Business Context and Reporting Period
This Form 10-Q covers the fiscal quarter ended May 3, 2003, for Federated Department Stores, Inc. (parent company of Macy's, Inc.). The report details the company's financial performance during a period marked by a difficult economic climate and significant strategic restructuring, including the consolidation of Rich's and Macy's stores in the Atlanta area and the final disposition of the Fingerhut Companies, Inc. operations.
Key Financial Metrics
| Metric | Q1 2003 | Q1 2002 |
|---|---|---|
| Net Sales | $3,291 million | $3,453 million |
| Gross Margin | $1,289 million (39.2%) | $1,375 million (39.8%) |
| Operating Income | $146 million | $221 million |
| Net Income | $46 million | $89 million |
| Diluted EPS | $0.24 | $0.43 |
| Operating Cash Flow | $204 million | $169 million |
| Cash and Equivalents | $744 million | $1,009 million |
| Total Debt (Short + Long Term) | $4,345 million | $4,865 million |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 4.7% year-over-year, driven by a 5.0% decline in comparable store sales. Weakness was concentrated in women's and men's sportswear, intimate apparel, and housewares.
- Profitability Pressure: Net income fell 48% to $46 million. Gross margin rate compressed to 39.2% from 39.8% due to higher net markdowns required to manage inventory levels. SG&A expenses as a percentage of sales increased to 34.8% from 33.4%, despite a slight dollar decrease, due to lower sales volume and $8 million in consolidation-related costs.
- Debt Reduction: Total debt decreased by approximately $520 million compared to the prior year, reflecting debt repayments and the assumption of receivables-backed debt by the buyer of Fingerhut assets.
- Discontinued Operations: The Fingerhut business was fully disposed of by the end of the prior fiscal year; thus, Q1 2003 results reflect only continuing operations, whereas Q1 2002 included $249 million in cash provided by discontinued operations.
Guidance, Outlook, and Risks
- 2003 Guidance: Management forecasts full-year 2003 diluted EPS from continuing operations of $3.10 to $3.25. Comparable store sales are expected to be flat to down 1.5% for the year.
- Restructuring Costs: The guidance includes estimated store-closing costs of $10–$15 million in Q2 and $12–$17 million in the second half of 2003.
- Strategic Branding: The company announced a strategy to leverage the Macy's brand, renaming The Bon Marche, Lazarus, and Goldsmith's stores to include "Macy's" starting August 1, 2003, with Burdines integration planned for February 2004.
- Capital Allocation: The company repurchased $120 million of treasury stock in Q1 and declared a quarterly dividend of $0.125 per share. A $500 million increase to the stock repurchase program was approved.
- Risks: Key risks include the difficult economic climate, consumer confidence levels, the impact of the SARS epidemic on merchandise procurement, and the execution risks associated with store consolidations and brand transitions.
Investor Verification Checklist
- Verify the impact of the 5.0% comparable store sales decline on future inventory management and markdown requirements.
- Monitor the execution of the Rich's-Macy's consolidation and the associated $22–$32 million in estimated store-closing costs for the remainder of 2003.
- Assess the effectiveness of the new "Macy's" branding strategy on sales recovery in the second half of the fiscal year.
- Review the status of the securities litigation regarding the former Fingerhut subsidiary and potential liability exposure.
- Confirm the company's ability to maintain liquidity given the reduction in borrowing capacity under the revolving credit facility to $200 million.