Nordstrom, Inc.
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NORDSTROM : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-K)

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03/20/2017 | 09:39 pm


Dollar, share and square footage amounts in millions except percentages, per
share and per square foot amounts
OVERVIEW
Nordstrom is a leading fashion specialty retailer offering apparel, shoes,
cosmetics and accessories for women, men, young adults and children. We offer an
extensive selection of high-quality brand-name and private label merchandise
through our various channels, including Nordstrom U.S. and Canada full-line
stores, Nordstrom.com, Nordstrom Rack stores, Nordstromrack.com/HauteLook, Trunk
Club
clubhouses and TrunkClub.com, Jeffrey boutiques and Last Chance clearance
stores. As of January 28, 2017, our stores are located in 40 states throughout
the United States and in three provinces in Canada. Our customers can
participate in our Nordstrom Rewards loyalty program which allows them to earn
points based on their level of spending. We also offer our customers a variety
of payment products and services, including credit and debit cards.
Our 2016 earnings per diluted share of $2.02, which included a goodwill
impairment charge of $1.12, exceeded our outlook of $1.70 to $1.80. Our results
were driven by continued operational efficiencies in inventory and expense
execution and demonstrated our team's speed and agility in responding to changes
in business conditions. We reached record sales of $14.5 billion for the year,
reflecting a net sales increase of 2.9% and comparable sales decrease of 0.4%
primarily driven by full-line stores. We achieved the following milestones in
multiple growth areas:
• Our expansion into Canada where we currently have five full-line stores,
including two that opened last fall, contributed total sales of $300 in
2016.



• Nordstrom.com sales reached over $2.5 billion, representing approximately



25% of full-price sales.



• Our off-price business reached $4.5 billion, with growth mainly driven by



our online net sales increase of 32% and 21 new store openings. Off-price



continues to be our largest source of new customers, gaining approximately 6



million in 2016.


• Our expanded Nordstrom Rewards program, which launched in the second



quarter, drove a strong customer response with 3.7 million customers joining



through our non-tender offer. We ended the year with a total of 7.8 million



active Nordstrom Rewards customers.



• Our working capital improvements contributed to the $1.6 billion in



operating cash flow and $0.6 billion in free cash flow.





From a merchandising perspective, we strive to offer a curated selection of the
best brands. As we look for new opportunities through our vendor partnerships,
we will continue to be strategic and pursue partnerships that are similar to our
portfolio and maintain relevance with our customers by delivering newness. Our
strategies around product differentiation include our ongoing efforts to grow
limited distribution brands such as Ivy Park, J.Crew and Good American, in
addition to our Nordstrom exclusive offering.
In 2016, we made focused efforts to improve our productivity, particularly
around our technology, supply chain and marketing. In technology, we increased
the productivity of delivering features to enhance the customer experience. In
supply chain, we focused on overall profitability by reducing split shipments
and editing out less profitable items online. In marketing, we strengthened our
capabilities around digital engagement so that we reach customers in a more
efficient and cost-effective manner. Through these efforts, we made significant
progress in improving operational efficiencies, reflected by moderated expense
growth of 10% in these three key areas, relative to an annual average of 20%
over the past five years.
With customer expectations changing faster than ever, it is important that we
remain focused on the customer. Moving forward, we believe our strategies give
us a platform for enhanced capabilities to better serve customers and increase
market share. Our obsession with our customers keeps us focused on speed,
convenience and personalization. We have good momentum in place and will
continue to make changes to ensure we are best serving customers and improving
our business now and into the future.



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RESULTS OF OPERATIONS
Our reportable segments are Retail and Credit. We analyze our results of
operations through earnings before interest and income taxes for our Retail
Business and Credit, while interest expense, income taxes and earnings per share
are discussed on a total Company basis.
RETAIL BUSINESS
Our Retail Business includes our Nordstrom U.S. and Canada full-line stores,
Nordstrom.com, Nordstrom Rack stores, Nordstromrack.com/HauteLook, Trunk Club,
Jeffrey boutiques and Last Chance clearance stores. For purposes of discussion
and analysis of our results of operations of our Retail Business, we combine our
Retail segment results with revenues and expenses in the "Corporate/Other"
column of Note 15: Segment Reporting in Item 8 (collectively, the "Retail
Business").
Certain metrics we use to evaluate the Retail Business may not be calculated in
a consistent manner among industry peers. Provided below are definitions of
metrics we present within our analysis of the Retail Business:
• Comparable Sales - sales from stores that have been open at least one full


year at the beginning of the year. Total Company comparable sales include



sales from our online channels.



• Gross Profit - net sales less cost of sales and related buying and occupancy



costs.



• Inventory Turnover Rate - annual cost of sales and related buying and



occupancy costs (for all segments) divided by the trailing 4-quarter average



inventory.



• Total Sales Per Square Foot - net sales divided by weighted-average square



footage.



• 4-wall Sales Per Square Foot - sales for Nordstrom U.S. and Canada full-line



stores, Nordstrom Rack stores, Trunk Club clubhouses, Jeffrey boutiques and



Last Chance clearance stores divided by their weighted-average square



footage.



Summary



The following table summarizes the results of our Retail Business:
Fiscal year 2016 2015 2014
% of net % of net % of net
Amount sales1 Amount sales1 Amount sales1
Net sales $14,498 100.0 % $14,095 100.0 % $13,110 100.0 %
Cost of sales and
related buying and
occupancy costs (9,434 ) (65.1 %) (9,161 ) (65.0 %) (8,401 ) (64.1 %)
Gross profit 5,064 34.9 % 4,934 35.0 % 4,709 35.9 %
Selling, general and
administrative
expenses (4,159 ) (28.7 %) (4,016 ) (28.5 %) (3,588 ) (27.4 %)
Goodwill impairment (197 ) (1.4 %) - - - -
Earnings before
interest and income
taxes $708 4.9 % $918 6.5 % $1,121 8.6 %



1 Subtotals and totals may not foot due to rounding.





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Retail Business Net Sales
In our ongoing effort to enhance the customer experience, we are focused on
providing customers with a seamless experience across our channels. While our
customers may engage with us through multiple channels, we know they value the
overall Nordstrom brand experience and view us simply as Nordstrom, which is
ultimately how we view our business. The following is a summary of our net sales
by channel for our Retail Business:
Fiscal year 2016 2015


2014



Net sales by channel:
Nordstrom full-line stores - U.S. $7,186 $7,633 $7,682
Nordstrom.com 2,519 2,300 1,996
Full-price 9,705 9,933 9,678

Nordstrom Rack 3,809 3,533 3,215
Nordstromrack.com/HauteLook 700 532 360
Off-price 4,509 4,065 3,575

Other retail1 554 378 116
Retail segment 14,768 14,376 13,369
Corporate/Other (270 ) (281 ) (259 )
Total net sales $14,498 $14,095 $13,110

Net sales increase 2.9 % 7.5 % 7.8 %

Comparable sales increase (decrease) by channel:
Nordstrom full-line stores - U.S. (6.4 %) (1.1 %) (0.5 %)
Nordstrom.com 9.5 % 15.2 % 23.1 %
Full-price (2.7 %) 2.3 % 3.6 %
Nordstrom Rack 0.2 % (1.0 %) 3.8 %
Nordstromrack.com/HauteLook 31.7 % 47.4 % 22.1 %
Off-price 4.5 % 4.3 % 5.7 %
Total Company (0.4 %) 2.7 % 4.0 %

Sales per square foot:
Total sales per square foot $498 $507 $493
4-wall sales per square foot 392 410 413
Full-line sales per square foot - U.S. 346 370


371



Nordstrom Rack sales per square foot 507 523


552





1 Other retail includes Nordstrom Canada full-line stores, Trunk Club and
Jeffrey boutiques.
Net Sales (2016 vs. 2015)
In 2016, total Company net sales increased 2.9%, while comparable sales
decreased 0.4%. During the year, we opened three Nordstrom full-line stores,
including two in Canada, and 21 Nordstrom Rack stores.
Full-price net sales, which consist of the U.S. full-line and Nordstrom.com
channels, decreased 2.3% compared with 2015, while comparable sales decreased
2.7%. Also on a comparable basis, full-price sales reflected a decrease in the
total number of items sold, partially offset by an increase in the average
selling price per item sold. The top-performing merchandise category was Beauty.
The West was the top-performing geographic region.
Off-price net sales, which consists of Nordstrom Rack and
Nordstromrack.com/HauteLook channels, increased 10.9%, compared with 2015 and
comparable sales increased 4.5%. Nordstromrack.com/HauteLook had a comparable
sales increase of 31.7% and now represents over 15% of off-price sales.
Nordstrom Rack net sales increased 7.8%, primarily attributable to 21 new store
openings in 2016. On a comparable basis, the total number of items sold
increased at Nordstrom Rack, partially offset by a decrease in the average
selling price per item sold. Kids was the top-performing merchandise category,
and the East was the top-performing geographic region.



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Net Sales (2015 vs. 2014)
In 2015, total Company net sales increased 7.5%, while comparable sales
increased 2.7%. During the year, we opened five Nordstrom full-line stores,
including two in Canada, and 27 Nordstrom Rack stores.
Full-price net sales increased 2.6% compared with 2014, while on a comparable
basis, sales increased 2.3%. These increases reflected continued momentum in our
Nordstrom.com channel, which increased 15%. Also on a comparable basis, the
total number of items sold and the average selling price per item sold
increased. The top-performing merchandise categories included Beauty and Women's
Apparel
. The Northwest was the top-performing U.S. full-line store geographic
region.
Off-price net sales increased 13.7%, compared with 2014, while on a comparable
basis, sales increased 4.3%. Nordstromrack.com/HauteLook experienced outsized
growth, with a net sales increase of 47%. Nordstrom Rack net
sales increased 9.9%, attributable to new store openings. On a comparable basis,
the average retail price per item sold increased at Nordstrom Rack, offset by a
decrease in the total number of items sold. Shoes and Beauty were the
top-performing merchandise categories and the South was the top-performing
geographic region.
Retail Business Gross Profit
The following table summarizes the Retail Business gross profit ("Retail GP"):
Fiscal year 2016 2015 2014
Retail gross profit $5,064 $4,934 $4,709


Retail gross profit as a % of net sales 34.9 % 35.0 % 35.9 %
Ending inventory per square foot $63.64 $67.97 $64.05
Inventory turnover rate


4.53 4.54 4.67


Gross Profit (2016 vs. 2015)
Our Retail GP rate was relatively flat compared with 2015, reflecting higher
occupancy costs associated with Nordstrom Rack and Canada store growth, in
addition to increased markdowns in the first half of the year to realign
inventory to sales trends. This was offset by strong inventory execution during
the remainder of the year and reduced competitive markdowns. Our ending
inventory per square foot decrease of 6.4% in 2016 reflected this strong
inventory execution.
Gross Profit (2015 vs. 2014)
Our Retail GP rate decreased 92 basis points compared with 2014 primarily due to
higher cost of sales driven by increased markdowns from lower than planned sales
and in response to an elevated promotional environment during the second half of
the year. Retail GP increased $225 in 2015 compared with 2014 due to an increase
in net sales, partially offset by increased markdowns.
Our inventory turnover rate decreased to 4.54 in 2015 due to softer sales trends
experienced during the second half of the year. Our ending inventory per square
foot increased 6.1% in 2015, which outpaced our sales per square foot increase
of 2.9%. The growth of our online channels contributed to increases in inventory
without corresponding increases in square footage.
Retail Business Selling, General and Administrative Expenses
Retail Business selling, general and administrative expenses ("Retail SG&A") are
summarized in the following table:
Fiscal year 2016 2015


2014



Selling, general and administrative
expenses $4,159 $4,016


$3,588



Selling, general and administrative
expenses as a % of net sales 28.7 % 28.5 %


27.4 %





Selling, General and Administrative Expenses (2016 vs. 2015)
Our Retail SG&A rate increased 19 basis points in 2016 and increased $143
compared with 2015 primarily due to technology and fulfillment expenses.
Selling, General and Administrative Expenses (2015 vs. 2014)
Our Retail SG&A rate increased 112 basis points in 2015 compared with 2014 due
to growth initiatives related to Trunk Club and Canada, higher fulfillment costs
supporting online growth and asset impairment charges (see Note 1: Nature of
Operations and Summary of Significant Accounting Policies in Item 8). Our Retail
SG&A increased $428 in 2015 due primarily to increased sales and growth
initiatives related to Canada and Trunk Club.
Retail Business Goodwill Impairment
We recognized a goodwill impairment charge of $197 in 2016 related to Trunk Club
(see Note 8: Fair Value Measurements in Item 8).


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CREDIT SEGMENT
The Nordstrom credit and debit card products are designed to strengthen customer
relationships and grow retail sales by providing loyalty benefits, valuable
services and payment products. We believe our credit business allows us to build
deeper relationships with our customers by fully integrating the Nordstrom
Rewards program with our retail business and providing better service, which in
turn fosters greater customer loyalty. Nordstrom cardholders tend to visit our
stores more frequently and spend more than non-cardholders. Nordstrom private
label credit and debit cards can be used at all of our U.S. retail channels,
while Nordstrom Visa credit cards also may be used for purchases outside of
Nordstrom ("outside volume").
In October 2015, we completed the sale of a substantial majority of our U.S.
Visa and private label credit card portfolio to TD (see Note 2: Credit Card
Receivable Transaction in Item 8).
Summary
The table below provides a detailed view of the operational results of our
Credit segment, consistent with Note 15: Segment Reporting in Item 8:
Fiscal year 2016 2015 2014
Credit card revenues, net $259 $342 $396
Credit expenses (162 ) (159 ) (194 )
Earnings before interest and income taxes 97 183 202
Interest expense1 - (13 ) (18 )
Earnings before income taxes $97 $170


$184




Credit and debit card volume2:
Outside $4,160 $4,309 $4,331
Inside 5,858 5,953 5,475
Total volume $10,018 $10,262 $9,806


1 Prior to the credit card receivable transaction on October 1, 2015, interest
expense was allocated to the Credit segment as if it carried debt of up to 80%
of the credit card receivables.
2 Volume represents sales on the total portfolio plus applicable taxes.
Credit Card Revenues, net
The following is a summary of our credit card revenues, net:
Fiscal year 2016 2015 2014
Finance charge revenue $6 $173 $253
Interchange fees 5 61 89


Late fees and other revenue 2 44 54
Credit program revenues, net 246 64 -
Total credit card revenues, net $259 $342 $396





Following the close of the credit card receivable transaction and pursuant to
the program agreement with TD, we receive our portion of the ongoing credit card
revenue, net of credit losses, from both the sold and newly generated credit
card receivables, which is recorded in credit program revenues, net. Asset
amortization and deferred revenue recognition associated with the assets and
liabilities recorded as part of the transaction are also recorded in credit
program revenues, net. Revenue earned under the program agreement is impacted by
the credit quality of receivables, both owned and serviced, and factors such as
deteriorating economic conditions, declining creditworthiness of cardholders and
the success of account management and collection activities may heighten the
risk of credit losses.
Prior to the close of the credit card receivable transaction, credit card
revenues included finance charges, interchange fees, late fees and other
revenue, recorded net of estimated uncollectible finance charges and fees.
Finance charges represent interest earned on unpaid balances while interchange
fees are earned from the use of Nordstrom Visa credit cards at merchants outside
of Nordstrom. Late fees are assessed when a credit card account becomes past
due. We continue to recognize revenue in this manner for the credit card
receivables retained subsequent to the close of the credit card receivable
transaction.
Credit Card Revenues, net decreased $83 in 2016 and $54 in 2015 due to the
credit card receivable transaction and the new program agreement.



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Credit Expenses
Credit expenses consist of operational, bad debt and occupancy expenses. Credit
expenses in 2016 were relatively flat compared with 2015 as there was a $64 gain
partially offset by $32 of expenses incurred in 2015 associated with the credit
card receivable transaction. Excluding the net impact of these items, credit
expenses decreased $29 in 2016 primarily due to the decrease in bad debt expense
since the sale of the credit card receivables in October of 2015.
TOTAL COMPANY RESULTS
Interest Expense, Net
Interest expense is summarized in the following table:
Fiscal year 2016 2015


2014



Interest on long-term debt and short-term borrowings $147 $153 $156
Less:
Interest income (1 ) - (1 )
Capitalized interest (25 ) (28 ) (17 )
Interest expense, net $121 $125 $138


Interest Expense, Net (2016 vs. 2015)
Interest expense, net decreased $4 in 2016 compared with 2015 primarily due to
the defeasance of our $325 Series 2011-1 Class A Notes in the third quarter of
2015.
Interest Expense, Net (2015 vs. 2014)
Interest expense, net decreased $13 in 2015 compared with 2014 due to an
increase in capitalized interest resulting from planned capital investments
related to technology, our Manhattan store and Nordstrom Rack and Canada store
openings in 2015.
Income Tax Expense
Income tax expense is summarized in the following table:
Fiscal year 2016 2015 2014
Income tax expense $330 $376 $465
Effective tax rate 48.2 % 38.6 % 39.2 %


The following table illustrates the components of our effective tax rate:
Fiscal year 2016 2015 2014
Statutory rate 35.0 % 35.0 % 35.0 %
Goodwill impairment 10.1 % - -



State and local income taxes, net of federal income taxes 5.1 % 4.1 %


3.8 %
Non-deductible acquisition-related items 0.6 % 0.4 % 0.9 %
Federal credits (0.6 %) (0.6 %) (0.2 %)
Other, net (2.0 %) (0.3 %) (0.3 %)
Effective tax rate 48.2 % 38.6 % 39.2 %


Income Tax Expense (2016 vs. 2015)
The increase in the effective tax rate for 2016 compared with 2015 was primarily
due to the non-deductible goodwill impairment charge of $197 related to Trunk
Club
(see Note 8: Fair Value Measurements in Item 8). Excluding the impact of
the Trunk Club goodwill impairment, our effective tax rate for 2016 would have
decreased approximately 1% compared with the prior year primarily due to an
increase in nontaxable income.
Income Tax Expense (2015 vs. 2014)
The decrease in the effective tax rate for 2015 compared with 2014 was primarily
due to a decrease in non-deductible acquisition-related items and the benefit of
income tax credits in 2015.


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Earnings Per Share
Earnings per share is as follows:
Fiscal year 2016 2015 2014
Basic $2.05 $3.22 $3.79
Diluted:
Actual $2.02 $3.15 $3.72
Adjusted1 $3.14 N/A N/A


1 A reconciliation of adjusted earnings per share, a non-GAAP financial measure,
to the closest GAAP measure is included on page 25.
Earnings Per Diluted Share (2016 vs. 2015)
The decrease in diluted earnings per share ("EPS") for 2016 compared with 2015
was primarily due to the goodwill impairment charge of $197 related to Trunk
Club
. Excluding the goodwill impairment charge, adjusted earnings per diluted
share compared with actual EPS for 2015 was relatively flat due to higher
technology and fulfillment costs supporting multi-channel growth, offset by a
decrease in shares outstanding as a result of share repurchases during the year.
Earnings Per Diluted Share (2015 vs. 2014)
The decrease in EPS for 2015 compared with 2014 was primarily due to lower
Retail Business earnings before interest and income taxes. This decrease was
partially offset by a decrease in weighted average shares outstanding resulting
from an increase in share repurchases.
Fourth Quarter Results
The following are our results for the fourth quarters of 2016 and 2015:
Quarter ended January 28, 2017 January 30, 2016
Net sales $4,243 $4,143
Credit card revenues, net 73 51
Gross profit 1,523 1,443
Gross profit (% of net sales) 35.9 % 34.8 %
Retail SG&A expenses (1,134 ) (1,136 )
Retail SG&A expenses (% of net sales) (26.7 %) (27.4 %)
Credit expenses (42 ) (36 )
Net earnings 201 180
EPS (diluted) $1.15 $1.00


Net Sales
Total Company net sales increased 2.4% in the fourth quarter of 2016, compared
with the same period in 2015, while comparable sales decreased 0.9%.
Full-price net sales decreased 2.8% for the quarter ended January 28, 2017,
compared with the same period in 2015, while comparable sales decreased 2.9%.
Also on a comparable basis for the quarter, full-price sales reflected a
decrease in the number of items sold, partially offset by an increase in the
average selling price per item sold. For the fourth quarter, the top-performing
merchandise categories were Women's Apparel and Beauty, and the East was the
top-performing geographic region.
Off-price net sales increased 10.7% for the quarter ended January 28, 2017,
compared with the same period in 2015, while comparable sales increased 4.3%.
Nordstrom Rack net sales increased 7.4% attributable to 21 new store openings
since the end of 2015. On a comparable basis, the number of items sold increased
at Nordstrom Rack, partially offset by a decrease in the average selling price
per item sold. Kids was the top-performing merchandise category and the East was
the top-performing geographic region for the quarter ended January 28, 2017.
Credit Card Revenues, net
Credit card revenues, net increased $22 for the quarter, compared with the same
period in the prior year, primarily due to higher amortization of the beneficial
interest asset in the fourth quarter of 2015.
Gross Profit
Our total Company gross profit rate increased 106 basis points compared with the
same period in 2015, reflecting strong inventory execution in addition to
reduced competitive markdowns. Inventory declined 2.5%, which reflected a
positive spread of 5 percentage points relative to sales growth.



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Retail Selling, General and Administrative Expenses
Our Retail SG&A rate decreased 67 basis points primarily due to asset impairment
charges occurring in the fourth quarter of 2015 and a non-operational legal
settlement gain of $22 in 2016. This was partially offset by performance-related
costs associated with company performance.
Credit Expenses
In the fourth quarter of 2016, total credit expenses increased $6 compared with
the fourth quarter of 2015, driven primarily by increased credit card settlement
fees and labor.
For further information on our quarterly results in 2016 and 2015, refer to Note
16: Selected Quarterly Data in Item 8.
Adjusted Earnings and Adjusted Earnings Per Share (Non-GAAP financial measures)
We believe that Adjusted Earnings and Adjusted Earnings Per Share provide useful
information to investors in evaluating our business performance for the quarter
and year ended January 28, 2017. The effect of excluding certain items from net
earnings provides management and shareholders an alternative measure to use in
evaluating our business performance period over period.
Adjusted Earnings and Adjusted Earnings Per Share are not measures of financial
performance under generally accepted accounting principles ("GAAP") and should
be considered in addition to, and not as a substitute for, net earnings,
earnings per share and diluted earnings per share or other financial measures
prepared in accordance with GAAP. Our method of determining non-GAAP financial
measures may differ from other companies' financial measures and therefore may
not be comparable to methods used by other companies. The financial measures
calculated under GAAP which are most directly comparable to Adjusted Earnings
and Adjusted Earnings Per Share are net earnings and diluted earnings per share,
which are reconciled below:
Quarter Ended January 28, 2017 Year Ended January 28, 2017
Amount Per Amount Per
Amount Share Amount Share
Net earnings $201 $1.15 $354 $2.02
Trunk Club goodwill
impairment - - 197 1.12
Tax effect of
non-deductible charges in
interim period1 39 0.22 - -
Adjusted Earnings $240 $1.37 $551 $3.14


1 The effect of taxes on the adjustments used to arrive at Adjusted Earnings is
calculated based on applying the estimated annual effective tax rate to Adjusted
Earnings plus other tax items for each interim period and is a result of the
non-deductible goodwill impairment charge in the third quarter of 2016.
2017 Outlook
Our expectations for 2017, which include the impact of the 53rd week, are as
follows:
Net sales (percent) 3 to 4 increase
Comparable sales (percent) Approximately flat
Retail EBIT $780 to $840 million
Credit EBIT Approximately $135 million
Earnings per diluted share (excluding
the impact of any future share
repurchase) $2.75 to $3.00



The 53rd week is estimated to add approximately $200 million to total sales and
is not included in comparable sales calculations.





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Return on Invested Capital ("ROIC") (Non-GAAP financial measure)
We believe ROIC is a useful financial measure for investors in evaluating the
efficiency and effectiveness of our use of capital and believe ROIC is an
important component of shareholders' return over the long term. In addition, we
incorporate ROIC in our executive incentive compensation measures. For the 12
fiscal months ended January 28, 2017, our ROIC decreased compared with the 12
fiscal months ended January 30, 2016, primarily due to reduced earnings largely
impacted by the Trunk Club goodwill impairment (see Note 8: Fair Value
Measurements in Item 8). The Trunk Club goodwill impairment had a negative
impact on ROIC of 3.3%.
We define ROIC as our net operating profit after tax divided by our average
invested capital using the trailing 12-month average. ROIC is not a measure of
financial performance under generally accepted accounting principles ("GAAP")
and should be considered in addition to, and not as a substitute for, return on
assets, net earnings, total assets or other financial measures prepared in
accordance with GAAP. Our method of determining non-GAAP financial measures may
differ from other companies' methods and therefore may not be comparable to
those used by other companies. The financial measure calculated under GAAP which
is most directly comparable to ROIC is return on assets. The following is a
reconciliation of the components of ROIC and return on assets:
12 Fiscal Months Ended
January 28, 2017 January 30, 2016 January 31, 2015 February 1, 2014 February 2, 2013
Net earnings $354 $600 $720 $734 $735
Add: income tax
expense 330 376 465 455 450
Add: interest expense 122 125 139 162 162
Earnings before
interest and income
tax expense 806 1,101 1,324 1,351 1,347

Add: rent expense 202 176 137 125 105
Less: estimated
depreciation on
capitalized operating
leases1 (108 ) (94 ) (74 ) (67 ) (56 )
Net operating profit 900 1,183 1,387 1,409 1,396

Less: estimated
income tax expense (416 ) (456 ) (544 ) (539 ) (530 )
Net operating profit
after tax $484 $727 $843 $870 $866

Average total assets $7,917 $9,076 $8,860 $8,398 $8,274
Less: average
non-interest-bearing
current liabilities2 (3,012 ) (2,993 ) (2,730 ) (2,430 ) (2,262 )
Less: average
deferred property
incentives and
deferred rent
liability2 (644 ) (548 ) (502 ) (489 ) (494 )
Add: average
estimated asset base
of capitalized
operating leases3 1,512 1,236 1,058 929 724
Average invested
capital $5,773 $6,771 $6,686 $6,408 $6,242

Return on assets 4.5 % 6.6 % 8.1 % 8.7 % 8.9 %
ROIC 8.4 % 10.7 % 12.6 % 13.6 % 13.9 %


1 Capitalized operating leases is our best estimate of the asset base we would
record for our leases that are classified as operating if they had met the
criteria for a capital lease or we had purchased the property. Asset base is
calculated as described in footnote 3 below.
2 Balances associated with our deferred rent liability have been classified as
long-term liabilities in the current period.
3 Based upon the trailing 12-month average of the monthly asset base. The asset
base for each month is calculated as the trailing 12 months of rent expense
multiplied by eight. The multiple of eight times rent expense is a commonly used
method of estimating the asset base we would record for our capitalized
operating leases described in footnote 1.



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LIQUIDITY AND CAPITAL RESOURCES
We strive to maintain a level of liquidity sufficient to allow us to cover our
seasonal cash needs and to maintain appropriate levels of short-term borrowings.
We believe that our operating cash flows, available credit facilities and
potential future borrowings are sufficient to finance our cash requirements for
the next 12 months and beyond.
Over the long term, we manage our cash and capital structure to maximize
shareholder return, maintain our financial position, manage refinancing risk and
allow flexibility for strategic initiatives. We regularly assess our debt and
leverage levels, capital expenditure requirements, debt service payments,
dividend payouts, potential share repurchases and other future investments. We
believe that as of January 28, 2017, our existing cash and cash equivalents
on-hand of $1,007, available credit facilities of $800 and potential future
operating cash flows and borrowings will be sufficient to fund these scheduled
future payments and potential long-term initiatives.
Operating Activities
The majority of our operating cash inflows are derived from sales. We also
receive cash payments for property incentives from developers. Our operating
cash outflows generally consist of payments to our merchandise vendors (net of
vendor allowances), payments to our employees for wages, salaries and other
employee benefits and payments to our landlords for rent. Operating cash
outflows also include payments for income taxes and interest payments on our
short-term and long-term borrowings. Net cash provided by operating activities
was $1,648 in 2016, $2,451 in 2015 and $1,220 in 2014.
Net cash provided by operating activities decreased by $803 between 2016 and
2015, primarily due to $1,297 of proceeds in 2015 from the sale of our credit
card receivables originated at Nordstrom (see Note 2: Credit Card Receivable
Transaction in Item 8). When removing the impact of the sale proceeds, operating
cash flows increased from 2015 primarily due to improvements in working capital.
Net cash provided by operating activities increased by $1,231 between
2015 and 2014, primarily due to sale proceeds from the credit card receivable
transaction. Also within operating activities, deferred income taxes, net and
prepaid expenses and other assets were impacted by a change in an IRS rule
regarding repairs of real property.
Investing Activities
Net cash used in investing activities was $791 in 2016, $144 in 2015 and $889 in
2014. The increase in cash used in 2016 compared with 2015 is primarily due to
$890 of proceeds in 2015 from the sale of our credit card receivables originated
at third parties, partially offset by a decrease in capital expenditures in
2016.
Capital Expenditures
Our capital expenditures over the last three years totaled $2,789, with $846 in
2016, $1,082 in 2015 and $861 in 2014. Capital expenditures decreased in 2016
compared with 2015 due to reduced spend associated with full-line relocations
and new full-line stores.
We receive property incentives from our developers, which we view operationally
as an offset to our capital expenditures. Developer incentives of $65 in 2016,
$156 in 2015 and $110 in 2014 are included in our cash provided by operations in
our Consolidated Statements of Cash Flows in Item 8.
Our capital expenditure percentages, net of property incentives, by category are
summarized as follows:
Fiscal year 2016 2015 2014
Category and expenditure allocation:
New stores, relocations and remodels 61 % 61 % 62 %
Information technology 28 % 33 % 35 %
Other1 11 % 6 % 3 %
Total 100 % 100 % 100 %


1 Other capital expenditures consist of ongoing improvements to our stores in
the ordinary course of business and expenditures related to various growth
initiatives.
Net capital expenditures in 2016, as well as over the next five years, are
primarily focused in the areas of investment in new stores, including continued
expansion into new markets such as Canada and Manhattan, and remodels of
existing full-line stores.


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The following table summarizes our store count and square footage activity:



Store count Square footage
Fiscal year 2016 2015 2014 2016 2015 2014
Total, beginning of year 323 292 260 28.6 27.1 26.0
Store openings1:
Nordstrom full-line stores
- U.S. and Canada 3 5 3 0.6 0.8 0.4
Nordstrom Rack and other
stores2 24 27 28 0.8 0.9 1.1
Stores acquired - - 4 - - -
Stores closed (1 ) (1 ) (3 ) (0.2 ) (0.2 ) (0.4 )
Total, end of year 349 323 292 29.8 28.6 27.1


1 Square footage includes adjustments due to store relocations and remodels.
2 Other includes Trunk Club clubhouses, Jeffrey boutiques and Last Chance
stores.
We had three store relocations in 2016, compared with one relocation in 2015 and
no relocations in 2014. To date in 2017, we have opened one Nordstrom Rack store
and plan to open 15 additional Nordstrom Rack stores and one Nordstrom full-line
store in Canada during the remainder of the year. Planned net store openings are
expected to increase our retail square footage by approximately 2%.
Our capital expenditures, net of property incentives, over the next five years
is expected to be approximately $3,400, compared with $3,600 over the previous
five years. Early in 2016, we completed a review of our five-year capital plan
which resulted in reduced spend primarily related to new stores and remodels.
Although we plan our spending in 2017 to be relatively flat compared with 2016,
we expect reduction in the following years.
Financing Activities
Net cash used in financing activities was $445 in 2016 compared with $2,539 in
2015 and $698 in 2014. Our financing activities include our borrowing activity,
payment of dividends and repurchases of common stock.
Borrowing Activity
In 2015, as a condition of closing the credit card receivable transaction, we
defeased $325 in secured Series 2011-1 Class A Notes in order to provide the
receivables to TD free and clear.
On March 9, 2017, we issued $350 aggregate principal amount of 4.00% senior
unsecured notes due March 2027 and $300 aggregate principal amount of 5.00%
senior unsecured notes due January 2044 (the "2044 Notes"). The 2044 Notes will
be a further issuance of, and will be fully fungible, rank equally in right of
payment and form a single series with, our outstanding 5.00% senior unsecured
notes due 2044. With the proceeds of these new notes, we plan to retire our $650
senior unsecured notes that are due January 2018 (see Note 7: Debt and Credit
Facilities in Item 8).
Dividends
In 2016, we paid dividends of $256, or $1.48 per share, compared with $1,185, or
$6.33 per share, in 2015 and $251, or $1.32 per share, in 2014. Dividends paid
in 2015 included a special cash dividend of $905, or $4.85 per share, in
addition to our quarterly dividends totaling $1.48 per share. The special
dividend was authorized by our Board of Directors on October 1, 2015 and was
paid using proceeds from the sale of our credit card receivables. In determining
the amount of dividends to pay, we analyze our dividend payout ratio and
dividend yield, while taking into consideration our current and projected
operating performance and liquidity. Our dividend payout ratio target range is
30% to 35% and is calculated as our dividend payments divided by net earnings.
In February 2017, subsequent to year end, we declared a quarterly dividend of
$0.37 per share, which was paid on March 15, 2017.
Share Repurchases
On October 1, 2015, our Board of Directors authorized a program to repurchase up
to $1,000 of our outstanding common stock, through March 1, 2017. During 2016,
we repurchased 5.9 shares of our common stock for an aggregate purchase price of
$282.
Our October 1, 2015 Board authorized share repurchase program, which had $529 of
remaining capacity as of January 28, 2017, expired on March 1, 2017. There was
$409 of unused capacity upon program expiration. In February 2017, our Board of
Directors authorized an additional program to repurchase up to $500 of our
outstanding common stock, through August 31, 2018. The actual number, price,
manner and timing of future share repurchases, if any, will be subject to market
and economic conditions and applicable SEC rules.



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Free Cash Flow (Non-GAAP financial measure)
Free Cash Flow is one of our key liquidity measures, and when used in
conjunction with GAAP measures, provides investors with a meaningful analysis of
our ability to generate cash from our business. For the year ended January 28,
2017
, Free Cash Flow decreased to $550 compared with $1,131 for the year ended
January 30, 2016, primarily due to proceeds received in 2015 related to the sale
of credit card receivables.
Free Cash Flow is not a measure of financial performance under GAAP and should
be considered in addition to, and not as a substitute for, operating cash flows
or other financial measures prepared in accordance with GAAP. Our method of
determining non-GAAP financial measures may differ from other companies' methods
and therefore may not be comparable to those used by other companies. The
financial measure calculated under GAAP which is most directly comparable to
Free Cash Flow is net cash provided by operating activities. The following is a
reconciliation of net cash provided by operating activities to Free Cash Flow:
Fiscal year 2016 2015


2014



Net cash provided by operating
activities $1,648 $2,451 $1,220
Less: capital expenditures (846 ) (1,082 ) (861 )
Less: cash dividends paid (256 ) (1,185 ) (251 )
Add: proceeds from sale of credit card
receivables originated at third parties - 890 -
Add (Less): change in credit card
receivables originated at third parties - 34 (8 )
Add (Less): change in cash book
overdrafts 4 23 (4 )
Free Cash Flow $550 $1,131 $96


Credit Capacity and Commitments
As of January 28, 2017, we had total short-term borrowing capacity of $800 under
our senior unsecured revolving credit facility ("revolver") that expires in
April 2020. Under the terms of our revolver, we pay a variable rate of interest
and a commitment fee based on our debt rating. The revolver is available for
working capital, capital expenditures and general corporate purposes. We have
the option to increase the revolving commitment by up to $200, to a total of
$1,000, provided that we obtain written consent from the lenders.
Our $800 commercial paper program allows us to use the proceeds to fund
operating cash requirements. Under the terms of the commercial paper agreement,
we pay a rate of interest based on, among other factors, the maturity of the
issuance and market conditions. The issuance of commercial paper has the effect,
while it is outstanding, of reducing available liquidity under the revolver by
an amount equal to the principal amount of commercial paper.
As of January 28, 2017, we had no issuances outstanding under our commercial
paper program and no borrowings outstanding under our revolver.
Our wholly owned subsidiary in Puerto Rico maintains a $52 unsecured borrowing
facility to support our expansion into that market. The facility expires in
November 2018 and borrowings on this facility incur interest based upon the
LIBOR plus 1.275% per annum and also incurs a fee based on our unused
commitment. As of January 28, 2017, we had $50 outstanding on this facility.
We have a registration statement on file with the SEC using a "shelf"
registration process. Under this shelf registration process, we may offer and
sell, from time to time, any combination of the securities described in a
prospectus to the registration statement, including registered debt, provided we
maintain Well-known Seasoned Issuer ("WKSI") status.
We maintain trade and standby letters of credit to facilitate our international
payments. As of January 28, 2017, we have $8 available and $1 outstanding under
the trade letter of credit and $15 available and $2 outstanding under the
standby letter of credit.
Plans for our Manhattan full-line store, which we currently expect to open in
2019, ultimately include owning a condominium interest in a mixed-use tower and
leasing certain nearby properties. As of January 28, 2017, we had approximately
$249 of fee interest in land, which is expected to convert to the condominium
interest once the store is constructed. We have committed to make future
installment payments based on the developer meeting pre-established construction
and development milestones. In the event that this project is not completed, the
opening may be delayed and we may be subject to future losses or capital
commitments in order to complete construction or to monetize our investment in
the land.


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Impact of Credit Ratings
Under the terms of our revolver, any borrowings we may enter into will accrue
interest for Euro-Dollar Rate Loans at a floating base rate tied to LIBOR, for
Canadian Dealer Offer Rate Loans at a floating rate tied to CDOR, and for Base
Rate Loans at the highest of: (i) the Euro-Dollar rate plus 100 basis points,
(ii) the federal funds rate plus 50 basis points and (iii) the prime rate.
The rate depends upon the type of borrowing incurred, plus in each case an
applicable margin. This applicable margin varies depending upon the credit
ratings assigned to our long-term unsecured debt. At the time of this report,
our long-term unsecured debt ratings, outlook and resulting applicable margin
were as follows:
Credit Ratings Outlook
Moody's Baa1 Stable
Standard & Poor's BBB+ Negative

Base Interest Applicable
Rate Margin
Euro-Dollar Rate Loan LIBOR 1.02 %
Canadian Dealer Offer Rate Loan CDOR 1.02 %
Base Rate Loan various -


Should the ratings assigned to our long-term unsecured debt improve, the
applicable margin associated with any such borrowings may decrease, resulting in
a lower borrowing cost under this facility. Should the ratings assigned to our
long-term unsecured debt worsen, the applicable margin associated with our
borrowings may increase, resulting in a higher borrowing cost under this
facility.
Debt Covenants
The revolver requires that we maintain an adjusted debt to earnings before
interest, income taxes, depreciation, amortization and rent ("EBITDAR") leverage
ratio of no more than four times (see the following additional discussion of
Adjusted Debt to EBITDAR). As of January 28, 2017, we were in compliance with
this covenant.


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Adjusted Debt to EBITDAR (Non-GAAP financial measure)
Adjusted Debt to EBITDAR is one of our key financial metrics, and we believe
that our debt levels are best analyzed using this measure. Our goal is to manage
debt levels to maintain an investment-grade credit rating and operate with an
efficient capital structure. In evaluating our debt levels, this measure
provides a reflection of our credit worthiness that could impact our credit
rating and borrowing costs. We also have a debt covenant that requires an
adjusted debt to EBITDAR leverage ratio of no more than four times. As of
January 28, 2017, our Adjusted Debt to EBITDAR was 2.4, compared with 2.2 as of
January 30, 2016. This increase was primarily driven by an increase in our
estimated capitalized operating lease liability.
Adjusted Debt to EBITDAR is not a measure of financial performance under GAAP
and should be considered in addition to, and not as a substitute for, debt to
net earnings, net earnings, debt or other financial measures prepared in
accordance with GAAP. Our method of determining non-GAAP financial measures may
differ from other companies' methods and therefore may not be comparable to
those used by other companies. The financial measure calculated under GAAP which
is most directly comparable to Adjusted Debt to EBITDAR is debt to net earnings.
The following is a reconciliation of the components of Adjusted Debt to EBITDAR
and debt to net earnings:
20161 20151
Debt $2,774 $2,805



Add: estimated capitalized operating lease liability2 1,616 1,405
Less: fair value hedge adjustment included in long-term debt (12 )



(24 )
Adjusted Debt $4,378 $4,186

Net earnings 354 600
Add: income tax expense 330 376
Add: interest expense, net 121 125
Earnings before interest and income taxes 805


1,101




Add: depreciation and amortization expenses 645


576



Add: rent expense 202


176



Add: non-cash acquisition-related charges3 198 9
EBITDAR $1,850 $1,862

Debt to Net Earnings 7.8 4.7
Adjusted Debt to EBITDAR 2.4 2.2


1 The components of Adjusted Debt are as of January 28, 2017 and January 30,
2016
, while the components of EBITDAR are for the 12 months ended January 28,
2017
and January 30, 2016.
2 Based upon the estimated lease liability as of the end of the period,
calculated as the trailing 12 months of rent expense multiplied by eight. The
multiple of eight times rent expense is a commonly used method of estimating the
debt we would record for our leases that are classified as operating if they had
met the criteria for a capital lease or we had purchased the property.
3 Our revolver agreement stipulates that non-cash charges (including goodwill or
other impairment charges) related to acquisitions be deducted in determining net
earnings for purposes of our debt covenant calculation. As such, the Trunk Club
goodwill impairment of $197 (see Note 8: Fair Value Measurements in Item 8) has
been added back to arrive at EBITDAR for the 12 months ended January 28, 2017.


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Contractual Obligations
The following table summarizes our contractual obligations and the expected
effect on our liquidity and cash flows as of January 28, 2017. We expect to fund
these commitments primarily with operating cash flows generated in the normal
course of business and credit available to us under existing and potential
future facilities.
Less than More than
Total 1 year 1 - 3 years 3 - 5 years 5 years
Long-term debt $4,409 $162 $285 $1,172 $2,790
Capital lease obligations 2 1 1 - -
Operating leases 2,849 277 601 536 1,435
Purchase obligations 1,661 1,466 193 2 -
Other long-term liabilities 353 50 57 41 205
Total $9,274 $1,956 $1,137 $1,751 $4,430


Included in the required debt repayments disclosed above are estimated total
interest payments of $1,569 as of January 28, 2017, payable over the remaining
life of the debt.
The capital and operating lease obligations in the table above do not include
payments for operating expenses that are required by most of our lease
agreements. Such expenses, which include common area charges, real estate taxes
and other executory costs, totaled $112 in 2016, $97 in 2015 and $88 in 2014. In
addition, some of our leases require additional rental payments based on a
percentage of our sales, referred to as "percentage rent." Percentage rent,
which is also excluded from the obligations in the table above, was $12 in 2016,
$13 in 2015 and $14 in 2014.
Purchase obligations primarily consist of purchase orders for unreceived goods
or services and capital expenditure commitments, including our Manhattan store.
Other long-term liabilities consist of workers' compensation and other liability
insurance reserves and postretirement benefits. The payment amounts presented
above were estimated based on historical payment trends. Other long-term
liabilities not requiring cash payments, such as deferred property incentives
and deferred revenue, were excluded from the table above. Also excluded from the
table above are unrecognized tax benefits of $34, as we are unable to reasonably
estimate the timing of future cash payments, if any, for these liabilities.
Off-Balance Sheet Arrangements
On October 1, 2015, we completed the sale of a substantial majority of our U.S.
Visa and private label credit card portfolio to TD (see Note 2: Credit Card
Receivable Transaction in Item 8). Pursuant to the program agreement with TD, we
offer and administer our loyalty program and perform other account servicing
functions. Credit card receivables serviced under this contract are $2,342 as
of January 28, 2017. We retained certain accounts receivable subsequent to the
sale and the unused credit card capacity available represents an off-balance
sheet commitment. As of January 28, 2017, this unfunded commitment was $124.
Other than items noted in the paragraph above, in addition to operating leases
entered into in the normal course of business and the development of our
Manhattan full-line store, we had no material off-balance sheet arrangements
during 2016.
CRITICAL ACCOUNTING ESTIMATES
The preparation of our financial statements requires that we make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and disclosure of contingent assets and liabilities. We base our
estimates on historical experience and other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ from these
estimates. The following discussion highlights the estimates we believe are
critical and should be read in conjunction with the Notes to Consolidated
Financial Statements in Item 8. Our management has discussed the development and
selection of these critical accounting estimates with the Audit Committee of our
Board of Directors and the Audit Committee has reviewed our disclosures that
follow.


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Revenue Recognition
We recognize revenue net of estimated returns and excluding sales taxes. Revenue
from sales to customers shipped directly from our stores, websites and catalog,
which includes shipping revenue when applicable, is recognized upon estimated
receipt by the customer. We estimate customer merchandise returns based on
historical return patterns and reduce sales and cost of sales accordingly.
Although we believe we have sufficient current and historical knowledge to
record reasonable estimates of sales returns, there is a possibility that actual
returns could differ from recorded amounts. In the past three years, there were
no significant changes in customer return behavior and we have made no material
changes to our estimates included in the calculations of our sales return
reserve. A 10% change in the sales return reserve would have had a $12 impact on
our net earnings for the year ended January 28, 2017.
Merchandise Inventories
Merchandise inventories are generally stated at the lower of cost or market
value using the retail inventory method (weighted-average cost). Under the
retail method, the valuation of inventories is determined by applying a
calculated cost-to-retail ratio to the retail value of ending inventory. The
value of our inventory on the balance sheet is then reduced by a charge to cost
of sales for retail inventory markdowns taken on the selling floor. To determine
if the retail value of our inventory should be marked down, we consider current
and anticipated demand, customer preferences, age of the merchandise and fashion
trends. Inherent in the retail inventory method are certain management judgments
that may affect the ending inventory valuation as well as gross profit.
We reserve for obsolescence based on historical trends and specific
identification. Our obsolescence reserve contains uncertainties as the
calculations require management to make assumptions and to apply judgment
regarding a number of factors, including market conditions, the selling
environment, historical results and current inventory trends.
We do not believe that the assumptions used in these estimates will change
significantly based on prior experience. In the past three years, we have made
no material changes to our estimates included in the calculations of the
obsolescence reserve. A 10% change in the obsolescence reserve would have had a
$3 impact on our net earnings for the year ended January 28, 2017.
Goodwill
We review our goodwill annually for impairment or when circumstances indicate
that the carrying value may exceed the fair value. We perform this evaluation at
the reporting unit level, comprised of the principal business units within our
Retail segment, through the application of a two-step fair value test. The first
step compares the carrying value of the reporting unit to its estimated fair
value, which is based on the expected present value of future cash flows (income
approach), comparable public companies and acquisitions (market approach) or a
combination of both. If fair value is lower than the carrying value, then a
second step is performed to quantify the amount of the impairment.
As part of our impairment testing, we utilize certain assumptions and apply
judgment regarding a number of factors. Significant estimates in the market
approach include identifying similar companies and acquisitions with comparable
business factors such as size, growth, profitability, risk and return of
investment, and assessing comparable earnings or revenue multiples in estimating
the fair value of the reporting unit. Assumptions in the income approach include
future cash flows for the business, future growth rates and discount rates.
Estimates of cash flows may differ from actual cash flows due to, among other
things, economic conditions, changes to the business model or changes in
operating performance. For Nordstrom.com, Jeffrey and HauteLook, the fair values
substantially exceeded carrying values and therefore we had no material goodwill
impairment in 2016, 2015 or 2014. A 10% change in the fair value of any of these
reporting units would not have had an impact on our net earnings for the year
ended January 28, 2017.
We recognized a goodwill impairment charge of $197 for the year ended
January 28, 2017 related to Trunk Club, resulting from changes to the long-term
operating plan that reflected lower expectations for growth and profitability
than previous expectations (see Note 1: Nature of Operations and Summary of
Significant Accounting Policies and Note 8: Fair Value Measurements in Item 8).
There were no material goodwill impairment charges related to Trunk Club in 2015
or 2014.
Impairment of Long-Lived Assets
When facts and circumstances indicate that the carrying values of long-lived
assets, including buildings, equipment and amortizable intangible assets, may be
impaired, we perform an evaluation of recoverability by comparing the carrying
values of the net assets to their related projected undiscounted future cash
flows, in addition to other quantitative and qualitative analyses.
Land, property and equipment are grouped at the lowest level at which there are
identifiable cash flows when assessing impairment. Cash flows for our retail
store assets are identified at the individual store level, while our intangible
assets associated with HauteLook and Trunk Club are identified at their
respective reporting unit levels. The assets recorded in connection with the
credit card receivable transaction are individually evaluated against the
anticipated cash flows under the program agreement (see Note 2: Credit Card
Receivable Transaction in Item 8).
Our estimates are subject to uncertainties and may be impacted by various
external factors such as economic conditions and market competition. While we
believe the inputs and assumptions utilized in our analyses of future cash flows
are reasonable, events or circumstances may change which could cause us to
revise these estimates.


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Stock-Based Compensation Expense
We grant stock-based awards under our 2010 Equity Incentive Plan ("2010 Plan"),
2002 Nonemployee Director Stock Incentive Plan ("2002 Plan") and Trunk Club
Value Creation Plan ("VCP"), and employees may purchase our stock at a discount
under our Employee Stock Purchase Plan ("ESPP"). We predominantly recognize
stock-based compensation expense related to stock-based awards at their
estimated grant date fair value, recorded on a straight-line basis over the
requisite service period. Compensation expense for certain award holders is
accelerated based upon achievement of age and years of service. The total
compensation expense is reduced by estimated forfeitures expected to occur over
the vesting period of the awards.
We estimate the grant date fair value of stock options using the Binomial
Lattice option valuation model. Stock-based compensation expense related to the
VCP is based on the grant date fair value of the payout scenario we believe is
probable using the Black-Scholes valuation model and is recognized on an
accelerated basis due to performance criteria and graded vesting features of the
plan. The fair value of restricted stock is determined based on the number of
shares granted and the quoted price of our common stock on the date of grant,
less the estimated present value of dividends over the vesting period.
Performance share units granted prior to 2016 are classified as liabilities and
revalued using the quoted price of our common stock as of each reporting date.
Performance share units granted in 2016 and beyond are classified as equity and
the fair value is determined using the Monte-Carlo valuation model.
Calculating the grant date fair value of stock-based awards is based on certain
assumptions and requires judgment, including estimating stock price volatility,
forfeiture rates, expected life and performance criteria. A 10% change in
stock-based compensation expense would have a $6 impact on our net earnings for
the year ended January 28, 2017.
Income Taxes
We use the asset and liability method of accounting for income taxes. Using this
method, deferred tax assets and liabilities are recorded based on differences
between the financial reporting and tax basis of assets and liabilities and for
operating loss and tax credit carryforwards. The deferred tax assets and
liabilities are calculated using the enacted tax rates and laws that are
expected to be in effect when the differences are expected to reverse. We
routinely evaluate the likelihood of realizing the benefit of our deferred tax
assets and may record a valuation allowance if, based on all available evidence,
it is determined that some portion of the tax benefit will not be realized.
We regularly evaluate the likelihood of realizing the benefit for income tax
positions we have taken in various federal, state and foreign filings by
considering all relevant facts, circumstances and information available. If we
believe it is more likely than not that our position will be sustained, we
recognize a benefit at the largest amount that we believe is cumulatively
greater than 50% likely to be realized. Our unrecognized tax benefit was $32 as
of January 28, 2017 and $19 as of January 30, 2016. Interest and penalties
related to income tax matters are classified as a component of income tax
expense.
Income taxes require significant management judgment regarding applicable
statutes and their related interpretation, the status of various income tax
audits and our particular facts and circumstances. Also, as audits are completed
or statutes of limitations lapse, it may be necessary to record adjustments to
our taxes payable, deferred taxes, tax reserves or income tax expense. Such
adjustments did not materially impact our effective income tax rate in 2016 or
2015.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1: Nature of Operations and Summary of Significant Accounting Policies
in Item 8 for a discussion of recent accounting pronouncements and the impact
these standards are anticipated to have on our results of operations, liquidity
or capital resources.


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