Business Context and Reporting Period
Company: Federated Department Stores, Inc. (operating Macy's and Bloomingdale's)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: 13 weeks ended April 30, 2005
Business Overview: The Company operates department stores across 34 states, Puerto Rico, and Guam. In March 2005, the Company completed the conversion of all co-branded regional stores to the Macy's nameplate, operating exclusively under the Macy's and Bloomingdale's brands. The Company launched a new customer loyalty program, Star Rewards, in coordination with this rebranding.
Key Financial Metrics
| Metric ($ millions) | Q1 2005 | Q1 2004 |
|---|---|---|
| Net Sales | 3,641 | 3,550 |
| Gross Margin | 1,465 | 1,427 |
| Operating Income | 252 | 217 |
| Net Income | 123 | 97 |
| Diluted EPS | $0.71 | $0.53 |
| Operating Cash Flow | 56 | 73 |
| Cash and Equivalents (End of Period) | 918 | 913 |
| Total Debt (Short + Long Term) | 3,861 | 4,065 |
Margins: Gross margin was 40.2% of net sales. Selling, general, and administrative (SG&A) expenses were 33.3% of net sales, down from 34.1% in the prior year.
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 2.6% year-over-year. Comparable store sales also increased 2.6%, driven by strength in jewelry, handbags, cosmetics, and sportswear. The "big ticket" home category (furniture, bedding) remained weaker.
- Profitability: Net income rose 26.8% to $123 million. This was driven by strong sales and gross margin performance, alongside a reduction in SG&A expenses as a percentage of sales.
- Expense Management: SG&A expenses in absolute dollars were relatively flat compared to the prior year, which included approximately $15 million in costs related to store closings and consolidations (Burdines-Macy's integration) that were not present in the current period.
- Interest Expense: Net interest expense decreased to $54 million from $60 million due to lower borrowing levels and increased income on invested cash.
- Cash Flow Presentation: The Company reclassified cash flows from non-proprietary credit card accounts from operating to investing activities. This reclassification increased reported operating cash flow for the prior year from $34 million to $73 million for comparability.
Guidance, Outlook, and Material Events
Merger with The May Department Stores Company
On February 27, 2005, the Company entered into a Merger Agreement to acquire The May Department Stores Company ("May").
- Consideration: Approximately $5.5 billion in cash and 97 million shares of Federated common stock.
- Timeline: Expected to close in the third quarter of 2005, subject to shareholder and regulatory approvals.
- Financial Impact: Expected to be accretive to earnings per share in 2007. The Company anticipates $450 million in annual cost savings by 2007 but expects to incur approximately $1 billion in one-time integration costs over three years.
- Dividend: The Company committed to increasing its annual dividend to $1 per share following the merger.
Credit Card Asset Sale
On June 2, 2005 (subsequent to the period end), the Company entered into an agreement to sell its proprietary and non-proprietary credit card accounts (FDS Credit Assets) and related receivables to Citibank, N.A. The sale price equates to approximately 111.5% of the receivables. The transaction is expected to close in the third fiscal quarter and is anticipated to be accretive to earnings.
Outlook (Excluding Merger and Credit Card Sale)
For the second quarter of 2005 (ending July 30, 2005), the Company forecasts:
- Comparable Store Sales: Increase of approximately 1.0%.
- Diluted EPS: $0.80 to $0.85 per share.
Risks and Contingencies
- Legal Proceedings: A securities class action lawsuit regarding the former Fingerhut subsidiary was dismissed with prejudice in March 2005. A Proposition 65 lawsuit regarding lead in fashion jewelry is pending in California; management does not expect a material impact.
- Merger Risks: Completion is subject to antitrust approval and shareholder votes. Termination fees of up to $350 million may be payable by either party under specific circumstances.
Investor Verification Checklist
- Merger Approval Status: Verify the progress of shareholder and antitrust approvals for the May Department Stores acquisition.
- Credit Card Sale Closing: Confirm the closing date and final terms of the Citibank credit card asset sale.
- Integration Costs: Monitor the realization of the projected $1 billion in one-time merger integration costs and the $450 million in annual savings.
- Comparable Store Sales: Validate the 1.0% comparable store sales growth forecast for Q2 2005 against actual results.
- Debt Levels: Assess the impact of the $5.5 billion cash payment for the May merger on the Company's leverage ratios and liquidity.