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SKS > SEC Filings for SKS > Form 10-K on 20-Mar-2013All Recent SEC Filings

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Form 10-K for SAKS INC


20-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

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

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 Form 10-K.

MANAGEMENT'S OVERVIEW

GENERAL

The operations of Saks Incorporated, a Tennessee corporation first incorporated in 1919, and its subsidiaries (collectively "we," "our," and "us") consist of Saks Fifth Avenue ("SFA") stores and SFA's e-commerce operations ("Saks Direct") as well as Saks Fifth Avenue OFF 5TH ("OFF 5TH") stores. Previously, we also operated Club Libby Lu ("CLL"), the operations of which were discontinued in January 2009. The operations of CLL are presented as discontinued operations on the Consolidated Statements of Income and the Consolidated Statements of Cash Flows for the prior year periods and are discussed below in "Discontinued Operations."

We are an omni-channel luxury retailer offering a wide assortment of distinctive fashion apparel, shoes, accessories, jewelry, cosmetics, and gifts. SFA stores are primarily free-standing stores in premier 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 February 2, 2013, we operated 43 SFA stores with a total of approximately 5.3 million square feet and 65 OFF 5TH stores with a total of approximately 1.9 million square feet.

We are primarily focused on the luxury retail sector. All of the goods that we sell are discretionary items. Consequently, a downturn in the economy or difficult economic conditions may result in fewer customers shopping in our stores or online. In response, we may have to increase the duration and/or frequency of promotional events and offer larger discounts in order to attract customers, which would reduce gross margin and adversely affect results of operations.

We continue 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 in information systems and to remodel existing selling space with a heightened focus on return on investment. We believe that our long-term strategic plans can deliver additional operating margin expansion in future years.

We seek to create value for our shareholders by improving returns on our invested capital. We attempt to generate improved operating margins by generating sales increases while improving merchandising margins and controlling expenses. We use operating cash flows to reinvest in the business and to repay debt or to repurchase equity. We actively manage our real estate portfolio by routinely evaluating opportunities to improve or close underproductive stores and open new stores.


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DISCONTINUED OPERATIONS

As of January 31, 2009, we discontinued the operations of our CLL business, which consisted of 98 leased, mall-based specialty stores, targeting girls aged 4-12 years old. Discontinued operations include nominal income for 2010 from residual CLL store closing activities.

HURRICANE SANDY

In November 2012, several 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 physical damage. The impact of Hurricane Sandy dissipated in December 2012 and sales trends returned to a more normalized level at that time.

FINANCIAL PERFORMANCE SUMMARY

Our fiscal year ends on the Saturday closest to January 31st. Fiscal year 2012 contained 53 weeks and ended on February 2, 2013 ("2012"). Fiscal years 2011 and 2010 each contained 52 weeks and ended on January 28, 2012 ("2011") and January 29, 2011 ("2010"), respectively.

Comparable store sales for fiscal 2012 discussed in MD&A does not include the additional week and is based on the 52 weeks ended January 26, 2013. On a consolidated basis, total net sales and comparable store sales for the year ended February 2, 2013 increased 4.4% and 3.2%, respectively. We recorded net income of $62.9 million, or $0.41 per diluted share compared to net income of $74.8 million, or $0.45 per diluted share, for the years ended February 2, 2013 and January 28, 2012, respectively.

The year ended February 2, 2013 included net after-tax charges of $9.5 million or $0.05 per share, primarily related to $7.2 million, or $0.04 per share, of asset impairment charges and store closing costs; $1.8 million, or $0.01 per share, related to the pre-opening costs associated with the opening of our new fulfillment center in Tennessee; a $1.7 million, or $0.01 per share, non-cash pension settlement charge related to excess lump sum distributions and $2.1 million, or $0.01 per share, loss on debt extinguishment related to the early retirement and conversion to equity of approximately $28.8 million (par value) of our 7.5% convertible debt. These charges were partially offset by a net after-tax gain of $3.3 million, or $0.02 per share, related to the reversal of state estimated income tax reserves deemed no longer necessary. Management estimates that the 53rd week added $0.03 per share to earnings per share in the current year.

The year ended January 28, 2012 included a net after-tax gain totaling $2.0 million, or $0.01 per share, primarily related to a $10.9 million, or $0.05 per share, gain related to the reversal of certain estimated state income tax reserves deemed no longer necessary. This gain was partially offset by a net after-tax charge of $5.6 million, or $0.03 per share, primarily related to a pension and related benefit charge, a third-party receivable write-down, severance and asset impairment charges. Additionally, we incurred a $3.0 million, or $0.01 per share, charge related to store closings and a $0.3 million loss on debt extinguishment related to the early retirement of approximately $1.9 million of senior notes during 2011.

The year ended January 29, 2011 included a net after-tax gain totaling $17.2 million, or $0.11 per share, primarily related to a $26.7 million, or $0.17 per share, gain related to the reversal of certain estimated income tax reserves deemed no longer necessary due to the expiration of the statute of limitations. This gain was partially offset by a net after-tax charge of $7.5 million, or $0.05 per share, primarily related to store closings and asset impairments and a $2.0 million, or $0.01 per share, non-cash pension settlement charge related to excess lump sum distributions during 2010.

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.


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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):



                                                                Fiscal Year Ended
                                                February 2,        January 28,        January 29,
                                                   2013                2012               2011
Net sales                                              100.0  %           100.0  %           100.0  %
Cost of sales (excluding depreciation and
amortization)                                          59.4               59.2               59.9

Gross margin                                           40.6               40.8               40.1
Selling, general & administrative expenses             25.8               25.5               25.7
Other operating expenses                               10.0               10.0               10.7
Impairments and dispositions                            0.4                0.3                0.5

Operating income                                        4.4                4.9                3.2
Interest expense                                       (1.2)              (1.6)              (2.0)
Loss on extinguishment of debt                         (0.1)               0.0                0.0
Other income, net                                       0.1                0.1                0.0

Income from continuing operations before
income taxes                                            3.2                3.4                1.2
Provision (benefit) for income taxes                    1.2                0.9               (0.5)

Income from continuing operations                       2.0                2.5                1.7
Discontinued operations:
Income from discontinued operations before
income taxes                                              -                  -                0.0
Provision for income taxes                                -                  -                0.0

Income from discontinued operations                       -                  -                0.0
Net income                                               2.0  %             2.5  %             1.7  %

FISCAL YEAR ENDED FEBRUARY 2, 2013 COMPARED TO FISCAL YEAR ENDED JANUARY 28,
2012

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from 2011 to 2012:



                                                     Total
                  (In millions)                     Company
                  2011 Operating Income          $       148.3

                  Store sales and margin                  49.5
                  Operating expenses                     (57.2)
                  Impairments and dispositions            (2.1)

                  Decrease                                (9.8)

                  2012 Operating Income          $       138.5

For the year ended February 2, 2013, our operating income was $138.5 million, compared to operating income of $148.3 million for the year ended January 28, 2012. The $9.8 million decrease in operating income was primarily driven by an increase in selling, general and administrative expenses ("SG&A") supporting the growth of Saks Direct, including incremental marketing expenses. The increase in SG&A also relates to additional investments in other omni-channel initiatives, including our information technology and system enhancements, known as Project Evolution. In addition, we incurred incremental costs associated with the opening of our new distribution center in Tennessee that became


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operational in July 2012 and an increase in asset impairment charges. These expense increases were partially offset by the higher gross margin dollars resulting from a 4.4% increase in net sales.

NET SALES

For the year ended February 2, 2013, total net sales increased 4.4% to $3,147.6 million from $3,013.6 million for the year ended January 28, 2012. Consolidated comparable store sales increased $92.0 million, or 3.2%, from $2,911.2 million for the year ended January 28, 2012 to $3,003.2 million for the year ended February 2, 2013. The year ended February 2, 2013 also includes an extra week, creating a 53-week fiscal year that occurs every six years in the accounting cycle for many retailers and resulted in a $42.0 million increase in total net sales.

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, as well as Saks Direct sales.

GROSS MARGIN

For the year ended February 2, 2013, gross margin was $1,277.7 million, or 40.6% of net sales, compared to $1,228.2 million, or 40.8% of net sales, for the year ended January 28, 2012. The increase in gross margin dollars was primarily a result of a 4.4% increase in net sales. The gross margin rate decrease of 20 basis points was primarily a result of underperformance in certain merchandise categories combined with our outsized inventory investments in key high-potential growth areas.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

For the year ended February 2, 2013, SG&A was $810.7 million, or 25.8% of net sales, compared to $767.6 million, or 25.5% of net sales, for the year ended January 28, 2012. The increase of $43.1 million in expenses was primarily driven by higher variable costs associated with the $134.0 million sales increase for the year and incremental expenses incurred to support growth areas such as Saks Direct, including additional marketing expenses. The increase also relates to additional investments in other omni-channel initiatives, including Project Evolution.

OTHER OPERATING EXPENSES

For the year ended February 2, 2013, other operating expenses were $316.3 million, or 10.0% of net sales, compared to $302.1 million, or 10.0% of net sales, for the year ended January 28, 2012. The increase of $14.2 million was driven by an increase in property and equipment rentals of $5.9 million primarily related to Project Evolution and new OFF 5TH stores and an increase in pre-opening costs of $3.4 million primarily related to our new fulfillment center in Tennessee which opened in July 2012. This increase was also driven by an increase in taxes other than income taxes of $3.1 million and an increase in depreciation and amortization of $1.8 million.

IMPAIRMENTS AND DISPOSITIONS

For the year ended February 2, 2013, impairments and dispositions totaled $12.2 million compared to $10.1 million for the year ended January 28, 2012. During 2012, we incurred $9.8 million of asset impairment charges related to held and used assets, $2.9 million of store closing costs associated with the closure of three SFA stores (primarily consisting of employee severance) and a net gain of $0.5 million from the sale of assets during the normal course of business. The prior year charges of $10.1 million included store-closing related costs of $4.9 million (primarily driven by a lease termination charge incurred in connection with the relocation of the Hilton Head, South Carolina OFF 5TH store), $5.0 million of asset impairments and $0.2 million of asset dispositions in the normal course of business.

INTEREST EXPENSE

Interest expense decreased to $37.2 million in 2012 from $48.1 million in 2011 and, as a percentage of net sales, was 1.2% in 2012 and 1.6% in 2011. The decrease of $10.9 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


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the debt discount on our convertible notes was $14.0 million and $13.0 million for the years ended February 2, 2013 and January 28, 2012, respectively.

LOSS ON EXTINGUISHMENT OF DEBT

During the year ended February 2, 2013, we recorded a loss on extinguishment of debt of $3.5 million related to the early retirement and conversion to equity of approximately $28.8 million of our 7.5% convertible debt. During the year ended January 28, 2012, we extinguished $1.9 million of our 7.375% senior notes resulting in a loss on extinguishment of debt of $0.5 million.

OTHER INCOME, NET

Other income decreased to $1.6 million in 2012 from $2.2 million in 2011. Other income in 2012 and 2011 was primarily related to interest income on cash and cash equivalents.

INCOME TAXES

For 2012 and 2011, the effective income tax rate for continuing operations differed from the federal statutory tax rate due to state income taxes and other items such as the change in the valuation allowance against state net operating losses ("NOL") carryforwards, the effect of concluding tax examinations and other tax reserve adjustments primarily relating to statute expirations. Including the effect of these items, our effective income tax rate for continuing operations was 36.7% and 26.6% in 2012 and 2011, respectively. The effective tax rate for 2012 was higher than the federal statutory tax rate as a result of state taxes and non-deductible compensation, which were partially offset by the release of a valuation allowance against state NOL carryforwards and tax credits. The effective tax rate for 2011 was less than the statutory tax rate as a result of a release of a valuation allowance against state NOL carryforwards.

FISCAL YEAR ENDED JANUARY 28, 2012 COMPARED TO FISCAL YEAR ENDED JANUARY 29,
2011

DISCUSSION OF OPERATING INCOME- CONTINUING OPERATIONS

The following table shows the changes in operating income from 2010 to 2011:



                                                              Total
           (In millions)                                     Company
           2010 Operating income - continuing operations   $      90.1
           Store sales and margin                                110.9
           Operating expenses                                    (55.7)
           Impairments and dispositions                            3.0

           Increase                                               58.2

           2011 Operating income - continuing operations   $     148.3

For the year ended January 28, 2012, our operating income totaled $148.3 million, a 170 basis point improvement as a percentage of net sales, from the operating income of $90.1 million in 2010. The 2011 operating income was driven by a 9.5% increase in comparable store sales as well as a gross margin rate increase of 70 basis points for the year ended January 28, 2012. The year-over-year increase in the gross margin rate was principally due to increased full-price selling and a reduced level of promotional activity.

NET SALES

For the year ended January 28, 2012, total net sales increased 8.2% to $3,013.6 million from $2,785.7 million for the year ended January 29, 2011. Consolidated comparable store sales increased $252.8 million, or 9.5%, from $2,658.2 million for the year ended January 29, 2011 to $2,911.0 million for the year ended January 28, 2012.


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GROSS MARGIN

For the year ended January 28, 2012, gross margin was $1,228.2 million, or 40.8% of net sales, compared to $1,117.3 million, or 40.1% of net sales, for the year ended January 29, 2011. The increase in gross margin dollars and gross margin rate was primarily the result of higher sales, increased full-price selling and a reduced level of promotional activity.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

For the year ended January 28, 2012, SG&A was $767.6 million, or 25.5% of net sales, compared to $716.0 million, or 25.7% of net sales, for the year ended January 29, 2011. The increase of $51.6 million in expenses was primarily driven by higher variable costs associated with the $227.9 million sales increase in 2011 as well as incremental expenses incurred to support the growth in Saks Direct. Additionally, we experienced an increase in proprietary credit card income related to contract changes with Capital One Financial Corporation.

OTHER OPERATING EXPENSES

For the year ended January 28, 2012, other operating expenses were $302.1 million, or 10.0% of net sales, compared to $298.1 million, or 10.7% of net sales, for the year ended January 29, 2011. The increase of $4.0 million was principally driven by an increase in taxes other than income taxes of $2.9 million, an increase in property and equipment rentals of $0.7 million and an increase in store pre-opening costs of $0.6 million. These increases were partially offset by a decrease in depreciation and amortization of $0.2 million.

IMPAIRMENTS AND DISPOSITIONS

For the year ended January 28, 2012, impairments and dispositions included net charges of $10.1 million compared to net charges of $13.1 million for the year ended January 29, 2011. During 2011 we incurred $4.9 million of store-closing related costs, primarily driven by a lease termination charge incurred in connection with the relocation of our Hilton Head, South Carolina OFF 5TH store. Also included in impairments and dispositions for 2011 were $5.0 million of asset impairments and $0.2 million of asset dispositions in the normal course of business. The prior year charges of $13.1 million included store-closing costs of $12.1 million associated with the closing of seven SFA stores and one OFF 5TH store and $1.0 million of asset impairments and dispositions in the normal course of business.

INTEREST EXPENSE

Interest expense decreased to $48.1 million in 2011 from $56.7 million in 2010 and, as a percentage of net sales, was 1.6% in 2011 and 2.0% in 2010. The decrease of $8.6 million was primarily due to the extinguishment of $22.9 million of the 7.5% senior notes that matured in December 2010 and extinguishment of $141.6 million of the 9.875% senior notes that matured in October 2011. Non-cash interest expense associated with the amortization of the debt discount on our convertible notes was $13.0 million and $11.9 million for the years ended January 28, 2012 and January 29, 2011, respectively.

LOSS ON EXTINGUISHMENT OF DEBT

During the year ended January 28, 2012, we extinguished $1.9 million of our 7.375% senior notes resulting in a loss on extinguishment of debt of $0.5 million. During the year ended January 29, 2011, we repurchased $0.8 million of the 7.0% senior notes which resulted in a loss on extinguishment of debt of $4.0 thousand.

OTHER INCOME, NET

Other income increased to $2.2 million in 2011 from $0.1 million in 2010. Other income in 2011 was primarily related to interest income on cash and cash equivalents. Other income in 2010 consisted primarily of $0.7 million of interest income on cash and cash equivalents offset by $0.6 million of casualty losses relating to the May 2010 flood at the Nashville, Tennessee OFF 5TH store.

INCOME TAXES

For 2011 and 2010, the effective income tax rate for continuing operations differed from the federal statutory tax rate due to state income taxes and other items such as the change in the valuation allowance against state NOL carryforwards, the effect of concluding tax examinations and other tax reserve adjustments primarily relating to statute


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expirations. Including the effect of these items, our effective income tax rate for continuing operations was 26.6% and (41.5%) in 2011 and 2010, respectively. The effective tax rate for 2011 was less than the federal statutory tax rate primarily due to a reversal in the valuation allowance against state NOL carryforwards. The effective tax benefit rate for 2010 was primarily due to the reversal of an uncertain tax position relating to statute expirations.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOW

Cash provided by operating activities from continuing operations was $174.4 million in 2012, $272.7 million in 2011 and $124.4 million in 2010. 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 $98.3 million decrease in cash flows from continuing operations in 2012 as compared to 2011 was primarily the result of changes in working capital, primarily an increase in inventory levels. The $148.3 million increase in cash flows from continuing operations in 2011 as compared to 2010 was primarily due to the increase in net income for the period and changes in working capital.

Cash used in investing activities from continuing operations was $128.3 million in 2012, $89.4 million in 2011, and $55.2 million in 2010. 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 $38.9 million increase in cash used in investing activities in 2012 was primarily related to an increase of $47.2 million in capital expenditures for the year. 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. The $34.2 million increase in cash used in investing activities in 2011 was primarily related to an increase of $26.4 million in capital expenditures for the year and the issuance of a note receivable, net of collections, in the amount of $7.4 million due from the provider of letters of credit required in connection with our workers' compensation and general liability insurance plans. Interest earned on the note receivable effectively reduces the cost of issuing letters of credit to insurance providers.

Cash used in financing activities from continuing operations was $165.9 million in 2012, $181.0 million in 2011, and $18.1 million in 2010. Cash used in financing activities in 2012 was primarily related to $167.4 million of common stock repurchases and $8.3 million of capital lease payments. In 2011, cash used in financing activities was primarily related to long-term debt payments resulting from the maturity of $141.6 million of our 9.875% senior notes, the redemption of $1.9 million of our 7.375% senior notes, $28.9 million of common stock repurchases and $3.0 million of debt financing costs incurred in connection with the amendment of our revolving credit facility. In 2010, cash used in financing activities primarily related to the payment of $22.9 million for the 7.5% senior notes that matured in December 2010 and the repurchase of $0.8 million of our 7.0% senior notes that mature in December 2013.

During 2012, we repurchased and retired an aggregate of 16.5 million shares of our common stock at an average price of $10.13 per share for a total cost of $167.4 million. During 2011, we repurchased and retired an aggregate of 3.5 million shares of our common stock at an average price of $8.18 per share . . .

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