Brian Lok

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EXECUTIVE SUMMARY

Nordstrom, Inc. is a well-known luxury, excellent customer service retail family clothing department store in Seattle, WA. Nordstrom, Inc. is founded in 1887 by 16-year-old John W. Nordstrom with $5 from Sweden with not a word of English to New York. After he registered the company, he worked as miner while he crossed to the country to the west coast of Washington. He then reunited with Carl Wallin and invested in his shoes company. They opened Wallin & Nordstrom in 1901 in downtown Seattle, which they always strive to provide exceptional service, selection, quality and value. This allows the company to become one of the leaders of the retail clothing industry. The purpose of this paper is to examine whether Nordstrom, Inc.’s strategic performance, financial conditions, and management effectiveness from the controller perspective based on the findings found from the financial statements.

Nordstrom, Inc.’s strategic performance has gone down because the company has been expanding their business to Canada, improving the online shopping structure to meet with the market needs. Thus, Nordstrom, Inc. has a decrease in return on equity from the decrease in return on sales and gross margin percentage. This year, Nordstrom, Inc. decided to expand their business to Canada with three to four stores a year, and acquire online retail stores to expand their online market that can maintain their business strategy and increase their market share in online market.

Moreover, Nordstrom, Inc. has promoted three family members as the Co-Presidents. The Corporate Governance and Nominating Committee decided that the Co-Presidents will be reviewed every year, based on their contribution and their independence towards the decision making to make sure the decisions are based on benefiting the business as a whole. Nordstrom’s effect management control systems help the company to mitigate the risks in order to provide an accurate financial statements.

Furthermore, Nordstrom’s financial condition has an increased in net sales after the fourth quarter, but the company has decreased in net earnings and operating margin due to the acquisition of Trunk Club. The company also uses the weighted-average method to value their inventory because it reduced by a charge to cost of sales for retail inventory markdowns taken on the selling floor. Besides, the company uses both GAAP and non-GAAP measures to help investors and financial analyst to understand the company’s capital and cash flow to assess the company’s profitability.

In conclusion, Nordstrom’s management is acting as custodian, which the company needs to be forward looking to maintain a strong corporate governance, works with the the business to ensure compliance and effective controls, custodian of assets and value protection, and conscience of the business. The controller can contribute the value to the company by planning, accounting, reporting, and controlling that the controller helps the management to provide valuable insight to help the company to become profitable and maintain their comparative advantage among their competitor

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REASONS FOR SELECTING NORDSTROM, INC.

Nordstrom, Inc. is a famous luxury brand within the retail clothing industry in the United States. However, the company recently is facing the threat of new entrants from online retail companies. Many online clothing retailers have changed the competitive environment from in-shop to online platform that affects Nordstrom profitability. Nordstrom has modified their business model to maintain their competitiveness within the industry. This is one of the reasons in selecting the company because they are willing to adopt to the market needs in maintaining their competitiveness. Nordstrom, Inc.’ corporate governance structure is another reason to choose this company. Nordstrom is a well-known family clothing retail company, where three of the board members are from the Nordstrom family, and are the co-president of Nordstrom, Inc.6 According to the course readings, there are three requirements for a strong corporate governance: the independence of the board, the attractiveness of the board, and the quality of the audit committee.2 This is another reason for choosing this company because the company needs to maintain its independence from family interest in filing the documents to the SEC. Moreover, Nordstrom used return on invested capital (ROIC), free cash flow, adjusted debt to EBITDAR as their non-GAAP measures as well as regular GAAP measures to discuss about their earnings. Through our class discussion on GAAP and non-GAAP measures, we mentioned that non-GAAP measures are usually overstated the earnings, but GAAP measures are usually understated. The company believes that both measures are essential for investor to assess the company’s financial performance, and gain better understanding of the company, which is one of the reasons in choosing this company.

STRATEGIC PERFORMANCE

Nordstrom, Inc. is committed to work relentlessly to give customers most compelling shopping experience possible in shop or online, wherever new opportunities arise.7 Nordstrom’s long lasting history along with establishing and strengthening their brand image has not only allowed the company to achieve their mission, but also solidify their position as a leading competitor within the the retail clothing industry. It exemplifies quality, superior luxury product, customer service in making it the company’s mist valued asset. Nordstrom, Inc. uses product differentiation strategy to identify themselves among all their competitors in order to maintain their well-known images. This provides an opportunity for the company to identify themselves as superior in terms of products and services other competitors offer. Thus, Nordstrom, Inc.’ strategies are based on expanding the online retail markets to maintain their competitiveness and maintain their wonderful quality of products and services that Nordstrom hold.

In financial perspective, Nordstrom, Inc. is not able to sustain or increase its gross margin and return on sales. The company’s gross margin has decreased from 39 percent in 2012 to 38 percent in 2015. In comparing with the Retail Apparel Industry’s gross margin, Nordstrom, Inc.’ gross margin is way lower than the industry average, 72 percent.7 This decrease and difference in gross margin is a result of the market trend changing from in-store shopping to online shopping in buying the similar quality of products with a lower price than the company offered in-store. Nordstrom, Inc. also has a decrease in return on sales of 7.81 percent in comparing to 11.10 percent in 2012.1 A decrease in return of sales means that Nordstrom, Inc. is pricing the product above the market average price, and might not have an effective expenditure in selling, general,

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and administrative expenses that cause a decrease in the company’s return on asset and return on equity ratios. Nordstrom, Inc.’ return on equity in 2015 was around 32 percent from 37.99 percent that affects the financial leverage ratio to increase from 3.79 in 2013 to 4.34. This shows the company is having a less liquidity in equity, which means the higher fluctuation in company’s earning. Nordstrom, Inc. decreased in gross margin and return on sales shows that the company might need to adjust the business strategy in having a higher return.

Nordstrom, Inc. should improve revenue per retail square footage and online shopping market share because the total revenue growth has decreased from the 7.70 percent in 2014 to 6.89 percent in 2015.7 Even though there is an increase in revenue per total gross retail square footage, the increase in net sales does not in proportion to the increase in the total gross retail square footage so the company does not have a positive growth in 2015. As Nordstrom defines themselves as a product differentiator, the company can improve their websites layout to help their customers to shop online that provide similar experience customers might have in a Nordstrom’s store. Improving website layout can help to fit with the current market needs, and encourage current and potential customers to use Nordstrom’s online shopping to increase in revenue growth.

Even though the company’s revenue per employee increased from $199,443 in 2013 to $210,373 in 2014, Nordstrom’s overall competitive as decreased by the other online retailers.7 This cause the company to decide to eliminate their employees from the headquarter to lower their employees cost, which is one of their highest expenditures. With the excellent customer service Nordstrom provided to their customers, the decrease in employees might not affect their retail sales performance but it might be a good idea to provide more training to their employees in increasing the revenue per employees to increase the revenue growth.

From a customer perspective, Nordstrom, Inc. provides a memorable and unique shopping experience to implement the product differentiation strategy. According to a research from Ryerson University, Nordstrom, Inc. will ensure there is adequate parking and provide valet parking during busy sales times, and the company believes that they have 15 seconds to get their customers to be enthused so the store layout features wide aisle to provide a free and wide area to their customers to shop which will increase their revenue growth.8 Another example will be Nordstrom, Inc. offers opportunity for customers to sit down, relax and have something to eat without leaving the store, which can enhance the customers’ experience and differentiate from their competitors to increase the comfort level of the shopping experience. Also, the company has provided a reward program credit card that encourage their customers to shop in Nordstrom and Nordstrom Rack that can sufficiently increase company’s revenue. However, Nordstrom should allow their customers to use the reward program to shop in Nordstrom owned online store to increase their online market share because customers might cancel the credit card once they are not able to shop online in non-Nordstrom store. Changing the reward program can increase the online shopping market share and the total revenue.

From the internal processes, Nordstrom, Inc. has maintained an effective and efficient controls by implementing the Nordstrom Partnership Guideline to their suppliers, employees, agents and communities. This guideline provides the best value product in the most equitable manner, and

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identify the potential suppliers with the same value that the company is pursuing. Nordstrom’s suppliers mostly manufacture their product in China so they require their suppliers, supplier’s manufacturers, factories not to employ anyone child labor, under the age of 15, and / or under the minimum ages established by applicable law in the country of manufacture. This helps to maintain the company’s image and corporate social responsibility.

Nordstrom, Inc.’s asset turnover has increased from 1.53 in 2014 to 2.09 in 2015 which is close to the industry average 2.18 showing that the company should improve the asset productivity.7 The company should improve the product sourcing, and managing any unused capacity to improve the asset turnover rate. It is important for the company to makes sure that the product quality does not affect the product differentiation strategy. However, the company’s inventory turnover has decreased from 5.07 in 2013 to 4.54 in 2015 which is lower than the industry average of 6.69.7 With the improvement of inventory turnover rate, the company can improve it asset turnover rate and return on equity to increase the total revenue growth.

At the end of 2015, Nordstrom, Inc. has started to improve their online shopping platform to meet with customer’s needs, and increase their competitiveness among the competitors. For example, Nordstromrack.com/HauteLook for women apparel is one of online shopping websites that Nordstrom is promoting for online shopping.7 With the improvement of the online shopping platform, the company is trying to attract customers to shop online with the same product quality and provides free shipping to customers. Nonetheless, the company should allow their loyal customers to use the company credit card to shop in any Nordstrom online store, which can retain the loyal customers that are not able to shop frequently in the local stores. Besides, with competition of online subscription-box, Nordstrom should consider to provide similar services to their loyal customers in providing a high quality product with similar prices than their competitors. This helps Nordstrom, Inc. to retain its comparative advantage in using the product differentiation strategy.

Corporate Governance

From the impact of the Sarbanes-Oxley Act (SOX), the U.S. Securities and Exchange commission (SEC) has required more accuracy in disclosing their corporate details to protect the shareholders and the general public. According to the course material, a strong corporate governance requires to have three elements to maintain its effectiveness: the independence of the board, the attentiveness of the board, and the quality of the audit committee.6 In comparing Nordstrom’s pre-sox and post-pox statements, the company has disclosed more information to increase the level of transparency and independency that can help the company to prevent any unethical behavior and accounting practices which might affect the integrity of the financial statements.

The changes imposed by the SEC have increased the board of independence for Nordstrom as a public retail-family owned business. Comparing the pre-sox and post-sox statements Nordstrom filed in 2001 and 2015 respectively, Nordstrom, Inc. has increased the number of the board of directors from eight to nine, and increased the number of independent directors from seven to eight. In both years, Nordstrom, Inc.’s board of directors have only one member from the Nordstrom family, which can show that Nordstrom, Inc. is trying to maintain their independence

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in decision making and the board of director is making best decision in terms of stakeholders. Also, most of the committees listed on the 2015 proxy statement are from different industry, which can provide diverse opinion to Nordstrom, Inc. for improvement.

According to the 2015 Proxy statement states that Nordstrom, Inc. has promoted Blake W. Nordstrom, Erik B. Nordstrom, Peter E. Nordstrom as the Co-President of Nordstrom, Inc.6 Family members from Nordstrom can be problematic because their relationships as part of the family members that they might hold their family interest into account for the company’s decision making process since they are the Co-President of the company. This might affect the the independence of the board to have a strong corporate governance structure.

Comparing the Proxy statements in 2001 and 2015, Nordstrom, Inc. has increased the type of committees across the board: Finance Committee and Technology Committee. Adding the Finance Committee can help Nordstrom to provide constructively opinions towards tax strategies, dividend payment, long-term debts, and investment in technology. Since all the finance committees are independence members, and from different companies and industry that can provide insight of what kind of investments a retail apparel company needs to make to be successful. For example, B. Kevin Turner is the Chief Operating Officer of Microsoft Corporations, a member of the Finance Committees, and the chair of Technology Committee of Nordstrom, Inc.6 He is able to provide insight to the company in investing in technology, and how technology can help to provide financial benefits to the company, like investing in online shopping. Besides, B. Kevin Turner’s background in working for Microsoft Corporation for more than 10 years. He is able to provide recommendations or opinions towards cyber security, data management after Nordstrom, Inc. implemented the new ERP system to manage their financial reporting.6

Since the number of family members being the President have increased, Nordstrom. Inc. has increased its disclosure in their proxy statement. The 2015 proxy statement has explained the reason why the three Nordstrom family members are appointed to be the Co-President of the company. Also, the Corporate Governance and Nominating Committee has established procedures in the case of an emergency or the retirement of one or more of the Co-President and review the overall performance of the Co-President in annual basis.6 The purpose of appointing the family members as the Co-President is they have been increasing the number of responsibilities for more than 35 years, and they are able to provide a customer-centric perspective in retailing and supporting to the company. Besides, the Proxy statements mentioned that three Co-Presidents will not change their compensation and they will be reviewed by independence party annually.6

Management Control Systems

Successful management control systems can prevent any fraudulent activity and help organization’s success. Nordstrom, Inc.’s successful internal control system helps their company to meet their financial and strategic goals. According to report of independent on the management control systems and the annual independent audit, Deloitte & Touche LLP provided a reasonable assurance that Nordstrom, Inc. has no material weaknesses in their internal control systems.7 According to the course reading, identifying goals, developing systems that encourage

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compliance, and evaluating the results are three elements needed to have a successful control system.9 Strategic and operational risks and economic and external market factor risks, legal and regulatory risks are the main type risks that Nordstrom, Inc. is trying to mitigate the risks. The Nordstrom Board of Directors oversees and assess the risk management of the company, and to make sure that risk management is part of the corporate culture before making the business decision that might affect the business as a whole.6 Moreover, Nordstrom, Inc. has their own internal audit department, which leaded by the Vice President of Internal Audit, to make sure they have regular assessment on their financial reporting system, and they have individual function teams, IT Audit and SOX Business risk, to make sure they are compliance with the regulations. Also, the Vice President of Internal Audit will be reviewed every year to make sure he/she is able to meet with the audit committee expectations. In conclusion, Nordstrom, Inc. has a strong management control system implemented that managements are able to identify, assess, and prioritize the risks to provide an accurate financial statements.

FINANCIAL CONDITION

According to Nordstrom’s earnings release for fourth quarter 2015, Nordstrom’s fourth quarter net sales increased 5.2 percent and comparable sales increased 1 percent, and the comparable sales increase of 0.9 percent in the third quarter.4 Nordstrom’s fourth quarter sales is one third of the 2015 total sales. This increase in net sales might because of the increase in number of stores in Canada and the Unites States. Company mentioned couple strategy and operational factor that might affect the company’s net sales in the following years: execution of product differentiation strategy in providing a seamless and high quality experience across all Nordstrom channels, enhancing ecommerce that will be driven by lots of variable cost, and fail to manage the capital will cause a negative impact on their operations and shareholders return.7 The company also reported that the operating margin decreased for 1.3 percent and net earnings decreased for 20 percent from year due to the Trunk club acquisition, and ongoing entry into Canada.7 Nordstrom, Inc. expects to increase net sales by 3.5 to 5 percent and comparable sales increase by 0 to 2 percent by bringing the ecommerce perspective into the company.7 Also, the company continues to increase its ecommerce market share by acquisition the current online retail company with similar business strategy., like Trunk club.

Nordstrom, Inc. discloses both GAAP and non-GAAP measures to provide investors with an additional information that they think investor should include to evaluate their financial condition and financial performance. Nordstrom, Inc. believes that Return on Invested Capital (ROIC) is a useful tool for investors in evaluating the efficiency and effectiveness of their use of capital, and to assess the shareholders’ return in long term. ROIC is calculated by net operating profit after tax divided by 12-month average invested capital, which this index provides an additional information apart from ROA, net earnings, total assets or other financial measures use under the GAAP. The company also uses the Statement of Cash Flow to represent show the breakdown the use of cash or capital in an effective and efficiency manner. Comparing the ROA under the GAAP and non-GAAP measures, it showed there is a 2 percent difference between two measures. Also, Nordstrom, Inc. uses the Free Cash Flow as one of the non-GAAP measures, which it is one of the key indexes to measure the liquidity, and it increased from $96 millions in 2014 to $1,131 millions in 2015 because the company received proceeds received from the sale of their credit card receivables, where partially offset by cash dividend paid.7 Nordstrom, Inc.

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suggested that the Free Cash Flow created under the non-GAAP measures should be used as an additional information from the Statement of Cash Flow created from GAAP measures. The company focused on their liability perspectives in using this index. Nordstrom uses this index to provide the impact on credit ratings and the debt covenants if there are any adjustment towards the Statement of Cash Flow under this measures. Comparing two measures, the company has a higher credit rating than using GAAP measures that provide an opportunity to have a lower interest rate for a long-term debt for merger and acquisition. Besides, Nordstrom, Inc. uses Adjusted Debt to EBITDAR to analysis the company debt levels, and this index can help to maintain their goal to manage debt levels to maintain an investment-grade credit rating and operate with an efficient capital structure, and this measure provides a reflection on how will the credits affect their credit rating and the interest might involve for the debts.7 Nordstrom’s internal management and financial analysis use both GAAP and non-GAAP measures in understanding and evaluating the company’s financial condition and financial performance. Both measures are useful for the internal management in terms of decision making according to their business strategy.

Nordstrom, Inc. uses an aggressive accounting principle and estimates that are comparable with the industry behavior. Nordstrom, Inc. uses the retail inventory method, which is the weighted-average cost, as their valuation for their merchandise inventory. Inventory only be around 13 percent of the total assets.7 Nordstrom, Inc. has been using the weighted-average method for the valuing their inventory because it can be reduced by a charge to cost of sales for retail inventory markdowns taken on the selling floor. As a retail apparel industry, Nordstrom’s accountability towards valuation of inventory will include the markdown providing by the retailers during the sales period, which will truly reflect the net sales on their financial statements. Since GAAP allows companies in the United States to use weighted-average method for valuing inventory, and the auditors from Deloitte provided a reasonable assurance on their financial statements with no material misstatement so using this valuation inventory method can help the company to correct record the sales amount.7

Nordstrom, Inc.’s effective tax rate has decreased from 39.2 percent in 2014 to 38.6 percent in 2015.7 Even though Nordstrom is an international company, the company is mainly located in Canada and the United State, which they decided to reinvest their capital in opening more stores in Canada. Moreover, Nordstrom provides gift card to their customers, which might create deferred tax asset for the company because Nordstrom will not be taxed by the IRS until customers have used the amount stored in the gift card.

MANAGEMENT EFFECTIVENESS

Nordstrom, Inc.’s management contribute organizational value as the custodian. Being a custodian, the management focus on governance, works with the business to ensure compliance and effective controls, custodian of assets and value protection, and conscience of the business.2 In terms of governance, Nordstrom, Inc. maintains a strong corporate governance structure through risk assessment, integrity, and the board independence. Even though the new three CO-President of Nordstrom, Inc. are from the Nordstrom family, the company required to have an annual review to make sure they contribute their values to the company in customer service industry, and they will have at least one board meeting in the year regarding the company’s

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strategy.6 The company also added two more board committees to meet the needs of expansion of the company to ensure the company have a diverse opinion and have necessary risk assessment before launching any new program.

Besides corporate governance, Nordstrom, Inc. works to ensure they are compliance and effective controls. In term of internal control, Nordstrom has an internal audit department to make sure their financial reporting systems are able to correctly function to provide accurate financial reports. Through evaluating the company risks, the company’s board committees and management are able to be compliant with the GAAP requirement in financial reporting.6

Nordstrom’s Partnership Guideline will be an appropriate example for Nordstrom, Inc. to be custodian of assets and value protection.3 The company maintains its ethical value not only towards their stakeholders, like employees, but they also required their suppliers, supplier’s manufacturer to follow the company ethical standard in promoting the corporate social responsibility. As Nordstrom is a publicly traded company, any negatively impact will directly affect the company’s performance and financial condition.

Also, Nordstrom, Inc. identifies several risks that the company might be facing in the future that might significantly affect their business strategy, which makes the company’s management and board committee more difficult to forecast the future to guide the company to be successful. However, Nordstrom, Inc. being a custodian, they are mitigating the risks by having a strong corporate governance, effective internal controls, which they can present an accurate financial report to the public and investors with risks included.

Nordstrom, Inc.’s management aware that they are acting as custodian, which means they will work on improving the company by bringing different values to the company. In recent years, the company has decided to increase their net sales and comparable sale every year by opening around three to four stores per year, and expanding their market share in the ecommerce industry. With the expansion in the ecommerce, Nordstrom, Inc.’s management needs to evaluate how it might affect their product differentiation strategy in both positively and negatively. Since they have a Technology committee, they will be expected to account for the risk assessment that prior to strengthen the online business.

HOW THE CONROLLER CAN ADD VALUE

According to the course material, the controller has four responsibilities: planning, accounting, reporting, and controlling.2 Through this four responsibilities, the controller is able to management’s effort in improving the business, and providing constructive values to the company. In planning function, the controller can provide the master budget, supporting budgets, and forecast to the management to make reasonable decision based on the data the company has from previous years. In Nordstrom’s situation, the controller is able to provide the budget and forecast to the management to make decision whether they should expand the business to Canada. Also, these budget can also determine the total debt to equity ratio and the long term debt to equity ratio to show whether the company will be in great differences in holding the debt for expanding the business.

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Accounting function is the traditional primary function of controller. Since Nordstrom, Inc. is expanding their business to Canada, the company will need to follow both IFRS and GAAP accounting standards,’` and process the transactions from Canada quickly. Nordstrom’s IT audit team is definitely helpful in making sure the financial reporting system are in place and functioning correctly to provide accurate financial reports. Also, the controller can reduce the cycle time of accounting activities to make sure that all the transactions are populated to the system and the controller is able to use those data to prepare the quarter and annual report, which ensure a quick and reliable information for decision making.

Within the reporting function, the controller is responsible for collecting data and turning it into an insightful material. Since the financial statements are the tools for communicating with the shareholders, creditors, financial analysts, regulators, customers and general public, it is importance for the controller to turn the data into meaningful information to value the company for future investment. Also, investors and financial analysts will be looking at the profit per employees, employee turnover, employee satisfaction, ROE per store to determine whether the company has a strong corporate governance, and management is able to use these data to spot out the areas for further improvement. In this function, the controller comes up with all the key metrics for the management to interpret any necessary changes with the decision making.

At last, the controller in controlling function should provide useful accounting information. Management and the board members will be looking at the accounting information provided by the controller to assess the company’s performance, and make sure that any business activities are lined up with their product differentiation strategy. Also, the controller’s responsibility starts with number, but not end with number, where they implement any control system to compliance with the SEC filing standards. The controlling function provides the management with an accurate accounting information that can help management better evaluate individual store performance, and implement necessary measure to improve the profitability.

These four functions the controller is able to add value and improve management’s role as a business partner that focus in value creation, acts as business advisor, and provide insight and robust challenge to support decision making. Also, the controller’s functions can help the management to compare with the industry performance in order to maintain their business strategy among the retail apparel industry. These four functions help the controller to add value, analysis the data to provide valuation decision making.

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APPENDICIES

1 CSIMarket (2016). Retail Apparel Industry. Retrieved March 30, 2016.

2 EY. (2008). The changing role of the financial controller, 1-13.

3 Nordstrom, Inc. (2011). Nordstrom Partnership Guideline. Retrieved March 30, 2016

4 Nordstrom, Inc. (2014). Fourth Quarter Earnings Release.

5 Nordstrom, Inc. (2001). Proxy 2001, Security Exchange Commission, Edgar.

6 Nordstrom, Inc. (2015). Proxy 2015, Security Exchange Commission, Edgar.

7 Nordstrom, Inc. (2015). Nordstrom, Inc. Annual Report: 10-K, Security Exchange Commission,

Edgar

8 Ryerson University (2014). Nordstrom, Inc.: Designing a Balanced Scorecard. Retrieved

March 30, 2016

9 Shortridge, R.T., & S.C. Yu. (2011). The evolution of corporate control systems, Strategic

Finance92 (12), 51-55.

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