Macy's, Inc. Q2 FY2020 Earnings Call

Good morning, and welcome to Macy's, Inc. Second Quarter 2020 Earnings Conference Call. Today's 90 minutes long conference is being recorded. I would now like to turn the call over to Mike McGuire, Head of Investor Relations. Please go ahead, sir.

Thank you, Operator. Good morning, everyone, and thanks for joining us on this conference call to discuss our second quarter 2020 results. With me on the call today are Jeff Gennette, our Chairman and CEO; and Felicia Williams, our Interim CFO. Jeff and Felicia have several prepared remarks to share after which we'll host the question-and-answer session. Given the time constraints and the number of people who want to participate, we ask that you please limit your questions to one with a quick follow-up. In addition to this call and our press release, we have posted a slide presentation on the Investors section of our website macysinc.com. The presentation summarizes the information in our prepared remarks and includes some additional facts and figures. I do have two housekeeping items to share. First, with our third quarter results, we'll be resuming our normal earnings report cadence. We'll be releasing results and hosting the associated earnings call on Thursday, November 19th, before market open. Second, Jeff and Felicia will be participating in a fireside chat at the Goldman Sachs Global Retailing Conference on Wednesday, September 9th, at 7:30 AM Eastern Time. Both events will be webcast on our Investor Relations website, so please mark your calendars. Keep in mind that all forward-looking statements are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainty that could cause actual results to differ materially from the expectations and assumptions mentioned today. A detailed discussion of these factors and uncertainties is contained in the Company's filings with the Securities and Exchange Commission. In discussing the results of our operations, we will be providing certain non-GAAP financial measures. You can find additional information regarding these non-GAAP financial measures as well as others used in our earnings release and our presentation located on the Investors section of our website. As a reminder, today's call is being webcast on our website and a replay will be available approximately 2 hours after the conclusion of this call and it will be archived on our website for one year. Now, I'd like to turn this over to Jeff.

Thanks Mike, and good morning, everyone, and thank you for joining us. As you saw in our press release this morning, despite the challenging environment Macy's, Inc.'s second quarter came in better than we had anticipated. I want to thank the Macy's, Bloomingdale's, and Bluemercury teams for their efforts in these extraordinary times. On today's call, Felicia will take you through the second quarter results and provide some perspective on how we're looking at the back half of the year. Then, I will provide some context on holiday 2020 and give an update on the Polaris strategy, which we launched in February. We will then open up the line for your questions. With that, I'll hand it over to Felicia.

Thank you, Jeff, and good morning, everyone. As Jeff said, the second quarter closed stronger than we anticipated and this strength happened across all three brands; Macy's, Bloomingdale's, and Bluemercury. Overall, we delivered sales of approximately $3.6 billion, a decline of 35.1% on an owned plus licensed comparable basis. We experienced some ups and downs during the quarter. For instance, some aspects of our business recovered more quickly than we originally modeled such as our stores which reopened stronger than anticipated and our digital business remained strong throughout the quarter. Luxury, particularly at Bloomingdale's, also outpaced our expectation. These factors contributed to the outperformance that we saw against our expectation. On the other hand, in our Star Rewards loyalty program, the foundation of our customer retention, migration, and acquisition strategy, year-over-year we saw our members' spend slightly lag our non-loyalty customers in the quarter, but we saw building momentum in August, starting in week one with our Star Money event. So far, we've enrolled 0.25 million people in the first three weeks of the fall season in our tender-neutral Bronze tier, which is approximately a 40% increase over prior year. Our stores saw sales decline of 61% in the quarter versus last year. As you know, we began reopening stores gradually during the first week of the quarter, but almost all stores reopened by the end of June. The trend in store results was closely correlated with the pace of reopening, as performance improved sequentially each month as the quarter progressed and we exited the quarter with July down 40%. We saw this progress despite July being negatively impacted by pockets of COVID flare-ups in various parts of the country; Florida, Georgia, and Texas among them. However, in many of those areas, where the resurgence slowed store recovery, the digital business helped to partially offset the pressure. Overall, our digital business accelerated its strong performance coming out of the end of the first quarter and grew by 53% in the second quarter. Digital penetration across the company increased to 54%, up approximately 10 percentage points versus the first quarter. However, with stores improving as the quarter progressed, digital penetration moderated at the end of the quarter with July coming in at 42% on digital growth of 25%. We expect this moderation to continue into the fall season as we discussed on our last call. In some urban markets, including New York City, San Francisco, and Chicago, we continue to see declines in traffic driven by the slow return of workers to the city center and the erosion in both international and domestic tourism. Thus, as expected, international tourism sales were down significantly in the quarter, and the decline impacted our Macy's Inc. comp by about 210 basis points. Within the Macy's brand, we saw strength in many of the categories that are in demand; home, particularly housewares and textiles, as well as fine jewelry, fragrances, activewear and sleepwear. We also continue to see softness in men's tailored and dresses, which is indicative of the work-from-home world in which we now live, as well as slowness in luggage due to greatly reduced travel. At Bloomingdale's, home and accessories were the strongest performers. Housewares drove the home trend, followed by textiles and tabletop. Handbags, fine jewelry, and women's shoes were also among the best performers. As with the Macy's brand, apparel continues to be challenging in both men's and women's. Interestingly, we believe we are benefiting from the current move away from spending on experiences toward spending on products, especially within luxury. From textiles to shoes, to handbags, to mattresses, to diamonds, luxury proved to be strong across almost every category of the Bloomingdale's business, significantly growing its penetration of the business year-over-year. Given our strength in this area, we are leaning harder into luxury in order to capitalize on the shift in spending. And at Bluemercury, bluemercury.com experienced a 105% sales growth in the second quarter and we saw our total web customers grow by more than 50% year-over-year with the strongest growth in May, moderating each month thereafter as retail locations began reopening. Turning to off-price, in the quarter, Backstage performed better than our main boxes, but still saw sales erosion of nearly 45% due to closures. We took appropriate markdowns during the quarter to clear through seasonal merchandise in Backstage into the third quarter in a clean inventory position. The sales recovery is expected to improve in the third quarter as we lean into stronger trends in home, casual, and basics. We generated credit revenue in the second quarter of $168 million, down $8 million versus last year. Our proprietary card penetration was down 590 basis points in the quarter at 40.8% this year compared to 46.7% last year. This year-over-year decline was largely due to a recent shift by consumers to debit card and cash, which appears to be tied to economic stimulus and unemployment checks being deposited directly into consumer bank accounts or loaded onto prepaid bank accounts. In addition, we derived about 85% of our new accounts from customers' face-to-face engagement with our store colleagues. As a result, with the majority of our stores opened for only a portion of the quarter as well as reduced in-store traffic once the stores reopened, new accounts were down significantly in the second quarter of 2020 versus the second quarter of 2019. Gross margin was 23.6%, down more than 15 percentage points from last year, but up significantly from first quarter's 17.1% as retail margins benefited from good sell-through of clearance merchandise as well as an improved mix. In fact, not only did we sell through our clearance merchandise much faster than we did in the first quarter, but we also sold through our regular priced merchandise at a faster pace. As a result, and importantly, we ended the quarter with inventory down 29% year-over-year, and we are entering the third quarter with clean inventory and an appropriate sales-to-stock ratio. As a percent of sales, SG&A expenses improved by 10 basis points in the quarter over last year to 39.2%. We recorded nearly $1.4 billion of SG&A expense, an improvement of approximately 36% from last year's second quarter, driven largely by strict expense management. Recall that we announced a reset of our cost base in February as part of our Polaris strategy and that was the primary driver of the improvement. The furlough of many of our colleagues in May and June and beginning of July, and the subsequent long-term and more permanent restructurings also contributed to the improvement. Overall, this quarter, we were very disciplined with our variable costs, which we fully control and we'll continue to limit and monitor. Given the current real estate environment, real estate transactions were minimal during the second quarter and we expect that the current environment will continue to weigh on what we originally targeted this year. We are still selling assets, but we are being more selective, given that the market has slowed and we are being very thoughtful about when to go to market on certain assets in order to maximize value. Year-to-date we've recognized $16 million in asset sale gains and the current expectation is that we will recognize about $50 million for the full year. We recognized $242 million of restructuring, impairment and other costs of which $154 million was for severance associated with the recent restructuring of our workforce. Additionally, we are extremely pleased to have completed approximately $4.5 billion of new financings during the quarter, much of which occurred before our first quarter call. To summarize, this included $1.3 billion of senior secured notes as well as a new $3.2 billion asset-backed credit facility. Recall that the proceeds of the notes were used to repay the outstanding borrowings under the previously existing unsecured credit facility. Additionally, we successfully executed Exchange Offers and Consent Solicitations for $465 million of our previously issued unsecured notes, allowing us to create greater financial flexibility for future needs. With all of these completed, we expect to have sufficient liquidity to fund our business for the foreseeable future while repaying upcoming debt maturities in fiscal 2020 and fiscal 2021. Notably, we finished the quarter in a strong liquidity position, with approximately $1.4 billion in cash and approximately $3 billion of untapped capacity in the new asset-backed credit facility. We incurred net interest expense of $69 million, an increase from $47 million in the prior-year period, driven by the additional debt during the quarter. We recorded a tax benefit of $298 million, representing an effective tax rate of 40.9%. This high rate reflects the impact of the carryback of net operating losses as permitted under the CARES Act. Summing it all up, we saw $251 million of adjusted net loss in the quarter versus income of $88 million last year. Adjusted EPS was a loss of $0.81 in the quarter compared to income of $0.28 last year, of which asset sale gains represent an EPS of about $0.01 last year. As you all recall, we withdrew our 2020 guidance in March. Given that there remain many unknowns and uncontrollable factors impacting consumer behavior and the retail landscape in these unprecedented times, we are not providing new guidance at this time. However, as we did on our last call, I would like to update you on our current thinking as it relates to the rest of the year. We continue to model various scenarios for the back half of the year, and ultimately, we continue to take a conservative approach to our forecasting. In July, we closed out the second quarter strong in the face of various challenges, many of which we previously outlined, and there are a number of factors that will likely impact our business in the back half of the year. As I've already noted, the possibility of pockets of COVID-19 resurgence and the erosion of international tourism remains headwinds, as does the slower recovery of our stores in urban areas. In addition, while receipts are beginning to flow more reliably, they are sluggish as a result of under planned demand from the global and national supply chains and as the supply chains open up, we are seeing bottlenecks in the ports as well as challenges with ground transportation. As you know, back-to-school season has been slow and we are anticipating possible impacts from recent challenges to the federal unemployment assistance. To combat these, we are adjusting our plans and placing more emphasis on key areas of the business such as service, value, marketing, product mix and supply chain. Encouragingly, in the markets where we saw the initial regional resurgence, while stores have seen a dip in sales, they have been regaining momentum in pockets. Many of the expectations we laid out on our last call remain the same and you can view those within the slide presentation posted on our website. To briefly summarize, we expect total Company comp to culminate in the third and fourth quarter down in the low-to-mid 20s range. We are forecasting slightly stronger digital growth and slightly weaker store recovery, given some of the disruption around the country. While the underlying parts have changed slightly, the sum of the parts remains the same. Gross margin expectations have not changed for the back half of the year. Thus quarterly margins might peak in the third quarter as slightly stronger digital growth expectations and recently announced holiday surcharges in the fourth quarter will lead to higher delivery expenses that weigh more heavily on fourth quarter margins. We continue to expect elevated levels of SG&A as a percent of our lower sales base despite improving year-over-year in the second quarter. For the fall season, this could be low-to-mid single digit percentage points higher than last year, as we said on our last earnings call. Remember that the second quarter benefited from a partial quarter of furloughs of our corporate colleagues. Now, nearly all of our colleagues have returned. However, our stores are still ramping up. This will result in a higher SG&A rate in the back half of the year, but we expect the rate to continue to improve as we leverage our fixed cost as sales improve. Credit revenues are expected to be depressed as we move through the year continuing into 2021 given potential consumer financial stress and the ongoing environmental factors I mentioned earlier. We are expecting to generate credit revenue as a percent of sales roughly in line with what we generated in the back half of last year. Finally, we continue to expect CapEx spend this year of about $450 million. We've scaled down and reprioritized our capital spend to support the digital business as well as our Polaris strategy. As we look beyond 2020 we're planning to have a moderated CapEx budget for the next year or two that reflects the fact that we are a smaller company and, again, concentrating on those initiatives that will help us to transform or to grow such as digital. We'll be prioritizing our capital spending on very strategic projects that have returns that clearly justify the spend. Overall, given the tumultuous environment, we are pleased with our spring performance. While we are planning the remainder of the year conservatively, we have the utmost confidence in our colleagues to successfully execute well on the things that we can control. We have the ability to pull levers and remain disciplined with our spending and investments and we have also demonstrated that we can skillfully navigate the changing environment with agility. With that, I'll turn it back over to Jeff.

Thank you, Felicia. So as Felicia noted, we continue to approach the back half of the year conservatively. Our immediate priority is to control what we can control, to deliver the third quarter and prepare for the critical holiday shopping season. There is uncertainty, but over the past several months, our teams have learned a great deal about working in this environment, and we will continue to adjust our actions quickly to both address challenges and take advantage of opportunity as we go through the back half of the year. The holidays are when Macy's shines and this year will be no exception. There are several things about holiday 2020 that won't change. First, America comes to Macy's and Bloomingdale's for gifting. We had a successful gifting strategy for holiday of 2019 and we're building on that for 2020 and believe the shift away from experiential gifting provides some upside for us. For holiday 2020 newness represents nearly 50% of the total gift assortment, led by items in beauty and home. We have great brands and are introducing new categories and in-demand content. And whether customers are shopping in our stores or on dot-com, we will have something for every person on their gifting list. Next, America comes to us for value. We have great content and the best brands at all price points throughout the holiday season. We further build out our 'gifts under' strategy, which we believe will resonate with customers in this environment. Customers will find great value at every price point for gifts under $15 all the way to luxury gifts. We are adjusting our promotional cadence to support an elongated holiday shopping season and we are expanding our fulfillment options so customers can better manage the trade-offs between cost and convenience. Third, America comes to us for celebration. We help bring special moments of the season to life, both big and small. We are reimagining our iconic events to deliver the magic of the holidays, from the Thanksgiving Day Parade to local tree lightings and holiday windows, to kick off holidays in our communities. We will help our customers celebrate at home with family and friends, whether it's writing letters to Santa to support our Believe campaign with Make-A-Wish or making a virtual visit to Santaland. 2020 has been a challenging year for the country and we need these moments of joy this year more than ever. But there are other aspects of the holiday 2020 season that will be different, as we meet customer expectations around convenience and safety. Let me cover some of those now. The dramatic channel shift that we've seen from stores to dot-com has required us to rework our fulfillment strategies. We've taken a number of steps to mitigate both customer friction and financial impact. We're optimizing inventory placement to meet customer demand wherever and however they shop; in our store, curbside, BOPIS and BOSS, vendor direct, dot-com or mobile, same-day delivery, and delayed delivery options. In digital, we are adjusting our assortment to meet trending demands including leveraging the flexibility of our vendor direct network. We are also improving product availability information and providing more shipping options and better clarity on delivery dates. In our stores, holiday 2020 operations will have an emphasis on traffic flow to ensure that our customers and colleagues have a safe experience. We will be taking actions in our stores to disperse typical bottlenecks and control occupancy levels. For instance, within At Your Service and our larger doors, we will have separate areas for returns versus pickups. We're also adjusting our promotional calendar to spread out traffic to our stores. Planning for holiday 2020 has been extensive and we intend to provide our customers with a great holiday experience. Strong execution of the third quarter and holiday 2020 are the top priorities of every Macy's Inc. colleague. So let's shift gears now to talk about the future. Our vision for Macy's Inc. remains unchanged. Our vision is to be the leading multi-branded fashion retailer from off-price to luxury, from online to offline, from on-mall to off-mall; we will offer convenient access to the fullness of our brands. Our customers want great fashion. We carry the best brands in America, and outside of their own sites and stores, we offer the strongest expression of these national brands. Our customers are omni-shoppers, and we will deliver a great experience, whether they are in our stores, our sites, or our app. Our customers come to us for the special moments of life, for celebration, special occasions, for gifts and to create shared memories. In our Polaris strategy, which we shared with you in February, remains the right strategy for us. But we've reexamined every point of the strategy for relevancy, viability and financial impact. We have fine-tuned our plans based on the needs of the customer today and where we think the opportunity is in the future. Our updated Polaris strategy focuses on areas where Macy's can differentiate and drive competitive advantage to first recover the business and then drive both top and bottom line growth. Retail today has been disrupted and while that disruption creates challenges, it also holds opportunity. With many competitors closing or struggling, we see the potential to bring new customers into our brands and gain market share. So let me take you through each of the five points of the Polaris strategy that we shared with you in February and cover the changes that we've made. We always start with the customer in mind and the first point of Polaris is strengthen customer relationships. We remain committed to strengthening our customer franchise and building profitable lifetime relationships with each of our customers. Loyalty continues to be important to us and we're pleased the investments in Macy's Star Rewards loyalty program that we launched in 2018 are paying off. As Felicia shared, during the enhanced federal unemployment payments, we did see a shift in spend away from proprietary cards. But on a positive note, we also saw a corresponding increase in sign-ups through our Bronze tender-neutral program. Our loyalty program is helping us build relationships with new customers, which is important because in the second quarter alone, we acquired nearly 4 million new customers to macys.com. We're creating value for them by expanding earn-every-day events and adding more Star Money days, and we are using our loyalty program to get our best customers back shopping with us. Longer term, we see continued potential to enhance loyalty programs across Macy's, Bloomingdale's and Bluemercury. We also continue to move forward on personalization, which strengthens customer relationships by presenting the customer with the most relevant products and messages. We have more than 40 million new customers in the Macy's brand alone and personalization will allow us to improve their experience and drive engagement and we will continue to pursue onsite and offsite monetization as a future growth driver. The second point of the Polaris strategy is to curate quality fashion. We continue to build on our fashion authority by curating national and private brands to support our customer's self-expression at all price points from off-price to luxury. While our ambition remains the same, the categories we focus on have changed. Dresses and men's tailored, two of our former destination businesses, have seen a nearly 70% sales decline in the spring season. While I believe these categories will come back over time, we don't expect that business to return to growth anytime soon. We've reexamined category roles in light of current customer demand and future potential and we've honed in on what we call the Focus Four. These are the four categories where customer demand is strong, we have a dominant or growing market position, and we feel we can drive profitable growth over a multiyear horizon. For Macy's these are fine jewelry, beauty, furniture and mattresses, and Backstage off-price. And for Bloomingdale's the Focus Four are luxury, advanced contemporary, textiles and Bloomingdale's The Outlet off-price. To support all of our product categories, we have access to some of the best brands in America. We are weathering this crisis together with our brand partners and are committed to a long-term vision of serving our shared customers. Maximizing our private brand offering remains an important part of the plan, as these products have some of our deepest customer connections and highest margins. While there has been a significant sales impact on some of our private brands, particularly in apparel, we have also seen strong performance in the private brand home and accessories category. As we stated in February, we intend to grow private brands to a 25% penetration. And given the importance of private brands to our profitability, we are accelerating the sourcing strategies that we shared with you in February. The third point of the strategy is accelerating digital growth. We will strategically invest across the enterprise to improve the digital experience, building customer lifetime value and driving profitable digital growth. In February, we shared that we will improve experience across both dot-com and our app, grow our omnichannel customer base, and improve profitability. These remain our priorities. But everything on the digital agenda has been accelerated. Customers have migrated online at unprecedented rates. By some estimates, retail has seen 10 years of digital growth in just three months. Few companies were adequately prepared to fully serve these migrating customers and those that rapidly invest in their digital retail infrastructure have significant opportunity. In an odd way, we've been able to move further and faster on our digital agenda because of this disruption. As we announced in February, we closed our San Francisco office where our digital business was formerly headquartered. We've been successful with recruitment and found strong digital talent in the New York metro area during the COVID epidemic. This influx of new talent has put fresh eyes and energy on the business and we expect that to continue. Digital as a higher penetration of our sales has some significant implications on our business model. We are improving profitability of the digital business by identifying opportunities for margin expansion, leveraging financial analytics for assortment prioritization and optimizing marketing spend allocation. Core to our efforts is improving the transparency in the data that helps drive business decisions and delivering more granular data to all of the business owners. This information allows us to identify areas of growth and opportunities to course correct. We can also prioritize assortments on our site and optimize channel mix to prioritize fulfillment where it is most profitable. This spring, when we saw a significant sales impact from COVID-19 and a rapid growth in digital, we took the opportunity to rewire our cost structure and resource allocation to support a more digitally focused business. You saw that in the SG&A numbers that Felicia shared. The fourth part of the strategy was around optimizing our store portfolio. Now, we look at it more broadly as optimizing the omni experience. We will innovate and optimize our stores, supply chain and call centers to ensure every customer can shop when, where and how they choose. The rapid customer migration to omni-shopping, coupled with the financial realities of our business, led us to adjust how we look at the stores aspect of the Polaris strategy. As always, our strategy is built on our customers' journey. And for today's customer, a strong omni experience is a baseline expectation. We've been tracking customer response as we reopened the stores, and it's encouraging to see consistently strong customer satisfaction scores. Driving some of this customer satisfaction are the enhanced health and safety measures that we've carefully taken. As it relates to our stores, we are pausing on investment in additional growth doors, although I will note that our prior investments over the past two years are paying off and the G150 continues to perform well. As a reminder, through the G150 strategy, we upgraded the stores that accounted for half of our 2019 brick and mortar sales. So, we expect to continue to benefit from those investments. We paused on our market-based ecosystem test, but we're now restarting those, albeit at a modified scale. We're continuing to focus on the Dallas, Atlanta and Washington DC markets. Over the next two years, we will open several smaller format off-mall Macy's and we will test a smaller format off-mall Bloomingdale's. In off-price, we will open several additional freestanding Backstage stores, continue the expansion of Bloomingdale's The Outlet and test Backstage online. As we shared in February, every off-mall store will have full service for pickup and returns. We continue to believe that the best malls in the country will thrive. However, we also know that Macy's and Bloomingdale's have high potential off-mall and in smaller formats. I do want to note that the number of stores that we plan to close hasn't changed since our previous announcement. However, we are monitoring the competition in both store and mall performance closely, and we will adjust our timelines if needed. In this more omni world, we need to use our entire network, stores, supply chain and our call centers, to maximize our capacity and serve our customers in a truly omni experience, from pre-purchase browsing to purchase, from pickup to delivery, and post-purchase to returns. With this, we need to flex our network and fulfillment strategy, given the acceleration of digital to focus on capacity expansion, cost efficiencies and providing customers with more choice and control over their delivery and returns experience. For instance, we're developing a centralized fulfillment network to demonstrate efficiencies and get products to stores and customers more quickly. The supply chain redesign that we shared with you in February is moving forward with an early emphasis on capacity planning and centralized fulfillment. At the start of the COVID-19 pandemic, call center volume and response time was a pain point for us, and we had significant disruption with our offshore partners. Within the US, in the span of two to three weeks, we developed and implemented a work from home option for our call center colleagues, and we are diversifying our geographic footprint to enable us to provide continuity of service to our customers in the event of regional or global resurgences. The last point of the Polaris strategy is reset the cost base. We will show discipline on cost management and create a culture of continuous assessment to derive the greatest ROI on every dollar spent. In February, we shared that we would reset our cost base, right-size the organization and expense base, balance top line and bottom line growth, and improve productivity and working capital, including faster inventory turns. The current environment has required us to make our organization even more efficient. Our Polaris cost savings target of $1.5 billion that we shared with you in February has now expanded to $2.1 billion, all by the end of 2022. We will continue our disciplined expense management to allow as much of the $2.1 billion as possible to flow to the bottom line, recognizing this will help mitigate higher costs from our aggressive lean into the digital business over the next two years and some will be invested in strategies to drive top line growth. Through our continued focus on disciplined expense management, we have created a Macy's that is better positioned to effectively compete today and in the future. To sum it all up, the updated Polaris strategy continues our work to strengthen customer relationships and build customer lifetime value; hones our merchandise strategy to focus on categories that matter most to customers today and have a long runway for growth; aggressively accelerates digital; optimizes all aspects of our network including stores, supply chain, call centers to deliver the best customer omni-channel experience; and delivers profitable growth on a rewired cost base. In closing, we are confident that we have the right strategy. We're focused on what's important now and in the future. We have resilient brands that will stand the test of time. We have an organization that knows how to execute through uncertainty by listening to our customers, following the data, reading the signs and pivoting quickly. I couldn't be more proud of our colleagues and thank each of them for their continued dedication to the business. The past six months have presented challenges that we never imagined and it forced us to make significant changes in how we run our business. But the changes we've made not only address today's climate but position us well for the future. We know that there are more challenges ahead, but I'm confident that Macy's Inc. will come out on the other side of this crisis stronger and ready to serve another generation of American consumers. Thank you, and now, we'll open up the line for questions.

(Operator instructions were provided.) We'll take our first question from Matthew Boss from JPMorgan. Please go ahead.

So, Jeff, can you speak to the interplay that you're expecting between the negative 40% brick and mortar store comps and the moderation in e-commerce that you saw exiting the second quarter as we think about the back half of the year? And just anything materially different that you've seen so far in August relative to the trends by channel that you saw in July?

Yes. So, what I'd say, Matt, is that we do expect that the trend line that we have in stores that we experienced in the month of July, that give or take, we can pull that forward. And that's a conservative approach, but that's where we have planned it, and August was in those expectations. And in digital, as we described on our last call, we do expect that to moderate. It's still going to be significant, but it's more in the line of what we experienced in the month of July. So, that kind of culminates between the way we're looking at the back half of the year, the down low-to-mid-20s for the full enterprise of Macy's, Inc. Now, we're seeing lots of things in between that. When you look at the month of August, some things were better, some things were worse, but as an overall characteristic, in line with what our expectations were. We've all talked about what happened in the back-to-school time frame, what happened with the cessation of the unemployment benefits, what happened with some of the resurgence. But there's also some good tailwinds that we've also seen. So, what we've seen is that now that we've got our inventory in parity with the demand that we're expecting in the back half of the year, we're seeing some really good regular-price sell-throughs in categories from off-price all the way to luxury. Our freight is moving very well right now. We've got good demand, and we're getting good response and receipts coming in to support that demand. So we feel very good about the gift assortments that are coming for the fourth quarter. So, we are taking a conservative approach to the back of the year. We have an upside scenario. We have a downside scenario. But we're staying really close to it. We're basically tracking where the customer is going and we've got the receipts there to support it.

And then just a follow-up, on the Polaris strategy and maybe thinking relative to the initial plan that you laid out at the Analyst Day a while back, what are the largest changes that you're making multi-year post the pandemic as we think about merchandising assortments and the margin opportunity over time?

Yes, I think the big thing there is really what is the mix of the business? And when you look at what digital is going to be of the overall business. So that has been a major consideration. We do expect that to be at least 40% of the business moving forward. We're clearly seeing that in 2020 with the door closures, but we think that, permanently, it is changing the complexion of the business. We feel very good about our digital team and how they're addressing that: where that demand is, how they're responding to that demand, how we're using that data, how we're building the supply chain to take full advantage of that to improve the profitability. So, we're expecting higher shipping costs, but we're expecting margin expansion based on all of what we're doing with personalization and new categories that we're getting into. We've obviously expanded vendor direct. We're looking at new categories based on what we've learned through COVID. So, we have a clear line of sight about how to grow that over time. That is the biggest change: what's going on with our digital business.

And now we take our next question from Oliver Chen from Cowen and Company. Please go ahead.

Regarding what's happening with the product assortment and consumer demand, what are your thoughts on how you've been able to reposition the assortment to what's attractive with at-home demand relative to some of the caution points around apparel? I would also love your thoughts on, as we approach Black Friday, just more generally how do you see this evolving and what's within your control that drive a safe yet compelling and value oriented experience? Thank you.

So, one of the benefits of being a department store is the range of brands and products and values that we can offer and we can pivot where the customer takes us. Certainly in COVID, we've seen big changes in the overall merchandise mix. Everybody is talking about what's happened with the need for more casual and active and that certainly is the case. But being at home, customers are making lots of changes with their home, be it new textiles or new home decor or new furniture or mattresses and that is a department store strength that gives us opportunities to grow those businesses disproportionately. So we've added a lot of categories online and categories in store. When you think about food and beverage, there are categories there as well. So the mix of the business has changed and we've added new brands and SKUs. Our strongest businesses have been in home, store, beauty and in certain accessory categories. One of the surprises has been the strength of luxury and that has been pronounced at Bloomingdale's, and we've also seen that in luxury categories at Macy's. So when you think about luxury mattresses above a certain price point, same thing in furniture, luxury fragrances, diamonds; all of those categories have been disproportionately strong. We expect and are reacting to that in terms of what we've got coming in for the balance of the year. As it relates to Black Friday, we do expect, as you're hearing from our competition, an elongated season. We recognize the concentration of customers that go into our stores during the Black Friday timeframe and we want to make sure that we are creating a safe environment for our customers and giving them options to purchase in advance. We also know the constraints with digital shipping and ensuring that our customers are able to get the values they want and the gifts they want in time for Christmas. We're going to be giving them lots of opportunities for that. The time between Thanksgiving and Christmas is still going to be incredibly important. But I do expect some demand to spread earlier, and we've got tactics and strategies to do that.

Our last question on the new customers to macys.com and new customer acquisition. What are you seeing in terms of maximizing and optimizing retention of the new customers and making sure that engagement can continue? Thanks.

That one has been good, Oliver, because we—as we mentioned—have 4 million new customers that came into macys.com in the second quarter. Of those, 3.8 million were brand new to the Macy's brand and the majority are more diverse and younger than our current base. We're focused on ensuring that the first purchase leads to a second purchase and developing them as omnichannel customers. We're using personalization to seed that, we're looking at look-alikes, we're starting to seed them offers, we're getting good response, and we're getting these customers into our Bronze loyalty program, which is strong. So our main mission with these new customers is to retain them and use the breadth of our price points and our brands across Macy's and Bloomingdale's to attract them. That's a top priority: to develop a relationship that can lead to a profitable lifetime relationship over time.

And now, we take our next question from Kimberly Greenberger of Morgan Stanley. Please go ahead.

Felicia, I'm just trying to parse through some of the commentary you made on the call this morning about the second half outlook and the way August has started. I think you indicated that the inventory levels are currently a little bit perhaps too lean, but back-to-school season is off to a bit of a slow start. So I'm wondering if you feel like your revenue trajectory here in the third quarter is being held back by these inventories. And then how should we think about inventory planning through the back half given the slow start here to back-to-school and then some of the other challenges that you identified?

Thanks, Kimberly, for the question. I indicated that our second quarter inventory is down 29% versus last year and we entered the fall with fresh inventories. We believe we have good sales-to-stock parities going into the fall season. Back-to-school started off slowly, but we think back-to-school will be much more elongated than in a typical year. Government orders and school districts changing the timing of back-to-school mean we must think about back-to-school differently. With respect to inventory planning in the back half of the year, we are working very closely with our vendor partners to ensure we have the receipts needed to support our sales plan and also receipts in the right categories, as Jeff mentioned. We feel good about our back half sales planning and we will continue to manage our inventory to drive better sell-throughs and working capital. We have restructured our planning team by combining planning into one team under the supply chain, which gives us the opportunity to make faster decisions about inventory planning and placement. We saw evidence of that in the second quarter, particularly with better sell-through on regular-priced merchandise. So we feel we're in good shape going into the back half of the year and have the team and agility to manage receipts and assortment planning.

I just wanted to follow up on your question on COVID markets. I think you said that they're actually showing strength or sequential improvements here in August. That seems encouraging, but I'm wondering if you could just expand on that? Thanks.

Sure. We've been watching COVID markets very closely and I gave examples of Texas, Georgia, Florida, which were areas of an initial resurgence. In those markets sales are coming back. They're coming back slowly, but they are coming back and that gives us some positivity going into the fall season. We've learned we have to be very reactive to sporadic store closures. For example, our Guam and Oahu stores in Hawaii were closed in reaction to local cases. In California, all indoor malls were closed at one point, but we remained open in locations with exterior doors and the ability to offer curbside pickup. All of the California malls should be open by the end of this week or early next week. We will react as needed. We've learned that we can react by remaining open, shifting to curbside, and increasing fulfillment through unaffected stores to minimize sales disruption.

Let me add one thing to what Felicia said. When you run retail as really local and when you think about our brick-and-mortar, we've become quite good at monitoring public health data, colleague and customer sentiment, and creating a watch list. At the end of July we had 38 locations in a higher risk category due to mounting resurgence. At the end of August there were only six stores in that category. As of this week we're down to zero. That shows our brick-and-mortar business is tracking where we had thought it would, and perhaps even a little better.

And now, we'll take our next question from Paul Lejuez from Citigroup. Please go ahead.

A question on SG&A. I think you mentioned SG&A was helped by both the February and July restructuring. Can you maybe walk through those two events, both talk about the gross and net savings from each that you'll generate on an annualized basis from those? And also, I think you mentioned the CARES Act. If you could also quantify what that helps in 2Q? Thanks.

Yes, Paul. So on SG&A, we did furlough the majority of our colleagues because of the pandemic, and we are seeing a benefit from that in May and June. With respect to the reduction in force, as you recall, we announced in July that we would be laying off about 3,900 of our corporate and management colleagues. At the time, we anticipated that we will receive an annualized benefit from that restructuring of about $630 million. You will see about a month of that benefit coming through in the second quarter. The reduction in force will be permanent and will impact the back half of the year and beyond. The furloughs were temporary and benefited the second quarter; that will reverse as we bring colleagues back, beginning in July, and as store, call center and logistics colleagues return as sales continue to improve. We expect to have our colleagues back in full force this month, and you will see a higher SG&A rate in the third and fourth quarter relative to the second quarter because of that furlough dynamic. With respect to the CARES Act, we had two benefits. One was payroll tax savings that benefited SG&A, and the other was a tax benefit due to the ability to carry back net operating losses as allowed under the CARES Act. That is where we saw the biggest benefit: a modest SG&A benefit and a material benefit on the tax line.

Thanks. Any quantification on that CARES Act benefit?

Nothing I can share at the moment, Paul.

Just one follow-up. Can you tell us what inventory was down in units in the second quarter? Thanks.

I don't have units on my fingertips. I can have Mike or Martha follow up with you after the call. I just have the 29% year-over-year decline at the moment.

Sure. Thank you. Good luck.

Let me add one thing: when you look at our average unit retail (AUR) at the end of the second quarter, AUR was depressed based on clearance that we had to move through. Based on the clean inventory position that we have, the AUR in August has been significantly better than last year, based on regular-price and luxury sell-throughs that we're getting in many categories. So we believe our inventory is in great position going into the back half of the year. Our sales-to-stock parity is in good shape and we have receipts flowing to react to customer demand, making shifts as demand changes.

And now, we'll take our next question from Lorraine Hutchinson from Bank of America. Please go ahead.

I wanted to ask about your gross margin. How much fulfillment cost pressure do you expect in the third and fourth quarter? And then, what is your outlook for merchandise margin now at the current inventory levels?

Thanks Lorraine. With respect to gross margin, we're thinking about it in three areas with respect to performance for the quarter and some applicability to the back half of the year. In the second quarter, we aggressively liquidated seasonal merchandise as our stores were closed. The second impact on gross margin in the quarter was the shift to digital and the corresponding delivery expense impact. The third area was mix, particularly Macy's brand mix going from higher-margin apparel to lower-margin home and active. As we think about gross margin in the back half of the year, we will continue to lean into digital. We have discussed the expected mix between digital and brick-and-mortar. Our gross margin expectations have not changed for the back half of the year, but we are expecting a peak in margin in the third quarter and some pressure in the fourth quarter due to higher delivery expense and recently announced holiday surcharges. Importantly, we are flowing fresh receipts. We entered the fall very clean and expect faster turns and better sell-throughs. We are focused on maintaining appropriate inventory levels and placing inventory in the right channels to satisfy customer demand and to be flexible across channels. With stores closed earlier, we want to ensure the right assortment and units in stores to handle buy-online-pickup-in-store, same-day delivery, and fulfillment center inventory to support ongoing digital demand.

You mentioned receipts being sluggish earlier. How confident are you that you can get what you need—the right mix of product—in time for holiday?

Our receipts have begun to flow more reliably. The disruptions we experienced are not unique to Macy's; there have been port challenges, container imbalances, and ground transportation constraints as everyone competes for capacity because of higher digital demand. We are controlling what we can—using vendor direct capabilities to fill white space. We are working closely with brand partners on assortment and receipts for the back half of the year. We are confident in our ability to work with brand partners and get the receipts needed.

When you think about the first and second quarters, the pandemic hit with store closures in mid-March and we canceled or curtailed receipts across private and market brands. We've made it past the receipt flow issues of the first and second quarter. We're seeing a more consistent stream of fresh goods coming in right now and expect that to improve through third quarter into fourth quarter. We feel pretty good about receipt flow, our liquidity position, and our stock-to-sales ratios.

Our next question comes from Chuck Grom from Gordon Haskett. Please go ahead.

On Slide 13, Jeff, you put the store base into five cohorts, which is an interesting slide. I was just wondering if you could give us your latest perspective on store closings down the road, particularly in those first and second quadrants where your sales per square foot looks like it's $150.

As we announced in February, closing neighborhood stores is a multi-year initiative and the number of total store closures hasn't changed. The timing may change. What we've learned through the pandemic and reopening is the value of having updated stores where customers feel comfortable. Neighborhood stores are performing well versus the overall average. Flagships are more pressured due to declines in international and domestic tourism and fewer office workers. We expect some malls, particularly lower-performing ones, to remain pressured. For now, the portfolio we have is working well and customers are using these stores for returns, pickups, and quick transactions.

When you look at comp compression over the past two months, how much is traffic aversion versus product mix? And how do you plan beyond the holiday into, say, spring 2021?

The category mix shifted: dresses and men's tailored categories have been hurt, while home, beauty, and certain accessories are stronger. We've increased categories online and vendor direct assortments, with half of SKU increases in home. New customers present an opportunity to convert them to omni shoppers. As for 2021 and 2022, we need to execute the third and fourth quarters first. We had a three-year plan that has been adjusted; we'll provide more detail as we progress through the back half of the year.

To add, on whether customers are comfortable shopping in our stores, our Net Promoter Scores show customers rate health and safety very positively in Macy's environments. We are investing in safety and operational changes. For holiday At Your Service, we'll have separate pickup and return areas to keep customers and colleagues safe. We're spending a lot of effort on a healthy environment and customers are telling us through NPS that we're doing well.

And now we take our next question from William Reuter from Bank of America. Please go ahead.

This is Mary Ann for Bill. Thanks for taking our question. I was curious on your centralized fulfillment capabilities. When do you expect those to be fully built out? And what kind of impact are you expecting that to have on your cost base now?

Felicia, do you want to take that?

There are a couple of aspects to the centralized fulfillment strategy. One is flow to centralized fulfillment, which we're driving. We are testing location-level pricing and expect to fully roll that out in fall of 2021. We're testing and expect full rollout through spring 2021. We're optimizing our point-of-sale strategies and strategic sourcing more broadly. We have strong ambitions in our supply chain to get the right content in the right channel at the right price and time. Our centralized fulfillment and inventory allocation strategy is underway. We've combined our supply chain and merchandise planning teams under one umbrella to facilitate faster decisions about inventory placement and we are seeing some benefits in faster turns. Location-level pricing testing will help drive more proactive markdowns, improve margin, and help sell-through. Taken as a whole, we expect centralized fulfillment to improve sales and margin over time and improve customer satisfaction. As digital penetration increases, customers demand improvements in time, quality, and certainty of delivery, and we're focused on meeting those KPIs.

And now, we take our next question from Dana Telsey from Telsey Group. Please go ahead.

Good morning, everyone. As you think about your charge card customers, what are you learning from them? How is that penetration holding? And then, can you go into any more commentary on the Backstage concept, how that's performing? And when do you test online? How do you expect that assortment to flow versus what you see in the stores? Thank you.

With respect to our credit card performance and penetration, this has been an interesting season. Credit penetration was down 590 basis points year-over-year in the quarter. As we entered August, we saw a moderation of that gap and an improvement. We believe this was driven by the cessation of economic stimulus that ended in July and reduced direct deposits into consumer bank accounts and prepaid cards. As stimulus has faded, consumers have been returning to proprietary credit cards, and the 590 basis point gap is beginning to narrow. We're watching delinquencies closely. Based on historical data, including the 2008 period, our banking partners anticipate that delinquencies may rise and could start to rise sooner than anticipated because stimulus has not been renewed. We are modeling potential impacts of consumer financial stress beginning in the late part of the back half of the year and into 2021. Currently, delinquency rates are relatively steady from first quarter to second quarter, but we continue to monitor them closely.

As for Backstage, customers love it and they value our price at Macy's and Bloomingdale's. Over the past four years we've hit a strong formula. Backstage comps are strong even where the main box may be declining. We're seeing improved margins in Backstage and strong sell-throughs. Our opportunity for Backstage lies in distribution and logistics costs; as we expand distribution and freestanding Backstage stores, and continue to expand Bloomingdale's The Outlet, profitability is growing. We plan to test Backstage online in the future; it's in our roadmap for 2021, but I can't provide specifics on timing or execution today.

And now, we take our next question from Carla Casella from JPMorgan. Please go ahead.

Two questions here. One is on COVID and rent: when do you expect to make up the rent payments that you were able to defer this year? Will that be something paid in 2020 or in 2021? On the CARES tax, when do you expect to get the cash benefit from the deferred taxes on the NOL carryback?

On the CARES Act, we will file our fiscal year 2020 tax return typically in the first quarter or early part of the second quarter following year, so the cash benefit would come at the earliest in the beginning of the third quarter after filing. It depends on when we complete and file the fiscal 2020 return, so the cash benefit timing is tied to that process. On rent and landlord negotiations: we have had many constructive conversations with landlords. We've set up an internal task force to go lease by lease and landlord by landlord. We have deferred and negotiated deferrals of some rent payments; however, the details vary by agreement. There have been combinations of deferrals of rent and tenant allowance matters, and terms have nuances. We have been respectful and collaborative with landlords. All rent expenses are being recognized in our books. I can't provide specifics on cash timing for each arrangement, but I do not anticipate negative cash implications from how these conversations are evolving.

On store closures, how many dark stores do you still own—stores closed that you still own? And can you update us on how many leases come up for renewal in the next one to two years?

I don't have that information at my fingertips. We are still committed to closing the 97 stores we previously announced, but some of that may accelerate. I can follow up after the call with composition of those leases.

And now we take our next question from Omar Saad from Evercore ISI. Please go ahead.

Thanks for taking my question. I wanted to follow up on your comment about dresses and men's suiting being down a lot. As we move through the pandemic and things start to stabilize, are you seeing any signs of demand in those dressier categories? And what's your medium- to longer-term outlook? Do you see a sticky shift to casual, athletic, home, or do you expect demand for dressier fashion to come back in 2021?

I believe both men's clothing and dresses will come back robustly. Right now, as restrictions open up locally, you're starting to see customers move toward casual dresses, whereas career and formal dresses remain challenged. Casual dresses have picked up. I believe the dress category will come back—Americans like to dress for occasions, and Macy's is a destination for that. In men's suits, the impact of long-term work-from-home is uncertain; businesses are rethinking in-person versus virtual work and some hybrid model will likely persist. That will influence wardrobe demand. Men's clothing is likely to recover over time; timing is uncertain, but we will be ready.

A follow-up: you mentioned members may have underperformed non-members in the quarter. Are there demographics driving that? Is it older customers more afraid of health issues? Any color would be great.

What we see in the data is that stores-only customers, who are generally older and located in specific pockets, have been more affected, particularly those uncomfortable with online shopping. Many older customers are omni shoppers and we have not seen a change in their behavior. We're seeing older, stores-only cohorts more depressed, but as malls and storefronts reopen and safety improves, those customers are returning. We track many segments of customers, and this is one of the distinctions we've observed.

And now, we'll take our next question from Paul Trussell from Deutsche Bank. Please go ahead.

Maybe to start, I wanted to follow up on your comments about the evolving role of the store. Can you discuss that in more detail and help us think about how you are remeasuring the profitability of a store and the decision to keep a door open given its support for digital operations? And as part of that, discuss the market ecosystem approach and the small format off-mall and Bloomingdale outlet locations.

The store remains a very important component of our brands. Customers like access to both digital and stores. In COVID, customers have been mission-based when visiting stores—higher conversion, less lingering. Stores are important for inspiration for some customers and for immediate gratification—pickups, returns, same-day delivery. About 30% of our digital transactions are fulfilled out of stores and we expect that to increase. Regarding ecosystems and small-format tests, in February we planned to test three markets to learn what small-format doors look like and how off-price freestanding stores perform. We're restarting those tests at a modified scale, focusing on Dallas, Atlanta and Washington DC. Over the next two years we'll open several smaller format off-mall Macy's and test a smaller format off-mall Bloomingdale's. We'll open several additional freestanding Backstage stores, expand Bloomingdale's The Outlet and test Backstage online. Every off-mall store will have full service for pickup and returns. We will learn whether these models extend beyond the initial markets and will evaluate how they drive lifetime value and customer acquisition.

Thanks. On SG&A, Polaris pre-COVID discussed $900 million and that target is now roughly $1.5 billion. Remind us where the incremental savings come from and where you expect the run-rate savings to be exiting this year?

High level: the initial Polaris savings we discussed in February included SG&A savings of about $900 million, $600 million in margin improvements, and then emerging from COVID we took additional reductions in force contributing another annualized $600 million of potential SG&A savings, yielding the expanded $1.5 billion (now $2.1 billion total by end of 2022). The components include leveraging marketing spend, reductions and efficiencies in the supply chain via centralized fulfillment, store-related efficiencies reflecting that we will be a smaller company and flex dollars more efficiently, and corporate overhead reductions from the reduction in force. We remain intensely focused on aggressive expense discipline and ensuring every dollar yields the greatest ROI. The savings are expected to ramp through 2022 as planned.

And now if we take the next question from Bob Drbul from Guggenheim. Please go ahead.

A question on mix and private brands. How are consumers trading good, better, best across your stores, and where is penetration of private branded merchandise versus national brands in apparel? Where are you in the commitment and how will that play out in the back half of the year?

When thinking about mix from off-price to luxury, those are our sweet spots. Rough AURs: Backstage around $12, Bloomingdale's around $90, Macy's around $35, Bloomingdale's The Outlet around $33—varies by category. We have flexibility to play across that spectrum. We're committed to growing private brands to about 25% penetration and have been working on sourcing to shorten lead times, digitize processes, consolidate factories, and share materials to improve speed and margins. Private brands are important to apparel, and we're accelerating sourcing work. We're committed to growing private brand content and exclusives as a strategic priority.

And now, we take our next question from Jay Sole from UBS. Please go ahead.

Jeff, you mentioned holiday demand could happen a little earlier this year and that you're trying to shift some sales earlier. Can you talk about your confidence in doing that and what tools you might use to make that happen?

Historically holiday demand has been concentrated between Thanksgiving and Christmas, but this year is different. Customers will respond to great values and brands, and we know how to execute on that. We use Black Friday in July as a dress rehearsal to see what customers respond to and then layer holiday on top of that. We've examined the entire promotional calendar from before Halloween through Black Friday, Cyber Monday and the weeks before Christmas. We anticipate customer concern for health and safety during compressed periods, so we'll spread demand, provide purchase options in advance, and communicate promotions to give customers time to receive gifts before holidays. This is baked into our margin and sales planning for the back half of the year. We're taking a conservative stance but are prepared to capture upside.

It appears there are no further questions at this time. Mr. McGuire, I'd like to turn the conference back to you for any additional or closing remarks.

I just want to say to everybody, thank you for your attention as we went through a long description of what we're working on. I appreciate everyone's interest in Macy's, Bloomingdale's and Bluemercury. Everybody have a great day.

This concludes today's call. Thank you for your participation. You may now disconnect.