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Business Context and Reporting Period

This Form 10-Q covers the 13-week fiscal period ended May 5, 2007, 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. During this period, the company completed the divestiture of its After Hours Formalwear business and finalized the sale of its David's Bridal and Priscilla of Boston businesses, which are reported as discontinued operations. The company officially changed its name to Macy's, Inc. effective June 1, 2007.

Key Financial Metrics

Profitability: Gross margin improved to 39.8% of net sales in Q1 2007 compared to 38.7% in Q1 2006. Operating income surged to $208 million from $20 million, driven by reduced integration costs and improved margins.

Liquidity: Cash and cash equivalents decreased from $1,211 million at the start of the quarter to $500 million at period end, primarily due to a $1,991 million share repurchase program.

Material Changes vs. Prior Period

• Net Income Turnaround: The company reported a net income of $36 million, a significant improvement from a net loss of $52 million in the prior year. This shift was largely due to a reduction in May integration costs from $123 million in 2006 to $36 million in 2007.
• Comparable Store Sales: While total net sales decreased slightly by 0.2% ($9 million), comparable store sales increased by 0.6%.
• Discontinued Operations: Q1 2007 included a $16 million loss from discontinued operations (primarily the sale of After Hours Formalwear), whereas Q1 2006 included $22 million of income from discontinued operations (Lord & Taylor and bridal group sales).
• Cost of Sales: Cost of sales decreased by $63 million, with the cost of sales rate improving from 61.2% to 60.2% due to fewer markdowns in legacy May locations.

Guidance, Outlook, and Risks

Management Commentary: Management expects to realize at least $450 million in annual cost savings starting in 2007 from the May merger integration. The company anticipates incurring approximately $64 million to $89 million in May integration costs for the remaining three quarters of fiscal 2007.

Capital Allocation: The board approved an additional $4,000 million share repurchase authorization. In Q1 2007, the company repurchased approximately 45 million shares for roughly $2,000 million. A quarterly dividend of $0.13 per share was declared, an increase from the previous $0.1275 rate.

Risks and Contingencies:

• Legal Proceedings: The company is defending against a class action lawsuit regarding the May merger and a securities class action alleging false statements regarding the integration of May operations.
• Tax Uncertainty: The adoption of FIN 48 resulted in a $1 million increase to accruals for uncertain tax positions. The company notes it is reasonably possible that unrecognized tax benefits could change within the next 12 months due to ongoing audits.
• Market Risks: Operations are sensitive to consumer confidence, employment levels, and competitive pressures from various retail channels.

Investor Verification Checklist

• Integration Cost Run-Rate: Verify if the projected $64-$89 million in remaining integration costs for fiscal 2007 aligns with actual quarterly spending trends.
• Share Repurchase Settlement: Confirm the final number of shares repurchased and the total cost upon settlement of the accelerated share repurchase agreements (initially 45 million shares).
• Discontinued Operations Finalization: Monitor the final accounting for the sales of Lord & Taylor, David's Bridal, and After Hours Formalwear to ensure no further adjustments to the loss on disposal.
• Debt Maturities: Review the schedule for upcoming debt maturities, including $400 million of senior notes due July 2007 and $225 million of senior debentures due October 2007.
• Comparable Store Sales Trend: Assess whether the 0.6% comparable store sales growth is sustainable given the competitive retail environment.