Saks Hurt by Sandy, Q4 Outlook Cautious

For the nine months ended October 27, 2012, total sales were $2,170.9 million, a 3.9 percent increase over total sales of $2,088.5 million for the prior year nine months ended October 29, 2011. Comparable store sales increased 4.3 percent for the nine months.

Overview of Results for the Third Quarter and Nine Months Ended October 27, 2012

For the third quarter ended October 27, 2012, the Company recorded net income of $22.6 million, or $.14 per diluted share. Those results included a reversal of approximately $3.3 million in Federal income tax reserves deemed no longer necessary. Excluding this item, the Company would have recorded net income of $19.3 million, or $.12 per share, for the quarter ended October 27, 2012. For the prior year third quarter ended October 29, 2011, the Company recorded net income of $17.8 million, or $.11 per diluted share.

For the nine months ended October 27, 2012, the Company recorded net income of $42.5 million, or $.28 per diluted share. Those results included after-tax charges totaling $1.5 million composed of $1.8 million of pre-opening costs associated with the Company�€�s new fulfillment center and $3.0 million of asset impairments and store closing costs, netted against the aforementioned $3.3 million income tax reserve reversal. Excluding these items, the Company would have recorded net income of $44.0 million, or $.29 per share, for the nine months ended October 27, 2012.

For the prior year nine months ended October 29, 2011, the Company recorded net income of $37.8 million, or $.24 per diluted share. Those results included after-tax charges totaling $2.9 million comprised of a pension and related benefit charge, a third-party receivable write-down, and an asset impairment charge totaling $1.8 million; $1.8 million of store closing expenses; a $0.3 million loss on debt extinguishment (related to the early retirement of approximately $1.9 million of senior notes); and a reversal of approximately $1.0 million in state income tax reserves deemed no longer necessary. Excluding these after-tax charges, the Company would have recorded net income of $40.7 million, or $.25 per share, for the nine months ended October 29, 2011.

Comments on the Third Quarter and Nine Months Ended October 27, 2012

Stephen I. Sadove, Chairman and Chief Executive Officer of the Company, noted, �€�In spite of the continued uncertain macro environment, we were pleased to post a modest year-over-year increase in operating income and net income for the third quarter.

�€�Our comparable store sales increase of 3.3 percent in the third quarter was below our initial expectation but was on top of a very solid 5.8 percent comparable store sales increase in the prior year third quarter. On a year-to-date basis, comparable store sales increased 4.3 percent, and similarly, this was on top of very strong 10.3 percent increase in the first nine months of last year.�€�

Sadove continued, �€�For the quarter, our gross margin rate deterioration was partially offset by modest SG&A leverage. The third quarter gross margin rate was slightly below our expectations, and the level of SG&A leverage modestly exceeded our expectations.�€�

Several merchandise categories showed sales strength during the third quarter, including women�€�s and men�€�s contemporary apparel, women�€�s and men�€�s shoes, handbags, fine jewelry, and fragrances. The New York City flagship store sales performance was positive and generally in line with the aggregate comparable store sales performance of the Company�€�s Saks Fifth Avenue stores during the quarter.

For the third quarter, the gross margin rate was 43.9 percent compared to last year�€�s third quarter rate of 44.2 percent. The gross margin rate decline was related principally to a modest increase in targeted promotional activity during the quarter. For the nine months, the gross margin rate was 41.9 percent compared to 42.1 percent in the first nine months of last year.

As a percent of sales, SG&A expenses were 27.3 percent in the third quarter this year compared to 27.5 percent in the prior year third quarter. The Company achieved leverage in the third quarter while incurring incremental SG&A expenses to support its omni-channel and Project Evolution (information technology systems and enhancements) initiatives. As a percent of sales (excluding certain items), SG&A expenses were 26.5 percent for the first nine months this year compared to 26.3 percent for the same period last year.

For the quarter, the Company�€�s operating income was 5.7 percent of sales compared to 5.7 percent of sales in the prior year third quarter. Excluding the aforementioned certain items, the Company�€�s operating income was 4.6 percent of sales for the current year nine months compared to 4.9 percent of sales in the prior year nine month period.

Balance Sheet Highlights

Consolidated inventories at October 27, 2012 totaled $927.1 million, a 5.1 percent increase over the prior year. Inventories increased 2.5 percent on a comparable stores basis.

At quarter end, the Company had approximately $74.2 million of cash on hand and no direct outstanding borrowings on its revolving credit facility. During the quarter, the Company repurchased a small amount of common stock, bringing the year-to-date repurchases to $79.1 million (approximately 8.0 million shares at an average price per share of $9.90).

In accordance with FASB Accounting Standard Codification 470 related to accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) (�€�ASC 470�€�), issuers of convertible debt instruments must separately account for the liability and equity components in a manner that will reflect the entity�€�s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. The discounts (the difference between the convertible rate and a nonconvertible borrowing rate on each issuance) on the Company�€�s two series of convertible notes are being accreted to interest expense through the note maturity dates. Accordingly, at October 27, 2012, $12.7 million of the $230 million 2.0 percent convertible notes balance and $6.5 million of the $120 million 7.5 percent convertible notes balance were classified in equity.

Funded debt (including capitalized leases, senior notes, and the debt and equity components of the convertible debentures) at October 27, 2012 totaled approximately $404.8 million, and debt-to-capitalization was 25.9 percent (without giving effect to cash on hand).

Net capital spending for the nine months ended October 27, 2012 totaled approximately $74.3 million.

Outlook for the Fourth Quarter of 2012

Sadove commented, �€�As the overall macroeconomic environment remains very uncertain, we continue to approach the future cautiously but very strategically. We remain focused on executing our core merchandising, service, and marketing strategies, and at the same time, we are making the systems and infrastructure investments necessary to evolve our business to more fully embrace omni-channel retailing. We are confident that these investments will position us for the future and will generate incremental sales and operating margin improvement over time. We remain very optimistic about the outlook for luxury retailing and for Saks Fifth Avenue.

�€�Having said that, sales trends have been soft for the first two weeks of November in the aftermath of Hurricane Sandy. Many of our stores, representing about 40 percent of our total company revenues, were directly impacted by the storm, and we have experienced a decline in saks.com sales generated from our customers in the Northeast. Additionally, sales in a number of our other stores, particularly in Florida, were indirectly affected by the storm, as many of our Northeastern customers have ties to those markets. In aggregate, we estimate that Hurricane Sandy impacted about 55 percent of our total company store revenue base. Based on these current sales trends we are adjusting our outlook for the fourth quarter, which we believe represents a more realistic view of the business.�€�

The Company�€�s assumptions for the balance of 2012 are outlined below. Variation from the sales trends, up or down, could materially impact the other assumptions listed.

    Year-over-year comparable store sales are expected to be relatively flat for the fourth quarter. This comparable store sales assumption is predicated on sales for the balance of the quarter returning to a growth rate similar to the comparable store sales increase posted in the third quarter.
    Comparable store inventory levels are expected to be up in the low-single digit range at fiscal year end.
    Based upon current inventory levels and composition and the Company�€�s promotional calendar and permanent markdown cadence, the Company expects its year-over-year gross margin rate to be flat to down 50 basis points in the fourth quarter.
    As a percent of sales on a year-over-year basis, the Company expects approximately 20 to 60 basis points of SG&A expense leverage in the fourth quarter. SG&A dollar increases are expected to primarily arise from incremental variable costs associated with planned sales growth (primarily sales associates�€� commissions) and investment spending to support the Company�€�s omni-channel initiatives and Project Evolution.
    Other Operating Expenses (rentals, depreciation, and taxes other than income taxes) are expected to total $84 million to $86 million for the fourth quarter. Depreciation and amortization, which are included in the above amounts, should total approximately $123 million for the full fiscal year.
    Based on existing debt arrangements, maturities, and interest rates, interest expense should total approximately $10 million for the fourth quarter.
    An effective tax rate of approximately 40.0 percent for the year.
    A basic common share count of approximately 150 million and a diluted common share count of approximately 194 million for the full fiscal year. Share counts used in earnings per share calculations are expected to fluctuate by quarter during the year based on income levels, convertible debt, and equity awards.
    Net capital expenditures of approximately $115 million for the full year.

The fiscal year ending February 2, 2013 contains a 53rd week which is included in the assumptions outlined above. Management estimates that the 53rd week will represent approximately $40 million in incremental revenues and incremental diluted earnings per share of approximately $.04 for the fiscal year.

Additional Comments on Hurricane Sandy

Eleven Saks Fifth Avenue stores out of the Company�€�s 45 stores were closed from one to seven days, including the Company�€�s New York flagship which was closed for two days. Fifteen of the Company�€�s 64 OFF 5TH stores were closed for up to five days. None of the Company�€�s stores sustained material damage.

Sadove noted, �€�We were as prepared as we could have been for such an event. Our business continuity plans were quickly executed, and we set about trying to assure that each of our associates was safe and that we could get our stores and support locations up and running as quickly as possible. This was a collaborative and inspiring effort among countless associates in our organization. It is truly remarkable what we were able to accomplish in just a few days.�€�

�€�Thankfully, none of our associates was injured, but many suffered devastating personal property losses and have been displaced due to the storm,�€� Sadove continued. �€�Several years ago, we established an associate relief fund for aiding associates and their families that were victim to such natural disasters. Following Hurricane Sandy, we made a meaningful corporate donation to this fund and will also match associate contributions to the fund. We were also proud to make a donation to the American Red Cross, our national charity partner, for their relief efforts. Seeing how everyone has come together to restore our Company�€�s operations and to assist those in need has been very moving. I am very proud of our entire organization.�€�

Sales Detail

Total sales numbers below represent owned department sales, leased department commissions, shipping and handling revenue, and sales return adjustments for Saks Fifth Avenue stores, Saks Fifth Avenue OFF 5TH stores, and Saks Direct. Total sales (in millions) for the third quarter and nine months ended October 27, 2012 compared to last year�€�s third quarter and nine months ended October 29, 2011 were: