Annual Reports

 
Quarterly Reports

  • 10-Q (Sep 5, 2013)
  • 10-Q (Jun 6, 2013)
  • 10-Q (Nov 28, 2012)
  • 10-Q (Aug 29, 2012)
  • 10-Q (May 31, 2012)
  • 10-Q (Dec 1, 2011)

 
8-K

 
Other

Saks 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-10.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


(Mark One)

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

For the quarterly period ended: October 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

 


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

As of November 15, 2006, the number of shares of the Registrant’s Common Stock outstanding was 138,872,544.

 



Table of Contents

TABLE OF CONENTS

 

PART I. FINANCIAL INFORMATION    Page No.

Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets – October 28, 2006, January 28, 2006 and October 29, 2005

   3

Condensed Consolidated Statements of Income – Three and Nine Months Ended October 28, 2006 and October 29, 2005

   4

Condensed Consolidated Statements of Cash Flows – Nine months ended October 28, 2006 and October 29, 2005

   5

Notes to Condensed Consolidated Financial Statements

   6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   33

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   49

Item 4. Controls and Procedures

   50

PART II. OTHER INFORMATION

  

Item 1. Legal Proceedings

   50

Item 1A. Risk Factors

   50

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   50

Item 6. Exhibits

   51

SIGNATURES

   52

 

2


Table of Contents

SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands)

(Unaudited)

 

               Restated
     October 28,
2006
   January 28,
2006
   October 29,
2005

ASSETS

        

Current Assets

        

Cash and cash equivalents

   $ 767,393    $ 77,312    $ 27,886

Merchandise inventories

     823,699      807,211      1,011,064

Other current assets

     159,363      165,085      129,822

Deferred income taxes, net

     31,521      119,558      74,610

Current assets - held for sale

     —        475,485      654,123
                    

Total current assets

     1,781,976      1,644,651      1,897,505

Property and Equipment, net

     1,108,330      1,340,868      1,358,694

Property and Equipment, net - held for sale

     —        436,412      436,163

Goodwill and Intangibles, net

     331      181,644      235,162

Goodwill and Intangibles, net - held for sale

     —        1,789      —  

Deferred Income Taxes, net

     158,370      191,480      251,694

Other Assets

     34,798      42,549      43,705

Other Assets - held for sale

     —        11,332      12,072
                    

TOTAL ASSETS

   $ 3,083,805    $ 3,850,725    $ 4,234,995
                    

LIABILITIES AND SHAREHOLDERS’ EQUITY

        

Current Liabilities

        

Trade accounts payable

   $ 283,972    $ 190,064    $ 298,080

Accrued expenses and other current liabilities

     390,632      448,486      424,042

Dividend payable

     564,987      1,629      1,919

Current portion of long-term debt

     6,890      7,803      7,519

Current liabilities - held for sale

     —        197,068      290,971
                    

Total current liabilities

     1,246,481      845,050      1,022,531

Long-Term Debt

     681,670      688,080      718,083

Long-Term Debt - held for sale

     —        34,656      33,819

Other Long-Term Liabilities

     135,090      203,583      236,089

Other Long-Term Liabilities - held for sale

     —        79,973      90,833
                    

Total liabilities

     2,063,241      1,851,342      2,101,355

Commitments and Contingencies

     —        —        —  

Shareholders’ Equity

     1,020,564      1,999,383      2,133,640
                    

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 3,083,805    $ 3,850,725    $ 4,234,995
                    

See notes to condensed consolidated financial statements.

 

3


Table of Contents

SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollar amounts in thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended     Nine Months Ended  
     October 28,
2006
    October 29,
2005
    October 28,
2006
    October 29,
2005
 

NET SALES

   $ 697,041     $ 645,152     $ 1,985,003     $ 1,960,560  

Cost of sales (excluding depreciation and amortization)

     404,610       381,157       1,211,210       1,211,699  
                                

Gross margin

     292,431       263,995       773,793       748,861  

Selling, general and administrative expenses

     182,327       208,437       563,698       615,631  

Other operating expenses

     81,127       80,082       240,113       241,165  

Store pre-opening costs

     70       559       359       928  

Impairments and dispositions

     2,420       (15,215 )     8,010       (17,836 )
                                

OPERATING INCOME (LOSS)

     26,487       (9,868 )     (38,387 )     (91,027 )

Interest expense

     (12,108 )     (14,252 )     (37,751 )     (64,475 )

Gain (loss) on extinguishment of debt

     —         (29 )     7       (29,020 )

Other income, net

     6,197       1,224       21,948       6,449  
                                

INCOME (LOSS) BEFORE INCOME TAXES

     20,576       (22,925 )     (54,183 )     (178,073 )

Provision (benefit) for income taxes

     8,098       (9,377 )     (25,225 )     (74,313 )
                                

INCOME (LOSS) FROM CONTINUING OPERATIONS

     12,478       (13,548 )     (28,958 )     (103,760 )

DISCONTINUED OPERATIONS:

        

Income (loss) from discontinued operations (including gain (loss) on disposal of ($13,071), $913, $192,076 and $156,003)

     (17,485 )     23,294       193,535       245,276  

Provision (benefit) for income taxes

     (11,185 )     9,521       132,356       116,926  
                                

INCOME (LOSS) FROM DISCONTINUED OPERATIONS

     (6,300 )     13,773       61,179       128,350  
                                

NET INCOME

   $ 6,178     $ 225     $ 32,221     $ 24,590  
                                

Per Share amounts - Basic

        

Income (loss) from continuing operations

   $ 0.09     $ (0.10 )   $ (0.21 )   $ (0.75 )

Income (loss) from discontinued operations

   $ (0.05 )   $ 0.10     $ 0.45     $ 0.92  

Net Income

   $ 0.05     $ 0.00     $ 0.24     $ 0.18  

Per Share Amounts - Diluted

        

Income (loss) from continuing operations

   $ 0.09     $ (0.10 )   $ (0.21 )   $ (0.75 )

Income (loss) from discontinued operations

   $ (0.05 )   $ 0.10     $ 0.45     $ 0.92  

Net Income

   $ 0.05     $ 0.00     $ 0.24     $ 0.18  

Weighted average common shares:

        

Basic

     135,646       139,541       135,043       138,996  

Diluted

     137,131       139,541       135,043       138,996  

See notes to condensed consolidated financial statements.

 

4


Table of Contents

SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollar amounts in thousands)

(Unaudited)

 

     Nine Months Ended  
     October 28,
2006
    October 29,
2005
 

Operating Activities:

    

Net income

   $ 32,221     $ 24,590  

Income from discontinued operations

     61,179       128,350  
                

Loss from continuing operations

     (28,958 )     (103,760 )

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

    

Depreciation and amortization

     93,089       94,981  

Impairments and dispositions

     7,466       (17,836 )

Equity compensation

     33,404       16,612  

Deferred income taxes

     121,147       23,554  

Excess tax benefit from stock-based compensation

     (3,212 )     —    

Gain (loss) on extinguishment of debt

     (7 )     29,020  

Change in operating assets and liabilities, net

     (121,919 )     (190,621 )
                

Net Cash Provided By (Used In) Operating Activities - Continuing Operations

     101,010       (148,050 )

Net Cash Used In Operating Activities - Discontinued Operations

     (120,494 )     31,490  
                

Net Cash Used In Operating Activities

     (19,484 )     (116,560 )

Investing Activities:

    

Purchases of property and equipment

     (78,515 )     (90,166 )

Proceeds from the sale of property and equipment

     171       13,236  
                

Net Cash Used In Investing Activities - Continuing Operations

     (78,344 )     (76,930 )

Net Cash Provided By Investing Activities - Discontinued Operations

     1,307,230       537,416  
                

Net Cash Provided By Investing Activities

     1,228,886       460,486  

Financing Activities:

    

Proceeds from revolving credit facility

     —         27,000  

Payments on long-term debt and capital lease obligations

     (5,430 )     (619,482 )

Cash dividends paid

     (542,766 )     (505 )

Excess tax benefit from stock-based compensation

     3,212       —    

Purchases and retirements of common stock

     (6,531 )     —    

Proceeds from issuance of common stock

     29,255       23,109  
                

Net Cash Used In Financing Activities - Continuing Operations

     (522,260 )     (569,878 )

Net Cash Used In Financing Activities - Discontinued Operations

     (149 )     (183 )
                

Net Cash Used In Financing Activities

     (522,409 )     (570,061 )

Increase (Decrease) In Cash and Cash Equivalents

     686,993       (226,135 )

Cash and cash equivalents at beginning of period

     77,312       257,104  

Plus: Cash and cash equivalents included in assets held for sale at beginning of year

     3,088       —    

Less: Cash and cash equivalents included in assets held for sale at end of period

       (3,083 )
                

Cash and cash equivalents at end of period

   $ 767,393     $ 27,886  
                

See notes to condensed consolidated financial statements.

 

5


Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Dollar amounts in thousands, except per share amounts)

(Unaudited)

NOTE 1 – GENERAL

BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement have been included. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Operating results for the three and nine months ended October 28, 2006 are not necessarily indicative of the results that may be expected for the year ending February 3, 2007. The financial statements include the accounts of Saks Incorporated and its subsidiaries (collectively, the “Company”). All intercompany amounts and transactions have been eliminated.

The Company revised its presentation of the Condensed Consolidated Statement of Cash Flows to reconcile net income to net cash provided by operating activities. Previously, the Company reconciled income from continuing operations to net cash provided by operating activities.

The accompanying balance sheet at January 28, 2006 has been derived from the audited financial statements at that date but does not include all disclosures required by accounting principles generally accepted in the United States of America. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in the Company’s 2005 Annual Report on Form 10-K for the year ended January 28, 2006.

ORGANIZATION

The Company completed the sale of its Saks Department Store Group (“SDSG”) Proffitt’s/McRae’s business to Belk, Inc. (“Belk”) effective midnight on July 2, 2005, the sale of SDSG’s Northern Department Store Group (NDSG) business to The Bon-Ton Stores, Inc. (“Bon-Ton”) effective midnight on March 4, 2006, and the sale of SDSG’s Parisian specialty department store business (“Parisian”) to Belk effective midnight on September 30, 2006. The sold businesses are presented as “discontinued operations” in the current and prior year periods. At October 28, 2006, the Company operated Saks Fifth Avenue, Off Fifth, and Club Libby Lu, which are reflected in the Company’s continuing operations.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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. Commissions from leased departments were $5,143 and $5,036 for the three months ended October 28, 2006 and October 29, 2005, respectively. Leased department sales were $36,413 and $35,949 for the three months ended October 28, 2006 and October 29, 2005, respectively, and

 

6


Table of Contents

were excluded from net sales. Commissions from leased departments were $17,154 and $17,056 for the nine months ended October 28, 2006 and October 29, 2005, respectively. Leased department sales were $121,141 and $122,475 for the nine months ended October 28, 2006 and October 29, 2005, 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 $754,715 at October 28, 2006 invested principally in money market funds and time deposits. Income earned on cash equivalents was $6,130 for the three-month period ended October 28, 2006 and was reflected in Other Income. For the nine-month periods ended October 28, 2006 and October 29, 2005 income earned on these cash equivalents was $21,599 and $5,855, respectively, and was reflected in Other Income. At October 29, 2005 and January 28, 2006, Current Assets – Held for Sale included $3,083 and $3,088, respectively, of NDSG store cash held for sale.

On March 6, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share to shareholders of record as of April 14, 2006. For the nine months ended October 28, 2006, the Company made dividend cash payments totaling $542,766, primarily relating to the $4.00 per common share dividend of which $538,964 was paid on May 1, 2006. During the third quarter, the Company declared another $4.00 dividend per common share, which totaled approximately $559,000. Approximately $549,000 of the special dividend was paid on November 30, 2006 to shareholders of record as of November 15, 2006. The remaining portion of the dividends will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.

Income Taxes – For continuing operations, the effective income tax rates for the three and nine-month periods ended October 28, 2006 were 39.4% and 46.6%, respectively, as compared to 40.9% and 41.7% for the three and nine-month periods ended October 29, 2005, respectively. The increase in the effective rate for the nine-month period ended October 28, 2006 was primarily the result of a benefit recognized to reduce tax reserves resulting from the conclusion of certain state tax examinations.

For discontinued operations, the effective income tax rates for the three and nine-month periods ended October 28, 2006 increased to 64.0% and 68.4%, respectively, from 40.9% and 47.7% for the three and nine-month periods ended October 29, 2005, respectively. The increase in the effective rate for the three-month period ended October 28, 2006 was primarily the result of a tax benefit from the sale of the Parisian business. This benefit was generated from the sale of Parisian stock, although both parties have agreed that the transaction may still be structured as an asset sale for tax purposes if a mutual agreement is reached by June 2007. The increase in the effective rate for the nine-month period ended October 28, 2006 was primarily the result of the write-off of goodwill related to the sale of the NDSG business, a substantial portion of which was non-deductible for tax purposes offset by the tax benefit generated from the Parisian sale.

 

7


Table of Contents

Components of the Company’s income tax expense for the three and nine-month periods ended October 28, 2006 were as follows:

 

     Three Months Ended     Nine Months Ended  
     October 28,
2006
    October 29,
2005
    October 28,
2006
    October 29,
2005
 

Continuing Operations:

        

Expected federal income taxes at 35%

   $ 7,202     $ (8,024 )   $ (18,953 )   $ (62,326 )

State income taxes, net of federal benefit

     1,488       (511 )     (4,945 )     (10,345 )

Effect of settling tax exams and other tax reserve adjustments

     —         —         (2,450 )     —    

Other items, net

     (592 )     (842 )     1,123       (1,642 )
                                

Provision (benefit) for income taxes

   $ 8,098     $ (9,377 )   $ (25,225 )   $ (74,313 )
                                

Discontinued Operations:

        

Expected federal income taxes at 35%

   $ (6,120 )   $ 8,153     $ 67,726     $ 85,847  

State income taxes, net of federal benefit

     (1,173 )     1,247       17,323       12,796  

Non-deductible goodwill

     —         —         51,192       17,663  

Parisian stock basis benefit

     (3,895 )     —         (3,895 )     —    

Other items, net

     3       121       10       620  
                                

Provision (benefit) for income taxes

   $ (11,185 )   $ 9,521     $ 132,356     $ 116,926  
                                

NOTE 2 – RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

As discussed in the Company’s 2005 Annual Report on Form 10-K, 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 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 was reported as a restatement of consolidated shareholders’ equity at February 2, 2002. 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, earnings per share or cash flows for any year currently presented.

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 Condensed Consolidated Balance Sheet accounts is as follows:

 

October 29, 2005

(in thousands)

   Previously
Reported
   Adjustments    

As

Restated

   Percent
Change
 

Current deferred income taxes, net

   $ 71,211    $ 3,399     $ 74,610    4.8 %

Non-current deferred income taxes, net

   $ 250,158    $ 1,536     $ 251,694    0.6 %

Accrued expenses

   $ 397,108    $ 26,934     $ 424,042    6.8 %

Total shareholders’ equity

   $ 2,155,639    $ (21,999 )   $ 2,133,640    -1.0 %

 

8


Table of Contents

NOTE 3 - EARNINGS PER COMMON SHARE

Calculations of earnings per common share (“EPS”) for the three and nine months ended October 28, 2006 and October 29, 2005 are as follows (income and shares in thousands):

 

    

For the Three Months Ended

October 28, 2006

  

For the Three Months Ended

October 29, 2005

     Income    Weighted
Average
Shares
   Per Share
Amount
   Income    Weighted
Average
Shares
   Per Share
Amount

Basic EPS

   $ 6,178    135,646    $ 0.05    $ 225    139,541    $ 0.00

Effect of dilutive stock options

      1,485      —         —        —  
                                     

Diluted EPS

   $ 6,178    137,131    $ 0.05    $ 225    139,541    $ 0.00
                                     
    

For the Nine Months Ended

October 28, 2006

  

For the Nine Months Ended

October 29, 2005

     Income    Weighted
Average
Shares
   Per Share
Amount
   Income    Weighted
Average
Shares
   Per Share
Amount

Basic EPS

   $ 32,221    135,043    $ 0.24    $ 24,590    138,996    $ 0.18

Effect of dilutive stock options

      —        —         —        —  
                                     

Diluted EPS

   $ 32,221    135,043    $ 0.24    $ 24,590    138,996    $ 0.18
                                     

Additionally, the Company had 3,052 and 4,472 option awards of potentially dilutive common stock outstanding at October 28, 2006 and October 29, 2005, respectively, that were not included in the computation of diluted EPS because the Company had a loss for the period or the exercise prices of the options were greater than the average market price of the common shares for the period. There were also 15,413 and 12,307 of potentially exercisable shares under convertible notes at October 28, 2006 and October 29, 2005, respectively, that were not included in the computation of diluted EPS due to the assumption of net share settlement as discussed below.

The Emerging Issues Task Force (“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 Financial Accounting Standards Board (“FASB”) is contemplating an amendment to Statement of Financial Accounting Standards (“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.

 

9


Table of Contents

NOTE 4 – DISCONTINUED OPERATIONS

On July 5, 2005, Belk acquired from the Company for approximately $623,000 in cash substantially all of the assets directly involved in the Proffitt’s business operations, 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. 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.

Upon the closing of the transaction, Belk entered into a Transition Services Agreement (“Proffitt’s TSA”) whereby the Company continued to provide certain back office services related to the Proffitt’s operations. Beginning with the second quarter of 2006, the back office services were substantially complete, and therefore, the Proffitt’s TSA no longer qualified as continuing involvement in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Asset.” Accordingly, the results of the Proffitt’s operations are reflected as discontinued operations in the accompanying condensed consolidated financial statements for all periods presented.

Additionally, on March 6, 2006, the Company sold to Bon-Ton all outstanding equity interests of certain of the Company’s subsidiaries that owned NDSG (operating under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers), either directly or indirectly. The consideration received consisted of approximately $1,115,000 in cash (reduced as described below based on changes in working capital), plus the assumption by Bon-Ton of approximately $35,000 of unfunded benefits liabilities and approximately $35,000 of capital leases. A working capital adjustment based on working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $75,000 resulting in net cash proceeds to the Company of approximately $1,040,000. 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 stores generated fiscal 2005 revenues of approximately $2,200,000. After considering the basis of the business sold, transaction fees and other costs, the Company realized a net gain of $204,892 on the sale.

Bon-Ton entered into a Transition Service Agreement with the Company (“NDSG TSA”), whereby the Company continued to provide, for varying transition periods, back office services related to the NDSG operations. The back-office services included certain information technology, telecommunications, credit, accounting and store planning services, among others. Bon-Ton compensates the Company for these services, as outlined in the NDSG TSA. The assets and liabilities associated with NDSG were classified as held for sale at October 29, 2005 and January 28, 2006 in the accompanying Condensed Consolidated Balance Sheets. Beginning with the third quarter of 2006, the NDSG TSA no longer qualified as continuing involvement in accordance with SFAS No. 144. Accordingly, the results of the NDSG operations are reflected as discontinued operations in the accompanying condensed consolidated financial statements for all periods presented.

 

10


Table of Contents

On October 2, 2006, the Company consummated the sale to Belk of all of the outstanding equity interests of the Company’s subsidiaries that conducted the Parisian business. The consideration received consisted of approximately $285,000 in cash (increased in accordance with a working capital adjustment). A preliminary working capital adjustment based on an estimate of working capital as of the effective time of the transaction increased the amount of cash proceeds by approximately $15,000. In addition, Belk reimbursed the Company at closing for approximately $7,000 in capital expenditures incurred in connection with the construction of four new Parisian stores. Belk also paid the Company a premium associated with the purchase of accounts and accounts receivable from Household Bank (SB), N.A. (now known as HSBC Bank Nevada, N.A.), in the amount of approximately $2,000. The foregoing resulted in total net cash proceeds to the Company of approximately $309,000. The estimated working capital is subject to a final working capital adjustment to determine final amounts as of the effective time of the transaction.

The disposition included Parisian’s operations consisting of, among other things, real and personal property, operating leases and inventory associated with 38 Parisian stores (which generated fiscal 2005 revenues of approximately $723,000), a 125,000 square foot administrative/headquarters facility in Birmingham, Alabama and a 180,000 square foot distribution center located in Steele, Alabama. After considering the basis of the business sold, transaction fees and other costs, the Company realized a loss of $12,816 on the sale.

In connection with the consummation of the Parisian transaction, the Company entered into a Transition Services Agreement with Belk dated September 30, 2006 (“Parisian TSA”). Pursuant to the Parisian TSA, the Company will continue to provide, for varying transition periods, back-office services related to the Company’s former Parisian specialty department store business. The back-office services include information technology, telecommunications, credit, accounting and store planning services, among others. In accordance with SFAS No. 144, the results of the Parisian operations are reflected as discontinued operations in the accompanying condensed consolidated financial statements.

Net sales of the aforementioned businesses that are included within discontinued operations in the accompanying Condensed Consolidated Statements of Income are $111,843 and $670,066 for the three-month periods ended October 28, 2006 and October 29, 2005, respectively, and are $624,290 and $2,219,969 for the nine months ended October 28, 2006 and October 29, 2005, respectively.

The following table represents the assets and liabilities of the disposed businesses:

 

     January 28,
2006
   October 29,
2005

Merchandise inventory

   $ 619,437    $ 800,996

Property and equipment

   $ 668,519    $ 655,375

Goodwill and intangibles

   $ 183,083    $ 224,979

Other current assets

   $ 51,989    $ 61,894

Accounts payable and other current liabilities

   $ 276,229    $ 394,833

Other long-term liabilities

   $ 132,367    $ 149,211

NOTE 5 – HISTORICAL QUARTERLY INFORMATION (UNAUDITED)

The Company is now presenting the results of the disposed SDSG businesses as discontinued operations. The following table represents historical summary quarterly financial information for all periods presented reflecting the disposed businesses as discontinued operations.

 

11


Table of Contents
     Three Months Ended     Three Months Ended    

Three Months

Ended

January 28,

2006

 
     April 29,
2006
    April 30,
2005
    July 29,
2006
    July 30,
2005
   

NET SALES

   $ 684,129     $ 715,081     $ 603,833     $ 600,327     $ 817,773  

Cost of sales (excluding depreciation and amortization)

     401,271       427,354       405,329       403,188       543,134  
                                        

Gross margin

     282,858       287,727       198,504       197,139       274,639  

Selling, general and administrative expenses

     184,889       205,612       196,482       201,582       214,863  

Other operating expenses

     81,301       80,924       77,685       80,159       86,408  

Store pre-opening costs

     172       186       117       183       299  

Impairments and dispositions

     4,330       (3,162 )     1,260       541       9,988  
                                        

OPERATING INCOME (LOSS)

     12,166       4,167       (77,040 )     (85,326 )     (36,919 )

Interest expense

     (14,045 )     (26,013 )     (11,598 )     (24,210 )     (12,713 )

Gain (loss) on extinguishment of debt

     —         —         7       (28,991 )     (355 )

Other income, net

     8,819       2,258       6,932       2,967       1,256  
                                        

INCOME (LOSS) BEFORE INCOME TAXES

     6,940       (19,588 )     (81,699 )     (135,560 )     (48,731 )

Benefit for income taxes

     (4,720 )     (8,426 )     (28,603 )     (56,510 )     (18,848 )
                                        

INCOME (LOSS) FROM CONTINUING OPERATIONS

     11,660       (11,162 )     (53,096 )     (79,050 )     (29,883 )

DISCONTINUED OPERATIONS:

          

Income from discontinued operations (including gain (loss) on disposal)

     208,992       45,671       2,028       176,312       76,167  

Provision for income taxes

     142,754       18,338       787       89,068       48,526  
                                        

INCOME FROM DISCONTINUED OPERATIONS

     66,238       27,333       1,241       87,244       27,641  
                                        

NET INCOME (LOSS)

   $ 77,898     $ 16,171     $ (51,855 )   $ 8,194     $ (2,242 )
                                        

Per-Share amounts - Basic

          

Income (loss) from continuing operations

   $ 0.09     $ (0.08 )   $ (0.39 )   $ (0.57 )   $ (0.22 )

Income from discontinued operations

   $ 0.49     $ 0.20     $ 0.01     $ 0.63     $ 0.20  

Net Income (Loss)

   $ 0.58     $ 0.12     $ (0.38 )   $ 0.06     $ (0.02 )

Per-Share Amounts - Diluted

          

Income (loss) from continuing operations

   $ 0.09     $ (0.08 )   $ (0.39 )   $ (0.57 )   $ (0.22 )

Income from discontinued operations

   $ 0.49     $ 0.20     $ 0.01     $ 0.63     $ 0.20  

Net Income (Loss)

   $ 0.57     $ 0.12     $ (0.38 )   $ 0.06     $ (0.02 )

Weighted average common shares:

          

Basic

     134,260       138,326       135,222       139,120       136,406  

Diluted

     136,097       138,326       135,222       139,120       136,406  

NOTE 6 - DEBT AND SHARE ACTIVITY

At the Company’s request, due to the sale of NDSG, the revolving credit facility was reduced from $800,000 to $500,000 in March 2006. In September 2006, the maturity date of the revolving credit facility was extended to September 2011.

During June 2006, the Company repurchased a total of approximately $193 in principal amount of senior notes. The repurchase of these notes resulted in a gain on extinguishment of debt of $7.

 

12


Table of Contents

On July 19, 2005, the Company completed cash tender offers and consent solicitations for three issues of its outstanding senior notes and consent solicitations with respect to two additional issues of its senior notes and its convertible notes. The Company repurchased a total of approximately $585,672 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 $28,991 related principally to the write-off of deferred financing costs and a premium on previously exchanged notes.

During the three months ended October 28, 2006 the Company repurchased 450 shares of its common stock at a cost of approximately $6,500. At October 28, 2006, there were 37,380 shares remaining available for repurchase under the Company’s existing share repurchase program.

NOTE 7 – EMPLOYEE BENEFIT PLANS

The Company sponsors a defined benefit cash balance pension plan for many employees of the Company. In conjunction with the sale of NDSG, the Company sold to Bon-Ton the assets, and Bon-Ton assumed the liabilities, of the Carson cash balance pension plan. The Company generally funds pension costs currently, subject to regulatory funding requirements. The components of net periodic pension expense related to the Company’s remaining pension plan for the three and nine months ended October 28, 2006 and October 29, 2005 were as follows:

 

     Three Months Ended     Nine Months Ended  
     October 28,
2006
    October 29,
2005
    October 28,
2006
    October 29,
2005
 

Service cost

   $ 1,200     $ 1,191     $ 3,906     $ 3,573  

Interest cost

     2,095       2,132       7,568       6,396  

Expected return on plan assets

     (2,324 )     (2,325 )     (8,243 )     (6,975 )

Net amortization of losses and prior service costs

     935       923       3,515       2,769  
                                

Net periodic pension expense

   $ 1,906     $ 1,921     $ 6,746     $ 5,763  
                                

A curtailment of the Company’s pension plan occurred during the quarter due to the benefit accrual freeze effective January 1, 2007 for all participants except those who have attained age 55 and completed 10 years of service as of January 1, 2007 and who continue to be a non-highly compensated employee. In accordance with SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,” the Company recognized a pre-tax curtailment gain of $4,303 during the quarter.

The Company voluntarily contributed approximately $11,800 to the Company’s pension plan in June 2006 and expects minimal funding requirements in 2007.

NOTE 8 – SHAREHOLDERS’ EQUITY

On October 3, 2006 the Company’s Board of Directors declared a cash dividend of $4.00 per common share, and the Company reduced shareholders’ equity for the $558,587 dividend.

 

13


Table of Contents

Approximately $549,000 of the dividend was paid on November 30, 2006 to shareholders of record as of November 15, 2006. At October 28, 2006 the entire balance of the dividend was included in Dividend Payable in the accompanying Condensed Consolidated Balance Sheet. The remaining portion of the dividend payable will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest. As a result of the November 30, 2006 $4.00 per common share dividend payment, the Human Resources and Compensation Committee of the Company’s Board of Directors exercised its discretion under anti-dilution provisions of the Company’s long-term incentive plan to adjust the exercise price and number of stock options to reflect the change in the share price on the December 1, 2006 ex-dividend date. In accordance with the provisions of SFAS 123R, “Accounting for Stock-Based Compensation,” the discretionary nature of the anti-dilution provisions will result in a modification of the options. Accordingly, the Company will record a pre-tax non-cash charge of $13,729 in its fourth fiscal quarter.

On March 6, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share to shareholders of record as of April 14, 2006, and the Company reduced shareholders’ equity for the $547,537 dividend. For the nine months ended October 28, 2006, the Company made dividend cash payments totaling $542,766, primarily relating to the $4.00 per common share dividend of which $538,964 was paid on May 1, 2006. The remaining portion of the dividend payable will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.

As a result of the May 1, 2006 $4.00 per common share dividend payment, the Human Resources and Compensation Committee of the Company’s Board of Directors exercised its discretion under anti-dilution provisions of the Company’s long-term incentive plan to adjust the exercise price and number of stock options to reflect the change in the share price on the May 2, 2006 ex-dividend date. In accordance with the provisions of SFAS 123R, the discretionary nature of the anti-dilution provisions resulted in a modification of the options. Accordingly, the measurement of the fair value of the options before and after the ex-dividend date was required resulting in a pre-tax non-cash charge of approximately $19,600.

The effect of this anti-dilution adjustment is presented below:

 

     As of the ex-dividend date   

As of

January 28,
2006

     Prior to
Adjustment
   After
Adjustment
  

Options outstanding

     7,148      8,845      8,400

Options exercisable

     6,870      8,501      8,032

Weighted average exercise price:

        

Options outstanding

   $ 16.58    $ 13.40    $ 15.84

Options exercisable

   $ 16.82    $ 13.59    $ 16.08

 

14


Table of Contents

The following table summarizes the changes in shareholders’ equity for the nine months ended October 28, 2006:

 

    Common
Stock
Shares
    Common
Stock
Amount
    Additional
Paid-In
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Loss
    Total
Shareholders’
Equity
 

Balance at January 28, 2006

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

Net income

          32,221         32,221  

Dividend - March 6, 2006 ($4.00 per share)

        (443,147 )     (104,390 )       (547,537 )

Dividend - October 3, 2006 ($4.00 per share)

        (558,587 )         (558,587 )

Elimination of NDSG minimum pension liability

            39,381       39,381  

Issuance of common stock

  2,382       238       29,017           29,255  

Income tax benefit related to employee stock plans

        5,874           5,874  

Net activity under stock compensation plans

  (337 )     (34 )     (6,265 )         (6,299 )

Stock-based compensation

        13,783           13,783  

Stock-based compensation SFAS123R dividend adjustment

        19,621           19,621  

Repurchase of common stock

  (450 )     (45 )     (6,486 )         (6,531 )
                                             

Balance at October 28, 2006

  137,600     $ 13,760     $ 1,048,789     $ (8,899 )   $ (33,086 )   $ 1,020,564  
                                             

NOTE 9 – STOCK-BASED COMPENSATION

The Company maintains a stock plan for the granting of options, stock appreciation rights, restricted stock, performance shares, and other forms of equity awards to employees and directors. Options granted generally vest over a four-year period after grant and have an exercise term of seven to ten years from the grant date. Restricted stock and performance shares generally vest one to ten years after the grant date and in some cases with accelerated vesting at the discretion of the Company’s Board of Directors.

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, 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.

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, and requires companies to expense the value of employee stock options and similar awards. Effective the beginning of the first quarter 2006, the Company adopted SFAS No.123R. The adoption of this standard had an immaterial effect on the Company’s third quarter of 2006 condensed consolidated financial statements. Total stock-based compensation expense, net of related tax effects, for the three and nine-month periods ended October 28, 2006 was approximately $2,319 and $20,377, respectively.

 

15


Table of Contents

Prior to the adoption of SFAS No. 123R, the Company presented all tax benefits resulting from the exercise of stock options as operating cash inflows in the consolidated statements of cash flows, in accordance with the provisions of EITF No 00-15, “Classification in the Statements of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option.” SFAS No. 123R requires the benefits of tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash inflows rather than operating cash inflows, on a prospective basis. This amount is shown as “Excess tax benefit from stock based compensation.”

Had compensation cost for the Company’s stock-based compensation plan issuances prior to 2003 been determined under the fair value method, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below.

 

    

Three Months Ended

October 29,

2005

   

Nine Months Ended
October 29,

2005

 

Net income as reported

   $ 225     $ 24,590  

Add: Stock-based compensation expense included in net income, net of related tax effects

     3,355       10,982  

Deduct: Total stock-based employee compensation expense determined under the fair value method

     (4,022 )     (13,606 )
                

Pro forma net income (loss)

   $ (442 )   $ 21,966  
                

Basic earnings per common share

    

As reported

   $ 0.00     $ 0.18  

Pro forma

   $ 0.00     $ 0.16  

Diluted earnings per common share

    

As reported

   $ 0.00     $ 0.18  

Pro forma

   $ 0.00     $ 0.16  

 

16


Table of Contents

The following table summarizes stock options outstanding at October 28, 2006 and changes during the quarter then ended:

 

     Shares     Weighted
Average
Exercise
Price
    Aggregate
Intrinsic Value

Outstanding at January 29, 2006

   8,400     $ 15.84    

Granted

   —         —      

Exercised

   (1,218 )     11.65    

Forfeited

   (34 )     12.97    
                

Outstanding at April 29, 2006

   7,148     $ 16.58    

Dividend Adjustment

   1,697       (3.87 )  

Granted

   —         —      

Exercised

   (205 )     9.93    

Forfeited

   (608 )     19.58    
                

Outstanding at July 29, 2006

   8,032     $ 13.06     $ 22,650

Granted

   —         —      

Exercised

   (907 )     11.97    

Forfeited

   (64 )     21.28    
                

Outstanding at October 28, 2006

   7,061     $ 13.06     $ 45,445

Exercisable at October 28, 2006

   6,969     $ 13.12     $ 44,433
                

The total intrinsic value of stock options exercised during the three and nine months ended October 28, 2006 was $4,156 and $14,534, respectively.

The following table summarizes information regarding stock options outstanding at October 28, 2006:

 

     Options Outstanding    Options Exercisable

Range of Exercise Prices

   Number
Outstanding
at October 28, 2006
   Weighted Average
Remaining
Contractual Life
(Years)
   Weighted Average
Exercise Price
   Number
Exercisable
at October 28, 2006
   Weighted Average
Remaining
Contractual Life
(Years)
   Weighted Average
Exercise Price

$4.99 to $9.14

   2,970    2.6    $ 7.54    2,918    2.5    $ 7.55

$9.15 to $13.48

   493    3.1    $ 10.50    453    2.9    $ 10.51

$13.49 to $20.23

   2,115    1.7    $ 15.05    2,115    1.7    $ 15.05

$20.24 to $31.44

   1,483    1.7    $ 22.13    1,483    1.7    $ 22.13
                                 
   7,061    2.2    $ 13.06    6,969    2.2    $ 13.12
                                 

 

17


Table of Contents

The following table summarizes restricted stock outstanding at October 28, 2006 and changes during the nine months then ended:

 

     Shares     Weighted
Average
Grant
Date Fair
Value

Outstanding at January 29, 2006

   2,440     $ 14.48

Granted

   661       19.72

Restrictions lapsed

   (173 )     9.60

Forfeited

   (1,004 )     15.13
            

Outstanding at April 29, 2006

   1,924     $ 16.66

Granted

   35       16.38

Restrictions lapsed

   (269 )     11.36

Forfeited

   —         —  
            

Outstanding at July 29, 2006

   1,690     $ 17.50

Granted

   16       15.79

Restrictions lapsed

   (98 )     12.94

Forfeited

   (90 )     15.83
            

Outstanding at October 28, 2006

   1,518     $ 17.71

As of October 28, 2006, the Company had unearned compensation amounts related to non-vested restricted stock of $8,470, included in Additional Paid-In Capital, which will be recognized over a weighted average period of 1 year.

STOCK PURCHASE PLAN

The stock purchase plan provides for the Company’s common stock to be purchased by eligible employees through payroll deductions at a 15% discount to market value. Under the plan, as of October 28, 2006, employees have contributed $490 to purchase shares at 85% of the lower of the fair market value on the first or last day of the fiscal year. The plan had 335 shares available for issuance as of October 28, 2006.

NOTE 10 - CONTINGENCIES

LEGAL CONTINGENCIES

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. Thereafter, the Company was informed that the

 

18


Table of Contents

Office of the United States Attorney for the Southern District of New York 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. The Company has responded to subpoenas and other requests for information from the SEC, including a subpoena requesting information concerning, among other items, the Company’s allocation to vendors of a portion of markdown costs associated with certain of the Company’s customer loyalty and other promotional activities, as well as information concerning markdowns, earnings, and other financial data for 1999-2003. The Company is continuing to fully cooperate with 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. On October 25, 2005 the Chapter 7 trustee for the bankruptcy estate of Kleinert’s Inc. filed a complaint against the Company and several of its subsidiaries in the United States Bankruptcy

Court for the Southern District of New York. In its initial complaint the plaintiff, as assignee, alleged 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 $4,000 which wrongful acts the plaintiff alleges caused the insolvency and bankruptcy of Kleinert’s Inc. On August 15, 2006 the plaintiff, as assignee, filed an amended complaint in which it asserts the following claims, among others: (1) defendants applied improper chargebacks to the accounts payable of Kleinert’s, which led to the extreme financial distress and Kleinert’s eventual bankruptcy and Kleinert’s incurred liabilities and lost profits of at least $100,000 and plaintiff requests punitive damages of no less than $50,000 (conversion claim); (2) from 1998- 2003 defendants charged back an amount not less than $4,000 to Kleinert’s and these chargebacks improperly benefited the defendants, and plaintiff requests $4,000 on this claim (unjust enrichment claim); (3) defendants falsely represented that its $4,000 in chargebacks were proper and Kleinert’s reliance on defendants’ misrepresentations caused Kleinert’s to lose not less than $4,000 and caused it to file for bankruptcy resulting in liabilities and lost profits of $100,000, and plaintiff requests punitive damages of no less than $50,000 (fraud claim); (4) defendants wrongfully charged back at least $4,000 and these unwarranted chargebacks assisted Kleinert’s officers and directors in booking fictitious sales revenue and accounts receivable and perpetrating a fraud on Kleinert’s lenders in excess of $25,000, and plaintiff requests punitive damages of no less than $50,000 (fraud claim); (5) defendants used dishonest, improper and unfair means in conducting business with Kleinert’s and interfered with Kleinert’s relationship with its lenders (tortious interference with prospective economic advantage claim); (6) defendants assisted officers of Kleinert’s in breaching their

 

19


Table of Contents

fiduciary duties to Kleinert’s and to its creditors by falsifying borrowing base certificates given to the lenders, and defendants knew that their improper chargeback scheme was assisting these breaches of fiduciary duty by Kleinert’s officers, with respect to which plaintiff requests $100,000 plus $50,000 in punitive damages (aiding and abetting breach of fiduciary duty claim); (7) defendants knew that their improper chargeback scheme was assisting the perpetration of fraud by Kleinert’s officers, and plaintiff requests $100,000 plus $50,000 in punitive damages (aiding and abetting fraud claim); and (8) various fraudulent conveyance claims with respect to which plaintiff requests damages of $4,000.

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.

The Company is defending itself vigorously in each of the foregoing vendor lawsuits.

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. On August 17, 2006 the SLC completed its investigation and has concluded that (1) it is not in the best interests of the Company to pursue the claims asserted in the three derivative cases and (2) the cases should be dismissed. The plaintiffs have agreed with the Company and the individual defendants to dismiss the cases with prejudice, and all parties to the cases will request the Court in each derivative case to enter a final order of dismissal.

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.

 

20


Table of Contents

NOTE 11 - NEW ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued Interpretation 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This interpretation clarifies the application of SFAS 109 by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements. The interpretation requires the Company to review all tax positions accounted for in accordance with SFAS 109 and apply a more-likely-than-not recognition threshold. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. Subsequent recognition, derecognition, and measurement is based on management’s best judgment given the facts, circumstances and information available at the reporting date. The guidance is effective for fiscal years beginning after December 15, 2006, which the Company intends to adopt in the first quarter of 2007. The Company has commenced the process of evaluating the expected effect of FIN 48 on the Company’s financial position and its results of operations, but it is currently not yet in a position to determine such effects.

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 15,413 shares.

During September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or a liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under SFAS No. 157, fair value measurements would be separately disclosed by level within the fair value hierarchy effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of this Statement and does not expect it to have a material impact on the Company’s results of operations or financial position.

On September 29, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). SFAS No. 158 requires an employer that sponsors one or more defined benefit pension plans or other postretirement plans to 1) recognize the funded status of a plan, measured as the difference between plan assets at fair value and the benefit obligation, in the balance sheet; 2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; 3) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end

 

21


Table of Contents

balance sheet; and 4) disclose in the notes to the financial statements additional information about the effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition assets or obligations. SFAS No. 158 will be applied prospectively for fiscal years ending after December 15, 2006. The Company does not anticipate that SFAS No. 158 will have a material effect on the Company’s results of operations or financial position.

NOTE 12 – STORE DISPOSITIONS AND OTHER ACTIVITIES

In October 2004, the Company announced its intention to close 12 Saks Fifth Avenue stores. The net pre-tax charges resulting from closing these stores are principally related to asset impairments, lease terminations, inventory write downs and severance costs, partially offset by gains on the disposition of one or more stores. As it relates to these closings, the Company realized net charges of $6,491 during the nine months ended October 28, 2006, primarily relating to lease termination costs at closed stores. The Company realized net gains of $597 during the nine months ended October 29, 2005, primarily resulting from net gains from the sale of closed stores, offset in-part by severance charges, markdowns and other costs associated with the closings. Severance costs represent the portion of accrued benefits for employees that will exit when the stores are closed. Lease termination costs are included in Impairments and Dispositions, markdown charges are included in Gross Margin, and severance costs are included in Selling, General & Administrative Expenses in the accompanying Condensed Consolidated Statements of Income.

The Company continuously evaluates its real estate portfolio and closes individual underproductive stores in the normal course of business as leases expire or as other circumstances indicate. The Company also performs an asset impairment analysis at each fiscal year end. During the nine months ended October 28, 2006, the Company incurred net charges of $1,946 related to asset impairments and other costs. During the nine months ended October 29, 2005, the Company incurred net charges of $628 related to asset impairments and other costs. Asset impairments are included in Impairments and Dispositions and severance costs are included in Selling, General & Administrative Expenses in the accompanying Condensed Consolidated Statements of Income. There were no amounts payable related to these charges at October 28, 2006.

During the three and nine months ended October 29, 2005, the Company also recorded a $16,514 gain related to the estimated insurance settlement on the Saks Fifth Avenue store in New Orleans which suffered substantial water, fire, and other damage related to Hurricane Katrina. The New Orleans store is covered by both property damage and business interruption insurance. The property damage coverage was paid to repair and/or replace the physical property damage and inventory loss, and the business interruption coverage reimbursed the Company for lost profits as

 

22


Table of Contents

well as continuing expenses related to loss mitigation, recovery, and reconstruction for the full duration of the reconstruction period plus three months. The Company reopened the New Orleans store on November 16, 2006. The gain, which represents the excess of the replacement cost over the net book value of the property, was included in Impairments and Dispositions in the accompanying Consolidated Statements of Income.

NOTE 13 – CONDENSED CONSOLIDATING FINANCIAL INFORMATION

The following tables present condensed consolidating financial information for: (1) Saks Incorporated and (2) on a combined basis, the guarantors of Saks Incorporated’s senior notes (which are all of the wholly owned subsidiaries of Saks Incorporated).

The condensed consolidating financial statements presented as of and for the three and nine-month periods ended October 28, 2006 and October 29, 2005 and as of January 28, 2006 reflect the legal entity compositions at the respective dates.

Separate financial statements of the guarantor subsidiaries are not presented because the guarantors are jointly, severally, fully and unconditionally liable under the guarantees. Borrowings and the related interest expense under the Company’s revolving credit agreement are allocated to Saks Incorporated and the guarantor subsidiaries under an intercompany revolving credit arrangement. There are also management and royalty fee arrangements among Saks Incorporated and the subsidiaries. At October 28, 2006, Saks Incorporated was the sole obligor for a majority of the Company’s long-term debt and maintained a small group of corporate employees.

 

23


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING BALANCE SHEETS AT OCTOBER 28, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
   Guarantor
Subsidiaries
   Eliminations     Consolidated

ASSETS

          

Current Assets

          

Cash and cash equivalents

   $ 754,715    $ 12,678      $ 767,393

Merchandise inventories

        823,699        823,699

Other current assets

        159,363        159,363

Deferred income taxes, net

        31,521        31,521
                            

Total Current Assets

     754,715      1,027,261      —         1,781,976

Property and Equipment, net

        1,108,330        1,108,330

Goodwill and Intangibles, net

        331        331

Deferred Income Taxes, net

        158,370        158,370

Other Assets

     11,905      22,893        34,798

Investment in and Advances to Subsidiaries

     1,442,163       ($ 1,442,163 )  
                            

Total Assets

   $ 2,208,783    $ 2,317,185    ($ 1,442,163 )   $ 3,083,805
                            

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current Liabilities

          

Trade accounts payable

      $ 283,972      $ 283,972

Accrued expenses and other current liabilities

   $ 10,471      380,161        390,632

Dividend payable

     564,987           564,987

Current portion of long-term debt

        6,890        6,890
                            

Total Current Liabilities

     575,458      671,023      —         1,246,481

Long-Term Debt

     612,278      69,392        681,670

Other Long-Term Liabilities

     483      134,607        135,090

Investment by and Advances from Parent

        1,442,163    ($ 1,442,163 )  

Shareholders’ Equity

     1,020,564           1,020,564
                            

Total Liabilities and Shareholders’ Equity

   $ 2,208,783    $ 2,317,185    ($ 1,442,163 )   $ 3,083,805
                            

 

24


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED OCTOBER 28, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

Net sales

     $ 697,041       $ 697,041  

Costs and expenses

        

Cost of sales

       404,610         404,610  

Selling, general and administrative expenses

   $ 1,843       180,484         182,327  

Other operating expenses

     21       81,106         81,127  

Store pre-opening costs

       70         70  

Impairments and dispositions

       2,420         2,420  
                              

Operating income (loss)

     (1,864 )     28,351     —         26,487  

Other income (expense)

        

Equity in earnings of subsidiaries - continuing operations

     15,947       ($15,947 )  

Interest expense

     (10,072 )     (2,036 )       (12,108 )

Other income, net

     6,197           6,197  
                              

Income from continuing operations before provision (benefit) for income taxes

     10,208       26,315     (15,947 )     20,576  

Provision (benefit) for income taxes

     (2,270 )     10,368         8,098  
                              

Income from continuing operations

     12,478       15,947     (15,947 )     12,478  
                              

Discontinued operations:

        

Equity in earnings of subsidiaries - discontinued operations (net of tax)

     (6,300 )     6,300    

Loss from discontinued operations (including loss on disposal of $13,071)

       (17,485 )       (17,485 )

Benefit for income taxes

       (11,185 )       (11,185 )
                              

Loss from discontinued operations

     (6,300 )     (6,300 )   6,300       (6,300 )
                              

Net income

   $ 6,178     $ 9,647     ($9,647 )   $ 6,178  
                              

 

25


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED OCTOBER 28, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

Net sales

     $ 1,985,003       $ 1,985,003  

Costs and expenses

        

Cost of sales

       1,211,210         1,211,210  

Selling, general and administrative expenses

   $ 5,171       558,527         563,698  

Other operating expenses

     102       240,011         240,113  

Store pre-opening costs

       359         359  

Impairments and dispositions

       8,010         8,010  
                                

Operating loss

     (5,273 )     (33,114 )     —         (38,387 )

Other income (expense)

        

Equity in earnings of subsidiaries - continuing operations

     (21,607 )     $ 21,607    

Interest expense

     (30,403 )     (7,348 )       (37,751 )

Gain on extinguishment of debt

     7           7  

Other income, net

     21,948           21,948  
                                

Loss from continuing operations before benefit for income taxes

     (35,328 )     (40,462 )     21,607       (54,183 )

Benefit for income taxes

     (6,370 )     (18,855 )       (25,225 )
                                

Loss from continuing operations

     (28,958 )     (21,607 )     21,607       (28,958 )
                                

Discontinued operations:

        

Equity in earnings of subsidiaries - discontinued operations (net of tax)

     61,179         (61,179 )  

Income from discontinued operations (including gain on disposal of $192,076)

       193,535         193,535  

Provision for income taxes

       132,356         132,356  
                                

Income from discontinued operations

     61,179       61,179       (61,179 )     61,179  
                                

Net income (loss)

   $ 32,221     $ 39,572     ($ 39,572 )   $ 32,221  
                                

 

26


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED OCTOBER 28, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

OPERATING ACTIVITIES

        

Net income

   $ 32,221     $ 39,572     ($39,572 )   $ 32,221  

Income from discontinued operations

     61,179       61,179     (61,179 )     61,179  
                              

Loss from continuing operations

     (28,958 )     (21,607 )   21,607       (28,958 )

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

        

Equity in earnings of subsidiaries - continuing operations

     21,607       (21,607 )  

Excess tax benefit from exercise of stock options

     (3,212 )         (3,212 )

Depreciation and amortization

       93,089         93,089  

Equity compensation

     33,404           33,404  

Deferred income taxes

       121,147         121,147  

Impairments and dispositions

       7,466         7,466  

Loss on extinguishment of debt

     (7 )         (7 )

Changes in operating assets and liabilities, net

     4,191       (126,110 )       (121,919 )
                              

Net Cash Provided By Operating Activities - Continuing Operations

     27,025       73,985     —         101,010  

Net Cash Used In Operating Activities - Discontinued Operations

       (120,494 )       (120,494 )
                              

Net Cash Provided By (Used In) Operating Activities

     27,025       (46,509 )   —         (19,484 )

INVESTING ACTIVITIES

        

Purchases of property and equipment

       (78,515 )       (78,515 )

Proceeds from the sale of assets

       171         171  
                              

Net Cash Used In Investing Activities - Continuing Operations

     —         (78,344 )   —         (78,344 )

Net Cash Provided By Investing Activities - Discontinued Operations

       1,307,230         1,307,230  
                              

Net Cash Provided By Investing Activities

     —         1,228,886     —         1,228,886  

FINANCING ACTIVITIES

        

Intercompany borrowings, contributions and distributions

     1,198,783       (1,198,783 )    

Payments on long-term debt and capital lease obligations

     (263 )     (5,167 )       (5,430 )

Payment of dividend

     (542,766 )         (542,766 )

Purchases and retirements of common stock

     (6,531 )         (6,531 )

Excess tax benefit from exercise of stock options

     3,212           3,212  

Proceeds from issuance of common stock

     29,255           29,255  
                              

Net Cash Providee By (Used In) Financing Activities - Continuing Operations

     681,690       (1,203,950 )   —         (522,260 )

Net Cash Used In Financing Activities - Discontinued Operations

       (149 )       (149 )
                              

Net Cash Provided By (Used In) Financing Activities

     681,690       (1,204,099 )   —         (522,409 )

Increase (Decrease) In Cash and Cash Equivalents

     708,715       (21,722 )       686,993  

Cash and Cash Equivalents at beginning of period

     46,000       31,312         77,312  

Plus: Cash and cash equivalents included in assets held for sale at beginning of year

       3,088         3,088  
                              

Cash and Cash Equivalents at end of period

   $ 754,715     $ 12,678     —       $ 767,393  
                              

 

27


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING BALANCE SHEETS AT OCTOBER 29, 2005

(Dollar Amounts In Thousands)

 

     RESTATED
     Saks
Incorporated
   Guarantor
Subsidiaries
   Eliminations     Consolidated

ASSETS

          

Current Assets

          

Cash and cash equivalents

      $ 27,886      $ 27,886

Merchandise inventories

        1,011,064        1,011,064

Other current assets

        129,822        129,822

Deferred income taxes, net

        74,610        74,610

Current assets - held for sale

   $ 5,435      648,688        654,123
                          

Total Current Assets

     5,435      1,892,070    —         1,897,505

Property and Equipment, net

        1,358,694        1,358,694

Property and Equipment, net - held for sale

     4,053      432,110        436,163

Goodwill and Intangibles, net

        235,162        235,162

Deferred Income Taxes, net

        251,694        251,694

Other Assets

     14,126      29,579        43,705

Other Assets - held for sale

        12,072        12,072

Investment in and Advances to Subsidiaries

     2,734,855       ($2,734,855 )  
                          

Total Assets

   $ 2,758,469    $ 4,211,381    ($2,734,855 )   $ 4,234,995
                          

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current Liabilities

          

Trade accounts payable

      $ 298,080      $ 298,080

Accrued expenses and other current liabilities

   $ 8,595      415,447        424,042

Dividend payable

     1,919           1,919

Current portion of long-term debt

        7,519        7,519

Current liabilities - held for sale

     1,359      289,612        290,971
                          

Total Current Liabilities

     11,873      1,010,658    —         1,022,531

Long-Term Debt

     612,356      105,727        718,083

Long-Term Debt - held for sale

        33,819        33,819

Other Long-Term Liabilities

     600      235,489        236,089

Other Long-Term Liabilities - held for sale

        90,833        90,833

Investment by and Advances from Parent

        2,734,855    ($2,734,855 )  

Shareholders’ Equity

     2,133,640           2,133,640
                          

Total Liabilities and Shareholders’ Equity

   $ 2,758,469    $ 4,211,381    ($2,734,855 )   $ 4,234,995
                          

 

28


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED OCTOBER 29, 2005

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

Net sales

     $ 645,152       $ 645,152  

Costs and expenses

        

Cost of sales

       381,157         381,157  

Selling, general and administrative expenses

   $ 1,861       206,576         208,437  

Other operating expenses

     25       80,057         80,082  

Store pre-opening costs

       559         559  

Impairments and dispositions

       (15,215 )       (15,215 )
                                

Operating loss

     (1,886 )     (7,982 )     —         (9,868 )

Other income (expense)

        

Equity in earnings of subsidiaries - continuing operations

     (6,031 )     $ 6,031    

Interest expense

     (12,030 )     (2,222 )       (14,252 )

Loss on extinguishment of debt

     (29 )         (29 )

Other income, net

     1,224           1,224  
                                

Loss from continuing operations before benefit for income taxes

     (18,752 )     (10,204 )     6,031       (22,925 )

Benefit for income taxes

     (5,204 )     (4,173 )       (9,377 )
                                

Loss from continuing operations

     (13,548 )     (6,031 )     6,031       (13,548 )

Discontinued operations:

        

Equity in earnings of subsidiaries - discontinued operations (net of tax)

     13,278         (13,278 )     —    

Income from discontinued operations (including loss on disposal of $913)

     837       22,457         23,294  

Provision for income taxes

     342       9,179         9,521  
                                

Income from discontinued operations

     13,773       13,278       (13,278 )     13,773  
                                

Net income (loss)

   $ 225     $ 7,247       ($7,247 )   $ 225  
                                

 

29


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED OCTOBER 29, 2005

(Dollar Amounts In Thousands)

 

     Restated  
     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

Net sales

     $ 1,960,560       $ 1,960,560  

Costs and expenses

        

Cost of sales

       1,211,699         1,211,699  

Selling, general and administrative expenses

   $ 5,563       610,068         615,631  

Other operating expenses

     87       241,078         241,165  

Store pre-opening costs

       928         928  

Impairments and dispositions

       (17,836 )       (17,836 )
                                

Operating loss

     (5,650 )     (85,397 )     —         (91,027 )

Other income (expense)

        

Equity in earnings of subsidiaries - continuing operations

     (80,350 )     $ 80,350    

Interest expense

     (12,030 )     (52,445 )       (64,475 )

Loss on extinguishment of debt

     (29,020 )         (29,020 )

Other income, net

     6,449           6,449  
                                

Loss from continuing operations before benefit for income taxes

     (120,601 )     (137,822 )     80,350       (178,073 )

Benefit for income taxes

     (16,841 )     (57,472 )       (74,313 )
                                

Loss from continuing operations

     (103,760 )     (80,350 )     80,350       (103,760 )

Discontinued operations:

        

Equity in earnings of subsidiaries - discontinued operations (net of tax)

     127,862         (127,862 )  

Income from discontinued operations (including gain on disposal of $156,003)

     837       244,439         245,276  

Provision for income taxes

     349       116,577         116,926  
                                

Income from discontinued operations

     128,350       127,862       (127,862 )     128,350  
                                

Net income (loss)

   $ 24,590     $ 45,317       ($45,317 )   $ 24,590  
                                

 

30


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED OCTOBER 29, 2005

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

OPERATING ACTIVITIES

        

Net income

   $ 24,590     $ 45,317     ($45,317 )   $ 24,590  

Income from discontinued operations

     128,350       127,862     (127,862 )     128,350  
                              

Loss from continuing operations

     (103,760 )     (82,545 )   82,545       (103,760 )

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

        

Equity in earnings of subsidiaries - continuing operations

     82,545       (82,545 )  

Extraordinary loss on extinguishment of debt

     29,020           29,020  

Depreciation and amortization

     789       94,192         94,981  

Equity compensation

     16,612           16,612  

Deferred income taxes

       23,554         23,554  

Impairments and dispositions

       (17,836 )       (17,836 )

Changes in operating assets and liabilities, net

     18,275       (208,896 )       (190,621 )
                              

Net Cash Provided By (Used In) Operating Activities - Continuing Operations

     43,481       (191,531 )   —         (148,050 )

Net Cash Used In Operating Activities - Discontinued Operations

       31,490         31,490  
                              

Net Cash Provided By (Used In) Operating Activities

     43,481       (160,041 )   —         (116,560 )

INVESTING ACTIVITIES

        

Purchases of property and equipment

       (90,166 )       (90,166 )

Proceeds from the sale of assets

       13,236         13,236  
                              

Net Cash Used In Investing Activities - Continuing Operations

     0       (76,930 )   —         (76,930 )

Net Cash Provided By Investing Activities - Discontinued Operations

       537,416         537,416  
                              

Net Cash Provided By Investing Activities

     —         460,486     —         460,486  

FINANCING ACTIVITIES

        

Intercompany borrowings, contributions and distributions

     301,584       (301,584 )    

Proceeds from issueing convertible senior notes

           0  

Proceeds from revolving credit facility

     27,000           27,000  

Payments on long-term debt and capital lease obligations

     (607,158 )     (12,324 )       (619,482 )

Cash dividends paid

     (505 )         (505 )

Proceeds from issuance of common stock

     23,109           23,109  
                              

Net Cash Used In Financing Activities - Continuing Operations

     (255,970 )     (313,908 )   —         (569,878 )

Net Cash Used In Financing Activities - Discontinued Operations

       (183 )       (183 )
                              

Net Cash Used In Financing Activities

     (255,970 )     (314,091 )   —         (570,061 )

Decrease In Cash and Cash Equivalents

     (212,489 )     (13,646 )       (226,135 )

Cash and Cash Equivalents at beginning of period

     212,001       45,103         257,104  

Less: Cash and cash equivalents included in assets held for sale at end of year

       (3,083 )       (3,083 )
                              

Cash and Cash Equivalents at end of period

   $ (488 )   $ 28,374     —       $ 27,886  
                              

 

31


Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING BALANCE SHEETS AT JANUARY 28, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
   Guarantor
Subsidiaries
   Eliminations     Consolidated

ASSETS

          

Current Assets

          

Cash and cash equivalents

   $ 46,000    $ 31,312      $ 77,312

Merchandise inventories

        807,211        807,211

Other current assets

        165,085        165,085

Deferred income taxes, net

        119,558        119,558

Current assets - held for sale

     4,225      471,260        475,485
                            

Total Current Assets

     50,225      1,594,426      —         1,644,651

Property and Equipment, net

        1,340,868        1,340,868

Property and Equipment, net - held for sale

     4,098      432,314        436,412

Goodwill and Intangibles, net

        181,644        181,644

Goodwill and Intangibles, net - held for sale

        1,789        1,789

Deferred Income Taxes, net

        191,480        191,480

Other Assets

     13,737      28,812        42,549

Other Assets - held for sale

        11,332        11,332

Investment in and Advances to Subsidiaries

     2,558,067       $ (2,558,067 )  
                            

Total Assets

   $ 2,626,127    $ 3,782,665    $ (2,558,067 )   $ 3,850,725
                            

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current Liabilities

          

Trade accounts payable

      $ 190,064      $ 190,064

Accrued expenses and other current liabilities

   $ 11,164      437,322        448,486

Dividend payable

     1,629           1,629

Current portion of long-term debt

        7,803        7,803

Current liabilities - held for sale

     1,056      196,012        197,068
                            

Total Current Liabilities

     13,849      831,201      —         845,050

Long-Term Debt

     612,295      75,785        688,080

Long-Term Debt - held for sale

        34,656        34,656

Other Long-Term Liabilities

     600      202,983        203,583

Other Long-Term Liabilities - held for sale

        79,973        79,973

Investment by and Advances from Parent

        2,558,067    $ (2,558,067 )  

Shareholders’ Equity

     1,999,383           1,999,383
                            

Total Liabilities and Shareholders’ Equity

   $ 2,626,127    $ 3,782,665    $ (2,558,067 )   $ 3,850,725
                            

 

32


Table of Contents

Item 2. 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 and has four major components:

 

    Management’s 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 report.

MANAGEMENT’S OVERVIEW

GENERAL

Saks Incorporated and its subsidiaries (together the “Company”) operations consist of Saks Fifth Avenue, Off Fifth, and Club Libby Lu. Previously, the Company also operated Saks Department Store Group (“SDSG”), which consisted of Proffitt’s and McRae’s (“Proffitt’s”) (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operated 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), and Parisian (sold to Belk in October 2006). The sold businesses are presented as discontinued operations in the current and prior year periods.

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 Saks Fifth Avenue products by catalog or online at saks.com. Off Fifth is intended to be the premier luxury off-price retailer in the United States. Off Fifth 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. Club Libby Lu consists of mall-based specialty stores, targeting girls aged 4-12 years old. At October 28, 2006, Saks operated 53 Saks Fifth Avenue stores with 5.9 million square feet, 50 Off 5th units with 1.4 million square feet, and 62 Club Libby Lu specialty stores with 0.1 million square feet.

RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

As discussed in the Company’s 2005 Annual Report on Form 10-K, the Company discovered that there was an error in the restatement of the consolidated financial statements contained in the Company’s 2004 Annual Report on Form 10-K. The error

 

33


Table of Contents

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 was reported as a restatement of consolidated shareholders’ equity at February 2, 2002. 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.

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 Condensed Consolidated Balance Sheet accounts is as follows:

 

October 29, 2005

(in thousands)

   Previously
Reported
   Adjustments    

As

Restated

   Percent
Change
 

Current deferred income taxes, net

   $ 71,211    $ 3,399     $ 74,610    4.8 %

Non-current deferred income taxes, net

   $ 250,158    $ 1,536     $ 251,694    0.6 %

Accrued expenses

   $ 397,108    $ 26,934     $ 424,042    6.8 %

Total shareholders’ equity

   $ 2,155,639    $ (21,999 )   $ 2,133,640    -1.0 %

DISCONTINUED OPERATIONS

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 business operations, 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.

On March 6, 2006, the Company sold to Bon-Ton all outstanding equity interests of certain of the Company’s subsidiaries that owned NDSG, either directly or indirectly. The consideration received consisted of approximately $1.12 billion in cash (reduced as described below based on changes in working capital), plus the assumption by Bon-Ton of approximately $35 million of unfunded benefit liabilities and approximately $35 million of capital leases. A working capital adjustment based on working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $75 million resulting in net cash proceeds to the Company of approximately $1.04 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. After considering the basis of the business sold, transaction fees and other costs, the Company realized a net gain of $204.9 million on the sale.

 

34


Table of Contents

On October 2, 2006, the Company consummated the sale to Belk of all of the outstanding equity interests of the Company’s subsidiaries that conducted the Parisian specialty department store business (“Parisian”). The consideration received consisted of approximately $285 million in cash (increased in accordance with a working capital adjustment). A preliminary working capital adjustment based on an estimate of working capital as of the effective time of the transaction increased the amount of cash proceeds by approximately $15 million. In addition, Belk reimbursed the Company at closing for approximately $7 million in capital expenditures incurred in connection with the construction of four new Parisian stores. Belk also paid the Company a premium associated with the purchase of accounts and accounts receivable from Household Bank (SB), N.A. (now known as HSBC Bank Nevada, N.A.), in the amount of approximately $2 million. The foregoing resulted in total net cash proceeds to the Company of approximately $309 million. The estimated working capital is subject to a final working capital adjustment to determine final amounts as of the effective time of the transaction. The disposition included Parisian’s operations consisting of, among other things, real and personal property, operating leases and inventory associated with 38 Parisian stores (which generated fiscal 2005 revenues of approximately $723 million), an administrative/headquarters facility in Birmingham, Alabama and a distribution center located in Steele, Alabama. After considering the basis of the business sold, transaction fees and other costs, the Company realized a loss of $12.8 million on the sale.

FINANCIAL PERFORMANCE SUMMARY

The Company recorded income from continuing operations of $12.5 million, or $0.09 per share compared to a loss from continuing operations of $13.5 million, or $0.10 per share, for the three months ended October 28, 2006 and October 29, 2005, respectively. After recognition of the Company’s after-tax loss from discontinued operations of $6.3 million, or $0.05 per share, related to the sale of the Parisian business, net income totaled $6.2 million, or $0.05 per share, for the third quarter ended October 28, 2006. For the three months ended October 29, 2005, net income totaled $0.2 million, or $0.00 per share, after recognition of the Company’s after-tax gain from discontinued operations of $13.8 million, or $0.09 per share.

The three-month period ended October 28, 2006 included net after-tax charges totaling $1.7 million, or $.01 per share, primarily related to asset impairments and dispositions. The current year third quarter also included legal and other expenses related to the investigations as described in “Part I - Financial Information, Note 10 - Legal Contingencies” of this Form 10-Q totaling approximately $0.4 million (net of taxes), approximately $4.7 million (net of taxes), or $0.03 per share, of severance and retention expenses as the Company downsizes its organizational structure following the disposition of its SDSG businesses, and a gain of $2.6 million (net of taxes), or $0.02 per share, related to a one-time gain on the curtailment of the Company’s pension plan.

 

35


Table of Contents

The three-month period ended October 29, 2005 included a net after-tax gain of $9.4 million, primarily related to a $10.0 million (net of taxes), or $0.07 per share, net gain related to the estimated insurance settlement on the New Orleans store that was damaged by Hurricane Katrina. The prior year third quarter also included approximately $6.2 million (net of taxes), or $0.04 per share, of severance and retention expenses, legal and other expenses related to the investigations totaling approximately $4.6 million (net of taxes), or $0.03 per share, expenses of $1.6 million (net of taxes), or $0.01 per share, related to the insurance deductible for the New Orleans store, and income of $2.2 million (net of taxes), or $0.02 per share, related to the Visa/Mastercard antitrust litigation settlement.

The Company recorded a loss from continuing operations of $29.0 million, or $0.21 per share compared to a loss from continuing operations of $103.8 million, or $0.75 per share, for the nine months ended October 28, 2006 and October 29, 2005, respectively. After recognition of the Company’s after-tax gain from discontinued operations of $61.2 million, or $0.45 per share, net income totaled $32.2 million, or $0.24 per share for the nine-month period ended October 28, 2006. Comparably, net income for the nine months ended October 29, 2005 totaled $24.6 million, or $0.17 per share, after recognition of the Company’s after-tax gain on discontinued operations of $128.4 million.

The nine-month period ended October 28, 2006 included net after-tax charges totaling $17.9 million, or $.13 per share, primarily related to a $12.8 million (net of taxes), or $0.09 per share, a non-cash charge related to the treatment under Financial Accounting Standard (SFAS) No. 123R “Accounting for Stock-Based Compensation,” of the anti-dilution adjustment made to outstanding options related to the Company’s $4 per common share dividend paid in May 2006 and $5.1 million (net of taxes), or $0.04 per share, of other charges largely related to asset impairments and dispositions. The current year period also included expenses of approximately $2.2 million (net of taxes), or $0.02 per share, related to legal and other costs associated with the previously disclosed investigations, expenses of approximately $12.3 million (net of taxes), or $0.09 per share, related to retention and severance, income of approximately $2.5 million (net of taxes), or $0.02 per share, due to the favorable conclusion of certain tax examinations, and a gain of $2.6 million (net of taxes), or $0.02 per share, related to a one-time gain on modifications made to the Company’s pension plan.

The comparable prior year period included a net after-tax loss of $7.6 million or $0.05 per share, primarily related to a $17.7 million (net of taxes), or $0.12 per share, loss on debt extinguishment, partially offset by net gains of $10.1 million (net of taxes), or $0.07 per share, principally related to the insurance settlement on the New Orleans store. The prior year nine months ended October 29, 2005 also included legal and other expenses related to the investigations totaling approximately $10.1 million (net of taxes), or $0.07 per share, approximately $9.6 million (net of taxes), or $0.07 per share, of severance and retention expenses, expenses of $1.6 million (net of taxes), or $0.01 per share, related to the insurance deductible for the New Orleans store, and income of $0.9 million (net of taxes), or $0.02 per share, relating to the Visa/MasterCard antitrust litigation settlement.

 

36


Table of Contents

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 shows, for the periods indicated, items from the Company’s Condensed Consolidated Statements of Income expressed as percentages of net sales. (numbers may not total due to rounding)

 

     Three Months Ended     Nine Months Ended  
     October 28,
2006
    October 29,
2005
    October 28,
2006
    October 29,
2005
 

Net sales

   100.0 %   100.0 %   100.0 %   100.0 %

Costs and expenses:

        

Cost of sales (excluding depreciation and amortization)

   58.0 %   59.1 %   61.0 %   61.8 %

Selling, general & administrative expenses

   26.2 %   32.3 %   28.4 %   31.4 %

Other operating expenses

   11.6 %   12.4 %   12.1 %   12.3 %

Store pre-opening costs

   0.0 %   0.1 %   0.0 %   0.0 %

Impairments and dispositions

   0.3 %   -2.4 %   0.4 %   -0.9 %
                        

Operating income (loss)

   3.8 %   -1.5 %   -1.9 %   -4.6 %

Other income (expense):

        

Interest expense

   -1.7 %   -2.2 %   -1.9 %   -3.3 %

Gain (loss) on extinguishment of debt

   0.0 %   0.0 %   0.0 %   -1.5 %

Other income, net

   0.9 %   0.2 %   1.1 %   0.3 %
                        

Income (loss) before income taxes

   3.0 %   -3.6 %   -2.7 %   -9.1 %

Provision (benefit) for income taxes

   1.2 %   -1.5 %   -1.3 %   -3.8 %
                        

Income (loss) from continuing operations

   1.8 %   -2.1 %   -1.5 %   -5.3 %

Discontinued operations:

        

Income (loss) from discontinued operations (including gain (loss) on disposal)

   -2.5 %   3.6 %   9.7 %   12.5 %

Provision (benefit) for income taxes

   -1.6 %   1.5 %   6.7 %   6.0 %
                        

Income (loss) from discontinued operations

   -0.9 %   2.1 %   3.1 %   6.5 %
                        

Net income

   0.9 %   0.0 %   1.6 %   1.3 %
                        

 

37


Table of Contents

THREE MONTHS ENDED OCTOBER 28, 2006 COMPARED TO THREE MONTHS ENDED OCTOBER 29, 2005

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from the three-month period ended October 29, 2005 to the three-month period ended October 28, 2006:

 

(In Millions)

   Total
Company
 

For the three months ended October 29, 2005

   $ (9.9 )

Store sales and margin

     28.4  

Operating expenses

     25.6  

Impairments and dispositions

     (17.6 )
        

Increase

     36.4  
        

For the three months ended October 28, 2006

   $ 26.5  
        

For the three-month period ended October 28, 2006, operating income improved to $26.5 million from an operating loss of $9.9 million in the same period last year. The improvement in operating income for the quarter was driven by an 8.8% increase in comparable store sales, a 110 basis point improvement in the gross margin rate due to improved sell-throughs of full priced merchandise, and a $26.1 million or 13% decline in SG&A expenses, which caused a 610 basis point improvement in the expense rate as a percent of sales. The SG&A expense and rate reduction was primarily due to improved expense leverage resulting from expense control, coupled with increasing comparable store sales, continued progress on the Company’s corporate infrastructure downsizing, and the elimination or reduction of items that the Company does not expect to be long-term continuing obligations such as investigation expenses, severance/retention expenses, and insurance deductible expenses related to the New Orleans store. The improvement in operating income was partially offset by a $17.6 million year-over-year increase in impairments and dispositions costs, primarily resulting from the $16.5 million gain recognized in the prior year quarter related to the New Orleans store insurance settlement.

NET SALES

For the three months ended October 28, 2006, total sales increased 8.0% to $697.0 million from $645.2 million for the three months ended October 29, 2005. Similarly, consolidated comparable store sales increased 8.8% year-over-year. The net effect of sales from new and closed stores resulted in a $3.3 million reduction.

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.

 

38


Table of Contents

GROSS MARGIN

For the three months ended October 28, 2006, gross margin was $292.4 million, or 42.0% of net sales, compared to $264.0 million, or 40.9% of net sales, for the three months ended October 29, 2005. The improvement in gross margin dollars and the gross margin rate was principally attributable to improved sell-throughs of full priced merchandise.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (“SG&A”)

For the three months ended October 28, 2006, SG&A was $182.3 million, or 26.2% of net sales, compared to $208.4 million, or 32.3% of net sales, for the three months ended October 29, 2005. Approximately one-half of the net decrease of $26.1 million in expenses and the decrease in expense rate was due to improved expense leverage resulting from expense control, coupled with increasing comparable store sales and continued progress on the Company’s corporate infrastructure downsizing. The balance of the decline was primarily attributable to a year-over-year elimination or reduction in items that the Company does not expect to be long-term continuing obligations such as investigation expenses ($6.8 million), severance/retention expenses ($2.3 million), and insurance deductible expenses related to the New Orleans store ($2.7 million).

OTHER OPERATING EXPENSES

For the three months ended October 28, 2006, other operating expenses, including store pre-opening costs, were $81.2 million, or 11.6% of net sales, compared to $80.6 million, or 12.5% of net sales, for the three months ended October 29, 2005. The modest increase of $0.6 million was driven primarily by higher store costs. As a percent of sales, other operating expenses decreased 90 basis points in 2006, reflecting the ability to leverage increased occupancy expenses on the increased sales.

IMPAIRMENTS AND DISPOSITIONS

For the three months ended October 28, 2006, the Company realized losses from impairments and dispositions of $2.4 million, or 0.3% of net sales, compared to a gain of $15.2 million, or 2.4% of net sales, for the three months ended October 29, 2005. The current quarter net charges were primarily due to lease termination costs related to store closings. The prior quarter net gains primarily related to the insurance settlement received on the New Orleans store.

INTEREST EXPENSE

For the three months ended October 28, 2006, interest expense was $12.1 million, or 1.7% of net sales, compared to $14.3 million, or 2.2% of net sales, for the three months ended October 29, 2005. The improvement of $2.2 million was primarily due to the reduction in debt resulting from the repurchase of $21.4 million of senior notes in August 2005.

 

39


Table of Contents

INCOME TAXES

For continuing operations, the effective income tax rates for the three-month periods ending October 28, 2006 and October 29, 2005 were 39.4% and 40.9%, respectively. The effective income tax rates for discontinued operations for the three-month period ending October 28, 2006 and October 29, 2005 were 64.0% and 40.9%, respectively. The increase in the effective rate for discontinued operations for the three-month period ended October 28, 2006 was primarily the result of a tax benefit from the sale of the Parisian business. This benefit was generated from the sale of Parisian stock although both parties have agreed that the transaction may still be structured as an asset sale for tax purposes if a mutual agreement is reached by June 2007.

NINE MONTHS ENDED OCTOBER 28, 2006 COMPARED TO NINE MONTHS ENDED OCTOBER 29, 2005

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from the nine-month period ended October 29, 2005 to the nine-month period ended October 28, 2006:

 

(In Millions)

   Total
Company
 

For the nine months ended October 29, 2005

   $ (91.0 )

Store sales and margin

     24.9  

Operating expenses

     53.5  

Impairments and dispositions

     (25.8 )
        

Increase

     52.6  
        

For the nine months ended October 28, 2006

   $ (38.4 )
        

For the nine-month period ended October 28, 2006, the Company’s operating loss totaled $38.4 million, a 58% improvement from the $91.0 million loss in the same period last year. Operating income was positively impacted by a 3.2% increase in comparable store

 

40


Table of Contents

sales, an 80 basis point improvement in the gross margin rate due to improved sell-throughs of full priced merchandise, and a $51.9 million or 8% decline in SG&A expenses, which caused a 300 basis point improvement in the expense rate as a percent of sales. The SG&A expense and rate reduction was primarily due to improved expense leverage as a result of expense control coupled with a comparable store sales increase as well as continued progress on the Company’s corporate infrastructure downsizing. Additionally, the elimination or reduction of items that the Company does not expect to be long-term continuing obligations such as investigation expenses, severance/retention expenses, and insurance deductible expenses related to the New Orleans store. The improvement in operating income was partially offset by a $25.8 million year-over-year increase in impairments and dispositions costs, primarily resulting from the $16.5 million gain recognized in the prior year period related to the New Orleans store insurance settlement and $8.0 million in current period charges related mainly to store closings.

NET SALES

For the nine months ended October 28, 2006 and October 29, 2005, total sales were $1,985.0 million and $1,960.6 million, respectively, representing a 1.2% increase year-over-year and a consolidated comparable store sales increase of 3.2%. The net effect of sales from new and closed stores resulted in a $30.0 million reduction.

GROSS MARGIN

For the nine months ended October 28, 2006, gross margin was $773.8 million, or 39.0% of net sales, compared to $748.9 million, or 38.2% of net sales, for the nine months ended October 29, 2005. The improvement in gross margin dollars and the gross margin rate was principally attributable to improved sell-throughs of full priced merchandise.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (“SG&A”)

For the nine months ended October 28, 2006, SG&A was $563.7 million, or 28.4% of net sales, compared to $615.6 million, or 31.4% of net sales, for the nine months ended October 29, 2005. The net decrease of $51.9 million in expenses was principally due to expense improvement resulting from the Company’s corporate infrastructure downsizing. Additionally, SG&A expense decreased as a result of a $13.0 million decrease in investigation related expenses, a $3.4 million reduction in year-over-year equity compensation costs, and a $2.7 million reduction in insurance deductible expenses related to the New Orleans store. The decrease in SG&A expenses was partially offset by the $19.6 million current period charge associated with SFAS 123R and a year-over-year increase of $4.9 million in retention costs associated with the strategic alternatives process.

OTHER OPERATING EXPENSES

For the nine months ended October 28, 2006, other operating expenses, including store pre-opening costs, were $240.5 million, or 12.1% of net sales, compared to $242.1

 

41


Table of Contents

million, or 12.3% of net sales, for the nine months ended October 29, 2005. As a percent of sales, other operating expenses decreased slightly, reflecting the ability to leverage essentially flat costs and a comparable store sales increase.

IMPAIRMENTS AND DISPOSITIONS

For the nine months ended October 28, 2006, the Company recognized net charges from impairments and dispositions of $8.0 million compared to net gains of $17.8 million for the nine months ended October 29, 2005. The current period net charges were primarily due to lease termination costs related to store closings, while the prior period net gains primarily related to the insurance settlement received on the New Orleans store.

INTEREST EXPENSE

For the nine months ended October 28, 2006, interest expense was $37.8 million, or 1.9% of net sales, compared to $64.5 million, or 3.3% of net sales, for the nine months ended October 29, 2005. The improvement of $26.7 million was primarily due to the reduction in debt resulting from the repurchase of $585.7 million and $21.4 million of senior notes in July 2005 and August 2005, respectively.

GAIN/(LOSS) ON EXTINGUISHMENT OF DEBT

During the nine months ended October 28, 2006, the Company repurchased a total of approximately $0.2 million in principal amount of senior notes. The repurchase of these notes resulted in a gain on extinguishment of debt of $7 thousand. For the nine months ended October 29, 2005, the Company repurchased a total of approximately $607.1 million in principal amount of senior notes. The repurchase of these notes resulted in a loss on extinguishment of debt of approximately $29.0 million related principally to the write-off of deferred financing costs and a premium on previously exchanged notes.

INCOME TAXES

For continuing operations, the effective income tax rates for the nine-month periods ending October 28, 2006 and October 29, 2005 were 46.6% and 41.7%, respectively. The increase in the effective rate for the nine-month period ending October 28, 2006 was primarily the result of a benefit recognized to reduce tax reserves resulting from the conclusion of certain state tax examinations. The effective income tax rates for discontinued operations for the nine-month periods ending October 28, 2006 and October 29, 2005 were 68.4% and 47.7%, respectively. The increase in the effective rate for discontinued operations for the nine-month period ended October 28, 2006 was primarily the result of the write-off of goodwill related to the sale of the NDSG business, a substantial portion of which was non-deductible for tax purposes, offset by the tax benefit as a result of the sale of the Parisian business.

 

42


Table of Contents

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 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 (used in) operating activities from continuing operations was $101.0 million for the nine months ended October 28, 2006 and ($148.1) million for the nine months ended October 29, 2005. Cash provided by operating activities principally represents income before depreciation and non-cash charges and after changes in working capital. The $249.1 million increase in 2006 from 2005 was largely due to the change in deferred income taxes.

Inventory, accounts payable and debt balances fluctuate throughout the year due to the seasonal nature of the Company’s business. Merchandise inventory balances at October 28, 2006 decreased from October 29, 2005 largely due to a reduction in merchandise inventory related to the sale of NDSG and Parisian. Offsetting this decrease was a comparable inventory increase of 3.0%.

Cash used in investing activities from continuing operations was $78.3 million for the nine months ended October 28, 2006 and $76.9 million for the nine months ended October 29, 2005. 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 and distribution centers). The $1.4 million increase in cash used in investing activities is primarily due to a reduction in proceeds received from the sale of property and equipment.

Property and equipment amounts at October 28, 2006 decreased from October 29, 2005 amounts primarily due to the disposal of assets related to the sale of NDSG and Parisian, depreciation on existing assets during the last twelve months and to store closings and impairments, partially offset by capital expenditures related to new store additions, expansions, replacements and the remodeling of existing stores. Goodwill and intangibles at October 28, 2006 also decreased from October 29, 2005 due to the sale of NDSG and Parisian, the SDSG goodwill impairment charges taken in the fourth quarter of 2005 and amortization expense during the last twelve months.

 

43


Table of Contents

Cash used in financing activities was $522.3 million for the nine months ended October 28, 2006 and $569.9 million for the nine months ended October 29, 2005. The current period use primarily relates to the payment of cash dividends totaling $542.8 million, while the prior period use primarily relates to the repurchase of approximately $607.1 million in principal amount of senior notes related to the completion of the tender offers and consent solicitations.

CASH BALANCES AND LIQUIDITY

The Company’s primary sources of short-term liquidity are cash on hand and availability under its revolving credit facility. At the Company’s request, due to the sale of NDSG, the revolving credit facility was reduced from $800 million to $500 million in March 2006. In September 2006, the maturity date of the revolving credit facility was extended to September 2011. At October 28, 2006 and October 29, 2005, the Company maintained cash and cash equivalent balances of $767.4 million and $31.0 million, respectively. At October 28, 2006, the Company had no borrowings under its $500 million revolving credit facility, and had $79.9 million in unfunded letters of credit representing utilization of availability under the facility, leaving unutilized availability under the facility of $420.1 million. The amount of cash borrowed under the Company’s revolving credit facility is 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.

The Company continuously focuses on effectively and efficiently deploying cash to generate shareholder value. Accordingly, the Company plans to maintain a portion of its existing cash on hand to provide flexibility for further balance sheet refinements, to invest in its core businesses, and to cover any transition costs related to the disposition of Proffitt’s, NDSG and Parisian. The Company’s current plan is to target any residual cash for additional shareholder distributions in the form of share repurchases, an additional dividend, or a combination of the two.

On October 3, 2006 the Company’s Board of Directors declared a cash dividend of $4.00 per share of the Company’s common stock, and the Company reduced shareholders’ equity for the $558.6 million dividend. Approximately $549.0 million of the dividend was paid on November 30, 2006 to shareholders of record as of November 15, 2006. At October 28, 2006 the entire balance of the dividend was included in Dividend Payable in the Condensed Consolidated Balance Sheet.

On March 6, 2006, the Company’s Board of Directors declared a cash dividend to shareholders of $4.00 per common share. On May 1, 2006, the Company paid approximately $539 million to shareholders of record as of April 14, 2006. The remaining portion of the dividends will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.

 

44


Table of Contents

On August 30, 2006, the Company repurchased 450 thousand shares of Saks’ common stock at a cost of approximately $6.5 million, which left 37 million shares available for repurchase under the Company’s existing share repurchase program.

CAPITAL STRUCTURE

The Company continuously evaluates its debt-to-capitalization ratio in light of the Company’s disposition of businesses, economic trends, business trends, levels of interest rates, and terms, conditions and availability of capital in the capital markets. At October 28, 2006, the Company’s capital and financing structure was comprised of a revolving credit agreement, senior unsecured notes, convertible senior unsecured notes, and capital and operating leases. At October 28, 2006, total debt was $688.6 million, representing a decrease of $70.8 million from the balance of $759.4 million at October 29, 2005. This decrease in debt was primarily the result of the payoff of the October 2005 balance on the revolving credit facility of $27.0 million, as well as the $33.8 million and the $1.9 million reduction in capital leases associated with the sale of NDSG and Parisian, respectively. Despite the decrease in debt, the debt-to-capitalization ratio increased to 40.1% from 26.1% in the prior year due to a reduction in Shareholders’ Equity, primarily related to the March 6, 2006 and the October 3, 2006 $4.00 per share dividends.

At October 28, 2006, the Company maintained a $500 million senior revolving credit facility maturing in 2011, which is secured by inventory and certain third party credit card accounts receivable. Borrowings are limited to a prescribed percentage of eligible inventories and receivables. 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. 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. At October 28, 2006, the Company had no borrowings under its $500 million revolving credit facility.

At October 28, 2006, the Company had $382.7 million of senior notes outstanding, excluding the convertible notes, comprised of five separate series having maturities ranging from 2008 to 2019 and interest rates ranging from 7.00% to 9.88%. 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 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.

 

45


Table of Contents

The Company had $230 million of convertible senior notes, at October 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 83.5609 shares per one thousand dollars in principal amount of notes. The most significant terms and conditions of the senior 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 until the Company’s share price exceeds the conversion price by 20% for a certain trading period; the Company can call the debt on or after March 11, 2011; the conversion rate is subject to a dilution adjustment; and the holder can convert upon a significant credit rating decline and upon a call. The Company used approximately $25 million of the proceeds from the issuances to enter into a 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 October 28, 2006 the Company had $76.3 million in capital leases 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.

The Company is obligated to fund a cash balance pension plan. 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 2007. As part of the sale of NDSG to Bon-Ton, the NDSG pension assets and liabilities were acquired by Bon-Ton.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

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, or obligations under material variable interests.

There were no material changes in the Company’s contractual obligations specified in Item 303(a)(5) of Regulation S-K during the three and nine months ended October 28, 2006. For additional information regarding the Company’s contractual obligations as of January 28, 2006, see the Management’s Discussion and Analysis section of the 2005 Form 10-K.

 

46


Table of Contents

CRITICAL ACCOUNTING POLICIES

A summary of the Company’s critical accounting policies is included in the Management Discussion and Analysis section of the Company’s Form 10-K for the year ended January 28, 2006 filed with the Securities and Exchange Commission.

NEW ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued Interpretation 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This interpretation clarifies the application of Statement 109 by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements. The interpretation requires the Company to review all tax positions accounted for in accordance with Statement 109 and apply a more-likely-than-not recognition threshold. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. Subsequent recognition, derecognition, and measurement is based on management’s best judgment given the facts, circumstances and information available at the reporting date. The guidance is effective for fiscal years beginning after December 15, 2006, which the Company intends to adopt in the first quarter of 2007. The Company has commenced the process of evaluating the expected effect of FIN 48 on the Company’s financial position and its results of operations, but it is currently not yet in a position to determine such effects.

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 15,413 shares.

During September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or a liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under SFAS No. 157, fair value measurements would be separately disclosed by level within the fair value hierarchy effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of this Statement and does not expect it to be material.

 

47


Table of Contents

On September 29, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). SFAS No. 158 requires an employer that sponsors one or more defined benefit pension plans or other postretirement plans to 1) recognize the funded status of a plan, measured as the difference between plan assets at fair value and the benefit obligation, in the balance sheet; 2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; 3) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end balance sheet; and 4) disclose in the notes to the financial statements additional information about the effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. SFAS No. 158 will be applied prospectively for fiscal years ending after December 15, 2006. The Company does not anticipate that SFAS No. 158 will have a material effect on the Company’s results of operations or financial position.

FORWARD-LOOKING INFORMATION

The information contained in this Form 10-Q 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.

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 retail sector; the effectiveness of planned advertising, marketing, and

 

48


Table of Contents

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 Securities and Exchange Commission 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 the 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; and 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. For additional information regarding these and other risk factors, please refer to Exhibit 99.1 to the Company’s Form 10-K for the fiscal year ended January 28, 2006 filed with the SEC, which may be accessed via EDGAR through the Internet at www.sec.gov.

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 3. 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.

Based on the Company’s market risk sensitive instruments (including variable rate debt) outstanding at October 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.

 

49


Table of Contents

Item 4. 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 the end of the period covered by this report. Based upon 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 disclosu