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Saks 10-K 2008 Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
(Mark One)
For Fiscal Year Ended: February 2, 2008 or
For the transition period from to Commission File Number: 1-13113
SAKS INCORPORATED (Exact Name of Registrant as Specified in Its Charter)
Registrant’s telephone number, including area code: (212) 940-5305
Securities Registered Pursuant to Section 12 (b) of the Act:
Securities Registered Pursuant to Section 12 (g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x Indicate by check mark if the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x The aggregate market value of the voting stock held by non-affiliates of the registrant as of August 3, 2007 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $2,647,120,988. As of March 15, 2008, the number of shares of the registrant’s Common Stock outstanding was 144,709,226. DOCUMENTS INCORPORATED BY REFERENCE Applicable portions of the Saks Incorporated Proxy Statement for the 2008 Annual Meeting of Shareholders to be held on June 4, 2008 are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
Item 1. Business.
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”), Off Fifth and Club Libby Lu (“CLL”). Previously, the Company also operated Saks Department Store Group (“SDSG”), which consisted of Proffitt’s and McRae’s (“Proffitt’s”) (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operated under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), and Parisian (sold to Belk in October 2006). The sold businesses are presented as discontinued operations in the consolidated statements of income and the consolidated statements of cash flows for the prior year periods and are discussed below at “Discontinued Operations.”
The Company is primarily a fashion retail organization offering a wide assortment of distinctive luxury 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 by catalog or online at www.saks.com. Off Fifth is intended to be the premier luxury off-price retailer in the United States. Off Fifth stores are primarily located in upscale mixed-use and off-price centers and offer luxury apparel, shoes, and accessories, targeting the value-conscious customer. CLL consists of mall-based specialty stores, targeting girls aged 4-12 years old. As of February 2, 2008, the Company operated 54 SFA stores with a total of approximately 6.0 million square feet, 48 Off Fifth stores with a total of approximately 1.4 million square feet, and 95 CLL specialty stores, which includes 75 standalone stores and 20 store-in-stores in the former SDSG businesses, with a total of approximately 139 thousand square feet.
Merchandising, sales promotion, and store operating support functions are conducted in New York, New York for SFA and Off Fifth and in Chicago, Illinois for CLL. The back office sales support functions for the Company, such as accounting, credit card administration, store planning and information technology, principally are located in the Company’s operations center in Jackson, Mississippi or in the SFA corporate offices in New York City.
The Company’s fiscal year ends on the Saturday closest to January 31. Fiscal year 2007 contained 52 weeks and ended on February 2, 2008, while fiscal year 2006 contained 53 weeks and ended on February 3, 2007. Fiscal year 2005 contained 52 weeks and ended on January 28, 2006.
Discontinued Operations
Sale of Assets
On July 5, 2005, Belk acquired from the Company for $622.7 million in cash substantially all of the assets directly involved in the Company’s Proffitt’s business operations, plus the assumption of approximately $1 million in capitalized lease obligations and the assumption of certain other ordinary course liabilities associated with the acquired assets. The assets sold included the real and personal property and inventory associated with 22 Proffitt’s stores and 25 McRae’s stores that generated fiscal 2004 revenues of approximately $784 million. The Company realized a net gain of $155.5 million on the sale.
On March 6, 2006, the Company sold to Bon-Ton all outstanding equity interests of certain of the Company’s subsidiaries that owned NDSG, either directly or indirectly. The consideration received consisted of approximately $1.12 billion in cash (reduced as described below based on changes in working capital), plus the
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assumption by Bon-Ton of approximately $35 million of unfunded benefit liabilities and approximately $35 million of capital leases. A working capital adjustment based on working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $75 million resulting in net cash proceeds to the Company of approximately $1.04 billion. The disposition included NDSG’s operations consisting of, among other things, the following: the real and personal property, operating leases and inventory associated with 142 NDSG units (31 Carson Pirie Scott stores, 14 Bergner’s stores, 10 Boston Store stores, 40 Herberger’s stores, and 47 Younkers stores), the administrative/headquarters facilities in Milwaukee, Wisconsin, and distribution centers located in Rockford, Illinois, Naperville, Illinois, Green Bay, Wisconsin, and Ankeny, Iowa. NDSG generated fiscal 2005 revenues of approximately $2.2 billion. The Company realized a net gain of $204.7 million on the sale.
On October 2, 2006, the Company sold to Belk all of the outstanding equity interests of the Company’s subsidiaries that conducted the Parisian specialty department store business (“Parisian”). The consideration received consisted of $285.0 million in cash (increased in accordance with a working capital adjustment described below). In addition, Belk reimbursed the Company at closing for $6.7 million in capital expenditures incurred in connection with the construction of four new Parisian stores. Belk also paid the Company a premium associated with the purchase of accounts and accounts receivable from Household Bank (SB), N.A. (now known as HSBC Bank Nevada, N.A., “HSBC”), in the amount of $2.3 million. A working capital adjustment based on working capital as of the effective time of the transaction increased the amount of cash proceeds by $14.2 million resulting in net cash proceeds of $308.2 million. The disposition included Parisian’s operations consisting of, among other things, the following: real and personal property, operating leases and inventory associated with 38 Parisian stores (which generated fiscal 2005 revenues of approximately $740 million), an administrative/headquarters facility in Birmingham, Alabama and a distribution center located in Steele, Alabama. The Company realized a net loss of $12.8 million on the sale.
Merchandising
SFA stores carry luxury merchandise from both core vendors and new and emerging designers. SFA has key relationships with the leading American and European fashion houses, including Giorgio Armani, Chanel, Gucci, Prada, Louis Vuitton, St. John, Zegna, Theory, Juicy Couture, David Yurman, Hugo Boss, Elie Tahari, Ralph Lauren, Akris and Burberry, among many others.
The Company has developed a knowledge of each of its trade areas and customer bases for its SFA and Off Fifth stores. This knowledge is gained through use of on-line merchandise information, store visits by senior management and merchandising personnel, and frequent communication between merchandising staff and store management. 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. 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.
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For the year ended February 2, 2008, SFA’s percentages of owned 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 most 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 a listing of these facilities.
The Company’s distribution facilities operate on a modern warehouse management system that leverages EDI (electronic data interchange) 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.
Return Policy
The Company offers its customers a fair and liberal return policy, consistent with other luxury retailers, at both SFA stores and online at www.saks.com. Approximately 24% of merchandise sold is later returned and the vast majority of merchandise returns occur within a matter of days of the selling transaction. The Company uses historical return patterns to estimate expected returns.
Information Technology
Company management believes that technological investments are necessary to support its business strategies, and, as a result, the Company is continually upgrading its information systems to improve efficiency and productivity. The Company recently completed an upgrade of its merchandising planning and allocation
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systems and is continuing to make further enhancements to these systems. The Company installed new point-of-sale equipment and software with enhanced clienteling capabilities in 23 stores in 2007. The Company intends to convert the balance of the store base in 2008.
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, credit card administration, 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.
Marketing
For the SFA stores, marketing principally emphasizes the latest fashion trends in luxury merchandise and primarily utilizes direct mail advertising, supplemented with national and local marketing efforts. To promote its image as the primary source of luxury goods in its trade areas, SFA sponsors numerous fashion shows and in-store special events highlighting the designers represented in the SFA stores. SFA 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. In-house advertising and sales promotion staffs produce most of the Company’s advertising.
For SFA, the Company utilizes data captured through the use of proprietary credit cards offered by 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. Pursuant to a program agreement with a term of ten years expiring in 2013, HSBC establishes and owns proprietary credit card accounts for the Company’s customers, retains the benefits and risks associated with the ownership of the accounts, receives the finance charge income and incurs the bad debts associated with those accounts. Pursuant to a servicing agreement with a ten-year term expiring in 2013, the Company continues to provide key customer service functions, including new account opening, transaction authorization, 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 a SFA and MasterCard co-branded credit card that functions as a traditional proprietary credit card when used at any SFA or Off Fifth store and at www.saks.com 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.
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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 direct 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 February 2, 2008, there were approximately 800 thousand proprietary credit accounts that have been active within the prior twelve months, and approximately 44% of the Company’s 2007 sales were transacted on HSBC’s proprietary credit cards.
Trademarks and Service Marks
The Company owns many trademarks and service marks including, but not limited to, “Saks Fifth Avenue,” “SFA,” “S5A,” “The Fifth Avenue Club,” “SAKSFIRST,” “SFA Signature,” “SFA Classic,” “SFA Sport.” “Off Fifth,” and “Club Libby Lu.” 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 slightly more than 20% of total Company sales in 2007 and plays a significant role in creating awareness for the Saks Fifth Avenue brand name.
Customer Service
The Company believes that good customer service contributes to increased store visits and purchases by its customers.
The Company’s goal is to deliver an inviting, customer-focused shopping experience to each customer. At SFA and Off Fifth, 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. Compensation for sales associates generally is a pay-for-performance program, based upon productivity. 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 keep detailed customer records, 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.”
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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. Generally, more than 30% of the Company’s sales are generated during the fourth quarter, and a large portion of its operating income is generated during the Fall season.
Competition
The retail business is highly competitive. The Company’s stores primarily compete with several national and regional department stores, specialty apparel stores, designer boutiques, outlet stores, and mail-order and electronic commerce retailers. Management believes that its knowledge of its trade areas and customer base, combined with the Company’s high level of customer service, broad selection of quality fashion merchandise at appropriate prices, innovative marketing, and strategic store locations, provides the opportunity for a competitive advantage.
Associates
As of March 1, 2008, the Company employed approximately 16,700 associates, of which approximately 23% 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. Approximately one percent of the Company’s associates are covered by collective bargaining agreements. The Company considers its relations with its associates to be good.
Website Access to Information
The Company provides access free of charge through the Company’s website, www.saksincorporated.com, 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”).
Certifications
The Company filed the certification of its Chief Executive Officer with the New York Stock Exchange (“NYSE”) in fiscal 2007 as required pursuant to Section 303A.12(a) of the NYSE Listed Company Manual, and the Company has filed the Sarbanes-Oxley 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, 32.1, and 32.2.
Item 1A. Risk Factors
The following are certain 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. The risks and uncertainties described below are not the only ones facing the Company. 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.
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A decline in the demand for luxury goods could have an adverse impact on the Company’s results of operations.
As a result of the sale of the SDSG businesses the Company has become primarily focused on the luxury retail sector. SFA stores, Off Fifth stores and www.saks.com 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. 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 increase expenses and adversely affect results of operations.
Poor economic conditions affect consumer spending and may significantly 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:
Changes in consumer confidence and fluctuations in financial markets can influence cyclical trends, particularly in the luxury sector. Reduced consumer confidence and spending may result in reduced demand for discretionary items and may force the Company to take significant inventory markdowns. Reduced demand may also require increased marketing and promotional expenses.
Additionally, a number 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 subject to a broad range of uncertainties arising out of world events.
The Company’s business and results of operations are subject to uncertainties arising out of world events, especially as these events may affect U.S. tourism. 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 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 in the future.
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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, 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 against 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. Following the sale of the Company’s SDSG businesses, the Company has become less diversified and is now reliant on its luxury retail business. A number of different competitive factors could have a material adverse effect on the Company’s business, results of operations and financial condition including:
The Company may not be able to continue to compete successfully with its existing or new competitors, or be assured that prolonged periods of deep discount pricing by its competitors will not have a material adverse effect on the Company’s business.
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 high-fashion 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 channels 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. The Company has no guaranteed supply arrangements with its principal merchandising sources. Accordingly, 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. 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 its business.
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The Company faces risks associated with consumer preferences and fashion trends.
Changes in consumer preferences or consumer 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. Early order commitments often are made far in advance of consumer acceptance. If the Company fails to anticipate accurately and respond to consumer preferences, 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. Further, new stores may not achieve operating results similar to those of its existing stores. The success of any future store openings will depend upon numerous factors, many of which are beyond the Company’s control, including the following:
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 depends, in turn, on adherence to shipping schedules and effective management of distribution centers. Although the Company believes that its receiving and distribution process is efficient, and the Company has appropriate contingency plans, unforeseen disruptions in operations due to fire, hurricanes or other catastrophic events, labor disagreements or shipping problems, may result in delays in the delivery of merchandise to the Company’s stores.
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.
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 shut down for any reason.
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The Company is dependent on external funding sources, which may not make available sufficient funds when the Company needs them.
The Company, like other retailers, relies on external funding sources to finance a portion of its operations and growth. Management currently believes that the Company’s cash flow from operations and funds available under its revolving credit facility will satisfy its capital requirements for the next 12 months. The Company’s ability to obtain additional financing is dependent upon its future operating performance, general economic and competitive conditions and financial, business and other factors, many of which the Company cannot control.
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,” “SFA,” “S5A,” “The Fifth Avenue Club,” “SAKSFIRST,” “SFA Signature,” “SFA Classic,” “SFA Sport.” “Off 5th,” and “Club Libby Lu.” 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. 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 cost to the Company is affected by the fluctuation of their local currency against the dollar or who price their merchandise in currencies other than the dollar. Although fluctuations in the Euro-U.S. dollar exchange rate have the largest impact on the Company’s business, it 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.
A privacy breach could adversely affect the Company’s business.
The protection of customer, employee, and company data is critical to the Company. In particular, the Company utilizes customer data captured through the use of proprietary credit cards to develop advertising and promotional events. The regulatory environment surrounding information security and privacy is increasingly demanding, with the frequent imposition of new and constantly changing requirements across business units. 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 lawsuits.
Ownership and leasing of significant amounts of real estate exposes the Company to possible liabilities and losses.
The majority of the SFA stores are owned while all of the Off Fifth and CLL 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 their costs 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
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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 cancel these leases. If an existing or future 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 store due to an existing operating covenant which may cause the Company to operate the location at a loss and prevent us from finding a more desirable location.
Item 1B. Unresolved Staff Comments
None.
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Item 1C. 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.
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.
Julia A. Bentley has served as Senior Vice President of Investor Relations and Communications and Corporate Secretary of the Company since September 1997. Ms. Bentley joined the Company in 1987 and has held various financial positions, including Chief Financial Officer. Prior to joining the Company, she was an audit manager with Ernst & Young.
Carolyn R. Biggs was named Executive Vice President of Stores and Store operations in February 2008. Ms. Biggs served as Executive Vice President of Stores, Store Visual, Planning and Construction from February 2007
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through January 2008. She joined the Company in July 1993 and has held various leadership positions since that time, including Senior Vice President and Director of Stores for SFA. Prior to joining the Company, she was General Manager of I. Magnin from 1988 to 1993 and held various merchandising positions for Bullocks from 1973 to 1988.
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 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. Prior to Reader’s Digest, Mr. Brizel was a member of the legal department of General Foods Corporation from 1983-1989 and an associate with the New York law firm of Summit, Rovins and Feldesman, from 1980-1983.
Denise Incandela was promoted to President, Saks Direct and Group Senior Vice President of the Company in February 2007. Ms. Incandela joined the Company in July 1999 and has held various leadership positions since that time, including Senior Vice President of Saks Direct. Prior to joining the Company, she was a senior consultant with McKinsey & Company.
Thomas G. Matthews was named Group Senior Vice President of Asset Protection, Logistics, Store Planning and Construction and Chief Ethics and Compliance Officer of the Company in February 2008. Mr. Matthews served as Group Senior Vice President of Asset Protection, Store Operations and Logistics and Chief Ethics and Compliance Officer from February 2007 until January 2008. From April 1999 until January 2007, Mr. Matthews served as Group Senior Vice President, Asset Protection, Store Operations, Ethics and Compliance. He joined the Company in 1993 as Vice President — Loss Prevention. Prior to joining the Company, Mr. Matthews served as Senior Vice President — Loss Prevention for Ann Taylor, Inc. from 1989 until 1992 and in various loss prevention positions for Lord & Taylor from 1976 to 1989.
Marc J. Metrick was named Group Senior Vice President and Chief Strategy Officer of the Company in February 2007. Mr. Metrick joined the Company in June 1995 as an executive trainee. Beginning in June 1997, Mr. Metrick served in various planning roles, including Vice President — Merchandise Planning and Senior Vice President — Strategic Planning.
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.
Michael Rodgers was named Executive Vice President of Service Operations and Chief Information Officer for the Company in February 2008. Mr. Rodgers served as Executive Vice President of Information Technology, Operations and Credit for the Company from May 2007 through January 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. Prior to joining the Company, he held credit management positions with Boscov’s and Woodward & Lothrop.
Terron E. Schaefer joined the Company in March 2004 as Senior Vice President of Marketing and was elevated to the post of Group Senior Vice President, Creative and Marketing in September 2006. Prior to joining the Company, Mr. Schaefer was Worldwide Creative Director for Simon Property Group from September 2003 until February 2004 and was the Co-founder and Co-CEO of style365.com from August 1998 to July 2002. He served as Senior Vice President, Marketing — Worldwide Retail for Warner Brothers from 1995 to 1998; and between 1988 to 1995 his retail experience included leadership positions in marketing at Macy’s West, Galerias
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Preciados, and Harrods. Mr. Schaefer also served in various leadership positions in marketing at Bloomingdale’s, William Filene and Sons, and at Hill Holliday Connors Cosmopulos. He began his marketing career with Doyle Dane Bernbach, where he rose to Vice President, International.
Robert T. Wallstrom was named President, Off Fifth and Group Senior Vice President of the Company in February 2007. 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. 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 served as Executive Vice President of Finance and Chief Accounting Officer from May 2005 until May 2007. He 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 SDSG from September 1999 to January 2003; and Executive Vice President of Operations for Parisian from February 2003 to May 2005. 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. Properties.
The Company currently operates two principal distribution facilities as follows:
The Company’s principal administrative offices are as follows:
During the first half of 2007, the Company completed the consolidation of its corporate staff and administration functions from Birmingham, Alabama into the existing SFA corporate offices in New York City and Jackson, Mississippi.
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The following table sets forth information about the Company’s stores as of March 14, 2008. The majority of the SFA stores are owned while all of the Off Fifth 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, store leases have primary terms ranging from 20 to 30 years and include renewal options ranging from 5 to 20 years. Off Fifth leases typically have shorter terms.
In addition to the stores listed above, the Company also operated 95 CLL specialty stores, which includes 75 standalone stores and 20 store-in-stores in the former SDSG businesses, at March 14, 2008. These stores are leased and are typically one to two thousand square feet of space in regional malls.
Item 3. Legal Proceedings.
Investigations
At management’s request, the Audit Committee of the Company’s Board of Directors conducted an internal investigation in 2004 and 2005. In 2004, the Company informed the Securities and Exchange Commission (“SEC”) of the Audit Committee’s internal investigation. Thereafter, the Company was informed by the SEC that it issued a formal order of private investigation. Thereafter, the Company was informed that the Office of the United States Attorney for the Southern District of New York had instituted an inquiry. On September 5, 2007, the SEC filed a complaint in the United Stated District Court for the Southern District of New York related to improper collections of vendor markdown allowances in one of six SFA merchandising divisions prior to 2004 and a 2002 internal investigation into these collections, the improper timing of the recording of inventory markdowns at Saks Fifth Avenue in 1999 and 2001 and related accounting and disclosure issues. The Company consented to the entry of a final judgment by the Court without admitting or denying the allegations of the complaint filed by the SEC. The final judgment permanently enjoins the Company and its officers and employees from violating the federal securities laws related to the Company’s reporting, record-keeping and internal controls. No fines or other monetary sanctions were levied against the Company. The Company fully cooperated with the SEC during the course of the SEC’s investigation.
Vendor Litigation
On May 17, 2005, International Design Concepts, LLC (“IDC”) commenced litigation against the Company in the United States District Court for the Southern District of New York raising various claims, including breach of contract, fraud and unjust enrichment. The suit alleges that from 1996 to 2003 the Company improperly took chargebacks and deductions for vendor markdowns, which resulted in IDC going out of business. The suit seeks damages in the amount of the unauthorized chargebacks and deductions. IDC filed a second amended complaint on June 14, 2005 asserting an additional claim for damages under the Uniform Commercial Code for vendor compliance chargebacks. On November 2, 2007 the Company and the plaintiff settled all of the claims, which were dismissed with prejudice by the court.
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On October 25, 2005 the Chapter 7 trustee for the bankruptcy estate of Kleinert’s Inc. filed a complaint against the Company and several of its subsidiaries in the United States Bankruptcy Court for the Southern District of New York. In its initial complaint the plaintiff, as assignee, alleged breach of contract, fraud, and unjust enrichment, among other causes of action, and seeks compensatory and punitive damages due to the Company’s assessment of alleged improper chargebacks against Kleinert’s Inc. totaling approximately $4 million which wrongful acts the plaintiff alleges caused the insolvency and bankruptcy of Kleinert’s Inc. On August 15, 2006 the plaintiff, as assignee, filed an amended complaint in which it asserted several claims including, but not limited to, the Company’s allegedly unauthorized chargebacks. The Company and plaintiff entered into a settlement agreement, which was approved by the Bankruptcy Court on November 14, 2007, and all of the claims were dismissed with prejudice.
On December 8, 2005 Adamson Apparel, Inc. filed a purported class action lawsuit against the Company in the United States District Court for the Northern District of Alabama. In its complaint the plaintiff asserts breach of contract claims and alleges that the Company improperly assessed chargebacks, timely payment discounts, and deductions for merchandise returns against members of the plaintiff class. The lawsuit seeks compensatory and incidental damages and restitution.
Other
The Company is involved in several 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.
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Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
The Company’s common stock trades on the New York Stock Exchange (“NYSE”) under the symbol SKS. The prices in the table below represent the high and low sales prices for the stock as reported by the NYSE.
Holders
As of March 14, 2008, there were approximately 2,263 shareholders of record of the Company’s common stock.
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Performance Graph
The following graph and table compare cumulative total shareholder return among the Company, 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.; J.C. Penney Company, Inc.; and, through the fiscal year ended January 29, 2005, The May Department Stores Company and The Neiman Marcus Group, Inc., both of which were acquired in 2005 and are no longer public companies) assuming an initial investment of $100 and reinvestment of dividends.
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”).
Dividends
During the fiscal year ended February 3, 2007, the Company declared a cash dividend of $4.00 per share of common stock payable on May 1, 2006 to holders of record on April 14, 2006. The dividend totaled approximately $548 million. During the same fiscal year, the Company declared a second cash dividend of $4.00 per share of common stock payable on November 30, 2006 to holders of record on November 15, 2006. The dividend totaled approximately $559 million. 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 paying dividends in the foreseeable future.
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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. The Company purchased approximately 1.7 million shares of common stock during the year ended February 2, 2008 for a total of approximately $27.5 million. The Company has remaining availability of approximately 35.7 million shares under its 70 million share repurchase authorization. The Company did not repurchase shares of common stock during the fourth quarter of fiscal 2007.
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 and the Company’s Consolidated Financial Statements and notes thereto and the other information contained elsewhere in this Form 10-K.
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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 is considered to have these major components:
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 and its subsidiaries (together the “Company”) operations consist of Saks Fifth Avenue (“SFA”), Off Fifth, and Club Libby Lu (“CLL”). Previously, the Company also operated Saks Department Store Group (“SDSG”), which consisted of Proffitt’s and McRae’s (“Proffitt’s”) (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operated under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), and Parisian (sold to Belk in October 2006). The sold businesses are presented as discontinued operations in the consolidated statements of income and the consolidated statements of cash flows for the prior year periods and are discussed below at “Discontinued Operations.”
The Company is a fashion retail organization offering a wide assortment of distinctive luxury 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 by catalog or online at www.saks.com. Off Fifth is intended to be the premier luxury off-price retailer in the United States. Off Fifth stores are primarily located in upscale mixed-use and off-price centers and offer luxury apparel, shoes, and accessories, targeting the value-conscious customer. CLL consists of mall-based specialty stores, targeting girls aged 4-12 years old. As of February 2, 2008, Saks operated 54 SFA stores with approximately 6.0 million square feet, 48 Off Fifth units with approximately 1.4 million square feet, and 95 CLL specialty stores, which includes 75 standalone stores and 20 store-in-stores in the former SDSG businesses, with approximately 139 thousand square feet.
As a result of the sale of the SDSG businesses, the Company has become 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 the 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 and expand 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.
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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 units.
DISCONTINUED OPERATIONS
On July 5, 2005, Belk acquired from the Company for $622.7 million in cash substantially all of the assets directly involved in the Company’s Proffitt’s business operations, plus the assumption of approximately $1 million in capitalized lease obligations and the assumption of certain other ordinary course liabilities associated with the acquired assets. The assets sold included the real and personal property and inventory associated with 22 Proffitt’s stores and 25 McRae’s stores that generated fiscal 2004 revenues of approximately $784 million. The Company realized a net gain of $155.5 million on the sale.
On March 6, 2006, the Company sold to Bon-Ton all outstanding equity interests of certain of the Company’s subsidiaries that owned NDSG, either directly or indirectly. The consideration received consisted of approximately $1.12 billion in cash (reduced as described below based on changes in working capital), plus the assumption by Bon-Ton of approximately $35 million of unfunded benefit liabilities and approximately $35 million of capital leases. A working capital adjustment based on working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $75 million resulting in net cash proceeds to the Company of approximately $1.04 billion. The disposition included NDSG’s operations consisting of, among other things, the following: the real and personal property, operating leases and inventory associated with 142 NDSG units (31 Carson Pirie Scott stores, 14 Bergner’s stores, 10 Boston Store stores, 40 Herberger’s stores, and 47 Younkers stores), the administrative/headquarters facilities in Milwaukee, Wisconsin and distribution centers located in Rockford, Illinois, Naperville, Illinois, Green Bay, Wisconsin, and Ankeny, Iowa. NDSG generated fiscal 2005 revenues of approximately $2.2 billion. The Company realized a net gain of $204.7 million on the sale.
On October 2, 2006, the Company sold to Belk of all of the outstanding equity interests of the Company’s subsidiaries that conducted the Parisian specialty department store business (“Parisian”). The consideration received consisted of $285.0 million in cash (increased in accordance with a working capital adjustment described below). In addition, Belk reimbursed the Company at closing for $6.7 million in capital expenditures incurred in connection with the construction of four new Parisian stores. Belk also paid the Company a premium associated with the purchase of accounts and accounts receivable from Household Bank (SB), N.A. (now known as HSBC Bank Nevada, N.A., “HSBC”), in the amount of $2.3 million. A working capital adjustment based on working capital as of the effective time of the transaction increased the amount of cash proceeds by $14.2 million resulting in total net cash proceeds of $308.2 million. The disposition included Parisian’s operations consisting of, among other things, the following: real and personal property, operating leases and inventory associated with 38 Parisian stores (which generated fiscal 2005 revenues of approximately $740 million), an administrative/headquarters facility in Birmingham, Alabama and a distribution center located in Steele, Alabama. The Company realized a net loss of $12.8 million on the sale.
SAKS FIFTH AVENUE NEW ORLEANS STORE
In late August 2005, the SFA store in New Orleans suffered substantial water, fire, and other damage related to Hurricane Katrina. The Company reopened the store in the fourth fiscal quarter of 2006 after necessary repairs and renovations were made to the property.
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The SFA New Orleans store was covered by both property damage and business interruption insurance. The property damage coverage paid to repair and/or replace the physical property damage and inventory loss, and the business interruption coverage reimbursed the Company for lost profits as well as continuing expenses related to loss mitigation, recovery, and reconstruction for the full duration of the reconstruction period plus three months. The Company recorded in 2005 both (i) a $14.7 million gain on the excess of the replacement insurance value over the recorded net book value of the lost and damaged assets and (ii) $2.6 million of expenses related to the insurance deductible. In 2006, the Company recorded an adjustment (credit) of $1.6 million related to the insurance deductible. In 2007, the Company recorded a gain of $13.5 million associated with the proceeds from the business interruption claims.
FINANCIAL PERFORMANCE SUMMARY
On a consolidated basis, both net sales and comparable store sales for the year ended February 2, 2008 increased 11.7%. The Company recorded income from continuing operations and net income of $47.5 million, or $0.31 per share, compared to a loss from continuing operations of $7.3 million, or $0.05 per share, for the years ended February 2, 2008 and February 3, 2007, respectively. After recognition of the Company’s after-tax gain from discontinued operations of $61.1 million, or $0.45 per share, net income totaled $53.7 million, or $0.40 per share for the year ended February 3, 2007.
The year ended February 2, 2008 included net after-tax charges totaling $16.2 million, or $.11 per share, primarily related to $18.1 million, or $0.12 per share, for retention, severance, and transition costs related to the Company’s downsizing and consolidation following the disposition of its SDSG businesses. Additionally, legal and investigation costs totaled $3.7 million, or $.02 per share, associated with the previously disclosed investigation by the SEC (which has been concluded) and the investigation by the Office of the United States Attorney for the Southern District of New York as well as the settlement of two related vendor lawsuits. The year ended February 2, 2008 also included a loss on extinguishment of debt totaling $3.4 million or $.02 per share, related to the repurchase of $106.3 million of senior notes, $2.9 million, or $.02 per share, related to asset impairments and dispositions, and $0.8 million expense related to a state tax adjustment. These expenses were partially offset by an insurance adjustment (credit) of $8.1 million, or $0.05 per share, related to the New Orleans Store, as well as a gain of $1.6 million, or $.01 per share, related to an Off Fifth store closing and the sale of an unused support facility. Lastly, there was a $3.0 million, or $.02 per share, state income tax valuation adjustment (credit).
The year ended February 3, 2007 included net after-tax charges totaling $34.3 million, or $0.25 per share, primarily due to $22.3 million, or $0.16 per share, for retention and severance and a $21.0 million, or $0.15 per share, non-cash charge related to the accounting treatment under the Statement of Financial Accounting Standard (SFAS) No. 123R “Accounting for Stock-Based Compensation,” (SFAS No. 123R) for the discretionary anti-dilution adjustment made to outstanding options in connection with the Company’s $4 per common share dividends paid in May and November 2006. Additionally, there was a charge of $7.8 million, or $0.06 per share, primarily related to asset impairments and dispositions, and expenses of $3.6 million, or $0.03 per share, related to legal and other costs associated with the previously disclosed investigations. This was partially offset by income of $16.8 million, or $0.12 per share, due to the favorable conclusion of certain tax examinations and the adjustment of certain tax valuation allowances, a gain of $2.6 million, or $0.02 per share, related to a one-time gain on the curtailment of the Company’s pension plan, and an insurance adjustment (credit) of $1.0 million, or $0.01 per share, related to the New Orleans store.
The year ended February 3, 2007 included an extra week, creating a 53-week fiscal year that occurs every six years in the accounting cycle for many retailers. Management estimates that the 53rd week added $0.06 per share to earnings per share for the year ended February 3, 2007.
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The year ended January 28, 2006 included net after-tax charges totaling $43.1 million, or $.31 per share, primarily related to a loss on extinguishment of debt totaling $17.9 million, or $.13 per share, as well as an expense of $15.4 million, or $.11 per share, related to retention and severance costs. Additionally there was an expense of $12.0 million, or $.09 per share, related to the aforementioned investigations, a charge of $6.1 million, or $.04 per share, related to asset impairments and dispositions. The year ended January 28, 2006, also included an expense of $1.6 million, or $.01 per share, related to the insurance deductible for the SFA New Orleans store. This was partially offset by a gain of $8.9 million, or $.06 per share, for the New Orleans store insurance settlement. Lastly, there was income of $1.0 million, or $.01 per share, related to the Company’s estimated share of proceeds from the Visa/MasterCard antitrust litigation settlement.
The retail environment is challenging and competitive. Uncertain conditions make the forecasting of near-term results difficult. The Company believes that execution of key strategic initiatives, as well as its expectations for long-term growth in the luxury retail market provides the Company an opportunity and the resources to enhance shareholder value.
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):
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FISCAL YEAR ENDED FEBRUARY 2, 2008 (“2007”) COMPARED TO FISCAL YEAR ENDED FEBRUARY 3, 2007 (“2006”)
DISCUSSION OF OPERATING INCOME — CONTINUING OPERATIONS
The following table shows the changes in operating income (loss) from 2006 to 2007:
For the year ended February 2, 2008, the Company’s operating income totaled $98.0 million, a 370 basis point improvement from an operating loss of $20.4 in the same period last year. Operating income was driven by a 11.7% increase in comparable store sales and expense management which resulted in a 330 basis point improvement in the expense rate as a percentage of sales. Additionally, the gross margin rate improved 40 basis points for the year ended February 2, 2008. The improvement in gross margin dollars and the gross margin rate was principally attributable to the higher sales driven by the strengthening of merchandise assortments by store and enhancements to the merchandise planning and allocation process.
NET SALES
For the year ended February 2, 2008, total sales increased 11.7% to $3,282.6 million from $2,940.0 million for the year ended February 3, 2007. The fiscal year ended February 3, 2007 included an extra week, creating a 53-week fiscal year that occurs every six years in the accounting cycle for many retailers which accounted for $43.6 million of the increase in sales above the year ended January 28, 2006. Consolidated comparable store sales increased $335 million, or 11.7% from $2,855.4 million for the 52-week period ended January 27, 2007 to $3,190.4 million at February 2, 2008. The previously mentioned 53rd week has been excluded from the comparable store sales calculation.
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, remodeled, converted and re-branded 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 February 2, 2008, gross margin was $1,283.4 million, or 39.1% of net sales, compared to $1,135.7 million, or 38.6% of net sales, for the year ended February 3, 2007. The improvement in gross margin dollars and gross margin rate was principally attributable to the higher sales driven by the strengthening of merchandise assortments by store and enhancements to the merchandise planning and allocation process.
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
For the year ended February 2, 2008, SG&A was $850.2 million, or 25.9% of net sales, compared to $819.2 million, or 27.9% of net sales, for the year ended February 3, 2007. The net increase of $30.9 million in expenses was primarily driven by higher variable expenses associated with the year over year sales increase of $342.6 million. The prior year period included a $33.4 million charge associated with the anti-dilution adjustment made to outstanding options related to the Company’s $4 per share dividend paid on May 1, 2006 and the $4 per share dividend paid on November 30, 2006. As a percentage of sales, SG&A decreased by 200 basis points over the prior year; however, excluding the anti-dilution adjustment noted above, SG&A expense as a percentage of sales declined 80 basis points over the prior year.
Amounts received from vendors in conjunction with compensation programs and cooperative advertising were consistent with the related gross compensation and cooperative advertising expenditures and therefore had no impact on SG&A expense, in dollars or as a percentage of net sales.
OTHER OPERATING EXPENSES
For the year ended February 2, 2008, other operating expenses were $330.4 million, or 10% of net sales, compared to $324.5 million, or 11% of net sales, for the year ended February 3, 2007. The increase of $6.0 million was principally driven by higher depreciation and amortization expense of $6.1 million and an increase in taxes other than income taxes of $6.2 million. This is partially offset by a decrease in property and equipment rentals of $6.7 million for the year ended February 2, 2008. As a percentage of sales, other operating expenses decreased slightly, reflecting the ability to leverage expenses as store sales increased.
IMPAIRMENTS AND DISPOSITIONS
For the year ended February 2, 2008, the Company recognized net charges from impairments and dispositions of $4.8 million compared to net charges of $12.4 million for the year ended February 3, 2007. The current and prior year net charges were primarily due to asset impairments in the normal course of business.
INTEREST EXPENSE
Interest expense declined to $42.3 million in 2007 from $50.1 million in 2006 and, as a percentage of net sales, decreased to 1.3% in 2007 from 1.7% in 2006. The decrease of $7.8 million was primarily due to the reduction in debt resulting from the repurchase of approximately $106.3 million of senior notes during the year ended February 2, 2008.
GAIN/(LOSS) ON EXTINGUISHMENT OF DEBT
During the year ended February 2, 2008, the Company repurchased a total of approximately $106.3 million of senior notes. The repurchase of these notes resulted in a loss on extinguishment of debt of $5.6 million. For the year ended February 3, 2007, the Company repurchased a total of approximately $0.2 million in principal amount of senior notes. The repurchase of these notes resulted in a gain on extinguishment of debt of $7 thousand.
OTHER INCOME, NET
Other income decreased to $24.9 million in 2007 from $28.4 million in 2006 primarily due to the decrease in interest income of $18.6 million as the Company invested the cash proceeds from the NDSG and Parisian dispositions prior to the payment of the May and November $4 per common share dividends in 2006. This is partially offset by an increase to other income of approximately $13.5 million due to the business interruption
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insurance settlement proceeds received for the SFA New Orleans store, which was destroyed in the aftermath of hurricane Katrina. Other income in 2007 also included $2.7 million related to an Off Fifth store closing and the sale of an unused support facility.
INCOME TAXES
For 2007 and 2006 the effective income tax rate differs from the federal statutory tax rate due to state income taxes and other items such as executive compensation, tax-exempt interest, the change in state deferred tax rates, the change in valuation allowance against state net operating loss carryforwards, and the effect of concluding tax examinations and other tax reserve adjustments. Including the effect of these items, the Company’s effective income tax rate was 36.7% and 48.7% in 2007 and 2006, respectively. Management anticipates that income tax rates in future years will be closer to 40%.
FISCAL YEAR ENDED FEBRUARY 3, 2007 (“2006”) COMPARED TO FISCAL YEAR ENDED JANUARY 28, 2006 (“2005”)
DISCUSSION OF OPERATING INCOME — CONTINUING OPERATIONS
The following table shows the changes in operating loss from 2005 to 2006:
For the year ended February 3, 2007, the Company’s operating loss totaled $20.4 million, an 84% improvement from the $127.9 million loss in the same period last year. Operating income was positively impacted by a 4.9% increase in comparable store sales, a 180 basis point improvement in the gross margin rate due to improved sell-throughs of full priced merchandise, and an $11.3 million decline in SG&A expenses. The SG&A expense reduction was primarily due to improved expense leverage resulting from expense control, coupled with increasing comparable store sales, continued progress on the Company’s corporate infrastructure downsizing, and the elimination or reduction of items that the Company does not expect to be long-term continuing obligations such as investigation expenses, severance/retention expenses, and insurance deductible expenses related to the SFA New Orleans store. The improvement in operating income was partially offset by a $33.4 million FAS 123R charge associated with the discretionary anti-dilution adjustment on outstanding options and by a $20.3 million year-over-year increase in impairments and dispositions costs, primarily resulting from the $14.7 million gain recognized in 2005 related to the SFA New Orleans store insurance settlement.
NET SALES
For the year ended February 3, 2007, total sales increased 5.8% to $2,940.0 million from $2,778.3 million for the year ended January 28, 2006. Consolidated comparable store sales increased 4.9% to $2,842.7 million for the year ended February 3, 2007 from $2,709.1 million for the year ended January 28, 2006. The net effect of sales from new and closed stores resulted in a $13.7 million reduction, while the net effect of the SFA New
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Orleans store also resulted in a $13. 7 million reduction. The year ended February 3, 2007 included an extra week, creating a 53-week fiscal year that occurs every six years in the accounting cycle for many retailers which accounted for $43.6 million of the increase in sales above 2005.
GROSS MARGIN
For the year ended February 3, 2007, gross margin was $1,135.7 million, or 38.6% of net sales, compared to $1,023.5 million, or 36.8% of net sales, for the year ended January 28, 2006. The improvement in gross margin dollars was due to the comparable sales increase of 4.9% and an improved gross margin rate. The increased gross margin rate was principally attributable to improved sell-throughs of full priced merchandise.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
For the year ended February 3, 2007, SG&A was $819.2 million, or 27.9% of net sales, compared to $830.5 million, or 29.9% of net sales, for the year ended January 28, 2006. The net decrease of $11.3 million in expenses was principally due to expense improvement resulting from the Company’s corporate infrastructure downsizing, offset partially by the $33.4 million charge associated with SFAS 123R. Additionally, SG&A expense decreased as a result of a $14.5 million decrease in investigation related expenses, a $4.3 million reduction in insurance deductible expenses related to the New Orleans store, and a $4.3 million reduction in pension expense related to the pension curtailment gain, and SG&A increased as a result of an $11.0 million increase in incentive compensation and a year-over-year increase of $11.1 million in retention costs associated with the SDSG strategic alternatives process.
Amounts received from vendors in conjunction with compensation programs and cooperative advertising were consistent with the related gross compensation and cooperative advertising expenditures and therefore had no impact on SG&A expense, in dollars or as a percentage of net sales.
OTHER OPERATING EXPENSES
For the year ended February 3, 2007, other operating expenses were $324.5 million, or 11.0% of net sales, compared to $328.8 million, or 11.8% of net sales, for the year ended January 28, 2006. As a percent of sales, other operating expenses decreased slightly, reflecting the ability to leverage essentially flat costs and a comparable store sales increase.
IMPAIRMENTS AND DISPOSITIONS
For the year ended February 3, 2007, the Company recognized net charges from impairments and dispositions of $12.4 million compared to net gains of $7.8 million for the year ended January 28, 2006. The net charges for the year ended February 3, 2007 were primarily due to impairments and disposition charges in the normal course of business and lease termination costs related to store closings, while the 2005 net gains primarily related to the insurance settlement received on the New Orleans store, partially offset by impairments and dispositions in the normal course of business.
INTEREST EXPENSE
Interest expense declined to $50.1 million in 2006 from $77.2 million in 2005 and, as a percentage of net sales, decreased to 1.7% in 2006 from 2.8% in 2005. The improvement of $27.1 million was due to the reduction in debt resulting from the repurchase of approximately $585.7 million and $21.4 million of senior notes in July 2005 and August 2005, respectively.
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GAIN/(LOSS) ON EXTINGUISHMENT OF DEBT
During the year ended February 3, 2007 the Company repurchased a total of approximately $0.2 million in principal amount of senior notes. The repurchase of these notes resulted in a gain on extinguishment of debt of $7 thousand. For the year ended January 28, 2006, the Company repurchased a total of approximately $607.1 million in principal amount of senior notes. The repurchase of these notes resulted in a loss on extinguishment of debt of approximately $29.4 million related principally to the write-off of deferred financing costs and a premium on previously exchanged notes.
OTHER INCOME, NET
Other income increased to $28.4 million in 2006 from $7.7 million in 2005 due principally to increased short-term investments as the Company invested the cash proceeds from the NDSG and Parisian dispositions prior to the payment of the May 2006 and November 2006 $4 per common share dividends.
INCOME TAXES
For 2006 and 2005 the effective income tax rate differs from the federal statutory tax rate due to state income taxes and other items such as executive compensation, tax-exempt interest, the change in state deferred tax rates, the change in valuation allowance against state net operating loss carryforwards, and the effect of concluding tax examinations. Including these items, the Company’s effective income tax rate was 48.7% and 41.1% in 2006 and 2005, respectively.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW
The primary needs for cash are to acquire or construct new stores, renovate and expand existing stores, provide working capital for new and existing stores and service debt. The Company anticipates that cash on hand, cash generated from operating activities and borrowings under its revolving credit agreement will be sufficient to meet its financial commitments and provide opportunities for future growth.
Cash provided by operating activities from continuing operations was $71.5 million in 2007, $151.0 million in 2006 and $97.9 million in 2005. Our accompanying consolidated statements of cash flows identify major differences between net income and net cash provided by operating activities for each of those years. Cash provided by operating activities principally 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 to support higher expected sales levels and accounts payable fluctuations are generally determined by the timing of merchandise purchases and payments. The $79.5 million decrease in cash flows from continuing operations in 2007 from 2006 was primarily due to a decrease in accounts payable and accrued liabilities and increased inventory levels, partially offset by higher net income. The $53.1 million increase in cash flows from continuing operations in 2006 from 2005 was primarily due to an increase in accounts payable and accrued liabilities and higher income from continuing operations, partially offset by increased inventory levels.
Cash used in investing activities from continuing operations was $128.6 million in 2007, $123.5 million in 2006 and $116.9 million in 2005. Cash used in investing activities principally consists of construction of new stores and renovation and expansion of existing stores and investments in support areas (e.g., technology and distribution centers). The $5.1 million increase in cash used in 2007 is primarily related to an increase in capital expenditures of approximately $17.3 million, partially offset by the increase in proceeds from the sale of SFA
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property of approximately $12.2 million. The $6.6 million increase in net cash used in 2006 is primarily due to proceeds received from the sale of property and equipment in 2005 that was non-recurring in nature.
Cash used in financing activities from continuing operations was $119.6 million in 2007, $1,041.2 million in 2006 and $762.2 million in 2005. The 2007 use relates to the repurchase of approximately $106.3 million in principal amount of senior notes. The 2006 use primarily relates to the payment of cash dividends totaling $1,095.0 million, while the 2005 use primarily relates to the repurchase of approximately $607.1 million in principal amount of senior notes due to the completion of the tender offers and consent solicitations.
On March 6, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share totaling approximately $547.5 million, and the Company reduced shareholders’ equity by that amount. Approximately $539.0 million of the dividend was paid on May 1, 2006 to shareholders of record as of April 14, 2006. The remaining portion of the dividend payable will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.
On October 3, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share totaling approximately $558.6 million, and the Company reduced shareholders’ equity by that amount. Approximately $552.0 million of the dividend was paid on November 30, 2006 to shareholders of record as of November 15, 2006. The remaining portion of the dividend payable will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.
During the year ended February 3, 2007, the Company repurchased 450 thousand shares of Saks’ common stock at a cost of approximately $6.5 million, which left 37.4 million shares available for repurchase under the Company’s existing share repurchase program.
During the year ended February 2, 2008, the Company repurchased approximately 1.7 million shares of its common stock at a cost of approximately $27.5 million. At February 2, 2008, there were 35.7 million shares remaining available for repurchase under the Company’s existing shares repurchase program.
CASH BALANCES AND LIQUIDITY
The Company’s primary sources of short-term liquidity are comprised of cash on hand and availability under its revolving credit facility. At the Company’s request, due to the sale of NDSG, the revolving credit facility was reduced from $800 million to $500 million in March 2006. In September 2006, the maturity date of the revolving credit facility was extended to September 2011. At February 2, 2008 and February 3, 2007, the Company maintained cash and cash equivalent balances of $101.2 million and $277.9 million, respectively. Exclusive of approximately $15.7 million and $12.4 million of store operating cash at February 2, 2008 and February 3, 2007, respectively, cash was invested principally in various money market funds. There was no restricted cash at February 2, 2008 and February 3, 2007.
At February 2, 2008, the Company had no direct borrowings under its $500 million revolving credit facility, and had $31.9 million in unfunded letters of credit, leaving unutilized availability under the facility of $468.1 million. The Company had maximum unfunded letters of credit of $48.3 million on its revolving credit facility during 2007. The amount of cash on hand and borrowings under the 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.
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CAPITAL STRUCTURE
The Company continuously evaluates its debt-to-capitalization ratio in light of economic trends, business trends, levels of interest rates, and terms, conditions and availability of capital in the capital markets. At February 2, 2008, 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. At February 2, 2008, total debt was $572.6 million, representing a decrease of $114.1 million from the balance of $686.7 million at February 3, 2007. This decrease in debt was primarily the result of the $106.3 million repurchase of senior notes in 2007. Additionally, the debt-to-capitalization ratio decreased to 32.8% from 38.5% in 2006, primarily as a result of the decrease in debt in 2007.
At February 2, 2008, the Company maintained a $500 million senior revolving credit facility maturing in 2011, which is secured by inventory and certain third party credit card accounts receivable. Borrowings are limited to a prescribed percentage of eligible inventories and receivables. There are no debt ratings-based provisions in the facility. The facility includes a fixed-charge coverage ratio requirement of 1 to 1 that the Company is subject to only if availability under the facility becomes less than $60 million. 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 principal of more than $20 million in that other instrument. At February 2, 2008, the Company had no borrowings under the revolving credit facility.
At February 2, 2008, the Company had $276.4 million of senior notes outstanding, excluding the convertible notes, comprised of five separate series having maturities ranging from 2008 to 2019 and interest rates ranging from 7.00% to 9.88%. The terms of each senior note call for all principal to be repaid at maturity. The senior notes have substantially identical terms except for the maturity dates and interest rates payable to investors. Each senior note contains limitations on the amount of secured indebtedness the Company may incur. The Company believes it has sufficient cash on hand, availability under its revolving credit facility and access to various capital markets to repay these notes at maturity.
On April 12, 2007, the Company announced the results of its modified “Dutch Auction” tender offer to purchase a portion of its 8.25% senior notes due November 15, 2008 for an aggregate purchase price not to exceed $100 million (the “offer cap”). The offer expired on April 11, 2007. The aggregate principal amount of notes validly tendered at or above the clearing spread exceeded the offer cap and the Company accepted $95.9 million aggregate principal amount of the notes, resulting in an aggregate purchase price of $100 million (plus an additional $3.2 million in aggregate accrued interest on such notes). The Company accepted for purchase first, all notes tendered at spreads above the clearing spread, and thereafter, the notes validly tendered at the clearing spread on a prorated basis according to the principal amount of such notes. During the three months ended May 5, 2007, the Company recorded a loss on extinguishment of approximately $5.2 million related to the repurchase of the notes.
During June and July 2007, the Company repurchased an additional $10.4 million in principal amount primarily relating to its 8.25% senior notes. The repurchase of these notes resulted in a loss on extinguishment of approximately $412 thousand.
The Company had $230 million of convertible senior notes, at February 2, 2008, that bear interest of 2.0% 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. The most significant terms and conditions of the senior notes include: the Company can settle a conversion with shares and/or cash; the holder may put the debt back to the Company in 2014 or 2019; the holder cannot convert until the Company’s share price is greater than 120% of the applicable conversion price for a certain
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trading period; the Company can call the debt on or after March 11, 2011; the conversion rate is subject to a dilution adjustment; and the holder can convert upon a significant credit rating decline and upon a call. The Company used approximately $25 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. The Company believes it has sufficient cash on hand, availability under its revolving credit facility and access to various capital markets to repay both the senior notes and convertible notes at maturity.
On January 10, 2008, the Company gave notice that holders of its $230.0 million 2.0% convertible senior unsecured notes due March 15, 2024 were entitled to convert the convertible notes into shares of the Company’s common stock due to the closing price of the Company’s common stock exceeding 120% of the convertible senior notes’ conversion price for at least 20 out of the last 30 consecutive trading days in the fourth calendar quarter of 2007. The holders of the convertible notes have until March 31, 2008 to convert their notes into shares of the Company’s common stock in accordance with, and subject to, the terms of the convertible notes indenture. Since the holders of the convertible notes have the ability to exercise their conversion rights, the convertible notes were classified within “current portion of long-term debt” on the Company’s February 2, 2008 balance sheet. As of March 25, 2008, no note holders had converted their notes into the Company’s common stock.
At February 2, 2008 the Company had $66.2 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 $5 million and $7 million per year.
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 minimal or no funding requirements in 2008. As part of the sale of NDSG to Bon-Ton, the NDSG pension assets and liabilities were acquired by Bon-Ton. Additionally, the Company curtailed its SFA pension plan during 2006 which froze benefit accruals for all participants except those who have attained age 55 and completed 10 years of service as of January 1, 2007 and who continue to be highly compensated employees.
CONTRACTUAL OBLIGATIONS
The contractual cash obligations at February 2, 2008 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 and amounts due under employment agreements. Amounts committed under open purchase orders for merchandise inventory represent approximately $520.0 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.
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On March 6, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share, and the Company reduced shareholders’ equity for the $547.5 million dividend. Approximately $539.0 million of the dividend was paid on May 1, 2006 to shareholders of record as of April 14, 2006. On October 3, 2006 the Company’s Board of Directors declared another cash dividend of $4.00 per common share, and the Company reduced shareholders’ equity for the $558.6 million dividend. Approximately $552.0 million of the dividend was paid on November 30, 2006 to shareholders of record as of November 15, 2006. The remaining portion of the dividends will be paid prospectively as, and to the extent, certain awards of restricted stock and performance shares vest.
Additionally, at February 2, 2008 and February 3, 2007, the Company had accrued approximately $4 million and $20 million related to retention and severance compensation in conjunction with its SDSG strategic alternative processes.
Other long-term liabilities excluded from the above table include deferred compensation obligations of $19.4 million. The timing of payments for this obligation is subject to employee elections and other employment factors. Other long-term liabilities also include non-cash obligations for deferred rent and deferred property incentives. Other unrecorded obligations that have been excluded from the contractual obligations table include contingent rent payments, amounts that might come due under change-in-control provisions of employment agreements, and common area maintenance costs. The Company had no funding requirements to its pension plan in 2007 and expects minimal or no funding requirements in 2008 and 2009.
Due to the uncertainty with respect to the timing of future cash flows associated with the Company’s unrecognized tax benefits at February 2, 2008, the Company is unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $44.6 million of unrecognized tax benefits have been excluded from the contractual obligations table above. See Note 6 to the Consolidated Financial Statements for a discussion on income taxes.
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.
CREDIT CARDS
Prior to April 15, 2003, the Company’s proprietary credit cards were issued by National Bank of the Great Lakes (“NBGL”), a wholly owned subsidiary of the Company. On April 15, 2003, the Company sold its proprietary credit card portfolio, consisting of the proprietary credit card accounts owned by NBGL and the Company’s ownership interest in the assets of a trust to HSBC, a third party financial institution.
As part of the transaction, for a term of ten years expiring in 2013 and pursuant to a program agreement, HSBC established and owns proprietary credit card accounts for customers of the Company’s operating subsidiaries, retains the benefits and risks associated with the ownership of the accounts, receives the finance charge income and incurs the bad debts associated with those accounts. During the ten-year term, pursuant to a servicing agreement, the Company continues to provide key customer service functions, including new account opening, transaction authorization, billing adjustments and customer inquiries, and receives compensation from HSBC for these services.
At the end of the ten-year term expiring in 2013, the agreement can be renewed for two two-year terms. At the end of the agreement, the Company has the right to repurchase, at fair value, all of the accounts and
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outstanding accounts receivable, negotiate a new agreement with HSBC or begin issuing private label credit cards itself or through others. The agreement allows the Company to terminate the agreement early following the occurrence of certain events, the most significant of which would be HSBC’s failure to pay owed amounts, bankruptcy, a change in control or a material adverse change in HSBC’s ability to perform under the agreement. The agreement also allows for HSBC to terminate the agreement if the Company fails to pay owed amounts or enters bankruptcy. Should either the Company or HSBC choose to terminate the agreement early, the Company has the right, but not the requirement, to repurchase the credit card accounts and associated accounts receivable from HSBC at their fair value. The Company is contingently liable to pay monies to HSBC in the event of an early termination or a significant disposition of stores. The contingent payment is based upon a declining portion of an amount established at the beginning of the ten-year agreement and on a prorated portion of significant store closings. The maximum contingent payment had the agreement been terminated early at February 2, 2008 would have been approximately $27.2 million. Management believes the risk of incurring a contingent payment is remote.
In September of 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 Fifth store and at Saks Direct or as a MasterCard 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.
CAPITAL NEEDS
The Company estimates capital expenditures for 2008 will be approximately $125 million, net of any proceeds, primarily for store expansions and renovations, enhancements to management information systems, maintenance capital and replacement capital expenditures.
The Company anticipates that working capital requirements related to existing stores, store expansions, store renovations and capital expenditures will be funded through cash on hand, cash provided by operations and the revolving credit agreement. Maximum availability under the revolving credit agreement is $500 million. There is no debt rating trigger. During periods in which availability under the agreement exceeds $60 million, the Company is not subject to financial covenants. If availability under the agreement were to decrease to less than $60 million, the Company would be subject to a minimum fixed charge coverage ratio of 1 to 1. During 2007, weighted average letters of credit issued under this credit agreement were $42.1 million. The highest amount of letters of credit outstanding under the agreement during 2007 was $48.3 million. The Company expects to generate adequate cash flows from operating activities combined with borrowings under its revolving credit agreement in order to sustain its current levels of operations.
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 aggregates 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.
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REVENUE RECOGNITION
Sales and the related gross margin are recorded at the time customers provide a satisfactory form of payment and take ownership of the merchandise. There are minimal accounting judgments and uncertainties affecting the application of this policy. The Company estimates the amount of goods that will be returned for a refund and reduces sales and gross margin by that amount. However, given that approximately 24% of merchandise sold is later returned and that the vast majority of merchandise returns occur within a matter of days of 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.
COST OF SALES AND INVENTORY VALUATION, EXCLUDING DEPRECIATION AND AMORTIZATION
The Company’s inventory is stated at the lower of LIFO cost or market using the retail method. Under the retail 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 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 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 in cost purchases.
SELF-INSURANCE RESERVES
The Company self-insures a substantial portion of the exposure for costs related primarily to employee medical, workers’ compensation and general liability. Expenses are recorded based on estimates for reported and incurred but not reported claims 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 estimates, self-insurance reserves could be affected if future claims experience differs significantly from the historical trends and assumptions.
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DEPRECIATION AND RECOVERABILITY OF CAPITAL ASSETS
Over forty percent of the Company’s assets at February 2, 2008 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.
LEASES
The Company leases stores, distribution centers, and administrative facilities under operating leases. Store lease agreements generally include rent holidays, rent escalation clauses and contingent rent provisions for percentage of sales in excess of specified levels. Most of the Company’s lease agreements include renewal periods at the Company’s option. The Company recognizes rent holiday periods and scheduled rent increases on a straight-line basis over the lease term beginning with the date the Company takes possession of the leased space and includes such rent expense in Store Pre-Opening Costs. The Company records tenant improvement allowances and rent holidays as deferred rent liabilities on the consolidated balance sheets and amortizes the deferred rent over the terms of the lease to rent expense in the consolidated statements of income. The Company records rent liabilities on the consolidated balance sheets for contingent percentage of sales lease provisions when the Company determines that it is probable that the specified levels will be reached during the fiscal year.
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INCOME AND OTHER TAXES
The majority of the Company’s deferred tax assets at February 2, 2008 consist of federal and state net operating loss carryforwards that will expire between 2008 and 2027. During 2007, the valuation allowance against net operating loss carryforwards was reduced based on projections of future profitability. At February 2, 2008 the Company believes that it will be sufficiently profitable during the periods from 2008 to 2027 to utilize all of its federal NOLs and a portion of its state NOLs. To the extent management’s estimates of future taxable income by jurisdiction are greater than or less than management’s current estimates, future increases or decreases in the benefit for net operating losses could occur.
The Company is routinely under audit by federal, state and local authorities in the areas of income taxes and the remittance of sales and use taxes. Audit authorities may question 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.
During 2007, an additional reserve of $1.8 million was established for issues raised in current state tax examinations and previously filed federal tax returns relating to prior periods. During 2006, the Company concluded a federal income tax examination for the 2003 and 2004 tax years and concluded a number of state income tax examinations as well which resulted in a decrease in the amount previously accrued for exposures related to uncertain tax positions of $10.2 million. At February 2, 2008, the Company believes it has appropriately accrued for exposures related to uncertain tax positions. 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.
The company adopted the provisions of the Financial Accounting Standards Board Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes effective as of the beginning of fiscal year 2007. As a result of the implementation of FIN No. 48, the Company recorded a $33.7 million decrease in the liability for unrecognized tax benefits which was accounted for as an increase to the beginning shareholder’s equity. Including the cumulative effect decrease, at the beginning and ending of 2007 the Company had approximately $44.0 million and $44.6 million of total gross unrecognized tax benefits, respectively. Of these totals, $12.6 million and $13.3 million (net of the federal benefit on state issues) represents the amounts of unrecognized tax benefits that, if recognized, would affect the effective income tax rate in any future periods. It is reasonably possible that the amount of unrecognized tax benefits will increase or decrease in the next twelve months as a result of settling uncertain tax positions. However, the Company does not anticipate this to result in any material changes to the amount of unrecognized tax benefits.
As a result of the analysis of uncertain tax positions (due to the adoption of FIN 48), the net deferred tax asset related to the state net operating loss carryforwards increased. Therefore, the Company performed a valuation allowance analysis to determine the realization of this asset. This analysis resulted in an additional valuation allowance of $19.3 million with the offset recorded to shareholders’ equity in accordance with Statement of Positions 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.” The Company is subject to the provisions of Statement of Position 90-7 for these net operating losses since these losses were acquired through the acquisition of a company that had previously filed bankruptcy.
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 for taxable years through January 29, 2005 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 currently has examinations in progress for several jurisdictions.
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PENSION PLANS
Pension expense is based on actuarial models used to estimate the total benefits ultimately payable to associates and is allocated to the service periods. The actuarial assumptions used to calculate pension costs are reviewed annually. 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 pension plans are valued annually on November 1st. The projected unit credit method is utilized in recognizing the pension liabilities.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). The Company adopted SFAS No. 158 prospectively on February 3, 2007. This Statement requires the Company to recognize an asset or liability for the overfunded or underfunded status of its pension and other postretirement benefit plans. SFAS No. 158 requires the Company to recognize all unrecognized prior service costs and credits and unrecognized actuarial gains and losses in accumulated other comprehensive income (“AOCI”), net of tax. Such amounts will be adjusted as they are subsequently recognized as components of net periodic benefit cost or income pursuant to the current recognition and amortization provisions.
Upon adoption of SFAS No. 158, the Company recorded a pension asset of $4.6 million and eliminated the prepaid pension asset of $47.7 million. Based on the funded status of the defined benefit pension and postretirement benefit plans as of February 3, 2007, the Company also recorded a net decrease in AOCI of $26.0 million. The adoption of SFAS No. 158 on February 3, 2007 had no impact on the Company’s earnings.
Pension assumptions are based upon management’s best estimates as of the annual measurement date.
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INFLATION AND DEFLATION
Inflation and deflation affect the costs incurred by the Company in its purchase of merchandise and in certain components of its SG&A expenses. The Company attempts to offset the effects of inflation, which has occurred in recent years in SG&A, through price increases and control of expenses, although the Company’s ability to increase prices is limited by competitive factors in its markets.
SEASONALITY
The Company’s business, like that of most retailers, is subject to seasonal influences, with a significant portion of net sales and net income realized during the second half of the fiscal year, which includes the holiday selling season. In light of these patterns, SG&A expenses are typically higher as a percentage of net sales during the first three fiscal quarters of each year, and working capital needs are greater in the last two fiscal quarters of each year. The increases in working capital needs during the fall season have typically been financed with cash flow from operations and borrowings under the Company’s revolving credit agreement. Generally, more than 30% of the Company’s sales are generated during the fourth quarter and a large portion of its operating income is generated during the fall season.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued Interpretation 48 (“FIN 48”) Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes. This interpretation clarifies the application of Statement 109 by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements. For a benefit to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The benefit to be recognized for a tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. FIN 48 also provides guidance on derecognition, classification of interest and penalties, accounting in interim periods, and disclosure. The Company adopted FIN 48 as of February 4, 2007.
During September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or a liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under SFAS No. 157, fair value measurements would be separately disclosed by level within the fair value hierarchy effective for fiscal years beginning after November 15, 2007. However, the FASB deferred the effective date of SFAS 157, until the beginning of our 2009 fiscal year, as it relates to fair value measurement requirements for nonfinancial assets and liabilities that are not remeasured at fair value on a recurring basis. The Company is currently evaluating the impact of adopting SFAS 157.
On September 29, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Plan and Other Postretirement Plans.” The Company adopted SFAS No. 158 prospectively on February 3, 2007. SFAS No. 158 requires an employer that sponsors one or more defined benefit pension plans or other
38
postretirement plans to 1) recognize the funded status of a plan, measured as the difference between plan assets at fair value and the benefit obligation, in the balance sheet; 2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; 3) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end balance sheet; and 4) disclose in the notes to the financial statements additional information about the effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition assets or obligations. The adoption of SFAS No. 158 did not have a material effect on the Company’s results of operations or financial position for the year ended February 3, 2007. Additionally, SFAS No. 158 will require the Company to change the measurement date for the assets and liabilities of its employee benefit plans from November 1 to the Company’s fiscal year end beginning with the year ending January 31, 2009.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value for Financial Assets and Financial Liabilities.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that currently are not required to be measured at fair value. This Statement is effective no later than fiscal years beginning on or after November 15, 2007. We believe this statement has an immaterial impact on the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which addresses the recognition and accounting for identifiable assets acquired, liabilities assumed, and non-controlling interests in business combinations. SFAS 141(R) also establishes expanded disclosure requirements for business combinations. SFAS 141(R) will become effective as of the beginning of the 2009 fiscal year. The adoption of this standard will not have a material impact on the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” This standard outlines the accounting and reporting for ownership interest in a subsidiary held by parties other than the parent. SFAS No. 160 is effective as of the beginning of the 2009 fiscal year. The adoption of this standard will not have a material impact on the consolidated financial statements.
The FASB is contemplating an amendment to SFAS No. 128, “Earnings Per Share,” that would require the Company to ignore the cash presumption of net share settlement and to assume share settlement for purposes of calculating diluted earnings per share. Although the Company is now required to ignore the contingent conversion provision on its convertible notes under EITF 04-08, it can still presume that it will satisfy the net share settlement upon conversion of the notes in cash, and thus exclude the effect of the conversion of the notes in its calculation of dilutive earnings per share. If and when the FASB amends SFAS No. 128, the effect of the changes would require the Company to use the if-converted method in calculating dilutive earnings per share except when the effect would be anti-dilutive. The effect of adopting the amendment to SFAS No. 128 would increase the number of shares in the Company’s dilutive calculation by 19,219 shares.
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
39
consolidated results might differ materially from projected forward-looking information if there are any material changes in management’s assumptions.
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 apparel and other merchandise carried by the Company and its ability to respond quickly to consumer trends; 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 Bank Nevada, N.A.; geo-political risks; 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.
Management undertakes no obligation to correct or update any forward-looking statements, whether as a result of new information, future events, or otherwise. Persons are advised, however, to consult any further disclosures management makes on related subjects in its reports filed with the SEC and in its press releases.
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, and derivative financial instrument activities, which are described in Notes 2 and 7 to the Consolidated Financial Statements appearing in Item 8 of this Form 10-K.
During 2004 the Company terminated all remaining interest rate swap agreements resulting in net losses. When combined with net gains from other previously cancelled interest rate swap agreements, the Company had total unamortized net losses of $350 thousand at February 3, 2007 that are being amortized as a component of interest expense through 2010. The Company had no net losses at February 2, 2008.
Based on the Company’s market risk sensitive instruments outstanding at February 2, 2008, 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. 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 F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
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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 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 discussions 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 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 accounting principles generally accepted in the United States of America. 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. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. 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. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or 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 the design and operation of the Company’s internal control over financial reporting as of the end of the period covered by this report based on criteria set forth in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation and management’s assessment, management believes that, as of the end of the period covered by this report, the Company’s internal control over financial reporting was effective “at the reasonable assurance level” based on those criteria.
The effectiveness of the Company’s internal control over financial reporting as of the end of the period covered by this report has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
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CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes in the Company’s internal controls over financial reporting that occurred during the quarter ended February 2, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Not applicable.
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Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this Item with respect to the Company’s directors is set forth in the section titled “Election of Directors” in the Company’s Proxy Statement for the 2008 Annual Meeting of Shareholders to be held on June 4, 2008 (the “Proxy Statement”) and is incorporated herein by reference. The information required by this Item with respect to the Company’s Code of Business Conduct and Ethics and audit committee (including the Company’s “audit committee financial expert”) is set forth in the section of the Proxy Statement titled “Corporate Governance” and is also incorporated herein by reference.
The information required by this Item with respect to the Company’s executive officers is included in Item 1C of this report under “Executive Officers of the Registrant.”
The information required by this Item with respect to compliance with Section 16(a) of the Exchange Act by the Company’s directors, executive officers and persons who own more than 10% of the Company’s common stock is set forth in the section of the Proxy Statement titled “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference.
Item 11. Executive Compensation.
The information required by this Item with respect to director and executive officer compensation and the Company’s Human Resources and Compensation Committee of the Board of Directors is included in the section of the Proxy Statement titled “Executive Compensation” and is incorporated herein by reference, except that the “Report of the Human Resources and Compensation Committee of the Board of Directors” 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 Exchange Act.
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 set forth in the section of the Proxy Statement titled “Outstanding Voting Securities” and is incorporated herein by reference.
The information required by this Item with respect to the Company’s equity compensation plans is set forth in the section titled “Equity Compensation Plan Information” in the Proxy Statement and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item with respect to transactions with related parties and the independence of the Company’s independent directors is set forth in the sections titled “Certain Transactions and Other Matters” and “Corporate Governance — Director Independence,” respectively, in the Proxy Statement and is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services.
The information required by this Item with respect to auditors’ services and fees is set forth in the section of the Proxy Statement titled “Ratification of Appointment of Registered Public Accounting Firm — PricewaterhouseCoopers LLP Fees and Services in 2007 and 2006” and is incorporated herein by reference.
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Item 15. Exhibits and Financial Statement Schedules.
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 either included in the financial statements or notes thereto or are not required or are not applicable and therefore have been omitted.
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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 on March 26, 2008.
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 indicated on March 26, 2008.
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46
FORM 10-K — ITEM 15(a)(3) AND 15(c) SAKS INCORPORATED AND SUBSIDIARIES EXHIBITS
E-1
E-2
E-3
E-4
E-5
E-6
E-7
SAKS INCORPORATED & SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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.
F-1
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Saks Incorporated
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Saks Incorporated (the Company) and its subsidiaries at February 2, 2008 and February 3, 2007, and the results of their operations and their cash flows for each of the three years in the period ended February 2, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 2, 2008, 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, 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 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.
As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for stock-based compensation in fiscal 2006. As discussed in Note 9, the Company changed the manner in which it accounts for defined benefit pension and other postretirement benefit plans in fiscal 2006. As discussed in Note 6, the Company changed the manner in which it accounts for uncertain tax positions in fiscal 2007.
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.
PricewaterhouseCoopers LLP Birmingham, Alabama March 26, 2008
F-2
SAKS INCORPORATED & SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these consolidated financial statements.
F-3
SAKS INCORPORATED & SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
F-4
SAKS INCORPORATED & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
F-5
SAKS INCORPORATED & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
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.
F-6
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share amounts)
NOTE 1 — GENERAL
ORGANIZATION
The Company’s operations consist of Saks Fifth Avenue (SFA), Off Fifth, and Club Libby Lu. Previously, the Company also operated Saks Department Store Group (“SDSG”), which consisted of Proffitt’s and McRae’s (“Proffitt’s”) (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operated under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), and Parisian (sold to Belk in October 2006). The sold businesses are presented as discontinued operations in the consolidated statements of income and the consolidated statements of cash flows for the prior year periods and are discussed below at “Discontinued Operations.”
DISCONTINUED OPERATIONS
On July 5, 2005, Belk acquired from the Company for approximately $623,000 in cash substantially all of the assets directly involved in the Proffitt’s business operations, plus the assumption of approximately $1,000 in capitalized lease obligations and the assumption of certain other ordinary course liabilities associated with the acquired assets. The assets sold included the real and personal property and inventory associated with 22 Proffitt’s stores and 25 McRae’s stores that generated fiscal 2004 revenues of approximately $784,000. The Company realized a net gain of $155,525 on the sale.
Upon the closing of the transaction, Belk entered into a Transition Services Agreement (“Proffitt’s TSA”) whereby the Company continued to provide certain back office services related to the Proffitt’s operations. Beginning with the second quarter of 2006, the back office services were substantially complete, and therefore, the Proffitt’s TSA no longer qualified as continuing involvement in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Accordingly, the results of the Proffitt’s operations are reflected as discontinued operations in the accompanying consolidated statements of income and the consolidated statements of cash flows for the prior year periods presented.
Additionally, on March 6, 2006, the Company sold to Bon-Ton all outstanding equity interests of certain of the Company’s subsidiaries that owned NDSG (operating under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers), either directly or indirectly. The consideration received consisted of approximately $1,115,000 in cash (reduced as described below based on changes in working capital), plus the assumption by Bon-Ton of approximately $35,000 of unfunded benefits liabilities and approximately $35,000 of capital leases. A working capital adjustment based on working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $75,000 resulting in net cash proceeds to the Company of approximately $1,040,000. The disposition included NDSG’s operations consisting of, among other things, the following: the real and personal property, operating leases and inventory associated with 142 NDSG units (31 Carson Pirie Scott stores, 14 Bergner’s stores, 10 Boston Store stores, 40 Herberger’s stores, and 47 Younkers stores), the administrative/headquarters facilities in Milwaukee, Wisconsin, and distribution centers located in Rockford, Illinois, Naperville, Illinois, Green Bay, Wisconsin, and Ankeny, Iowa. NDSG stores generated fiscal 2005 revenues of approximately $2,168,000. The Company realized a net gain of $204,729 on the sale.
Bon-Ton entered into a Transition Service Agreement with the Company (“NDSG TSA”), whereby the Company continued to provide, for varying transition periods, back office services related to the NDSG
F-7
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
operations. The back-office services included certain information technology, telecommunications, credit, accounting and store planning services, among others. Bon-Ton compensated the Company for these services, as outlined in the NDSG TSA. The results of the NDSG operations are reflected as discontinued operations in the accompanying consolidated statements of income and the consolidated statements of cash flows for the prior year periods presented.
On October 2, 2006, the Company sold to Belk of all of the outstanding equity interests of the Company’s subsidiaries that conducted the Parisian business. The consideration received consisted of approximately $285,000 in cash (increased in accordance with a working capital adjustment). A working capital adjustment based on working capital as of the effective time of the transaction increased the amount of cash proceeds by approximately $14,200. In addition, Belk reimbursed the Company at closing for approximately $6,700 in capital expenditures incurred in connection with the construction of four new Parisian stores. Belk also paid the Company a premium associated with the purchase of accounts and accounts receivable from Household Bank (SB), N.A. (now known as HSBC Bank Nevada, N.A., “HSBC”), in the amount of approximately $2,300. The foregoing resulted in total net cash proceeds to the Company of approximately $308,200.
The disposition included Parisian’s operations consisting of, among other things, the following: real and personal property, operating leases and inventory associated with 38 Parisian stores (which generated fiscal 2005 revenues of approximately $740,000), a 125,000 square foot administrative/headquarters facility in Birmingham, Alabama and a 180,000 square foot distribution center located in Steele, Alabama. The Company realized a net loss of $12,811 on the sale.
In connection with the consummation of the Parisian transaction, the Company entered into a Transition Services Agreement with Belk (“Parisian TSA”). Pursuant to the Parisian TSA, the Company provided, for varying transition periods, back-office services related to the Company’s former Parisian specialty department store business. The back-office services included information technology, telecommunications, credit, accounting and store planning services, among others. The results of the Parisian operations are reflected as discontinued operations in the accompanying consolidated statements of income and the consolidated statements of cash flows for the prior year periods presented.
Net sales of the aforementioned businesses that are included within discontinued operations in the accompanying Consolidated Statements of Income are $624,290 and $3,175,019 for 2006 and 2005, respectively.
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated.
The Company’s fiscal year ends on the Saturday closest to January 31. Fiscal year 2007 contained 52 weeks and ended on February 2, 2008, while fiscal year 2006 contained 53 weeks and ended on February 3, 2007. Fiscal year 2005 contained 52 weeks and ended on January 28, 2006.
F-8
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
Certain 2005 amounts in the accompanying statements of cash flows have been revised to reflect the operating cash flows attributable to our discontinued operations. The Company reclassified $62,655 from deferred income taxes from continuing operations to net cash provided by operating activities — discontinued operations on the statement of cash flows for fiscal 2005. Net cash provided by operating activities was not affected.
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. Net sales are recognized at the time customers provide a satisfactory form of payment and take ownership of the merchandise or direct its shipment. Revenue associated with gift certificates is recognized upon redemption of the certificate.
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 $30,189, $26,558, $26,236 in 2007, 2006, and 2005, respectively. Leased department sales were $217,636, $180,639, and $179,419 in 2007, 2006, and 2005, respectively, and were excluded from net sales.
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 $85,492 and $265,508 at February 2, 2008 and February 3, 2007, respectively, primarily consisting of money market funds, demand and time deposits. Income earned on cash equivalents was $6,190, $27,963, and $6,829 for the fiscal years ended February 2, 2008, February 3, 2007, and January 28, 2006, respectively, and was reflected in Other Income. There were no balances of restricted cash at February 2, 2008 and February 3, 2007.
On March 6, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share to shareholders of record as of April 14, 2006, and the Company reduced shareholders’ equity for the $ 547,537 dividend. On October 3, 2006 the Company’s Board of Directors declared another cash dividend of $4.00 per common share to shareholders of record as of November 15, 2006, and the Company reduced shareholders’ equity for the $558,587 dividend. For the year ended February 3, 2007, the Company made dividend cash payments totaling $1,095,025, primarily relating to the aggregate $8.00 per common share dividends. The remaining portion of the dividends will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.
MERCHANDISE INVENTORIES AND COST OF SALES (excluding depreciation and amortization)
Merchandise inventories are valued by the retail method and are stated at the lower of cost (last-in, first-out “LIFO”) or market and include freight, buying and distribution costs. The Company takes markdowns related to slow moving inventory, ensuring the appropriate inventory valuation. At February 2, 2008 and February 3, 2007, the LIFO value of inventories exceeded market value and, as a result, inventory was stated at the lower market amount.
F-9
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
Consignment merchandise on hand of $150,527 and $139,431 at February 2, 2008 and February 3, 2007, respectively, is not reflected in the consolidated balance sheets.
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 in the cost of purchases.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses (“SG&A”) are comprised principally of the costs related to employee compensation and benefits in the selling and administrative support areas; advertising; store and headquarters occupancy, operating and maintenance costs exclusive of rent, depreciation, and property taxes; proprietary credit card promotion, issuance and servicing costs; insurance programs; telecommunications; and other operating expenses not specifically categorized elsewhere in the consolidated statements of income. Advertising and sales promotion costs are generally 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:
STORE PRE-OPENING COSTS
Store pre-opening costs primarily consist of rent expense incurred during the construction of new stores and payroll and related media costs incurred in connection with new store openings and are expensed when 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. For financial reporting purposes, depreciation is computed principally using the straight-line method over the estimated useful lives of the assets. Buildings and improvements are depreciated over 20 to 40 years while fixtures and equipment are primarily depreciated over 3 to 15 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. Terms of leases used in the determination of estimated useful lives 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 computer software are capitalized and amortized using the straight-line method over 3 to
F-10
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
10 years. Costs incurred in the discovery and post-implementation stages of internally created computer software are generally expensed as incurred.
When constructing stores, the Company receives allowances from landlords. 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.
On a yearly basis and as changes in circumstances arise, the Company evaluates the recoverability of its property and equipment based upon the utilization of the assets and expected future cash flows, in accordance with SFAS No. 144. Write-downs associated with the evaluation and any gains or losses on the sale of assets recorded at the time of disposition are reflected in Impairments and Dispositions.
IMPAIRMENTS & DISPOSITIONS
The Company continuously evaluates its real estate portfolio and closes individual underproductive stores in the normal course of business as leases expire or as other circumstances indicate. The Company also performs an asset impairment analysis at each fiscal year end. During the year ended February 2, 2008, February 3, 2007 and January 28, 2006, the Company incurred net charges of $4,816, $6,344, and $7,156, respectively, related to asset impairments and other costs in the normal course of business.
During the fiscal year ended January 28, 2006, the Company also recorded a $14,670 gain related to the insurance settlement on the SFA store in New Orleans which suffered substantial water, fire, and other damage related to Hurricane Katrina. The SFA New Orleans store is covered by both property damage and business interruption insurance. The property damage coverage has paid to repair and/or replace the physical property damage and inventory loss, and the business interruption coverage reimbursed the Company for lost profits as well as continuing expenses related to loss mitigation, recovery, and reconstruction for the full duration of the reconstruction period plus three months. The gain, which represents the excess of the replacement cost over the net book value of the property, was included in Impairments and Dispositions in the accompanying Consolidated Statements of Income. The Company reopened the store in the fourth quarter of 2006 after necessary repairs and renovations were made to the property. In 2007, the Company recorded a $13,543 gain associated with the proceeds from the business interruption claims, which is included in other income in the accompanying consolidated statements of income.
In 2005, the Company also recorded a $2,987 goodwill impairment charge related to CLL. This charge was included in Impairments and Dispositions in the accompanying Consolidated Statements of Income.
OPERATING LEASES
The Company leases stores, distribution centers, and administrative facilities under operating leases. Store lease agreements generally include rent holidays, rent escalation clauses and contingent rent provisions for
F-11
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
percentage of sales in excess of specified levels. Most of the Company’s lease agreements include renewal periods at the Company’s option. The Company recognizes rent holiday periods and scheduled rent increases on a straight-line basis over the lease term beginning with the date the Company takes possession of the leased space and includes such rent expense in Store Pre-Opening Costs. The Company records tenant improvement allowances and rent holidays as deferred rent liabilities on the consolidated balance sheets and amortizes the deferred rent on a straight–line basis over the life of the lease to rent expense in the consolidated statements of income. The Company records rent liabilities on the consolidated balance sheets for contingent percentage of sales lease provisions when the Company determines that it is probable that the specified levels will be reached during the fiscal year.
GOODWILL AND INTANGIBLES
The Company has allocated the purchase price of previous purchase transactions to identifiable tangible assets and liabilities based on estimates of their fair values and identifiable intangible assets, with the remainder allocated to goodwill. SFAS No. 142, “Goodwill and Other Intangible Assets,” requires the discontinuation of goodwill amortization and the periodic testing (at least annually) for the impairment of goodwill and intangible assets. At each year-end balance sheet date and as changes in circumstances arise, the Company performs an evaluation of the recoverability of its goodwill by comparing the estimated fair value to the carrying amount of its assets and goodwill. For the years ended February 2, 2008 and February 3, 2007, there was no goodwill reflected in the consolidated balance sheet as the Company disposed of all remaining goodwill in conjunction with the sale of NDSG.
Amortization of the remaining amortizable intangible asset is provided on the straight-line basis over the estimated useful lives of the asset.
SELF-INSURANCE RESERVES
The Company self-insures a substantial portion of the exposure for costs related primarily to employee medical, workers’ compensation and general liability. Expenses are recorded based on estimates for reported and incurred but not reported claims 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 estimates, self-insurance reserves could be affected if future claims experience differs significantly from the historical trends and assumptions.
DERIVATIVES
The Company uses financial derivatives only to manage its costs and risks in conjunction with specific business transactions. All derivative instruments are recognized on the balance sheet at fair value. The Company cancelled all of its interest rate swap agreements during 2004 resulting in $3,100 of net losses. When combined with net gains from other previously cancelled interest rate swap agreements, the Company had total unamortized net losses of $350 and $584 at February 3, 2007 and January 28, 2006, respectively, that are being amortized as a component of interest expense through 2010. The Company had no unamortized net losses at February 2, 2008.
The Company issued $230,000 of convertible senior unsecured notes during 2004 that bear interest of 2.0% and mature in 2024. The Company used approximately $25,000 of the proceeds from the issuance of the notes 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.
F-12
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
STOCK-BASED COMPENSATION PLANS
The Company maintains an equity incentive plan for the granting of options, stock appreciation rights, performance shares, restricted stock, and other forms of equity awards to employees and directors. Options granted generally vest over a four-year period after grant and have an exercise term of seven to ten years from the grant date. Restricted stock and performance shares generally vest one to three years after the grant date, although applicable plans permit accelerated vesting in certain circumstances at the discretion of the Human Resources and Compensation Committee of the Board of Directors.
Compensation cost for restricted stock and performance shares that cliff vest are expensed straight line over the requisite service period. Restricted stock and performance shares with graded vesting features are treated as multiple awards based upon the vesting date. The Company records compensation costs for these awards straight line over the requisite service period for each separately vesting portion of the award. Compensation cost for stock option awards with graded vesting are expensed straight line over the requisite service period.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued the Statement of Financial Accounting Standard (“SFAS”) No.123 (revised 2004), “Share-Based Payments.” This statement, referred to as “SFAS No. 123R,” revised SFAS No. 123, and requires companies to expense the value of employee stock options and similar awards. Effective January 29, 2006, the Company adopted SFAS No.123R. The adoption of this standard had an immaterial effect on the Company’s 2006 consolidated financial statements. Total stock-based compensation expense, net of related tax effects, for the years ended February 2, 2008, February 3, 2007, and January 28, 2006 were approximately $4,634, $31,764 and $10,822, respectively.
The Company adopted the alternative transition method, as permitted by FASB Staff Position No. FAS 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards,” to calculate the tax effects of stock-based compensation pursuant to SFAS No. 123R for these awards that were outstanding upon adoption of SFAS No. 123R. The alternative transition method allows the use of simplified methods to calculate the beginning capital-in-excess-of-par pool and the consolidated statements of cash flows. Prior to the adoption of SFAS No. 123R, the Company presented all tax benefits resulting from the exercise of stock options as operating cash inflows in the consolidated statements of cash flows, in accordance with the provisions of Emerging Issues Task Force (“EITF”) No 00-15, “Classification in the Statements of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option.” SFAS No. 123R requires the benefits of tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash inflows rather than operating cash inflows, on a prospective basis. This amount is shown as “Excess tax benefit from stock based compensation.”
F-13
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
Had compensation cost for the Company’s stock-based compensation plan issuances prior to 2003 been determined under the fair value method, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below.
EARNINGS PER SHARE
Basic earnings per share (“EPS”) have been computed based on the weighted average number of common shares outstanding.
The Company had 688, 6,546, and 10,840 option awards of potentially dilutive common stock outstanding at February 2, 2008, February 3, 2007, and January 28, 2006, respectively, that were not included in the computation of diluted EPS because the Company had a loss from continuing operations for the period or the exercise prices of the options were greater than the average market price of the common shares for the period. There were also 19,219 of potentially exercisable shares under the convertible notes at February 2, 2008 and February 3, 2007, and 15,413 of potentially exercisable shares under the convertible notes at January 28, 2006, that were not included in the computation of diluted EPS due to the assumption of net share settlement as discussed below. Additionally, included in the computation of diluted EPS as of February 2, 2008 are 11,190 potentially dilutive shares associated with shares the Company would issue to settle the difference between the fair value and the par value of the convertible notes upon conversion and the shares to be issued upon the exercise of a call option the Company sold at the time of issuance of the convertible debentures.
F-14
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
If the holders of the convertible notes exercise their conversion rights, the Company intends to pay cash equal to 100 percent of the principal amount of the convertible notes. In the event that the cash conversion price exceeds 100 percent of the principal amount of the 2% convertible notes, the Company’s intention is to issue common stock for the difference between the par value and fair value at the time of conversion. The Company has $101,162 of cash available as well as availability under the senior revolving credit facility as of February 2, 2008. The cash on hand as well as the availability of borrowings under the senior credit facility provide an adequate source of liquidity to pay 100% of the principal amount of the notes if the holders exercise their conversion rights.
The FASB is contemplating an amendment to SFAS No. 128, “Earnings Per Share,” that would require the Company to ignore the cash presumption of net share settlement and to assume share settlement for purposes of calculating diluted earnings per share. Although the Company is now required to ignore the contingent conversion provision on its convertible notes under EITF 04-08, it can still presume that it will satisfy the net share settlement of the par value upon conversion of the notes in cash, and thus exclude the effect of the conversion of the notes in its calculation of diluted earnings per share. If and when the FASB amends SFAS No. 128, the effect of the changes would require the Company to use the if-converted method in calculating diluted earnings per share except when the effect would be anti-dilutive. The effect of adopting the amendment to SFAS No. 128 would increase the number of shares in the Company’s diluted calculation by 19,219 shares as of February 2, 2008.
PENSION PLANS
Pension expense is based on actuarial models used to estimate the total benefits ultimately payable to associates and is allocated to the 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 pension plans are valued annually on November 1st. The projected unit credit method is utilized in recognizing the pension liabilities.
GIFT CARDS
The Company sells gift cards with no expiration dates. At the time gift cards are sold, no revenue is recognized; rather 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 aggregated $27,003, and $37,300 at February 2, 2008, and February 3, 2007, respectively.
Outstanding gift cards may be subject to state escheatment laws. The Company periodically evaluates unredeemed gift cards and if a determination is made that it is remote that the gift card will be redeemed and if it is determined that the gift card is not subject to escheatment, then the Company will reverse the unredeemed liability. The total reversal reflected in net sales for the year ended February 2, 2008 was $11,701. There was no gift card breakage reflected in net sales in fiscal 2006 and 2005.
F-15
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
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 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.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued Interpretation 48 (“FIN 48”) Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes. This interpretation clarifies the application of Statement 109 by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements. For a benefit to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The benefit to be recognized for a tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. FIN 48 also provides guidance on derecognition, classification of interest and penalties, accounting in interim periods, and disclosure. The Company adopted FIN 48 as of February 4, 2007, as required. The cumulative effect of adopting FIN 48 was recorded as an adjustment to shareholders’ equity in the first quarter of 2007.
The FASB is contemplating an amendment to SFAS No. 128, “Earnings Per Share,” that would require the Company to ignore the cash presumption of net share settlement and to assume share settlement for purposes of calculating diluted earnings per share. Although the Company is now required to ignore the contingent conversion provision on its convertible notes under EITF 04-08, it can still presume that it will satisfy the net share settlement upon conversion of the notes in cash, and thus exclude the effect of the conversion of the notes in its calculation of dilutive earnings per share. If and when the FASB amends SFAS No. 128, the effect of the changes would require the Company to use the if-converted method in calculating dilutive earnings per share except when the effect would be anti-dilutive. The effect of adopting the amendment to SFAS No. 128 would increase the number of shares in the Company’s dilutive calculation by 19,219 shares.
During September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or a liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under SFAS No. 157, fair value measurements would be separately disclosed by level within the fair value hierarchy effective for fiscal years beginning after November 15, 2007. However, the FASB deferred the effective date of SFAS 157, until the beginning of our 2009 fiscal year, as it relates to fair value measurement requirements for nonfinancial assets and liabilities that are not remeasured at fair value on a recurring basis. The Company is currently evaluating the impact of adopting SFAS 157.
On September 29, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). The Company adopted SFAS No. 158 prospectively on February 3, 2007. SFAS No. 158 requires an employer that sponsors one or more defined benefit pension plans or other postretirement plans to 1) recognize the funded status of a plan, measured as the difference between plan assets at fair value and the benefit obligation, in the balance sheet; 2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the
F-16
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
period but are not recognized as components of net periodic benefit cost; 3) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end balance sheet; and 4) disclose in the notes to the financial statements additional information about the effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition assets or obligations. The adoption of SFAS No. 158 did not have a material effect on the Company’s results of operations or financial position for the fiscal year ended February 3, 2007. Additionally, SFAS No. 158 will require the Company to change the measurement date for the assets and liabilities of its employee benefit plans from November 1 to the Company’s fiscal year end beginning with the year ending January 31, 2009.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that currently are not required to be measured at fair value. This Statement is effective no later than fiscal years beginning on or after November 15, 2007. We believe this statement has an immaterial impact on the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which addresses the recognition and accounting for identifiable assets acquired, liabilities assumed, and non-controlling interests in business combinations. SFAS 141(R) also establishes expanded disclosure requirements for business combinations. SFAS 141(R) will become effective as of the beginning of the 2009 fiscal year. The adoption of this standard will not have a material impact on the consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” This standard outlines the accounting and reporting for ownership interest in a subsidiary held by parties other than the parent. SFAS No. 160 is effective as of the beginning of the 2009 fiscal year. The adoption of this standard will not have a material impact on the consolidated financial statements.
NOTE 3 — PROPRIETARY CREDIT CARD RECEIVABLES
On April 15, 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, a third party financial institution.
HSBC, an affiliate of HSBC Holdings PLC, offers proprietary credit card accounts to the Company’s customers. Pursuant to a program agreement with a term of ten years expiring in 2013, HSBC establishes and owns proprietary credit card accounts for the Company’s customers, retains the benefits and risks associated with the ownership of the accounts, receives the finance charge income and incurs the bad debts associated with those accounts. During the ten-year term, pursuant to a servicing agreement, the Company continues to provide key customer service functions, including new account opening, transaction authorization, billing adjustments and customer inquiries, and receives compensation from HSBC for these services.
At the end of the ten-year term expiring in 2013, the agreement can be renewed for two two-year terms. At the end of the agreement, the Company has the right to repurchase, at fair value, all of the accounts and outstanding accounts receivable, negotiate a new agreement with HSBC or begin issuing private label credit cards itself or through others. The agreement allows the Company to terminate the agreement early following the occurrence of certain events, the most significant of which would be HSBC’s failure to pay owed amounts,
F-17
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
bankruptcy, a change in control or a material adverse change in HSBC’s ability to perform under the agreement. The agreement also allows for HSBC to terminate the agreement if the Company fails to pay owed amounts or enters bankruptcy. Should either the Company or HSBC choose to terminate the agreement early, the Company has the right, but not the requirement, to repurchase the credit card accounts and associated accounts receivable from HSBC at their fair value. The Company is contingently liable to pay monies to HSBC in the event of an early termination or a significant disposition of stores. The contingent payment is based upon a declining portion of an amount established at the beginning of the ten-year agreement and on a prorated portion of significant store closings. The maximum contingent payment had the agreement been terminated early at February 2, 2008 would have been approximately $27,234. Management believes the risk of incurring a contingent payment is remote.
In September of 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 Fifth 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. The credit contribution was represented by program compensation and servicing compensation. For 2007, 2006, and 2005, the components of the credit contribution included in SG&A were $28,754, $58,038, and $61,047, respectively
NOTE 4 — PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
Depreciation expense was $134,608, $128,495, and $133,529 in 2007, 2006, and 2005, respectively.
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SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
NOTE 5 — INTANGIBLE ASSETS
The components of amortizable intangible assets at February 2, 2008 were as follows:
Amortization expense was $27 in 2007, 2006, and 2005, and will remain consistent for each of the next 5 years.
NOTE 6 — INCOME TAXES
The components of income tax expense (benefit) were as follows:
F-19
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
Components of the net deferred tax asset or liability recognized in the consolidated balance sheets were as follows:
At February 2, 2008, the Company had deferred tax assets of $13,926 related to U.S. Federal Net Operating Loss (NOL) carryforwards of $39,789. The total Federal NOL carryforwards are $61,629 which includes $21,840 of excess tax deductions associated with our stock option plans which have yet to reduce taxes payable. Upon the utilization of these carryforwards, the associated tax benefits of $8,518 will be recorded to Additional Paid-in-Capital. This amount considers the fact that the carryforwards are restricted under federal income tax change-in-ownership rules. The federal and state NOL carryforwards will expire between 2008 and 2027. The Company believes it will be sufficiently profitable during the periods from 2008 to 2027 to utilize all of its federal NOLs and a portion of its existing state NOLs. A valuation allowance has been established against that portion of the existing state NOLs that the Company currently does not anticipate being able to utilize based on current projections.
During 2007, the valuation allowance was evaluated on a jurisdiction-by-jurisdiction basis which resulted in a net reduction to the overall valuation allowance of $2,957 based on projections of future profitability. A similar analysis was performed in 2006, which resulted in a net reduction to the overall valuation allowance of $1,465.
As a result of the analysis of uncertain tax positions (due to the adoption of FIN 48), the net deferred tax asset related to the state net operating loss carryforwards increased. Therefore, the Company performed a valuation allowance analysis to determine the realization of this asset. This analysis resulted in an additional valuation allowance of $19,258 with the offset recorded to shareholders’ equity in accordance with Statement of
F-20
SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
Positions 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.” The Company is subject to the provisions of Statement of Position 90-7 for these net operating losses since these losses were acquired through the acquisition of a company that had previously filed bankruptcy.
Income tax expense varies from the amount computed by applying the statutory federal income tax rate to income before taxes. The reasons for this difference were as follows:
During 2007, an additional reserve of $1,793 was established for issues raised in current state tax examinations and previously filed federal tax returns related to prior periods. During 2006, the Company favorably concluded certain tax examinations which resulted in an income tax benefit of $10,150. The Company analyzed its positions related to the reserve for tax exposures and determined the amount was adequate. The Company will continue to analyze its positions related to the reserve for tax exposures on an ongoing basis.
The Company made income tax payments, net of refunds received of $(17,492), $34,222 and, $18,278 during 2007, 2006 and 2005, respectively.
The Company adopted the provisions of FIN No. 48, effective as of the beginning of fiscal year 2007. As a result of the implementation of FIN No. 48, the Company recorded a $33,671 decrease in the liability for unrecognized tax benefits which was accounted for as an increase to the beginning shareholder’s equity. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits follows:
Including the cumulative effect decrease, at the beginning and ending of 2007 the Company had approximately $43,956 and $44,646 of total unrecognized tax benefits, respectively. Of these totals, $12,575 and $13,264 (net of the federal benefit on state issues) represents the amounts of unrecognized tax benefits that, if recognized, would affect the effective income tax rate in any future periods. It is reasonably possible that the amount of unrecognized tax benefits will increase or decrease in the next twelve months as a result of settling uncertain tax positions. However, the Company does not anticipate this to result in any material changes to the amount of unrecognized tax benefits.
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SAKS INCORPORATED & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (In thousands, except per share amounts)
The Company recognizes interest accrued related to unrecognized tax benefits and penalties in income tax expense. During the year ended February 2, 2008, the Company recognized approximately $337 in interest and penalties. The Company had approximately $3,230 for the payment of interest and penalties accrued as of February 2, 2008.
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 for taxable years through January 29, 2005 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 currently has examinations in progress for several jurisdictions.
NOTE 7 — DEBT
A summary of Long-Term Debt is as follows:
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