FORM 10-K
Annual Report Pursuant to Section 13
Federated Department Stores, Inc.
7 West Seventh Street
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act:
None
The Company has filed all reports required to be filed by Section 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.
Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in registrant’s definitive proxy or information statements incorporated by reference in Part III of this Form 10-K. o
Indicate by checkmark whether registrant is an accelerated filer (as defined in Exchange Act Rule 126-2). Yes þ No o
There were 187,327,448 shares of the Company’s Common Stock outstanding as of April 4, 2003, excluding shares held in the treasury of the Company or by subsidiaries of the Company.
The aggregate market value of the Company’s Common Stock, excluding shares held in the treasury of the Company or by subsidiaries of the Company, based upon the last sale price as reported on the New York Stock Exchange Composite Tape on August 2, 2002, was approximately $6,299,600,000.
Documents Incorporated by Reference
Portions of the definitive proxy statement (the “Proxy Statement”) relating to the Company’s Annual Meeting of Stockholders to be held on May 16, 2003 (the “Annual Meeting”), are incorporated by reference in Part III hereof.
TABLE OF CONTENTS
Unless the context requires otherwise references to “2002,” “2001,” “2000,” “1999” and “1998” are references to the Company’s fiscal years ended February 1, 2003, February 2, 2002, February 3, 2001, January 29, 2000 and January 30, 1999 respectively.
Forward-Looking Statements
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,” “think,” “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 (a) risks and uncertainties relating to the possible invalidity of the underlying beliefs and assumptions, (b) possible changes or developments in social, economic, business, industry, market, legal and regulatory circumstances and conditions, (c) 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, and (d) attacks or threats of attacks by terrorists or war. Furthermore, future results of the operations of the Company could differ materially from historical results or current expectations because of a variety of factors that affect the Company, including transaction costs associated with the renovation, conversion and transitioning of retail stores in regional markets; the outcome and timing of sales and leasing in conjunction with the disposition of retail store properties; the retention, reintegration and transitioning of displaced employees; competitive pressures from department and specialty stores, general merchandise stores, manufacturers’ outlets, off-price and discount stores, and all other retail channels; and general consumer-spending levels, including the impact of the availability and level of consumer debt, and the effects of the weather. 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 1. Business.
General. The Company is a Delaware corporation. The Company and its predecessors have been operating department stores since 1820.
As of February 1, 2003, the Company, through its subsidiaries, operated 394 department stores and 61 furniture galleries and other specialty stores under the names “Bloomingdale’s,” “The Bon Marché,” “Burdines,” “Goldsmith’s,” “Lazarus,” “Macy’s” and “Rich’s.” The stores are located in 34 states, Puerto Rico and Guam, with 145 stores being located on the west coast, 103 stores in the southeast, 93 stores in the northeast, 51 stores in the midwest and the remaining 63 stores spread in other areas of the United States and its territories. The department stores sell a wide range of merchandise, including men’s, women’s and children’s apparel and accessories, cosmetics, home furnishings and other consumer goods,
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The Company, through its Bloomingdale’s and Macy’s West subsidiaries, conducts direct-to-customer mail catalog and electronic commerce businesses under the names “Bloomingdale’s By Mail” and “macys.com.” Additionally, the Company offers on-line bridal registry and gift purchase facilities to customers.
Through its subsidiary, Fingerhut Companies, Inc. (“Fingerhut”), the Company previously sold a broad range of products and services through catalogs, direct marketing and the Internet, including (i) Figi’s, a food and gift catalog business; (ii) Arizona Mail Order and Bedford Fair, both apparel catalog businesses; and (iii) Popular Club, a membership-based general merchandise catalog business. Fingerhut also provided services to third parties. On January 16, 2002, the Company’s Board of Directors approved a plan to dispose of the operations of 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. During 2002, the Company, through separate transactions with third parties, sold substantially all of the assets of Fingerhut and its subsidiaries, including the Fingerhut core catalog operation, the Fingerhut receivables portfolio and related assets, the operations of Arizona Mail Order and Figi’s as ongoing businesses, the operations of Popular Club Plan, as an ongoing business and certain real property assets. Effective February 2, 2002, the Company began reporting Fingerhut’s results as discontinued operations in the Company’s consolidated financial statements. The historical percentage of the Company’s consolidated net sales attributable to Fingerhut was 7% for the 52 weeks ended February 2, 2002 and 10% for the 53 weeks ended February 3, 2001. Because the Fingerhut core catalog operation, the related receivables portfolio and the Arizona Mail Order, Figi’s and Popular Club Plan operations constituted a single business segment, the Company treated their disposition as a liquidation of the segment. The Company now operates in one segment as an operator of department stores.
The Company provides various support functions to its retail operating divisions on an integrated, company-wide basis.
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FACS, FSG, FMG and certain departments in the Company’s corporate offices also offer their services to unrelated third parties.
The Company’s executive offices are located at 7 West Seventh Street, Cincinnati, Ohio 45202, telephone number: (513) 579-7000 and 151 West 34th Street, New York, New York 10001, telephone number: (212) 494-1602.
Employees. As of February 1, 2003, the Company had approximately 113,000 regular full-time and part-time employees. Because of the seasonal nature of the retail business, the number of employees peaks in the Christmas season. Approximately 10% of the Company’s employees as of February 1, 2003 were represented by unions. Management considers its relations with employees to be satisfactory.
Seasonality. The retail business is seasonal in nature with a high proportion of sales and operating income generated in the months of November and December. Working capital requirements fluctuate during the year, increasing somewhat in mid-summer in anticipation of the fall merchandising season and increasing substantially prior to the Christmas season when the Company must carry significantly higher inventory levels.
Purchasing. The Company purchases merchandise from many suppliers, no one of which accounted for more than 5% of the Company’s net purchases during 2002. The Company has no long-term purchase commitments or arrangements with any of its suppliers, and believes that it is not dependent on any one supplier. The Company considers its relations with its suppliers to be satisfactory.
Competition. The retailing industry, in general, and the department store and direct-to-customer businesses, in particular, are intensely competitive. Generally, the Company’s stores and direct-to-customer business operations compete with other department stores in the geographic areas in which they operate, as well as numerous other types of retail outlets, including specialty stores, general merchandise stores, off-price and discount stores, new and established forms of home shopping (including the Internet, mail order catalogs and television) and manufacturers’ outlets. The operators of department stores with which the Company competes to a substantial degree include Dillard’s, J.C. Penney, Kohl’s, May, Nordstrom, and Sears. The Company seeks to attract customers by offering superior selections, value pricing, and strong private label merchandise in stores that are located in premier locations, and by providing an exciting
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Available Information. The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act available free of charge through its internet website athttp://www.fds.com as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission.
Item 1A. Executive Officers of the Registrant.
The following table sets forth certain information regarding the executive officers of the Company:
James M. Zimmerman has been Chairman of the Board since May 1997, and Chief Executive Officer of the Company from May 1997 until February 25, 2003; prior thereto he served as the President and Chief Operating Officer of the Company since May 1988.
Terry J. Lundgren has been President and Chief Executive Officer of the Company since February 26, 2003; prior thereto he served as the President/ Chief Operating Officer and Chief Merchandising Officer of the Company since April 15, 2002. Prior to April 15, 2002 Mr. Lundgren served as the President and Chief Merchandising Officer of the Company since May 1997 and served as the Chairman of the Company’s Federated Merchandising Group division from February 1994 until February 19, 1998.
Ronald W. Tysoe has been Vice Chair, Finance and Real Estate, of the Company since April 1990 and served as Chief Financial Officer of the Company from April 1990 until October 31, 1997.
Thomas G. Cody has been Vice Chair, Legal, Human Resources, Internal Audit and External Affairs, since February 26, 2003; prior thereto he served as the Executive Vice President, Legal and Human Resources, of the Company since May 1988.
Tom Cole has been Vice Chair, Support Operations, since February 26, 2003 and Chairman of FLO since 1995, FSG since 2001 and FACS since 2002.
Janet E. Grove has been Vice Chair, Merchandising, Private Brand and Product Development, since February 26, 2003 and Chairman of FMG since 1998 and Chief Executive Officer of FMG since 1999.
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Susan D. Kronick has been Vice Chair, Department Store Divisions, since February 26, 2003; prior thereto she served as Group President, Regional Department Stores, since 2001.
Karen M. Hoguet has been Senior Vice President of the Company since April 1991 and Chief Financial Officer of the Company since October 31, 1997. Mrs. Hoguet also served as the Treasurer of the Company from January 1992 until July 6, 1999.
Dennis J. Broderick has been Secretary of the Company since July 1993 and Senior Vice President and General Counsel of the Company since January 1990.
Joel A. Belsky has been Vice President and Controller of the Company since October 1996. Prior thereto he served as Divisional Vice President and Deputy Controller of the Company since March 1993.
Item 2. Properties.
The properties of the Company consist primarily of stores and related facilities, including warehouses and distribution and fulfillment centers. The Company also owns or leases other properties, including corporate office space in Cincinnati and New York and other facilities at which centralized operational support functions are conducted. As of February 1, 2003, the Company operated 455 stores in 34 states, Puerto Rico and Guam, comprising a total of approximately 83,500,000 square feet. Of such stores, 198 were owned, 171 were leased and 86 stores were operated under arrangements where the Company owned the building and leased the land. All owned properties are held free and clear of mortgages. Pursuant to various shopping center agreements, the Company is obligated to operate certain stores for periods of up to 20 years. Some of these agreements require that the stores be operated under a particular name. Most leases require the Company to pay real estate taxes, maintenance and other costs; some also require additional payments based on percentages of sales and some contain purchase options. Certain of the Company’s real estate leases have terms that extend for significant numbers of years and provide for rental rates that increase over time.
Item 3. Legal Proceedings.
The Company and certain members of its senior management have been named defendants in five substantially identical purported class action complaints filed on behalf of persons who purchased shares of the Company between February 23, 2000 and July 20, 2000. Originally filed in August, September and October 2000, in the United States District Court for the Southern District of New York, the actions have been consolidated into a single case (In Re Federated Department Stores, Inc. Securities Litigation, Case No. 00-CV-6362 (RCC)) and a consolidated amended complaint (the “Complaint”) has been filed. The Complaint alleges violations 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 intends to defend vigorously against those allegations. A motion to dismiss the Complaint is pending. Discovery has not commenced.
On February 14 and February 26, 2002, two essentially identical shareholder derivative lawsuits were filed in a Minnesota state court, purportedly on behalf of the Company, naming as defendants the Company’s directors, its Fingerhut subsidiary and certain officers of Fingerhut. The defendants have removed these lawsuits to the United States District Court for the District of Minnesota (Wesenberg vs.
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Item 4. Submission of Matters to a Vote of Security-Holders.
None.
PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.
The Common Stock is listed on the New York Stock Exchange (the “NYSE”) under the trading symbol “FD.” As of February 1, 2003, the Company had approximately 12,932 stockholders of record. The following table sets forth for each fiscal quarter during 2002 and 2001 the high and low sales prices per share of Common Stock as reported on the NYSE Composite Tape:
The Company has not paid any dividends on its Common Stock during its two most recent fiscal years, but may consider paying dividends on the Common Stock in the future.
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Item 6. Selected Financial Data.
The selected financial data set forth below should be read in conjunction with the Consolidated Financial Statements and the notes thereto and the other information contained elsewhere in this report.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of 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. As part of the consolidation, seven stores were closed. The Company currently anticipates that two locations will be renovated and reopened as Bloomingdale’s, one location will be renovated and reopened as a Rich’s-Macy’s furniture gallery and four locations will be sold or leased for other retail use. 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.
On July 9, 2001, the Company completed its acquisition of Liberty House, Inc. (“Liberty House”), a department store retailer operating 11 department stores and seven resort and specialty stores in Hawaii and one department store in Guam. The total purchase price of the Liberty House acquisition was approximately $200 million, consisting of approximately $183 million of cash and the assumption of approximately $17 million of indebtedness. The acquisition was accounted for under the purchase method of accounting and, accordingly, the results of operations of Liberty House have been included in the Company’s results of operations from the date of acquisition and the purchase price has been allocated to Liberty House’s assets and liabilities based on their estimated fair values as of that date. All Liberty House stores were subsequently converted to Macy’s stores in 2001.
On February 2, 2001, the Company decided to close its Stern’s department store division, and to convert most of its Stern’s stores to Macy’s and Bloomingdale’s stores, in order to expand and strengthen Macy’s and Bloomingdale’s. Also, on November 29, 2001, the Company announced the reorganization of its department store-related catalog and e-commerce operations to conduct its continuing Internet and catalog business exclusively throughmacys.com and Bloomingdale’s By Mail.
As a result of continuing declines in interest rates and the market value of the Company’s defined benefit pension plan assets, the Company was required to increase its minimum pension liability and reduce stockholders’ equity at February 1, 2003 by $261 million, net of tax effect. This adjustment did not affect the Company’s reported earnings or pension plan funding requirements. However, the Company
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The following discussion should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that reflect the Company’s plans, estimates and beliefs. The Company’s actual results could materially differ from those discussed in these forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in “Forward-Looking Statements.”
Results of Operations
Comparison of the 52 Weeks Ended February 1, 2003 and the 52 Weeks Ended February 2, 2002. Net income for 2002 totaled $818 million compared to a net loss for 2001 of $276 million.
Net sales for 2002 totaled $15,435 million, compared to net sales of $15,651 million for 2001, a decrease of 1.4%. The overall sales trend in 2002 was negatively impacted by a difficult economic climate. On a comparable store basis (sales from stores in operation throughout 2001 and 2002), net sales decreased 3.0% compared to 2001. By family of business, sales were relatively strong in private brands, furniture, jewelry and young men’s. The weakest businesses were the soft home areas – tabletop (china, silver, glass), textiles and housewares.
Cost of sales was 60.0% of net sales for 2002, compared to 61.2% for 2001. Cost of sales as a percent of net sales, excluding $53 million in inventory valuation adjustments, was 60.9% in 2001. The cost of sales rate in 2002 benefited from lower net markdowns resulting from the lower inventory levels throughout 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 expenses (“SG&A”) were 31.3% of net sales for 2002 compared to 30.7% for 2001. Finance charge income on proprietary accounts receivable was $353 million for 2002, down from $361 million in 2001, primarily due to the decrease in average accounts receivable balances. Amounts charged to expense for doubtful proprietary accounts receivable were $143 million for 2002, compared to $128 million in 2001, reflecting slightly higher delinquency rates during 2002. Included in SG&A expenses for 2002 were approximately $68 million of costs, 0.4% of net sales, incurred in the fourth quarter in connection with the Rich’s-Macy’s consolidation and other announced store closings. These costs were primarily real estate related and also included severance. In 2001, there was approximately $29 million of costs, 0.2% of net sales, incurred in the fourth quarter in connection with store closings included in SG&A expenses, also primarily related to real estate write-downs. SG&A expenses in 2002 benefited from lower goodwill and intangible amortization as a result of the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” Effective February 3, 2002, the Company ceased amortizing goodwill and indefinite lived intangible assets. SG&A expenses in 2001 included amortization expense of $28 million, 0.2% of net sales, related to goodwill and indefinite lived intangible assets. The effect of the non-amortization provisions of SFAS No. 142 was offset by the impact of higher occupancy related expenses, such as depreciation, rent, taxes and insurance.
During 2001, the Company incurred asset impairment and restructuring charges related to its department store business. These costs related primarily to the closing of its Stern’s department store division and subsequent integration into its Macy’s and Bloomingdale’s operations, the acquisition of Liberty House and subsequent integration into Macy’s and the reorganization of its department-store-
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Net interest expense was $295 million for 2002 compared to $324 million for 2001, primarily due to lower levels of borrowings.
The Company’s effective income tax rate of 39.1% for 2002 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 other items. The Company’s effective income tax rate of 33.6% for 2001 differs from the federal income tax statutory rate of 35.0% principally because of the effect of the disposition of its Stern’s subsidiary, state and local income taxes and permanent differences arising from the amortization of intangible assets and other items. Income tax expense for 2001 reflects a $44 million benefit related to the recognition of the effect of the difference between the financial reporting and tax bases of the Company’s investment in Stern’s Department Stores, Inc. upon disposition.
During 2002, through various transactions, the Company completed the sale of the Arizona Mail Order, Figi’s and Popular Club Plan businesses conducted by Fingerhut’s subsidiaries, completed the sale of Fingerhut’s core catalog accounts receivable portfolio, with the buyer assuming $450 million of receivables-backed debt, and 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 the foregoing sale transactions 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 for 2002 totaling $307 million of income before income taxes, or $180 million after income taxes. As of February 1, 2003, substantially all Fingerhut assets had been disposed of and substantially all Fingerhut liabilities had been settled.
Comparison of the 52 weeks ended February 2, 2002 and the 53 weeks ended February 3, 2001. The net loss for 2001 was $276 million compared to a net loss of $184 million for 2000.
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Net sales for 2001 totaled $15,651 million, compared to net sales of $16,638 million for 2000, a decrease of 5.9%. The sales decrease reflects a weak economy, the events of September 11th and the closing of Stern’s. The overall sales trend was disappointing, particularly in such categories as men’s, tabletop (china, silver, glass) and luggage. However, sales were relatively strong in private brands, juniors’ and young men’s. On a comparable store basis (sales from stores in operation throughout 2000 and 2001, including Stern’s stores in operation throughout the first quarter of 2000 and 2001, and adjusting for the impact of the 53rd week in 2000), net sales for 2001 decreased 5.3% compared to 2000.
Cost of sales was 61.2% of net sales for 2001, compared to 59.8% for 2000. Cost of sales as a percent of net sales, excluding $53 million of inventory valuation adjustments, was 60.9% in 2001, reflecting higher markdowns taken in 2001 which were needed, given the large decline in sales, to reduce inventories to more appropriate levels, particularly in fashion apparel categories. The Company ended 2001 with inventories down 7%, compared to 2000. The valuation of merchandise inventories on the last-in, first-out basis did not impact cost of sales in either period.
SG&A expenses were 30.7% of net sales for 2001, compared to 29.5% for 2000. SG&A expenses decreased 2.2% in actual dollars compared to 2000, however, due to the lower sales level, SG&A expenses increased 1.2 percentage points as a percent of net sales. The Company was able to reduce total selling expenses, although not enough to compensate for the sales decrease. In 2001, there was approximately $29 million of costs, 0.2% of net sales, incurred in the fourth quarter in connection with store closings included in SG&A expenses, primarily related to real estate write-downs. Additionally, an increase in relatively fixed costs, such as depreciation and amortization, utilities, etc., contributed greatly to the higher SG&A expense rate. Finance charge income was $361 million for 2001, up from $349 million in 2000, primarily due to the growth in average accounts receivable balances. Amounts charged to expense for doubtful accounts receivable were $128 million for 2001, compared to $106 million in 2000, also due to the growth in average accounts receivable balances.
During 2001, the Company incurred asset impairment and restructuring charges related to its department store business. These costs related primarily to the closing of its Stern’s department store division and subsequent integration into its Macy’s and Bloomingdale’s operations, the acquisition of Liberty House and subsequent integration into Macy’s and the reorganization of its department-store-related catalog and e-commerce operations. The Company recorded $215 million of asset impairment and restructuring charges during 2001, including $53 million of inventory valuation adjustments as a part of cost of sales. The $53 million of inventory valuation adjustments included $33 million related to the Stern’s conversion, $17 million related to the Liberty House integration and $3 million related to the catalog and e-commerce reorganization. These inventory valuation adjustments consisted of markdowns on merchandise that was sold at Stern’s, Liberty House or through the Company’s catalog and e-commerce channels and that would not continue to be sold following the conversion of the Stern’s and Liberty House stores and the reorganization of the catalog and e-commerce business. The $162 million of asset impairment and restructuring charges included $38 million of costs associated with converting the Stern’s stores into Macy’s (including store remodeling costs, advertising, credit card issuance and promotion and other name change expenses), $35 million of costs to close and sell certain Stern’s stores (including lease obligations and other store closing expenses), $18 million of severance costs related to the Stern’s closure, $9 million of Stern’s duplicate central office costs, $10 million of costs associated with converting the Liberty House stores into Macy’s (including advertising, credit card issuance and promotion and other name change expenses), $4 million of Liberty House duplicate central office costs, $40 million of fixed asset and capitalized software write-downs related to the catalog and e-commerce reorganization,
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Net interest expense was $324 million for 2001, compared to $321 million for 2000.
The Company’s effective income tax rate of 33.6% for 2001 differs from the federal income tax statutory rate of 35.0% principally because of the effect of the disposition of its Stern’s subsidiary, state and local income taxes and permanent differences arising from the amortization of intangible assets and other items. Income tax expense for 2001 reflects a $44 million benefit related to the recognition of the effect of the difference between the financial reporting and tax bases of the Company’s investment in Stern’s Department Stores, Inc. upon disposition. The Company’s effective income tax rate of 40.1% 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.
The net loss from discontinued operations includes only the results of the operating segment of Fingerhut (including its three catalog subsidiaries, Arizona Mail Order, Figi’s, and Popular Club Plan). The net loss from discontinued operations for 2001 was $14 million, compared to a loss of $1,005 million for 2000. The loss in 2000 included $882 million of pre-tax charges related to intangible, investment and fixed asset write-downs and other costs and expenses associated with the downsizing of the Fingerhut core catalog operations. In 2001, the Company also recorded a $770 million loss related to the disposal of Fingerhut, including $292 million of estimated operating losses expected during the wind-down period.
Liquidity and Capital Resources
The Company’s principal sources of liquidity are cash from operations, cash on hand and the credit facilities, described below.
Net cash provided by continuing operating activities in 2002 was $1,168 million, compared to $1,372 million for 2001. Cash provided by operating activities in 2002 reflects smaller decreases in accounts receivable, merchandise inventories, accounts payable and accrued liabilities, an increase in current income taxes and a decrease in deferred income taxes.
Net cash used by continuing investing activities was $637 million for 2002. Continuing investing activities for 2002 included purchases of property and equipment totaling $568 million and capitalized software of $59 million. Continuing investing activities for 2001 included the acquisition of Liberty House at a net cash cost of $175 million, purchases of property and equipment totaling $615 million and capitalized software of $36 million. The Company opened thirteen full line department stores, one home store and one furniture gallery during 2002.
The Company intends to open six new department stores, two new home stores and four furniture galleries in 2003, all before the next Christmas season. The Company’s budgeted capital expenditures are approximately $650 million for 2003, $650 million for 2004 and $650 million for 2005. Management presently anticipates funding such expenditures with cash from operations.
Net cash used by the Company for continuing financing activities was $1,375 million in 2002. The Company repaid $1,015 million of borrowings during 2002, consisting principally of $598 million of receivables backed financings and $400 million of 8.125% senior notes. The Company purchased 11.4 million shares of its Common Stock under its stock repurchase program during 2002 at an
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Net cash provided to the Company by discontinued operations was $924 million, after the payment of approximately $529 million of related debt, for the 52 weeks ended February 1, 2003, primarily due to the sale of Fingerhut’s core catalog accounts receivable portfolio and the sale of the Arizona Mail Order, Figi’s and Popular Club Plan businesses and various other Fingerhut assets.
The Company finances its proprietary credit card receivables, which arise solely from sales originated in the conduct of the Company’s retail operations, using on-balance sheet financing arrangements, including term receivables-backed certificates issued by a subsidiary of the Company together with receivables-backed commercial paper issued by another subsidiary of the Company. At February 1, 2003, these arrangements included a $375 million asset-backed commercial paper program. Under the $375 million commercial paper program, a special purpose subsidiary of the Company issues commercial paper backed by a Class A Variable Funding Certificate issued out of the Prime Credit Card Master Trust which holds the proprietary receivables. If the subsidiary is unable to issue commercial paper to fund maturities of outstanding commercial paper, it has a liquidity facility with a number of banks which will fund loans in order to repay the commercial paper. The commercial paper investors have no recourse back to the Company. As of February 1, 2003, and February 2, 2002, there was no such commercial paper or loan outstanding.
The Company finances its non-proprietary credit card receivables, which arise from transactions originated by merchants that accept third-party credit cards issued by the Company’s FDS Bank subsidiary, using on-balance sheet financing arrangements. Under these arrangements, a special purpose subsidiary of the Company sells Class A and Class B Variable Funding Certificates issued out of the Prime Credit Card Master Trust II (“Trust II”) which holds the non-proprietary receivables to three unrelated bank commercial paper conduit programs. The commercial paper conduit programs have agreed to purchase certificates of up to $700 million in the aggregate. Receivables-backed financings classified as short-term debt at February 1, 2003, consist of $486 million of debt under these arrangements.
Prior to July 2002, the Company financed its non-proprietary credit card receivables through an off-balance sheet sale arrangement. During July 2002, in connection with the extension of the financing arrangement related to the Company’s non-proprietary credit card receivables, the Company’s special purpose subsidiary took certain actions which resulted in the consolidation of Trust II for financial reporting purposes. In particular, the documentation governing the arrangement was amended to provide the Company’s special purpose subsidiary the ability to unilaterally remove transferred assets from Trust II. Under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” this amendment disqualified the arrangement for sale treatment and requires secured borrowing treatment for all sales of the Company’s non-proprietary credit card receivables pursuant to this arrangement. The principal assets and liabilities of Trust II consist of non-proprietary credit card receivables transferred by the Company to Trust II in transactions previously accounted for as sales under SFAS No. 140 and the related debt issued by Trust II. As a result of the Company’s actions, the transfer of receivables and debt are being treated as secured borrowings as of and subsequent to July 5, 2002. All assets and liabilities of Trust II were consolidated at fair value. These actions increased the Company’s consolidated assets and debt by $479 million at July 5, 2002.
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The Company is a party to a five-year $1,200 million revolving credit facility that expires in June 2006 and a 364-day $400 million revolving credit facility that expires in June 2003 (which the Company expects to extend annually, subject to an assessment of liquidity needs). At February 1, 2003, the Company had no borrowings outstanding under either of these facilities, but had $31 million of letters of credit outstanding under the five-year facility. The issuance of commercial paper under the Company’s $1,600 million unsecured commercial paper facility program will have the effect, while such commercial paper is outstanding, of reducing the Company’s borrowing capacity under the Company’s $1,600 million bank credit agreements by an amount equal to the face amount of such commercial paper. As of February 1, 2003, there was no such commercial paper outstanding. The credit agreements governing those facilities require the Company to maintain a specified interest coverage ratio of no less than 3.25 and a specified leverage ratio of no more than .62. At February 1, 2003, the Company was in compliance with these requirements by significant margins. Management believes that the likelihood of the Company defaulting on the foregoing debt covenants is remote absent any material negative event affecting the U.S. economy as a whole. However, if the Company’s results of operations or operating ratios deteriorate to a point where the Company is not in compliance with any of its debt covenants and the Company is unable to obtain a waiver, much of the Company’s debt would be in default and could become due and payable immediately.
At February 1, 2003, the Company had contractual obligations as follows:
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 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. For short term liquidity, the Company also relies on its $1,600 million unsecured commercial paper facility, a $375 million asset-backed commercial paper program relating to the Company’s proprietary credit card receivables and three asset-backed bank conduit commercial paper programs relating to the Company’s non-proprietary credit card receivables (discussed above) in an aggregate amount of $700 million. Access to the unsecured commercial paper program is dependent on the Company’s credit rating; a downgrade in its short-term rating would hinder its ability to access this market. If the Company is unable to access the unsecured commercial paper market, it has the ability to access $1,600 million pursuant to its bank credit
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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.
Critical Accounting Policies
Allowance for Doubtful Accounts
The Company evaluates the collectibility of its proprietary and non-proprietary accounts receivable based on a combination of factors, including analysis of historical trends, aging of accounts receivable, write-off experience and expectations of future performance. Proprietary and non-proprietary accounts receivable are considered delinquent if more than one scheduled minimum payment is missed. Delinquent proprietary accounts are generally written off automatically after the passage of 210 days without receiving a full scheduled monthly payment. Delinquent non-proprietary accounts are written off automatically after the passage of 180 days without receiving a full scheduled monthly payment. Accounts are written off sooner in the event of customer bankruptcy or other circumstances that make further collection unlikely. The Company reserves for doubtful proprietary accounts based on a loss-to-collections rate and doubtful non-proprietary accounts based on a roll-reserve rate. At February 1, 2003, a 0.1 percentage point change in the result of the loss-to-collections rate would impact the proprietary reserve for doubtful accounts by approximately $2 million. At February 1, 2003, a 0.1 percentage point change in the result of the roll-reserve rate would impact the non-proprietary reserve for doubtful accounts by approximately $1 million.
Merchandise Inventories
Merchandise inventories are valued at the lower of cost or market using the last-in, first-out (LIFO) retail inventory method. Under the retail inventory method, inventory is segregated into departments of merchandise having similar characteristics, and is stated at its current retail selling value. Inventory retail values are converted to a cost basis by applying specific average cost factors for each merchandise department. Cost factors represent the average cost-to-retail ratio for each merchandise department based on beginning inventory and the fiscal year purchase activity. The retail inventory method inherently requires management judgments and contains estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory, which may impact the ending inventory valuation as well as gross margins.
Permanent markdowns designated for clearance activity are recorded when the utility of the inventory has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise and fashion trends. When a decision is made to permanently mark down merchandise, the resulting gross profit reduction is recognized in the
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Shrinkage is estimated as a percentage of sales for the period from the last inventory date to the end of the fiscal period. Such estimates are based on experience and the most recent physical inventory results. While it is not possible to quantify the impact from each cause of shrinkage, the Company has loss prevention programs and policies that minimize shrinkage experience. Physical inventories are taken within each merchandise department at least twice annually and inventory records are adjusted accordingly.
Long-Lived Asset Impairment and Restructuring Charges
The carrying value of long-lived assets are periodically reviewed by the Company whenever events or changes in circumstances indicate that a potential impairment has occurred. For long-lived assets held for use, a potential impairment has occurred if projected future undiscounted cash flows are less than the carrying value of the assets. The estimate of cash flows includes management’s assumptions of cash inflows and outflows directly resulting from the use of those assets in operations. When a potential impairment has occurred, an impairment write-down is recorded if the carrying value of the long-lived asset exceeds its fair value. The Company believes its estimated cash flows are sufficient to support the carrying value of its long-lived assets. If estimated cash flows significantly differ in the future, the Company may be required to record asset impairment write-downs.
For long-lived assets held for disposal by sale, an impairment charge is recorded if the carrying amount of the assets exceeds its fair value less costs to sell. Such valuations include estimations of fair values and incremental direct costs to transact a sale. For long-lived assets to be abandoned, the Company considers the asset to be disposed of when it ceases to be used. If the Company commits to a plan to abandon a long-lived asset before the end of its previously estimated useful life, depreciation estimates are revised accordingly. In addition, liabilities arise such as severance, contractual obligations and other accruals associated with store closings from decisions to dispose of assets. The Company estimates these liabilities based on the facts and circumstances in existence for each restructuring decision. The amounts the Company will ultimately realize or disburse could differ from the amounts assumed in arriving at the asset impairment and restructuring charge recorded.
Self-Insurance Reserves
The Company is self-insured for workers compensation and public liability claims up to certain maximum liability amounts. Although the amounts accrued are actuarially determined based on analysis of historical trends of losses, settlements, litigation costs and other factors, the amounts the Company will ultimately disburse could differ from such accrued amounts.
Pension and Supplementary Retirement Plans
The Company has a funded defined benefit pension plan (the “Pension Plan”) and an unfunded defined benefit supplementary retirement plan (the “SERP”). The Company accounts for these plans using SFAS No. 87, “Employers’ Accounting for Pensions.” Under SFAS No. 87, pension expense is recognized on an accrual basis over employees’ approximate service periods. Pension expense calculated under SFAS No. 87 is generally independent of funding decisions or requirements.
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The fair value of the Pension Plan assets decreased from $1,480 million at February 2, 2002 to $1,276 million at February 1, 2003. Lower investment returns (in the case of the Pension Plan), benefit payments and declining discount rates resulted in the funded status of the Pension Plan changing from $83 million overfunded at February 2, 2002 to $207 million underfunded at February 1, 2003 and the underfunded status of the SERP increasing from $180 million at February 2, 2002 to $216 million at February 1, 2003. Funding requirements for the Pension Plan are determined by government regulations, not SFAS No. 87. Although no funding contribution was required, the Company made a $50 million voluntary funding contribution to the Pension Plan in 2002. The Company currently anticipates that it will not be required to make any additional contribution to the Pension Plan until 2005.
At February 1, 2003, the Company had unrecognized actuarial losses of $513 million for the Pension Plan and $90 million for the SERP. These losses will be recognized as a component of pension expense in future years in accordance with SFAS No. 87.
The calculation of pension expense and pension liability requires the use of a number of assumptions. Changes in these assumptions can result in different expense and liability amounts, and future actual experience may differ significantly from current expectations. The Company believes that the most critical assumptions relate to the long-term rate of return on plan assets (in the case of the Pension Plan), the discount rate used to determine the present value of projected benefit obligations and the weighted average rate of increase of future compensation levels.
The Company has assumed that the Pension Plan assets will generate a long-term rate of return of 9.0% for 2003. This rate is lower than the assumed rate of 9.75% used for 2002. The Company develops its long-term rate of return assumption by evaluating input from several professional advisors taking into account the asset allocation of the portfolio and long-term asset class return expectations, as well as long-term inflation assumptions. Pension expense increases as the expected rate of return on the Pension Plan assets decreases. Lowering the expected long-term rate of return on the Pension Plan assets by 0.75% (from 9.75% to 9.0%) increased the estimated 2003 pension expense by approximately $12 million.
The Company discounted its future pension obligations using a rate of 6.75% at December 31, 2002, compared to 7.25% at December 31, 2001. The Company determines the appropriate discount rate based on the current yield earned on an index of investment-grade long-term bonds. Pension liability and future pension expense both increase as the discount rate is reduced. Lowering the discount rate by 0.50% (from 7.25% to 6.75%) increased pension liability at February 1, 2003 by approximately $69 million and increased estimated 2003 pension expense by approximately $4 million.
The assumed weighted average rate of increase in future compensation levels was 5.8% as of December 31, 2002 and December 31, 2001 for the Pension Plan and 7.7% as of December 31, 2002 and December 31, 2001 for the SERP. The Company develops its increase of future compensation level assumption based on recent experience. Pension liability and future pension expense both increase as the weighted average rate of increase of future compensation levels is increased. Increasing the weighted average rate of increase of future compensation levels by 0.25% would increase the projected benefit obligation at February 1, 2003 by approximately $6 million and increase estimated 2003 pension expense by approximately $1 million.
Discontinued Operations
At February 2, 2002, discontinued operations included management’s best estimates of the amounts expected to be realized on the sale or wind-down of assets and businesses of the Fingerhut operations,
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Included in the estimated loss on disposal, the Company recorded losses related to Fingerhut’s core catalog accounts receivable portfolio through an estimated four year wind-down period. The calculated loss included estimates regarding customer payment rates, write-off rates, finance charge income, late fee income, and operating expenses, such as collection costs, necessary to carry out the wind-down of the portfolio. These estimates were based on a third party offer to purchase the portfolio, historical experience and industry data where available.
The estimated loss from the Fingerhut core catalog operations during the wind-down period included assumptions of revenues to be earned and estimated expenses to be incurred based on historical experience as well as through detailed departmental plans regarding the costs necessary to complete the liquidation in the planned timeframe.
Losses on inventory were recognized based on estimated recovery values expected to be received from a third party liquidator. Write-downs of property, plant and equipment were based on historical recovery rates for similar liquidations of personal property and brokerage quotes, where available, for real estate properties. Other assets, such as tradenames, customer lists, supplies, prepaid expenses, and capitalized software, were written-down to estimated net realizable value, which in some cases was zero due to their lack of marketability.
The loss on sale of the Fingerhut subsidiaries was estimated using market value quotes from an investment bank, projected net book values of each subsidiary at the expected sale dates, and expenses necessary to disconnect the subsidiaries’ support functions from Fingerhut’s core catalog operations.
Severance and retention were estimated based on the then current workforce, employment needs through the wind-down period, employment agreements where applicable, years of service, and estimated payout based on the general severance and retention plan offered to employees. Remaining lease obligations or contractual cancellation penalties were estimated based on a review of the contract terms in place.
Estimated interest expense was allocated to discontinued operations based upon the debt balances attributable to those operations.
As of February 1, 2003, substantially all Fingerhut assets had been disposed of and substantially all Fingerhut liabilities had been settled.
New Pronouncements
In 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” and clarifies the requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The adoption of this statement did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
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In 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This statement rescinds or amends existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. SFAS No. 145 is effective for transactions occurring after May 15, 2002. The Company does not anticipate that the adoption of this statement will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
Also in 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation” and 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 stock-based compensation and amends the disclosure provisions therein. The Company does not anticipate that the adoption of this statement will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In 2002, the FASB issued EITF Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” This issue addresses the reseller’s accounting for cash consideration received from a vendor. The Company’s current accounting policy related to certain consideration received from a vendor is consistent with the provisions of this issue and therefore, the Company does not anticipate that the adoption of this statement will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” This statement establishes accounting standards for recognition and measurement of a liability for the costs of asset retirement obligations. The provisions of this statement are effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not anticipate that the adoption of this statement will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
Outlook
On February 25, 2003, the Company issued earnings guidance for 2003 and expects to achieve earnings per share from continuing operations of $3.05 to $3.25: 14 to 19 cents a share in the first quarter, 55 to 60 cents a share in the second quarter and $2.44 to $2.54 a share in the second half of the fiscal year, which ends January 31, 2004. These estimates include store-closing costs of $35 million in the first quarter and $5 million in both the second quarter and the second half of the year. Additionally, comparable store sales of flat to down 1.5 percent is forecasted for 2003: down 2 to 3 percent in the first quarter, down 1 to 2 percent in the second quarter and between down 1 percent to up 1 percent in the second half of 2003. In estimating comparable store sales and earnings per share, the Company assumed that general economic conditions and consumer confidence and demand would be such that the forecasted amounts of comparable store sales would be achieved, the gross margin rate would be flat for the year, although it is likely to be down compared to 2002 for the first half of the year, and SG&A dollars, excluding the aforementioned store-closing costs, are assumed to increase 2 to 2.5 percent, with larger increases assumed in the second half of the year when the sales growth is assumed to be higher. The accuracy of these assumptions and of the resulting forecasts is subject to uncertainties and circumstances beyond the Company’s control. Consequently, actual results could differ materially from the forecasted results.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company is exposed to market risk from changes in interest rates which may adversely affect its financial position, results of operations and cash flows. In seeking to minimize the risks from interest rate fluctuations, the Company manages exposures through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. The Company does not use financial instruments for trading or other speculative purposes and is not a party to any leveraged financial instruments.
The Company is exposed to interest rate risk primarily through its customer lending and borrowing activities, which are described in Notes 6 and 10 to the Consolidated Financial Statements. The majority of the Company’s borrowings are under fixed rate instruments. However, the Company, from time to time, may use interest rate swap and interest rate cap agreements to help manage its exposure to interest rate movements and reduce borrowing costs. See Notes 10 and 17 to the Consolidated Financial Statements, which are incorporated herein by reference.
Based on the Company’s market risk sensitive instruments (including variable rate debt and derivative financial instruments) outstanding at February 1, 2003, the Company has determined that there was no material market risk exposure to the Company’s consolidated financial position, results of operations or cash flows as of such date.
Item 8. Consolidated Financial Statements and Supplementary Data.
Information called for by this item is set forth in the Company’s Consolidated Financial Statements and supplementary data contained in this report and is incorporated herein by this reference. Specific financial statements and supplementary data can be found at the pages listed in the following index.
INDEX
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information called for by this item is set forth under Item 1 “Election of Directors” and “Compliance with Section 16(a) of the Securities Exchange Act of 1934” in the Proxy Statement, and in Item 1A “Executive Officers of the Registrant,” and incorporated herein by reference.
Item 11. Executive Compensation.
Information called for by this item is set forth under “Executive Compensation” and “Compensation Committee Report on Executive Compensation” in the Proxy Statement and incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information called for by this item is set forth under “Stock Ownership “ in the Proxy Statement and incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
Information called for by this item is set forth under “Certain Relationships and Related Transactions” in the Proxy Statement and incorporated herein by reference.
Item 14. Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) as of a date within 90 days prior to the filing of this report. 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. Subsequent to the date of this evaluation, there have not been any significant changes in the Company’s internal controls or, to management’s knowledge, in other factors that could significantly affect the Company’s internal controls.
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PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are filed as part of this report:
1. Financial Statements:
The list of financial statements required by this item is set forth in Item 8 “Consolidated Financial Statements and Supplementary Data” and is incorporated herein by reference.
2. Financial Statement Schedules:
All schedules are omitted because they are inapplicable, not required, or the information is included elsewhere in the Consolidated Financial Statements or the notes thereto.
3. Exhibits:
The following exhibits are filed herewith or incorporated by reference as indicated below.
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(b) Reports on Form 8-K.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on April 16, 2003.
* The undersigned, by signing his name hereto, does sign and execute this Annual Report on Form 10-K pursuant to the Powers of Attorney executed by the above-named officers and directors and filed herewith.
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CERTIFICATIONS
I, Terry L. Lundgren, Chief Executive Officer of Federated Department Stores, Inc., certify that:
April 16, 2003
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I, Karen M. Hoguet, Chief Financial Officer of Federated Department Stores, Inc., certify that:
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
F-1
MANAGEMENT’S REPORT
To the Shareholders of
The integrity and consistency of the consolidated financial statements of Federated Department Stores, Inc. and subsidiaries, which were prepared in accordance with accounting principles generally accepted in the United States of America, are the responsibility of management and properly include some amounts that are based upon estimates and judgments.
The Company maintains a system of internal accounting controls, which is supported by a program of internal audits with appropriate management follow-up action, to provide reasonable assurance, at appropriate cost, that the Company’s assets are protected and transactions are properly recorded. Additionally, the integrity of the financial accounting system is based on careful selection and training of qualified personnel, organizational arrangements which provide for appropriate division of responsibilities and communication of established written policies and procedures.
The consolidated financial statements of the Company have been audited by KPMG LLP, independent certified public accountants. Their report expresses their opinion as to the fair presentation, in all material respects, of the financial statements and is based upon their independent audits conducted in accordance with auditing standards generally accepted in the United States of America.
The Audit Review Committee, composed solely of outside directors, meets periodically with the independent certified public accountants, the internal auditors and representatives of management to discuss auditing and financial reporting matters. In addition, the independent certified public accountants and the Company’s internal auditors meet periodically with the Audit Review Committee without management representatives present and have free access to the Audit Review Committee at any time. The Audit Review Committee is responsible for recommending to the Board of Directors the engagement of the independent certified public accountants, which is subject to shareholder approval, and the general oversight review of management’s discharge of its responsibilities with respect to the matters referred to above.
James M. Zimmerman
Terry J. Lundgren
Karen M. Hoguet
Joel A. Belsky
F-2
INDEPENDENT AUDITORS’ REPORT
The Board of Directors and Shareholders Federated Department Stores, Inc.:
We have audited the accompanying consolidated balance sheets of Federated Department Stores, Inc. and subsidiaries as of February 1, 2003 and February 2, 2002, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for the fifty-two week period ended February 1, 2003, the fifty-two week period ended February 2, 2002 and the fifty-three week period ended February 3, 2001. These consolidated financial statements are the responsibility of management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Federated Department Stores, Inc. and subsidiaries as of February 1, 2003 and February 2, 2002, and the results of their operations and their cash flows for the fifty-two week period ended February 1, 2003, the fifty-two week period ended February 2, 2002 and the fifty-three week period ended February 3, 2001, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 9 to the consolidated financial statements, during the fifty-two week period ended February 1, 2003, Federated Department Stores, Inc. and subsidiaries adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”
Cincinnati, Ohio
F-3
FEDERATED DEPARTMENT STORES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(millions, except per share data)
The accompanying notes are an integral part of these Consolidated Financial Statements.
F-4
CONSOLIDATED BALANCE SHEETS
(millions)
F-5
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Federated Department Stores, Inc. (the “Company”) is a retail organization operating department stores that sell a wide range of merchandise, including men’s, women’s and children’s apparel and accessories, cosmetics, home furnishings and other consumer goods.
The Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. The Company from time to time invests in companies engaged in complementary businesses. Investments in companies in which the Company has the ability to exercise significant influence, but not control, are accounted for by the equity method. All other investments are carried at cost. All significant intercompany transactions have been eliminated.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates and assumptions are subject to inherent uncertainties, which may result in actual amounts differing from reported amounts.
Certain reclassifications were made to prior years’ amounts to conform with the classifications of such amounts for the most recent year.
The Company operates in one segment as an operator of department stores.
Fingerhut Companies, Inc. (“Fingerhut”), a wholly-owned subsidiary, is being accounted for as a discontinued operation (see Note 2). Accordingly, for financial statement purposes, the assets, liabilities, results of operations and cash flows of this business have been segregated from those of continuing operations for all periods presented.
Cash includes cash and liquid investments with original maturities of three months or less.
The Company offers proprietary credit to its customers under revolving accounts and also offers non-proprietary revolving account credit cards. Such revolving accounts are accepted on customary revolving credit terms and offer the customer the option of paying the entire balance on a 25-day basis without incurring finance charges. Alternatively, customers may make scheduled minimum payments and incur finance charges which are competitive with other retailers and lenders, respectively. Minimum payments vary from 2.5% to 100.0% of the account balance, depending on the size of the balance. The Company also offers proprietary credit on deferred billing terms for periods not to exceed one year. Such accounts are convertible to revolving credit, if unpaid, at the end of the deferral period. Finance charge income is treated as a reduction of selling, general and administrative expenses.
The Company evaluates the collectibility of its proprietary and non-proprietary accounts receivable based on a combination of factors, including analysis of historical trends, aging of accounts receivable, write-off experience and expectations of future performance. Proprietary and non-proprietary accounts receivable are considered delinquent if more than one scheduled minimum payment is missed. Delinquent
F-8
proprietary accounts are generally written off automatically after the passage of 210 days without receiving a full scheduled monthly payment. Delinquent non-proprietary accounts are written off automatically after the passage of 180 days without receiving a full scheduled monthly payment. Accounts are written off sooner in the event of customer bankruptcy or other circumstances that make further collection unlikely. The Company reserves for doubtful proprietary accounts based on a loss-to-collections rate and doubtful non-proprietary accounts based on a roll-reserve rate.
Merchandise inventories are valued at lower of cost or market using the last-in, first-out (LIFO) retail inventory method. Under the retail inventory method, inventory is segregated into departments of merchandise having similar characteristics, and is stated at its current retail selling value. Inventory retail values are converted to a cost basis by applying specific average cost factors for each merchandise department. Cost factors represent the average cost-to-retail ratio for each merchandise department based on beginning inventory and the fiscal year purchase activity. The retail inventory method inherently requires management judgments and contains estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory, which may impact the ending inventory valuation as well as gross margins.
Permanent markdowns designated for clearance activity are recorded when the utility of the inventory has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise and fashion trends. When a decision is made to permanently mark down merchandise, the resulting gross profit reduction is recognized in the period the markdown is recorded.
The Company receives cash or allowances from merchandise vendors as purchase price adjustments and in connection with cooperative advertising programs. Purchase price adjustments are credited to cost of sales and cooperative advertising allowances are credited against advertising expense in accordance with Emerging Issues Task Force (“EITF”) Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.”
Depreciation and amortization are provided primarily on a straight-line basis over the shorter of estimated asset lives or related lease terms. Estimated asset lives range from 15 to 50 years for buildings and building equipment and 3 to 15 years for fixtures and equipment. Real estate taxes and interest on construction in progress and land under development are capitalized. Amounts capitalized are amortized over the estimated lives of the related depreciable assets.
The Company receives contributions from developers and merchandise vendors to fund building improvements and the construction of vendor shops. Such contributions are netted against the capital expenditures.
F-9
For long-lived assets held for disposal by sale, an impairment charge is recorded if the carrying amount of the asset exceeds its fair value less costs to sell. Such valuations include estimations of fair values and incremental direct costs to transact a sale. For long-lived assets to be abandoned, the Company considers the asset to be disposed of when it ceases to be used. If the Company commits to a plan to abandon a long-lived asset before the end of its previously estimated useful life, depreciation estimates are revised accordingly. Prior to February 3, 2002, for long-lived assets held for disposal, whether by abandonment or sale, an impairment charge was recorded if the carrying amount of the assets exceeded its fair value less costs to sell. Such valuations included estimations of fair values, costs to dispose, and time periods over which to sell the assets.
In addition, liabilities arise such as severance, contractual obligations and other accruals associated with store closings from decisions to dispose of assets. The Company estimates these liabilities based on the facts and circumstances in existence for each restructuring decision. The amounts the Company will ultimately realize or disburse could differ from the amounts assumed in arriving at the asset impairment and restructuring charge recorded.
Goodwill and intangible assets having indefinite lives, which were previously amortized on a straight-line basis over the periods benefited, are no longer being amortized to earnings, but instead are subject to periodic testing for impairment. Goodwill and other intangible assets of a reporting unit are tested for impairment on an annual basis and more frequently if certain indicators are encountered. Intangible assets with determinable useful lives continue to be amortized over their estimated useful lives.
The Company capitalizes purchased and internally developed software and amortizes such costs to expense on a straight-line basis over 2-5 years. Capitalized software is included in other assets.
The Company, through its actuaries, utilizes assumptions when estimating the liabilities for pension and other employee benefit plans. These assumptions, where applicable, include the discount rates used to determine the actuarial present value of projected benefit obligations, the rate of increase in future compensation levels, the long-term rate of return on assets and the growth in health care costs. The cost of these benefits is recognized in the financial statements over an employee’s term of service with the
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Company and the prepaid pension or accrued liabilities are reported in other assets or other liabilities, as appropriate.
Sales of merchandise are recorded at the time of delivery and reported net of merchandise returns. An estimated allowance for future sales returns is recorded and cost of sales is adjusted accordingly.
Advertising and promotional costs, net of cooperative advertising allowances, amounted to $713 million for the 52 weeks ended February 1, 2003, $750 million for the 52 weeks ended February 2, 2002 and $808 million for the 53 weeks ended February 3, 2001. Department store non-direct response advertising and promotional costs are expensed as incurred. Direct response advertising and promotional costs for Bloomingdale’s By Mail are deferred and expensed over the period during which the sales are expected to occur, generally one to four months.
Shipping and handling fees and costs do not represent a significant portion of the Company’s operations and both items have consistently been included in selling, general and administrative expenses. Shipping and handling fees amounted to $43 million, $43 million and $44 million for the 52 weeks ended February 1, 2003, the 52 weeks ended February 2, 2002 and the 53 weeks ended February 1, 2001, respectively. Shipping and handling costs amounted to $39 million, $41 million and $42 million for the 52 weeks ended February 1, 2003, the 52 weeks ended February 2, 2002 and the 53 weeks ended February 1, 2001, respectively.
Financing costs are amortized using the effective interest method over the life of the related debt.
Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and net operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company records derivative transactions according to the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, which establishes accounting and reporting standards for derivative instruments and hedging activities and requires recognition of all derivatives as either assets or liabilities and measurement of those instruments at fair value. The Company makes limited use of derivative financial instruments. On the date that the Company enters into a derivative contract, the Company designates the derivative instrument as either a fair value hedge, cash flow hedge or as a free-standing derivative instrument, each of which would receive different accounting treatment. Prior to entering into a hedge transaction, the Company formally documents the relationship between hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking various hedge transactions. Derivative instruments that the Company may use as part of its interest rate risk management strategy include interest rate swap and interest rate cap agreements (see Note 17).
The Company accounts for its stock-based employee compensation plan in accordance with Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations (see Note 15). No
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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 if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” for options granted subsequent to January 28, 1995.
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In 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” This statement establishes accounting standards for recognition and measurement of a liability for the costs of asset retirement obligations. The provisions of the Statement are effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not anticipate that the adoption of this statement will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
2. Discontinued Operations
On January 16, 2002, the Company’s Board of Directors approved a plan to dispose of the operations of 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.
During 2002, through various transactions, the Company completed the sale of the Arizona Mail Order, Figi’s and Popular Club Plan businesses conducted by Fingerhut’s subsidiaries, completed the sale of Fingerhut’s core catalog accounts receivable portfolio, with the buyer assuming $450 million of receivables-backed debt, and 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. As of February 1, 2003, substantially all Fingerhut assets had been disposed of and substantially all Fingerhut liabilities had been settled. Proceeds from the foregoing sale transactions 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. This favorable variance, together with the favorable variance in actual operating losses described below, resulted in an adjustment to the loss on disposal of discontinued operations for 2002 totaling $307 million of income before income taxes, or $180 million of income after income taxes.
The Company originally estimated operating losses during the Fingerhut phase-out period of $292 million, net of tax effect. Actual operating losses for the 52 weeks ended February 1, 2003 were approximately $37 million, net of tax effect. This favorable variance resulted from the earlier than planned disposition of Fingerhut assets and is reflected in the $180 million adjustment to the loss on disposal of discontinued operations described above.
The disposal of the operations of Fingerhut, including the Arizona Mail Order, Figi’s and Popular Club Plan businesses conducted by Fingerhut’s subsidiaries, generated $924 million of cash during the 52 weeks ended February 1, 2003, after the payment of approximately $529 million of related debt.
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In connection with the sale of the Fingerhut core catalog accounts receivable portfolio, the Company entered into certain indemnification agreements with the purchaser. The indemnification agreements extend for a period of five years subsequent to the closing of this transaction. The maximum amount of potential future payments cannot be determined because the indemnification is an unlimited obligation. Based on the nature of these indemnifications, the Company considers the probability of future payments to be remote.
A loss on disposal of the Fingerhut operations was recorded in the fourth quarter of fiscal 2001. This loss included significant estimated losses associated with the wind-down of the operations of Fingerhut, the wind-down of the Fingerhut core catalog accounts receivable portfolio, the sale of inventory and property and equipment, the sale of subsidiary catalog businesses and severance and retention costs
Estimated losses associated with the wind-down of the Fingerhut core catalog accounts receivable portfolio were based upon various assumptions and estimates, including an assumed four-year wind-down period and estimated customer payment rates, write-off rates, finance charge income, late fee income, and operating expenses, such as collection costs. These assumptions and estimates were based on a third party offer to purchase the portfolio, historical experience and industry data where available.
Estimated losses associated with the Fingerhut core catalog operations were based upon various assumptions and estimates, including with respect to revenues and expenses during the wind-down period. Those assumptions and estimates were based on historical experience and derived from detailed departmental plans regarding the costs necessary to complete the liquidation in the planned timeframe.
The after-tax loss from discontinued operations for the 52 weeks ended February 2, 2002 was $14 million, or $.07 per diluted share.
Estimated interest expense has been allocated to discontinued operations based upon the debt balances attributable to those operations. Interest expense allocated to discontinued operations was $82 million for the 52 weeks ended February 2, 2002 and $116 million for the 53 weeks ended February 3,
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2001. Additionally, interest expense of $77 million was included in the estimated operating losses from the measurement date to the disposal date, which was included in the loss on disposal of discontinued operations.
The net assets of Fingerhut included within discontinued operations were as follows:
The Company acquired Fingerhut on March 18, 1999. Discontinued operations include Fingerhut sales which totaled $1,244 million for the 52 weeks ended February 2, 2002 and $1,769 million for the 53 weeks ended February 3, 2001. The loss from discontinued operations was $22 million, net of an income tax benefit of $8 million for the 52 weeks ended February 2, 2002 and $1,257 million, net of an income tax benefit of $252 million for the 53 weeks ended February 3, 2001.
During the 53 weeks ended February 3, 2001, the Company recorded asset impairment and restructuring charges related to its Fingerhut business totaling $882 million. In response to a significant credit delinquency problem associated with Fingerhut’s core catalog operations, the Company reevaluated the long-term operating projections of, and performed an asset impairment analysis for, each Fingerhut business. This analysis included projected future undiscounted and discounted cash flows disaggregated for each Fingerhut business unit under a variety of operating assumptions, under a two-step impairment test.
First, using undiscounted projected future cash flows for each Fingerhut business, management determined that an impairment existed for only one of the businesses, and a write-down of certain fixed assets and goodwill was recorded in accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” Secondly, using discounted projected cash flows at a discount rate commensurate with the Company’s cost of capital, management determined that an impairment existed at several other Fingerhut businesses, including the core catalog business, and a write-down of goodwill and credit file intangibles was recorded in accordance with APB Opinion No. 17, “Intangible Assets.”
As a result of the above, the Company recorded asset write-downs of $673 million for goodwill and credit file intangibles and $18 million for Fingerhut fixed assets during the 53 weeks ended February 3, 2001. During this same period, the Company recorded a write-down of $105 million of certain strategic equity investments made and held by Fingerhut as a result of the Company’s determination, based on uncertain financing alternatives and comparisons to their market values or market values of similar publicly traded businesses, that these equity investments were impaired on an other than temporary basis. These investments were in companies that, through commercial relationships entered into in connection with the investments, expanded Fingerhut’s Internet offerings and direct marketing strategic initiatives (e.g.,
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through website affiliations) and were integrally related – in terms of their genesis, purpose, nature, implementation and oversight – to the operations of Fingerhut.
The Company also recorded $86 million of restructuring costs during the 53 weeks ended February 3, 2001 related to the downsizing of the Fingerhut core catalog operations, including $35 million of inventory valuation adjustments. The remaining $51 million of restructuring costs consisted of write-downs of property and other assets associated with the closing of collection and call centers and other duplicate facilities totaling $26 million, an adjustment to the carrying value of certain accounts receivable associated with a discontinued business amounting to $9 million and related severance costs totaling $16 million. The severance costs covered approximately 2,100 employees.
3. Acquisition
On July 9, 2001, the Company completed its acquisition of Liberty House, Inc. (“Liberty House”), a department store retailer operating 11 department stores and seven resort and specialty stores in Hawaii and one department store in Guam. The total purchase price of the Liberty House acquisition was approximately $200 million, consisting of approximately $183 million of cash and the assumption of approximately $17 million of indebtedness. The acquisition was accounted for under the purchase method of accounting and, accordingly, the results of operations of Liberty House have been included in the Company’s results of operations from the date of acquisition and the purchase price has been allocated to Liberty House’s assets and liabilities based on their estimated fair values as of that date. The amount of goodwill and other identifiable intangibles related to the Liberty House acquisition amounted to $84 million. Such goodwill has not been amortized, in accordance with the provisions of SFAS No. 142.
4. Asset Impairment and Restructuring Charges
During the 52 weeks ended February 2, 2002, the Company incurred asset impairment and restructuring charges related to its department store business. These costs related primarily to the closing of its Stern’s department store division and subsequent integration into its Macy’s and Bloomingdale’s operations, the acquisition of Liberty House and subsequent integration into Macy’s and the reorganization of its department-store-related catalog and e-commerce operations.
The Company recorded $53 million of inventory valuation adjustments, primarily related to discontinued merchandise lines, as a part of cost of sales during 2001. The inventory valuation adjustments included $33 million related to the Stern’s conversion, $17 million related to the Liberty House integration and $3 million related to the catalog and e-commerce reorganization. These inventory valuation adjustments consist of markdowns on merchandise that was sold at Stern’s, Liberty House or through the Company’s catalog and e-commerce channels and that would not continue to be sold following the conversion of the Stern’s and Liberty House stores and the reorganization of the catalog and e-commerce business.
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Asset impairment charges consist of:
During the 52 weeks ended February 2, 2002, asset impairment charges included fixed asset and capitalized software write-downs related to the catalog and e-commerce reorganization and losses on Stern’s stores which the Company expected to close and sell. Also during the 52 weeks ended February 2, 2002, the Company recorded a write-down of an investment as a result of the Company’s determination, based on uncertain financing alternatives and a comparison to market values of similar publicly traded businesses, that this equity investment was impaired on an other than temporary basis.
During the 53 weeks ended February 3, 2001, asset impairment charges included losses on Stern’s stores which the Company expected to close and sell and an adjustment to the carrying value of certain accounts receivable that would be uncollectable because of the Stern’s closure. During this same period, the Company recorded a write-down of investments as a result of the Company’s determination, based on uncertain financing alternatives and comparisons to their market value or market values of similar publicly traded businesses, that these equity investments were impaired on an other than temporary basis.
Restructuring charges consist of:
During the 52 weeks ended February 2, 2002, restructuring charges included costs associated with converting the Stern’s stores into Macy’s (including store remodeling costs, advertising, credit card issuance and promotion and other name change expenses), severance costs related to the Stern’s closure, costs to close and sell certain Stern’s stores (including lease obligations and other store closing expenses), Stern’s duplicate central office costs, costs associated with converting the Liberty House stores into Macy’s
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(including advertising, credit card issuance and promotion and other name change expenses), Liberty House duplicate central office costs and other exit costs associated with the catalog and e-commerce reorganization.
During the 53 weeks ended February 3, 2001, restructuring charges included costs to close and sell certain Stern’s stores, primarily related to lease obligations.
In general, the Company recorded restructuring charges as expenses when they were incurred. The only costs that were accrued at the time management committed to the store closure, store conversion or reorganization plans were severance costs and lease obligations related to the Stern’s closure, pursuant to EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).”
The following table shows the activity associated with the Stern’s restructuring accruals:
The $14 million reserve that the Company still expects to pay out relates to liabilities associated with the disposition of Stern’s properties.
The $18 million reserve that the Company expected to pay out related to liabilities associated with the disposition of Stern’s properties. The 2001 restructuring charge for severance covered approximately 2,500 people and the remaining accrual at February 2, 2002 related to approximately 50 people.
5. Extraordinary Item
The extraordinary item for the 52 weeks ended February 2, 2002 represents costs of $16 million, net of income tax benefit of $6 million, associated with the repurchase of the $350 million 6.125% Term Enhanced ReMarketable Securities.
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6. Accounts Receivable
Sales through the Company’s proprietary credit plans were $4,128 million for the 52 weeks ended February 1, 2003, $4,154 million for the 52 weeks ended February 2, 2002 and $4,384 million for the 53 weeks ended February 3, 2001. The credit plans relating to certain operations of the Company are owned by a third party. Finance charge income related to proprietary credit card holders amounted to $353 million for the 52 weeks ended February 1, 2003, $361 million for the 52 weeks ended February 2, 2002 and $349 million and for the 53 weeks ended February 3, 2001. Subsequent to July 5, 2002, finance charge income related to non-proprietary credit card holders amounted to $33 million. Prior to July 5, 2002 under the financing arrangement related to the Company’s non-proprietary credit card receivables, all transfers of the Company’s non-proprietary credit card receivables to a trust qualified for sale treatment and therefore were accounted for as off-balance sheet financing transactions (see Note 10).
Changes in the allowance for doubtful accounts related to proprietary credit card holders are as follows:
Changes in the allowance for doubtful accounts related to non-proprietary credit card holders are as follows:
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7. Inventories
Merchandise inventories were $3,359 million at February 1, 2003, compared to $3,376 million at February 2, 2002. At these dates, the cost of inventories using the LIFO method approximated the cost of such inventories using the FIFO method. The application of the LIFO method did not impact cost of sales for the 52 weeks ended February 1, 2003, the 52 weeks ended February 2, 2002 or the 53 weeks ended February 3, 2001.
8. Properties and Leases
In connection with various shopping center agreements, the Company is obligated to operate certain stores within the centers for periods of up to 20 years. Some of these agreements require that the stores be operated under a particular name.
The Company leases a portion of the real estate and personal property used in its operations. Most leases require the Company to pay real estate taxes, maintenance and other executory costs; some also require additional payments based on percentages of sales and some contain purchase options. Certain of the Company’s real estate leases have terms that extend for significant numbers of years and provide for rental rates that increase over time. In addition, certain of these leases contain covenants that restrict the ability of the tenant (typically a subsidiary of the Company) to take specified actions (including the payment of dividends or other amounts on account of its capital stock) unless the tenant satisfies certain financial tests.
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Minimum rental commitments (excluding executory costs) at February 1, 2003, for noncancellable leases are:
Capitalized leases are included in the Consolidated Balance Sheets as property and equipment while the related obligation is included in short-term ($6 million) and long-term ($54 million) debt. Amortization of assets subject to capitalized leases is included in depreciation and amortization expense. Total minimum lease payments shown above have not been reduced by minimum sublease rentals of approximately $40 million on operating leases.
Rental expense consists of:
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9. Goodwill and Other Intangible Assets
Effective February 3, 2002, the Company adopted SFAS No. 142,“Goodwill and Other Intangible Assets.” Upon adoption, the Company ceased amortizing goodwill and indefinite lived intangible assets and determined that an impairment loss was not present. Impairment will be examined on an annual basis and more frequently if certain indicators are encountered. Intangible assets with determinable useful lives will continue to be amortized over their estimated useful lives.
The Company recorded $43 million of tax benefits as a reduction to goodwill during the 52 weeks ended February 1, 2003 (see Note 12).
The following summarizes the Company’s goodwill and other intangible assets and amortization expense:
The customer lists are being amortized over their estimated useful life of 7 years.
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The following is an illustration of the impact on income from continuing operations and net income, including discontinued operations, as if SFAS No. 142 was effective beginning January 30, 2000:
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10. Financing
The Company’s debt was as follows:
Interest expense was as follows:
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Future maturities of long-term debt, other than capitalized leases, are shown below:
The information set forth in the preceding table assumes that holders of the 6.79% senior debentures due 2027 will elect to have such debentures repaid in full in 2004.
During the 52 weeks ended February 1, 2003, the Company repaid $1,015 million of borrowings, consisting principally of $598 million of receivables backed financings and $400 million of 8.125% Senior Notes.
During July 2002, in connection with the extension of the financing arrangement related to the Company’s non-proprietary credit card receivables, the Company’s special purpose subsidiary took certain actions which resulted in the consolidation of the Prime Credit Card Master Trust II (“Trust II”) for financial reporting purposes. In particular, the documentation governing the arrangement was amended to provide the Company’s special purpose subsidiary the ability to unilaterally remove transferred assets from Trust II. Under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” this amendment disqualified the arrangement for sale treatment and requires secured borrowing treatment for all sales of the Company’s non-proprietary credit card receivables pursuant to this arrangement. The principal assets and liabilities of Trust II consist of non-proprietary credit card receivables transferred by the Company to Trust II in transactions previously accounted for as sales under SFAS No. 140 and the related debt issued by Trust II. As a result of the Company’s actions, the transfer of receivables and debt are being treated as secured borrowings as of and subsequent to July 5, 2002. All assets and liabilities of Trust II were consolidated at fair value. These actions increased the Company’s consolidated assets and debt by $479 million at July 5, 2002.
The Company’s bank credit agreements require the Company to maintain certain financial ratios. At February 1, 2003, the Company was in compliance with these requirements by significant margins. Management believes that the likelihood of the Company defaulting on a debt covenant is remote absent any material negative event affecting the U.S. economy as a whole. However, if the Company’s results of operations or operating ratios deteriorate to a point where the Company is not in compliance with any of its debt covenants and the Company is unable to obtain a waiver, much of the Company’s debt would be in default and could become due and payable immediately.
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The following summarizes certain components of the Company’s debt:
Receivables Backed Financings
The Company finances its proprietary credit card receivables, which arise solely from sales originated in the conduct of the Company’s retail operations, using on-balance sheet financing arrangements, including term receivables-backed certificates issued by a subsidiary of the Company together with receivables-backed commercial paper issued by another subsidiary of the Company. At February 1, 2003, these arrangements included a $375 million asset-backed commercial paper program. Under the $375 million commercial paper program, a special purpose subsidiary of the Company issues commercial paper backed by a Class A Variable Funding Certificate issued out of the Prime Credit Card Master Trust (the “Trust”) which holds the proprietary receivables. If the subsidiary is unable to issue commercial paper to fund maturities of outstanding commercial paper, it has a liquidity facility with a number of banks which will fund loans in order to repay the commercial paper. The commercial paper investors have no recourse back to the Company. As of February 1, 2003, and February 2, 2002, there was no such commercial paper or loan outstanding.
At February 1, 2003, these arrangements also included $400 million of receivables backed certificates representing undivided interests in the Trust. Investors in this debt have no recourse back to the Company. This debt is classified as long-term debt, bears interest at 6.7% and matures in November 2005.
The Company finances its non-proprietary credit card receivables, which arise from transactions originated by merchants that accept third-party credit cards issued by the Company’s FDS Bank subsidiary, using on-balance sheet financing arrangements. Under these arrangements, a special purpose subsidiary of the Company sells Class A and Class B Variable Funding Certificates issued out of Trust II which holds the non-proprietary receivables to three unrelated bank commercial paper conduit programs. The commercial paper conduit programs have agreed to purchase certificates of up to $700 million in the aggregate. Receivables-backed financings classified as short-term debt at February 1, 2003, consist of $486 million of debt under these arrangements with an average interest rate of 1.4%.
The entire proprietary and non-proprietary accounts receivable portfolios are used to secure the applicable receivables-backed financing programs.
Prior to July 2002, the financing of the Company’s non-proprietary credit card receivables was through an off-balance sheet sale arrangement. Under this arrangement, FDS Bank, a subsidiary of the Company, sold its non-proprietary credit card receivables to another wholly-owned special purpose subsidiary of the Company which in turn transferred the purchased receivables to Trust II, a bankruptcy-remote, qualified special purpose entity. A special purpose subsidiary of the Company had sold certain interests in Trust II to unrelated bank commercial paper conduit programs. Proceeds from these sales plus excess cash flow from Trust II were used to buy the receivables from FDS Bank. The two commercial paper conduit programs had agreed to buy interests of up to $600 million in the aggregate. These interests were variable and fluctuated with the level of receivables. Trust II had issued three classes of certificates: Class A, Class B and Class C certificates. The bank conduit programs held the Class A and Class B certificates and the Company’s special purpose subsidiary retained the Class C certificates, which were subordinated interests that served as a credit enhancement to the Class A and Class B certificates
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and exposed the Company’s retained trust assets to possible credit losses. The Company’s special purpose subsidiary also held a required 2% seller’s interest and the residual interest in the trust. The investors and the trust had no recourse against the Company beyond the trust assets. In order to maintain the committed level of securitized assets, the Company’s special purpose subsidiary reinvested cash collections on securitized accounts in additional balances. During the period that the non-proprietary credit card receivables were financed off-balance sheet in the 52 weeks ended February 1, 2003, proceeds from collections which were reinvested amounted to $1,336 million. During the 52 weeks ended February 2, 2002, proceeds from collections which were reinvested amounted to $3,057 million.
Prior to July 2002, the issuance of the certificates to outside investors was considered to be a sale, which resulted in an immaterial gain to the Company. The Company also retained servicing responsibilities for which it received annual servicing fees, approximating 2% of the outstanding balances. During the period that the non-proprietary credit card receivables were financed off-balance sheet in the 52 weeks ended February 1, 2003, $5 million of servicing fees were received. During the 52 weeks ended February 2, 2002, $12 million of servicing fees were received.
The Company’s special purpose subsidiary intended to hold its Class C certificates and contractually required seller’s interest to maturity. The residual interest was considered available-for-sale. Due to the revolving nature of the underlying credit card receivables, the high principal payment rate and the reserve for anticipated credit losses, the carrying value of the retained interest in transferred credit card receivables approximated fair value and was included in other assets. Key economic assumptions used in measuring the retained interests at the date of securitization resulting from securitizations completed during the 52 weeks ended February 1, 2003 and February 2, 2002 include the estimated payment rate, anticipated credit losses and the discount rate applied to the residual cash flows. During the period that the non-proprietary credit card receivables were financed off-balance sheet in the 52 weeks ended February 1, 2003, the weighted average estimated payment rate was 44.2%, the anticipated credit losses averaged 5.3% and the discount rate used on the residual cash flows was 10.2%. For the 52 weeks ended February 2, 2002, the weighted average estimated payment rate was 42.1%, the anticipated credit losses averaged 5.2% and the discount rate used on the residual cash flows was 10.5%.
As of February 2, 2002, the securitized non-proprietary credit card balances were $630 million, the related retained interest included in other assets was $111 million and purchased interests of $500 million were held by third parties under this off-balance sheet arrangement.
Bank Credit Agreements
The Company and certain financial institutions are parties to (i) the Five-Year Credit Agreement, pursuant to which such financial institutions have provided the Company with a $1,200 million revolving loan facility which expires June 29, 2006 (the “Five-Year Facility”) and (ii) the 364-Day Credit Agreement, pursuant to which such financial institutions have provided the Company with a $400 million revolving loan facility which expires June 27, 2003, and must be extended annually (the “364-Day Facility” and, together with the Five-Year Facility, the “Revolving Loan Facilities”). The Company’s obligations under the Revolving Loan Facilities are not secured or guaranteed.
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As of February 1, 2003 and February 2, 2002, there were no revolving credit loans outstanding under the Revolving Loan Facilities. However, there were $31 million and $46 million of standby letters of credit outstanding under the Revolving Loan Facilities at February 1, 2003 and February 2, 2002, respectively. Revolving loans under the Revolving Loan Facilities bear interest based on various published rates.
Commercial Paper
The Company established a $1,600 million program for the issuance from time to time of unsecured commercial paper. The issuance of commercial paper under the program will have the effect, while such commercial paper is outstanding, of reducing the Company’s borrowing capacity under the Revolving Loan Facilities by an amount equal to the principal amount of such commercial paper. As of February 1, 2003 and February 2, 2002, there was no such commercial paper outstanding.
Senior Notes and Debentures
The senior notes and the senior debentures are unsecured obligations of the Company. The holders of the senior debentures due 2027 may elect to have such debentures repaid on July 15, 2004 at 100% of the principal amount thereof, together with accrued and unpaid interest to the date of repayment.
Other Financing Arrangements
There were also $22 million of trade letters of credit outstanding at February 1, 2003 and February 2, 2002.
11. Accounts Payable and Accrued Liabilities
Liabilities to customers include an estimated allowance for future sales returns of $42 million and $43 million at February 1, 2003 and February 2, 2002, respectively. Adjustments to the allowance for future sales returns, which amounted to a credit of $1 million for the 52 weeks ended February 1, 2003, a charge of $1 million for the 52 weeks ended February 2, 2002 and a credit of $1 million for the 53 weeks ended February 3, 2001, are reflected in cost of sales. Included in other liabilities at February 1, 2003 is $6 million of severance, related to the Rich’s-Macy’s consolidation, to be paid in conjunction with an ongoing benefit arrangement.
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12. Taxes
Income tax expense is as follows:
The income tax expense reported differs from the expected tax computed by applying the federal income tax statutory rate of 35% for the 52 weeks ended February 1, 2003, the 52 weeks ended February 2, 2002 and the 53 weeks ended February 3, 2001 to income from continuing operations before income taxes and extraordinary item. The reasons for this difference and their tax effects are as follows:
In connection with the Stern’s restructuring, income tax expense for 2001 reflects a $44 million benefit related to the recognition of the effect of the difference between the financial reporting and tax bases of the Company’s investment in Stern’s Department Stores, Inc. upon disposition.
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The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
During the 52 weeks ended February 1, 2003, the Company recorded an additional $43 million of tax benefits related to an acquired enterprise’s net operating loss carryforwards (“NOLs”) and reduced goodwill accordingly. As of February 1, 2003, the Company had NOLs of approximately $407 million which are available through 2009.
13. Retirement Plans
The Company has a defined benefit plan (“Pension Plan”) and a defined contribution plan (“Savings Plan”) which cover substantially all employees who work 1,000 hours or more in a year. In addition, the Company has a defined benefit supplementary retirement plan which includes benefits, for certain employees, in excess of qualified plan limitations. For the 52 weeks ended February 1, 2003, the 52 weeks ended February 2, 2002 and the 53 weeks ended February 1, 2001 net retirement expense for these plans totaled $32 million, $22 million and $27 million, respectively.
Measurement of plan assets and obligations for the Pension Plan and the defined benefit supplementary retirement plan are calculated as of December 31 of each year. The discount rates used to determine the actuarial present value of projected benefit obligations under such plans were 6.75% as of December 31, 2002 and 7.25% as of December 31, 2001. The assumed weighted average rate of increase in future compensation levels was 5.8% as of December 31, 2002 and December 31, 2001 for the Pension Plan and 7.7% as of December 31, 2002 and December 31, 2001 for the defined benefit supplementary
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retirement plan. The long-term rate of return on assets (Pension Plan only) was 9.00% as of December 31, 2002 and 9.75% as of December 31, 2001.
Pension Plan
The following provides a reconciliation of benefit obligations, plan assets and funded status of the Pension Plan as of December 31, 2002 and 2001:
The accumulated benefit obligation for the Pension Plan was $1,382 million as of December 31, 2002.
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Net pension income for the Company’s Pension Plan included the following actuarially determined components:
As permitted under SFAS No. 87, “Employers’ Accounting for Pensions,” the amortization of any prior service cost is determined using a straight-line amortization of the cost over the average remaining service period of employees expected to receive benefits under the Pension Plan.
The Company’s policy is to fund the Pension Plan at or above the minimum required by law. For the 2002 plan year, no funding contribution was required; however, a $50 million voluntary funding contribution was made. For the 2001 plan year, no funding contribution was required or made. Plan assets are held by independent trustees.
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Supplementary Retirement Plan
The following provides a reconciliation of benefit obligations, plan assets and funded status of the supplementary retirement plan as of December 31, 2002 and 2001:
The accumulated benefit obligation for the supplementary retirement plan was $169 million and $135 million as of December 31, 2002 and December 31, 2001, respectively.
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Net pension costs for the supplementary retirement plan included the following actuarially determined components:
As permitted under SFAS No. 87, “Employers’ Accounting for Pensions,” the amortization of any prior service cost is determined using a straight-line amortization of the cost over the average remaining service period of employees expected to receive benefits under the plan.
Savings Plan
The Savings Plan includes a voluntary savings feature for eligible employees. The Company’s contribution is based on the Company’s annual earnings and the minimum contribution is 33 1/3% of an employee’s eligible savings. Expense for the Savings Plan amounted to $28 million for the 52 weeks ended February 1, 2003, $21 million for the 52 weeks ended February 2, 2002 and $29 million for the 53 weeks ended February 3, 2001.
Deferred Compensation Plan
The Company has a deferred compensation plan wherein eligible executives may elect to defer a portion of their compensation each year as either stock credits or cash credits. The Company transfers shares to a trust to cover the number management estimates will be needed for distribution on account of stock credits currently outstanding. At February 1, 2003 and February 2, 2002, the liability under the plan, which is reflected in other liabilities, was $37 million and $34 million, respectively. Expense for the 52 weeks ended February 1, 2003, the 52 weeks ended February 2, 2002 and the 53 weeks ended February 3, 2001 was immaterial.
14. Postretirement Health Care and Life Insurance Benefits
In addition to pension and other supplemental benefits, certain retired employees currently are provided with specified health care and life insurance benefits. Eligibility requirements for such benefits vary by division and subsidiary, but generally state that benefits are available to eligible employees who retire after a certain age with specified years of service. Certain employees are subject to having such benefits modified or terminated.
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The following provides a reconciliation of benefit obligations, plan assets and funded status of the postretirement obligations as of December 31, 2002 and 2001:
Net postretirement benefit expense included the following actuarially determined components:
The discount rate used in determining the actuarial present value of unfunded postretirement benefit obligations was 6.75% as of December 31, 2002 and 7.25% as of December 31, 2001.
The future medical benefits provided by the Company for certain employees are based on a fixed amount per year of service, and the accumulated postretirement benefit obligation is not affected by increases in health care costs. However, the future medical benefits provided by the Company for certain other employees are affected by increases in health care costs. For purposes of determining the present values of unfunded postretirement benefit obligations, the annual growth rate in the per capita cost of various components of such medical benefit obligations was assumed to range from 7.0% to 11.0% in the first year, and to decrease gradually for each such component to 6.0% by 2005 and to remain at that level thereafter. The foregoing growth-rate assumption has a significant effect on such determination. To
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illustrate, increasing such assumed growth rates by one percentage point would increase the present value of unfunded postretirement benefit obligation as of December 31, 2002 by $9 million and the net periodic postretirement benefit expense for 2002 by $1 million. Alternatively, decreasing such assumed growth rates by one percentage point would decrease the present value of unfunded postretirement benefit obligations as of December 31, 2002 by $9 million and the net periodic postretirement benefit expense for 2002 by $1 million.
As permitted under SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” the amortization of any prior service cost is determined using a straight-line amortization of the cost over the average remaining service period of employees expected to receive benefits under the plan.
15. Equity Plan
The Company has adopted an equity plan intended to provide an equity interest in the Company to key management personnel and thereby provide additional incentives for such persons to devote themselves to the maximum extent practicable to the businesses of the Company and its subsidiaries. The equity plan is administered by the Compensation Committee of the Board of Directors (the “Compensation Committee”). The Compensation Committee is authorized to grant options, stock appreciation rights and restricted stock to officers and key employees of the Company and its subsidiaries. The equity plan also provides for the award of options to non-employee directors.
Stock option transactions are as follows:
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The following summarizes information about stock options which remain outstanding as of February 1, 2003:
As of February 1, 2003, 5.4 million shares of Common Stock were available for additional grants pursuant to the Company’s equity plan, of which 105,300 shares were available for grant in the form of restricted stock. No shares of Common Stock were granted in the form of restricted stock during the 52 weeks ended February 1, 2003. During the 52 weeks ended February 2, 2002, 234,278 shares of Common Stock were granted in the form of restricted stock, with 221,278 shares at a market value of $43.00 fully vesting after four years and 13,000 shares at a market value of $38.60 fully vesting after three years. During the 53 weeks ended February 3, 2001, 122,700 shares of Common Stock were granted in the form of restricted stock at a market value of $39.81 vesting ratably over a four-year period. Compensation expense is recorded for all restricted stock grants based on the amortization of the fair market value at the time of grant of the restricted stock over the period the restrictions lapse. There have been no grants of stock appreciation rights under the equity plan.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used:
16. Shareholders’ Equity
The authorized shares of the Company consist of 125.0 million shares of preferred stock (“Preferred Stock”), par value of $.01 per share, with no shares issued, and 500.0 million shares of Common Stock, par value of $.01 per share, with 265.3 million shares of Common Stock issued and 190.2 million shares of Common Stock outstanding at February 1, 2003 and 265.0 million shares of Common Stock issued and 200.8 million shares of Common Stock outstanding at February 2, 2002 (with shares held in the Company’s treasury or by subsidiaries of the Company being treated as issued, but not outstanding).
The Company purchased 11.4 million shares of its Common Stock in 2002 at a cost of approximately $390 million and 7.4 million shares of its Common Stock in 2001 at an approximate cost of $300 million,
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under its stock repurchase program. As of February 1, 2003, the Company had approximately $210 million of the $1,500 million authorization remaining. 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.
In 2001, the Company issued 9.0 million shares of its Common Stock upon the exercise of the Company’s Series D warrants.
Common Stock
The holders of the Common Stock are entitled to one vote for each share held of record on all matters submitted to a vote of shareholders. Subject to preferential rights that may be applicable to any Preferred Stock, holders of Common Stock are entitled to receive ratably such dividends as may be declared by the Board of Directors in its discretion, out of funds legally available therefor.
Preferred Share Purchase Rights
Each share of Common Stock is accompanied by one right (a “Right”) issued pursuant to the Share Purchase Rights Agreement between the Company and The Bank of New York, as Rights Agent. Each Right entitles the registered holder thereof to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $.01 per share (the “Series A Preferred Shares”), of the Company at a price (the “Purchase Price”) of $62.50 per one one-hundredth of a Series A Preferred Share (subject to adjustment).
In general, the Rights will not become exercisable or transferable apart from the shares of Common Stock with which they were issued unless a person or group of affiliated or associated persons becomes the beneficial owner of, or commences a tender offer that would result in beneficial ownership of, 20% or more of the outstanding shares of Common Stock (any such person or group of persons being referred to as an “Acquiring Person”). Thereafter, under certain circumstances, each Right (other than any Rights that are or were beneficially owned by an Acquiring Person, which Rights will be void) could become exercisable to purchase at the Purchase Price a number of shares of Common Stock having a market value equal to two times the Purchase Price. The Rights will expire on December 19, 2004 unless earlier redeemed by the Company at a redemption price of $.03 per Right (subject to adjustment).
Treasury Stock
Treasury stock contains shares repurchased under the stock repurchase program, shares issued to wholly owned subsidiaries of the Company in connection with an acquisition, shares maintained in a trust related to the deferred compensation plans and shares repurchased to cover employee tax liabilities related to other stock plan activity.
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Changes in the number of shares held in the treasury are as follows:
Additions to treasury stock for restricted stock and the deferred compensation plans represent shares accepted in lieu of cash to cover employee tax liabilities upon lapse of restrictions for restricted stock and upon distribution of Common Stock under the deferred compensation plans.
Under the deferred compensation plans, shares are maintained in a trust to cover the number estimated to be needed for distribution on account of stock credits currently outstanding. Changes in the number of shares held in the trust are as follows:
17. Financial Instruments and Concentrations of Credit Risk
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and short-term investments
The carrying amount approximates fair value because of the short maturity of these instruments.
Accounts receivable
The carrying amount approximates fair value because of the short average maturity of the instruments, and because the carrying amount reflects a reasonable estimate of losses from doubtful accounts.
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Notes Receivable
The fair value of notes receivable is estimated using discounted cash flow analysis, based on estimated market discount rates.
Long-term debt
The fair values of the Company’s long-term debt, excluding capitalized leases, are estimated based on the quoted market prices for publicly traded debt or by using discounted cash flow analysis, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Interest rate cap agreements
The fair values of the interest rate cap agreements are estimated based on current settlement prices of comparable contracts obtained from dealer quotes.
Interest rate swap agreements
The fair values of the interest rate swap agreements are obtained from dealer quotes. The values represent the estimated amount the Company would pay or receive to terminate the agreements at the reporting date, taking into account current interest rates and the current creditworthiness of the swap counterparties.
The estimated fair values of certain financial instruments of the Company are as follows:
The interest rate cap agreements are used, in effect, to hedge interest rate risk related to a portion of the variable rate indebtedness under the Company’s Receivables Backed Financings.
The interest rate swap agreements were used, in effect, to convert a portion of the Company’s fixed-rate debt to variable rate debt.
Commitments to extend credit under revolving agreements relate primarily to the aggregate unused credit limits and unused lines of credit extended under the Company’s credit plans. These commitments generally can be terminated at the option of the Company. It is unlikely that the total commitment amount will represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis.
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and customer accounts receivable. The Company places its
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temporary cash investments in what it believes to be high credit quality financial instruments. Credit risk with respect to customer accounts receivable is concentrated in the geographic regions in which the Company operates stores. Such concentrations, however, are considered to be limited because of the Company’s large number of customers and their dispersion across many regions.
18. Earnings Per Share
The reconciliation of basic earnings per share to diluted earnings per share based on income from continuing operations before extraordinary item is as follows:
In addition to the warrants and stock options reflected in the foregoing table, stock options to purchase 23.0 million, 10.0 million and 9.2 million shares of common stock at prices ranging from $32.44 to $79.44 per share were outstanding at February 1, 2003, February 2, 2002 and February 3, 2001, respectively, 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.
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19. Quarterly Results (unaudited)
Unaudited quarterly results for the 52 weeks ended February 1, 2003 and the 52 weeks ended February 2, 2002, were as follows:
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