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Business Context and Reporting Period

Company: Federated Department Stores, Inc. (operating as Macy's, Inc.)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: 13 and 39 weeks ended October 28, 2006
Business Overview: The Company operates retail stores under the Macy's and Bloomingdale's brands. The period reflects the ongoing integration of The May Department Stores Company (acquired August 2005), including the conversion of regional nameplates to Macy's and the divestiture of non-core assets such as the Lord & Taylor division and the bridal group business.

Key Financial Metrics

Note: Debt figures represent the sum of Short-term debt and Long-Term Debt as of the period end.

Material Changes vs. Prior Period

• Profitability Decline: Net income for the 13 weeks ended Oct 28, 2006, turned to a loss of $3 million compared to $436 million in the prior year. This was driven by $145 million in May integration costs (including $28 million in inventory valuation adjustments) and a $23 million loss from discontinued operations (primarily the sale of Lord & Taylor). The prior year included a $480 million one-time gain on the sale of credit card accounts.
• Revenue Growth: Net sales increased 6% ($331 million) in the quarter and 39% year-to-date, largely due to the inclusion of May stores. Comparable store sales increased 5.9% in the quarter and 3.5% year-to-date.
• Expense Increases: Selling, General, and Administrative (SG&A) expenses rose due to higher depreciation, amortization, and the adoption of SFAS 123R (stock-based compensation expense of $73 million YTD vs. $7 million prior year).
• Debt Reduction: Total debt decreased significantly from $11.6 billion to $8.6 billion, aided by proceeds from the sale of credit card accounts to Citibank and the sale of discontinued operations.

Guidance, Outlook, and Risks

• Integration Costs: Management anticipates incurring approximately $110 million in May integration costs in the remaining quarter of fiscal 2006. Expected annual cost savings from the merger are at least $450 million starting in 2007.
• Divestitures: The Company completed the sale of Lord & Taylor for $1.047 billion. Agreements were signed to sell the bridal group business (David's Bridal, etc.) for $850 million, expected to close in Q1 2007.
• Capital Markets Activity: In late November 2006, the Company issued $1.1 billion in new notes and used proceeds to repurchase $957 million of higher-interest debt, expecting a one-time pre-tax gain of $54 million in Q4 2006 and reduced interest expense in 2007.
• Share Repurchases: The Board approved an additional $2 billion authorization for share repurchases. Approximately $1.55 billion remained available as of Oct 28, 2006.
• Risks: Key risks include the successful integration of May operations, realization of cost synergies, competitive pressures, and general consumer spending levels. Legal proceedings regarding the May merger remain pending but are expected to be contested vigorously.

Investor Verification Checklist

• Integration Progress: Verify the timeline and cost realization of the May integration, specifically the $450 million annual savings target for 2007.
• Discontinued Operations: Confirm the closing dates and final proceeds for the bridal group business sale ($850 million) and any remaining store divestitures.
• Debt Structure: Review the impact of the November 2006 debt refinancing on future interest expense and the remaining debt maturity profile.
• Comparable Sales: Monitor the sustainability of the 5.9% comparable store sales growth, particularly in the "home" categories which showed weakness in acquired May stores.
• Stock-Based Compensation: Assess the ongoing impact of SFAS 123R on future earnings, as stock-based compensation expense increased significantly ($73 million YTD).