10-Q 1 0001.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal quarter ended July 29, 2000. FEDERATED DEPARTMENT STORES, INC. 151 West 34th Street New York, New York 10001 (212) 494-1602 and 7 West Seventh St. Cincinnati, Ohio 45202 (513) 579-7000 Delaware 1-13536 13-3324058 (State of Incorporation) (Commission File No.) (I.R.S. Employer Identification Number) The Registrant has filed all reports required to be filed by Section 12, 13 or 15 (d) of the Act during the preceding 12 months and has been subject to such filing requirements for the past 90 days. 201,918,002 shares of the Registrant's Common Stock, $.01 par value, were outstanding as of August 26, 2000. PART I -- FINANCIAL INFORMATION FEDERATED DEPARTMENT STORES, INC. Consolidated Statements of Income (Unaudited) (millions, except per share figures) 13 Weeks Ended 26 Weeks Ended July 29, July 31, July 29, July 31, 2000 1999 2000 1999 Net Sales $ 4,065 $ 4,006 $ 8,097 $ 7,606 Cost of sales 2,379 2,319 4,774 4,493 Selling, general and administrative expenses 1,466 1,369 2,850 2,570 Operating Income 220 318 473 543 Interest expense (110) (87) (210) (165) Interest income 2 2 3 5 Income Before Income Taxes 112 233 266 383 Federal, state and local income tax expense (49) (96) (114) (159) Net Income $ 63 $ 137 $ 152 $ 224 Basic earnings per share $ .31 $ .65 $ .73 $ 1.07 Diluted earnings per share $ .30 $ .61 $ .72 $ 1.02 The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. FEDERATED DEPARTMENT STORES, INC. Consolidated Balance Sheets (Unaudited) (millions) July 29, January 29, July 31, 2000 2000 1999 ASSETS: Current Assets: Cash $ 296 $ 218 $ 357 Accounts receivable 3,818 4,313 3,512 Merchandise inventories 3,932 3,589 3,635 Supplies and prepaid expenses 231 230 221 Deferred income tax assets 183 172 142 Total Current Assets 8,460 8,522 7,867 Property and Equipment - net 6,757 6,828 6,689 Intangible Assets - net 1,703 1,735 1,807 Other Assets 655 607 516 Total Assets $ 17,575 $ 17,692 $ 16,879 LIABILITIES AND SHAREHOLDERS' EQUITY: Current Liabilities: Short-term debt $ 1,714 $ 1,284 $ 1,402 Accounts payable and accrued liabilities 2,992 3,043 2,905 Income taxes 97 225 46 Total Current Liabilities 4,803 4,552 4,353 Long-Term Debt 4,452 4,589 4,704 Deferred Income Taxes 1,458 1,444 1,240 Other Liabilities 548 555 586 Shareholders' Equity 6,314 6,552 5,996 Total Liabilities and Shareholders' Equity $ 17,575 $ 17,692 $ 16,879 The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. FEDERATED DEPARTMENT STORES, INC. Consolidated Statements of Cash Flows (Unaudited) (millions) 26 Weeks Ended 26 Weeks Ended July 29, 2000 July 31, 1999 Cash flows from operating activities: Net income $ 152 $ 224 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 322 324 Amortization of intangible assets 42 36 Amortization of financing costs 4 3 Amortization of unearned restricted stock 3 - Changes in assets and liabilities: Decrease in accounts receiv 499 178 Increase in merchandise inventories (340) (211) Increase in supplies and prepaid expenses (1) (19) Decrease in other assets not separately identified (32) (20) Increase (decrease) in accounts payable and accrued liabilities not separately identified (74) 30 Decrease in current income taxes (126) (52) Increase in deferred income taxes 1 1 Decrease in other liabilities not separately identified (6) (7) Net cash provided by operating activities 444 487 Cash flows from investing activities: Purchase of property and equipment (251) (241) Capitalized software (37) (21) Investments in companies (31) (49) Acquisition of Fingerhut Companies, Inc., net of cash acquired - (1,539) Disposition of property and equipment 53 23 Net cash used by investing activities (266) (1,827) Cash flows from financing activities: Debt issued 350 1,299 Financing costs (3) (10) Debt repaid (57) (31) Increase in outstanding checks 2 81 Acquisition of treasury stock (431) - Issuance of common stock 39 51 Net cash provided (used) by financing activities (100) 1,390 Net increase in cash $ 78 $ 50 Cash at beginning of period 218 307 Cash at end of period $ 296 $ 357 Supplemental cash flow information: Interest paid $ 196 $ 144 Interest received 3 4 Income taxes paid (net of refunds received) 242 194 Schedule of non cash investing and financing activities: Debt assumed in acquisition - 125 Equity issued in acquisition - 12 Consolidation of net assets and debt of previously unconsolidated subsidiary - 1,132 The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. FEDERATED DEPARTMENT STORES, INC. Notes to Consolidated Financial Statements (Unaudited) 1. Summary of Significant Accounting Policies A description of the Company's significant accounting policies is included in the Company's Annual Report on Form 10-K for the fiscal year ended January 29, 2000 (the "1999 10-K"). The accompanying Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto in the 1999 10-K. Because of the seasonal nature of the retail business, the results of operations for the 13 and 26 weeks ended July 29, 2000 and July 31, 1999 (which do not include the Christmas season) are not indicative of such results for the fiscal year. Substantially all department store merchandise inventories are valued by the retail method and stated on the LIFO (last-in, first-out) basis, which is generally lower than market. Direct-to-customer merchandise inventories are stated at the lower of FIFO (first-in, first-out) cost or market. The Consolidated Financial Statements as of and for the 13 and 26 weeks ended July 29, 2000 and July 31, 1999, 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. Certain reclassifications were made to prior period amounts to conform with the classifications of such amounts for the most recent periods. 2. Acquisition On March 18, 1999, the Company purchased Fingerhut Companies, Inc. ("Fingerhut") for a purchase price of approximately $1,720 million, including the assumption of $125 million of debt. The Fingerhut acquisition is being accounted for under the purchase method of accounting. Accordingly, the Company's results of operations do not include Fingerhut's results of operations for any period prior to March 18, 1999 and the purchase price has been allocated to Fingerhut's assets and liabilities based on the estimated fair value of these assets and liabilities as of March 18, 1999. 3. Segment Data The Company conducts its business through two segments, department stores and direct-to-customer. The department store segment sells a wide range of merchandise, including men's, women's and children's apparel and accessories, cosmetics, home furnishings and other consumer goods. The direct-to-customer segment (Fingerhut, Bloomingdale's By Mail, bloomingdales.com, Macy's By Mail, macys.com and certain other direct marketing activities) sells a broad range of products and services directly to consumers via catalogs, direct marketing and the Internet. "Corporate and other" consists of the income or expense associated with the corporate office and certain items managed on a company-wide basis (e.g., intangibles, financial instruments, investments, retirement benefits and properties held for sale or disposition). The financial information for each segment is reported on the basis used internally by the Company to evaluate performance and allocate resources. 13 Weeks Ended 26 Weeks Ended July 29, July 31, July 29, July 31, 2000 1999 2000 1999 (millions) Net Sales: Department Stores $ 3,644 $ 3,569 $ 7,185 $ 7,006 Direct-to-Customer 421 437 912 600 Total $ 4,065 $ 4,006 $ 8,097 $ 7,606 Operating income: Department Stores $ 428 $ 398 $ 736 $ 671 Direct-to-Customer (183) (27) (206) (29) Corporate and other (25) (53) (57) (99) Total $ 220 $ 318 $ 473 $ 543 Depreciation and amortization expense: Department Stores $ 149 $ 151 $ 298 $ 304 Direct-to-Customer 10 14 22 17 Corporate and other 23 22 47 39 Total $ 182 $ 187 $ 367 $ 360 4. Earnings Per Share The following tables set forth the computation of basic and diluted earnings per share: 13 Weeks Ended July 29, 2000 July 31, 1999 (millions, except per share data) Income Shares Income Shares Net income and average number of shares outstanding $ 63 206.1 $ 137 209.5 Shares to be issued under deferred compensation plans - .5 - .4 63 206.6 137 209.9 Basic earnings per share $ .31 $ .65 Effect of dilutive securities: Warrants - 1.0 - 8.8 Stock options - .9 - 3.2 $ 63 208.5 $ 137 221.9 Diluted earnings per share $ .30 $ .61 26 Weeks Ended July 29, 2000 July 31, 1999 (millions, except per share data) Income Shares Income Shares Net income and average number of shares outstanding $ 152 209.2 $ 224 209.0 Shares to be issued under deferred compensation plans - .5 - .4 152 209.7 224 209.4 Basic earnings per share $ .73 $ 1.07 Effect of dilutive securities: Warrants - 1.5 - 7.3 Stock options - 1.2 - 2.5 $ 152 212.4 $ 224 219.2 Diluted earnings per share $ .72 $ 1.02 FEDERATED DEPARTMENT STORES, INC. Notes to Consolidated Financial Statements (Unaudited) In addition to the warrants and stock options reflected in the foregoing tables, warrants and stock options to purchase 12.7 million and .8 million shares of common stock at prices ranging from $34.38 to $79.44 per share were outstanding at July 29, 2000 and July 31, 1999, respectively, but were not included in the computation of diluted earnings per share because the exercise price thereof exceeded the average market price and would have been antidilutive. FEDERATED DEPARTMENT STORES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations For purposes of the following discussion, all references to "second quarter of 2000" and "second quarter of 1999" are to the Company's 13-week fiscal periods ended July 29, 2000 and July 31, 1999, respectively, and all references to "2000" and "1999" are to the Company's 26-week fiscal periods ended July 29, 2000 and July 31, 1999, respectively. Results of Operations Comparison of the 13 Weeks Ended July 29, 2000 and July 31, 1999 Net sales for the second quarter of 2000 totaled $4,065 million, compared to net sales of $4,006 million for the second quarter of 1999, an increase of 1.5%. Net sales for department stores for the second quarter of 2000 were $3,644 million, compared to net sales of $3,569 million for the second quarter of 1999, an increase of 2.1%. On a comparable store basis (sales from stores in operation throughout 1999 and 2000), net sales for department stores for the second quarter of 2000 increased 1.9% compared to the second quarter of 1999. Net sales for the direct-to-customer segment totaled $421 million for the second quarter of 2000 compared to $437 million for the second quarter of 1999. Cost of sales was 58.5% of net sales for the second quarter of 2000, compared to 57.9% for the second quarter of 1999. The increase in the cost of sales rate reflects additional markdowns taken through the second quarter of 2000, which enabled the Company to keep in-store inventories fresh and fashion-current. The valuation of department store 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 36.1% of net sales for the second quarter of 2000 compared to 34.2% for the second quarter of 1999. Department store SG&A expenses improved 1.1% as a percent of department store net sales, reflecting the impact of lower non-payroll expenses and higher finance charge income. SG&A expenses for the direct-to- customer segment in the second quarter of 2000 were negatively impacted by higher than anticipated bad debt expenses resulting from increased credit delinquencies at Fingerhut. The higher credit related expenses in the direct-to-customer segment and increased costs related to recently launched businesses combined to offset the improvement in the department store SG&A expense rate and produce a 1.9% increase in the overall SG&A expense rate for the second quarter of 2000. The Company believes that the credit delinquency problem at Fingerhut will negatively impact direct-to-customer operating profits by $200 - $250 million through the remainder of the year. With a view to resolving the credit delinquency problem at Fingerhut, management has begun the process of comprehensively evaluating the Fingerhut operations and businesses. This process could result in the implementation of a plan that may result in the incurrence of one-time restructuring costs. Net interest expense was $108 million for the second quarter of 2000, compared to $85 million for the second quarter of 1999. The higher interest expense for the second quarter of 2000 is due primarily to the increased outstanding debt resulting from the consolidation of the Fingerhut Master Trust for financial reporting purposes. The Company's effective income tax rate of 43.5% for the second quarter of 2000 differs from the federal income tax statutory rate of 35.0% principally because of the effect of state and local income taxes and permanent differences arising from the amortization of intangible assets and from other non- deductible items. Comparison of the 26 Weeks Ended July 29, 2000 and July 31, 1999 Net sales for 2000 totaled $8,097 million, compared to net sales of $7,606 million for 1999, an increase of 6.5%. Net sales for department stores for 2000 were $7,185 million, compared to net sales of $7,006 million for 1999, an increase of 2.6%. On a comparable store basis, net sales for department stores for 2000 increased 2.4% compared to 1999. Net sales for the direct-to-customer segment totaled $912 million for 2000 (which includes Fingerhut for the entire period) compared to $600 million for 1999 (which includes Fingerhut from and after the March 18, 1999 acquisition date). Cost of sales was 59.0% of net sales for 2000, compared to 59.1% for 1999. Cost of sales as a percent of net sales for both department stores and the direct-to-customer segment for 2000 were relatively flat compared to the same period a year ago. 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 35.2% of net sales for 2000 compared to 33.8% for 1999. Department store SG&A expenses improved 0.7% as a percent of department store net sales, reflecting the impact of lower non-payroll expenses, including depreciation expense, and higher finance charge income. SG&A expenses for the direct-to-customer segment in 2000 were negatively impacted by higher than anticipated bad debt expenses resulting primarily from increased credit delinquencies at Fingerhut during the second quarter of 2000. The higher credit related expenses in the direct-to-customer segment during the second quarter of 2000, increased costs related to recently launched businesses and increased amortization expense resulting from the Fingerhut acquisition combined to offset the improvement in the department store SG&A expense rate and produce a 1.4% increase in the overall SG&A expense rate for 2000. Net interest expense was $207 million for 2000, compared to $160 million for 1999. The higher interest expense for 2000 is due primarily to the increased outstanding debt resulting from the Fingerhut acquisition and the consolidation of the Fingerhut Master Trust for financial reporting purposes. The Company's effective income tax rate of 42.8% for 2000 differs from the federal income tax statutory rate of 35.0% principally because of the effect of state and local income taxes and permanent differences arising from the amortization of intangible assets and from other non-deductible items. Liquidity and Capital Resources The Company's principal sources of liquidity are cash from operations, cash on hand and certain available credit facilities. Net cash provided by operating activities in 2000 was $444 million, a decrease of $43 million compared to the $487 million provided in 1999. This reflects greater decreases in 2000 in non-merchandise accounts payable and accrued liabilities due to the timing of the Fingerhut acquisition and greater decreases in income tax liabilities. The lower net income resulting from higher reserves for bad debt at Fingerhut was offset by greater decreases in 2000 in accounts receivable. The greater increases in 2000 in merchandise inventories were offset by greater increases in merchandise accounts payable. Net cash used by investing activities was $266 million for 2000. Investing activities for 2000 included purchases of property and equipment totaling $251 million, capitalized software of $37 million and investments in companies engaged in complementary businesses totaling $31 million. The Company opened two new department stores and one new furniture gallery during 2000, and plans to open eight additional department stores and two additional furniture galleries during the remainder of 2000. Net cash used by the Company for all financing activities was $100 million in 2000. On June 6, 2000, the Company issued $350 million of 8.5% Senior Notes due 2010. The Company purchased 11.6 million shares of its Common Stock under its stock repurchase program during 2000 at a cost of $429 million. On August 25, 2000, the Board of Directors approved a $500 million increase to the current 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. Also during 2000, the Company issued 1.0 million shares of its Common Stock and received $35 million in proceeds from the exercise of the Company's Series B Warrants, which expired on February 15, 2000. Management believes the department store business and other retail businesses will continue to consolidate. Accordingly, the Company intends from time to time to consider additional acquisitions of, and investments in, department stores, Internet-related companies, catalog companies and other complementary assets and companies. Management believes that, with respect to its current operations, cash on hand and funds from operations, together with its credit facilities, will be sufficient to cover its reasonably foreseeable working capital, capital expenditure and debt service requirements. 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. 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 existing indebtedness or for other corporate purposes. PART II -- OTHER INFORMATION FEDERATED DEPARTMENT STORES, INC. Item 1. Legal Proceedings The Company and certain members of its senior management have been named defendants in two substantially identical purported class action complaints (the "Complaints") filed on behalf of persons who purchased shares of the Company between February 23, 2000 and July 20, 2000. The Complaints were filed on August 24 and August 30, 2000, in the United States District Court for the Southern District of New York. The Complaints allege violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder, on the basis that the Company, among other things, made false and misleading statements regarding its financial condition and results of operations and failed to disclose material information relating to the credit delinquency problem at Fingerhut. The plaintiffs are seeking unspecified amounts of compensatory damages and costs, including legal fees. Management believes that the allegations contained in the Complaints are without merit and intends to vigorously defend against the allegations contained in the Complaints. Item 5. Other Information This report and other reports, statements and information previously or subsequently filed by the Company with the Securities and Exchange Commission (the "SEC") contain or may contain forward-looking statements. Such statements are based upon the beliefs and assumptions of, and on information available to, the management of the Company at the time such statements are made. The following are or may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995: (i) statements preceded by, followed by or that include the words "may," "will," "could," "should," "believe," "expect," "future," "potential," "anticipate," "intend," "plan," "estimate," or "continue" or the negative or other variations thereof and (ii) statements regarding matters that are not historical facts. Such forward-looking statements are subject to various risks and uncertainties, including (i) risks and uncertainties relating to the possible invalidity of the underlying beliefs and assumptions, (ii) possible changes or developments in social, economic, business, industry, market, legal and regulatory circumstances and conditions, and (iii) actions taken or omitted to be taken by third parties, including customers, suppliers, business partners, competitors and legislative, regulatory, judicial and other governmental authorities and officials. In addition to any risks and uncertainties specifically identified in the text surrounding such forward-looking statements, the statements in the immediately preceding sentence and the statements under captions such as "Risk Factors" and "Special Considerations" in reports, statements and information filed by the Company with the SEC from time to time constitute cautionary statements identifying important factors that could cause actual amounts, results, events and circumstances to differ materially from those reflected in such forward-looking statements. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 4.1 Fourth Supplemental Trust Indenture, dated as of June 6, 2000, by and among the Company and Citibank, N.A. (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated as of June 5, 2000). 10.1 Eleventh Amendment to Amended and Restated Pooling and Servicing Agreement, dated as of March 23, 2000, by and among Prime Receivables Corporation, FDS National Bank and The Chase Manhattan Bank. 10.2 Tenth Amendment to Receivables Purchase Agreement, dated as of March 23, 2000, by and among The Originators listed on the signature page thereto and Prime Receivables Corporation. 10.3 First Amendment to Series 1999-1 Variable Funding Supplement, dated as of August 1, 2000, by and among Prime II Receivables Corporation, FDS National Bank, The Chase Manhattan Bank, Market Street Funding Corporation and PNC Bank, National Association. 10.4 First Amendment to Series 1997-1 Variable Funding Supplement, dated as of June 19, 2000, by and among Prime II Receivables Corporation, FDS National Bank and The Chase Manhattan Bank. 10.5 Third Amended and Restated Credit Agreement, dated as of July 24, 2000, by and among the Company, the Initial Lenders named therein, Citibank, N.A., as Administrative Agent and Paying Agent, The Chase Manhattan Bank, as Administrative Agent, Fleet National Bank, as Syndication Agent, and Bank of America, N.A., as Documentation Agent. 10.6 Second Amendment Agreement to Fingerhut Receivables, Inc. Security Purchase Agreement, dated as of July 20, 2000, by and among Fingerhut Receivables, Inc., Kitty Hawk Funding Corporation, Falcon Asset Securitization Corporation, Four Winds Funding Corporation, Bank of America, N.A., Bank One, NA (Main Office Chicago), Norddeutsche Landesbank Girozentrale, New York Branch and/or Cayman Island Branch, and Commerzbank Aktiengesellschaft, Chicago Branch. 27 Financial Data Schedule (b) Reports on Form 8-K 1. Current Report on Form 8-K dated May 31, 2000 reporting matters under Item 5 and related exhibits under Item 7 thereof. 2. Current Report on Form 8-K dated June 2, 2000 reporting matters under Item 5 and Item 7 thereof. FEDERATED DEPARTMENT STORES, INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized. FEDERATED DEPARTMENT STORES, INC. Date September 11, 2000 /s/ Dennis J. Broderick Dennis J. Broderick Senior Vice President, General Counsel and Secretary /s/ Joel A. Belsky Joel A. Belsky Vice President and Controller (Principal Accounting Officer)