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SKS > SEC Filings for SKS > Form 10-Q on 28-Nov-2012All Recent SEC Filings

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Form 10-Q for SAKS INC


28-Nov-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 condensed consolidated financial statements and related notes thereto contained elsewhere in this report.

MANAGEMENT'S OVERVIEW

GENERAL

The operations of Saks Incorporated and its subsidiaries (collectively "we," "our," and "us") consist of Saks Fifth Avenue ("SFA") stores and SFA e-commerce operations ("Saks Direct") as well as Saks Fifth Avenue OFF 5TH ("OFF 5TH"). We are 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 a luxury off-price retailer. 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 October 27, 2012, we operated 45 SFA stores with a total of approximately 5.4 million square feet and 64 OFF 5TH stores with a total of approximately 1.9 million square feet.

FINANCIAL PERFORMANCE SUMMARY

For the third quarter ended October 27, 2012, we recorded net income of $22.6 million, or $0.14 per diluted share. The results included after-tax income of $3.3 million, or $0.02 per share, related to the release of a valuation allowance no longer deemed necessary related to federal tax credits.

For the third quarter ended October 29, 2011, we recorded net income of $17.8 million, or $0.11 per diluted share.

We believe that an understanding of our 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 presented, selected items from
our Consolidated Statements of Income, expressed as percentages of net sales
(numbers may not total due to rounding):



                                              Three Months Ended                         Nine Months Ended
                                       October 27,           October 29,          October 27,          October 29,
                                           2012                 2011                 2012                 2011
Net sales                                     100.0  %             100.0  %             100.0  %             100.0  %
Cost of sales (excluding
depreciation and amortization)                 56.1                 55.8                 58.1                 57.9

Gross margin                                   43.9                 44.2                 41.9                 42.1

Selling, general & administrative
expenses                                       27.3                 27.5                 26.5                 26.4
Other operating expenses                       10.9                 10.9                 10.9                 11.0
Impairments and dispositions                    0.0                  0.0                  0.2                  0.2

Operating income                                5.7                  5.7                  4.2                  4.6

Interest expense                               (1.3)                (1.7)                (1.3)                (1.8)
Loss on extinguishment of debt                    -                    -                    -                  0.0
Other income, net                               0.0                  0.1                  0.1                  0.1

Income before income taxes                      4.4                  4.1                  3.0                  2.8

Provision for income taxes                      1.2                  1.5                  1.0                  1.0

Net income                                      3.2  %               2.6  %               2.0  %               1.8  %

THREE MONTHS ENDED OCTOBER 27, 2012 COMPARED TO THREE MONTHS ENDED OCTOBER 29,
2011

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from the three-month
period ended October 29, 2011 to the three-month period ended October 27, 2012:



                                                             Total
           (In millions)                                    Company
           For the three months ended October 29, 2011   $       39.7

           Store sales and margin                                 7.1
           Operating expenses                                    (6.1)

           Increase                                               1.0

           For the three months ended October 27, 2012   $       40.7

For the three months ended October 27, 2012, our operating income was $40.7 million compared to operating income of $39.7 million in the same period last year. The $1.0 million increase in operating income for the quarter was driven primarily by the higher gross margin resulting from a 3.3% increase in comparable store sales. This was partially offset by an increase in selling, general and administrative expenses supporting the growth of Saks Direct and other omni-channel initiatives, including our information technology and systems enhancements known as Project Evolution.

NET SALES

For the three months ended October 27, 2012, total net sales increased 3.0% to $713.2 million from $692.3 million for the three months ended October 29, 2011. Comparable store sales increased $22.2 million, or 3.3%, from $669.9 million for the three months ended October 29, 2011 to $692.1 million for the three months ended October 27, 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.

GROSS MARGIN

For the three months ended October 27, 2012, gross margin was $313.0 million, or 43.9% of net sales, compared to $305.8 million, or 44.2% of net sales, for the three months ended October 29, 2011. Our gross margin rate decreased 30 basis points in the quarter primarily as a result of a modest period-over-period increase in targeted promotional activity.

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

For the three months ended October 27, 2012, SG&A was $194.6 million, or 27.3% of net sales, compared to $190.2 million, or 27.5% of net sales, for the three months ended October 29, 2011. The period-over-period increase was primarily the result of higher variable costs associated with the $20.9 million sales increase for the period and strategic investment spending to support growth areas such as Saks Direct and other omni-channel initiatives such as Project Evolution.

OTHER OPERATING EXPENSES

For the three months ended October 27, 2012, other operating expenses, including property and equipment rentals, depreciation and amortization, taxes other than income taxes and store pre-opening costs, were $77.4 million, or 10.9% of net sales, compared to $75.7 million, or 10.9% of net sales, for the three months ended October 29, 2011. The increase in operating expenses of $1.7 million was primarily driven by an increase in property and equipment rentals of $2.0 million.

IMPAIRMENTS AND DISPOSITIONS

For the three months ended October 27, 2012, impairment and disposition costs were $0.2 million compared to $0.2 million for the three months ended October 29, 2011. The current and prior period charges were primarily due to losses on the disposal of assets during the normal course of business.

INTEREST EXPENSE

For the three months ended October 27, 2012, interest expense was $9.3 million, or 1.3% of net sales, compared to $11.9 million, or 1.7% of net sales, for the three months ended October 29, 2011. The decrease of $2.6 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 our convertible notes was $3.6 million and $3.3 million for the three months ended October 27, 2012 and October 29, 2011, respectively.

INCOME TAXES

The effective income tax rates for the three-month periods ended October 27, 2012 and October 29, 2011 were 28.2% and 37.4%, respectively. The decrease in the effective tax rate for the three months ended October 27, 2012 is primarily due to the release of a $3.3 million valuation allowance no longer deemed necessary related to federal tax credits.

As of October 27, 2012, gross deferred tax assets related to U.S. federal and state net operating loss ("NOL"), alternative minimum tax credit and other federal tax credit carryforwards were $91.5 million. 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 principally due to difficult market and macroeconomic conditions. We have concluded, based on the weight of all available positive and negative evidence, that all but $18.1 million of these tax benefits relating to certain state losses are more likely than not to be realized in the future. Therefore, the valuation allowance as of October 27, 2012 was $18.1 million.


NINE MONTHS ENDED OCTOBER 27, 2012 COMPARED TO NINE MONTHS ENDED OCTOBER 29, 2011

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from the nine-month
period ended October 29, 2011 to the nine-month period ended October 27, 2012:



                                                            Total
           (In millions)                                   Company
           For the nine months ended October 29, 2011    $       96.3

           Store sales and margin                                29.2
           Operating expenses                                   (31.9)
           Impairments and dispositions                          (1.9)

           Decrease                                              (4.6)

           For the nine months ended October 27, 2012    $       91.7

For the nine months ended October 27, 2012, our operating income was $91.7 million compared to operating income of $96.3 million in the same period last year. The $4.6 million decrease in operating income for the nine months was primarily driven by an increase in selling, general and administrative expenses supporting the growth of Saks Direct and other omni-channel initiatives, including Project Evolution. In addition, we incurred incremental costs associated with the opening of our new distribution center in Tennessee that became operational in July 2012 and higher asset impairment charges. These expense increases were partially offset by the higher gross margin resulting from the 4.3% increase in comparable store sales.

NET SALES

For the nine months ended October 27, 2012, total net sales increased 3.9% to $2,170.9 million from $2,088.5 million for the nine months ended October 29, 2011. Comparable store sales increased $85.8 million, or 4.3%, from $2,014.4 million for the nine months ended October 29, 2011 to $2,100.2 million for the nine months ended October 27, 2012.

GROSS MARGIN

For the nine months ended October 27, 2012, gross margin was $909.5 million, or 41.9% of net sales, compared to $880.3 million, or 42.1% of net sales, for the nine months ended October 29, 2011. Our gross margin rate decreased 20 basis points in the period primarily as a result of incremental markdowns in certain merchandise categories during our normal clearance cycle in the second quarter and a modest increase in period-over-period targeted promotional activity during the third quarter.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

For the nine months ended October 27, 2012, SG&A was $575.4 million, or 26.5% of net sales, compared to $552.0 million, or 26.4% of net sales, for the nine months ended October 29, 2011. The year-over-year increase was primarily the result of higher variable costs associated with the $82.5 million sales increase for the period and targeted investment spending to support growth areas such as Saks Direct and other omni-channel initiatives, such as Project Evolution.

OTHER OPERATING EXPENSES

For the nine months ended October 27, 2012, other operating expenses were $237.2 million, or 10.9% of net sales, compared to $228.7 million, or 11.0% of net sales, for the nine months ended October 29, 2011. The increase in operating expenses of $8.5 million was principally driven by increases in property and equipment rentals of $4.0 million, as well as increases in store pre-opening costs of $3.4 million primarily related to our new fulfillment center in Tennessee which opened in July 2012.

IMPAIRMENTS AND DISPOSITIONS

For the nine months ended October 27, 2012, impairment and disposition costs were $5.2 million compared to $3.3 million for the nine months ended October 29, 2011. The current period charge was primarily due to asset impairment charges as well as final expenses related to the closing of our SFA Pittsburgh store. The prior year charges were primarily driven by a lease termination charge incurred in connection with the relocation of our Hilton Head OFF 5TH store.


INTEREST EXPENSE

For the nine months ended October 27, 2012, interest expense was $28.3 million, or 1.3% of net sales, compared to $38.5 million, or 1.8% of net sales, for the nine months ended October 29, 2011. The decrease of $10.2 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 our convertible notes was $10.5 million and $9.6 million for the nine months ended October 27, 2012 and October 29, 2011, respectively.

INCOME TAXES

The effective income tax rates for the nine-month periods ended October 27, 2012 and October 29, 2011 were 34.7% and 35.7%, respectively. The decrease in the effective tax rate for the nine months ended October 27, 2012 is primarily due to the release of a valuation allowance no longer deemed necessary related to federal tax credits which was partially offset by the write-off of a deferred tax asset associated with non-deductible compensation.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOW

Net cash provided by operating activities was $37.1 million for the nine months ended October 27, 2012 and $119.0 million for the nine months ended October 29, 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 $81.9 million decrease is primarily due to changes in working capital.

Net cash used in investing activities was $87.0 million for the nine months ended October 27, 2012 and $63.9 million for the nine months ended October 29, 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 $23.1 million increase in cash used in investing activities is primarily due to an increase in capital expenditures for the period. A portion of the increase in capital expenditures relates to Project Evolution, a multi-year project to enhance our information technology systems that will result in the migration of our existing merchandising, planning, procurement, finance, and human resources systems to an enterprise-wide systems solution.

Net cash used in financing activities was $76.0 million for the nine months ended October 27, 2012 and $179.3 million for the nine months ended October 29, 2011. The $103.3 million decrease in cash used in financing activities is primarily due to $144.0 million of long-term debt payments primarily related to the maturity of our 9.875% senior notes in October 2011 and $3.0 million of financing fees paid in the prior year related to the amendment of our revolving credit facility. There were no such payments in the current period. This was partially offset by a $50.2 million increase in repurchases of our common stock and an $8.1 million increase in excess tax benefits from stock-based compensation.

CASH BALANCES AND LIQUIDITY

Our primary sources of short-term liquidity are cash from operations, cash on hand, and availability under our $500.0 million revolving credit facility. As of October 27, 2012 and October 29, 2011, we maintained cash and cash equivalents balances of $74.2 million and $73.7 million, respectively. Exclusive of $4.8 million and $6.1 million of store operating cash as of October 27, 2012 and October 29, 2011, respectively, cash was invested primarily in money market funds, demand deposits, and time deposits. As of October 27, 2012, we had no direct outstanding borrowings under our revolving credit facility and had $493.9 million of availability, based on our inventory and receivable balances and after giving effect to outstanding letters of credit.

Our 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. We anticipate that our working capital requirements related to existing stores, store renovations and capital expenditures will be funded through cash on hand, cash provided by operations, and our 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 our ability to generate sufficient cash flows to operate our business. We expect to be able to manage our working capital and capital expenditures so as to maintain sufficient levels of liquidity. Depending upon our actual and anticipated sources and uses of liquidity, conditions in the capital markets and other factors, we 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.

HURRICANE SANDY

Subsequent to the end our fiscal third quarter, many of our stores were directly impacted by Hurricane Sandy and were closed for several days. We also had a decline in Saks Direct sales generated from our customers in the Northeast and experienced some supply chain disruptions from the storm. However, none of our stores sustained material damage. While we cannot yet fully assess the impact of Hurricane Sandy and its aftermath, we do anticipate that it will have a negative impact on our results of operations for the fourth quarter ending February 2, 2013.

CAPITAL STRUCTURE

We continuously evaluate our 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 October 27, 2012, our capital and financing structure consisted of a revolving credit facility, senior unsecured notes, convertible senior unsecured notes, and capital and operating leases. As of October 27, 2012, total funded debt (including the equity component of the convertible notes) was $404.8 million, representing a decrease of $1.0 million from the balance of $405.8 million at October 29, 2011. Additionally, our debt-to-capitalization ratio decreased to 25.9% as of October 27, 2012 from 26.2% as of October 29, 2011.

During the nine months ended October 27, 2012, we repurchased and retired an aggregate of 8.0 million shares of common stock at an average price of $9.90 and a total cost of $79.1 million. During the nine months ended October 29, 2011, we repurchased and retired an aggregate of 3.5 million shares of common stock at an average price of $8.18 and a total cost of $28.9 million. As of October 27, 2012, there were 21.2 million shares available for repurchase under our share repurchase program.

Revolving Credit Facility

We have 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 our 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 we are subject to only if availability under the facility is less than $62.5 million. As of October 27, 2012, we were not subject to the fixed charge coverage ratio requirement as our availability under the facility exceeded $62.5 million. Based on the inventory and credit card receivables balances as of October 27, 2012, we had $493.9 million of availability under the facility, after deducting outstanding letters of credit of $6.1 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 resulting in the acceleration of more than $20.0 million in that other instrument. As of October 27, 2012, we had no direct outstanding borrowings under the revolving credit facility.

Senior Notes

Excluding the convertible notes, as of October 27, 2012, we 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 we may incur. There are no financial covenants or debt-ratings-based provisions associated with these notes. We believe we will have sufficient cash on hand, availability under our revolving credit facility, and access to various capital markets to repay the senior notes at maturity.

7.5% Convertible Notes

As of October 27, 2012, we had $120.0 million of convertible notes outstanding that bear cash interest semi-annually 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 our common stock at a conversion rate of 180.5869 shares per one thousand dollars in principal amount of notes. We can settle a conversion with shares, cash, or a combination thereof at our discretion.


Upon issuance of the convertible notes, we 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 $6.5 million will be accreted to interest expense over the remaining 1.1 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 October 27, 2012, we 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 our 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 us in 2014 or 2019 and the convertible notes became callable at our option beginning on March 21, 2011. We can settle a conversion of the notes with shares, cash, or a combination thereof at our discretion. The holders may convert the notes at the following times, among others: (i) if our 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 us. As of October 27, 2012, none of the criteria were met.

We estimated the fair value of the liability component, as of the date of issuance, of our 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 date of issuance until the first put date in 2014, resulting in an increase in non-cash interest expense. The current unamortized discount of $12.7 million will be recognized over the remaining 1.4 year period.

We believe we will have sufficient cash on hand, availability under our revolving credit facility, and access to various capital markets to retire both convertible notes at maturity.

Capital Leases

As of October 27, 2012, we had $52.7 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 us to make periodic lease payments, aggregating between approximately $7.0 million and $10.0 million per year, excluding interest payments.

Pension Plan

We are obligated to fund a defined-benefit cash balance pension plan. Our current policy is to maintain at least the minimum funding requirements specified by the Employee Retirement Income Security Act of 1974. We amended the Saks Fifth Avenue Pension Plan ("Pension Plan") during 2006, freezing benefit . . .

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