Macy's, Inc. (M) FY 2023 MD&A

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to promote understanding of the results of operations and financial condition of the Company. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of operations for 2022 compared to 2021 and 2020. The discussion that follows includes a comparison of our results of operations and liquidity and capital resources for the fiscal years ended January 28, 2023 to January 29, 2022 and January 30, 2021. For a full discussion of changes from the fiscal year ended January 29, 2022 to the fiscal year ended January 30, 2021, refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended January 29, 2022 (filed March 25, 2022). This section also 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 "Risk Factors" and "Forward-Looking Statements."

Fiscal 2022 Overview

The Company successfully navigated 2022 from a position of financial and operational strength. Despite an increasingly volatile macroeconomic climate, through the ongoing execution of the Company's Polaris strategy detailed further below, it remained agile, pivoted to meet customer demand and elevated its approach to inventory management. The Company built a solid foundation for long-term, profitable sales growth through investments in its supply chain, data and analytics, pricing science, digital and technology which have enabled its operations and colleagues to become more efficient and flexible. In evaluating 2022 performance, the Company considered its results against 2021. Certain financial highlights are as follows:

•Comparable sales increased 0.3% on an owned basis and 0.6% on an owned-plus-licensed basis.

•Net credit card revenue increased $31 million to $863 million.

•The gross margin rate was 37.4%, a decrease from 38.9%.

•Selling, general & administrative (SG&A) expenses increased $270 million to $8,317 million, or 34.0% of net sales, an increase of 110 basis points.

•Net income was $1,177 million, a decrease from net income of $1,430 million. Net income adjusted for impairment, restructuring and other costs, settlement charges, and losses on early retirement of debt declined from adjusted net income of $1,668 million to adjusted net income of $1,259 million.

•Earnings before interest, taxes, depreciation and amortization excluding restructuring, impairment, store closings and other costs and settlement charges (Adjusted EBITDA) were $2,648 million, a decline from $3,320 million.

•Diluted earnings per share were $4.19, compared to diluted earnings per share of $4.55. On an adjusted basis, diluted earnings per share were $4.48, compared to adjusted diluted earnings per share of $5.31.

•Merchandise inventories were down 3% and inventory turnover decreased 4%.

See pages 30 to 32 for reconciliations of the non-GAAP financial measures presented above to the most comparable U.S. generally accepted accounting principles (GAAP) financial measures and other important information.

Company Strategy

During 2022, the Company continued to execute its Polaris strategy and these actions impacted its operating results for the year, notably:

•Win With Fashion and Style: By offering a wide assortment of categories, products and brands from off-price to luxury, the Company continued to reach a broad and diverse range of customers during 2022. The Company is committed to providing quality fashion newness through reimagining its private brand portfolio, which is in its early stages and is expected to begin to take shape in fiscal 2023, building best-in-class experiences though partnerships with brands such as, but not limited to, Pandora and Sunglass Hut and growing relevancy for the next generation of customers through its omni-channel brand platform Own Your Style. Modernizing the supply chain allowed the Company to maintain freshness in every category and brand during 2022, including those that were down-trending.

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•Deliver Clear Value: The Company has leveraged data analytics and pricing tools to efficiently plan, place and price inventory, including location level pricing, competitive pricing and point-of -sale pricing work. With these actions, the Company is strategically taking markdowns and reducing broad-based promotions to improve the productivity of sell-throughs. These collective activities have contributed to nine consecutive quarters of higher average unit retail.

•Excel in Digital Shopping: While the Company experienced deceleration in the growth of its digital channel during 2022 as consumers shifted back to in-store shopping, the Company continued to make digital investments to serve customers' lifestyle needs through several initiatives. These included continued enhancements in personalized offers and communication with customers; enhancements to its mobile app to allow customers to shop their personal style, price check in-store, manage their Star Rewards and track orders; and, further develop its live shopping in-app experience. Macy's digital Marketplace launched in late September 2022, which features a collection of new brands, products and categories from third-party sellers, representing a pathway to introduce customers to new merchandise options while limiting inventory risk. Bloomingdale's is expected to launch a similar digital marketplace in the second half of 2023. Also, Macy's Media Network (MMN), an in-house media platform that enables business-to-business monetization of advertising partnerships, generated approximately $144 million of net income in 2022, an increase of 34% from 2021.

•Enhance Store Experience: The Company continues to invest in physical stores to support its omni-channel ecosystem and build new capabilities to help make the shopping experience convenient and compelling. The Company made strides in repositioning its store fleet through strategic expansion of off-mall, smaller format stores which now includes eight Market by Macy's and two Bloomies locations. The Company is currently evaluating the right number and mix of on and off-mall locations. Since February 2020, the Company has closed its most significant underperforming stores, exited failing centers and improved the existing store experience, while delaying closures of others that are cash flow positive. Finally, the Company introduced permanent Toys “R” Us shops within all Macy’s locations which resulted in toy sales for the year more than doubling from 2021.

•Modernize Supply Chain: The Company has continued to update its supply chain infrastructure and network, while leveraging improved data and analytics capabilities in fulfillment strategies to meet customers' desire for speed and convenience and improving inventory placement and productivity. Through its actions, the Company is building a faster, more efficient and flexible network through market-based mini-fulfillment centers in select stores and testing robotics and automation in select fulfillment centers. Finally, the Company plans to open a new distribution center in Texas in mid-2023 and a new fulfillment center in North Carolina in 2025.

•Enable Transformation: The Company is focused on investing in the right talent, technology infrastructure and data analytics to increase agility in reacting to customers and the market regardless of the channel in which customers interact. As part of the Company's ongoing commitment to attract and retain talent, it made significant investments in its colleagues’ benefit programs in 2022, including launching the Guild Education partnership that provides free education benefits, raising the company-wide minimum rate to $15 per hour and increasing compensation and benefits for colleagues across Macy’s Inc.

In addition to the pillars of the Polaris strategy above, the Company is committed to providing value to people, communities and the planet through the evolution of its Mission Every One social purpose platform. In early November, the Company launched S.P.U.R. Pathways: Shared Purpose, Unlimited Reach, with its partner Momentus Capital. S.P.U.R. Pathways is a multi-year, multi-faceted program that ultimately is expected to provide up to $200 million of funding. The Company is committed to contribute approximately $30 million over five years to empower new brands across the Company’s network of stores and broaden the Company’s range of suppliers. The funding is designed to advance entrepreneurial growth, close wealth gaps and address systemic barriers faced by diverse-owned and underrepresented businesses serving the retail industry.

Looking forward, in addition to the existing strategies and initiatives discussed above, the Company will focus on the following five primary growth vectors that represent strategic investments designed to target future long-term profitable sales growth:

•Macy's private brands reimagination - designed to drive customer loyalty, be a differentiator for the business, complement national brands matrix and benefit gross margin.

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•Market by Macy's and Bloomies off-mall store expansion - integral role in supporting the omnichannel ecosystem, which we expect to unlock the full potential by testing and learning in 2023 and potentially incrementally accelerating openings in 2024 if stores continue to outperform.

•Digital marketplace - on a multi-year journey with marketplace, keeping a pulse on market dynamics and shifts to deliver the best experience for customers and sellers.

•Luxury brands - attracting and retaining luxury customer through differentiated products, services and experiences at Bloomingdale's, Bluemercury and beauty at Macy's.

•Personalized offers and communication - opportunity to build loyalty, grow customer lifetime value and product margins, creating tailored and intimate customer experience.

The Company will monitor its operating results against pillars of the Polaris strategy and the growth vectors as it progresses through 2023.

Analysis of Results of Operations

See pages 32 to 34 for reconciliations of these non-GAAP financial measures to their most comparable GAAP financial measure and for other important information.

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Comparison of 2022 and 2021

Net sales for 2022 were relatively flat to the same period in the prior year as the Company navigated a volatile macroeconomic environment and inflation; however, comparable store sales increased from 2021 on both an owned and owned plus licensed basis. During 2022, consumer shopping behavior shifted toward gifting and occasion-based categories, with strength in beauty, men's tailored apparel, dresses, shoes and luggage. Pandemic-driven categories such as active, casual and soft home, underperformed the prior year. Digital sales as a percent of net sales decreased compared to the prior year largely due to a shift back to in-store shopping.

The increase in net credit card revenues was driven by better than expected bad debt levels, higher credit balances within the portfolio and higher spending on the co-brand credit card.

The decrease in the gross margin rate was primarily due to lower merchandise margin (approximately 170 bps), which was driven by higher markdowns and promotions, particularly in pandemic related categories as a result of the shift in consumer demand as well as heightened competitive retail landscape due to elevated industry-wide inventory levels. This was partially offset by a reduction in delivery expense (approximately 20 basis points), which coincides with the reduction in the digital sales penetration rate. Inventory turnover decreased 4% over 2021 and inventory was down 3% compared to 2021, mainly due to disciplined inventory management, strategic use of data analytics, the alignment of the merchandising team and the successful integrations and modernization of the supply chain.

SG&A expenses increased in 2022 both in dollars and as a percent to net sales. The increase in SG&A expense and as a percent to net sales corresponds with the Company filling a significant number of positions that were open in the prior year as well as adjustments to colleague compensation and benefits to remain competitive and attract the best talent, including increasing the Company's minimum wage to $15/hour starting May 1, 2022.

2022 asset sale gains mainly consist of gains from the sale of 6 properties, versus approximately 18 properties sold at a gain in 2021.

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Impairment, restructuring and other costs in 2022 and 2021 primarily related to the write-off of capitalized software assets.

The Company records non-cash net benefit plan income relating to the Company's defined benefit plans. This income includes the net amount of interest cost, expected return on plan assets and amortization of prior service costs or credits and actuarial gains and losses. The decrease in benefit plan income from 2021 to 2022 was mainly driven by a decrease in the plan asset returns and higher discount rates as a result of market conditions.

The settlement charges in 2022 were primarily related to the pro-rata recognition of net actuarial losses associated with the Company's defined benefit retirement plans as the result of lump sum distributions associated with retiree distribution elections. The charges in 2021 were higher than 2022 as they primarily related to the transfer of fully funded pension obligations for certain retirees and beneficiaries through the purchase of a group annuity contract with an insurance company.

The decrease in net interest expense, excluding losses on early retirement of debt, was primarily driven by interest savings associated with the redemption of the Company's $1.3 billion aggregate principal amount of its senior secured notes due 2025 in August 2021, as well as the financing activities completed in the first quarter of 2022.

In 2022, losses on early retirement of debt were recognized due to the early payment of $1.1 billion aggregate principal amount of senior notes and debentures in the first quarter of 2022. In 2021, losses on early retirement of debt were recognized primarily due to redemption of the entire outstanding $1.3 billion amount of the Company's senior secured notes due 2025 in the third quarter of 2021, as well as the repurchase of $500 million aggregate principal amount of notes in a tender offer in the first quarter of 2021.

In 2022, income tax expense of $341 million, or 22.5% of pretax income reflects a different effective tax rate as compared to the company’s federal income tax statutory rate of 21% driven primarily by the impact of state and local taxes, offset by the benefit of state tax settlements. In 2021, income tax expense of $436 million, or 23.4% of pretax income, reflects a different effective tax rate as compared to the company's federal income tax statutory rate of 21% primarily by the impact of state and local taxes.

Guidance

On March 2, 2023, the Company disclosed in its release of preliminary earnings its performance expectations for 2023, presented on a 53-week basis unless otherwise noted. The 2023 outlook was as follows:

•Net sales between $23.7 billion to $24.2 billion,

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•Comparable owned-plus-licensed sales, on a 52-week basis, are expected to be down approximately 2% to 4% from 2022,

•Digital sales approximately 32% to 34% of net sales,

•Credit card revenue, net approximately 3.1% of net sales,

•Gross margin rate between approximately 38.7% and 39.2%,

•SG&A expenses as a percentage of net sales approximately 36.3%,

•Gains on sale of real estate between $60 million and $75 million,

•Benefit plan income of approximately $12 million,

•Depreciation and amortization expense of approximately $910 million,

•Adjusted EBITDA between approximately 10.3% and 10.8% of net sales,

•Net interest expense of approximately $165 million,

•An adjusted tax rate of approximately 24.5%,

•Diluted shares outstanding of approximately 282 million,

•Adjusted diluted EPS between $3.67 and $4.11, and

•Capital expenditures of approximately $1 billion.

The Company does not provide reconciliations of the forward-looking non-GAAP measures of comparable owned plus licensed sales change, adjusted EBITDA, adjusted tax rate and adjusted diluted earnings per share to the most directly comparable forward-looking GAAP measures because the timing and amount of excluded items are unreasonably difficult to fully and accurately estimate. See Important Information Regarding Non-GAAP Financial Measures.

Liquidity and Capital Resources

The Company's principal sources of liquidity are cash from operations, cash on hand and the asset-based credit facility described below. Material contractual obligations arising in the normal course of business primarily consist of long-term debt and related interest payments, lease obligations, merchandise purchase obligations, retirement plan benefits, and self-insurance reserves. See Notes 4, 6 and 9 to the consolidated financial statements included in Item 8 of this Report for amounts outstanding on January 28, 2023, related to leases, debt, and retirement plans, respectively. Merchandise purchase obligations represent future merchandise payables for inventory purchased from various suppliers through contractual arrangements and are expected to be funded through cash from operations.

We believe that our available cash, together with expected future cash generated from operations, the amount available under our credit facility, and credit available in the market will be sufficient to satisfy our anticipated needs for working capital, capital expenditures, and cash dividends for at least the next 12 months and the foreseeable future thereafter.

Capital Allocation

The Company's capital allocation goals include maintaining a healthy balance sheet and investment-grade credit metrics to be best-positioned for access to bank and capital market funding under all economic scenarios, followed by investing in the business through initiatives to drive long-term profitable growth and returning capital to shareholders through modest yet predictable dividends and share repurchases, absent more attractive investment alternatives.

The Company ended the year with a cash and cash equivalents balance of $862 million, a decrease from $1,712 million in 2021. Also, the Company is party to the Asset Based Lending (ABL) Credit Facility with certain financial institutions providing for a $3,000 million Revolving ABL Facility. As of January 28, 2023, borrowing capacity of the ABL Credit Facility was $2,935 million, which considers a $65 million reduction due to standby letters of credit outstanding and borrowing availability was $2,531 million, which considers a further $404 million reduction due to inventory levels and its impact on the ABL borrowing base.

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Operating Activities

Net cash provided by operating activities was $1,615 million in 2022 compared to $2,712 million in 2021. The decrease from 2021 to 2022 was mainly driven by lower adjusted EBITDA and a $582 million income tax refund as a result of the CARES Act received in 2021.

The Company's future material contractual obligations and commitments as it relates to operating activities as of January 28, 2023 are approximately $6.8 billion of operating lease obligations primarily due after 2027 and $2.6 billion of other obligations, primarily consisting of merchandise purchase obligations due in less than one year. Note 4 and Note 14 to the Financial Statements provide additional information on operating leases and other obligations, respectively.

Investing Activities

The Company's 2022 capital expenditures were $1,295 million, mainly driven by enhanced omni-channel capabilities, digital and technology, data and analytics, and supply chain modernization. The Company also opened ten new stores in 2022 across nameplates and formats, and continued to invest in its current stores.

The Company expects capital expenditures to be approximately $1.0 billion during 2023. The Company's spend will be primarily focused on initiatives that will accelerate our profitable growth, including digital and technology investments, data and analytics, supply chain modernization and omni-channel capabilities, including our growth vectors. These expenditures are expected to be financed with cash from operations and existing cash and cash equivalents. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of capital expenditure needs or based on the current economic environment.

Financing Activities

Dividends

The Company paid dividends totaling $173 million in 2022 and $90 million in 2021. The Board of Directors declared regular quarterly dividends of 15.75 cents per share on the Company’s common stock, paid on April 1, 2022, July 1, 2022, October 3, 2022 and January 3, 2023, to Macy’s, Inc. shareholders of record at the close of business on March 15, 2022, June 15, 2022, September 15, 2022 and December 15, 2022, respectively.

On February 24, 2023, the Company's Board of Directors declared a regular quarterly dividend of 16.54 cents per share on its common stock, payable April 3, 2023, to shareholders of record at the close of business on March 15, 2023. Subsequent dividends will be subject to approval of the Board of Directors, which will depend on market and other conditions.

Stock Repurchases

The Company completed its 2021 $500 million share repurchase program by January 29, 2022. During 2021, the Company repurchased 20.5 million shares of its common stock, which represents more than 6.5% of shares outstanding, at an average cost of $24.40 per share.

On February 22, 2022, the Company announced that its Board of Directors authorized a new $2.0 billion share repurchase program, which does not have an expiration date. During 2022, the Company repurchased approximately 24.0 million shares of its common stock at an average cost of $24.98 per share for $600 million. As of January 28, 2023, $1.4 billion remains available under the authorization. Repurchases may be made from time to time in the open market or through privately negotiated transactions in accordance with applicable securities laws, including Rule 10b-18 under the Securities Exchange Act of 1934, on terms determined by the Company.

Debt Transactions

The Company completed the following debt transactions in 2022:

•On March 3, 2022, the Company entered into a third amendment to the ABL Credit Facility which provides for a new Revolving Credit Facility of $3.0 billion.

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•On March 8, 2022, the Company completed a tender offer in which $8 million of certain senior secured notes were tendered for early settlement and the collateral that secured the remaining $352 million of the Company’s senior secured notes was automatically released.

•On March 10, 2022, the Company issued $425 million of senior notes due 2030 and $425 million of senior notes due 2032 in a private offering. Proceeds from the issuance, together with cash on hand, were used to redeem $1.1 billion of certain of its outstanding senior notes and pay fees and expenses in connection with the offering.

•The Company borrowed and repaid $1,959 million under the ABL Credit Facility in 2022. The Company had no outstanding borrowings under the ABL Credit Facility as of January 28, 2023.

At January 28, 2023, no notes or debentures contained provisions requiring acceleration of payment upon a debt rating downgrade. However, the terms of approximately $2,409 million in aggregate principal amount of the Company's senior notes outstanding at that date require the Company to offer to purchase such notes at a price equal to 101% of their principal amount plus accrued and unpaid interest if there is both a change of control (as defined in the applicable indenture) of the Company and the notes are rated by specified rating agencies at a level below investment grade.

The Company's future contractual obligations and commitments as it relates to financing activities as of January 28, 2023 are $3.0 billion of long-term debt obligations and $1.8 billion of related interest, $65 million of standby letters of credit and $24 million of finance lease obligations. Note 6 and Note 4 to the Financial Statements provide additional information on debt and finance leases, respectively.

As of January 28, 2023, the Company's credit rating and outlook were as described in the table below, reflecting the substantially improved credit profile of the Company.

Guarantor Summarized Financial Information

The Company has senior unsecured notes and senior unsecured debentures (collectively the Unsecured Notes) outstanding with an aggregate principal amount of $3,007 million outstanding as of January 28, 2023, with maturities ranging from 2025 to 2043. The Unsecured Notes constitute debt obligations of Macy's Retail Holdings, LLC (MRH, or Subsidiary Issuer), a 100%-owned subsidiary of Macy's, Inc. (Parent together with the Subsidiary Issuer are the Obligor Group), and are fully and unconditionally guaranteed on a senior unsecured basis by Parent. The Unsecured Notes rank equally in right of payment with all of the Company’s existing and future senior unsecured obligations, senior to any of the Company’s future subordinated indebtedness, and are structurally subordinated to all existing and future obligations of each of the Company’s subsidiaries that do not guarantee the Unsecured Notes. Holders of the Company’s secured indebtedness, including any borrowings under the ABL Credit Facility, will have a priority claim on the assets that secure such secured indebtedness; therefore, the Unsecured Notes and the related guarantee are effectively subordinated to all of the Subsidiary Issuer’s and Parent and their subsidiaries’ existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness.

The following tables include combined financial information of the Obligor Group. Investments in subsidiaries of $9,146 million as of January 28, 2023 have been excluded from the Summarized Balance Sheets. Equity in the earnings of non-Guarantor subsidiaries of $2,169 million have been excluded from the Summarized Statement of Operations. The combined financial information of the Obligor Group is presented on a combined basis with intercompany balances and transactions within the Obligor Group eliminated.

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Summarized Balance Sheet

a)Includes net amounts due to non-Guarantor subsidiaries of $6,784 million

Summarized Statement of Operations

a)Income pertains to transactions with ABL Borrower, a non-Guarantor subsidiary

b)Includes $1,008 million of dividend income from non-Guarantor subsidiaries

Important Information Regarding Non-GAAP Financial Measures

The Company reports its financial results in accordance with GAAP. However, management believes that certain non-GAAP financial measures provide users of the Company's financial information with additional useful information in evaluating operating performance. Management believes that providing supplemental changes in comparable sales on an owned plus licensed basis, which includes the impact of growth in comparable sales of departments licensed to third parties, assists in evaluating the Company's ability to generate sales growth, whether through owned businesses or departments licensed to third parties, on a comparable basis, and in evaluating the impact of changes in the manner in which certain departments are operated. Earnings (loss) before interest, taxes, depreciation and amortization (EBITDA) is a non-GAAP financial measure that the company believes provides meaningful information about its operational efficiency by excluding the impact of changes in tax law and structure, debt levels and capital investment. In addition, management believes that excluding certain items that are not associated with the Company's core operations and that may vary substantially in frequency and magnitude period-to-period from net income (loss), diluted earnings (loss) per share attributable to Macy's, Inc. shareholders and EBITDA provide useful supplemental measures that assist in evaluating the Company's ability to generate earnings and leverage sales, respectively, and to more readily compare these metrics between past and future periods. Management also believes that EBITDA and Adjusted EBITDA are frequently used by investors and securities analysts in their evaluations of companies, and that such supplemental measures facilitate comparisons between companies that have different capital and financing structures and/or tax rates. The Company uses certain non-GAAP financial measures as performance measures for components of executive compensation.

The Company does not provide reconciliations of the forward-looking non-GAAP measures of comparable owned plus licensed sales change, adjusted EBITDA, adjusted tax rate and adjusted diluted earnings per share to the most directly comparable forward-looking GAAP measures because the timing and amount of excluded items are unreasonably difficult to fully and accurately estimate. For the same reasons, the Company is unable to address the probable significance of the unavailable information, which could be material to future results.

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Non-GAAP financial measures should be viewed as supplementing, and not as an alternative or substitute for, the Company's financial results prepared in accordance with GAAP. Certain of the items that may be excluded or included in non-GAAP financial measures may be significant items that could impact the Company's financial position, results of operations or cash flows and should therefore be considered in assessing the Company's actual and future financial condition and performance. Additionally, the amounts received by the Company on account of sales of departments licensed to third parties are limited to commissions received on such sales. The methods used by the Company to calculate its non-GAAP financial measures may differ significantly from methods used by other companies to compute similar measures. As a result, any non-GAAP financial measures presented herein may not be comparable to similar measures provided by other companies.

Changes in Comparable Sales

The following is a tabular reconciliation of the non-GAAP financial measure of changes in comparable sales on an owned plus licensed basis, to GAAP comparable sales (i.e., on an owned basis), which the Company believes to be the most directly comparable GAAP financial measure.

(1)Represents the period-to-period percentage change in net sales from stores in operation throughout the year presented and the immediately preceding year and all online sales, excluding commissions from departments licensed to third parties. Stores impacted by a natural disaster or undergoing significant expansion or shrinkage remain in the comparable sales calculation unless the store, or a material portion of the store, is closed for a significant period of time. No stores have been excluded as a result of the COVID-19 pandemic. Definitions and calculations of comparable sales differ among companies in the retail industry.

(2)Represents the impact of including the sales of departments licensed to third parties occurring in stores in operation throughout the year presented and the immediately preceding year and all online sales in the calculation of comparable sales. The Company licenses third parties to operate certain departments in its stores and online and receives commissions from these third parties based on a percentage of their net sales. In its financial statements prepared in conformity with GAAP, the Company includes these commissions (rather than sales of the departments licensed to third parties) in its net sales. The Company does not, however, include any amounts in respect of licensed department sales (or any commissions earned on such sales) in its comparable sales in accordance with GAAP (i.e., on an owned basis). The amounts of commissions earned on sales of departments licensed to third parties are not material to its net sales for the periods presented.

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Adjusted Net Income (Loss) and Adjusted Diluted Earnings (Loss) Per Share

The following is a tabular reconciliation of the non-GAAP financial measures adjusted net income (loss) to GAAP net income (loss) and adjusted diluted earnings (loss) per share to GAAP diluted earnings (loss) per share, which the Company believes to be the most directly comparable GAAP measures.

EBITDA and Adjusted EBITDA

The following is a tabular reconciliation of the non-GAAP financial measure EBITDA and Adjusted EBITDA to GAAP net income, which the Company believes to be the most comparable GAAP measure.

Critical Accounting Estimates

The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report.

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Merchandise Inventories

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 its cost value is derived from the current retail selling value. The retail inventory method inherently requires management judgments and 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 margin reduction is recognized in the period the markdown is recorded.

Long-Lived Asset Impairment and Restructuring Charges

The carrying values of long-lived assets, inclusive of right of use (ROU) assets, are periodically reviewed by the Company whenever events or changes in circumstances indicate that the carrying value may not be recoverable, such as historical operating losses or plans to close stores before the end of their previously estimated useful lives. Additionally, on an annual basis, the recoverability of the carrying values of individual stores is evaluated. 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.

If the Company commits to a plan to dispose of a long-lived asset before the end of its previously estimated useful life or changes its use of corporate assets, estimated cash flows are revised accordingly, and the Company may be required to record an asset impairment charge. Additionally, related 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.

Goodwill and Intangible Assets

The Company reviews the carrying value of its goodwill and other intangible assets with indefinite lives at least annually, as of the end of fiscal May, or more frequently if an event occurs or circumstances change, for possible impairment in accordance with ASC Topic 350, Intangibles - Goodwill and Other. For impairment testing, goodwill has been assigned to reporting units which consist of the Company's retail operating divisions. Macy's and bluemercury are the only reporting units with goodwill as of January 28, 2023, and 98% of the Company's goodwill is allocated to the Macy's reporting unit.

The Company may elect to evaluate qualitative factors to determine if it is more likely than not that the fair value of a reporting unit or fair value of indefinite lived intangible assets is less than its carrying value. If the qualitative evaluation indicates that it is more likely than not that the fair value of a reporting unit or indefinite lived intangible asset is less than its carrying amount, a quantitative impairment test is required. Alternatively, the Company may bypass the qualitative assessment for a reporting unit or indefinite lived intangible asset and directly perform the quantitative assessment. This determination can be made on an individual reporting unit or asset basis, and performance of the qualitative assessment may resume in a subsequent period.

The quantitative impairment test involves estimating the fair value of each reporting unit and indefinite lived intangible asset and comparing these estimated fair values with the respective reporting unit or indefinite lived intangible asset carrying value. If the carrying value of a reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to such excess, limited to the total amount of goodwill allocated to the reporting unit. If the carrying value of an individual indefinite lived intangible asset exceeds its fair value, such individual indefinite lived intangible asset is written down by an amount equal to such excess.

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Estimating the fair values of reporting units and indefinite lived intangible assets involves the use of significant assumptions, estimates and judgments with respect to a variety of factors, including projected sales, gross margin and SG&A expense rates, capital expenditures, cash flows and the selection and use of an appropriate discount rate and market values and multiples of earnings and revenues of similar public companies. Projected sales, gross margin and SG&A expense rate assumptions and capital expenditures are based on the Company's annual business plan or other forecasted results. Discount rates reflect market-based estimates of the risks associated with the projected cash flows of the reporting unit or indefinite lived intangible asset.

The use of different assumptions, estimates or judgments in the goodwill impairment testing process, including with respect to the estimated future cash flows of the Company's reporting units, the discount rate used to discount such estimated cash flows to their net present value, and the reasonableness of the resultant implied control premium relative to the Company's market capitalization, could materially increase or decrease the fair value of the reporting unit and/or its net assets and, accordingly, could materially increase or decrease any related impairment charge.

For the Company's annual impairment assessment as of the end of fiscal May 2022 and 2021, the Company elected to perform a qualitative impairment test on its goodwill and intangible assets with indefinite lives and concluded that it is more likely than not that the fair values exceeded the carrying values and goodwill and intangible assets with indefinite lives were not impaired.

The Company continues to monitor the key inputs to the fair values of its reporting units. A decline in market capitalization or future declines in macroeconomic factors or business conditions may result in additional impairment charges in future periods.

Income Taxes

Income taxes are estimated based on the tax statutes, regulations and case law of the various jurisdictions in which the Company operates. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and net operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred income tax assets are evaluated for recoverability based on all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. Deferred income tax assets are reduced by a valuation allowance when it is more likely than not that some portion of the deferred income tax assets will not be realized.

Uncertain tax positions are recognized if the weight of available evidence indicates that it is more likely than not that the tax position will be sustained on examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Uncertain tax positions meeting the more-likely-than-not recognition threshold are then measured to determine the amount of benefit eligible for recognition in the financial statements. Each uncertain tax position is measured at the largest amount of benefit that is more likely than not to be realized upon ultimate settlement.

Uncertain tax positions are evaluated and adjusted as appropriate, while taking into account the progress of audits of various taxing jurisdictions. Resolution of these matters could have a material impact on the Company's consolidated financial position, results of operations or cash flows.

Significant judgment is required in evaluating the Company's uncertain tax positions, provision for income taxes, and any valuation allowance recorded against deferred tax assets. Although the Company believes that its judgments are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in the Company's historical income provisions and accruals.

Pension and Supplementary Retirement Plans

The Company has a funded defined benefit pension plan (the Pension Plan) and an unfunded defined benefit supplementary retirement plan (the SERP). The Company accounts for these plans in accordance with ASC Topic 715, Compensation - Retirement Benefits. Under ASC Topic 715, an employer recognizes the funded status of a defined benefit postretirement plan as an asset or liability on the balance sheet and recognizes changes in that funded status in the year in which the changes occur through comprehensive income (loss). Additionally, pension expense is generally recognized on an accrual basis over the average remaining lifetime of participants. The pension expense calculation is generally independent of funding decisions or requirements.

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The Pension Protection Act of 2006 provides the funding requirements for the Pension Plan which are different from the employer's accounting for the plan as outlined in ASC Topic 715. No funding contributions were required, and the Company made no funding contributions to the Pension Plan in 2022 and 2021. As of the date of this report, the Company does not anticipate making funding contributions to the Pension Plan in 2023.

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 Plan) and the discount rate used to determine the present value of projected benefit obligations.

The Company's assumed annual long-term rate of return for the Pension Plan's assets was 4.60% for 2022, 5.75% for 2021 and 6.25% for 2020 based on expected future returns on the portfolio of assets. As of January 28, 2023, the Company increased the assumed annual long-term rate of return for the Pension Plan's assets from 4.60% to 5.30% based on expected future returns on the portfolio of assets. The Company develops its expected 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 Plan decreases or increases, respectively. Lowering or raising the expected long-term rate of return assumption on the Pension Plan's assets by 0.25% would increase or decrease the estimated 2023 pension expense by approximately $6 million.

The Company discounted its future pension obligations using a weighted-average rate of 4.73% at January 28, 2023 and 3.06% at January 29, 2022 for the Pension Plan and 4.74% at January 28, 2023 and 3.10% at January 29, 2022 for the SERP. The discount rate used to determine the present value of the Company's Pension Plan and SERP obligations is based on a yield curve constructed from a portfolio of high quality corporate debt securities with various maturities. Each year's expected future benefit payments are discounted to their present value at the appropriate yield curve rate, thereby generating the overall discount rate for Pension Plan and SERP obligations. As the discount rate is reduced or increased, the pension liability would increase or decrease, respectively, and future pension expense would decrease or increase, respectively. Lowering the discount rates by 0.25% would increase the projected benefit obligations at January 28, 2023 by approximately $49 million and would decrease estimated 2023 pension expense by approximately $2 million. Increasing the discount rates by 0.25% would decrease the projected benefit obligations at January 28, 2023 by approximately $46 million and would increase estimated 2023 pension expense by approximately $2 million.

The Company estimates the service and interest cost components of net periodic benefit costs for the Pension Plan and SERP. This method uses a full yield curve approach in the estimation of these components of net periodic benefit costs. Under this approach, the Company applies discounting using individual spot rates from the yield curve composed of the rates of return from a portfolio of high quality corporate debt securities available at the measurement date. These spot rates align to each of the projected benefit obligation and service cost cash flows.