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Business Context and Reporting Period

This Form 10-Q covers Federated Department Stores, Inc. (parent of Macy's, Inc.) for the fiscal quarter ended November 3, 2001 (13 weeks) and the year-to-date period ended November 3, 2001 (39 weeks). The company operates two primary segments: Department Stores (including Macy's, Bloomingdale's, and the recently acquired Liberty House) and Fingerhut (direct marketing). The reporting period was significantly impacted by the September 11 terrorist attacks, a difficult economic climate, and major strategic restructuring, including the closure of the Stern's division and the downsizing of Fingerhut.

Key Financial Metrics

Margins: Cost of sales was 60.8% of net sales for the quarter and 60.6% for the 39-week period. Selling, general, and administrative (SG&A) expenses were 35.3% of net sales for the quarter and 34.0% for the 39-week period.

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 10.0% in the quarter and 7.8% year-to-date compared to the prior year. Department store sales fell 8.1% (quarter) and 4.7% (YTD), while Fingerhut sales dropped significantly due to strategic downsizing.
• Profitability Improvement: Despite lower sales, the company returned to profitability. Net income for the quarter was $3 million compared to a loss of $668 million in the prior year. Year-to-date net income was $171 million versus a loss of $516 million.
• Restructuring Charges: The company recorded $23 million in asset impairment and restructuring charges in the quarter and $78 million year-to-date. This is a significant reduction from the $760 million in charges recorded in the same periods of 2000, which were primarily related to massive write-downs of the Fingerhut business.
• Comparable Store Sales: Department store comparable store sales decreased 8.6% in the quarter and 5.0% year-to-date.

Guidance, Outlook, and Risks

• Revised Guidance: Management lowered comparable store sales projections for the fourth quarter to a decline of 7-10% due to the September 11 attacks and economic weakness. Earnings expectations for fiscal 2001 were lowered to between $2.85 and $3.00 per share (excluding extraordinary items and restructuring charges).
• Future Restructuring: The company anticipates incurring an additional $40-$50 million in restructuring charges related to the Stern's closure and Liberty House integration by year-end. Additionally, a new reorganization of mail catalog and e-commerce businesses is expected to incur $50-$60 million in charges in the fourth quarter, largely non-cash.
• Acquisitions: The company completed the acquisition of Liberty House, Inc. for approximately $200 million in July 2001.
• Legal Proceedings: The company is a defendant in five consolidated class-action lawsuits alleging false statements regarding financial condition and credit delinquency at Fingerhut. Management intends to defend vigorously.
• Liquidity: The company maintains a $1,200 million unsecured revolving credit facility and a $400 million facility. Management believes cash on hand and operating funds are sufficient to cover foreseeable requirements.

Investor Verification Checklist

• Restructuring Costs: Verify the timing and cash impact of the anticipated $90-$110 million in additional restructuring charges for the remainder of fiscal 2001.
• Fingerhut Performance: Assess the long-term viability of the downsized Fingerhut segment and the impact of the previous $795 million write-down on future earnings.
• Debt Servicing: Review the company's ability to service its debt load ($6.25 billion total) amidst declining sales and the recent repurchase of $350 million in securities.
• Legal Exposure: Monitor the status of the class-action lawsuits regarding Fingerhut credit delinquency disclosures.
• Seasonality: Note that the reported periods exclude the critical Christmas holiday season; full-year results will be heavily dependent on Q4 performance.