Item 1. Business.
Description of Business
The operations of Saks Incorporated, a Tennessee corporation first incorporated in 1919, and its subsidiaries (together the “Company”) consist of Saks Fifth Avenue (“SFA”) stores and SFA e-commerce operations (“Saks Direct”) as well as Saks Fifth Avenue OFF 5TH (“OFF 5TH”).
The Company is an omni-channel luxury retailer offering a wide assortment of distinctive fashion apparel, shoes, accessories, jewelry, cosmetics, and gifts. SFA stores are principally free-standing stores in exclusive shopping destinations or anchor stores in upscale regional malls. Customers may also purchase SFA products online at saks.com or by catalog. OFF 5TH is intended to be the premier luxury off-price retailer in the United States. OFF 5TH stores are primarily located in upscale mixed-use and off-price centers and offer luxury apparel, shoes, and accessories, targeting the value-conscious customer. As of January 28, 2012, the Company operated 46 SFA stores with a total of approximately 5.5 million square feet and 60 OFF 5TH stores with a total of approximately 1.7 million square feet.
Merchandising, sales promotion, and store operating support functions reside in New York, New York. The back office sales support functions for the Company, such as accounting, credit card administration, store planning, and information technology, are located principally in the Company’s operations center in Jackson, Mississippi or in the SFA corporate offices in New York, New York.
The Company’s fiscal year ends on the Saturday closest to January 31st. Fiscal years 2011, 2010, and 2009 each contained 52 weeks and ended on January 28, 2012 (“2011”), January 29, 2011 (“2010”), and January 30, 2010 (“2009”), respectively.
Merchandising
The Company’s stores and Saks Direct carry luxury merchandise from both core vendors and new and emerging designers, supplemented with select private brand offerings. The Company has key relationships with the leading American and European fashion houses, including Giorgio Armani, Oscar de la Renta, Dolce and Gabbana, Chanel, Gucci, Prada, Louis Vuitton, St. John, Zegna, Theory, Cartier, David Yurman, Hugo Boss, Elie Tahari, Tory Burch, Ralph Lauren, Akris and Burberry, among many others.
The Company has developed knowledge of each of its trade areas and customer bases for its operations. This knowledge is gained through use of on-line merchandise sell-through information, store visits by senior management and merchandising personnel, and frequent communication between merchandising staff, store management, and customers who shop in store and/or online. The Company strives to tailor each store’s merchandise assortment to the characteristics of its trade areas and customer bases and to the lifestyle needs of its local customers.
Certain departments in the Company’s SFA stores are leased to independent companies in order to provide high quality service and merchandise where specialization and expertise are critical. The leased departments are designed to complement the Company’s owned merchandising departments. The principal leased departments in the SFA stores are furs and certain designer handbags and jewelry. The terms of the lease agreements typically are between one and seven years and may require the lessee to pay for a portion of the fixtures and provide its own employees. Management regularly evaluates the performance of the leased departments and requires compliance with established customer service guidelines.
For the year ended January 28, 2012, the Company’s percentages of net sales (exclusive of sales generated by leased departments) by major merchandise category were as follows:
Inventory Purchasing and Distribution
Consistent with practices in the retail industry, the Company purchases merchandise assortments and volumes to coincide with the seasonality of the business and expected customer demand. Retailers typically purchase and receive larger amounts of merchandise in the fall as they prepare for the holiday shopping season (primarily November and December).
The Company purchases merchandise from many vendors. Management monitors profitability and sales history with vendors and believes it has alternative sources available for each category of merchandise it purchases. Management believes it maintains good relationships with its vendors.
The Company has two distribution facilities serving its stores. Refer to “Item 2. Properties” for additional information about these facilities.
The Company’s distribution facilities operate on a modern warehouse management system that leverages electronic data interchange (“EDI”) technology in conjunction with high-speed automated conveyor systems in order to receive and distribute merchandise as economically as possible to the Company’s stores. Many of the Company’s vendors also utilize EDI technology which permits merchandise to be ‘cross docked’ from the receiving department to the shipping department, with very little handling. The distribution centers also use efficient radio frequency hand-held devices to scan barcodes on merchandise that is too large or fragile for the conveyor system. The warehouse management system is interfaced to the Company’s mainframe to execute ‘booking’ of the merchandise to the stores and to pass the appropriate records to accounting for invoice payment and reconciliation.
In 2010, the Company installed an advanced robotics system for receiving and fulfilling Saks Direct orders in its primary distribution facility located in Aberdeen, Maryland. The automation provided by the robotics system has significantly increased productivity, improved space utilization, and improved customer service since becoming fully operational in mid-2011.
In February 2012, the Company announced its plans to expand its distribution and fulfillment capacity by adding a new facility in Tennessee in mid-2012. The new facility, which totals approximately 564,000 square feet and will be leased, is necessary to support the Company’s omni-channel strategy and planned sales growth in Saks Direct. The Company will continue to operate its existing distribution facilities located in Aberdeen, Maryland and Ontario, California.
Return Policy
The Company offers its customers a fair and liberal return policy, consistent with other luxury retailers, at SFA stores, online at saks.com, and at OFF 5TH stores. Merchandise purchased on saks.com may be returned to SFA stores. Approximately 22% of merchandise sold is later returned, and a large percentage of merchandise returns occur within a matter of days of the selling transaction. The Company uses historic return patterns to estimate expected returns.
Information Technology
Company management believes that technological investments are necessary to support its business operations and strategies, and, as a result, the Company is continually upgrading its information systems to improve efficiency and productivity. Between 2006 and 2009, the Company completed significant upgrades to its merchandise planning and allocation systems and installed new point-of-sale equipment and software with enhanced clienteling capabilities in each of its SFA stores. In 2010, the Company made significant investments in demand chain management systems, focused on improving the allocation of merchandise to the stores and also invested in an advanced robotics system for receiving and fulfilling Saks Direct orders. In 2011, the Company made certain technology investments to support its omni-channel approach to the business. The Company implemented “one view” of the customer, providing a consolidated repository for all customer data across the Company’s channels, enabling improved and more accurate customer analytics and an enhanced ability to target market to its customers. In addition, also in 2011, the Company implemented “one view” of the inventory, integrating SFA’s in store and Saks Direct inventory systems.
The Company’s information systems provide information deemed necessary for management operating decisions, cost management programs, and customer service enhancements. Individual data processing systems include point-of-sale and sales reporting, purchase order management, receiving, merchandise planning and control, payroll, human resources, general ledger, and accounts payable systems. Bar code ticketing is used, and scanning is utilized at point-of-sale terminals. Information is made available on Company systems to merchandising staff and store management on a timely basis.
The use of EDI technology allows the Company to speed the flow of information and merchandise in an attempt to capitalize on emerging sales trends, maximize inventory turnover, and minimize out-of-stock conditions. EDI technology includes an advance shipping notice system (“ASN”). The ASN system identifies discrepancies between merchandise that is ready to be shipped from a supplier’s warehouse and that which was ordered from the supplier. This early identification provides the Company with a window of time to resolve any discrepancies in order to speed merchandise through the distribution facilities and into its stores.
During 2012, to further support future growth and the Company’s omni-channel retailing approach, the Company will begin a substantial multi-year transformation of and investment in both foundational systems and emerging technology. This technology will deliver new merchandising, finance and human resource capabilities on an integrated application suite for the entire Company.
Marketing
The Company’s marketing principally emphasizes the latest fashion trends in luxury merchandise and primarily utilizes direct mail (catalogs) and targeted email advertising, supplemented with national and local marketing efforts. To promote its image as one of the primary sources of luxury goods in its trade areas, the Company sponsors numerous fashion shows and in-store special events highlighting the designers represented in the Company’s stores. The Company also participates in “cause-related” marketing. This includes special in-store events and related advertising designed to drive store traffic, while raising funds for charitable organizations and causes such as women’s cancer research. The Company’s in-house marketing and sales promotion staff work with outside agencies to produce the Company’s marketing materials and campaigns.
The Company utilizes data captured through the use of proprietary credit cards offered by HSBC Bank Nevada, N.A. (“HSBC”) to develop advertising and promotional events targeted at specific customers who have purchasing patterns for certain brands, departments, and store locations.
Proprietary Credit Cards
HSBC offers proprietary credit card accounts to the Company’s customers. In April 2003, the Company entered into a program agreement with HSBC for a term of ten years expiring in 2013 pursuant to which HSBC owns and issues proprietary credit cards to the Company’s customers. The Company and HSBC have entered into several amendments to the program agreement since 2003. Under the terms of the program agreement, the risks and revenues generated by interest and fees on the portfolio are apportioned between HSBC and the Company. On November 11, 2011, the Company entered into a sixth amendment of its credit card program agreement which provided for an extension of the term of the agreement to April 15, 2018, subject to certain early termination rights set forth in the agreement.
Pursuant to a servicing agreement with HSBC also expiring in April 2018, the Company continues to provide key customer service functions, including new account openings, transaction authorizations, billing adjustments and customer inquiries, and receives compensation from HSBC for the provision of these services.
In September of 2006, the Company entered into agreements with HSBC and MasterCard International Incorporated to issue co-branded MasterCard cards to new and existing proprietary credit card customers. Under this program, qualifying customers are issued an SFA and MasterCard co-branded credit card that functions as a traditional proprietary credit card when used at any SFA store and at Saks Direct or as a MasterCard card when used at any unaffiliated location that accepts MasterCard cards. HSBC establishes and owns the co-brand accounts, retains the benefits associated with the ownership of the accounts, receives the finance charge and other income from the accounts, and incurs the bad debts associated with the accounts.
Historically, proprietary credit card holders have shopped more frequently with the Company and purchased more merchandise than customers who pay with cash or third-party credit cards. The Company also makes frequent use of the names and addresses of the proprietary credit card holders in its targeted marketing efforts.
The Company seeks to expand the number and use of the proprietary credit cards by, among other things, providing monetary incentives to sales associates to open new credit accounts, which generally can be opened while a customer is visiting one of the Company’s stores. Customers who open accounts are entitled to a discount on the first day’s purchases. Customers using the proprietary credit card are eligible for the SaksFirst loyalty program that rewards customers for spending on their proprietary charge cards. Additionally, co-brand card customers earn SaksFirst points for purchases made at unaffiliated locations. Increased spending on the proprietary cards is intended to result in an increased rate of reward. Rewards come in the form of electronic gift cards that are redeemable on future purchases. In addition, members of the loyalty program are eligible for other rewards and benefits including special shopping events and travel discounts.
As of January 28, 2012, there were approximately 621,000 proprietary credit accounts that were active within the prior twelve months, accounting for 36.3% of the Company’s 2011 sales.
Trademarks and Service Marks
The Company owns many trademarks and service marks including, but not limited to, “Saks Fifth Avenue,” “Saks & Company,” “SFA,” “S5A,” “The 5TH Avenue Club,” “SAKSFIRST,” “Saks Fifth Avenue Men’s Collection,” and “OFF 5TH.” Management believes its trademarks and service marks are important and that the loss of certain of its trademarks or trade names, particularly the store nameplates, could have a material adverse effect on the Company. Many of the Company’s trademarks and service marks are registered in the United States Patent and Trademark Office. The terms of these registrations are generally ten years, and they are renewable for additional ten-year periods indefinitely so long as the marks are in use at the time of renewal. The Company is not aware of any claims of infringement or other challenges to its right to use its marks that would have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.
Reliance on Fifth Avenue Store
The Company’s flagship SFA store located on Fifth Avenue in New York City accounted for approximately 22% of total Company sales in 2011 and plays a significant role in creating awareness for the Saks Fifth Avenue brand.
Customer Service
The Company believes that good customer service contributes to increased loyalty and incremental purchases by its customers. The Company’s goal is to deliver a memorable, customer-focused shopping experience to each customer, whether shopping in store or online.
At SFA and OFF 5TH, the Company seeks to enable its customers to discover both accessible and high-end fashion in a warm, welcoming environment, guided by knowledgeable sales associates. For the SFA stores, compensation for sales associates is generally a commission-based program. These sales associates undergo extensive service, selling, and product-knowledge training and are encouraged to maintain frequent, personal contact with their customers. Sales associates are encouraged to utilize detailed customer data available through the Company’s point-of-sale equipment and software for their clienteling efforts, send personalized thank-you notes, and routinely communicate with customers to advise them of new merchandise offerings and special promotions. Typical SFA stores also provide comfortable seating areas, and most SFA stores offer a complimentary personal shopping service called “The Fifth Avenue Club.”
The Company believes that it offers a high level of service for customers shopping online at saks.com through easy-to-use site navigation and functionality and many customer-friendly features such as product reviews, runway videos of apparel, detailed product descriptions, sizing information, interviews with designers, and multiple angle shots of merchandise. In addition, the Company places high importance on quick, accurate product delivery and an efficient and friendly call center.
Seasonality
The Company’s business, like that of many retailers, is subject to seasonal influences, with a significant portion of its sales and net income realized during the second half of the fiscal year, which includes the holiday selling season. Approximately 30% of the Company’s sales are generated during the fourth quarter, and normally a large portion of its operating income is generated during the fall season.
Competition
The retail business is highly competitive. The Company’s stores and e-commerce operations primarily compete with several national and regional department stores, specialty apparel stores, designer boutiques, outlet stores, and e-commerce and mail-order retailers. Management believes that its omni-channel approach to the business, knowledge of its trade areas and customer base, high level of customer service, broad selection of quality fashion merchandise at appropriate prices, innovative marketing, strategic store locations, and e-commerce presence positions the Company for a competitive advantage.
Associates
As of January 28, 2012, the Company employed approximately 13,500 associates, of which approximately 25% were employed on a part-time basis. The Company hires additional temporary associates and increases the hours of part-time associates during seasonal peak selling periods. Less than 1.0% of the Company’s associates are covered by collective bargaining agreements. The Company considers its relations with its associates to be good.
Inflation and Deflation
Inflation and deflation affect the costs incurred by the Company in its purchase of merchandise and in certain components of its selling, general and administrative expenses. The Company does not believe that inflation has had a material effect on its results of operations during the periods presented; however, there can be no assurance that the Company’s business will not be affected by inflation in the future.
Discontinued Operations
As of January 31, 2009, the Company discontinued the operations of its Club Libby Lu (“CLL”) business, the operations of which are presented as discontinued operations on the Consolidated Statements of Income and the Consolidated Statements of Cash Flows for the prior year periods. CLL consisted of 98 leased, mall-based specialty stores, targeting girls aged 4-12 years old. CLL generated revenues of approximately $52.2 million for 2008 and was not profitable. The Company incurred nominal charges in 2010 and 2009 associated with closing the stores.
Website Access to Information
The Company provides access, free of charge, to the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”) through the Company’s website, www.saksincorporated.com.
Certifications
The Company filed the certification of its Chief Executive Officer with the New York Stock Exchange (“NYSE”) in fiscal 2011 as required pursuant to Section 303A.12(a) of the NYSE Listed Company Manual, and the Company has filed the Sarbanes-Oxley Act Section 302 and Section 906 certifications of its principal executive officer and principal financial officer with the SEC, which are attached hereto as Exhibits 31.1, 31.2, and 32.1.
Item 1A.
Item 1A. Risk Factors.
The following are risk factors that affect the Company’s business, financial condition, results of operations, and cash flows, some of which are beyond the Company’s control. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report on Form 10-K. If any of the events described below were to actually occur, the Company’s business, financial condition, results of operations or cash flows could be adversely affected and results could differ materially from expected and historical results.
A decline in the demand for luxury goods due to difficult macroeconomic conditions has had and could continue to have an adverse impact on the Company’s results of operations.
The Company is focused on the luxury retail sector. SFA stores, Saks Direct and OFF 5TH stores offer a wide assortment of luxury fashion apparel, shoes, accessories, jewelry, cosmetics, and gift items. All of the goods that the Company sells are discretionary items. Changes in consumer confidence and fluctuations in financial markets can influence cyclical trends, particularly in the luxury sector. Consequently, starting in the fall of 2008, the downturn in the economy resulted in fewer customers shopping in the Company’s stores. In response, and in order to reduce inventory levels, the Company was required to take additional markdowns and to increase promotional events, which negatively impacted the Company’s profitability in 2008 and 2009. In addition, as a result of the decrease in consumer spending, the Company was forced to reduce costs. Although the luxury sector experienced a recovery in 2010 and 2011, there can be no assurance that the economy will continue to improve or that the Company will be successful in sustaining profitability. In addition, in the event that the Company is unsuccessful in sustaining profitability, the Company may not be able to realize its net deferred tax assets, which would require the Company to record a valuation allowance that could have a material impact on its results of operations in the period in which it is recorded.
Poor economic conditions have affected and may continue to affect consumer spending which has harmed and may continue to harm the Company’s business.
The retail industry is continuously subject to domestic and international economic trends. The success of the Company’s business depends to a significant extent upon the level of consumer spending. A number of factors affect the level of consumer spending on merchandise that the Company offers, including, among other things:
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general economic, industry, and weather conditions;
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the performance of the financial, equity, and credit markets;
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current and expected unemployment levels;
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crude oil prices that affect gasoline and heating oil prices;
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the level of consumer debt;
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the level of consumer savings;
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interest rates;
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tax rates and policies;
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consumer confidence in future economic conditions; and
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war, terrorism, and other hostilities.
Additionally, several of the Company’s stores are in tourist markets, including the flagship SFA New York store. A downturn in economic conditions or other events such as terrorist activity could impact travel and thus negatively affect the results of operations for stores located within these tourist markets. Increases in transportation and fuel costs, the financial condition of the airline industry and its impact on air travel, and sustained recessionary periods in the U.S. and internationally could also unfavorably impact results of the stores located within these tourist markets.
The Company’s business and results of operations are also subject to uncertainties arising out of world events. These uncertainties may include a global economic slowdown, changes in consumer spending or travel, an increase in gasoline and commodity prices, epidemics, and the economic consequences of natural disasters, military action, political events or terrorist activity (including threats of terrorist activity). Any future events arising as a result of terrorist activity, natural disasters or other world events may have a material impact on the Company’s business, its ability to source products, results of operations, and financial condition.
The Company’s flagship SFA New York store is also susceptible to volatility in the financial markets and employment and compensation trends in the financial sector.
The Company is restricted in its ability to incur additional debt which may affect its ability to adequately finance its operations.
The Company’s revolving credit facility, senior notes, and 2.0% convertible notes contain restrictions on liens, and sale/leaseback transactions, and its revolving credit facility also contains restrictions on additional indebtedness, in each case, subject to certain limited exceptions. These restrictions under the revolving credit agreement and the outstanding notes may affect the Company’s ability to obtain additional debt financing or financing on favorable terms if its cash flow from operations and funds available under its revolving credit facility are insufficient to satisfy its working capital requirements.
The Company is unable to predict the impact of potential disruptions in the credit markets and the resulting costs or constraints in obtaining financing on its business and financial results.
The Company’s principal sources of cash come from the Company’s operating activities and borrowings under its revolving credit facility. During certain periods in the past, disruptions in the credit markets have had a significant adverse impact on a number of financial institutions and have affected the cost of capital available to the Company. The Company cannot predict with any certainty the impact of any further disruption in the credit environment or any resulting material impact on its liquidity, future financing costs, or financial results.
The Company is dependent on its relationships with certain designers, vendors, and other sources of merchandise.
The Company’s relationships with established and emerging designers are a key factor in its position as a retailer of luxury merchandise, and a substantial portion of its revenues are attributable to its sales of designer merchandise. Many of the Company’s key vendors limit the number of retail outlets they use to sell their merchandise, and competition among luxury retailers to obtain and sell these goods is intense. The Company’s relationships with its designers have been a significant contributor to its past success. Although the Company has supply arrangements with some of its merchandising sources, there can be no assurance that such sources will continue to meet the Company’s quality, style, and volume requirements. Moreover, nearly all of the top designer brands sold by the Company are also sold by competing retailers, and many of these top designer brands also have their own dedicated retail stores and/or their own e-commerce sites. If one or more of these
top designers were to cease providing the Company with adequate supplies of merchandise or, conversely, were to increase sales of merchandise through its own stores or to the stores of other competitors, the Company’s business could be adversely affected. In addition, any decline in the popularity or quality of any of these designer brands could adversely affect the Company’s business.
The Company’s business and results of operations may be adversely affected by weather conditions and natural disasters.
The Company’s business is adversely affected by unseasonable weather conditions. Periods of unseasonably warm weather in the fall or winter or unseasonably cold or wet weather in the spring or summer affect consumer apparel purchases and could have a material adverse effect on the Company’s results of operations and financial condition. Additionally, severe weather conditions such as winter snowstorms or natural disasters such as hurricanes, tornadoes, earthquakes, and floods may adversely affect the Company’s results of operations and financial condition.
The Company’s business is intensely competitive and increased or new competition could have a material adverse effect on the Company.
The retail industry is intensely competitive. As a retailer offering a broad selection of luxury fashion apparel, shoes, accessories, jewelry, cosmetics, and gift items, the Company currently competes with a diverse group of retailers, including e-commerce retailers, which sell, among other products, products similar to those of the Company. The Company also competes in particular markets with a substantial number of retailers that specialize in one or more types of products that the Company sells. A number of different competitive factors could have a material adverse effect on the Company’s business, results of operations and financial condition including:
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increased operational efficiencies of competitors;
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competitive pricing strategies, including deep discount pricing by a broad range of retailers during periods of poor consumer confidence or economic instability;
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expansion of product offerings by existing competitors;
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entry by new competitors into markets in which the Company currently operates; and
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adoption by existing competitors of innovative retail sales methods.
The Company may not be able to continue to compete successfully with its existing or new competitors, and prolonged periods of deep discount pricing by its competitors may have a material adverse effect on the Company’s business.
The Company faces risks associated with consumer preferences, demand, and fashion trends.
Changes in consumer preferences, demand and interest could have a material adverse effect on the Company’s business. In addition, fashion trends could materially impact sales. Success in the retail business depends, in part, on the Company’s ability to anticipate consumer preferences and demand. Early order commitments often are made far in advance of consumer acceptance. If the Company fails to anticipate preferences accurately and respond to consumer preferences and demand, it could experience lower sales, excess inventories, and lower profit margins, any of which could have a material adverse effect on the Company’s results of operations and financial condition.
The Company faces a number of risks in opening new stores.
As part of its growth strategy, the Company could potentially increase the total number of stores, which may include opening new stores in both new and existing markets. The Company may not be able to operate any new stores profitably. The success of any future store openings will depend upon numerous factors, many of which are beyond the Company’s control, including the following:
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the ability of management to adequately analyze and identify suitable markets and individual store sites within those markets;
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the ability to attract appropriate vendors;
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the competition for suitable store sites;
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the ability to negotiate favorable lease terms with landlords;
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the availability of employees to staff new stores and the Company’s ability to hire, train, motivate, and retain store personnel; and
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the ability to attract customers and generate sales sufficient to operate new stores profitably.
In future years, the Company may enter into additional markets. These markets may have different competitive conditions, consumer trends, and discretionary spending patterns than its existing markets, which may cause new stores in these markets to be less successful than stores in existing markets.
The loss of, or disruption in, the Company’s centralized distribution centers would have a material adverse effect on the Company’s business and operations.
The Company depends on the orderly operation of the receiving and distribution process, which relies on adherence to shipping schedules and effective management of distribution centers. Although the Company believes that its receiving and distribution process is efficient and that the Company has appropriate contingency plans, unforeseen disruptions in operations due to fire, severe weather conditions, natural disasters, or other catastrophic events, labor disagreements, or other shipping problems may result in the loss of inventory and/or delays in the delivery of merchandise to the Company’s stores and customers.
Additionally, freight cost is impacted by changes in fuel prices. Fuel prices affect freight cost both on inbound freight from vendors to the distribution centers and outbound freight from the distribution centers to the Company’s stores.
The Company has an orderly plan to transition a portion of its distribution and fulfillment operations from its Maryland facility to a new facility in Tennessee, scheduled for mid-2012. However, the Company could experience disruption in its operations due to unexpected issues with employee hiring and retention, installation of equipment, or construction delays, among other things.
Although the Company maintains business interruption and property insurance, management cannot be assured that the Company’s insurance coverage will be sufficient, or that insurance proceeds will be timely paid to the Company, if any of the distribution centers are damaged or shut down for any reason.
Loss of the Company’s trademarks and service marks or damage to the Company’s brand could have a material adverse effect on the Company’s results of operations.
The Company owns many trademarks and service marks including, but not limited to, “Saks Fifth Avenue,” “Saks & Company,” “SFA,” “S5A,” “The 5TH Avenue Club,” “SAKSFIRST,” “Saks Fifth Avenue Men’s Collection,” and “OFF 5TH.” Management believes its trademarks and service marks are important and that the loss of certain of its trademarks or trade names, particularly the store nameplates, could have a material adverse effect on the Company. Many of the Company’s trademarks and service marks are registered with the United States Patent and Trademark Office. In addition, the Company has a well-recognized brand that it believes represents unsurpassed customer service and quality merchandise. Any significant damage to the Company’s brand or reputation may negatively impact same-store sales, lower employee morale and productivity, and diminish customer trust, resulting in a reduction in shareholder value.
Fluctuations in foreign currency could have an adverse impact on the Company’s business.
The Company purchases a substantial portion of its inventory from foreign suppliers whose functional currency is not the U.S. dollar. Although fluctuations in the Euro-U.S. dollar exchange rate have the largest impact on the Company’s business, the Company procures goods from many countries and, consequently, is affected by fluctuations in the U.S. dollar relative to the currencies of the countries from which the Company purchases goods. Accordingly, changes in the value of the dollar relative to foreign currencies may increase the Company’s cost of goods sold. If the Company is unable to pass such cost increases on to its customers or the higher cost of the products results in decreased consumption, gross margins and ultimately earnings would decrease.
If the Company does not have the ability to successfully upgrade, maintain and secure our information systems to support the needs of the organization, it could have an adverse impact on the Company’s business.
The Company relies heavily on information systems to manage operations, including a full range of retail, financial, sourcing and merchandising systems, and regularly makes investments to upgrade, enhance or replace these systems. The reliability and capacity of information systems is critical. Despite the Company’s preventative efforts, its systems are vulnerable from time to time to damage or interruption from, among other things, security breaches, computer viruses, power outages and other technical malfunctions. Any disruptions affecting the Company’s information systems, or any delays or difficulties in transitioning to new systems or in integrating them with current systems, could have a material adverse impact on the Company’s business. In addition, the Company’s ability to continue to operate its business without significant interruption in the event of a disaster or other disruption depends in part on the ability of the Company’s information systems to operate in accordance with its disaster recovery and business continuity plans.
In 2012, the Company will begin a substantial multi-year transformation of and investment in its foundational merchandising, finance, and human resources systems. The Company has an orderly plan to transition its existing legacy systems to the new systems. However, the Company could experience disruption in its operations due to unexpected issues with employee hiring, retention, and training and installation of equipment or software, among other things.
A privacy breach could adversely affect the Company’s business.
The protection of customer, employee, and company data is critical to the Company. The regulatory environment and industry standards surrounding information security and privacy continue to evolve in response to increased threats to information security. In addition, customers have a high expectation that the Company will adequately protect their personal information. A significant breach of customer, employee, or company data could damage the Company’s reputation and result in lost sales, fines, or litigation resulting in a decrease in the Company’s earnings.
Ownership and leasing of significant amounts of real estate exposes the Company to possible liabilities and losses.
A significant percentage of the Company’s SFA stores and one OFF 5TH store are owned. The remainder of the Company’s SFA and OFF 5TH stores are leased. Accordingly, the Company is subject to all of the risks associated with owning and leasing real estate. In particular, the value of the assets could decrease, and costs to operate stores could increase, because of changes in the investment climate for real estate, demographic trends, and supply or demand for the use of the store, which may result from competition from similar stores in the area, as well as liability for environmental conditions.
Store leases generally require the Company to pay a fixed minimum rent and a variable amount based on a percentage of annual sales at that location. The Company generally cannot terminate these leases. If a store is not profitable, and the Company decides to close it, the Company may be committed to perform certain obligations under the applicable lease including, among other things, paying rent for the balance of the applicable lease term. In addition, as each of the leases expires, the Company may be unable to negotiate renewals, either on commercially acceptable terms or at all, which could cause the Company to close stores in desirable locations.
If an existing owned store is not profitable, and the Company decides to close it, the Company may be required to record an impairment charge and/or exit costs associated with the disposal of the store.
In addition, the Company may not be able to close an unprofitable owned or leased store due to an existing operating covenant which may cause the Company to operate the location at a loss which could result in an impairment charge.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Executive Officers of the Registrant.
The name, age, and position held with the Company for each of the executive officers of the Company are set forth below.
Name
Age
Position
Stephen I. Sadove
Chairman of the Board of Directors and Chief Executive Officer
Ronald L. Frasch
President and Chief Merchandising Officer
Michael A. Brizel
Executive Vice President and General Counsel
Jennifer S. de Winter
Executive Vice President of Stores
Denise Incandela
Executive Vice President and Chief Marketing Officer; President, Saks Direct
Christine A. Morena
Executive Vice President of Human Resources
Michael Rodgers
Executive Vice President and Chief Information and Operations Officer
Robert T. Wallstrom
Executive Vice President; President, OFF 5TH
Kevin G. Wills
Executive Vice President of Finance and Chief Financial Officer
Stephen I. Sadove was named Chief Executive Officer of the Company in January 2006 and assumed the additional role of Chairman of the Board of Directors in May 2007. Mr. Sadove joined the Company in January 2002 as Vice Chairman and assumed the additional responsibility of Chief Operating Officer in March 2004. Prior to joining the Company, Mr. Sadove served as Senior Vice President of Bristol-Myers Squibb and President of Bristol-Myers Squibb Worldwide Beauty Care from 1996 until January 2002. From 1991 until 1996, Mr. Sadove held various other executive positions with Bristol-Myers Squibb. From 1975 until 1991, Mr. Sadove held various positions of increasing responsibility with General Foods USA.
Ronald L. Frasch was named President and Chief Merchandising Officer of the Company in February 2007. Mr. Frasch joined SFA in January 2004, served in a non-executive capacity through November 2004, and held the post of Vice Chairman and Chief Merchant of SFA from November 2004 until January 2007. Prior to joining the Company, he served as Chairman and Chief Executive Officer of Neiman Marcus Group’s Bergdorf Goodman from April 2000 until January 2004. Prior to that, he held merchandising and executive posts with other companies including GFT USA, Escada USA, Neiman Marcus, and SFA.
Michael A. Brizel joined the Company in April 2007 and was named to the post of Executive Vice President and General Counsel in May 2007. Mr. Brizel is also the Company’s Chief Ethics and Compliance Officer. Mr. Brizel served in a variety of positions of increasing responsibility with The Reader’s Digest Association, Inc. between 1989 and April 2007, including Senior Vice President and General Counsel, a position he assumed in 2002. Mr. Brizel was a member of the legal department of General Foods Corporation from 1983 to 1989 and an associate with the New York law firm of Summit, Rovins and Feldesman (and its predecessors) from 1980 to 1983.
Jennifer S. de Winter was named Executive Vice President of Stores in June 2008. She joined Saks Fifth Avenue in 1995 and held various merchandising positions of increasing responsibility, including the post of Group Senior Vice President and General Merchandise Manager of Fashion and Fine Jewelry, Watches, Women’s Shoes, Handbags, and Soft Accessories from May 2001 until June 2008. Ms. de Winter began her retail career in 1983 at Macy’s, where she held various merchandising positions through 1995 including Vice President, Divisional Merchandise Manager.
Denise Incandela was promoted to President, Saks Direct and Executive Vice President of the Company in June 2010 and assumed the additional role of Chief Marketing Officer of Saks Fifth Avenue in September 2011. After serving as a leader in the retail practice and as a consultant to Saks for five years while at McKinsey & Company, Ms. Incandela joined Saks Incorporated in 1999 to spearhead the development of the Saks Direct business for Saks Fifth Avenue. In 2002, she was named Senior Vice President of Business Development and Saks Direct, and in February 2007, she was promoted to President, Saks Direct and Group Senior Vice President of the Company. Ms. Incandela began her career as the Assistant to the Chief Financial Officer at Shearson Lehman Brothers.
Christine A. Morena joined the Company in January 2007 as Executive Vice President of Human Resources. Ms. Morena spent her career from 1976 through 2006 with AT&T Inc., where she held various positions of increasing responsibility, including Senior Vice President of Human Resources for AT&T Corporation, a subsidiary of AT&T Inc., a position she held from 2002 through 2006.
Michael Rodgers was named Executive Vice President and Chief Information and Operations Officer for the Company in February 2008. Mr. Rodgers joined McRae’s, Inc. (acquired by the Company in 1994) in 1993 as Director of Credit. He was promoted to Vice President of Credit for the Company in 1996 and to Senior Vice President of Credit in 1997, a position he held until 2002. Mr. Rodgers served as Executive Vice President of Operations from 2002 until April 2007. Mr. Rodgers served as Executive Vice President of Information Technology, Operations and Credit for the Company from May 2007 through January 2008. Prior to joining the Company, he held credit management positions with Boscov’s and Woodward & Lothrop.
Robert T. Wallstrom was named President, OFF 5TH and Executive Vice President of the Company in June 2010. Mr. Wallstrom joined the Company in June 1995 and has held various leadership positions since that time, including Senior Vice President and General Manager of the SFA flagship store in New York City between May 2002 and January 2007. He served as President, OFF 5TH and Group Senior Vice President of the Company from February 2007 through May 2010. Prior to joining the Company, he was a store manager for Macy’s/Bullocks.
Kevin G. Wills was named Executive Vice President and Chief Financial Officer of the Company in May 2007. Mr. Wills joined the Company in September 1997 and has served in the following capacities: Vice President of Financial Reporting from September 1997 to August 1998; Senior Vice President of Strategic Planning from September 1998 to August 1999; Senior Vice President of Planning and Administration of Saks Department Store Group from September 1999 to January 2003; Executive Vice President of Operations for Parisian from February 2003 to May 2005; and Executive Vice President of Finance and Chief Accounting Officer from May 2005 until May 2007. Prior to joining the Company, Mr. Wills was Vice President and Controller for the Tennessee Valley Authority and before that, he was an audit manager with Coopers and Lybrand (now PricewaterhouseCoopers LLP).
Item 2.
Item 2. Properties.
The following table summarizes the location, total square footage, and ownership status of the Company’s distribution centers, operations center, and corporate offices as of January 28, 2012:
The majority of the SFA stores and one OFF 5TH store are owned or owned buildings on leased land. All other SFA and OFF 5TH stores are leased. Store leases generally require the Company to pay a fixed minimum rent and a variable amount based on a percentage of annual sales at that location. Generally, the Company is responsible under its store leases for a portion of mall promotion and common area maintenance expenses and for certain utility, property tax, and insurance expenses. Generally, SFA store leases have initial terms ranging from 20 to 30 years and include renewal options ranging from 5 to 20 years. OFF 5TH leases typically have shorter terms.
The following tables set forth information about the Company’s stores as of January 28, 2012:
* Owned locations include owned stores and owned buildings on leased land.
A summary of stores by geographic location as of January 28, 2012 is as follows:
Store count activity for the year ended January 28, 2012 is as follows:
Item 3.
Item 3. Legal Proceedings.
On February 2, 2011, the plaintiffs in Dawn Till and Mary Josephs v. Saks Incorporated et al, filed a complaint, with which the Company was served on March 10, 2011, in a purported class and collective action in the U.S. District Court for the Northern District of California. The complaint alleges that the plaintiffs were improperly classified as exempt from the overtime pay requirements of the Fair Labor Standards Act (“FLSA”) and the California Labor Code and that the Company failed to pay overtime, provide itemized wage statements and provide meal and rest periods. On March 8, 2011, the plaintiffs filed an amended complaint adding a claim for penalties under the California Private Attorneys General Act of 2004. The plaintiffs seek to proceed collectively under the FLSA and as a class under the California statutes on behalf of individuals who have been employed by OFF 5TH as Selling and Service Managers, Merchandise Team Managers, or Department Managers and similar titles. On February 8, 2012, the same plaintiffs’ counsel from the Till case filed a complaint, with which the Company was served on March 2, 2012, in the U.S. District Court for the Southern District of New York, alleging essentially the same FLSA claim and related claims under New York state law (Tate - Small et al v. Saks Incorporated et al). The Company believes that its managers at OFF 5TH have been properly classified as exempt under both federal and state law and intends to defend these lawsuits vigorously. It is not possible to predict whether the courts will permit these actions to proceed collectively or as a class.
In addition to the litigation described in the preceding paragraph, the Company is involved in legal proceedings arising from its normal business activities and has accruals for losses where appropriate. Management believes that none of these legal proceedings will have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.
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
The Company’s common stock is traded on the New York Stock Exchange under the symbol “SKS”. The table below sets forth the high and low sales prices of the Company’s common stock as reported on the New York Stock Exchange during each quarter of 2011 and 2010.
Holders
As of March 9, 2012, there were approximately 2,260 shareholders of record of the Company’s common stock.
Dividends
During 2011 and 2010, the Company did not declare any dividends. Future dividends, if any, will be determined by the Company’s Board of Directors in light of circumstances then existing, including earnings, financial requirements, and general business conditions. The Company does not anticipate declaring dividends in the near term.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides equity compensation plan information for all plans approved and not approved by the Company’s shareholders, as of January 28, 2012:
(1) This amount represents shares of common stock available for issuance under the 2009 Long-term Incentive Plan. Awards available for grant under the 2009 Long-term Incentive Plan include stock options, stock appreciation rights, restricted stock, performance shares, and other forms of equity awards.
(2) On April 9, 1997, the Board approved the Company’s 1997 Stock-Based Incentive Plan (the “1997 Plan”) to assist in attracting, retaining, and motivating employees and directors. The Board amended the 1997 Plan several times. The exercise price for all outstanding options awarded under the 1997 Plan equals the fair market value of the common stock on the date of grant. Most options vest in four installments over four years and expire after ten years. Unvested options generally are forfeited if employment is terminated. In the event of a change in control or a potential change in control, the Board of Directors may accelerate awards under the 1997 Plan or provide that such awards be cashed out in connection with the transaction. As of January 28, 2012, under the 1997 Plan, there were (i) options outstanding to purchase 41 shares, (ii) 8 shares of restricted stock outstanding, and (iii) no shares remaining available for issuance.
Performance Graph
The following graph and table compare the cumulative total shareholder return for the last five fiscal years of the Company’s common stock, the S&P Midcap 400 Index, the S&P 500 Department Stores Index, and a Retail Peer Group Index (weighted by market capitalization and consisting of Dillard’s, Inc.; Macy’s, Inc.; Nordstrom, Inc.; and J.C. Penney Company, Inc.) assuming an initial investment of $100 and reinvestment of dividends.
The information contained in this “Performance Graph” section shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), except to the extent that the Company specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The Company has a share repurchase program that authorizes it to purchase shares of the Company’s common stock. During 2011, the Company repurchased and retired an aggregate of 3.5 million shares of its common stock. The Company did not repurchase any shares of its common stock during the fourth quarter of 2011. The Company has remaining availability of 29.2 million shares under its 70.0 million authorized share repurchase program.
Item 6.
Item 6. Selected Financial Data.
The selected financial data set forth below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Company’s Consolidated Financial Statements and notes thereto and the other information contained elsewhere in this Form 10-K.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management’s Discussion and Analysis (“MD&A”) is intended to provide an analytical view of the business from management’s perspective of operating the business and has the following components:
•
Overview
•
Results of Operations
•
Liquidity and Capital Resources
•
Contractual Obligations and Off-Balance Sheet Arrangements
•
Critical Accounting Policies and Estimates
MD&A should be read in conjunction with the consolidated financial statements and related notes thereto contained elsewhere in this Form 10-K.
OVERVIEW
GENERAL
The operations of Saks Incorporated, a Tennessee corporation first incorporated in 1919, and its subsidiaries (together the “Company”) consist of Saks Fifth Avenue (“SFA”) stores and SFA e-commerce operations (“Saks Direct”) as well as Saks Fifth Avenue OFF 5TH (“OFF 5TH”). Previously, the Company also operated Club Libby Lu (“CLL”), the operations of which were discontinued in January 2009. The operations of CLL are presented as discontinued operations on the Consolidated Statements of Income and the Consolidated Statements of Cash Flows for the prior year periods and are discussed below in “Discontinued Operations.”
The Company is an omni-channel luxury retailer offering a wide assortment of distinctive fashion apparel, shoes, accessories, jewelry, cosmetics, and gifts. SFA stores are principally free-standing stores in exclusive shopping destinations or anchor stores in upscale regional malls. Customers may also purchase SFA products online at saks.com or by catalog. OFF 5TH is intended to be the premier luxury off-price retailer in the United States. OFF 5TH stores are primarily located in upscale mixed-use and off-price centers and offer luxury apparel, shoes, and accessories, targeting the value-conscious customer. As of January 28, 2012, the Company operated 46 SFA stores with a total of approximately 5.5 million square feet and 60 OFF 5TH stores with a total of approximately 1.7 million square feet.
The Company is primarily focused on the luxury retail sector. All of the goods that the Company sells are discretionary items. Consequently, a downturn in the economy or difficult economic conditions may result in fewer customers shopping in the Company’s stores or online. In response, the Company may have to increase the duration and/or frequency of promotional events and offer larger discounts in order to attract customers, which would reduce gross margin and adversely affect results of operations.
The Company continues to make targeted investments in key areas to improve customer service and enhance merchandise assortment and allocation effectiveness. In addition, strategic investments are being made to remodel existing selling space with a heightened focus on return on investment. The Company believes that its long-term strategic plans can deliver additional operating margin expansion in future years.
The Company seeks to create value for its shareholders by improving returns on its invested capital. The Company attempts to generate improved operating margins by generating sales increases while improving merchandising margins and controlling expenses. The Company uses operating cash flows to reinvest in the business and to repurchase debt or equity. The Company actively manages its real estate portfolio by routinely evaluating opportunities to improve or close underproductive stores and open new stores.
DISCONTINUED OPERATIONS
As of January 31, 2009, the Company discontinued the operations of its CLL business, which consisted of 98 leased, mall-based specialty stores, targeting girls aged 4-12 years old. Discontinued operations include nominal charges (income) for 2009 and 2010 from residual CLL store closing activities.
FINANCIAL PERFORMANCE SUMMARY
On a consolidated basis, total net sales and comparable store sales for the year ended January 28, 2012 increased 8.2% and 9.5%, respectively. The Company recorded income from continuing operations of $74.8 million, or $0.45 per share compared to income from continuing operations of $47.4 million, or $0.30 per share, for the years ended January 28, 2012 and January 29, 2011, respectively. After recognition of the Company’s after-tax gain from discontinued operations of $0.4 million, net income totaled $47.8 million, or $0.30 per share for the year ended January 29, 2011.
The year ended January 28, 2012 included a net after-tax gain totaling $2.0 million or $0.01 per share, primarily related to a $10.9 million or $0.05 per share gain related to the reversal of certain estimated state income tax reserves deemed no longer necessary. This gain was partially offset by a net after-tax charge of $5.6 million or $0.03 per share, primarily related to a pension and related benefit charge, a third-party receivable write-down, severance and asset impairment charges. Additionally, the Company incurred a $3.0 million or $0.01 per share charge related to store closings and a $0.3 million loss on debt extinguishment related to the early retirement of approximately $1.9 million of senior notes during 2011.
The year ended January 29, 2011 included a net after-tax gain totaling $17.2 million or $0.11 per share, primarily related to a $26.7 million or $0.17 per share gain related to the reversal of certain estimated income tax reserves deemed no longer necessary due to the expiration of the statute of limitations. This gain was partially offset by a net after-tax charge of $7.5 million or $0.05 per share, primarily related to store closings and asset impairments and a $2.0 million or $0.01 per share non-cash pension charge related to excess lump sum distributions during 2010.
The year ended January 30, 2010 included net after-tax charges totaling $10.4 million or $0.07 per share, primarily related to $17.3 million or $0.12 per share of asset impairment charges incurred in the normal course of business and a $3.1 million or $0.02 per share non-cash pension charge related to excess lump sum distributions during 2009 primarily resulting from the Company’s 2009 reductions-in-force. The year ended January 30, 2010 also included a net gain of $10.0 million or $0.07 per share, related to federal and state tax adjustments. The net gain included income resulting from an increase in the state deferred tax rate, release of tax reserves due to the expiration of the statute of limitations and reversal of a portion of the valuation allowance against deferred tax assets.
The Company believes that an understanding of its reported financial condition and results of operations is not complete without considering the effect of all other components of MD&A included herein.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected items from the Company’s Consolidated Statements of Income, expressed as percentages of net sales (numbers may not total due to rounding):
FISCAL YEAR ENDED JANUARY 28, 2012 COMPARED TO FISCAL YEAR ENDED JANUARY 29, 2011
DISCUSSION OF OPERATING INCOME- CONTINUING OPERATIONS
The following table shows the changes in operating income from 2010 to 2011:
For the year ended January 28, 2012, the Company’s operating income totaled $148.3 million, a 170 basis point improvement as a percentage of net sales, from the operating income of $90.1 million in the same period last year. The current year operating income was driven by a 9.5% increase in comparable store sales as well as a gross margin rate increase of 70 basis points for the year ended January 28, 2012. The year-over-year increase in the gross margin rate was principally due to increased full-price selling and a reduced level of promotional activity.
NET SALES
For the year ended January 28, 2012, total net sales increased 8.2% to $3,013.6 million from $2,785.7 million for the year ended January 29, 2011. Consolidated comparable store sales increased $252.8 million, or 9.5%, from $2,658.2 million for the year ended January 29, 2011 to $2,911.0 million for the year ended January 28, 2012.
Comparable store sales are calculated on a rolling 13-month basis. Thus, to be included in the comparison, a store must be open for 13 months. The additional month is used to transition the first month impact of a new store opening. Correspondingly, closed stores are removed from the comparable store sales comparison when they begin liquidating merchandise. Expanded or remodeled stores are included in the comparable store sales comparison, except for the periods in which they are closed for remodeling and renovation.
GROSS MARGIN
For the year ended January 28, 2012, gross margin was $1,228.2 million, or 40.8% of net sales, compared to $1,117.3 million, or 40.1% of net sales, for the year ended January 29, 2011. The increase in gross margin dollars and gross margin rate was primarily the result of higher sales, increased full-price selling and a reduced level of promotional activity.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (“SG&A”)
For the year ended January 28, 2012, SG&A was $767.6 million, or 25.5% of net sales, compared to $716.0 million, or 25.7% of net sales, for the year ended January 29, 2011. The increase of $51.6 million in expenses was primarily driven by higher variable costs associated with the $227.9 million sales increase for the year as well as incremental expenses incurred to support the growth in Saks Direct. Additionally, the Company experienced an increase in proprietary credit card income related to the previously announced contract changes with HSBC.
OTHER OPERATING EXPENSES
For the year ended January 28, 2012, other operating expenses were $302.1 million, or 10.0% of net sales, compared to $298.1 million, or 10.7% of net sales, for the year ended January 29, 2011. The increase of $4.0 million was principally driven by an increase in taxes other than income taxes of $2.9 million, an increase in property and equipment rentals of $0.7 million and an increase in store pre-opening costs of $0.6 million. These increases were partially offset by a decrease in depreciation and amortization of $0.2 million.
IMPAIRMENTS AND DISPOSITIONS
For the year ended January 28, 2012, impairments and dispositions included net charges of $10.1 million compared to net charges of $13.1 million for the year ended January 29, 2011. During 2011, the Company incurred $4.9 million of store-closing related costs, primarily driven by a lease termination charge incurred in connection with the relocation of the Hilton Head OFF 5TH store. Also included in impairments and dispositions for 2011 were $5.0 million of asset impairments and $0.2 million of asset dispositions in the normal course of business. The prior year charges of $13.1 million included store-closing costs of $12.1 million associated with the closing of seven SFA stores and one OFF 5TH store and $1.0 million of asset impairments and dispositions in the normal course of business.
INTEREST EXPENSE
Interest expense decreased to $48.1 million in 2011 from $56.7 million in 2010 and, as a percentage of net sales, was 1.6% in 2011 and 2.0% in 2010. The decrease of $8.6 million was primarily due to the extinguishment of $22.9 million of the 7.5% senior notes that matured in December 2010 and extinguishment of $141.6 million of the 9.875% senior notes that matured in October 2011. Non-cash interest expense associated with the amortization of the debt discount on the Company’s convertible notes was $13.0 million and $11.9 million for the years ended January 28, 2012 and January 29, 2011, respectively.
LOSS ON EXTINGUISHMENT OF DEBT
During the year ended January 28, 2012, the Company extinguished $1.9 million of its 7.375% senior notes resulting in a loss on extinguishment of debt of $0.5 million. During the year ended January 29, 2011, the Company repurchased $0.8 million of the 7.0% senior notes which resulted in a loss on extinguishment of debt of $4.0 thousand.
OTHER INCOME, NET
Other income increased to $2.2 million in 2011 from $0.1 million in 2010. Other income in 2011 was primarily related to interest income on cash and cash equivalents. Other income in 2010 consisted primarily of $0.7 million of interest income on cash and cash equivalents offset by $0.6 million of casualty losses relating to the May 2010 flood at the Nashville, Tennessee OFF 5TH store.
INCOME TAXES
For 2011 and 2010, the effective income tax rate for continuing operations differed from the federal statutory tax rate due to state income taxes and other items such as the change in the valuation allowance against state NOL carryforwards, the effect of concluding tax examinations and other tax reserve adjustments primarily relating to statute expirations. Including the effect of these items, the Company’s effective income tax rate for continuing operations was 26.6% and (41.5%) in 2011 and 2010, respectively. The effective tax rate for 2011 was less than the statutory tax rate primarily due to a reversal in the valuation allowance against state NOL carryforwards. The effective tax benefit rate for 2010 was primarily due to the reversal of an uncertain tax position relating to statute expirations.
FISCAL YEAR ENDED JANUARY 29, 2011 COMPARED TO FISCAL YEAR ENDED JANUARY 30, 2010
DISCUSSION OF OPERATING INCOME (LOSS) - CONTINUING OPERATIONS
The following table shows the changes in operating income (loss) from 2009 to 2010:
For the year ended January 29, 2011, the Company’s operating income totaled $90.1 million, a 530 basis point improvement as a percentage of net sales, from the operating loss of $54.5 million in 2009. The 2010 operating income was driven by a 6.4% increase in comparable store sales as well as a gross margin rate increase of 350 basis points for the year ended January 29, 2011. The year-over-year increase in the gross margin rate was principally due to increased full-price selling and a reduced level of promotional activity.
NET SALES
For the year ended January 29, 2011, total net sales increased 5.9% to $2,785.7 million from $2,631.5 million for the year ended January 30, 2010. Consolidated comparable store sales increased $161.6 million, or 6.4%, from $2,531.6 million for the year ended January 30, 2010 to $2,693.2 million for the year ended January 29, 2011.
GROSS MARGIN
For the year ended January 29, 2011, gross margin was $1,117.3 million, or 40.1% of net sales, compared to $963.4 million, or 36.6% of net sales, for the year ended January 30, 2010. The increase in gross margin dollars and gross margin rate was primarily the result of higher sales, increased full-price selling and a reduced level of promotional activity.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
For the year ended January 29, 2011, SG&A was $716.0 million, or 25.7% of net sales, compared to $674.3 million, or 25.6% of net sales, for the year ended January 30, 2010. The increase of $41.6 million in expenses was primarily driven by higher variable costs associated with the $154.2 million sales increase for the year as well as incremental expenses incurred to support the growth in Saks Direct. Additionally, the Company experienced a reduction in proprietary credit card income related to contract changes with HSBC.
OTHER OPERATING EXPENSES
For the year ended January 29, 2011, other operating expenses were $298.1 million, or 10.7% of net sales, compared to $314.3 million, or 12.0% of net sales, for the year ended January 30, 2010. The decrease of $16.2 million was principally driven by a
decrease in depreciation and amortization expense of $16.5 million as a result of reduced capital expenditures during 2010 and asset impairment charges recorded during the year ended January 30, 2010. Additionally, the Company incurred lower property and equipment rentals of $3.3 million and a decrease in store pre-opening costs of $1.0 million. These decreases were partially offset by an increase in taxes other than income taxes of $4.6 million.
IMPAIRMENTS AND DISPOSITIONS
For the year ended January 29, 2011, impairments and dispositions included net charges of $13.1 million compared to net charges of $29.3 million for the year ended January 30, 2010. The 2010 charges included closing costs associated with the Plano, Texas; Mission Viejo, California; Southampton, New York; Portland, Oregon; San Diego, California; and Charleston, South Carolina SFA store closures, the Reno, Nevada OFF 5TH store closure, and the previously announced agreement to close the Denver, Colorado SFA store during the first quarter ending April 30, 2011. The Company incurred $12.1 million of store closing-related costs associated with those locations, including $10.1 million of net lease termination costs, $4.2 million of asset impairment and disposal costs, $2.5 million of severance costs, and $3.8 million of other store-closing related costs, all of which were offset in part by a deferred rent benefit of $8.5 million. Also included in impairments and dispositions for 2010 were $1.0 million of asset impairments and dispositions in the normal course of business. The 2009 charges were primarily due to asset impairments and dispositions in the normal course of business.
INTEREST EXPENSE
Interest expense increased to $56.7 million in 2010 from $49.5 million in 2009 and, as a percentage of net sales, was 2.0% in 2010 and 1.9% in 2009. The increase of $7.2 million was primarily due to the issuance of $120.0 million of convertible notes in May 2009 and the amortization of financing costs associated with these notes and the amended revolving credit facility. Non-cash interest expense associated with the amortization of the debt discount on the Company’s convertible notes was $11.9 million and $9.8 million for the years ended January 29, 2011 and January 30, 2010, respectively.
GAIN (LOSS) ON EXTINGUISHMENT OF DEBT
During the year ended January 29, 2011, the Company repurchased $0.8 million of the 7.0% senior notes which resulted in a loss on extinguishment of debt of $4.0 thousand. During the year ended January 30, 2010, the Company extinguished approximately $23.0 million of senior notes. The repurchase of these notes resulted in a gain on extinguishment of debt of $0.8 million.
OTHER INCOME, NET
Other income decreased to $0.1 million in 2010 from $1.0 million in 2009. Other income in 2010 was primarily related to $0.7 million of interest income which was offset by $0.6 million of casualty losses relating to the May 2010 flood at the Nashville, Tennessee OFF 5TH store. Other income in 2009 was primarily attributable to interest income.
INCOME TAXES
For 2010 and 2009, the effective income tax rate for continuing operations differed from the federal statutory tax rate due to state income taxes and other items such as the change in the valuation allowance against state NOL carryforwards, the effect of concluding tax examinations and other tax reserve adjustments primarily relating to statute expirations, and the change in the overall state tax rate. Including the effect of these items, the Company’s effective income tax rate for continuing operations was (41.5%) and 43.6% in 2010 and 2009, respectively. The effective tax benefit rate for 2010 was primarily due to the reversal of an uncertain tax position relating to statute expirations.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW
Cash provided by operating activities from continuing operations was $272.7 million in 2011, $124.4 million in 2010 and $205.9 million in 2009. Cash provided by operating activities primarily represents income before depreciation and non-cash charges and after changes in working capital. Working capital is significantly impacted by changes in inventory and accounts payable. Inventory levels typically increase or decrease to support expected sales levels, and accounts payable fluctuations are generally determined by the timing of merchandise purchases and payments. The $148.3 million increase in cash flows from continuing operations in 2011 as compared to 2010 was primarily due to the increase in net income for the period and changes in working capital. The $81.5 million decrease in cash flows from continuing operations in 2010 as compared to 2009 was primarily the result of changes in working capital, driven by an increase in inventory levels to support the increased sales for the period.
Cash used in investing activities from continuing operations was $89.4 million in 2011, $55.2 million in 2010, and $73.9 million in 2009. Cash used in investing activities primarily relates to construction of new stores, renovation and expansion of existing stores, and investments in support areas (e.g., technology and distribution centers). The $34.2 million increase in cash used in 2011 was primarily related to an increase of $26.4 million in capital expenditures for the year and the issuance of a note receivable, net of collections, in the amount of $7.4 million due from Natixis Funding Corporation, the provider of letters of credit required in connection with the Company’s workers’ compensation and general liability insurance plans. Interest earned on the note receivable effectively reduces the cost of issuing letters of credit to insurance providers. The $18.7 million decrease in cash used in 2010 was primarily related to a decrease in capital expenditures for the year.
Cash used in financing activities from continuing operations was $181.0 million in 2011, as compared to $18.1 million in 2010 and cash provided by financing activities of $18.8 million in 2009. Cash used in financing activities in 2011 was primarily due to long-term debt payments resulting from the maturity of $141.6 million of the Company’s 9.875% senior notes, the redemption of $1.9 million of the Company’s 7.375% senior notes, $28.9 million of share repurchases made during the year and $3.0 million of debt financing costs incurred in connection with the amendment of the Company’s revolving credit facility. In 2010, cash used in financing activities related to the payment of $22.9 million for the 7.5% senior notes that matured in December 2010 and repurchase of $0.8 million of the Company’s 7.0% senior notes that mature in December 2013. In 2009, cash provided by financing activities included $120.0 million of proceeds from the issuance of the 7.5% convertible notes and $95.1 million of proceeds, net of issuance costs, from the issuance of 14.9 million shares of the Company’s common stock. These inflows were partially offset by the repayment of borrowings under the revolving credit facility of $156.7 million, the early extinguishment of $23.0 million of the Company’s 7.5% senior notes due in December 2010, the payment of $13.1 million of financing costs incurred in connection with the issuance of the Company’s 7.5% convertible notes and an amendment to the revolving credit facility agreement.
During 2011, the Company repurchased and retired an aggregate of 3.5 million shares of its common stock at an average price of $8.18 per share and a total cost of $28.9 million. During 2010 and 2009, there were no repurchases of common stock. As of January 28, 2012, there were approximately 29.2 million shares remaining available for repurchase under the Company’s existing share repurchase program.
CASH BALANCES AND LIQUIDITY
The Company’s primary sources of short-term liquidity are cash on hand and availability under its $500.0 million revolving credit facility. The amount of cash on hand and borrowings under that facility are influenced by a number of factors, including sales, inventory levels, vendor terms, the level of capital expenditures, cash requirements related to financing instruments, and the Company’s tax payment obligations, among others. As of January 28, 2012 and January 29, 2011, the Company maintained cash and cash equivalent balances of $200.2 million and $197.9 million, respectively. Exclusive of $4.7 million and $7.9 million of store operating cash as of January 28, 2012 and January 29, 2011, respectively, cash was invested primarily in money market funds, demand deposits, and time deposits.
The primary needs for cash are to fund operations, acquire or construct new stores, renovate and expand existing stores, provide working capital for new and existing stores, invest in technology and distribution centers and service debt. The Company estimates capital expenditures for 2012 will be between $110 and $120 million, net of tenant allowances and other proceeds. The Company anticipates that working capital requirements related to existing stores, store renovations and capital expenditures will be funded through cash on hand, cash provided by operations, and the revolving credit facility.
There are numerous general business and economic factors affecting the retail industry. These factors include consumer confidence levels, intense competition, global economic conditions and financial market stability. Significant changes in one or more of these factors could potentially have a material adverse impact on the Company’s ability to generate sufficient cash flows to operate its business. The Company expects to be able to manage its working capital and capital expenditure amounts so as to maintain sufficient levels of liquidity. Depending upon its actual and anticipated sources and uses of liquidity, conditions in the capital markets and other factors, the Company may from time to time consider the issuance of debt or other securities or other possible capital market transactions for the purpose of raising capital which could be used to refinance current indebtedness or for other corporate purposes.
CAPITAL STRUCTURE
The Company continuously evaluates its debt-to-capitalization ratio in light of business and economic trends, interest rate levels, and the terms, conditions and availability of capital in the capital markets. As of January 28, 2012, the Company’s capital and financing structure was comprised of a revolving credit facility, senior unsecured notes, convertible senior unsecured notes, and capital and operating leases. As of January 28, 2012, total funded debt (including the equity component of the convertible notes)
was $405.0 million, representing a decrease of $144.3 million from the balance of $549.3 million at January 29, 2011. This decrease in debt was primarily the result of the maturity of $141.6 million of the Company’s 9.875% senior notes and the redemption of $1.9 million of the Company’s 7.375% senior notes and a net decrease in capital lease obligations of $0.8 million. Additionally, the Company’s debt-to-capitalization ratio decreased to 25.6% in 2011 from 32.9% in 2010.
Revolving Credit Facility
As of January 28, 2012, the Company maintained a $500.0 million revolving credit facility, which is subject to a borrowing base equal to a specified percentage of eligible inventory and certain credit card receivables. As the Company’s inventory levels fluctuate, these changes will, at times, cause the borrowing capacity to fall below the stated $500.0 million maximum. In March 2011, the Company entered into an amendment to its existing revolving credit agreement. The amendment extended the maturity date of the facility to March 2016 and favorably revised certain terms of the existing facility, including, among other things, lower interest rates and fees. The maximum borrowing capacity of the amended facility remains at $500.0 million. As of January 28, 2012, the Company had no direct borrowings under its revolving credit facility. Based on the inventory and credit card receivable balances as of January 28, 2012, the Company had $471.5 million of availability under the facility, after deducting outstanding letters of credit of $6.4 million.
There are no debt ratings-based provisions in the revolving credit facility. The facility contains default provisions that are typical for this type of financing, including a provision that would trigger a default of the facility if a default were to occur in another debt instrument resulting in the acceleration of more than $20.0 million in principal under that other instrument. Borrowings under the facility bear interest at a per annum rate of either: (i) LIBOR plus a percentage ranging from 2.00% to 2.50%, or (ii) the higher of the prime rate or the federal funds rate plus a percentage ranging from 1.00% to 1.50%. Letters of credit are charged a per annum fee equal to the then applicable LIBOR borrowing spread (for standby letters of credit) or the applicable LIBOR spread minus 0.50% (for documentary or commercial letters of credit). The Company also pays a fee ranging from 0.38% to 0.50% per annum on the average daily unused borrowing capacity. The facility includes a fixed-charge coverage ratio requirement of 1.0 to 1.0 that the Company is subject to only if availability under the facility is less than $62.5 million. As of January 28, 2012, the Company was not subject to the fixed charge coverage ratio requirement.
Senior Notes
Excluding the convertible notes, as of January 28, 2012, the Company had $2.1 million of senior notes outstanding that mature in 2013 with an interest rate of 7.0%. The terms of the senior notes call for all principal to be repaid at maturity and places limitations on the amount of secured indebtedness the Company may incur. There are no financial covenants or debt-ratings-based provisions associated with these notes. The Company believes it will have sufficient cash on hand, availability under its revolving credit facility, and access to various capital markets to repay the senior notes at maturity.
During October 2011, the Company paid $141.6 million upon maturity of its 9.875% senior notes.
During April 2011, the Company completed a redemption of $1.9 million of its 7.375% senior notes that were set to mature in 2019. The redemption of these notes resulted in a loss on extinguishment of $0.5 million.
During December 2010, the Company paid $22.9 million upon maturity of its 7.5% senior notes.
During May 2010, the Company repurchased $0.8 million of its 7.0% senior notes that were set to mature in December 2013. The repurchase of these notes resulted in an immaterial loss on extinguishment of debt.
In June and July 2009, the Company repurchased $23.0 million of its 7.5% senior notes that matured in December 2010. The repurchase of these notes resulted in a gain on extinguishment of $0.8 million.
7.5% Convertible Notes
As of January 28, 2012, the Company had $120.0 million of convertible notes outstanding that bear cash interest semiannually at an annual rate of 7.5% and mature in 2013. The provisions of the convertible notes allow the holder to convert the notes at any time to shares of the Company’s common stock at a conversion rate of 180.5869 shares per one thousand dollars in principal amount of notes. The Company can settle a conversion with shares, cash, or a combination thereof at its discretion. In May 2009, the Company received net proceeds from the convertible notes of approximately $115.3 million after deducting initial purchasers’ discounts and offering expenses. The Company used the net proceeds to pay down amounts outstanding under its revolving credit facility and for general corporate purposes.
Upon issuance of the convertible notes, the Company estimated the fair value of the liability component of the 7.5% convertible notes, assuming a 13.0% non-convertible borrowing rate, to be $98.0 million. The difference between the fair value and the principal amount of the 7.5% convertible notes was $22.0 million. This amount was recorded as a debt discount and as an increase to additional paid-in capital as of the issuance date. The current unamortized discount of $10.4 million is being accreted to interest expense over the remaining 1.8 year period to the maturity date of the notes in December 2013 resulting in an increase in non-cash interest expense.
2.0% Convertible Senior Notes
As of January 28, 2012, the Company had $230.0 million of convertible senior notes outstanding that bear interest at a rate of 2.0% per annum and mature in 2024. The provisions of the convertible notes allow the holder to convert the notes to shares of the Company’s common stock at a conversion rate of 83.5609 shares per one thousand dollars in principal amount of notes (subject to an anti-dilution adjustment). The holder may put the debt back to the Company in 2014 or 2019 and the convertible notes became callable at the option of the Company beginning on March 21, 2011. The Company can settle a conversion of the notes with shares, cash, or a combination thereof at its discretion. The holders may convert the notes at the following times, among others: (i) if the Company’s share price is greater than 120% of the applicable conversion price for a certain trading period; (ii) if the credit ratings of the convertible notes are below a certain threshold; or (iii) upon the occurrence of certain consolidations, mergers or share exchange transactions involving the Company. As of January 28, 2012, none of the criteria were met.
The Company used approximately $25.0 million of the proceeds from the issuances to enter into a convertible note hedge and written call options on its common stock to reduce the exposure to dilution from the conversion of the notes. As of January 28, 2012, both the convertible note hedge and written call options had expired.
The Company estimated the fair value of the liability component, as of the date of issuance, of its 2.0% convertible senior notes assuming a 6.25% non-convertible borrowing rate to be $158.1 million. The difference between the fair value and the principal amount of the notes was $71.9 million. This amount was recorded as a debt discount and as an increase to additional paid-in capital as of the issuance date. The discount is being amortized over the expected life of a similar liability that does not have an associated equity component (considering the effects of embedded features other than the conversion option). Since the holders of the convertible notes have put options in 2014 and 2019, the debt instrument is being accreted to par value using the effective interest method from issuance until the first put date in 2014, resulting in an increase in non-cash interest expense. The current unamortized discount of $19.2 million will be recognized over the remaining 2.1 year period.
The Company believes it will have sufficient cash on hand, availability under its revolving credit facility, and access to various capital markets to repay both the convertible notes at maturity.
Capital Leases
As of January 28, 2012, the Company had $52.9 million in capital leases covering various properties and pieces of equipment. The terms of the capital leases provide the lessor with a security interest in the asset being leased and require the Company to make periodic lease payments, aggregating between $6.0 million and $8.0 million per year, excluding interest payments.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The contractual cash obligations at January 28, 2012 associated with the Company’s capital structure, as well as other contractual obligations, are illustrated in the following table:
The Company’s purchase obligations principally consist of purchase orders for merchandise, store construction contract commitments, maintenance contracts, and services agreements. Amounts committed under open purchase orders for merchandise inventory represent approximately $462 million of the purchase obligations within one year, a substantial portion of which are cancelable without penalty prior to a date that precedes the vendor’s scheduled shipment date.
Other long-term liabilities consist of the Company’s liabilities related to its supplemental executive retirement plan. Additionally, the Company is obligated to fund a cash balance pension plan. The Company’s current policy is to maintain at least the minimum funding requirements specified by the Employee Retirement Income Security Act of 1974. The Company expects funding requirements of approximately $4.4 million in 2012, which is included within other long-term liabilities in the table above.
Long-term liabilities excluded from the above table include deferred compensation obligations of $12.4 million as the timing of payments for this obligation is subject to employee elections and other employment factors. Other long-term liabilities excluded from the above table include non-cash obligations for deferred rent and deferred property incentives. In addition, other unrecorded obligations that have been excluded from the contractual obligations table include contingent rent payments, property taxes, insurance payments, amounts that might come due under change-in-control provisions of employment agreements, and common area maintenance costs.
Due to the uncertainty with respect to the timing of future cash flows associated with the Company’s unrecognized tax benefits at January 28, 2012, the Company is unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $14.2 million of unrecognized tax benefits have been excluded from the contractual obligations table above.
The Company has not entered into any off-balance sheet arrangements which would be reasonably likely to have a current or future material effect, such as obligations under certain guarantees or contracts, retained or contingent interests in assets transferred to an unconsolidated entity or similar arrangements, obligations under certain derivative arrangements, and obligations under material variable interests.
From time to time the Company has issued guarantees to landlords under leases of stores operated by its subsidiaries. Certain of these stores were sold in connection with the sale of the Saks Department Store Group to Belk, Inc. in 2005 and the sale of the Northern Department Store Group to The Bon-Ton Stores, Inc. in 2006. If the purchasers fail to perform certain obligations under the leases guaranteed by the Company, the Company could have obligations to landlords under such guarantees. Based on the information currently available, management does not believe that its potential obligations under these lease guarantees would be material.
CREDIT CARDS
HSBC offers proprietary credit card accounts to the Company’s customers. In April 2003, the Company entered into a program agreement with HSBC for a term of ten years expiring in 2013 pursuant to which HSBC owns and issues proprietary credit cards to the Company’s customers. The Company and HSBC have entered into several amendments to the program agreement since 2003. Under the terms of the program agreement, the risks and revenues generated by interest and fees on the portfolio are apportioned between HSBC and the Company. On November 11, 2011, the Company entered into a sixth amendment of its credit card program agreement which provided for an extension of the term of the agreement to April 15, 2018, subject to certain early termination rights set forth in the agreement.
Pursuant to a servicing agreement with HSBC also expiring in April 2018, the Company continues to provide key customer service functions, including new account openings, transaction authorizations, billing adjustments and customer inquiries, and receives compensation from HSBC for the provision of these services.
In September of 2006, the Company entered into agreements with HSBC and MasterCard International Incorporated to issue co-branded MasterCard cards to new and existing proprietary credit card customers. Under this program, qualifying customers are issued an SFA and MasterCard co-branded credit card that functions as a traditional proprietary credit card when used at any SFA or OFF 5TH store and at Saks Direct or as a MasterCard card when used at any unaffiliated location that accepts MasterCard cards. HSBC establishes and owns the co-brand accounts, retains the benefits associated with the ownership of the accounts, receives the finance charge and other income from the accounts, and incurs the bad debts associated with the accounts.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company’s critical accounting policies and estimates are discussed in the notes to the consolidated financial statements. Certain judgments and estimates utilized in implementing these accounting policies are likewise discussed in each of the notes to the consolidated financial statements. The following discussion sets forth the judgments and uncertainties affecting the application of these policies and estimates and the likelihood that materially different amounts would be reported under varying conditions and assumptions.
REVENUE RECOGNITION
Revenue from the sale of merchandise at the Company’s retail stores is recognized at the time customers provide a satisfactory form of payment and take delivery of the merchandise. Revenue from the sale of merchandise from Saks Direct is recognized upon estimated receipt of merchandise by the customer. The Company estimates the amount of goods that will be returned for a refund based on historical trends and reduces sales and gross margin by that amount. Given that approximately 22% of merchandise sold is later returned and that the vast majority of merchandise returns occur within a short time after the selling transaction, the risk of the Company realizing a materially different amount for sales and gross margin than reported in the consolidated financial statements is minimal.
Revenue associated with gift cards is recognized upon redemption by the customer. Breakage income associated with unredeemed gift cards is recognized if the gift card is not subject to state escheatment laws when the likelihood of customer redemption is determined to be remote.
COST OF SALES AND INVENTORY VALUATION
Merchandise inventories are stated at the lower of cost or market, with cost being determined using the retail first-in, first-out (“FIFO”) method. 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 to the retail value of inventories. The cost of the inventory reflected on the consolidated balance sheet is decreased with a charge to cost of sales contemporaneous with the lowering of the retail value of the inventory on the sales floor through the use of markdowns. Hence, earnings are negatively impacted as the merchandise is being devalued with markdowns prior to the sale of the merchandise. The areas requiring significant management judgment include (1) setting the original retail value for the merchandise held for sale, (2) 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 (3) estimating the shrinkage that has occurred through theft during the period 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 setting original retail prices for merchandise held for sale too high, failure to identify a decline in perceived value of inventories and process the appropriate retail value markdowns, and overly optimistic or overly conservative inventory shrinkage estimates. The Company believes it has the appropriate merchandise valuation and pricing controls in place to minimize the risk that its inventory values would be materially under or overvalued.
The Company regularly records a provision for estimated shrinkage, thereby reducing the carrying value of merchandise inventory. A complete physical inventory of all of the Company’s stores and distribution facilities is performed annually, with the recorded amount of merchandise inventory being adjusted to coincide with this physical count. The differences between the estimated amount of shrinkage and the actual amount realized have been insignificant.
The Company receives vendor-provided support in different forms. When vendors provide support for inventory markdowns, the Company records the support as a reduction of cost of sales. Such support is recorded in the period that the corresponding markdowns are taken. When the Company receives inventory-related support that is not designated for markdowns, the Company includes this support as a reduction of the cost of purchases.
SELF-INSURANCE RESERVES
The Company self-insures a substantial portion of its exposure for costs related primarily to employee medical, workers’ compensation and general liability. Expenses are recorded based on estimates for reported claims and claims that have been incurred but not yet reported, considering a number of factors, including historical claims experience, severity factors, litigation costs, inflation and other assumptions. Although the Company does not expect the amount it will ultimately pay to differ significantly from its estimates, self-insurance reserves could be affected if future claims experience differs significantly from the historical trends and assumptions.
DEPRECIATION AND RECOVERABILITY OF CAPITAL ASSETS
Over 40% of the Company’s assets at January 28, 2012 are represented by investments in property and equipment. Determining appropriate depreciable lives and reasonable assumptions for use in evaluating the carrying value of capital assets requires judgments and estimates.
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Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Land is not depreciated. Buildings and building improvements are depreciated over 20 to 40 years. Store fixtures are depreciated over 10 years. Equipment utilized in stores (e.g., escalators) and in support areas (e.g., distribution centers, technology) and fixtures in support areas are depreciated over 3 to 10 years. Leasehold improvements are amortized over the shorter of their estimated useful lives or their related lease terms, generally ranging from 10 to 20 years. Costs incurred for the development of internal-use software are capitalized and amortized over 3 to 10 years. Generally, there is no estimated salvage value at the end of the useful life of the assets.
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Costs incurred when constructing stores, including interest expense, are capitalized. The Company may receive allowances from landlords related to the construction. If the landlord is determined to be the primary beneficiary of the property, then the portion of those allowances attributable to the property owned by the landlord is considered to be a deferred rent liability, whereas the corresponding capital expenditures related to that store are considered to be prepaid rent. Allowances in excess of the amounts attributable to the property owned by the landlord are considered improvement allowances and are recorded as deferred rent liabilities that are amortized over the life of the lease. Capital expenditures are also reduced when the Company receives cash and allowances from merchandise vendors to fund the construction of vendor shops.
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To the extent the Company remodels or otherwise replaces or disposes of property and equipment prior to the end of their assigned depreciable lives, the Company could realize a gain or loss on the disposition. To the extent assets continue to be used beyond their assigned depreciable lives, no depreciation expense is recognized. The Company reassesses the depreciable lives in an effort to reduce the risk of significant losses or gains at disposition and utilization of assets with no depreciation charges. The reassessment of depreciable lives involves utilizing historical remodel and disposition activity and forward-looking capital expenditure plans.
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Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable, such as opening a new store near an existing store, announcing plans for a store closure, a history of store operating losses, etc. The impairment evaluation requires management to make assumptions and apply judgment to estimate future cash flows and asset fair values, including selection of a discount rate and assumptions regarding key store variables such as sales, gross margin rates, and store expenses.
LEASES
The Company leases the land or the land and building at many of its stores, as well as its distribution centers, offices, administrative facilities, and certain equipment. Most of these leases are classified as operating leases. Most of the Company’s lease agreements include renewal periods at the Company’s option. Store lease agreements generally include rent holidays, rent escalation clauses, and contingent rent provisions that require additional payments based on a percentage of sales in excess of specified levels. Contingent rental payments are recognized when the Company determines that it is probable that the specified levels will be reached during the fiscal year. For leases that contain rent holiday periods and scheduled rent increases, the Company recognizes rent expense on a straight-line basis over the lease term from the date the Company takes possession of the leased property. The difference between the straight-line rent amounts and amounts payable under the lease agreements are recorded as deferred rent. Tenant improvement allowances and other lease incentives are recorded as deferred rent liabilities and are recognized on a straight-line basis over the life of the lease.
INCOME AND OTHER TAXES
The majority of the Company’s net deferred tax assets of $225.9 million at January 28, 2012 consist of federal and state NOL carryforwards that will expire between 2012 and 2030. The majority of the NOL carryforward is a result of the net operating losses incurred during the fiscal years ended January 30, 2010 and January 31, 2009 principally due to difficult market and macroeconomic conditions. The Company concluded, based on the weight of all available positive and negative evidence that all but $19.2 million of these tax benefits relating to certain state losses are more likely than not to be realized in the future. Therefore, a valuation allowance for the $19.2 million has been established. The Company evaluates the realizability of its deferred tax assets on a quarterly basis. In 2011 and 2010, this evaluation resulted in a net reduction to the reserve against state deferred tax assets of $11.8 million and $2.2 million, impacting the Company’s results of operations. A similar analysis was performed in 2009, which resulted in an additional reserve against state deferred tax assets of $3.0 million.
The Company is routinely under examination by federal, state and local taxing authorities in the areas of income taxes and the remittance of sales and use taxes. These examinations include questioning the timing and amount of deductions, the allocation of income among various tax jurisdictions and compliance with federal, state and local tax laws. In evaluating the exposure associated with various tax filing positions, the Company often accrues for exposures related to uncertain tax positions.
The Company had approximately $14.2 million and $14.3 million of gross unrecognized tax benefits as of January 28, 2012 and January 29, 2011, respectively. As of January 28, 2012, $3.6 million represents the amount of unrecognized tax benefits that, if recognized, would impact the effective income tax rate in any future periods. The Company continually evaluates its tax filing positions and to the extent the Company prevails on audits or statutes of limitation expire, the unrecognized tax benefits could be realized.
The Company files a consolidated U.S. federal income tax return as well as state tax returns in multiple state jurisdictions. The Company has completed examinations by the Internal Revenue Service or the statute of limitations has expired for taxable years through February 2, 2008 with no significant adjustments. With respect to the state and local jurisdictions, the Company has completed examinations in many jurisdictions through the same period and beyond and currently has no examinations in progress.
PENSION PLANS
The Company sponsors a funded defined-benefit cash balance pension plan (“Pension Plan”) and an unfunded supplemental executive retirement plan (“SERP”) for certain employees of the Company. Effective January 1, 2007, the Company amended the Pension Plan, suspending future benefit accruals for all participants, except certain participants who as of December 31, 2006 had attained age 55, completed 10 years of credited service, and who are not considered to be highly compensated employees. Effective March 13, 2009, the Company amended the Pension Plan, suspending future benefit accruals for all remaining participants.
The Company’s funding policy requires contributions to the Pension Plan be at least equal to the minimum funding requirement, as determined under the Employee Retirement Income Security Act of 1974. The Company may make additional contributions from time to time, generally not to exceed the maximum tax-deductible limitation. The Pension Plan and SERP obligations are valued annually as of the Company’s fiscal year-end balance sheet date. The projected unit credit method is utilized in computing the pension obligations. Net periodic benefit cost is based on actuarial models used to estimate the total benefits ultimately payable to participants and is allocated to the respective service periods. The actuarial assumptions used to calculate benefit costs are reviewed annually.
Pension assumptions are based upon management’s best estimates as of the annual measurement date.
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The discount rate is primarily used in calculating the Company’s pension obligation, which is represented by the accumulated benefit obligation (“ABO”) and the projected benefit obligation (“PBO”) and in calculating net periodic benefit cost. The discount rate utilized is based upon pension discount curves and bond portfolio curves over a duration that is similar to the expected future cash flows of the plans as of the measurement date. The discount rate used to calculate the ABO and PBO as of January 28, 2012 was 3.6% and 3.8% for the Pension Plan and SERP, respectively. To the extent the discount rate increases or decreases, the Company’s PBO is decreased or increased, respectively. The estimated effect of a 0.25% change in the discount rate is approximately $2.7 million on the PBO and approximately $0.2 million on net periodic benefit cost. To the extent the PBO increases, the after-tax effect of such increases would reduce other comprehensive income and shareholders’ equity.
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The expected long-term rate of return on plan assets is used primarily in calculating the expected return on plan assets component of the Company’s net periodic benefit cost. The Company’s estimate of the expected long-term rate of return considers the historical returns on plan assets, as well as the future expectations of returns on classes of assets within the target asset allocation of the plan asset portfolio. The assumed expected long-term rate of return on plan assets is the weighted average rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the PBO. The Company’s investment strategy is to maintain a diversified portfolio of assets with the primary goal of ensuring that funds are available to meet the Pension Plan’s benefit obligations when they become due, while maintaining an appropriate level of risk. The Pension Plan’s target asset allocation is determined by the Company’s Retirement Committee and as of January 28, 2012, the Pension Plan’s target asset allocation was approximately 35% equity, 60% fixed income, and 5% real estate. To the extent the actual rate of return on assets realized is greater than or less than the assumed rate of return, that year’s net periodic benefit cost is not affected. Rather, the gain or loss is recognized in accumulated other comprehensive income and would reduce or increase future net periodic benefit cost over the average life expectancy of the plan’s participants, to the extent that the cumulative gains or losses exceed 10% of the greater of the PBO or market-related value of plan assets. The Company’s expected long-term rate of return on plan assets was 7.5% in 2011. The estimated effect of a 0.50% change in the long-term rate of return on plan assets is $0.6 million on the net periodic benefit cost.
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The assumed average rate of compensation increase is the average annual compensation increase expected over the remaining employment periods for the participating employees and is primarily used in calculating the PBO and net periodic benefit cost. No assumption was used in 2011 and 2010 as the Pension Plan was amended to suspend future benefit accruals for all participants.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-11, Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”). ASU 2011-11 enhances disclosure requirements regarding financial instruments and derivative instruments that are either offset or subject to an enforceable master netting arrangement or similar agreement. ASU 2011-11 requires disclosure of both net and gross information for these assets and liabilities in order to enhance comparability between those entities that prepare their financial statements in accordance with U.S. GAAP and those entities that prepare their financial statements in accordance with International Financial Reporting Standards. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods. The adoption of ASU 2011-11 will not affect the consolidated financial position, results of operations or cash flows of the Company.
In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 requires reporting entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and is to be applied retrospectively. The adoption of ASU 2011-05 will not affect the consolidated financial position, results of operations, or cash flows of the Company. In December 2011, the FASB issued Accounting Standards Update No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (“ASU 2011-12”). ASU 2011-12 defers the effective date of the portions of ASU 2011-05 relating to the presentation of reclassification adjustments of items out of accumulated other comprehensive income. All other requirements of ASU 2011-05 are not affected by ASU 2011-12. The adoption of ASU 2011-12 will not affect the consolidated financial position, results of operations or cash flows of the Company.
In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), which amends the existing fair value guidance to improve consistency in the application and disclosure of fair value measurements in U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 provides certain clarifications to the existing guidance, changes certain fair value principles, and enhances disclosure requirements. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and is to be applied prospectively. The Company does not expect the adoption of ASU 2011-04 to have an impact on the consolidated financial statements.
ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS
In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”), which requires reporting entities to make new disclosures about recurring or nonrecurring fair value measurements including significant transfers into and out of Level 1 and Level 2 fair value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. ASU 2010-06 was effective for reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which became effective for periods beginning after December 15, 2010. Adoption of this pronouncement did not impact the Company’s consolidated financial statements.
Effective February 1, 2009, the Company retrospectively adopted a new standard related to accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). The standard specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. The effect of the adoption is disclosed in Note 6.
RELATED PARTY TRANSACTIONS
See Item 13, Certain Relationships and Related Transactions, in this Form 10-K.
FORWARD-LOOKING INFORMATION
The information contained in this Form 10-K that addresses future results or expectations is considered “forward-looking” information within the definition of the Federal securities laws. Forward-looking information in this document can be identified through the use of words such as “may,” “will,” “intend,” “plan,” “project,” “expect,” “anticipate,” “should,” “would,” “believe,” “estimate,” “contemplate,” “possible,” and “point.” The forward-looking information is premised on many factors, some of which are outlined below. Actual consolidated results might differ materially from projected forward-looking information.
The forward-looking information and statements are or may be based on a series of projections and estimates and involve risks and uncertainties. These risks and uncertainties include such factors as: the level of consumer spending for luxury apparel and other merchandise carried by the Company and its ability to respond quickly to consumer trends; macroeconomic conditions and their effect on consumer spending; the Company’s ability to secure adequate financing; adequate and stable sources of merchandise; the competitive pricing environment within the retail sector; the effectiveness of planned advertising, marketing, and promotional campaigns; favorable customer response to relationship marketing efforts of proprietary credit card loyalty programs; appropriate inventory management; effective expense control; successful operation of the Company’s proprietary credit card strategic alliance with HSBC; geo-political risks; the performance of the financial markets; changes in interest rates; and fluctuations in foreign currency. For additional information regarding these and other risk factors, please refer to Item 1A of Part I in this Form 10-K.
The Company undertakes no obligation to correct or update any forward-looking statements, whether as a result of new information, future events, or otherwise.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
The Company’s exposure to market risk primarily arises from changes in interest rates and the U.S. equity and bond markets. The effects of changes in interest rates on earnings generally have been small relative to other factors that also affect earnings, such as sales and operating margins. The Company seeks to manage exposure to adverse interest rate changes through its normal operating and financing activities, and if appropriate, through the use of derivative financial instruments. Such derivative instruments can be used as part of an overall risk management program in order to manage the costs and risks associated with various financial exposures. The Company does not enter into derivative instruments for trading purposes. The Company is exposed to interest rate risk primarily through its borrowings under its revolving credit facility.
Based on the Company’s market risk sensitive instruments outstanding at January 28, 2012, the Company has determined that there was no material market risk exposure to the Company’s consolidated financial position, results of operations, or cash flows as of such date.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Information called for by this item is set forth in the Company’s Consolidated Financial Statements and supplementary data contained in this report beginning on page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of such date. The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, management of the Company conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of the end of the period covered by this report based on the framework set forth in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that, as of January 28, 2012, the Company’s internal control over financial reporting was effective based on those criteria.
PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the financial statements included in this report, has issued an attestation report on the Company’s internal control over financial reporting which appears in Item 15.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended January 28, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
Not applicable.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this Item with respect to the Company’s directors is incorporated by reference to the section entitled “Election of Directors” in the Company’s Proxy Statement to be filed in connection with the Company’s 2012 Annual Meeting of Shareholders (the “Proxy Statement”). The information required by this Item with respect to the Company’s Code of Business Conduct and Audit Committee (including the Company’s “audit committee financial expert”) is incorporated by reference to the section of the Proxy Statement entitled “Corporate Governance.”
The information required by this Item with respect to the Company’s executive officers is set forth under “Executive Officers of the Registrant” in this Form 10-K Report.
The information required by this Item with respect to Section 16(a) of the Exchange Act is incorporated by reference to the section of the Proxy Statement entitled “Section 16(a) Beneficial Ownership Reporting Compliance.”
Item 11.
Item 11. Executive Compensation.
The information required by this Item with respect to director and executive officer compensation is incorporated by reference to the section of the Proxy Statement entitled “Executive Compensation.”
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item with respect to security ownership of certain beneficial owners and management is incorporated by reference to the section of the Proxy Statement entitled “Stock Ownership of Certain Beneficial Owners and Management.”
The remaining information called for by this item relating to “Securities Authorized for Issuance under Equity Compensation Plans” is provided in Part II, Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of this Form 10-K Report.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item with respect to certain relationships and related transactions, and director independence is incorporated by reference to the sections of the Proxy Statement entitled “Certain Relationships and Related Transactions” and “Corporate Governance.”
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required by this Item with respect to principal accountants fees and services is incorporated by reference to the section of the Proxy Statement entitled “Fees Paid to Auditors.”
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a) The following documents are filed as part of this report:
(1)-(2) Financial Statements and Schedules
The list of consolidated financial statements and schedules set forth in the Index to Consolidated Financial Statements on page herein is incorporated herein by reference. All other financial statement schedules are omitted since they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes thereto.
(3) Exhibits
The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this report and such Exhibit Index is incorporated herein by reference.
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.
Saks Incorporated
(Registrant)
By:
/s/ Kevin G. Wills
Kevin G. Wills
Date: March 16, 2012
Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities and 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.
EXHIBIT INDEX
* Filed herewith
# Management contract or compensatory plan or arrangement
 Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
SAKS INCORPORATED & SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
F- 2
Consolidated Statements of Income
F- 3
Consolidated Balance Sheets
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Saks Incorporated:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Saks Incorporated and its subsidiaries at January 28, 2012 and January 29, 2011, and the results of their operations and their cash flows for each of the three years in the period ended January 28, 2012 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2012 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Birmingham, Alabama
March 16, 2012
SAKS INCORPORATED & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
SAKS INCORPORATED & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
SAKS INCORPORATED & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(In thousands)
(1) Accumulated Other Comprehensive Loss is composed of net gains and losses associated with the Company’s defined benefit pension plan.
The accompanying notes are an integral part of these consolidated financial statements.
SAKS INCORPORATED & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Supplemental cash flow information and non-cash investing and financing activities
are further described in the accompanying notes
The accompanying notes are an integral part of these consolidated financial statements.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 1: NATURE OF OPERATIONS
Saks Incorporated, a Tennessee corporation first incorporated in 1919, and its subsidiaries (together the “Company”) consist of Saks Fifth Avenue (“SFA”) stores and SFA e-commerce operations (“Saks Direct”) as well as Saks Fifth Avenue OFF 5TH (“OFF 5TH”). Previously, the Company also operated Club Libby Lu (“CLL”) (the operations of which were discontinued in January 2009).
As of January 31, 2009, the Company discontinued the operations of its CLL business, which consisted of 98 leased, mall-based specialty stores, targeting girls aged 4-12 years old. Discontinued operations include nominal charges (income) for 2009 and 2010 from residual CLL store closing activities.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Fiscal Year
The Company’s fiscal year ends on the Saturday closest to January 31st. Fiscal years 2011, 2010, and 2009 ended on January 28, 2012 (“2011”), January 29, 2011 (“2010”), and January 30, 2010 (“2009”), respectively.
Recently Issued Accounting Pronouncements
In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-11, Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”). ASU 2011-11 enhances disclosure requirements regarding financial instruments and derivative instruments that are either offset or subject to an enforceable master netting arrangement or similar agreement. ASU 2011-11 requires disclosure of both net and gross information for these assets and liabilities in order to enhance comparability between those entities that prepare their financial statements in accordance with U.S. GAAP and those entities that prepare their financial statements in accordance with International Financial Reporting Standards. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods. The adoption of ASU 2011-11 will not affect the consolidated financial position, results of operations or cash flows of the Company.
In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 requires reporting entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and is to be applied retrospectively. The adoption of ASU 2011-05 will not affect the consolidated financial position, results of operations, or cash flows of the Company. In December 2011, the FASB issued Accounting Standards Update No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (“ASU 2011-12”). ASU 2011-12 defers the effective date of the portions of ASU 2011-05 relating to the presentation of reclassification adjustments of items out of accumulated other comprehensive income. All other requirements of ASU 2011-05 are not affected by ASU 2011-12. The adoption of ASU 2011-12 will not affect the consolidated financial position, results of operations or cash flows of the Company.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), which amends the existing fair value guidance to improve consistency in the application and disclosure of fair value measurements in U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 provides certain clarifications to the existing guidance, changes certain fair value principles, and enhances disclosure requirements. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and is to be applied prospectively. The Company does not expect the adoption of ASU 2011-04 to have an impact on the consolidated financial statements.
Adoption of New Accounting Pronouncements
In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”), which requires reporting entities to make new disclosures about recurring or nonrecurring fair value measurements including significant transfers into and out of Level 1 and Level 2 fair value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. ASU 2010-06 was effective for reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which became effective for periods beginning after December 15, 2010. Adoption of this pronouncement did not impact the Company’s consolidated financial statements.
Effective February 1, 2009, the Company retrospectively adopted a new standard related to accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). The standard specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. The effect of the adoption is disclosed in Note 6.
Net Sales
Net sales include sales of merchandise (net of returns and exclusive of sales taxes), commissions from leased departments, shipping and handling revenues related to merchandise sold, and breakage income from unredeemed gift cards. Sales of merchandise from the Company’s retail stores are recognized at the time customers provide a satisfactory form of payment and take delivery of the merchandise. Sales of merchandise from Saks Direct are recognized upon estimated receipt of merchandise by the customer. Revenue associated with gift cards is recognized upon redemption of the card.
The Company estimates the amount of goods that will be returned for a refund and reduces sales and gross margin by that amount.
Commissions from leased departments included in net sales were $43,184, $31,832, and $27,180 during 2011, 2010, and 2009, respectively. Leased department sales were $300,537, $233,422, and $200,535 during 2011, 2010, and 2009, respectively, and were excluded from net sales.
The following table summarizes net sales by major merchandise category for 2011, 2010, and 2009:
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Cash and Cash Equivalents
Cash and cash equivalents primarily consist of cash on hand in the stores, deposits with banks, and investments with banks and financial institutions that have original maturities of three months or less. Cash equivalents are stated at cost, which approximates fair value. Cash equivalents totaled $195,449 and $190,007 as of January 28, 2012 and January 29, 2011, respectively, primarily consisting of money market funds, demand deposits, and time deposits. Income earned on cash equivalents was $1,252, $551, and $36 for 2011, 2010, and 2009, respectively, and was reflected in other income on the accompanying Consolidated Statements of Income. There were no compensating balance arrangements as of January 28, 2012. The Company had a compensating balance of $10,000 as of January 29, 2011, related to the Company’s purchasing card program.
Merchandise Inventories and Cost of Sales
Merchandise inventories are stated at the lower of cost or market. Cost is determined using the retail first-in, first-out (“FIFO”) method and includes freight, buying and distribution costs. The Company takes markdowns related to slow moving inventory, ensuring the appropriate inventory valuation.
The Company regularly records a provision for estimated shrinkage, thereby reducing the carrying value of merchandise inventory. A complete physical inventory of all of the Company’s stores and distribution facilities is performed annually, with the recorded amount of merchandise inventory being adjusted to coincide with this physical count. The differences between the estimated amount of shrinkage and the actual amount realized have been insignificant.
The Company receives vendor-provided support in different forms. When the vendor provides support for inventory markdowns, the Company records the support as a reduction to cost of sales. Such support is recorded in the period that the corresponding markdowns are taken. When the Company receives inventory-related support that is not designated for markdowns, the Company includes this support as a reduction of the cost of purchases.
Consignment merchandise on hand of $93,897 and $109,877 as of January 28, 2012 and January 29, 2011, respectively, is not reflected on the Consolidated Balance Sheets.
Selling, General and Administrative Expenses (“SG&A”)
SG&A expenses consist primarily of employee compensation and benefit costs related to the selling and administrative support functions; advertising; operating and maintenance costs; proprietary credit card promotion, issuance and servicing costs; insurance programs; telecommunications; shipping and handling costs; and other operating expenses not specifically categorized elsewhere on the Consolidated Statements of Income. Payroll taxes, rent, depreciation, and property taxes are not included in SG&A.
Advertising and sales promotion costs are expensed in the period in which the advertising event takes place.
The Company receives allowances and expense reimbursements from merchandise vendors and from the owner of the proprietary credit card portfolio which are netted against the related expense:
•
Allowances received from merchandise vendors in conjunction with incentive compensation programs for employees who sell the vendors’ merchandise and netted against the related compensation expense were $35,657, $36,098, and $41,846 in 2011, 2010, and 2009, respectively.
•
Allowances received from merchandise vendors in conjunction with jointly produced and distributed print and television media and netted against the gross expenditures for such advertising were $30,526, $29,323, and $33,287 in 2011, 2010, and 2009, respectively. Net advertising expenses were $59,036, $45,465, and $36,025 in 2011, 2010, and 2009, respectively.
•
Expense reimbursements received from the owner of the Company’s proprietary credit card portfolio are discussed at Note 3 to these consolidated financial statements.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Store Pre-Opening Costs
Store pre-opening costs primarily consist of rent expense incurred during the construction of new stores, payroll, and related media costs incurred in connection with new store openings. These costs are expensed as incurred. Rent expense is generally incurred for six to twelve months prior to a store’s opening date.
Property and Equipment
Property and equipment are stated at historical cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Buildings and building improvements are depreciated over 20 to 40 years while fixtures and equipment are depreciated over 3 to 10 years. Leasehold improvements are amortized over the shorter of their estimated useful lives or their related lease terms, generally ranging from 10 to 20 years. Lease terms may include renewal periods at the Company’s option if exercise of the option is determined to be reasonably assured at the inception of the lease. Costs incurred for the development of internal-use computer software are capitalized and amortized using the straight-line method over 3 to 10 years. Costs incurred during the discovery and post-implementation stages of internally-developed computer software are expensed as incurred.
Costs incurred when constructing stores, including interest expense, are capitalized. The Company may receive allowances from landlords related to the construction. If the landlord is determined to be the primary beneficiary of the property, then the portion of those allowances attributable to the property owned by the landlord is considered to be a deferred rent liability, whereas the corresponding capital expenditures related to that store are considered to be prepaid rent. Allowances in excess of the amounts attributable to the property owned by the landlord are considered leasehold improvement allowances and are recorded as deferred rent liabilities that are amortized over the life of the lease. Capital expenditures are reduced when the Company receives cash and allowances from merchandise vendors to fund the construction of vendor shops.
Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the estimated future undiscounted cash flows resulting from the use and eventual disposition of the store assets are less than the carrying value of such assets, an impairment loss is recognized for the difference between the estimated fair value and the carrying value. The evaluation is performed at the lowest level of identifiable cash flows, which is primarily at the individual store level. Long-lived asset impairment charges are included in impairments and dispositions on the Consolidated Statements of Income.
Impairments and Dispositions
Impairment and disposition costs include costs associated with store closures, including employee severance and lease termination fees, asset impairment and disposal charges, and other store closure activities. Additionally, impairment and disposition costs include long-lived asset impairment charges related to assets held and used and losses related to asset dispositions made during the normal course of business.
The Company continuously evaluates its real estate portfolio and closes underproductive stores in the normal course of business as leases expire or as other circumstances dictate. During 2011, the Company closed one SFA store and two OFF 5TH stores. The Company incurred $5,065 of store closing costs primarily related to a lease termination fee and employee severance. Also included in impairment and disposition costs for 2011 is $5,041 of asset impairment charges related to held and used assets.
During 2010, the Company incurred costs associated with the closing of seven SFA stores and one OFF 5TH store. The Company incurred $12,045 of store closing-related costs associated with these locations. Also included in impairment and disposition costs for 2010 are $785 of asset impairment charges related to held and used assets and $255 of losses on the disposal of assets during the normal course of business.
During 2009, the Company incurred $28,176 of asset impairment charges related to held and used assets and $1,172 of losses on the disposal of assets during the normal course of business.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., exit price) in the principal and most advantageous market for the 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 into three levels:
Level 1: Quoted market prices in active markets for identical assets or liabilities
Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data
Level 3: Unobservable inputs reflecting the reporting entity’s own assumptions
As of January 28, 2012 and January 29, 2011, the Company had no financial assets or liabilities measured at fair value on a recurring basis.
Assets and liabilities that are measured at fair value on a non-recurring basis include the Company’s long-lived assets. During 2011, long-lived assets held and used with a carrying value of $7,533 were written down to their estimated fair value of $2,492, resulting in an impairment loss of $5,041. During 2010, long-lived assets held and used with a carrying value of $785 were written down to their estimated fair value of $0, resulting in an impairment loss of $785. The fair values of long-lived assets held and used were determined using an income-based approach and are classified as Level 3 within the fair value hierarchy. Significant inputs include projections of future cash flows and discount rates. These inputs are based on assumptions from the perspective of market participants.
The fair value of cash and cash equivalents, accounts payable and accrued liabilities approximates carrying value due to the short-term maturities of these assets and liabilities. See Note 6 for disclosure of the fair value of long-term debt.
Operating Leases
The Company leases the land or the land and building at many of its stores, as well as its distribution centers, administrative facilities, and certain equipment. Most of these leases are classified as operating leases. Most of the Company’s lease agreements include renewal periods at the Company’s option. Store lease agreements generally include rent holidays, rent escalation clauses, and contingent rent provisions that require additional payments based on a percentage of sales in excess of specified levels. Contingent rental payments are recognized when the Company determines that it is probable that the specified levels will be reached during the fiscal year. For leases that contain rent holiday periods and scheduled rent increases, the Company recognizes rent expense on a straight-line basis over the lease term from the date the Company takes possession of the leased property. The difference between the straight-line rent amounts and amounts payable under the leases are recorded as deferred rent. Tenant improvement allowances and other lease incentives are recorded as deferred rent liabilities and are recognized on a straight-line basis over the life of the lease. As of January 28, 2012 and January 29, 2011, deferred rent liabilities were $66,524 and $57,042, respectively. These amounts are included in other long-term liabilities on the Consolidated Balance Sheets.
Self-Insurance Reserves
The Company self-insures a substantial portion of its exposure for costs related to employee medical, workers’ compensation and general liability. Expenses are recorded based on estimates for reported claims and claims that have been incurred but not reported, considering a number of factors, including historical claims experience, severity factors, litigation costs, inflation, and other assumptions. Although the Company does not expect the amount that it will ultimately pay to differ significantly from its estimates, self-insurance reserves could be affected if future claims experience differs significantly from historical trends and assumptions. In October 2010, the Company executed a loss portfolio transfer with its insurance carrier in the amount of $11,450 related to current and future workers’ compensation claims for fiscal years 1999 through 2008. This transaction reduced the Company’s workers’ compensation liability by approximately the same amount.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Earnings (Loss) per Share (“EPS”)
Basic EPS is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. For the years ended January 28, 2012, January 29, 2011, and January 30, 2010, the computations of diluted EPS assume that the Company’s convertible notes would be settled in shares of common stock. Diluted EPS is computed by adjusting: (i) the income available to common shareholders for the amount of interest expense recognized related to the convertible notes, and (ii) the weighted-average number of common shares outstanding to assume conversion of the Company’s convertible notes and the issuance of all other dilutive potential common shares, if the effect is dilutive. The following table sets forth the computation of basic and diluted EPS:
The following table presents additional potentially dilutive common shares excluded from diluted earnings (loss) per share because the effect of including these potentially dilutive common shares would have been anti-dilutive:
(1) Represents the number of options outstanding at the end of each period. Application of the treasury stock method would reduce this amount if they had a dilutive effect and were included in the computation of diluted EPS.
For the year ended January 28, 2012, there were 40,889 potentially dilutive shares under the Company’s 7.5% and 2.0% convertible notes that were included in the computation of diluted EPS because inclusion of the potentially dilutive shares and related interest expense has a dilutive effect.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
For the years ended January 29, 2011 and January 30, 2010, there were 40,889 potentially dilutive shares under the Company’s 7.5% and 2.0% convertible notes that were not included in the computation of diluted EPS because inclusion of the potentially dilutive shares and related interest expense would be anti-dilutive.
Stock-Based Compensation Plans
The Company maintains an equity incentive plan, which allows for the granting of stock options, stock appreciation rights, restricted stock, performance share awards and other forms of equity awards to employees, directors, and officers. Stock options granted generally vest over a four-year period from the grant date and have contractual terms of seven to ten years from the grant date. Restricted stock and performance share awards generally vest over periods ranging from three to five years from the grant date, although the equity incentive plan permits accelerated vesting in certain circumstances at the discretion of the Human Resources and Compensation Committee (“HRCC”) of the Board of Directors.
The Company recognizes compensation expense for stock option awards with graded vesting on a straight-line basis over the requisite service period. Compensation expense related to restricted stock and performance share awards that cliff vest are expensed on a straight-line basis over the requisite service period. Restricted stock awards with graded-vesting features are treated as multiple awards based upon the vesting date. The Company records compensation expense for these awards on a straight-line basis over the requisite service period for each separately vesting portion of the award.
Pension Plans
Pension expense is based on actuarial models used to estimate the total benefits ultimately payable to participants and is allocated to the respective service periods. The Company’s funding policy provides that contributions to the pension trusts shall be at least equal to the minimum funding requirement of the Employee Retirement Income Security Act of 1974. The Company may provide additional contributions from time to time, generally not to exceed the maximum tax-deductible limitation. The Company’s pension plans are valued annually as of the fiscal year-end balance sheet date. Actuarial gains and losses are amortized over the average life expectancy of the plan’s participants, to the extent the cumulative gains or losses exceed 10% of the greater of the projected benefit obligation or market-related value of plan assets.
Gift Cards
The Company sells gift cards with no expiration dates. At the time gift cards are sold, no revenue is recognized and a liability is established for the value of the card. The liability is relieved and revenue is recognized when the gift cards are redeemed by the customer for merchandise. The liability for unredeemed gift cards was $28,933 and $34,241 as of January 28, 2012 and January 29, 2011, respectively and is included in accrued expenses on the Consolidated Balance Sheets.
The Company periodically evaluates unredeemed gift cards and if it determines that the likelihood of customer redemption is remote and the gift card is not subject to state escheatment laws, then the Company will recognize breakage income and reverse the related liability. Breakage income included in net sales during 2011, 2010, and 2009 was $3,112, $3,565, and $5,751, respectively.
Loyalty Program
The Company maintains a customer loyalty program in which customers accumulate points for each qualifying purchase. On an annual basis, the customers receive a gift card to apply to future purchases. The amount of the gift card is based on the level of points accumulated during the year. The Company estimates the net cost of these gift cards that will be earned and redeemed and records this amount in cost of sales as points are accumulated.
Income Taxes
The Company uses 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.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Segment Reporting
SFA, Saks Direct, and OFF 5TH have been aggregated into one reportable segment based on the aggregation criteria outlined in the authoritative accounting literature.
NOTE 3: PROPRIETARY CREDIT CARDS
In April 2003, the Company sold its proprietary credit card portfolio, consisting of the proprietary credit card accounts owned by the National Bank of the Great Lakes and the Company’s ownership interest in the assets of the trust, to HSBC Bank Nevada, N.A. (“HSBC”), a third party financial institution.
HSBC, an affiliate of HSBC Holdings PLC, offers proprietary credit card accounts to the Company’s customers. HSBC establishes and owns proprietary credit card accounts for the Company’s customers. Under the terms of the program agreement, the risks and revenues generated by interest and fees on the portfolio are apportioned between HSBC and the Company. Pursuant to a servicing agreement, the Company continues to provide key customer service functions, including new account openings, transaction authorizations, billing adjustments and customer inquiries, and receives compensation from HSBC for these services.
The Company and HSBC have entered into several amendments to the program agreement since 2003. In November 2011, the Company entered into a sixth amendment, which provides for an extension of the term of the program agreement to 2018, subject to certain termination rights set forth in the program agreement, as well as an amendment of the risk and revenue sharing provisions, certain of which were applied retroactively from April 15, 2011. The sixth amendment also amends, among other provisions, certain of the early termination provisions of the program agreement otherwise applicable in respect of HSBC’s sale of its credit card business to Capital One Financial Corporation.
In September 2006, the Company entered into agreements with HSBC and MasterCard International Incorporated to issue a co-branded MasterCard card to new and existing proprietary credit card customers. Under this program, qualifying customers are issued a SFA and MasterCard branded credit card that functions as a traditional proprietary credit card when used at any SFA or OFF 5TH store and at Saks Direct or as a MasterCard card when used at any unaffiliated location that accepts MasterCard cards. HSBC establishes and owns the co-brand accounts, retains the benefits and sales associated with the ownership of the accounts, receives the finance charge and other income from the accounts, and incurs the bad-debts associated with the accounts.
With the exception of depreciation expense, all components of the credit card operations are included in SG&A on the Consolidated Statements of Income. The credit contribution comprises program compensation and servicing compensation. For 2011, 2010, and 2009, the components of the credit contribution included in SG&A were $33,088, $24,204, and $29,425, respectively.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 4: PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
Amounts above include gross assets recorded under capital leases for buildings and equipment of $98,595 and $12,985, respectively as of January 28, 2012 and $98,595 and $7,056, respectively as of January 29, 2011. Amortization of capital lease assets is included in depreciation expense. Accumulated depreciation of assets recorded under capital leases was $93,327 and $89,686 as of January 28, 2012 and January 29, 2011, respectively. During 2011 and 2010, capital lease asset additions were $5,929 and $2,800, which are considered non-cash investing activities. There were no capital lease asset additions in 2009.
Depreciation expense was $118,513, $118,669, and $135,135 in 2011, 2010, and 2009, respectively.
NOTE 5: INCOME TAXES
The components of income tax expense (benefit) from continuing operations are as follows:
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The income tax expense (benefit) from continuing operations varies from the amounts computed by applying the statutory federal income tax rate to income before taxes. The reasons for these differences are as follows:
The components of the net deferred tax asset recognized on the Consolidated Balance Sheets are as follows:
The federal and state net operating loss (“NOL”) carryforwards will expire between 2012 and 2030. The majority of the NOL carryforward is a result of the net operating losses incurred during the fiscal years ended January 30, 2010 and January 31, 2009 due principally to difficult market and macroeconomic conditions. The Company has concluded, based on the weight of all available positive and negative evidence that all but $19,217 of these tax benefits relating to certain state losses are more likely than not to be realized in the future. Therefore, a valuation allowance for the $19,217 has been established.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The Company evaluates the realizability of its deferred tax assets on a quarterly basis. In 2011 and 2010, this evaluation resulted in a net reduction to the reserve against state deferred tax assets of $11,782 and $2,228, respectively, impacting the Company’s results of operations. A similar analysis was performed in 2009, which resulted in an additional reserve against state deferred tax assets of $3,045. The Company will continue to assess the need for additional valuation allowances in the future. If future results are less than projected or tax planning strategies are no longer viable, then additional valuation allowances may be required to reduce the deferred tax assets which could have a material impact on the Company’s results of operations in the period in which it is recorded.
The Company made income tax payments, net of income tax refunds received of $4,776 and $2,191 during 2011 and 2010, respectively. During 2009, the Company received income tax refunds of $4,727, net of income tax payments.
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows:
The Company analyzed its positions related to the reserve for tax exposures and determined that the amount was adequate. The Company will continue to analyze its positions related to the reserve for tax exposures on an ongoing basis. At January 28, 2012, $3,572 represents the amount of unrecognized tax benefits that, if recognized, would impact the effective income tax rate in future periods. The Company continually evaluates its tax filing positions and to the extent the Company prevails on audits or statutes of limitation expire, the unrecognized tax benefits could be realized. The Company does not anticipate any material changes in unrecognized tax benefits within twelve months of January 28, 2012.
The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. During the years ended January 28, 2012, January 29, 2011, and January 30, 2010, the Company recognized a benefit of $927, $1,391, and $63, respectively from interest and penalties, net of related tax effects. The Company has accrued $2,400 and $3,614 for interest and penalties as of January 28, 2012 and January 29, 2011, respectively.
The Company files a consolidated U.S. federal income tax return as well as state tax returns in multiple state jurisdictions. The Company has completed examinations by the Internal Revenue Service or the statute of limitations has expired for taxable years through February 2, 2008. With respect to the state and local jurisdictions, the Company has completed examinations in many jurisdictions through the same period and beyond and currently has no examinations in progress.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 6: DEBT
A summary of long-term debt and capital lease obligations is as follows:
(1) Amount represents the $120,000 convertible notes, net of the unamortized discount of $10,451 and $15,223 as of January 28, 2012 and January 29, 2011, respectively.
(2) Amount represents the $230,000 convertible notes, net of the unamortized discount of $19,160 and $27,352 as of January 28, 2012 and January 29, 2011, respectively.
(3) Disclosure regarding fair value of capital leases is not required.
The fair values of the long-term debt instruments were estimated based on quotes obtained from financial institutions for the same or similar instruments or on the basis of quoted market prices.
Revolving Credit Facility
The Company has a $500,000 revolving credit facility, subject to a borrowing base equal to a specified percentage of eligible inventory and certain credit card receivables. The availability is based primarily on current levels of inventory, less outstanding letters of credit.
In March 2011, the Company entered into an amendment to its existing revolving credit agreement. The amendment extended the maturity date of this facility from November 23, 2013 to March 29, 2016 and revised certain terms of the existing revolving credit facility. The maximum committed borrowing capacity of the amended facility remains at $500,000. Fees incurred associated with the amendment to the revolving credit agreement were $2,961.
The obligations under the facility are guaranteed by certain of the Company’s existing and future domestic subsidiaries, and the obligations are secured by the Company’s and the guarantors’ merchandise inventories and certain third party receivables. Borrowings under the facility bear interest at a per annum rate of either: (i) LIBOR plus a percentage ranging from 2.00% to 2.50%, or (ii) the higher of the prime rate or the federal funds rate plus a percentage ranging from 1.00% to 1.50%. Letters of credit are charged a per annum fee equal to the then applicable LIBOR borrowing spread (for standby letters of credit) or the applicable LIBOR spread minus 0.50% (for documentary or commercial letters of credit). The Company also pays an unused line fee ranging from 0.38% to 0.50% per annum on the average daily unused revolver.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
During periods in which availability under the agreement is $62,500 or more, the Company is not subject to financial covenants. If and when availability under the agreement decreases to less than $62,500, the Company will be subject to a minimum fixed charge coverage ratio of 1.0 to 1.0. There is no debt rating trigger. As of January 28, 2012, the Company was not subject to the minimum fixed charge coverage ratio. The credit agreement contains default provisions that are typical for this type of financing, including a provision that would trigger a default under the credit agreement if a default were to occur in another debt instrument resulting in the acceleration of principal of more than $20,000 under that other instrument.
The revolving credit agreement permits additional debt in specific categories including the following (each category being subject to limitations as described in the revolving credit agreement): (i) debt arising from permitted sale/leaseback transactions; (ii) debt to finance purchases of machinery, equipment, real estate and other fixed assets; (iii) debt in connection with permitted acquisitions; and (iv) unsecured debt. The revolving credit agreement also permits other debt (including permitted sale/leaseback transactions) in an aggregate amount not to exceed $500,000 at any time, including secured debt, so long as it is a permitted lien as defined by the revolving credit agreement. The revolving credit agreement also places certain restrictions on, among other things, asset sales, the ability to make acquisitions and investments, and to pay dividends.
The Company routinely issues stand-by and documentary letters of credit principally related to the funding of insurance reserves. Outstanding letters of credit reduce availability under the revolving line of credit. During 2011, the average amount of letters of credit issued under the credit agreement was $13,060. The highest amount of letters of credit outstanding under the agreement during 2011 was $20,159. As of January 28, 2012, the Company had no direct outstanding borrowings and had letters of credit outstanding of $6,443. Based on the letters of credit outstanding and the balance of eligible inventory and credit card receivables, the Company had $471,522 of availability under the facility as of January 28, 2012.
Senior Notes
As of January 28, 2012, the Company had $2,125 of unsecured senior notes outstanding that mature in 2013 with an interest rate of 7.0%. The senior notes are guaranteed by all of the subsidiaries that guarantee the Company’s revolving credit facility. The notes permit certain sale/leaseback transactions but place certain restrictions around the use of proceeds generated from a sale/leaseback transaction. The terms of the senior notes require all principal to be repaid at maturity. There are no financial covenants associated with these notes, and there are no debt-rating triggers.
During April 2011, the Company redeemed $1,911 of its 7.375% senior notes that were set to mature in 2019. The redemption of these notes resulted in a loss on extinguishment of $539.
During May 2010, the Company repurchased $797 of its 7.0% senior notes that were set to mature in 2013. The repurchase of these notes resulted in a loss on extinguishment of $4.
In June and July 2009, the Company repurchased $23,013 of its 7.5% senior notes that matured in December 2010. The repurchase of these notes resulted in a gain on extinguishment of $783.
Convertible Notes
7.5% Convertible Notes
The Company issued $120,000 of 7.5% convertible notes in May 2009 (the “7.5% Convertible Notes”). The 7.5% Convertible Notes mature in December 2013 and are convertible, at the option of the holders at any time, into shares of the Company’s common stock at a conversion rate of $5.54 per share of common stock (21,670 shares of common stock to be issued upon conversion). The Company can settle a conversion of the notes with shares, cash, or a combination thereof at its discretion.
Authoritative accounting literature requires the allocation of convertible debt proceeds between the liability component and the embedded conversion option (i.e., the equity component). The liability component of the debt instrument is accreted to par value using the effective interest method over the remaining life of the debt. The accretion is reported as a component of interest expense. The equity component is not subsequently revalued as long as it continues to qualify for equity treatment. Upon issuance,
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
the Company estimated the fair value of the liability component of the 7.5% Convertible Notes, assuming a 13.0% non-convertible borrowing rate, to be $97,994. The difference between the fair value and the principal amount of the 7.5% Convertible Notes was $22,006. This amount was recorded as a debt discount and as an increase to additional paid-in capital as of the issuance date. The discount is being accreted to interest expense over the 4.5 year period to the maturity date of the notes in December 2013 resulting in an increase in non-cash interest expense.
The following tables provide additional information about the Company’s 7.5% Convertible Notes.
The remaining period over which the unamortized discount will be recognized is 1.8 years. As of January 28, 2012, the if-converted value of the notes exceeded its principal amount by $91,066.
The 7.5% Convertible Notes are classified within long-term debt on the Consolidated Balance Sheets as of January 28, 2012 and January 29, 2011 because the Company can settle the principal amount of the notes with shares, cash, or a combination thereof at its discretion.
2.0% Convertible Senior Notes
The Company issued $230,000 of 2.0% convertible senior notes in March 2004 (the “2.0% Convertible Notes”). The 2.0% Convertible Notes mature in 2024 and, in certain circumstances, allow the holders to convert the notes to shares of the Company’s common stock at a conversion rate of $11.97 per share of common stock (19,219 shares of common stock to be issued upon conversion) subject to an anti-dilution adjustment. The holders may put the debt back to the Company in 2014 or 2019 and the debt became callable at the option of the Company on March 21, 2011. The Company can settle a conversion of the notes with shares, cash or a combination thereof at its discretion. The holders may convert the notes at the following times, among others: (i) if the Company’s share price is greater than 120% of the applicable conversion price for a certain trading period; (ii) if the credit ratings of the notes are below a certain threshold; or (iii) upon the occurrence of certain consolidations, mergers or share exchange transactions involving the Company. As of January 28, 2012, none of the conversion criteria were met.
In connection with the issuance of the 2.0% Convertible Notes, the Company entered into a convertible note hedge and written call options on its common stock to reduce the Company’s exposure to dilution from the conversion of the 2.0% Convertible Notes. These transactions were accounted for as a net reduction of shareholders’ equity of $25,000 in 2004. As of January 28, 2012, both the convertible note hedge and written call options had expired. As of January 29, 2011, the estimated net fair value of the convertible note hedge and written call options was $4,901.
The Company estimated the fair value of the liability component of the 2.0% Convertible Notes at the date of issuance, assuming a 6.25% non-convertible borrowing rate, to be $158,148. The difference between the fair value and the principal amount of the 2.0% Convertible Notes was $71,852. This amount was recorded as a debt discount and as an increase to additional paid-in capital as of the issuance date. In accordance with the authoritative accounting guidance, the debt discount should be amortized over the expected life of a similar liability that does not have an associated equity component (considering the effects of embedded features
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
other than the conversion option). Since the holders of the notes have put options in 2014 and 2019, the debt instrument is accreted to par value using the effective interest method from issuance until the first put date in 2014 resulting in an increase in non-cash interest expense.
The following tables provide additional information about the Company’s 2.0% Convertible Notes.
The remaining period over which the unamortized discount will be recognized is 2.1 years. As of January 28, 2012, the if-converted value of the notes did not exceed its principal amount.
The 2.0% Convertible Notes are classified within long-term debt on the Consolidated Balance Sheets as of January 28, 2012 and January 29, 2011 because the Company can settle the principal amount of the notes with shares, cash or a combination thereof at its discretion.
Maturities
At January 28, 2012, maturities of long-term debt and capital lease obligations for the next five years and thereafter are as follows:
The Company made interest payments of $31,681, $35,286, and $36,388, of which $955, $721, and $758 was capitalized into property and equipment during 2011, 2010, and 2009, respectively.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 7: COMMITMENTS AND CONTINGENCIES
Operating Leases and Other Purchase Commitments
The Company leases certain property and equipment under various non-cancelable capital and operating leases. The leases provide for monthly fixed amount rentals or contingent rentals based upon sales in excess of stated amounts and normally require the Company to pay real estate taxes, insurance, common area maintenance costs and other occupancy costs. Generally, the leases have primary terms ranging from 20 to 30 years and include renewal options ranging from 5 to 20 years.
At January 28, 2012, future minimum rental commitments under capital leases and non-cancelable operating leases consisted of the following:
Total rental expense for operating leases was $99,184, $98,501, and $101,756, during 2011, 2010, and 2009, respectively, including contingent rent of $16,054, $14,284, and $13,301, respectively, and common area maintenance costs of $11,919, $11,611, and $12,299, respectively.
As of January 28, 2012, the Company may be required to deliver shares and/or cash to holders of the convertible notes described in Note 6 prior to the stated maturity date of said notes based on the value of the Company’s common stock.
In the normal course of business, the Company purchases merchandise under purchase commitments; enters into contractual commitments with real estate developers and construction companies for new store construction and store remodeling; and maintains contracts for various information technology, telecommunications, maintenance and other services. Commitments for purchasing merchandise generally do not extend beyond six months and may be cancelable several weeks prior to the vendor shipping the merchandise. Contractual commitments for the construction and remodeling of stores are typically lump sum or cost plus construction contracts. Contracts to purchase various services are generally less than two year commitments and are cancelable within several weeks notice.
From time to time the Company has issued guarantees to landlords under leases of stores operated by its subsidiaries. Certain of these stores were sold in connection with the Saks Department Store Group and the Northern Department Store Group transactions which occurred in July 2005 and March 2006, respectively. If the purchasers fail to perform certain obligations under the leases guaranteed by the Company, the Company could have obligations to landlords under such guarantees. Based on the information currently available, management does not believe that its potential obligations under these lease guarantees would be material.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Legal Contingencies
On February 2, 2011, the plaintiffs in Dawn Till and Mary Josephs v. Saks Incorporated et al, filed a complaint, with which the Company was served on March 10, 2011, in a purported class and collective action in the U.S. District Court for the Northern District of California. The complaint alleges that the plaintiffs were improperly classified as exempt from the overtime pay requirements of the Fair Labor Standards Act (“FLSA”) and the California Labor Code and that the Company failed to pay overtime, provide itemized wage statements and provide meal and rest periods. On March 8, 2011, the plaintiffs filed an amended complaint adding a claim for penalties under the California Private Attorneys General Act of 2004. The plaintiffs seek to proceed collectively under the FLSA and as a class under the California statutes on behalf of individuals who have been employed by OFF 5TH as Selling and Service Managers, Merchandise Team Managers, or Department Managers and similar titles. On February 8, 2012, the same plaintiffs’ counsel from the Till case filed a complaint, with which the Company was served on March 2, 2012, in the U.S. District Court for the Southern District of New York, alleging essentially the same FLSA claim and related claims under New York state law (Tate - Small et al v. Saks Incorporated et al). The Company believes that its managers at OFF 5TH have been properly classified as exempt under both federal and state law and intends to defend these lawsuits vigorously. It is not possible to predict whether the courts will permit these actions to proceed collectively or as a class. The Company cannot reasonably estimate the possible loss or range of loss, if any, that may arise from these matters.
In addition to the litigation described in the preceding paragraph, the Company is involved in legal proceedings arising from its normal business activities and has accruals for losses where appropriate. Management believes that none of these legal proceedings will have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.
Income Taxes
The Company is routinely under examination by federal, state or local taxing authorities in the areas of income taxes and the remittance of sales and use taxes. These examinations include questioning the timing and amount of deductions, the allocation of income among various tax jurisdictions and compliance with federal, state and local tax laws. As of January 28, 2012, certain state sales and use tax examinations were ongoing. Based on annual evaluations of tax filing positions, the Company believes it has adequately accrued for its income tax exposures. To the extent the Company were to prevail in matters for which accruals have been established or be required to pay amounts in excess of reserves, the Company’s effective tax rate in a given financial statement period may be materially impacted.
NOTE 8: EMPLOYEE BENEFIT PLANS
Deferred Compensation Plan
The Company sponsors a non-qualified deferred compensation plan wherein eligible employees can defer a portion of their compensation or unvested restricted stock and allocate the deferrals to a choice of investment options. The liability for compensation deferred under this plan was $12,428 and $13,169 as of January 28, 2012 and January 29, 2011, respectively. The Company manages the risk of changes in the fair value of the liability for deferred compensation by electing to match its liability under the plan with investment vehicles that offset a substantial portion of its exposure. The cash value of the investment vehicles was $12,000 and $12,568 as of January 28, 2012 and January 29, 2011, respectively, and is included in other assets on the accompanying Consolidated Balance Sheets.
Employee Savings Plan
The Company sponsors a qualified defined contribution savings plan (“Savings Plan”) that covers substantially all full-time employees. Eligible employees may elect regular payroll deductions of up to 90% of their eligible compensation, as defined in the plan document, on a pre-tax basis, subject to Internal Revenue Service (“IRS”) limitations. The Company makes contributions matching a portion of the employees’ contribution on the first 5% of compensation that a participant elects to contribute. The employer matching contribution was suspended in 2009. Effective July 2010, the Company’s matching contribution was reinstated at a rate of 10%. The employer matching contribution rate for 2011 was 35%. Expenses incurred in connection with the Savings Plan for 2011, 2010, and 2009 were $4,497, $297, and $0, respectively. As of January 28, 2012 and January 29, 2011,
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
total assets invested by participants under the Savings Plan were $424,251 and $414,402, respectively. As of January 28, 2012 approximately 1% of the Savings Plan’s assets were invested in the Company’s stock at the discretion of the participating employees. Effective February 2012, the employer matching contribution rate was increased to 40%.
Defined Benefit Plans
The Company sponsors a funded defined-benefit cash balance pension plan (“Pension Plan”) and an unfunded supplemental executive retirement plan (“SERP”) for certain employees of the Company. Effective January 1, 2007, the Company amended the Pension Plan, suspending future benefit accruals for all participants, except certain participants who as of December 31, 2006 had attained age 55, completed 10 years of credited service, and who are not considered to be highly compensated employees. Effective March 13, 2009, the Company amended the Pension Plan, suspending future benefit accruals for all remaining participants.
Net Periodic Benefit Cost and Amounts Recognized in Other Comprehensive Income (Loss)
The components of pre-tax net periodic pension cost and other amounts recognized in other comprehensive income (loss) related to the Pension Plan and SERP for the years ended January 28, 2012, January 29, 2011, and January 30, 2010 were as follows:
(1) The Company recorded a non-cash settlement charge of $3,654 and $5,121 in 2010 and 2009, respectively. There was no settlement charge in 2011.
As of January 28, 2012 and January 29, 2011, amounts recognized in accumulated other comprehensive loss that have not yet been recognized as a component of net periodic benefit cost consist of a pre-tax net loss of $89,865 and $75,560, respectively. The estimated pre-tax net loss that is expected to be amortized from accumulated other comprehensive loss into net periodic benefit cost during 2012 is $2,904.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Benefit Obligations and Funded Status
The following provides a reconciliation of benefit obligations, plan assets and the funded status of the Pension Plan and SERP as of January 28, 2012 and January 29, 2011:
Assumptions
The weighted-average assumptions used to determine the Company’s benefit obligation are as follows:
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The weighted-average assumptions used to determine the net periodic benefit cost are as follows:
The assumptions used in the determination of the Company’s obligations and benefit cost are based upon management’s best estimates as of the annual measurement date. The discount rate is primarily used in calculating the Company’s pension obligation, which is represented by the accumulated benefit obligation (“ABO”) and the projected benefit obligation (“PBO”) and in calculating net periodic benefit cost. The discount rate utilized was based upon pension discount curves and bond portfolio curves over a duration that is similar to the Pension Plan’s expected future cash flows as of the measurement date.
This expected long-term rate of return on plan assets is used primarily in calculating the expected return on plan assets component of the Company’s net periodic benefit cost. The Company’s estimate of the expected long-term rate of return considers the historical returns on plan assets, as well as the future expectations of returns on classes of assets within the target asset allocation of the plan asset portfolio. The expected long-term rate of return on plan assets is the weighted-average rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the PBO.
The assumed average rate of compensation increase is the average annual compensation increase expected over the remaining employment periods for the participating employees and is primarily used in calculating the PBO and net periodic benefit cost. No assumption was used in 2010 or 2011 as the Pension Plan was amended to suspend all future benefit accruals for all participants.
Plan Assets
The Company’s investment strategy is to maintain a diversified portfolio of assets with the primary goal of ensuring that funds are available to meet the Pension Plan’s benefit obligations when they become due, while maintaining an appropriate level of risk. The Pension Plan’s target asset allocation is determined by the Company’s Retirement Committee, taking into consideration the amounts and timing of projected liabilities, the Company’s funding policies, expected returns on various asset categories, as well as the risk characteristics of, and correlations among, the various asset classes. The Pension Plan does not hold any investments in the Company’s common stock. Actual asset allocations as of January 28, 2012 and January 29, 2011 and the targeted asset allocation as of January 28, 2012 by asset category are as follows:
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Fair Value Measurements
The following table sets forth the fair value of the Pension Plan’s financial assets by level within the fair value hierarchy as of January 28, 2012 and January 29, 2011:
The following table summarizes changes in the fair value of Level 3 assets for the year ended January 28, 2012 and January 29, 2011:
There have been no changes in the valuation techniques used to measure the fair value of the Pension Plan’s assets as of January 28, 2012 and January 29, 2011. Investments in common/collective trust funds are valued at the net asset value per unit as determined by the trustee of the common/collective trust funds on each valuation date, without further adjustment as a practical expedient. The net asset value per unit is determined by the trustee of the common/collective trust funds based on the fair values of the underlying assets. Underlying assets that are traded on national securities exchanges are valued based on the last reported sale or settlement price for each such security on the valuation date. Underlying assets that are not traded in public markets or for which quoted prices are not readily available are valued based on broker/dealer quotes or valuation estimates from internal pricing models, which utilize inputs that are primarily observable. Underlying assets consisting of real estate are valued based on periodic independent appraisals.
The common/collective trust funds have various procedures regarding liquidity, which may include advance notification requirements and specific periodic dates for providing such liquidity. The real estate common/collective trust fund has certain restrictions whereby the trustee may reserve the right to limit the portion of an investment that may be redeemed at any one time, either by an individual investor or in the aggregate by all such investors of the fund. Additionally, this fund only permits transactions on a quarterly basis and requires advance notification of 110 calendar days. The majority of the common/collective trust funds in which the Pension Plan invests do not have restrictions on redemption frequency, nor do they have advance notification requirements.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Contributions and Estimated Future Benefit Payments
The Company generally funds pension costs currently, subject to regulatory funding requirements. The Company expects funding requirements of approximately $4,378 in 2012.
In November 2010 the Company voluntarily contributed 1,755 newly issued shares of the Company’s common stock valued at $19,961. The purpose of the voluntary contribution was to strengthen the funded status of the Pension Plan and reduce the amount of future funding requirements. As required by the investment policy of the Pension Plan, the shares were sold in an orderly manner as soon as practicable after the contribution was made.
As of January 28, 2012, the following Pension Plan and SERP benefit payments are expected to be paid:
NOTE 9: SHAREHOLDERS’ EQUITY
The Company has a share repurchase program that authorizes it to purchase shares of the Company’s common stock. During August 2011, the Company repurchased and retired an aggregate of 3,537 shares of common stock at an average price of $8.18 per share and a total cost of $28,932. There were no shares repurchased during 2010 and 2009. As of January 28, 2012, there were 29,172 shares remaining available for repurchase under the Company’s share repurchase program.
In July 2009, the Company filed a shelf registration statement with the SEC permitting the Company to issue securities, in one or more offerings, with a maximum aggregate offering price of $400,000. The shelf registration statement covers a variety of securities including common stock, preferred stock, warrants, and debt securities.
Under the shelf registration statement, the Company completed a public offering of approximately 14,925 shares of its common stock in October 2009, at an offering price of $6.70 per share for $95,095 in proceeds, net of issuance costs. The net proceeds were used to reduce borrowings under the Company’s revolving credit facility and for general corporate purposes.
In November 2010, the Company contributed 1,755 shares of the Company’s common stock to the Company’s Pension Plan, in consideration for a credit against future funding obligations, which is considered a non-cash financing activity. The shares were valued for purposes of the contribution at $19,961 (See Note 8). As required by the investment policy of the Pension Plan, the shares were sold by the Pension Plan in an orderly manner as soon as practicable after the contribution was made. The Company filed with the SEC prospectus supplements to the Company’s existing effective shelf registration statement covering the resale of the shares by the Pension Plan.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 10: STOCK-BASED COMPENSATION
The Company maintains an equity incentive plan, which allows for the granting of stock options, stock appreciation rights, restricted stock, performance share awards and other forms of equity awards to employees, directors, and officers. As of January 28, 2012, there were 2,675 shares available for future grants under the equity incentive plan. Stock options granted generally vest over a four-year period from the grant date and have a contractual term of seven to ten years from the grant date. Restricted stock and performance share awards generally vest over periods ranging from three to five years from the grant date, although the equity incentive plan permits accelerated vesting in certain circumstances at the discretion of the HRCC of the Board of Directors. The Company does not use cash to settle any of its stock-based awards and issues new shares of common stock upon the exercise of stock options and the granting of restricted stock and performance shares.
Total stock-based compensation expense and related tax benefits recognized in fiscal years 2011, 2010, and 2009 are as follows:
Stock Options
The fair value of stock options is determined on the grant date utilizing the Black-Scholes valuation model. The Black-Scholes model estimates the expected value employees will receive from the stock options based on a number of assumptions, such as interest rates, employee exercises, the Company’s stock price and dividend yield. The weighted-average Black-Scholes fair value assumptions utilized in determining grant-date fair values are as follows:
The expected term is the period over which employee groups are expected to hold the stock options until they are exercised and it determines the period for which the risk-free interest rate, volatility, and dividend yield must be applied. The expected term is calculated using the simplified method. The risk-free interest rate is based on the U.S. Treasury rate securities that mature over the expected term of the stock option. Volatility reflects movements in the Company’s stock price over the most recent historical period equivalent to the expected term. The dividend yield is zero as the Company does not anticipate declaring dividends in the near term.
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
A summary of the stock option activity for 2011 is presented below:
There were no stock options granted during 2011 or 2010. The weighted-average grant-date fair value of stock options granted during 2009 was $1.15. The total intrinsic value of stock options exercised during 2011, 2010, and 2009 was $1,650, $1,888, and $115, respectively. The net tax benefit realized from stock options exercised during 2011 was $559. Cash proceeds received from the exercise of stock options during 2011 was $516. The total fair value of stock options vested during 2011, 2010, and 2009 was $2,146, $2,169, and $2,265, respectively. As of January 28, 2012, total unrecognized compensation expense related to non-vested stock options, including an estimate for pre-vesting forfeitures, was $298, which is expected to be recognized over a weighted-average period of 0.8 years.
The following table summarizes information about stock options outstanding and exercisable as of January 28, 2012:
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Restricted Stock
The fair value of restricted stock is based on the closing market price of the Company’s common stock on the date of grant. A summary of restricted stock awards activity for 2011 is presented below:
The Company granted restricted stock awards of 895, 1,096, and 2,351 shares to certain employees in 2011, 2010, and 2009, respectively. The weighted-average grant-date fair value of restricted stock awards granted in 2011, 2010, and 2009 was $11.23, $7.65, and $2.99, respectively. The total fair value of restricted stock that vested in 2011, 2010, and 2009 was $13,453, $6,134, and $3,940, respectively. As of January 28, 2012, total unrecognized compensation expense related to non-vested restricted stock awards, including an estimate for pre-vesting forfeitures, was $11,517, which is expected to be recognized over a weighted-average period of 2.1 years.
Performance Shares
Under the equity incentive plan, the Company may grant performance share awards that vest based on the outcome of certain performance criteria that are established and approved by the HRCC of the Board of Directors. The actual number of performance shares earned is based on the level of performance achieved over the performance period, typically one year from the grant date, relative to established financial and operating goals, none of which are considered market conditions. For performance share awards granted during 2011, the amount of shares that can be earned ranges from 0% to 125% of the number of performance share awards granted. For performance share awards granted during 2010 and 2009, the amount of shares that could be earned ranged from 0% to 100%. In addition to the performance criteria, performance shares do not vest unless employees remain employed by the Company during the requisite service period, which is typically three years from the grant date. The fair value of performance share awards is determined based on the closing market price of the Company’s common stock on the date of grant.
A summary of performance share award activity for 2011 is presented below:
The Company granted performance share awards of 306, 503, and 1,112 to certain employees in 2011, 2010, and 2009, respectively. The weighted-average grant-date fair value of performance share awards granted in 2011, 2010, and 2009 was $12.31, $7.20, and
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
$2.36, respectively. The total fair value of performance share awards that vested in 2011, 2010, and 2009 was $239, $9,186, and $134, respectively. As of January 28, 2012, total unrecognized compensation expense related to non-vested performance share awards, including an estimate for pre-vesting forfeitures, was $3,989, which is expected to be recognized over a weighted-average period of 1.9 years.
Employee Stock Purchase Plan
The Employee Stock Purchase Plan (“ESPP”) allows for shares of the Company’s common stock to be purchased by eligible employees through payroll deductions at a 15% discount to market value. In 2009, the HRCC of the Board of Directors suspended the employee stock purchase plan indefinitely.
NOTE 11: CLUB LIBBY LU CLOSURE
During the fourth quarter of 2008, the Company discontinued the operations of its CLL specialty store business which consisted of 98 leased, mall-based stores. Along with the previous disposition of the Saks Department Store Group businesses, CLL was no longer determined to be a strategic fit for the Company. As of January 28, 2012, there were no amounts payable remaining for the CLL store closings.
NOTE 12: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summarized quarterly financial information for 2011 and 2010 is as follows:
SAKS INCORPORATED & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 13: CONDENSED CONSOLIDATING FINANCIAL INFORMATION
The following tables present condensed consolidating financial information for 2011, 2010, and 2009 for: (1) Saks Incorporated and (2) on a combined basis, the guarantors of Saks Incorporated’s senior notes (which are all of the 100%-owned subsidiaries of Saks Incorporated).
The condensed consolidating financial statements presented as of and for the years ended January 28, 2012, January 29, 2011, and January 30, 2010 reflect the legal entity compositions at the respective dates.
Separate financial statements of the guarantor subsidiaries are not presented because the guarantors are jointly, severally, fully and unconditionally liable under the guarantees. Borrowings and the related interest expense under the Company’s revolving credit agreement are allocated to Saks Incorporated and the guarantor subsidiaries under an intercompany revolving credit arrangement. There is also a management fee arrangement among Saks Incorporated and its subsidiaries. At January 28, 2012, Saks Incorporated was the sole obligor for the majority of the Company’s long-term debt and employed a small group of corporate employees.
SAKS INCORPORATED & SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
FOR THE YEAR ENDED JANUARY 28, 2012
SAKS INCORPORATED & SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
AS OF JANUARY 28, 2012
SAKS INCORPORATED & SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JANUARY 28, 2012
SAKS INCORPORATED & SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
FOR THE YEAR ENDED JANUARY 29, 2011
SAKS INCORPORATED & SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
AS OF JANUARY 29, 2011
SAKS INCORPORATED & SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JANUARY 29, 2011
SAKS INCORPORATED & SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
FOR THE YEAR ENDED JANUARY 30, 2010
SAKS INCORPORATED & SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JANUARY 30, 2010
Schedule II
Valuation and Qualifying Accounts
(In thousands)
(1) Deductions consist of actual returns, net of related costs and commissions
(2) Release of valuation allowance against state net operating loss carryforwards.