Saks 10-Q 2008 Q2 Quarterly report

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: August 4, 2007 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 or other jurisdiction of incorporation)	(IRS Employer Identification No.)

12 East 49th Street New York, New York	10017
(Address of principal executive offices)	(Zip Code)

212-940-5305

(Registrant’s telephone number, including area code)

Indicate by check mark whether 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 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, 2007, the number of shares of the Registrant’s Common Stock outstanding was 143,411,860.

TABLE OF CONTENTS

	Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets – August 4, 2007, February 3, 2007 and July 29, 2006	3
Condensed Consolidated Statements of Income – Three and Six Months Ended August 4, 2007 and July 29, 2006	4
Condensed Consolidated Statements of Cash Flows – Six Months Ended August 4, 2007 and July 29, 2006	5
Notes to Condensed Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3. Quantitative and Qualitative Disclosures About Market Risk	43
Item 4. Controls and Procedures	44
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	44
Item 1A. Risk Factors	45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 4. Submission of Matters to a Vote of Security Holders	45
Item 6. Exhibits	47
SIGNATURES	48

2

SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands)

(Unaudited)

	August 4, 2007		February 3, 2007		July 29, 2006
ASSETS
Current Assets
Cash and cash equivalents	$	128,374	$	277,883	$	500,914
Merchandise inventories		801,693		785,302		641,784
Other current assets		112,131		146,893		179,184
Deferred income taxes, net		24,607		40,763		33,317
Current Assets - held for sale		—		—		177,343
Total current assets		1,066,805		1,250,841		1,532,542
Property and Equipment, net		1,082,893		1,099,331		1,109,412
Property and Equipment, net - held for sale		—		—		226,320
Goodwill and Intangibles, net		310		324		338
Goodwill and Intangibles, net - held for sale		—		—		4,030
Deferred Income Taxes, net		151,090		152,754		157,648
Other Assets		35,967		41,053		35,644
Other Assets - held for sale		—		—		1,032
TOTAL ASSETS	$	2,337,065	$	2,544,303	$	3,066,966
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Trade accounts payable	$	211,968	$	231,038	$	190,782
Accrued expenses and other current liabilities		246,272		382,346		361,481
Dividend payable		2,659		12,729		6,981
Current portion of long-term debt		235,643		236,667		7,106
Current liabilities - held for sale		—		—		78,292
Total current liabilities		696,542		862,780		644,642
Long-Term Debt		339,744		450,010		683,180
Long-Term Debt - held for sale		—		—		1,638
Other Long-Term Liabilities		169,857		135,374		144,570
Other Long-Term Liabilities - held for sale		—		—		26,729
Total liabilities		1,206,143		1,448,164		1,500,759
Commitments and Contingencies		—		—		—
Shareholders’ Equity		1,130,922		1,096,139		1,566,207
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	2,337,065	$	2,544,303	$	3,066,966

See notes to condensed consolidated financial statements.

3

SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollar amounts in thousands, except per share amounts)

(Unaudited)

	Three Months Ended						Six Months Ended
	August 4, 2007			July 29, 2006			August 4, 2007			July 29, 2006
NET SALES	$	694,106		$	603,833		$	1,486,853		$	1,287,962
Cost of sales (excluding depreciation and amortization)		447,340			405,329			911,807			806,600
Gross margin		246,766			198,504			575,046			481,362
Selling, general and administrative expenses		194,258			196,482			407,103			381,371
Other operating expenses:
Property and equipment rentals		27,212			26,928			55,549			55,143
Depreciation and amortization		34,728			31,755			66,526			62,472
Taxes other than income taxes		19,749			19,002			41,969			41,371
Store pre-opening costs		125			117			261			289
Impairments and dispositions		3,314			1,260			3,698			5,590
OPERATING LOSS		(32,620	)		(77,040	)		(60	)		(64,874	)
Interest expense		(9,921	)		(11,598	)		(21,901	)		(25,643	)
Gain (Loss) on extinguishment of debt		(412	)		7			(5,634	)		7
Other income, net		1,735			6,932			4,570			15,751
LOSS BEFORE INCOME TAXES		(41,218	)		(81,699	)		(23,025	)		(74,759	)
Benefit for income taxes		(16,592	)		(28,603	)		(9,436	)		(33,323	)
LOSS FROM CONTINUING OPERATIONS		(24,626	)		(53,096	)		(13,589	)		(41,436	)
DISCONTINUED OPERATIONS:
Income from discontinued operations		—			2,028			—			211,020
Provision for income taxes		—			787			—			143,541
INCOME FROM DISCONTINUED OPERATIONS		—			1,241			—			67,479
NET INCOME (LOSS)	$	(24,626	)	$	(51,855	)	$	(13,589	)	$	26,043
Per-Share amounts - Basic
Loss from continuing operations	$	(0.17	)	$	(0.39	)	$	(0.10	)	$	(0.31	)
Income from discontinued operations	$	—		$	0.01		$	—		$	0.50
Net Income (Loss)	$	(0.17	)	$	(0.38	)	$	(0.10	)	$	0.19
Per-Share Amounts - Diluted
Loss from continuing operations	$	(0.17	)	$	(0.39	)	$	(0.10	)	$	(0.31	)
Income from discontinued operations	$	—		$	0.01		$	—		$	0.50
Net Income (Loss)	$	(0.17	)	$	(0.38	)	$	(0.10	)	$	0.19
Weighted average common shares:
Basic		141,882			135,222			141,065			134,741
Diluted		141,882			135,222			141,065			134,741

See notes to condensed consolidated financial statements.

4

SAKS INCORPORATED and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollar amounts in thousands)

(Unaudited)

	Six Months Ended
	August 4, 2007			July 29, 2006
Operating Activities:
Net Income (loss)	$	(13,589	)	$	26,043
Income from discontinued operations		—			67,479
Loss from continuing operations		(13,589	)		(41,436	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		66,526			62,472
Impairments and dispositions		3,698			5,590
Equity compensation		3,001			29,603
Deferred income taxes		(1,438	)		95,276
Excess tax benefit from stock-based compensation		(8,575	)		(2,568	)
Loss (Gain) on extinguishment of debt		5,634			(7	)
Change in operating assets and liabilities, net		(70,879	)		(74,786	)
Net Cash (Used In) Provided By Operating Activities - Continuing Operations		(15,622	)		74,144
Net Cash Used In Operating Activities - Discontinued Operations		—			(98,327	)
Net Cash Used In Operating Activities		(15,622	)		(24,183	)
Investing Activities:
Purchases of property and equipment		(60,380	)		(42,973	)
Proceeds from the sale of property and equipment		7,806			171
Net Cash Used In Investing Activities - Continuing Operations		(52,574	)		(42,802	)
Net Cash Provided By Investing Activities - Discontinued Operations		—			1,013,502
Net Cash (Used In) Provided By Investing Activities		(52,574	)		970,700
Financing Activities:
Payments on long-term debt and capital lease obligations		(116,140	)		(3,647	)
Cash dividends paid		(7,427	)		(542,185	)
Excess tax benefit from stock-based compensation		8,575			2,568
Proceeds from issuance of common stock		33,679			18,398
Net Cash Used In Financing Activities - Continuing Operations		(81,313	)		(524,866	)
Net Cash Used In Financing Activities - Discontinued Operations		—			(96	)
Net Cash Used In Financing Activities		(81,313	)		(524,962	)
Increase (Decrease) in Cash and Cash Equivalents		(149,509	)		421,555
Cash and cash equivalents at beginning of period		277,883			77,312
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	$	128,374		$	500,914

See notes to condensed consolidated financial statements.

5

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 in the United States of America (“GAAP”) for interim financial information and in compliance 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 GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement have been included. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Operating results for the three and six months ended August 4, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending February 2, 2008 (fiscal year 2007). The financial statements include the accounts of Saks Incorporated and its subsidiaries (collectively, the “Company”). All intercompany amounts and transactions have been eliminated.

The accompanying condensed consolidated balance sheet at February 3, 2007 has been derived from the audited financial statements at that date but does not include all disclosures required by GAAP. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in the Company’s 2006 Annual Report on Form 10-K for the fiscal year ended February 3, 2007.

Certain prior year amounts in the accompanying condensed consolidated financial statements have been reclassified to conform with the 2007 presentation.

ORGANIZATION

The Company’s operations consist of Saks Fifth Avenue (SFA), Off Fifth, and Club Libby Lu. Previously, the Company also operated Saks Department Store Group (“SDSG”), which consisted of Proffitt’s and McRae’s (“Proffitt’s”) (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operated under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), and Parisian (sold to Belk in October 2006). The sold businesses are presented as discontinued operations in the condensed consolidated statements of income, the condensed consolidated balance sheets and the condensed consolidated statements of cash flows for the prior year periods and are discussed in Note 2 “Discontinued Operations.”

6

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 $6,184 and $5,525 for the three months ended August 4, 2007 and July 29, 2006, respectively. Leased department sales were $42,831 and $38,513 for the three months ended August 4, 2007 and July 29, 2006, respectively, and were excluded from net sales. Commissions from leased departments were $13,307 and $12,011 for the six months ended August 4, 2007 and July 29, 2006, respectively. Leased department sales were $93,098 and $84,728 for the six months ended August 4, 2007 and July 29, 2006, 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 totaled $116,629 and $483,057 at August 4, 2007 and July 29, 2006, respectively, primarily consisting of money market funds, demand and time deposits. Income earned on cash equivalents was $1,735 and $6,825 for the three-month periods ended August 4, 2007 and July 29, 2006, respectively, and is reflected in Other Income. For the six-month periods ended August 4, 2007 and July 29, 2006 income earned on these cash equivalents was $4,446 and $15,470, respectively, which was reflected in Other Income.

Income Taxes – The effective income tax rate for the three and six-month periods ended August 4, 2007 was 40.3% and 41%, respectively, as compared to 35% and 44.6% for continuing operations, for the three and six-month periods ended July 29, 2006. The increase in the effective rate for the three-month period ended August 4, 2007 was primarily the result of an adjustment to the valuation allowance on state net operating loss carryforwards recognized during the three-month period ended July 29, 2006. The decrease in the effective tax rate for the six-month period ended August 4, 2007 was primarily the result of the settlement of certain state tax examinations as well as other state tax benefits in the six-month period ended July 29, 2006.

For discontinued operations, the effective income tax rate for the three and six-month periods ended July 29, 2006 was 38.8% and 68%, respectively. This effective income tax rate was higher than the expected rate due to the write-off of non-deductible goodwill related to the sale of NDSG.

7

Components of the Company’s income tax expense for the three and six-month periods ended August 4, 2007 and June 29, 2006 were as follows:

	Three Months Ended						Six Months Ended
	August 4, 2007			July 29, 2006			August 4, 2007			July 29, 2006
Continuing Operations:
Expected federal income taxes at 35%	$	(14,426	)	$	(28,595	)	$	(8,058	)	$	(26,166	)
State income taxes, net of federal benefit		(1,649	)		(8,580	)		(831	)		(12,791	)
Effect of settling tax exams and other tax reserve adjustments		(186	)		—			(307	)		(2,450	)
Other items, net		(331	)		8,572			(240	)		8,084
Benefit for income taxes	$	(16,592	)	$	(28,603	)	$	(9,436	)	$	(33,323	)
Discontinued Operations:
Expected federal income taxes at 35%	$	—		$	710		$	—		$	73,857
State income taxes, net of federal benefit		—			77			—			18,496
Non-deductible goodwill		—			—			—			51,188
Provision for income taxes	$	—		$	787		$	—		$	143,541

The Company adopted the provisions of the Financial Accounting Standards Board (“FASB”) Interpretation 48, Accounting for Uncertainty in Income Taxes (FIN 48) effective as of the beginning of fiscal year 2007. As a result of the implementation the Company recorded a $33,672 decrease in the liability for unrecognized tax benefits which was accounted for as an increase to the beginning shareholder’s equity. As of February 4, 2007 the Company had total gross unrecognized tax benefits of $43,956. Of this total, $12,575 represents the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate.

It is reasonably possible that the amount of unrecognized tax benefits will increase or decrease in the next twelve months as a result of settling uncertain tax positions. However, the Company does not anticipate this to result in any material change to the amount of unrecognized tax benefits.

As a result of the analysis of uncertain tax positions (due to the adoption of FIN 48), the net deferred tax asset related to the state net operating loss carryforwards increased. Therefore, the company performed a valuation allowance analysis to determine the realization of this asset. This analysis resulted in an additional valuation allowance of $19,258 with the offset recorded to shareholders’ equity in accordance with Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.” The Company is subject to the provisions of Statement of Position 90-7 for these net operating losses since they were acquired through the acquisition of a company that had previously filed bankruptcy.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had approximately $2,443 in interest and penalties related to unrecognized tax benefits accrued as of February 4, 2007.

8

The Company files a consolidated U.S. Federal income tax return as well as state tax returns in multiple state jurisdictions. The Company has completed examinations by the Internal Revenue Service for taxable years through January 29, 2005 with no significant adjustments. With respect to the state and local jurisdictions, the Company has completed examinations in many jurisdictions through the same period and currently has examinations in progress for several jurisdictions.

NOTE 2 – DISCONTINUED OPERATIONS

On March 6, 2006, the Company sold to Bon-Ton all outstanding equity interests of certain of the Company’s subsidiaries that owned NDSG (operating under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers), either directly or indirectly. The consideration received consisted of approximately $1,115,000 in cash (reduced as described below based on changes in working capital), plus the assumption by Bon-Ton of approximately $35,000 of unfunded benefits liabilities and approximately $35,000 of capital leases. A working capital adjustment based on working capital as of the effective time of the transaction reduced the amount of cash proceeds by approximately $75,000 resulting in net cash proceeds to the Company of approximately $1,040,000. The disposition included NDSG’s operations consisting of, among other things, the following: 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), 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 year 2005 revenues of approximately $2,168,000. The Company realized a net gain of $204,729 on the sale.

Bon-Ton entered into a Transition Service Agreement with the Company (“NDSG TSA”), whereby the Company continued to provide, for varying transition periods, back office services related to the NDSG operations. The back-office services included certain information technology, telecommunications, credit, accounting and store planning services, among others. Bon-Ton compensated the Company for these services, as outlined in the NDSG TSA. The results of the NDSG operations are reflected as discontinued operations in the accompanying condensed consolidated statements of income and the condensed consolidated statements of cash flows for the prior year periods presented.

On October 2, 2006, the Company sold to Belk all of the outstanding equity interests of the Company’s subsidiaries that conducted the Parisian business. The consideration received consisted of approximately $285,000 in cash (increased in accordance with a working capital adjustment). A working capital adjustment based on working capital as of the effective time of the transaction increased the amount of cash proceeds by approximately $14,200. In addition, Belk reimbursed the Company at closing for approximately $6,700 in capital expenditures incurred in connection with the construction of four new Parisian stores. Belk also paid the Company a premium associated with the purchase of accounts and accounts receivable from Household Bank (SB), N.A. (now known as HSBC Bank Nevada, N.A., “HSBC”), in the amount of approximately $2,300. The foregoing resulted in total net cash proceeds to the Company of approximately $308,200.

9

The disposition included Parisian’s operations consisting of, among other things, the following: real and personal property, operating leases and inventory associated with 38 Parisian stores (which generated fiscal year 2005 revenues of approximately $740,000), a 125,000 square foot administrative/headquarters facility in Birmingham, Alabama and a 180,000 square foot distribution center located in Steele, Alabama. The Company realized a net loss of $12,811 on the sale.

In connection with the consummation of the Parisian transaction, the Company entered into a Transition Services Agreement with Belk (“Parisian TSA”). Pursuant to the Parisian TSA, the Company provided, for varying transition periods, back-office services related to the Company’s former Parisian specialty department store business. The back-office services included information technology, telecommunications, credit, accounting and store planning services, among others. The results of the Parisian operations are reflected as discontinued operations in the accompanying condensed consolidated statements of income, the condensed consolidated balance sheets and the condensed consolidated statements of cash flows for the prior year periods presented.

Net sales of the aforementioned businesses that are included within discontinued operations in the accompanying condensed consolidated statements of income for the three and six months ended July 29, 2006 are $156,823 and $512,477, respectively.

NOTE 3 – EARNINGS PER COMMON SHARE

Calculations of earnings per common share (“EPS”) for the three and six months ended August 4, 2007 and July 29, 2006 are as follows (income and shares in thousands):

	For the Three Months Ended August 4, 2007							For the Three Months Ended July 29, 2006
	Net Loss			Weighted Average Shares	Per Share Amount			Net Loss			Weighted Average Shares	Per Share Amount
Basic EPS	$	(24,626	)	141,882	$	(0.17	)	$	(51,855	)	135,222	$	(0.38	)
Effect of dilutive stock options and convertible debentures		—		—		—			—		—		—
Diluted EPS	$	(24,626	)	141,882	$	(0.17	)	$	(51,855	)	135,222	$	(0.38	)
	For the Six Months Ended August 4, 2007							For the Six Months Ended July 29, 2006
	Net Loss			Weighted Average Shares	Per Share Amount			Net Income			Weighted Average Shares	Per Share Amount
Basic EPS	$	(13,589	)	141,065	$	(0.10	)	$	26,043		134,741	$	0.19
Effect of dilutive stock options and convertible debentures		—		—		—			—		—		—
Diluted EPS	$	(13,589	)	141,065	$	(0.10	)	$	26,043		134,741	$	0.19

10

All potentially dilutive shares of common stock have been excluded from the computation of diluted EPS because the Company reported losses from continuing operations for all periods presented. The Company had 752 and 1,551 option awards of potentially dilutive common stock outstanding as of August 4, 2007 and July 29, 2006. In addition, the Company had 651 and 3,305 option awards of potentially dilutive common stock outstanding at August 4, 2007 and July 29, 2006 with exercise prices exceeding the average market price for the period. There were also 19,219 and 15,413 of potentially exercisable shares under the convertible notes at August 4, 2007 and July 29, 2006, respectively, that were not included in the computation of diluted EPS due to the assumption of net share settlement as discussed below (See Note 4). Additionally, the Company had 14,343 shares of potentially dilutive shares, which were excluded from diluted EPS associated with shares the Company would issue to settle the difference between the fair value and the par value of the convertible notes upon conversion and the shares to be issued upon the exercise of a call option the Company sold at the time of issuance of the convertible debentures.

The Emerging Issues Task Force (“EITF”) reached a consensus, EITF 04-08, “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share,” whereby the contingent conversion provisions should be ignored and therefore an issuer should apply the if-converted method in calculating diluted earnings per share. This consensus became effective for periods ending after December 15, 2004, and requires retroactive application to all periods presented. 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 of the par value upon conversion of the notes in cash, and thus exclude the effect of the conversion of the notes in its calculation of diluted earnings per share. However, 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.

NOTE 4 – DEBT AND SHARE ACTIVITY

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

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

On April 12, 2007, the Company announced final results of its modified “Dutch Auction” tender offer to purchase a portion of its 8.25% senior notes due November 15, 2008 for an aggregate purchase price not to exceed $100,000 (the “offer cap”). The offer expired on April 11, 2007. The aggregate principal amount of notes validly tendered at or above the clearing spread exceeded the offer cap, and the Company accepted $95,872 aggregate principal amount of the notes, resulting in an aggregate purchase price of $100,000 (plus an additional $3,230 in aggregate accrued interest on such notes). The Company accepted for purchase first, all notes tendered at spreads above the clearing spread, and thereafter, the notes validly tendered at the clearing spread on a prorated basis according to the principal amount of such notes. During the three months ended May 5, 2007, the Company recorded a loss on extinguishment of debt of approximately $5,222 related to the repurchase of the notes.

11

During June and July 2007, the Company repurchased an additional $10,420 in principal amount primarily relating to its 8.25% senior notes. The repurchase of these notes resulted in a loss on extinguishment of debt of approximately $412.

On July 10, 2007, the Company gave notice that holders of its $230,000 2.0% convertible senior unsecured notes due March 15, 2024 were entitled to convert the convertible notes into shares of the Company’s common stock due to the closing price of the Company’s common stock exceeding 120% of the convertible senior notes’ conversion price for at least 20 out of the last 30 consecutive trading days in the second calendar quarter of 2007. The holders of the convertible notes have until September 30, 2007 to convert their notes into shares of the Company’s common stock in accordance with, and subject to, the terms of the convertible notes indenture. Since the holders of the convertible notes have the ability to exercise their conversion rights, the convertible notes were classified within “current portion of long-term debt” on the Company’s August 4, 2007 balance sheet. As of September 6, 2007, no note holders had converted their notes into the Company’s common stock.

During the six months ended August 4, 2007, the Company did not purchase any shares of the Company’s common stock. At August 4, 2007, there were 37,380 shares remaining available for repurchase under the Company’s existing share repurchase program.

NOTE 5 – EMPLOYEE BENEFIT PLANS

The Company sponsors a defined benefit cash balance pension plan for many employees of the Company. In conjunction with the sale of NDSG, the Company sold to Bon-Ton the assets, and Bon-Ton assumed the liabilities, of the Carson Pirie Scott cash balance pension plan. The Company generally funds pension costs currently, subject to regulatory funding requirements. The components of net periodic pension expense related to the Company’s remaining pension plan for the three and six months ended August 4, 2007 and July 29, 2006 were as follows:

	Three Months Ended						Six Months Ended
	August 4, 2007			July 29, 2006			August 4, 2007			July 29, 2006
Service cost	$	331		$	1,200		$	662		$	2,400
Interest cost		1,838			2,095			3,676			4,190
Expected return on plan assets		(2,782	)		(2,324	)		(5,564	)		(4,648	)
Net amortization of losses and prior service costs		813			935			1,626			1,870
Net periodic pension expense	$	200		$	1,906		$	400		$	3,812

The Company expects minimal or no funding requirements in 2007 and 2008.

NOTE 6 – SHAREHOLDERS’ EQUITY

On March 6, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share totaling approximately $547,500, and the Company reduced shareholders’ equity

12

by that amount. Approximately $539,000 of the dividend was paid on May 1, 2006 to shareholders of record as of April 14, 2006. The remaining portion of the dividend payable will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.

On October 3, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share totaling approximately $558,600, and the Company reduced shareholders’ equity by that amount. Approximately $552,000 of the dividend was paid on November 30, 2006 to shareholders of record as of November 15, 2006. The remaining portion of the dividend payable will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.

The following table summarizes the changes in shareholders’ equity for the six months ended August 4, 2007:

	Common Stock Shares		Common Stock Amount			Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
Balance at February 3, 2007	140,440		$	14,048		$	1,097,817		$	12,620		$	(28,346	)	$	1,096,139
Adoption of FIN 48							36,528			(2,856	)					33,672
Increase valuation allowance							(19,258	)								(19,258	)
Net loss										(13,589	)					(13,589	)
Dividend adjustment - canceled restricted shares							2,643									2,643
Issuance of common stock	2,877			288			33,391									33,679
Income tax benefit related to employee stock plans							7,736									7,736
Net activity under stock compensation plans	676			68			292									360
Restricted shares withheld for taxes	(594	)		(63	)		(13,398	)								(13,461	)
Stock-based compensation							3,001									3,001
Balance at August 4, 2007	143,399		$	14,341		$	1,148,752		$	(3,825	)	$	(28,346	)	$	1,130,922

NOTE 7 – STOCK-BASED COMPENSATION

The Company maintains an equity stock plan for the granting of options, stock appreciation rights, performance shares, restricted stock, and other forms of equity awards to employees and directors. Options granted generally vest over a four-year period after grant and have an exercise life of seven to ten years from the grant date. Restricted stock and performance shares generally vest one to ten years after the grant date, although applicable plans permit accelerated vesting in certain circumstances at the discretion of the Human Resources and Compensation Committee of the Board of Directors.

13

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payments.” This statement, referred to as “SFAS No. 123R,” revised SFAS No. 123, and requires companies to expense the value of employee stock options and similar awards. Effective January 29, 2006, the Company adopted SFAS No. 123R. The adoption of this standard had an immaterial effect on the Company’s fiscal year 2006 consolidated financial statements. Total stock-based compensation expense resulting from the adoption of SFAS No. 123R, net of related tax effects, for the three and six months ended August 4, 2007 was $1,084 and $1,801, respectively, and total stock-based compensation expense for the three and six months ended July 29, 2006 was $17,545 and $20,478, respectively.

As of August 4, 2007, the Company had unearned compensation amounts related to restricted stock of $18,544 included in Additional Paid-In Capital, which will be recognized over a weighted average period of less than three years.

NOTE 8 – 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. On September 5, 2007, the SEC filed a complaint in United States District Court for the Southern District of New York related to improper collections of vendor markdown allowances in one of six Saks Fifth Avenue merchandising divisions prior to 2004 and a 2002 internal investigation into these collections, the improper timing of the recording of inventory markdowns at Saks Fifth Avenue in 1999 and 2001 and related accounting and disclosure issues. The Company consented to the entry of a final judgment by the Court without admitting or denying the allegations of the complaint filed by the SEC. The final judgment permanently enjoins the Company and its officers and employees from violating the federal securities laws related to the Company’s reporting, record-keeping and internal controls. No fines or other monetary sanctions were levied against the Company. The Company fully cooperated with the SEC during the course of the SEC’s investigation.

14

Vendor Litigations

On May 17, 2005, International Design Concepts, LLC (“IDC”) commenced litigation 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 million 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

15

fraud by Kleinert’s officers, and plaintiff requests $100,000 plus $50,000 in punitive damages (aiding and abetting fraud claim); and (8) various fraudulent conveyance claims with respect to which plaintiff requests damages of $4,000.

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

Other

The Company is involved in 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 9 – NEW ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued FIN 48, an interpretation of SFAS No. 109, “Accounting for Income Taxes.” 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. For a benefit to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The benefit to be recognized for 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. FIN 48 also provides guidance on derecognition, classification of interest and penalties, accounting in interim periods, and disclosure. The Company adopted FIN 48 as of February 4, 2007.

During September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or a liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under SFAS No. 157, fair value measurements would be separately disclosed by level within the fair value hierarchy effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of this Statement.

On September 29, 2006, the FASB issued SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). The Company adopted SFAS No. 158 prospectively on February 3, 2007. SFAS No. 158 requires an employer that sponsors one or more defined benefit pension plans or other postretirement plans to 1) recognize the funded status of a plan, measured as the difference between plan assets at fair value and the

16

benefit obligation, in the balance sheet; 2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; 3) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end balance sheet; and 4) disclose in the notes to the financial statements additional information about the effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition assets or obligations. The adoption of SFAS No. 158 did not have a material effect on the Company’s results of operations or financial position for the fiscal year ended February 3, 2007. Additionally, SFAS No. 158 will require the Company to change the measurement date for the assets and liabilities of its employee benefit plans from November 1 to the Company’s fiscal year end beginning with the fiscal year ending January 31, 2009.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that currently are not required to be measured at fair value. This Statement is effective no later than fiscal years beginning on or after November 15, 2007. The Company is currently evaluating the impact this standard may have on its financial statements.

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 of the par value upon conversion of the notes in cash, and thus exclude the effect of the conversion of the notes in its calculation of diluted 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 diluted 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 diluted calculation by 19,219 shares.

NOTE 10 – STORE DISPOSITIONS AND OTHER ACTIVITIES

The Company continuously evaluates its real estate portfolio and closes underproductive stores in the normal course of business as leases expire or as other circumstances indicate. The Company also performs an asset impairment analysis at each fiscal year end. During the three and six months ended August 4, 2007, the Company incurred net charges of $3,314 and $3,698, respectively, primarily related to asset impairments in the normal course of business. During the three and six months ended July 29, 2006, the Company incurred net charges of $1,260 and $5,590, respectively, primarily related to asset impairments in the normal course of business. Asset impairments are included in Impairments and Dispositions in the accompanying Condensed Consolidated Statements of Income.

During the three and six months ended August 4, 2007, the Company incurred expenses of approximately $3,390 and $25,961, respectively, for severance, retention and transition costs in connection with the Company downsizing following the disposition of its SDSG businesses

17

(discussed in Note 2). Expenses for severance, retention and transition costs for the three and six months ended July 29, 2006 were $5,735 and $12,242, respectively. Severance, retention and transition costs are included in Selling, General & Administrative Expenses in the accompanying Condensed Consolidated Statements of Income. There was a $15,859 payable related to these charges at August 4, 2007.

NOTE 11 – 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 August 4, 2007 and July 29, 2006 and as of February 3, 2007 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 August 4, 2007, Saks Incorporated was the sole obligor for a majority of the Company’s long-term debt and maintained a small group of corporate employees.

18

SAKS INCORPORATED

CONDENSED CONSOLIDATING BALANCE SHEETS AT AUGUST 4, 2007

(Dollar Amounts In Thousands)

	Saks Incorporated		Guarantor Subsidiaries		Eliminations		Consolidated
ASSETS
Current Assets
Cash and cash equivalents	$	116,629	$	11,745			$	128,374
Merchandise inventories				801,693				801,693
Other current assets				112,131				112,131
Deferred income taxes, net				24,607				24,607
Total Current Assets		116,629		950,176	—			1,066,805
Property and Equipment, net				1,082,893				1,082,893
Goodwill and Intangibles, net				310				310
Deferred Income Taxes, net				151,090				151,090
Other Assets		9,405		26,562				35,967
Investment in and Advances to Subsidiaries		1,519,357			(1,519,357	)
Total Assets	$	1,645,391	$	2,211,031	($1,519,357	)	$	2,337,065
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Trade accounts payable				211,968				211,968
Accrued expenses and other current liabilities		8,115		240,816				248,931
Dividend payable
Current portion of long-term debt		230,000		5,643				235,643
Total Current Liabilities		238,115		458,427	—			696,542
Long-Term Debt		276,354		63,390				339,744
Other Long-Term Liabilities				169,857				169,857
Investment by and Advances from Parent				1,519,357	(1,519,357	)
Shareholders’ Equity		1,130,922						1,130,922
Total Liabilities and Shareholders’ Equity	$	1,645,391	$	2,211,031	($1,519,357	)	$	2,337,065

19

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED AUGUST 4, 2007

(Dollar Amounts In Thousands)

	Saks Incorporated			Guarantor Subsidiaries			Eliminations		Consolidated
Net sales				$	694,106				$	694,106
Costs and expenses
Cost of sales					447,340					447,340
Selling, general and administrative expenses	$	967			193,291					194,258
Other operating expenses		18			81,671					81,689
Store pre-opening costs					125					125
Impairments and dispositions					3,314					3,314
Operating loss		(985	)		(31,635	)		—		(32,620	)
Other income (expense)
Equity in earnings of subsidiaries		(20,370	)				$	20,370
Interest expense		(7,606	)		(2,315	)				(9,921	)
Loss on extinguishment of debt		(412	)							(412	)
Other income, net		1,735								1,735
Loss before benefit for income taxes		(27,638	)		(33,950	)		20,370		(41,218	)
Benefit for income taxes		(3,012	)		(13,580	)				(16,592	)
Net Loss		($24,626	)		($20,370	)	$	20,370		($24,626	)

20

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE SIX MONTHS ENDED AUGUST 4, 2007

(Dollar Amounts In Thousands)

	Saks Incorporated			Guarantor Subsidiaries			Eliminations		Consolidated
Net sales				$	1,486,853				$	1,486,853
Costs and expenses
Cost of sales					911,807					911,807
Selling, general and administrative expenses	$	2,598			404,505					407,103
Other operating expenses		51			163,993					164,044
Store pre-opening costs					261					261
Impairments and dispositions					3,698					3,698
Operating Income (Loss)		(2,649	)		2,589			—		(60	)
Other income (expense)
Equity in earnings of subsidiaries		(1,161	)				$	1,161
Interest expense		(17,377	)		(4,524	)				(21,901	)
Loss on extinguishment of debt		(5,634	)							(5,634	)
Other income, net		4,570								4,570
Loss before benefit for income taxes		(22,251	)		(1,935	)		1,161		(23,025	)
Provision (Benefit) for income taxes		(8,662	)		(774	)				(9,436	)
Net Income (Loss)		($13,589	)		($1,161	)	$	1,161		($13,589	)

21

SAKS INCORPORATED

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED AUGUST 4, 2007

(Dollar Amounts In Thousands)

	Saks Incorporated			Guarantor Subsidiaries			Eliminations			Consolidated
OPERATING ACTIVITIES
Net Income (Loss)		($13,589	)		($1,161	)	$	1,161			($13,589	)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Equity in earnings of subsidiaries		1,161						(1,161	)		—
Excess tax benefit from exercise of stock options		(8,575	)								(8,575	)
Depreciation and amortization					66,526						66,526
Equity compensation		3,002									3,002
Deferred income taxes					(1,438	)					(1,438	)
Impairments and dispositions					3,698						3,698
Loss on extinguishment of debt		5,634									5,634
Changes in operating assets and liabilities, net		(5,247	)		(65,633	)					(70,880	)
Net Cash Provided By (Used In) Operating Activities		(17,614	)		1,992			—			(15,622	)
INVESTING ACTIVITIES
Purchases of property and equipment					(60,380	)					(60,380	)
Proceeds from the sale of assets					7,806						7,806
Net Cash Used In Investing Activities		—			(52,574	)		—			(52,574	)
FINANCING ACTIVITIES
Intercompany borrowings, contributions and distributions		(55,692	)		55,692						—
Payments on long-term debt and capital lease obligations		(110,400	)		(5,740	)					(116,140	)
Payment of dividend		(7,427	)								(7,427	)
Excess tax benefit from exercise of stock options		8,575									8,575
Proceeds from issuance of common stock		33,679									33,679
Net Cash Provided By (Used In) Financing Activities		(131,265	)		49,952			—			(81,313	)
Decrease In Cash and Cash Equivalents		(148,879	)		(630	)		—			(149,509	)
Cash and Cash Equivalents at beginning of period		265,508			12,375						277,883
Cash and Cash Equivalents at end of period	$	116,629		$	11,745			—		$	128,374

22

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

23

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				$	603,833					$	603,833
Costs and expenses
Cost of sales					405,329						405,329
Selling, general and administrative expenses	$	1,865			194,617						196,482
Other operating expenses		49			77,636						77,685
Store pre-opening costs					117						117
Impairments and dispositions					1,260						1,260
Operating Loss		(1,914	)		(75,126	)		—			(77,040	)
Other income (expense)
Equity in earnings of subsidiaries		(49,779	)				$	49,779
Interest expense		(10,141	)		(1,457	)					(11,598	)
Gain on extinguishment of debt		7									7
Other income, net		6,932									6,932
Income from continuing operations before Benefit for income taxes		(54,895	)		(76,583	)		49,779			(81,699	)
Benefit for income taxes		(1,799	)		(26,804	)					(28,603	)
Loss from continuing operations		(53,096	)		(49,779	)		49,779			(53,096	)
Discontinued operations:
Equity in earnings of subsidiaries - discontinued operations (net of tax)		1,241						(1,241	)
Income from discontinued operations					2,028						2,028
Provision for income taxes					787						787
Income from discontinued operations		1,241			1,241			(1,241	)		1,241
Net loss		($51,855	)		($48,538	)	$	48,538			($51,855	)

24

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				$	1,287,962					$	1,287,962
Costs and expenses
Cost of sales					806,600						806,600
Selling, general and administrative expenses	$	3,329			378,042						381,371
Other operating expenses		81			158,905						158,986
Store pre-opening costs					289						289
Impairments and dispositions					5,590						5,590
Operating loss		(3,410	)		(61,464	)		—			(64,874	)
Other income (expense)
Equity in earnings of subsidiaries		(43,922	)				$	43,922
Interest expense		(20,286	)		(5,357	)					(25,643	)
Gain on extinguishment of debt		7									7
Other income, net		15,751									15,751
Income from continuing operations before Benefit for income taxes		(51,860	)		(66,821	)		43,922			(74,759	)
Benefit for income taxes		(10,424	)		(22,899	)					(33,323	)
Loss from continuing operations		(41,436	)		(43,922	)		43,922			(41,436	)
Discontinued operations:
Equity in earnings of subsidiaries - discontinued operations (net of tax)		67,479						(67,479	)
Income from discontinued operations (including gain on disposal of $204,729)					211,020						211,020
Provision for income taxes					143,541						143,541
Income from discontinued operations		67,479			67,479			(67,479	)		67,479
Net income	$	26,043		$	23,557			($23,557	)	$	26,043

25

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		$	23,557		($23,557	)	$	26,043
Income from discontinued operations		67,479			67,479		(67,479	)		67,479
Loss from continuing operations		(41,436	)		(43,922	)	43,922			(41,436	)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Equity in earnings of subsidiaries		43,922					(43,922	)		—
Depreciation and amortization					62,472					62,472
Provision for employee stock compensation		29,603								29,603
Deferred income taxes					95,276					95,276
Impairments and dispositions					5,590					5,590
Excess tax benefit from stock-based compensation		(2,568	)							(2,568	)
Gain/loss on extinguishment of debt		(7	)							(7	)
Changes in operating assets and liabilities, net		4,487			(79,273	)				(74,786	)
Net Cash Provided by (Used In) Operating Activities - Continuing Operation		34,001			40,143		—			74,144
Net Cash Used In Operating Activities - Discontinued Operations					(98,327	)				(98,327	)
Net Cash Provided By (Used In) Operating Activities		34,001			(58,184	)	—			(24,183	)
INVESTING ACTIVITIES
Purchases of property and equipment					(42,973	)				(42,973	)
Proceeds from the sale of assets					171					171
Net Cash Used In Investing Activities - Continuing Operations		—			(42,802	)	—			(42,802	)
Net Cash Provided by Investing Activities - Discontinued Operations		1,013,502								1,013,502
Net Cash Provided By Investing Activities		1,013,502			(42,802	)	—			970,700
FINANCING ACTIVITIES
Intercompany borrowings, contributions and distributions		(88,938	)		88,938
Payments on long-term debt and capital lease obligations		(193	)		(3,454	)				(3,647	)
Excess tax benefit from stock-based compensation		2,568								2,568
Payment of Dividend		(542,185	)							(542,185	)
Proceeds from issuance of common stock		18,398								18,398
Net Cash Provided by (Used) In Financing Activities - Continuing Operation		(610,350	)		85,484		—			(524,866	)
Net Cash Used In Financing Activities - Discontinued Operations		(96	)							(96	)
Net Cash Provided By (Used In) Financing Activities		(610,446	)		85,484		—			(524,962	)
Increase 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 year					(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 FEBRUARY 3, 2007

(Dollar Amounts In Thousands)

	Saks Incorporated		Guarantor Subsidiaries		Eliminations			Consolidated
ASSETS
Current Assets
Cash and cash equivalents	$	265,508	$	12,375				$	277,883
Merchandise inventories				785,302					785,302
Other current assets				146,893					146,893
Deferred income taxes, net				40,763					40,763
Total Current Assets		265,508		985,333		—			1,250,841
Property and Equipment, net				1,099,331					1,099,331
Goodwill and Intangibles, net				324					324
Deferred Income Taxes, net				152,754					152,754
Other Assets		11,126		29,927					41,053
Investment in and Advances to Subsidiaries		1,454,660			($	1,454,660	)
Total Assets	$	1,731,294	$	2,267,669	($	1,454,660	)	$	2,544,303
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Trade accounts payable			$	231,038				$	231,038
Accrued expenses and other current liabilities	$	22,552		372,523					395,075
Current portion of long-term debt		230,000		6,667					236,667
Total Current Liabilities		252,552		610,228		—			862,780
Long-Term Debt		382,336		67,674					450,010
Other Long-Term Liabilities		267		135,107					135,374
Investment by and Advances from Parent				1,454,660	($	1,454,660	)
Shareholders’ Equity		1,096,139							1,096,139
Total Liabilities and Shareholders’ Equity	$	1,731,294	$	2,267,669	($	1,454,660	)	$	2,544,303

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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 and has four major components:

• Management’s Overview

• Results of Operations

• Liquidity and Capital Resources

• Critical Accounting Policies

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

MANAGEMENT’S OVERVIEW

GENERAL

Saks Incorporated and its subsidiaries’ (together the “Company”) operations consist of Saks Fifth Avenue (“SFA”), Off Fifth, and Club Libby Lu (“CLL”). Previously, the Company also operated Saks Department Store Group (“SDSG”), which consisted of Proffitt’s and McRae’s (“Proffitt’s”) (sold to Belk, Inc. (“Belk”) in July 2005), the Northern Department Store Group (“NDSG”) (operated under the nameplates of Bergner’s, Boston Store, Carson Pirie Scott, Herberger’s and Younkers and sold to The Bon-Ton Stores, Inc. (“Bon-Ton”) in March 2006), and Parisian (sold to Belk in October 2006). The sold businesses are presented as discontinued operations in the condensed consolidated statements of income, the condensed consolidated balance sheets and the condensed consolidated statements of cash flows for the prior year periods and are discussed below at “Discontinued Operations.”

SFA stores are principally free-standing stores in exclusive shopping destinations or anchor stores in upscale regional malls, and the stores typically offer a wide assortment of distinctive luxury fashion apparel, shoes, accessories, jewelry, cosmetics and gifts. Customers may also purchase SFA products offered in catalogs or online at www.saks.com. Off Fifth is intended to be the premier luxury off-price retailer in the United States and also provides an outlet for the sale of end-of-season clearance merchandise. Off Fifth stores are primarily located in upscale mixed-use and off-price centers and offer luxury apparel, shoes, accessories, cosmetics and decorative home furnishings, targeting the value-conscious customer. CLL consists of mall-based specialty stores, targeting girls aged 4-12 years old. As of August 4, 2007, Saks operated 54 SFA stores with 6.0 million square feet, 49 Off 5th units with 1.4 million square feet, and 88 CLL specialty stores, which includes 67 standalone stores and 21 store-in-stores in the former SDSG businesses, with 0.1 million square feet.

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DISCONTINUED OPERATIONS

On July 5, 2005, Belk acquired from the Company for $622.7 million in cash substantially all of the assets directly involved in the Company’s Proffitt’s business operations, plus the assumption of approximately $1 million in capitalized lease obligations and the assumption of certain other ordinary course liabilities associated with the acquired assets. The assets sold included the real and personal property and inventory associated with 22 Proffitt’s stores and 25 McRae’s stores that generated fiscal 2004 revenues of approximately $784 million. 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 following: 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), administrative/headquarters facilities in Milwaukee, Wisconsin, and distribution centers located in Rockford, Illinois, Naperville, Illinois, Green Bay, Wisconsin, and Ankeny, Iowa. NDSG generated fiscal year 2005 revenues of approximately $2.2 billion. The Company realized a net gain of $204.7 million on the sale.

On October 2, 2006, the Company sold to Belk all of the outstanding equity interests of the Company’s subsidiaries that conducted the Parisian specialty department store business (“Parisian”). The consideration received consisted of $285.0 million in cash (increased in accordance with a working capital adjustment described below). In addition, Belk reimbursed the Company at closing for $6.7 million in capital expenditures incurred in connection with the construction of four new Parisian stores. Belk also paid the Company an additional amount associated with the purchase of accounts and accounts receivable from Household Bank (SB), N.A. (now known as HSBC Bank Nevada, N.A., “HSBC”), in the amount of $2.3 million. A working capital adjustment based on working capital as of the effective time of the transaction increased the amount of cash proceeds by $14.2 million resulting in net cash proceeds of $308.2 million. The disposition included Parisian’s operations consisting of, among other things, the following: real and personal property, operating leases and inventory associated with 38 Parisian stores (which generated fiscal 2005 revenues of approximately $740 million), an administrative/headquarters facility in Birmingham, Alabama and a distribution center located in Steele, Alabama. The Company realized a net loss of $12.8 million on the sale.

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FINANCIAL PERFORMANCE SUMMARY

The Company recorded a net loss of $24.6 million, or $0.17 per share for the three months ended August 4, 2007. For the three months ended July 29, 2006, a net loss was recorded from continuing operations of $53.1 million, or $0.39 per share. After recognition of the Company’s after-tax gain from discontinued operations of $1.2 million, or $0.01 per share, the net loss totaled $51.9 million, or $0.38 per share, for the prior year second quarter ended July 29, 2006.

The three-month period ended August 4, 2007 included charges totaling $2.0 million (net of taxes), or $.01 per share, primarily related to retention, severance and transition costs related to the Company downsizing and consolidation following the disposition of its SDSG businesses. The current year second quarter also included $2.0 million or $.01 per share (net of taxes), related to asset impairment and dispositions and a loss on extinguishment of debt totaling $.2 million (net of taxes), related to the repurchase of $10.4 million of senior notes.

The three-month period ended July 29, 2006 included charges of $.8 million (net of taxes), or $0.01 per share, primarily related to impairments and dispositions. The prior year second quarter also included approximately $3.7 million (net of taxes), or $0.03 per share, of severance and retention expenses, approximately $.8 million (net of taxes), or $0.01 per share, of legal and other expenses related to the SEC and United States Attorney investigations, and $12.8 million (net of taxes), or $0.09 per share, primarily related to the treatment under Financial Accounting Standard 123R (“FAS 123R”) of the anti-dilution adjustment made to outstanding options related to the Company’s $4 per share dividend paid in May 2006.

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.

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RESULTS OF OPERATIONS

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

	Three Months Ended				Six Months Ended
	August 4, 2007		July 29, 2006		August 4, 2007		July 29, 2006
Net sales	100.0	%	100.0	%	100.0	%	100.0	%
Costs and expenses:
Cost of sales (excluding depreciation and amortization)	64.4	%	67.1	%	61.3	%	62.6	%
Selling, general & administrative expenses	28.0	%	32.5	%	27.4	%	29.6	%
Other operating expenses	11.8	%	12.9	%	11.0	%	12.3	%
Store pre-opening costs	0.0	%	0.0	%	0.0	%	0.0	%
Impairments and dispositions	0.5	%	0.2	%	0.2	%	0.4	%
Operating Loss	-4.7	%	-12.8	%	0.0	%	-5.0	%
Other income (expense):
Interest expense	-1.4	%	-1.9	%	-1.5	%	-2.0	%
Loss on extinguishment of debt	-0.1	%	0.0	%	-0.4	%	0.0	%
Other income, net	0.2	%	1.1	%	0.3	%	1.2	%
Loss before income taxes	-5.9	%	-13.5	%	-1.5	%	-5.8	%
Benefit for income taxes	-2.4	%	-4.7	%	-0.6	%	-2.6	%
Loss from continuing operations	-3.5	%	-8.8	%	-0.9	%	-3.2	%
Discontinued operations:
Income from discontinued operations (including gain on disposal)	0.0	%	0.3	%	0.0	%	16.4	%
Provision for income taxes	0.0	%	0.1	%	0.0	%	11.1	%
Income from discontinued operations	0.0	%	0.2	%	0.0	%	5.2	%
Net income (loss)	-3.5	%	-8.6	%	-0.9	%	2.0	%

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THREE MONTHS ENDED AUGUST 4, 2007 COMPARED TO THREE MONTHS ENDED JULY 29, 2006

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from the three-month period ended July 29, 2006 to the three-month period ended August 4, 2007:

(In Millions)	Total Company
For the three months ended July 29, 2006	$	(77.0	)
Store sales and margin		48.3
Operating expenses		(1.8	)
Impairments and dispositions		(2.1	)
Increase		44.4
For the three months ended August 4, 2007	$	(32.6	)

For the three-month period ended August 4, 2007, operating loss totaled $32.6 million, a 57.7% improvement from the $77.0 million loss for same period last year. The improvement in operating income for the quarter was driven by a 13.2% increase in comparable store sales and expense management which resulted in a 560 basis point improvement in the expense rate as a percent of sales. The prior year quarter included a $19.7 million charge associated with the anti-dilution adjustment made to outstanding options related to the Company’s $4 per share dividend paid on May 1, 2006. The gross margin rate also improved 270 basis points for the quarter, primarily as a result of fewer markdowns.

NET SALES

For the three months ended August 4, 2007, total sales increased 14.9% to $694.1 million from $603.8 million for the three months ended July 29, 2006. Similarly, consolidated comparable store sales increased 13.2% year-over-year. The net effect of sales from new and closed stores resulted in a $.6 million increase and the effect of the reopening of the New Orleans store resulted in a $11.7 million increase.

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 and converted stores are included in the comparable store sales comparison, except for the periods in which they are closed for remodeling and renovation.

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GROSS MARGIN

For the three months ended August 4, 2007, gross margin was $246.8 million, or 35.6% of net sales, compared to $198.5 million, or 32.9% of net sales, for the three months ended July 29, 2006. The improvement in gross margin dollars was primarily the result of the 15% increase in sales. The gross margin rate improvement was primarily the result of fewer markdowns.

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

For the three months ended August 4, 2007, SG&A was $194.3 million, or 28% of net sales, compared to $196.5 million, or 32.5% of net sales, for the three months ended July 29, 2006. The $2.2 million decrease was primarily driven by a prior year second quarter charge of $19.7 million associated with FAS123R, which was partially offset by an increase in variable expenses associated with the 2007 second quarter $90.3 million sales increase. Additionally, severance/retention and transition expenses decreased by $2.3 million from the same period last year as the Company is essentially complete with the downsizing and consolidation following the disposition of its SDSG businesses. As a percentage of sales, SG&A decreased by 450 basis points over the prior year; however, excluding the FAS123R charge, SG&A expenses would have declined approximately 130 basis points year over year.

OTHER OPERATING EXPENSES

For the three months ended August 4, 2007, other operating expenses, including store pre-opening costs, were $81.8 million, or 11.8% of net sales, compared to $77.8 million, or 12.9% of net sales, for the three months ended July 29, 2006. This increase of $4.0 million was driven primarily by higher depreciation and amortization costs. As a percent of sales, other operating expenses decreased 110 basis points in 2007, reflecting the ability to leverage primarily fixed costs on the increased sales.

IMPAIRMENTS AND DISPOSITIONS

For the three months ended August 4, 2007, the Company realized losses from impairments and dispositions of $3.3 million, or 0.5% of net sales, compared to a loss of $1.3 million, or 0.2% of net sales, for the three months ended July 29, 2006. The current and prior quarter net charges were primarily due to asset impairments in the normal course of business.

INTEREST EXPENSE

For the three months ended August 4, 2007, interest expense was $9.9 million, or 1.4% of net sales, compared to $11.6 million, or 1.9% of net sales, for the three months ended July 29, 2006. The improvement of $1.7 million was primarily due to the reduction in debt resulting from the repurchase of $106.3 million of senior notes during the six months ending August 4, 2007.

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INCOME TAXES

For continuing operations, the effective income tax rates for the three-month periods ended August 4, 2007 and July 29, 2006 were 40.3% and 35%, respectively. The increase in the effective rate for the three-month period ended August 4, 2007 was primarily the result of an adjustment to the valuation allowance on state net operating loss carryforwards recognized during the three-month period ended July 29, 2006. The effective income tax rate for discontinued operations for the three-month period ended July 29, 2006 was 38.8%. The effective income tax rate was higher than the expected rate due to the write-off of non-deductible goodwill related to the sale of NDSG.

SIX MONTHS ENDED AUGUST 4, 2007 COMPARED TO SIX MONTHS ENDED JULY 29, 2006

DISCUSSION OF OPERATING INCOME

The following table shows the changes in operating income from the six-month period ended August 4, 2007 to the six-month period ended July 29, 2006:

(In Millions)	Total Company
For the six months ended July 29, 2006	$	(64.9	)
Store sales and margin		93.7
Operating expenses		(30.8	)
Impairments and dispositions		1.9
Increase		64.8
For the six months ended August 4, 2007	$	(0.1	)

For the six-month period ended August 4, 2007, operating loss improved to $0.1 million from an operating loss of $64.9 million for the six-month period ended July 29, 2006. The improvement in operating income for the six months ended August 4, 2007 was driven by a 13.9% increase in comparable store sales and expense management which resulted in a 360 basis point improvement in the expense rate as a percent of sales. The gross margin rate also improved 130 basis points for the six months ended August 4, 2007. The improvement in gross margin dollars and the gross margin rate was principally attributable to the higher sales driven by the strengthening of merchandise assortments by store and enhancements to the merchandise planning and allocation process.

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NET SALES

For the six months ended August 4, 2007, total sales increased 15.4% to $1.5 billion from $1.3 billion for the six months ended July 29, 2006. Similarly, consolidated comparable store sales increased 13.9% year-over-year. The net effect of sales from new and closed stores resulted in a $1.8 million reduction, while the net effect of the reopening of the New Orleans store resulted in a $25.8 million increase.

GROSS MARGIN

For the six months ended August 4, 2007, gross margin was $575 million, or 38.7% of net sales, compared to $481.4 million, or 37.4% of net sales, for the six months ended July 29, 2006. The improvement in gross margin dollars and the gross margin rate was principally attributable to the higher sales driven by the strengthening of merchandise assortments by store and enhancements to the merchandise planning and allocation process.

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

For the six months ended August 4, 2007, SG&A was $407.1 million, or 27.4% of net sales, compared to $381.4 million, or 29.6% of net sales, for the six months ended July 29, 2006. The net increase of $25.7 million in expenses was primarily driven by higher variable expenses associated with the year over year sales increase of $198.9 million and an increase of $13.7 million of severance/retention and transition costs due to the Company downsizing and consolidation following the disposition of its SDSG businesses, which management does not expect to be long-term continuing obligations of the Company. The SG&A increase was offset in part by a prior year second quarter charge of $19.7 million associated with FAS123R. As a percentage of sales, SG&A decreased by 220 basis points over the prior year; however, excluding the FAS123R charge, SG&A expenses would have declined approximately 70 basis points year over year.

OTHER OPERATING EXPENSES

For the six months ended August 4, 2007, other operating expenses, including store pre-opening costs, were $164.3 million, or 11% of net sales, compared to $159.3 million, or 12.4% of net sales, for the six months ended July 29, 2006. The increase of $5 million was principally driven by higher depreciation and amortization expense of $4 million.

IMPAIRMENTS AND DISPOSITIONS

For the six months ended August 4, 2007, the Company realized losses from impairments and dispositions of $3.7 million, or 0.2% of net sales, compared to a loss of $5.6 million, or 0.4% of net sales, for the six months ended July 29, 2006. The current and prior quarter net charges were primarily due to asset impairments in the normal course of business.

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INTEREST EXPENSE

For the six months ended August 4, 2007, interest expense was $21.9 million, or 1.5% of net sales, compared to $25.6 million, or 2% of net sales, for the six months ended July 29, 2006. The improvement of $3.7 million was primarily due to the reduction in debt resulting from the repurchase of $106.3 million of senior notes during the six months ended August 4, 2007.

INCOME TAXES

For continuing operations, the effective income tax rates for the six-month periods ended August 4, 2007 and July 29, 2006 were 41% and 44.6%, respectively. The decrease in the effective rate for the six-month period ended August 4, 2007 was primarily the result of the settlement of certain state tax examinations as well as other state tax benefits during the six-month period ended July 29, 2006. The effective income tax rate for discontinued operations for the six-month period ended July 29, 2006 was 68%. The effective income tax rate was higher than the expected rate due to the write-off of non-deductible goodwill related to the sale of NDSG.

The Company adopted the provisions of FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) effective as of the beginning of fiscal year 2007. As a result of the implementation the Company recorded a $33.7 million decrease in the liability for unrecognized tax benefits which was accounted for as an increase to the beginning shareholder’s equity. As of February 4, 2007 the Company had total gross unrecognized tax benefits of $44.0 million. Of this total, $12.6 million represents the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate.

It is reasonably possible that the amount of unrecognized tax benefits will increase or decrease in the next twelve months as a result of settling uncertain tax positions. However, the Company does not anticipate this to result in any material change to the amount of unrecognized tax benefits.

As a result of the analysis of uncertain tax positions (due to the adoption of FIN 48), the net deferred tax asset related to the state net operating loss carryforwards increased. Therefore, the company performed a valuation allowance analysis to determine the realization of this asset. This analysis resulted in an additional valuation allowance of $19.3 million with the offset recorded to shareholder’s equity in accordance with Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.” The Company is under the provisions of Statement of Position 90-7 for these net operating losses since they were acquired through the acquisition of a company that had previously filed bankruptcy.

The Company files a consolidated U.S. Federal income tax return as well as state tax returns in multiple state jurisdictions. The Company has completed examinations by the

36

Internal Revenue Service for taxable years through January 29, 2005 with no significant adjustments. With respect to the state and local jurisdictions, the Company has completed examinations in many jurisdictions through the same period and currently has examinations in progress for several jurisdictions.

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 available cash, 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 (used in) provided by operating activities from continuing operations was $(15.6) million for the six months ended August 4, 2007 and $74.1 million for the six months ended July 29, 2006. Cash (used in) provided by operating activities principally represents income (loss) before depreciation and non-cash charges and after changes in working capital. The $89.7 million decrease in 2007 from 2006 was largely due to the changes in deferred income taxes and equity compensation.

Inventory, accounts payable and debt balances fluctuate throughout the year due to the seasonal nature of the Company’s business. Merchandise inventory balances at August 4, 2007 increased from July 29, 2006 due to planned increased inventories at SFA. Consolidated comparable inventories increased approximately 23% over last year, attributable to the Company’s ongoing initiative of a targeted inventory reinvestment strategy.

Cash used in investing activities from continuing operations was $52.6 million for the six months ended August 4, 2007 and $42.8 million for the six months ended July 29, 2006. 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 $9.8 million increase in cash used is primarily due to an increase in capital expenditures of approximately $17.4 million, partially offset by the increase in proceeds from the sale of SFA property of approximately $7.6 million.

Property and equipment amounts at August 4, 2007 decreased from July 29, 2006 amounts primarily due to the disposal of assets related to the sale of Parisian and the sale of SFA property, 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 August 4, 2007 also decreased from July 29, 2006 due to the sale of Parisian and amortization expense during the last twelve months.

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Cash used in financing activities from continuing operations was $81.3 million for the six months ended August 4, 2007 and $524.9 million for the six months ended July 29, 2006. The current period use primarily relates to the repurchase of approximately $106.3 million in principal amount of senior notes, while the prior period use primarily relates to the payment of cash dividends totaling $542.2 million.

CASH BALANCES AND LIQUIDITY

The Company’s primary sources of short-term liquidity are cash on hand and availability under its revolving credit facility. At the Company’s request, due to the sale of NDSG, the revolving credit facility was reduced from $800 million to $500 million in March 2006. In September 2006, the maturity date of the revolving credit facility was extended to September 2011. At August 4, 2007 and July 29, 2006, the Company maintained cash and cash equivalent balances of $128.4 million and $500.9 million, respectively. Exclusive of approximately $11.7 million and $18.9 million of store operating cash at August 4, 2007 and July 29, 2006, respectively, cash was invested principally in various money market funds at August 4, 2007 and July 29, 2006, respectively. There was no restricted cash as of August 4, 2007 and July 29, 2006.

On March 6, 2006, the Company’s Board of Directors declared a cash dividend of $4.00 per common share totaling approximately $547,500, and the Company reduced shareholders’ equity by that amount. Approximately $539,000 of the dividend was paid on May 1, 2006 to shareholders of record as of April 14, 2006. The remaining portion of the dividend payable will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.

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 Company’s existing share repurchase program.

On October 3, 2006 the Company’s Board of Directors declared a cash dividend of $4.00 per common share totaling approximately $558,600, and the Company reduced shareholders’ equity by that amount. Approximately $552,000 of the dividend was paid on November 30, 2006 to shareholders of record as of November 15, 2006. The remaining portion of the dividend payable will be paid prospectively as, and to the extent, awards of restricted stock and performance shares vest.

At August 4, 2007, the Company had no direct borrowings under its $500 million revolving credit facility, and had $47.3 million in unfunded letters of credit, leaving unutilized availability under that facility of $452.7 million. The amount of cash on hand and borrowings under the facility are influenced by a number of factors, including sales, inventory levels, vendor terms, the level of capital expenditures, cash requirements related to financing instruments, and the Company’s tax payment obligations, among others.

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

CAPITAL STRUCTURE

The Company continuously evaluates its debt-to-capitalization ratio in light of the Company’s disposition of businesses, economic trends, business trends, levels of interest rates, and terms, conditions and availability of capital in the capital markets. At August 4, 2007, 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. On August 4, 2007, total debt was $575.4 million, representing a decrease of $116.5 million from the balance of $691.9 million at July 29, 2006. This decrease in debt was primarily the result of the $106.3 million repurchase of senior notes and the $2.0 million reduction in capital leases associated with the sale of Parisian. Despite the decrease in debt, the debt-to-capitalization ratio increased to 33.7% from 30.8% in the prior year due to a reduction in Shareholders’ Equity, primarily related to the October 3, 2006 $4.00 per share dividend.

At August 4, 2007, the Company maintained a $500 million senior revolving credit facility maturing in 2011, which is secured by inventory and certain third party credit card accounts receivable. Borrowings are limited to a prescribed percentage of eligible inventories and receivables. There are no debt ratings-based provisions in the facility. The facility includes a fixed-charge coverage ratio requirement of 1 to 1 that the Company is subject to only if availability under the facility becomes less than $60 million. The facility contains default provisions that are typical for this type of financing, including a provision that would trigger a default of the facility if a default were to occur in another debt instrument resulting in the acceleration of principal of more than $20 million in that other instrument. At August 4, 2007, the Company had no direct borrowings under the revolving credit facility.

At August 4, 2007, the Company had $276.4 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.

On April 12, 2007, the Company announced the results of its modified “Dutch Auction” tender offer to purchase a portion of its 8.25% senior notes due November 15, 2008 for an aggregate purchase price not to exceed $100 million (the “offer cap”). The offer expired

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on April 11, 2007. The aggregate principal amount of notes validly tendered at or above the clearing spread exceeded the offer cap and the Company accepted $95.9 million aggregate principal amount of the notes, resulting in an aggregate purchase price of $100 million (plus an additional $3.2 million in aggregate accrued interest on such notes). The Company accepted for purchase first, all notes tendered at spreads above the clearing spread, and thereafter, the notes validly tendered at the clearing spread on a prorated basis according to the principal amount of such notes. During the three months ended May 5, 2007, the Company recorded a loss on extinguishment of debt of approximately $5,222 related to the repurchase of the notes.

During June and July 2007, the Company repurchased an additional $10,420 in principal amount primarily relating to its 8.25% senior notes. The repurchase of these notes resulted in a loss on extinguishment of debt of approximately $412.

At August 4, 2007, the Company had $230 million of convertible senior notes that bear interest of 2.0% and mature in 2024. The provisions of the convertible notes allow the holder to convert the notes to shares of the Company’s common stock at a conversion rate of 83.5609 shares per one thousand dollars in principal amount of notes. The most significant terms and conditions of the senior notes include: the Company can settle a conversion of the par value 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.

During the quarter ended August 4, 2007, the aforementioned conversion criterion was met. The closing price of the Company’s common stock exceeded 120% of the convertible senior notes’ conversion price for at least 20 out of the last 30 consecutive trading days in the second calendar quarter of 2007. On July 10, 2007, the Company gave notice that holders of the convertible notes could convert them into shares of the Company’s common stock until September 30, 2007 in accordance with, and subject to, the terms of the convertible notes indenture. Since the holders of the convertible notes had the ability to exercise their conversion rights, the convertible notes were classified within the “current portion of long-term debt” on the Company’s August 4, 2007 balance sheet. As of September 6, 2007, no note holders had converted their notes into shares of the Company’s common stock

At August 4, 2007 the Company had $69.0 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 $5 million and $7 million per year.

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The Company is obligated to fund a cash balance pension plan. The Company’s current policy is to maintain at least the minimum funding requirements specified by the Employee Retirement Income Security Act of 1974. The Company expects minimal or no funding requirements in 2007. As part of the sale of NDSG to Bon-Ton, the NDSG pension assets and liabilities were acquired by Bon-Ton. Additionally, the Company curtailed its SFA pension plan during 2006 which froze benefit accruals for all participants except those who have attained age 55 and completed 10 years of service as of January 1, 2007 and who continue to be highly compensated employees.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

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

There were no material changes in the Company’s contractual obligations specified in Item 303(a)(5) of Regulation S-K during the three and six months ended August 4, 2007. For additional information regarding the Company’s contractual obligations as of February 3, 2007, see the Management’s Discussion and Analysis section of the 2006 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 February 3, 2007 filed with the Securities and Exchange Commission.

NEW ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued FIN 48, an interpretation of SFAS No. 109, “Accounting for Income Taxes.” 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. For a benefit to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The benefit to be recognized for 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. FIN 48 also provides guidance on derecognition, classification of interest and penalties, accounting in interim periods, and disclosure. The Company adopted FIN 48 as of February 4, 2007.

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During September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or a liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under SFAS No. 157, fair value measurements would be separately disclosed by level within the fair value hierarchy effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of this Statement.

On September 29, 2006, the FASB issued SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). The Company adopted SFAS No. 158 prospectively on February 3, 2007. SFAS No. 158 requires an employer that sponsors one or more defined benefit pension plans or other postretirement plans to 1) recognize the funded status of a plan, measured as the difference between plan assets at fair value and the benefit obligation, in the balance sheet; 2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; 3) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end balance sheet; and 4) disclose in the notes to the financial statements additional information about the effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition assets or obligations. The adoption of SFAS No. 158 did not have a material effect on the Company’s results of operations or financial position for the fiscal year ended February 3, 2007. Additionally, SFAS No. 158 will require the Company to change the measurement date for the assets and liabilities of its employee benefit plans from November 1 to the Company’s fiscal year end beginning with the fiscal year ending January 31, 2009.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that currently are not required to be measured at fair value. This Statement is effective no later than fiscal years beginning on or after November 15, 2007. The Company is currently evaluating the impact this standard may have on its financial statements.

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 of the par value upon conversion of the notes in cash, and thus exclude the effect of the conversion of the notes in its calculation of diluted earnings per share. If and when the FASB amends SFAS No. 128, the effect of the changes would require the

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Company to use the if-converted method in calculating diluted 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 diluted calculation by 19,219 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; and changes in interest rates.For additional information regarding these and other risk factors, please refer to the Company’s Form 10-K for the fiscal year ended February 3, 2007 filed with the SEC, which may be accessed via EDGAR through the Internet at www.sec.gov.

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

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company’s exposure to market risk primarily arises from changes in interest rates and the U.S. equity and bond markets. The effects of changes in interest rates on earnings generally have been small relative to other factors that also affect earnings, such as sales and operating margins. The Company seeks to manage exposure to adverse interest rate changes through its normal operating and financing activities, and if appropriate, through the use of derivative financial instruments. Such derivative instruments can be used as part of an overall risk management program in order to manage the costs and risks

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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 August 4, 2007, 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

DISCLOSURE CONTROLS AND PROCEDURES

Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report. Based upon this evaluation, the Company’s Chief Executive Officer and Chief Financial 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 the Company in the reports it files 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 the Company’s management, including the Chief Executive Officer and Chief Financial Officer, to allow timely discussions regarding required disclosures.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There were no changes in the Company’s internal controls over financial reporting that occurred during the quarter ended August 4, 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.

The information in “Part I – Financial Information, Note 8 – Contingencies – Legal Contingencies,” is incorporated into this Item by reference.

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Item 1A. RISK FACTORS

With respect to the risk factor titled “The Company believes that its previously disclosed internal investigations, and related inquiries by the SEC and the Office of the United States Attorney for the Southern District of New York, adversely affected the Company’s results of operations for its 2005 fiscal year, which adverse effect could continue” disclosed in “Item 1A. Risk Factors” of the Company’s Form 10-K for the year ended February 3, 2007, see “Part I – Financial Information, Note 8 – Contingencies — Legal Contingencies.”

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

During the quarter ended August 4, 2007, the Company did not sell any equity securities which were not registered under the Securities Act.

The Company has a share repurchase program that authorizes it to purchase shares of the Company’s common stock in order to both distribute cash to stockholders and manage dilution resulting from shares issued under the Company’s equity compensation plans. At August 4, 2007, 37.4 million shares remained available for repurchase under the Company’s 70.0 million share repurchase authorization. During the quarter ended August 4, 2007, the Company did not repurchase any of its equity securities.

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

The Company held an annual meeting of shareholders on June 6, 2007 for the following purposes:

Item 1: To elect three Directors to hold office for the term specified in the Company’s proxy statement, dated May 3, 2007 (the “Proxy Statement”) or until their respective successors have been elected and qualified;

Item 2: To approve the Saks Incorporated 2007 Senior Executive Bonus Plan;

Item 3: To ratify the appointment of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for the current fiscal year ending February 2, 2008; and

Item 4: To vote on a shareholder proposal concerning cumulative voting for the election of Directors.

Each of these items is described in the Proxy Statement which was filed with the SEC.

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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
Stanton J. Bluestone	125,111,946	2,525,110
Robert B. Carter	123,888,333	3,748,723
Donald E. Hess	123,875,273	3,761,783

There were no abstentions and broker non-votes with respect to this proposal. Each of the nominees for election was approved.

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

	FOR	AGAINST	ABSTAIN	BROKER NON-VOTES
Item 2	108,610,807	4,670,032	107,382	14,248,835
Item 3	126,233,675	1,346,141	57,243	—
Item 4	35,812,340	77,342,797	233,085	14,248,834

Accordingly, Items 2 and 3 were adopted by the Company’s shareholders.

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Item 6. EXHIBITS

10.1	Employment Agreement dated as of July 31, 2007 between Saks Incorporated and Stephen I. Sadove (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 31, 2007).
10.2	Employment Agreement dated as of July 31, 2007 between Saks Incorporated and Ronald L. Frasch (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on July 31, 2007).
10.3	Amendment No. 1 to the Saks Incorporated 2004 Long-term Incentive Plan (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on July 31, 2007 (No. 001-13113)).
10.4	2007 Saks Incorporated Senior Executive Incentive Bonus Plan (incorporated by reference to Exhibit 10.1 to the Company’s Current report on Form 8-K filed on June 7, 2007 (No. 001-13113)
31.1	Certification of Chief Executive Officer, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial 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 Financial 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
Date September 7, 2007	/s/ Kevin G. Wills
	Kevin G. Wills
	On behalf of registrant and as Executive Vice President and Chief Financial Officer (Principal Financial Officer)

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