The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and include our accounts and the accounts of our subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior period amounts to conform to the current year presentation.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Our fiscal year ends on the Saturday closest to January 31st. Fiscal year 2012 contained 53 weeks and ended on February 2, 2013 (“2012”). Fiscal years 2011 and 2010 each contained 52 weeks and ended on January 28, 2012 (“2011”) and January 29, 2011 (“2010”), respectively.

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). ASU 2013-02 requires entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, entities are required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. For amounts not required to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures under U.S. GAAP that provide additional detail about those amounts. For public entities, ASU 2013-02 is effective for reporting periods beginning after December 15, 2012. The adoption of ASU 2013-02 will not affect our consolidated financial position, results of operations, or cash flows.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 requires reporting entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In December 2011, the FASB indefinitely deferred certain provisions of ASU 2011-05 related to the presentation of reclassification adjustments of items out of accumulated other comprehensive income. In January 2013, the FASB issued ASU 2013-02 which sets forth the requirements related to the presentation of reclassifications adjustments of items out of accumulated other comprehensive income. Effective January 29, 2012, we adopted the applicable portions of ASU 2011-05. The adoption did not affect our consolidated financial position, results of operations, or cash flows.

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), which amends the existing fair value guidance to improve consistency in the application and disclosure of fair value measurements in U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 provides certain clarifications to the existing guidance, changes certain fair value principles, and enhances disclosure requirements. Effective January 29, 2012, we adopted ASU 2011-04. The adoption of ASU 2011-04 resulted in additional disclosures but did not affect our consolidated financial position, results of operations, or cash flows.

Net sales include sales of merchandise (net of returns and exclusive of sales taxes), commissions from leased departments, shipping and handling revenues related to merchandise sold, and breakage income from unredeemed gift cards. Sales of merchandise shipped directly to customers from our retail stores and Saks Direct are recognized upon estimated receipt of merchandise by the customer. Sales of merchandise at our retail stores are recognized at the time customers provide a satisfactory form of payment and take delivery of the merchandise. Commissions from leased departments are recognized at the time merchandise is sold to customers. Revenue associated with gift cards is recognized upon redemption of the card. We estimate the amount of goods that will be returned for a refund and reduce sales and gross margin by that amount.

Commissions from leased departments included in net sales were $48,536, $43,184, and $31,832 during 2012, 2011, and 2010, respectively. Leased department sales were $341,778, $300,537, and $233,422 during 2012, 2011, and 2010, respectively, and were excluded from net sales.

The following table summarizes net sales by major merchandise category for 2012, 2011, and 2010:

		2012			2011			2010
		Net Sales		% of Sales	Net Sales		% of Sales	Net Sales		% of Sales
Women's apparel		$	1,095,222	34.8%	$	1,049,760	34.8%	$	1,001,783	36.0%
Women's accessories			606,054	19.3%		580,568	19.3%		537,301	19.3%
Cosmetics and fragrances			379,975	12.1%		368,867	12.2%		357,023	12.8%
Men's apparel, shoes, and accessories			516,773	16.4%		487,352	16.2%		449,957	16.2%
Women's shoes			403,628	12.8%		368,137	12.2%		315,725	11.3%
Other			145,902	4.6%		158,909	5.3%		123,956	4.4%
	Total	$	3,147,554	100.0%	$	3,013,593	100.0%	$	2,785,745	100.0%

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 $76,561 and $195,449 as of February 2, 2013 and January 28, 2012, respectively, primarily consisting of money market funds and demand deposits. Income earned on cash equivalents was $451, $1,252, and $551 for 2012, 2011, and 2010, respectively, and was reflected in other income on the accompanying Consolidated Statements of Income. There were no compensating balance arrangements as of February 2, 2013 and January 28, 2012.

Merchandise inventories are stated at the lower of cost or market. Cost is determined using the retail first-in, first-out (“FIFO”) method and includes freight, buying and distribution costs. We take markdowns related to slow moving inventory, ensuring the appropriate inventory valuation.

We regularly record a provision for estimated shrinkage, thereby reducing the carrying value of merchandise inventory. A complete physical inventory of all of our stores and distribution facilities is performed annually, with the recorded amount of merchandise inventory being adjusted to coincide with this physical count. The differences between the estimated amount of shrinkage and the actual amount realized have been insignificant.

We receive vendor-provided support in different forms. When the vendor provides support for inventory markdowns, we record the support as a reduction to cost of sales. Such support is recorded in the period that the corresponding markdowns are taken. When we receive inventory-related support that is not designated for markdowns, we include this support as a reduction of the cost of purchases.

Consignment merchandise on hand of $88,393 and $93,897 as of February 2, 2013 and January 28, 2012, respectively, is not reflected on the Consolidated Balance Sheets.

SG&A expenses consist primarily of employee compensation and benefit costs related to the selling and administrative support functions, advertising, operating and maintenance costs, proprietary credit card promotion, issuance and servicing costs, insurance programs, telecommunications, shipping and handling costs, and other operating expenses not specifically categorized elsewhere on the Consolidated Statements of Income. Shipping and handling costs included in SG&A expense were $28,370, $25,363, and $21,412 in 2012, 2011, and 2010, respectively. Payroll taxes, rent, depreciation, and property taxes are not included in SG&A.

Advertising and sales promotion costs are expensed in the period in which the advertising event takes place.

We receive allowances and expense reimbursements from merchandise vendors and from the owner of the proprietary credit card portfolio which are netted against the related expense:

Store pre-opening costs primarily consist of rent expense incurred during the construction of new stores, payroll, and related media costs incurred in connection with new store openings and costs related to opening our new distribution center. These costs are expensed as incurred. Rent expense is generally incurred for six to twelve months prior to a store's opening date.

Property and equipment are stated at historical cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Buildings and building improvements are depreciated over 20 to 40 years while fixtures and equipment are depreciated over 3 to 10 years. Leasehold improvements are amortized over the shorter of their estimated useful lives or their related lease terms, generally ranging from 10 to 20 years. Lease terms may include renewal periods at our option if exercise of the option is determined to be reasonably assured at the inception of the lease. Costs incurred for the development of internal-use computer software are capitalized and amortized using the straight-line method over 3 to 10 years. Costs incurred during the preliminary project and post-implementation stages of internally-developed computer software are expensed as incurred.

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

Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the estimated future undiscounted cash flows resulting from the use and eventual disposition of the assets are less than the carrying value of such assets, an impairment loss is recognized for the difference between the estimated fair value and the carrying value. The evaluation is performed at the lowest level of identifiable cash flows, which is primarily at the individual store level. Long-lived asset impairment charges are included in impairments and dispositions on the Consolidated Statements of Income.

Impairment and disposition costs include costs associated with store closures, including employee severance and lease termination fees, asset impairment and disposal charges, and other store closure activities. Additionally, impairment and disposition costs include long-lived asset impairment charges related to assets held and used and losses related to asset dispositions made during the normal course of business.

We continuously evaluate our real estate portfolio and close underproductive stores in the normal course of business as leases expire or as other circumstances dictate. During 2012, we closed three SFA stores. We incurred $2,944 of store closing costs associated with these locations, primarily consisting of employee severance. Also included in impairments and disposition costs for 2012 was $9,797 of asset impairment charges related to held and used assets, and a net gain of $565 from the sale of assets during the normal course of business.

During 2011, we closed one SFA store and two OFF 5TH stores. We incurred $5,065 of store closing costs primarily related to a lease termination fee and employee severance. Also included in impairment and disposition costs for 2011 was $5,041 of asset impairment charges related to held and used assets.

During 2010, we incurred costs associated with the closing of seven SFA stores and one OFF 5TH store. We incurred $12,045 of store closing-related costs associated with these locations. Also included in impairment and disposition costs for 2010 were $785 of asset impairment charges related to held and used assets and $255 of losses on the disposal of assets during the normal course of business.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., exit price) in the principal and most advantageous market for the asset or liability. Assets and liabilities are classified using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels:

Level 1: Quoted market prices in active markets for identical assets or liabilities

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data

The carrying value of our financial instruments, including cash and cash equivalents, receivables, accounts payable, and accrued expenses as of February 2, 2013 and January 28, 2012 approximated their fair value due to the short-term nature of these financial instruments. See Note 6 for disclosure of the fair value of long-term debt.

Assets and liabilities that are measured at fair value on a non-recurring basis include our long-lived assets. During 2012, long-lived assets held and used with a carrying value of $10,361 were written down to their estimated fair value of $564, resulting in an impairment loss of $9,797. During 2011, long-lived assets held and used with a carrying value of $7,533 were written down to their estimated fair value of $2,492, resulting in an impairment loss of $5,041. The fair values of long-lived assets held and used were determined using an income-based approach and are classified as Level 3 within the fair value hierarchy. Significant inputs include projections of future cash flows and discount rates. These inputs are based on assumptions from the perspective of market participants.

We lease the land or the land and building at many of our stores, as well as our distribution centers, administrative facilities, and certain equipment. Most of these leases are classified as operating leases. Most of our lease agreements include renewal periods at our option. Store lease agreements generally include rent holidays, rent escalation clauses, and contingent rent provisions that require additional payments based on a percentage of sales in excess of specified levels. Contingent rental payments are recognized when we determine that it is probable that the specified levels will be reached during the fiscal year. For leases that contain rent holiday periods and scheduled rent increases, we recognize rent expense on a straight-line basis over the lease term from the date we take possession of the leased property. The difference between the straight-line rent amounts and amounts payable under the lease agreements is recorded as deferred rent. Tenant improvement allowances and other lease incentives are recorded as deferred rent liabilities and are recognized on a straight–line basis over the life of the lease. As of February 2, 2013 and January 28, 2012, deferred rent liabilities were $78,671 and $66,524, respectively. These amounts are included in other long-term liabilities on the Consolidated Balance Sheets.

We self-insure a substantial portion of our exposure for costs related to employee medical benefits, workers' compensation, and general liability. Expenses are recorded based on estimates for reported claims and claims that have been incurred but not reported, considering a number of factors, including historical claims experience, severity factors, litigation costs, inflation, and other assumptions. Although we do not expect the amount that we will ultimately pay to differ significantly from our estimates, self-insurance reserves could be affected if future claims experience differs significantly from historical trends and assumptions.

Basic EPS is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. For the years ended February 2, 2013, January 28, 2012, and January 29, 2011, the computations of diluted EPS assume that our convertible notes would be settled in shares of common stock. Diluted EPS is computed by adjusting: (i) the income available to common shareholders for the amount of interest expense recognized related to the convertible notes, and (ii) the weighted-average number of common shares outstanding to assume conversion of our convertible notes and the issuance of all other dilutive potential common shares, if the effect is dilutive. The following table sets forth the computation of basic and diluted EPS:

			2012					2011					2010
						Per					Per					Per
			Net			Share		Net			Share		Net			Share
			Income		Shares	Amount		Income		Shares	Amount		Income		Shares	Amount
Basic EPS			$	62,882	149,689	$	0.42	$	74,790	155,149	$	0.48	$	47,846	154,325	$	0.31
	Effect of dilutive potential
		common shares		8,485	24,005		(0.01)		16,204	45,088		(0.03)		―	4,088		(0.01)
Diluted EPS			$	71,367	173,694	$	0.41	$	90,994	200,237	$	0.45	$	47,846	158,413	$	0.30

For the year ended February 2, 2013, the computation of diluted EPS includes the effect of 21,103 shares that could be issued upon conversion of our 7.5% convertible notes and the related interest expense, net of tax, of $8,485 as the effect is dilutive. For the year ended January 28, 2012, the computation of diluted EPS includes the effect of 40,889 shares that could be issued upon the conversion of our 7.5% and 2.0% convertible notes and the related interest expense, net of tax of $16,204 as the effect is dilutive. The following table presents potentially dilutive securities excluded from the computations of diluted EPS:

		2012		2011		2010
Stock options¹		1,258	²	1,285	²	1,344	²
Written call options¹		n/a		n/a		19,219	²
Performance shares¹		―		25	³	50	³
Contingently convertible securities:
	7.5% Convertible Notes	―		―		21,670	⁴
	2.0% Convertible Notes	19,219	⁴	―		19,219	⁴

We maintain an equity incentive plan, which allows for the granting of stock options, stock appreciation rights, restricted stock, performance share awards and other forms of awards to employees, directors, and officers. Stock options granted generally vest over a four-year period from the grant date and have contractual terms of seven to ten years from the grant date. Restricted stock and performance share awards generally vest over periods ranging from three to five years from the grant date, although the equity incentive plan permits accelerated vesting in certain circumstances at the discretion of the Human Resources and Compensation Committee (“HRCC”) of the Board of Directors.

We recognize compensation expense for stock option awards with graded vesting on a straight-line basis over the requisite service period. Compensation expense related to restricted stock and performance share awards that cliff-vest are expensed on a straight-line basis over the requisite service period. Restricted stock awards with graded-vesting features are treated as multiple awards based upon the vesting date. We record compensation expense for these awards on a straight-line basis over the requisite service period for each separately vesting portion of the award.

Pension expense is based on actuarial models used to estimate the total benefits ultimately payable to participants and is allocated to the respective service periods. Our funding policy provides that contributions to the pension trusts shall be at least equal to the minimum funding requirement of the Employee Retirement Income Security Act of 1974. We may provide additional contributions from time to time, generally not to exceed the maximum tax-deductible limitation. Our pension plans are valued annually as of the fiscal year-end balance sheet date. The market-related fair value of plan assets used to calculate the expected return on plan assets is fair value. Actuarial gains and losses are amortized over the average life expectancy of the plan's participants, to the extent the cumulative gains or losses exceed 10% of the greater of the projected benefit obligation or market-related value of plan assets.

We sell gift cards with no expiration dates. At the time gift cards are sold, no revenue is recognized and a liability is established for the value of the card. The liability is relieved and revenue is recognized when the gift cards are redeemed by the customer for merchandise. The liability for unredeemed gift cards was $29,781 and $28,933 as of February 2, 2013 and January 28, 2012, respectively and is included in accrued expenses on the Consolidated Balance Sheets.

We periodically evaluate unredeemed gift cards and if we determine that the likelihood of customer redemption is remote and the gift card is not subject to state escheatment laws, then we will recognize breakage income and reverse the related liability. Breakage income included in net sales during 2012, 2011, and 2010 was $2,733, $3,112, and $3,565, respectively.

We maintain a customer loyalty program in which customers accumulate points for each qualifying purchase. On an annual basis, or upon request, customers receive a gift card to apply to future purchases. The amount of the gift card is based on the level of points accumulated during the year. We estimate the net cost of these gift cards that will be earned and redeemed and record this amount in cost of sales as points are accumulated.

We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

SFA, Saks Direct, and OFF 5TH have been aggregated into one reportable segment based on the aggregation criteria outlined in the authoritative accounting literature.