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Saks 10-K 2006
Form 10-K for fiscal year ended January 28, 2006
Table of Contents
Index to Financial Statements

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K


(Mark One)

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For Fiscal Year Ended: January 28, 2006

or

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from             to            

Commission File Number: 1-13113


SAKS INCORPORATED

(Exact Name of Registrant as Specified in Its Charter)


Tennessee   62-0331040
(State of Incorporation)   (I.R.S. Employer Identification Number)

750 Lakeshore Parkway

Birmingham, Alabama

  35211
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (205) 940-4000


Securities Registered Pursuant to Section 12 (b) of the Act:

 

Title of each class


 

Name of Each Exchange on which registered


Common Shares, par value $0.10 and

Preferred Stock Purchase Rights

  New York Stock Exchange

Securities Registered Pursuant to Section 12 (g) of the Act: None


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨    No  x

Indicate by check mark if the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x                     Accelerated filer  ¨                     Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of the voting stock held by non-affiliates of the registrant as of July 29, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $2,815,407,977.

As of March 31, 2006, the number of shares of the registrant’s Common Stock outstanding was 136,110,472.

DOCUMENTS INCORPORATED BY REFERENCE

Applicable portions of the Saks Incorporated Proxy Statement for the 2006 Annual Meeting of Shareholders to be held on June 7, 2006 are incorporated by reference into Part III of this Form 10-K.



Table of Contents
Index to Financial Statements

TABLE OF CONTENTS

 

PART I

    
     Item 1.  

Business

   1
     Item 1A.  

Risk Factors

   7
     Item 1B.  

Unresolved Staff Comments

   11
     Item 1C.  

Executive Officers of the Registrant

   11
     Item 2.  

Properties

   12
     Item 3.  

Legal Proceedings

   13
     Item 4.  

Submission of Matters to a Vote of Security Holders

   14

PART II

    
     Item 5.  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   16
     Item 6.  

Selected Financial Data

   18
     Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   19
     Item 7A.  

Quantitative And Qualitative Disclosures About Market Risk

   41
     Item 8.  

Financial Statements and Supplementary Data

   42
     Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   42
     Item 9A.  

Controls and Procedures

   42
     Item 9B.  

Other Information

   44

PART III

    
     Item 10.  

Directors and Executive Officers of the Registrant

   46
     Item 11.  

Executive Compensation

   46
     Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   46
     Item 13.  

Certain Relationships and Related Transactions

   46
     Item 14.  

Principal Accountant Fees and Services

   46

PART IV

    
     Item 15.  

Exhibits and Financial Statement Schedules

   47

SIGNATURES

   48

EXHIBIT INDEX

   E-1

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

   F-1
    

Report of Independent Registered Accounting Firm

   F-2
    

Consolidated Statements of Income

   F-4
    

Consolidated Balance Sheets

   F-5
    

Consolidated Statements of Shareholders’ Equity

   F-6
    

Consolidated Statements of Cash Flows

   F-7
    

Notes to Consolidated Financial Statements

   F-8

Financial Statement Schedule

    

Report of Independent Registered Public Accounting Firm on Financial Statement Schedule

   F-49

Schedule II – Valuation and Qualifying Accounts

   F-50
    

Certification of principal executive officer

    
    

Certification of principal financial officer

    


Table of Contents
Index to Financial Statements

PART I

 

Item 1. Business.

 

General

 

Saks Incorporated, a Tennessee corporation first incorporated in 1919, and its subsidiaries (together the “Company”) currently operate Parisian, Club Libby Lu and Saks Fifth Avenue Enterprises (“SFAE”). In prior years, the Company operated both SFAE and Saks Department Store Group (“SDSG”), which consisted of Proffitt’s and McRae’s (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operating under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), Parisian and Club Libby Lu.

 

Parisian includes 38 specialty department stores in nine states. Parisian stores are principally anchor stores in leading regional or community malls, and the stores typically offer a broad selection of high quality branded and private label merchandise. Parisian revenues totaled approximately $723 million in 2005.

 

Club Libby Lu includes 57 mall-based specialty stores, targeting girls aged 4-12 years old. Club Libby Lu revenues totaled approximately $46 million in 2005.

 

SFAE includes Saks Fifth Avenue (“SFA”) luxury department stores (55 stores in 25 states) and Off 5th Saks Fifth Avenue Outlet stores (“Off 5th”) (50 stores in 23 states). Saks Fifth Avenue stores are principally free-standing stores in exclusive shopping destinations or anchor stores in upscale regional malls, and the stores typically offer a wide assortment of distinctive luxury fashion apparel, shoes, accessories, jewelry, cosmetics and gifts. Customers may also purchase SFA products by catalog or online at saks.com. Off 5th is intended to be the premier luxury off-price retailer in the United States. Off 5th stores are primarily located in upscale mixed-use and off-price centers and offer luxury apparel, shoes, accessories, cosmetics and decorative home furnishings, targeting the value-conscious customer. SFAE revenues totaled approximately $2.7 billion in 2005.

 

Merchandising, sales promotion, and store operating support functions are conducted in Birmingham, Alabama for Parisian; in Chicago, Illinois for Club Libby Lu; and in New York, New York for SFAE. Certain back office sales support functions for the Company, such as accounting, credit card administration, store planning and information technology, are primarily located in Jackson, Mississippi. Other support functions are located in Birmingham, Alabama.

 

On July 5, 2005, Belk acquired from the Company for $622.7 million in cash substantially all of the assets directly involved in the Company’s Proffitt’s and McRae’s business operations (hereafter described as “Proffitt’s”), plus the assumption of approximately $1 million in capitalized lease obligations and the assumption of certain other ordinary course liabilities associated with the acquired assets. The assets sold included the real and personal property and inventory associated with 22 Proffitt’s stores and 25 McRae’s stores that generated fiscal 2004 revenues of approximately $700 million. After considering the assets and liabilities sold, liabilities settled, transaction fees and severance, the Company realized a net gain of $155.5 million on the sale.

 

A summary of each business segment’s revenue, profitability and total assets is shown in Note 15: Segment Information, under Notes to Consolidated Financial Statements within Item 8 (Consolidated Financial Statements and Supplementary Data of this Form 10-K) which is contained in this report.

 

Recent Developments

 

Sale of Assets

 

On March 6, 2006, the Company sold of all outstanding equity interests of certain of the Company’s subsidiaries that owned, directly or indirectly, the Company’s NDSG unit, to Bon-Ton. The consideration

 

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Index to Financial Statements

received consisted of approximately $1.11 billion in cash (reduced as described below based on changes in working capital), plus the assumption by Bon-Ton of approximately $40 million of unfunded benefit liabilities and approximately $35 million of capital leases. A preliminary working capital adjustment based on an estimate of working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $60 million resulting in net cash proceeds to the Company of approximately $1.05 billion. The disposition included NDSG’s operations consisting of, among other things, the real and personal property, operating leases and inventory associated with 142 NDSG units (31 Carson Pirie Scott stores, 14 Bergner’s stores, 10 Boston Store stores, 40 Herberger’s stores, and 47 Younkers stores); the administrative/headquarters facilities in Milwaukee, Wisconsin; and distribution centers located in Rockford, Illinois, Naperville, Illinois; Green Bay, Wisconsin, and Ankeny, Iowa. NDSG generated fiscal 2005 revenues of approximately $2.2 billion.

 

On January 9, 2006, the Company announced that it is exploring strategic alternatives for the Parisian specialty department store business, which could include its sale.

 

Merchandising

 

Parisian stores are known for their distinctive merchandise offerings. Parisian stores typically carry brands such as Karen Kane, BCBG, Garfield & Marks, Tahari, Jig Saw, Robert Talbott, Tommy Bahama, Joseph Abboud, Hugo Boss, Callaway, Cutter & Buck, Bobbi Brown, Laura Mercier, Trish McEvoy, MAC, Donald Pliner, Stuart Weitzman, Kate Spade, Ferragamo, Via Spiga and Brighton, which are typically carried only at specialty stores. Parisian also supplements its merchandise assortments with a selection of proprietary brands and premier national brands.

 

SFA stores carry luxury merchandise from both core vendors and new and emerging designers. SFA has key relationships with the leading American and European fashion houses, including Giorgio Armani, Chanel, Gucci, Prada, St. John, Zegna, Theory, Juicy, David Yurman and Burberry.

 

The Company has developed a knowledge of each of its trade areas and customer bases for its Parisian, SFA and Off 5th stores. This knowledge is gained through the Company’s regional merchandising structure in conjunction with store visits by senior management and merchandising personnel and use of on-line merchandise information. The Company strives to tailor each store’s merchandise assortment to the characteristics of its trade areas and customer bases and to the lifestyle needs of its local customers.

 

Certain departments in the Company’s stores are leased to independent companies in order to provide high quality service and merchandise where specialization, focus, and expertise are critical. The leased departments vary by store to complement the Company’s owned merchandising departments. The principal leased department in the Parisian stores is fine jewelry, and the principal leased departments in the SFA stores are furs and certain designer handbags. The terms of the lease agreements typically are between one and seven years and may require the lessee to pay for a portion of the fixtures and provide its own employees. Management regularly evaluates the performance of the leased departments and requires compliance with established customer service guidelines.

 

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Index to Financial Statements

For the year ended January 28, 2006, the Company’s percentages of owned sales (exclusive of sales generated by leased departments) by major merchandise category were as follows:

 

     SDSG

    SFA

 

Women’s Apparel

   25.8 %   38.5 %

Cosmetics

   13.7 %   16.4 %

Men’s Apparel

   13.7 %   13.7 %

Accessories

   8.7 %   18.6 %

Shoes

   9.0 %   8.5 %

Home, gifts and furniture

   13.8 %   0.9 %

Children’s Apparel

   6.2 %   0.6 %

Intimate Apparel

   3.9 %   1.8 %

Junior’s Apparel

   3.6 %   0.0 %

Outerwear

   1.6 %   1.0 %
    

 

Total

   100.0 %   100.0 %
    

 

 

Purchasing and Distribution

 

The Company purchases merchandise from many vendors. Management monitors profitability and sales history with each vendor and believes it has alternative sources available for each category of merchandise it purchases. Management believes it maintains good relationships with its vendors.

 

The Company has three distribution facilities serving its stores. Refer to “Item 2. Properties” for a listing of these facilities.

 

Each of the Company’s distribution facilities is linked electronically to the Company’s merchandising staff through a warehouse management system that updates the on-hand quantities of each purchase order received. The Company utilizes electronic data interchange (“EDI”) technology with the majority of its vendors, which is designed to move merchandise onto the selling floor more quickly and cost-effectively by allowing vendors to deliver floor-ready merchandise to the distribution facilities. High-speed automated conveyor systems then scan bar coded labels and divert incoming cartons of merchandise to the proper processing areas. Many types of merchandise are processed in the receiving area and immediately “cross docked” to the shipping dock for delivery to the stores. Certain processing areas are staffed with personnel equipped with hand-held radio frequency terminals that can scan a vendor’s bar code and transmit the necessary information to a computer to record merchandise on hand for each store.

 

Information Technology

 

Company management believes that technological investments are necessary to support its business strategies, and, as a result, the Company is continually upgrading its information systems to improve efficiency and productivity.

 

The Company’s information systems provide information deemed necessary for management operating decisions, cost reduction programs, and customer service enhancements. Individual data processing systems include point-of-sale and sales reporting, purchase order management, receiving, merchandise planning and control, payroll, human resources, general ledger, credit card administration, and accounts payable systems. Bar code ticketing is used, and scanning is utilized at point-of-sale terminals. Information is made available on-line to merchandising staff and store management on a timely basis.

 

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Index to Financial Statements

The use of EDI technology allows the Company to speed the flow of information and merchandise in an attempt to capitalize on emerging sales trends, maximize inventory turnover, and minimize out-of-stock conditions. EDI technology includes an advance shipping notice system (“ASN”). The ASN system identifies discrepancies between merchandise that is ready to be shipped from a supplier’s warehouse and that which was ordered from the supplier. This early identification provides the Company with a window of time to resolve any discrepancies in order to speed merchandise through the distribution facilities and into its stores.

 

Marketing

 

For Parisian, advertising campaigns include fashion and image advertising, special events and store promotions. Parisian uses a multi-media marketing approach, including direct mail, television, radio, and newspaper. To promote its image as the fashion and style leader in its trade areas, Parisian also sponsors local fashion shows and in-store special events highlighting its key brands and offerings.

 

For the SFA stores, marketing principally emphasizes the latest fashion trends in luxury merchandise and primarily utilizes direct mail advertising, supplemented with national and local marketing efforts. To promote its image as the primary source of luxury goods in its trade areas, SFA sponsors numerous fashion shows and in-store special events highlighting the designers represented in the SFA stores. SFA also participates in “cause-related” marketing. This includes special in-store events and related national advertising designed to drive store traffic, while raising funds for charitable causes and organizations such as women’s cancer research.

 

In-house advertising and sales promotion staffs produce the Company’s advertising for both Parisian and SFAE.

 

For both Parisian and SFA, the Company utilizes data captured through the use of proprietary credit cards offered by HSBC Bank Nevada, National Association (“HSBC”) to develop advertising and promotional events targeted at specific customers who have purchasing patterns for certain brands, departments, and store locations.

 

Proprietary Credit Cards

 

HSBC, an affiliate of HSBC Holdings PLC, offers proprietary credit card accounts to the Company’s customers. Pursuant to a program agreement with a term of ten years expiring in 2013, HSBC establishes and owns proprietary credit card accounts for the Company’s customers, retains the benefits and risks associated with the ownership of the accounts, receives the finance charge income and incurs the bad debts associated with those accounts. Pursuant to a servicing agreement with a ten-year term expiring in 2013, the Company continues to provide key customer service functions, including new account opening, transaction authorization, billing adjustments and customer inquiries, and receives compensation from HSBC for the provision of these services.

 

Prior to April 15, 2003, the Company established and owned the proprietary credit card accounts and retained the benefits and risks associated with the ownership of the accounts. Historically, proprietary credit card holders have shopped more frequently with the Company and purchased more merchandise than customers who pay with cash or third-party credit cards. The Company also makes frequent use of the names and addresses of the proprietary credit card holders in its direct marketing efforts.

 

The Company seeks to expand the number and use of the proprietary credit cards by, among other things, providing incentives to sales associates to open new credit accounts, which generally can be opened while a customer is visiting one of the Company’s stores. Customers who open accounts are frequently entitled to discounts on initial and subsequent purchases. Proprietary credit card customers are sometimes offered private shopping nights, direct mail catalogs, special discounts, and advance notice of sale events. The Company has created various loyalty programs that reward customers for frequency and volume of proprietary charge card usage.

 

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Index to Financial Statements

There are approximately 4.9 million proprietary credit accounts that have been active within the prior twelve months, and approximately 45% of the Company’s 2005 sales were transacted on HSBC’s proprietary credit cards.

 

Trademarks and Service Marks

 

The Company owns many registered trademarks and service marks, including, but not limited to, “Saks Fifth Avenue,” “SFA,” “S5A,” “The Fifth Avenue Club,” and “Off 5th,” along with its various other store names and its private brands. Management believes its trademarks and service marks are important and that the loss of certain of its trademarks or trade names, particularly the store nameplates, could have a material adverse effect on the Company. Many of the Company’s trademarks and service marks are registered in the United States Patent and Trademark Office. The terms of these registrations are generally ten years, and they are renewable for additional ten-year periods indefinitely so long as the marks are in use at the time of renewal. The Company is not aware of any claims of infringement or other challenges to its right to register or use its marks in the United States that would have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.

 

From time to time, the Company also licenses the trademarks of designers and celebrities so as to be able to offer differentiated product in its stores. During 2005, examples of such licenses included those for the trademarks Jane Seymour, Laura Ashley, and Ruff Hewn, each of which the Company has the right to use in certain merchandise categories.

 

Reliance on Fifth Avenue Store

 

The Company’s Flagship Saks Fifth Avenue store located on Fifth Avenue in New York City accounted for approximately 9% of total Company owned sales and approximately 20% of SFAE’s owned sales in 2005 and plays a significant role in creating awareness for the Saks Fifth Avenue brand name.

 

Customer Service

 

The Company believes that good customer service contributes to increased store visits and purchases by its customers.

 

At Parisian, One-on-One Personalized Service is the key tenet of the signature service program. The majority of Parisian selling zones require a high degree of consultative selling, including most men’s and women’s clothing, shoes, cosmetics, intimate apparel and jewelry. These departments offer one-on-one service and dedicated checkout facilities and are staffed by associates with specialized product training.

 

Parisian offers fast, friendly and efficient service in the remaining areas of the stores. To expedite transactions in these areas, Parisian has consolidated the check-out registers into centralized customer service centers. These areas are highly visible and always staffed with knowledgeable, friendly sales associates ready to deliver efficient transactions.

 

At SFAE, the Company’s goal is to deliver an inviting, customer-focused shopping experience and to “expertly deliver personalized style” to each customer. SFAE wants its customers to be able to discover both accessible and high-end fashion in a warm, welcoming environment, guided by knowledgeable sales associates. Compensation for sales associates is, in part, based upon customer satisfaction measures and productivity. Sales associates undergo extensive service, selling, and product-knowledge training and are encouraged to maintain frequent, personal contact with their customers. Sales associates are instructed to keep detailed customer records,

 

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Index to Financial Statements

send personalized thank-you notes, and routinely communicate with customers to advise them of new merchandise offerings and special promotions. Typical stores also provide comfortable seating areas and refreshments throughout the store. Most SFA stores offer a complimentary personal shopping service called “The Fifth Avenue Club.”

 

At both Parisian and SFAE, good customer service is encouraged through the development and monitoring of sales/productivity goals and through specific award and recognition programs.

 

Seasonality

 

The Company’s business, like that of many retailers, is subject to seasonal influences, with a significant portion of its sales and net income realized during the second half of the fiscal year, which includes the holiday selling season. Generally, more than 30% of the Company’s sales and a large portion of its operating income are generated during the fourth fiscal quarter.

 

Competition

 

The retail business is highly competitive. The Company’s stores compete with several national and regional department stores, specialty apparel stores, designer boutiques, outlet stores, discount stores, general and mass merchandisers, and mail-order and electronic commerce retailers, some of which have greater financial and other resources than those of the Company. Management believes that its knowledge of its trade areas and customer base, combined with providing a high level of customer service and a broad selection of quality fashion merchandise at appropriate prices in good store locations, provides the opportunity for a competitive advantage.

 

Associates

 

As of March 31, 2006, the Company employed approximately 23,000 associates, of which approximately 30% were employed on a part-time basis. The Company hires additional temporary associates and increases the hours of part-time associates during seasonal peak selling periods. Less than one percent of the Company’s associates are covered by collective bargaining agreements. The Company considers its relations with its associates to be good.

 

Website Access to Information

 

The Company provides access free of charge through the Company’s website, www.saksincorporated.com, to the Company’s annual report on Form 10-K, quarterly reports on From 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”).

 

Certifications

 

The Company has filed the certification of its Chief Executive Officer with the New York Stock Exchange (“NYSE”) in fiscal 2005 as required pursuant to Section 303A.12(a) of the NYSE Listed Company Manual, and the Company has filed the Sarbanes-Oxley Section 302 certifications of its principal executive officer and principal financial officer with the SEC, which are attached hereto as Exhibits 31.1 and 31.2.

 

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Item 1A. Risk Factors

 

The following are certain risk factors that affect the Company’s business, financial condition, results of operations and cash flows, some of which are beyond the Company’s control. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report on Form 10-K. The risks and uncertainties described below are not the only ones facing the Company. If any of the events described below actually occur, the Company’s business, financial condition, results of operations or cash flows could be adversely affected and differ materially from expected and historical results.

 

Poor economic conditions affect consumer spending and may significantly harm the Company’s business.

 

The retail industry is continuously subject to domestic and international economic trends. The success of the Company’s business depends to a significant extent upon the level of consumer spending. A number of factors affect the level of consumer spending on merchandise that the Company offers, including, among other things:

 

    General economic, industry and weather conditions;

 

    High crude oil prices, that affect gasoline and heating oil prices;

 

    The level of consumer debt;

 

    Interest rates;

 

    Tax rates and policies;

 

    War, terrorism and other hostilities; and

 

    Consumer confidence in future economic conditions.

 

Changes in consumer confidence and fluctuations in financial markets can influence cyclical trends, particularly in the luxury sector, and can also cause secular trends in certain traditional department store trade areas. The merchandise the Company sells generally consists of discretionary items. Reduced consumer confidence and spending may result in reduced demand for discretionary items and may force the Company to take significant inventory markdowns. Reduced demand also may require increased selling and promotional expenses.

 

Additionally, a number of the Company’s stores are in tourist markets, including the flagship Saks Fifth Avenue New York store. A downturn in economic conditions or other events such as terrorist activity could impact travel and thus negatively affect the results of operations for stores located within these tourist markets. Increases in transportation and fuel costs, the financial condition of the airline industry and its impact on air travel and sustained recessionary periods in the U.S. and internationally could also unfavorably impact future results of the stores located within these tourist markets.

 

The Company’s business and results of operations are subject to a broad range of uncertainties arising out of world events.

 

The Company’s business and results of operations are subject to uncertainties arising out of world events, especially as these events may affect U.S. tourism. These uncertainties may include a global economy slowdown, changes in consumer spending or travel, the increase in gasoline and natural prices, epidemics (such as SARS and bird flu) and the economic consequences of natural disasters, military action or terrorist activity (including threats of terrorist activity). Any future events arising as a result of terrorist activity, natural disasters or other world events may have a material impact on the Company’s business, its ability to source products, results of operations and financial condition in the future.

 

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The Company’s business and results of operations may be adversely affected by weather conditions and natural disasters.

 

The Company’s business is adversely affected by unseasonable weather conditions. Periods of unseasonably warm weather in the fall or winter or unseasonably cold or wet weather in the spring or summer affect consumer apparel purchases and could have a material adverse effect on the Company’s results of operations and financial condition. Additionally, natural disasters such as hurricanes, tornadoes, earthquakes, etc. may adversely affect the Company’s results of operations and financial condition.

 

The Company’s business is intensely competitive and increased or new competition could have a material adverse effect on the Company.

 

The retail industry is intensely competitive. As a retailer offering a broad selection of upper-moderate to luxury fashion apparel, shoes, accessories, jewelry, cosmetics and decorative home and gift items, the Company currently competes against a diverse group of retailers, including e-commerce retailers, which sell, among other products, products similar to those of the Company. The Company also competes in particular markets with a substantial number of retailers that specialize in one or more types of products that the Company sells. Due to the sale of Proffitt’s and NDSG and the potential strategic alternatives for Parisian, the Company has become increasingly less diversified and is now predominantly reliant on its luxury retail sector. The volatility of SFAE and the Company’s ability to restore and maintain profitability at SFAE, make the Company even more susceptible to material adverse effects resulting from the highly competitive industry. A number of different competitive factors could have a material adverse effect on the Company’s business, results of operations and financial condition including:

 

    Increased operational efficiencies of competitors;

 

    Competitive pricing strategies, including deep discount pricing by a broad range of retailers during periods of poor consumer confidence or economic instability;

 

    Expansion by existing competitors;

 

    Entry by new competitors into markets in which the Company currently operates; and

 

    Adoption by existing competitors of innovative retail sales methods, including e-commerce and gift cards.

 

The Company may not be able to continue to compete successfully with its existing or new competitors, or be assured that prolonged periods of deep discount pricing by its competitors will not have a material adverse effect on the Company’s business.

 

The Company faces risks associated with consumer preferences and fashion trends.

 

Changes in consumer preferences or consumer interest could have a material adverse effect on the Company’s business. In addition, fashion trends could materially impact sales. Success in the retail business depends, in part, on the Company’s ability to anticipate consumer preferences. Early order commitments often are made far in advance of consumer acceptance. If the Company fails to anticipate accurately and respond to consumer preferences, it could experience lower sales, excess inventories and lower profit margins, any of which could have a material adverse effect on the Company’s results of operations and financial condition.

 

Any failure by the Company to manage divestitures and other significant transactions successfully could harm the Company’s financial results, business and prospects.

 

As part of the Company’s strategy to continually increase shareholder value, the Company recently sold its Proffitt’s and NDSG businesses. Additionally, the Company is currently evaluating potential strategic alternatives for Parisian, which could possibly include its sale. In order to complete the strategic alternatives

 

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process successfully, the Company must find a purchaser that is willing to pay an acceptable price for the business. The Company must also manage post-closing issues, such as fulfilling all responsibilities entered into in both signed and contemplated purchase agreements, including Transition Services Agreements (“TSA”). Both Bon-Ton and Belk entered into TSA’s whereby the Company will continue to provide, for varying transition periods, certain back office services related to the sold operations. If the Company fails to complete successfully a transaction that furthers its strategic objectives, the Company may be required to expend resources above and beyond what is anticipated, the Company may be at a competitive disadvantage or the Company may be adversely affected by negative market perceptions, any of which may have a material adverse effect on the Company’s revenue, gross margin and profitability.

 

In addition, the pricing and other terms of the Company’s TSA contracts may require management to make estimates and assumptions at the time the Company enters into these contracts, and management may fail to identify all of the factors necessary to estimate its costs accurately. Any increased or unexpected costs, unanticipated delays or failure to achieve contractual obligations could have an adverse financial impact.

 

Managing a transaction requires varying levels of management resources, which may divert management’s attention from other business operations. The transaction could result in significant costs and expenses and charges to earnings, including those related to severance pay, employee benefit costs, asset impairment charges and other liabilities, legal, accounting and financial advisory fees, and required payments to executive officers and key employees under retention plans. In addition, the Company’s effective tax rate on an ongoing basis is uncertain, and a transaction could impact the effective tax rate. The Company also may experience risks relating to the challenges and costs of closing a transaction and the risk that an announced transaction may not close. As a result, any completed, pending or future transactions may contribute to financial results that differ from the investment community’s expectations.

 

The Company faces a number of risks in opening new stores.

 

Management remains confident regarding the future prospects for SFAE. SFAE has a highly recognized brand name in luxury retailing, a top quality real estate portfolio led by the New York flagship store, and strong vendor relationships. Management plans to capitalize on the growth prospects and competitive dynamics of the luxury sector. As part of its growth strategy, SFAE could potentially increase the total number of stores, which may include opening new stores in both new and existing markets. SFAE may not be able to operate any new stores profitably. Further, new stores may not achieve similar operating results to those of its existing stores. The success of any future store openings will depend upon numerous factors, many of which are beyond SFAE’s control, including the following:

 

    The ability of management to adequately analyze and identify suitable markets and individual store sites within those markets;

 

    The ability to attract appropriate vendors;

 

    The competition for suitable store sites;

 

    The ability to negotiate favorable lease terms with landlords;

 

    The availability of employees to staff new stores and SFAE’s ability to hire, train, motivate and retain store personnel; and

 

    The ability to attract customers and generate sales sufficient to operate new stores profitably.

 

SFAE may enter into additional markets in 2006 and beyond. These markets may have different competitive conditions, consumer trends and discretionary spending patterns than its existing markets, which may cause new stores in these markets to be less successful than stores in existing markets.

 

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Index to Financial Statements

The loss of, or disruption in, the Company’s centralized distribution centers would have a material adverse effect on the Company’s business and operations.

 

The Company depends on the orderly operation of the receiving and distribution process, which depends, in turn, on adherence to shipping schedules and effective management of distribution centers. Although the Company believes that its receiving and distribution process is efficient, unforeseen disruptions in operations due to fire, hurricanes or other catastrophic events, labor disagreements or shipping problems, may result in delays in the delivery of merchandise to the Company’s stores.

 

Additionally, freight cost is impacted by changes in fuel prices through surcharges. Fuel prices and surcharges affect freight cost both on inbound freight from vendors to the distribution centers and outbound freight from the distribution centers to the Company’s stores.

 

Although the Company maintains business interruption and property insurance, management cannot be assured that the Company’s insurance coverage will be sufficient, or that insurance proceeds will be timely paid to the Company, if any of the distribution centers are shut down for any reason.

 

The Company is dependent on external funding sources, which may not make available sufficient funds when the Company needs them.

 

The Company, like other retailers, relies on external funding sources to finance a portion of its operations and growth. Management currently believes that the Company’s cash flow from operations and funds available under its revolving credit facility will satisfy its capital requirements for the next 12 months. The Company’s ability to obtain additional financing is dependent upon its future operating performance, general economic and competitive conditions and financial, business and other factors, many of which the Company cannot control.

 

The Company believes that its previously disclosed internal investigations, and related inquiries by the SEC and the Office of the United States Attorney for the Southern District of New York, adversely affected the Company’s results of operations for its 2005 fiscal year, which adverse effect could continue.

 

The Company understands that the inquiries by the SEC and the Office of the United States Attorney for the Southern District of New York are continuing. The Company understands that these inquiries were initiated as a result of previously disclosed internal investigations by the Company. The Company believes that the publicly disclosed findings of the internal investigations, and the restatement by the Company of previously published financial information as reflected in its Annual Report on Form 10-K for 2004, adversely affected the Company’s ability, at least temporarily, to collect vender allowances from some SFAE merchandise vendors and may have damaged, at least temporarily, SFAE’s reputation among SFAE’s merchandise vendors and the investment community generally. These adverse effects could continue to negatively impact the future results of SFAE’s operations, which as of March 4, 2006 comprised the Company’s principal business, and the market price of the Company’s common stock. The Company’s internal investigations also resulted in disciplinary actions being taken against a number of SFAE associates. These disciplinary actions eliminated the employment positions of several experienced merchandising associates and adversely affected associate morale and focus on SFAE’s business. These adverse effects could continue.

 

The inquiries by the SEC and the Office of the United States Attorney for the Southern District of New York could result in enforcement action or actions being taken against the Company, including the imposition of fines and penalties that could adversely affect the Company’s financial condition and results of operations. During 2005 and continuing into the first quarter of 2006, the Company incurred significantly larger legal and related fees, compared to prior periods, as a result of the investigations. The Company expects that it will continue to incur significant legal fees with respect to the investigations, the end and outcome of which the Company cannot predict.

 

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Item 1B. Unresolved Staff Comments

 

None.

 

Item 1C. Executive Officers of the Registrant.

 

The name, age, and position held with the Company for each of the executive officers of the Company are set forth below.

 

Name


   Age

  

Position


R. Brad Martin

   54   

Chairman of the Board of Directors

Stephen I. Sadove

   54   

Chief Executive Officer; Director

James A. Coggin

   63   

President and Chief Administrative Officer

Douglas E. Coltharp

   44   

Executive Vice President and Chief Financial Officer

Charles J. Hansen

   58   

Executive Vice President and General Counsel

Kevin G. Wills

   40   

Executive Vice President of Finance and Chief Accounting Officer

Charles G. Tharp

   54   

Executive Vice President of Human Resources

Julia A. Bentley

   47   

Senior Vice President of Investor Relations and Communications; Corporate Secretary

 

R. Brad Martin has served as a Director since 1984 and became Chairman of the Board in February 1987. He served as Chief Executive Officer from July 1989 until January 2006.

 

Stephen I. Sadove was named Chief Executive Officer of the Company in January 2006. He joined the Company in January 2002 as Vice Chairman and assumed the additional responsibility of Chief Operating Officer in March 2004. Mr. Sadove served as Senior Vice President of Bristol-Myers Squibb and President of Bristol-Myers Squibb Worldwide Beauty Care from 1996 until January 2002. From 1991 until 1996, Mr. Sadove held various other executive positions with Bristol-Myers Squibb. From 1975 until 1991, Mr. Sadove held various positions of increasing responsibility with General Foods USA.

 

James A. Coggin was named President and Chief Administrative Officer of the Company in November 1998. Mr. Coggin served as President and Chief Operating Officer of the Company from March 1995 to November 1998 and served as Executive Vice President and Chief Administrative Officer of the Company from March 1994 to March 1995. From 1971 to March 1994, Mr. Coggin served in various management and executive positions with McRae’s, Inc.

 

Douglas E. Coltharp joined the Company in November 1996 as Executive Vice President and Chief Financial Officer. From 1987 to November 1996, Mr. Coltharp was employed by Nationsbank (currently Bank of America), where he held a variety of positions including the post of Senior Vice President of Corporate Finance.

 

Charles J. Hansen was promoted to Executive Vice President and General Counsel of the Company in September 2003. He served in several capacities in the Company’s Law Department from February 1998 to September 2003, most recently as Senior Vice President and Deputy General Counsel. Prior to that, he served in various legal capacities with Carson Pirie Scott & Co. and its predecessors, including the post of Vice President, General Counsel, and Secretary. Prior to that, he was an attorney with Baxter International, Inc. and Shearman & Sterling.

 

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Kevin G. Wills was appointed to Executive Vice President of Finance and Chief Accounting Officer, the Company’s principal accounting officer, in May 2005. He joined the Company in September 1997 and has served in the following capacities: Vice President of Financial Reporting from September 1997 to August 1998; Senior Vice President of Strategic Planning from September 1998 to August 1999; Senior Vice President of Planning and Administration of SDSG from September 1999 to January 2003; and Executive Vice President of Operations for the Company’s Parisian business from February 2003 to May 2005. Prior to joining the Company, Mr. Wills was Vice President and Controller for the Tennessee Valley Authority and before that, he was an audit manager with Coopers and Lybrand, predecessor firm to PricewaterhouseCoopers, LLP.

 

Charles G. Tharp, Ph.D. joined the Company in January 2006 as Executive Vice President Human Resources. Prior to joining the Company he was Professor of Human Resource Management at Rutgers University and co-director of the Executive Master in HR Leadership program from July 2002 to January 2006. From November 1987 to July 2002, Mr. Tharp was employed by Bristol-Myers Squibb where he held a variety of positions including Senior Vice President of Human Resources.

 

Julia A. Bentley has served as Senior Vice President of Investor Relations and Communications and Secretary of the Company since September 1997. Ms. Bentley joined the Company in 1987 and has held various financial positions, including Chief Financial Officer. Prior to joining the Company she was an audit manager with Ernst & Young.

 

Item 2. Properties.

 

The Company currently operates three principal distribution facilities as follows:

 

Company Stores Served


   Location of Facility

   Square Feet

   Owned/Leased

Parisian

   Steele, Alabama    180,000    Owned

Saks Fifth Avenue, Off 5th and Saks Direct

   Aberdeen, Maryland    514,000    Leased

Saks Fifth Avenue and Off 5th

   Ontario, California    120,000    Leased

 

The Company’s principal administrative offices are as follows:

 

Office


   Location of Facility

   Square Feet

   Owned/Leased

Parisian stores support offices and Corporate administration

   Birmingham, Alabama    125,000    Owned

Corporate Operations Center

   Jackson, Mississippi    272,000    Owned

Saks Fifth Avenue corporate offices

   New York, New York    298,000    Leased

Saks Fifth Avenue support offices

   Aberdeen, Maryland    70,000    Leased

CLL support offices

   Chicago, Illinois    46,000    Leased

 

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Index to Financial Statements

The following table sets forth information about the Company’s stores as of March 31, 2006. The majority of the Company’s stores are leased. Store leases generally require the Company to pay a fixed minimum rent and a variable amount based on a percentage of annual sales at that location. Generally, the Company is responsible under its store leases for a portion of mall promotion and common area maintenance expenses and for certain utility, property tax, and insurance expenses. Typically, the Company contributes to common mall maintenance and is responsible for property tax and insurance expenses at its owned locations. Generally, store leases have primary terms ranging from 20 to 30 years and include renewal options ranging from 5 to 20 years. Off 5th leases typically have shorter terms.

 

    Owned Locations

  Leased Locations

  Total

   

Store Name


  Number
Of Units


  Gross Square
Feet (in mil.)


  Number
Of Units


  Gross Square
Feet (in mil.)


  Number
Of Units


  Gross Square
Feet (in mil.)


 

Primary

Locations


Parisian

  12   1.5   26   3.1   38   4.6   Southeast & Midwest
   
 
 
 
 
 
   

Saks Fifth Avenue

  29   3.9   26   2.2   55   6.1   National

Off 5th

  —     0.0   50   1.4   50   1.4   National
   
 
 
 
 
 
   

SFAE

  29   3.9   76   3.6   105   7.5    
   
 
 
 
 
 
   

Total

  41   5.4   102   6.7   143   12.1    
   
 
 
 
 
 
   

 

In addition to the stores listed above, SDSG also operated 57 Club Libby Lu specialty stores at March 31, 2006. These stores are leased and are typically one to two thousand square feet of space in regional malls.

 

Item 3. Legal Proceedings.

 

Investigations

 

At management’s request, the Audit Committee of the Company’s Board of Directors conducted an internal investigation in 2004 and 2005. In 2004, the Company informed the SEC of the Audit Committee’s internal investigation. Thereafter, the Company was informed by the SEC that it issued a formal order of private investigation, and the Company was informed by the Office of the United States Attorney for the Southern District of New York that it had instituted an inquiry. The Company believes that the subject of these inquiries includes one or more of the matters that were the subject of the investigations by the Audit Committee and possibly includes related matters. The results of the Audit Committee’s internal investigation have been previously disclosed by the Company. On October 11, 2005, the Company received a subpoena from the SEC for information concerning, among other items, SFAE’s allocation to vendors of a portion of markdown costs associated with certain of SFAE’s customer loyalty and other promotional activities, as well as information concerning markdowns, earnings, and other financial data for 1999-2003. The Company has provided the requested information to the SEC. The Company is continuing to fully cooperate with both the SEC and the Office of the United States Attorney.

 

Vendor Litigation

 

On May 17, 2005, International Design Concepts, LLC (“IDC”), filed suit against the Company in the United States District Court for the Southern District of New York raising various claims, including breach of contract, fraud and unjust enrichment. The suit alleges that from 1996 to 2003 the Company improperly took chargebacks and deductions for vendor markdowns, which resulted in IDC going out of business. The suit seeks damages in the amount of the unauthorized chargebacks and deductions. IDC filed a second amended complaint on June 14, 2005 asserting an additional claim for damages under the Uniform Commercial Code for vendor compliance chargebacks.

 

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Index to Financial Statements

On October 25, 2005 the Chapter 7 trustee for the bankruptcy estate of Kleinert’s Inc. filed a complaint in the United States Bankruptcy Court for the Southern District of New York. In its complaint the plaintiff alleges breach of contract, fraud, and unjust enrichment, among other causes of action, and seeks compensatory and punitive damages due to the Company’s assessment of alleged improper chargebacks against Kleinert’s Inc. totaling approximately $4 million, which wrongful acts the plaintiff alleges caused the insolvency and bankruptcy of Kleinert’s Inc. The plaintiff is seeking to amend its complaint to include the allegation, among other allegations, that unidentified employees of the Company engaged in practices designed to assist officers and other employees of Kleinert’s Inc. to manipulate its financial reports.

 

On December 8, 2005 Adamson Apparel, Inc. filed a purported class action lawsuit against the Company in the United States District Court for the Northern District of Alabama. In its complaint the plaintiff asserts breach of contract claims and alleges that the Company improperly assessed chargebacks, timely payment discounts, and deductions for merchandise returns against members of the plaintiff class. The lawsuit seeks compensatory and incidental damages and restitution.

 

Shareholders’ Derivative Suits

 

On April 29, 2005, a shareholder derivative action was filed in the Circuit Court of Jefferson County, Alabama for the putative benefit of the Company against the members of the Board of Directors and certain executive officers alleging breach of their fiduciary duties in failing to correct or prevent problems with the Company’s accounting and internal control practices and procedures, among other allegations. Two similar shareholder derivative actions were filed on May 4, 2005 and May 5, 2005, respectively, in the Chancery Court of Davidson County, Tennessee. All three actions generally seek unspecified damages and disgorgement by the executive officers named in the complaints of cash and equity compensation received by them.

 

On July 12, 2005, the Board of Directors created a Special Litigation Committee (“SLC”) to investigate the derivative claims and to determine whether the litigation is in the best interests of the Company. The SLC’s investigation is ongoing.

 

Other

 

The Company is involved in several legal proceedings arising from its normal business activities and has accruals for losses where appropriate. Management believes that none of these legal proceedings will have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.

 

Item 4. Submission of Matters to a Vote of Security Holders.

 

The Company held an annual meeting of shareholders on December 8, 2005 for the following purposes:

 

Item 1: To elect three Directors to hold office for the term specified or until their respective successors have been elected and qualified

 

Item 2: To ratify the appointment of PricewaterhouseCoopers LLP as the Company’s independent auditors for the current fiscal year ending January 28, 2006

 

Item 3: To approve an amendment to the Company’s amended and restated charter to eliminate specified supermajority voting requirements

 

Item 4: To vote on a shareholder proposal concerning the Company’s classified Board of Directors

 

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Index to Financial Statements

Item 5: To vote on a shareholder proposal concerning cumulative voting for the election of Directors

 

Item 6: To vote on a shareholder proposal concerning Director-election vote standard

 

The number of votes cast for and withheld for each nominee for the Company’s Board of Directors under Item 1 were as follows:

 

     FOR

   WITHHELD

Michael S. Gross

   101,082,124    19,296,797

Nora P. McAniff

   110,416,159    9,962,762

Stephen I. Sadove

   114,603,155    5,775,766

 

The number of votes cast for, against and abstain for Items 2,3,4 and 5 were as follows

 

     FOR

   AGAINST

   ABSTAIN

Item 2

   119,443,068    897,892    37,960

Item 3

   97,236,661    2,602,594    49,699

Item 4

   49,649,195    50,125,346    114,410

Item 5

   31,156,484    68,590,154    142,312

Item 6

   30,504,684    69,279,058    105,210

 

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Index to Financial Statements

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information

 

The Company’s common stock trades on the New York Stock Exchange (“NYSE”) under the symbol SKS. The prices in the table below represent the high and low sales prices for the stock as reported by the NYSE.

 

     Year Ended
January 28, 2006


   Year Ended
January 29, 2005


     High

   Low

   High

   Low

First Quarter

   $ 19.27    $ 13.82    $ 17.92    $ 14.37

Second Quarter

   $ 21.40    $ 16.46    $ 15.62    $ 12.66

Third Quarter

   $ 24.58    $ 15.73    $ 13.09    $ 11.67

Fourth Quarter

   $ 19.48    $ 15.81    $ 15.00    $ 11.97

 

Holders

 

As of March 31, 2006, there were approximately 1,987 shareholders of record of the Company’s common stock.

 

Dividends

 

During the fiscal year ended January 29, 2005, the Company declared a special cash dividend of $2.00 per share of common stock payable on May 17, 2004 to holders of record on April 30, 2004. The dividend payout totaled approximately $285 million. The Company did not declare any dividends to common shareholders for the fiscal year ended January 28, 2006. However, on March 6, 2006, the Company announced that its Board of Directors had declared a special cash dividend of $4.00 per share of common stock payable on May 1, 2006 to holders of record on April 14, 2006. Future dividends, if any, will be determined by the Company’s Board of Directors in light of circumstances then existing, including earnings, financial requirements, and general business conditions.

 

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Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

The Company has a share repurchase program that authorizes it to purchase shares of common stock in order to both distribute cash to stockholders and manage dilution resulting from shares issued under the Company’s equity compensation plans. The Company’s authorization was increased by 35 million shares during the fourth quarter of 2005. The Company purchased 12.9 million shares of common stock during the year for a total of approximately $224 million. The Company has remaining availability of approximately 37.8 million shares under its 70 million share repurchase authorization. The following are details of repurchases under this program for the fourth quarter of fiscal 2005:

 

Period

(in thousands except average price paid per share)


   Total Number
of Shares
Repurchased


  

Average

Price Paid
per Share


  

Total Number

of Shares

Repurchased as

Part of Publicly
Announced
Authorizations


  

Maximum Number of
Shares that May Yet Be

Repurchased Under the

Announced
Authorizations (a)


Repurchases from October 30, 2005 through November 26, 2005

   7,183    $ 17.61    7,183    8,507

Repurchases from November 27, 2005 through December 31, 2005

   5,677    $ 17.12    5,677    37,830

Repurchases from January 1, 2006 through January 28, 2006

   —      $ —      —      37,830
    
         
    

Total

   12,860    $ 17.40    12,860     
    
         
    

(a) As of January 28, 2006, the Company’s Board of Directors has authorized 70,025 total shares, of which 35,000 were authorized in 2005. The Company has utilized 32,195 of these shares to date.

 

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Index to Financial Statements

Item 6. Selected Financial Data.

 

The selected financial data set forth below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Company’s Consolidated Financial Statements and notes thereto and the other information contained elsewhere in this Form 10-K.

 

    Year Ended

 

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)


  January 28,
2006


    January 29,
2005


    January 31,
2004


    February 1,
2003


    February 2,
2002


 

CONSOLIDATED INCOME STATEMENT DATA:

                                       

Net sales

  $ 5,953,352     $ 6,437,277     $ 6,055,055     $ 5,911,122     $ 6,070,568  

Cost of sales (excluding depreciation and amortization)

    3,742,459       3,995,460       3,761,458       3,707,604       3,931,661  
   


 


 


 


 


Gross margin

    2,210,893       2,441,817       2,293,597       2,203,518       2,138,907  

Selling, general and administrative expenses

    1,548,747       1,614,658       1,489,383       1,370,881       1,421,561  

Other operating expenses

    565,421       601,183       579,056       580,675       584,949  

Impairments and dispositions

    (105,361 )*     31,751       8,150       19,547       45,215  

Integration charges

    —         —         (62 )     9,981       1,539  
   


 


 


 


 


Operating income

    202,086       194,225       217,070       222,434       85,643  

Interest expense

    (85,778 )     (114,035 )     (117,372 )     (128,353 )     (135,357 )

Gain (loss) on extinguishment of debt

    (29,375 )     —         (10,506 )     709       26,110  

Other income, net

    7,705       4,048       5,004       2,112       3,489  
   


 


 


 


 


Income (loss) before income taxes and cumulative effect of accounting change

    94,638       84,238       94,196       96,902       (20,115 )

Provision (benefit) for income taxes

    72,290       23,153       21,832       39,200       (7,167 )
   


 


 


 


 


Income (loss) before cumulative effect of accounting change

    22,348       61,085       72,364       57,702       (12,948 )

Cumulative effect of a change in accounting principle, net of taxes

    —         —         —         (45,593 )**     —    
   


 


 


 


 


Net income (loss)

  $ 22,348     $ 61,085     $ 72,364     $ 12,109     $ (12,948 )***
   


 


 


 


 


Basic earnings per common share:

                                       

Before cumulative effect of accounting change

  $ 0.16     $ 0.44     $ 0.52     $ 0.40     $ (0.09 )

After cumulative effect of accounting change

  $ 0.16     $ 0.44     $ 0.52     $ 0.08     $ (0.09 )

Diluted earnings per common share:

                                       

Before cumulative effect of accounting change

  $ 0.16     $ 0.42     $ 0.51     $ 0.39     $ (0.09 )

After cumulative effect of accounting change

  $ 0.16     $ 0.42     $ 0.51     $ 0.08     $ (0.09 )

Weighted average common shares:

                                       

Basic

    138,348       139,470       139,824       142,750       141,988  

Diluted

    143,571       144,034       142,921       146,707       141,988  

CONSOLIDATED BALANCE SHEET DATA:

                                       

Working capital ****

  $ 819,601     $ 1,115,460     $ 1,060,094     $ 1,151,176     $ 997,670  

Total assets ****

  $ 3,850,725     $ 4,709,014     $ 4,684,357     $ 4,611,788     $ 4,643,260  

Long-term debt, less current portion

  $ 722,736     $ 1,346,222     $ 1,125,637     $ 1,327,381     $ 1,356,580  

Shareholders’ equity ****

  $ 1,999,383     $ 2,062,418     $ 2,271,337     $ 2,221,615     $ 2,237,915  

Cash dividends (per share)

  $ —       $ 2.00     $ —       $ —       $ —    

* Fiscal 2005 includes a $155.5 million gain on the sale of Proffitt’s and a $51.5 million goodwill impairment charge.
** Represents the cumulative effect of a change in accounting for goodwill in accordance with SFAS No. 142.
*** Net loss principally reflects decline in operating income following the effects of September 11, 2001.
**** Represents restated balances at January 29, 2005, January 31, 2004, February 1, 2003 and February 2, 2002. See “Restatement of Previously Issued Financial Statements” in Item 7 for additional information.

 

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

 

Management’s Discussion and Analysis (“MD&A”) is intended to provide an analytical view of the business from management’s perspective of operating the business and is considered to have these major components:

 

    Overview

 

    Results of Operations

 

    Liquidity and Capital Resources

 

    Critical Accounting Policies

 

MD&A should be read in conjunction with the consolidated financial statements and related notes thereto contained elsewhere in this document.

 

OVERVIEW

 

GENERAL

 

Saks Incorporated, and its subsidiaries (together the “Company”) currently operate Parisian, Club Libby Lu and Saks Fifth Avenue Enterprises (“SFAE”). In prior years, the Company operated both SFAE and Saks Department Store Group (“SDSG”) which consisted of Proffitt’s and McRae’s (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operating under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), Parisian and Club Libby Lu. The Company’s merchandise offerings primarily consist of apparel, shoes, cosmetics and accessories, and to a lesser extent, gifts and home items. The Company offers national branded merchandise complemented by differentiated product through exclusive merchandise from core vendors, assortments from unique and emerging suppliers, and proprietary brands.

 

The Company seeks to create value for its shareholders through improving returns on its invested capital. The Company attempts to generate improved operating margins through generating sales increases while improving merchandising margins and controlling expenses. The Company uses operating cash flows to reinvest in the business and to repurchase debt or equity. The Company actively manages its real estate portfolio by routinely evaluating opportunities to improve or close underproductive stores and open new units.

 

SALE OF BUSINESSES

 

On July 5, 2005, Belk acquired from the Company for $622.7 million in cash substantially all of the assets directly involved in the Company’s Proffitt’s and McRae’s business operations (hereafter described as “Proffitt’s”), plus the assumption of approximately $1 million in capitalized lease obligations and the assumption of certain other ordinary course liabilities associated with the acquired assets. The assets sold included the real and personal property and inventory associated with 22 Proffitt’s stores and 25 McRae’s stores which generated fiscal 2004 revenues of approximately $700 million. After considering the assets and liabilities sold, liabilities settled, transaction fees and severance, the Company realized a net gain of $155.5 million on the sale.

 

On March 6, 2006, the Company sold all outstanding equity interests of certain of the Company’s subsidiaries that owned, directly or indirectly, the Company’s NDSG unit, to Bon-Ton. The consideration received consisted of approximately $1.11 billion in cash (reduced as described below based on changes in working capital), plus the assumption by Bon-Ton of approximately $40 million of unfunded benefit liabilities and approximately $35 million of capital leases. A preliminary working capital adjustment based on an estimate

 

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Index to Financial Statements

of working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $60 million resulting in net cash proceeds to the Company of approximately $1.05 billion. Management estimates a pre-tax gain ranging from $290 million to $300 million and an after-tax gain ranging from $115 million to $125 million on the transaction. The disposition included NDSG’s operations consisting of, among other things, the real and personal property, operating leases and inventory associated with 142 NDSG units (31 Carson Pirie Scott stores, 14 Bergner’s stores, 10 Boston Store stores, 40 Herberger’s stores, and 47 Younkers stores); the administrative/headquarters facilities in Milwaukee, Wisconsin; and distribution centers located in Rockford, Illinois, Naperville, Illinois; Green Bay, Wisconsin, and Ankeny, Iowa. NDSG generated fiscal 2005 revenues of approximately $2.2 billion. The assets and liabilities associated with NDSG have been appropriately classified as held for sale at January 28, 2006 in the accompanying consolidated balance sheet.

 

The Company announced on January 9, 2006 that it was exploring strategic alternatives for its Parisian specialty department store business (“Parisian”) (which generated fiscal 2005 revenues of approximately $723 million). The strategic alternatives could include the sale of Parisian.

 

SAKS FIFTH AVENUE NEW ORLEANS STORE

 

In late August 2005, the SFAE store in New Orleans suffered substantial water, fire, and other damage related to Hurricane Katrina. The Company anticipates reopening the store in the fourth fiscal quarter of 2006 after necessary repairs and renovations are made to the property.

 

The SFAE New Orleans store is covered by both property damage and business interruption insurance. The property damage coverage will pay to repair and/or replace the physical property damage and inventory loss, and the business interruption coverage will reimburse the Company for lost profits as well as continuing expenses related to loss mitigation, recovery, and reconstruction for the full duration of the reconstruction period plus three months. The Company recorded in 2005 both (i) a $14.7 million gain on the excess of the replacement insurance value over the recorded net book value of the lost and damaged assets and (ii) $2.6 million of expenses related to the insurance deductible.

 

Total company revenues and operating income were negatively affected by approximately $26 million and $13 million, respectively, for the year ended January 28, 2006, due to the New Orleans store closing. Prior to the closing, the New Orleans store generated annual revenues in excess if $50 million and operating income of approximately $12 million.

 

RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

 

The Company discovered that there was an error in the restatement of the consolidated financial statements contained in the 2004 Annual Report on Form 10-K. The Company undertook, as part of its normal closing process, a detailed review of its accounts at which time the error was discovered. The error resulted from clerical mistakes in the computation, preparation and review of the tax effect of the restatement adjustments to financial statements prior to February 2, 2002. The correction of the error has been reported as a restatement of consolidated shareholders’ equity at the opening balance sheet date. The error affected the Company’s consolidated balance sheets and statements of shareholders’ equity and had no effect on the Company’s consolidated statements of income, EPS or cash flows for any year currently presented.

 

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The Company has made adjustments to its previously issued consolidated financial statements to correct for this error. The effect of the restatement relating to this error on the Company’s consolidated balance sheet accounts is as follows:

 

January 29, 2005

(in thousands)


   Previously
Reported


    Adjustments 

   

As

Restated


   Percent
Change


 

Current deferred income taxes, net

   $ 178,558    $ 3,399     $ 181,957    1.9 %

Non-current deferred income taxes, net

     166,364      1,536       167,900    0.9 %

Accrued expenses

     468,896      26,934       495,830    5.7 %

Total shareholders’ equity

     2,084,417      (21,999 )     2,062,418    -1.1 %

January 31, 2004

(in thousands)


   Previously
Reported


   Adjustments

   

As

Restated


   Percent
Change


 

Current deferred income taxes, net

   $ 76,602    $ 2,311     $ 78,913    3.0 %

Non-current deferred income taxes, net

     120,342      1,529       121,871    1.3 %

Accrued expenses

     364,572      25,839       390,411    7.1 %

Total shareholders’ equity

     2,293,336      (21,999 )     2,271,337    -1.0 %

February 1, 2003

(in thousands)


   Previously
Reported


   Adjustments

   

As

Restated


   Percent
Change


 

Current deferred income taxes, net

   $ 52,725    $ 2,311     $ 55,036    4.4 %

Non-current deferred income taxes, net

     138,449      1,529       139,978    1.1 %

Accrued expenses

     344,800      25,839       370,639    7.5 %

Total shareholders’ equity

     2,243,614      (21,999 )     2,221,615    -1.0 %

February 2, 2002

(in thousands)


   Previously
Reported


   Adjustments

   

As

Restated


   Percent
Change


 

Current deferred income taxes, net

   $ 72,523    $ 2,311     $ 74,834    3.2 %

Non-current deferred income taxes, net

     183,193      1,529       184,722    0.8 %

Accrued expenses

     394,551      25,839       420,390    6.5 %

Total shareholders’ equity

     2,259,914      (21,999 )     2,237,915    -1.0 %

 

FINANCIAL PERFORMANCE SUMMARY

 

The retail industry is continuously subject to domestic and international economic trends. Changes in consumer confidence and fluctuations in financial markets can influence cyclical trends, particularly in the luxury sector, and can also cause secular trends in certain traditional department store trade areas. Additionally, a number of the Company’s stores are in tourist markets, including the flagship Saks Fifth Avenue New York store.

 

On a consolidated basis, net sales for the year ended January 28, 2006 decreased 7.5%, while comparable store sales grew 2.1%. The comparable store sales increase was comprised of a 0.6% increase at SDSG and a 4.0% increase at SFAE. Earnings for the year ended January 28, 2006 declined to $22.3 million or $0.16 per share from $61.1 million or $0.42 per share for the year ended January 29, 2005. The current year included a net gain of $7.7, net of taxes, or $0.06 per share, primarily related to a $0.52 per share gain on the sale of Proffitt’s, a $0.06 per share net gain related to the estimated insurance settlement on SFAE New Orleans store that was damaged by Hurricane Katrina, offset in-part by a $0.12 per share loss on the extinguishment of debt, a $0.34 per share goodwill impairment charge, and expenses of $0.06 per share of store asset impairments and the disposition of assets associated with store closings. The prior year included net charges of $29.9 million, net of taxes, or

 

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$0.21 per share, primarily related to store closings (principally at SFAE). A summary of the 2005 and 2004 (charges)/gains are outlined below:

 

     Year Ended

 
     January 28,
2006


    January 29,
2005


 

Belk Transaction (Sale of Proffitt’s):

                

Impairments and Dispositions

   $ 156,326     $ —    

Gross Margin (markdowns)

     (801 )     —    

SFAE Store Closings:

                

Impairments and Dispositions

     2,625       (17,295 )

Gross Margin (markdowns)

     (241 )     (7,136 )

SG&A (principally severance)

     (1,316 )     (3,711 )

SDSG North Carolina Store Closings:

                

Impairments and Dispositions

     87       (2,400 )

Gross Margin (markdowns)

     (581 )     (505 )

Other Impairments and Dispositions

     (2,149 )     (12,056 )

Loss on Debt Extinguishment

     (29,375 )     —    

Goodwill Impairment

     (51,529 )        

Other

     112       —    

Income Taxes:

                

Income Tax Effect of Above Items

     (65,419 )     15,733  

Change in Income Tax Reserves

     —         (2,555 )
    


 


TOTAL

   $ 7,739     $ (29,925 )
    


 


 

Additionally, several other items, including expenses related to the Company’s investigations ($11.4 million net of taxes or $.08 per share), retention programs ($15.4 million net of taxes or $.11 per share), and the insurance deductible for the SFAE New Orleans store ($1.6 million net of taxes or $.01 per share), as well as income related to the Company’s estimated share of proceeds from Visa/MasterCard antitrust litigation settlement ($2.2 million net of taxes or $.02 per share), were included in the current year’s results.

 

SFAE realized a 4.0% comparable store sales increase during 2005; however, its operating income declined to $22.3 million from $118.8 million primarily due to a substantial decline in gross margin dollars and rate and an increase in SG&A expenses. SG&A expenses increased principally as a result of the costs associated with the aforementioned investigations; investments in marketing, store, and other key strategic initiatives; and certain costs related to organizational changes.

 

SDSG experienced a 0.6% comparable store sales increase during the year ended January 28, 2006, and operating income declined by $5.7 million to $155.2 million. The decline was attributable to the loss of previous operating income of $49.3 million due to the Proffitt’s sale, partially offset by lower NDSG depreciation expense of $16.2 million due to the assets being classified as held for sale beginning with the fourth quarter of 2005. Excluding the effects of Proffitt’s and no NDSG depreciation for the fourth quarter, operating income would have increased by approximately $28 million, or 25% for the year.

 

The Company also took actions during 2005 intended to further improve its financial position and strengthen its balance sheet. Specifically, the Company reduced funded debt (including capitalized leases) by $623.4 million, or nearly 50%, primarily by repurchasing $607.1 million in senior notes with the proceeds from the sale of Proffitt’s. Additionally the Company repurchased 12.9 million shares of common stock for approximately $224 million (there were approximately 37.8 million shares remaining under the authorization at

 

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Index to Financial Statements

year end). The Company ended 2005 with approximately $80 million of cash and no borrowings on its $800 million revolving credit facility (which matures in 2009). At the Company’s request, due to the sale of NDSG, its availability under its revolving credit facility was reduced to $500 million in March 2006.

 

The retail environment is challenging and competitive. Uncertain conditions make the forecasting of near-term results difficult. The Company believes that execution of key strategic initiatives, as well as its expectations for long-term growth in the luxury retail market, and completion of the strategic alternatives process for Parisian will provide the Company an opportunity and the methods to create shareholder value.

 

As previously discussed, Belk acquired substantially all of the assets directly involved in the Company’s Proffitt’s business operations. Additionally, in March 2006 Bon-Ton acquired substantially all of the assets directly involved in the Company’s NDSG business operations. As the Company consummates such transactions, its operations and earnings will reflect the removal of these businesses and accordingly will be more dependent on the luxury sector and the SFAE operations.

 

The Company believes that an understanding of its reported financial condition and results of operations is not complete without considering the effect of all other components of MD&A included herein.

 

RESULTS OF OPERATIONS

 

The following table sets forth, for the periods indicated, selected items from the Company’s consolidated statements of income, expressed as percentages of net sales (numbers may not total due to rounding):

 

     Year Ended

 
     January 28,
2006


    January 29,
2005


    January 31,
2004


 

Net sales

   100.0 %   100.0 %   100.0 %

Cost of sales (excluding depreciation and amotization)

   62.9     62.1     62.1  
    

 

 

Gross margin

   37.1     37.9     37.9  

Selling, general and administrative expenses

   26.0     25.1     24.6  

Other operating expenses

   9.5     9.3     9.6  

Impairments and dispositions

   -1.8     0.5     0.1  
    

 

 

Operating income

   3.4     3.0     3.6  

Interest expense

   (1.4 )   (1.8 )   (1.9 )

Gain (loss) on extinguishment of debt

   (0.5 )   0.0     (0.2 )

Other income (expense), net

   0.1     0.1     0.1  
    

 

 

Income before income taxes

   1.6     1.3     1.6  

Provision for income taxes

   1.2     0.4     0.4  
    

 

 

Net income

   0.4 %   0.9 %   1.2 %
    

 

 

 

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FISCAL YEAR ENDED JANUARY 28, 2006 (“2005”) COMPARED TO FISCAL YEAR ENDED

JANUARY 29, 2005 (“2004”)

 

DISCUSSION OF OPERATING INCOME

 

The following table shows the changes in operating income from 2004 to 2005:

 

(In Millions)


   SDSG

    SFAE

    Items not
allocated


    Total
Company


 

FY 2004 Operating Income

   $ 160.9     $ 118.8     $ (85.5 )   $ 194.2  

Store sales and margin

     3.4       (71.3 )     6.9       (61.0 )

Operating expenses

     40.2       (25.2 )     (35.6 )     (20.6 )

Effect of Proffitt’s sale

     (49.3 )     —         —         (49.3 )

Impairments and dispositions

     —         —         137.1       137.1  

Severance and other costs

     —         —         1.7       1.7  
    


 


 


 


Increase (Decrease)

     (5.7 )     (96.5 )     110.1       7.9  

FY 2005 Operating Income

   $ 155.2     $ 22.3     $ 24.6     $ 202.1  
    


 


 


 


 

On a consolidated basis, net sales decreased 7.5% (principally due to the Proffitt’s sale), while comparable store sales increased 2.1%. The consolidated net sales decrease and the substantial deterioration in the gross margin rate at SFAE led to a decline in consolidated gross margin. The gain from the sale of Proffitt’s offset by the goodwill impairment change, increased operating expenses, the loss of operating income related to Proffitt’s and the deterioration in the gross margin rate at SFAE, resulted in an increase in operating income of $7.9 million to $202.1 million.

 

At SFAE, comparable store sales increased 4.0%; however, the gross margin rate declined substantially, related to (i) unsatisfactory inventory management, which led to substantially higher markdowns and (ii) a year-over-year decline in vendor markdown support. Additionally, an increase in operating expenses primarily reflected costs associated with the previously mentioned investigations; the SFAE New Orleans store insurance deductible; investments in marketing, store and other key strategic initiatives; and certain costs related to organizational changes. As a result, operating income declined by $96.5 million. Excluding the closure of the New Orleans store, which reduced operating income by $13.4 million, the net effect of new and closed stores reduced operating income by $11.7 million at SFAE.

 

At SDSG, comparable store sales increased 0.6%. Operating income for 2005 totaled $155.2 million, a $5.7 million decline from $160.9 million in prior year. The decline was attributable to the loss of operating income from the Proffitt’s sale, partially offset by lower NDSG depreciation. The net effect of new and closed stores resulted in a decrease in operating income of $4.3 million.

 

Expenses and charges not allocated to the segments decreased by $110.0 million primarily due to the gain associated with the sale of Proffitt’s of $155.5 million and the gain from the estimated insurance settlement on the SFAE New Orleans store of $14.7 million, offset by the goodwill impairment of $51.5 million, and increased equity, retention and severance compensation as the Company evaluates and completes its strategic alternative process.

 

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NET SALES

 

The following table shows relevant sales information by segment for 2005 compared to 2004:

 

     Net Sales

  

Total

Decrease


   

Total %

Decrease


   

Comp %

Increase


 

(In Millions)


   2005

   2004

      

SDSG

   $ 3,220.9    $ 3,700.0    $ (479.1 )   -12.9 %   0.6 %

SFAE

     2,732.4      2,737.3      (4.9 )   -0.2 %   4.0 %
    

  

  


 

 

Consolidated

   $ 5,953.3    $ 6,437.3    $ (484.0 )   -7.5 %   2.1 %
    

  

  


 

 

 

For the year ended January 28, 2006, total sales decreased 7.5% year over year, and consolidated comparable store sales increased 2.1%. Comparable sales increased at SFAE by 4.0% while total sales were negatively affected by approximately $26 million for 2005 due to the New Orleans store closing. SDSG experienced a 0.6% increase in comparable store sales. The net effect of sales lost from new and closed stores resulted in a $604.7 million reduction, due principally to the sale of Proffitt’s.

 

Comparable store sales are calculated on a rolling 13-month basis. Thus, to be included in the comparison, a store must be open for 13 months. The additional month is used to transition the first month impact of a new store opening. Correspondingly, closed stores are removed from the comparable store sales comparison when they begin liquidating merchandise. Expanded, remodeled, converted and re-branded stores are included in the comparable store sales comparison, except for the periods in which they are closed for remodeling and renovation.

 

GROSS MARGIN

 

For the year ended January 28, 2006, gross margin was $2,210.9 million, or 37.1% of net sales, compared to $2,441.8 million, or 37.9% of net sales, for the year ended January 29, 2005. Aside from the lost contribution from the sale of Proffitt’s and the prior year SFAE store closings which totaled approximately $220 million, the reduction in gross margin dollars and rate was primarily attributable to the aforementioned merchandising issues at SFAE, whereby key members of management, the merchandising team, and the finance group were largely focused on activities surrounding the investigations and a consequential amount of merchant turnover took place during the period. In addition, due to the ongoing investigations, SFAE’s ability to collect certain vendor markdown allowances was impacted principally during the first half of the year, which negatively affected gross margin.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

For the year ended January 28, 2006, SG&A was $1,548.7 million, or 26.0% of net sales, compared to $1,614.7 million, or 25.1% of net sales, for the year ended January 29, 2005. The net decrease of $66.0 million in expenses was largely due to the elimination of prior year expenses of $93.3 million resulting from the sale of Proffitt’s, partially offset by costs associated with the previously mentioned investigations, equity compensation and retention compensation totaling $52.5 million. The net effect of new and closed stores decreased SG&A by approximately $34.1 million.

 

Amounts received from vendors in conjunction with compensation programs and cooperative advertising were consistent with the related gross compensation and cooperative advertising expenditures and therefore had no impact on SG&A expense, in dollars or as a percentage of net sales.

 

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Index to Financial Statements

OTHER OPERATING EXPENSES

 

For the year ended January 28, 2006, other operating expenses, including store pre-opening costs, were $565.4 million, or 9.5% of net sales, compared to $601.2 million, or 9.3% of net sales, for the year ended January 29, 2005. The decrease of $35.8 million was largely driven by a reduction in depreciation, rent and property and payroll taxes related to the sale of Proffitt’s and the cessation of depreciation on the NDSG assets during the fourth of 2005 due to the classification of these assets as “held for sale.”

 

IMPAIRMENTS AND DISPOSITIONS

 

The Company realized (gains)/losses from impairments and dispositions of ($105.4) million and $31.8 million in 2005 and 2004, respectively. The current period net gain primarily related to a $156.3 million gain on the sale of Proffitt’s offset in-part by a $51.5 million SDSG goodwill impairment charge. The Company performed its annual evaluation of the recoverability of SDSG’s goodwill as required by Statement of Financial Accounting Standards (“SFAS”) No. 142. Considering the effects of the sale of Proffitt’s, the agreement to sell NDSG, and the recently announced strategic alternative process for Parisian, the Company determined that a portion of the SDSG goodwill was impaired. Prior year charges were principally due to the impairment of store assets related to the SFAE store closings and other impairment and disposition charges in the normal course of business.

 

INTEREST EXPENSE

 

Interest expense declined to $85.8 million in 2005 from $114.0 million in 2004 and, as a percentage of net sales, decreased to 1.4% in 2005 from 1.8% in 2004. The improvement of $28.3 million was due to the reduction in debt resulting from the repurchase of approximately $585.7 million and $21.4 million of senior notes in July 2005 and August 2005, respectively.

 

LOSS ON EXTINGUISHMENT OF DEBT

 

During July 2005 the Company repurchased a total of approximately $585.7 million in principal amount of senior notes. The notes were repurchased at par, which included a consent fee. Additionally, during August 2005, the Company repurchased $21.4 million of additional senior notes at par through open market repurchases. The repurchase of these notes resulted in a loss on extinguishment of debt of approximately $29.4 million related principally to the write-off of deferred financing costs and a premium on previously exchanged notes.

 

OTHER INCOME (EXPENSE), NET

 

Other income increased to $7.7 million in 2005 from $4.0 million in 2004 due principally to higher yields on invested cash in 2005.

 

INCOME TAXES

 

For 2005 and 2004 the effective income tax rate differs from the federal statutory tax rate due to state income taxes and other items such as non-deductible goodwill, the change in valuation allowance against state net operating loss carryforwards and the effect of concluding tax examinations. The increase in the effective rate in 2005 was attributable to the write-off of goodwill which was principally non-deductible for tax purposes, as well as an income tax benefit recorded in 2004 related to the change in valuation allowance against state net operating loss carryforwards. Excluding these items, the Company’s effective income tax rate was 41.3% in 2005. Management anticipates that income tax rates in future years will be slightly less than the 2005 rate of 41.3%.

 

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Index to Financial Statements

FISCAL YEAR ENDED JANUARY 29, 2005 (“2004”) COMPARED TO FISCAL YEAR ENDED

JANUARY 31, 2004 (“2003”)

 

DISCUSSION OF OPERATING INCOME

 

The following table shows the changes in operating income from 2003 to 2004:

 

(In Millions)


   SDSG

    SFAE

    Items not
allocated


    Total
Company


 

FY 2003 Operating Income

   $ 175.1     $ 103.0     $ (61.1 )   $ 217.0  

Store sales and margin

     29.4       126.4       (7.7 )     148.1  

Operating expenses

     (43.6 )     (110.6 )     (0.7 )     (154.9 )

Impairments and dispositions

     —         —         (23.6 )     (23.6 )

Severance, reorganization and other charges

     —         —         7.6       7.6  
    


 


 


 


Increase (Decrease)

     (14.2 )     15.8       (24.4 )     (22.8 )

FY 2004 Operating Income

   $ 160.9     $ 118.8     $ (85.5 )   $ 194.2  
    


 


 


 


 

Consolidated comparable store sales increased 5.3% during 2004, which led to a $148.1 million improvement in gross margin. Increased operating expenses associated with the sales increase, an investment in key strategic initiatives and impairments and dispositions costs associated with store closings offset the margin improvement and contributed to a decline in consolidated operating income of $22.8 million.

 

In a competitive traditional department store environment, a 1.6% comparable store sales increase at SDSG resulted in a $29.4 million improvement in gross margin. An increase in operating expenses of $43.6 million was caused by higher selling expenses associated with the sales increase, a reduction in year-over-year property tax refunds and spending related to investments in supply chain management initiatives. The net effect of new and closed stores reduced operating income at SDSG by approximately $4.0 million.

 

Consistent with the aforementioned trends in the luxury sector, SFAE realized a comparable store sales increase of 10.8% in 2004, which contributed to a $126.4 million improvement in gross margin. An increase of $110.6 million in operating expenses at SFAE reflected the increase in selling payroll and advertising expenses to support this sales increase, in addition to incremental expenses associated with strategic store and marketing investments and certain organizational changes. The net effect of new and closed stores contributed approximately $4.0 million of operating income at SFAE.

 

Expenses and charges not allocated to the segments increased by $24.4 million, due largely to a $23.6 million increase in impairment and disposition costs and $7.7 million in markdowns, principally resulting from announced SFAE store closings. A decrease of $7.6 million in severance and other charges was primarily due to a reduction in year-over-year reorganization costs.

 

NET SALES

 

The following table shows relevant sales information by segment for 2004 compared to 2003:

 

     Net Sales

  

Total

Increase


  

Total %

Increase


   

Comp %

Increase


 

(In Millions)


   2004

   2003

       

SDSG

   $ 3,700.0    $ 3,619.7    $ 80.3    2.3 %   1.6 %

SFAE

     2,737.3      2,435.3      302.0    12.5 %   10.8 %
    

  

  

  

 

Consolidated

   $ 6,437.3    $ 6,055.0    $ 382.3    6.3 %   5.3 %
    

  

  

  

 

 

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The majority of the sales increase was due to a consolidated comparable store sales increase of 5.3%. The increase in comparable store sales was primarily attributable to a continued improvement in the economy, principally in the luxury sector as evidenced by a 10.8% comparable store sales increase at SFAE. A slowing sales trend at SDSG during the second half of the year reflected the challenging environment in the traditional department store sector and resulted in a 1.6% comparable store sales increase at SDSG. In addition to the comparable store sales increase, sales generated from new stores added $104.2 million, and were offset by a decline in sales of $32.0 million from the sale or closure of underproductive stores.

 

Comparable store sales are calculated on a rolling 13-month basis. Thus, to be included in the comparison, a store must be open for 13 months. The additional month is used to transition the first month impact of a new store opening. Correspondingly, closed stores are removed from the comparable store sales comparison when they begin liquidating merchandise. Expanded, remodeled, converted and re-branded stores are included in the comparable store sales comparison, except for the periods in which they are closed for remodeling and renovation.

 

GROSS MARGIN

 

Gross margin increased $148.1 million in 2004 from 2003. The increase in gross margin dollars was primarily attributable to the increase in sales at SFAE. Below plan sales at SDSG resulted in higher markdowns at SDSG partially offsetting the increased gross margin at SFAE. Approximately $130.0 million of the improvement was the effect of the comparable store sales increase and a reduction in markdown activity. Approximately $38.0 million of incremental gross margin contribution related to new stores, and was partially offset by the loss of approximately $20.0 million in gross margin from the sale or closure of stores.

 

The gross margin rate was relatively flat at 37.9% versus 2003, due primarily to the reduction in promotional activity at SFAE, partially offset by higher markdowns at SDSG. Amounts received from vendors as partial reimbursement for markdowns in 2004 were proportionate to the amounts realized in 2003 and did not materially alter the year-over-year improvement in gross margin as a percentage of net sales.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

Selling, general and administrative expenses (“SG&A”) increased $125.3 million, or 8.4%, in 2004 over 2003, largely due to an increase in sales support costs consisting principally of selling payroll and supplies costs, primarily at SFAE; costs associated with investing in the business and streamlining the organizational structure; and a reduction in the proprietary credit card contribution as a result of the sale of the portfolio. The net effect of new and closed stores added approximately $20.0 million of additional expenses to SG&A.

 

Amounts received from vendors in conjunction with compensation programs and cooperative advertising were consistent with the related gross compensation and cooperative advertising expenditures and therefore had no impact on SG&A expense, in dollars or as a percentage of net sales.

 

SG&A as a percentage of net sales increased to 25.1% in 2004 from 24.6% in 2003. The rate increase reflected the investment in key strategic initiatives and organizational changes, in addition to the decline in net credit contribution on the increase in net sales.

 

OTHER OPERATING EXPENSES

 

Other operating expenses in 2004 increased by $22.1 million from 2003 driven by higher percentage rent expense resulting from the sales increase, higher payroll taxes related to sales driven compensation increases and

 

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Index to Financial Statements

a reduction in year-over-year property tax refunds. Other operating expenses as a percentage of net sales were 9.3% in 2004 compared to 9.6% in 2003, reflecting the ability to leverage increased occupancy expenses on the increase in sales.

 

IMPAIRMENTS AND DISPOSITIONS

 

The Company recognized net charges from impairments and dispositions of $31.8 million and $8.2 million in 2004 and 2003, respectively. Charges in 2004 were principally due to the impairment of store assets related to SFAE store closings and other impairment and disposition charges in the normal course of business. Impairments and disposition charges in 2003 were principally due to the impairment or closure of underproductive stores, the write-off of software, and other asset dispositions.

 

INTEREST EXPENSE

 

Interest expense declined to $114.0 million in 2004 from $117.4 million in 2003 and, as a percentage of net sales, decreased to 1.8% in 2004 from 1.9% in 2003. The improvement was primarily the result of a reduction in interest rates resulting from fixed to floating swap agreements and the exchange of higher coupon senior notes for lower coupon senior notes in 2003, and was partially offset by interest expense on the convertible notes. To the extent the Company utilizes operating cash flows to repurchase debt and without regard to changes in interest rates, interest expense could be reduced on a prospective basis.

 

LOSS ON EXTINGUISHMENT OF DEBT

 

The loss on extinguishment of debt in 2003 of $10.5 million resulted largely from a premium paid on the exchange offer of 2008 senior notes.

 

OTHER INCOME (EXPENSE), NET

 

Other income decreased to $4.0 million in 2004 from $5.0 million in 2003 due to lower interest income resulting from lower balances of invested cash. In 2003, the Company realized a gain from the sale of its proprietary credit card portfolio of approximately $5.0 million and realized a loss from an equity investment in FAO, Inc. of approximately $5.0 million.

 

INCOME TAXES

 

For 2004 and 2003 the effective income tax rate differs from the federal statutory tax rate due to state income taxes and other items such as the change in valuation allowance against state net operating loss carryforwards, the recognition of deferred tax assets for alternative minimum tax credit carryforwards and the effect of concluding tax examinations. The increase in the effective rate in 2004 was attributable to fact that the benefit in 2003 related to the conclusion of tax examinations and the recognition of deferred tax assets for alternative minimum tax credit carryforwards was greater than the benefit in 2004 from the reduction in the valuation allowance on state-related net operating loss carryforwards. Additional tax reserve exposure items were also identified in 2004 which increased the effective income tax rate. Excluding these items, the Company’s effective income tax rate was 36.5% in 2004.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOW

 

The primary needs for cash are to acquire or construct new stores, renovate and expand existing stores, provide working capital for new and existing stores and service debt. The Company anticipates that cash on hand, cash generated from operating activities and borrowings under its revolving credit agreement will be sufficient to meet its financial commitments and provide opportunities for future growth.

 

Cash provided by operating activities was $188.1 million in 2005, $358.8 million in 2004 and $473.7 million in 2003. Cash provided by operating activities principally represents income before depreciation and amortization charges and losses from impairments and dispositions and also includes changes in working capital. The decrease in 2005 from 2004 was primarily due to the disposal of assets related to the sale of Proffitt’s. The decrease in 2004 from 2003 was primarily due to the receipt of proceeds from the sale of the proprietary credit card portfolio in 2003.

 

Cash provided by (used in) investing activities was $397.7 million in 2005, $(176.5) million in 2004 and $(186.8) million in 2003. Cash used in investing activities principally consists of construction of new stores and renovation and expansion of existing stores and investments in support areas (e.g., technology, distribution centers, e-business infrastructure). The $574.2 million increase in 2005 is primarily due to the $622.4 million of proceeds received from the sale of Proffitt’s. The 2004 decrease in net cash used in 2004 was primarily attributable to proceeds received from the sale of stores.

 

Cash used in financing activities was $(762.5) million in 2005, $(291.1) million in 2004 and $(130.2) million in 2003. The 2005 year over year change was principally attributable to the repurchase of approximately $607.1 million in principal amount of senior notes due to the completion of the tender offers and consent solicitations as described in the Capital Structure disclosure. The 2004 year over year change was principally attributable to payments of a $283.1 million special one-time cash dividend and $142.6 million of 2004 senior note maturities and subsequent open market repurchases, offset by current period net proceeds received from the issuance of $230.0 million of convertible notes.

 

CASH BALANCES AND LIQUIDITY

 

The Company’s primary sources of short-term liquidity are comprised of cash on hand and availability under its $800 million revolving credit facility. At the Company’s request, due to the sale of NDSG, the revolving credit facility was reduced to $500 million in March 2006. At January 28, 2006 and January 29, 2005, the Company maintained cash and cash equivalent balances of $80.4 million (including $3 million of NDSG store cash held for sale) and $257.1 million, respectively. Exclusive of approximately $34 million and $45 million of store operating cash at January 28, 2006 and January 29, 2005, respectively, cash was invested principally in various money market funds at January 28, 2006 and January 29, 2005, respectively. There was no restricted cash at January 28, 2006 and January 29, 2005.

 

At January 28, 2006, the Company had no borrowings under its $800 million revolving credit facility, and had $78.6 million in unfunded letters of credit, leaving unutilized availability under the facility of $721.4 million. The Company had maximum borrowings of $103.0 million on its revolving credit facility during 2005. The amount of cash on hand and borrowings under the facility are influenced by a number of factors, including sales, inventory levels, vendor terms, the level of capital expenditures, cash requirements related to financing instruments, and the Company’s tax payment obligations, among others.

 

On March 15, 2004, the Company’s Board of Directors declared a special one-time cash dividend of $2.00 per common share to shareholders of record as of April 30, 2004. The Company reduced retained earnings and

 

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additional paid-in capital for the $285.6 million dividend, and on or after May 17, 2004, the Company paid $283.9 million of the dividend using cash on hand to fund the payment. The remaining portion of the dividend has been accrued and will be paid prospectively as restricted shares vest.

 

As described previously, on March 6, 2006, Bon-Ton acquired from the Company substantially all outstanding equity interests directly or indirectly involved in the Company’s NDSG unit. The consideration received consisted of approximately $1.05 billion in cash. In conjunction with the sale of NDSG, the Company announced that its Board of Directors had declared a special cash dividend of $4.00 per common share. The special cash dividend will be payable on May 1, 2006 to shareholders of record as of April 14, 2006. The dividend will total approximately $540 million based on the current shares outstanding.

 

CAPITAL STRUCTURE

 

The Company continuously evaluates its debt-to-capitalization position in light of economic trends, business trends, levels of interest rates, and terms, conditions and availability of capital in the capital markets. At January 28, 2006, the Company’s capital structure was comprised of a revolving credit agreement, senior unsecured notes, convertible senior unsecured notes, capital and operating leases and real estate mortgage financing. At January 28, 2006, the Company’s total debt was $730.5 million, representing a decrease of $623.4 million from the balance of $1,353.9 million at January 29, 2005. This decrease in debt was primarily the result of the repurchase of approximately $585.7 million in principal amount of senior notes related to the completion of the tender offers and consent solicitations discussed below. Additionally, the Company repurchased $21.4 million of senior notes at par through unsolicited open market repurchases during August 2005. This decrease in debt decreased the fiscal year end debt to total capitalization percentage to 26.8% from 39.6% in the prior year.

 

At January 28, 2006, the Company maintained an $800 million revolving credit facility maturing in 2009, which is secured by eligible inventory and certain third party credit card accounts receivable. Borrowings are limited to a prescribed percentage of eligible assets. At the Company’s request, the lenders reduced the availability under the Company’s revolving credit facility to $500 million in March 2006 following the sale of NDSG. There are no debt ratings-based provisions in the facility. The facility includes a fixed-charge coverage ratio requirement of 1 to 1 that the Company is subject to only if availability under the facility becomes less than $60 million (previously $100 million). The facility contains default provisions that are typical for this type of financing, including a provision that would trigger a default of the facility if a default were to occur in another debt instrument resulting in the acceleration of principal of more than $20 million in that other instrument.

 

The Company had approximately $382.9 million of senior notes outstanding as of January 28, 2006 comprised of five separate series having maturities ranging from 2008 to 2019. The terms of each senior note call for all principal to be repaid at maturity. The senior notes have substantially identical terms except for the maturity dates and the interest rates payable to investors. Each senior note contains limitations on the amount of secured indebtedness the Company may incur. The Company believes it has sufficient cash on hand, availability under its revolving credit facility and access to various capital markets to repay these notes at maturity.

 

The Company had $230 million of convertible notes, at January 28, 2006, that bear interest of 2.0% and mature in 2024. The provisions of the convertible notes allow the holder to convert the notes to shares of the Company’s common stock at a conversion rate of 53.5087 shares per one thousand dollars in principal amount of notes. The most significant terms and conditions of the convertible notes include: the Company can settle a conversion with shares and/or cash; the holder may put the debt back to the Company in 2014 or 2019; the holder cannot convert the notes until the Company’s share price exceeds the conversion price by 20% for a certain trading period; the Company can call the notes on or after March 11, 2011; the conversion rate is subject to a dilution adjustment; and the holder can convert the notes upon a significant credit rating decline and upon a call. The Company used approximately $25 million of the proceeds from the issuance of the notes to enter into a

 

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convertible note hedge and written call options on its common stock to reduce the exposure to dilution from the conversion of the notes. The Company believes it has sufficient cash on hand, availability under its revolving credit facility and access to various capital markets to repay both the senior notes and convertible notes at maturity.

 

At January 28, 2006 the Company had $118 million in capital leases (of which $35 million related to NDSG) covering various properties and pieces of equipment. The terms of the capital leases provide the lessor with a security interest in the asset being leased and require the Company to make periodic lease payments, aggregating between $6 million and $8 million per year.

 

At January 28, 2006, the Company is obligated to fund two cash balance pension plans (one of which related to NDSG). The Company’s current policy is to maintain at least the minimum funding requirements specified by the Employee Retirement Income Security Act of 1974. The Company expects minimal funding requirements in 2006 and 2007. As part of the sale of NDSG to Bon-Ton, the NDSG pension assets and liabilities were assumed by Bon-Ton.

 

On June 14, 2005, the Company received a notice of default with respect to its convertible notes. The notice of default was given by a note holder that stated that it owned more than 25% of the convertible notes. The notice of default stated that the Company breached covenants in the indenture for the convertible notes. In response to this receipt of a notice of default, on June 20, 2005, the Company announced that it would commence cash tender offers and consent solicitations for three issues of its senior notes and consent solicitations with respect to two additional issues of its senior notes and its convertible notes.

 

On July 19, 2005 the Company completed these cash tender offers and consent solicitations. The consent solicitations (including those that were part of the tender offers) offered holders a one-time fee in exchange for their consent to proposed amendments to the indenture for each issue of notes. Upon completion of the tender offers and consent solicitations, the Company repurchased a total of approximately $585.7 million in principal amount of senior notes and received consents from holders of a majority of every issue of its senior notes and of its convertible notes. The notes were repurchased at par, which included a consent fee. The repurchase of these notes resulted in a loss on extinguishment of debt of approximately $29.4 million related principally to the write-off of deferred financing costs and a premium on previously exchanged notes. During August 2005, the Company repurchased $21.4 million of additional senior notes at par through unsolicited open market repurchases.

 

CONTRACTUAL OBLIGATIONS

 

The contractual cash obligations at January 28, 2006 associated with the Company’s capital structure, as well as other contractual obligations are illustrated in the following table:

 

     Payments Due by Period

(Dollars in Millions)


   Within 1 year

   Years 2-3

   Years 4-5

   After Year 5

   Total

Long-Term Debt, including interest

   $ 38    $ 264    $ 90    $ 448    $ 840

Capital Lease Obligations, including interest

     24      50      45      247      366

Operating Leases

     125      233      198      457      1,013

Purchase Obligations

     877      49      4      —        930
    

  

  

  

  

Total Contractual Cash Obligations

   $ 1,066    $ 596    $ 337    $ 1,150    $ 3,149
    

  

  

  

  

 

The Company’s purchase obligations principally consist of purchase orders for merchandise, store construction contract commitments, maintenance contracts and services agreements and amounts due under

 

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employment agreements. Amounts committed under open purchase orders for merchandise inventory represent approximately $800 million of the purchase obligations within one year, a substantial portion of which are cancelable without penalty prior to a date that precedes the vendor’s scheduled shipment date.

 

On March 6, 2006, the Company announced that its Board of Directors had declared a special cash dividend of $4.00 per common share. The special cash dividend will be payable on May 1, 2006 to shareholders of record as of April 14, 2006. The dividend will total approximately $540 million based on the current shares outstanding.

 

Additionally at January 28, 2006, the Company had accrued approximately $20 million related to retention compensation in conjunction with its strategic alternative processes, which is payable within the next two years.

 

Other cash obligations that have been excluded from the contractual obligations table include contingent rent payments, amounts that might come due under change-in-control provisions of employment agreements, common area maintenance costs, interest costs associated with debt obligations, deferred rentals and pension funding obligations. The Company contributed $404 thousand to its pension plans in January 2006 to reduce the underfunding and expects minimal funding requirements in 2006 and 2007. Benefit payments to plan participants under the Company’s pension plans are estimated to approximate $35 million annually, of which approximately $20 million related to NDSG and $15 million related to SFAE.

 

The Company has not entered into any off-balance sheet arrangements which would be reasonably likely to have a current or future material effect, such as obligations under certain guarantees or contracts; retained or contingent interests in assets transferred to an unconsolidated entity or similar arrangements; obligations under certain derivative arrangements; and obligations under material variable interests.

 

CREDIT CARDS

 

Prior to April 15, 2003, the Company’s proprietary credit cards were issued by National Bank of the Great Lakes (“NBGL”), a wholly owned subsidiary of the Company. On April 15, 2003, the Company sold its proprietary credit card portfolio, consisting of the proprietary credit card accounts owned by NBGL and the Company’s ownership interest in the assets of the trust to Household Bank (SB), N.A. (now HSBC Bank Nevada, N.A., “HSBC”), a third party financial institution.

 

In connection with the sale, the Company received an amount in cash equal to the difference of (1) the sum of 100% of the outstanding accounts receivable balances, a premium, and the value of investments held in securitization accounts minus (2) the outstanding principal balance, together with unpaid accrued interest, of specified certificates held by public investors, which certificates were assumed by HSBC at the closing. The Company’s net cash proceeds from the transaction were approximately $300 million. After allocating the cash proceeds to the sold accounts, the retained interest in the securitized receivables, and an ongoing program agreement, the Company realized a gain of approximately $5 million. The cash proceeds allocated to the ongoing program agreement were deferred and will be reflected as a reimbursement of continuing credit card related expenses over the life of the agreement.

 

As part of the transaction, for a term of ten years expiring in 2013 and pursuant to a program agreement, HSBC established and owns proprietary credit card accounts for customers of the Company’s operating subsidiaries, retains the benefits and risks associated with the ownership of the accounts, receives the finance charge income and incurs the bad debts associated with those accounts. During the ten-year term, pursuant to a servicing agreement, the Company continues to provide key customer service functions, including new account opening, transaction authorization, billing adjustments and customer inquiries, and receives compensation from HSBC for these services.

 

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At the end of the ten-year term expiring in 2013, the agreement can be renewed for two two-year terms. At the end of the agreement, the Company has the right to repurchase, at fair value, all of the accounts and outstanding accounts receivable, negotiate a new agreement with HSBC or begin issuing private label credit cards itself or through others. The agreement allows the Company to terminate the agreement early following the incurrence of certain events, the most significant of which would be HSBC’s failure to pay owed amounts, bankruptcy, a change in control or a material adverse change in HSBC’s ability to perform under the agreement. The agreement also allows for HSBC to terminate the agreement if the Company fails to pay owed amounts or enters bankruptcy. Should either the Company or HSBC choose to terminate the agreement early, the Company has the right, but not the requirement, to repurchase the credit card accounts and associated accounts receivable from HSBC at their fair value. The Company is contingently liable to pay monies to HSBC in the event of an early termination or a significant disposition of stores. The contingent payment is based upon a declining portion of an amount established at the beginning of the ten-year agreement and on a prorated portion of significant store closings. Because HSBC acknowledged that each of Bon-Ton and Belk entered into an agreement with HSBC with respect to the credit card accounts and associated accounts receivable at NDSG and Proffitt’s, respectively, that satisfied certain requirements in the Company’s agreement with HSBC, this contingent payment was not applicable to the sales of NDSG and Proffitt’s. The maximum contingent payment had the agreement been terminated early at January 28, 2006 would have been approximately $85.0 million. Management believes the risk of incurring a contingent payment is remote.

 

CAPITAL NEEDS

 

The Company estimates capital expenditures for 2006 will approximate $175 million to $200 million, net of anticipated proceeds of $25 million, primarily for the construction of new stores opening in 2006, initial construction work on stores expected to open in 2007, store expansions and renovations, enhancements to management information systems, maintenance capital and replacement capital expenditures.

 

The Company anticipates that working capital requirements related to new and existing stores and capital expenditures will be funded through cash on hand, cash provided by operations and the revolving credit agreement. Maximum availability under the revolving credit agreement is $500 million. There is no debt rating trigger. During periods in which availability under the agreement exceeds $60 million, the Company is not subject to financial covenants. If availability under the agreement were to decrease to less than $60 million, the Company would be subject to a minimum fixed charge coverage ratio of 1 to 1. During 2005, weighted average borrowings and letters of credit issued under this credit agreement were $116.2 million. The highest amount of borrowings and letters of credit outstanding under the agreement during 2005 was $254.3 million. The Company expects to generate adequate cash flows from operating activities combined with borrowings under its revolving credit agreement in order to sustain its current levels of operations.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The Company’s critical accounting policies and estimates are discussed in the notes to the consolidated financial statements. Certain judgments and estimates utilized in implementing these accounting policies are likewise discussed in each of the notes to the consolidated financial statements. The following discussion aggregates the judgments and uncertainties affecting the application of these policies and estimates and the likelihood that materially different amounts would be reported under varying conditions and assumptions.

 

REVENUE RECOGNITION

 

Sales and the related gross margin are recorded at the time customers provide a satisfactory form of payment and take ownership of the merchandise. There are minimal accounting judgments and uncertainties

 

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affecting the application of this policy. The Company estimates the amount of goods that will be returned for a refund and reduces sales and gross margin by that amount. However, given that approximately 15% of merchandise sold is later returned and that the vast majority of merchandise returns are effected within a matter of days of the selling transaction, the risk of the Company realizing a materially different amount for sales and gross margin than reported in the consolidated financial statements is minimal.

 

COST OF SALES AND INVENTORY VALUATION, EXCLUDING DEPRECIATION AND AMORTIZATION

 

The Company’s inventory is stated at the lower of LIFO cost or market using the retail method. Under the retail method, the valuation of inventories at cost and the resulting gross margins are determined by applying a calculated cost-to-retail ratio to the retail value of inventories. The cost of the inventory reflected on the consolidated balance sheet is decreased with a charge to cost of sales contemporaneous with the lowering of the retail value of the inventory on the sales floor through the use of markdowns. Hence, earnings are negatively impacted as the merchandise is being devalued with markdowns prior to the sale of the merchandise. The areas requiring significant management judgment include (1) setting the original retail value for the merchandise held for sale, (2) recognizing merchandise for which the customer’s perception of value has declined and appropriately marking the retail value of the merchandise down to the perceived value, and (3) estimating the shrinkage that has occurred through theft during the period between physical inventory counts. These judgments and estimates, coupled with the averaging processes within the retail method, can, under certain circumstances, produce varying financial results. Factors that can lead to different financial results include setting original retail values for merchandise held for sale at too high a level, failure to identify a decline in perceived value of inventories and process the appropriate retail value markdowns and overly optimistic or overly conservative shrinkage estimates. The Company believes it has the appropriate merchandise valuation and pricing controls in place to minimize the risk that its inventory values would be materially under or overvalued.

 

The Company receives vendor provided support in different forms. When the vendor provides support for inventory markdowns, the Company records the support as a reduction to cost of sales. Such support is recorded in the period that the corresponding markdowns are taken. When the Company receives inventory-related support that is not designated for markdowns, the Company includes this support as a reduction in cost purchases.

 

CREDIT CARD INCOME AND EXPENSES

 

Following the sale of the Company’s proprietary credit card business in April 2003, the Company no longer maintains a retained interest in the credit card receivables. There are minimal accounting judgments and uncertainties affecting the accounting for the credit card program compensation, credit card servicing compensation and servicing expenses. Initial proceeds allocated to the program and servicing agreement are being amortized into income ratably over the lives of the agreement. Ongoing income associated with honoring the credit cards under the program agreement, promoting the credit cards and servicing the credit cards is recognized monthly contemporaneous with providing these services.

 

Prior to the sale, the carrying value of the Company’s retained interest in credit card receivables required a substantial amount of management judgment and estimates. At the time credit card receivables were sold to third-party investors through the securitization program, generally accepted accounting principles required that the Company recognize a gain or loss equal to the excess of the estimated fair value of the consideration to be received from the individual interest sold over the cost of the receivables sold. As the receivables were collected, the estimated gains and losses were reconciled to the actual gains and losses. Given that the Company generated credit card receivables of approximately $3 billion per year and average outstanding sold receivables were generally $1.0 billion to $1.2 billion, a substantial majority of the annual estimated credit gains and losses had

 

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been reconciled to actual gains and losses. Only that portion of the gains and losses attributable to the outstanding securitized portfolio at year end remained subject to estimating risk.

 

SELF-INSURANCE RESERVES

 

The Company self-insures a substantial portion of the exposure for costs related primarily to employee medical, workers’ compensation and general liability. Expenses are recorded based on estimates for reported and incurred but not reported claims considering a number of factors, including historical claims experience, severity factors, litigation costs, inflation and other assumptions. Although the Company does not expect the amount it will ultimately pay to differ significantly from estimates, self-insurance reserves could be affected if future claims experience differs significantly from the historical trends and assumptions.

 

DEPRECIATION AND RECOVERABILITY OF CAPITAL ASSETS

 

Over one-half of the Company’s assets at January 28, 2006 are represented by investments in property, equipment and goodwill. Determining appropriate depreciable lives and reasonable assumptions for use in evaluating the carrying value of capital assets requires judgments and estimates.

 

    The Company principally utilizes the straight-line depreciation method and a variety of depreciable lives. Land is not depreciated. Buildings and improvements are depreciated over 20 to 40 years. Store fixtures are depreciated over 10 years. Equipment utilized in stores (e.g., escalators) and in support areas (e.g., distribution centers, technology) and fixtures in support areas are depreciated over 3 to 15 years. Leasehold improvements are amortized over the shorter of their estimated useful lives or their related lease terms, generally ranging from 10 to 20 years. Internally generated computer software is amortized over 3 to 10 years. Generally, no estimated salvage value at the end of the useful life of the assets is considered.

 

    When constructing stores, the Company receives allowances from landlords. If the landlord is determined to be the primary beneficiary of the property, then the portion of those allowances attributable to the property owned by the landlord is considered to be a deferred rent liability, whereas the corresponding capital expenditures related to that store are considered to be prepaid rent. Allowances in excess of the amounts attributable to the property owned by the landlord are considered improvement allowances and are recorded as deferred rent liabilities that are amortized over the life of the lease. Capital expenditures are also reduced when the Company receives cash and allowances from merchandise vendors to fund the construction of vendor shops.

 

    To the extent the Company remodels or otherwise replaces or disposes of property and equipment prior to the end of their assigned depreciable lives, the Company could realize a loss or gain on the disposition. To the extent assets continue to be used beyond their assigned depreciable lives, no depreciation expense is being realized. The Company reassesses the depreciable lives in an effort to reduce the risk of significant losses or gains at disposition and utilization of assets with no depreciation charges. The reassessment of depreciable lives involves utilizing historical remodel and disposition activity and forward-looking capital expenditure plans.

 

   

Recoverability of the carrying value of store assets is assessed upon the occurrence of certain events (e.g., opening a new store near an existing store or announcing plans for a store closing) and, absent certain events, annually. The recoverability assessment requires judgment and estimates for future store generated cash flows. The underlying estimates for cash flows include estimates for future sales, gross margin rates, inflation and store expenses. During 2005, the Company recorded $16.8 million in impairment charges in the normal course of business primarily associated with stores in which the estimated discounted cash flows would not recover the carrying value of the store assets. The Company

 

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recorded a $156.3 million gain associated with the sale of Proffitt’s. In addition, SFAE recorded a $2.6 million gain associated with store closings. There are other stores in which current cash flows are not adequate to recover the carrying value of the store assets. However, the Company believes that estimated sales growth and gross margin improvement will enhance the cash flows of these stores such that the carrying value of the store assets will be recovered. Generally these stores were recently opened and require a two to five year period to develop the customer base to attain the required cash flows. To the extent management’s estimates for sales growth and gross margin improvement are not realized, future annual assessments could result in impairment charges.

 

GOODWILL AND INTANGIBLES

 

The Company has allocated the purchase price of previous purchase transactions to identifiable tangible assets and liabilities based on estimates of their fair values and identifiable intangible assets, with the remainder allocated to goodwill. SFAS No. 142, “Goodwill and Other Intangible Assets,” requires the discontinuation of goodwill amortization and the periodic testing (at least annually) for the impairment of goodwill and intangible assets. At each year-end balance sheet date and as changes in circumstances arise, the Company performs an evaluation of the recoverability of its SDSG goodwill by comparing the estimated fair value to the carrying amount of its assets and goodwill. As a result, in 2005 the Company recorded a charge of $51.5 million due to the impairment of SDSG goodwill. The Company also disposed of approximately $88.0 million of goodwill during 2005 related to the sale of Proffitt’s.

 

LEASES

 

The Company leases stores, distribution centers, and administrative facilities under operating leases. Store lease agreements generally include rent holidays, rent escalation clauses and contingent rent provisions for percentage of sales in excess of specified levels. Most of the Company’s lease agreements include renewal periods at the Company’s option. The Company recognizes rent holiday periods and scheduled rent increases on a straight-line basis over the lease term beginning with the date the Company takes possession of the leased space and includes such rent expense in Store Pre-Opening Costs. The Company records tenant improvement allowances and rent holidays as deferred rent liabilities on the consolidated balance sheets and amortizes the deferred rent over the terms of the lease to rent expense in the consolidated statements of income. The Company records rent liabilities on the consolidated balance sheets for contingent percentage of sales lease provisions when the Company determines that it is probable that the specified levels will be reached during the fiscal year.

 

INCOME AND OTHER TAXES

 

The majority of the Company’s deferred tax assets at January 28, 2006 consist of federal and state net operating loss carryforwards that will expire between 2006 and 2024. During 2005 the valuation allowance against net operating loss carryforwards was reduced based on projections of future profitability which include a gain related to the sale of the NDSG business in 2006. At January 28, 2006 the Company believes that it will be sufficiently profitable during the periods from 2006 to 2024 to utilize all of its federal NOLs and a significant portion of its state NOLs. To the extent management’s estimates of future taxable income by jurisdiction are greater than or less than management’s current estimates, future increases or decreases in the benefit for net operating losses could occur.

 

The Company is routinely under audit by federal, state and local authorities in the areas of income taxes and the remittance of sales and use taxes. Audit authorities may question the timing and amount of deductions, the allocation of income among various tax jurisdictions and compliance with federal, state and local tax laws. In evaluating the exposure associated with various tax filing positions, the Company often accrues charges for exposures related to uncertain tax positions.

 

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During 2004, the Company recorded a benefit of $4.6 million related to the expiration of the statute of limitations with respect to certain tax examination periods which was recorded as a credit to Shareholder’s Equity in accordance with SOP 90-7. In addition, an increase to the reserve for tax exposures of $2.6 million was recorded as an income tax expense for additional exposures.

 

During 2003, the Company concluded a federal income tax examination for the 1998 and 1999 tax years on terms favorable to previously accrued exposures associated with those tax years. Accordingly, the Company decreased the amount previously accrued for exposures related to uncertain tax positions. Additionally, the Company identified exposures related to state tax filing positions and determined the need to provide for additional reserves. The net effect of this federal and state reserve adjustment resulted in an income tax benefit of $7.2 million and a credit to shareholders’ equity of $3.9 million.

 

At January 28, 2006, the Company believes it has appropriately accrued for exposures related to uncertain tax positions. To the extent the Company were to prevail in matters for which accruals have been established or be required to pay amounts in excess of reserves, the Company’s effective tax rate in a given financial statement period may be materially impacted. At January 28, 2006, two of the Company’s three open tax years were undergoing examination by the Internal Revenue Service and certain state examinations were ongoing as well.

 

PENSION PLANS

 

Pension expense is based on information provided by outside actuarial firms that use assumptions to estimate the total benefits ultimately payable to associates and allocates this cost to service periods. The actuarial assumptions used to calculate pension costs are reviewed annually. The pension plans are valued annually on November 1st. The projected unit credit method is utilized in recognizing the pension liabilities.

 

Pension assumptions are based upon management’s best estimates, after consulting with outside investment advisors and actuaries, as of the annual measurement date.

 

    The assumed discount rate utilized is based upon pension discount curves and bond portfolio curves over a duration similar to the plan’s liabilities as of the measurement date. The discount rate is utilized principally in calculating the Company’s pension obligation, which is represented by the Accumulated Benefit Obligation (ABO) and the Projected Benefit Obligation (PBO) and in calculating net pension expense. At November 1, 2005, the discount rate was 5.65%. To the extent the discount rate increases or decreases, the Company’s ABO is decreased or increased, respectively. The estimated effect of a 0.25% change in the discount rate is $8.4 million on the ABO and $0.6 million on annual pension expense. To the extent the ABO increases, the after-tax effect of such increase serves to reduce Other Comprehensive Income and Shareholders’ Equity.

 

    The assumed expected long-term rate of return on assets is the weighted average rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the PBO. It is the Company’s policy to invest approximately 65% of the pension fund assets in equities, 30% in fixed income securities and 5% in real estate. This expected average long-term rate of return on assets is based principally on the advice of the Company’s outside investment advisors. This rate is utilized principally in calculating the expected return on plan assets component of the annual pension expense. To the extent the actual rate of return on assets realized over the course of a year is greater than the assumed rate, that year’s annual pension expense is not affected. Rather, this gain reduces future pension expense over a period of approximately 15 to 20 years. To the extent the actual rate of return on assets is less than the assumed rate, that year’s annual pension expense is likewise not affected. Rather, this loss increases pension expense over approximately 15 to 20 years. During 2005 and 2004, the Company utilized 8.0% as the expected long-term rate of return on assets.

 

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Index to Financial Statements
    The assumed average rate of compensation increases is the average annual compensation increase expected over the remaining employment periods for the participating employees. This rate is estimated to be 4% for the periods following November 1, 2005 and is utilized principally in calculating the PBO and annual pension expense. The estimated effect of a 0.25% change in the assumed rate of compensation increases would not be material to the PBO or annual pension expense.

 

    At November 1, 2005, the Company had unrecognized pension expense of $129.6 million related to the expected return on assets exceeding actual investment returns; actual compensation increases exceeding assumed average rate of compensation and plan amendments, contributions subsequent to the measurement date and other differences between underlying actuarial assumptions and actual results. This delayed recognition of expense is incorporated into the $71.4 million underfunded status of the plans at November 1, 2005. In January 2006 and January 2005, the Company voluntarily contributed $404 thousand and $474 thousand, respectively, to the plan to reduce underfunding. The Company expects minimal funding requirements in 2006 and 2007.

 

INFLATION AND DEFLATION

 

Inflation and deflation affect the costs incurred by the Company in its purchase of merchandise and in certain components of its SG&A expenses. The Company attempts to offset the effects of inflation, which has occurred in recent years in SG&A, through price increases and control of expenses, although the Company’s ability to increase prices is limited by competitive factors in its markets. The Company attempts to offset the effects of merchandise deflation, which has occurred in recent years, through control of expenses.

 

SEASONALITY

 

The Company’s business, like that of most retailers, is subject to seasonal influences, with a significant portion of net sales and net income realized during the second half of the fiscal year, which includes the holiday selling season. In light of these patterns, SG&A expenses are typically higher as a percentage of net sales during the first three fiscal quarters of each year, and working capital needs are greater in the last two fiscal quarters of each year. The increases in working capital needs during the fall season have typically been financed with cash flow from operations and borrowings under the Company’s revolving credit agreement. Generally, more than 30% of the Company’s net sales and substantially all of net income are generated during the fourth fiscal quarter.

 

NEW ACCOUNTING PRONOUNCEMENTS

 

During 2004, the EITF reached a consensus, EITF 04-08, “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share,” whereby the contingent conversion provisions should be ignored and therefore an issuer should apply the if-converted method in calculating dilutive earnings per share. This consensus became effective for periods ending after December 15, 2004, and requires retroactive application to all periods presented. Furthermore, the FASB is contemplating an amendment to SFAS No. 128, “Earnings Per Share,” that would require the Company to ignore the cash presumption of net share settlement and to assume share settlement for purposes of calculating diluted earnings per share. Although the Company is now required to ignore the contingent conversion provision on its convertible notes under EITF 04-08, it can still presume that it will satisfy the net share settlement upon conversion of the notes in cash, and thus exclude the effect of the conversion of the notes in its calculation of dilutive earnings per share. If and when the FASB amends SFAS No. 128, the effect of the changes would require the Company to use the if-converted method in calculating dilutive earnings per share except when the effect would be anti-dilutive. The effect of adopting the amendment to SFAS No. 128 would increase the number of shares in the Company’s dilutive calculation by 12,307 shares. A final Statement is expected to be issued in the second quarter of 2006.

 

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In November 2004, the FASB issued SFAS No. 151, “Inventory Costs – An Amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS No. 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2006. The Company has determined that SFAS No. 151 does not have a material effect on the Company’s financial position or its results of operations.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment”. This statement, referred to as “SFAS No. 123R,” revised SFAS No. 123, “Accounting for Stock-Based compensation”, and requires companies to expense the value of employee stock options and similar awards. This standard is effective for annual periods beginning after June 15, 2005.

 

Until 2003, the Company recorded compensation expense for all stock-based compensation plan issuances prior to 2003 using the intrinsic value method. Compensation expense, if any, was measured as the excess of the market price of the stock over the exercise price of the award on the measurement date. In 2003, in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123,” the Company began expensing the fair value of all stock-based grants over the vesting period on a prospective basis utilizing the Black-Scholes model.

 

With the adoption of SFAS No. 123R, the Company will be required to expense all stock options over the vesting period in its statement of operations, including the remaining vesting period associated with unvested options outstanding as of January 28, 2006. For the years ended January 28, 2006, January 29, 2005 and January 31, 2004, total stock-based employee compensation expense, net of related tax effects, determined under this new standard would have been approximately $12 million, $20 million and $30 million, respectively. The Company will be required to adopt SFAS No. 123R in the first quarter of 2006. The Company evaluated the effect of the adoption of this standard and has determined that it will have an immaterial effect of less than a $600 thousand on the Company’s financial position and its results of operations.

 

In March 2005, the staff issued guidance on SFAS No. 123R. Additionally, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) to assist companies by simplifying some of the implementation challenges of SFAS No. 123R while enhancing the information that investors receive. SAB 107 creates a framework that reinforces the flexibility allowed, specifically when valuing employee stock options and permits individuals, acting in good faith, to conclude differently on the fair value of employee stock options.

 

RELATED PARTY TRANSACTIONS

 

A summary of the Company’s related party transactions is included in Item 13., Certain Relationships and Related Transactions, in this Form 10-K.

 

FORWARD-LOOKING INFORMATION

 

The information contained in this Form 10-K that addresses future results or expectations is considered “forward-looking” information within the definition of the Federal securities laws. Forward-looking information in this document can be identified through the use of words such as “may,” “will,” “intend,” “plan,” “project,” “expect,” “anticipate,” “should,” “would,” “believe,” “estimate,” “contemplate,” “possible,” and “point.” The forward-looking information is premised on many factors, some of which are outlined below. Actual consolidated results might differ materially from projected forward-looking information if there are any material changes in management’s assumptions.

 

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The forward-looking information and statements are or may be based on a series of projections and estimates and involve risks and uncertainties. These risks and uncertainties include such factors as: the level of consumer spending for apparel and other merchandise carried by the Company and its ability to respond quickly to consumer trends; adequate and stable sources of merchandise; the competitive pricing environment within the department and specialty store industries as well as other retail channels; the effectiveness of planned advertising, marketing, and promotional campaigns; favorable customer response to relationship marketing efforts of proprietary credit card loyalty programs; appropriate inventory management; effective expense control; successful operation of the Company’s proprietary credit card strategic alliance with HSBC Bank Nevada, N.A.; geo-political risks; changes in interest rates; the outcome of the formal investigation by the SEC and the inquiry the Company understands has been commenced by the Office of the United States Attorney for the Southern District of New York into matters that were the subject of the investigations conducted during 2004 and 2005 by the Audit Committee of the Company’s Board of Directors and any related matters that may be under investigation or the subject of inquiry; the ultimate amount of reimbursement to vendors of improperly collected markdown allowances; the ultimate impact of improper timing of recording of inventory markdowns; the ultimate impact of incorrect timing of recording of vendor markdown allowances; the outcome of the shareholder litigation that has been filed relating to the matters that were the subject of the Audit Committee’s initial investigation; the effects of the delay in the filing with the SEC of the Company’s Form 10-K for the fiscal year ended January 29, 2005 and its Quarterly Reports on Form 10-Q for the fiscal quarters ended April 30, 2005 and July 30, 2005; the successful performance by the Company of its obligations under transition services agreements with Belk, Inc. and The Bon-Ton Stores, Inc., and the success of the Company’s exploration of strategic alternatives for its Parisian business. For additional information regarding these and other risk factors, please refer to Item 1B of this Annual Report on Form 10-K and to Exhibit 99.1 filed as part of this report and incorporated by reference herein.

 

Management undertakes no obligation to correct or update any forward-looking statements, whether as a result of new information, future events, or otherwise. Persons are advised, however, to consult any further disclosures management makes on related subjects in its reports filed with the SEC and in its press releases.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

 

The Company’s exposure to market risk primarily arises from changes in interest rates and the U.S. equity and bond markets. The effects of changes in interest rates on earnings generally have been small relative to other factors that also affect earnings, such as sales and operating margins. The Company seeks to manage exposure to adverse interest rate changes through its normal operating and financing activities, and if appropriate, through the use of derivative financial instruments. Such derivative instruments can be used as part of an overall risk management program in order to manage the costs and risks associated with various financial exposures. The Company does not enter into derivative instruments for trading purposes, as clearly defined in its risk management policies. The Company is exposed to interest rate risk primarily through its borrowings, and derivative financial instrument activities, which are described in Notes 2 and 8 to the Consolidated Financial Statements appearing in Item 8 of this Form 10-K.

 

At January 28, 2006 and at January 29, 2005 the Company had no derivative instruments outstanding. During 2004 the Company terminated all remaining interest rate swap agreements resulting in net losses. When combined with net gains from other previously cancelled interest rate swap agreements, the Company had total unamortized net losses of $584 thousand and $18 thousand at January 28, 2006 and January 29, 2005, respectively, that are being amortized as a component of interest expense through 2010.

 

Based on the Company’s market risk sensitive instruments outstanding at January 28, 2006, the Company has determined that there was no material market risk exposure to the Company’s consolidated financial position, results of operations, or cash flows as of such date.

 

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Item 8. Financial Statements and Supplementary Data.

 

Information called for by this item is set forth in the Company’s Consolidated Financial Statements and supplementary data contained in this report beginning on page F-1.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A. Controls and Procedures.

 

DISCLOSURE CONTROLS AND PROCEDURES

 

Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Accounting Officer, the Company conducted an evaluation of the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of January 28, 2006. Based on this evaluation, the Company’s Chief Executive Officer and Chief Accounting Officer concluded that the Company’s disclosure controls and procedures were effective as of such date. The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Accounting Officer, to allow timely discussions regarding required disclosure.

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 

Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Accounting Officer, the Company conducted an evaluation of the effectiveness of the design and operation of the Company’s internal control over financial reporting as of January 28, 2006 based on criteria set forth in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on the management’s assessment, management believes that, as of January 28, 2006, the Company’s internal control over financial reporting was effective based on those criteria.

 

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Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of January 28, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

 

In 2004, the Company identified material weaknesses in the accuracy of the recording of vendor-provided markdown allowances and in the selection, application and monitoring of certain of its accounting policies. For additional information regarding the material weaknesses, see the discussion under Item 9A Controls and Procedures contained in the Company’s report on Form 10-K for the fiscal year ended January 29, 2005.

 

During 2005, the Company implemented a number of remediation measures to address the material weaknesses described above. The remediation activities included:

 

    Enhanced controls over the recording of vendor-provided markdown support transactions to include increased and standardized documentation and increased review and monitoring controls;

 

    Issued an enhanced accounting policy regarding vendor-provided markdown support and conducted improved training and education reviews regarding the proper accounting for vendor-provided markdown support;

 

    Implemented new internal audit programs to test and monitor compliance with the Company’s accounting policy for vendor-provided markdown support; and

 

    Enhanced controls over the selection, application and monitoring of its accounting policies and improved communication across the accounting and operating organizations.

 

As of January 28, 2006, the Company has determined that the new controls are effectively designed and have demonstrated effective operation to enable management to conclude the material weaknesses identified in 2004 have been remediated.

 

MANAGEMENT CONSIDERATION OF RESTATEMENT

 

In connection with the preparation of the consolidated financial statements for fiscal 2005, an error was discovered in the computation of the tax effect of previously restated financial statements prior to February 2, 2002. The error affected the Company’s consolidated balance sheets and statement of shareholders’ equity and had no effect on the Company’s EPS, consolidated statements of operations, or cash flows as presented in this Form 10-K. As a result of the effect on the consolidated balance sheets and statement of shareholders’ equity, the Company has restated its previously issued consolidated financial statements for the fiscal years ended January 29, 2005 and January 31, 2004.

 

In coming to the conclusion that our disclosure controls and procedures and our internal control over financial reporting were effective as of January 28, 2006, management considered, among other things, the control deficiency related to the computation of income taxes, which resulted in the need to restate our previously issued financial statements as disclosed in Note 3, Restatement of Previously Issued Financial Statements, included in Item 8 of this Form 10-K. Management has concluded that the control deficiency that resulted in the restatement of the previously issued financial statements did not constitute a material weakness as of January 28, 2006 because management determined that as of January 28, 2006 there were controls designed and in place to prevent or detect a material misstatement and therefore, the likelihood of income tax expense, deferred tax assets, deferred tax liabilities, and accrued expenses being materially misstated is not more than remote.

 

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Item 9B. Other Information

 

On April 5, 2006 the Company entered into an Employment Agreement dated April 5, 2006 with Charles G. Tharp (“Mr. Tharp”), the Company’s Executive Vice President-Human Resources (the “Tharp Agreement”). The following is a brief description of the terms and conditions of the Tharp Agreement, which does not have a term, that are material to the Company: (1) a base salary of $500,000; (2) an annual cash bonus for plan achievement at the target level of 50% of base salary and for plan achievement at the maximum level of 75% of base salary; (3) an award of 30,000 performance shares for each of the Company’s 2006, 2007, and 2008 fiscal years, with each award to include performance targets and performance measures determined by the Human Resources and Compensation Committee of the Company’s Board of Directors and a one-year performance period; (4) the Company will pay to Mr. Tharp within five business days after each of February 22, 2007 and February 22, 2008 an amount in cash equal to the product of the New York Stock Exchange closing price of the Company’s Common Stock on the applicable February 22 and 10,000, plus an amount equal to dividends paid on 10,000 shares of the Company’s Common Stock; (5) upon termination without cause the Company will pay Mr. Tharp as severance two times base salary and one times target bonus, and a prorated number of shares of restricted stock, and a prorated amount of the cash payments described in (4) above will vest; (6) if the termination of employment occurs in anticipation of, or on or after a change in control, all performance shares will fully vest at the target level and all restricted stock will fully vest, and Mr. Tharp will be entitled to participate in the Company’s medical plans, with family coverage, for 2 years from date of termination of employment, and the Company will reimburse Mr. Tharp for COBRA costs less normal associate costs and for the following six months the Company will reimburse Mr. Tharp for the entire cost of medical plan coverage; (7) if Mr. Tharp violates the non-competition requirements of the Tharp Agreement the Company’s obligation to make a severance payment would terminate; (8) if any severance payment would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code the Company will make a gross-up payment to Mr. Tharp with respect to such tax if the severance payment subject to the excise tax exceeds a specified threshold; (9) the Company may terminate the Tharp Agreement for cause in which event no base salary, bonus, or severance payment will be paid to Mr. Tharp following termination; (10) for purposes of the Tharp Agreement, “cause” means (i) conviction of Mr. Tharp, after all applicable rights of appeal have been exhausted or waived, for any crime that materially discredits the Company or is materially detrimental to the reputation or goodwill of the Company, (ii) commission of any material act of fraud or dishonesty by Mr. Tharp against the Company or commission of an immoral or unethical act that materially reflects negatively on the Company, if first Mr. Tharp is provided with written notice of the claim and with an opportunity to contest it before the Board of Directors, (iii) Mr. Tharp’s violation of the Company’s Code of Business Conduct and Ethics, which violation Mr. Tharp knows or reasonably should know could reasonably be expected to result in a material adverse effect on the Company, if first Mr. Tharp is provided with written notice of the violation and with an opportunity to contest it before the Board of Directors, or (iv) Mr. Tharp’s continual and material breach of Mr. Tharp’s obligations under the Tharp Agreement to serve the Company diligently, as determined by the Human Resources and Compensation Committee of the Board of Directors after Mr. Tharp has been given written notice of the breach and a reasonable opportunity to cure the breach; (11) Mr. Tharp will maintain the confidentiality of the Company’s proprietary and confidential information; (12) for one year following termination Mr. Tharp will not engage in specified categories of associations with specified competitors, will not disparage the Company, and will not solicit any employee of the Company to leave that employment; (13) if Mr. Tharp brings any action to enforce his rights under the Tharp Agreement after a change in control, the Company will reimburse him for his reasonable costs, including attorney’s fees, incurred; (14) the Company may assign its obligations under the Tharp Agreement to any acquirer of, or other successor to, all or substantially all of the business of the Company (whether direct or indirect, by purchase of assets or the Company’s common stock, merger, consolidation or otherwise); and (15) Mr. Tharp will reasonably cooperate in good faith with the Company as and when requested by the Company with regard to all current and future internal and government inquiries and investigations, litigation and administrative agency proceedings, and other legal or accounting matters.

 

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The foregoing summary of the Tharp Agreement is qualified in its entirety by reference to the full text of the Tharp Agreement, a copy of which is included as Exhibit 10.36 to this Annual Report on Form 10-K and is incorporated herein by reference.

 

On April 5, 2006, pursuant to authorization by the Company’s Board of Directors, the Company entered into indemnification agreements (the “Indemnification Agreements”) with each of the Company’s non-employee Directors and with certain executives of the Company, including each of the following executive officers: R. Brad Martin, Stephen I. Sadove, James A. Coggin, Douglas E. Coltharp, Charles J. Hansen and Kevin G. Wills (individually, an “Indemnitee”). Each of the Indemnification Agreements provides, among other things, that the Indemnitee shall have a contractual right (i) to indemnification to the fullest extent permitted by applicable law for losses suffered or expenses incurred in connection with any threatened, pending or completed litigation or other proceeding relating to the Indemnitee’s service as a director or officer of the Company, (ii) subject to certain limitations and procedural requirements, to the advancement of expenses paid or incurred in connection with such litigation or other proceeding, (iii) to certain procedural and other protections effective upon a change in control of the Company, including but not limited to the creation of a trust for the benefit of the Indemnitee, and (iv) to coverage under the Company’s directors’ and officers’ insurance policy, to the extent that the Company maintains such an insurance policy.

 

The foregoing summary of the Indemnification Agreements is qualified in its entirety by reference to the full text of the form of the Indemnification Agreement, a copy of which is included as Exhibit 10.37 to this Annual Report on Form 10-K and is incorporated herein by reference.

 

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PART III

 

Item 10. Directors and Executive Officers of the Registrant.

 

The information set forth under the caption “Election of Directors” in the Saks Incorporated Proxy Statement for the 2006 Annual Meeting of Shareholders to be held on June 7, 2006 (the “Proxy Statement”), which appears prior to the caption “Election of Directors – Further Information Concerning Directors,” is incorporated herein by reference. The information in the Proxy Statement regarding the Company’s Code of Business Conduct and Ethics and the Company’s Audit Committee (including the Company’s “audit committee financial expert”) set forth under the caption “Election of Directors – Further Information Concerning Directors” is also incorporated herein by reference.

 

The information required under this item with respect to the Company’s Executive Officers is incorporated by reference from Item 1C of this report under “Executive Officers of the Registrant.”

 

The information set forth under the caption “Election of Directors — Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement, with respect to compliance with Section 16(a) by the Company’s Directors, Executive Officers and persons who own more than 10% of the Company’s Common Stock, is incorporated herein by reference.

 

Item 11. Executive Compensation.

 

The information in the Proxy Statement set forth under the caption “Election of Directors - Further Information Concerning Directors — Directors’ Fees,” and under the caption “Election of Directors” which appears beginning with the caption “Executive Compensation” and prior to the caption “Certain Relationships and Related Transactions,” with respect to Director and Executive Officer compensation, is incorporated herein by reference.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

The information set forth under the caption “Outstanding Voting Securities” in the Proxy Statement, with respect to security ownership of certain beneficial owners and management, is incorporated herein by reference.

 

The information set forth under the caption “Election of Directors — Equity Compensation Plan Information” in the Proxy Statement, with respect to equity compensation plans approved and not approved by security holders, is incorporated herein by reference.

 

Item 13. Certain Relationships and Related Transactions.

 

The information set forth under the caption “Election of Directors — Certain Relationships and Related Transactions” in the Proxy Statement, with respect to certain relationships and related transactions, is incorporated herein by reference.

 

Item 14. Principal Accountant Fees and Services.

 

The information set forth under the caption “Ratification of Appointment of Registered Public Accounting Firm — PricewaterhouseCoopers LLP Fees and Services in 2005 and 2004” in the Proxy Statement is incorporated herein by reference.

 

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PART IV

 

Item 15. Exhibits and Financial Statement Schedules.

 

(a) The following documents are filed as a part of this report:

 

  (1) Financial Statements – The financial statements listed on page F-1 herein.

 

  (2) Financial Statement Schedule – The financial statement schedule listed on page F-1 herein.

 

  (3) Exhibits – The exhibits listed on the accompanying Index to Exhibits appearing at page E-1.

 

(b) The exhibits listed on the accompanying Index to Exhibits appearing at page E-1 are filed as exhibits to this report.

 

(c) Financial Statement Schedule

 

Schedule II – Valuation and Qualifying Accounts

 

All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are either included in the financial statements or notes thereto or are not required or are not applicable and therefore have been omitted.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on April 7, 2006.

 

SAKS INCORPORATED
By:   /s/    KEVIN G. WILLS        
    Kevin G. Wills
    Executive Vice President of Finance and
    Chief Accounting Officer

 

Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on April 7, 2006.

 

/s/    STEPHEN I. SADOVE        
Stephen I. Sadove
Chief Executive Officer
Director
Principal Executive Officer
/s/    KEVIN G. WILLS        
Kevin G. Wills
Executive Vice President of Finance and
Chief Accounting Officer
Principal Financial and Accounting Officer
/s/    R. BRAD MARTIN        
R. Brad Martin
Chairman of the Board
/s/    RONALD DE WAAL        
Ronald de Waal
Vice Chairman of the Board
/s/    STANTON J. BLUESTONE        
Stanton J. Bluestone
Director
/s/    ROBERT B. CARTER        
Robert B. Carter
Director
/s/    JULIUS W. ERVING        
Julius W. Erving
Director

 

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/s/    MICHAEL S. GROSS        
Michael S. Gross
Director
/s/    DONALD E. HESS        
Donald E. Hess
Director
/s/    NORA P. MCANIFF        
Nora P. McAniff
Director
/s/    C. WARREN NEEL        
C. Warren Neel
Director
/s/    MARGUERITE W. SALLEE        
Marguerite W. Sallee
Director
/s/    CHRISTOPHER J. STADLER        
Christopher J. Stadler
Director

 

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FORM 10-K—ITEM 15(a)(3) AND 15(c)

SAKS INCORPORATED AND SUBSIDIARIES

EXHIBITS

 

Exhibit No.

  

Description


2.1    Asset Purchase Agreement between Saks Incorporated and Belk, Inc. dated as of April 28, 2005 (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed May 2, 2005)
2.2    Purchase Agreement between Saks Incorporated and The Bon-Ton Stores, Inc. dated as of October 29, 2005 (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed on November 3, 2005)
2.3    Amendment No. 1 to Purchase Agreement dated as of February 16, 2006 between Saks Incorporated and The Bon-Ton Stores, Inc. (incorporated by reference form the Exhibits to the Form 8-K filed on February 21, 2006)
3.1    Amended and Restated Charter of Saks Incorporated (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended January 29, 2000)
3.2    Amended and Restated Bylaws of Saks Incorporated (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended February 1, 2003)
4.1    Indenture, dated as of November 9, 1998, among Saks Incorporated, the Subsidiary Guarantors, and The First National Bank of Chicago, as trustee (8 1/4% Notes due 2008) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed November 19, 1998)
4.2    Indenture, dated as of December 2, 1998, among Saks Incorporated, the Subsidiary Guarantors, and The First National Bank of Chicago, as trustee (7 1/2% Notes due 2010) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed December 4, 1998)
4.3    Indenture, dated as of February 17, 1999, among Saks Incorporated, the Subsidiary Guarantors, and The First National Bank of Chicago, as trustee (7 3/8% Notes due 2019) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed February 19, 1999)
4.4    Indenture, dated as of October 4, 2001, among Saks Incorporated, the Subsidiary Guarantors, and Bank One Trust Company, National Association, as trustee (9 7/8% Notes due 2011) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed October 11, 2001)
4.5    Registration Rights Agreement between Proffitt’s, Inc. and Parisian, Inc. dated July 8, 1996 (incorporated by reference from the Exhibits to the Form S-4/A Registration Statement No. 333-09043 of Proffitt’s, Inc. filed August 16, 1996)
4.6    Registration Rights Agreement between Proffitt’s, Inc. and specified stockholders of Saks Holdings, Inc. dated July 4, 1998 (incorporated by reference from the Exhibits to the Form 8-K of Proffitt’s, Inc. filed July 8, 1998)
4.7    Second Amended and Restated Rights Agreement, dated as of October 4, 2004, by and between Saks Incorporated and The Bank of New York, as Rights Agent (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed October 10, 2004)
4.8    Indenture, dated as of December 8, 2003, among Saks Incorporated, the Subsidiary Guarantors named therein, and the Bank of New York, as Trustee (7% Notes due 2013) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed December 11, 2003)

 

E-1


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Exhibit No.

  

Description


4.9    Registration Rights Agreement, dated as of December 8, 2003, among Saks Incorporated, certain of its subsidiaries named therein, Citigroup Global Markets Inc., Goldman, Sachs & Company, Wachovia Capital Markets, LLC, Banc One Capital Markets, Inc. and ABN AMRO Incorporated (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed December 11, 2003)
4.10    Indenture, dated as of March 23, 2004, between Saks Incorporated, the Subsidiary Guarantors named therein, and The Bank of New York Trust Company, N.A., as trustee (2.00% Convertible Senior Notes due 2024) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed March 26, 2004)
4.11    Registration Rights Agreement, dated as of March 23, 2004, among Saks Incorporated, certain subsidiaries of Saks Incorporated named therein, Goldman, Sachs & Co. and Citigroup Global Markets Inc., as representatives of the purchasers (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed March 26, 2004)
4.12    Supplemental Indenture, dated as of July 1, 2005, among Saks Incorporated, the Subsidiary Guarantors named therein, and The Bank of New York Trust Company, N.A., as trustee (2.00% Convertible Senior Notes due 2024) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed July 6, 2005)
4.13    Fourth Supplemental Indenture, dated as of July 1, 2005, among Saks Incorporated, the Subsidiary Guarantors named therein, and JPMorgan Chase Bank, N.A., as trustee (9 7/8% Notes due 2011) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed July 6, 2005)
4.14    Seventh Supplemental Indenture, dated as of July 1, 2005, among Saks Incorporated, the Subsidiary Guarantors named therein, and JPMorgan Chase Bank, N.A., as trustee (8 1/4% Notes due 2008) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed July 6, 2005)
4.15    Seventh Supplemental Indenture, dated as of July 19, 2005, among Saks Incorporated, the Subsidiary Guarantors named therein, and J.P. Morgan Trust Company, National Association, as trustee (7 1/2% Notes due 2010) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed July 21, 2005)
4.16    Second Supplemental Indenture, dated as of July 19, 2005, among Saks Incorporated, the Subsidiary Guarantors named therein, and The Bank of New York Trust Company, N.A., as trustee (7% Notes due 2013) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed July 21, 2005)
4.17    Seventh Supplemental Indenture, dated as of July 19, 2005, among Saks Incorporated, the Subsidiary Guarantors named therein, and J.P. Morgan Trust Company, National Association, as Trustee (7 3/8% Notes due 2019) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed July 21, 2005)
4.18    Instrument of Resignation, Appointment and Acceptance, dated as of August 22, 2005, among Saks Incorporated, J.P. Morgan Trust Company, National Association, and The Bank Of New York Trust Company, N.A. (8 1/4% Notes due 2008) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed August 25, 2005)

 

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Index to Financial Statements
Exhibit No.

  

Description


4.19    Instrument of Resignation, Appointment and Acceptance, dated as of August 22, 2005, among Saks Incorporated, J.P. Morgan Trust Company, National Association, and The Bank Of New York Trust Company, N.A. (7 1/2% Notes due 2010) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed August 25, 2005)
4.20    Instrument of Resignation, Appointment and Acceptance, dated as of August 22, 2005, among Saks Incorporated, J.P. Morgan Trust Company, National Association, and The Bank Of New York Trust Company, N.A. (9 7/8% Notes due 2011) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed August 25, 2005)
4.21    Instrument of Resignation, Appointment and Acceptance, dated as of August 22, 2005, among Saks Incorporated, J.P. Morgan Trust Company, National Association, and The Bank Of New York Trust Company, N.A. (7 3/8% Notes due 2019) (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed August 25, 2005)
10.1    Amended and restated Credit Agreement, dated as of November 26, 2003, among Saks Incorporated, as borrower, Fleet Retail Group, Inc., as Agent, and the other financial institutions party thereto, as lenders (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed March 16, 2004)
10.2    First Amendment and Waiver to Credit Agreement and Second Amendment to Security Agreement, dated June 6, 2005, among Saks Incorporated, as borrower; Fleet Retail Group, Inc., as Agent; Citicorp North America, Inc., as Syndication Agent; Wachovia Bank, National Association, JPMorgan Chase Bank and General Electric Capital Corporation, as Co-Documentation Agents; and the other financial institutions party thereto, as lenders (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated filed September 1, 2005)
10.3    Second Amendment and Waiver to Credit Agreement, dated January 26, 2006, among Saks Incorporated, as borrower; Fleet Retail Group, Inc., as Agent; Citicorp North America, Inc., as Syndication Agent; Wachovia Bank, National Association, JPMorgan Chase Bank, N.A. and General Electric Capital Corporation, as Co-Documentation Agents; and the other financial institutions party thereto, as lenders (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed February 1, 2006)
10.4    Supplemental Transaction Agreement, dated as of April 14, 2003, among Saks Incorporated, National Bank of the Great Lakes, Saks Credit Corporation, Household Finance Corporation, and Household Bank (SB), N.A. (incorporated by reference from the Exhibits from the Form 8-K of Saks Incorporated filed April 29, 2003)
10.5    Servicing Agreement, dated as of April 15, 2003, between Jackson Office Properties, Inc., as successor to McRae’s, Inc., and Household Corporation (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed April 29, 2003)
10.6    Program Agreement, dated as of April 15, 2003, among Saks Incorporated, Jackson Office Properties, Inc. (as successor to McRae’s, Inc.), and Household Bank (SB), N.A. (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed April 29, 2003)
10.7    Amended and Restated Transition Service Agreement dated as of March 10, 2006 between Saks Incorporated and The Bon-Ton Stores, Inc. (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed on March 10, 2006)

 

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Index to Financial Statements
Exhibit No.

  

Description


MANAGEMENT CONTRACTS, COMPENSATORY PLANS, OR ARRANGEMENTS, ETC.
10.8    Saks Incorporated Amended and Restated Employee Stock Purchase Plan (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended February 2, 2002)
10.9    Saks Incorporated Amended and Restated 1994 Long-Term Incentive Plan (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended January 30, 1999)
10.10    Saks Incorporated Amended and Restated 1997 Stock-Based Incentive Plan (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended February 3, 2001)
10.11    Form of Stock Option Agreement Pursuant to the Saks Incorporated Amended and Restated 1997 Stock-Based Incentive Plan (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated filed September 1, 2005)
10.12    Saks Incorporated 2004 Long-Term Incentive Plan (incorporated by reference from Exhibit B to the proxy statement of Saks Incorporated filed April 28, 2004)
10.13    Saks Incorporated 401(k) Retirement Plan (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended January 30, 1999)
10.14    Trust Agreement for the Saks Incorporated 401(k) Retirement Plan (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended January 30, 1999)
10.15    Saks Incorporated Deferred Compensation Plan (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended February 1, 2003)
10.16    Carson Pirie Scott & Co. 1993 Stock Incentive Plan as Amended and Restated as of March 19, 1997 (incorporated by reference from the Exhibits to the Form 10-K of Carson Pirie Scott & Co. for the fiscal year ended February 2, 1997)
10.17    Carson Pirie Scott & Co. 1996 Long-Term Incentive Plan (incorporated by reference from the Exhibits to the Form 10-K of Carson Pirie Scott & Co. for the fiscal year ended February 2, 1997)
10.18    Saks Holdings, Inc. 1996 Management Stock Incentive Plan, dated as of February 1, 1996 (incorporated by reference from the Exhibits to the Form S-1 of Saks Holdings, Inc. Registration Statement No. 333-2426)
10.19    Amendment to the Saks Holdings, Inc. 1996 Management Stock Incentive Plan, dated as of February 1, 1996 (incorporated by reference from the Exhibits to the Form S-1 of Saks Holdings, Inc. Registration Statement No. 333-2426)
10.20    Form of Stock Option Agreement Pursuant to the Saks Holdings, Inc. 1996 Management Stock Incentive Plan, dated February 1, 1996 (incorporated by reference from the Exhibits to the Form S-1 of Saks Holdings, Inc. Registration No. 333-2426)
10.21    Amended and Restated Employment Agreement between R. Brad Martin and Saks Incorporated dated as of December 8, 2004 (incorporated by reference from the Exhibit 10.1 to the Form 10-Q of Saks Incorporated for the quarterly period ended October 30, 2004)

 

E-4


Table of Contents
Index to Financial Statements
Exhibit No.

  

Description


10.22    Saks Incorporated 2003 Senior Executive Bonus Plan (incorporated by reference from Attachment A to the Saks Incorporated Proxy Statement for the 2003 Annual Meeting of Shareholders)
10.23    Saks Incorporated Executive Severance Plan effective September 13, 2000 (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended February 3, 2001)
10.24    Amended and Restated 2000 Change of Control and Material Transaction Severance Plan (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed November 18, 2004)
10.25    Employment Agreement between Saks Incorporated and Stephen I. Sadove, Vice Chairman of Saks Incorporated, dated January 7, 2002 (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended February 2, 2002)
10.26    Restricted Stock Agreement between Kevin Wills and Saks Incorporated, dated May 18, 2005, and the Supplement to the Restricted Stock Agreement, dated May 18, 2005 (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed on May 18, 2005)
10.27    Form of Performance Share Agreement between Saks Incorporated and each recipient, dated June 16, 2004 (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed on June 29, 2005)
10.28    Supplement to Performance Share Agreement between Saks Incorporated and R. Brad Martin, dated June 27, 2005 (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed on June 29, 2005)
10.29    Form of Supplement to Performance Share Agreement between Saks Incorporated and each recipient, dated June 27, 2005 (incorporated by reference from the Exhibits to the Form 8-K of Saks Incorporated filed on June 29, 2005)
10.30    Form of Restricted Stock Agreement with respect to the Saks Incorporated 2004 Long-Term Incentive Plan (incorporated by reference from the Exhibits to the Form 10-Q of Saks Incorporated filed on October 3, 2005)
10.31    Form of Supplement to Restricted Stock Agreement with respect to the Saks Incorporated 2004 Long-Term Incentive Plan (incorporated by reference from the Exhibits to the Form 10-Q of Saks Incorporated filed on October 3, 2005)
10.32    Employment Agreement between Saks Incorporated and James A. Coggin, President and Chief Administrative Officer, dated March 15, 2003 (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ending February 1, 2003)
10.33    Employment Agreement between Saks Incorporated and Douglas E. Coltharp, Executive Vice President and Chief Financial Officer, dated March 15, 2003 (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ending February 1, 2003)
10.34    Employment Agreement between Saks Incorporated and Charles J. Hansen, Executive Vice President and General Counsel, dated June 20, 2003 (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated for the fiscal year ended January 31, 2004)
10.35    Employment Agreement between Saks Incorporated and Kevin Wills, Executive Vice President of Finance and Chief Accounting Officer, dated May 13, 2005 (incorporated by reference from the Exhibits to the Form 10-K of Saks Incorporated filed September 1, 2005)
10.36    *Employment Agreement by and between Saks Incorporated and Charles G. Tharp, Executive Vice President-Human Resources, dated April 5, 2006
10.37    *Form of Indemnification Agreement, dated as of April 5, 2006, between Saks Incorporated, and each of the counterparties thereto

 

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Index to Financial Statements
Exhibit No.

  

Description


21.1    *Subsidiaries of the registrant
23.1    *Consents of Independent Registered Public Accounting Firm
31.1    *Certification of the principal executive officer of Saks Incorporated required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
31.2    *Certification of the principal accounting officer of Saks Incorporated required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
32.1    *Certification of principal executive officer of Saks Incorporated Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    *Certification of the principal accounting officer of Saks Incorporated Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1    *Cautionary Statements Relating to Forward-Looking Information
99.2    *Saks Incorporated Employee Stock Purchase Plan Financial Statements for the years ended December 31, 2005 and December 31, 2004

* Filed herewith

 

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Table of Contents
Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Consolidated Financial Statements

    

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Statements of Income for the fiscal years ended January 28, 2006, January 29, 2005, and January 31, 2004

   F-4

Consolidated Balance Sheets at January 28, 2006 and January 29, 2005

   F-5

Consolidated Statements of Changes in Shareholders’ Equity for the fiscal years ended January 28, 2006, January 29, 2005, and January 31, 2004

   F-6

Consolidated Statements of Cash Flows for the fiscal years ended January 28, 2006, January 29, 2005, and January 31, 2004

   F-7

Notes to Consolidated Financial Statements

   F-8

Financial Statement Schedule

    

Report of Independent Registered Public Accounting Firm on Financial Statement Schedule

   F-49

Schedule II – Valuation and Qualifying Accounts

   F-50

 

All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.

 

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Table of Contents
Index to Financial Statements

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Saks Incorporated:

 

We have completed integrated audits of Saks Incorporated’s January 28, 2006 and January 29, 2005 consolidated financial statements and of its internal control over financial reporting as of January 28, 2006, and an audit of its January 31, 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

 

Consolidated financial statements

 

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Saks Incorporated (the Company) at January 28, 2006 and January 29, 2005, and the results of its operations and its cash flows for each of the three years in the period ended January 28, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As described in Note 3 to the consolidated financial statements, the Company has restated its January 29, 2005 and January 31, 2004 consolidated financial statements.

 

Effective February 2, 2003, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment to SFAS No. 123,” as explained in Note 2.

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of January 28, 2006 based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2006, based on criteria established in Internal Control – Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s

 

F-2


Table of Contents
Index to Financial Statements

assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

LOGO

Birmingham, AL

April 4, 2006

 

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Table of Contents
Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

 

     Year Ended

 

(In Thousands, except per share amounts)


   January 28,
2006


    January 29,
2005


    January 31,
2004


 

NET SALES

   $ 5,953,352     $ 6,437,277     $ 6,055,055  

Cost of sales (excluding depreciation and amortization)

     3,742,459       3,995,460       3,761,458  
    


 


 


Gross margin

     2,210,893       2,441,817       2,293,597  

Selling, general and administrative expenses

     1,548,747       1,614,658       1,489,383  

Other operating expenses

                        

Property and equipment rentals

     190,471       203,451       196,174  

Depreciation and amortization

     210,115       229,145       228,319  

Taxes other than income taxes

     160,723       164,067       149,101  

Store pre-opening costs

     4,112       4,520       5,462  

Impairments and dispositions

     (105,361 )     31,751       8,150  

Integration charges

     —         —         (62 )
    


 


 


OPERATING INCOME

     202,086       194,225       217,070  

Interest expense

     (85,778 )     (114,035 )     (117,372 )

Loss on extinguishment of debt

     (29,375 )     —         (10,506 )

Other income, net

     7,705       4,048       5,004  
    


 


 


INCOME BEFORE INCOME TAXES

     94,638       84,238       94,196  

Provision for income taxes

     72,290       23,153       21,832  
    


 


 


NET INCOME

   $ 22,348     $ 61,085     $ 72,364  
    


 


 


Earnings per common share:

                        

Basic earnings per common share

   $ 0.16     $ 0.44     $ 0.52  
    


 


 


Diluted earnings per common share

   $ 0.16     $ 0.42     $ 0.51  
    


 


 


Weighted average common shares:

                        

Basic

     138,348       139,470       139,824  

Diluted

     143,571       144,034       142,921  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

           Restated

 

(In Thousands, except per share amounts)


   January 28,
2006


    January 29,
2005


 

ASSETS

                

CURRENT ASSETS

                

Cash and cash equivalents

   $ 77,312     $ 257,104  

Merchandise inventories

     807,211       1,516,271  

Other current assets

     165,085       127,082  

Deferred income taxes, net

     119,558       181,957  

Current assets—held for sale

     475,485       —    
    


 


TOTAL CURRENT ASSETS

     1,644,651       2,082,414  

PROPERTY AND EQUIPMENT, NET OF DEPRECIATION

     1,340,868       2,046,839  

PROPERTY AND EQUIPMENT, NET OF DEPRECIATION—held for sale

     436,412       —    

GOODWILL AND INTANGIBLES, NET OF AMORTIZATION

     181,644       323,761  

GOODWILL AND INTANGIBLES, NET OF AMORTIZATION—held for sale

     1,789          

DEFERRED INCOME TAXES, NET

     191,480       167,900  

OTHER ASSETS

     42,549       88,100  

OTHER ASSETS—held for sale

     11,332       —    
    


 


TOTAL ASSETS

   $ 3,850,725     $ 4,709,014  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                

CURRENT LIABILITIES

                

Accounts payable

   $ 190,064     $ 378,394  

Accrued expenses

     372,821       495,830  

Accrued compensation and related items

     68,228       71,831  

Sales taxes payable

     9,066       13,184  

Current portion of long-term debt

     7,803       7,715  

Current liabilities—held for sale

     197,068       —    
    


 


TOTAL CURRENT LIABILITIES

     845,050       966,954  

LONG-TERM DEBT

     688,080       1,346,222  

LONG-TERM DEBT—held for sale

     34,656       —    

OTHER LONG-TERM LIABILITIES

     203,583       333,420  

LONG-TERM LIABILITIES—held for sale

     79,973       —    

COMMITMENTS AND CONTINGENCIES

     —         —    

SHAREHOLDERS’ EQUITY

                

Preferred stock—$1.00 par value; Authorized—10,000 shares;

                

Issued and outstanding—none

     —         —    

Common stock—$0.10 par value; Authorized—500,000 shares;

                

Issued and outstanding—136,005 shares and 140,115 shares

     13,601       14,012  

Additional paid-in capital

     1,994,979       2,094,302  

Accumulated other comprehensive loss

     (72,467 )     (86,818 )

Retained earnings

     63,270       40,922  
    


 


TOTAL SHAREHOLDERS’ EQUITY

     1,999,383       2,062,418  
    


 


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 3,850,725     $ 4,709,014  
    


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

 

(In Thousands)


  Common
Stock
Shares


    Common
Stock
Amount


    Additional
Paid-In
Capital


    Retained
Earnings


    Accumulated
Other
Comprehensive
Loss


    Total
Shareholders’
Equity


 

Balance at February 1, 2003 as previously reported

  144,960     $ 14,496     $ 2,131,091     $ 167,185     $ (69,158 )   $ 2,243,614  

Adjustments to restate (Note 3)

                          (21,999 )             (21,999 )
   

 


 


 


 


 


Balance at February 1, 2003 as restated

  144,960       14,496       2,131,091       145,186       (69,158 )     2,221,615  

Net income

                          72,364               72,364  

Change in minimum pension liability

                                  (2,452 )     (2,452 )
                                         


Comprehensive income

                                          69,912  

Issuance of common stock

  4,325       431       36,266                       36,697  

Income tax benefit related to employee stock plans

                  4,512                       4,512  

Income tax effect of exam resolutions

                  3,923                       3,923  

Income tax effect of AMT credit carryforwards

                  1,366                       1,366  

Net activity under stock compensation plans

  454       46       7,803                       7,849  

Repurchase of common stock

  (7,904 )     (790 )     (73,747 )                     (74,537 )
   

 


 


 


 


 


Balance at January 31, 2004 as restated

  141,835       14,183       2,111,214       217,550       (71,610 )     2,271,337  

Net income

                          61,085               61,085  

Change in minimum pension liability

                                  (15,208 )     (15,208 )
                                         


Comprehensive income

                                          45,877  

Issuance of common stock

  2,714       272       27,699                       27,971  

Income tax benefit related to employee stock plans

                  8,450                       8,450  

Income tax effect of NOL carryforwards

                  71,023                       71,023  

Income tax effect of statute expiration

                  4,586                       4,586  

Dividend Paid (as restated)

                  (47,838 )     (237,713 )             (285,551 )

Net activity under stock compensation plans

  1,769       177       13,720                       13,897  

Convertible notes:

                                             

Hedge and call option

                  (25,043 )                     (25,043 )

Income tax effect

                  15,268                       15,268  

Repurchase of common stock

  (6,203 )     (620 )     (84,777 )                     (85,397 )
   

 


 


 


 


 


Balance at January 29, 2005 as restated

  140,115       14,012       2,094,302       40,922       (86,818 )     2,062,418  

Net income

                          22,348               22,348  

Change in minimum pension liability

                                  14,351       14,351  
                                         


Comprehensive income

                                          36,699  

Issuance of common stock

  8,195       820       82,688                       83,508  

Income tax benefit related to employee stock plans

                  20,281                       20,281  

Decrease in tax valuation allowance

                  2,525                       2,525  

Activity under stock compensation plans

  555       55       17,540                       17,595  

Repurchase of common stock

  (12,860 )     (1,286 )     (222,357 )                     (223,643 )
   

 


 


 


 


 


Balance at January 28, 2006

  136,005     $ 13,601     $ 1,994,979     $ 63,270     $ (72,467 )   $ 1,999,383  
   

 


 


 


 


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-6


Table of Contents
Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

    Year Ended

 

(In Thousands)


  January 28,
2006


    January 29,
2005


    January 31,
2004


 

OPERATING ACTIVITIES

                       

Net income

  $ 22,348     $ 61,085     $ 72,364  

Adjustments to reconcile net income to net cash provided by operating activities:

                       

Loss on extinguishment of debt

    29,375       —         10,506  

Depreciation and amortization

    210,115       229,145       228,319  

Provision for employee stock compensation

    17,595       13,897       7,849  

Deferred income taxes

    37,262       6,744       13,041  

Impairments and dispositions

    (105,361 )     31,751       8,150  

Net cash from sale of proprietary credit cards

    —         —         300,911  

Changes in operating assets and liabilities:

                       

Retained interest in accounts receivable

    —         —         (42,680 )

Merchandise inventories

    103,531       (77,819 )     (138,990 )

Other current assets

    (38,092 )     36,392       24,025  

Accounts payable and accrued liabilities

    (69,793 )     3,065       52,079  

Other operating assets and liabilities

    (18,908 )     54,561       (61,845 )
   


 


 


NET CASH PROVIDED BY OPERATING ACTIVITIES

    188,072       358,821       473,729  
   


 


 


INVESTING ACTIVITIES

                       

Purchases of property and equipment

    (236,589 )     (198,274 )     (186,834 )

Business acquisitions and investments

    —         —         (14,012 )

Proceeds from sale of stores and property and equipment

    13,236       21,802       14,020  

Proceeds from the sale of Proffitt’s/McRae’s

    622,404       —         —    

Store cash transferred related to sale of Proffitt’s/McRae’s

    (1,340 )     —         —    
   


 


 


NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

    397,711       (176,472 )     (186,826 )
   


 


 


FINANCING ACTIVITIES

                       

Proceeds from issuance of convertible senior notes

    —         230,000       —    

Payments for hedge and call options associated with convertible notes

    —         (25,043 )     —    

Payments on long-term debt and capital lease obligations

    (621,557 )     (155,522 )     (92,055 )

Cash dividends paid

    (795 )     (283,127 )     —    

Purchases and retirements of common stock

    (223,643 )     (85,397 )     (74,537 )

Proceeds from issuance of common stock

    83,508       27,971       36,370  
   


 


 


NET CASH USED IN FINANCING ACTIVITIES

    (762,487 )     (291,118 )     (130,222 )
   


 


 


INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

    (176,704 )     (108,769 )     156,681  

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

    257,104       365,873       209,192  

LESS: CASH AND CASH EQUIVALENTS INCLUDED IN ASSETS HELD FOR SALE AT END OF YEAR

    (3,088 )     —         —    
   


 


 


CASH AND CASH EQUIVALENTS AT END OF YEAR

  $ 77,312     $ 257,104     $ 365,873  
   


 


 


 

Non-cash investing and financing activities are further described in the accompanying notes.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-7


Table of Contents
Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollar amounts in thousands, except per share amounts)

 

NOTE 1 – GENERAL

 

ORGANIZATION

 

Saks Incorporated (hereinafter the “Company”) is a retailer currently operating, through its subsidiaries, traditional and luxury department stores. At January 28, 2006, the Company operated the Saks Department Store Group (“SDSG”), which consisted of Proffitt’s and McRae’s (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operating under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), Parisian and Club Libby Lu specialty stores. The Company also operated Saks Fifth Avenue Enterprises (“SFAE”), which consisted of Saks Fifth Avenue stores and Saks Off 5th stores.

 

SALE OF BUSINESSES

 

On July 5, 2005, Belk acquired from the Company for $622,700 in cash substantially all of the assets directly involved in the Company’s Proffitt’s and McRae’s business operations (hereafter described as “Proffitt’s”), plus the assumption of approximately $1,000 in capitalized lease obligations and the assumption of certain other ordinary course liabilities associated with the acquired assets. The assets sold included the real and personal property and inventory associated with 22 Proffitt’s stores and 25 McRae’s stores that generated fiscal 2004 revenues of approximately $700,000.

 

Upon the closing of the transaction, Belk entered into a Transition Services Agreement (“Belk TSA”) whereby the Company will continue to provide, for varying transition periods, certain back office services related to the Proffitt’s operations. Such operations include certain information technology, telecommunications, credit, store planning and distribution services, among others. The services provided will cease as Belk becomes able to absorb the operations within its back office infrastructure. The Belk TSA qualifies as continuing involvement in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, and therefore, precludes the presentation of the sold business as discontinued operations within the accompanying consolidated financial statements.

 

The following table provides details of the disposed operations of the Proffitt’s business, had it operated on a stand-alone basis, that are included within the accompanying consolidated balance sheets at January 29, 2005 and the consolidated statements of income for the years ended January 28, 2006 and January 29, 2005.

 

     January 29,
2005


Merchandise inventory

   $ 164,306

Property and equipment

   $ 270,922

Goodwill

   $ 88,000

Other current assets

   $ 3,895

Accounts payable and other current liabilities

   $ 45,935

Long-term liabilities

   $ 4,761
     2005

   2004

Net sales

   $ 263,257    $ 690,326

Net income

   $ 1,898    $ 16,937

Diluted earnings per share

   $ 0.01    $ 0.12

 

F-8


Table of Contents
Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except per share amounts)

 

After considering the assets and liabilities sold, liabilities settled, transaction fees and severance, the Company realized a net gain of $155,525 on the sale. Asset impairments (gains), transaction fees and other costs are included in Impairments and Dispositions, and severance costs are included in Selling, General & Administrative Expenses in the accompanying Consolidated Statements of Income. There were no amounts payable, related to this transaction, at January 28, 2006. The components of these charges are as follows:

 

     2005 Charges/
(Gains)


    Cash
(Proceeds)/
Payments


    Net Assets Sold

Asset Impairments (Gains)

   $ (161,175 )   $ (622,700 )   $ 461,525

Transaction Fees and Other Costs

     4,849       4,849       —  

Severance

     801       801       —  
    


 


 

     $ (155,525 )   $ (617,050 )   $ 461,525
    


 


 

 

Additionally, on March 6, 2006, the Company sold all outstanding equity interests of certain of the Company’s subsidiaries that owned, directly or indirectly, NDSG, to Bon-Ton. The consideration received consisted of approximately $1,110,000 in cash (reduced as described below based on changes in working capital), plus the assumption by Bon-Ton of approximately $40,000 of unfunded benefits liabilities and approximately $35,000 of capital leases. A preliminary working capital adjustment based on an estimate of working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $60,000 resulting in net cash proceeds to the Company of approximately $1,050,000. Management estimates a pre-tax gain ranging from $290,000 to $300,000 and an after-tax gain ranging from $115,000 to $125,000 on the transaction. The disposition included NDSG’s operations consisting of, among other things, the real and personal property, operating leases and inventory associated with 142 NDSG units (31 Carson Pirie Scott stores, 14 Bergner’s stores, 10 Boston Store stores, 40 Herberger’s stores, and 47 Younkers stores); the administrative/headquarters facilities in Milwaukee, Wisconsin; and distribution centers located in Rockford, Illinois, Naperville, Illinois; Green Bay, Wisconsin, and Ankeny, Iowa.

 

Bon-Ton entered into a Transition Service Agreement with the Company (“Bon-Ton TSA”), whereby the Company will continue to provide, for varying transition periods, back office services related to the NDSG operations. The back-office services include certain information technology, telecommunications, credit, accounting and store planning services, among others. Bon-Ton will compensate the Company for these services provided, as outlined in the Bon-Ton TSA. NDSG stores generated fiscal 2005 revenues of approximately $2,200,000. The assets and liabilities associated with NDSG have been classified as held for sale at January 28, 2006 in the accompanying consolidated balance sheet.

 

The Company announced on January 9, 2006 that it was exploring strategic alternatives for its Parisian specialty department store business (“Parisian”) (which generated fiscal 2005 revenues of approximately $723,000). The strategic alternatives could include the sale of Parisian.

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and

 

F-9


Table of Contents
Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except per share amounts)

 

liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. The accompanying consolidated financial statements include the results of operations for Proffitt’s through July 2, 2005.

 

The Company’s fiscal year ends on the Saturday closest to January 31. Fiscal years 2005, 2004 and 2003 each contained 52 weeks and ended on January 28, 2006, January 29, 2005, and January 31, 2004, respectively.

 

NET SALES

 

Net sales include sales of merchandise (net of returns and exclusive of sales taxes), commissions from leased departments and shipping and handling revenues related to merchandise sold. Net sales are recognized at the time customers provide a satisfactory form of payment and take ownership of the merchandise or direct its shipment. Revenue associated with gift certificates is recognized upon redemption of the certificate.

 

The Company estimates the amount of goods that will be returned for a refund and reduces sales and gross margin by that amount. However, given that approximately 15% of merchandise sold is later returned and that the vast majority of merchandise returns are affected within a matter of days of the selling transaction, the risk of the Company realizing a materially different amount for sales and gross margin than reported in the consolidated financial statements is minimal.

 

Revenues from shipping and handling included in net sales were $218, $2,091 and $3,179 in 2005, 2004 and 2003, respectively. Commissions from leased departments included in net sales were $41,728, $47,003 and $45,872 in 2005, 2004 and 2003, respectively. Leased department sales were $289,073, $322,026 and $315,511 in 2005, 2004 and 2003, respectively, and were excluded from net sales.

 

CASH AND CASH EQUIVALENTS

 

Cash and cash equivalents primarily consist of cash on hand in the stores, deposits with banks and investments with banks and financial institutions that have original maturities of three months or less. Cash equivalents are stated at cost, which approximates fair value. Cash equivalents included $46,000 and $212,000 at January 28, 2006 and January 29, 2005, respectively, invested principally in money market funds. Interest income earned on these cash equivalents was $6,829, $3,680 and $4,895 for the fiscal years ended January 28, 2006, January 29, 2005 and January 31, 2004, respectively, and was reflected in Other Income. There were no balances of restricted cash at January 28, 2006 or January 29, 2005, respectively.

 

MERCHANDISE INVENTORIES AND COST OF SALES (excluding depreciation and amortization)

 

Merchandise inventories are valued by the retail method and are stated at the lower of cost (last-in, first-out “LIFO”) or market and include freight, buying and distribution costs. The Company takes markdowns related to slow moving inventory, ensuring the appropriate inventory valuation. At January 28, 2006 and January 29, 2005, the LIFO value of inventories exceeded market value and, as a result, inventory was stated at the lower market amount.

 

F-10


Table of Contents
Index to Financial Statements

SAKS INCORPORATED & SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except per share amounts)

 

Consignment merchandise on hand of $114,436 and $117,198 at January 28, 2006 and January 29, 2005, respectively, is not reflected in the consolidated balance sheets.

 

The Company receives vendor provided support in different forms. When the vendor provides support for inventory markdowns, the Company records the support as a reduction to cost of sales. Such support is recorded in the period that the corresponding markdowns are taken. When the Company receives inventory-related support that is not designated for markdowns, the Company includes this support as a reduction in cost of purchases.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

Selling, general and administrative expenses (“SG&A”) are comprised principally of the costs related to employee compensation and benefits in the selling and administrative support areas; advertising; store and headquarters occupancy, operating and maintenance costs exclusive of rent, depreciation, and property taxes; proprietary credit card promotion, issuance and servicing costs; insurance programs; telecommunications; and other operating expenses not specifically categorized elsewhere in the consolidated statements of income. All advertising and sales promotion costs are expensed in the period incurred. Belk and Bon-Ton each entered into transition services agreements whereby the Company will continue to provide, for varying transition periods, certain back office services related to the sold operations. The Company received approximately $7,000 in 2005 as compensation for these services under its agreement with Belk. The Company receives allowances and expense reimbursements from merchandise vendors and from the owner of the proprietary credit card portfolio which are netted against the related expense: