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Business Context and Reporting Period

This Form 10-Q covers Federated Department Stores, Inc. (Macy's, Inc.) for the fiscal quarter ended August 2, 2003 (13 weeks) and the first half of the fiscal year ended August 2, 2003 (26 weeks). The company operates department stores under various banners, including Macy's, Bloomingdale's, and regional names. During this period, the company continued the integration of Rich's and Macy's in the Atlanta area and announced a strategy to leverage the Macy's brand across other regional banners (Bon Marche, Lazarus, Goldsmith's) starting in the fall of 2003. The company also completed the disposal of its Fingerhut Companies, Inc. operations, which are reported as discontinued operations.

Key Financial Metrics

Margins: Gross margin rate was 41.0% for the quarter and 40.1% for the six-month period. SG&A expenses were 33.3% of sales for the quarter and 34.0% for the six-month period.

Material Changes vs. Prior Period

• Sales Decline: Net sales decreased 1.5% in the quarter and 3.1% for the six-month period compared to the prior year. Comparable store sales declined 1.2% in the quarter and 3.1% for the six-month period.
• Profitability: Income from continuing operations decreased 10% in the quarter ($120M vs $133M) and 25% for the six-month period ($166M vs $222M). This decline is attributed to lower sales volumes and higher net markdowns.
• Discontinued Operations: The prior year periods included $149 million in after-tax income from the disposal of Fingerhut operations. No such income was recorded in the current periods as the disposal was completed in the prior year.
• Cost Structure: Cost of sales as a percentage of net sales increased slightly due to higher markdowns required to maintain inventory levels. SG&A expenses in absolute dollars were relatively flat but increased as a percentage of sales due to the revenue decline.
• Debt Reduction: Net interest expense decreased due to lower borrowing levels. The company repaid $454 million in debt during the six-month period.

Guidance, Outlook, and Risks

• Outlook: Management forecasts comparable store sales to be between down 1% and up 1% for the third and fourth quarters of 2003. Earnings per share from continuing operations for the remainder of fiscal 2003 are expected to be $2.40 to $2.50.
• Restructuring: The company expects additional store-closing costs of approximately $10 million in the third quarter and $2 million in the fourth quarter related to the Rich's-Macy's consolidation and other closures.
• Capital Allocation: The company repurchased $227 million of its own stock during the six-month period and has $485 million remaining under its repurchase authorization. Capital expenditures for 2003 are expected to be $600-$625 million.
• Risks and Contingencies:
  • Legal Proceedings: The company is a defendant in consolidated securities class action litigation regarding alleged misstatements related to the former Fingerhut subsidiary. A motion to dismiss is pending.
  • Market Conditions: Future results depend on general economic conditions, consumer confidence, and competitive pressures.
  • Integration Risks: Costs and operational challenges associated with the consolidation of regional banners under the Macy's nameplate.

Key Facts for Investor Verification

• Verify the impact of the "Macy's" brand consolidation strategy on future comparable store sales and operating margins.
• Confirm the timeline and cost implications of the remaining store closures and the Rich's-Macy's integration.
• Monitor the status of the securities class action litigation regarding the former Fingerhut subsidiary.
• Assess the company's ability to maintain liquidity given the reduction in borrowing capacity under its credit facility to $1.4 billion.
• Track the effectiveness of inventory management strategies to reduce markdowns while maintaining sales volume.