The Company is a retail organization operating retail stores that sell a wide range of merchandise, including men’s, women’s and children’s apparel and accessories, cosmetics, home furnishings and other consumer goods in 45 states, the District of Columbia, Puerto Rico and Guam. The Company’s operations are significantly impacted by competitive pressures from department stores, specialty stores and mass merchandisers and all other retail channels. The Company’s operations are also significantly impacted by general consumer-spending levels, which are driven in part by consumer confidence and employment levels.

      In 2003, the Company commenced the implementation of a strategy to more fully utilize its Macy’s brand. This strategy allows the Company to magnify the impact of its marketing efforts on a nationwide basis, as well as to leverage major events such as the Macy’s Thanksgiving Day Parade and Macy’s 4th of July fireworks. On March 6, 2005, the Company completed the conversion of all of the Company’s regional department store nameplates to the Macy’s nameplate. As a result, prior to the acquisition of The May Department Stores Company (“May”), the Company operated coast-to -coast exclusively under two retail brands – Macy’s and Bloomingdale’s.

      In early 2004, the Company announced a further step in reinventing its department stores – the creation of a centralized organization to be responsible for the overall strategy, merchandising and marketing of home-related categories of business in all of its Macy’s-branded stores. While its benefits have taken longer to be realized, the centralized operation is still expected to accelerate future sales in these categories largely by improving and further differentiating the Company’s home-related merchandise assortments.

      Over the past three years, the Company focused on four key priorities for improving the business over the longer term: differentiating and editing merchandise assortments; simplifying pricing; improving the overall shopping experience; and communicating better with customers through more brand focused and effective marketing. The Company believes that its recent results indicate that these strategies are working and that the customer is responding in a favorable manner. In 2005, the Company launched a new nationwide Macy’s customer loyalty program, called Star Rewards, in coordination with the launch of the Macy’s nameplate in cities across the country. The program provides an enhanced level of offers and benefits to Macy’s best credit card customers.

      On August 30, 2005, the Company completed its merger with May (the “Merger”). The results of May’s operations have been included in the consolidated financial statements since that date. The aggregate purchase price for May was approximately $11.7 billion, including approximately $5.7 billion of cash and approximately 100 million shares of Company common stock and options to purchase an additional 9.4 million shares of Company common stock valued at approximately $6.0 billion in the aggregate. In connection with the Merger, the Company also assumed approximately $6.0 billion of May debt.

      The Merger is expected to have a material effect on the Company’s consolidated financial position, results of operations and cash flows. The Company expects to realize approximately $175 million of cost savings in 2006 and $450 million of annual cost savings starting in 2007, resulting from the consolidation of central functions, division integrations and the adoption of best practices across the combined company. The Merger is also expected to accelerate comparable store sales growth. In addition, the Company anticipates incurring approximately $1.0 billion in one-time costs related to the acquisition and integration, spread out over a three-year period, commencing after the acquisition in 2005.

      The Company expects to add about 400 Macy’s locations nationwide in 2006 as it converts the regional department store nameplates acquired through the Merger. In conjunction with the conversion process, the Company has identified approximately 80 locations which will be divested starting in 2006, including approximately 40 current May stores operating in 11 states under various nameplates, as well as approximately 40 Macy’s stores operating in 15 states. Locations identified for divestiture accounted for approximately $2.2 billion of 2005 sales on a pro forma basis. On September 20, 2005 and January 12, 2006, the Company announced its intention to dispose of the acquired May Bridal Group division, which includes the operations of David’s Bridal, After Hours Formalwear and Priscilla of Boston, and the acquired Lord & Taylor division of May, respectively. As a result of the Company’s decision to dispose of these businesses, these businesses are being reported as discontinued operations. Unless otherwise indicated, the following discussion relates to the Company’s continuing operations. The Company is continuing to study its store portfolio in light of the Merger and some plans may change as conversion dates approach.

      In June 2005, the Company entered into a Purchase, Sale and Servicing Transfer Agreement (the “Purchase Agreement”) with Citibank, N.A. pursuant to which the Company agreed to sell to Citibank (i) the proprietary and non-proprietary credit card accounts owned by the Company, together with related receivables balances, and the capital stock of Prime Receivables Corporation, a wholly owned subsidiary of the Company, which owned all of the Company’s interest in the Prime Credit Card Master Trust (the “FDS Credit Assets”), (ii) the “Macy’s” credit card accounts owned by GE Money Bank and Monogram Credit Services, LLC (collectively, “GE Bank”), together with related receivables balances (the “GE/ Macy’s Credit Assets”), upon the termination of the Company’s credit card program agreement with GE Bank, and (iii) the proprietary credit card accounts owned by May, together with related receivables balances (the “May Credit Assets”), prior to August 30, 2006. The purchase by Citibank of the FDS Credit Assets was completed on October 24, 2005.

      In connection with the Purchase Agreement, the Company and Citibank entered into a long-term marketing and servicing alliance pursuant to the terms of a Credit Card Program Agreement (the “Program Agreement”) with an initial term of 10 years commencing from the date of the last closing under the Purchase Agreement and, unless terminated by either party as of the expiration of the initial term, an additional renewal term of three years. The Program Agreement provides for, among other things, (i) the ownership by Citibank of the accounts purchased by Citibank pursuant to the Purchase Agreement, (ii) the ownership by Citibank of new accounts opened by the Company’s customers, (iii) the provision of credit by Citibank to the holders of the credit cards associated with the foregoing accounts, (iv) the servicing of the foregoing accounts, and (v) the allocation between Citibank and the Company of the economic benefits and burdens associated with the foregoing and other aspects of the alliance.

      The sales prices provided for in the Purchase Agreement equate to approximately 111.5% of the receivables to be included in the FDS Credit Assets, the GE/ Macy’s Credit Assets and the May Credit Assets, and the Company will receive ongoing payments under the Program Agreement. The transactions contemplated by the Purchase Agreement and the Program Agreement are expected to be accretive to the Company’s earnings per share, particularly as the sales of the GE/ Macy’s Credit Assets and the May Credit Assets are completed.

      The Company has provided GE Bank with a notice of its election to terminate the Company’s credit card program agreement with GE Bank effective as of May 1, 2006. On April 4, 2006, the Company entered into a Sale and Purchase Agreement with GE Bank pursuant to which, subject to the receipt of all required regulatory approvals, the Company shall purchase from GE Bank all of the GE/ Macy’s Credit

Assets owned by GE Bank as of 11:59 p.m. on the day immediately preceding the closing date. Pursuant to the credit card program agreement, the purchase price for the GE/ Macy’s Credit Assets will be equal to the “net book value” (as such term is defined in the credit card program agreement) of the assets to be purchased as of the purchase date.

      The following discussion should be read in conjunction with our Consolidated Financial Statements and the related notes included elsewhere in this report. The following discussion contains forward-looking statements that reflect the Company’s plans, estimates and beliefs. The Company’s actual results could materially differ from those discussed in these forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in “Forward-Looking Statements.”

      Comparison of the 52 Weeks Ended January 28, 2006 and the 52 Weeks Ended January 29, 2005. Net income for 2005 increased to $1,406 million compared to $689 million for 2004. Net income for 2005 includes income from discontinued operations of $33 million. The increase in income from continuing operations in 2005 reflects the $480 million gain on the sale of the FDS Credit Assets as well as the impact of the acquisition of May.

      Net sales for 2005 totaled $22,390 million, compared to net sales of $15,776 million for 2004, an increase of 41.9%. Net sales for September 2005 through January 2006 include the continuing operations of May. On a comparable store basis (sales from Bloomingdale’s and Macy’s stores in operation throughout 2004 and 2005 and all Internet sales and mail order sales from continuing businesses), net sales increased 1.3% compared to 2004. Sales in 2005 were strongest at Bloomingdale’s and Macy’s Florida. Sales of the Company’s private label brands continued to be strong in 2005 in all Macy’s-branded stores. By family of business, sales in 2005 were strong in shoes, handbags, cosmetics and fragrances and men’s and women’s sportswear. The weaker businesses during 2005 continued to be in the home-related areas.

      Cost of sales was 59.3% of net sales for 2005, compared to 59.5% for 2004. Included in cost of sales for 2004 were $36 million of markdowns, 0.2% of net sales, associated with the Macy’s home store centralization and the Burdines-Macy’s consolidation in Florida. The cost of sales rate in 2005 was essentially flat with the cost of sales rate in 2004, excluding the impact of the markdowns in 2004. These markdowns were primarily related to merchandise that was being sold at Macy’s-branded stores and which was not reordered following the Burdines-Macy’s consolidation and home store centralization. Gross margin for 2005 reflects $25 million of inventory valuation adjustments related to the integration of May and Federated merchandise assortments. The valuation of department store merchandise inventories on the last-in, first-out basis did not impact cost of sales in either period.

      Selling, general and administrative (“SG&A”) expenses were 31.2% of net sales for 2005, compared to 31.6% for 2004. Included in SG&A expenses for 2004 were approximately $63 million of costs, 0.4% of net sales, incurred in connection with store closings, the Burdines-Macy’s consolidation and the home store centralization. The SG&A rate in 2005 was negatively impacted by the sale of the FDS Credit Assets.

      May integration costs for 2005 amounted to $169 million, primarily related to impairment charges for certain Macy’s stores to be closed and sold.

      A pre-tax gain of approximately $480 million was recorded in 2005 in connection with the sale of the FDS Credit Assets.

      Net interest expense was $380 million for 2005, compared to $284 million for 2004. The increase in interest expense during 2005 as compared to 2004 is due to the increased levels of borrowings associated with the acquisition of May, offset in part by the reduction in receivables-backed borrowings due to the sale of the FDS Credit Assets. Net interest expense for 2005 includes $17 million of interest income related to the settlement of various tax examinations. Net interest expense for 2004 includes $59 million of costs associated with the repurchase of $274 million of the Company’s 8.5% senior notes due 2010.

      The Company’s effective income tax rates of 32.8% for 2005 and 38.3% for 2004 differ from the federal income tax statutory rate of 35.0%, and on a comparative basis, principally because of the reduction in the valuation allowance associated with capital loss carryforwards, the settlement of various tax examinations and the effect of state and local income taxes. Federal, state and local income tax expense for 2005 benefited from approximately $85 million related to the reduction in the valuation allowance associated with the capital loss carryforwards realized as a result of the sale of the FDS Credit Assets and $10 million related to the settlement of various tax examinations.

      For 2005, income from the discontinued operations of the acquired Lord & Taylor and bridal group businesses, net of income taxes, was $33 million on sales of approximately $957 million.

      Comparison of the 52 Weeks Ended January 29, 2005 and the 52 Weeks Ended January 31, 2004. Net income for 2004 totaled $689 million, compared to net income of $693 million for 2003. Net income for 2004 reflects strong sales and gross margin performance in 2004, offset by higher SG&A expenses, interest expense associated with the repurchase of $274 million of the Company’s 8.5% senior notes due 2010 and higher income tax expense. Income tax expense during 2003 benefited from a $38 million favorable tax adjustment.

      Net sales for 2004 totaled $15,776 million, compared to net sales of $15,412 million for 2003, an increase of 2.4%. On a comparable store basis (sales from stores in operation throughout 2003 and 2004), net sales increased 2.6% compared to 2003. Bloomingdale’s and Burdines-Macy’s produced the strongest sales performance in 2004 compared to 2003. Sales of the Company’s private label brands continued to sell extremely well throughout the store and the penetration of the Company’s private brands increased in 2004 to 17.4% of sales in Macy’s-branded stores. By family of business, sales were strong in handbags, jewelry and cosmetics as well as in children’s apparel.

      Cost of sales was 59.5% of net sales for 2004 and 2003. Included in cost of sales for 2004 were $36 million of markdowns associated with the Macy’s home store centralization and the consolidation of six Macy’s stores operating in Florida into the Burdines-Macy’s organization. These markdowns are primarily related to merchandise that was being sold at Macy’s-branded stores that will not continue to be sold following the home store centralization and the Burdines-Macy’s consolidation. The cost of sales rate and corresponding gross margin in 2004, excluding the home store centralization and the Burdines-Macy’s consolidation markdowns, benefited from lower net markdowns due to the lower inventory levels and improved sales. Merchandise inventories were down 3% at the end of 2004 as compared to the end of 2003. The valuation of merchandise inventories on the last-in, first-out basis did not impact cost of sales in either period.

      SG&A expenses were 31.6% of net sales for 2004 compared to 31.8% for 2003. SG&A expenses in 2004 reflect higher pension costs and higher selling-related costs, partially offset by improved bad debt expense. Included in SG&A expenses for 2004 were approximately $63 million of costs incurred in connection with the home store centralization, the Burdines-Macy’s consolidation and other store closings.

Included in SG&A expenses for 2003 were approximately $59 million of costs incurred in connection with the Rich’s-Macy’s and Burdines-Macy’s consolidations and other announced store closings

      Net interest expense was $284 million for 2004 compared to $257 million for 2003. Net interest expense for 2004 includes $59 million of costs associated with the repurchase of $274 million of the Company’s 8.5% senior notes due 2010, partially offset by the impact of lower levels of borrowings.

      The Company’s effective income tax rates of 38.3% for 2004 and 36.0% for 2003 differ from the federal income tax statutory rate of 35.0%, and on a comparative basis, principally because of the effect of state and local income taxes and the impact of a $38 million favorable tax adjustment in 2003. The favorable tax adjustment in 2003 reduced income tax expense by $38 million and resulted from a change in estimate of the effective tax rate at which existing deferred tax assets and liabilities will ultimately be settled.

      The Company’s principal sources of liquidity are cash from operations, cash on hand and the credit facilities described below.

      Net cash provided by continuing operating activities in 2005 was $1,950 million, compared to the $1,507 million provided in 2004, reflecting improved operating performance, including the impact of the acquisition of May.

      Net cash used by continuing investing activities was $2,506 million for 2005, compared to $727 million for 2004. Investing activities for 2005 include the cash outflow associated with the acquisition of May of $5,321 million and the cash inflow associated with the sale of the FDS Credit Assets of $3,583 million. Investing activities for 2005 also included purchases of property and equipment totaling $568 million, capitalized software of $88 million and an increase in non-proprietary accounts receivable of $131 million. Investing activities for 2004 included purchases of property and equipment totaling $467 million, capitalized software of $81 million, an increase in non-proprietary accounts receivable of $236 million and $30 million collection of notes receivable.

      The Company opened two new Macy’s department stores during 2005 and opened six new department stores under legacy May nameplates since the acquisition of May. The Company opened four department stores, four furniture stores and expanded into two additional locations in existing malls in 2004. The Company intends to open four new department stores, one new furniture gallery, reopen one or two of the former May stores being converted to Bloomingdale’s and reopen some of the five hurricane related closings in Florida and Louisiana before the fourth quarter of 2006. The Company’s budgeted capital expenditures are approximately $1.6 billion for 2006 and approximately $1.1 to $1.2 billion for each of 2007 and 2008. Management presently anticipates funding such expenditures with cash from operations.

      Net cash used by the Company for all continuing financing activities was $58 million for 2005, including the issuance of $4,580 million of short-term debt used to finance the acquisition of May, the repayment of approximately $4,755 million of debt, the issuance of $336 million of its common stock, primarily related to the exercise of stock options, and $157 million of cash dividends paid. The debt repaid in 2005 includes $1.2 billion of receivables backed financings and approximately $3.4 billion of acquisition-related borrowings, which repayments were primarily funded from the net proceeds received from the sale of the FDS Credit Assets. The Company acquired no shares of its common stock under its share repurchase program during 2005.

      Net cash used by the Company for all continuing financing activities was $837 million for 2004, including $365 million of debt repayments, the acquisition of 18.3 million shares of its common stock at an approximate cost of $901 million, the issuance of $298 million of its common stock, primarily related to the exercise of stock options, and $93 million of cash dividends paid. The debt repaid in 2004 includes the repurchase of $274 million of the Company’s 8.5% senior notes due 2010 and $85 million of the Company’s 6.79% senior debentures due 2027. Certain holders of the Company’s 6.79% senior debentures due 2027 elected to have such debentures repaid on July 15, 2004 at 100% of the principal amount thereof, together with accrued interest to the date of repayment.

      The Company’s board of directors approved additional $750 million authorizations to the Company’s existing share repurchase program on February 27, 2004 and July 20, 2004. In connection with the May acquisition, the Company suspended repurchases under the Company’s share repurchase program. As of January 28, 2006, the share repurchase program had approximately $670 million of authorization remaining. The Company currently anticipates resuming its share repurchase program sometime in the second or third quarter of 2006.

      The Company is a party to a five-year credit agreement with certain financial institutions providing for revolving credit borrowings and letters of credit in an aggregate amount not to exceed $2.0 billion (which amount may be increased to $2.5 billion at the option of the Company) outstanding at any particular time. This agreement expires August 30, 2010 and replaces the previous five-year credit agreement which was set to expire June 29, 2006. As of January 28, 2006, the Company had no borrowings outstanding under the five-year credit agreement.

      In connection with the Merger, the Company entered into a 364-day bridge credit agreement with certain financial institutions providing for revolving credit borrowings in an aggregate amount initially not to exceed $5.0 billion outstanding at any particular time. The aggregate amount of the facility will be reduced upon the receipt by the Company of net cash proceeds from certain events, including certain sales or other dispositions of assets aggregating $100 million or more, the issuance of certain equity interests and the incurrence of certain long term indebtedness. The aggregate amount of the facility has been reduced to $2.25 billion as a result of the proceeds received from the sale of the FDS Credit Assets. As of January 28, 2006, the Company had no borrowings outstanding under the 364-day bridge credit agreement.

      In connection with the Merger, the Company entered into an unsecured commercial paper program pursuant to which it may issue and sell commercial paper in an aggregate amount outstanding at any particular time not to exceed its then-current combined borrowing availability under the revolving credit facilities described above. As of January 28, 2006, the Company had $1,199 million of commercial paper outstanding under its commercial paper program.

      The Company funded the cash consideration payable in the Merger originally through cash on hand and borrowings under its 364-day bridge credit agreement. The Company subsequently issued commercial paper and utilized the proceeds thereof and additional cash on hand to pay down the borrowings under the 364-day bridge credit agreement.

      The Company’s bank credit agreements require the Company to maintain a specified interest coverage ratio of no less than 3.25 and a specified leverage ratio of no more than .62. The interest coverage ratio for 2005 was 7.80 and at January 28, 2006 the leverage ratio was .41. Management believes that the likelihood of the Company defaulting on these requirements in the future is remote absent any material negative event affecting the U.S. economy as a whole. However, if the Company’s results of operations or operating ratios deteriorate to a point where the Company is not in compliance with any of its debt covenants and

the Company is unable to obtain a waiver, much of the Company’s debt would be in default and could become due and payable immediately.

      At January 28, 2006, the Company had contractual obligations (within the scope of Item 303(a)(5) of Regulation  S-K) as follows:

      “Other obligations” in the foregoing table consist primarily of significant merchandise purchase obligations and obligations under outsourcing arrangements, construction contracts, employment contracts, group medical/dental/life insurance programs and energy and other supply agreements identified by the Company. The Company’s merchandise purchase obligations fluctuate on a seasonal basis, typically being higher in the summer and early fall and being lower in the late winter and early spring. The Company purchases a substantial portion of its merchandise inventories and other goods and services otherwise than through binding contracts. Consequently, the amounts shown as “Other obligations” in the foregoing table do not reflect the total amounts that the Company would need to spend on goods and services in order to operate its businesses in the ordinary course.

      Management believes that, with respect to the Company’s current operations, cash on hand and funds from operations, together with its credit facilities and other capital resources, will be sufficient to cover the Company’s reasonably foreseeable working capital, capital expenditure and debt service requirements in both the near term and over the longer term. The Company’s ability to generate funds from operations may be affected by numerous factors, including general economic conditions and levels of consumer confidence and demand; however, the Company expects to be able to manage its working capital levels and capital expenditure amounts so as to maintain sufficient levels of liquidity. For short-term liquidity, the Company also relies on its unsecured commercial paper facility (which is discussed above). Access to the unsecured commercial paper program is primarily dependent on the Company’s credit ratings; a downgrade in its short-term ratings could hinder its ability to access this market. If the Company is unable to access the unsecured commercial paper market, it has the current ability to access $4.25 billion pursuant to its bank credit agreements, subject to compliance with the interest coverage and leverage ratio requirements discussed above and other requirements under the agreements. Depending upon conditions in the capital markets and other factors, the Company will from time to time consider the issuance of debt or other securities, or other possible capital markets transactions, the proceeds of which could be used to refinance current indebtedness or for other corporate purposes.

      Management believes the retail business will continue to consolidate. The Company intends from time to time to consider additional acquisitions of, and investments in, department stores and other complementary assets and companies. Acquisition transactions, if any, are expected to be financed from one or more of the following sources: cash on hand, cash from operations, borrowings under existing or new credit facilities and the issuance of long-term debt, commercial paper or other securities, including common stock.

      The Company evaluates the collectibility of its proprietary accounts receivable based on a combination of factors, including analysis of historical trends, aging of accounts receivable, write-off experience and expectations of future performance. Proprietary accounts receivable are considered delinquent if more than one scheduled minimum payment is missed. Delinquent proprietary accounts are generally written off automatically after the passage of 180 days without receiving a full scheduled monthly payment. Accounts are written off sooner in the event of customer bankruptcy or other circumstances that make further collection unlikely. The Company reserves for doubtful proprietary accounts with a methodology based upon historical write-off performance in addition to factoring in a flow rate performance tied to the customer delinquency trend. At January 28, 2006, a 0.1 percentage point change in the result of the reserve methodology would impact the proprietary reserve for doubtful accounts by approximately $2 million.

      Merchandise inventories are valued at the lower of cost or market using the last-in, first-out (LIFO) retail inventory method. Under the retail inventory method, inventory is segregated into departments of merchandise having similar characteristics, and is stated at its current retail selling value. Inventory retail values are converted to a cost basis by applying specific average cost factors for each merchandise department. Cost factors represent the average cost-to -retail ratio for each merchandise department based on beginning inventory and the fiscal year purchase activity. The retail inventory method inherently requires management judgments and contains estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory, which may impact the ending inventory valuation as well as gross margins.

      Permanent markdowns designated for clearance activity are recorded when the utility of the inventory has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise and fashion trends. When a decision is made to permanently mark down merchandise, the resulting gross profit reduction is recognized in the period the markdown is recorded. The Company receives cash allowances from merchandise vendors as purchase price adjustments. Purchase price adjustments are credited to cost of sales in accordance with Emerging Issues Task Force (“EITF”) Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.”

      Shrinkage is estimated as a percentage of sales for the period from the last inventory date to the end of the fiscal period. Such estimates are based on experience and the most recent physical inventory results. While it is not possible to quantify the impact from each cause of shrinkage, the Company has loss prevention programs and policies that are intended to minimize shrinkage. Physical inventories are

generally taken within each merchandise department annually and inventory records are adjusted accordingly.

      The carrying values of long-lived assets are periodically reviewed by the Company whenever events or changes in circumstances indicate that a potential impairment has occurred. For long-lived assets held for use, a potential impairment has occurred if projected future undiscounted cash flows are less than the carrying value of the assets. The estimate of cash flows includes management’s assumptions of cash inflows and outflows directly resulting from the use of those assets in operations. When a potential impairment has occurred, an impairment write-down is recorded if the carrying value of the long-lived asset exceeds its fair value. The Company believes its estimated cash flows are sufficient to support the carrying value of its long-lived assets. If estimated cash flows significantly differ in the future, the Company may be required to record asset impairment write-downs.

      For long-lived assets held for disposal by sale, an impairment charge is recorded if the carrying amount of the assets exceeds its fair value less costs to sell. Such valuations include estimations of fair values and incremental direct costs to transact a sale. For long-lived assets to be abandoned, the Company considers the asset to be disposed of when it ceases to be used. If the Company commits to a plan to abandon a long-lived asset before the end of its previously estimated useful life, depreciation estimates are revised accordingly. In addition, liabilities arise such as severance, contractual obligations and other accruals associated with store closings from decisions to dispose of assets. The Company estimates these liabilities based on the facts and circumstances in existence for each restructuring decision. The amounts the Company will ultimately realize or disburse could differ from the amounts assumed in arriving at the asset impairment and restructuring charge recorded.

      The carrying value of goodwill and other intangible assets with indefinite lives are reviewed annually for possible impairment. The impairment review is based on a discounted cash flow approach at the reporting unit level, that requires significant management judgment with respect to sales, gross margin and expense growth rates, and the selection and use of an appropriate discount rate. The use of different assumptions would increase or decrease estimated discounted future operating cash flows and could increase or decrease an impairment charge. The occurrence of an unexpected event or change in circumstances, such as adverse business conditions or other economic factors, would determine the need for impairment testing between annual impairment tests.

      The Company is self-insured for workers compensation and public liability claims up to certain maximum liability amounts. Although the amounts accrued are actuarially determined by third parties based on analysis of historical trends of losses, settlements, litigation costs and other factors, the amounts the Company will ultimately disburse could differ from such accrued amounts.

      The Company has funded defined benefit pension plans (the “Pension Plans”) and unfunded defined benefit supplementary retirement plans (the “SERPs”). The Company accounts for these plans using SFAS No. 87, “Employers’ Accounting for Pensions.” Under SFAS No. 87, pension expense is recognized on an accrual basis over employees’ approximate service periods. Pension expense calculated under

SFAS No. 87 is generally independent of funding decisions or requirements. The Company anticipates that pension expense and other retirement costs relating to continuing operations will increase by approximately $75 million in 2006, compared to 2005, reflecting a full year of expenses related to May.

      Funding requirements for the Pension Plans are determined by government regulations, not SFAS No. 87. Although no funding contributions were required, the Company made a $136 million voluntary funding contribution to the Pension Plans in 2005 and a $100 million voluntary funding contribution to the Pension Plans in 2004. The Company currently anticipates that it will not be required to make any additional contributions to the Pension Plans until 2008. The Company has not yet determined whether a voluntary contribution will be made to the Pension Plans prior to this date.

      At January 28, 2006, the Company had unrecognized actuarial losses of $437 million for the Pension Plans and $92 million for the SERPs. These losses will be recognized as a component of pension expense in future years in accordance with SFAS No. 87.

      The calculation of pension expense and pension liabilities requires the use of a number of assumptions. Changes in these assumptions can result in different expense and liability amounts, and future actual experience may differ significantly from current expectations. The Company believes that the most critical assumptions relate to the long-term rate of return on plan assets (in the case of the Pension Plans), the discount rate used to determine the present value of projected benefit obligations and the weighted average rate of increase of future compensation levels.

      The Company has assumed that the Pension Plans’ assets will generate a long-term rate of return of 8.75% for 2006 and 2005. The Company develops its long-term rate of return assumption by evaluating input from several professional advisors taking into account the asset allocation of the portfolio and long-term asset class return expectations, as well as long-term inflation assumptions. Pension expense increases or decreases as the expected rate of return on the assets of the Pension Plans decreases or increases, respectively. Lowering the expected long-term rate of return on the Pension Plans’ assets by 0.25% (from 8.75% to 8.50%) would increase the estimated 2006 pension expense by approximately $6 million and raising the expected long-term rate of return on the Pension Plans’ assets by 0.25% (from 8.75% to 9.00%) would decrease the estimated 2006 pension expense by approximately $6 million.

      The Company discounted its future pension obligations using a rate of 5.70% at December 31, 2005, compared to 5.75% at December 31, 2004. The Company determines the appropriate discount rate with reference to the current yield earned on an index of investment-grade long-term bonds and the impact of a yield curve analysis to account for the difference in duration between the long-term bonds and the Pension Plans’ and SERPs’ estimated payments. Pension liability and future pension expense both increase or decrease as the discount rate is reduced or increased, respectively. Lowering the discount rate by 0.25% (from 5.70% to 5.45%) would increase the projected benefit obligation at January 28, 2006 by approximately $125 million and would increase estimated 2006 pension expense by approximately $13 million. Increasing the discount rate by 0.25% (from 5.70% to 5.95%) would decrease the projected benefit obligation at January 28, 2006 by approximately $121 million and would decrease estimated 2006 pension expense by approximately $19 million.

      The assumed weighted average rate of increase in future compensation levels was 5.4% as of December 31, 2005 and December 31, 2004 for the Pension Plans, and 7.2% as of December 31, 2005 and December 31, 2004 for the SERPs. The Company develops its increase of future compensation level assumption based on recent experience. Pension liabilities and future pension expense both increase or decrease as the weighted average rate of increase of future compensation levels is increased or decreased,

respectively. Increasing or decreasing the assumed weighted average rate of increase of future compensation levels by 0.25% would increase or decrease the projected benefit obligation at January 28, 2006 by approximately $15 million and change estimated 2006 pension expense by approximately $3 million.

      In November 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs – An Amendment of ARB No. 43, Chapter 4.” This statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and is effective for fiscal years beginning after June 15, 2005. The Company does not anticipate that the adoption of this statement will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

      In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets – An Amendment of APB Opinion No. 29, “Accounting for Nonmonetary Transactions.” This statement eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of Accounting Principles Board (“APB”) Opinion No. 29, and replaces it with an exception for exchanges that do not have commercial substance. The provisions of the statement are effective for fiscal periods beginning after June 15, 2005. The Company does not anticipate that the adoption of this statement will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Under the provisions of this statement, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition alternatives include retrospective and prospective adoption methods. Under the retrospective method, prior periods may be restated based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either for all periods presented or as of the beginning of the year of adoption. The prospective method requires that compensation expense be recognized beginning with the effective date, based on the requirements of this statement, for all share-based payments granted after the effective date, and based on the requirements of SFAS 123, for all awards granted to employees prior to the effective date of this statement that remain unvested on the effective date.

      The Company has decided to adopt SFAS 123R for its fiscal year beginning January 29, 2006 using the prospective method. The impact of adopting SFAS 123R cannot be accurately estimated since it will depend on levels of share-based awards granted in the future, the stock price at the date of grant and other factors used in the Black-Scholes options pricing model. However, had the Company adopted SFAS 123R in prior periods, the impact of this statement would have approximated the impact of the fair value recognition provisions of SFAS 123 as previously disclosed by the Company on a pro forma basis.

      In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”), which amended certain provisions of SFAS No. 133 and SFAS No. 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement (new basis) event after the beginning of a company’s first fiscal year that begins after September 15, 2006. The Company does not anticipate that the adoption of this statement will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

      The Company is exposed to market risk from changes in interest rates which may adversely affect its financial position, results of operations and cash flows. In seeking to minimize the risks from interest rate fluctuations, the Company manages exposures through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. The Company does not use financial instruments for trading or other speculative purposes and is not a party to any leveraged financial instruments.

      The Company is exposed to interest rate risk primarily through its customer lending and borrowing activities, which are described in Notes 6 and 10 to the Consolidated Financial Statements. The majority of the Company’s borrowings are under fixed rate instruments. However, the Company, from time to time, may use interest rate swap and interest rate cap agreements to help manage its exposure to interest rate movements and reduce borrowing costs. At January 28, 2006, the Company was not a party to any derivative financial instruments. See Notes 10 and 17 to the Consolidated Financial Statements, which are incorporated herein by reference.

      Based on the Company’s market risk sensitive instruments (primarily variable rate debt) outstanding at January 28, 2006, the Company has determined that there was no material market risk exposure to the Company’s consolidated financial position, results of operations or cash flows as of such date.