability projections, market royalty rates decrease or the weighted average cost of capital increases. This could negatively affect our financial results and net worth.
Our continued success is substantially dependent on positive perceptions of our company, which, if eroded, could adversely affect our customer, employee and vendor relationships.
We have a reputation associated with a high level of integrity, customer service and quality merchandise, which is one of the reasons customers shop with us and employees choose us as a place of employment. To be successful in the future, we must continue to preserve, grow and leverage the value of our reputation. Reputational value is based in large part on perceptions. While reputations may take decades to build, negative incidents or developments, including actions taken by our business partners, industry conditions or our operating performance and liquidity and/or perceptions as to our performance and liquidity, can quickly erode trust and confidence, particularly if they result in adverse mainstream and social media publicity, governmental investigations or litigation. Any significant damage to our reputation could negatively impact sales, diminish customer trust, reduce employee morale and productivity, lead to difficulties in recruiting and retaining qualified employees or cause difficulties in our vendor or other business and financial relationships.
A breach in information privacy could negatively impact our operations.
The protection of our customer, employee and company data is critically important to us. We utilize customer data collected through both our proprietary credit card programs and our in-store and online activities. Additionally, we may share personal information with certain third party vendors and service providers as needed for them to assist with various aspects of our business. Our customers and employees have a high expectation that we will adequately safeguard and protect their personal information. Despite our security measures and our requirements that third party vendors and service providers maintain security measures to the extent they have access to personal information, our or our vendors’ information technology and infrastructure may be vulnerable to criminal cyber-attacks or security incidents due to employee error, malfeasance or other vulnerabilities. The increased use of mobile phones, tablets and wireless networks to make purchases and to transmit data has
further increased the complexity and cost associated with ensuring protection of transmitted information. During the ordinary course of business, the Company experiences and expects to continue to experience limited compromises or potential compromises of personal information due to unauthorized external attempts to access information and has experienced significant compromises in the past including those described below. Any such incident could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. In addition, we outsource certain functions, such as customer communication platforms and credit card transaction processing, and these relationships allow for the storage and processing of customer information by third parties, which could result in security breaches impacting our customers.
We have taken steps to further strengthen the security of our computer systems and continue to assess, maintain and enhance the ongoing effectiveness of our information security systems. However, the techniques used by criminals to obtain unauthorized access to sensitive data change frequently and often are not recognizable until launched against a target. Accordingly, we may be unable to anticipate these techniques or implement adequate preventative measures. It is therefore possible that in the future we may suffer a criminal attack, unauthorized parties may gain access to personal information in our possession and we may not be able to identify any such incident in a timely manner.
As described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we incurred costs in fiscal years 2017, 2016 and 2015 associated with a cyber-attack that we discovered in January 2014 relating to the clandestine installation of malicious software on our computer systems that attempted to collect payment card data (the “Cyber-Attack”), including investigative, legal and other costs. In the future, state enforcement authorities may also impose fines or other remedies against us. Such costs are not currently estimable but could be material to our future results of operations.
As described in Item 3, "Legal Proceedings" and Note 12 of the Notes to Consolidated Financial Statements in Item 15, the Cyber-Attack gave rise to putative class action litigation on behalf of customers and regulatory investigations. This putative class action has settled and the settlement agreement has received preliminary approval by the court. At this point, we are unable to predict the developments in, outcome of, and economic and other consequences of pending litigation or government inquiries related to this matter. Any future criminal cyber-attack or data security incident may damage our reputation and relationships with our customers and may result in additional regulatory investigations, legal proceedings or liability under laws that protect the privacy of personal information, all of which may adversely affect our business, financial condition and results of operations.
Conditions in the countries where we source our merchandise and international trade conditions could adversely affect us.
A substantial majority of our merchandise is manufactured overseas, mostly in Europe and, to a lesser extent, China, Mexico and South America, and delivered to us by our vendors as finished goods. As a result, political or financial instability, labor strikes, natural disasters or other events resulting in the disruption of trade or transportation from other countries or the imposition of additional regulations relating to foreign trade could cause significant delays or interruptions in the supply of our merchandise or increase our costs, either of which could have an adverse effect on our business. If we are forced to source merchandise from other countries, such merchandise might be more expensive or of a different or inferior quality from the merchandise we now sell. If we were unable to adequately replace the merchandise we currently source with merchandise produced elsewhere, our business could be adversely affected.
Additionally, current political issues in the U.S., the United Kingdom and other European countries have created significant uncertainty regarding international trade policy. These developments are widely anticipated to increase regulatory complexities and, potentially, lead to the increase or implementation of import tariffs that may affect our costs of importing merchandise. Major adverse changes in trade policy or relations, including the imposition of tariffs on goods that we import or export could adversely affect our results of operations.
Our business is affected by foreign currency fluctuations and inflation.
We purchase a substantial portion of our inventory from foreign suppliers whose costs are affected by the fluctuation of their local currency against the U.S. dollar or who price their merchandise in currencies other than the U.S. dollar. While fluctuations in the Euro-U.S. dollar exchange rate can affect us most significantly, we source merchandise from numerous countries and thus are affected by changes in numerous other currencies and, generally, by fluctuations in the value of the U.S. dollar relative to such currencies. During fiscal year 2015, the U.S. dollar began to strengthen against the Euro and other international currencies and the U.S. dollar remained relatively strong through fiscal years 2016 and 2017. The United Kingdom's June 2016 referendum to leave the European Union caused the values of the Euro and the British pound to decline further relative to the U.S. dollar and has created market uncertainty with respect to the future strength of the Euro and the British pound, which may contribute to continued strength of the U.S. dollar relative to those currencies. We believe a stronger
U.S. dollar may (i) create disincentives to, or changes in the pattern, practice or frequency of, travel to and spending by foreign tourists in the regions in which we operate our retail stores and (ii) increase U.S. consumers’ willingness or ability to travel abroad and purchase merchandise we offer for sale at relatively lower prices from foreign retailers. See "A significant portion of our revenue is from our stores in four states, which exposes us to economic circumstances or catastrophic occurrences affecting those states" above. In addition, we believe a strengthening of the U.S. dollar relative to foreign currencies, most notably the Euro, may impact the retail prices of merchandise offered for sale and/or our cost of goods sold. Any of these effects or their continuation could cause our revenues or product margins to decrease.
We have also experienced certain inflationary effects in our cost base due to increases in selling, general and administrative expenses, particularly with regard to employee health care and other benefits. Inflation can negatively impact our margins and profitability if we are unable to increase prices or cut costs to offset the effects of inflation in our cost base.
Funding requirements or benefit payment costs under our pension plan could impact our financial results and cash flows.
We sponsor a defined benefit pension plan and we are required to make funding contributions to the plan to maintain its funded status. Funding requirements are based on, among other things, actuarial assumptions regarding benefit costs and anticipated future returns on plan assets (which depend in part on future interest rates). Significant changes in interest rates, actuarial assumptions (including expected mortality rates), fluctuations in the fair value of plan assets and benefit payments could affect the funded status of our Pension Plan and could increase future funding requirements. Any significant increase in pension plan funding requirements or a decision to make voluntary lump-sum payments to plan participants could negatively impact our cash flows, financial condition, liquidity or results of operations.
Economic, political and other risks associated with our international operations could adversely affect our revenues and international growth prospects.
As part of our business strategy, we intend to increase our sales outside the United States. We have limited experience operating overseas subsidiaries and managing non-U.S. employees and, as a result, may encounter cultural challenges with local practices and customs that may result in harm to our reputation and the value of our brands. Our international revenues are subject to a number of risks inherent to operating in foreign countries, and any expansion of our international operations will increase the effects of these risks. These risks include: (i) political or civil instability of foreign markets (including acts of terrorism) and general economic conditions; (ii) foreign governments’ restrictive trade policies; (iii) sudden policy changes by foreign agencies or governments; (iv) the imposition of, or increase in, duties, taxes, government royalties or non-tariff trade barriers; (v) difficulty in collecting international accounts receivable and potentially longer payment cycles; (vi) restrictions on repatriation of cash and investments in operations in certain countries; (vii) problems entering international markets with different cultural bases, consumer preferences and competitive environments; (viii) labor unrest in foreign markets; (ix) compliance with laws and regulations applicable to international operations, such as the Foreign Corrupt Practices Act and regulations promulgated by the Office of Foreign Asset Control; and (x) operating in new, developing or other markets in which there are significant uncertainties regarding the interpretation, application and enforceability of laws and regulations relating to contract and intellectual property rights. Any of these risks could have a material adverse effect on our international operations and our growth strategy.
We outsource certain business processes to third party vendors, which subjects us to risks, including disruptions in our business, compromise of data and increased costs.
We outsource certain technology-related processes to third parties. These include credit card authorization and processing, insurance claims processing, payroll processing, record keeping for retirement and benefit plans and certain information technology functions. In addition, we depend on third party vendors for delivery of our merchandise from manufacturers and to our customers. We review outsourcing alternatives on a regular basis and may decide to outsource additional processes in the future. If third party providers fail to meet our performance standards and expectations, including with respect to data security, our reputation, revenues and results of operations could be adversely affected. In addition, we could face increased costs associated with finding replacement vendors or hiring new employees to provide these services in-house.
The loss of senior management or attrition among our buyers or key sales associates could adversely affect our business.
Our success in the global luxury merchandise industry is dependent on our senior management team, buyers and key sales associates. We rely on the experience of our senior management, and their knowledge of our business and industry would be difficult to replace. Several executives have departed the Company during fiscal years 2017 and 2016, and such departures cause us to incur costs and diversion of management attention to locate and retain quality replacements and to fulfill the
functions of those positions until they are filled. Additionally, if we were to lose a portion of our buyers or key sales associates, our ability to benefit from long-standing relationships with key designers or to provide relationship-based customer service could suffer. We may not be able to retain our current senior management team, buyers or key sales associates and the loss of any of these individuals could adversely affect our business. We do not maintain key person insurance on any employee.
Our business may be adversely affected by union activities.
Certain employees of our Bergdorf Goodman stores, representing less than 1% of our total employees, are subject to a collective bargaining agreement. Additionally, some of our vendors that service our properties and contractors or subcontractors that may be hired for store construction or remodeling projects have unionized employees. We may experience disruptions at our stores or other pressure as a result of protests or other activities by our vendors' or our labor unions. Additionally, the unionization of a more significant portion of our workforce could increase the overall costs at the affected locations and adversely affect our flexibility to run our business competitively and otherwise adversely affect our business, financial condition and results of operations.
Changes in our credit card arrangements and regulations with respect to those arrangements could adversely impact our business.
We maintain a proprietary credit card program through which credit is extended to customers and have a related marketing and servicing alliance with affiliates of Capital One. Pursuant to the Program Agreement, Capital One currently offers credit cards and non-card payment plans under both the "Neiman Marcus" and "Bergdorf Goodman" brand names. Also, we receive payments from Capital One based on sales transacted on our proprietary credit cards. These payments are based on the profitability of the credit card portfolio as determined under the Program Agreement and are impacted by a number of factors including credit losses incurred and our allocable share of the profits generated by the credit card portfolio, which in turn may be impacted by credit ratings as determined by various rating agencies. In addition, we receive payments from Capital One for marketing and servicing activities we provide to Capital One. The Program Agreement terminates in July 2020 (renewable thereafter for three-year terms), subject to early termination provisions.
In connection with the Program Agreement, we have changed and may continue to change the terms of credit offered to our customers. In addition, Capital One has discretion over certain policies and arrangements with credit card customers and may change these policies and arrangements in ways that affect our relationships with these customers. Our credit ratings also impact revenue sharing under the Program Agreement. Beginning in July 2017, in accordance with the provisions of the credit card program agreement, our allocable share of the profits generated by the credit card portfolio was reduced as a result of our current credit ratings by S&P and Moody's. Moreover, changes in credit card use, payment patterns and default rates may result from a variety of economic, legal, social and other factors that we cannot control or predict with certainty. Any such changes in our credit card arrangements may adversely affect our credit card program and, ultimately, our business.
Credit card operations such as our proprietary program through Capital One are subject to numerous federal and state laws such as the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the "CARD Act") and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") that impose disclosure and other requirements upon the origination, servicing and enforcement of credit accounts and limitations on the maximum amount of finance charges that may be charged by a credit provider . The CARD Act included new and revised rules and restrictions on credit card pricing, finance charges and fees, customer billing practices and payment application. The Dodd-Frank Act was enacted in July 2010 and increased the regulatory requirements affecting providers of consumer credit. These changes significantly restructured regulatory oversight and other aspects of the financial industry, created a new federal agency to supervise and enforce consumer lending laws and regulations and expanded state authority over consumer lending. Additional regulation under these statutes and interpretations of these new rules may be implemented and we may be required to make changes to our credit card practices and systems. Any regulation or change in the regulation of credit arrangements, pursuant to the CARD Act, the Dodd-Frank Act or otherwise, that would materially limit the availability of credit to our customer base could adversely affect our business.
We are subject to risks associated with owning and leasing substantial amounts of real estate.
We own or lease substantial amounts of real estate, primarily our retail stores and office facilities, and many of the stores we own are subject to ground leases or operating covenants. Accordingly, we are subject to all of the risks associated with owning and leasing real estate. In particular, the value of the relevant assets could decrease, or costs to operate stores could increase, in either case because of changes in the supply or demand of available store locations, demographic trends or the overall investment climate for real estate. Pursuant to the operating covenants in certain of our leases and due to the fact that we generally cannot cancel our leases at our option without incurring potentially significant exit costs, we could be
required to continue to maintain, operate and make lease payments on a store that no longer meets our performance expectations, requirements or current operating strategies. The terms of our real estate leases, including renewal options, range from ten to 130 years. We believe that we have been able to lease real estate on favorable terms, but there is no guarantee that we will be able to continue to negotiate these terms in the future. If we are not able to enter into new leases or renew existing leases on terms acceptable to us, our business and results of operations could be adversely affected.
Our ability to timely deliver merchandise to our stores and customers is dependent on a limited number of distribution facilities. The loss of, or disruption in, one or more of our distribution facilities could adversely affect our business and operations.
We operate a limited number of distribution facilities. Our ability to meet the needs of our retail stores and online operations depends on the proper operation of these distribution facilities. Although we believe that we have appropriate contingency plans, unforeseen disruptions in operations due to freight difficulties, strikes, fire, weather conditions, natural disasters or for any other reason may result in the loss of inventory and/or delays in the delivery of merchandise to our stores and customers. In such an event, our customers may decide to purchase merchandise from our competitors instead of from us. In addition, we could incur higher costs and longer lead times associated with the distribution of our merchandise during the time it takes to reopen or replace a damaged facility. Any of the foregoing factors could adversely affect our business, financial condition and results of operations.
Our business may be adversely affected by catastrophic events and extreme or unseasonable weather conditions.
Unforeseen events, including war, terrorism and other international conflicts, public health issues and natural disasters such as earthquakes, hurricanes or tornadoes, whether occurring in the United States or abroad, could disrupt our supply chain operations, international trade or result in political or economic instability. Any of the foregoing events could result in property losses, reduce demand for our merchandise, impact our store operations or make it difficult or impossible to obtain merchandise from our suppliers.
Extreme weather conditions in the areas in which our stores are located, particularly in markets where we have multiple stores, could adversely affect our business. Heavy snowfall, rainfall or other extreme weather conditions over a prolonged period might make it difficult for our customers to travel to our stores and thereby reduce our revenues and profitability. During the first quarter of fiscal year 2018, Hurricane Harvey and Hurricane Irma significantly impacted our stores in Houston, Texas and in Florida, requiring these stores to close for several days at a time and impacting our customers’ ability and willingness to shop at those locations. Given the importance of these stores to our business, we expect these closures will negatively impact our results of operations for the first quarter of fiscal 2018. Our business is also susceptible to unseasonable weather conditions. For example, extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season could render a portion of our inventory incompatible with those unseasonable conditions. Reduced sales from extreme or prolonged unseasonable weather conditions could adversely affect our business.
Our failure to comply with, or developments in, laws, rules or regulations could affect our business or results of operations.
We are subject to customs, anti-corruption laws, truth-in-advertising, intellectual property, labor and other laws, including consumer protection regulations, credit card regulations, environmental laws and zoning and occupancy ordinances that regulate retailers generally and/or govern the importation, promotion and sale of merchandise, regulate wage and hour matters with respect to our employees and govern the operation of our retail stores and warehouse facilities. Although we undertake to monitor our compliance with and developments in these laws, rules and regulations, if these laws are violated by us or our importers, designers, manufacturers, distributors or other business partners, or if the interpretation of these laws, rules or regulations changes, we could experience delays in shipments and receipt of merchandise, suffer damage to our reputation or be subject to fines or other penalties under the controlling regulations, any of which could adversely affect our business or results of operations. For a more detailed description of current lawsuits and other litigation to which we are party, see Item 3, "Legal Proceedings" and Note 12 of the Notes to Consolidated Financial Statements in Item 15.
If we are unable to enforce our intellectual property rights, if we are accused of infringing a third party’s intellectual property rights, or if the merchandise we purchase from vendors is alleged to have infringed a third party’s intellectual property rights, our business or results of operations may be adversely affected.
Our future success and competitive position depend in part on our ability to maintain and protect our brand. We and our subsidiaries currently own various intellectual property rights in the United States and in various foreign jurisdictions that differentiate us from our competitors, including our trademarks, tradenames and service marks, such as the “Neiman Marcus,” “Bergdorf Goodman” and “mytheresa” marks. We currently rely on a combination of copyright, trademark, trade dress and
unfair competition laws to establish and protect our intellectual property and other proprietary rights, but the steps we take to protect such rights may be inadequate to prevent infringement of our trademarks and proprietary rights by others. Such unauthorized use of our trademarks, trade secrets, or other proprietary rights may cause significant damage to our brands and have an adverse effect on our business. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States and there can be no assurance that we are adequately protected in all countries or that we will prevail when defending our trademark or proprietary rights. The loss or reduction of any of our significant intellectual property or proprietary rights could have an adverse effect on our business.
Additionally, third parties may assert claims against us alleging infringement, misappropriation or other violations of their intellectual property or other proprietary rights, whether or not the claims have merit. Such claims could be time consuming and expensive to defend and may divert management’s attention and resources. This could have an adverse effect on our business or results of operations and cause us to incur significant litigation costs and expenses. In addition, resolution of such claims may require us to cease using the relevant intellectual property or other rights or selling the allegedly infringing products, or to license rights from third parties.
We purchase merchandise from vendors that may incorporate protected intellectual property and we do not independently investigate whether these vendors legally hold intellectual property rights to merchandise that they are manufacturing or distributing. As a result, we rely upon the vendors’ representations and indemnifications set forth in our purchase orders and supplier agreements concerning their right to sell us the products that we purchase from them. If a third party claims to have rights with respect to merchandise we purchased from a vendor, or if we acquire unlicensed merchandise, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of such merchandise if the distributor or vendor is unwilling or unable to reimburse us and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages and injunctions. Any of these results could harm our brand image and have a material adverse effect on our business and growth.
Our high level of fixed lease obligations could adversely affect our business, financial condition and results of operations.
Our high level of fixed lease obligations will require us to use a significant portion of cash generated by our operations to satisfy these obligations and could adversely affect our ability to obtain future financing to support our growth or other operational investments. We will require substantial cash flows from operations to make our payments under our operating leases, which in some cases provide for periodic adjustments in our rent rates. If we are not able to make the required payments under the leases, the owners of or lenders with a security interest in the relevant stores, distribution centers or administrative offices may, among other things, repossess those assets, which could adversely affect our ability to conduct our operations. In addition, our failure to make payments under our operating leases could trigger defaults under other leases or under agreements governing our indebtedness, which could cause the counterparties under those agreements to accelerate the obligations due thereunder.
Claims under our insurance plans and policies may differ from our estimates, which could adversely affect our results of operations.
We use a combination of insurance and self-insurance plans to provide for potential liabilities for workers’ compensation, general liability, business interruption, property and directors’ and officers’ liability insurance, vehicle liability and employee health-care benefits. Our insurance coverage may not be sufficient, and any insurance proceeds may not be timely paid to us. In addition, liabilities associated with the risks that are retained by us are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions, and our business, financial condition and results of operations may be adversely affected if such assumptions are incorrect.
Risks Related to our Indebtedness
Our substantial indebtedness could adversely affect our business, financial condition and results of operations and our ability to fulfill our obligations with respect to such indebtedness.
As of July 29, 2017, the principal amount of our total indebtedness was approximately $4.8 billion, and we had unused commitments under our revolving credit facilities available to us of $651.1 million, subject to a borrowing base, of which (i) $90.0 million of such capacity is available to us subject to certain restrictions as more fully described in Note 8 of the Notes to Consolidated Financial Statements in Item 15 and (ii) $17.1 million of such capacity is available only to MyTheresa under its credit facilities and not to our U.S. operations.
The existence and terms of our substantial indebtedness could adversely affect our business, financial condition and results of operations by:
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making it more difficult for us to satisfy our obligations with respect to our indebtedness;
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limiting our ability to incur, or guarantee, additional indebtedness or obtain additional financing to fund future working capital, capital expenditures, acquisitions, execution of our business and growth strategies or other general corporate requirements;
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requiring a substantial portion of our cash flows to be dedicated to debt service payments instead of other purposes, thereby reducing the amount of cash flows available for working capital, capital expenditures, acquisitions and other general corporate purposes and future growth;
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limiting our ability to pay dividends or make other distributions in respect of, or repurchase or redeem, capital stock;
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increasing our vulnerability to general adverse economic, industry and competitive conditions and government regulations;
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exposing us to the risk of increased interest rates as certain of our borrowings, including borrowings under our credit facilities, are at variable rates of interest;
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limiting our flexibility in planning for and reacting to changes in the industry in which we compete and our ability to take advantage of new business opportunities;
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placing us at a disadvantage compared to other, less leveraged competitors;
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increasing our cost of borrowing; and
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causing our suppliers or other parties with which we maintain business relationships to experience uncertainty about our future and seek alternative relationships with third parties or seek to alter their business relationships with us.
We may also incur substantial indebtedness in the future, subject to the restrictions contained in the indentures governing the Notes and the credit agreements governing our credit facilities. If such new indebtedness is in an amount greater than our current indebtedness levels, the related risks that we now face could intensify. However, we cannot assure you that any such additional financing will be available to us on acceptable terms or at all. See “-Our ability to obtain adequate financing or raise capital in the future may be limited.”
We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments on or refinance our debt obligations depends on our financial condition and results of operations, which are subject to prevailing economic and competitive conditions and to financial, business, legislative, regulatory and other factors beyond our control. As a result, we cannot assure you that our business will generate a level of cash flows from operating activities sufficient to permit us to make payments on our indebtedness.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and may have to undertake alternative financing plans, such as refinancing or restructuring our indebtedness, selling our assets, reducing or delaying capital investments or seeking to raise additional capital. Our ability to restructure or refinance our indebtedness or to raise additional capital will depend on the conditions of the capital markets and our financial condition at such time. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of existing or future debt instruments may also restrict us from adopting some of these alternatives.
If we cannot make scheduled payments on our debt, we will be in default and holders of the Notes and the lenders under our Senior Secured Credit Facilities (as defined below) could declare all outstanding principal and interest to be due and payable, the lenders under our Senior Secured Credit Facilities could terminate their commitments to loan additional money to us and we could be forced into bankruptcy or liquidation.
The occurrence of any of the foregoing would materially and adversely affect our business, financial position and results of operations.
Our debt agreements contain restrictions that may limit our flexibility in operating our business.
The indentures governing the Notes and the credit agreements governing our Senior Secured Credit Facilities contain, and any agreements governing future indebtedness will likely contain, a number of restrictive covenants that impose significant operating and financial restrictions, including restrictions on our ability to engage in acts that may be in our long-term best interest, including restrictions on our and our subsidiaries' ability to:
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incur additional indebtedness and guarantee indebtedness;
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create liens;
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make investments, loans or advances;
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merge or consolidate;
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sell assets, including capital stock of subsidiaries or make acquisitions;
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pay dividends or make other distributions in respect of, or repurchase or redeem, capital stock;
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prepay, redeem or repurchase certain indebtedness;
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enter into transactions with affiliates; and
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alter our lines of business.
In addition, the springing financial covenant in the credit agreement governing our asset-based revolving credit facility (the "Asset-Based Revolving Credit Facility") requires the maintenance of a minimum fixed charge coverage ratio, which covenant is triggered when excess availability under our Asset-Based Revolving Credit Facility is less than the greater of $50.0 million and 10% of the Line Cap (as defined in the credit agreement governing the Asset-Based Revolving Credit Facility) then in effect. Our ability to meet the financial covenant could be affected by events beyond our control. Additional restrictions will apply if excess availability remains below the greater of $50.0 million and 10% of the Line Cap then in effect, including increased reporting requirements and additional administrative agent control rights over certain of our accounts.
A breach of the covenants under the indentures governing the Notes or under the credit agreements governing our Senior Secured Credit Facilities could result in an event of default under the applicable debt document. Such a default, if not cured or waived, may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt that is subject to an applicable cross-acceleration or cross-default provision. In addition, an event of default under the credit agreements governing our Senior Secured Credit Facilities would permit the lenders under our Senior Secured Credit Facilities to terminate all commitments to extend further credit under the facilities. Furthermore, if we were unable to repay the amounts due and payable under our Senior Secured Credit Facilities, those lenders could proceed against the collateral granted to them to secure that indebtedness. If our lenders or holders of the Notes accelerate the repayment of our borrowings, we and our subsidiaries may not have sufficient assets to repay that indebtedness.
Based on the foregoing factors, the operating and financial restrictions and covenants in our current debt agreements and any future financing agreements could adversely affect our ability to finance future operations or capital needs or to engage in other business activities.
Our ability to obtain adequate financing or raise capital in the future may be limited.
Our business and operations may consume resources faster than we anticipate or generate less cash than we anticipate. To support our operating strategy, we must have sufficient capital to continue to make significant investments in our new and existing stores, online operations and advertising. While some of these investments can be financed with borrowings under our Asset-Based Revolving Credit Facility, the amount of such borrowings is limited to a periodic borrowing base valuation of our accounts receivable and domestic inventory and is therefore potentially subject to significant fluctuations, as well as certain discretionary rights of the administrative agent of our Asset-Based Revolving Credit Facility in respect of the calculation of such borrowing base value.
Since availability under our Asset-Based Revolving Credit Facility and/or cash generated by our operations may not be sufficient to allow us to fund our capital requirements in the future, we may need to raise additional funds through debt financing, the issuance of new equity or debt securities or a combination of both. Additional financing may not be available on favorable terms or at all.
In addition, the credit and securities markets and the financial services industry have recently experienced disruption characterized by the bankruptcy, failure, collapse or sale of various financial institutions, increased volatility in securities prices, diminished liquidity and credit availability and intervention from the U.S. and other governments. Additionally, many retailers including some of our competitors have recently experienced or are currently experiencing financial difficulties, including several that have entered bankruptcy or have engaged in other debt restructuring activities. The cost and availability of credit has been and may continue to be adversely affected by these conditions. We cannot be certain that funding for our capital needs will be available from our existing financial institutions and the credit and securities markets if needed, and if available, to the extent required, and on acceptable terms.
The Asset-Based Revolving Credit Facility matures on July 25, 2021 (or July 25, 2020 if the Company’s obligations under its senior secured term loan facility have not been repaid or the maturity date thereof has not been extended to October 25, 2021 or later), the senior secured term loan facility (as amended, the "Senior Secured Term Loan Facility" and, together with the Asset-Based Revolving Credit Facility, the "Senior Secured Credit Facilities") matures on October 25, 2020, the 8.00% senior cash pay notes due 2021 (the "Cash Pay Notes") and the 8.75%/9.50% senior PIK toggle notes due 2021 (the "PIK Toggle Notes") mature on October 15, 2021, and the 7.125% senior debentures due 2028 (the "2028 Debentures" and, collectively with the Cash Pay Notes and the PIK Toggle Notes, the "Notes") mature on June 1, 2028. If we cannot renew or refinance the foregoing indebtedness upon their respective maturities or, more generally, obtain funding when needed, in each case on acceptable terms, we may be unable to continue to fund our capital requirements, which may have an adverse effect on our business, financial condition and results of operations.
A future lowering or withdrawal of the ratings assigned to our debt securities by rating agencies may increase our future borrowing costs and reduce our access to capital.
Our indebtedness currently has a non-investment grade rating, and any rating assigned could be lowered or withdrawn entirely by a rating agency if, in that rating agency’s judgment, future circumstances relating to the basis of the rating, such as adverse changes in our business, warrant. Our indebtedness was downgraded twice by Standard & Poor’s and once by Moody’s during fiscal year 2017. Any additional downgrade by any ratings agency may increase the interest rate on our Senior Secured Credit Facilities, limit our access to vendor financing on favorable terms or otherwise result in higher borrowing costs, and likely would make it more difficult or more expensive for us to obtain additional debt financing.
We are a holding company with no operations and may not have access to sufficient cash to make payments on our outstanding indebtedness.
We are a holding company and do not have any direct operations. Our only significant assets are the equity interests we directly and indirectly hold in our subsidiaries. As a result, we are dependent upon dividends and other payments from our subsidiaries to generate the funds necessary to meet our outstanding debt service and other obligations. Our subsidiaries may not generate sufficient cash from operations to enable us to make principal and interest payments on our indebtedness. In addition, our subsidiaries are separate and distinct legal entities and, except for our existing and future subsidiaries that will be the guarantors of our indebtedness, any payments on dividends, distributions, loans or advances to us by our subsidiaries could be subject to legal and contractual restrictions on dividends. In addition, payments to us by our subsidiaries will be contingent upon our subsidiaries’ earnings. Additionally, we may be limited in our ability to cause any future joint ventures to distribute their earnings to us. Subject to certain qualifications, our subsidiaries are permitted under the terms of our indebtedness to incur additional indebtedness that may restrict payments from those subsidiaries to us. There can be no assurance that agreements governing the current and future indebtedness of our subsidiaries will permit those subsidiaries to provide us with sufficient cash to fund payments of principal, premiums, if any, and interest on our indebtedness when due. In the event that we do not receive distributions or other payments from our subsidiaries, we may be unable to make required payments on our debt.
Despite our level of indebtedness, we and our subsidiaries may still incur substantially more debt. This could further exacerbate the risks to our financial condition described above.
We and our subsidiaries may incur significant additional indebtedness in the future. Although the indentures governing the Notes and the credit agreements governing our Senior Secured Credit Facilities contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions, and the additional indebtedness incurred in compliance with these restrictions could be substantial. As of July 29, 2017, our Asset-Based Revolving Credit Facility and our mytheresa.com credit facilities (the "mytheresa.com Credit Facilities") provide for borrowings of unused commitments of up to $651.1 million, subject to a borrowing base, of which (i) $90.0 million of such capacity is available to us subject to certain restrictions as more fully described in Note 8 of the Notes to Consolidated Financial Statements in Item 15 and (ii) $17.1 million of such capacity is available only to MyTheresa under its credit facilities
and not to our U.S. operations. Additionally, (i) our Senior Secured Term Loan Facility may be increased by an amount equal to (x) $650.0 million plus (y) an unlimited amount so long as, in the case of new indebtedness secured on a pari passu basis with our Senior Secured Term Loan Facility, on a pro forma basis our maximum senior secured first lien net leverage ratio, as defined in the credit agreement governing the Senior Secured Term Loan Facility, does not exceed 4.25 to 1.00, and in the case of new indebtedness secured on a junior basis to our Senior Secured Term Loan Facility, subordinated in right of payment to our Senior Secured Term Loan Facility or, in the case of certain incremental equivalent loan debt, unsecured and pari passu in right of payment with our Senior Secured Term Loan Facility, on a pro forma basis our maximum total net leverage ratio, as defined in the credit agreement governing the Senior Secured Term Loan Facility, does not exceed 7.00 to 1.00, in each case subject to certain conditions, and (ii) our Asset-Based Revolving Credit Facility can be increased by up to $200.0 million. If new debt is added to our current debt levels, the related risks that we and the guarantors now face would increase. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
The amount of borrowings permitted under our Asset-Based Revolving Credit Facility may fluctuate significantly, which may adversely affect our liquidity, results of operations and financial position.
The amount of borrowings permitted at any time under our Asset-Based Revolving Credit Facility is limited to a periodic borrowing base valuation of our accounts receivable and domestic inventory. As a result, our access to credit under our Asset-Based Revolving Credit Facility is potentially subject to significant fluctuations depending on the value of the borrowing base eligible assets as of any measurement date, as well as certain discretionary rights of the administrative agent of our Asset-Based Revolving Credit Facility in respect of the calculation of such borrowing base value. Our inability to borrow under or the early termination of our Asset-Based Revolving Credit Facility may adversely affect our liquidity, results of operations and financial position.
We have elected in the past, and may elect in the future, to pay interest on the PIK Toggle Notes in the form of PIK Interest or partial PIK Interest rather than in the form of Cash Interest, which would increase the aggregate principal amount of our outstanding indebtedness.
The indenture governing the PIK Toggle Notes allows us to elect to pay either 50% or all of the interest due on the PIK Toggle Notes for such period in PIK Interest (as defined below) by either increasing the principal amount of the outstanding PIK Toggle Notes or by issuing new PIK Toggle Notes for the entire amount of the interest payment, thereby increasing the aggregate principal amount of the PIK Toggle Notes. For the interest period commencing on April 15, 2017 and continuing through October 14, 2017, we elected to pay interest in the form of PIK Interest at a higher rate of 9.50% rather than making such interest payment in cash, which will result in the issuance of $28.5 million of additional PIK Toggle Notes in October 2017. We intend to elect to pay interest in the form of PIK Interest or partial PIK Interest on our semi-annual interest payment due in April 2018 and may additionally elect to do so with respect to the payment due in October 2018. If we elect PIK Interest or partial PIK Interest with respect to these interest payments, we would accrue interest at a higher rate than the cash-pay portion of the PIK Toggle Notes, which would increase the aggregate principal amount of the outstanding PIK Toggle Notes, which in turn would further increase our substantial indebtedness. See “-Our substantial indebtedness could adversely affect our business, financial condition and results of operations and our ability to fulfill our obligations with respect to such indebtedness,” and see Note 8 of the Notes to Consolidated Financial Statements in Item 15 for a further description of the terms of the PIK Toggle Notes.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Borrowings under our Senior Secured Credit Facilities are at variable rates of interest and expose us to interest rate risk. We have hedged a portion of our variable rate debt obligations against interest rate fluctuations by using standard hedging instruments, but we are not required to do so and may not continue to do so in the future. Interest rates are currently at historically low levels. If interest rates increase and we are unable to effectively hedge our interest rate risk, our debt service obligations on the variable rate indebtedness will increase even though the amount borrowed may remain the same, and our net earnings and cash flows, including cash available for servicing our indebtedness, will correspondingly decrease. Assuming all revolving loans are fully drawn (and to the extent that LIBOR is in excess of the 1.00% floor rate with respect to our Senior Secured Term Loan Facility), each quarter point change in interest rates would result in a $5.8 million change in annual interest expense on the indebtedness under our Senior Secured Credit Facilities, taking into account the effect of existing interest rate hedging arrangements. To reduce interest rate volatility, we have entered into interest rate swaps that involve the exchange of floating for fixed rate interest payments on a portion of our floating rate indebtedness from December 2016 through October 2020. However, we are exposed to interest rate risk for the portion of our variable rate indebtedness not covered by those swap agreements. Additionally, such hedging arrangements may not fully mitigate our interest rate risk and may subject us to mark-to-market losses when they are adjusted to reflect changes in fair value from time to time in accordance with accounting rules.
We are controlled by the Sponsors, whose interests as equity holders may conflict with those of the lenders under our Senior Secured Credit Facilities and the holders of the Notes.
We are controlled by the Sponsors. The Sponsors control the election of a majority of our directors and thereby have the power to control our affairs and policies, including the appointment of management, the issuance of additional stock and the declaration and payment of dividends. The Sponsors do not have any liability for any obligations under our indebtedness and their interests may be in conflict with those of the lenders under our Senior Secured Credit Facilities and the holders of the Notes. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the Sponsors may pursue strategies that favor equity investors over debt investors. Our equity holders may have an interest in pursuing acquisitions, divestitures, financing or other transactions that, in their judgment, could enhance the value of their equity investments, even though such transactions may involve risk to holders of our debt. Additionally, the Sponsors may make investments in businesses that directly or indirectly compete with us, or may pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our main corporate headquarters are located at the Neiman Marcus store location in downtown Dallas, Texas. Other operating headquarters are located in another location in Dallas, Texas, New York, New York and Munich, Germany.
Properties that we use in our operations include Neiman Marcus stores, Bergdorf Goodman stores, Last Call stores, and distribution, support and office facilities. As of October 3, 2017, the approximate aggregate square footage of the properties used in our operations was as follows:
Neiman Marcus Stores. As of October 3, 2017, we operated 42 Neiman Marcus stores, with an aggregate total property size of approximately 5,596,000 square feet. The following table sets forth certain details regarding each Neiman Marcus store:
(1) Owned subject to partial ground lease.
(2) Leased.
(3) Owned buildings on leased land.
(4) Owned.
* Mortgaged to secure our Senior Secured Credit Facilities and the 2028 Debentures.
Bergdorf Goodman Stores. We operate two Bergdorf Goodman stores, both of which are located in Manhattan at 58th Street and Fifth Avenue. The following table sets forth certain details regarding these stores:
(1) Leased.
Last Call Stores. As of October 3, 2017, we operated 38 Last Call stores in 14 states that average approximately 24,000 square feet each in size. During fiscal year 2017, we began a process to assess our Last Call footprint and closed four of our Last Call stores. On September 12, 2017, we announced that we will be closing ten additional Last Call stores in fiscal year 2018 in order to optimize our Last Call store portfolio. We will continue to evaluate our off-price business and seek to optimize the operations of Last Call in the future.
Distribution, Support and Office Facilities. We own approximately 41 acres of land in Longview, Texas, where our primary distribution facility is located. The 612,000 square foot Longview facility is the principal merchandise processing and distribution facility for Neiman Marcus stores. In fiscal year 2013, we opened a 198,000 square foot distribution facility in Pittston, Pennsylvania to support the future growth and initiatives of the Company. We lease three regional service centers in New York, Florida and California.
We also own approximately 50 acres of land in Irving, Texas, where our online operating headquarters and distribution facility are located. In addition, we currently lease another regional distribution facility in Dallas, Texas to support our online operations. We also lease a 182,000 square foot facility outside of Munich, Germany to support our MyTheresa operations.
Lease Terms. We lease a significant percentage of our stores and, in certain cases, the land upon which our stores are located. The terms of these leases, assuming all outstanding renewal options are exercised, range from ten to 130 years. The lease on the Bergdorf Goodman Main Store expires in 2050, with no renewal options, and the lease on the Bergdorf Goodman Men’s Store expires in 2020, with a ten-year renewal option. Most leases provide for fixed monthly rentals or contingent rentals based upon revenues in excess of stated amounts and normally require us to pay real estate taxes, insurance, common area maintenance costs and other occupancy costs.
For further information on our properties and lease obligations, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 12 of the Notes to Consolidated Financial Statements in Item 15.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Information for this item is included in Note 12 of the Notes to Consolidated Financial Statements in Item 15, and incorporated herein by reference.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Subsequent to the Acquisition and the Conversion, our membership unit is privately held and there is no established public trading market for such unit.
Dividends
We do not currently intend to pay any dividends, distributions or other similar payments on our membership unit in the foreseeable future. Instead, we currently intend to use all of our earnings for the operation and growth of our business and the repayment of indebtedness.
We did not declare or pay any dividends, distributions or other amounts on our membership unit in fiscal year 2017 or 2016.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is qualified in entirety by our Consolidated Financial Statements and the related notes thereto contained in Item 15 and should be read in conjunction with "Business" in Item 1, "Risk Factors" in Item 1A and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and related notes contained in Item 15. Unless otherwise specified, the meanings of all defined terms in Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") are consistent with the meanings of such terms as defined in the Notes to Consolidated Financial Statements in Item 15. This discussion contains forward-looking statements. Please see “Special Note Regarding Forward-Looking Statements” for a discussion of the risks, uncertainties and assumptions relating to our forward-looking statements.
Overview
Neiman Marcus Group LTD LLC (the "Company") is a luxury omni-channel retailer conducting store and online operations principally under the Neiman Marcus, Bergdorf Goodman, Last Call and MyTheresa brand names. References to “we,” “our” and “us” are used to refer to the Company or collectively to the Company and its subsidiaries, as appropriate to the context. The Company is a subsidiary of Mariposa Intermediate Holdings LLC ("Holdings"), which in turn is a subsidiary of Neiman Marcus Group, Inc., a Delaware corporation ("Parent"). Parent is owned by entities affiliated with Ares Management, L.P. and Canada Pension Plan Investment Board (together, the "Sponsors") and certain co-investors. The Company's operations are conducted through its direct wholly owned subsidiary, The Neiman Marcus Group LLC ("NMG"). The Sponsors acquired the Company on October 25, 2013 (the "Acquisition"). Prior to the Acquisition, we were owned by Newton Holding, LLC, which was controlled by investment funds affiliated with TPG Global, LLC (collectively with its affiliates, "TPG") and Warburg Pincus LLC (together with TPG, the "Former Sponsors").
We conduct our specialty retail store and online operations on an omni-channel basis. As our store and online operations have similar economic characteristics, products, services and customers, our operations constitute a single omni-channel reportable segment.
Our fiscal year ends on the Saturday closest to July 31. Like many other retailers, we follow a 4-5-4 reporting calendar, which means that each fiscal quarter consists of thirteen weeks divided into periods of four weeks, five weeks and four weeks. All references to (i) fiscal year 2017 relate to the fifty-two weeks ended July 29, 2017, (ii) fiscal year 2016 relate to the fifty-two weeks ended July 30, 2016 and (iii) fiscal year 2015 relate to the fifty-two weeks ended August 1, 2015. References to fiscal year 2014 and years preceding and fiscal year 2018 and years thereafter relate to our fiscal years for such periods.
Certain financial information of the Company and its subsidiaries is presented on a consolidated basis and is presented as "Predecessor" or "Successor" to indicate whether it relates to the period preceding the Acquisition or the period succeeding the Acquisition, respectively. The Acquisition and the allocation of the purchase price were recorded for accounting purposes as of November 2, 2013, the end of our first quarter of fiscal year 2014.
In connection with the Acquisition, the Company incurred substantial new indebtedness, in part in replacement of former indebtedness. See “Liquidity and Capital Resources.” In addition, the purchase price paid in connection with the Acquisition was allocated to state the acquired assets and liabilities at fair value. The purchase accounting adjustments increased the carrying value of our property and equipment and inventory, revalued our intangible assets related to our tradenames, customer lists and favorable lease commitments and revalued our long-term benefit plan obligations, among other things. As a result, the Successor financial information subsequent to the Acquisition is not necessarily comparable to the Predecessor financial information.
Certain amounts presented in tables are subject to rounding adjustments and, as a result, the totals in such tables may not sum.
Investments and Strategic Initiatives
We are investing in strategies to grow our revenues and profits. Strategies we have pursued and continue to pursue include:
•
We are investing in technology to enhance the customer shopping experiences in both our online and store operations, including the launch of NMG One in fiscal year 2017. NMG One is an integrated merchandising and distribution system designed to enable us to purchase, share, manage and sell our inventories across our omni-channel operations and brands more efficiently;
•
We are making capital investments to remodel our existing stores as well as to open new stores in select markets such as Garden City, New York (opened in February 2016), Fort Worth, Texas (opened in February 2017) and New York City (currently scheduled to open in fiscal year 2019);
•
We are re-engineering our costs to optimize our resources and organizational processes through a comprehensive review project we refer to as "Organizing for Growth". In connection with Organizing for Growth, we eliminated approximately 315 positions in fiscal year 2017 and approximately 500 positions in fiscal year 2016 across our stores, divisions and facilities; and
•
We have expanded our international footprint by acquiring MyTheresa in October 2014.
These issues also affected our financial reporting processes and required us to apply supplemental and manual controls to provide adequate control over financial reporting. See Item 9A. "Controls and Procedures - Changes in Internal Control over Financial Reporting."
Summary of Results of Operations
A summary of our results of operations is as follows:
•
Revenues - Our revenues for fiscal year 2017 were $4,706.0 million, a decrease of 4.9% from $4,949.5 million in fiscal year 2016. Comparable revenues for fiscal year 2017 decreased 5.2% compared to fiscal year 2016. In fiscal year 2017, revenues generated by our online operations were $1,471.7 million, or 31.3% of consolidated revenues. Comparable revenues from our online operations in fiscal year 2017 increased 2.5% from fiscal year 2016.
Changes in comparable revenues by quarter in fiscal year 2017 were:
We believe the lower levels of revenues in fiscal year 2017 were impacted by a number of factors, including:
•
the volatility and uncertainty in domestic and global economic conditions and the resulting impact on the market for luxury merchandise;
•
the strength of the U.S. dollar against international currencies, most notably the Euro and British pound, and a resulting impact on tourism and spending by international customers in the U.S.;
•
a significant and sustained decline in the global price for crude oil and the resulting impact on stakeholders in the oil and gas industries, particularly in the Texas markets in which we have a significant presence; and
•
implementation and conversion issues related to NMG One, which prevented us from fulfilling certain customer demand both in our stores and websites.
•
Cost of Goods Sold Including Buying and Occupancy Costs (Excluding Depreciation) ("COGS") - Compared to fiscal year 2016, COGS as a percentage of revenues increased 130 basis points in fiscal year 2017. The increase in COGS, as a percentage of revenues, was primarily attributable to:
•
decreased product margins due primarily to:
•
higher markdowns and promotional costs incurred on lower than expected revenues; and
•
higher delivery and processing costs; and
•
the deleveraging of buying and occupancy costs.
At July 29, 2017, consolidated inventories totaled $1,153.7 million, a 2.5% increase from July 30, 2016. Merchandise inventories supporting our U.S. operations increased 0.4% and merchandise inventories supporting
our MyTheresa operations increased 38.1% from the prior fiscal year. We have and will continue to work aggressively to align our inventory levels and purchases with anticipated future customer demand.
•
Selling, General and Administrative Expenses (Excluding Depreciation) ("SG&A") - Compared to fiscal year 2016, SG&A as a percentage of revenues increased 140 basis points in fiscal year 2017. The higher levels of SG&A expenses, as a percentage of revenues, were primarily attributable to:
•
the deleveraging of a significant portion of our SG&A expenses, primarily payroll and benefits;
•
higher levels of expenses and other costs incurred in connection with:
•
(i) investments in technology, (ii) the growth of our international footprint through MyTheresa and (iii) costs related to the opening of new stores and the remodeling of existing stores; and
•
certain corporate expenses, primarily professional fees;
•
lower favorable non-cash adjustments to the required liability for stock option awards requiring variable accounting; and
•
higher credit card chargebacks and other fees.
•
Impairment Charges - Based upon (i) the continuation of adverse economic and business trends, (ii) revisions to our anticipated future operating results and (iii) increases in the weighted average cost of capital used in estimating the fair value of our tradenames and our reporting units under a discounted cash flow model, we determined certain of our tradenames, goodwill, and long-lived assets to be impaired and recorded impairment charges aggregating $510.7 million in fiscal year 2017 and $466.2 million in fiscal year 2016.
Liquidity - At July 29, 2017, we had outstanding revolving credit facilities aggregating $917.1 million consisting of (i) our Asset-Based Revolving Credit Facility of $900.0 million in the U.S. and (ii) the mytheresa.com Credit Facilities of $17.1 million, or €15.0 million. Pursuant to these credit facilities, we had outstanding borrowings of $263.0 million, all of which represents borrowings under our Asset-Based Revolving Credit Facility, and outstanding letters of credit and guarantees of $3.0 million as of July 29, 2017. Our borrowings under these credit facilities fluctuate based on our seasonal working capital requirements, which generally peak in our first and third quarters. At July 29, 2017, we had unused borrowing commitments aggregating $651.1 million, subject to a borrowing base, of which (i) $90.0 million of such capacity is available to us subject to certain restrictions as more fully described in Note 8 of the Notes to Consolidated Financial Statements in Item 15 and (ii) $17.1 million of such capacity is available only to MyTheresa and not to our U.S. operations. Additionally, we held cash and cash equivalents and credit card receivables of $88.1 million bringing our available liquidity to $739.2 million at July 29, 2017, inclusive of the amount available to MyTheresa. We believe that cash generated from our operations along with our existing cash balances and available sources of financing will enable us to meet our anticipated cash obligations during the next 12 months.
Outlook - Economic conditions in the luxury retail industry have been and will continue to be impacted by a number of factors, including the rate of economic growth, the volatility and uncertainty in domestic and global economic and political conditions, fluctuations in the exchange rate of the U.S. dollar against international currencies, most notably the Euro and British pound, fluctuations in crude oil and fuel prices, uncertainty regarding governmental spending and tax policies and overall consumer confidence. We believe such factors negatively impacted our operations in fiscal years 2017 and 2016 and may continue to have an adverse impact on our future results of operations. As a result, we intend to operate our business and manage our cash requirements in a way that balances these economic conditions and current business trends with our long-term initiatives and growth strategies.
Results of Operations
Performance Summary
The following table sets forth certain items expressed as percentages of revenues for the periods indicated:
Set forth in the following table is certain summary information with respect to our operations for the periods indicated:
(1)
Comparable revenues include (i) revenues derived from our retail stores open for more than fifty-two weeks, including stores that have been relocated or expanded, and (ii) revenues from our online operations. Comparable revenues exclude revenues of (i) closed stores and (ii) designer websites created and operated pursuant to contractual arrangements with certain designer brands that had expired by the first quarter of fiscal year 2015. As MyTheresa was acquired in October 2014, comparable revenues for fiscal year 2015 exclude revenues from MyTheresa.
Comparable revenues for fiscal year 2016 include revenues from MyTheresa beginning in the second quarter of fiscal year 2016.
(2)
Sales per square foot are calculated as revenues of our Neiman Marcus and Bergdorf Goodman full-line stores for the applicable period divided by weighted average square footage. Weighted average square footage includes a percentage of period-end square footage for new and closed stores equal to the percentage of the period during which they were open.
(3)
Amounts represent gross capital expenditures and exclude developer contributions of $37.4 million, $38.3 million and $34.7 million, respectively, for the periods presented.
(4)
For an explanation of EBITDA and Adjusted EBITDA as measures of our operating performance and a reconciliation to net earnings (loss), see “-Non-GAAP Financial Measures.”
Key Factors Affecting Our Results
Revenues. We generate our revenues from the sale of luxury merchandise. Components of our revenues include:
•
Sales of merchandise - Revenues are recognized at the later of the point-of-sale or the delivery of goods to the customer. Revenues are reduced when our customers return goods previously purchased. We maintain reserves for anticipated sales returns based primarily on our historical trends. Revenues exclude sales taxes collected from our customers.
•
Delivery and processing - We generate revenues from delivery and processing charges related to certain merchandise deliveries to our customers.
Our revenues can be affected by the following factors:
•
general domestic and global economic and industry conditions, including inflation, deflation, changes related to interest rates and foreign currency exchange rates, rates of economic growth, current and expected unemployment levels and government fiscal and monetary policies;
•
the performance of the financial, equity and credit markets;
•
our ability to anticipate, identify and respond effectively to changing consumer demands, fashion trends and consumer shopping preferences and acquire goods meeting customers’ tastes and preferences;
•
consumer disposable income levels, consumer confidence levels, the availability, cost and level of consumer debt and consumer behaviors towards incurring and paying debt;
•
national and global geo-political uncertainty;
•
changes in the level of consumer spending generally and, specifically, on luxury goods;
•
the strength of the U.S. dollar against international currencies, most notably the Euro and British pound, and a resulting impact on tourism and spending by international customers in the U.S.;
•
a significant and sustained decline in the global price for crude oil and the resulting impact on stakeholders in the oil and gas industries, particularly in the Texas markets in which we have a significant presence;
•
changes in prices for commodities and energy, including fuel;
•
current and expected tax rates and policies;
•
a material disruption in our information systems, or delays or difficulties in implementing or integrating new systems or enhancing or expanding current systems, or our failure to achieve the anticipated benefits of any new or updated information systems;
•
changes in the level of full-price sales;
•
changes in the level and timing of promotional events conducted;
•
changes in the level of delivery and processing revenues collected from our customers; and
•
changes in the composition and the rate of growth of our sales transacted in store and online.
In addition, our revenues are seasonal, as discussed below under “Seasonality.”
Cost of Goods Sold Including Buying and Occupancy Costs (Excluding Depreciation). COGS consists of the following components:
•
Inventory costs - We utilize the retail inventory method of accounting. Under the retail inventory method, the valuation of inventories at cost and the resulting gross margins are determined by applying a calculated cost-to-retail ratio, for various groupings of similar items, to the retail value of our inventories. The cost of the inventory reflected in the Consolidated Financial Statements is decreased by charges to cost of goods sold at average cost and the retail value of the inventory is lowered through the use of markdowns. Earnings are negatively impacted when merchandise is marked down. With the introduction of new fashions in the first and third fiscal quarters of each fiscal year and our emphasis on full-price selling in these quarters, a lower level of markdowns and higher margins are characteristic of these quarters.
Inventory costs are also decreased by charges to cost of goods sold for estimates of shrinkage that has occurred between physical count dates.
•
Buying costs - Buying costs consist primarily of salaries and expenses incurred by our merchandising and buying operations.
•
Occupancy costs - Occupancy costs consist primarily of rent, property taxes and operating costs of our retail, distribution and support facilities. A significant portion of our buying and occupancy costs are fixed in nature and are not dependent on the revenues we generate.
•
Delivery and processing costs - Delivery and processing costs consist primarily of delivery charges we pay to third party carriers and other costs related to the fulfillment of customer orders not delivered at the point-of-sale.
Consistent with industry business practice, we receive allowances from certain of our vendors in support of the merchandise we purchase for resale. Certain allowances are received to reimburse us for markdowns taken or to support the gross margins that we earn in connection with the sales of the vendor’s merchandise. These allowances result in an increase to gross margin when we earn the allowances and they are approved by the vendor. Other allowances we receive represent reductions to the amounts we pay to acquire the merchandise. These allowances reduce the cost of the acquired merchandise and are recognized at the time the goods are sold. We received vendor allowances of $83.6 million, or 1.8% of revenues, in fiscal year 2017, $100.8 million, or 2.0% of revenues, in fiscal year 2016 and $94.8 million, or 1.9% of revenues, in fiscal year 2015. The amounts of vendor allowances we receive fluctuate based partially on the level of markdowns taken and did not have a significant impact on the year-over-year change in gross margin during fiscal years 2017, 2016 or 2015.
Changes in our COGS as a percentage of revenues can be affected by the following factors:
•
our ability to order an appropriate amount of merchandise to match customer demand and the related impact on the level of net markdowns and promotions costs incurred;
•
customer acceptance of and demand for the merchandise we offer in a given season and the related impact of such factors on the level of full-price sales;
•
factors affecting revenues generally, including pricing and promotional strategies, product offerings and actions taken by competitors;
•
changes in delivery and processing costs and our ability to pass such costs on to our customers;
•
changes in occupancy costs associated primarily with the opening of new stores or distribution facilities; and
•
the amount of vendor reimbursements we receive during the reporting period.
Selling, General and Administrative Expenses (Excluding Depreciation). SG&A consists principally of costs related to employee compensation and benefits in the selling and administrative support areas and advertising and marketing costs. A significant portion of our SG&A expenses is variable in nature and is dependent on the revenues we generate.
Advertising costs consist primarily of (i) online marketing costs, (ii) advertising costs incurred related to the production of the photographic content for our websites and (iii) costs incurred related to the production, printing and distribution of our print catalogs and other promotional materials mailed to our customers. Net marketing and advertising expenses were $183.0 million, or 3.9% of revenues, in fiscal year 2017, $178.9 million, or 3.6% of revenues, in fiscal year 2016 and $165.7 million, or 3.3% of revenues, in fiscal year 2015. The increase in net marketing and advertising expenses as
a percentage of revenue of approximately 30 basis points in fiscal year 2017 from the prior year consisted of (i) approximately 10 basis points in support of our U.S. operations and (ii) approximately 20 basis points related to the expansion of our international footprint through MyTheresa.
We receive advertising allowances from certain of our merchandise vendors. Substantially all the advertising allowances we receive represent reimbursements of direct, specific and incremental costs that we incur to promote the vendor’s merchandise in connection with our various advertising programs, primarily catalogs and other print media and digital media. Advertising allowances fluctuate based on the level of advertising expenses incurred and are recorded as a reduction of our advertising costs when earned. Advertising allowances were approximately $50.1 million, or 1.1% of revenues, in fiscal year 2017, $54.8 million, or 1.1% of revenues, in fiscal year 2016 and $55.0 million, or 1.1% of revenues, in fiscal year 2015.
We also receive allowances from certain merchandise vendors in connection with compensation programs for employees who sell the vendor’s merchandise. These allowances are netted against the related compensation expenses that we incur. Amounts received from vendors related to compensation programs were $62.4 million, or 1.3% of revenues, in fiscal year 2017, $70.3 million, or 1.4% of revenues, in fiscal year 2016 and $76.4 million, or 1.5% of revenues, in fiscal year 2015.
Changes in our SG&A expenses are affected primarily by the following factors:
•
changes in the level of our revenues;
•
changes in the number of sales associates, which are due primarily to new store openings and expansion of existing stores, and the health care and related benefits expenses incurred as a result of such changes;
•
changes in expenses incurred in connection with our advertising and marketing programs; and
•
changes in expenses related to employee benefits due to general economic conditions such as rising health care costs.
Income From Credit Card Program. We maintain a proprietary credit card program through which credit is extended to customers and have a related marketing and servicing alliance with affiliates of Capital One. Pursuant to the Program Agreement, Capital One currently offers credit cards and non-card payment plans under both the "Neiman Marcus" and "Bergdorf Goodman" brand names.
We receive payments from Capital One based on sales transacted on our proprietary credit cards. We recognize income from our credit card program when earned. In the future, the income from our credit card program may:
•
increase or decrease based upon the level of utilization of our proprietary credit cards by our customers;
•
increase or decrease based upon the overall profitability and performance of the credit card portfolio due to the level of bad debts incurred or changes in interest rates, among other factors;
•
increase or decrease based upon future changes to our credit card program in response to changes in regulatory requirements or other changes related to, among other things, the interest rates applied to unpaid balances and the assessment of late fees; and
•
decrease based upon the level of future marketing and other services we provide to Capital One.
Additionally, beginning in July 2017, in accordance with the provisions of the credit card program agreement, our allocable share of the profits generated by the credit card portfolio was reduced as a result of our current credit ratings by S&P and Moody's.
Impairment of Indefinite-lived Intangible Assets, Goodwill and Long-lived Assets. We assess the recoverability of the carrying values of indefinite-lived intangible assets and goodwill as well as our store assets, consisting of property and equipment, customer lists and favorable lease commitments, annually in the fourth quarter of each fiscal year and upon the occurrence of certain events. These impairment assessments related to tradenames and goodwill are performed for three of our reporting units - Neiman Marcus, Bergdorf Goodman and MyTheresa.
Since fiscal year 2016, we have experienced declines in our operating results and we believe our operating results have been adversely impacted by a number of factors including, among other things:
•
the volatility and uncertainty in domestic and global economic conditions and the resulting impact on the market for luxury merchandise;
•
the strength of the U.S. dollar against international currencies, most notably the Euro and British pound, and a resulting impact on tourism and spending by international customers in the U.S.; and
•
a significant and sustained decline in the global price for crude oil and the resulting impact on stakeholders in the oil and gas industries, particularly in the Texas markets in which we have a significant presence.
Based upon our assessment of economic conditions, our expectations of future business conditions and trends, our projected revenues, earnings, and cash flows as well as other market factors such as the weighted average cost of capital and valuation multiples, we determined that impairment charges were required to state certain of our intangible and long-lived assets to their estimated fair value.
We recorded impairment charges aggregating $466.2 million in fiscal year 2016. These impairment charges were driven primarily by revisions to our anticipated future operating trends in light of adverse economic and business trends existing as of the end of fiscal year 2016 and, to a lesser extent, increases in the weighted average cost of capital used in estimating the fair value of our tradenames and reporting units under a discounted cash flow method. These impairments related to certain of our tradenames, goodwill and long-lived assets primarily associated with our Neiman Marcus brand.
We recorded impairment charges aggregating $510.7 million in fiscal year 2017. These impairment charges were driven both by (i) changes in market conditions related to increases in the weighted average cost of capital and valuation multiples and (ii) further deterioration of operating trends during such periods. In fiscal year 2017, we recorded impairment charges of $153.8 million in the second quarter and $357.0 million in the fourth quarter. These impairment charges related to certain of our tradenames, goodwill and long-lived assets primarily associated with our Neiman Marcus and Bergdorf Goodman brands.
We continue to undertake initiatives to help drive revenues and streamline business activities and will continue to closely monitor our financial condition and results of operations. However, there is a risk that we may continue to experience challenging economic conditions and operating pressures, which in turn could increase the risk of additional impairment charges in future periods.
Effective Income Tax Rate. Our effective income tax rate may fluctuate from period to period due to a variety of factors, including changes in our assessment of certain tax contingencies, valuation allowances, changes in federal, state and foreign tax laws, outcomes of administrative audits, changes in our corporate structure, the impact of other discrete or non-recurring items and the mix of earnings among our U.S. and foreign operations, where the statutory rates are generally lower than in the United States. As a result, our effective income tax rate may vary significantly from the federal statutory tax rate.
Seasonality
We conduct our selling activities in two primary selling seasons-Fall and Spring. The Fall season is comprised of our first and second fiscal quarters and the Spring season is comprised of our third and fourth fiscal quarters.
Our first fiscal quarter is generally characterized by a higher level of full-price sales with a focus on the initial introduction of Fall season fashions. Marketing activities designed to stimulate customer purchases, a lower level of markdowns and higher margins are characteristic for this quarter. Our second fiscal quarter is more focused on promotional activities related to the December holiday season, the early introduction of resort season collections from certain designers and the sale of Fall season goods on a marked down basis. As a result, margins are typically lower in our second fiscal quarter. However, due to the seasonal increase in revenues that occurs during the holiday season, our second fiscal quarter is typically the quarter in which our revenues are the highest and in which expenses as a percentage of revenues are the lowest. Our working capital requirements are also the greatest in the first and second fiscal quarters as a result of higher seasonal requirements.
Our third fiscal quarter is generally characterized by a higher level of full-price sales with a focus on the initial introduction of Spring season fashions. Marketing activities designed to stimulate customer purchases, a lower level of markdowns and higher margins are again characteristic for this quarter. Revenues are generally the lowest in our fourth fiscal quarter with a focus on promotional activities offering Spring season goods to customers on a marked down basis, resulting in lower margins during the quarter. Our working capital requirements are typically lower in our third and fourth fiscal quarters compared to the other quarters.
A large percentage of our merchandise assortment, particularly in the apparel, fashion accessories and shoe categories, is ordered months in advance of the introduction of such goods. For example, women’s apparel, men’s apparel, shoes and handbags are typically ordered six to nine months in advance of the products being offered for sale while jewelry and other categories are typically ordered three to six months in advance. As a result, our success depends in large part on our ability to anticipate and identify fashion trends and consumer shopping preferences and to identify and react effectively to rapidly changing consumer demands in a timely manner.
We monitor the sales performance of our inventories throughout each season. We seek to order additional goods to supplement our original purchasing decisions when the level of customer demand is higher than originally anticipated. However, in certain merchandise categories, particularly fashion apparel, our ability to purchase additional goods can be limited. This can result in lost sales opportunities in the event of higher than anticipated demand for the merchandise we offer or a higher than anticipated level of consumer spending. Conversely, in the event we buy merchandise that is not accepted by our customers or the level of consumer spending is less than we anticipated, we could incur a higher than anticipated level of markdowns, net of vendor allowances, resulting in lower operating profits. Any failure on our part to anticipate, identify and respond effectively to these changes could adversely affect our business, financial condition and results of operations.
Results of Operations for the Fiscal Year Ended July 29, 2017 Compared to the Fiscal Year Ended July 30, 2016
Revenues. Our revenues for fiscal year 2017 of $4,706.0 million decreased by $243.5 million, or 4.9%, from $4,949.5 million in fiscal year 2016. Comparable revenues for fiscal year 2017 decreased 5.2% compared to fiscal year 2016.
Changes in comparable revenues by quarter were:
In fiscal year 2017, we generated negative comparable revenue increases. We believe the lower levels of revenues were impacted by a number of factors, including:
•
the volatility and uncertainty in domestic and global economic conditions and the resulting impact on the market for luxury merchandise;
•
the strength of the U.S. dollar against international currencies, most notably the Euro and British pound, and a resulting impact on tourism and spending by international customers in the U.S.;
•
a significant and sustained decline in the global price for crude oil and the resulting impact on stakeholders in the oil and gas industries, particularly in the Texas markets in which we have a significant presence; and
•
the implementation and conversion issues related to NMG One, which prevented us from fulfilling certain customer demand both in our stores and websites.
Revenues generated by our online operations in fiscal year 2017 were $1,471.7 million, or 31.3% of consolidated revenues. Comparable revenues from our online operations in fiscal year 2017 increased 2.5% from the prior fiscal year.
Cost of Goods Sold Including Buying and Occupancy Costs (Excluding Depreciation). COGS increased to 68.4% of revenues in fiscal year 2017 from 67.1% of revenues in fiscal year 2016. Compared to the prior year, COGS as a percentage of revenues increased by 130 basis points due primarily to:
•
decreased product margins of approximately 100 basis points due primarily to:
•
higher markdowns and promotional costs of approximately 70 basis points incurred on lower than expected revenues; and
•
higher delivery and processing costs of approximately 20 basis points; and
•
the deleveraging of buying and occupancy costs of approximately 30 basis points.
Selling, General and Administrative Expenses (Excluding Depreciation). SG&A expenses as a percentage of revenues increased to 24.0% in fiscal year 2017 compared to 22.6% of revenues in fiscal year 2016. Compared to the prior year, SG&A as a percentage of revenues increased 140 basis points due primarily to:
•
the deleveraging of a significant portion of our SG&A expenses, primarily payroll and benefits, of approximately 50 basis points on the lower level of revenues;
•
higher levels of expenses and other costs of approximately 45 basis points incurred in connection with:
•
(i) investments in technology, (ii) the growth of our international footprint through MyTheresa and (iii) costs related to the opening of new stores and the remodeling of existing stores; and
•
certain corporate expenses, primarily professional fees;
•
lower favorable non-cash adjustments to the required liability for stock option awards requiring variable accounting of approximately 20 basis points; and
•
higher credit card chargebacks and other fees of approximately 15 basis points.
Income from Credit Card Program. Income from our credit card program was $60.1 million, or 1.3% of revenues, in fiscal year 2017 compared to $60.6 million, or 1.2% of revenues, in fiscal year 2016.
Depreciation and Amortization Expenses. Depreciation expense was $225.5 million, or 4.8% of revenues, in fiscal year 2017 compared to $226.9 million, or 4.6% of revenues, in fiscal year 2016.
Amortization of intangible assets (primarily customer lists and favorable lease commitments) was $104.0 million, or 2.2% of revenues, in fiscal year 2017 compared to $111.2 million, or 2.2% of revenues, in fiscal year 2016.
Other Expenses. Other expenses in fiscal year 2017 aggregated $29.7 million, or 0.6% of revenues, compared to $27.1 million, or 0.5% of revenues, in fiscal year 2016. Other expenses consisted of the following components:
We incurred professional fees and other costs aggregating $21.3 million in fiscal year 2017 and $24.3 million in fiscal year 2016 in connection with Organizing for Growth, NMG One and the evaluation of potential strategic alternatives. In connection with Organizing for Growth, we eliminated approximately 315 positions in fiscal year 2017 and approximately 500 positions in fiscal year 2016 across our stores, divisions and facilities. We incurred severance costs of $7.2 million in fiscal year 2017 and $10.2 million in fiscal year 2016.
In October 2014, we acquired MyTheresa, a luxury retailer headquartered in Munich, Germany. Acquisition costs consisted primarily of professional fees as well as adjustments of our earn-out obligations to estimated fair value at each reporting date. The final earn-out obligation was paid in March 2017.
We discovered in January 2014 that malicious software was clandestinely installed on our computer systems. In fiscal years 2017 and 2016, we incurred legal and other expenses in connection with the Cyber-Attack.
In the third quarter of fiscal year 2016, we recorded a $5.6 million net gain related to the closure and relocation of our regional service center in New York.
Impairment Charges. In fiscal year 2017, we assessed the recoverability of the carrying values of our indefinite-lived intangible assets and goodwill as well as our store assets as a result of (i) increases in the weighted average cost of capital used in estimating the fair value of our tradenames and our reporting units under a discounted cash flow model, (ii) the continuation of adverse economic and business trends and (iii) revisions to our anticipated future operating results. We
recorded impairment charges of $510.7 million in fiscal year 2017 and $466.2 million in fiscal year 2016 to state certain of our intangible and long-lived assets, primarily related to our Neiman Marcus and Bergdorf Goodman brands, to their estimated fair value.
Operating Loss. We had operating losses of $453.2 million, or 9.6% of revenues, in fiscal year 2017 compared to operating losses of $261.7 million, or 5.3% of revenues, in fiscal year 2016. Included in operating loss in fiscal year 2017 were:
•
impairment charges of $510.7 million; and
•
other expenses of $29.7 million.
Included in operating loss in fiscal year 2016 were:
•
impairment charges of $466.2 million; and
•
other expenses of $27.1 million.
Interest Expense, net. Net interest expense was $295.7 million in fiscal year 2017 and $285.6 million in fiscal year 2016. The significant components of interest expense are as follows:
With respect to the PIK Toggle Notes, we elected to pay the October 2017 interest payment in the form of PIK Interest, which accrues at a rate of 9.50% per annum and will result in the issuance of $28.5 million of additional PIK Toggle Notes in October 2017.
Income Tax Benefit. Our effective income tax rate of 29.0% and 25.8% on the losses for fiscal years 2017 and 2016 were less than the federal statutory tax rate of 35%. No income tax benefits exist related to the goodwill impairment charges of $196.2 million recorded in fiscal year 2017 and $199.2 million recorded in fiscal year 2016. Excluding the impact of the goodwill impairment charges, our effective income tax rates were 39.3% for fiscal year 2017 and 40.6% for fiscal year 2016, which exceeded the federal statutory tax rate due primarily to state income taxes.
While our future effective income tax rate will depend on the factors described above, we currently anticipate that our effective income tax rate in future periods will be closer to our historical effective income tax rate of approximately 37.9% to 39.2%.
We file income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions. The Internal Revenue Service ("IRS") finalized its audits of our fiscal year 2012 and short-year 2013 (prior to the Acquisition) federal income tax returns. With respect to state, local and foreign jurisdictions, with limited exceptions, we are no longer subject to income tax audits for fiscal years before 2013. We believe our recorded tax liabilities as of July 29, 2017 are sufficient to cover any potential assessments made by the IRS or other taxing authorities and we will continue to review our recorded tax liabilities for potential audit assessments based upon subsequent events, new information and future circumstances. We believe it is reasonably possible that adjustments to the amounts of our unrecognized tax benefits could occur within the next 12 months as a result of settlements with tax authorities or expiration of statutes of limitations. At this time, we do not believe such adjustments will have a material impact on our Consolidated Financial Statements.
Results of Operations for the Fiscal Year Ended July 30, 2016 Compared to the Fiscal Year Ended August 1, 2015
Revenues. Our revenues for fiscal year 2016 of $4,949.5 million decreased by $145.6 million, or 2.9%, from $5,095.1 million in fiscal year 2015. Comparable revenues for fiscal year 2016 decreased 4.1% compared to fiscal year 2015.
Changes in comparable revenues by quarter were:
In fiscal year 2016, we generated negative comparable revenue increases. We believe these results were impacted by a number of factors, including:
•
the volatility and uncertainty in domestic and global economic conditions and the resulting impact on the market for luxury merchandise;
•
the strengthening of the U.S. dollar against international currencies, most notably the Euro and British pound, a resulting impact on tourism and spending by international customers in the U.S.; and
•
a significant decline in the global price for crude oil and the resulting impact on stakeholders in the oil and gas industries, particularly in the Texas markets in which we have a significant presence.
Revenues generated by our online operations in fiscal year 2016 were $1,436.1 million, or 29.0% of consolidated revenues. Comparable revenues from our online operations in fiscal year 2016, which included the revenues of MyTheresa beginning in the second quarter of fiscal year 2016, increased 4.4% from the prior year.
Cost of Goods Sold Including Buying and Occupancy Costs (Excluding Depreciation). COGS increased to 67.1% of revenues in fiscal year 2016 from 64.9% of revenues in fiscal year 2015. Compared to the prior year, COGS as a percentage of revenues increased by 220 basis points due primarily to:
•
decreased product margins of approximately 200 basis points due primarily to higher markdowns and promotional costs incurred on lower than expected revenues; and
•
the deleveraging of buying and occupancy costs of approximately 20 basis points.
Selling, General and Administrative Expenses (Excluding Depreciation). SG&A expenses as a percentage of revenues decreased to 22.6% in fiscal year 2016 compared to 22.8% of revenues in fiscal year 2015. This decrease is due primarily to:
•
payroll, incentive compensation and benefits expense savings realized of approximately 50 basis points in connection with Organizing for Growth and other efficiency initiatives; and
•
lower non-cash stock compensation expenses of approximately 20 basis points due to a reduction in the required liability for stock option awards requiring variable accounting; partially offset by
•
higher levels of expenses of approximately 30 basis points incurred in connection with our strategic initiatives, including costs related to the opening of new stores (our store in Garden City, New York opened in February 2016), the remodeling of existing stores, investments in technology and the growth of our international revenues through MyTheresa; and
•
higher selling costs of approximately 20 basis points due to higher marketing expenses, related primarily to our online operations, and higher levels of credit card chargebacks subsequent to regulatory changes effective October 2015 with respect to retailers' liabilities for such losses.
Income from Credit Card Program. Income from our credit card program was $60.6 million, or 1.2% of revenues, in fiscal year 2016 compared to $52.8 million, or 1.0% of revenues, in fiscal year 2015. Compared to the prior year, income from our credit card program as a percentage of revenues increased by 20 basis points due primarily to increases in both the overall profitability of the credit card portfolio and the portion of income contractually allocable to the Company.
Depreciation and Amortization Expenses. Depreciation expense was $226.9 million, or 4.6% of revenues, in fiscal year 2016 compared to $185.6 million, or 3.6% of revenues, in fiscal year 2015. The increase in depreciation expense in fiscal year 2016 compared to fiscal year 2015 was driven by a higher level of capital spending since the Acquisition related to new stores, store remodels and omni-channel initiatives.
Amortization of intangible assets (primarily customer lists and favorable lease commitments) was $111.2 million, or 2.2% of revenues, in fiscal year 2016 compared to $137.3 million, or 2.7% of revenues, in fiscal year 2015. Amortization expense as a percentage of revenues decreased by 50 basis points in fiscal year 2016 due primarily to lower amortization charges with respect to our customer lists. Our customer lists are amortized using accelerated methods which reflect the pattern in which we receive the economic benefit of the asset.
Other Expenses. Other expenses in fiscal year 2016 aggregated $27.1 million, or 0.5% of revenues, compared to $39.5 million, or 0.8% of revenues, in fiscal year 2015. Other expenses consisted of the following components:
We incurred professional fees and other costs aggregating $24.3 million in fiscal year 2016 in connection with our Organizing for Growth and NMG One strategic initiatives. In connection with Organizing for Growth, we eliminated approximately 500 positions across our stores, divisions and facilities on October 1, 2015 and incurred $10.2 million of severance costs.
In October 2014, we acquired MyTheresa, a luxury retailer headquartered in Munich, Germany. Acquisition costs consisted primarily of professional fees as well as adjustments of our earn-out obligations to estimated fair value at each reporting date.
We discovered in January 2014 that malicious software was clandestinely installed on our computer systems. In fiscal year 2016 and 2015, we incurred investigative, legal and other expenses in connection with the Cyber-Attack.
In the third quarter of fiscal year 2016, we recorded a $5.6 million net gain related to the closure and relocation of our regional service center in New York.
Impairment Charges. Based upon our assessment of economic conditions, our expectations of future business conditions and trends and our projected revenues, earnings and cash flows, we determined certain of our property and equipment, other definite-lived intangible assets, tradenames and goodwill to be impaired, primarily related to our Neiman Marcus brand, and recorded impairment charges in the fourth quarter of fiscal year 2016 aggregating $466.2 million.
Operating Earnings (Loss). We had operating losses of $261.7 million, or 5.3% of revenues, in fiscal year 2016 compared to operating earnings of $318.0 million, or 6.2% of revenues, in fiscal year 2015. Included in operating loss in fiscal year 2016 were:
•
impairment charges of $466.2 million; and
•
other expenses of $27.1 million.
Included in operating earnings in fiscal year 2015 were:
•
other expenses of $39.5 million; and
•
impact of purchase accounting adjustments that increased COGS by $6.8 million related to the step-up in the carrying value of the acquired MyTheresa inventories.
Interest Expense, net. Net interest expense was $285.6 million in fiscal year 2016 and $289.9 million in fiscal year 2015. The significant components of interest expense are as follows:
Income Tax Expense (Benefit). Our effective income tax rate of 25.8% on the loss for fiscal year 2016 was less than the federal statutory tax rate of 35%. No income tax benefit exists related to the $199.2 million goodwill impairment charge recorded in fiscal year 2016. Excluding the impact of the goodwill impairment charge, our effective income tax rate was 40.6% for fiscal year 2016, which exceed the federal statutory tax rate due primarily to state income taxes.
Our effective income tax rate of 46.8% on the earnings for fiscal year 2015 exceeded the federal statutory tax rate due primarily to:
•
state income taxes; and
•
the non-deductible portion of transaction and other costs incurred in connection with the MyTheresa acquisition.
Non-GAAP Financial Measures
To supplement our financial information presented in accordance with generally accepted accounting principles ("GAAP"), we use EBITDA and Adjusted EBITDA to monitor and evaluate the performance of our business and believe the presentation of these measures enhances investors’ ability to analyze trends in our business and evaluate our performance relative to other companies in our industry. We define (i) EBITDA as earnings before interest, taxes, depreciation and amortization and (ii) Adjusted EBITDA as earnings before interest, taxes, depreciation and amortization, further adjusted to eliminate the effects of items management does not believe are representative of our ongoing performance. These financial metrics are not presentations made in accordance with GAAP.
EBITDA and Adjusted EBITDA should not be considered as alternatives to operating earnings (loss) or net earnings (loss) as measures of operating performance. In addition, EBITDA and Adjusted EBITDA are not presented as and should not be considered as alternatives to cash flows as measures of liquidity. EBITDA and Adjusted EBITDA have important limitations as analytical tools and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP.
These limitations include the fact that:
•
EBITDA and Adjusted EBITDA:
•
exclude certain tax payments that may represent a reduction in cash available to us;
•in the case of Adjusted EBITDA, exclude certain adjustments for purchase accounting;
•
do not reflect changes in, or cash requirements for, our working capital needs, capital expenditures or contractual commitments;
•
do not reflect our significant interest expense; and
•
do not reflect the cash requirements necessary to service interest or principal payments on our debt.
•
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements; and
•
other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
In calculating these financial measures, we make certain adjustments that are based on assumptions and estimates that may prove inaccurate. In addition, in the future we may incur expenses similar to those eliminated in this presentation. The following table reconciles net earnings (loss) as reflected in our Consolidated Statements of Operations prepared in accordance with GAAP to EBITDA and Adjusted EBITDA:
(1)
In fiscal year 2017, we recorded pretax impairment charges related to (i) $309.7 million for the writedown to fair value of the net carrying value of tradenames, (ii) $196.2 million for the writedown to fair value of goodwill and (iii) $4.8 million for the writedown to fair value of the net carrying value of certain long-lived assets.
In fiscal year 2016, we recorded pretax impairment charges related to (i) $228.9 million for the writedown to fair value of the net carrying value of tradenames, (ii) $199.2 million for the writedown to fair value of goodwill and (iii) $38.1 million for the writedown to fair value of the net carrying value of certain long-lived assets.
(2)
The carrying values of inventories acquired in connection with the Acquisition and the acquisition of MyTheresa were stepped up to estimated fair value as of the respective acquisition dates and amortized into cost of goods sold as the acquired inventories were sold.
(3)
Rental obligations and deferred real estate credits were revalued at fair value in connection with the Acquisition. These fair value adjustments increase post-acquisition rent expense.
(4)
Amounts relate to costs and expenses incurred in connection with the Acquisition and the acquisition of MyTheresa and are not expected to recur subsequent to fiscal year 2017.
(5)
Non-cash stock-based compensation includes a $4.7 million adjustment recorded in fiscal year 2017 and a $14.3 million adjustment recorded in fiscal year 2016 to reduce our liability awards to estimated fair value.
(6)
Amounts represent direct and incremental expenses incurred in connection with the openings of new stores as well as remodels to our existing stores.
(7)
Amounts represent direct expenses incurred in connection with strategic initiatives, primarily NMG One and Organizing for Growth.
(8)
For a further description of the Cyber-Attack, see Item 1A, “Risk Factors-Risks Related to Our Business and Industry-A breach in information privacy could negatively impact our operations” and Note 12 of the Notes to Consolidated Financial Statements.
(9)
Amount represents a net gain related to the closure and relocation of our regional service center in New York.
(10)
Amounts relate to our equity in losses and professional fees incurred in connection with our prior non-controlling investment in an Asian e-commerce retailer.
(11)
Amounts represent management fees paid to the Former Sponsors prior to the Acquisition.
(12)
Excluded from the adjustments to calculate Adjusted EBITDA are the estimated impacts from the launch of our new NMG One integrated merchandising and distribution system in the first quarter of fiscal year 2017. We experienced issues with respect to the functionality and capabilities of certain portions of the new system. These issues primarily related to the processing of inventory receipts at our distribution centers, the timely payment of certain merchandise receipts, the transfer of inventories to our stores and the presentation of inventories on our websites. These issues prevented us from fulfilling certain customer demand in both our stores and websites.
As a result of these implementation issues, we believe:
•
our revenues were adversely impacted;
•
incremental markdowns were incurred;
•
additional incremental costs, primarily for consulting services, were incurred; and
•
significant internal resources were allocated to address these issues.
Based on available data, we estimate that these issues resulted in unrealized revenues of approximately $55 to $65 million during fiscal year 2017. However, we believe the full impact of the NMG One implementation issues on our revenues is likely greater because there are a number of ways in which our business has been disrupted that we cannot directly track or measure.
Inflation and Deflation
We believe changes in revenues and net earnings that have resulted from inflation or deflation have not been material during the past three fiscal years. We have experienced certain inflationary effects in our cost base due to increases in selling, general and administrative expenses, particularly with regard to employee health care and other benefits. For more information regarding the effects of changes in foreign currency exchange rates, see Item 7A, "Quantitative and Qualitative Disclosures About Market Risk-Foreign Currency Risk."
Liquidity and Capital Resources
Our liquidity requirements consist principally of:
•
the funding of our merchandise purchases;
•
operating expense requirements;
•
debt service requirements;
•
capital expenditures for expansion and growth strategies, including new store construction, store remodels and upgrades of our management information systems;
•
income tax payments; and
•
obligations related to our defined benefit pension plan ("Pension Plan").
Our primary sources of short-term liquidity are comprised of cash and cash equivalents (including credit card receivables), availability under the Asset-Based Revolving Credit Facility and vendor payment terms. The amounts of cash and cash equivalents and borrowings under the Asset-Based Revolving Credit Facility are influenced by a number of factors, including revenues, working capital levels, vendor terms, the level of capital expenditures, cash requirements related to financing instruments and debt service obligations, Pension Plan funding obligations and tax payment obligations, among others.
Our working capital requirements fluctuate during the fiscal year, increasing substantially during the first and third quarters of each fiscal year as a result of higher seasonal levels of inventories. We have typically financed our cash requirements with available cash and cash equivalents, cash flows from operations and, if necessary, with cash provided from borrowings under our revolving credit facilities. Pursuant to these credit facilities, we had outstanding borrowings of $263.0 million as of July 29, 2017, all of which represents borrowings under our Asset-Based Revolving Credit Facility, compared to $165.0 million as of July 30, 2016. At July 29, 2017, we had unused borrowing commitments of $651.1 million, subject to a borrowing base, of which (i) $90.0 million of such capacity is available to us subject to the maintenance of a minimum fixed charge coverage ratio and to further restrictions described below under "Financing Structure at July 29, 2017" and (ii) $17.1 million of such capacity is available only to MyTheresa under its credit facilities and not to our U.S. operations. Additionally, we held cash and cash equivalents and credit card receivables of $88.1 million bringing our available liquidity to $739.2 million at July 29, 2017, inclusive of the amount available to MyTheresa.
Under the Asset-Based Revolving Credit Facility, if "excess availability" falls below 10% of aggregate revolving commitments, we will be required to maintain a minimum fixed charge coverage ratio and we may be subject to further restrictions as discussed below under "Financing Structure at July 29, 2017".
We believe that cash generated from our operations, our existing cash and cash equivalents and available sources of financing will be sufficient to fund our cash requirements during the next 12 months, including merchandise purchases, operating expenses, anticipated capital expenditure requirements, debt service requirements, income tax payments and obligations related to our Pension Plan.
We regularly evaluate our liquidity profile, and various financing, refinancing and other alternatives for opportunities to enhance our capital structure and address maturities under our existing debt arrangements. If opportunities are available on favorable terms, we may seek to refinance, exchange, amend or extend the terms of our existing debt or issue or incur additional debt, and may engage with existing and prospective holders of our debt in connection with such matters. Although we are actively pursuing opportunities to improve our capital structure, some or all of the foregoing potential transactions or other alternatives may not be available to us or announced in the foreseeable future or at all.
Net cash provided by our operating activities was $147.0 million in fiscal year 2017 compared to $310.6 million fiscal year 2016. In fiscal year 2017, the decrease in net cash provided by operating activities was driven by (i) the decline in cash generated by our operating activities on a lower level of revenues and (ii) higher working capital requirements driven by higher inventories. Additionally, we made required fundings to our Pension Plan of $10.7 million in fiscal year 2017.
Net cash used for investing activities, primarily representing capital expenditures, was $204.6 million in fiscal year 2017 compared to $302.3 million in fiscal year 2016. The decrease in capital expenditures in fiscal year 2017 reflects lower spending for NMG One, the construction of new stores and the remodeling of existing stores.
Currently, we project capital expenditures for fiscal year 2018 to be approximately $208 to $218 million. Net of developer contributions, capital expenditures for fiscal year 2018 are projected to be approximately $155 to $165 million. We have managed and will continue to manage the level of capital spending in a manner designed to balance current economic conditions and business trends with our long-term initiatives and growth strategies.
Net cash provided by financing activities of $40.4 million in fiscal year 2017 was comprised primarily of (i) net borrowings of $98.0 million under our Asset-Based Revolving Credit Facility due to seasonal working capital requirements, partially offset by (ii) repayments of borrowings of $29.4 million under our Senior Secured Term Loan Facility, (iii) payment of $22.9 million for the MyTheresa contingent earn-out obligation for calendar year 2016 and (iv) $5.4 million for debt issuance costs. Net cash used for financing activities of $21.6 million in fiscal year 2016 was comprised primarily of (i) repayments of borrowings of $29.4 million under our Senior Secured Term Loan Facility and (ii) payment of $27.2 million for the MyTheresa contingent earn-out obligation for calendar year 2015, partially offset by (iii) net borrowings of $35.0 million under our Asset-Based Revolving Credit Facility due to seasonal working capital requirements.
Subject to applicable restrictions in our credit agreements and indentures, we or our affiliates, at any time and from time to time, may purchase, redeem or otherwise retire our outstanding debt securities or term loans, including through open market or privately negotiated transactions with third parties or pursuant to one or more tender or exchange offers or otherwise, upon such terms and at such prices, as well as with such consideration, as we, or any of our affiliates, may determine.
Financing Structure at July 29, 2017
Our major sources of funds are comprised of our revolving credit facilities aggregating $917.1 million, the $2,839.6 million Senior Secured Term Loan Facility, $960.0 million Cash Pay Notes, $600.0 million PIK Toggle Notes, $125.0 million 2028 Debentures (each as described in more detail below), vendor payment terms and operating leases.
Revolving Credit Facilities. Our revolving credit facilities consists of our Asset-Based Revolving Credit Facility, which supports our U.S. operations and the mytheresa.com Credit Facilities, which support the MyTheresa operations.
Asset-Based Revolving Credit Facility. At July 29, 2017, we have an Asset-Based Revolving Credit Facility with a maximum committed borrowing capacity of $900.0 million. The Asset-Based Revolving Credit Facility matures on July 25, 2021 (or July 25, 2020 if our obligations under our Senior Secured Term Loan Facility or any permitted refinancing thereof have not been repaid or the maturity date thereof has not been extended to October 25, 2021 or later). At July 29, 2017, we had outstanding borrowings of $263.0 million under this facility, outstanding letters of credit of $1.8 million and unused commitments of $635.3 million, subject to a borrowing base, of which $90.0 million of such capacity is available to us subject to certain restrictions as more fully described below.
Availability under the Asset-Based Revolving Credit Facility is subject to a borrowing base. The Asset-Based Revolving Credit Facility includes borrowing capacity available for letters of credit (up to $150.0 million, with any such issuance of letters of credit reducing the amount available under the Asset-Based Revolving Credit Facility on a dollar-for-dollar basis) and for borrowings on same-day notice. The borrowing base is equal to at any time the sum of (a) 90% of the net orderly liquidation value of eligible inventory, net of certain reserves, plus (b) 90% of the amounts owed by credit card processors in respect of eligible credit card accounts constituting proceeds from the sale or disposition of inventory, less certain reserves, plus (c) 100% of segregated cash held in a restricted deposit account.
Our excess availability could decrease as a result of, among other things, decreases in inventory or increases in outstanding debt (including letters of credit). Our failure to meet the Excess Availability Condition (as defined below) could limit our operational flexibility and growth. To the extent that excess availability is not equal to or greater than the greater of (a) 10% of the lesser of (1) the aggregate revolving commitments and (2) the borrowing base and (b) $50.0 million (the "Excess Availability Condition"), we will be required to maintain a minimum fixed charge coverage ratio. Additional restrictions will apply if the Excess Availability Condition is not met for five consecutive business days, including increased reporting requirements and additional administrative agent control rights over certain of our accounts. These restrictions will continue until the Excess Availability Condition is satisfied and their imposition may limit our operational flexibility. At July 29, 2017, these restrictions limited our borrowing capacity to $90.0 million of unused commitments under the Asset-Based Revolving Credit Facility.
The weighted average interest rate on the outstanding borrowings pursuant to the Asset-Based Revolving Credit Facility was 3.11% at July 29, 2017.
See Note 8 of the Notes to Consolidated Financial Statements in Item 15, which contains a further description of the terms of the Asset-Based Revolving Credit Facility.
Mytheresa.com Credit Facilities. Our subsidiary mytheresa.com GmbH, through which we operate mytheresa.com, is party to two credit facility agreements and related security arrangements. The first facility, entered into October 1, 2015, is a revolving credit line for up to €6.5 million in availability and bears interest at a fixed rate of 2.39% (until further notice) for any loan drawn under the overdraft facility and at rates to be agreed on a case-by-case basis for money market loans and guarantees. The second facility, entered into June 8, 2017, is a revolving credit line for up to €8.5 million in availability and bears interest at a fixed rate of 2.25% (until further notice) for any loan drawn under the overdraft facility at rates to be agreed on a case-by-case basis for any other loans.
Both facilities are secured by certain inventory held by mytheresa.com GmbH and certain contractual claims. The facilities are not guaranteed by, and are non-recourse to, us or any of our U.S. subsidiaries or affiliates. Each facility contains restrictive covenants prohibiting mytheresa.com GmbH from distributing or making available loan proceeds to any affiliates including us or any of our other subsidiaries and requiring mytheresa.com GmbH to maintain a minimum economic equity ratio. The agreements also contain usual and customary events of default, the occurrence of which may result in all outstanding amounts under the facility agreements becoming due and payable immediately. There is no scheduled amortization under either facility and neither facility has a specified maturity date. However, each lender may terminate its respective facility at any time provided that mytheresa.com GmbH is given a customary reasonable opportunity to secure alternative financing.
As of July 29, 2017, mytheresa.com GmbH had no outstanding borrowings, guarantees of $1.2 million, or €1.1 million, and unused commitments of $15.9 million, or €13.9 million.
Senior Secured Term Loan Facility. At July 29, 2017, the outstanding balance under the Senior Secured Term Loan Facility was $2,839.6 million. The principal amount of the loans outstanding is due and payable in full on October 25, 2020.
Depending on our senior secured first lien net leverage ratio (as defined in the credit agreement governing the Senior Secured Term Loan Facility), we could be required to prepay outstanding term loans from a certain portion of our annual excess cash flow (as defined in the credit agreement governing the Senior Secured Term Loan Facility). Required excess cash flow payments commence at 50% of our annual excess cash flow (which percentage will be reduced to (a) 25% if our senior secured first lien net leverage ratio (as defined in the credit agreement governing the Senior Secured Term Loan Facility) is equal to or less than 4.0 to 1.0 but greater than 3.5 to 1.0 and (b) 0% if our senior secured first lien net leverage ratio is equal to or less than 3.5 to 1.0). We also must offer to prepay outstanding term loans at 100% of the principal amount to be prepaid, plus accrued and unpaid interest, with the proceeds of certain asset sales and debt issuances, subject to certain exceptions and reinvestment rights.
The interest rate on the outstanding borrowings pursuant to the Senior Secured Term Loan Facility was 4.47% at July 29, 2017.
See Note 8 of the Notes to Consolidated Financial Statements in Item 15, which contains a further description of the terms of the Senior Secured Term Loan Facility.
Cash Pay Notes. We have outstanding $960.0 million aggregate principal amount of 8.00% Senior Cash Pay Notes. The Cash Pay Notes mature on October 15, 2021.
See Note 8 of the Notes to Consolidated Financial Statements in Item 15, which contains a further description of the terms of the Cash Pay Notes and Note 17 of the Notes to Consolidated Financial Statements in Item 15 for a description of certain subsidiaries that we have designated as "Unrestricted Subsidiaries" under the indenture governing the Cash Pay Notes.
PIK Toggle Notes. We have outstanding $600.0 million aggregate principal amount of 8.75%/9.50% Senior PIK Toggle Notes. The PIK Toggle Notes mature on October 15, 2021. Interest on the PIK Toggle Notes is payable semi-annually in arrears on each April 15 and October 15. Interest on the PIK Toggle Notes, subject to certain restrictions, may be paid (i) entirely in cash, (ii) entirely by increasing the principal amount of the PIK Toggle Notes by the relevant interest payment amount, or (iii) 50% in Cash Interest and 50% in PIK Interest. Cash Interest on the PIK Toggle Notes accrues at a rate of 8.75% per annum. PIK Interest on the PIK Toggle Notes accrues at a rate of 9.50% per annum. Interest on the PIK Toggle Notes was paid entirely in cash for the first seven interest payments. We elected to pay the October 2017 interest payment in the form of PIK Interest, which will result in the issuance of $28.5 million of additional PIK Toggle Notes in October 2017. We intend to elect to pay interest in the form of PIK Interest or partial PIK Interest on our semi-annual interest payment due in April 2018 and may additionally elect to do so with respect to the payment due in October 2018. If we elect PIK Interest or partial PIK
Interest with respect to these interest payments, we must deliver a notice of such election to the trustee no later than one day prior to the beginning of the relevant semi-annual interest period. We will evaluate our financial position prior to each future interest period to determine the appropriate election at that time.
See Note 8 of the Notes to Consolidated Financial Statements in Item 15, which contains a further description of the terms of the PIK Toggle Notes and Note 17 of the Notes to Consolidated Financial Statements in Item 15 for a description of certain subsidiaries that we have designated as "Unrestricted Subsidiaries" under the indenture governing the PIK Toggle Notes.
2028 Debentures. We have outstanding $125.0 million aggregate principal amount of 7.125% Senior Debentures. The 2028 Debentures mature on June 1, 2028.
See Note 8 of the Notes to Consolidated Financial Statements in Item 15, which contains a further description of the terms of the 2028 Debentures.
Interest Rate Swaps. At July 29, 2017, we had outstanding floating rate debt obligations of $3,102.6 million. In April and June of 2016, we entered into floating to fixed interest rate swap agreements for an aggregate notional amount of $1,400.0 million to limit our exposure to interest rate increases related to a portion of our floating rate indebtedness. These swap agreements hedge a portion of our contractual floating rate interest commitments related to our Senior Secured Term Loan Facility from December 2016 to October 2020. As a result of the April 2016 swap agreements, our effective interest rate as to $700.0 million of floating rate indebtedness will be fixed at 4.9120% from December 2016 through October 2020. As a result of the June 2016 swap agreements, our effective interest rate as to an additional $700.0 million of floating rate indebtedness will be fixed at 4.7395% from December 2016 to October 2020. The interest rate swap agreements expire in October 2020.
Contractual Obligations and Commitments
The following table summarizes our estimated significant contractual cash obligations at July 29, 2017:
(1)
The above table does not reflect future excess cash flow prepayments, if any, that may be required under the Senior Secured Term Loan Facility.
(2)
At July 29, 2017, there were no outstanding borrowings under the mytheresa.com Credit Facilities.
(3)
The cash obligations for interest requirements assume (a) interest requirements on our fixed-rate debt obligations at their contractual rates, with interest paid in PIK interest for the October 2017 payment and the remaining interest paid entirely in cash with respect to the PIK Toggle Notes, (b) interest requirements on floating rate debt obligations not subject to interest rate swaps at rates in effect at July 29, 2017 and (c) interest requirements on floating rate debt obligations subject to interest rate swaps at the fixed rates provided through the swap agreements. Borrowings pursuant to the Senior Secured Term Loan Facility bear interest at floating rates, primarily based on LIBOR, but in no
event less than a floor rate of 1.00%, plus applicable margins. A 1% increase in the rates relating to the portion of our floating rate debt obligations that is not hedged would increase annual interest requirements by approximately $17 million during fiscal year 2018.
(4)
At July 29, 2017 (the most recent measurement date), our actuarially calculated projected benefit obligation for our Pension Plan was $620.9 million and the fair value of the assets was $380.2 million, resulting in a net liability of $240.7 million, which is included in other long-term liabilities at July 29, 2017. Our policy is to fund our Pension Plan at or above the minimum amount required by law. We made contributions of $10.7 million to the Pension Plan in fiscal year 2017 and no contributions during fiscal year 2016. As of July 29, 2017, we believe we will be required to contribute $25.1 million to the Pension Plan in fiscal year 2018. The amounts and timing of our contributions to our Pension Plan are subject to a number of uncertainties, including interest rate fluctuations and the investment performance of the assets held by the Pension Plan. We do not believe these uncertainties will have a material impact on our future liquidity. See Note 11 of the Notes to Consolidated Financial Statements in Item 15, which contains a further description of our Pension Plan.
(5)
Included in other long-term liabilities at July 29, 2017 are our liabilities for our SERP and Postretirement Plans aggregating $111.9 million. Our scheduled obligations with respect to our SERP Plan and Postretirement Plan liabilities consist of expected benefit payments through 2027, as currently estimated using information provided by our actuaries. In addition, other long-term liabilities at July 29, 2017 included our liabilities related to (i) uncertain tax positions (including related accruals for interest and penalties) of $2.6 million and (ii) other obligations aggregating $44.2 million, primarily for employee benefits and accrued interest related to our PIK Toggle Notes. Future cash obligations related to these liabilities are not currently estimable.
(6)
Construction commitments relate primarily to obligations pursuant to contracts for the construction of new stores and the remodels of existing stores expected as of July 29, 2017. These amounts represent the gross construction costs and exclude developer contributions of approximately $54.5 million, which we expect to receive pursuant to the terms of the construction contracts.
In the normal course of our business, we issue purchase orders to vendors/suppliers for merchandise. Our purchase orders are not unconditional commitments but, rather represent executory contracts requiring performance by the vendors/suppliers, including the delivery of the merchandise prior to a specified cancellation date and the compliance with product specifications, quality standards and other requirements. In the event of the vendor’s failure to meet the agreed upon terms and conditions, we may cancel the order.
The following table summarizes the expiration of our other significant commercial commitments outstanding at July 29, 2017:
(1)
As of July 29, 2017, we had outstanding borrowings of $263.0 million under the Asset-Based Revolving Credit Facility, outstanding letters of credit of $1.8 million and unused commitments of $635.3 million, subject to a borrowing base, of which $90.0 million of such capacity is available to us subject to certain restrictions as more fully described in Note 8 of the Notes to Consolidated Financial Statements in Item 15. Our working capital requirements are greatest in the first and second fiscal quarters as a result of higher seasonal requirements. See “-Financing Structure at July 29, 2017-Asset-Based Revolving Credit Facility” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Seasonality.”
In addition to the items presented above, our other principal commercial commitments are comprised of common area maintenance costs, tax and insurance obligations and contingent rent payments.
Off-Balance Sheet Arrangements
We had no off-balance sheet arrangements, other than operating leases entered into in the normal course of business, during fiscal year 2017. See Note 12 of the Notes to Consolidated Financial Statements in Item 15 for more information about our operating leases.
Critical Accounting Policies
Our accounting policies are more fully described in Note 1 of the Notes to Consolidated Financial Statements in Item 15 of this Annual Report. As disclosed in Note 1 of the Notes to Consolidated Financial Statements, the preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions about future events. These estimates and assumptions affect the amounts of assets, liabilities, revenues and expenses and the disclosure of gain and loss contingencies at the date of the accompanying Consolidated Financial Statements appearing elsewhere in this Annual Report on Form 10-K. Our current estimates are subject to change if different assumptions as to the outcome of future events were made. We evaluate our estimates and assumptions on an ongoing basis and predicate those estimates and assumptions on historical experience and on various other factors that we believe are reasonable under the circumstances. We make adjustments to our estimates and assumptions when facts and circumstances dictate. Since future events and their effects cannot be determined with absolute certainty, actual results may differ from the estimates and assumptions used in preparing the accompanying Consolidated Financial Statements.
We believe the following critical accounting policies encompass the more significant judgments and estimates used in the preparation of our Consolidated Financial Statements.
Revenues. Revenues include sales of merchandise and services and delivery and processing revenues related to merchandise sold. Revenues are recognized at the later of the point of sale or the delivery of goods to the customer. Revenues associated with gift cards are recognized at the time of redemption by the customer. Revenues exclude sales taxes collected from our customers.
Delivery and processing revenues were $58.7 million in fiscal year 2017, $50.6 million in fiscal year 2016 and $50.1 million in fiscal year 2015.
Revenues are reduced when customers return goods previously purchased. We maintain reserves for anticipated sales returns primarily based on our historical trends related to returns by our customers. Our reserves for anticipated sales returns were $47.0 million at July 29, 2017 and $45.3 million at July 30, 2016. As the vast majority of merchandise returns are made in less than 30 days after the sales transaction, we believe the risk that actual returns differ from our estimates is minimal and would not have a material impact on our Consolidated Financial Statements.
Fair Value Measurements. Certain of our assets and liabilities are required to be measured at fair value on a recurring basis. Fair value is the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. Assets and liabilities are classified using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value as follows:
•
Level 1 - Unadjusted quoted prices for identical instruments traded in active markets.
•
Level 2 - Observable market-based inputs or unobservable inputs corroborated by market data.
•
Level 3 - Unobservable inputs reflecting management’s estimates and assumptions.
Merchandise Inventories and Cost of Goods Sold. We utilize the retail inventory method of accounting. Under the retail inventory method, the valuation of inventories at cost and the resulting gross margins are determined by applying a calculated cost-to-retail ratio, for various groupings of similar items, to the retail value of our inventories. The cost of the inventory reflected in the Consolidated Financial Statements is decreased by charges to cost of goods sold at average cost and the retail value of the inventory is lowered through the use of markdowns. Earnings are negatively impacted when merchandise is marked down. As we adjust the retail value of our inventories through the use of markdowns to reflect market conditions, our merchandise inventories are stated at the lower of cost or market.
The areas requiring significant management judgment related to the valuation of our inventories include (i) setting the original retail value for the merchandise held for sale, (ii) recognizing merchandise for which the customer’s perception of value has declined and appropriately marking the retail value of the merchandise down to the perceived value and
(iii) estimating the shrinkage that has occurred between physical inventory counts. These judgments and estimates, coupled with the averaging processes within the retail method, can, under certain circumstances, produce varying financial results. Factors that can lead to different financial results include (i) determination of original retail values for merchandise held for sale, (ii) identification of declines in perceived value of inventories and processing the appropriate retail value markdowns and (iii) overly optimistic or conservative estimation of shrinkage. In prior years, we have not made material changes to our estimates of shrinkage or markdown requirements on inventories held as of the end of our fiscal years. We do not believe that changes in the assumptions and estimates, if any, used in the valuation of our inventories at July 29, 2017 will have a material effect on our future operating performance.
Consistent with industry business practice, we receive allowances from certain of our vendors in support of the merchandise we purchase for resale. Certain allowances are received to reimburse us for markdowns taken or to support the gross margins that we earn in connection with the sales of the vendor’s merchandise. These allowances result in an increase to gross margin when we earn the allowances and they are approved by the vendor. Other allowances we receive represent reductions to the amounts we pay to acquire the merchandise. These allowances reduce the cost of the acquired merchandise and are recognized at the time the goods are sold. The amounts of vendor allowances we receive fluctuate based partially on the level of markdowns taken and did not have a significant impact on the year-over-year change in gross margin during fiscal years 2017, 2016 or 2015. We received vendor allowances of $83.6 million, or 1.8% of revenues, in fiscal year 2017, $100.8 million, or 2.0% of revenues, in fiscal year 2016 and $94.8 million, or 1.9% of revenues, in fiscal year 2015.
Cost of goods sold also includes delivery charges we pay to third party carriers and other costs related to the fulfillment of customer orders not delivered at the point-of-sale.
Long-lived Assets. Property and equipment are stated at cost less accumulated depreciation. In connection with the Acquisition, the cost basis of the acquired property and equipment was adjusted to its estimated fair value. For financial reporting purposes, we compute depreciation principally using the straight-line method over the estimated useful lives of the assets. Buildings and improvements are depreciated over five to 30 years while fixtures and equipment are depreciated over three to 15 years. Leasehold improvements are amortized over the shorter of the asset life or the lease term (which may include renewal periods when exercise of the renewal option is at our discretion and exercise of the renewal option is considered reasonably assured). Costs incurred for the development of internal computer software are capitalized and amortized using the straight-line method over three to ten years.
We assess the recoverability of the carrying values of our store assets, consisting of property and equipment, customer lists and favorable lease commitments, annually and upon the occurrence of certain events. The recoverability assessment with respect to our long-lived assets is performed at the store level. This assessment is based upon the comparison of the undiscounted cash flows anticipated to be generated from the store to the net carrying value of the store assets. To the extent the undiscounted store-level cash flows are not sufficient to recover the net carrying value of the store assets, the assets are impaired and written down to their estimated fair value based upon discounted future cash flows. Based upon the review of our store-level assets, we identified certain property and equipment, other definite-lived intangible assets and favorable lease commitments to be impaired by $4.8 million in fiscal year 2017 and $38.1 million in fiscal year 2016.
The recoverability assessment related to store-level assets requires judgments and estimates of future revenues, gross margin rates and store expenses. We base these estimates upon our past and expected future performance. We believe our estimates are appropriate in light of current and future market conditions and the best information available at the assessment date. However, future impairment charges could be required if we do not achieve our current revenue or cash flow projections.
Indefinite-lived Intangible Assets and Goodwill. Indefinite-lived intangible assets, such as our Neiman Marcus, Bergdorf Goodman and MyTheresa tradenames and goodwill, are not subject to amortization. Rather, we assess the recoverability of indefinite-lived intangible assets and goodwill in the fourth quarter of each fiscal year and upon the occurrence of certain events.
The recoverability assessment with respect to each of the tradenames used in our operations requires us to estimate the fair value of the asset as of the assessment date. Such determination is made using discounted cash flow techniques (Level 3 determination of fair value). Significant inputs to the valuation model include:
•
future revenue and profitability projections associated with the tradename;
•
estimated market royalty rates that could be derived from the licensing of our tradenames to third parties in order to establish the cash flows accruing to the benefit of the Company as a result of our ownership of our tradenames; and
•
rate used to discount the estimated royalty cash flow projections to their present value (or estimated fair value).
If the recorded carrying value of the tradename exceeds its estimated fair value, an impairment charge is recorded to write the tradename down to its estimated fair value. We currently estimate that the fair value of our tradenames decreases by approximately $289 million for each 0.5% decrease in market royalty rates and by approximately $58 million for each 0.25% increase in the weighted average cost of capital. Based upon the review of our tradenames, we determined certain of our tradenames were impaired and recorded impairment charges aggregating $309.7 million in fiscal year 2017 and $228.9 million in fiscal year 2016.
Pursuant to current accounting guidance related to the testing of goodwill for impairment adopted in the fourth quarter of fiscal year 2017, the assessment of the recoverability of the goodwill associated with our Neiman Marcus, Bergdorf Goodman and MyTheresa reporting units involves the comparison of the estimated enterprise fair value of each of our reporting units to its recorded carrying value. We estimate the enterprise fair value based on discounted cash flow techniques (Level 3 determination of fair value). Significant inputs to the valuation model include:
•
estimated future cash flows;
•
growth assumptions for future revenues as well as future gross margin rates, expense rates, capital expenditures and other estimates; and
•
rate, based on our estimated weighted average cost of capital, used to discount our estimated future cash flow projections to their present value (or estimated fair value).
If the recorded carrying value of a reporting unit exceeds its estimated enterprise fair value, an impairment charge is recorded to goodwill for the amount by which the carrying amount exceeds the reporting unit's fair value. We currently estimate that a 5% decrease in the estimated fair value of the enterprise value of each of our reporting units as compared to the values used in the preparation of these financial statements would increase the impairment charge related to goodwill by approximately $275 million. In addition, we currently estimate that the fair value of our goodwill decreases by approximately $207 million for each 0.25% increase in the discount rate used to estimate fair value. Based upon the review of our recorded goodwill balances, we determined that certain of our goodwill balances were impaired and recorded impairment charges aggregating $196.2 million in fiscal year 2017.
Prior to the adoption of the new accounting guidance, our assessment process involved a second step in which we allocated the enterprise fair value to the fair value of the reporting unit's net assets. Any enterprise value in excess of amounts allocated to such net assets represented the implied fair value of goodwill for that reporting unit. If the carrying value of goodwill for a reporting unit exceeded the implied fair value of goodwill, an impairment charge was recorded to write goodwill down to its fair value. The assessment performed in the fourth quarter of fiscal year 2016 was performed utilizing the two-step process. Based on this process, we determined that certain of our goodwill balances were impaired and recorded impairment charges aggregating $199.2 million in fiscal year 2016.
The impairment testing process related to our indefinite-lived intangible assets is subject to inherent uncertainties and subjectivity. The use of different assumptions, estimates or judgments with respect to the estimation of the projected future cash flows and the determination of the discount rate used to reduce such projected future cash flows to their net present value could materially increase or decrease any related impairment charge. We believe our estimates are appropriate based upon current and future market conditions and the best information available at the assessment date. However, future impairment charges could be required if we do not achieve our current cash flow, revenue and profitability projections, market royalty rates decrease or the weighted average cost of capital increases.
Benefit Plans. We sponsor a defined benefit pension plan ("Pension Plan"), an unfunded supplemental executive retirement plan ("SERP Plan") which provides certain employees additional pension benefits and a postretirement plan providing eligible employees limited postretirement health care benefits ("Postretirement Plan"). In calculating our obligations and related expense, we make various assumptions and estimates, after consulting with outside actuaries and advisors. The annual determination of expense involves calculating the estimated total benefits ultimately payable to plan participants. We utilize a spot rate methodology in the estimation of the interest cost component of net periodic benefit cost, which uses the individual spot rates along the yield curve corresponding to benefit payments. The Pension Plan, SERP Plan and Postretirement Plan are valued as of the end of each fiscal year. As of the third quarter of fiscal year 2010, benefits offered to all employees under our Pension Plan and SERP Plan were frozen.
Significant assumptions related to the calculation of our obligations include the discount rates used to calculate the present value of benefit obligations to be paid in the future, the expected long-term rate of return on assets held by the Pension
Plan and the health care cost trend rate for the Postretirement Plan. We review these assumptions annually based upon currently available information, including information provided by our actuaries.
Significant assumptions utilized in the calculation of our projected benefit obligations as of July 29, 2017 and future expense requirements for our Pension Plan, SERP Plan and Postretirement Plan, and sensitivity analysis related to changes in these assumptions, are as follows:
Stock Compensation. At the date of grant, the stock option exercise price equals or exceeds the fair market value of Parent's common stock. Because Parent is privately held and there is no public market for its common stock, the fair market value of Parent's common stock is determined by the Board of Directors of Parent (the "Parent Board") or the Compensation Committee, as applicable, at the time option grants are awarded. The estimate of the fair market value of Parent's common stock utilizes both discounted cash flow techniques and the review of market data and involves assumptions regarding a number of complex and subjective variables. Significant inputs to the common stock valuation model include:
•
future revenue, cash flow and/or profitability projections;
•
growth assumptions for future revenues as well as future gross margin rates, expense rates, capital expenditures and other estimates;
•
rates, based on our estimated weighted average cost of capital, used to discount the estimated cash flow projections to their present value (or estimated fair value);
•
recent transactions and valuation multiples for publicly held companies deemed similar to Parent;
•
economic conditions and other factors deemed material to the valuation process; and
•
valuations of Parent performed by third parties.
Newly Adopted and Recent Accounting Pronouncements
For information with respect to newly adopted and recent accounting pronouncements and the impact of these pronouncements on our Consolidated Financial Statements, see Note 1 of the Notes to Consolidated Financial Statements in Item 15.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks, which include significant deterioration of the U.S. and foreign markets, changes in U.S. interest rates, foreign currency exchange rates, including the devaluation of the U.S. dollar, and the effects of economic uncertainty that may affect the prices we pay our vendors in the foreign countries in which we do business. We do not engage in financial transactions for trading or speculative purposes.
Interest Rate Risk
The market risk inherent in our financial instruments represents the potential loss arising from adverse changes in interest rates. We do not enter into derivative financial instruments for trading purposes. We seek to manage exposure to adverse interest rate changes through our normal operating and financing activities. We are exposed to interest rate risk through our borrowing activities, which are described in Note 8 of the Notes to Consolidated Financial Statements.
At July 29, 2017, we had outstanding floating rate debt obligations of $3,102.6 million consisting primarily of outstanding borrowings under our Senior Secured Term Loan Facility. Borrowings pursuant to the Senior Secured Term Loan Facility bear interest at floating rates, primarily based on LIBOR, but in no event less than a floor rate of 1.00%, plus applicable margins. The interest rate on the outstanding borrowings pursuant to the Senior Secured Term Loan Facility was 4.47% at July 29, 2017. A further description of the terms of the Senior Secured Term Loan Facility is set forth in Note 8 of the Notes to Consolidated Financial Statements.
In April and June of 2016, we entered into floating to fixed interest rate swap agreements for an aggregate notional amount of $1,400.0 million to limit our exposure to interest rate increases related to a portion of our floating rate indebtedness. These swap agreements hedge a portion of our contractual floating rate interest commitments related to our Senior Secured Term Loan Facility from December 2016 to October 2020. As a result of the April 2016 swap agreements, our effective interest rate as to $700.0 million of floating rate indebtedness will be fixed at 4.9120% from December 2016 through October 2020. As a result of the June 2016 swap agreements, our effective interest rate as to an additional $700.0 million of floating rate indebtedness will be fixed at 4.7395% from December 2016 to October 2020. We estimate that a 1% increase in the rates relating to the portion of our floating rate debt obligations that is not hedged would increase annual interest requirements by approximately $17 million during fiscal year 2018.
Foreign Currency Risk
We purchase a substantial portion of our inventory from foreign suppliers whose costs are affected by the fluctuation of their local currency against the U.S. dollar or who price their merchandise in currencies other than the U.S. dollar. While fluctuations in the Euro-U.S. dollar exchange rate can affect us most significantly, we source merchandise from numerous countries and thus are affected by changes in numerous other currencies and, generally, by fluctuations in the value of the U.S. dollar relative to such currencies. Beginning in fiscal year 2015, the U.S. dollar began to strengthen against the Euro and other international currencies. We believe a strengthening U.S. dollar may (i) create disincentives to, or changes in the pattern, practice or frequency of, travel to and spending by foreign tourists in the regions in which we operate our retail stores and (ii) impact U.S. consumers’ willingness or ability to travel abroad and purchase merchandise we offer for sale at lower prices from foreign retailers. In addition, we believe a strengthening of the U.S. dollar relative to foreign currencies, most notably the Euro and British pound, may impact the retail prices of merchandise offered for sale and/or our cost of goods sold. Any of these effects could cause our revenues or product margins to decrease.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following Consolidated Financial Statements of the Company and supplementary data are included as pages through at the end of this Annual Report on Form 10-K:
Index
Page
Number
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Loss
Consolidated Statements of Cash Flows
Consolidated Statements of Member Equity
Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
a.
Disclosure Controls and Procedures
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation as of July 29, 2017, under the supervision and with the participation of our Chief Executive Officer and Interim Chief Financial Officer, as well as other key members of our management, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and Interim Chief Financial Officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, accumulated, processed, summarized, reported and communicated on a timely basis and within the time periods specified in the Securities and Exchange Commission’s rules and forms.
b.
Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rule 13a-15(f). Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of July 29, 2017. During its assessment, management did not identify any material weaknesses in our internal control over financial reporting.
c.
Changes in Internal Control Over Financial Reporting
In the first quarter of fiscal year 2017, we launched implementation of an integrated merchandising and distribution system, NMG One. This implementation was not in response to an identified control deficiency or weakness. The implementation was significant in scale and complexity and has resulted in changes to our business processes, primarily related to the procurement, processing, distribution and valuation of our merchandising inventories. In connection with the implementation, management is in the process of updating the design and documentation of internal control processes and procedures to align our internal controls with our new business processes and the capabilities of the new system. In response to certain issues that we experienced in fiscal year 2017 related to the implementation, and discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations-Investments and Strategic Initiatives," management also applied, and expects to continue to apply, certain supplemental and manual controls and processes to provide adequate control over financial reporting during the period of transition from our legacy system to the new NMG One system. Management will continue to monitor and evaluate the effectiveness of these controls and processes and consider the need for additional measures that may be required to address deficiencies related to the implementation.
Other than as described above, there have been no changes in our internal controls over financial reporting during the quarter ended July 29, 2017 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth certain information regarding the Company’s executive officers and members of the Parent Board as of the date of this filing:
Executive Officers
Karen W. Katz. Ms. Katz has served as our Director, President and Chief Executive Officer since October 6, 2010. She served as Executive Vice President and as a member of the Office of the Chairman from October 2007 until October 2010. From December 2002 to October 2010, she served as President and Chief Executive Officer of Neiman Marcus Stores. Ms. Katz is a member of the board of directors of Under Armour, Inc., a performance footwear, apparel and equipment company, and formerly served on the board of directors of Pier 1 Imports, Inc., a home decor and furniture retailer. Since joining us in 1985, Ms. Katz has been in charge of a variety of our business units and has demonstrated strong and consistent leadership. She has an extensive understanding of our customers and the retail industry that enables her to promote a unified direction for both the Parent Board and management.
James J. Gold. In April 2014, Mr. Gold was elected President, Chief Merchandising Officer with responsibility for leading our merchandising and planning organization for Neiman Marcus Stores and Online. His prior service includes President and Chief Executive Officer of Specialty Retail from October 2010 to April 2014 and from May 2004 to October 2010, President and Chief Executive Officer of Bergdorf Goodman. Mr. Gold served as Senior Vice President, General Merchandise Manager of Neiman Marcus Stores from December 2002 to May 2004, as Division Merchandise Manager from June 2000 to December 2002, and as Vice President of the Neiman Marcus Last Call Clearance Division from March 1997 to June 2000.
John E. Koryl. Mr. Koryl was elected President, Neiman Marcus Stores and Online in April 2014 responsible for store operations and sales, e-commerce domestic and international operations and sales, site merchandising, site optimization and customer care. From June 2011 to April 2014, he served as President of Neiman Marcus Direct. From August 2009 until June 2011, he held the position of Senior Vice President, eCommerce Marketing & Analytics at Williams-Sonoma, Inc., a premier specialty retailer of home furnishings. From September 2006 until August 2009, he was Senior Director, Marketing Solutions with eBay, Inc., an online auction and shopping website, and held various other managerial positions with eBay, Inc. since June 2005. Mr. Koryl is also currently a director of Guitar Center Holdings, Inc., a musical instruments retailer, and has previously served on the board of Petco Animal Supplies, Inc., a leading pet specialty retailer.
Carrie M. Tharp. Ms. Tharp joined us in October 2016 as Senior Vice President and Chief Marketing Officer. From June 2013 to September 2016, she served as Senior Vice President, Chief Marketing Officer and Head of E-Commerce at Fossil Group, Inc., a design, marketing and distribution company. Prior to joining Fossil Group, she served as Vice President of Global Strategy and Customer Insights with Travelocity, a leading online travel company, from April 2012 to June 2013 and Vice President of Strategy and Chief of Staff with Dean Foods Company, a publicly traded food and beverage company, from March 2009 to March 2012. She held previous roles with Bain and Company and TXU Energy Retail.
Sarah W. Miller. Ms. Miller has served as Senior Vice President and Chief Information Officer since September 2016. From July 2013 to September 2016, she served as our Vice President of Enterprise Applications. From 2007 until joining us in July 2013, she served in various roles of increasing responsibility for information technology at Lowe’s Companies, Inc., a home improvement retailer, most recently as Director of IT Operational Excellence and Business Intelligence. Prior to Lowe’s Companies, she was the Chief Information Officer for Nash Finch Company, a food distribution company. She began her career with IBM.
Tracy M. Preston. Ms. Preston joined us as Senior Vice President and General Counsel on February 18, 2013. She was appointed Corporate Secretary in January 2016. From January 2002 until February 2013, she held various positions, including Chief Compliance Officer and Chief Counsel for global supply chain, global human resources and litigation, at Levi Strauss & Co., a brand-name apparel company. Previously she was a partner with the law firm of Orrick, Herrington & Sutcliffe LLP.
T. Dale Stapleton. In September 2010, Mr. Stapleton was elected Senior Vice President and Chief Accounting Officer, and he has served as our Interim Chief Financial Officer since June 30, 2017. From August 2001 to September 2010, he served as Vice President and Controller. Mr. Stapleton served as Vice President and Controller at CompUSA Inc. from 1999 to 2000.
Joseph N. Weber. Mr. Weber joined us on September 4, 2012 as Senior Vice President, Chief Human Resources Officer. Prior to joining us, he held various positions at Bank of America Corporation since 2006, most recently Head, Human Resources Europe, Middle East, Africa, Latin America and Canada. Previously he was with Dell, Inc., a technology products and services company, from 2000 until 2006 and General Electric Company, a global industrial company, from 1995 until 2000.
Directors
Information pertaining to Ms. Katz may be found above in the section entitled “-Executive Officers.”
David B. Kaplan. Mr. Kaplan is Chairman of the Parent Board and has served as a member of the Parent Board since October 2013. Mr. Kaplan is a Co-Founder of Ares Management, L.P. ("Ares Management"), which is affiliated with some of our Sponsors, and a Director and Partner of Ares Management GP LLC, Ares Management’s general partner. He is a Partner of Ares Management, Co-Head of its Private Equity Group and a member of its Management Committee. He additionally serves on several of the investment committees for the funds managed by the Ares Private Equity Group. Mr. Kaplan joined Ares Management in 2003 from Shelter Capital Partners, LLC, a private equity firm, where he was a Senior Principal from June 2000 to April 2003. From 1991 through 2000, Mr. Kaplan was affiliated with, and a Senior Partner of, Apollo Management, L.P., a global alternative investment manager, and its affiliates, during which time he completed multiple private equity investments from origination through exit. Prior to Apollo Management, L.P., Mr. Kaplan was a member of the Investment Banking Department at Donaldson, Lufkin & Jenrette Securities Corp., an investment banking and securities firm. Mr. Kaplan currently serves as Chairman of the board of directors of Smart & Final Stores, Inc., a value-oriented food and everyday staples retailer, and as a member of the boards of directors of ATD Corporation, a replacement tire distributor, and the parent entities of 99 Cents Only Stores LLC, a deep-discount retailer, Floor and Decor Outlets of America, Inc., a specialty retailer of hard surface flooring and related accessories, and Guitar Center, Inc., a musical instruments retailer. Mr. Kaplan’s previous public company board of directors experience includes Maidenform Brands, Inc., an intimate apparel retailer, where he served as the company’s Chairman, GNC Holdings, Inc., a specialty retailer of health and wellness products, Dominick’s Supermarkets, Inc., a grocery store retailer, Stream Global Services, Inc., a business process outsourcing provider, Orchard Supply Hardware Stores Corporation, a home improvement retailer, and Allied Waste Industries Inc., a waste services company. Mr. Kaplan also serves on the board of directors of Cedars-Sinai Medical Center and serves on the President’s Advisory Group of the University of Michigan. Mr. Kaplan graduated with High Distinction, Beta Gamma Sigma, from the University of Michigan, School of Business Administration with a B.B.A. concentrating in Finance. Mr. Kaplan’s over 25 years of experience managing investments in, and serving on the boards of directors of, companies operating in various industries led to the conclusion that he should serve as a member of the Parent Board.
Nora A. Aufreiter. Ms. Aufreiter has served as a member of the Parent Board since January 2014. She is a Director Emeritus of McKinsey and Company, a global management consulting firm, retiring in June 2014 after more than 27 years with McKinsey, most recently as a director and senior partner. During her years at McKinsey, she worked with major retailers, financial institutions and other consumer-facing companies in the U.S., Canada and internationally. Over the course of her career she led the North American Retail practice, the Toronto office, as well as McKinsey’s Consumer Digital, Omni Channel and Branding service lines. Ms. Aufreiter also serves on the boards of directors of The Kroger Company, one of the world’s largest supermarket operators, the Bank of Nova Scotia, Canada’s most international bank with operations in over 55 countries and Cadillac Fairview, one of North America's largest owners, operators and developers of commercial real estate. She is also a director of several non-profit organizations including St. Michael's Hospital in Toronto, the Canadian Opera Company and the Dean's advisory board of Western University in London, Ontario Ms. Aufreiter began her career at Bank of America as a corporate finance officer. She has an M.B.A. from the Harvard Business School and a H.B.A. from The University of Western Ontario’s Ivey School of Business. Ms. Aufreiter’s digital, omni channel, branding and retail experience greatly enhances the Parent Board's effectiveness.
Norman H. Axelrod. Mr. Axelrod has served as a member of the Parent Board since October 2013. Beginning in 1988, Mr. Axelrod served as Chief Executive Officer and a member of the board of directors of Linens ‘n Things, Inc., a retailer of home textiles, housewares and decorative home accessories, was appointed as Chairman of its board of directors in 1997, and served in such capacities until its acquisition in February 2006. Mr. Axelrod is also the Chairman of the board of directors of the parent entity of Floor and Decor Outlets of America, Inc., a specialty retailer of hard surface flooring and related accessories, and serves on the boards of directors of the parent entities of Smart & Final Stores Inc., a value-oriented food and everyday staples retailer, 99 Cents Only Stores LLC, a deep-discount retailer, and Guitar Center, Inc., a musical instruments retailer. Mr. Axelrod has also previously served as the Chairman of the boards of directors of GNC Holdings, Inc., a specialty retailer of health and wellness products, National Bedding Company LLC, a mattress and bedding product manufacturer, and Simmons Company, a mattress and bedding product manufacturer, and as a member of the boards of directors of Reebok International Ltd., a leading worldwide designer and marketer of sports, fitness and casual footwear, apparel and equipment, and Maidenform Brands, Inc., an intimate apparel retailer. Mr. Axelrod has provided consulting services to certain Ares entities. Mr. Axelrod received a B.S. in Management and Marketing from Lehigh University and an M.B.A. from New York University. Mr. Axelrod’s vast experience in the retail industry led to the conclusion that he should serve as a member of the Parent Board.
Philippe E. Bourguignon. Mr. Bourguignon has served as a member of the Parent Board since April 2014. He serves as Vice Chairman of Revolution Places LLC, a travel and tourism company that promotes a healthy lifestyle, and served as CEO of Exclusive Resorts, a premier travel and lifestyle club, until May 2015, at which point he was appointed Executive Co-Chairman. He also acts as Chairman of Miraval Resort, an acclaimed resort located in northern Tucson, Arizona. Prior to joining Revolution Places, Mr. Bourguignon was co-CEO of the Davos-based World Economic Forum, an international institution committed to improving the state of the world through public-private cooperation, in 2003 and 2004 and Chairman and CEO of Euro Disney, an operator of European theme parks and hotels. He served previously as chairman and CEO of Club Med, an operator of all-inclusive resorts. Mr. Bourguignon began his career in tourism with the Accor group, one of the largest hotel groups in the world. During his 14-year tenure with Accor, he served as vice president of Development for Asia/Middle East and executive vice president of North America before being promoted to president of Accor for the Asia/Pacific region. Mr. Bourguignon currently serves on the board of directors of VF Wine, Inc., a wine and spirit resource provider. He previously served as a member of the board of directors for Zipcar, a car-sharing transportation provider, and eBay, an online marketplace provider. Mr. Bourguignon’s qualifications to serve on the Parent Board include his broad-based knowledge of luxury brands, entrepreneurial spirit and keen sense of business acumen.
Adam B. Brotman. Mr. Brotman has served as a member of the Parent Board since April 2014. He is Executive Vice President of Global Retail Operations at Starbucks Coffee Company, a premier roaster and retailer of specialty coffee, where he serves as a key member of the Starbucks senior leadership team. Prior to joining Starbucks in April 2009, Mr. Brotman held several key leadership positions at leading digital media companies, and most recently was CEO of Barefoot Yoga Company, a consumer products e-commerce company. He served as Senior Vice President at Corbis, a digital content and worldwide entertainment and licensing company, and founded PlayNetwork, Inc., a leading provider of in-store digital media and entertainment services for businesses worldwide. Mr. Brotman holds a Bachelor of Arts degree from the University of California, Los Angeles, and a Juris Doctor from the University of Washington. He serves on several corporate and non-profit boards including MOD Pizza and Brooks Running Shoes Company. He previously served on the board of directors of PlayNetwork, Inc. Mr. Brotman’s vast experience in today’s technology and social media is a great asset to our omni-channel brand.
Graeme M. Eadie. Mr. Eadie was elected as a member of the Parent Board in May 2017. He is a Senior Managing Director and is chair of the Private Investments department's investment committee and Private Credit investment committee plus a member of the senior investment committee and the Investment Planning Committee of CPPIB. Previously, he was
Senior Managing Director of the Real Assets department of CPPIB, which encompasses real estate (both debt and equity investments), infrastructure and agricultural investments. Prior to joining CPPIB in June 2005, Mr. Eadie held multiple roles including Chief Financial Officer, President and Chief Operating Officer of Cadillac Fairview, one of Canada's largest owners and developers of commercial real estate. Mr. Eadie has also held senior management positions with a number of entities in the retail and manufacturing areas and formerly was a Trustee of the Morguard Real Estate Investment Trust and a Director of the Ontario Realty Corporation. He serves as a director for Aliansce Shopping Centres and as a trustee for Choice Properties. Mr. Eadie holds B.Comm. and M.Sc. (Business Administration) degrees from the University of British Columbia. His experience as a private equity investor and extensive expertise in commercial real estate led to the conclusion that he should serve as a member of the Parent Board.
Dennis T. Gies. Mr. Gies has served as a member of the Parent Board since July 2016. He is a Partner in the Private Equity Group of Ares Management, which is affiliated with some of our Sponsors. Mr. Gies joined Ares Management in 2006 from UBS Investment Bank, where he participated in the execution of a variety of transactions, including leveraged buyouts, mergers and acquisitions, dividend recapitalizations and debt and equity financings. Mr. Gies currently serves on the boards of directors of Smart & Final Stores, Inc., a value-oriented food and everyday staples retailer, and the parent entities of 99 Cents Only Stores LLC, a deep-discount retailer, and Deva Holdings, Inc., a professional and prestige hair care brand. Mr. Gies also serves on the Board of Trustees of the Center for Early Education in Los Angeles, California. Mr. Gies graduated with an MS in Electrical Engineering from the University of California, Los Angeles and with a BS in Electrical Engineering from Virginia Tech. Mr. Gies’ financial expertise and his experience as a private equity investor evaluating and managing investments in companies across various industries led to the conclusion that he should serve as a member of the Parent Board.
Scott T. Nishi. Mr. Nishi has served as a member of the Parent Board since September 2013. He is a Senior Principal in the Direct Private Equity group of CPPIB Equity, which is affiliated with certain of our Sponsors. Mr. Nishi serves on the boards of directors of the parent entity of Petco Animal Supplies, a leading retailer of pet food and supplies, and the parent entity of 99 Cents Only Stores LLC, a deep-discount retailer. Mr. Nishi joined CPPIB Equity in 2007 from Oliver Wyman, a management consultancy where he advised consumer, healthcare and technology companies. Previously, Mr. Nishi was at Launchworks, a venture capital firm that invested in early stage technology companies. Mr. Nishi holds an MBA from the Richard Ivey School of Business at the University of Western Ontario and a B.Sc. from the University of British Columbia. Mr. Nishi’s financial expertise, as well as experience as a private equity investor evaluating and managing investments in companies across various industries, led to the conclusion that he should serve as a member of the Parent Board.
Board Composition and Terms
As of July 29, 2017, the Parent Board was composed of nine directors. Each director serves for annual terms until his or her successor is elected and qualified, or until such director’s earlier death, resignation or removal.
Pursuant to the terms of the Stockholders Agreement, dated October 25, 2013, by and among Parent, our Sponsors and the other security holders party thereto (the "Stockholders Agreement"), each of our Sponsors has the right to designate three members of the Parent Board and to jointly designate two independent members of the Parent Board, in each case for so long as they or their respective affiliates own at least 25% of the shares of Parent’s Class A Common Stock, par value $0.001 per share ("Class A Common Stock") that they owned as of the closing of the Acquisition. The Stockholders Agreement also provides for the election of the current chief executive officer of Parent to the Parent Board and, to the extent permitted by applicable laws and regulations and subject to certain exceptions, for equal representation on the boards of directors of our subsidiaries with respect to directors designated by our Sponsors and the appointment of at least one of the directors designated by each Sponsor to each committee of the Parent Board. For additional detail regarding the Stockholders Agreement, see “Certain Relationships and Related Transactions, and Director Independence-Stockholders Agreement.”
Committees of the Parent Board
The Parent Board has the authority to appoint committees and, subject to certain exceptions, to delegate to such committees the power and authority of the Parent Board to manage the business and affairs of Parent, and in turn, Holdings and the Company, and perform administrative functions. The Parent Board has established an Audit Committee and a Compensation Committee, and the composition and responsibilities of these standing committees are described below. Members will serve on these committees until their resignation or until otherwise determined by the Parent Board.
Audit Committee
The members of the Audit Committee are Messrs. Gies and Nishi. The Audit Committee assists the Parent Board in its oversight of (i) our financial statements, (ii) our compliance with legal and regulatory requirements, (iii) any independent registered public accounting firm engaged by us and (iv) our internal audit function.
The Parent Board has not affirmatively determined whether any of the members of the Audit Committee meet the criteria set forth in the rules and regulations of the SEC for an “audit committee financial expert” because at the present time the Parent Board believes that the members of the Audit Committee are collectively capable of analyzing and evaluating our financial statements and understanding the internal controls and procedures for financial reporting.
Compensation Committee
The members of the Compensation Committee are Mr. Eadie and Mr. Kaplan, who serves as its Chairman. The Compensation Committee (i) oversees the discharge of the responsibilities of the Parent Board relating to compensation of our officers and other key employees, (ii) reviews and evaluates our overall compensation philosophy, (iii) oversees our equity-based incentive plans and other compensation and benefit plans and (iv) prepares the compensation committee report on executive compensation included in this report.
Code of Ethics
We have adopted a Code of Ethics and Conduct, which is applicable to all our directors, officers and employees. We have also adopted a Code of Ethics for Financial Professionals that applies to all professionals serving in a finance, accounting, treasury, tax or investor relations role throughout our organization, including the Chief Executive Officer, the Chief Financial Officer and the Chief Accounting Officer. Both the Code of Ethics and Conduct and the Code of Ethics for Financial Professionals may be accessed through our website at www.neimanmarcusgroup.com under the “Investor Information-Corporate Governance-Governance Documents” section.
Section 16(a) Beneficial Ownership Reporting Compliance
In light of our status as a privately held company, Section 16(a) of the Securities Exchange Act of 1934, as amended, does not apply to our directors, executive officers or significant owners of our equity securities.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
This Compensation Discussion and Analysis is designed to provide an understanding of our compensation philosophy, core principles and arrangements that are applicable to the named executive officers listed in the Summary Compensation Table.
The named executive officers for fiscal year 2017 (the "named executive officers") are:
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Karen W. Katz, who serves as President and Chief Executive Officer and a member of the Parent Board and is our principal executive officer;
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James J. Gold, who serves as President, Chief Merchandising Officer;
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John E. Koryl, who serves as President, Neiman Marcus Stores and Online;
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Carrie M. Tharp, who serves as Senior Vice President and Chief Marketing Officer;
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T. Dale Stapleton, who serves as Interim Chief Financial Officer, Senior Vice President and Chief Accounting Officer and our principal financial officer;
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Michael Fung, who served as Interim Executive Vice President, Chief Financial Officer and Chief Operating Officer pursuant to a temporary consulting agreement during fiscal year 2017;
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Donald T. Grimes, former Executive Vice President, Chief Operating Officer and Chief Financial Officer; and
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Joshua G. Schulman, former President of Bergdorf Goodman and NMG International.
Compensation Philosophy and Objectives. We have been in business for over a century and are one of the largest luxury, multi-branded, omni-channel fashion retailers in the world. Our continued success depends on the skills of talented executives who are dedicated to achieving solid financial performance, providing outstanding service to our customers and managing our assets wisely. Our compensation program - comprised of base salary, annual bonus, long-term incentives and benefits - is designed to meet the following objectives:
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Recruit and retain executives who possess exceptional ability, experience and vision to sustain and promote our preeminence in the marketplace.
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Motivate and reward the achievement of our short- and long-term goals and operating plans.
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Align the interests of our executives with the financial and strategic objectives of our stockholders.
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Provide total compensation opportunities that meet the expectations of a highly skilled executive team, are aligned and consistent with our underlying performance, and are competitive with the compensation practices and levels offered by companies with whom we compete for executive talent.
Individual Compensation Components
Base Salary. Base salary is intended to provide a base level of compensation commensurate with an executive’s job title, role, tenure and experience. We utilize base salary as a building block of our compensation program, establishing a salary range for particular positions based on survey data and job responsibilities. Being competitive in base salary is a minimum requirement to recruit and retain skilled executives. Specifically, base salary levels of the named executive officers are determined based on a combination of factors, including our compensation philosophy, market compensation data, competition for key executive talent, the named executive officer’s experience, leadership, achievement of specified business objectives, individual performance, our overall budget for merit increases and attainment of our financial goals. Salaries are generally reviewed shortly after the end of each fiscal year as part of our performance and compensation review process as well as at other times to recognize a promotion, change in job responsibilities or performance. Merit increases are usually awarded to the named executive officers in the same percentage range as all employees and are based on overall performance and competitive market data, except in those situations where individual performance and other factors justify awarding increases above or below this range. Merit increases typically range between two and eight percent.
In addition, Ms. Katz and Mr. Gold have employment agreements, and Mr. Grimes had an employment agreement, that set minimum salaries, more fully described under the heading “Employment and Other Compensation Agreements” below. Mr. Fung had a consulting agreement that set forth the terms of his service, more fully described under the heading "Employment and Other Compensation Agreements" below.
Annual Incentive Bonus. Annual bonus incentives tied to short-term objectives form the second building block of our compensation program and are designed to provide incentives to achieve certain financial goals of the Company. Financial goals, which are used to determine annual bonus incentives for all employees, emphasize profitability and asset management. The Compensation Committee believes that a significant portion of annual cash compensation for the named executive officers should be at risk and tied to our operational and financial results.
All currently-serving named executive officers are eligible for annual bonus incentives. Threshold, target and maximum annual performance incentives, stated as a percentage of base salary, are established for each of the named executive officers at the beginning of each fiscal year. The objectives set for our named executive officers are based primarily on our overall financial results. When an executive officer has responsibility for a particular business unit or division, the performance goals also include the operational performance of that unit or division. Actual awards earned by the named executive officers are determined based on an assessment of our overall performance and a review of each named executive officer’s contribution to our overall performance. Other components may also be considered from time to time at the discretion of the Compensation Committee.
The employment agreements of Ms. Katz and Mr. Gold contain, and Mr. Grimes's employment agreement contained, provisions regarding target levels and the payment of annual incentives and are more fully described under the heading “Employment and Other Compensation Agreements” below.
Long-term Incentives. Long-term incentives in the form of stock options and restricted stock awards are intended to promote sustained high performance and to align our executives’ interests with those of our equity investors. As stock options create value for the executives, and restricted stock awards have increased value for our executives, if the value of our
Company increases, this creates a direct correlation between the interests of our executives and the interests of our equity investors.
Equity awards become effective on the date of grant, which typically coincides with the date of approval by the Compensation Committee or, if later, the date of a new hire or a promotion. We have no set practice as to when the Company makes equity grants, and we evaluate from time to time whether grants should be made.
The Parent Board made initial stock option grants on November 5, 2013 under the NM Mariposa Holdings, Inc. Management Equity Incentive Plan (the "Management Incentive Plan") to the named executive officers (other than Mr. Grimes, Ms. Tharp and Mr. Fung who had not yet joined us) and other senior officers. The initial stock option grants were made following the Acquisition to retain the senior management team and enable them to share in our growth along with our equity investors. The initial stock option grants were awarded at an exercise price of $1,000 per share and consisted of time-vested non-qualified stock options and performance-vested non-qualified stock options. The Compensation Committee granted time-vested non-qualified stock options and performance-vested non-qualified stock options to Ms. Tharp on October 27, 2016 in connection with her hiring and to Mr. Fung on February 6, 2017 in connection with his consulting engagement, in each case at an exercise price of $1,000 per share. Each grant of non-qualified stock options consists of options to purchase an equal number of shares of Class A Common Stock and Parent's Class B Common Stock, par value $0.001 per share ("Class B Common Stock" and together with Class A Common Stock, "Parent common stock"). On each of the first five anniversaries of the date of the grant, 20% of the time-vested non-qualified stock options vest and become exercisable, resulting in such stock options becoming fully vested and exercisable on the fifth anniversary date of the grant. The performance-vested non-qualified stock options vest on the achievement of certain performance hurdles. The stock options expire on the tenth anniversary date of the grant.
In October 2016, the Compensation Committee granted restricted shares of Parent common stock to each of the named executive officers (other than Mr. Fung, who had not joined us at that time). As used herein, a "restricted share" refers to one share of Class A Common Stock and one share of Class B Common Stock together. These restricted shares vest, subject to continued employment, in equal annual installments with the first vesting date on December 1, 2017. Restricted shares held by Ms. Katz, and Messrs. Gold and Koryl vest in four annual installments and restricted shares held by Ms. Tharp and Mr. Stapleton vest in three annual installments. During a limited period after each vesting date and subject to other limitations, each recipient will have the ability to require Parent to repurchase his or her vested shares for a purchase price equal to the fair market value of Parent common stock. The restricted shares were granted in order to provide an enhanced incentive for members of the executive team, including named executive officers, to continue providing service to us by providing them the potential to earn cash payments in the near-term for a portion of their equity awards.
Risk Assessment of Compensation Policies and Programs
We have reviewed our compensation policies and programs for all employees, including the named executive officers, and we do not believe that these policies and practices create risks that are reasonably likely to have a material adverse effect on the Company. The three major components of our overall compensation program were reviewed and the following conclusions were made:
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Base salaries are determined by an industry peer group analysis and on the overall experience of each individual. Merit increases are based on financial as well as individual performance and are generally kept within a specified percentage range for all employees, including the named executive officers.
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We grant long-term incentive awards in the form of stock option grants and restricted share awards to align the interests of participants with those of our equity investors.
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Annual incentive bonus awards are based on our Plan Earnings (as defined below under the heading "2017 Executive Officer Compensation") and sales. For Bergdorf Goodman, annual incentive bonus awards are based on Plan Earnings and sales of both the Company as a whole and Bergdorf Goodman specifically. The annual incentive bonus awards are all set at the beginning of each fiscal year based on the achievement of goals that the Compensation Committee believes will be challenging yet attainable. Maximum target payouts are capped at a pre-established percentage of base salary.
The Compensation Committee has the authority to adjust incentive plan payouts and the granting of stock option or restricted share awards, which may further reduce any business risk associated with such plan payouts and equity grants. The Compensation Committee also monitors compensation policies and programs to determine whether risk management objectives are being met.
Executive Officer Compensation
Process for Evaluating Executive Officer Performance
Role of the Compensation Committee. The Compensation Committee is responsible for determining the compensation of our named executive officers and for establishing, implementing and monitoring adherence to our executive compensation philosophy. The Compensation Committee charter authorizes the committee to retain and terminate compensation consultants to provide advice with respect to compensation of the named executive officers. The Compensation Committee is further authorized to approve the fees the Company will pay, and terms of engagement of, any consultant it may retain.
The Compensation Committee considers input from our CEO and compensation consultants in making determinations regarding our executive compensation program and the individual contribution of each of our named executive officers. The CEO does not play a role in decisions affecting her own compensation. The CEO’s performance and compensation are reviewed and determined solely by the Compensation Committee.
In developing and reviewing the executive incentive programs, the Compensation Committee considers the business risks inherent in program designs to ensure that they do not incentivize executives to take unacceptable levels of business risk for the purpose of increasing their incentive plan awards. The Compensation Committee intends for the plan design to be conservative in this respect and that the compensation components provide appropriate checks and balances to encourage executive incentives to be consistent with the interests of our equity investors. The Compensation Committee believes that the mix of compensation components used in the determination of our named executive officers’ total compensation does not encourage our named executive officers to take undesirable risks relating to the business. For further information, see “Risk Assessment of Compensation Policies and Programs” above.
Role of Management. As part of our annual planning process, the CEO, with assistance from external consultants, develops and recommends a compensation program for all executive officers. Based on performance assessments, the CEO attends a meeting of the Compensation Committee held for the purpose of considering each individual executive’s annual compensation and recommends the base salary and any incentive bonus awards or long-term incentive awards, if applicable, for each of the executive officers, including the other named executive officers. The CEO does not participate in the portion of the Compensation Committee meeting during which her own compensation is discussed and does not provide recommendations with respect to her own compensation package.
Role of the Compensation Consultants. The Compensation Committee generally retains the services of compensation consultants for limited purposes. Management retains an independent compensation consultant, Korn Ferry Hay Group, to provide comparative market data regarding executive compensation to assist the Compensation Committee in establishing reference points for the base salary, annual incentive and long-term incentive components of our compensation package. Korn Ferry Hay Group also provides information regarding general market trends in compensation, compensation practices of other retail companies and regulatory and compliance developments. Management also engaged W.T. Haigh and Company, Inc. on a limited basis in fiscal year 2017 to consult on long-term compensation design. The fees paid to Korn Ferry Hay Group and W.T. Haigh for their services in fiscal year 2017 did not exceed $120,000 in either case. Neither Korn Ferry Hay Group nor W.T. Haigh has any other affiliations with us, nor does either provide other services to us.
2017 Executive Officer Compensation
Ultimately, our named executive officers’ total compensation is based on the level of performance of the Company and/or the Company’s applicable business unit or division. The Compensation Committee uses its discretion in making decisions on the overall compensation packages of our executive officers based on current market conditions, business trends and overall Company performance.
We have identified an industry peer group that includes the 15 companies listed below for purposes of benchmarking the compensation of our named executive officers. These companies are intended to represent our competitors for business and talent. Their executive compensation programs are compared to ours, as is the compensation of individual executives if the jobs of such executives are sufficiently similar to make the comparison meaningful. The comparison data is generally intended to ensure that the compensation of our named executive officers, both individually and as a whole, is appropriately competitive relative to our performance. We believe that this practice is appropriate in light of the high level of commitment, job demands and the expected performance contribution required from each of our executive officers. We generally target our direct compensation to be positioned between the 50th and 75th percentile levels of the compensation packages received by executives in our peer group of industry related companies. In the first quarters of fiscal years 2018 and 2016, our compensation consultant, Korn Ferry Hay Group, conducted benchmarking reviews of the compensation of all of our senior officers,
including our named executive officers. No significant changes in design or levels of executive compensation were made with respect to fiscal year 2017 as a result of Korn Ferry Hay Group's most recent review.
Abercrombie & Fitch
Michael Kors
Coach
Nordstrom
The Gap
Ralph Lauren
Hudson's Bay
Restoration Hardware
J.C. Penney
Tiffany & Co.
Kohl’s
Urban Outfitters
L Brands (formerly Limited)
Williams-Sonoma
Macy's
In addition to benchmarking against the select companies above, we also review various third party compensation survey reports. The peer group also previously included Ann Inc. and Kate Spade. These two companies were removed from the benchmarking review in the first quarter of fiscal year 2018 as they had previously been acquired.
Base Salary. The table below shows the base salaries for fiscal years 2016 and 2017 for each of the named executive officers, except for Mr. Fung who was not an employee and received a monthly consulting fee of $60,000 in lieu of a salary. None of our named executive officers who were serving during fiscal year 2016 received a base salary increase for fiscal year 2017.
(1)
Ms. Tharp joined the Company in October 2016 and was not an executive officer during any part of fiscal year 2016; amount reflects her annualized base salary.
(2)
Mr. Grimes resigned effective November 14, 2016 and Mr. Schulman resigned effective May 10, 2017; amounts reflect their respective annualized base salaries during their employment.
Amounts actually earned by each of the named executive officers in fiscal years 2015, 2016 and 2017 are listed in the Summary Compensation Table.
In September 2017, the Compensation Committee approved a salary increase for Mr. Koryl to $700,000 annually, effective October 2017. The Compensation Committee approved the increase to align Mr. Koryl’s salary with market practices and to encourage the retention of Mr. Koryl’s services during the implementation of important strategic customer and other initiatives aimed at increasing sales. In determining Mr. Koryl’s increased salary the Compensation Committee considered Mr. Koryl’s expertise in online retail operations and information prepared by Korn Ferry Hay Group concerning market-competitive compensation within the peer group.
Annual Incentive Bonus. In determining annual incentive bonus amounts for the named executive officers, the Compensation Committee considers their performance relative to the pre-established goals that are set at the beginning of the fiscal year. The Compensation Committee set the threshold, target and maximum performance targets at levels they believed were challenging, yet attainable, based on historical company performance and industry and market conditions. Goals were established at the division and business unit levels where appropriate for each of the named executive officers. As it relates to our annual incentive compensation program, this performance assessment is a key variable in determining the amount of total compensation paid to our named executive officers.
Fiscal year 2017 target annual incentives and relative performance weights for the named executive officers were as follows (as a non-employee consultant, Mr. Fung did not participate in the annual incentive bonus plan):
(1)
Ms. Tharp joined the Company in October 2016.
(2)
Mr. Grimes resigned effective November 14, 2016 and Mr. Schulman resigned effective May 10, 2017.
(3)
Since Mr. Schulman had responsibility over Bergdorf Goodman, 50% of his performance goals were to be based on the results of Bergdorf Goodman.
Ms. Katz, the individual with the greatest overall responsibility for company performance, was granted the largest incentive opportunity in comparison to her base salary to weight her annual cash compensation mix more heavily towards performance-based compensation.
Corporate Performance Targets. At the end of each fiscal year, the Compensation Committee evaluates the Company’s performance against the financial and strategic performance targets set at the beginning of the fiscal year.
Metrics used for each executive, as well as the relative weights assigned to the metrics, are based on strategic business drivers of the particular business unit or division that the executive manages. For fiscal year 2017, such metrics were based on Plan Earnings (as defined below) and sales. Bonus payout percentages for fiscal year 2017 are as follows:
We define Plan Earnings as earnings before interest, taxes, depreciation, amortization and impairment charges, further adjusted to eliminate the effects of items the Compensation Committee does not consider in assessing the Company's ongoing performance such as non-cash stock-based compensation expense, certain advisory and other fees, and certain other expenses.
2017 Annual Incentive Bonus. Actual operating performance for fiscal year 2017 for each of the Neiman Marcus Group and Bergdorf Goodman was below the applicable performance thresholds set at the beginning of the year, and therefore no annual incentive bonus amounts were paid to any of the named executive officers with respect to either operating division.
Ms. Katz and Mr. Gold have minimum threshold, target and maximum percentages of incentive payouts pursuant to their employment agreements. These employment agreements are more fully described under “Employment and Other Compensation Agreements.”
2017 Discretionary Bonuses. After careful consideration of our results of operations and their respective performance, the Compensation Committee approved discretionary bonuses of $75,000 each to Mr. Gold and Mr. Koryl for fiscal year 2017.
The Compensation Committee awarded these amounts in recognition of the strategic leadership that Messrs. Gold and Koryl demonstrated in fiscal year 2017 during continued challenges in the retail environment.
2017 Retention Bonuses. In February 2017, the Compensation Committee approved retention bonuses for Ms. Tharp and Mr. Stapleton. Bonuses of $172,000 to Ms. Tharp and $225,000 to Mr. Stapleton will be paid in January 2018, subject to their respective continued employment with the Company on the payment date.
The Compensation Committee determined to award these bonuses to Ms. Tharp and Mr. Stapleton and determined the respective amounts in recognition of the importance of their respective roles to the Company’s pursuit of certain important customer and strategic initiatives in fiscal year 2017 and the first part of fiscal year 2018 and to secure the retention of their services during that time.
Co-Invest Options. At the time of the Acquisition, we had outstanding vested and unvested stock options (referred to as "Predecessor Stock Options"). Certain management employees including the named executive officers that were employed by us at the time elected to exchange a portion of their Predecessor Stock Options for stock options to purchase shares of Parent (the "Co-Invest Options"). The Co-Invest Options are fully vested. The number of stock options and exercise prices were adjusted pursuant to an exchange ratio in connection with the Acquisition. The Co-Invest Options are exercisable at any time prior to the applicable expiration dates related to the original grant of the Predecessor Stock Options. The Co-Invest Options contain sale and repurchase provisions that expire upon an initial public offering.
On September 8, 2017, the Compensation Committee approved grants of non-qualified Co-Invest Options (the “New Co-Invest Options”) to the named executive officers who previously held Co-Invest Options. The New Co-Invest Options have the effect of replacing the previous Co-Invest Options held by those named executive officers, which were cancelled, and extending the expiration date to the tenth anniversary of the grant date. All other terms of the New Co-Invest Options remain unchanged from the terms of the cancelled Co-Invest Options.
Parent Stock Options. On November 5, 2013, the Parent Board granted time-vested non-qualified stock options and performance-vested non-qualified stock options to the named executive officers that were employed by us at the time pursuant to the Management Incentive Plan. Each grant of non-qualified stock options consists of options to purchase an equal number of shares of Class A Common Stock and Class B Common Stock. The size of stock option grants to the named executive officers in connection with the Acquisition was determined by the Parent Board based on the experience of its members in establishing compensation for companies across multiple industries, as well as the input of the Company’s CEO, who has significant experience in the Company’s industry and a deep understanding of the respective duties and responsibilities of the named executive officers. At the time of the Acquisition, the Parent Board determined the size of the grant of stock options to Ms. Katz. The Parent Board or Compensation Committee also, in consultation with Ms. Katz, determined the sizes of the grants of stock options to the other named executive officers.
The Compensation Committee granted time-vested non-qualified stock options and performance-vested non-qualified stock options pursuant to the Management Incentive Plan on October 27, 2016 to Ms. Tharp in connection with her hiring, and on February 6, 2017 to Mr. Fung in connection with his engagement as Interim Executive Vice President, Chief Financial Officer and Chief Operating Officer.
Subject to continued employment, 20% of the time-vested non-qualified stock options vest and become exercisable on each of the first five anniversaries of the date of the grant (or, in the case of Ms. Tharp and Mr. Fung, their respective start dates), resulting in such options becoming fully vested and exercisable on the fifth anniversary of such applicable date. The performance-vested options vest on the achievement of certain performance hurdles. In September 2016, the Compensation Committee approved amendments to the performance-vested options to revise the performance hurdles. As amended, the performance-vested options vest when the amount of capital returned to the Sponsors with respect to their shares (at least 50% of which is in cash) exceeds the applicable multiple of the capital invested by the Sponsors, and the internal rate of return exceeds ten percent. The applicable multiple with respect to 40% of the performance-vested options is 1.5x; with respect to 30% of the performance-vested options is 1.75x; and with respect to 30% of the performance-vested options is 2.25x. These time-vested and performance-vested non-qualified stock options were granted at an exercise price of $1,000 per share and such options will expire no later than the tenth anniversary of the grant date. The time-vested non-qualified stock options and the performance-vested non-qualified stock options contain sale and repurchase provisions (including repurchase provisions in the event of a participant's termination of employment) that expire upon an initial public offering.
In September 2016, the Compensation Committee determined that the exercise prices of the time-vested and performance-vested non-qualified stock options that were originally granted to Mr. Grimes at $1,205 per share were
substantially higher than the fair market value of Parent common stock as of September 2016. In order to enhance the retentive value of these options, the Compensation Committee approved a repricing of these options to an exercise price of $1,000 per share, which is the same as the exercise price of the time-vested and performance-vested non-qualified stock options held by the other named executive officers. These options were forfeited upon Mr. Grimes's resignation in November 2016.
Restricted Share Awards. On October 27, 2016, the Compensation Committee granted restricted shares of Parent common stock to each of the named executive officers (other than Mr. Fung, who had not joined us at that time and did not receive such an award due to his status as an interim consultant). These restricted shares vest, subject to continued employment, in equal annual installments with the first vesting date on December 1, 2017. Restricted shares held by Ms. Katz, Mr. Gold and Mr. Koryl vest in four annual installments and restricted shares held by Ms. Tharp and Mr. Stapleton vest in three annual installments. During a limited period after each vesting date and subject to other limitations, each recipient will have a put right to require Parent to repurchase his or her vested shares for a purchase price equal to the fair market value of Parent’s common stock. Except for certain termination acceleration provisions in Ms. Katz's award described below under "Employment and Other Compensation Agreements - Option and Restricted Stock Agreements with Ms. Katz," a recipient will forfeit all unvested restricted shares and may not exercise the put right with respect to any vested shares following the termination of his or her employment for any reason. The restricted shares are subject to certain repurchase provisions that expire upon an initial public offering.
Other Compensation Components
We maintain the following compensation components to provide a competitive total rewards package that supports retention of key executives.
Health and Welfare Benefits. Executive officers are eligible to participate under the same plans as all other eligible employees for medical, dental, vision, disability and life insurance. The named executive officers also receive benefits under a supplemental medical policy available to our senior executives. These benefits are intended to be competitive with benefits offered in the retail industry.
Pension Plan. Prior to 2008, most non-union employees over age 21 who had completed one year of service with 1,000 or more hours participated in our defined benefit pension plan (referred to as the "Pension Plan"), which paid benefits upon retirement or termination of employment. The Pension Plan is a “career-accumulation” plan, under which a participant earns each year a retirement annuity equal to one percent of his or her compensation for the year up to the Social Security wage base and one and a half percent of his or her compensation for the year in excess of such wage base. A participant becomes fully vested after five years of service with us. Effective as of December 31, 2007, eligibility and benefit accruals under the Pension Plan were frozen for all participants except for those “Rule of 65” employees who elected to continue participation in the Pension Plan. “Rule of 65” employees included only those active employees who had completed at least ten years of service and whose combined years of service and age equaled at least 65 as of December 31, 2007. Ms. Katz was a “Rule of 65” employee as of December 31, 2007, and elected to continue participation in the Pension Plan. For Mr. Gold and Mr. Stapleton, benefits and accruals under the Pension Plan were frozen effective as of December 31, 2007. Effective August 1, 2010, all benefits and accruals under the Pension Plan were frozen and all remaining participants were moved into our Retirement Savings Plan (referred to as the "RSP"), a new enhanced 401(k) plan. Ms. Katz’s benefits and accruals under the Pension Plan were moved into the RSP effective December 31, 2010.
Savings Plans. Effective January 1, 2008, our RSP was established and offered to all employees, including the named executive officers, as the primary retirement plan. Benefits and accruals under a previous 401(k) plan, our Employee Savings Plan (referred to as the "ESP"), as well as benefits and accruals under the Pension Plan, were frozen as of that date. All future and current employees who were not already enrolled in the ESP were automatically enrolled in the RSP. “Rule of 65” employees, as described above, were given a choice to either continue participation in the Pension Plan and the ESP or freeze what was earned under those plans through December 31, 2007 and participate in the RSP. The RSP is a tax-qualified defined contribution 401(k) plan that allows participants to contribute up to the limit prescribed by the Internal Revenue Service on a pre-tax basis. The Company matches 100% of the first 3% and 50% of the next 3% of pay that is contributed to the RSP. All employee contributions to the RSP are fully vested upon contribution. Company matching contributions vest after two years of service. The Company matched 100% of the first 2% and 25% of the next 4% of pay that was contributed to the ESP. All employee contributions to the ESP were fully vested upon contribution. Company matching contributions vested after three years of service. Effective August 1, 2010, benefits and accruals under the ESP were frozen for the remaining “Rule of 65” active employees and such participants were moved into the RSP. Messrs. Koryl and Schulman became eligible to participate in the RSP one year after their respective hire dates. Mr. Grimes became eligible to participate in the RSP on his hire date and the Company began matching his contributions on January 15, 2016.
Supplemental Retirement Plan and Key Employee Deferred Compensation Plan. U.S. tax laws limit the amount of benefits that we can provide under our tax-qualified plans. We maintain our Supplemental Executive Retirement Plan (referred to as the "SERP Plan") and our Key Employee Deferred Compensation Plan (referred to as the "KEDC Plan"), which are unfunded, non-qualified arrangements intended to provide the named executive officers and certain other key employees with additional benefits, including the benefits that they would have received under the RSP if the tax law limitations did not apply and if certain other components of compensation could be included in calculation of benefits under our tax-qualified plans. Prior to 2008, executive, administrative and professional employees (other than those employed as salespersons) with an annual base salary at least equal to a minimum established by the Company were eligible to participate in the SERP Plan. Similar to the Pension Plan, effective December 31, 2007, eligibility and benefit accruals under the SERP Plan were frozen for all participants not meeting the “Rule of 65” and such participants were moved into our Defined Contribution Supplemental Executive Retirement Plan ("DC SERP"). Effective August 1, 2010, all benefits and accruals under the SERP Plan for “Rule of 65” employees were frozen and such participants were moved into the DC SERP. SERP Plan related benefits are more fully described under “Pension Benefits.”
Participation in the KEDC Plan is limited to employees whose base salary is in excess of $300,000 and who meet other stated criteria. Amounts in excess of those benefits provided under the 401(k) plans are credited to the account balances of each KEDC Plan participant. KEDC Plan benefits are more fully described under “Non-qualified Deferred Compensation.”
Matching Gift Program. All employees, including the named executive officers, may participate in our matching gift program. Under the program, we will match charitable contributions by employees up to a maximum of $2,000 per qualifying organization on a two-for-one basis in each calendar year. For any contribution made to a qualifying organization in which the employee has an active involvement (as evidenced by service on the organization’s governing body or in one of its working committees), the basis of our matching contribution may, upon application by the employee, be increased to a level greater than two-for-one.
Perquisites. We provide perquisites and other personal benefits that we believe are reasonable and consistent with the nature of individual responsibilities to provide a competitive level of total compensation to our executives. We believe the level of perquisites is within an acceptable range of what is offered by a group of industry related companies. The Compensation Committee believes that these benefits are aligned with the Company’s desire to attract and retain highly skilled management talent for the benefit of all stockholders. The value of these benefits to the named executive officers is set forth in the Summary Compensation Table under the column “All Other Compensation” and details about each benefit are set forth in a table following the Summary Compensation Table.
Compensation Following Employment Termination or Change of Control
Employment Agreements. To support the continuity of senior leadership, we have employment agreements with Ms. Katz and Mr. Gold that provide, among other things, for payments to the executive following a termination of employment by the executive for “good reason” or a termination of the executive’s employment by us without “cause.” The triggering events constituting “good reason” and “cause” were negotiated to provide protection to us in the event of certain terminations of employment that could cause harm to us as well as to provide protection to the executive. The employment agreements for Ms. Katz and Mr. Gold also provide for certain payments to the executives upon death or “disability.” The employment agreements for Ms. Katz and Mr. Gold also contain restrictive covenant provisions to protect the Company. For a detailed description of the terms of the employment agreements, see “Employment and Other Compensation Agreements.”
Confidentiality, Non-Competition and Termination Benefits Agreements. Each of Messrs. Koryl and Stapleton and Ms. Tharp is a party to a confidentiality, non-competition and termination benefits agreement with us and intended to protect the Company. The confidentiality, non-competition and termination benefits agreements provide for severance benefits if the employment of the affected individual is terminated by us other than for death, “disability,” or “cause” or by the executive for "good reason." Mr. Koryl's and Mr. Stapleton's agreements provide for severance payments equal to one and one-half of their respective annual base salary, payable over an 18-month period, and reimbursement for COBRA premiums for the same period. Ms. Tharp's agreement provides for a severance payment equal to annual base salary, payable over a 12-month period, and reimbursement for COBRA premiums for the same period.
Other. We have change of control provisions in the Management Incentive Plan that allow the Parent Board or Compensation Committee to accelerate the vesting of equity awards upon a change of control.
Consideration of Tax and Accounting Treatment of Compensation
As a general matter, the Parent Board and the Compensation Committee review and consider the various tax and accounting implications of compensation programs we utilize.
Accounting for Stock-Based Compensation. We account for stock-based payments in accordance with the provisions of ASC Topic 718, “Compensation-Stock Compensation.” When setting equity compensation, the Compensation Committee considers the estimated cost for financial reporting purposes of any equity compensation it is considering. However, the accounting impact does not have a material impact on the design of our equity compensation plan.
Compensation Committee Interlocks and Insider Participation
As noted above, the members of the Compensation Committee are currently Mr. Eadie and Mr. Kaplan, who serves as its Chairman. None of our executive officers currently serve, or in the past year have served, as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on the Parent Board or the Compensation Committee.
COMPENSATION COMMITTEE REPORT
The Compensation Committee has reviewed and discussed with management the above Compensation Discussion and Analysis. Based on our review and discussions with management, the Compensation Committee recommended to the Parent Board that the Compensation Discussion and Analysis be included in this Report.
COMPENSATION COMMITTEE
David Kaplan
Graeme Eadie
Summary Compensation Table
The following table sets forth the annual compensation for the named executive officers.
(1)
The amounts for Messrs. Gold and Koryl for fiscal year 2017 represent discretionary bonuses described above under "Compensation Discussion and Analysis - 2017 Executive Officer Compensation - 2017 Discretionary Bonuses." The amounts for Messrs. Gold, Koryl, Grimes and Schulman for fiscal year 2016 represent discretionary bonuses. The amount for Mr. Grimes for fiscal year 2015 represents a one-time signing bonus pursuant to the terms and conditions of his employment agreement.
(2)
The amounts reflect the aggregate grant date fair value for the awards computed in accordance with ASC Topic 718. These amounts reflect the grant date fair value and do not represent the actual value that may be realized by the named executive officers.
In September 2016, the Compensation Committee approved amendments to the performance-vested options to revise the performance hurdles. No incremental fair value was recognized in connection with these amendments.
Also in September 2016, the Compensation Committee repriced the exercise price of options to purchase 11,000 shares held by Mr. Grimes from $1,205 per share to $1,000 per share. The incremental fair value of such stock options is reported in this column for Mr. Grimes in accordance with FASB ASC Topic 718.
(3)
The amounts reported in the Non-Equity Incentive Plan Compensation column reflect the actual amounts earned under the performance-based annual cash incentive compensation plan described under “Annual Incentive Bonus.”
(4)
The amounts in this column represent the change in the actuarial value of the named executive officers’ benefits under our retirement and supplemental executive retirement plans from July 31, 2016 to July 29, 2017. This “change in the actuarial value” is the difference between the fiscal year 2016 and fiscal year 2017 present value of the pension benefits accumulated as of year-end by the named executive officers, assuming that the benefit is not paid until age 65. These amounts were computed using the same assumptions used for financial statement reporting purposes under ASC Subtopic 715-30, “Defined Benefit Plans - Pension” as described in Note 11 of the Notes to Consolidated Financial Statements.
Ms. Katz, Mr. Gold and Mr. Stapleton are the only named executive officers that participate in our retirement and supplemental executive retirement plans as of July 29, 2017. The actuarial value of such named executive officers’ benefits under our retirement and supplemental executive retirement plans decreased from July 31, 2016 to July 29, 2017 by $178,000, $51,000 and $18,000, respectively. Also included in this column for Ms. Katz is $4,363 of earnings in the Key Employee Deferred Compensation Plan that were in excess of 120% of the federal long-term rate for the period from July 31, 2016 to July 29, 2017.
(5)
Includes all items listed in the following table entitled “All Other Compensation.” The value of perquisites and other personal benefits is provided in this column and in the footnotes below even if the amount is less than the reporting threshold established by the SEC.
The table below sets forth all other compensation for each of the named executive officers.
(1)
The amount for Ms. Katz reflects an annual payment of $15,000 in lieu of reimbursement for New York accommodations, as well as a tax gross-up for associated income taxes, paid pursuant to Ms. Katz’s employment contract. The amount for Mr. Gold reflects an annual payment of $7,500 in lieu of reimbursement for New York accommodations, as well as a tax gross-up for associated income taxes, pursuant to an arrangement with Mr. Gold.
(2)
The amounts shown represent gross-up payments made in connection with New York non-resident taxes.
(3)
Amount represents reimbursements for Mr. Fung's temporary living expenses in Dallas, Texas.
(4)
Amount represents reimbursements for the costs of commuting to and from Mr. Fung's personal residence in Austin, Texas to our corporate headquarters in Dallas, Texas, and for miscellaneous personal expenses in connection with his provision of services to us in Dallas.
Grants of Plan-Based Awards
The following table sets forth the non-equity incentive plan awards to our named executive officers for fiscal year 2017 that could have been payable pursuant to our annual incentive bonus and equity awards granted pursuant to our long-term equity plans.
(1)
Non-equity incentive plan awards represent the threshold, target and maximum opportunities under our performance-based annual incentive bonus program for fiscal year 2017. The actual amounts earned under this plan are disclosed in the Summary Compensation Table. For a detailed discussion of the annual incentive awards for fiscal year 2017, see “2017 Executive Officer Compensation - Annual Incentive Bonus.” Mr. Grimes and Mr. Schulman's annual incentive awards were forfeited upon their resignations from the Company in November 2016 and May 2017, respectively.
(2)
Represents the number of restricted shares granted to each of our named executive officers during fiscal year 2017 other than Mr. Fung. For a description of the terms of the restricted shares, see "2017 Executive Officer Compensation - Restricted Share Awards" above. Mr. Grimes and Mr. Schulman's restricted share awards were forfeited without compensation upon their departures from the Company in November 2016 and May 2017, respectively.
(3)
Represents time-vested non-qualified stock options awarded in fiscal year 2017 pursuant to the Management Incentive Plan. The time-vested options vest 20% on each of the first five anniversaries of the date of the recipient's start date, resulting in the options becoming fully vested on the fifth anniversary date of the start date, and expire on the tenth anniversary of the grant date. For a detailed discussion, see “Long-term Incentives” and “Stock Options.”
(4)
Represents performance-vested non-qualified stock options awarded in fiscal year 2017 pursuant to the Management Incentive Plan. The performance-vested non-qualified options expire on the tenth anniversary of the grant date. The performance-vested options vest on the achievement of certain performance hurdles. The performance-vested options vest when the amount of capital returned to the Sponsors (at least 50% of which is in cash) exceeds the applicable multiple of the capital invested by the Sponsors, and the internal rate of return exceeds 10%. The applicable multiple with respect to 40% of the performance-vested options is 1.5x, with respect to 30% of the performance-vested options
is 1.75x and with respect to 30% of the performance-vested options is 2.25x. For a detailed discussion, see “Long-term Incentives” and “Stock Options.”
(5)
Because we were privately held and there was no public market for Parent common stock, the exercise price of the stock options was determined by the Parent Board or Compensation Committee, as applicable, at the time option grants are awarded and was in excess of the fair market value of Parent common stock. In determining the fair market value of Parent common stock, the Parent Board or the Compensation Committee, as applicable, considered such factors as any recent transactions involving Parent common stock, our actual and projected financial results, the principal amount of our indebtedness, valuations of us performed by third parties and other factors it believes are material to the valuation process.
(6)
For option and restricted share awards in fiscal year 2017, these amounts reflect the aggregate grant date fair value for the awards computed in accordance with ASC Topic 718. The assumptions used in calculating these amounts are described under the caption Stock-Based Awards in Note 14 of the Notes to Consolidated Financial Statements. On September 6, 2016, the Compensation Committee repriced the exercise price of options to purchase 11,000 shares held by Mr. Grimes from $1,205 per share to $1,000 per share. Amount reported in this column for Mr. Grimes includes the incremental fair value of such stock options calculated in accordance with FASB ASC Topic 718.
(7)
Represents time-vested non-qualified stock options initially awarded in fiscal year 2015 to Mr. Grimes under the Management Incentive Plan and repriced in September 2016 as described in footnote (6) above.
(8)
Represents performance-vested non-qualified stock options initially awarded in fiscal year 2015 to Mr. Grimes under the Management Incentive Plan and repriced in September 2016 as described in footnote (6) above.
Outstanding Equity Awards at Fiscal Year End
The following table sets forth certain information regarding the total number and aggregate value of stock options held by each of our named executive officers at the end of fiscal year 2017.
(1)
Non-qualified Co-Invest Options rolled over from Predecessor Stock Options as a result of the Acquisition with number of options and exercise prices adjusted pursuant to an exchange ratio. The Co-Invest Options are fully vested and exercisable at any time prior to the expiration dates related to the original grant of the Predecessor Stock Options. Co-Invest Options and Predecessor Stock Options are more fully described in the sections entitled “Co-Invest Options” and “Predecessor Stock Options.” On September 8, 2017, the Co-Invest Options reported in this table were replaced by grants of New Co-Invest Options with the effect of extending the expiration date to the tenth anniversary of the grant date, but otherwise with the same terms.
(2)
Non-qualified stock options designated as time-vested stock options granted pursuant to the Management Incentive Plan on November 5, 2013 at an exercise price of $1,000. Each grant of time-vested stock options consists of options to purchase an equal number of shares of Class A Common Stock and Class B Common Stock. Subject to continued employment, 20% of the time-vested non-qualified options vest and become exercisable on each of the first five anniversaries of the closing date of the Acquisition, resulting in such options becoming fully vested and exercisable on October 25, 2018. The time-vested stock options expire on the tenth anniversary of the grant date.
(3)
Non-qualified stock options designated as performance-vested stock options granted pursuant to the Management Incentive Plan on November 5, 2013 at an exercise price of $1,000. The performance-vested options vest on the achievement of certain performance hurdles. In September 2016, the Compensation Committee approved amendments to the performance-vested options to revise the performance hurdles. As amended, the performance-vested options vest when the amount of capital returned to the Sponsors (at least 50% of which is in cash) exceeds the applicable multiple of the capital invested by the Sponsors, and the internal rate of return exceeds ten percent. The applicable multiple with respect to 40% of the performance-vested options is 1.5x, with respect to 30% of the performance-vested options is 1.75x and with respect to 30% of the performance-vested options is 2.25x. If the named executive’s officer employment is terminated by us without cause or by the named executive officer for good reason, the performance-vested stock options will be eligible to vest in connection with a change in control or initial public offering for 180 days following such termination. If Ms. Katz's employment is terminated as a result of her retirement after the third anniversary of the grant date, certain of her awards remain eligible to vest following such retirement. Each grant of performance-vested non-qualified stock options consists of options to purchase an equal number of shares of Class A Common Stock and Class B Common Stock.
(4)
Restricted shares granted October 27, 2016. These restricted shares vest, subject to continued employment, in equal annual installments with the first vesting date on December 1, 2017. Restricted shares held by Ms. Katz, and Messrs. Gold and Koryl vest in four equal annual installments and restricted shares held by Ms. Tharp and Mr. Stapleton vest in three equal annual installments.
(5)
There is no public market for our common stock. Amounts reported in this column are based on the fair market value of our Class A Common Stock and Class B Common Stock as of April 30, 2017, the most recent practicable date prior to July 29, 2017.
(6)
In February 2017, Mr. Koryl transferred all of the equity awards reported in this table to trusts for the benefit of his family for no consideration.
(7)
Non-qualified stock options designated as time-vested stock options granted pursuant to the Management Incentive Plan on October 27, 2016 at an exercise price of $1,000. Each grant of time-vested stock options consists of options to purchase an equal number of shares of Class A Common Stock and Class B Common Stock. Subject to continued employment, 20% of the time-vested non-qualified options vest and become exercisable on each of the first five anniversaries of October 3, 2016, resulting in such options becoming fully vested and exercisable on October 3, 2021. The time-vested stock options expire on the tenth anniversary of the grant date.
(8)
Non-qualified stock options designated as performance-vested stock options granted pursuant to the Management Incentive Plan on October 27, 2016 at an exercise price of $1,000. The performance-vested stock options vest on the achievement of the performance hurdles described in footnote (4) to this table. If Ms. Tharp's employment is terminated by us without cause or by her for good reason, the performance-vested stock options will be eligible to vest in connection with a change in control or initial public offering for 30 days following such termination. Each grant of performance-vested non-qualified stock options consists of options to purchase an equal number of shares of Class A Common Stock and Class B Common Stock.
(8)
Each of Messrs. Fung, Grimes and Schulman forfeited his outstanding equity awards without consideration upon his respective departure from the Company, with the exception of Mr. Schulman's co-invest options.
Option Exercises and Stock Vested
No stock options issued to our named executive officers were exercised and no restricted shares vested during fiscal year 2017.
Pension Benefits
The following table sets forth certain information with respect to retirement payments and benefits under the Pension Plan and the SERP Plan for each of our named executive officers.
(1)
Computed as of July 29, 2017, which is the same pension measurement date used for financial statement reporting purposes with respect to our Consolidated Financial Statements and notes thereto.
(2)
For purposes of calculating the amounts in this column, retirement age was assumed to be the normal retirement age of the later of age 65 or the fifth anniversary of the individual’s "date of hire," as defined in the Pension Plan. A description of the valuation method and all material assumptions applied in quantifying the present value of accumulated benefit is set forth in Note 11 of the Notes to Consolidated Financial Statements.
(3)
Ms. Katz’s service credit exceeds the 25-year maximum set forth in the SERP Plan. Pursuant to an agreement with us, Ms. Katz was entitled to an additional year of credit for each full year of service after she reached the 25-year maximum until December 31, 2010, with all service frozen as of such date. In addition, if her employment is terminated by us for any reason other than death, “disability,” “cause,” if we do not renew her employment term, or if she terminates her employment with us for “good reason” or “retirement” and she has not yet reached 65, her SERP Plan benefit will not be reduced solely by reason of her failure to reach 65 as of the termination date. Ms. Katz’s employment agreement also provides that the amount credited to her under the DC SERP shall not be less than the present value of the additional benefits she would have accrued under the SERP Plan after December 31, 2010 had the SERP Plan remained in effect through the end of her employment term. The value of Ms. Katz’s benefit with all service is $5,209,000. The value with 25 years of service under the SERP Plan is $4,984,000; therefore, the value of the additional year of service in excess of her actual service is $225,000.
(4)
Effective December 31, 2007, benefit accruals for Mr. Gold and Mr. Stapleton under the Pension Plan and the SERP Plan were frozen, as further described below.
The Pension Plan is a funded, tax-qualified pension plan. Prior to 2008, most non-union employees over age 21 who had completed one year of service with 1,000 or more hours were eligible to participate in the Pension Plan, which paid benefits upon retirement or termination of employment. Effective as of December 31, 2007, eligibility and benefit accruals under the Pension Plan were frozen for all participants except for those “Rule of 65” employees who elected to continue participating in the Pension Plan. The Pension Plan is a “career-accumulation” plan, under which a participant earns each year a retirement annuity equal to one percent of his or her compensation for the year up to the Social Security wage base and 1.5 percent of his or her compensation for the year in excess of such wage base. “Compensation” for this purpose generally includes salary, bonuses, commissions and overtime but not in excess of the limits imposed upon annual compensation under
Section 401(a)(17) of the Internal Revenue Code of 1986, as amended (the "Code") (the "IRS Limit"). The IRS Limit for calendar year 2017 is $270,000, increased from $265,000 in calendar year 2016, and is generally adjusted annually for cost-of-living increases. Benefits under the Pension Plan become fully vested after five years of service with us. Effective August 1, 2010, benefit accruals were frozen for the remaining “Rule of 65” employees and such participants were given the opportunity to participate in the RSP.
The SERP Plan is an unfunded, non-qualified plan under which benefits are paid from our general assets to supplement Pension Plan benefits and Social Security. Prior to 2008, executive, administrative and professional employees (other than those employed as salespersons) with an annual base salary at least equal to a minimum established by the Company were eligible to participate. Similar to the Pension Plan, effective December 31, 2007, eligibility and benefit accruals under the SERP Plan were frozen for all participants except for those “Rule of 65” employees who elected to continue participating in the Pension Plan. At normal retirement age (the later of age 65 and the fifth anniversary of the participant’s date of hire), an eligible participant with 25 or more years of service is entitled to full benefits in the form of monthly payments under the SERP Plan computed as a straight life annuity, equal to 50 percent of the participant’s average monthly compensation for the highest consecutive 60 months preceding retirement less 60 percent of his or her estimated annual primary Social Security benefit, offset by the benefit accrued by the participant under the Pension Plan. The amount is then adjusted actuarially to determine the actual monthly payments based on the time and form of payment. For this purpose, “compensation” includes salary but does not include bonuses. If the participant has fewer than 25 years of service, the combined benefit is proportionately reduced. Benefits under the SERP Plan become fully vested after five years of service. The SERP Plan is designed to comply with the requirements of Section 409A of the Code. Along with the Pension Plan and the ESP, benefit accruals under the SERP Plan were frozen for the remaining “Rule of 65” employees effective August 1, 2010 and those remaining participants were given the opportunity to participate in the DC SERP.
Non-qualified Deferred Compensation
The amounts reported in the table below represent deferrals, distributions and Company matching contributions credited pursuant to the KEDC Plan and Company contributions credited pursuant to the DC SERP (the "Executive Contributions"). The following table contains information regarding the KEDC and the DC SERP.
(1)
The amounts reported as Executive Contributions in Last Fiscal Year are also included as Salary in the Summary Compensation Table.
(2)
Ms. Tharp will become eligible to participate in the DC SERP in January 2018, the first January after the one-year anniversary of her start date.
The KEDC Plan allows eligible employees to elect to defer up to 15% of base pay and up to 15% of annual performance bonus each year. Eligible employees generally are those employees who have completed one year of service with us, have annual base pay of at least $300,000 and are otherwise designated as eligible by our employee benefits committee; provided, however, that effective January 1, 2008, only those persons who were eligible for the KEDC as of January 1, 2007 are permitted to continue participating in the KEDC. No new participants will be added. We also credit a matching contribution each pay period equal to (A) the sum of (i) 100% of the sum of the employee’s KEDC Plan deferrals and the maximum RSP deferral that the employee could have made under such plan for such pay period, to the extent that such sum does not exceed 2% of the employee’s compensation for such pay period, and (ii) 25% of the sum of the employee’s KEDC Plan deferrals and the maximum RSP deferral that the employee could have made under such plan for such pay period, to the extent that such sum does not exceed the next 4% of the employee’s compensation for such pay period, minus (B) the maximum possible match the employee could have received under the RSP for such pay period. Such amounts are credited to a bookkeeping account for the employee and are fully vested with respect to matching contributions made for calendar years prior to 2008. Amounts attributable to matching contributions, plus interest thereon, for calendar years on and after 2008 are subject to forfeiture if the employee is terminated for cause. Accounts are credited monthly with interest at an annual rate equal to the prime interest rate published in The Wall Street Journal on the last business day of the preceding calendar quarter. Amounts credited to an employee’s account become payable to the employee upon separation from service, death, unforeseeable emergency, or our change of control. In the event of separation of service, payment is made in a lump sum in the calendar quarter following the calendar quarter in which the separation occurs although if the employee is eligible for retirement upon such separation, payment may be deferred until the following year or the nine subsequent years, and may be made in a lump sum or in installments over a period of up to ten years, depending upon the distribution form elected by the employee. There is no separate funding for the amounts payable under the KEDC Plan, rather we make payment from our general assets.
The DC SERP is an unfunded, non-qualified deferred compensation plan under which benefits are paid from our general assets to provide eligible employees with the opportunity to receive employer contributions on the portion of their eligible compensation that exceeds the IRS Limit. Eligible employees generally are those employees who have completed one year of service with the Company, who have annual base pay of at least 80% of the IRS Limit (or were eligible to participate in the SERP Plan as of December 31, 2007 and ceased to be eligible to participate in the SERP Plan as of January 1, 2008), and who are otherwise designated as eligible by our employee benefits committee. We will make transitional and non-transitional credits to the accounts of eligible participants each pay period. Transitional credits apply only to participants who were eligible to participate in the SERP Plan as of December 31, 2007 but ceased participating in the SERP Plan as of that date and became a participant in the DC SERP on January 1, 2008. The amount of a transitional credit is the product of a participant’s eligible compensation in excess of the IRS Limit and an applicable percentage ranging from 0% to 6% depending upon the age of the participant. Non-transitional credits apply to all eligible participants. The amount of a non-transitional credit is the product of a participant’s eligible compensation in excess of the IRS Limit and 10.5%. All transitional and non-transitional credits are credited to a bookkeeping account and vest upon the earlier of (i) an eligible employee’s attainment of five years of service, (ii) an eligible employee’s attainment of age 65, (iii) an eligible employee’s death, (iv) an eligible employee’s "disability," and (v) a change of control (as defined in the DC SERP) while in our employ. Notwithstanding the preceding, amounts credited to an account are subject to forfeiture if the employee is terminated for cause. Accounts are credited monthly with interest at an annual rate equal to the prime interest rate published in The Wall Street Journal on the last business day of the preceding calendar quarter. Vested amounts credited to an employee’s account become payable in the form of five annual installments beginning upon the later of the employee’s separation from service and age 55, or such later age as the employee may elect. Upon the employee’s death or “disability” or upon our change of control, vested amounts credited to an employee’s account will be paid in a single lump sum.
Employment and Other Compensation Agreements
We have entered into employment agreements with Ms. Katz, Mr. Gold and Mr. Grimes. Each of Mr. Koryl, Ms. Tharp, Mr. Stapleton and Mr. Schulman is a party to a confidentiality, non-competition and termination benefits agreement. Mr. Fung was party to a consulting agreement during his service as Interim Executive Vice President, Chief Financial Officer and Chief Operating Officer.
Employment Agreement with Ms. Katz
In connection with the Acquisition, we entered into a new employment agreement with Karen W. Katz which became effective on October 25, 2013 and will extend until the fourth anniversary thereof and thereafter be subject to automatic one-year renewals of the term if neither party submits a notice of termination at least three months prior to the end of the then-current term. The agreement may be terminated by either party on three months’ notice, subject to severance obligations in the event of termination under certain circumstances described herein. Pursuant to the agreement, Ms. Katz's base salary will not
be less than $1,070,000 unless the reduction is pursuant to a reduction in the annual salaries of all senior executives by substantially equal amounts or percentages.
Ms. Katz’s agreement also provides that she will participate in our annual incentive bonus plan. The actual amounts will be determined according to the terms of the annual incentive bonus program and will be payable at the discretion of the Compensation Committee. However, Ms. Katz’s agreement provides for a minimum bonus of 50% of her base salary if threshold performance targets are achieved. If applicable goals are met at target level she will be entitled to 125% of base salary while her maximum bonus will be 250% of base salary contingent on the applicable goals being met.
Additionally, Ms. Katz is entitled to receive reimbursement of up to $5,000 for financial and tax planning advice as well as a lump sum cash payment during each year of the employment term in the amount of $15,000 in lieu of any reimbursement of hotel or other lodging expenses incurred in connection with business trips to New York, plus an amount necessary to gross-up such payment for income tax purposes. Ms. Katz's agreement generally also provides for reimbursement of liability for any New York state and city taxes, on an after-tax basis.
The agreement provides that if (i) during the term, her employment is terminated by the Company for any reason other than death, “disability,” or “cause” (each as defined in the employment agreement), (ii) during the term, she terminates her employment for “good reason” or “retirement” (as defined in the employment agreement), or (iii) her employment terminates upon expiration of the term following the provision by us of a notice of non-renewal, and, in any such case, on the date of such termination she has not yet reached age 65, her SERP Plan benefit shall not be reduced according to the terms of the SERP Plan solely by reason of her failure to reach age 65 as of the termination date. During the employment term, she will accrue benefits under the DC SERP, provided that the amounts credited to her account as of the last day of her employment term shall not be less than the present value of the additional benefits she would have accrued under the SERP Plan had it remained in effect.
If we terminate Ms. Katz’s employment without “cause” or if she resigns for “good reason” or following her receipt of a notice of non-renewal from us relating to the employment term, she will be entitled to receive, subject to her execution and non-revocation of a waiver and release agreement, (i) an amount of annual incentive pay equal to a prorated portion of her target bonus amount for the year in which the employment termination date occurs, and (ii) a lump sum equal to (A) 18 times (or 12 times in the case of non-renewal by us) the monthly COBRA premium applicable to Ms. Katz, plus (B) six times the monthly premium if Ms. Katz elected coverage as a retiree under our group medical plan for retired employees in effect under our group medical plan, other than in the case of non-renewal by us, plus (C) two times (or one times in the case of non-renewal by us) the sum of her base salary and target bonus, at the level in effect as of the employment termination date (collectively, the "Severance Payment"). Ms. Katz is also entitled to continuation of certain benefits for a two-year period (or a one-year period in the case of non-renewal by us) following a termination of her employment for any reason as set forth more fully in her employment agreement.
For purposes of Ms. Katz’s employment agreement, “cause” is generally defined as one or more of the following: (i) Ms. Katz’s willful and material failure to substantially perform her duties, or other material breach of her employment agreement; (ii) Ms. Katz’s (A) willful misconduct or (B) gross negligence, in each case which is materially injurious to the Company or any of our affiliates; (iii) Ms. Katz’s willful breach of her fiduciary duty or duty of loyalty to the Company or any of our affiliates; or (iv) Ms. Katz’s commission of any felony or other serious crime involving moral turpitude.
For purposes of Ms. Katz’s employment agreement, “good reason” is generally defined as any of the following without Ms. Katz’s consent: (i) a material failure by the Company to comply with its obligations regarding assumption by a successor, compensation and the related provisions of the employment agreement; (ii) a material reduction in Ms. Katz’s responsibilities or duties; (iii) any relocation of Ms. Katz’s place of business to a location 50 miles or more from the current location; (iv) the reduction in Ms. Katz’s title or reporting relationships; (v) so long as none of Parent's shares or any successor are listed on a national securities exchange, any action or inaction by the Company or Parent's shareholders that prevents Ms. Katz from serving on the Parent Board, other than (A) as required by law, (B) occurs because of a reorganization where Ms. Katz will serve on the board or boards of the successor(s) to our business, or (C) occurs in connection with the termination of Ms. Katz's employment due to death, by us for cause or disability or by Ms. Katz without good reason or for retirement; or (vi) our material breach of the employment agreement.
If Ms. Katz retires from the Company, she will be entitled to receive, subject to her execution and non-revocation of a waiver and release agreement, a lump sum equal to one times the sum of her base salary and target bonus, at the level in effect as of the employment termination date (the "Retirement Payment").
Ms. Katz will be required to repay the Severance Payment or Retirement Payment, as applicable, if she violates certain restrictive covenants in her agreement or if she is found to have engaged in certain acts of wrongdoing, each as further described in the agreement.
If Ms. Katz’s employment terminates before the end of the term due to her death or “disability” we will pay her or her estate, as applicable, (i) any unpaid salary through the date of termination and any bonus payable for the preceding fiscal year that has otherwise not already been paid, (ii) any accrued but unused vacation days, (iii) any reimbursement for business travel and other expenses to which she is entitled, and (iv) an amount of annual incentive pay equal to a prorated portion of her target bonus amount for the year in which the employment termination date occurs.
Ms. Katz’s agreement also contains obligations on her part regarding non-competition and non-solicitation of employees following the termination of her employment for any reason, confidential information and non-disparagement of us and our business. The non-competition agreement generally prohibits Ms. Katz during employment and for a period of two years after termination from becoming a director, officer, employee or consultant for any competing business that owns or operates a luxury specialty retail store or certain specifically listed businesses. The agreement also requires that she disclose and assign to us any trademarks or inventions developed by her which relate to her employment by us or to our business.
Option and Restricted Stock Agreements with Ms. Katz
Option Agreements. In connection with the Acquisition, the Parent Board granted Ms. Katz 25,099 time-vested stock options that vest on each of the first five anniversaries of the closing date of the Acquisition, subject to continued employment, pursuant to a Time-Vested Non-Qualified Stock Option Agreement dated November 5, 2013 (the “Katz Time-Based Option”). Under the terms of the Katz Time-Based Option, if Ms. Katz’s employment is terminated by us without cause or by her for good reason (as both terms are defined above), by reason of our non-renewal of her employment agreement or on account of Ms. Katz’s retirement, then the stock options that would have vested in the 12-month period following the date of such termination of employment will accelerate and vest. If, following a change in control but before an initial public offering, Ms. Katz’s employment is terminated by us without cause or by her for good reason, the outstanding and unvested stock options subject to time-based vesting will accelerate and vest.
In addition, the Parent Board granted Ms. Katz 25,099 performance-vested stock options that vest upon our achievement of certain performance hurdles pursuant to a Performance-Vested Non-Qualified Stock Option Agreement dated November 5, 2013 (the “Katz Performance-Based Option”). Under the terms of the Katz Performance-Based Option, Ms. Katz will be eligible for vesting upon the achievement of certain performance hurdles in connection with an initial public offering or change of control within 180 days after a termination by us without cause, by Ms. Katz for good reason or by reason of our non-renewal of her employment agreement. Additionally, if Ms. Katz retires on or after October 25, 2016 (the third anniversary of the closing date of the Acquisition) and before October 25, 2017, she will be eligible for partial vesting if a performance hurdle is achieved within 18 months of her retirement. If Ms. Katz retires on or after October 25, 2017, she will be eligible for full vesting if a performance hurdle is achieved within three years of her retirement, in each case subject to a one-year extension of the post-retirement vesting availability period if an initial public offering at a threshold price per share occurs within one year of her retirement.
In connection with a termination of Ms. Katz's employment by the Company without cause, or by Ms. Katz for any reason other than retirement, Ms. Katz will have 180 days following the date of termination to exercise vested stock options. In connection with Ms. Katz's retirement, she will have three years to exercise the vested portion of her time-vested stock options (or four years if an initial public offering at a sufficient price per share occurs within one year following such retirement). If, following a change in control and before an initial public offering, Ms. Katz’s employment is terminated by us without cause or by her for good reason, she will have the right for 90 days following the date of such termination to cause us to repurchase the outstanding vested portion of her time-vested and performance-vested stock options.
Restricted Stock Agreement. In October 2016, the Compensation Committee granted Ms. Katz 4,557 shares of restricted stock pursuant to a restricted stock award agreement ("Katz Restricted Stock Agreement"). Under the terms of the Katz Restricted Stock Agreement, if Ms. Katz’s employment is terminated by us without cause or by her for good reason (as both terms are defined above) or by reason of our non-renewal of her employment agreement, then the restricted shares that would have vested in the 12-month period following the date of such termination of employment will accelerate and vest. If, following a change in control but before an initial public offering, Ms. Katz’s employment is terminated by us without cause or by her for good reason, all outstanding and unvested restricted shares will accelerate and vest. Additionally, if Ms. Katz’s employment is terminated by us without cause or by her for good reason or by reason of our non-renewal of her employment agreement, she will have the ability to exercise a put right and to cause the Company to repurchase her vested shares for the fair market value during the first put period within the twelve months following termination of her employment.
Employment Agreement with Mr. Gold
In connection with the Acquisition, we entered into a new employment agreement with James J. Gold, President, Specialty Retail, which became effective on October 25, 2013. The employment agreement is for a four-year term with automatic extensions of one year unless either party provides three months’ written notice of non-renewal. The agreement provides that Mr. Gold’s annual base salary will not be less than $770,000, unless the reduction is pursuant to a reduction of the annual salaries of all senior executives by substantially equal amounts or percentages. The agreement also provides that Mr. Gold will participate in the Company’s annual incentive bonus program with a minimum bonus of 25% of his base salary if threshold performance targets are achieved, a target bonus of 75% of his base salary and a maximum bonus of 150% of his base salary. The actual incentive bonus under the agreement will be determined according to the terms of the annual incentive bonus program and will be payable based on the achievement of performance objectives, as determined at the discretion of the Parent Board. Additionally, under the agreement, Mr. Gold is entitled to receive reimbursement of up to $5,000 for financial and tax planning advice.
The agreement provides that if we terminate Mr. Gold's employment without ‘‘cause’’ or if Mr. Gold resigns for ‘‘good reason’’ or following the non-renewal of his agreement by us, he will be entitled to receive, subject to his execution and non-revocation of a waiver and release agreement, (i) an amount of annual incentive pay equal to a prorated portion of his target bonus amount for the year in which the employment termination date occurs, and (ii) a payment equal to (A) 18 times (or 12 times in the case of non-renewal by us) the monthly COBRA premium applicable to Mr. Gold, and (B) one and one-half times (or one times in the case of non-renewal by us) the sum of his base salary and target bonus, at the level in effect as of the employment termination date. The payment described in clause (ii) would be paid in a lump sum to the extent subject to a particular exemption from Section 409A of the Code and otherwise will be paid in installments.
For purposes of the employment agreement, ‘‘cause’’ is generally defined as one or more of the following: (i) Mr. Gold's willful and material failure to substantially perform his duties, or any other material breach of his employment agreement; (ii) Mr. Gold's (A) willful misconduct or (B) gross negligence, in each case which is materially injurious to the Company or any of our affiliates; (iii) Mr. Gold's willful breach of his fiduciary duty or duty of loyalty to the Company or any of our affiliates; or (iv) Mr. Gold's commission of any felony or other serious crime involving moral turpitude.
For purposes of the employment agreement, ‘‘good reason’’ is generally defined as any of the following without Mr. Gold's prior consent: (i) a material failure by the Company to comply with its obligations regarding assumption by a successor, compensation and the related provisions of the employment agreement; (ii) a material reduction in Mr. Gold's responsibilities or duties; (iii) a material change in the geographic location at which Mr. Gold must perform services; (iv) a material reduction in Mr. Gold's title or reporting relationships; or (v) our material breach of the employment agreement.
According to the agreement, Mr. Gold would be required to repay his severance payments if he violates certain restrictive covenants in his agreement or if he is found to have engaged in certain acts of wrongdoing, all as further described in the agreement. According to the agreement, if Mr. Gold's employment terminates before the end of the term due to his death or ‘‘disability,’’ we would pay him or his estate, as applicable, his accrued obligations and an amount of annual incentive pay equal to a prorated portion of his target bonus amount for the year in which the employment termination date occurs.
The agreement also contains obligations regarding non-competition and non-solicitation of employees for 18 months following the termination of Mr. Gold's employment for any reason, confidential information and non-disparagement of us and our business. The agreement also requires that Mr. Gold disclose and assign to us any trademarks or inventions developed by him that relate to his employment by us or to our business.
Confidentiality, Non-Competition and Termination Benefits Agreements with Mr. Koryl, Ms. Tharp, Mr. Stapleton and Mr. Schulman
Messrs. Koryl, Stapleton and Schulman and Ms. Tharp are each party to a confidentiality, non-competition and termination benefits agreement that provides for severance benefits if the employment of the affected individual is terminated by the Company other than in the event of death, “total disability,” termination for “cause” or the executive's resignation for “good reason” (each as defined in the confidentiality, non-competition and termination benefits agreements). These agreements provide for a severance payment equal to one and one-half annual base salary payable over an 18-month period for Mr. Koryl, Mr. Stapleton and Mr. Schulman and a severance payment equal to annual base salary payable over a 12-month period for Ms. Tharp, and reimbursement for monthly COBRA premiums for the same period. Each confidentiality, non-competition and termination benefits agreement contains restrictive covenants, including non-competition and non-solicitation covenants for the applicable 18- or 12-month severance payment period, as a condition to receipt of any payments payable thereunder. In the case of Mr. Schulman, none of these post-termination benefits provisions were triggered by his departure.
For purposes of these confidentiality, non-competition and termination benefits agreements, ‘‘cause’’ is generally defined as: (i) a breach of duty by the executive in the course of his or her employment involving fraud, acts of dishonesty, disloyalty, or moral turpitude; (ii) conduct that is materially detrimental to the Company, monetarily or otherwise, or reflects unfavorably on the Company or the executive to such an extent that the Company’s best interests reasonably require the termination of the executive’s employment; (iii) the executive’s violation of his or her obligations under the agreement or at law; (iv) the executive’s failure to comply with or enforce Company policies concerning equal employment opportunity, including engaging in sexually or otherwise harassing conduct; (v) the executive’s repeated insubordination or failure to comply with or enforce other personnel policies of the Company or our affiliates; (vi) the executive’s failure to devote his or her full working time and best efforts to the performance of his responsibilities to the Company or our affiliates; or (vii) the executive’s conviction of or entry of a plea agreement or consent decree or similar arrangement with respect to a felony, other serious criminal offense, or any violation of federal or state securities laws.
For purposes of these confidentiality, non-competition and termination benefits agreements, ‘‘good reason’’ is generally defined as any of the following without the executive’s prior consent: (i) a material diminution in the executive’s base compensation; (ii) a material diminution in the executive’s authority, duties, or responsibilities; (iii) a material diminution in the authority, duties, or responsibilities of the officer to whom the executive is required to report; (iv) a material diminution in the budget over which the executive retains authority; (v) a material change in the geographic location at which the executive must perform services; and (vi) any other action or inaction that constitutes a material breach by the Company of the agreement.
Consulting Agreement with Mr. Fung
Mr. Fung served as our Interim Executive Vice President, Chief Financial Officer and Chief Operating Officer from November 2016 through June 2017 pursuant to a consulting agreement. His consulting agreement provided for an initial term of 180 days, with automatic 30 day extensions. Mr. Fung received a monthly consulting fee of $60,000 per month during the term of the consulting agreement. In addition, Mr. Fung's consulting agreement provided eligibility to receive a fee premium, after the end of the consulting arrangement, with a target amount of $60,000 for achieving certain benchmarks determined by the Parent Board or a committee thereof, which fee premium was not paid. The consulting agreement provided that if Mr. Fung’s consulting services are terminated by the Company for any reason other than for cause (as defined in the consulting agreement), death or disability (as defined in the consulting agreement) or by Mr. Fung due to material breach of the consulting agreement by NMG or Parent, Mr. Fung would receive the monthly consulting fees for the remainder of the initial 180-day term and any earned fee premium.
The consulting agreement provided for an award of time-vested non-qualified stock options and performance-vested non-qualified stock options to purchase a total of 786 shares of Class A common stock and Class B common stock of Parent pursuant to the Management Incentive Plan, which options were formally granted by the Compensation Committee in February 2017. Additionally, the consulting agreement provided for reimbursement of Mr. Fung's reasonable out-of-pocket expenses in connection with his temporary residence in Dallas, Texas, including round trip airfare for Mr. Fung to Dallas and rental of a furnished apartment (up to a maximum of $5,000 per month) and an automobile (up to a maximum of $1,500 per month).
Employment Agreement with Mr. Grimes
Donald T. Grimes served as our Executive Vice President, Chief Operating Officer and Chief Financial Officer from June 2015 through November 2016. In connection with his election to that position, we entered into an employment agreement with him, effective as of June 15, 2015. Pursuant to the employment agreement, Mr. Grimes’s annual base salary was $725,000. Mr. Grimes participated in our annual incentive bonus program with a target bonus of 75% of his base salary, and a maximum bonus of 150% of his base salary, with the actual incentive bonus determined according to the terms of the annual incentive bonus program and (i) payable based on the achievement of performance objectives, as determined at the discretion of the Parent Board and (ii) subject to Mr. Grimes’s continued employment through the date bonuses are paid, except as otherwise described below. Mr. Grimes also received a signing bonus of $300,000. Mr. Grimes was eligible to participate in our relocation policies applicable to senior executives, and was required to make a prorated repayment because he resigned his employment without "good reason" in November 2016, which was prior to the second anniversary of his start date. Additionally, Mr. Grimes received reimbursement of up to $5,000 for financial and tax planning advice. Mr. Grimes’s employment agreement included certain restrictive covenants, including non-disparagement of us and our business, non-competition and non-solicitation of employees, customers and suppliers, in each case, for 18 months following the termination of his employment for any reason, and provisions regarding confidential information.
Potential Payments Upon Termination or Change-in-Control
The tables below show certain potential payments that would have been made to the named executive officers if his or her employment had terminated on July 29, 2017 under various scenarios, including a change of control. Because the payments to be made to a named executive officer depend on several factors, the actual amounts to be paid out upon a named executive officer’s termination of employment can only be determined at the time of an executive’s separation from us. See "Employment and Other Compensation Agreements" for a more detailed discussion of the restrictive covenants that are conditions to the receipt of the severance payments.
Messrs. Grimes and Schulman resigned from the Company in November 2016 and May 2017, respectively. The Company and Mr. Fung agreed not to renew his consulting engagement and such engagement ended on June 30, 2017. As such, none of them is qualified to receive any severance payments nor payments upon a change in control. Furthermore, in connection with such departures, their outstanding equity awards have been forfeited, except that Mr. Schulman retains his vested and exercisable Co-Invest Options described above under "Outstanding Equity Awards at Fiscal Year End."
Karen W. Katz
(1)
Represents a lump sum payment of one times the sum of base salary and target bonus payable if Ms. Katz retires and provides at least 12 months' notice to the Parent Board, the SERP benefit level enhancement provided in Ms. Katz's employment agreement, 12 months' acceleration of Ms. Katz's time-vested stock options and a lump sum payout under the deferred compensation plans. See “Non-qualified Deferred Compensation” for a more detailed discussion of the deferred compensation plans. Additionally, Ms. Katz would receive the SERP benefits as described in footnote (3) to the table under “Pension Benefits” above.
(2)
Represents Ms. Katz’s target bonus (payable in a lump sum), a lump sum payout under the deferred compensation plan and defined contribution plan, and a lump sum basic life insurance benefit payment of $1,000,000 payable by the Company’s life insurance provider to Ms. Katz’s beneficiaries upon her death.
(3)
Represents Ms. Katz’s target bonus (payable in a lump sum), lump sum payout under the deferred compensation plan and defined contribution plan, and long-term disability payments of $20,000 per month for 12 months payable from the Company’s long-term disability insurance provider.
(4)
Represents a lump sum payment of two times target bonus and two times base salary, an additional one times target bonus (payable in a lump sum), the SERP benefit level enhancement provided in Ms. Katz's employment agreement, 12 months' acceleration of Ms. Katz's time-vested stock options and restricted shares, and a lump sum payout under the deferred compensation plan and defined contribution plan. The amount included for health and welfare benefits represents a lump-sum payment equal to the value of 18 months of COBRA premiums and six months of retiree medical premiums. Calculations were based on COBRA rates currently in effect. The amount included for life insurance represents coverage for a period of two years at the same benefit level in effect at the time of termination. Additionally, Ms. Katz would receive the SERP benefits as described in footnote (3) to the table under “Pension Benefits” above. Also see “Employment and Other Compensation Agreements” in this section.
(5)
Represents full acceleration of Ms. Katz's time-vested stock options and restricted shares (applicable only in connection with a termination by the Company without cause or by Ms. Katz for good reason (i) prior to an initial public offering and (ii) following a change in control) and a lump sum payout under the deferred compensation plan and defined contribution plan. In connection with such a termination, Ms. Katz would also receive (without duplication) the amounts described in the column under the heading "Termination without cause or for good reason" and the SERP benefits as described in footnote (3) to the table under “Pension Benefits” above.
(6)
As of July 29, 2017, the fair market value of Parent common stock underlying Ms. Katz's options was lower than the exercise price of such options.
(7)
Amounts reported are based on the fair market value of our Class A Common Stock and Class B Common Stock as of April 30, 2017, the most recent practicable date prior to July 29, 2017.
James J. Gold
(1)
Represents a lump sum payout under the deferred compensation plan. See “Non-qualified Deferred Compensation” for a more detailed discussion.
(2)
Represents Mr. Gold’s target bonus, a lump sum payout under the defined contribution plan and a lump sum basic life insurance benefit payment of $1,000,000 payable by the Company’s life insurance provider to Mr. Gold’s beneficiaries upon his death.
(3)
Represents Mr. Gold’s target bonus, lump sum payout under the defined contribution plan, and long-term disability payments of $20,000 per month for 12 months payable from the Company’s long-term disability insurance provider.
(4)
Represents 1.5 times Mr. Gold’s base salary and target bonus, an additional one times target bonus, a payout under the defined contribution plan, and 18 months of COBRA premiums. Calculations were based on COBRA rates currently in effect. All these amounts are payable in a lump sum except for the salary payment to the extent that it is not subject to a particular exemption from Section 409A of the Code, in which case the non-exempt portion will be paid in installments. See “Employment and Other Compensation Agreements” in this section.
(5)
Represents a lump sum payout under the defined contribution plan.
(1)
Represents a lump sum payout under the defined contribution plan. See “Non-qualified Deferred Compensation” for a detailed discussion.
(2)
Represents a lump sum basic life insurance benefit payment of $1,000,000 payable by the Company’s life insurance provider to each of Mr. Koryl, Ms. Tharp and Mr. Stapleton upon their death and a lump sum payout under the defined contribution plan.
(3)
Represents long-term disability payments of $20,000 per month for 12 months payable from the Company’s long-term disability insurance provider and a lump sum payout under the defined contribution plan.
(4)
Represents a lump sum payment of 1.5 times base salary Mr. Koryl and Mr. Stapleton and 1 times base salary for Ms. Tharp. The amount included for health and welfare benefits represents a continuation of COBRA benefits for a period of 18 months for Mr. Koryl and Mr. Stapleton and 12 months for Ms. Tharp. Calculations were based on COBRA rates currently in effect. See “Employment and Other Compensation Agreements” in this section.
(5)
Represents a lump sum payout under the DC SERP.
Director Compensation
The Parent Board sets the compensation for each director who is not an officer of or otherwise employed by us (a "non-executive director"). Non-executive directors who are employed by Ares or CPPIB or their respective affiliates do not receive compensation for their services as directors. Ms. Aufreiter and Messrs. Axelrod, Bourguignon and Brotman are not employed by Ares or CPPIB or their respective affiliates and are the only directors who earned compensation for services as a director for fiscal year 2017. Pursuant to board service agreements entered into between Parent and each of the non-executive officers, each non-executive director receives an annual fee of $50,000 for his or her service as a director on the Parent Board. Such fee will be prorated for the actual number of days served in any quarter and is paid in arrears following the end of each quarter. The non-executive directors are also reimbursed for any out-of-pocket expenses. Actual fees earned in fiscal year 2017 are set forth in the Director Summary Compensation table below.
Director Summary Compensation Table
(1)
Each director listed in the table above holds 393 time-vested stock options, of which 235 are vested, and 393 performance-based stock options, none of which are vested, to purchase Class A Common Stock and Class B Common Stock at an aggregate exercise price of $1,000 per unit, consisting of a share of Class A Common Stock and Class B Common Stock together.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth information regarding equity compensation plans of Parent approved by stockholders and equity compensation plans of Parent not approved by stockholders as of July 29, 2017.
(1)
This number represents shares of Class A Common Stock and Class B Common Stock issuable under the Management Incentive Plan that was approved by holders of a majority of the shares of Parent common stock on October 25, 2013 and the NM Mariposa Holdings, Inc. Vice President Long Term Incentive Plan (the "VP Long Term Incentive Plan") that was approved by a majority of the shares of Parent common stock on February 25, 2014. The Management Incentive Plan became effective on October 25, 2013 and will expire on October 25, 2023 and the VP Long Term Incentive Plan became effective on February 25, 2014 and will expire on February 25, 2024.
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth, as of September 21, 2017, certain information relating to the beneficial ownership of the common stock of Parent, the sole member of Holdings, which in turn is the sole member of the Company, by (i) each person or group known by us to own beneficially more than 5% of the outstanding shares of Class A Common Stock and Class B Common Stock, (ii) each of our directors, (iii) each of our named executive officers and (iv) all of our executive officers and directors as a group. Beneficial ownership for the purposes of the following table is determined in accordance with the rules and regulations of the SEC. These rules generally provide that a person is the beneficial owner of securities if such person has or shares the power to vote or direct the voting of securities, or to dispose or direct the disposition of securities or has the right to acquire such powers within 60 days. For purposes of calculating each person’s percentage ownership, Parent common stock issuable pursuant to options exercisable within 60 days are included as outstanding and beneficially owned for that person or group, but are not deemed outstanding for the purposes of computing the percentage ownership of any other person. Except as disclosed in the footnotes to this table and subject to applicable community property laws, we believe, based on the information furnished to us, that each beneficial owner identified in the table below possesses sole voting and investment power over all Parent common stock shown as beneficially owned by the beneficial owner. The information in the table below does not necessarily indicate beneficial ownership for any other purpose. The percentages of shares outstanding provided in the table below are based on 1,579,454 shares of Class A Common Stock and 1,579,454 shares of Class B Common Stock outstanding as of September 21, 2017.
(1)
Except as otherwise noted, the address of each beneficial owner is c/o Neiman Marcus, 1618 Main Street, Dallas, Texas 75201.
(2)
Pursuant to the terms of the Stockholders Agreement, each of our Sponsors has the right to designate three members of the Parent Board and to jointly designate two independent members of the Parent Board, in each case for so long as they or their respective affiliates own at least 25% of the shares of Class A Common Stock that they owned as of the closing of the Acquisition. Each stockholder that is a party to the Stockholders Agreement has agreed to vote their shares of Parent common stock in favor of such designees. The Stockholders Agreement also contains significant transfer restrictions and certain rights of first offer, tag-along rights, and drag-along rights. As a result, each of our Sponsors may be deemed to be the beneficial owner of the Class A Common Stock and Class B Common Stock
directly owned by the other parties to the Stockholders Agreement, including the other Sponsor. While our Sponsors have shared beneficial ownership of the shares of Parent common stock directly owned by the other parties to the Stockholders Agreement, each of our Sponsors expressly disclaims beneficial ownership of the shares of Class A Common Stock and Class B Common Stock directly held by the other Sponsor, and, as a result, such shares have not been included in the table above for purposes of calculating the number of shares beneficially owned by affiliates of Ares Management, L.P. ("Ares Management") or CPP Investment Board (USRE) Inc.
For additional detail regarding the Stockholders Agreement, see “Certain Relationships and Related Transactions, and Director Independence-Stockholders Agreement.”
(3)
Represents shares of Parent common stock held directly by Ares Corporate Opportunities Fund III, L.P. ("ACOF III"), Ares Corporate Opportunities Fund IV, L.P. ("ACOF IV") and ACOF Mariposa Holdings LLC ("ACOF Mariposa"). The manager of ACOF III is ACOF Operating Manager III, LLC ("ACOF Operating Manager III"), and the sole member of ACOF Operating Manager III is Ares Management LLC. The manager of ACOF IV is ACOF Operating Manager IV, LLC ("ACOF Operating Manager IV"), and the sole member of ACOF Operating Manager IV is Ares Management LLC. The manager of ACOF Mariposa is ACOF IV.
The sole member of Ares Management LLC is Ares Management Holdings L.P. ("Ares Management Holdings") and the general partner of Ares Management Holdings is Ares Holdco LLC ("Ares Holdco"). The sole member of Ares Holdco is Ares Holdings Inc. ("Ares Holdings"), whose sole stockholder is Ares Management. The general partner of Ares Management is Ares Management GP LLC ("Ares Management GP") and the sole member of Ares Management GP is Ares Partners Holdco LLC ("Ares Partners" and, together with ACOF III, ACOF IV, ACOF Mariposa, ACOF Operating Manager III, ACOF Operating Manager IV, Ares Management LLC, Ares Management Holdings, Ares Holdco, Ares Holdings, Ares Management, and Ares Management GP, the "Ares Entities"). Ares Partners is managed by a board of managers, which is composed of Michael Arougheti, R. Kipp deVeer, David Kaplan, Antony Ressler and Bennett Rosenthal. Decisions by Ares Partners’ board of managers generally are made by a majority of the members, which majority, subject to certain conditions, must include Antony Ressler. Each of the Ares Entities (other than each of ACOF III, ACOF IV and ACOF Mariposa with respect to the shares held directly by it) and the members of Ares Partners’ board of managers and the other directors, officers, partners, stockholders, members and managers of the Ares Entities expressly disclaims beneficial ownership of the shares of Parent common stock. The address of each Ares Entity is 2000 Avenue of the Stars, 12th Floor, Los Angeles, California 90067.
(4)
223,050 of these shares of Class B Common Stock are subject to (i) a call right that allows CPP Investment Board (USRE) Inc. to repurchase such shares at any time for de minimis consideration and (ii) a proxy set forth in the Stockholders Agreement which may be exercised if ACOF Mariposa fails to take certain actions requested by CPP Investment Board (USRE) Inc. to elect or remove the directors of Parent or certain other matters.
(5)
CPP Investment Board (USRE) Inc. is a wholly owned subsidiary of Canada Pension Plan Investment Board ("CPPIB"). CPPIB is managed by a board of directors. Because the board of directors acts by consensus/majority approval, none of the directors of the board of directors has sole voting or dispositive power with respect to the shares of common stock of Parent owned by CPP Investment Board (USRE) Inc. The address of each of CPP Investment Board (USRE) Inc. and CPPIB is c/o Canada Pension Plan Investment Board, One Queen Street East, Suite 2500, Toronto, ON, M5C 2W5.
(6)
Consists of (i) shares of Class A Common Stock and Class B Common Stock issuable upon the exercise of options which are currently exercisable or which will become exercisable within 60 days of September 21, 2017 and (ii) in the case of Ms. Katz, Messrs. Gold and Koryl, Ms. Tharp and Mr. Stapleton, outstanding restricted shares of Class A Common Stock and Class B Common Stock , all of which shares are subject to the provisions of the Stockholders Agreement. In the case of Ms. Aufreiter and Messrs. Axelrod and Bourguignon, excludes shares of Class A Common Stock and Class B Common Stock held directly by such persons and in which such persons have a pecuniary interest but that are deemed to be beneficially owned by our Sponsors by virtue of the Stockholders Agreement.
(7)
Mr. Brotman’s address is c/o of Starbucks, 2401 Utah Avenue S, Seattle, Washington 98134.
(8)
The address of Messrs. Kaplan and Gies is c/o Ares Management LLC, 2000 Avenue of the Stars, 12th Floor, Los Angeles, California 90067. Mr. Kaplan is a Senior Partner of Ares Management GP and a Senior Partner of Ares Management, Co-Head of its Private Equity Group and a member of its board of managers. Mr. Gies is a Principal in the Private Equity Group of Ares Management. Messrs. Kaplan and Gies each expressly disclaim beneficial ownership of the shares of Parent common stock owned by the Ares Entities.
(9)
The address of Messrs. Eadie and Nishi is c/o Canada Pension Plan Investment Board, One Queen Street East, Suite 2600, Toronto, ON, M5C 2W5. Mr. Eadie is Senior Managing Director at CPPIB Equity. Mr. Nishi is a Principal at CPPIB Equity. Messrs. Eadie and Nishi each expressly disclaim beneficial ownership of the shares of Parent common stock owned by CPP Investment Board (USRE) Inc.
(10)
Mr. Koryl's shares of Class A Common Stock and Class B Common Stock and options to purchase shares of Class A Common Stock and Class B Common Stock are held by trusts for the benefit of his family.
(11)
Excludes shares of Class A Common Stock and Class B Common Stock in which such persons have a pecuniary interest but that are deemed to be beneficially owned by our Sponsors by virtue of the Stockholders Agreement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Stockholders Agreement
Upon completion of the Acquisition, Parent entered into the Stockholders Agreement, dated as of October 25, 2013, among Parent and each of its stockholders (the "Stockholders Agreement"). Pursuant to the terms of the Stockholders Agreement, each of our Sponsors has the right to designate three members of the Parent Board and to jointly designate two independent members of the Parent Board, in each case for so long as they or their respective affiliates own at least 25% of the shares of Class A Common Stock that they owned as of the closing of the Acquisition. The Stockholders Agreement also provides for the election of the then current chief executive officer of Parent to the Parent Board and, to the extent permitted by applicable laws and regulations and subject to certain exceptions, for equal representation on the boards of directors of our subsidiaries with respect to directors designated by our Sponsors and the appointment of at least one of the directors designated by each Sponsor to each committee of the Parent Board.
In addition, certain significant corporate actions require either (i) the approval of a majority of directors on the Parent Board, including at least one director designated by each of our Sponsors, or (ii) the approval of our Sponsors, in each case subject to the requirement that the applicable Sponsor and its affiliates own at least ten percent of the then outstanding shares of Class A Common Stock. These actions include the incurrence of additional indebtedness over $10 million in the aggregate outstanding at any time (subject to certain exceptions), the issuance or sale of any of our capital stock over $25 million in the aggregate (subject to certain exceptions), the sale, transfer or acquisition of any assets with a value of over $10 million outside the ordinary course of business, the declaration or payment of dividends (subject to certain exceptions), entering into any merger, reorganization or recapitalization (subject to certain exceptions), amendments to Parent’s charter or bylaws, approval of our annual budget and other similar actions.
The Stockholders Agreement also contains significant transfer restrictions and certain rights of first offer, tag-along rights and drag-along rights. In addition, the Stockholders Agreement contains registration rights that, among other things, require Parent to register common stock held by the stockholders who are parties to the Stockholders Agreement if Parent registers for sale, either for its own account or for the account of others, shares of its common stock, subject to certain exceptions.
Under the Stockholders Agreement, certain affiliate transactions, including certain affiliate transactions between us, on the one hand, and our Sponsors or any of their respective affiliates, on the other hand, require either the approval of (i) a majority of disinterested directors or (ii) the holders of a majority of the shares of Class A Common Stock held by certain institutional stockholders who are parties to the Stockholders Agreement.
Management Services Agreements
Upon completion of the Acquisition, NMG and Parent entered into management services agreements, dated as of October 25, 2013, among NMG, Parent and affiliates of our Sponsors (the "Management Services Agreements"). Under each of the Management Services Agreements, affiliates of our Sponsors provide NMG and Parent with certain management and financial services. In exchange for such services, NMG and Parent have agreed to reimburse affiliates of our Sponsors for certain expenses and provide customary indemnification. For fiscal year 2017, $61,598 was reimbursed to affiliates of Ares and $54,955 was reimbursed to affiliates of CPPIB.
Senior Secured Term Loan Facility
Upon the closing of the Acquisition, we entered into the Senior Secured Term Loan Facility, under which various funds affiliated with Ares, one of our Sponsors, are lenders. As of July 29, 2017, these affiliated funds had term loans in the amount of $10.5 million. In fiscal year 2017, an aggregate of $0.3 million in principal and $1.7 million in interest was paid to affiliates of Ares in respect of amounts borrowed under the Senior Secured Term Loan Facility, the largest amount of principal on term loans held by affiliates of Ares during this period was $48.3 million and interest on these borrowings accrued at a weighted average rate of 4.26% per year. As of July 29, 2017, borrowings under the Senior Secured Term Loan Facility accrued interest at a rate of 4.47% per year.
Director Independence
Though not formally considered by the Parent Board because we are not a listed issuer, we have evaluated the independence of the members of the Parent Board using the independence standards of the New York Stock Exchange. We believe that Ms. Aufreiter and Messrs. Axelrod, Bourguignon, Brotman, Eadie, Gies, Kaplan and Nishi are independent directors within the meaning of the listing standards of the New York Stock Exchange.
Indemnification of Officers, Directors and Our Sole Member
Parent’s certificate of incorporation and bylaws provide that Parent will indemnify each of its directors and officers to the fullest extent permitted by Delaware law. Our operating agreement also contains similar provisions relating to our executive officers and Holdings, our sole member. In addition, Parent’s certificate of incorporation and bylaws contain provisions limiting our directors’ obligations in respect of corporate opportunities.
Purchases of Products in the Ordinary Course of Business
Certain of our related persons may, either directly or through their respective affiliates, enter into commercial transactions with us from time to time in the ordinary course of business, primarily for the purchase of merchandise. Our executive officers and certain of our non-employee directors receive a merchandise discount on the same basis available to all of our employees. We believe that none of the transactions with such persons is significant enough to be considered material to such persons or to us.
Review, Approval or Ratification of Transactions with Related Persons
Although we have not adopted formal procedures for the review, approval or ratification of transactions with related persons, the Parent Board reviews potential transactions with those parties we have identified as related parties prior to the consummation of the transaction, and we adhere to the general policy that such transactions should only be entered into if they are approved by the Parent Board, in accordance with applicable law, and in accordance with the restrictions on affiliate transactions in the Stockholders Agreement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Audit Committee pre-approves the use of audit and audit-related services following approval of the independent registered public accounting firm’s audit plan. All services detailed in the audit plan are considered pre-approved. If, during the course of the audit, the independent registered public accounting firm expects fees to exceed the approved fee estimate, those fees must be approved in advance by the Audit Committee.
Principal Accounting Fees and Services
Audit Fees. The aggregate fees billed for the audits of the Company’s annual financial statements for the fiscal years ended July 29, 2017 and July 30, 2016 and for the reviews of the financial statements included in our Quarterly Reports on Form 10-Q were $1,514,000 and $1,574,000, respectively.
Audit-Related Fees. The aggregate fees billed for audit-related services for the fiscal years ended July 29, 2017 and July 30, 2016 were $70,000 and $112,000, respectively. These fees related to accounting research and consultation services.
Tax Fees. The aggregate fees billed for tax services for the fiscal years ended July 29, 2017 and July 30, 2016 were $636,000 and $552,000, respectively. These fees are related to tax compliance and planning.
All Other Fees. The aggregate fees billed for all other services not included above for the fiscal years ended July 29, 2017 and July 30, 2016 totaled approximately $210,000 and $293,000, respectively. These fees primarily related to permitted advisory services.
The Audit Committee has considered and concluded that the provision of permissible non-audit services is compatible with maintaining our independent registered public accounting firm’s independence.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this report.
1.
Financial Statements
The list of financial statements required by this item is set forth in Item 8.
2.
Index to Financial Statement Schedules
Page
Number
Report of Independent Registered Public Accounting Firm
Schedule II-Valuation and Qualifying Accounts and Reserves
All other financial statement schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are not applicable.
3. Exhibits
Note Regarding Corporate Names
Exhibit titles and references to previous filings below refer to entities by their historical names at the time the documents filed in the respective exhibits were created or filed, as applicable. In some cases, entities’ names have subsequently changed:
•
Newton Acquisition, Inc. was renamed Neiman Marcus, Inc. in February 2006;
•
Newton Acquisition Merger Sub, Inc. merged with and into The Neiman Marcus Group, Inc. in October 2005, with The Neiman Marcus Group, Inc. continuing as the surviving corporation;
•
Neiman Marcus, Inc. was renamed Neiman Marcus Group LTD Inc. on August 28, 2013;
•
Neiman Marcus Group LTD Inc. was renamed Neiman Marcus Group LTD LLC on October 28, 2013;
•
The Neiman Marcus Group, Inc. was renamed The Neiman Marcus Group LLC on October 28, 2013; and
•
NM Mariposa Holdings, Inc. was renamed Neiman Marcus Group, Inc. on May 29, 2015.
(1) Portions of these exhibits have been omitted pursuant to a request for confidential treatment.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Loss
Consolidated Statements of Cash Flows
Consolidated Statements of Member Equity
Notes to Consolidated Financial Statements
Schedule II - Valuation and Qualifying Accounts and Reserves
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
We are responsible for the integrity and objectivity of the financial and operating information contained in this Annual Report, including the consolidated financial statements covered by the Report of Independent Registered Public Accounting Firm. These statements were prepared in conformity with generally accepted accounting principles and include amounts that are based on our best estimates and judgment.
We maintain a system of internal controls, which provides management with reasonable assurance that transactions are recorded and executed in accordance with its authorizations, assets are properly safeguarded and accounted for, and records are maintained so as to permit preparation of financial statements in accordance with generally accepted accounting principles. This system includes written policies and procedures, an organizational structure that segregates duties, financial reviews and a comprehensive program of periodic audits by the internal auditors. We have also instituted policies and guidelines, which require employees to maintain a high level of ethical standards.
In addition, the Audit Committee of the Board of Directors meets periodically with management, the internal auditors and the independent registered public accounting firm to review internal accounting controls, audit results and accounting principles and practices and annually recommends to the Board of Directors the selection of the independent registered public accounting firm.
We are responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Under our supervision and with the participation of other key members of our management, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was effective as of July 29, 2017. During its assessment, management did not identify any material weaknesses in our internal control over financial reporting.
KAREN W. KATZ
President and Chief Executive Officer
T. DALE STAPLETON
Interim Chief Financial Officer, Senior Vice President and Chief Accounting Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Member of Neiman Marcus Group LTD LLC
We have audited the accompanying consolidated balance sheets of Neiman Marcus Group LTD LLC (the "Company") as of July 29, 2017 and July 30, 2016, and the related consolidated statements of operations, comprehensive loss, cash flows and member equity for each of the three fiscal years in the period ended July 29, 2017. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States) and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Neiman Marcus Group LTD LLC at July 29, 2017 and July 30, 2016, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended July 29, 2017 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 1 to the Consolidated Financial Statements, the Company changed its method for testing goodwill for impairment as a result of the adoption of the amendments to the FASB Accounting Standards Codification resulting from Accounting Standards Update No. 2017-04, "Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment". Our opinion is not modified with respect to this matter.
NEIMAN MARCUS GROUP LTD LLC
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements.
NEIMAN MARCUS GROUP LTD LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
See Notes to Consolidated Financial Statements.
NEIMAN MARCUS GROUP LTD LLC
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
See Notes to Consolidated Financial Statements.
NEIMAN MARCUS GROUP LTD LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to Consolidated Financial Statements.
NEIMAN MARCUS GROUP LTD LLC
CONSOLIDATED STATEMENTS OF MEMBER EQUITY
See Notes to Consolidated Financial Statements.
NEIMAN MARCUS GROUP LTD LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Neiman Marcus Group LTD LLC (the "Company") is a luxury omni-channel retailer conducting store and online operations principally under the Neiman Marcus, Bergdorf Goodman, Last Call and MyTheresa brand names. References to “we,” “our” and “us” are used to refer to the Company or collectively to the Company and its subsidiaries, as appropriate to the context.
The Company is a subsidiary of Mariposa Intermediate Holdings LLC ("Holdings"), which in turn is a subsidiary of Neiman Marcus Group, Inc., a Delaware corporation ("Parent"). Parent is owned by entities affiliated with Ares Management, L.P. and Canada Pension Plan Investment Board (together, the "Sponsors") and certain co-investors. The Sponsors acquired the Company on October 25, 2013 (the "Acquisition"). The Company’s operations are conducted through its direct wholly owned subsidiary, The Neiman Marcus Group LLC ("NMG").
In October 2014, we acquired MyTheresa, a luxury retailer headquartered in Munich, Germany. The operations of MyTheresa are conducted primarily through the mytheresa.com website.
The accompanying Consolidated Financial Statements set forth financial information of the Company and its subsidiaries on a consolidated basis. All significant intercompany accounts and transactions have been eliminated.
Our fiscal year ends on the Saturday closest to July 31. Like many other retailers, we follow a 4-5-4 reporting calendar, which means that each fiscal quarter consists of thirteen weeks divided into periods of four weeks, five weeks and four weeks. All references to (i) fiscal year 2017 relate to the fifty-two weeks ended July 29, 2017, (ii) fiscal year 2016 relate to the fifty-two weeks ended July 30, 2016 and (iii) fiscal year 2015 relate to the fifty-two weeks ended August 1, 2015.
ESTIMATES AND CRITICAL ACCOUNTING POLICIES
We are required to make estimates and assumptions about future events in preparing our financial statements in conformity with generally accepted accounting principles ("GAAP"). These estimates and assumptions affect the amounts of assets, liabilities, revenues and expenses and the disclosure of gain and loss contingencies at the date of the accompanying Consolidated Financial Statements.
While we believe that our past estimates and assumptions have been materially accurate, the amounts currently estimated are subject to change if different assumptions as to the outcome of future events were made. We evaluate our estimates and assumptions on an ongoing basis and predicate those estimates and assumptions on historical experience and on various other factors that we believe are reasonable under the circumstances. We make adjustments to our estimates and assumptions when facts and circumstances dictate. Since future events and their effects cannot be determined with absolute certainty, actual results may differ from the estimates and assumptions used in preparing the accompanying Consolidated Financial Statements.
Purchase Accounting. We account for acquisitions in accordance with the provisions of Accounting Standards Codification ("ASC") Topic 805, Business Combinations, whereby the purchase price paid to effect the acquisitions was allocated to state the acquired assets and liabilities at fair value. The Acquisition and the allocation of the purchase price were recorded for accounting purposes as of November 2, 2013, the end of our first quarter of fiscal year 2014. The MyTheresa acquisition and the allocation of the purchase price were recorded for accounting purposes as of November 1, 2014, the end of our first quarter of fiscal year 2015. In connection with the allocations of the purchase price, we made estimates of the fair values of our long-lived and intangible assets based upon assumptions related to the future cash flows, discount rates and asset lives utilizing currently available information, and in some cases, valuation results from independent valuation specialists, which resulted in increases in the carrying value of our property and equipment and inventory, the revaluation of intangible assets for our tradenames, customer lists and favorable lease commitments, the revaluation of our long-term benefit plan obligations and, with respect to the MyTheresa acquisition, the recording of our contingent earn-out obligation at estimated fair value, among other things.
Fair Value Measurements. Certain of our assets and liabilities are required to be measured at fair value on a recurring basis. Fair value is the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly
transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. Assets and liabilities are classified using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value as follows:
•
Level 1 - Unadjusted quoted prices for identical instruments traded in active markets.
•
Level 2 - Observable market-based inputs or unobservable inputs corroborated by market data.
•
Level 3 - Unobservable inputs reflecting management’s estimates and assumptions.
Cash and Cash Equivalents. Cash and cash equivalents primarily consist of cash on hand in our stores, deposits with banks and overnight investments with banks and financial institutions. Cash equivalents are stated at cost, which approximates fair value. Our cash management system provides for the reimbursement of all major bank disbursement accounts on a daily basis. Accounts payable includes outstanding checks not yet presented for payment of $39.6 million at July 29, 2017 and $47.4 million at July 30, 2016.
Merchandise Inventories and Cost of Goods Sold. We utilize the retail inventory method of accounting. Under the retail inventory method, the valuation of inventories at cost and the resulting gross margins are determined by applying a calculated cost-to-retail ratio, for various groupings of similar items, to the retail value of our inventories. The cost of the inventory reflected in the Consolidated Financial Statements is decreased by charges to cost of goods sold at average cost and the retail value of the inventory is lowered through the use of markdowns. Earnings are negatively impacted when merchandise is marked down. As we adjust the retail value of our inventories through the use of markdowns to reflect market conditions, our merchandise inventories are stated at the lower of cost or market.
The areas requiring significant management judgment related to the valuation of our inventories include (i) setting the original retail value for the merchandise held for sale, (ii) recognizing merchandise for which the customer’s perception of value has declined and appropriately marking the retail value of the merchandise down to the perceived value and (iii) estimating the shrinkage that has occurred between physical inventory counts. These judgments and estimates, coupled with the averaging processes within the retail method, can, under certain circumstances, produce varying financial results. Factors that can lead to different financial results include (i) determination of original retail values for merchandise held for sale, (ii) identification of declines in perceived value of inventories and processing the appropriate retail value markdowns and (iii) overly optimistic or conservative estimation of shrinkage. In prior years, we have not made material changes to our estimates of shrinkage or markdown requirements on inventories held as of the end of our fiscal years.
Consistent with industry business practice, we receive allowances from certain of our vendors in support of the merchandise we purchase for resale. Certain allowances are received to reimburse us for markdowns taken or to support the gross margins that we earn in connection with the sales of the vendor’s merchandise. These allowances result in an increase to gross margin when we earn the allowances and they are approved by the vendor. Other allowances we receive represent reductions to the amounts we pay to acquire the merchandise. These allowances reduce the cost of the acquired merchandise and are recognized at the time the goods are sold. The amounts of vendor allowances we receive fluctuate based partially on the level of markdowns taken and did not have a significant impact on the year-over-year change in gross margin during fiscal years 2017, 2016 or 2015. We received vendor allowances of $83.6 million, or 1.8% of revenues, in fiscal year 2017, $100.8 million, or 2.0% of revenues, in fiscal year 2016 and $94.8 million, or 1.9% of revenues, in fiscal year 2015.
We obtain certain merchandise, primarily precious jewelry, on a consignment basis to expand our product assortment. Consignment merchandise held by us with a cost basis of $393.1 million at July 29, 2017 and $416.5 million at July 30, 2016 is not reflected in our Consolidated Balance Sheets.
Cost of goods sold also includes delivery charges we pay to third party carriers and other costs related to the fulfillment of customer orders not delivered at the point-of-sale.
Long-lived Assets. Property and equipment are stated at cost less accumulated depreciation. In connection with the Acquisition, the cost basis of the acquired property and equipment was adjusted to its estimated fair value. For financial reporting purposes, we compute depreciation principally using the straight-line method over the estimated useful lives of the assets. Buildings and improvements are depreciated over five to 30 years while fixtures and equipment are depreciated over three to 15 years. Leasehold improvements are amortized over the shorter of the asset life or the lease term (which may include renewal periods when exercise of the renewal option is at our discretion and exercise of the renewal option is considered reasonably assured). Costs incurred for the development of internal computer software are capitalized and amortized using the straight-line method over three to ten years.
We assess the recoverability of the carrying values of our store assets, consisting of property and equipment, customer lists and favorable lease commitments, annually and upon the occurrence of certain events. The recoverability assessment with respect to our long-lived assets is performed at the store level. This assessment is based upon the comparison of the undiscounted cash flows anticipated to be generated from the store to the net carrying value of the store assets. To the extent the undiscounted store-level cash flows are not sufficient to recover the net carrying value of the store assets, the assets are impaired and written down to their estimated fair value based upon discounted future cash flows. Based upon the review of our store-level assets, we identified certain property and equipment, other definite-lived intangible assets and favorable lease commitments to be impaired by $4.8 million in fiscal year 2017 and $38.1 million in fiscal year 2016.
The recoverability assessment related to store-level assets requires judgments and estimates of future revenues, gross margin rates and store expenses. We base these estimates upon our past and expected future performance. We believe our estimates are appropriate in light of current and future market conditions and the best information available at the assessment date. However, future impairment charges could be required if we do not achieve our current revenue or cash flow projections.
Intangible Assets Subject to Amortization. Favorable lease commitments are amortized straight-line over the remaining lives of the leases, ranging from four to 55 years (weighted average life of 30 years) from the Acquisition date. Our definite-lived intangible assets, which primarily consist of customer lists, are amortized using accelerated methods which reflect the pattern in which we receive the economic benefit of the asset, currently estimated at six to 16 years (weighted average life of 13 years) from the respective acquisition dates.
Total amortization of all intangible assets recorded in connection with acquisitions for the next five fiscal years is currently estimated as follows (in thousands):
Indefinite-lived Intangible Assets and Goodwill. Indefinite-lived intangible assets, such as our Neiman Marcus, Bergdorf Goodman and MyTheresa tradenames and goodwill, are not subject to amortization. Rather, we assess the recoverability of indefinite-lived intangible assets and goodwill in the fourth quarter of each fiscal year and upon the occurrence of certain events.
The recoverability assessment with respect to each of the tradenames used in our operations requires us to estimate the fair value of the asset as of the assessment date. Such determination is made using discounted cash flow techniques (Level 3 determination of fair value). Significant inputs to the valuation model include:
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future revenue and profitability projections associated with the tradename;
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estimated market royalty rates that could be derived from the licensing of our tradenames to third parties in order to establish the cash flows accruing to the benefit of the Company as a result of our ownership of our tradenames; and
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rate used to discount the estimated royalty cash flow projections to their present value (or estimated fair value).
If the recorded carrying value of the tradename exceeds its estimated fair value, an impairment charge is recorded to write the tradename down to its estimated fair value. Based upon the review of our tradenames in fiscal years 2017 and 2016, we determined certain of our tradenames were impaired and recorded impairment charges aggregating $309.7 million in fiscal year 2017 and $228.9 million in fiscal year 2016.
Pursuant to current accounting guidance related to the testing of goodwill for impairment adopted in the fourth quarter of fiscal year 2017, the assessment of the recoverability of the goodwill associated with our Neiman Marcus, Bergdorf Goodman and MyTheresa reporting units involves the comparison of the estimated enterprise fair value of each of our reporting units to its recorded carrying value. We estimate the enterprise fair value based on discounted cash flow techniques (Level 3 determination of fair value). Significant inputs to the valuation model include:
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estimated future cash flows;
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growth assumptions for future revenues as well as future gross margin rates, expense rates, capital expenditures and other estimates; and
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rate, based on our estimated weighted average cost of capital, used to discount our estimated future cash flow projections to their present value (or estimated fair value).
If the recorded carrying value of a reporting unit exceeds its estimated enterprise fair value, an impairment charge is recorded to goodwill for the amount by which the carrying amount exceeds the reporting unit's fair value. Based upon the review of our recorded goodwill balances, we determined that certain of our goodwill balances were impaired and recorded impairment charges aggregating $196.2 million in fiscal year 2017.
Prior to the adoption of the new accounting guidance, our assessment process involved a second step in which we allocated the enterprise fair value to the fair value of the reporting unit's net assets. Any enterprise value in excess of amounts allocated to such net assets represented the implied fair value of goodwill for that reporting unit. If the carrying value of goodwill for a reporting unit exceeded the implied fair value of goodwill, an impairment charge was recorded to write goodwill down to its fair value. The assessment performed in the fourth quarter of fiscal year 2016 was performed utilizing the two-step process. Based on this process, we determined that certain of our goodwill balances were impaired and recorded impairment charges aggregating $199.2 million in fiscal year 2016.
The impairment testing process related to our indefinite-lived intangible assets is subject to inherent uncertainties and subjectivity. The use of different assumptions, estimates or judgments with respect to the estimation of the projected future cash flows and the determination of the discount rate used to reduce such projected future cash flows to their net present value could materially increase or decrease any related impairment charge. We believe our estimates are appropriate based upon current and future market conditions and the best information available at the assessment date. However, future impairment charges could be required if we do not achieve our current cash flow, revenue and profitability projections, market royalty rates decrease or the weighted average cost of capital increases.
Leases. We lease a significant portion of our retail stores and office facilities. Stores we own are often subject to ground leases. The terms of our real estate leases, including renewal options, range from ten to 130 years. Most leases provide for fixed monthly minimum rentals or contingent rentals based upon sales in excess of stated amounts and normally require us to pay real estate taxes, insurance, common area maintenance costs and other occupancy costs. For leases that contain predetermined, fixed calculations of minimum rentals, we recognize rent expense on a straight-line basis over the lease term. We recognize contingent rent expenses when it is probable that the sales thresholds will be reached during the year.
We typically receive cash allowances from developers related to the construction of our stores. We record these allowances as deferred real estate credits, which we recognize as a reduction of rent expense on a straight-line basis over the lease term beginning with the date we take possession of the leased asset. We received construction allowances aggregating $37.4 million in fiscal year 2017, $38.3 million in fiscal year 2016 and $34.7 million in fiscal year 2015.
In some cases, a developer will construct a retail store to our requirements pursuant to a lease agreement between the developer and the Company. Typically, the lease agreement provides for the construction and financing of the store shell by the developer and our subsequent construction and financing of the interior finish-out of the store. Since we are involved in the construction of the leased store in these types of arrangements, we must consider the nature and extent of our involvement during the construction period which, in some cases, may result in us being deemed the accounting owner of the construction project. In such cases, ASC Topic 840, Leases, ("ASC Topic 840") requires that we record an asset for the developer's construction costs related to the store shell (included in construction in progress) and recognize an offsetting deferred financing obligation. Upon completion of the project, we perform a sale-leaseback analysis to determine if these assets and the related financing obligation can be derecognized from our Consolidated Balance Sheets. Capitalized costs incurred by a developer aggregated $96.9 million at July 29, 2017 and $46.1 million at July 30, 2016 related to a retail store under construction.
Benefit Plans. We sponsor a defined benefit pension plan ("Pension Plan"), an unfunded supplemental executive retirement plan ("SERP Plan") which provides certain employees additional pension benefits and a postretirement plan providing eligible employees limited postretirement health care benefits ("Postretirement Plan"). In calculating our obligations and related expense, we make various assumptions and estimates, after consulting with outside actuaries and advisors. The annual determination of expense involves calculating the estimated total benefits ultimately payable to plan participants. We utilize a spot rate methodology in the estimation of the interest cost component of net periodic benefit cost, which uses the individual spot rates along the yield curve corresponding to benefit payments. The Pension Plan, SERP Plan and
Postretirement Plan are valued as of the end of each fiscal year. As of the third quarter of fiscal year 2010, benefits offered to all employees under our Pension Plan and SERP Plan were frozen.
Significant assumptions related to the calculation of our obligations include the discount rates used to calculate the present value of benefit obligations to be paid in the future, the expected long-term rate of return on assets held by the Pension Plan and the health care cost trend rate for the Postretirement Plan, as more fully described in Note 11. We review these assumptions annually based upon currently available information, including information provided by our actuaries.
Our obligations related to our employee benefit plans are included in other long-term liabilities.
Self-insurance and Other Employee Benefit Reserves. We use estimates in the determination of the required accruals for general liability, workers’ compensation and health insurance. We base these estimates upon an examination of historical trends, industry claims experience and independent actuarial estimates. Although we do not expect that we will ultimately pay claims significantly different from our estimates, self-insurance reserves could be affected if future claims experience differs significantly from our historical trends and assumptions.
Derivative Financial Instruments. We enter into derivative financial instruments, primarily interest rate swap and cap agreements, to hedge the variability of our cash flows related to a portion of our floating rate indebtedness. The derivative financial instruments are recorded at estimated fair value at each balance sheet date and included in assets or liabilities in our Consolidated Balance Sheets.
Revenues. Revenues include sales of merchandise and services and delivery and processing revenues related to merchandise sold. Revenues are recognized at the later of the point of sale or the delivery of goods to the customer. Revenues associated with gift cards are recognized at the time of redemption by the customer. Revenues exclude sales taxes collected from our customers.
Delivery and processing revenues were $58.7 million in fiscal year 2017, $50.6 million in fiscal year 2016 and $50.1 million in fiscal year 2015.
Revenues are reduced when customers return goods previously purchased. We maintain reserves for anticipated sales returns primarily based on our historical trends related to returns by our customers. Our reserves for anticipated sales returns were $47.0 million at July 29, 2017 and $45.3 million at July 30, 2016.
Buying and Occupancy Costs. Our buying costs consist primarily of salaries and expenses incurred by our merchandising and buying operations. Occupancy costs primarily include rent, property taxes and operating costs of our retail, distribution and support facilities and exclude depreciation expense.
Selling, General and Administrative Expenses (Excluding Depreciation). Selling, general and administrative expenses consist principally of costs related to employee compensation and benefits in the selling and administrative support areas and advertising and marketing costs.
We receive allowances from certain merchandise vendors in connection with compensation programs for employees who sell the vendors’ merchandise. These allowances are netted against the related compensation expenses that we incur. Amounts received from vendors related to compensation programs were $62.4 million, or 1.3% of revenues, in fiscal year 2017, $70.3 million, or 1.4% of revenues, in fiscal year 2016 and $76.4 million, or 1.5% of revenues, in fiscal year 2015.
Consistent with industry practice, we receive advertising allowances from certain of our merchandise vendors. Substantially all the advertising allowances we receive represent reimbursements of direct, specific and incremental costs that we incur to promote the vendor’s merchandise in connection with our various advertising programs, primarily catalogs and other print media and digital media. Advertising allowances fluctuate based on the level of advertising expenses incurred and are recorded as a reduction of our advertising costs when earned. Advertising allowances were approximately $50.1 million, or 1.1% of revenues, in fiscal year 2017, $54.8 million, or 1.1% of revenues, in fiscal year 2016 and $55.0 million, or 1.1% of revenues, in fiscal year 2015.
We incur costs to advertise and promote the merchandise assortment offered through our store and online operations. We expense advertising costs for print media costs and promotional materials mailed to our customers at the time of mailing to the customer. We amortize the costs of print catalogs during the periods we expect to generate revenues from such catalogs, generally three months. We expense the costs incurred to produce the photographic content on our websites, as well as website design and web marketing costs, as incurred. Net marketing and advertising expenses were $183.0 million, or 3.9% of
revenues, in fiscal year 2017, $178.9 million, or 3.6% of revenues, in fiscal year 2016 and $165.7 million, or 3.3% of revenues, in fiscal year 2015.
Stock Compensation. At the date of grant, the stock option exercise price equals or exceeds the fair market value of Parent's common stock. Because Parent is privately held and there is no public market for its common stock, the fair market value of Parent's common stock is determined by the Board of Directors of Parent (the "Parent Board") or the Compensation Committee, as applicable, at the time option grants are awarded. The estimate of the fair market value of Parent's common stock utilizes both discounted cash flow techniques and the review of market data and involves assumptions regarding a number of complex and subjective variables. Significant inputs to the common stock valuation model include:
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future revenue, cash flow and/or profitability projections;
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growth assumptions for future revenues as well as future gross margin rates, expense rates, capital expenditures and other estimates;
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rates, based on our estimated weighted average cost of capital, used to discount the estimated cash flow projections to their present value (or estimated fair value);
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recent transactions and valuation multiples for publicly held companies deemed similar to Parent;
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economic conditions and other factors deemed material to the valuation process; and
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valuations of Parent performed by third parties.
Income from Credit Card Program. We maintain a proprietary credit card program through which credit is extended to customers and have a related marketing and servicing alliance with affiliates of Capital One Financial Corporation ("Capital One"). Pursuant to our agreement with Capital One (the "Program Agreement"), Capital One currently offers credit cards and non-card payment plans under both the "Neiman Marcus" and "Bergdorf Goodman" brand names. Effective July 1, 2013, we amended and extended the Program Agreement to July 2020 (renewable thereafter for three-year terms), subject to early termination provisions.
We receive payments from Capital One based on sales transacted on our proprietary credit cards. These payments are based on the profitability of the credit card portfolio as determined under the Program Agreement and are impacted by a number of factors including credit losses incurred and our allocable share of the profits generated by the credit card portfolio, which in turn may be impacted by credit ratings as determined by various rating agencies. In addition, we receive payments from Capital One for marketing and servicing activities we provide to Capital One. We recognize income from our credit card program when earned.
Additionally, beginning in July 2017, in accordance with the contractual provisions of the credit card program agreement, our allocable share of the profits generated by the credit card portfolio was reduced as a result of our current credit ratings by S&P and Moody's.
Gift Cards. The gift cards sold to our customers have no stated expiration dates and, in some cases, are subject to actual and/or potential escheatment rights in various of the jurisdictions in which we operate. Unredeemed gift cards were $45.5 million at July 29, 2017 and $44.3 million at July 30, 2016.
We recognized gift card breakage of $1.7 million in fiscal year 2017, $1.3 million in fiscal year 2016 and $1.4 million in fiscal year 2015 as a component of revenues.
Loyalty Program. We maintain a customer loyalty program in which customers earn points for qualifying purchases. Upon reaching specified levels, points are redeemed for awards, primarily gift cards. The estimates of the costs associated with the loyalty program require us to make assumptions related to customer purchasing levels and redemption rates. At the time the qualifying sales giving rise to the loyalty program points are made, we defer the portion of the revenues on the qualifying sales transactions equal to the estimated retail value of the gift cards to be redeemed upon conversion of the earned points to gift cards. We record the deferral of revenues related to gift card awards under our loyalty program as a reduction of revenues.
Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We are routinely under audit by federal, state or local authorities in the area of income taxes. We regularly evaluate the likelihood of realization of tax benefits derived from positions we have taken in various federal and state filings after
consideration of all relevant facts, circumstances and available information. If we believe it is more likely than not that our position will be sustained, we recognize the benefit we believe is cumulatively greater than 50% likely to be realized.
Foreign Currency. We translate the assets and liabilities denominated in a foreign currency into U.S. dollars using the exchange rate in effect at the balance sheet date. Revenues and expenses are translated into U.S. dollars using weighted average exchange rates during the year. We record these translation adjustments as a component of accumulated other comprehensive loss on the Consolidated Balance Sheets.
Segments. We conduct our specialty retail store and online operations on an omni-channel basis. As our store and online operations have similar economic characteristics, products, services and customers, our operations constitute a single omni-channel reportable segment.
Newly Adopted Accounting Pronouncements. In April 2015, the Financial Accounting Standards Board (the "FASB") issued guidance related to the accounting for cloud computing arrangements. Under this guidance, if a cloud computing arrangement includes a software license, the software license element should be accounted for in a manner consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the arrangement should be accounted for as a service contract. We adopted this guidance in the first quarter of fiscal year 2017 on a prospective basis. The adoption of this guidance did not have a material impact on our Consolidated Financial Statements.
In January 2017, the FASB issued guidance to simplify how an entity is required to test goodwill for impairment. The new standard allows (i) entities to perform annual, or interim, goodwill impairment testing by comparing the reporting unit's fair value with its carrying amount and (ii) recognize impairment charges for the amount by which the carrying amount exceeds the reporting unit’s fair value. Pursuant to prior guidance, a goodwill impairment loss was determined by comparing the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill. In computing the implied fair value of goodwill, an entity had to perform procedures to determine the fair value of its assets and liabilities at the impairment testing date consistent with procedures that are required in determining the fair value of assets acquired and liabilities assumed in a business combination. We adopted this guidance in fiscal year 2017 on a prospective basis in connection with our assessment of the recoverability of the carrying values of our indefinite-lived intangible assets and goodwill. Prior to adopting this guidance, our assessment process involved a second step in which we allocated the enterprise fair value to the fair value of the reporting unit's net assets. Any enterprise value in excess of amounts allocated to such net assets represented the implied fair value of goodwill for that reporting unit. If the carrying value of goodwill for a reporting unit exceeded the implied fair value of goodwill, an impairment charge was recorded to write goodwill down to its fair value. The assessment performed in the fourth quarter of fiscal year 2016 was performed utilizing the two-step process.
Recent Accounting Pronouncements. In March 2016, the FASB issued guidance to simplify how share-based payments are accounted for and presented in the financial statements, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The standard allows (i) entities to withhold an amount up to the employees' maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award and (ii) forfeitures to be either estimated, as required currently, or recognized when they occur. This new guidance is effective for us as of the first quarter of fiscal year 2018.
In May 2014, the FASB issued guidance to clarify the principles for revenue recognition. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes previous revenue recognition guidance. While our evaluation of the impact of adopting this standard is ongoing, we believe the new guidance will impact our accounting for sales returns, our loyalty program and certain promotional programs. This new guidance is effective for us no earlier than the first quarter of fiscal year 2019.
In May 2017, the FASB issued guidance to clarify which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The standard requires modification accounting only if changes in the terms or conditions results in changes of the fair value, the vesting conditions or the classification of the award as an equity instrument or a liability. This new guidance is effective for us as of the first quarter of fiscal year 2019.
In February 2016, the FASB issued guidance that requires a lessee to recognize assets and liabilities arising from leases on the balance sheet. Previous GAAP did not require lease assets and liabilities to be recognized for most leases. Additionally, companies are permitted to make an accounting policy election not to recognize lease assets and liabilities for leases with a term of 12 months or less. For both finance leases and operating leases, the lease liability should be initially measured at the present value of the remaining contractual lease payments. The recognition, measurement and presentation of
expenses and cash flows arising from a lease by a lessee will not significantly change under this new guidance. This new guidance is effective for us as of the first quarter of fiscal year 2020.
In August 2017, the FASB issued guidance to simplify how hedge accounting arrangements are accounted for and presented in the financial statements, including the assessment of hedge effectiveness. Under the new standard, all changes in the value of the hedging instrument included in the assessment of effectiveness will be recorded in other comprehensive income and reclassified to earnings in the same income statement line item when the hedged item affects earnings. This new guidance is effective for us as of the first quarter of fiscal year 2020.
With respect to each of the recent accounting pronouncements described above, we are currently evaluating which application methods to adopt and the impact of adopting these new accounting standards on our Consolidated Financial Statements.
NOTE 2. MYTHERESA ACQUISITION
In October 2014, we acquired MyTheresa, a luxury retailer headquartered in Munich, Germany. The operations of MyTheresa are conducted primarily through the mytheresa.com website. The purchase price paid to acquire MyTheresa, net of cash acquired, was $181.7 million, which was financed through a combination of cash and debt. In addition, the MyTheresa purchase agreement contained contingent earn-out payments to the sellers aggregating up to €55.0 million based on operating performance for calendar years 2015 and 2016. In March 2017, we paid $26.9 million, or €25.5 million, to the sellers related to calendar year 2016 (of which $22.9 million, or €18.1 million, represented the acquisition date fair value of the obligation). In April 2016, we paid $29.8 million, or €26.5 million, to the sellers related to calendar year 2015 (of which $27.2 million, or €21.6 million, represented the acquisition date fair value of the obligation). As of July 29, 2017, the Company has no further obligation related to the contingent earn-out payments to the sellers of MyTheresa. MyTheresa results of operations are included in our consolidated results of operations beginning in the second quarter of fiscal year 2015.
NOTE 3. FAIR VALUE MEASUREMENTS
The following table shows the Company’s financial assets and liabilities that are required to be measured at fair value on a recurring basis in our Consolidated Balance Sheets:
The fair value of the interest rate swaps is estimated using industry standard valuation models using market-based observable inputs, including interest rate curves.
The fair value of the contingent earn-out obligation incurred in connection with the acquisition of MyTheresa was estimated as of the acquisition date using a valuation model that measured the present value of the probable cash payments based upon the forecasted operating performance of MyTheresa and a discount rate that captured the risk associated with the obligation. We updated our assumptions based on new developments and adjusted the carrying value of the obligation to its estimated fair value at each reporting date. As of July 29, 2017, the Company has no further earn-out obligations.
Because Parent is privately held and there is no public market for its common stock, the fair market value of Parent's common stock is determined by the Parent Board or the Compensation Committee, as applicable. In determining the fair market value of Parent's common stock, the Parent Board or the Compensation Committee, as applicable, considers such factors as any recent transactions involving Parent's common stock, the Company’s actual and projected financial results, the
principal amount of the Company’s indebtedness, valuations of the Company performed by third parties and other factors it believes are material to the valuation process. Significant inputs to the common stock valuation model are updated as applicable and the carrying value of the obligation is adjusted to its estimated fair value at each reporting date.
The carrying values of cash and cash equivalents, credit card receivables and accounts payable approximate fair value due to their short-term nature. We determine the fair value of our long-term debt on a non-recurring basis, which results are summarized as follows:
We estimated the fair value of long-term debt using (i) prevailing market rates for debt of similar remaining maturities and credit risk for the senior secured asset-based revolving credit facility (as amended, the "Asset-Based Revolving Credit Facility") and the senior secured term loan facility (as amended, the "Senior Secured Term Loan Facility" and, together with the Asset-Based Revolving Credit Facility, the "Senior Secured Credit Facilities") and (ii) quoted market prices of the same or similar issues for the $960.0 million aggregate principal amount of 8.00% Senior Cash Pay Notes due 2021 (the "Cash Pay Notes"), the $600.0 million aggregate principal amount of 8.75%/9.50% Senior PIK Toggle Notes due 2021 (the "PIK Toggle Notes") and the $125.0 million aggregate principal amount of 7.125% Debentures due 2028 (the "2028 Debentures" and, together with the Cash Pay Notes and the PIK Toggle Notes, the "Notes").
In connection with purchase accounting, we adjusted the carrying values of our long-lived and intangible assets to their estimated fair values at the acquisition date. The fair value estimates were based upon assumptions related to the future cash flows, discount rates and asset lives utilizing currently available information, and in some cases, valuation results from independent valuation specialists (Level 3 determination of fair value). Subsequent to the Acquisition, we determine the fair value of our long-lived and intangible assets on a non-recurring basis in connection with our periodic evaluations of such assets for potential impairment and record impairment charges when such fair value estimates are lower than the carrying values of the assets.
NOTE 4. PROPERTY AND EQUIPMENT, NET
The significant components of our net property and equipment are as follows:
Included in construction in progress are $96.9 million at July 29, 2017 and $46.1 million at July 30, 2016 of capitalized costs incurred by a developer to construct the shell of a building that we will lease and operate as a retail store upon completion of construction. We are deemed to be the owner of the building shell for accounting purposes and are therefore required to recognize an asset for a developer's construction costs related to the store shell and an offsetting deferred financing obligation.
NOTE 5. INTANGIBLE ASSETS, NET AND GOODWILL
The significant components of our intangible assets and goodwill are as follows:
NOTE 6. IMPAIRMENT CHARGES
Since fiscal year 2016, we have experienced declines in our operating results and we believe our operating results have been adversely impacted by a number of factors including, among other things:
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the volatility and uncertainty in domestic and global economic conditions and the resulting impact on the market for luxury merchandise;
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the strength of the U.S. dollar against international currencies, most notably the Euro and British pound, and a resulting impact on tourism and spending by international customers in the U.S.; and
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a significant and sustained decline in the global price for crude oil and the resulting impact on stakeholders in the oil and gas industries, particularly in the Texas markets in which we have a significant presence.
Based upon our assessment of current economic conditions, our expectations of future business conditions and trends, our projected revenues, earnings, and cash flows as well as other market factors such as the weighted average cost of capital and valuation multiples, we determined that impairment charges were required to state certain of our intangible and long-lived assets to their estimated fair value as follows:
We recorded impairment charges aggregating $466.2 million in fiscal year 2016. These impairment charges were driven primarily by revisions to our anticipated future operating trends in light of adverse economic and business trends existing as of the end of fiscal year 2016 and, to a lesser extent, increases in the weighted average cost of capital used in estimating the fair value of our tradenames and reporting units under a discounted cash flow model. These impairments related to certain of our tradenames, goodwill and long-lived assets primarily associated with our Neiman Marcus brand. Our assessment in fiscal year 2016 was performed prior to the adoption of new accounting guidance issued related to the testing of goodwill for impairment and utilized a second step wherein we allocated the enterprise fair value to the fair value of the reporting unit's net assets to determine the writedown of goodwill.
We recorded impairment charges aggregating $510.7 million in fiscal year 2017. These impairment charges were driven both by (i) changes in market conditions related to increases in the weighted average cost of capital and valuation
multiples and (ii) further deterioration of operating trends during such periods. In fiscal year 2017, we recorded impairment charges of $153.8 million in the second quarter and $357.0 million in the fourth quarter. These impairment charges related to certain of our tradenames, goodwill and long-lived assets primarily associated with our Neiman Marcus and Bergdorf Goodman brands. Our assessment in fiscal year 2017 was performed subsequent to the adoption of new accounting guidance issued related to the testing of goodwill for impairment as discussed in Note 1 under "- Newly Adopted Accounting Pronouncements".
We continue to undertake initiatives to help drive revenues and streamline business activities and will continue to closely monitor our financial condition and results of operations. However, there is a risk that we may continue to experience challenging economic conditions and operating pressures, which in turn could increase the risk of additional impairment charges in future periods.
NOTE 7. ACCRUED LIABILITIES
The significant components of accrued liabilities are as follows:
NOTE 8. LONG-TERM DEBT
The significant components of our long-term debt are as follows:
Asset-Based Revolving Credit Facility. At July 29, 2017, we have an Asset-Based Revolving Credit Facility with a maximum committed borrowing capacity of $900.0 million. The Asset-Based Revolving Credit Facility matures on July 25, 2021 (or July 25, 2020 if our obligations under our Senior Secured Term Loan Facility or any permitted refinancing thereof have not been repaid or the maturity date thereof has not been extended to October 25, 2021 or later). At July 29, 2017, we had outstanding borrowings of $263.0 million under this facility, outstanding letters of credit of $1.8 million and unused commitments of $635.3 million, subject to a borrowing base, of which $90.0 million of such capacity is available to us subject to certain restrictions as more fully described below.
Availability under the Asset-Based Revolving Credit Facility is subject to a borrowing base. The Asset-Based Revolving Credit Facility includes borrowing capacity available for letters of credit (up to $150.0 million, with any such
issuance of letters of credit reducing the amount available under the Asset-Based Revolving Credit Facility on a dollar-for-dollar basis) and for borrowings on same-day notice. The borrowing base is equal to at any time the sum of (a) 90% of the net orderly liquidation value of eligible inventory, net of certain reserves, plus (b) 90% of the amounts owed by credit card processors in respect of eligible credit card accounts constituting proceeds from the sale or disposition of inventory, less certain reserves, plus (c) 100% of segregated cash held in a restricted deposit account. To the extent that excess availability is not equal to or greater than the greater of (a) 10% of the lesser of (1) the aggregate revolving commitments and (2) the borrowing base and (b) $50.0 million, we will be required to maintain a minimum fixed charge coverage ratio. Additional restrictions will apply if this condition is not met for five consecutive business days, including increased reporting requirements and additional administrative agent control rights over certain of our accounts. These restrictions will continue until the condition is satisfied and their imposition may limit our operational flexibility.
The Asset-Based Revolving Credit Facility permits us to increase commitments under the Asset-Based Revolving Credit Facility or add one or more incremental term loans to the Asset-Based Revolving Credit Facility by an amount not to exceed $200.0 million. However, the lenders are under no obligation to provide any such additional commitments or loans, and any increase in commitments or incremental term loans will be subject to customary conditions precedent. If we were to request any such additional commitments and the existing lenders or new lenders were to agree to provide such commitments, the size of the Asset-Based Revolving Credit Facility could be increased to $1,100.0 million, but our ability to borrow would still be limited by the amount of the borrowing base. The cash proceeds of any incremental term loans may be used for working capital and general corporate purposes.
At July 29, 2017, borrowings under the Asset-Based Revolving Credit Facility bore interest at a rate per annum equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate of Deutsche Bank AG New York Branch (the administrative agent), (2) the federal funds effective rate plus ½ of 1.00% and (3) the adjusted one-month LIBOR plus 1.00% or (b) LIBOR, subject to certain adjustments, in each case plus an applicable margin of 0.75% with respect to base rate borrowings and 1.75% with respect to LIBOR borrowings at July 29, 2017. The applicable margin is based on the average historical excess availability under the Asset-Based Revolving Credit Facility, and is up to 1.00% with respect to base rate borrowings and up to 2.00% with respect to LIBOR borrowings, in each case with one 0.25% step down based on achievement and maintenance of a certain senior secured first lien net leverage ratio (as defined in the credit agreement governing the Asset-Based Revolving Credit Facility). The weighted average interest rate on the outstanding borrowings pursuant to the Asset-Based Revolving Credit Facility was 3.11% at July 29, 2017. In addition, we are required to pay a commitment fee in respect of unused commitments at a rate of up to 0.375% per annum. We must also pay customary letter of credit fees and agency fees.
If at any time the aggregate amount of outstanding revolving loans, unreimbursed letter of credit drawings and undrawn letters of credit under the Asset-Based Revolving Credit Facility exceeds the lesser of (a) the aggregate revolving commitments and (b) the borrowing base, we will be required to repay outstanding loans or cash collateralize letters of credit in an aggregate amount equal to such excess, with no reduction of the commitment amount. If the excess availability under the Asset-Based Revolving Credit Facility is less than the greater of (a) 10% of the lesser of (1) the aggregate revolving commitments and (2) the borrowing base and (b) $50.0 million for a period of five or more consecutive business days, funds held in a collection account maintained with the agent would be applied to repay the loans and other obligations and cash collateralize letters of credit. We would then be required to make daily deposits in the collection account maintained with the agent under the Asset-Based Revolving Credit Facility.
We may voluntarily reduce the unutilized portion of the commitment amount and repay outstanding loans at any time without premium or penalty other than customary breakage costs with respect to LIBOR loans. There is no scheduled amortization under the Asset-Based Revolving Credit Facility. The principal amount of the revolving loans outstanding thereunder will be due and payable in full on July 25, 2021 (or July 25, 2020 if our obligations under our Senior Secured Term Loan Facility or any permitted refinancing thereof have not been repaid or the maturity date thereof has not been extended to October 25, 2021 or later).
The Asset-Based Revolving Credit Facility is guaranteed by Holdings and each of our current and future direct and indirect wholly owned subsidiaries (subsidiary guarantors) other than (a) unrestricted subsidiaries, (b) certain immaterial subsidiaries, (c) foreign subsidiaries and any domestic subsidiary of a foreign subsidiary, (d) certain holding companies of foreign subsidiaries, (e) captive insurance subsidiaries, not for profit subsidiaries, or a subsidiary which is a special purpose entity for securitization transactions or like special purposes and (f) any subsidiary that is prohibited by applicable law or contractual obligation from acting as a guarantor or which would require governmental approval to provide a guarantee. At July 29, 2017, the assets of non-guarantor subsidiaries, primarily (i) NMG Germany GmbH, through which we conduct the operations of MyTheresa, (ii) NMG International LLC, a holding company with respect to our foreign operations and (iii) Nancy Holdings LLC, which holds legal title to certain real property used by us in conducting our operations, aggregated
$416.0 million, or 5.4% of consolidated total assets. All obligations under the Asset-Based Revolving Credit Facility, and the guarantees of those obligations, are secured, subject to certain significant exceptions described below, by substantially all of the assets of Holdings, the Company and the subsidiary guarantors, including:
•
a first-priority security interest in personal property consisting of inventory and related accounts, cash, deposit accounts, all payments received by the Company or the subsidiary guarantors from credit card clearinghouses and processors or otherwise in respect of all credit card charges for sales of inventory by the Company and the subsidiary guarantors, certain related assets and proceeds of the foregoing;
•
a second-priority pledge of 100% of the Company’s capital stock and certain of the capital stock held by Holdings, the Company or any subsidiary guarantor (which pledge, in the case of any foreign subsidiary is limited to 100% of the non-voting stock (if any) and 65% of the voting stock of such foreign subsidiary); and
•
a second-priority security interest in, and mortgages on, a significant portion of the Company's owned real property and equipment and substantially all other tangible and intangible assets of Holdings, the Company and each subsidiary guarantor, but excluding, among other things, leasehold interests.
Capital stock and other securities of a subsidiary of the Company that are owned by the Company or any subsidiary guarantor will not constitute collateral under the Asset-Based Revolving Credit Facility to the extent that such securities cannot secure the 2028 Debentures or other secured public debt obligations without requiring the preparation and filing of separate financial statements of such subsidiary in accordance with applicable SEC rules. As a result, the collateral under the Asset-Based Revolving Credit Facility will include shares of capital stock or other securities of subsidiaries of the Company or any subsidiary guarantor only to the extent that the applicable value of such securities (on a subsidiary-by-subsidiary basis) is less than 20% of the aggregate principal amount of the 2028 Debentures or other secured public debt obligations of the Company.
The Asset-Based Revolving Credit Facility contains covenants limiting, among other things, dividends and other restricted payments, investments, loans, advances and acquisitions, and prepayments or redemptions of other indebtedness. These covenants permit such restricted actions in an unlimited amount, subject to the satisfaction of certain payment conditions, principally that we must have (x) pro forma excess availability under the Asset-Based Revolving Credit Facility for each day of the 30-day period prior to such actions, which exceeds the greater of $90.0 million or 15% of the lesser of (a) the revolving commitments under the Asset-Based Revolving Credit Facility and (b) the borrowing base and (y) a pro forma fixed charge coverage ratio of at least 1.0 to 1.0, unless pro forma excess availability for each day of the 30-day period prior to such actions under the Asset-Based Revolving Credit Facility would exceed the greater of (1) $200.0 million and (2) 25% of the lesser of (i) the aggregate revolving commitments under the Asset-Based Revolving Credit Facility and (ii) the borrowing base. The Asset-Based Revolving Credit Facility also contains customary affirmative covenants and events of default, including a cross-default provision in respect of any other indebtedness that has an aggregate principal amount exceeding $50.0 million.
Senior Secured Term Loan Facility. We have a credit agreement and related security and other agreements for the $2,950.0 million Senior Secured Term Loan Facility. At July 29, 2017, the outstanding balance under the Senior Secured Term Loan Facility was $2,839.6 million. The principal amount of the loans outstanding is due and payable in full on October 25, 2020.
The Senior Secured Term Loan Facility permits us to increase the term loans or add a separate tranche of term loans by an amount not to exceed $650.0 million plus an unlimited amount that would result (a) in the case of any incremental term loan facility to be secured equally and ratably with the term loans, a senior secured first lien net leverage ratio equal to or less than 4.25 to 1.00, and (b) in the case of any incremental term loan facility to be secured on a junior basis to the term loans, to be subordinated in right of payment to the term loans or unsecured and pari passu in right of payment with the term loans, a total net leverage ratio equal to or less than the total net leverage ratio as of October 25, 2013.
At July 29, 2017, borrowings under the Senior Secured Term Loan Facility bore interest at a rate per annum equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate of Credit Suisse AG (the administrative agent), (2) the federal funds effective rate plus ½ of 1.00% and (3) the adjusted one-month LIBOR plus 1.00%, or (b) an adjusted LIBOR (for a period equal to the relevant interest period, and in any event, never less than 1.00%), subject to certain adjustments, in each case plus an applicable margin. The applicable margin is up to 2.25% with respect to base rate borrowings and up to 3.25% with respect to LIBOR borrowings. The applicable margin is subject to adjustment based on our senior secured first lien net leverage ratio. The applicable margin with respect to outstanding LIBOR borrowings was 3.25% at July 29, 2017. The interest rate on the outstanding borrowings pursuant to the Senior Secured Term Loan Facility was 4.47% at July 29, 2017.
Subject to certain exceptions and reinvestment rights, the Senior Secured Term Loan Facility requires that 100% of the net cash proceeds from certain asset sales and debt issuances and 50% (which percentage will be reduced to 25% if our senior secured first lien net leverage ratio, as defined in the credit agreement governing the Senior Secured Term Loan Facility, is equal to or less than 4.0 to 1.0 but greater than 3.5 to 1.0 and will be reduced to 0% if our senior secured first lien net leverage ratio is equal to or less than 3.5 to 1.0) from excess cash flow, as defined in the credit agreement governing the Senior Secured Term Loan Facility, for each of our fiscal years (commencing with the period ended July 26, 2015) must be used to prepay outstanding term loans under the Senior Secured Term Loan Facility at 100% of the principal amount to be prepaid, plus accrued and unpaid interest. We were not required to prepay any outstanding term loans pursuant to the annual excess cash flow requirements for fiscal years 2017 and 2016.
We may repay all or any portion of the Senior Secured Term Loan Facility at any time, subject to redeployment costs in the case of prepayment of LIBOR borrowings other than the last day of the relevant interest period. The Senior Secured Term Loan Facility amortizes in equal quarterly installments of $7.4 million, less certain voluntary and mandatory prepayments, with the remaining balance due at final maturity.
The Senior Secured Term Loan Facility is guaranteed by Holdings and each of our current and future subsidiary guarantors other than (a) unrestricted subsidiaries, (b) certain immaterial subsidiaries, (c) foreign subsidiaries and any domestic subsidiary of a foreign subsidiary, (d) certain holding companies of foreign subsidiaries, (e) captive insurance subsidiaries, not for profit subsidiaries, or a subsidiary which is a special purpose entity for securitization transactions or like special purposes and (f) any subsidiary that is prohibited by applicable law or contractual obligation from acting as a guarantor or which would require governmental approval to provide a guarantee. At July 29, 2017, the assets of non-guarantor subsidiaries, primarily (i) NMG Germany GmbH, through which we conduct the operations of MyTheresa, (ii) NMG International LLC, a holding company with respect to our foreign operations and (iii) Nancy Holdings LLC, which holds legal title to certain real property used by us in conducting our operations, aggregated $416.0 million, or 5.4% of consolidated total assets. All obligations under the Senior Secured Term Loan Facility, and the guarantees of those obligations, are secured, subject to certain significant exceptions described below, by substantially all of the assets of Holdings, the Company and the subsidiary guarantors, including:
•
a first-priority pledge of 100% of the Company's capital stock and certain of the capital stock held by the Company, Holdings or any subsidiary guarantor (which pledge, in the case of any foreign subsidiary is limited to 100% of the non-voting stock (if any) and 65% of the voting stock of such foreign subsidiary);
•
a first-priority security interest in, and mortgages on, a significant portion of the Company's owned real property and equipment and substantially all other tangible and intangible assets of the Company, Holdings and each subsidiary guarantor, but excluding, among other things, leasehold interests and the collateral described below; and
•
a second-priority security interest in personal property consisting of inventory and related accounts, cash, deposit accounts, all payments received by the Company or the subsidiary guarantors from credit card clearinghouses and processors or otherwise in respect of all credit card charges for sales of inventory by the Company and the subsidiary guarantors, certain related assets and proceeds of the foregoing.
Capital stock and other securities of a subsidiary of the Company that are owned by the Company or any subsidiary guarantor will not constitute collateral under the Senior Secured Term Loan Facility to the extent that such securities cannot secure the 2028 Debentures or other secured public debt obligations without requiring the preparation and filing of separate financial statements of such subsidiary in accordance with applicable SEC rules. As a result, the collateral under the Senior Secured Term Loan Facility will include shares of capital stock or other securities of subsidiaries of the Company or any subsidiary guarantor only to the extent that the applicable value of such securities (on a subsidiary-by-subsidiary basis) is less than 20% of the aggregate principal amount of the 2028 Debentures or other secured public debt obligations of the Company.
The credit agreement governing the Senior Secured Term Loan Facility contains a number of negative covenants and covenants related to the security arrangements for the Senior Secured Term Loan Facility. The credit agreement also contains customary affirmative covenants and events of default, including a cross-default provision in respect of any other indebtedness that has an aggregate principal amount exceeding $50.0 million.
Cash Pay Notes. The Company, along with Mariposa Borrower, Inc. as co-issuer, incurred indebtedness in the form of $960.0 million aggregate principal amount of 8.00% Senior Cash Pay Notes due 2021. Interest on the Cash Pay Notes is payable semi-annually in arrears on each April 15 and October 15. The Cash Pay Notes are guaranteed by the same entities that guarantee the Senior Secured Term Loan Facility, other than Holdings. The Cash Pay Notes are unsecured and the guarantees are full and unconditional. At July 29, 2017, the redemption price at which we may redeem the Cash Pay Notes, in
whole or in part, as set forth in the indenture governing the Cash Pay Notes, was 106.000%. The Cash Pay Notes mature on October 15, 2021.
The Cash Pay Notes include certain restrictive covenants that limit our ability to, among other things: (i) incur additional debt or issue certain preferred stock, (ii) pay dividends, redeem stock or make other distributions, (iii) make other restricted payments or investments, (iv) create liens on assets, (v) transfer or sell assets, (vi) create restrictions on payment of dividends or other amounts by us to our restricted subsidiaries, (vii) engage in mergers or consolidations, (viii) engage in certain transactions with affiliates and (ix) designate our subsidiaries as unrestricted subsidiaries. The Cash Pay Notes also contain a cross-acceleration provision in respect of other indebtedness that has an aggregate principal amount exceeding $50.0 million.
PIK Toggle Notes. The Company, along with Mariposa Borrower, Inc. as co-issuer, incurred indebtedness in the form of $600.0 million aggregate principal amount of 8.75%/9.50% Senior PIK Toggle Notes due 2021. The PIK Toggle Notes are guaranteed by the same entities that guarantee the Senior Secured Term Loan Facility, other than Holdings. The PIK Toggle Notes are unsecured and the guarantees are full and unconditional. At July 29, 2017, the redemption price at which we may redeem the PIK Toggle Notes, in whole or in part, as set forth in the indenture governing the PIK Toggle Notes, was 106.563%. The PIK Toggle Notes mature on October 15, 2021.
Interest on the PIK Toggle Notes is payable semi-annually in arrears on each April 15 and October 15. Interest on the PIK Toggle Notes, subject to certain restrictions, may be paid (i) entirely in cash ("Cash Interest"), (ii) entirely by increasing the principal amount of the PIK Toggle Notes by the relevant interest payment amount ("PIK Interest"), or (iii) 50% in Cash Interest and 50% in PIK Interest. Cash Interest on the PIK Toggle Notes accrues at a rate of 8.75% per annum. PIK Interest on the PIK Toggle Notes accrues at a rate of 9.50% per annum. Interest on the PIK Toggle Notes was paid entirely in cash for the first seven interest payments. We elected to pay the October 2017 interest payment in the form of PIK Interest, which will result in the issuance of $28.5 million of additional PIK Toggle Notes in October 2017. We intend to elect to pay interest in the form of PIK Interest or partial PIK Interest on our semi-annual interest payment due in April 2018 and may additionally elect to do so with respect to the payment due in October 2018. If we elect PIK Interest or partial PIK Interest with respect to these interest payments, we must deliver a notice of such election to the trustee no later than one day prior to the beginning of the relevant semi-annual interest period. We will evaluate our financial position prior to each future interest period to determine the appropriate election at that time.
The PIK Toggle Notes include certain restrictive covenants that limit our ability to, among other things: (i) incur additional debt or issue certain preferred stock, (ii) pay dividends, redeem stock or make other distributions, (iii) make other restricted payments or investments, (iv) create liens on assets, (v) transfer or sell assets, (vi) create restrictions on payment of dividends or other amounts by us to our restricted subsidiaries, (vii) engage in mergers or consolidations, (viii) engage in certain transactions with affiliates and (ix) designate our subsidiaries as unrestricted subsidiaries. The PIK Toggle Notes also contain a cross-acceleration provision in respect of other indebtedness that has an aggregate principal amount exceeding $50.0 million.
2028 Debentures. NMG has outstanding $125.0 million aggregate principal amount of our 7.125% Senior Debentures due 2028. The 2028 Debentures are secured by a first lien security interest on certain collateral subject to liens granted under the Senior Secured Credit Facilities constituting (a) (1) 100% of the capital stock of certain of NMG’s existing and future domestic subsidiaries, and (2) 100% of the non-voting stock and 65% of the voting stock of certain of NMG’s existing and future foreign subsidiaries and (b) a significant portion of NMG's owned real property, in each case, to the extent required by the terms of the indenture governing the 2028 Debentures. The 2028 Debentures contain covenants that restrict NMG’s ability to create liens and enter into sale and lease back transactions. The collateral securing the 2028 Debentures will be released upon the release of liens on such collateral under the Senior Secured Credit Facilities and any other debt (other than the 2028 Debentures) secured by such collateral. Capital stock and other securities of a subsidiary of NMG that are owned by NMG or any subsidiary will not constitute collateral under the 2028 Debentures to the extent such property does not constitute collateral under the Senior Secured Credit Facilities as described above. The 2028 Debentures are guaranteed on an unsecured, senior basis by the Company. The guarantee is full and unconditional. The guarantee of the 2028 Debentures is subject to automatic release if the requirements for legal defeasance or covenant defeasance of the 2028 Debentures are satisfied, or if NMG’s obligations under the indenture governing the 2028 Debentures are discharged. At July 29, 2017, our non-guarantor subsidiaries consisted principally of (i) Bergdorf Goodman, Inc., through which we conduct the operations of our Bergdorf Goodman stores; (ii) NM Nevada Trust, which holds legal title to certain real property and intangible assets used by us in conducting our operations; (iii) NMG Germany GmbH, through which we conduct the operations of MyTheresa; (iv) NMG International LLC, a holding company with respect to our foreign operations; and (v) Nancy Holdings LLC, which holds legal title to certain real property used by us in conducting our operations. The 2028 Debentures include certain restrictive covenants
and a cross-acceleration provision in respect of any other indebtedness that has an aggregate principal amount exceeding $15.0 million. The 2028 Debentures mature on June 1, 2028.
Mytheresa.com Credit Facilities. Our subsidiary mytheresa.com GmbH, through which we operate mytheresa.com, is party to two credit facility agreements (the "mytheresa.com Credit Facilities"). The first facility, entered into October 1, 2015, is a revolving credit line for up to €6.5 million in availability and bears interest at a fixed rate of 2.39% (until further notice) for any loan drawn under the overdraft facility and at rates to be agreed on a case-by-case basis for money market loans and guarantees. The second facility, entered into June 8, 2017, is a revolving credit line for up to €8.5 million in availability and bears interest at a fixed rate of 2.25% (until further notice) for any loan drawn under the overdraft facility and at rates to be agreed on a case-by-case basis for any other loans.
Both facilities are secured by certain inventory held by mytheresa.com GmbH and certain contractual claims. The facilities are not guaranteed by, and are non-recourse to, us or any of our U.S. subsidiaries or affiliates. Each facility contains restrictive covenants prohibiting mytheresa.com GmbH from distributing or making available loan proceeds to any affiliates including us or any of our other subsidiaries and requiring mytheresa.com GmbH to maintain a minimum economic equity ratio. The agreements also contain usual and customary events of default, the occurrence of which may result in all outstanding amounts under the facility agreements becoming due and payable immediately. There is no scheduled amortization under either facility and neither facility has a specified maturity date. However, each lender may terminate its respective facility at any time provided that mytheresa.com GmbH is given a customary reasonable opportunity to secure alternative financing.
As of July 29, 2017, mytheresa.com GmbH had no outstanding borrowings, guarantees of $1.2 million, or €1.1 million, and unused commitments of $15.9 million, or €13.9 million.
Maturities of Long-term Debt. At July 29, 2017, annual maturities of long-term debt during the next five fiscal years and thereafter are as follows (in millions):
The previous table does not reflect future excess cash flow prepayments, if any, that may be required under the Senior Secured Term Loan Facility.
Interest Expense, net. The significant components of interest expense are as follows:
NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS
Interest Rate Swaps. At July 29, 2017, we had outstanding floating rate debt obligations of $3,102.6 million. In April and June of 2016, we entered into floating to fixed interest rate swap agreements for an aggregate notional amount of $1,400.0 million to limit our exposure to interest rate increases related to a portion of our floating rate indebtedness. These swap
agreements hedge a portion of our contractual floating rate interest commitments related to our Senior Secured Term Loan Facility from December 2016 to October 2020. As a result of the April 2016 swap agreements, our effective interest rate as to $700.0 million of floating rate indebtedness will be fixed at 4.9120% from December 2016 through October 2020. As a result of the June 2016 swap agreements, our effective interest rate as to an additional $700.0 million of floating rate indebtedness will be fixed at 4.7395% from December 2016 to October 2020. The fair value of our interest rate swap agreements was a gain of $3.6 million at July 29, 2017, which amount is included in other long-term assets, and a loss of $13.2 million at July 30, 2016, which amount is included in other long-term liabilities. The interest rate swap agreements expire in October 2020.
We designated the interest rate swaps as cash flow hedges. As cash flow hedges, unrealized gains on our outstanding interest rate swaps are recognized as assets while unrealized losses are recognized as liabilities. Our interest rate swap agreements are highly, but not perfectly, correlated to the changes in interest rates to which we are exposed. As a result, unrealized gains and losses on our interest rate swap agreements are designated as effective or ineffective. The effective portion of such gains or losses will be recorded as a component of accumulated other comprehensive loss while the ineffective portion of such gains or losses will be recorded as a component of interest expense.
In addition, we realize a gain or loss on our interest rate swap agreements in connection with each required interest payment on our floating rate indebtedness. The realized gains or losses effectively adjust the contractual interest requirements pursuant to the terms of our floating rate indebtedness to the interest requirements at the fixed rates established in the interest rate swap agreements. These realized gains or losses are reclassified to interest expense from accumulated other comprehensive loss.
Interest Rate Caps. In April 2014, we entered into interest rate cap agreements (at a cost of $2.0 million) for an aggregate notional amount of $1,400.0 million to hedge the variability of our cash flows related to a portion of our floating rate indebtedness. The interest rate cap agreements effectively capped LIBOR related to our Senior Secured Term Loan Facility at 3.00% from December 2014 through December 2016 with respect to the $1,400.0 million notional amount of such agreements. The interest rate cap agreements expired in December 2016. Gains and losses realized due to the expiration of applicable portions of the interest rate caps were reclassified to interest expense at the time our quarterly interest payments were made.
A summary of the recorded amounts related to our interest rate swaps and interest rate caps reflected in our Consolidated Statements of Operations is as follows:
The amount of losses recorded in other comprehensive loss at July 29, 2017 that is expected to be reclassified into interest expense in the next 12 months, if interest rates remain unchanged, is approximately $3.4 million.
NOTE 10. INCOME TAXES
The significant components of income tax expense (benefit) are as follows:
The significant components of earnings (loss) before income taxes are as follows:
A reconciliation of income tax expense (benefit) to the amount calculated based on the federal and state statutory rates is as follows:
Our effective income tax rates of 29.0% and 25.8% on the losses for fiscal years 2017 and 2016 were less than the federal statutory tax rate of 35%. No income tax benefits exist related to the goodwill impairment charges of $196.2 million recorded in fiscal year 2017 and $199.2 million recorded in fiscal year 2016. Excluding the impact of the goodwill impairment charges, our effective income tax rates were 39.3% for fiscal year 2017 and 40.6% for fiscal year 2016, which exceeded the federal statutory tax rate due primarily to state income taxes. Our effective income tax rate of 46.8% on the earnings for fiscal year 2015 exceeded the federal statutory tax rate due primarily to state income taxes and the non-deductible portion of transaction and other costs incurred in connection with the MyTheresa acquisition.
We have and intend to continue to reinvest all earnings generated by our foreign operations outside of the U.S. As such, no provision for federal or state income taxes is required as of July 29, 2017. If our intentions change or if these funds
are needed for our U.S. operations, we would be required to accrue or pay U.S. taxes on some or all of these undistributed earnings and our effective tax rate would increase. Determination of the unrecognized deferred tax liability that would be incurred if such amounts were repatriated, if any, is not practicable because the calculation is complex and subject to significant volatility.
Significant components of our net deferred income tax asset (liability) are as follows:
The net deferred tax liability of $1,156.8 million at July 29, 2017 decreased from $1,296.8 million at July 30, 2016. This decrease of $140.0 million was comprised primarily of (i) $117.4 million decrease in deferred tax liabilities resulting from impairment charges incurred in connection with our tradenames and (ii) $38.3 million increase in deferred tax assets related to a federal net operating loss ("NOL") carryforward.
At July 29, 2017, the Company has gross U.S. federal NOLs of $97.7 million and credit carryforwards of $2.0 million. Gross state NOLs are $28.5 million and state credit carryforwards are $1.7 million. The federal NOLs and credit carryforwards will expire in 2037 while the state NOLs and credit carryforwards will expire beginning in 2021 through 2037, if not utilized. All NOLs are expected to be used prior to the end of the carryforward period. A gross net operating loss of $8.5 million exists in the foreign jurisdiction of Luxembourg. A full valuation allowance has been set up against the Luxembourg NOL.
The Company assesses whether deferred tax assets should be recognized based upon the consideration of both positive and negative evidence. Although realization is not assured, the Company believes that the realization of the recognized deferred tax assets is more likely than not based on expectations of future taxable income.
At July 29, 2017, the gross amount of unrecognized tax benefits was $2.2 million ($1.4 million of which would impact our effective tax rate, if recognized). We classify interest and penalties as a component of income tax expense (benefit) and our liability for accrued interest and penalties was $0.4 million at July 29, 2017 and $0.4 million at July 30, 2016. A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:
We file income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions. The Internal Revenue Service ("IRS") finalized its audits of our fiscal year 2012 and short-year 2013 (prior to the Acquisition) federal income tax returns. With respect to state, local and foreign jurisdictions, with limited exceptions, we are no longer subject to income tax audits for fiscal years before 2013. We believe our recorded tax liabilities as of July 29, 2017 are sufficient to cover any potential assessments made by the IRS or other taxing authorities and we will continue to review our recorded tax liabilities for potential audit assessments based upon subsequent events, new information and future circumstances. We believe it is reasonably possible that adjustments to the amounts of our unrecognized tax benefits could
occur within the next 12 months as a result of settlements with tax authorities or expiration of statutes of limitations. At this time, we do not believe such adjustments will have a material impact on our Consolidated Financial Statements.
Subsequent to the Acquisition, Parent and its subsidiaries, including the Company, file U.S. federal income taxes as a consolidated group. The Company has elected to be treated as a corporation for U.S. federal income tax purposes and all operations of Parent are conducted through Holdings and its subsidiaries, including the Company. Income taxes incurred by Parent are reflected by the Company and its subsidiaries in the preparation of our Consolidated Financial Statements. There are no differences in current and deferred income taxes between the Company and Parent.
NOTE 11. EMPLOYEE BENEFIT PLANS
Description of Benefit Plans. We currently maintain defined contribution plans consisting of a retirement savings plan ("RSP") and a defined contribution supplemental executive retirement plan ("Defined Contribution SERP Plan"). As of January 1, 2011, employees may make pretax contributions to the RSP and we match an employee’s contribution up to a maximum of 6% of the employee’s compensation subject to statutory limitations for a potential maximum match of 75% of employee contributions. We also sponsor an unfunded key employee deferred compensation plan, which provides certain employees with additional benefits. Our aggregate expense related to these plans was approximately $27.7 million in fiscal year 2017, $28.0 million in fiscal year 2016 and $30.5 million in fiscal year 2015.
In addition, we sponsor a defined benefit pension plan ("Pension Plan") and an unfunded supplemental executive retirement plan ("SERP Plan") that provides certain employees additional pension benefits. As of the third quarter of fiscal year 2010, benefits offered to all participants in our Pension Plan and SERP Plan were frozen. Retirees and active employees hired prior to March 1, 1989 are eligible for certain limited postretirement health care benefits ("Postretirement Plan") if they meet certain service and minimum age requirements.
Our obligations for employee benefit plans, included in other long-term liabilities, are as follows:
Benefit Obligations. Our obligations for the Pension Plan, SERP Plan and Postretirement Plan are valued as of the end of each fiscal year. Changes in our obligations pursuant to our Pension Plan, SERP Plan and Postretirement Plan during fiscal years 2017 and 2016 are as follows:
Cost of Benefits. The components of the expenses (income) we incurred under our Pension Plan, SERP Plan and Postretirement Plan are as follows:
For purposes of determining pension expense, the expected return on plan assets is calculated using the market related value of plan assets. The market related value of plan assets does not immediately recognize realized gains and losses. Rather, these effects of realized gains and losses are deferred initially and amortized over three years in the determination of the market related value of plan assets. At July 29, 2017, the market related value of plan assets exceeded the fair value by $12.4 million.
Actuarial Loss (Gain). Our projected benefit obligation is adjusted at the end of each fiscal year based upon updated assumptions as to discount rates (as further described below), differences between the actual and expected earnings on our Pension Plan assets, mortality assumptions and other factors. In fiscal year 2017, we decreased our obligations for our employee benefit plans for actuarial gains of $60.6 million ($36.8 million net of taxes) primarily as a result of increases in applicable discount rates and updates to our mortality assumptions.
Expected Benefit Payments. A summary of expected benefit payments related to our Pension Plan, SERP Plan and Postretirement Plan is as follows:
Pension Plan Assets and Investment Valuations. Changes in the assets held by our Pension Plan in fiscal years 2017 and 2016 are as follows:
The Pension Plan’s investments are stated at fair value or estimated fair value, as more fully described below. Purchases and sales of securities are recorded on the trade date. Interest income is recorded on the accrual basis. Dividends are recorded on the ex-dividend date.
Assets held by our Pension Plan are invested in accordance with the provisions of our approved investment policy. The Pension Plan’s strategic asset allocation was structured to reduce volatility through diversification and enhance return to approximate the amounts and timing of the expected benefit payments. The asset allocation for our Pension Plan at the end of fiscal years 2017 and 2016 and the target allocation for fiscal year 2018, by asset category, are as follows:
Pension Plan investments in mutual funds and U.S. government securities are classified as Level 1 investments within the fair value hierarchy. Investments in mutual funds and U.S. government securities are valued at fair value based on quoted market prices at year-end.
Pension Plan investments in corporate debt securities and certain other investments are classified as Level 2 investments within the fair value hierarchy. Other Level 2 investments are valued using updated quotes from market makers or broker-dealers recognized as market participants, information from market sources integrating relative credit information, observed market movements and sector news, all of which are applied to pricing applications and models.
Pension Plan investments in common/collective trusts, hedge funds and limited partnership interests are not classified within the fair value hierarchy. Investments in common/collective trusts are valued based on net asset values on the last business day of the Pension Plan's year end as determined by the sponsors of such trusts and can be redeemed daily. Hedge funds are valued at estimated fair value based on net asset value as determined by the respective fund manager based on the valuation of the underlying securities. Limited partnership interests in venture capital investments are valued at estimated fair value based on net asset value as determined by the respective fund investment manager. The hedge funds and limited partnerships allocate gains, losses and expenses to the Pension Plan as described in the agreements.
Hedge funds and limited partnership interests are redeemable at net asset value to the extent provided in the documentation governing the investments. Redemption of these investments may be subject to restrictions including lock-up periods where no redemptions are allowed, restrictions on redemption frequency and advance notice periods for redemptions. As of July 29, 2017, certain of these investments were subject to restrictions on redemption frequency, ranging from daily to every three years and certain of these investments are subject to advance notice requirements, ranging from three-day notification to 180-day notification.
Investment securities, in general, are exposed to various risks such as interest rate, credit and overall market volatility. Due to the level of risk associated with certain investment securities, it is reasonably possible that changes in the values of investment securities will occur in the near term and that such changes could materially affect the amounts reported in the statements of net assets available for benefits. The valuation methods previously described above may produce a fair value calculation that may not be indicative of net realized value or reflective of future fair values.
The following tables set forth by level, within the fair value hierarchy, the Pension Plan’s assets at fair value as of July 29, 2017 and July 30, 2016.
Funding Policy and Status. Our policy is to fund the Pension Plan at or above the minimum level required by law. In fiscal year 2017, we were required to contribute $10.7 million to the Pension Plan. In fiscal year 2016, we were not required to make contributions to the Pension Plan. As of July 29, 2017, we believe we will be required to contribute $25.1 million to the Pension Plan in fiscal year 2018.
Assumptions. Significant assumptions related to the calculation of our obligations pursuant to our employee benefit plans include the discount rates used to calculate the present value of benefit obligations to be paid in the future, the expected long-term rate of return on assets held by our Pension Plan and the health care cost trend rate for the Postretirement Plan. We review these assumptions annually based upon currently available information. The assumptions we utilized in calculating the projected benefit obligations and periodic expense of our Pension Plan, SERP Plan and Postretirement Plan are as follows:
Discount Rate. The assumed discount rate utilized is based on a spot rate methodology in the estimation of the interest cost component of net periodic benefit cost, which uses the individual spot rates along the yield curve corresponding to benefit payments. The discount rate is utilized principally in calculating the present values of our benefit obligations and related expenses.
Expected Long-Term Rate of Return on Plan Assets. The assumed expected long-term rate of return on assets is the weighted average rate of earnings, net of investment and administrative expenses, expected on the funds invested or to be invested by the Pension Plan to provide for the plan’s obligations. At July 29, 2017, the expected long-term rate of return on plan assets was 5.50%. We estimate the expected average long-term rate of return on assets based on historical returns, our future asset performance expectations using currently available market and other data and the advice of our outside actuaries and advisors. To the extent the actual rate of return on assets realized over the course of a year is greater than the assumed rate, that year’s annual pension expense is not affected. Rather, this gain reduces future pension expense over a period of approximately 22 years. To the extent the actual rate of return on assets is less than the assumed rate, that year’s annual pension expense is likewise not affected. Rather, this loss increases pension expense over approximately 22 years.
Health Care Cost Trend Rate. The assumed health care cost trend rate represents our estimate of the annual rates of change in the costs of the health care benefits currently provided by the Postretirement Plan. The health care cost trend rate implicitly considers estimates of health care inflation, changes in health care utilization and delivery patterns, technological advances and changes in the health status of the plan participants.
NOTE 12. COMMITMENTS AND CONTINGENCIES
Leases. We lease certain property and equipment under various operating leases. The leases provide for fixed monthly rentals and/or contingent rentals based upon sales in excess of stated amounts and normally require us to pay real estate taxes, insurance, common area maintenance costs and other occupancy costs. Generally, the leases have primary terms ranging from five to 99 years and include renewal options ranging from three to 80 years.
Rent expense and related occupancy costs under operating leases is as follows:
Future minimum rental commitments (excluding renewal options) under non-cancelable leases for the next five fiscal years and thereafter are as follows (in thousands):
Employment and Consumer Class Actions Litigation. In 2007, Bernadette Tanguilig filed a lawsuit in the Superior Court of California for San Francisco County alleging wrongful termination and retaliation arising from her refusal to sign the Company’s mandatory arbitration agreement. Ms. Tanguilig later filed several amendments to her complaint adding claims under the California Labor Code Private Attorneys General Act ("PAGA") and class action allegations of wage and hour violations. She also added Juan Carlos Pinela as an additional plaintiff. In December 2013, the Company filed a motion to dismiss Ms. Tanguilig’s claims based on her failure to bring her claims to trial within five years as required by California law. In February 2014, the Company’s motion was granted and Ms. Tanguilig’s claims were dismissed. Ms. Tanguilig appealed. Briefing is complete, and a judicial panel has been assigned. The parties have requested oral argument, but no date has been set.
In October 2011, the court ordered Mr. Pinela (a co-plaintiff in the Tanguilig case) to arbitrate his claims in accordance with the mandatory arbitration agreement. Mr. Pinela filed a demand for arbitration seeking to arbitrate both his individual and class claims, which the Company argued was in violation of the class action waiver in the arbitration agreement. This led to further proceedings in the trial court, a stay of the arbitration, and a decision by the trial court to reconsider and vacate its order compelling arbitration, which the Company appealed. In June 2015, the appellate court upheld the trial court’s denial of the Company’s motion to compel arbitration of Mr. Pinela’s claims. The Company’s petition for rehearing by the appellate court and petition for review by the California Supreme Court were denied, and the case was returned to the trial court. On December 10, 2015, the trial court issued a stay of the case pending the conclusion of the Tanguilig appeal, which remains in effect.
We recorded our currently estimable liabilities with respect to Ms. Tanguilig's employment class action litigation claims in fiscal year 2014, which amount was not material to our financial condition or results of operations. We will continue to evaluate the Tanguilig matter, and our recorded reserve for such matter, based on subsequent events, new information and future circumstances.
The National Labor Relations Board ("NLRB") has been pursuing a complaint alleging that the Mandatory Arbitration Agreement’s class action prohibition violates employees’ rights to engage in concerted activity. The administrative law judge issued a recommended decision and order finding that the Company's Arbitration Agreement and class action waiver violated the National Labor Relations Act, which were affirmed by the NLRB in August 2015. On August 12, 2015, we filed our petition for review of the NLRB's order with the U.S. Court of Appeals for the Fifth Circuit. This case is stayed while another similar case is pending before the U.S. Supreme Court.
On August 7, 2014, a putative class action complaint was filed against The Neiman Marcus Group LLC in Los Angeles County Superior Court by a customer, Linda Rubenstein, in connection with the Company's Last Call stores in California. Ms. Rubenstein alleges that the Company has violated various California consumer protection statutes by implementing a marketing and pricing strategy that suggests that clothing sold at Last Call stores in California was originally offered for sale at full-line Neiman Marcus stores when allegedly, it was not, and that the Company lacks adequate information to support its comparative pricing labels. In September 2014, we removed the case to the U.S. District Court for the Central District of California. After dismissing Ms. Rubenstein’s original and first amended complaint, the court dismissed her second amended complaint in its entirety in May 2015, without leave to amend, and Ms. Rubenstein appealed. In April 2017, the Court of Appeal reversed, holding that Ms. Rubenstein’s allegations were sufficient to proceed past the pleadings stage of litigation. The case has been transferred back to the district court and has a trial date of July 24, 2018. On September 7, 2017, the district court issued an order permitting Ms. Rubenstein to file a proposed Third Amended Complaint, which modifies the putative class period. Additionally, Ms. Rubenstein filed a motion for class certification, which is currently set for hearing on December 18, 2017.
The Company has several wage and hour putative class action matters pending in California. The earliest, filed in December 2015 and amended in February 2016, was filed against The Neiman Marcus Group, Inc. by Holly Attia and seven other named plaintiffs, seeking to certify a class of nonexempt employees for alleged violations for failure to pay overtime
wages, failure to provide meal and rest breaks, failure to reimburse business expenses, failure to timely pay wages due at termination and failure to provide accurate itemized wage statements. Plaintiffs also allege derivative claims for restitution under California unfair competition law and a representative claim for penalties under PAGA, and all related damages for alleged violations (restitution, statutory penalties under PAGA, and attorneys' fees, interest and costs of suit). The case was removed to the U.S. District Court for the Central District of California in March 2016, and the Company filed a motion to compel arbitration and requested to stay the PAGA claim. In June 2016, the court granted the motion and compelled arbitration of the individual claims. The court retained jurisdiction of the PAGA claim and stayed that claim pending the outcome of arbitration. In October 2016, the court granted the plaintiffs' motion for reconsideration of the arbitration decision based on a recent decision by the Ninth Circuit Court of Appeals in Morris v. Ernst & Young, LLP, and reversed its order compelling arbitration. The Company appealed. The U.S. Supreme Court granted certiorari of the Morris decision, and the Ninth Circuit appeal is currently stayed pending the Supreme Court's decision. In June 2017, the district court stayed the entire case pending the Supreme Court’s decision in Morris.
On June 1, 2016, a PAGA representative action was filed against The Neiman Marcus Group, Inc. in the same court as Attia by Xuan Hien Nguyen pleading only PAGA claims and asserting the same factual allegations as the plaintiffs in Attia. The Company filed a motion to dismiss or to stay the case. In September 2016, the court granted the Company's motion and stayed the Nguyen case in light of Attia. At a status conference on September 5, 2017, the court maintained the stay and set a further status conference for November 8, 2017.
On July 28, 2016, former employee Milca Connolly also filed a representative action alleging only PAGA claims against The Neiman Marcus Group raising substantially identical claims to those raised in both Attia and Nguyen. The Company filed a motion to dismiss or stay the case in light of Attia and Nguyen. In November 2016, the court granted the Company's motion to stay the case. At a status conference on September 5, 2017, the court maintained the stay and set a further status conference for November 8, 2017.
On September 27, 2016, a dormant Illinois putative class action lawsuit, Catherine Ohle v. Neiman Marcus Group, originally filed in the Circuit Court of Cook County, was revived by an Illinois appeals court when it reversed a June 2014 trial court's order granting summary judgment to the Company and dismissing the matter in its entirety. In Ohle, the plaintiff alleged that the Company’s prior practice of conducting pre-employment credit checks of sales associates and considering credit history as a factor in its hiring decisions violated the Illinois Employee Credit Privacy Act. The appellate court reversed, holding that no exemption applied. The Company appealed the decision to the Illinois Supreme Court, and review was denied on January 25, 2017. The case was returned to the trial court for further proceedings. On September 19, 2017, the court granted final approval of a class settlement.
In addition, we are currently involved in various other legal actions and proceedings that arose in the ordinary course of business. With respect to the matters described above as well as all other current outstanding litigation involving us, we believe that any liability arising as a result of such litigation will not have a material adverse effect on our financial condition, results of operations or cash flows.
Cyber-Attack Class Actions Litigation. In January 2014, three class actions relating to a cyber-attack on our computer systems in 2013 (the "Cyber-Attack") were filed and later voluntarily dismissed by the plaintiffs between February and April 2014. The plaintiffs had alleged negligence and other claims in connection with their purchases by payment cards and sought monetary and injunctive relief. Three additional putative class actions relating to the Cyber-Attack were filed in March and April 2014, also alleging negligence and other claims in connection with plaintiffs’ purchases by payment cards. Two of the cases were voluntarily dismissed. The third case, Hilary Remijas v. The Neiman Marcus Group, LLC, was filed on March 12, 2014 in the U.S. District Court for the Northern District of Illinois. On June 2, 2014, an amended complaint in the Remijas case was filed, which added three plaintiffs (Debbie Farnoush and Joanne Kao, California residents; and Melissa Frank, a New York resident) and asserted claims for negligence, implied contract, unjust enrichment, violation of various consumer protection statutes, invasion of privacy and violation of state data breach laws. The Company moved to dismiss the Remijas amended complaint, and the court granted the Company's motion on the grounds that the plaintiffs lacked standing due to their failure to demonstrate an actionable injury. Plaintiffs appealed the district court's order dismissing the case to the Seventh Circuit Court of Appeals, and the Seventh Circuit Court of Appeals reversed the district court's ruling, remanding the case back to the district court. The Company filed a petition for rehearing en banc, which the Seventh Circuit Court of Appeals denied. The Company filed a motion for dismissal on other grounds, which the court denied. The parties jointly requested, and the court granted, an extension of time for filing a responsive pleading, which was due on December 28, 2016. On February 9, 2017, the court denied the parties' request for another extension of time, dismissed the case without prejudice, and stated that plaintiffs could file a motion to reinstate. On March 8, 2017, plaintiffs filed a motion to reinstate, which the court granted on March 16, 2017. On March 17, 2017, plaintiffs filed a motion seeking preliminary approval of a class action settlement resolving this action, which the court granted on June 21, 2017. The court set for October 26, 2017 as the date for a fairness
hearing and consideration of final approval of the class action settlement. In September 2017, purported settlement class members filed two objections asking the court to deny final approval of the proposed settlement. The plaintiffs’ and the Company’s responses to the objections are due on October 19, 2017.
In addition to class actions litigation, payment card companies and associations may require us to reimburse them for unauthorized card charges and costs to replace cards and may also impose fines or penalties in connection with the security incident, and enforcement authorities may also impose fines or other remedies against us. We have also incurred other costs associated with this security incident, including legal fees, investigative fees, costs of communications with customers and credit monitoring services provided to our customers. At this point, we are unable to predict the developments in, outcome of, and economic and other consequences of pending or future litigation or regulatory investigations related to, and other costs associated with, this matter. We will continue to evaluate these matters based on subsequent events, new information and future circumstances.
Other. We had $1.8 million of irrevocable letters of credit and $3.4 million in surety bonds outstanding at July 29, 2017, relating primarily to merchandise imports and state sales tax and utility requirements.
NOTE 13. ACCUMULATED OTHER COMPREHENSIVE LOSS
The following table summarizes the changes in accumulated other comprehensive loss by component (amounts are recorded net of related income taxes):
The amounts reclassified from accumulated other comprehensive loss are recorded within interest expense on the Consolidated Statements of Operations.
NOTE 14. STOCK-BASED AWARDS
Incentive Plans. Parent established various incentive plans pursuant to which eligible employees, consultants and non-employee directors are eligible to receive stock-based awards. Under the incentive plans, Parent is authorized to grant stock options, restricted stock and other types of awards that are valued in whole or in part by reference to, or are payable or otherwise based on, the shares of common stock of Parent. Charges with respect to options issued by Parent pursuant to the incentive plans are reflected by the Company in the preparation of our Consolidated Financial Statements.
Co-Invest Options. In connection with the Acquisition, certain executive officers of the Company rolled over a portion of the amounts otherwise payable in settlement of their pre-Acquisition stock options into stock options of Parent representing options to purchase a total of 56,979 shares of common stock of Parent (the "Co-Invest Options").
The number of Co-Invest Options issued upon conversion of pre-Acquisition stock options was equal to the product of (a) the number of shares subject to the applicable pre-Acquisition stock options multiplied by (b) the ratio of the per share merger consideration over the fair market value of a share of Parent, which was approximately 3.1x (the "Exchange Ratio"). The exercise price of each pre-Acquisition stock option was adjusted by dividing the original exercise price of the pre-Acquisition stock option by the Exchange Ratio. Following the conversion, the exercise prices of the Co-Invest Options range from $180 to $644 per share. As of the date of the Acquisition, the aggregate intrinsic value of the Co-Invest Options equaled the aggregate intrinsic value of the rolled over pre-Acquisition stock options. The Co-Invest Options are fully vested and are exercisable at any time prior to the applicable expiration dates related to the original grant of the pre-Acquisition options. The Co-Invest Options contain sale and repurchase provisions.
On September 8, 2017, the Compensation Committee approved grants of non-qualified Co-Invest Options (the “New Co-Invest Options”) to certain continuing employees who previously held Co-Invest Options. The New Co-Invest Options have the effect of replacing the previous Co-Invest Options held by those employees, which were cancelled, and extending the expiration date to the tenth anniversary of the grant date. All other terms of the New Co-Invest Options remain unchanged from the terms of the cancelled Co-Invest Options.
Non-Qualified Stock Options. Pursuant to the terms of the incentive plans, Parent granted time-vested and performance-vested non-qualified stock options to certain executive officers, employees and non-employee directors of the Company. These non-qualified stock options will expire no later than the tenth anniversary of the grant date.
Accounting for Stock Options. Prior to an initial public offering ("IPO"), in the event the optionee ceases to be an employee of the Company, Parent generally has the right to repurchase shares issued upon exercise of vested stock options at fair market value and shares underlying vested unexercised stock options for the difference between the fair market value of the underlying share on the date of such optionee's termination of employment and the exercise price. However, other than with respect to the Co-Invest Options, if the optionee voluntarily leaves the Company without good reason (as defined in the incentive plans) or is terminated for cause, the repurchase price is the lesser of the exercise price of such options or the fair value of such awards at the employee termination date. For certain optionees, in the event of the retirement of the optionee, the repurchase price is the fair value at the retirement date. Parent's repurchase rights expire upon completion of an IPO, including with respect to the Co-Invest Options.
We currently account for stock options issued to certain optionees who will become retirement eligible prior to the expiration of their stock options ("Retirement Eligible Optionees") as variable awards using the liability method as these optionees could receive a cash settlement of their awards at the time of retirement should Parent exercise its repurchase rights with respect to such shares. Under the liability method, we recognize the estimated liability for option awards held by Retirement Eligible Optionees over the vesting periods of such awards. In periods in which the estimated fair value of our equity increases, we increase our stock compensation liability. Conversely, in periods in which the estimated fair value of our equity decreases, we reduce our stock compensation liability. These increases/decreases are recorded as stock compensation expense and are included in selling, general and administrative expenses. With respect to time-vested options held by non-Retirement Eligible Optionees, such options are effectively forfeited should the optionee voluntarily leave the Company without good reason or be terminated for cause prior to an IPO. As a result, we currently record no expense or liability with respect to such options. With respect to performance-vested options, such options are effectively forfeited should the optionee voluntarily leave the Company without good reason or be terminated for cause prior to achievement of the performance condition. As a result, we currently record no expense or liability with respect to such options.
A summary of our liabilities for our variable stock option awards is as follows:
Outstanding Stock Options. A summary of stock option activity is as follows:
Grant Date Fair Value of Stock Options. At the date of grant, the stock option exercise price equals or exceeds the fair market value of Parent's common stock. Because Parent is privately held and there is no public market for its common stock, the fair market value of Parent's common stock is determined by the Parent Board or the Compensation Committee, as applicable, at the time option grants are awarded (Level 3 determination of fair value). In determining the fair market value of Parent's common stock, the Parent Board or the Compensation Committee, as applicable, considers such factors as any recent transactions involving Parent's common stock, the Company’s actual and projected financial results, the principal amount of the Company’s indebtedness, valuations of the Company performed by third parties and other factors it believes are material to the valuation process.
We use the Black-Scholes option-pricing model to determine the fair value of our options as of the date of grant. We used the following assumptions to estimate the fair value for stock options at the grant date:
Expected volatility is based on estimates of implied volatility of our peer group.
In September 2016, the Compensation Committee determined that the exercise prices of certain time-vested and performance-vested stock options were higher than the current fair market value of Parent's common stock. In order to enhance the retentive value of these options, the Compensation Committee approved (1) a repricing of 18,225 time-vested and performance-vested stock options to an exercise price of $1,000 per share and (2) modifications to the performance metrics applicable to all performance-vested stock options.
Restricted Stock. On October 27, 2016, Parent approved grants of 26,954 restricted shares of common stock of Parent to certain executive officers and management employees. Subject to continued employment, shares of restricted stock will vest over three or four years in equal increments on each anniversary of December 1, 2016. Each year beginning in calendar 2017, subject to certain limitations, each recipient will have the ability to require Parent to acquire his or her vested shares (the "put right") during the 14-day period following the release of the Company's earnings in respect of its first fiscal quarter (such period, the "put period") for a purchase price equal to the fair market value of Parent's common stock at the beginning of the put period. Except as described below with respect to our Chief Executive Officer, a recipient will forfeit all unvested shares of restricted stock and may not exercise the put right with respect to any vested shares following the termination of his or her employment for any reason. Following a voluntary departure without good reason or a termination for cause, we have the right to repurchase any vested shares of restricted stock at par value ($0.001 per share).
If our Chief Executive Officer's employment is terminated by Parent without cause, by her for good reason (as defined in her employment agreement) or by reason of the non-renewal of her employment agreement, (i) prior to a change in control of Parent, all unvested shares of restricted stock that would have vested in the 12-month period following the date of such termination of employment will accelerate and vest, and (ii) following a change in control but before an IPO, all unvested shares of restricted stock will accelerate and vest. Upon such termination, our Chief Executive Officer will have the ability to exercise the put right with respect to vested shares in the first put period following termination of employment.
At July 29, 2017, the recorded liability with respect to unvested restricted shares was $1.2 million at July 29, 2017.
Outstanding Restricted Shares. A summary of restricted share activity is as follows:
Stock Compensation Expense (Benefit). The following table summarizes our stock-based compensation expense (benefit):
NOTE 15. REVENUES
The following table represents our revenues by merchandise category as a percentage of revenues:
NOTE 16. OTHER EXPENSES
Other expenses consists of the following components:
We incurred professional fees and other costs aggregating $21.3 million in fiscal year 2017, $24.3 million in fiscal year 2016 and $11.6 million in fiscal year 2015 in connection with review of our resources and organizational processes ("Organizing for Growth"), implementation of our integrated merchandising and distribution system ("NMG One") and the evaluation of potential strategic alternatives. In connection with Organizing for Growth, we eliminated approximately 315 positions in fiscal year 2017 and approximately 500 positions in fiscal year 2016 across our stores, divisions and facilities. We incurred severance costs of $7.2 million in fiscal year 2017 and $10.2 million in fiscal year 2016.
In October 2014, we acquired MyTheresa, a luxury retailer headquartered in Munich, Germany. Acquisition costs consisted primarily of professional fees as well as adjustments of our earn-out obligations to estimated fair value at each reporting date. The final earn-out obligation was paid in March 2017.
We discovered in January 2014 that malicious software was clandestinely installed on our computer systems. In fiscal years 2017, 2016 and 2015, we incurred investigative, legal and other expenses in connection with the Cyber-Attack. We expect to incur ongoing costs related to the Cyber-Attack for the foreseeable future. Such expenses are not currently estimable but could be material to our future results of operations.
In the third quarter of fiscal year 2016, we recorded a $5.6 million net gain related to the closure and relocation of our regional service center in New York.
NOTE 17. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (with respect to NMG's obligations under the Senior Secured Credit Facilities, Cash Pay Notes and PIK Toggle Notes)
All of NMG’s obligations under the Senior Secured Credit Facilities are guaranteed by Holdings and our current and future direct and indirect wholly owned subsidiaries, subject to exceptions as more fully described in Note 8. All of NMG's obligations under the Cash Pay Notes and the PIK Toggle Notes are guaranteed by the same entities that guarantee the Senior Secured Credit Facilities, other than Holdings. Currently, the Company’s non-guarantor subsidiaries under the Senior Secured Credit Facilities, Cash Pay Notes and PIK Toggle Notes consist principally of (i) NMG Germany GmbH, through which we conduct the operations of MyTheresa, (ii) NMG International LLC, a holding company with respect to our foreign operations and (iii) Nancy Holdings LLC, which holds legal title to certain real property used by us in conducting our operations and described below under "- Results of Operations and Financial Condition of Unrestricted Subsidiaries". The non-guarantor subsidiary Nancy Holdings LLC had no assets or operations prior to March 10, 2017.
The following condensed consolidating financial information represents the financial information of the Company and its non-guarantor subsidiaries under the Senior Secured Credit Facilities, Cash Pay Notes and PIK Toggle Notes prepared on the equity basis of accounting. The information is presented in accordance with the requirements of Rule 3-10 under the SEC’s Regulation S-X. The financial information may not necessarily be indicative of results of operations, cash flows or financial position had the non-guarantor subsidiaries operated as independent entities.
Results of Operations and Financial Condition of Unrestricted Subsidiaries. On March 10, 2017, the Board of Directors of Parent designated certain of our subsidiaries as “unrestricted subsidiaries” for purposes of the indenture governing the Cash Pay Notes and the indenture governing the PIK Toggle Notes. These subsidiaries were previously or simultaneously designated as "unrestricted subsidiaries" under the Asset-Based Revolving Credit Facility and the Senior Secured Term Loan Facility. At July 29, 2017, the unrestricted subsidiaries consisted primarily of (i) NMG Germany GmbH, through which we conduct the operations of MyTheresa and (ii) Nancy Holdings LLC, which holds legal title to certain real property located in McLean, Virginia, San Antonio, Texas and Longview, Texas used by us in conducting our operations.
Pursuant to the terms of the indentures governing the Cash Pay Notes and the PIK Toggle Notes, we are presenting the following financial information with respect to the unrestricted subsidiaries separate from the Company and its restricted subsidiaries. The unrestricted subsidiary Nancy Holdings LLC had no assets or operations prior to March 10, 2017. The financial information of NMG Germany GmbH as of July 30, 2016 and as of August 1, 2015 was substantially the same as the financial information presented for “Non-Guarantor Subsidiaries” for such periods included in the tables above in this Note 17. The difference in net earnings of the unrestricted subsidiaries for the fiscal year ended July 29, 2017 compared to the net earnings of the non-guarantor subsidiaries for such periods, as presented in the tables above in this Note 17, consisted primarily of a net interest income of approximately $1.4 million per fiscal quarter associated with an intercompany note payable by the MyTheresa unrestricted subsidiaries and held by NMG International LLC, which is a non-guarantor restricted subsidiary.
This information may not necessarily be indicative of the financial condition and results of operations of the unrestricted subsidiaries had they operated as independent entities during the periods presented.
Information with respect to the unrestricted subsidiaries with respect to the Cash Pay Notes and PIK Toggle Notes is as follows:
NOTE 18. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (with respect to NMG's obligations under the 2028 Debentures)
All of NMG’s obligations under the 2028 Debentures are guaranteed by the Company. The guarantee by the Company is full and unconditional and is subject to automatic release if the requirements for legal defeasance or covenant defeasance of the 2028 Debentures are satisfied, or if NMG’s obligations under the indenture governing the 2028 Debentures are discharged. Currently, the Company’s non-guarantor subsidiaries under the 2028 Debentures consist principally of (i) Bergdorf Goodman, Inc., through which we conduct the operations of our Bergdorf Goodman stores; (ii) NM Nevada Trust, which holds legal title to certain real property and intangible assets used by NMG in conducting its operations; (iii) NMG Germany GmbH, through which we conduct the operations of MyTheresa; (iv) NMG International LLC, a holding company with respect to our foreign operations; and (v) Nancy Holdings LLC, which holds legal title to certain real property used by NMG in conducting its operations and described in Note 17 under "- Results of Operations and Financial Condition of Unrestricted Subsidiaries". The non-guarantor subsidiary Nancy Holdings LLC had no assets or operations prior to March 10, 2017.
The following condensed consolidating financial information represents the financial information of the Company and its non-guarantor subsidiaries under the 2028 Debentures, prepared on the equity basis of accounting. The information is presented in accordance with the requirements of Rule 3-10 under the SEC’s Regulation S-X. The financial information may not necessarily be indicative of results of operations, cash flows or financial position had the non-guarantor subsidiaries operated as independent entities.
NOTE 19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(1)
Gross profit includes revenues less cost of goods sold including buying and occupancy costs (excluding depreciation).
(2)
For fiscal years 2017 and 2016, net earnings (loss) includes pretax impairment charges to writedown the net carrying value of certain tradenames, goodwill and long-lived assets to fair value, which were as follows:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NEIMAN MARCUS GROUP LTD LLC
By:
/s/ T. DALE STAPLETON
T. Dale Stapleton
Interim Chief Financial Officer, Senior Vice President and Chief Accounting Officer
Dated:
October 10, 2017
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SCHEDULE II
NEIMAN MARCUS GROUP LTD LLC
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(in thousands)
Three years ended July 29, 2017
(A) Reserves for self-insurance relate to our medical, dental, worker's compensation and general liability plans.
(B) Gross margin on actual sales returns, net of commissions.
(C) Claims and expenses paid, net of employee contributions.