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SKS > SEC Filings for SKS > Form 10-Q on 31-May-2012All Recent SEC Filings

Show all filings for SAKS INC

Form 10-Q for SAKS INC


31-May-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Management's Discussion and Analysis ("MD&A") is intended to provide an analytical view of the business from management's perspective of operating the business and has the following components:

Management's Overview

Results of Operations

Liquidity and Capital Resources

Contractual Obligations and Off-Balance Sheet Arrangements

Critical Accounting Policies and Estimates

MD&A should be read in conjunction with the consolidated financial statements and related notes thereto contained elsewhere in this report.

MANAGEMENT'S OVERVIEW

GENERAL

The operations of Saks Incorporated and its subsidiaries (together the "Company") consist of Saks Fifth Avenue ("SFA") stores and SFA e-commerce operations ("Saks Direct") as well as Saks Fifth Avenue OFF 5TH ("OFF 5TH"). The Company is an omni-channel luxury retailer offering a wide assortment of distinctive fashion apparel, shoes, accessories, jewelry, cosmetics, and gifts. SFA stores are principally free-standing stores in exclusive shopping destinations or anchor stores in upscale regional malls. Customers may also purchase SFA products online at saks.com or by catalog. OFF 5TH is intended to be the premier luxury off-price retailer in the United States. OFF 5TH stores are primarily located in upscale mixed-use and off-price centers and offer luxury apparel, shoes, and accessories, targeting the value-conscious customer. As of April 28, 2012, the Company operated 45 SFA stores with a total of approximately 5.4 million square feet and 61 OFF 5TH stores with a total of approximately 1.8 million square feet.

FINANCIAL PERFORMANCE SUMMARY

For the first quarter ended April 28, 2012, the Company recorded net income of $32.1 million, or $0.18 per diluted share. The results included after-tax charges of $0.6 million, or $0.01 per share, composed of $0.4 million of pre-opening costs associated with the Company's new fulfillment center opening in Tennessee in August 2012 and $0.2 million of final expenses related to the Saks Fifth Avenue Pittsburgh store closing.

For the first quarter ended April 30, 2011, the Company recorded net income of $28.4 million, or $0.16 per diluted share. The results included after-tax charges of $1.8 million, or $0.01 per share, of store closing costs primarily related to the lease termination charge incurred in connection with the relocation of the Hilton Head OFF 5TH store and a $0.3 million loss on extinguishment of debt related to the early retirement of the $1.9 million 7.375% senior notes.

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.


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RESULTS OF OPERATIONS

The following table sets forth, for the periods presented, selected items from
the Company's Consolidated Statements of Income, expressed as percentages of net
sales (numbers may not total due to rounding):



                                                        Three Months Ended
                                                   April 28,          April 30,

                                                      2012               2011
     Net sales                                          100.0  %          100.0  %
     Cost of sales                                        55.6              55.9

     Gross margin                                         44.4              44.1

     Selling, general & administrative expenses           25.2              24.6
     Other operating expenses                             10.5              10.8
     Impairments and dispositions                          0.0               0.4

     Operating income                                      8.6               8.3

     Interest expense                                     (1.2 )            (1.9 )
     Loss on extinguishment of debt                         -               (0.1 )
     Other income, net                                     0.1               0.1

     Income before income taxes                            7.5               6.5

     Provision for income taxes                            3.2               2.5

     Net income                                           4.3  %            3.9  %

THREE MONTHS ENDED APRIL 28, 2012 COMPARED TO THREE MONTHS ENDED APRIL 30, 2011

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income for the three-month
period ended from April 30, 2011 to April 28, 2012:



                                                           Total
           (In millions)                                  Company
           For the three months ended April 30, 2011   $         60.4

           Store sales and margin                                14.6
           Operating expenses                                   (12.7 )
           Impairments and dispositions                           2.6

           Increase                                               4.5

           For the three months ended April 28, 2012   $         64.9

For the three months ended April 28, 2012, the Company's operating income was $64.9 million compared to operating income of $60.4 million in the same period last year. The $4.5 million improvement in operating income for the quarter was primarily driven by a 4.8% increase in comparable store sales as well as a 30 basis points improvement in the period-over-period gross margin rate resulting from increased full-price selling.

NET SALES

For the three months ended April 28, 2012, total net sales increased 3.8% to $753.6 million from $726.0 million for the three months ended April 30, 2011. Comparable store sales increased $33.5 million, or 4.8%, from $697.3 million for the three months ended April 30, 2011 to $730.8 million for the three months ended April 28, 2012.

Comparable store sales are calculated on a rolling 13-month basis. Thus, to be included in the comparison, a store must be open for 13 months. The additional month is used to transition the first month impact of a new store opening. Correspondingly, closed stores are removed from the comparable store sales comparison when they begin liquidating merchandise. Expanded or remodeled stores are included in the comparable store sales comparison.


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GROSS MARGIN

For the three months ended April 28, 2012, gross margin was $334.5 million, or 44.4% of net sales, compared to $319.9 million, or 44.1% of net sales, for the three months ended April 30, 2011. The Company's gross margin rate increased 30 basis points in the quarter primarily as a result of increased full-price selling compared to the same period last year.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A")

For the three months ended April 28, 2012, SG&A was $190.0 million, or 25.2% of net sales, compared to $178.4 million, or 24.6% of net sales, for the three months ended April 30, 2011. The period-over-period increase was primarily the result of higher variable costs associated with the $27.6 million sales increase for the period and targeted investment spending to support growth areas such as Saks Direct and other omni-channel initiatives.

OTHER OPERATING EXPENSES

For the three months ended April 28, 2012, other operating expenses, including property and equipment rentals, depreciation and amortization, taxes other than income taxes and store pre-opening costs, were $79.2 million, or 10.5% of net sales, compared to $78.3 million, or 10.8% of net sales, for the three months ended April 30, 2011. As a percentage of sales, other operating expenses improved by 30 basis points year-over-year. The increase in operating expenses of $0.9 million was principally driven by increases in property and equipment rentals of $0.8 million and store pre-opening costs of $0.7 million which were partially offset by lower depreciation and amortization.

IMPAIRMENTS AND DISPOSITIONS

For the three months ended April 28, 2012, impairment and disposition costs were $0.3 million compared to $2.9 million for the three months ended April 30, 2011. The current period charge was primarily due to the final expenses related to the Saks Fifth Avenue Pittsburgh store closing. The prior year charges were primarily driven by a lease termination charge incurred in connection with the relocation of the Hilton Head OFF 5th store.

INTEREST EXPENSE

For the three months ended April 28, 2012, interest expense was $9.4 million, or 1.2% of net sales, compared to $13.6 million, or 1.9% of net sales, for the three months ended April 30, 2011. The decrease of $4.2 million was primarily due to the extinguishment of $141.6 million of the 9.875% senior notes that matured in October 2011. Non-cash interest expense associated with the amortization of the debt discount on the Company's convertible notes was $3.4 million and $3.1 million for the three months ended April 28, 2012 and April 30, 2011, respectively.

INCOME TAXES

The effective income tax rate for the three-month periods ended April 28, 2012 and April 30, 2011 was 42.9% and 39.3%, respectively. The increase in the effective tax rate for the three months ended April 28, 2012 is primarily due to the write-off of a deferred tax asset associated with non-deductible compensation and an increase in state tax expense.

The Company's Consolidated Balance Sheet as of April 28, 2012 includes a gross deferred tax asset of $102.0 million related to U.S. federal and state net operating loss ("NOL") and alternative minimum tax credit carryforwards. The majority of the NOL carryforward is a result of the NOLs incurred during the fiscal years ended January 30, 2010 and January 31, 2009 due principally to difficult market and macroeconomic conditions. The Company has concluded, based on the weight of all available positive and negative evidence, that all but $18.8 million of these tax benefits relating to certain state losses are more likely than not to be realized in the future. Therefore, a valuation allowance in the amount of $18.8 million has been established.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOW

Net cash provided by operating activities was $2.4 million for the three months ended April 28, 2012 and $21.9 million for the three months ended April 30, 2011. Cash provided by operating activities primarily represents income before depreciation and non-cash charges and after changes in working capital. Working capital is significantly impacted by changes in inventory and accounts payable. Inventory levels typically increase or decrease to support expected sales levels and accounts payable fluctuations are generally determined by the timing of merchandise purchases and payments. The $19.5 million decrease is primarily due to changes in working capital.


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Net cash used in investing activities was $20.6 million for the three months ended April 28, 2012 and $11.9 million for the three months ended April 30, 2011. Cash used in investing activities primarily relates to construction of new stores, renovation and expansion of existing stores, and investments in support areas (e.g., technology and distribution centers). The $8.7 million increase in cash used in investing activities is related to an increase in capital expenditures for the period.

Net cash provided by financing activities was $7.1 million for the three months ended April 28, 2012 and net cash used in financing activities was $5.8 million for the three months ended April 30, 2011. The $12.9 million change in cash flows from financing activities is primarily due to an $8.0 million increase in excess tax benefits from stock-based compensation. Additionally, there were $3.0 million of financing fees and $2.4 million of long-term debt payments made in the prior year related to the amendment of the Company's revolving credit facility and the redemption of the Company's 7.375% senior notes. There were no such payments in the current period.

CASH BALANCES AND LIQUIDITY

The Company's primary sources of short-term liquidity are cash on hand and availability under its $500.0 million revolving credit facility. As of April 28, 2012 and April 30, 2011, the Company maintained cash and cash equivalent balances of $189.0 million and $202.0 million, respectively. Exclusive of $5.3 million and $9.2 million of store operating cash as of April 28, 2012 and April 30, 2011, respectively, cash was invested primarily in money market funds, demand deposits, and time deposits.

The primary needs for cash are to fund operations, acquire or construct new stores, renovate and expand existing stores, provide working capital for new and existing stores, invest in technology and distribution centers and service debt. Additionally, the Company began a multi-year transformation of its information technology systems that will result in the migration of its existing merchandising, finance, and human resources systems to an enterprise-wide systems solution. The Company anticipates that working capital requirements related to existing stores, store renovations and capital expenditures will be funded through cash on hand, cash provided by operations, and the revolving credit facility.

There are numerous general business and economic factors affecting the retail industry. These factors include consumer confidence levels, intense competition, global economic conditions and financial market stability. Significant changes in one or more of these factors could potentially have a material adverse impact on the Company's ability to generate sufficient cash flows to operate its business. The Company expects to be able to manage its working capital and capital expenditure amounts so as to maintain sufficient levels of liquidity. Depending upon its actual and anticipated sources and uses of liquidity, conditions in the capital markets and other factors, the Company may from time to time consider the issuance of debt or other securities or other possible capital market transactions for the purpose of raising capital which could be used to refinance current indebtedness or for other corporate purposes.

CAPITAL STRUCTURE

The Company continuously evaluates its debt-to-capitalization ratio in light of business and economic trends, interest rate levels, and the terms, conditions and availability of capital in the capital markets. As of April 28, 2012, the Company's capital and financing structure consisted of a revolving credit facility, senior unsecured notes, convertible senior unsecured notes, and capital and operating leases. As of April 28, 2012, total funded debt (including the equity component of the convertible notes) was $407.9 million, representing a decrease of $142.7 million from the balance of $550.6 million at April 30, 2011. This decrease in debt was primarily the result of the maturity of $141.6 million of the Company's 9.875% senior notes in October 2011. Additionally, the Company's debt-to-capitalization ratio decreased to 25.2% as of April 28, 2012 from 32.5% as of April 30, 2011.

Revolving Credit Facility

The Company has a $500.0 million revolving credit facility that matures in March 2016 and is subject to a borrowing base equal to a specified percentage of eligible inventory and certain credit card receivables. As the Company's inventory levels fluctuate, these changes may, at times, cause the borrowing capacity to fall below the stated $500.0 million maximum. There are no debt ratings-based provisions in the revolving credit facility. The facility includes a fixed-charge coverage ratio requirement of 1.0 to 1.0 that the Company is subject to only if availability under the facility is less than $62.5 million. As of April 28, 2012, the Company was not subject to the fixed charge coverage ratio requirement as its availability under the facility exceeded $62.5 million. Based on the inventory and credit card receivables balances as of April 28, 2012, the Company had $494.2 million of availability under the facility, after deducting outstanding letters of credit of $5.8 million. The facility contains default provisions that are typical for this type of financing, including a provision that would trigger a default under the facility if a default were to occur in another debt instrument


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resulting in the acceleration of more than $20.0 million in that other instrument. As of April 28, 2012, the Company had no direct outstanding borrowings under the revolving credit facility.

Senior Notes

Excluding the convertible notes, as of April 28, 2012, the Company had $2.1 million of senior notes outstanding that mature in 2013 with an interest rate of 7.0%. The terms of the senior notes call for all principal to be repaid at maturity and places limitations on the amount of secured indebtedness the Company may incur. There are no financial covenants or debt-ratings-based provisions associated with these notes. The Company believes it will have sufficient cash on hand, availability under its revolving credit facility, and access to various capital markets to repay the senior notes at maturity.

7.5% Convertible Notes

As of April 28, 2012, the Company had $120.0 million of convertible notes outstanding that bear cash interest semiannually at an annual rate of 7.5% and mature in 2013. The provisions of the convertible notes allow the holder to convert the notes at any time to shares of the Company's common stock at a conversion rate of 180.5869 shares per one thousand dollars in principal amount of notes. The Company can settle a conversion with shares, cash, or a combination thereof at its discretion.

Upon issuance of the convertible notes, the Company estimated the fair value of the liability component of the 7.5% convertible notes, assuming a 13.0% non-convertible borrowing rate, to be $98.0 million. The difference between the fair value and the principal amount of the 7.5% convertible notes was $22.0 million. This amount was recorded as a debt discount and as an increase to additional paid-in capital as of the issuance date. The current unamortized discount of $9.2 million is being accreted to interest expense over the remaining 1.6 year period to the maturity date of the notes in December 2013 resulting in an increase in non-cash interest expense.

2.0% Convertible Senior Notes

As of April 28, 2012, the Company had $230.0 million of convertible senior notes outstanding that bear interest at a rate of 2.0% per annum and mature in 2024. The provisions of the convertible notes allow the holder to convert the notes to shares of the Company's common stock at a conversion rate of 83.5609 shares per one thousand dollars in principal amount of notes (subject to an anti-dilution adjustment). The holder may put the debt back to the Company in 2014 or 2019 and the convertible notes became callable at the option of the Company beginning on March 21, 2011. The Company can settle a conversion of the notes with shares, cash, or a combination thereof at its discretion. The holders may convert the notes at the following times, among others: (i) if the Company's share price is greater than 120% of the applicable conversion price for a certain trading period; (ii) if the credit ratings of the convertible notes are below a certain threshold; or (iii) upon the occurrence of certain consolidations, mergers or share exchange transactions involving the Company. As of April 28, 2012, none of the criteria were met.

The Company estimated the fair value of the liability component, as of the date of issuance, of its 2.0% convertible senior notes assuming a 6.25% non-convertible borrowing rate to be $158.1 million. The difference between the fair value and the principal amount of the notes was $71.9 million. This amount was recorded as a debt discount and as an increase to additional paid-in capital as of the issuance date. The discount is being amortized over the expected life of a similar liability that does not have an associated equity component (considering the effects of embedded features other than the conversion option). Since the holders of the convertible notes have put options in 2014 and 2019, the debt instrument is being accreted to par value using the effective interest method from issuance until the first put date in 2014, resulting in an increase in non-cash interest expense. The current unamortized discount of $17.0 million will be recognized over the remaining 1.9 year period.

The Company believes it will have sufficient cash on hand, availability under its revolving credit facility, and access to various capital markets to retire both convertible notes at maturity.

Capital Leases

As of April 28, 2012, the Company had $55.8 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 approximately $6.0 million and $9.0 million per year, excluding interest payments.

Pension Plan

The Company is obligated to fund a defined-benefit 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 amended the


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Saks Fifth Avenue Pension Plan ("Pension Plan") during 2006, freezing benefit accruals for all participants except those who have attained age 55 and completed 10 years of credited service as of January 1, 2007, who are considered to be non-highly compensated employees. In January 2009, the Company suspended future benefit accruals for all remaining participants in the plan, effective March 13, 2009. The Company contributed $0.9 million to the Pension Plan during the three months ended April 28, 2012 and expects additional funding requirements of approximately $3.5 million for the remainder of fiscal year 2012.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

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, or obligations under material variable interests.

There were no other material changes in the Company's contractual obligations specified in Item 303(a)(5) of Regulation S-K during the three months ended April 28, 2012. For additional information regarding the Company's contractual obligations as of January 28, 2012, see the Management's Discussion and Analysis section of the Company's Annual Report on Form 10-K/A for the year ended January 28, 2012.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

A summary of the Company's critical accounting policies and estimates is included in the Management Discussion and Analysis section of the Company's Annual Report on Form 10-K/A for the year ended January 28, 2012.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In December 2011, the FASB issued Accounting Standards Update No. 2011-11, Disclosures about Offsetting Assets and Liabilities ("ASU 2011-11"). ASU 2011-11 enhances disclosure requirements regarding financial instruments and derivative instruments that are either offset or subject to an enforceable master netting arrangement or similar agreement. ASU 2011-11 requires disclosure of both net and gross information for these assets and liabilities in order to enhance comparability between those entities that prepare their financial statements in accordance with U.S. GAAP and those entities that prepare their financial statements in accordance with International Financial Reporting Standards. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods. The adoption of ASU 2011-11 will not affect the consolidated financial position, results of operations or cash flows of the Company.

ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS

In June 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income ("ASU 2011-05"). ASU 2011-05 requires reporting entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In December 2011, the FASB indefinitely deferred certain provisions of ASU 2011-05 related to the presentation of reclassification adjustments of items out of accumulated other comprehensive income. Effective January 29, 2012, the Company adopted the applicable portions of ASU 2011-05. The adoption did not affect the consolidated financial position, results of operations, or cash flows of the Company.

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs ("ASU 2011-04"), which amends the existing fair value guidance to improve consistency in the application and disclosure of fair value measurements in U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 provides certain clarifications to the existing guidance, changes certain fair value principles, and enhances disclosure requirements. Effective January 29, 2012, the Company adopted ASU 2011-04. The adoption of ASU 2011-04 resulted in additional disclosures but did not affect the consolidated financial position, results of operations, or cash flows of the Company.

FORWARD-LOOKING INFORMATION

The information contained in this Form 10-Q 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,"


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"estimate," "contemplate," "possible," and "point." The forward-looking information is premised on many factors, some of which are outlined below. Actual consolidated results might differ materially from projected forward-looking information.

The forward-looking information and statements are or may be based on a series of projections and estimates and involve risks and uncertainties. These risks and uncertainties include such factors as: the level of consumer spending for luxury apparel and other merchandise carried by the Company and its ability to respond quickly to consumer trends; macroeconomic conditions and their effect on consumer spending; the Company's ability to secure adequate financing; adequate . . .

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