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Saks 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. 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: July 29, 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 August 31, 2006, the number of shares of the Registrant’s Common Stock outstanding was 136,988,131.

 



Table of Contents

TABLE OF CONTENTS

 

     Page No.
PART I. FINANCIAL INFORMATION   

Item 1. Financial Statements (Unaudited)

  

Condensed Consolidated Balance Sheets – July 29, 2006, January 28, 2006 and July 30, 2005

   3

Condensed Consolidated Statements of Income – Three and Six Months Ended July 29, 2006 and July 30, 2005

   4

Condensed Consolidated Statements of Cash Flows – Six Months ended July 29, 2006 and July 30, 2005

   5

Notes to Condensed Consolidated Financial Statements

   6

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

   34

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   51

Item 4. Controls and Procedures

   51
PART II. OTHER INFORMATION   

Item 1. Legal Proceedings

   52

Item 1A. Risk Factors

   52

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

   52

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

   53

Item 6. Exhibits

   54

SIGNATURES

   55

 

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Table of Contents

SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands)

(Unaudited)

 

               Restated
    

July 29,

2006

   January 28,
2006
  

July 30,

2005

ASSETS

        

Current Assets

        

Cash and cash equivalents

   $ 500,914    $ 77,312    $ 249,964

Merchandise inventories

     641,784      807,211      1,283,715

Other current assets

     179,184      165,085      162,849

Deferred income taxes, net

     33,317      119,558      88,345

Current assets - held for sale

     177,343      475,485      —  
                    

Total current assets

     1,532,542      1,644,651      1,784,873

Property and Equipment, net

     1,109,412      1,340,868      1,780,744

Property and Equipment, net - held for sale

     226,320      436,412      —  

Goodwill and Intangibles, net

     338      181,644      235,362

Goodwill and Intangibles, net - held for sale

     4,030      1,789      —  

Deferred Income Taxes, net

     157,648      191,480      235,208

Other Assets

     35,644      42,549      58,692

Other Assets - held for sale

     1,032      11,332      —  
                    

TOTAL ASSETS

   $ 3,066,966    $ 3,850,725    $ 4,094,879
                    

LIABILITIES AND SHAREHOLDERS’ EQUITY

        

Current Liabilities

        

Trade accounts payable

   $ 190,782    $ 190,064    $ 393,823

Accrued expenses and other current liabilities

     368,462      450,115      501,753

Current portion of long-term debt

     7,106      7,803      7,525

Current liabilities - held for sale

     78,292      197,068      —  
                    

Total current liabilities

     644,642      845,050      903,101

Long-Term Debt

     683,180      688,080      755,167

Long-Term Debt - held for sale

     1,638      34,656      —  

Other Long-Term Liabilities

     144,570      203,583      322,525

Other Long-Term Liabilities - held for sale

     26,729      79,973      —  
                    

Total liabilities

     1,500,759      1,851,342      1,980,793

Commitments and Contingencies

     —        —        —  

Shareholders’ Equity

     1,566,207      1,999,383      2,114,086
                    

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 3,066,966    $ 3,850,725    $ 4,094,879
                    

See notes to condensed consolidated financial statements.

 

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SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollar amounts in thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended     Six Months Ended  
     July 29,
2006
   

July 30,

2005

   

July 29,

2006

   

July 30,

2005

 

NET SALES

   $ 760,656     $ 1,214,530     $ 1,800,409     $ 2,602,054  

Cost of sales (excluding depreciation and amortization)

     506,051       788,683       1,143,591       1,630,383  
                                

Gross margin

     254,605       425,847       656,818       971,671  

Selling, general and administrative expenses

     235,488       356,987       510,622       718,954  

Other operating expenses

     92,311       135,144       198,862       274,219  

Store pre-opening costs

     218       598       504       858  

Impairments and dispositions

     1,532       225       (199,454 )     (3,024 )
                                

OPERATING INCOME (LOSS)

     (74,944 )     (67,107 )     146,284       (19,336 )

Interest expense

     (11,666 )     (26,314 )     (25,781 )     (54,524 )

Gain (loss) on extinguishment of debt

     7       (28,991 )     7       (28,991 )

Other income, net

     6,932       2,967       15,751       5,225  
                                

INCOME (LOSS) BEFORE INCOME TAXES

     (79,671 )     (119,445 )     136,261       (97,626 )

Provision (benefit) for income taxes

     (27,816 )     (49,813 )     110,218       (41,751 )
                                

INCOME (LOSS) FROM CONTINUING OPERATIONS

     (51,855 )     (69,632 )     26,043       (55,875 )

DISCONTINUED OPERATIONS:

        

Income from operations of Proffitt’s/McRae’s

        

(including gain on disposal of $156,916)

     —         160,196       —         164,460  

Provision for income taxes

     —         82,370       —         84,220  
                                

GAIN FROM DISCONTINUED OPERATIONS

     —         77,826       —         80,240  
                                

NET INCOME (LOSS)

   $ (51,855 )   $ 8,194     $ 26,043     $ 24,365  
                                

Per-Share amounts - Income (Loss) from Continuing Operations:

        

Earnings (loss) per common share

   $ (0.38 )   $ (0.50 )   $ 0.19     $ (0.40 )

Diluted earnings (loss) per common share

   $ (0.38 )   $ (0.50 )   $ 0.19     $ (0.40 )

Per-Share Amounts - Net Income (Loss):

        

Earnings (loss) per common share

   $ (0.38 )   $ 0.06     $ 0.19     $ 0.18  

Diluted earnings (loss) per common share

   $ (0.38 )   $ 0.06     $ 0.19     $ 0.17  

Weighted average common shares:

        

Basic

     135,222       139,120       134,741       138,723  

Diluted

     135,222       145,005       136,593       144,372  

See notes to condensed consolidated financial statements.

 

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SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollar amounts in thousands)

(Unaudited)

 

     Six Months Ended  
    

July 29,

2006

    July 30,
2005
 

Operating Activities:

    

Income (loss) from continuing operations

   $ 26,043     $ (55,875 )

Income from operations of Proffitt’s/McRaes (Including gain on disposal of $156,916)

     —         80,240  

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

    

Depreciation and amortization

     72,689       104,191  

Impairments and dispositions

     (200,202 )     (3,024 )

Equity compensation

     29,603       11,113  

Deferred income taxes

     95,276       26,305  

Excess tax benefit from stock-based compensation

     (2,568 )     —    

Gain (loss) on extinguishment of debt

     (7 )     28,991  

Change in operating assets and liabilities, net

     (45,017 )     (11,449 )
                

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

     (24,183 )     180,492  

Net Cash Used In Operating Activities - Discontinued Operations

     —         (143,963 )
                

Net Cash Provided By (Used In) Operating Activities

     (24,183 )     36,529  

Investing Activities:

    

Purchases of property and equipment

     (67,025 )     (92,679 )

Proceeds from the sale of property and equipment

     171       13,224  

Proceeds from the sale of NDSG

     1,040,664       —    

Store cash transferred related to sale of NDSG

     (3,110 )     —    
                

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

     970,700       (79,455 )

Net Cash Provided By Investing Activities - Discontinued Operations

       612,695  
                

Net Cash Provided By Investing Activities

     970,700       533,240  

Financing Activities:

    

Payments on long-term debt and capital lease obligations

     (3,743 )     (589,234 )

Cash dividends paid

     (542,185 )     (448 )

Excess tax benefit from stock-based compensation

     2,568       —    

Proceeds from issuance of common stock

     18,398       12,884  
                

Net Cash Used In Financing Activities - Continuing Operations

     (524,962 )     (576,798 )

Net Cash Used In Financing Activities - Discontinued Operations

       (111 )
                

Net Cash Used In Financing Activities

     (524,962 )     (576,909 )

Increase (Decrease) In Cash and Cash Equivalents

     421,555       (7,140 )

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 year

     (1,041 )     —    
                

Cash and cash equivalents at end of period

   $ 500,914     $ 249,964  
                

See notes to condensed consolidated financial statements.

 

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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. These financial statements are unaudited. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement have been included. Operating results for the three and six months ended July 29, 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.

In order to maintain consistency and comparability between periods presented, certain amounts have been reclassified from previously reported financial statements to conform to the financial statement presentation of the current period. These reclassifications have no effect on previously reported net income, shareholders’ equity or cash flows.

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.

ORGANIZATION

The Company is a retailer currently operating, through its subsidiaries, luxury and traditional department stores. At July 29, 2006, the Company operated Saks Fifth Avenue Enterprises (“SFAE”), which consisted of Saks Fifth Avenue stores and Saks Off 5th stores. The Company also operated the Saks Department Store Group (“SDSG”), which consisted of Parisian and Club Libby Lu specialty stores.

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 $6,297 and $8,570 for the three months ended July 29, 2006 and July 30, 2005, respectively. Leased department sales were $43,826 and $57,512 for the three months ended July 29, 2006 and July 30, 2005, respectively, and were excluded from net sales. Commissions from leased departments were $14,674 and $17,757 for the six months

 

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Table of Contents

ended July 29, 2006 and July 30, 2005, respectively. Leased department sales were $102,989 and $121,771 for the six months ended July 29, 2006 and July 30, 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 $483,057 at July 29, 2006, invested principally in money market funds and time deposits, and $222,315 at July 30, 2005, invested principally in money market funds. Income earned on cash equivalents was $6,825 and $2,883 for the three-month periods ended July 29, 2006 and July 30, 2005, respectively, and was reflected in Other Income. For the six-month periods ended July 29, 2006 and July 30, 2005 income earned on these cash equivalents was $15,470 and $4,771, respectively, which was reflected in Other Income. For the six months ended July 29, 2006, the Company made dividend cash payments totaling $542,185, primarily relating to the $4.00 dividend of which $538,964 was paid on May 1, 2006.

Income Taxes – The effective income tax rate for the three and six-month periods ended July 29, 2006 decreased to 35% and increased to 80.9%, respectively, from 79.9% and 63.5% for the three and six-month periods ended July 30, 2005, respectively. The decrease in the three-month effective rate is primarily the result of the write-off of non-deductible goodwill associated with the sale of Proffitt’s and McRae’s (hereafter described as “Proffitt’s”) in the three-month period ending July 30, 2005. The increase in the effective rate for the six-month period ended July 29, 2006 was primarily the result of the write-off of $176,993 of goodwill related to the sale of the Northern Department Store Group (“NDSG”) as discussed in Note 4, of which a substantial portion is non-deductible for tax purposes. The increase was partially offset by a benefit recognized to reduce certain tax reserves resulting from the conclusion of certain state tax examinations.

Components of the Company’s income tax expense for the three and six-month periods ended July 29, 2006 were as follows:

 

     Three Months Ended     Six Months Ended  
    

July 29,

2006

   

July 29,

2006

 

Expected federal income taxes at 35%

   $ (27,866 )   $ 47,691  

State income taxes, net of federal benefit

     (2,146 )     12,062  

Non-deductible goodwill

     —         51,192  

Effect of settling tax exams and other tax reserve adjustments

     —         (2,450 )

Other items, net

     2,196       1,723  
                

Provision (benefit) for income taxes

   $ (27,816 )   $ 110,218  
                

 

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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:

 

July 30, 2005

(in thousands)

   Previously
Reported
   Adjustments    

As

Restated

   Percent
Change
 

Current deferred income taxes, net

   $ 84,946    $ 3,399     $ 88,345    4.0 %

Non-current deferred income taxes, net

   $ 233,672    $ 1,536     $ 235,208    0.7 %

Accrued expenses

   $ 474,819    $ 26,934     $ 501,753    5.7 %

Total shareholders’ equity

   $ 2,136,085    $ (21,999 )   $ 2,114,086    -1.0 %

NOTE 3 - EARNINGS PER COMMON SHARE

Calculations of earnings per common share (“EPS”) for the three and six months ended July 29, 2006 and July 30, 2005 are as follows (income and shares in thousands):

 

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For the Three Months Ended

July 29, 2006

   

For the Three Months Ended

July 30, 2005

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

Basic EPS

   $ (51,855 )   135,222    $ (0.38 )   $ 8,194    139,120    $ 0.06  

Effect of dilutive stock options

     —        —          5,885      —    
                                         

Diluted EPS

   $ (51,855 )   135,222    $ (0.38 )   $ 8,194    145,005    $ 0.06  
                                         
    

For the Six Months Ended

July 29, 2006

   

For the Six Months Ended

July 30, 2005

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

Basic EPS

   $ 26,043     134,741    $ 0.19     $ 24,365    138,723    $ 0.18  

Effect of dilutive stock options

     1,852      —          5,649      (0.01 )
                                         

Diluted EPS

   $ 26,043     136,593    $ 0.19     $ 24,365    144,372    $ 0.17  
                                         

Additionally, the Company had 3,305 and 4,469 share awards of potentially dilutive common stock outstanding at July 29, 2006 and July 30, 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 July 29, 2006 and July 30, 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) recently 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 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.

 

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NOTE 4 – SALE OF BUSINESSES

On July 5, 2005, Belk, Inc. (“Belk”) acquired from the Company for approximately $623,000 in cash substantially all of the assets directly involved in 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.

Upon the closing of the transaction, Belk entered into a Transition Services Agreement (“Belk 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 Belk TSA no longer qualified as continuing involvement in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The sold business is presented as discontinued operations as of July 30, 2005 within the accompanying Condensed Consolidated financial statements.

The following table provides details of the disposed operations of Proffitt’s, had it operated on a stand-alone basis, that are included in the accompanying Condensed Consolidated Statement of Income for the three and six-month periods ended July 30, 2005.

 

     Three Months Ended     Six Months Ended
    

July 29,

2005

   

July 29,

2005

Net sales

   $ 100,702     $ 263,257

Net income

   $ (1,008 )   $ 1,898

Diluted earnings per share

   $ (0.01 )   $ 0.01

Additionally, on March 6, 2006, the Company sold to The Bon-Ton Stores, Inc. (“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

 

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$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. The assets and liabilities associated with NDSG were classified as held for sale at January 28, 2006 in the accompanying Condensed Consolidated Balance Sheet.

Bon-Ton entered into a Transition Service Agreement with the Company (“Bon-Ton TSA”), whereby the Company will continue to provide, for varying transition periods, back office services related to the NDSG operations. The back-office services include certain information technology, telecommunications, credit, accounting and store planning services, among others. Bon-Ton will compensate the Company for these services provided, as outlined in the Bon-Ton TSA. The Bon-Ton TSA qualifies as continuing involvement in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” and therefore, precludes the presentation of the sold business as discontinued operations within the accompanying consolidated financial statements.

The following table provides details of the disposed operations of NDSG, had it operated on a stand-alone basis, that are included within the accompanying Condensed Consolidated Balance Sheets at January 28, 2006 and July 30, 2005 and the Condensed Consolidated Statement of Income for the three-month period ended July 29, 2006 and July 30, 2005.

 

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          January 28,
2006
    July 30,
2005

Merchandise inventory

      $ 453,858     $ 444,571

Property and equipment

      $ 436,412     $ 439,165

Goodwill and intangibles

      $ 173,789     $ 172,000

Other current assets

      $ 32,767     $ 56,465

Accounts payable and other current liablities

      $ 256,499     $ 220,529

Other long-term liabilities

      $ 114,618     $ 122,405
     Three Months Ended    Six Months Ended
    

July 30,

2005

   July 29,
2006
    July 30,
2005

Net sales

   $ 456,684    $ 181,725     $ 948,958

Net income

   $ 1,033    $ (1,857 )   $ 10,608

Diluted earnings per share

   $ 0.01    $ (0.01 )   $ 0.07

After considering the basis of the business sold, transaction fees and other costs, the Company realized a net gain of $205,147 on the sale. Asset impairments, gains, transaction fees and other costs are included in Impairments and Dispositions. The components of these 2006 charges/gains are as follows:

 

     2006 Charges/
(Gains)
    Cash
Proceeds/
(Payments)
    Basis of
Assets Sold
 

Asset Impairments (Gains)

   $ (226,695 )   $ 1,040,960     $ (814,265 )

Transaction Fees and Other Costs

     21,548       (20,469 )     (1,079 )
                        
   $ (205,147 )   $ 1,020,491     $ (815,344 )
                        

The Company announced on August 2, 2006 that it had reached an agreement to sell its Parisian specialty department store business (“Parisian”) (which generated fiscal 2005 revenues of approximately $723,000) to Belk for a purchase price of $285,000 in cash subject to a net working capital adjustment. The sale will include Parisian’s operations consisting of real and personal property, operating leases, and inventory associated with 38 Parisian stores, a 125,000 square foot administrative/headquarters facility in Birmingham, Alabama, and an 180,000 square foot distribution center located in Steele, Alabama. The transaction is subject to customary closing conditions, including the expiration or termination of all waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act, and is expected to be completed in the third fiscal quarter of 2006. The assets and liabilities associated with Parisian were classified as held for sale at July 29, 2006 in the accompanying Condensed Consolidated Balance Sheet.

 

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NOTE 5 - DEBT AND SHARE ACTIVITY

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.

On June 14, 2005, the Company received a notice of default with respect to its convertible notes. The notice of default was given by a note holder that stated that it owned more than 25% of the convertible notes. The notice of default stated that the Company breached covenants in the indenture for the convertible notes that require the Company to (1) file with the Securities and Exchange Commission and the trustee for the convertible notes Annual Reports on Form 10-K and other reports, and (2) deliver to the trustee for the convertible notes, within a 120-day period after the end of the Company’s fiscal year ended January 29, 2005, a compliance certificate specified by the convertible notes indenture. In response to this receipt of a notice of default, on June 20, 2005, the Company announced that it would commence cash tender offers and consent solicitations for three issues of its outstanding senior notes and consent solicitations with respect to two additional issues of its senior notes and its convertible notes.

On July 19, 2005, the Company completed these cash tender offers and consent solicitations. The consent solicitations (including those that were part of the tender offers) offered holders a one-time fee in exchange for their consent to proposed amendments to the indenture for each issue of notes that would, among other things, extend to October 31, 2005, for purposes of the indentures, the Company’s deadlines to file the Company’s 2004 Annual Report on Form 10-K and the Company’s Quarterly Report on Form 10-Q for the first and second quarters of 2005. Upon completion of the tender offers and consent solicitations, 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 first six months ended July 29, 2006 the Company did not purchase any shares of Saks’ common stock. At July 29, 2006, there were 37,830 shares remaining available for repurchase under the Company’s existing share repurchase program. Subsequent to the end of the quarter, on August 30, 2006, the Company repurchased 450 shares of Saks’ common stock at a cost of approximately $6,500, which left 37,380 shares available for repurchase under authorized programs.

NOTE 6 – EMPLOYEE BENEFIT PLANS

The Company sponsors defined benefit cash balance pension plans for many employees of Carson’s and SFAE. In conjunction with the sale of NDSG, the Company sold to Bon-Ton the assets of 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 for the three and six months ended July 29, 2006 and July 30, 2005 were as follows:

 

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     Three Months Ended     Six Months Ended  
     July 29,
2006
    July 30,
2005
    July 29,
2006
    July 30,
2005
 

Service cost

   $ 1,200     $ 1,913     $ 2,706     $ 3,826  

Interest cost

     2,095       5,442       5,473       10,884  

Expected return on plan assets

     (2,324 )     (5,761 )     (5,919 )     (11,522 )

Net amortization of losses and prior service costs

     935       2,599       2,580       5,198  
                                

Net periodic pension expense

   $ 1,906     $ 4,193     $ 4,840     $ 8,386  
                                

The Company voluntarily contributed approximately $11,800 in June 2006 and expects minimal funding requirements in 2007.

NOTE 7 – SHAREHOLDERS’ EQUITY

On March 6, 2006, the Company’s Board of Directors declared a special one-time cash dividend of $4.00 per common share to shareholders of record as of April 14, 2006 and reduced shareholders’ equity for the $547,537 dividend. For the six months ended July 29, 2006, the Company made dividend cash payments totaling $542,185, primarily relating to the $4.00 dividend of which $538,964 was paid on May 1, 2006. The remaining portion of the dividend payable of less than $7,000 will be paid prospectively as restricted shares vest.

As a result of the May 1, 2006 $4.00 per share dividend, the Human Resources Committee of the Company’s Board of Directors exercised its discretion under anti-dilution provisions of the Company’s employee stock option plans 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 FAS 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 $19,600 charge.

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

 

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The following table summarizes the changes in shareholders’ equity for the six months ended July 29, 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

           26,043         26,043  

Dividend paid ($4.00 per share)

         (443,150 )     (104,387 )       (547,537 )

Elimination of NDSG minimum pension liability

             39,381       39,381  

Issuance of common stock

   1,475       148       18,250           18,398  

Income tax benefit related to employee stock plans

         4,237           4,237  

Net activity under stock compensation plans

   (442 )     (46 )     6,727           6,681  

Stock-based compensation FAS123R dividend adjustment

         19,621           19,621  
                                              

Balance at July 29, 2006

   137,038     $ 13,703     $ 1,600,664     $ (15,074 )   $ (33,086 )   $ 1,566,207  
                                              

NOTE 8 – STOCK-BASED COMPENSATION

The Company maintains stock plans for the granting of options, stock appreciation rights and restricted shares to employees and directors. Options granted generally vest over a four-year period after issue and have an exercise term of seven to ten years from the grant date. Restricted 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, “Accounting for Stock-Based compensation”, 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, and recognized stock-based compensation expense in the condensed consolidated financial statements for stock options granted on and subsequent to 2003 and the portion vesting in the first fiscal quarter 2006 for options granted prior to, but not vested as of February 1, 2003, based on the grant date fair value in accordance with the original provisions of SFAS No. 123. The adoption of this standard had an immaterial effect of less than $100 on the Company’s second quarter of 2006 condensed consolidated financial statements. Total stock-based compensation expense, net of related tax effects, for the three and six-month periods ended July 29, 2006 was approximately $17,545 and $20,478, respectively.

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

 

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Table of Contents

flows, in accordance with the provisions of the Emerging Issues Task Force (“EITF”) Issue 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     Six Months Ended  
    

July 30,

2005

   

July 30,

2005

 

Net income as reported

   $ 8,194     $ 24,365  

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

     5,882       7,627  

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

     (6,841 )     (9,584 )
                

Pro forma net income

   $ 7,235     $ 22,408  
                

Basic earnings per common share

    

As reported

   $ 0.06     $ 0.18  

Pro forma

   $ 0.05     $ 0.16  

Diluted earnings per common share

    

As reported

   $ 0.06     $ 0.17  

Pro forma

   $ 0.05     $ 0.16  

 

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The following table summarizes stock options outstanding at July 29, 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

Exercisable at July 29, 2006

   7,876     $ 13.16     $ 21,423

The total intrinsic value of stock options exercised during the three and six months ended July 29, 2006 was $1,270 and $10,478, respectively.

The following table summarizes information regarding stock options outstanding at July 29, 2006:

 

     Options Outstanding    Options Exercisable

Range of Exercise Prices

   Number
Outstanding
at July 29,
2006
   Weighted
Average
Remaining
Contractual
Life (Years)
   Weighted
Average
Exercise
Price
   Number
Exercisable
at July 29,
2006
   Weighted
Average
Exercise
Price

$4.99 to $9.14

   3,170    2.8    $ 7.55    3,053    $ 7.56

$9.15 to $13.48

   711    2.9    $ 10.90    671    $ 10.93

$13.49 to $20.23

   2,610    1.8    $ 14.91    2,611    $ 14.91

$20.24 to $31.44

   1,541    2.0    $ 22.25    1,541    $ 22.25
                            
   8,032    2.3    $ 13.06    7,876    $ 13.16
                            

 

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The following table summarizes restricted stock outstanding at July 29, 2006 and changes during the six months then ended:

 

     Shares     Weighted
Average
Grant
Price

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

As of July 29, 2006, the Company had unearned compensation amounts related to restricted stock of $9,929, included in Additional Paid-In Capital.

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% discounts to market value. Under the plan, as of July 29, 2006, employees have contributed $455 to purchase shares at 85% of the fair market value on the last day of the purchase period. The plan had 335 shares available for issuance as of July 29, 2006.

NOTE 9 - 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 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, SFAE’s allocation to vendors of a portion of markdown costs associated with certain of SFAE’s customer loyalty and other promotional activities, as well as information concerning markdowns, earnings, and other financial data for 1999-2003. The Company is continuing to fully cooperate with the SEC and the Office of the United States Attorney.

 

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Table of Contents

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 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.

 

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Table of Contents

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 SLC has directed the Company to move the Court in each derivative case to dismiss the case, and the Company intends to take that action.

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.

NOTE 10 - 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

 

20


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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.

NOTE 11 - SEGMENT INFORMATION

The following tables represent summary segment financial information and are consistent with management’s view of the business operating structure.

 

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Table of Contents
     Three Months Ended     Six Months Ended  
    

July 29,

2006

   

July 30,

2005

   

July 29,

2006

   

July 30,

2005

 

Net sales:

        

Saks Department Stores Group

   $ 169,071     $ 624,579     $ 536,522     $ 1,306,333  

Saks Fifth Avenue Enterprises

     591,585       589,951       1,263,887       1,295,721  
                                
   $ 760,656     $ 1,214,530     $ 1,800,409     $ 2,602,054  
                                

Operating Income (Loss):

        

Saks Department Stores Group

   $ (981 )   $ (929 )   $ (2,797 )   $ 14,955  

Saks Fifth Avenue Enterprises

     (33,357 )     (42,826 )     6,336       (1,996 )

Items not allocated

     (40,606 )     (23,352 )     142,745       (32,295 )
                                
   $ (74,944 )   $ (67,107 )   $ 146,284     $ (19,336 )
                                

Depreciation and Amortization:

        

Saks Department Stores Group

   $ 7,449     $ 26,235     $ 15,484     $ 52,086  

Saks Fifth Avenue Enterprises

     28,937       25,660       56,063       50,852  

Other

     538       693       1,142       1,253  
                                
   $ 36,924     $ 52,588     $ 72,689     $ 104,191  
                                

Total Assets:

        

Saks Department Stores Group

   $ 478,709     $ 1,625,482     $ 478,709     $ 1,625,482  

Saks Fifth Avenue Enterprises

     1,717,538       1,676,902       1,717,538       1,676,902  

Other

     870,719       792,495       870,719       792,495  
                                
   $ 3,066,966     $ 4,094,879     $ 3,066,966     $ 4,094,879  
                                

Capital Expenditures:

        

Saks Department Stores Group

   $ 13,354     $ 18,400     $ 23,046     $ 36,842  

Saks Fifth Avenue Enterprises

     26,539       25,271       41,022       40,417  

Other

     796       9,361       2,957       15,420  
                                
   $ 40,689     $ 53,032     $ 67,025     $ 92,679  
                                

“Operating Income” for the segments includes net sales; cost of sales; direct selling, general, and administrative expenses; other direct operating expenses for the respective segment; and an allocation of certain operating expenses, including depreciation, shared by the two segments. Items not allocated are those items not considered by the chief operating decision maker in measuring the assets and profitability of the segments. These amounts are generally represented by two categories: (1) general corporate assets and expenses and other amounts including, but not limited to, treasury, investor relations, legal (except for the costs associated with the Audit Committee investigation which have been allocated to SFAE) and finance support services, and general corporate management; and (2) certain items, while often times related to the operations of a segment, are not considered by segment operating management, corporate operating management and the chief operating decision maker in assessing segment operating performance. During the three and six-month periods ended July 29, 2006 and July 30, 2005, items not allocated were comprised of the following:

 

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Table of Contents
     Three Months Ended     Six Months Ended  
     July 29,
2006
    July 30,
2005
    July 29,
2006
    July 30,
2005
 

General corporate expenses

   $ (19,235 )   $ (21,562 )   $ (37,062 )   $ (32,818 )

Impairments and dispositions

     (1,532 )     (225 )     199,454       3,024  

Other items, net

     (19,839 )     (1,565 )     (19,647 )     (2,501 )
                                

Items not allocated

   $ (40,606 )   $ (23,352 )   $ 142,745     $ (32,295 )
                                

General corporate expenses decreased during the three-month period ending July 29, 2006 due to a reduction in year-over-year equity compensation costs. During the three-month periods ended July 29, 2006, impairment and dispositions primarily related to store closures. Other items increased during the three months ended July 29, 2006, primarily due to the FAS 123R expenses associated with the anti-dilution adjustments.

For the six-month period ending July 29, 2006, general corporate expenses increased due to retention and severance costs associated with the sale of Proffitt’s and NDSG and the contemplated strategic alternatives at Parisian, partially offset by the year-over-year reduction in equity compensation costs. During the six-month period ended July 29, 2006, impairment and dispositions primarily consisted of a gain associated with the sale of NDSG, and for the six-month period ended July 30, 2005, impairment and dispositions primarily related to the sale of closed stores. Other items increased during the six months ended July 29, 2006, primarily due to the FAS 123R expenses associated with the anti-dilution adjustments.

NOTE 12 – STORE DISPOSITIONS AND OTHER ACTIVITIES

In October 2004, the Company announced its intention to close 12 SFAE 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 SFAE closings, the Company realized net charges of $473 during the six months ended July 29, 2006, primarily relating to asset impairments at closed stores. The Company realized net gains of $1,261 during the six months ended July 30, 2005, primarily resulting from net gains from the sale of closed stores, offset 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. There were no amounts payable related to these charges at July 29, 2006.

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, as well as performs an asset impairment analysis at each fiscal year end. During the six months ended July 29, 2006, the Company incurred net charges of $5,246 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

 

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the accompanying Condensed Consolidated Statements of Income. There were no amounts payable related to these charges at July 29, 2006. The components of these charges/gains are as follows:

 

     2006
Charges/
(Gains)
   Cash
(Proceeds)/
Payments
    Non-Cash Uses

Asset Impairments

   $ 5,202    $ (141 )   $ 5,343

Other Costs

     44      37       7
                     
   $ 5,246    $ (104 )   $ 5,350
                     

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 six-month periods ended July 29, 2006 and July 30, 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 July 29, 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.

 

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SAKS INCORPORATED

CONDENSED CONSOLIDATING BALANCE SHEETS AT JULY 29, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
   Guarantor
Subsidiaries
   Eliminations     Consolidated

ASSETS

          

Current Assets

          

Cash and cash equivalents

   $ 483,057    $ 17,857      $ 500,914

Merchandise inventories

        641,784        641,784

Other current assets

        179,184        179,184

Deferred income taxes, net

        33,317        33,317

Current assets - held for sale

        177,343        177,343
                            

Total Current Assets

     483,057      1,049,485      —         1,532,542

Property and Equipment, net

        1,109,412        1,109,412

Property and Equipment, net - held for sale

        226,320        226,320

Goodwill and Intangibles, net

        338        338

Goodwill and Intangibles, net - held for sale

        4,030        4,030

Deferred Income Taxes, net

        157,648        157,648

Other Assets

     12,267      23,377        35,644

Other Assets - held for sale

        1,032        1,032

Investment in and Advances to Subsidiaries

     1,695,409       $ (1,695,409 )  
                            

Total Assets

   $ 2,190,733    $ 2,571,642    $ (1,695,409 )   $ 3,066,966
                            

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current Liabilities

          

Trade accounts payable

      $ 190,782      $ 190,782

Accrued expenses and other current liabilities

   $ 12,115      356,347        368,462

Current portion of long-term debt

        7,106        7,106

Current liabilities - held for sale

        78,292        78,292
                            

Total Current Liabilities

     12,115      632,527      —         644,642

Long-Term Debt

     612,221      70,959        683,180

Long-Term Debt - held for sale

        1,638        1,638

Other Long-Term Liabilities

     190      144,380        144,570

Other Long-Term Liabilities - held for sale

        26,729        26,729

Investment by and Advances from Parent

        1,695,409    $ (1,695,409 )  

Shareholders’ Equity

     1,566,207           1,566,207
                            

Total Liabilities and Shareholders’ Equity

   $ 2,190,733    $ 2,571,642    $ (1,695,409 )   $ 3,066,966
                            

 

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Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED JULY 29, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations    Consolidated  

Net sales

     $ 760,656        $ 760,656  

Costs and expenses

         

Cost of sales

       506,051          506,051  

Selling, general and administrative expenses

   $ 1,865       233,623          235,488  

Other operating expenses

     49       92,262          92,311  

Store pre-opening costs

       218          218  

Impairments and dispositions

       1,532          1,532  
                               

Operating loss

     (1,914 )     (73,030 )     —        (74,944 )

Other income (expense)

         

Equity in earnings of subsidiaries

     (48,461 )     $ 48,461   

Interest expense

     (10,141 )     (1,525 )        (11,666 )

Gain on extinguishment of debt

     7            7  

Other income, net

     6,932            6,932  
                               

Loss before provision (benefit) for income taxes

     (53,577 )     (74,555 )     48,461      (79,671 )

Provision (benefit) for income taxes

     (1,722 )     (26,094 )        (27,816 )
                               

Net loss

   $ (51,855 )   $ (48,461 )   $ 48,461    $ (51,855 )
                               

 

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SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE SIX MONTHS ENDED JULY 29, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

Net sales

   $ 2,070     $ 1,798,339       $ 1,800,409  

Costs and expenses

        

Cost of sales

     1,535       1,142,056         1,143,591  

Selling, general and administrative expenses

     3,800       506,822         510,622  

Other operating expenses

     104       198,758         198,862  

Store pre-opening costs

       504         504  

Impairments and dispositions

       (199,454 )       (199,454 )
                                

Operating income (loss)

     (3,369 )     149,653       —         146,284  

Other income (expense)

        

Equity in earnings of subsidiaries

     82,767       $ (82,767 )  

Interest expense

     (20,286 )     (5,495 )       (25,781 )

Gain on extinguishment of debt

     7           7  

Other income, net

     15,751           15,751  
                                

Income before provision for income taxes

     74,870       144,158       (82,767 )     136,261  

Provision for income taxes

     48,827       61,391         110,218  
                                

Net income

   $ 26,043     $ 82,767     $ (82,767 )   $ 26,043  
                                

 

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SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JULY 29, 2006

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

OPERATING ACTIVITIES

        

Net income

   $ 26,043     $ 82,767     $ (82,767 )   $ 26,043  

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

        

Equity in earnings of subsidiaries

     (82,767 )       82,767    

Excess tax benefit from exercise of stock options

     (2,568 )         (2,568 )

Depreciation and amortization

       72,689         72,689  

Equity compensation

     29,603           29,603  

Deferred income taxes

       95,276         95,276  

Impairments and dispositions

       (200,202 )       (200,202 )

Gain on extinguishment of debt

     (7 )         (7 )

Changes in operating assets and liabilities, net

     4,487       (49,504 )       (45,017 )
                                

Net Cash Provided By (Used In) Operating Activities

     (25,209 )     1,026       —         (24,183 )

INVESTING ACTIVITIES

        

Purchases of property and equipment

       (67,025 )       (67,025 )

Proceeds from the sale of assets

       171         171  

Proceeds from the sale of NDSG

     1,040,664           1,040,664  

Cash paid related to sale of NDSG

       (3,110 )       (3,110 )
                                

Net Cash Provided by Investing Activities

     1,040,664       (69,964 )     —         970,700  

FINANCING ACTIVITIES

        

Intercompany borrowings, contributions and distributions

     (56,986 )     56,986      

Payments on long-term debt and capital lease obligations

     (193 )     (3,550 )       (3,743 )

Payment of dividend

     (542,185 )         (542,185 )

Excess tax benefit from exercise of stock options

     2,568           2,568  

Proceeds from issuance of common stock

     18,398           18,398  
                                

Net Cash Provided By (Used In) Financing Activities

     (578,398 )     53,436       —         (524,962 )

Increase (Decrease) In Cash and Cash Equivalents

     437,057       (15,502 )       421,555  

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  

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

       (1,041 )       (1,041 )
                                

Cash and Cash Equivalents at end of period

   $ 483,057     $ 17,857       —       $ 500,914  
                                

 

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SAKS INCORPORATED

CONDENSED CONSOLIDATING BALANCE SHEETS AT JULY 30, 2005

(Dollar Amounts In Thousands)

 

      RESTATED
     Saks
Incorporated
   Guarantor
Subsidiaries
   Eliminations     Consolidated

ASSETS

          

Current Assets

          

Cash and cash equivalents

   $ 221,950    $ 28,014      $ 249,964

Merchandise inventories

     3,804      1,279,911        1,283,715

Other current assets

        162,849        162,849

Deferred income taxes, net

        88,345        88,345
                            

Total Current Assets

     225,754      1,559,119      —         1,784,873

Property and Equipment, net

     4,279      1,776,465        1,780,744

Goodwill and Intangibles, net

        235,362        235,362

Deferred Income Taxes, net

        235,208        235,208

Other Assets

     14,892      43,800        58,692

Investment in and Advances to Subsidiaries

     2,514,166       $ (2,514,166 )  
                            

Total Assets

   $ 2,759,091    $ 3,849,954    $ (2,514,166 )   $ 4,094,879
                            

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current Liabilities

          

Trade accounts payable

   $ 951    $ 392,872      $ 393,823

Accrued expenses and other current liabilities

     9,772      491,981        501,753

Current portion of long-term debt

        7,525        7,525
                            

Total Current Liabilities

     10,723      892,378      —         903,101

Long-Term Debt

     633,682      121,485        755,167

Other Long-Term Liabilities

     600      321,925        322,525

Investment by and Advances from Parent

        2,514,166    $ (2,514,166 )  

Shareholders’ Equity

     2,114,086           2,114,086
                            

Total Liabilities and Shareholders’ Equity

   $ 2,759,091    $ 3,849,954    $ (2,514,166 )   $ 4,094,879
                            

 

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Table of Contents

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED JULY 30, 2005

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations    Consolidated  

Net sales

   $ 4,932     $ 1,209,598        $ 1,214,530  

Costs and expenses

         

Cost of sales

     2,859       785,824          788,683  

Selling, general and administrative expenses

     2,889       354,098          356,987  

Other operating expenses

     431       134,713          135,144  

Store pre-opening costs

       598          598  

Impairments and dispositions

       225          225  
                               

Operating loss

     (1,247 )     (65,860 )     —        (67,107 )

Other income (expense)

         

Equity in earnings of subsidiaries

     (45,688 )     $ 45,688   

Interest expense

     (19,654 )     (6,660 )        (26,314 )

Loss on extinguishment of debt

     (28,991 )          (28,991 )

Other income, net

     2,967            2,967  
                               

Income (loss) before income taxes

     (92,613 )     (72,520 )     45,688      (119,445 )

Benefit for income taxes

     (22,981 )     (26,832 )        (49,813 )
                               

Income (loss) from continuing operations

     (69,632 )     (45,688 )     45,688      (69,632 )

Discontinued operations:

         

Income from operations of Proffitt’s/McRae’s
(including gain on disposal of $156,916)

       160,196          160,196  

Provision for income taxes

       82,370          82,370  
                               

Gain from discontinued operations

       77,826          77,826  
                               

Net income (loss)

   $ (69,632 )   $ 32,138     $ 45,688    $ 8,194  
                               

 

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SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE SIX MONTHS ENDED JULY 30, 2005

(Dollar Amounts In Thousands)

 

      Restated  
     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations    Consolidated  

Net sales

   $ 10,903     $ 2,591,151        $ 2,602,054  

Costs and expenses

         

Cost of sales

     6,446       1,623,937          1,630,383  

Selling, general and administrative expenses

     5,989       712,965          718,954  

Other operating expenses

     901       273,318          274,219  

Store pre-opening costs

       858          858  

Impairments and dispositions

       (3,024 )        (3,024 )
                               

Operating loss

     (2,433 )     (16,903 )     —        (19,336 )

Other income (expense)

         

Equity in earnings of subsidiaries

     (18,958 )     $ 18,958   

Interest expense

     (41,335 )     (13,189 )        (54,524 )

Loss on extinguishment of debt

     (28,991 )          (28,991 )

Other income, net

     5,225            5,225  
                               

Income (loss) before benefit for income taxes

     (86,492 )     (30,092 )     18,958      (97,626 )

Benefit for income taxes

     (30,617 )     (11,134 )        (41,751 )
                               

Income from continuing operations

     (55,875 )     (18,958 )     18,958      (55,875 )

Discontinued operations:

         

Income from operations of Proffitt’s/McRae’s
(including gain on disposal of $156,916)

       164,460          164,460  

Provision for income taxes

       84,220          84,220  
                               

Gain from discontinued operations

       80,240          80,240  
                               

Net income (loss)

   $ (55,875 )   $ 61,282     $ 18,958    $ 24,365  
                               

 

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SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JULY 30, 2005

(Dollar Amounts In Thousands)

 

     Saks
Incorporated
    Guarantor
Subsidiaries
    Eliminations     Consolidated  

OPERATING ACTIVITIES

        

Loss from continuing operations

   $ (55,875 )   $ (18,958 )   $ 18,958     $ (55,875 )

Income from operations of Proffitt’s/McRae’s (Including gain on disposal of $156,916)

       80,240         80,240  

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

        

Equity in earnings of subsidiaries

     18,958         (18,958 )  

Extraordinary loss on extinguishment of debt

     28,991           28,991  

Depreciation and amortization

     538       103,653         104,191  

Equity compensation

     11,113           11,113  

Deferred income taxes

       26,305         26,305  

Impairments and dispositions

       (3,024 )       (3,024 )

Changes in operating assets and liabilities, net

     17,990       (29,439 )       (11,449 )
                                

Net Cash Provided By Operating Activities - Continuing Operations

     21,715       158,777       0       180,492  

Net Cash Used In Operating Activities - Discontinued Operations

       (143,963 )       (143,963 )
                                

Net Cash Provided By Operating Activities

     21,715       14,814       0       36,529  

INVESTING ACTIVITIES

        

Purchases of property and equipment

       (92,679 )       (92,679 )

Proceeds from the sale of assets

       13,224         13,224  
                                

Net Cash Used In Investing Activities - Continuing Operations

     0       (79,455 )     0       (79,455 )

Net Cash Provided By Investing Activities - Discontinued Operations

       612,695         612,695  
                                

Net Cash Provided By Investing Activities

     —         533,240       —         533,240  

FINANCING ACTIVITIES

        

Intercompany borrowings, contributions and distributions

     561,470       (561,470 )    

Payments on long-term debt and capital lease obligations

     (585,672 )     (3,562 )       (589,234 )

Cash dividends paid

     (448 )         (448 )

Proceeds from issuance of common stock

     12,884           12,884  
                                

Net Cash Used In Financing Activities - Continuing Operations

     (11,766 )     (565,032 )     0       (576,798 )

Net Cash Used In Financing Activities - Discontinued Operations

       (111 )       (111 )
                                

Net Cash Used In Financing Activities

     (11,766 )     (565,143 )     —         (576,909 )

Increase (Decrease) In Cash and Cash Equivalents

     9,949       (17,089 )       (7,140 )

Cash and Cash Equivalents at beginning of period

     212,001       45,103         257,104  
                                

Cash and Cash Equivalents at end of period

   $ 221,950     $ 28,014       —       $ 249,964  
                                

 

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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

     4,225      802,986        807,211

Other current assets

        165,085        165,085

Deferred income taxes, net

        119,558        119,558

Current assets - held for sale

        475,485        475,485
                            

Total Current Assets

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

Property and Equipment, net

     4,098      1,336,770        1,340,868

Property and Equipment, net - held for sale

        436,412        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

   $ 1,056    $ 189,008      $ 190,064

Accrued expenses and other current liabilities

     12,793      437,322        450,115

Current portion of long-term debt

        7,803        7,803

Current liabilities - held for sale

        197,068        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
                            

 

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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 of operating the business and is considered to have 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”) is a retailer currently operating two principal business segments in 33 states: Saks Fifth Avenue Enterprises (“SFAE”), which consists of Saks Fifth Avenue and Off 5th; and Saks Department Store Group (“SDSG”), which consists of Parisian and Club Libby Lu. In prior years, SDSG consisted of Proffitt’s and McRae’s (“Proffitt’s”) (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operating under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), Parisian and Club Libby Lu.

The Company’s merchandise offerings primarily consist of apparel, shoes, cosmetics and accessories, and to a lesser extent, gifts and home items. The Company offers national branded merchandise complemented by differentiated product through exclusive merchandise from core vendors, assortments from unique and emerging suppliers, and proprietary brands. At July 29, 2006, Saks operated 54 Saks Fifth Avenue stores with 6.0 million square feet, 50 Off 5th units with 1.4 million square feet, 38 Parisian stores with 4.6 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 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

 

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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:

 

July 30, 2005

(in thousands)

   Previously
Reported
   Adjustments    

As

Restated

   Percent
Change
 

Current deferred income taxes, net

   $ 84,946    $ 3,399     $ 88,345    4.0 %

Non-current deferred income taxes, net

   $ 233,672    $ 1,536     $ 235,208    0.7 %

Accrued expenses

   $ 474,819    $ 26,934     $ 501,753    5.7 %

Total shareholders’ equity

   $ 2,136,085    $ (21,999 )   $ 2,114,086    -1.0 %

SALE OF BUSINESSES

On July 5, 2005, Belk acquired from the Company for $622.7 million in cash substantially all of the assets directly involved in the Company’s Proffitt’s 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.

The Company announced on August 2, 2006 that it had reached an agreement to sell its Parisian specialty department store business (“Parisian”) (which generated fiscal 2005

 

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revenues of approximately $723 million) to Belk for a purchase price of $285 million in cash subject to a net working capital adjustment. The sale will include Parisian’s operations consisting of real and personal property, operating leases, and inventory associated with 38 Parisian stores, a 125,000 square foot administrative/headquarters facility in Birmingham, Alabama, and a 180,000 square foot distribution center located in Steele, Alabama. The transaction is subject to customary closing conditions, including the expiration or termination of all waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act, and is expected to be completed in the third fiscal quarter of 2006.

FINANCIAL PERFORMANCE SUMMARY

The Company recorded a net loss of $51.9 million, or $0.38 per share compared to net income of $8.2 million, or $0.06 per share, for the three months ended July 29, 2006 and July 30, 2005, respectively. The current year period included net after-tax charges totaling $13.9 million, or $.10 per share, primarily consisting of (i) a $12.8 million, or $0.09 per share, non-cash charge related to the treatment under Financial Accounting Standard (SFAS) No. 123R, “Accounting for Stock-Based compensation,” of the anti-dilutive adjustment made to outstanding options related to the Company’s $4 per share dividend and (ii) a $1.1 million, or $0.01 per share, charge primarily related to asset impairments and dispositions. The current year second quarter also included legal and other expenses related to the investigations totaling approximately $0.8 million (net of taxes), or $0.01 per share, and approximately $3.6 million (net of taxes), or $0.03 per share, of severance and retention expenses. The comparable prior year period included an after-tax gain on discontinued operations of $77.8 million, or $0.54 per share, related to Proffitt’s, partially offset by an after-tax loss of $18.8 million, or $0.13 per share, primarily related to a loss on debt extinguishment. The prior year second quarter also included legal and other expenses related to the investigations totaling approximately $3.3 million (net of taxes), or $0.02 per share, and approximately $3.5 million (net of taxes), or $0.02 per share, of severance and retention expenses.

SFAE experienced a 3.4% comparable store sales increase during the three-month period ended July 29, 2006, and its operating loss totaled $33.4 million, a 22% improvement from the $42.8 million loss in the same period last year. Operating income was positively impacted by a year-over-year decline of approximately $5 million in investigation related expenses and negatively impacted by approximately $1 million associated with the lost operating income contribution from the New Orleans store, closed as a result of Hurricane Katrina.

SDSG experienced a 1.0% comparable store sales increase during the three-month period ended July 29, 2006 and generated an operating loss of $1.0 million compared to an operating loss of $0.9 million last year. Operating income on a year-over-year basis was negatively affected by approximately $19 million from the sale of NDSG and positively impacted by approximately $11 million related to cost reductions primarily related to the strategic alternatives process as well as prior year litigation and supply chain initiatives expenses.

 

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Items not allocated to the business segments changed significantly during the year-over-year three-month period. During the three months ended July 29, 2006, the Company incurred a $19.6 million non-cash charge related to the treatment under FAS 123R of the anti-dilutive adjustment made to the outstanding options related to the Company’s $4 per share dividend and $1.5 million in charges related to asset impairments and dispositions. During the three-month period ended July 30, 2005, the Company incurred net charges of $1.8 million primarily related to severance, markdown and other costs associated with the closings of stores.

SFAE realized a 0.4% comparable store sale increase during the six-month period ended July 29, 2006 and experienced an improvement in operating income of $8.3 million to $6.3 million. Operating income was positively impacted by a year-over-year decline of approximately $7 million in investigation related expenses and negatively impacted by approximately $5 million associated with the lost operating income contribution from the closed New Orleans store.

SDSG experienced a 0.8% comparable store sales decrease during the six-month period ended July 29, 2006 and generated an operating loss of $2.7 million compared to operating income of $15.0 million last year. Operating income on a year-over-year basis was negatively affected by approximately $55 million from the sale of NDSG and positively impacted by approximately $34 million related to cost reductions primarily related to the strategic alternatives process as well as prior year litigation and supply chain initiatives expenses.

Items not allocated to the business segments changed significantly during the year-over-year six-month period. During the six months ended July 29, 2006, the Company incurred net gains of $199.4 primarily associated with the sale of NDSG, partially offset by the $19.6 million FAS 123R charge mentioned above. During the six-month period ending July 30, 2005, the Company incurred net gains of $3.0 million primarily related to gains associated with closed stores, partially offset by $2.5 million in severance, markdown and other costs associated with the closings of stores.

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)

 

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     Three Months Ended     Six Months Ended  
     July 29,
2006
    July 30,
2005
    July 29,
2006
    July 30,
2005
 

Net sales

   100.0 %   100.0 %   100.0 %   100.0 %

Costs and expenses:

        

Cost of sales (excluding depreciation and amortization)

   66.5 %   64.9 %   63.5 %   62.7 %

Selling, general & administrative expenses

   31.0 %   29.4 %   28.4 %   27.6 %

Other operating expenses

   12.1 %   11.1 %   11.0 %   10.5 %

Store pre-opening costs

   0.0 %   0.0 %   0.0 %   0.0 %

Impairments and dispositions

   0.2 %   0.0 %   -11.1 %   -0.1 %
                        

Operating income (loss)

   -9.9 %   -5.5 %   8.1 %   -0.7 %

Other income (expense):

        

Interest expense

   -1.5 %   -2.2 %   -1.4 %   -2.1 %

Gain (loss) on extinguishment of debt

   0.0 %   -2.4 %   0.0 %   -1.1 %

Other income, net

   0.9 %   0.2 %   0.9 %   0.2 %
                        

Income (loss) before income taxes

   -10.5 %   -9.8 %   7.6 %   -3.8 %

Provision (benefit) for income taxes

   -3.7 %   -4.1 %   6.1 %   -1.6 %
                        

Income (loss) from continuing operations

   -6.8 %   -5.7 %   1.4 %   -2.1 %

Discontinued operations:

        

Income from operations of Proffitt’s/McRae’s

        

(including gain on disposal of $156,916)

   0.0 %   13.2 %   0.0 %   6.3 %

Provision for income taxes

   0.0 %   6.8 %   0.0 %   3.2 %
                        

Gain from discontinued operations

   0.0 %   6.4 %   0.0 %   3.1 %
                        

Net income (loss)

   -6.8 %   0.7 %   1.4 %   0.9 %
                        

 

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THREE MONTHS ENDED JULY 29, 2006 COMPARED TO THREE MONTHS ENDED JULY 30, 2005

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from the three-month period ended July 30, 2005 to the three-month period ended July 29, 2006:

 

(In Millions)

   SDSG     SFAE     Items not
allocated
    Total
Company
 

For the three months ended July 30, 2005

   $ (0.9 )   $ (42.8 )   $ (23.4 )   $ (67.1 )

Store sales and margin

     3.3       (0.7 )     0.6       3.2  

Operating expenses

     16.0       10.1       2.3       28.4  

Effect of NDSG sale

     (19.4 )       (0.3 )     (19.7 )

Impairments and dispositions

     —         —         (1.0 )     (1.0 )

FAS 123R charge, severance and other costs

     —         —         (18.7 )     (18.7 )
                                

Increase (Decrease)

     (0.1 )     9.4       (17.1 )     (7.8 )
                                

For the three months ended July 29, 2006

   $ (1.0 )   $ (33.4 )   $ (40.5 )   $ (74.9 )
                                

Consolidated

For the three months ended July 29, 2006, total revenues declined 37.4% year-over-year, primarily reflecting the sale of NDSG, and consolidated comparable store sales improved 2.9%. The consolidated gross margin rate declined by 160 basis points from last year, principally due to the sale of NDSG. As a percent of sales, SG&A expenses increased by approximately 160 basis points over the prior year; however, excluding the $19.6 million charge associated with FAS 123R, SG&A expenses would have declined approximately 100 basis points year-over-year.

SFAE

At SFAE, comparable store sales increased 3.4%, and the gross margin rate was essentially flat with last year. SFAE operating income improved by $9.4 million, largely due to a decline in SG&A expenses, principally related to investigation related expenses ($5.2 million), and operating expenses consisting primarily of payroll and advertising costs, slightly offset by the year-over-year decrease in operating income contribution associated with the closed New Orleans store ($1.4 million).

SDSG

SDSG’s first quarter consolidated performance reflected a comparable store sales improvement of 1.0% and a total sales decline of 72.9%, primarily related to the sale of NDSG. (The Proffitt’s business through July 2, 2005 is reflected as discontinued operations.) Operating income declined by $0.1 million to an operating loss of $1.0 million. SDSG’s year-over-year gross margin rate was essentially flat for the quarter.

 

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Operating income on a year-over-year basis was negatively affected by $19.4 million from the sale of NDSG and positively impacted by cost reductions connected with the strategic alternatives process and other cost reductions resulting from prior year litigation and supply chain initiatives expenses. Through careful expense management, as a percent of sales, SG&A expenses declined modestly but other operating expenses rose slightly over the prior year.

Expenses and charges not allocated to the segments increased by $17.2 million primarily due to the $19.6 million charge related to the treatment, under FAS 123R, of the anti-dilutive adjustment made to outstanding options related to the Company’s $4 per share dividend.

NET SALES

The following table shows relevant net sales information by segment for the three-month periods ended July 29, 2006 and July 30, 2005:

 

     Three Months Ended                   

(In Millions)

   July 29,
2006
   July 30,
2005
   Total
Change
    Total %
Change
    Comp %
Change
 

SFAE

   $ 591.6    $ 589.9    $ 1.7     0.3 %   3.4 %

SDSG

     169.1      624.6      (455.5 )   -72.9 %   1.0 %
                                  

Consolidated

   $ 760.7    $ 1,214.5    $ (453.8 )   -37.4 %   2.9 %
                                  

For the three months ended July 29, 2006, total sales decreased 37.4%, and consolidated comparable store sales increased 2.9%. SFAE experienced a 3.4% increase in comparable store sales and a 0.3% total sales increase. SDSG experienced a 1.0% increase in comparable store sales and a 72.9% total sales decrease, primarily related to the sale of NDSG.

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

GROSS MARGIN

For the three months ended July 29, 2006, gross margin was $254.6 million, or 33.5% of net sales, compared to $425.8 million, or 35.1% of net sales, for the three months ended July 30, 2005. The decline in gross margin dollars and the gross margin rate was principally attributable to the lost contribution from the sale of NDSG. The gross margin rate at both SDSG and SFAE was essentially flat on a year-over-year basis.

 

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

For the three months ended July 29, 2006, SG&A was $235.5 million, or 31.0% of net sales, compared to $357.0 million, or 29.4% of net sales, for the three months ended July 30, 2005. The net decrease of $121.5 million in expenses was largely due to the elimination of prior year expenses associated with the sale of NDSG ($119.0 million), a reduction in year-over-year equity compensation costs ($6.5 million), and a decline in investigation related expenses ($5.2 million), partially offset by the current period charge associated with FAS 123R ($19.6 million). As a percent of sales, SG&A increased by approximately 160 basis points over the prior year. Excluding the $19.6 million charge associated with FAS 123R, SG&A expenses would have declined by approximately 100 basis points year-over-year.

OTHER OPERATING EXPENSES

For the three months ended July 29, 2006, other operating expenses, including store pre-opening costs, were $92.5 million, or 12.2% of net sales, compared to $135.7 million, or 11.2% of net sales, for the three months ended July 30, 2005. The decrease of $43.2 million was largely driven by a reduction in depreciation, rent and property and payroll taxes related to the sold NDSG business. As a percent of sales, other operating expenses increased 100 basis points because these expenses are higher as a percent of sales for SFAE and Parisian than at the SDSG businesses that were sold.

IMPAIRMENTS AND DISPOSITIONS

For the three months ended July 29, 2006 and July 30, 2005, the Company realized losses from impairments and dispositions of $1.5 million and $0.2 million, respectively. The current and prior quarter net losses were primarily due to the write-off of fixed assets related to store closings.

INTEREST EXPENSE

For the three months ended July 29, 2006, interest expense was $11.7 million, or 1.5% of net sales, compared to $26.3 million, or 2.2% of net sales, for the three months ended July 30, 2005. The improvement of $14.1 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 June 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.

 

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For the three months ended July 30, 2005, the Company repurchased a total of approximately $585.7 million in principal amount of senior notes. The notes were repurchased at par, which included a consent fee. 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

The effective income tax rates for the three-month periods ending July 29, 2006 and July 30, 2005 were 35% and 79.9%, respectively. The decrease in the effective rate is primarily the result of the write-off of nondeductible goodwill associated with the sale of Proffitt’s in the three-month period ending July 30, 2005.

SIX MONTHS ENDED JULY 29, 2006 COMPARED TO SIX MONTHS ENDED JULY 30, 2005

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from the six-month period ended July 30, 2005 to the six-month period ended July 29, 2006:

 

(In Millions)

   SDSG     SFAE     Items not
allocated
    Total
Company
 

For the six months ended July 30, 2005

   $ 15.0     $ (2.0 )   $ (32.3 )   $ (19.3 )

Store sales and margin

     (0.5 )     (7.1 )     0.8       (6.8 )

Operating expenses

     37.9       15.4       (4.2 )     49.1  

Effect of NDSG sale

     (55.1 )       205.1       150.0  

Impairments and dispositions

     —         —         (8.7 )     (8.7 )

Severance and other costs

     —         —         (18.0 )     (18.0 )
                                

Increase (Decrease)

     (17.7 )     8.3       175.0       165.6  
                                

For the six months ended July 29, 2006

   $ (2.7 )   $ 6.3     $ 142.7     $ 146.3  
                                

Consolidated

On a consolidated basis, net sales decreased 30.8% principally due to the sale of NDSG, while comparable store sales were flat at 0.0%. Consolidated comparable store sales were comprised of a 0.4% increase at SFAE and a 0.8% decrease at SDSG. The gain from the sale of NDSG of $205.1 million, partially offset by the FAS 123R charge of $19.6 million noted above resulted in an increase in operating income of $165.6 million to $146.3 million.

SFAE

At SFAE, comparable store sales increased 0.4%, and the gross margin rate remained relatively flat. SFAE’s operating income improved by $8.3 million. The improvement was driven by a year-over-year decline in operating expenses of $15.4 million, primarily

 

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due to the 7.3% decrease in SG&A related to a decline in investigation related expenses and legal fees, partially offset by the decrease in operating income contribution associated with the closed New Orleans store ($5.2 million).

SDSG

At SDSG, comparable store sales decreased 0.8%, and total sales declined 58.9%, primarily related to the sale of NDSG. Similarly, operating income declined by $17.7 million to a loss of $2.7 million. Operating income on a year-over-year basis was negatively affected by $55.1 million from the sale of the NDSG business and positively affected by approximately $9 million related to prior year litigation and supply chain initiatives.

Items not allocated to the segments improved by $175.0 million primarily due to the gain associated with the sale of NDSG ($205.1 million), slightly offset by the $19.6 million charge related to the treatment, under FAS 123R, of the anti-dilutive adjustment made to outstanding options related to the Company’s $4 per share dividend.

NET SALES

The following table shows relevant net sales information by segment for the six-month periods ended July 29, 2006 and July 30, 2005:

 

     Six Months Ended                   

(In Millions)

   July 29,
2006
   July 30,
2005
   Total
Change
    Total %
Change
    Comp %
Change
 

SDSG

   $ 536.5    $ 1,306.4    $ (769.9 )   -58.9 %   -0.8 %

SFAE

     1,263.9      1,295.7      (31.8 )   -2.5 %   0.4 %
                                  

Consolidated

   $ 1,800.4    $ 2,602.1    $ (801.7 )   -30.8 %   0.0 %
                                  

For the six months ended July 29, 2006, total sales decreased 30.8% year over year, and consolidated comparable store sales were flat at 0.0%. Comparable sales increased 0.4% at SFAE while total sales were negatively affected by approximately $26 million for the six months ended July 29, 2006 due to the New Orleans store closing as a result of Hurricane Katrina. SDSG experienced a 0.8% decline in comparable store sales and a 58.9% total sales decrease, primarily related to the sale of NDSG. The net effect of sales from new and closed stores resulted in an $11.7 million reduction.

GROSS MARGIN

For the six months ended July 29, 2006, gross margin was $656.8 million, or 36.5% of net sales, compared to $971.7 million, or 37.3% of net sales, for the six months ended July 30, 2005. The decline in gross margin dollars and rate was principally attributable to the lost contribution from the sale of NDSG.

 

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

For the six months ended July 29, 2006, SG&A was $510.6 million, or 28.4% of net sales, compared to $719.0 million, or 27.6% of net sales, for the six months ended July 30, 2005. The net decrease of $208.4 million in expenses was largely due to the year-over-year decrease in expenses associated with the sale of NDSG of approximately $187 million, a $7.1 million decrease in investigation related expenses, a $6.5 million reduction in year-over-year equity compensation costs, and a $6.6 million decrease in legal fees, partially offset by the $19.6 million current period charge associated with FAS 123R and a year-over-year increase of $6.7 million in retention costs associated with the strategic alternatives process. As a percent of sales, SG&A increased by 80 basis points over the prior year; however, excluding the FAS 123R charge, SG&A expenses would have declined approximately 30 basis points year-over-year.

OTHER OPERATING EXPENSES

For the six months ended July 29, 2006, other operating expenses, including store pre-opening costs, were $199.4 million, or 11.1% of net sales, compared to $275.1 million, or 10.6% of net sales, for the six months ended July 30, 2005. The decrease of $75.7 million was principally driven by less depreciation, rent and tax expenses resulting from the sale of NDSG.

IMPAIRMENTS AND DISPOSITIONS

For the six months ended July 29, 2006 and July 30, 2005, the Company realized gains from impairments and dispositions of $199.5 million and $3.0 million, respectively. The current period net gain primarily related to the gain on the sale of NDSG, while the prior period net gain primarily related to the sale of closed stores.

INTEREST EXPENSE

For the six months ended July 29, 2006, interest expense was $25.8 million, or 1.4% of net sales, compared to $54.5 million, or 2.1% of net sales, for the six months ended July 30, 2005. The improvement of $28.7 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 six months ended July 29, 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 six months ended July 30, 2005, the Company repurchased a total of approximately $585.7 million in principal amount of senior notes. The notes were repurchased at par, which included a consent fee. 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.

 

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INCOME TAXES

The effective income tax rates for the six-month periods ending July 29, 2006 and July 30, 2005 were 80.9% and 63.5%, respectively. The effective rate for the six-month period ending July 29, 2006 was adversely impacted by the write-off of nondeductible goodwill associated with the NDSG sale and was partially offset by a benefit recognized to reduce certain tax reserves resulting from the conclusion of state tax examinations. The effective rate for the six-month period ending July 30, 2005 was adversely impacted by the write-off of nondeductible goodwill associated with the sale of Proffitt’s and was partially offset by a benefit recognized to increase the state deferred tax rate after the sale of Proffitt’s. Excluding these items, the Company’s effective income tax rate was 39.4% and 39.0% for the six-month period ending July 29, 2006 and July 30, 2005 respectively.

In July 2006, the Financial Accounting Standards Board (FASB) released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (FIN 48). FIN 48 provides a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The company will adopt this Interpretation in the first quarter of 2007 and the cumulative effects, if any, will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The company is evaluating the expected effect of FIN 48 on its Consolidated Financial Statements and is not yet in a position to determine such effects.

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 was ($24.2) million for the six months ended July 29, 2006 and $36.5 million for the six months ended July 30, 2005. Cash provided by operating activities principally represents income before depreciation and non-cash charges and after changes in working capital. The $60.7 million decrease in 2006 from 2005 was largely due to the gain on the disposal of assets from the sale of NDSG during 2006.

Inventory, accounts payable and debt balances fluctuate throughout the year due to the seasonal nature of the Company’s business. Merchandise inventory balances at July 29, 2006 decreased from July 30, 2005 largely due to a reduction in merchandise inventory related to the sale of NDSG.

 

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Cash provided by investing activities was $970.7 million for the six months ended July 29, 2006 and $533.2 million for the six months ended July 30, 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 $437.5 million increase is primarily due to the $1,041.0 million of current period proceeds received from the sale of NDSG, offset partially by the prior period proceeds of $622.4 million received from the sale of Proffitt’s.

Property and equipment amounts at July 29, 2006 decreased from July 30, 2005 amounts primarily due to the disposal of assets related to the sale of NDSG, 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 July 29, 2006 also decreased from July 30, 2005 due to the sale of NDSG, the SDSG goodwill impairment charges taken in the fourth quarter of 2005 and amortization expense during the last twelve months.

Cash used in financing activities was $525.0 million for the six months ended July 29, 2006 and $576.9 million for the six months ended July 30, 2005. The current period use primarily relates to the payment of cash dividends totaling $542.2 million, while the prior period use primarily relates to the repurchase of approximately $585.7 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, availability under its revolving credit facility and anticipated proceeds of approximately $285 million upon the closing of the Parisian transaction in the third fiscal quarter of 2006. 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. At July 29, 2006 and July 30, 2005, the Company maintained cash and cash equivalent balances of $502.0 million and $250.0 million, respectively. At July 29, 2006, the Company had no borrowings under its $500 million revolving credit facility, and had $127.1 million in unfunded letters of credit representing utilization of availability under the facility, leaving unutilized availability under the facility of $372.9 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 excess cash to generate shareholder value. Accordingly, the Company plans to maintain a portion of

 

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its existing cash on hand plus the anticipated proceeds from the Parisian sale to maintain appropriate financial leverage for its residual businesses, 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 March 6, 2006, the Company’s Board of Directors declared a special one-time 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 dividend payable of less than $7 million will be paid prospectively as restricted shares vest.

During the six months ended July 29, 2006 the Company did not repurchase any shares of Sak’s common stock. At July 29, 2006, there were 37.8 million shares remaining available for repurchase under the Company’s existing share repurchase program. Subsequent to the end of the quarter, on August 30, 2006, the Company repurchased 450 thousand shares of Saks common stock at a cost of approximately $6.5 million, which left 37.4 million shares available for repurchase under the authorized programs.

The Company believes it has sufficient cash on hand, availability under its revolving credit facility, and access to various capital markets to repay any of the Company’s senior notes at maturity.

CAPITAL STRUCTURE

The Company continuously evaluates its debt-to-capitalization 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 July 29, 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 July 29, 2006, total debt was $692.3 million, representing a decrease of $70.4 million from the balance of $762.7 million at July 30, 2005. This decrease in debt was primarily the result of the repurchase of $21.4 million of senior notes at par through unsolicited open market repurchases during August 2005, as well as the $34.6 million reduction in capital leases related to the sale of NDSG. Despite the decrease in debt, the debt to total capitalization percentage increased to 30.7% from 26.5% in the prior year due to a reduction in Shareholders’ Equity, primarily related to the $4.00 per share dividend. On March 6, 2006, the Company’s Board of Directors declared a special one-time cash dividend of $4.00 per common share to shareholders of record as of April 14, 2006 and reduced shareholders’ equity for the $546,611 dividend.

At July 29, 2006, the Company maintained a $500 million senior revolving credit facility maturing in 2009, 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.

 

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At July 29, 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.

The Company had $230 million of convertible senior notes, at July 29, 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 67.0142 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 July 29, 2006 the Company had $80.0 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 for SFAE. The Company’s current policy is to maintain at least the minimum funding requirements specified by the Employee Retirement Income Security Act of 1974. The Company expects minimal funding requirements in 2006 and 2007. As part of the sale of NDSG to Bon-Ton, the NDSG pension assets and liabilities were 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; and obligations under material variable interests.

 

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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 six months ended July 29, 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.

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

 

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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.

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 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; 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; and the successful consummation of the Parisian transaction. 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.

 

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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 July 29, 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.

Item 4. 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 July 29, 2006. 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 disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Accounting Officer, to allow timely discussions regarding required disclosures.

 

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PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.

There have been no material developments in the legal proceedings described under the caption “Item 3—Legal Proceedings” in the 2005 Form 10-K.

In addition to the proceedings described under the caption “Item 3 – Legal Proceedings” in the 2005 Form 10-K, 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 an ongoing material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.

Item 1A. RISK FACTORS

There have been no material changes from our risk factors previously disclosed in “Item 1A. Risk Factors” of the Company’s 2005 Form 10-K for the year ended January 28, 2006.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the quarter ended July 29, 2006, the Company did not sell any equity securities which were not registered under the Securities Act or repurchase any of its equity securities.

On December 8, 2005, the Company announced that in anticipation of the closing of the NDSG transaction, its Board of Directors had approved a 35.0 million share increase in its common share repurchase authorization, bringing the total number of authorized shares to 70.0 million. At July 29, 2006, 37.8 million shares remained available for repurchase under these programs. The following are details of repurchases under this program for the first quarter of fiscal 2006:

 

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Period

(in thousands except average price paid per share)

 

Period

   Total Number
of Shares
Repurchased
   Average
Price Paid
per Share
  

Total Number

of Shares

Repurchased as

Part of Publicly
Announced Authorizations

   Maximum Number of
Shares that May Yet Be
Repurchased Under the
Announced Authorizations (a)

Repurchases from April 30, 2006 through May 27, 2006

   —      $ —      —      37,830

Repurchases from May 28, 2006 through July 1, 2006

   —      $ —      —      37,830

Repurchases from July 2, 2006 through July 29, 2006

   —      $ —      —      37,830
               

Total

   —      $ —      —     
               

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

 

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

The Company held an annual meeting of shareholders on June 7, 2006 for the following purposes:

 

Item 1:    To elect five Directors to hold office for the term specified or until their respective successors have been elected and qualified;
Item 2:    To ratify the appointment of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for the current fiscal year ending February 3, 2007; and
Item 3:    To vote on a shareholder proposal concerning cumulative voting for the election of Directors.

 

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

 

     FOR    WITHHELD

Ronald de Waal

   102,662,991    3,594,077

R. Brad Martin

   101,228,668    5,028,400

C. Warren Neel

   97,091,457    9,165,611

Marguerite W. Sallee

   97,352,551    8,904,517

Christopher J. Stadler

   102,869,370    3,387,698

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

 

     FOR    AGAINST    ABSTAIN

Item 2

   99,834,319    6,290,480    132,269

Item 3

   32,350,181    49,314,830    1,599,175

 

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Item 6. EXHIBITS

 

31.1   Certification of Chief Executive Officer, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2   Certification of Chief Accounting Officer, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1   Certification of Chief Executive Officer, Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)
32.2   Certification of Chief Accounting Officer, Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

SAKS INCORPORATED
Registrant
September 6, 2006
Date

/s/ Kevin G. Wills

Kevin G. Wills
Executive Vice President of Finance and
Chief Accounting Officer

 

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