A description of the Company's significant accounting policies is included in the Company's Annual Report on Form 10-K for the fiscal year ended February 1, 2003 (the "2002 10-K"). The accompanying Unaudited Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto in the 2002 10-K.

Because of the seasonal nature of the retail business, the results of operations for the 13 weeks ended May 3, 2003 and May 4, 2002 (which do not include the Christmas season) are not necessarily indicative of such results for the fiscal year.

The Consolidated Financial Statements for the 13 weeks ended May 3, 2003 and May 4, 2002, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) considered necessary to present fairly, in all material respects, the consolidated financial position and results of operations of the Company and its subsidiaries.

Effective February 2, 2003, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure" and SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 145 rescinds or amends existing authoritative pronouncements to limit the circumstances under which gains and losses from the extinguishment of debt will be treated as extraordinary items, to make various technical corrections and clarifications and to describe the applicability of certain of these pronouncements under changed conditions. SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation" and Accounting Principles Board ("APB") Opinion No. 28, "Interim Financial Reporting" to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stoc k-based compensation and amends the disclosure provisions therein. SFAS No. 143 establishes accounting standards for recognition and measurement of a liability for the costs of asset retirement obligations. The adoption of these statements did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.

In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The Company does not anticipate that the adoption of this statement on August 3, 2003 will have a material impact on the Company's consolidated financial position, results of operations or cash flows.

The Company accounts for its stock-based employee compensation plan in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan have an exercise price at least equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," for stock options granted. The Company estimates the fair value of each employee stock option grant on the date of grant using the Black-Scholes option-pricing model.

During the fourth quarter of 2002, the Company recorded certain costs and expenses associated with the Rich's-Macy's consolidation, including $6 million of severance costs, in SG&A.

The Company recorded restructuring charges in 2001 and 2000, including long-term lease obligations related to the disposition of Stern's properties and severance costs associated with the closing of its Stern's department store division.

The following tables show the activity associated with the restructuring accruals:

The $13 million reserve that the Company still expects to pay out relates to liabilities associated with the disposition of Stern's properties. The remaining Rich's-Macy's severance is still expected to be paid.

The $17 million reserve that the Company expected to pay out related to liabilities associated with the disposition of Stern's properties. The $1 million of Stern's severance costs that remained accrued at May 4, 2002 was paid prior to August 3, 2002.

In addition to the stock options reflected in the foregoing table, stock options to purchase 28.9 million and 14.1 million shares of common stock at prices ranging from $27.31 to $79.44 per share were outstanding at May 3, 2003 and May 4, 2002, respectively, but were not included in the computation of diluted earnings per share because the exercise price thereof exceeded the average market price and their inclusion would have been antidilutive.

For purposes of the following discussion, all references to "first quarter of 2003" and "first quarter of 2002" are to the Company's 13-week fiscal periods ended May 3, 2003 and May 4, 2002, respectively.

In January 2003, the Company announced and commenced the implementation of its plans to integrate the stores of Rich's and Macy's in the metro Atlanta area and operate these and all other Rich's stores under a combined "Rich's-Macy's" nameplate, effective February 2, 2003. As part of the consolidation, seven stores were closed. The Company currently anticipates that two locations will be renovated and reopened as Bloomingdale's, one location will be renovated and reopened as a Rich's-Macy's furniture gallery and four locations will be sold or leased for other retail use. In the near term, the store closings and store closing costs are expected to have a negative impact on net sales and operating income, but in the longer term all of these actions are expected to positively affect operating income, cash flows from operations and return on investment.

On January 16, 2002, the Company's Board of Directors approved a plan to dispose of the operations of Fingerhut Companies, Inc. ("Fingerhut"), including the Arizona Mail Order, Figi's and Popular Club Plan businesses conducted by Fingerhut's subsidiaries, which were acquired by the Company on March 18, 1999. The decision to dispose of Fingerhut was based on management's determination that there was no longer strategic value to Federated in retaining the Fingerhut operations and there was no expectation, based on Fingerhut's historical earnings and future prospects, that this business would contribute meaningfully to the Company's future financial performance. The plan of disposition approved by the Company's board of directors contemplated a disposal by liquidation of the Fingerhut core catalog operations and a disposal by sale of Fingerhut's three catalog subsidiaries, Arizona Mail Order, Figi's and Popular Club Plan. As of February 1, 2003, substantially all Fingerhut assets had been disposed of and sub stantially all Fingerhut liabilities had been settled.

The Company's Consolidated Financial Statements for all periods account for Fingerhut as a discontinued operation as a result of the Company's decision to dispose of the Fingerhut operations. Unless otherwise indicated, the following discussion relates to the Company's continuing operations.

Net income for the first quarter of 2003 totaled $46 million compared to $89 million for the first quarter of 2002. The lower net income results from a combination of lower sales and higher cost of sales, partially offset by lower selling, general and administrative ("SG&A") expenses.

Net sales for the first quarter of 2003 totaled $3,291 million, compared to net sales of $3,453 million for the first quarter of 2002, a decrease of 4.7%. The overall sales trend in the first quarter of 2003 was negatively impacted by the difficult economic climate. On a comparable store basis (sales from stores in operation throughout the first quarter of 2002 and the first quarter of 2003), net sales for the first quarter of 2003 decreased 5.0% compared to the first quarter of 2002. By family of business, sales were strongest in jewelry, cosmetics, juniors, young men's, men's tailored clothing and furniture. The weakest businesses were women's and men's sportswear, intimate apparel, women's shoes and small ticket home areas, especially housewares and tabletop (china, silver, glass).

Cost of sales was 60.8% of net sales for the first quarter of 2003, compared to 60.2% for the first quarter of 2002. The cost of sales rate for the first quarter of 2003 reflects higher net markdowns due to the weak sales trend and to maintain inventories at appropriate levels. Merchandise inventories were down 3.8% at the end of the quarter as compared to the first quarter of 2002. 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 34.8% of net sales for the first quarter 2003 compared to 33.4% for the first quarter of 2002. SG&A expenses in actual dollars for the first quarter of 2003 were down slightly compared to the first quarter of 2002; however, due to the lower sales level, SG&A expenses increased 1.4 percentage points as a percent of net sales. Included in SG&A expenses for the first quarter of 2003 were approximately $8 million of costs, primarily accelerated depreciation, incurred in connection with the Rich's-Macy's consolidation and other announced store closings. The higher SG&A expense rate reflects higher depreciation and amortization expense, higher pension expense and higher selling costs, although selling costs in dollars were lower in the first quarter of 2003 than the prior year.

Net interest expense was $70 million for the first quarter of 2003, compared to $74 million for the first quarter of 2002.

The Company's effective income tax rate of 39.9% for the first quarter of 2003 and 39.7% for the first quarter of 2002 differ from the federal income tax statutory rate of 35.0% principally because of the effect of state and local income taxes.

The Company's principal sources of liquidity are cash from operations, cash on hand and available credit facilities.

Net cash provided by continuing operating activities in the first quarter of 2003 was $204 million, compared to the $169 million provided in the first quarter of 2002. Cash provided by continuing operating activities in the first quarter of 2003 reflects a smaller increase in merchandise inventories and an increase in current income taxes payable in 2003 versus a decrease in 2002, partially offset by a smaller decrease in accounts receivable.

Net cash used by continuing investing activities was $52 million for the first quarter of 2003, compared to the $92 million used in the first quarter of 2002. Investing activities for the first quarter of 2003 included purchases of property and equipment totaling $41 million and capitalized software of $13 million. Investing activities for the first quarter of 2002 included purchases of property and equipment totaling $81 million and capitalized software of $11 million. The Company opened one new home store during the first quarter of 2003 and plans to open seven additional department stores, five furniture galleries and a home store during the remainder of 2003. The Company's budgeted capital expenditures are approximately $650 million for 2003.

Net cash used by the Company for all continuing financing activities was $124 million for the first quarter of 2003, including $120 million for the acquisition of treasury stock.

On April 16, 2003, the Company's Board of Directors declared an initial quarterly dividend of 12.5 cents per share on Federated Common Stock. The dividend is payable July 1, 2003 to shareholders of record at the close of business on June 16, 2003. The Company currently intends to pay regular quarterly dividends going forward. On the same date, the Company's Board of Directors also approved a $500 million increase to the Company's existing stock repurchase program. During the first quarter of 2003, the Company purchased 4.3 million shares of its Common Stock under the stock repurchase program at an approximate cost of $120 million. As of May 3, 2003, the Company had approximately $590 million of authorization remaining under the Company's stock repurchase program. The Company may continue or, from time to time, suspend repurchases of shares under its stock repurchase program, depending on prevailing market conditions, alternate uses of capital and other factors.

Net cash provided to the Company by discontinued operations was $249 million for the first quarter of 2002, primarily due to customer payments on accounts receivable.

In June 2003, the Company took action to renew its 364-day revolving credit facility to June 25, 2004 and voluntarily reduce the borrowing capacity under this facility to $200 million. As a result, the Company's ability to borrow under the Company's bank credit agreements and commercial paper program will be reduced to a maximum of $1,400 million.

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 and capital transactions 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 its liquidity levels. 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 department store business and other retail businesses 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 through a combination of cash on hand and from operations and the possible issuance from time to time of long-term debt or other securities.

The Company is assuming that general economic and other conditions and consumer confidence and demand will be such that comparable store sales will be flat to down 1.5 percent for 2003: down 2 to 3 percent in the second quarter and between down 1 percent and up 1 percent in the second half of the fiscal year, which ends January 31, 2004. Comparable store sales for the month of May decreased a lower than expected 0.8%. If the Company's sales continue to exceed expectations, the sales performance in the second quarter would be better than the projected down 2 to 3 percent. The Company presently expects to achieve earnings per share from continuing operations in 2003 of $3.10 to $3.25: 50 to 55 cents a share in the second quarter and $2.40 to $2.50 a share in the second half of 2003. These estimates include additional store-closing costs of $10 to $15 million in the second quarter and $12 to $17 million in the second half of the year. In connection with these estimates, the Company is assuming that t he gross margin rate will be approximately flat for the year, although it is likely to be down compared to 2002 for the second quarter, and SG&A dollars, excluding the aforementioned store-closing costs, will increase slightly, with larger increases assumed in the second half of the year when the sales growth is assumed to be higher.

On May 22, 2003, the Company announced a strategy to more fully leverage its Macy's brand. Effective August 1, 2003, The Bon Marche stores will operate as The Bon - Macy's, Lazarus stores will operate as Lazarus - Macy's and Goldsmith's stores will operate as Goldsmith's - Macy's. Effective February 1, 2004, Burdines stores will operate as Burdines - Macy's and the seven Macy's stores currently operating in Florida will be integrated into the Burdines - Macy's organization. The Company believes that these changes will allow the Company to benefit from the expansion of the Macy's brand and should lead to more efficient operations.

The accuracy of the assumptions and the resulting forecasts described above is subject to uncertainties and circumstances beyond the Company's control. Consequently, actual results could differ materially from the forecasted results. See "Forward-Looking Statements" for a discussion of matters that could cause actual results to vary from the Company's expectations.

Item 4. Controls and Procedures

The Company's Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) as of a date within 90 days prior to the filing of this report. Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission's rules and forms. Subsequent to the date of this evaluation, there have not been any significant changes in the Company's internal controls or, to management's knowledge, in other factors that could significantly affect the Company's internal controls.