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Business Context and Reporting Period

This Form 10-Q covers the fiscal quarter ended July 30, 2005, and the 26-week period ended on the same date for Federated Department Stores, Inc. (operating as Macy's, Inc.). The company operates department stores under the Macy's and Bloomingdale's brands across 34 states, Puerto Rico, and Guam. A material subsequent event occurred on August 30, 2005, when the company completed the acquisition of The May Department Stores Company ("May") for approximately $5.7 billion in cash and 100 million shares of common stock.

Key Financial Metrics

Note: Total Debt for July 30, 2005, is the sum of Short-term debt ($1,229M) and Long-Term Debt ($2,634M).

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 1.2% in the quarter and 1.9% for the 26-week period compared to the prior year. Comparable store sales rose 1.1% for the quarter and 1.8% for the 26-week period.
• Profitability: Net income more than doubled in the quarter ($148M vs. $78M) and increased 55% for the 26-week period ($271M vs. $175M). This was driven by higher sales, lower expense rates, and significantly reduced interest expense.
• Expense Management: Selling, general, and administrative (SG&A) expenses as a percentage of sales improved to 33.3% in 2005 from 34.2% in 2004. Cost of sales as a percentage of sales improved to 58.7% from 59.0% in the quarter.
• Interest Expense: Net interest expense dropped to $54 million for the quarter from $119 million in the prior year, largely due to lower borrowings and the absence of $59 million in costs related to the repurchase of senior notes in 2004.
• Liquidity: Cash and cash equivalents increased to $1,399 million from $868 million at the beginning of the fiscal year. Operating cash flow for the 26-week period increased to $665 million from $586 million.

Guidance, Outlook, and Risks

• Merger Integration: Following the acquisition of May, the company expects the merger to be accretive to earnings per share in 2007. It anticipates $450 million in annual cost savings by 2007 but expects to incur approximately $1 billion in one-time integration costs over three years.
• Store Portfolio: The company plans to add approximately 330 Macy's locations in 2006 by converting regional nameplates. Conversely, it identified 75 locations for divestiture starting in 2006, representing approximately $2.1 billion in 2004 sales.
• Credit Card Sale: The company entered into an agreement to sell its proprietary and non-proprietary credit card accounts to Citibank. The transaction is expected to be accretive to earnings, with the initial closing expected in the third fiscal quarter of 2005.
• Dividends: The company committed to increasing its annual dividend to $1 per share following the completion of the May merger.
• Risks: Key risks include the successful integration of May, realization of cost synergies, competitive pressures, and general consumer spending levels. The company also faces a civil action in California regarding lead in fashion jewelry, though management does not expect a material financial impact.

Investor Verification Checklist

• Verify the final closing date and regulatory approval status of the credit card asset sale to Citibank.
• Monitor the progress of the May Department Stores integration and the realization of the projected $450 million in annual cost savings.
• Track the execution of the store divestiture plan (75 locations) and the conversion of regional stores to the Macy's brand.
• Review the impact of the $1 billion in one-time merger costs on future quarterly earnings.
• Confirm the status of the California Proposition 65 litigation regarding lead in jewelry.