Chargebacks Crisis: Saks Inc. to Repay $21.5M to Vendors

Saks Inc. said it is investigating "improper collections" of vendor markdowns and will restate earnings from fiscal 1999 to the third quarter of 2004.

NEW YORK — Saks Inc. apparently squeezed certain vendors for several years, but now it’s payback time.

Saks has revealed an internal investigation involving “improper collections of vendor markdown allowances” and said it would pay back, or otherwise compensate, unnamed resources in an amount to total $21.5 million. In addition, it will restate earnings from fiscal 1999 to the third quarter of fiscal 2004 as a result of the repayments and accounting errors on leased departments.Saks said it has informed the Securities and Exchange Commission about its internal investigation of the markdown allowances and that the SEC has opened an informal inquiry of its own.

Chargebacks and markdowns long have been a major bone of contention between vendors and retailers, and Saks’ almost unprecedented decision to repay vendors could force the issue out into the open.

The news of the investigation came as Saks Inc. reported income for the fourth quarter ended Jan. 29 of $94.8 million, or 67 cents a diluted share, versus $80.6 million, or 56 cents, a gain of 17.6 percent over the same year-ago period. Sales for the quarter rose 4.9 percent to $2.07 billion from $1.97 billion.

The impropriety revealed by Saks on Friday reportedly occurred in the bridge area of Saks Fifth Avenue. Saks Inc. would not confirm that, but said it occurred in one merchandising division of SFA.

It’s also believed that Onward Kashiyama USA is among the vendors getting paid back. The vendor, which supplied Kors merchandise to Saks, has sued the retailer for $9,275,643 for “substantial deductions and credits which were not allowed under the terms of the agreement,” according to legal papers. Saks would not comment on the litigation.

Meanwhile, Saks said it will cooperate with the SEC inquiry. A majority of these improper collections occurred during the company’s 2000, 2001 and 2002 fiscal years and a lesser amount occurred during the 1999 and 2003 fiscal years. None occurred in 2004. Fred Wilson has been chairman and chief executive officer of SFA for the past year, succeeding Christina Johnson, who was ceo from February 2000 to October 2003. She succeeded Philip Miller. Saks did not lay blame on any executives, but did say its investigation could lead to actions against some personnel. The investigation is expected to be completed by the end of this month.

This story first appeared in the March 7, 2005 issue of WWD.  Subscribe Today.

Saks also is correcting $31.6 million in accounting errors related to leased departments in its stores. Among the leased departments important to SFA are Louis Vuitton and Christian Dior. For the period from fiscal 1999 through the third quarter of fiscal 2004, the total estimated impact will be to reduce reported pretax income by $31.6 million, including an approximately $10 million increase in previous impairment charges.

The situation at Saks could open a can of worms in the industry and put more retailers and their margin and markdown money agreements on notice, and under the watchful eye of the SEC. These practices fall under the umbrella of chargebacks, a widespread practice where retailers charge vendors for a variety of things, generally related to strictly complying with packaging, shipping and delivery-date agreements. However, new government rules of full disclosure require that markdown money has to be taken and charged to the vendor in the year the retailer bought the merchandise.

“We live in more stringent times,” said one competitor of Saks. 

Christopher T. Owen, attorney for Onward Kashiyama, which held the Kors license from 1995 to 2003, believes his client’s suit sparked the Saks admission. Onward filed a complaint against Saks on May 3 over excessive markdown demands and Saks answered it a month later, denying the allegations and requesting the complaint be dismissed.  Onward ended its Kors agreement in 2003. While Owen contended that “Onward Kashiyama is not a corporation that likes to sue companies,” he said what prompted the suit against Saks was the way the retailer took markdown money without giving any explanations.

“They told us we had a debit balance,” said Owen. He said he would get invoices for payments, and there would be large numbers for markdowns. “Some were legitimate for advertising. I don’t deny a portion was legitimate, but when the markdown numbers became so large we had a deficit balance, we felt we were getting nowhere with them.”

Owen explained that from 1999 to 2003, “it got to the point where we were delivering millions of dollars worth of merchandise, and they’d send us a bill of what we owed them.” He said when Onward would ask for an explanation of the markdowns, “it was met with absolute silence.” He said that Onward asked for $9.3 million, “but our subsequent investigation showed improper charges were between $12 million and $13 million from 1999 to 2003….Once I sent them a letter to please explain this, they sent me $716,000 with no explanation,” he added.

Owen said Saks took various discounts, including an 8/10 discount, “even when they paid nine months after deliveries.” The 8/10 policy enables a retailer to take an 8 percent discount if it pays the vendor within 10 days.

Owen said he had a conference with Justice Ira Gammerman last Wednesday in the New York County Supreme Court, and a decision to mediate the dispute was reached. “As of Wednesday, Saks was pleading ignorant of what this case was about,” said Owen. The judge on several occasions ordered that Saks provide Onward Kashiyama with the documents on how it determined the markdowns, but Saks never delivered, claimed Owen.

Saks executives declined to comment on the lawsuit.

Some sources said ‘kiting’, or tacking on chargebacks to unsuspecting resources at the end of a season, is not unusual in retail. Hypothetically, a retailer “borrows” a large sum from a vendor to meet its margin goal, and says it will make it up to the vendor by purchasing a certain amount of inventory the next year. But the following year comes and the retailer reneges on the agreement.

When it comes to negotiating margin agreements and markdown money, the bridge area, as one merchant said, is “very entrepreneurial” compared with other product categories, where there is little or no room for bargaining. Designer collections are said to leave virtually no room; accessories are a very high-margin business to begin with so little need for negotiating is usually seen; cosmetics companies run their own areas in department stores, and men’s wear tends to be a mixed bag, said the merchant. “You are not going to get anything from Chanel or Prada.”

The merchant described a wide variety of deals, such as offering 2 percent off purchases to use for markdown or advertising dollars; sometimes a vendor will take a return of excess merchandise, or an RTV, meaning return to vendor, or a combination of both.

“There is a lot of handshaking done, but then there can also be written agreements. In some cases, vendors will chart out a seasonal plan with a department store. It could say you buy X amount of merchandise and if you have a 90 percent sell-through, you don’t get markdown money. With 80 percent sell-through, we’ll give you a 5 percent discount, and 50 percent sell-through, you get X amount of markdown dollars.

“Some vendors keep extremely close to the retailers. They have merchandisers in the buyer’s office once a week looking at sales and stocks. Vendors are adding more merchandisers to monitor the business. Years ago, there weren’t as many.”

Said another source: “Some stores work the markdown money monthly, others could be quarterly, or seasonally, or not at all. There is no secret thing that goes on.”

Another executive said retailers can book charges to vendors in funny ways, and have been known to play games with sales numbers and vendor agreements that may not have been in writing at the end of the selling season. With Saks, some unnamed vendors wondered whether the bridge area chargebacks were related to warehouse and logistic issues.

“Bridge is where the big support dollars come from. Companies like Ellen Tracy have huge volumes of business with stores like Saks,” said the executive. At Saks, bridge is believed to be the biggest category in ready-to-wear. Key labels include Ellen Tracy and Dana Buchman, which are both part of Liz Claiborne; DKNY, part of LVMH Moët Hennessy Louis Vuitton; Eileen Fisher; David Meister, and Lafayette 148.

One consultant said, “I suspect Saks was not doing anything that was dishonest. I think it’s more about putting undue pressure on vendors and [buyers] coming back to vendors for more money, even more than what they previously stipulated.”

The practice of squeezing vendors stems from retailers’ corporate offices setting financial goals and leaving it up to buyers, divisionals and general merchandisers, as well as the ceo and president, to negotiate with vendors to achieve the targets. Buyers generally don’t arrange margin agreements on their own.

Another source said that, in the formation of margin agreements, vendors are under “extreme duress….You either sign up, or you’re out. They could have an agreement, but if business ends up worse than expected with margins at 35 percent instead of 40, retailers go back and ask for the other five points.”

Hiroaki Sumi, president and ceo of Onward Kashiyama U.S.A., said Friday that Kors merchandise had been selling well at Saks. “Sales were good, but as time passed and this markdown issue came up, it was impossible to tell. We thought it was going well, but Saks said otherwise because of the extent of the markdowns.”

Vendors were surprised by Saks’ admission.

“My God,” said Bud Konheim, chairman and ceo of Nicole Miller. “Whatever caused Saks to do this is at work in the other stores and you’re going to see the other shoe fall. It’s in Saks’ best interest to make sure the other guys get caught if they’re getting caught. This can’t be Saks alone. Come on, get real.”

Konheim speculated that Saks took markdown allowances without authorization. This involves retailers delaying payments, and adjusting them later, based on sell-throughs. This forces the vendor to go back to the retailer and negotiate for the rest of their payment.

Generally, it’s larger manufacturers, such as Jones Apparel Group, Liz Claiborne Inc. and Kellwood Co., that end up funding markdown allowances. Executives at these companies declined to comment.

The vendors had to contend with higher-than-expected markdowns during the fourth quarter, when full-price sales were not as robust as expected.

“The quarter was more difficult and promotional than we anticipated it would be, causing us to liquidate additional excess inventory and fund more markdowns,” said Claiborne’s chairman and ceo, Paul Charron, on a conference call with Wall Street Wednesday. “This resulted in a gross-profit rate which was about 100 basis points below our original expectations, but was necessary to ensure that our inventory was in good shape heading into spring.” Among Claiborne’s divisions are Ellen Tracy, Dana Buchman, Juicy Couture and Lucky Jeans.

Jones and Kellwood were each hit hard by markdowns during the fourth quarter and had to pre-announce that earnings would not come up to expectations.

Asked about the markdown situation, Mickey Klein, vice president of Elie Tahari, said: “We do monitor it very carefully.” However, regarding Saks: “We have a great relationship with them.”

Rick Roberts, ceo of Cynthia Steffe, also said he hasn’t had a markdown problem with Saks Fifth Avenue. “We have a wonderful relationship with them. They have not been worse than other people. It’s been a very easy relationship. We’ve had great sell-throughs.”

John Idol, ceo of Michael Kors LLC, said he was not aware of any excess markdown money that was paid by vendors to Saks. “Clearly, there are situations where manufacturers give markdown money to various retailers. Hopefully, it’s done in an honest way between the retailer and the manufacturer.”

Allan Ellinger, partner at Marketing Management Group, noted, “Very often a store or a buyer will put the vendor’s payment on what’s called ‘buyer’s hold’ and they’re going to hold that payment as ransom until they negotiate, if they need to negotiate a markdown allowance.”

He described Saks’ intention to reimburse vendors as “an amazing precedent.”

Saks has been aggressive in the pursuit of markdown money, but not as aggressive as Federated or May, said Ellinger. “This is going to give our industry the vendor structure courage to get out there and fight for their money,” predicted Ellinger. “There is now a modicum of hope.” Saks Inc. on Friday posted a fourth-quarter profit, but due to its ongoing internal investigation and its situation with leased operations accounting, the company will revise its financial statements for fiscal 1999 through the third quarter of fiscal 2004.

One vendor said on Friday in reaction to the Saks announcement: “I never heard of that option [to reimburse]. The usual practice is, two years down the road, the retailer tells you they forgot to charge you for something and that you now owe a certain amount.” The same vendor called chargebacks a “profit center” for retailers.

Shares of Saks Inc. closed Friday at $15.02, down 58 cents, in trading on the New York Stock Exchange. The intraday low was $14.45. The trading volume Friday was 2.94 million shares, while the average number of shares that typically change hands is 1.17 million.

In discussing its fourth-quarter results by division, Saks Inc. said same-store sales at Saks department stores grew by 1.1 percent, while operating income was flat with last year’s performance. At SFAE, comps rose by 8.4 percent, but excess clearance-related markdowns led to a decline in gross margin rate, the company said. The operating income at SFAE declined by $6 million, or 8 percent, over the prior year.

During a conference call to Wall Street, R. Brad Martin, chairman and ceo of the $6.4 billion Saks Inc., said, “The quality of the execution of our customer service and our store operating strategies and focus at the store level at [the department store group] was very solid in 2004.”

As for Saks Fifth Avenue, Martin said the division last year accomplished a “solid foundation for a very bright future in this exceptional franchise.” He added that merchandise assortments are being strengthened by offering a more “consistent matrix of brands across the best Saks stores by making focused investments in high-growth-opportunity businesses, such as our explosive growth in contemporary apparel and designer apparel, women’s shoes and handbags and continually introducing new vendors and designers to the Saks Fifth Avenue offering.”

For 2004, income fell by 23.9 percent to $60.9 million, or 42 cents a diluted share, from $80 million, or 56 cents, in 2003. Sales for the year gained 6.3 percent to $6.44 billion from $6.06 billion.

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