Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended July 29, 2006, for Federated Department Stores, Inc. (operating primarily as Macy's, Inc.). The filing reflects the company's status as a large accelerated filer following the August 2005 acquisition of The May Department Stores Company. The reporting period includes the integration of May operations, the conversion of regional nameplates to the Macy's brand, and the classification of the Lord & Taylor division and May bridal group as discontinued operations pending sale.
Key Financial Metrics
| Metric | 13 Weeks Ended July 29, 2006 |
26 Weeks Ended July 29, 2006 |
13 Weeks Ended July 30, 2005 |
26 Weeks Ended July 30, 2005 |
|---|---|---|---|---|
| Net Sales | $5,995 million | $11,925 million | $3,623 million | $7,264 million |
| Gross Margin | $2,391 million (39.9%) | $4,688 million (39.3%) | $1,497 million (41.3%) | $2,962 million (40.8%) |
| Operating Income | $422 million | $442 million | $291 million | $543 million |
| Net Income | $317 million | $265 million | $148 million | $271 million |
| Diluted EPS (Net Income) | $0.57 | $0.47 | $0.42 | $0.78 |
| Cash and Equivalents | $1,062 million | (Balance Sheet as of July 29, 2006) | ||
| Total Debt (Short + Long Term) | $8,633 million | (Balance Sheet as of July 29, 2006) | ||
| Operating Cash Flow (26 wks) | $2,281 million | $665 million |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 65% ($2,372 million) in the quarter and 64% ($4,661 million) year-to-date, primarily driven by the inclusion of May Department Stores operations. Comparable store sales increased 4.6% for the quarter and 2.2% year-to-date.
- Integration Costs: The company recorded $177 million in May integration costs for the quarter (including $134 million in inventory valuation adjustments) and $306 million year-to-date. These costs impacted operating income but are expected to yield long-term savings.
- One-Time Gains: A pre-tax gain of $191 million was recorded in both the quarter and year-to-date periods from the sale of credit card accounts and receivables to Citibank.
- Tax Benefit: A $155 million tax refund from an IRS settlement resulted in an $80 million tax benefit, significantly lowering the effective tax rate to 12.9% for the quarter compared to 37.7% in the prior year.
- Discontinued Operations: Income from discontinued operations (Lord & Taylor and bridal businesses) totaled $35 million for the quarter and $57 million year-to-date.
Guidance, Outlook, and Risks
- Cost Savings: Management expects to realize approximately $175 million in cost savings in 2006 and at least $450 million annually starting in 2007 from the May integration.
- Future Integration Costs: The company anticipates incurring an additional $344 million to $419 million in May integration costs for the remainder of fiscal 2006.
- Divestitures: The company plans to divest approximately 80 stores (including 40 May locations). As of September 7, 2006, 63 stores had been sold or agreed upon. The sale of the Lord & Taylor division for $1,195 million is expected to close in the third quarter of 2006.
- Liquidity: The company maintains a $2 billion credit facility (extended to 2011) and recently received significant liquidity from the sale of credit card assets. Management believes current resources are sufficient for working capital and debt service.
- Risks: Key risks include the successful integration of May operations, realization of synergies, competitive pressures, and general consumer spending levels. Legal proceedings regarding the May merger are ongoing but are expected to be contested vigorously.
Investor Verification Checklist
- Integration Progress: Verify the timeline and actual realization of the projected $450 million annual cost savings from the May merger.
- Store Portfolio: Monitor the completion of the 80-store divestiture plan and the conversion of remaining May stores to the Macy's nameplate.
- Discontinued Operations: Confirm the closing of the Lord & Taylor sale to NRDC Equity Partners and the final valuation of the bridal group assets.
- Debt Management: Track the repayment of short-term bridge financing associated with the May acquisition and the company's leverage ratios post-integration.
- Comparable Sales: Assess whether the 4.6% comparable store sales growth is sustainable as the company transitions to a fully integrated national brand.