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BELK INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Overview Belk, Inc., together with its subsidiaries (collectively, the "Company" or "Belk"), is the nation's largest family owned and operated department store business in the United States, with 299 stores in 16 states, as of August 2, 2014. With stores located primarily in the southern United States and with a growing eCommerce business on its belk.com website, the Company generated revenues of $4.0 billion for the fiscal year 2014, and together with its predecessors, has been successfully operating department stores since 1888. Belk is committed to providing its customers a compelling shopping experience and merchandise that reflects "Modern. Southern. Style." The following discussion, which presents the results of the Company, should be read in conjunction with the Company's consolidated financial statements as of February 1, 2014 and for the year then ended, and related Notes and Management's Discussion and Analysis of Financial Condition and Results of Operations, all contained in the Company's Annual Report on Form 10-K for the year ended February 1, 2014. The Company's fiscal year is a 52- or 53-week period ending on the Saturday closest to each January 31st. All references to "fiscal year 2014" refer to the 52-week fiscal year ended February 1, 2014, all references to "fiscal year 2015" refer to the 52-week fiscal year that will end January 31, 2015, and all references to "fiscal year 2016" refer to the 52-week fiscal year that will end January 30, 2016. The Company's revenues increased by 0.8% in the second quarter of fiscal year 2015 to $906.5 million. Comparable store revenues increased 0.6% primarily as a result of continued increasing eCommerce sales and execution of the Company's key initiatives. Our eCommerce revenues increased by $15.3 million, or 43.1%, and contributed to comparable store revenues by 1.8% for the period. The Company calculates comparable store revenue as sales from stores that have reached the one-year anniversary of their opening as of the beginning of the fiscal year and eCommerce revenues, but excludes closed stores. Stores undergoing remodeling, expansion or relocation remain in the comparable store revenue calculation. Definitions and calculations of comparable store revenue differ among companies in the retail industry. Operating income was $58.8 million in both the second quarter of fiscal year 2015 and fiscal year 2014. Net income increased to $30.6 million, or $0.77 per basic and diluted share, in the second quarter of fiscal year 2015 compared to $30.5 million, or $0.74 per basic share and $0.73 per diluted share, during the same period in fiscal year 2014. The Company's revenues increased by 0.3% for the first six months of fiscal year 2015 to $1,861.6 million. Comparable store revenues increased 0.2%. Our eCommerce revenues increased by $31.8 million, or 42.8%, and contributed to comparable store revenues by 1.8% for the period. Operating income decreased to $99.9 million for the first six months of fiscal year 2015 from $113.2 million during the same period in fiscal year 2014. Net income decreased to $49.9 million, or $1.24 per basic share and $1.23 per diluted share, for the first six months of fiscal year 2015, compared to $58.7 million, or $1.39 per basic share and $1.38 per diluted share, during the same period in fiscal year 2014. Belk seeks to provide customers with a convenient and enjoyable shopping experience both in stores and online at belk.com, by offering an appealing merchandise mix that includes extensive assortments of brands, styles and sizes. Belk stores and belk.com sell top national brands of fashion apparel, shoes and accessories for women, men and children, as well as cosmetics, home furnishings, housewares, fine jewelry, gifts and other types of quality merchandise. The Company also sells exclusive private label brands, which offer customers differentiated merchandise selections. Larger Belk stores may include hair salons, spas, restaurants, optical centers and other amenities. The Company seeks to be the leading department store in its markets by selling merchandise to customers that meet their needs for fashion, selection, value, quality and service. To achieve this goal, Belk's business strategy focuses on quality merchandise assortments, effective marketing and sales promotion strategies, attracting and retaining talented, well-qualified associates to deliver superior customer service, and operating efficiently with investments in information technology and process improvement. The Company operates retail department stores in the highly competitive retail industry. Management believes that the principal competitive factors for retail department store operations include merchandise selection, quality, value, 13-------------------------------------------------------------------------------- Table of Contents customer service and convenience. The Company believes it faces strong competitors in all of these areas. The Company's primary competitors are traditional department stores, mass merchandisers, national apparel chains, individual specialty apparel stores, direct merchant firms and online retailers, including Macy's, Inc., Dillard's, Inc., Nordstrom, Inc., Kohl's Corporation, Target Corporation, Sears Holding Corporation, TJX Companies, Inc., Wal-Mart Stores, Inc., J.C. Penney Company, Inc., and Amazon.com, Inc. The Company has focused its growth strategy on new stores, expanding and remodeling existing stores, developing new merchandising concepts in targeted demand centers, and expanding its online capabilities. In addition, in April 2013 the Company announced a strategy to expand the number of Belk flagship locations. Belk currently operates 18 flagship stores that meet certain standards based on size, sales volume, location, premium brand assortments and Belk brand image. Under this strategy, the Company plans to increase the number of flagship stores over the next five years through expansions and remodels of existing stores, enhancement of premium brand offerings in existing stores, and opening new stores that meet the flagship store criteria. Results of Operations The following table sets forth, for the periods indicated, the percentage relationship to revenues of certain items in the Company's unaudited condensed consolidated statements of income, as well as a period comparison of changes in comparable store revenues. Three Months Ended Six Months Ended August 2, August 3, August 2, August 3, 2014 2013 2014 2013 SELECTED FINANCIAL DATA Revenues 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold (including occupancy, distribution and buying expenses) 66.7 66.9 67.2 67.2 Selling, general and administrative expenses 26.9 26.5 27.5 26.6 Gain on sale of property and equipment 0.1 - 0.1 - Asset impairment and exit costs - 0.1 - 0.1 Operating income 6.5 6.5 5.4 6.1 Interest expense, net 1.3 1.2 1.2 1.2 Income before income taxes 5.2 5.3 4.1 4.9 Income tax expense 1.8 1.9 1.4 1.8 Net income 3.4 3.4 2.7 3.2 Comparable store net revenue increase 0.6 3.2 0.2 4.2 Revenues The following table gives information regarding the percentage of revenues contributed by each merchandise area for each of the respective periods. There were no changes for the periods as reflected in the table below. Three Months Ended Six Months Ended August 2, August 3, August 2, August 3, Merchandise Areas 2014 2013 2014 2013 Women's 37 % 37 % 36 % 36 % Cosmetics, Shoes and Accessories 30 31 32 33 Men's 18 18 17 17 Home 8 8 8 8 Children's 7 6 7 6 Total 100 % 100 % 100 % 100 % Comparison of the Three and Six Months Ended August 2, 2014 and August 3, 2013 Revenues. The Company's revenues for the three months ended August 2, 2014 increased 0.8%, or $7.0 million, to $906.5 million from $899.5 million during the same period in fiscal year 2014. The increase is primarily attributable to a 0.6% increase in comparable store revenues and a $7.2 million increase from new stores, partially offset by a $5.8 million decrease in revenues from closed stores. The increase in comparable store revenues was generally the result of 14 -------------------------------------------------------------------------------- Table of Contents general economic conditions, where a soft sales environment persisted in the beginning of the quarter but improved towards the end of the period. The number of units sold and average unit selling price were flat compared to the prior year. Merchandise categories achieving the highest growth rate included children's shoes, women's contemporary and better sportswear, juniors and children's apparel. The Company's revenues for the six months ended August 2, 2014 increased 0.3%, or $6.3 million, to $1,861.6 million from $1,855.3 million during the same period in fiscal year 2014. The increase is primarily attributable to a 0.2% increase in comparable store revenues and a $12.7 million increase from new stores, partially offset by a $9.8 million decrease in revenues from closed stores. The increase in comparable store revenues was generally the result of general economic conditions, where a soft sales environment persisted, similar to the first quarter of fiscal year 2015 trend, into the second quarter but improved towards the end of the period. The number of units sold and average unit selling price were flat compared to the prior year. Merchandise categories achieving the highest growth rate included children's shoes, women's contemporary and better sportswear, juniors and children's apparel. Cost of goods sold. Cost of goods sold was $604.9 million, or 66.7% of revenues, for the three months ended August 2, 2014 compared to $601.9 million, or 66.9% of revenues, for the same period in fiscal year 2014. The slight decrease in cost of goods sold as a percentage of revenues was primarily attributable to higher initial markup on our goods, offset by higher markdown activity and by increased shipping and handling and fulfillment center costs associated with the 43.1% increase in eCommerce sales. Cost of goods sold was $1,251.0 million, or 67.2% of revenues, for the six months ended August 2, 2014 compared to $1,247.1 million, or 67.2% of revenues, for the same period in fiscal year 2014. The increase in the amount of cost of goods sold was primarily attributable to an increase in revenues for the six months ended August 2, 2014. Cost of goods sold as a percentage of revenues was flat due to higher initial markup on our goods, offset by higher markdown activity and by increased shipping and handling and fulfillment center costs associated with the 42.8% increase in eCommerce sales. Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses were $243.8 million, or 26.9% of revenues, for the three months ended August 2, 2014, compared to $238.2 million, or 26.5% of revenues, for the same period in fiscal year 2014. The increase in SG&A expense of $5.6 million was substantially due to our investments in key strategic initiatives, consisting of increased payroll and consulting services, as well as increased depreciation expense resulting from recent system implementations. This was offset primarily by a decrease in advertising expenses. The investments in key strategic initiatives and increased depreciation expense, offset by the decreased advertising expenses also increased SG&A as a percentage of revenues. SG&A expenses were $511.5 million, or 27.5% of revenues for the six months ended August 2, 2014, compared to $494.1 million, or 26.6% of revenues for the same period in fiscal year 2014. The increase in SG&A expenses was substantially due to our investments in key strategic initiatives, consisting of increased payroll and consulting services, as well as increased depreciation expense resulting from recent system implementations. The investments in key strategic initiatives and the increased depreciation expense also increased SG&A as a percentage of revenues. Income tax expense. Income tax expense for the three months ended August 2, 2014 was $16.5 million, or 35.0% of pre-tax income, compared to $17.1 million, or 35.9% of pre-tax income, for the three months ended August 3, 2013. The decrease in the income tax rate was due primarily to the fiscal year 2014 decrease in the North Carolina state tax rate. Income tax expense for the six months ended August 2, 2014 was $26.7 million, or 34.9% of pre-tax income, compared to $32.6 million, or 35.7% of pre-tax income, for the six months ended August 3, 2013. The decrease in income tax expense was due primarily to the decrease in net income before income taxes for the six months ended August 2, 2014. The decrease in the income tax rate was due primarily as a result of higher non-taxable corporate owned life insurance income and the fiscal year 2014 decrease in the North Carolina state tax rate. Seasonality and Quarterly Fluctuations Due to the seasonal nature of the retail business, the Company has historically experienced and expects to continue to experience seasonal fluctuations in its revenues, operating income and net income. A disproportionate amount of the Company's revenues and a substantial amount of operating and net income are realized during the fourth quarter, which includes the holiday selling season. If for any reason the Company's revenues were below seasonal norms during the fourth quarter, the Company's annual results of operations could be adversely affected. The Company's inventory levels generally reach their highest levels in anticipation of increased revenues during these months. 15-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources The Company's primary sources of liquidity are cash on hand of $159.0 million as of August 2, 2014, cash flows from operations, and borrowings under debt facilities, which consist of a $350.0 million credit facility and $375.0 million in senior notes. The credit facility, which matures in November 2015, allows for up to $250.0 million of outstanding letters of credit. The credit facility charges interest based upon certain Company financial ratios and the interest spread was calculated at August 2, 2014 using LIBOR plus 125 basis points, or 1.41%. The credit facility contains restrictive covenants including leverage and fixed charge coverage ratios. The Company's calculated leverage ratio dictates the LIBOR spread that will be charged on outstanding borrowings in the subsequent quarter. The leverage ratio is calculated by dividing adjusted debt, which is the sum of the Company's outstanding debt and last four quarters of rent expense multiplied by a factor of eight, by the last four quarters of pre-tax income plus net interest expense, rent expense, and non-cash items, such as depreciation, amortization, and impairment expense. At August 2, 2014, the maximum leverage ratio allowed under the credit facility was 4.0, and the calculated leverage ratio was 1.98. The Company was in compliance with all covenants as of August 2, 2014 and expects to remain in compliance with all debt covenants for the next twelve months and foreseeable future. As of August 2, 2014, the Company had $14.3 million of standby letters of credit outstanding under the credit facility, and availability under the credit facility was $335.7 million. The senior notes have restrictive covenants that are similar to the Company's credit facility, and had the following terms as of August 2, 2014: Amount (in millions) Type of Rate Rate Maturity Date $ 100.0 Fixed 5.31 % July 2015 125.0 Fixed 6.20 % August 2017 50.0 Fixed 5.70 % November 2020 100.0 Fixed 5.21 % January 2022 $ 375.0 The debt facilities place certain restrictions on mergers, consolidations, acquisitions, sales of assets, indebtedness, transactions with affiliates, leases, liens, investments, dividends and distributions, exchange and issuance of capital stock and guarantees, and require maintenance of minimum financial ratios, which include a leverage ratio, consolidated debt to consolidated capitalization ratio and a fixed charge coverage ratio. These ratios are calculated exclusive of non-cash charges, such as fixed assets, goodwill and other intangible asset impairments. Belk has planned investments totaling approximately $700 million over a three-year period that began in fiscal year 2014 in key strategic initiatives focused on information technology that delivers new business capabilities; excelling in customer service; creating compelling shopping environments through new stores and remodels and an expanded flagship strategy; supply chain initiatives that align distribution capabilities to maximize sales and service; and a comprehensive Omnichannel initiative. Management believes that cash on hand of $159.0 million as of August 2, 2014, cash flows from operations and existing credit facilities will be sufficient to cover working capital needs, stock repurchases, dividends, capital expenditures, pension contributions and debt service requirements for the next twelve months and foreseeable future. Net cash provided by operating activities was $112.6 million for the six months ended August 2, 2014 compared to $113.9 million for the same period in fiscal year 2014. The slight decrease in cash flows from operating activities for the six months ended August 2, 2014 was principally due to a $49.0 million decrease in inventory, net of merchandise payables, partially offset by a $25.0 million decrease in pension contributions, an $11.8 million decrease in accrued income taxes, and an $8.1 million increase in depreciation expense. 16-------------------------------------------------------------------------------- Table of Contents Net cash used by investing activities was $111.5 million for the six months ended August 2, 2014 compared to $103.3 million for the same period in fiscal year 2014. The increase in cash used by investing activities was due to an $8.9 million increase in capital expenditures in the first six months of fiscal year 2015 compared to the same period in fiscal year 2014. Net cash used by financing activities was $137.5 million for the six months ended August 2, 2014 compared to $113.3 million for the same period in fiscal year 2014. The increase in cash used by financing activities was primarily due to a $33.0 million increase in dividends paid in the first three months of fiscal year 2015 compared to the same period in fiscal year 2014, as the regular dividend normally paid in April following the end of the fiscal year was accelerated in the prior year and paid in fiscal year 2013. This was partially offset by a $7.6 million decrease in the shares redeemed during the tender offer finalized in May 2014 versus the May 2013 tender offer. Contractual Obligations and Commercial Commitments A table representing the scheduled maturities of the Company's contractual obligations and commercial commitments as of February 1, 2014 was included under the heading "Contractual Obligations and Commercial Commitments" of the Company's Annual Report on Form 10-K for the fiscal year ended February 1, 2014. There have been no material changes from the information included in the Form 10-K. Off-Balance Sheet Arrangements The Company has not created, and is not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating the Company's business. The Company does not have any arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect the Company's liquidity or the availability of capital resources. New Accounting Pronouncements In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2014-15, "Presentation of Financial Statements - Going Concern (Subtopic 205-40)," which requires disclosure of uncertainties about an entity's ability to continue as a going concern. This guidance will be effective at the beginning of fiscal year 2018, and the Company does not expect the adoption to have an impact on the condensed consolidated financial statements or related disclosures. In May 2014, the FASB issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers (Topic 606)," which implements a five step process of how an entity should recognize revenue in order to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective at the beginning of fiscal year 2018, and early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the impact that the adoption will have on the condensed consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting. In April 2014, the FASB issued Accounting Standards Update No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity," which changes the definition of a discontinued operation and the requirements for reporting discontinued operations. This guidance will be effective at the beginning of fiscal year 2016, and the Company does not expect the adoption to have a material impact on the condensed consolidated financial statements. Impact of Inflation or Deflation Although the Company expects that operations will be influenced by general economic conditions, including rising food, fuel and energy prices, management does not believe that inflation has had a material effect on the Company's results of operations. However, there can be no assurance that our business will not be affected by such factors in the future. |