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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended November 3, 2007, and the 39-week period ended on the same date for Macy's, Inc. (formerly Federated Department Stores, Inc.). The Company operates over 850 department stores under the Macy's and Bloomingdale's brands across 45 states and territories. The reporting period reflects the ongoing integration of The May Department Stores Company, acquired in 2005, and the divestiture of the Lord & Taylor division and bridal group businesses, which are reported as discontinued operations.

Key Financial Metrics

Note: Total Debt calculated as Short-term debt ($1,634) + Long-Term Debt ($9,097).

Material Changes vs. Prior Period

• Revenue: Net sales for the 13 weeks increased slightly by 0.3% ($20 million) to $5,906 million. However, comparable store sales declined 0.8%. For the 39-week period, net sales decreased 0.5% to $17,719 million, with comparable store sales down 1.0%.
• Profitability: Net income for the quarter improved from a loss of $3 million in 2006 to $33 million in 2007. This improvement is largely due to the absence of significant losses from discontinued operations in the current quarter (specifically the Lord & Taylor disposal loss in 2006) and reduced May integration costs ($17 million in 2007 vs. $117 million in 2006).
• Cost Structure: Cost of sales as a percentage of net sales increased to 60.7% in the quarter (from 59.7% in 2006) due to higher net markdowns. SG&A expenses increased slightly to 35.9% of sales.
• Discontinued Operations: The 2006 period included significant one-time items, including a $63 million pre-tax loss on the sale of Lord & Taylor and a $191 million gain on the sale of credit card receivables. The 2007 period includes a $7 million loss on the sale of After Hours Formalwear.

Guidance, Outlook, and Risks

• Integration Costs: Management anticipates incurring approximately $60 million to $70 million in May integration costs in the fourth quarter of fiscal 2007, most of which will be non-cash charges.
• Capital Allocation: The Company repurchased approximately 45.7 million shares in 2007 under an accelerated share repurchase program. As of November 3, 2007, approximately $1,170 million of authorization remained. A quarterly dividend of $0.13 per share was declared.
• Liquidity: The Company maintains a $2,000 million revolving credit facility (extended to 2012) and an unsecured commercial paper program with $968 million outstanding as of the period end. Management believes current resources are sufficient for foreseeable requirements.
• Risks and Contingencies:
  • Legal Proceedings: The Company is defending against multiple class-action lawsuits alleging breach of fiduciary duty and securities violations related to the May integration and stock price inflation. The Company intends to contest these vigorously.
  • Tax Uncertainty: Approximately $75 million of unrecognized tax benefits may be recognized within the next 12 months, potentially affecting the effective tax rate.
  • Market Conditions: Operations are sensitive to consumer confidence, employment levels, and competitive pressures from various retail channels.

Investor Verification Checklist

• Comparable Store Sales: Verify the trend of declining comparable store sales (-0.8% Q3, -1.0% YTD) and its impact on future revenue guidance.
• Integration Run-Rate: Confirm the expected $60-$70 million in Q4 integration costs and the timeline for realizing the projected $450 million in annual cost savings.
• Debt Levels: Review the increase in total debt to $10.7 billion and the associated interest expense ($407 million for 39 weeks) relative to operating cash flow.
• Legal Exposure: Assess the potential financial impact of the pending securities and fiduciary duty lawsuits regarding the May merger.
• Inventory Management: Monitor the increase in merchandise inventories ($7,012 million) and the associated markdowns required to maintain inventory levels.