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Business Context and Reporting Period

Company: Federated Department Stores, Inc. (operating brands include Macy's, Bloomingdale's, The Bon Marché, Burdines, Lazarus, Rich's, and Goldsmith's).

Reporting Period: Fiscal year ended February 2, 2002 (52 weeks).

Operations: The Company operates 459 department stores across 34 states, Puerto Rico, and Guam. It also conducts direct-to-customer businesses via catalogs and e-commerce. A significant strategic shift occurred in 2002 with the decision to dispose of the Fingerhut Companies, Inc. subsidiary, which is now reported as discontinued operations.

Key Financial Metrics

Margins: Cost of sales was 61.2% of net sales in 2002 (up from 59.8% in 2001). Selling, general, and administrative (SG&A) expenses were 30.7% of net sales (up from 29.5% in 2001).

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 5.9% to $15.65 billion, driven by a weak economy, the impact of September 11th, and the closing of the Stern's division. Comparable store sales declined 5.3%.
• Discontinued Operations: The Company recorded a $770 million loss on the disposal of Fingerhut Companies, Inc., including estimated operating losses during the wind-down period. This was the primary driver of the net loss for the year.
• Restructuring Charges: The Company incurred $215 million in asset impairment and restructuring charges, primarily related to the conversion of Stern's stores to Macy's and Bloomingdale's, the integration of Liberty House, and catalog/e-commerce reorganization.
• Inventory Reduction: Merchandise inventories decreased 7% to $3.38 billion, positioning the company for future margin improvement.
• Acquisition: Completed the acquisition of Liberty House, Inc. for approximately $200 million in July 2001.

Guidance, Outlook, and Risks

2002 Guidance (Issued Feb 26, 2002):

• Earnings Per Share (Continuing Ops): Expected to be between $3.30 and $3.55.
• Comparable Store Sales: Forecasted to increase 1% to 1.5% for the full year.

Management Commentary: Management expects to fund capital expenditures (budgeted at $700 million for 2002) from operations. The Company maintains a $1.5 billion stock repurchase authorization, with approximately $600 million remaining as of February 2, 2002.

Risks and Contingencies:

• Legal Proceedings: The Company is a defendant in five consolidated class action lawsuits alleging securities violations related to financial disclosures and the Fingerhut credit delinquency issue. Additionally, shareholder derivative lawsuits were filed regarding the disposition of Fingerhut.
• Debt Covenants: While currently in compliance, a deterioration in operating ratios could trigger a default on debt covenants, making much of the debt callable.
• Accounting Changes: Adoption of SFAS No. 142 in 2002 will eliminate goodwill amortization, expected to increase annual income from continuing operations by approximately $24 million.

Investor Verification Checklist

• Fingerhut Disposal: Verify the status of negotiations to sell Fingerhut as a going concern versus the liquidation plan, as the $770 million loss is based on estimates.
• Restructuring Costs: Confirm the actual cash outflow for the $215 million in restructuring charges and the timeline for Stern's conversion completion.
• Legal Exposure: Monitor the progress of the securities class action and derivative lawsuits regarding Fingerhut.
• Debt Covenants: Review the specific financial ratios required by bank credit agreements to assess sensitivity to further sales declines.
• Inventory Valuation: Assess the adequacy of inventory reserves given the 7% reduction and the 5.9% sales decline.