Macy's - 10-Q quarterly report FY

Because of the seasonal nature of the retail business, the results of operations for the 13 and 26 weeks ended August 2, 2003 and August 3, 2002 (which do not include the Christmas season) are not necessarily indicative of such results for the fiscal year.

The Consolidated Financial Statements for the 13 and 26 weeks ended August 2, 2003 and August 3, 2002, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) considered necessary to present fairly, in all material respects, the consolidated financial position and results of operations of the Company and its subsidiaries.

Effective February 2, 2003, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure" and SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 145 rescinds or amends existing authoritative pronouncements to limit the circumstances under which gains and losses from the extinguishment of debt will be treated as extraordinary items, to make various technical corrections and clarifications and to describe the applicability of certain of these pronouncements under changed conditions. SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation" and Accounting Principles Board ("APB") Opinion No. 28, "Interim Financial Reporting" to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for st ock-based compensation and amends the disclosure provisions therein. SFAS No. 143 establishes accounting standards for recognition and measurement of a liability for the costs of asset retirement obligations. The adoption of these statements did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.

In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The adoption of this statement on August 3, 2003 did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.

The Company accounts for its stock-based employee compensation plan in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan have an exercise price at least equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," for stock options granted. The Company estimates the fair value of each employee stock option grant on the date of grant using the Black-Scholes option-pricing model.

The $13 million reserve that the Company still expects to pay out relates to liabilities associated with the disposition of Stern's properties. The remaining Rich's-Macy's severance is still expected to be paid.

The $15 million reserve that the Company expected to pay out related to liabilities associated with the disposition of Stern's properties.

In addition to the stock options reflected in the foregoing tables, stock options to purchase 14.9 million shares of common stock at prices ranging from $35.65 to $79.44 per share were outstanding at August 2, 2003 and stock options to purchase 13.8 million shares of common stock at prices ranging from $40.44 to $79.44 per share were outstanding at August 3, 2002 but were not included in the computation of diluted earnings per share because the exercise price thereof exceeded the average market price and their inclusion would have been antidilutive.

For purposes of the following discussion, all references to "second quarter of 2003" and "second quarter of 2002" are to the Company's 13-week fiscal periods ended August 2, 2003 and August 3, 2002, respectively, and all references to "2003" and "2002" are to the Company's 26-week fiscal periods ended August 2, 2003 and August 3, 2002, respectively.

On May 22, 2003, the Company announced a strategy to more fully leverage its Macy's brand. Beginning in the fall season of 2003, The Bon Marche stores operate as Bon - Macy's, Lazarus stores operate as Lazarus - Macy's and Goldsmith's stores operate as Goldsmith's - Macy's. Beginning in fiscal 2004, Burdines stores will operate as Burdines - Macy's and the seven Macy's stores currently operating in Florida will be integrated into the Burdines - Macy's organization. The Company believes that these changes will allow the Company to benefit from the expansion of the Macy's brand and should lead to more efficient operations.

In January 2003, the Company announced and commenced the implementation of its plans to integrate the stores of Rich's and Macy's in the metro Atlanta area and operate these and all other Rich's stores under a combined "Rich's-Macy's" nameplate, effective February 2, 2003. As part of the consolidation, certain stores were closed; however, one location was renovated and partially reopened as a Rich's-Macy's furniture gallery in July 2003 and two locations continue to be renovated and plan to reopen as Bloomingdale's later this year. In the near term, the store closings and store closing costs are expected to have a negative impact on net sales and operating income, but in the longer term all of these actions are expected to positively affect operating income, cash flows from operations and return on investment.

On January 16, 2002, the Company's board of directors approved a plan to dispose of the operations of Fingerhut Companies, Inc. ("Fingerhut"), including the Arizona Mail Order, Figi's and Popular Club Plan businesses conducted by Fingerhut's subsidiaries, which were acquired by the Company on March 18, 1999. The decision to dispose of Fingerhut was based on management's determination that there was no longer strategic value to Federated in retaining the Fingerhut operations and there was no expectation, based on Fingerhut's historical earnings and future prospects, that this business would contribute meaningfully to the Company's future financial performance. The plan of disposition approved by the Company's board of directors contemplated a disposal by liquidation of the Fingerhut core catalog operations and a disposal by sale of Fingerhut's three catalog subsidiaries, Arizona Mail Order, Figi's and Popular Club Plan. As of February 1, 2003, substantially all Fingerhut assets had been disposed of and substantially all Fingerhut liabilities had been settled.

The Company's Consolidated Financial Statements for all periods account for Fingerhut as a discontinued operation as a result of the Company's decision to dispose of the Fingerhut operations. Unless otherwise indicated, the following discussion relates to the Company's continuing operations.

Results of Operations

Comparison of the 13 Weeks Ended August 2, 2003 and August 3, 2002

Income from continuing operations and net income for the second quarter of 2003 totaled $120 million, compared to income from continuing operations of $133 million and net income of $282 million for the second quarter of 2002. The second quarter of 2002 included $149 million of income from the disposal of discontinued operations, net of tax effect. The decrease in income from continuing operations for the second quarter of 2003 compared to the second quarter of 2002 reflects a lower level of sales.

Net sales for the second quarter of 2003 totaled $3,434 million, down 1.5% compared to net sales of $3,486 million for the second quarter of 2002. On a comparable store basis (sales from stores in operation throughout 2002 and 2003), net sales for the second quarter of 2003 decreased 1.2% compared to the second quarter of 2002. Bloomingdale's and Rich's/Lazarus/Goldsmith's-Macy's had the strongest sales performance during the second quarter of 2003 with the weakest performance experienced at Burdines. Sales of the Company's private label brands continue to outperform the national brands. By family of business, sales were strongest in career apparel, big ticket home areas and cosmetics. The weakest businesses were housewares and children's.

Cost of sales was 59.0% of net sales for the second quarter of 2003, compared to 58.8% for the second quarter of 2002. In the second quarter of 2003, the cost of sales rate and corresponding gross margin rate reflects higher net markdowns as a percent to net sales in order to maintain inventories at appropriate levels. Merchandise inventories were down 6.0% at the end of the second quarter of 2003 as compared to the second quarter of 2002. The valuation of merchandise inventories on the last-in, first-out basis did not impact cost of sales in either period.

Selling, general and administrative ("SG&A") expenses were 33.3% of net sales for the second quarter of 2003, compared to 32.6% for the second quarter of 2002, due primarily to the lower sales level. SG&A expenses in actual dollars for the second quarter of 2003 were up 0.8% compared to the second quarter of 2002 due to $10 million of costs incurred in connection with the Rich's-Macy's consolidation and other announced store closings.

Net interest expense was $65 million for the second quarter of 2003, compared to $78 million for the second quarter of 2002, primarily due to the lower level of borrowings.

The Company's effective income tax rate of 39.6% for the second quarter of 2003 and the second quarter of 2002 differ from the federal income tax statutory rate of 35.0% principally because of the effect of state and local income taxes.

During July 2002, the Company completed the sale of Fingerhut's core catalog accounts receivable portfolio, with the buyer assuming $450 million of receivables-backed debt, and in a separate transaction completed the sale of various other Fingerhut assets, including two distribution centers, the corporate headquarters, a data center, existing inventory, the Fingerhut name, customer lists and other miscellaneous property and equipment. Proceeds from these sales and collections on customer accounts receivable prior to the sale, net of operating expenses, exceeded the amount estimated to be received through wind-down of the portfolio and liquidation of the assets, resulting in an adjustment to the loss on disposal of discontinued operations totaling $236 million of income before income taxes, or $149 million after income taxes.

Comparison of the 26 Weeks Ended August 2, 2003 and August 3, 2002

Income from continuing operations and net income for 2003 totaled $166 million, compared to income from continuing operations of $222 million and net income of $371 million for 2002. Net income for 2002 included $149 million of income from the disposal of discontinued operations, net of tax effect. The lower income from continuing operations results from a combination of lower sales and higher cost of sales, partially offset by lower net interest expense.

Net sales for 2003 totaled $6,725 million, compared to net sales of $6,939 million for 2002, a decrease of 3.1%. On a comparable store basis (sales from stores in operation throughout 2002 and 2003), net sales also decreased 3.1% compared to 2002. By family of business, sales were strongest in furniture and cosmetics. The weakest businesses were the small ticket home areas, especially housewares.

Cost of sales was 59.9% of net sales for 2003, compared to 59.5% for 2001. The cost of sales rate in 2003 reflects higher net markdowns as a percent to net sales due to the weak sales trend and to maintain inventories at appropriate levels. The valuation of department store merchandise inventories on the last-in, first-out basis did not impact cost of sales in either period.

SG&A expenses were 34.0% of net sales for 2003 compared to 33.0% for 2002. SG&A expenses in actual dollars for 2003 were essentially flat compared to 2002; however, due to the lower sales level, SG&A expenses increased 1.0 percentage point as a percent to net sales. Included in SG&A expenses for 2003 were approximately $18 million of costs incurred in connection with the Rich's-Macy's consolidation and other announced store closings. Higher depreciation and amortization expense and the Rich's-Macy's consolidation costs in 2003 were offset by lower selling costs, lower advertising expense and improvements related to the Company's credit card operations. Although selling costs and advertising expenses were lower in actual dollars in 2003, as a percent to net sales they were consistent with 2002.

Net interest expense was $135 million for 2003, compared to $152 million for 2002, primarily due to the lower level of borrowings.

The Company's effective income tax rate of 39.7% for 2003 and 2002 differ from the federal income tax statutory rate of 35.0% principally because of the effect of state and local income taxes.

During July 2002, the Company completed the sale of Fingerhut's core catalog accounts receivable portfolio, with the buyer assuming $450 million of receivables-backed debt, and in a separate transaction completed the sale of various other Fingerhut assets, including two distribution centers, the corporate headquarters, a data center, existing inventory, the Fingerhut name, customer lists and other miscellaneous property and equipment. Proceeds from these sales and collections on customer accounts receivable prior to the sale, net of operating expenses, exceeded the amount estimated to be received through wind-down of the portfolio and liquidation of the assets, resulting in an adjustment to the loss on disposal of discontinued operations totaling $236 million of income before income taxes, or $149 million after income taxes.

The Company's principal sources of liquidity are cash from operations, cash on hand and available credit facilities.

Net cash provided by continuing operating activities in 2003 was $719 million, compared to the $556 million provided in 2002. Cash provided by continuing operating activities in 2003 reflects a smaller increase in merchandise inventories and increases in current and deferred income taxes payable in 2003 versus decreases in 2002, partially offset by a smaller decrease in accounts receivable.

Net cash used by continuing investing activities was $181 million for 2003. Investing activities for 2003 included purchases of property and equipment totaling $156 million and capitalized software of $27 million. Investing activities for 2002 included purchases of property and equipment totaling $219 million, capitalized software of $23 million and the acceptance of a $39 million note receivable related to the sale of certain Fingerhut assets. The Company opened one department store, one home store and four furniture galleries during 2003 and plans to open five additional department stores and a home store during the remainder of 2003. The Company now expects capital expenditures to be approximately $600-$625 million for 2003, down from a budget of $650 million due to a delay in certain projects.

Net cash used by the Company for all continuing financing activities was $690 million for 2003, including the repayment of $450 million of 8.5% senior notes and approximately $227 million for the acquisition of treasury stock.

On April 16, 2003, the Company's board of directors approved a $500 million increase to the Company's existing stock repurchase program. During 2003, the Company purchased 7.3 million shares of its Common Stock under the stock repurchase program at an approximate cost of $227 million. As of August 2, 2003, the Company had approximately $485 million of authorization remaining under the Company's stock repurchase program. The Company may continue or, from time to time, suspend repurchases of shares under its stock repurchase program, depending on prevailing market conditions, alternate uses of capital and other factors.

Net cash provided to the Company by discontinued operations was $622 million for 2002, primarily due to the sale of Fingerhut's core catalog accounts receivable portfolio and the sale of various other Fingerhut assets.

In 2003, the Company renewed its 364-day revolving credit facility to June 25, 2004 and voluntarily reduced the borrowing capacity under this facility to $200 million. As a result, the Company's ability to borrow under the Company's bank credit agreements and commercial paper program has been reduced to a maximum of $1,400 million.

On August 22, 2003, the Company's board of directors declared a quarterly dividend of 12.5 cents per share on Federated Common Stock. The dividend is payable October 1, 2003 to shareholders of record at the close of business on September 15, 2003.

Management believes that, with respect to the Company's current operations, cash on hand and funds from operations, together with its credit facilities and other capital resources, will be sufficient to cover the Company's reasonably foreseeable working capital, capital expenditure and debt service requirements and capital transactions in both the near term and over the longer term. The Company's ability to generate funds from operations may be affected by numerous factors, including general economic conditions and levels of consumer confidence and demand; however, the Company expects to be able to manage its working capital levels and capital expenditure amounts so as to maintain its liquidity levels. Depending upon conditions in the capital markets and other factors, the Company will from time to time consider the issuance of debt or other securities, or other possible capital markets transactions, the proceeds of which could be used to refinance current indebtedness or for other corporate purposes.

Management believes the department store business and other retail businesses will continue to consolidate. The Company intends from time to time to consider additional acquisitions of, and investments in, department stores and other complementary assets and companies. Acquisition transactions, if any, are expected to be financed through a combination of cash on hand and from operations and the possible issuance from time to time of long-term debt or other securities.

Outlook

The Company is assuming that general economic and other conditions and consumer confidence and demand will be such that comparable store sales will be between down 1 percent and up 1 percent for both the third and fourth quarters of 2003. The Company presently expects to achieve earnings per share from continuing operations in the remainder of fiscal 2003 of $2.40 to $2.50, consisting of $.25 to $.30 a share in the third quarter and $2.15 to $2.20 a share in the fourth quarter of 2003. These estimates include additional store-closing costs of approximately $10 million in the third quarter and $2 million in the fourth quarter. In connection with these estimates, the Company is assuming that the gross margin rate will be up slightly for the remainder of the year, compared to last year, and SG&A dollars, excluding the aforementioned store-closing costs, will also increase slightly compared to last year.

The accuracy of the assumptions and the resulting forecasts described above is subject to uncertainties and circumstances beyond the Company's control. Consequently, actual results could differ materially from the forecasted results. See "Forward-Looking Statements" for a discussion of matters that could cause actual results to vary from the Company's expectations.

The Company's Chief Executive Officer and Chief Financial Officer have carried out, as of August 2, 2003, an evaluation of the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)). Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission's rules and forms. There were no changes in the Company's internal control over financial reporting that occurred during the Company's most recently completed fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.