Macy's, Inc. Q1 FY2022 Earnings Call

Good morning, and welcome to Macy's, Inc. Q1 2022 Earnings Conference Call. Today's conference is being recorded. I would now like to turn the conference over to Mike McGuire, Head of Investor Relations. Please, go ahead.

Thank you, operator. Good morning, everyone, and thanks for joining us to discuss our first quarter 2022 results. As always, with me on the call today are Jeff Gennette, our Chairman and CEO; and Adrian Mitchell, our CFO. Jeff and Adrian have prepared remarks that they'll share. After which, we'll provide time for your questions. Given the time constraints, we ask that participants in the Q&A please limit their questions to one, hopefully, single part question. Along with our press release from earlier this morning, the slide presentation has been posted on the Investors section of our website, macysinc.com. In addition to information from our prepared remarks, the presentation includes supplementary facts and figures to assist you in your analysis of Macy's. Also note that unless otherwise noted, the comparisons that we'll speak to this morning will be versus 2021. Comparisons to 2019 are provided where appropriate to best benchmark our performance, given the impact of the pandemic in 2020. I do have one housekeeping item to share with you this morning. We noted in our earlier press release that on Tuesday, June 7, at 8:00 AM Eastern Daylight Time, Jeff and Adrian will be participating in a fireside chat at the Evercore ISI Consumer and Retail Conference. This event will be webcast live on our Investor Relations website. So please circle the date on your calendars and plan to tune in. Now for the good stuff. 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 uncertainties 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 our 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 on the Investors section. Finally, as a reminder, today's call is being webcast on our website. A replay will be available approximately two hours after the conclusion of this call and it will be archived on our website for one year. With that, I'll turn the call over to Jeff.

Thanks, Mike, and good morning, everyone. Thank you for joining us. The first quarter presented a unique combination of challenges across a highly dynamic and uncertain operating environment, with mounting inflation, rising interest rates, a volatile stock market, COVID-19 lockdowns in Asia and the war in Ukraine. Nevertheless, I'm pleased to say that Macy's Inc. delivered solid results, thanks in large part to the efficiencies we built into our business through the Polaris strategy. Throughout the quarter, our team stayed focused on the customer and we executed on our plan for long-term growth. We leveraged our transformation muscle and quickly pivoted to satisfy customers with what and where they wanted to shop. As a result, quarterly net sales were in line with our expectations at $5.3 billion, a 13.6% increase compared to the prior year. Comparable owned plus licensed sales increased 12.4% and average unit retail was up approximately 8%. We beat our earnings expectations. We generated $211 million more in adjusted EBITDA in the first quarter than in the same period in 2021. And our adjusted diluted EPS was $1.08 for the quarter, almost three times higher than the prior year's $0.39. Looking at each of our nameplates, comparable sales for the Macy's brand increased 10.1% on an owned plus licensed basis. We saw a notable shift in consumer shopping behavior between channels, with better-than-expected sales in stores and lower-than-expected digital sales. This dynamic underscores the resilience of our omnichannel strategy, which I'll talk about in a couple of minutes. Macy's sales were also affected by an accelerated category shift away from the popular pandemic categories, such as casual and activewear as well as Soft Home, and into more occasion-based apparel, like dresses, women's shoes, men's clothing, and furnishings. This shift accelerated faster than we expected. It contributed to an increase in store foot traffic as consumers are more likely to shop in-person for occasion-based apparel. We were pleased to see that our balanced assortment allowed us to meet the shift and capture sales. Our Macy's customer base remained healthy during the quarter. On a trailing 12-month basis, we now have 44.4 million active customers. That's a 14% increase over where we were in the first quarter of 2021 and the highest active customer level in four years. We are also encouraged to see strong engagement by our most loyal customers. On a trailing 12-month basis, our 29.1 million Star Rewards program members made up 69% of Macy's brand, owned plus licensed sales. That's up nearly 6 percentage points from the prior year. Our Bloomingdale's brand performed strongly, exceeding expectations both in stores and online, as luxury consumer spending remained robust. Comp sales on an owned plus licensed basis were up 26.9%. This was driven by strong sales of dresses, men's tailored, men's and women's contemporary, and luggage. About 4 million people shopped the Bloomingdale's brand for the trailing 12 months ending Q1. That's a 21% increase compared to where we were as of the first quarter of 2021. Overall, this robust broad-based performance is a testament to how the Bloomingdale's team has evolved the product assortment to be relevant for new younger generations that are investing in both their wardrobes and their homes. At Bluemercury, the team continued to build on its momentum and posted another improved quarter. Comparable sales on an owned plus licensed basis were up 25.2%. This was driven by an increase in store traffic coupled with better-than-expected growth in private brands. During the quarter, as mask restrictions lifted, Bluemercury saw the return of color, particularly in lip, face, and eye categories. Now let me circle back to the importance of our omnichannel strategy. Across our nameplates, it's clear that our customers were changing how they shop during the quarter, and we were ready. As COVID-19 restrictions loosened in the US, people grew more comfortable returning to normal activities. They went back to the office at least a few days a week. They attended group events and celebrations and resumed in-store shopping. Our strong performance underscores the strength of our omnichannel ecosystem and our success in building a seamless shopping experience that accommodates changes in customer behavior. Notably, more than 88% of our omnichannel markets grew sales. Breaking this down further between channels, growth in our digital channel slowed from last quarter, but sales remained elevated over 2021 and 2019 levels. Digital sales were up 2% versus 2021 and up 34% versus 2019. For Macy's, which represents the lionshare of digital sales, traffic was up 1% from the quarter of 2021. As consumer shopping behavior shifted from digital to in-person, we took steps during the quarter to increase traffic, including paid search and personalization, which helped to attract more visitors. At the same time, Macy's saw conversion decline by 5%, driven by consumers online shifting back to in-store purchases, which was partially due to the return of occasion-based apparel. We know that the consumer shopping journey often begins online even when the ultimate purchase happens in the store. We're continuing to drive traffic to our digital platforms with that in mind and further underscoring the benefit of our omnichannel ecosystem. We're focused on personalization. That's an important growth engine and we continue to ramp up our capabilities to increase engagement, particularly with our highly engaged omnichannel shoppers, our best segments. Today, we're starting to see the results of this personalization work with revenue driven by personalized product recommendations up 13% during the quarter. While we're still in the early innings of these initiatives, we're pleased with these results. And we continue to test and iterate to find the best communication channels, frequency, messages, and offers. Our app's performance continued to be a standout, with active customers increasing 14% to 7.4 million in the quarter. And we continue to make progress in preparing for our new Macy's Marketplace, which we'll launch during the third quarter, and we expect to scale it over the course of the second half. We'll share more on this as we get closer to launch. As I mentioned, sales in stores grew as consumer comfort levels rose along with their desire to return to in-store shopping. But these gains were also a result of the investments we made to make our stores a style destination through our new brand platform, Own Your Style. There are also benefits of our focus on trend merchandising, which enables our customers to shop for full looks, rather than just items. We're also investing in our customer service experience by enhancing At Your Service centers in every store. Additionally, we continue to make progress scaling our smaller optimal store formats like Market by Macy's. These will be integral in supporting our digitally-led omnichannel ecosystem. During the quarter, we also benefited from international tourist traffic, particularly from Central and South America, as well as Europe, aiding stores like our flagships at Herald Square in New York and Union Square in San Francisco, along with many of our downtown locations. While our downtown locations continue to lag in performance versus 2019, we saw a year-over-year improvement in their sales trend, with these locations outperforming the balance of the stores. We're also continuing to see strong performance from our Backstage store-within-store locations. These locations, open more than a year, posted a high single-digit comp increase versus last year, driven by continued strong performance in kids apparel, men's, dresses, missy sportswear, and luggage as well as higher average unit retails. We're also expanding this off-price presence in strategic spots that advance the Macy's value spectrum strategy. During the quarter, we announced that we will open 37 new Backstage store-within-store locations nationwide. In the month of May, we opened our 300th Backstage location as well as our largest store-within-store location in our Herald Square flagship. Both of which are significant achievements for our off-price portfolio. So, in summary, we're pleased with our results this quarter, particularly our ability to navigate the difficult macro and economic environment. Now, I'd like to provide more details on how we're dealing with the economic headwinds. First, I'd like to share some color on supply chain and inventory productivity. As I mentioned earlier, we saw a rise in consumer demand in occasion-based merchandise categories, while at the same time, we experienced a deceleration in casual, active, and soft home categories, both at a faster pace than we anticipated. Simultaneously, supply chain constraints relaxed, resulting in a higher percentage of receipts than we expected. The combination of these factors created an imbalance in our overall inventory levels as well as by channel. The good news is that we were able to navigate these demand and supply trends, thanks to our underlying work to improve pricing science and our disciplined purchasing behavior, coupled with leaner inventories entering the year. As a result, we delivered strong improvement in both inventory turn and gross margin compared to both 2021 and 2019 levels. At quarter end, our work resulted in inventories rising 17% from 2021 levels on a 13.6% increase in net sales. And this shift in consumer demand for more occasion-based categories like dresses and tailored clothing is a good thing for Macy's, as it is where we shine. With our broad assortment base, we are pivoting to those categories and building replenishment stock in our bestsellers. We are continuing to closely watch supply chain dynamics. While constraints loosened up in the first quarter, there is still a significant amount of uncertainty with the lockdowns in China and the ongoing labor negotiations in the LA port. Factors like these drive us to continue taking a prudent and disciplined approach with our lead times and forecasting. We're making adjustments as needed with ongoing communications with our partners to ensure that we can adapt to changing consumer demand and have the right inventory available at the right levels and at the right time. We're also closely monitoring evolving shopping behaviors relating to the ebbing of the COVID pandemic combined with mounting inflation and macroeconomic volatility. During the first quarter, all income tiers continued to engage with us, led by the higher-income and middle-income consumers. Luxury sales remained a standout for our business as shopping behavior among high-income consumers has so far remained less affected by inflation. These trends show the benefit of our balanced portfolio across nameplates. We operate across the value spectrum, from off-price to luxury. This, coupled with our wide assortment of categories, products and brands gives us the ability to flex with consumer demand. Now I'll pivot to our merchandising strategy for the Macy's brand. We're putting a lot of focus here as we look to engage more customers and grow market share. We are in the early stages of reimagining our private brand portfolio and realigning our private brand team under new leadership in partnership with our broader merchandising and sourcing teams. Our goal is to have a private brand portfolio that is differentiated, defendable, and durable. That the team is developing original designs and distinctive brand identities, values, and principles that foster brand love, with a modernized size and fit approach so that all our customers are empowered to own their personal style. This work is underscored by customer data and analytics to ensure that we have the right value equation and competitive pricing architecture. And while specifics at its composition we're not yet ready to share, we're considering all avenues, including the launch of new brands as well as a rethink and refresh of current brands, all centered around giving the customer what they want. I'm looking forward to sharing additional details on this work in the future. Before I pass it over to Adrian, I want to thank our colleagues for their continued hard work and dedication. They are demonstrating tenacity and executing our strategy and building a seamless shopping experience, all while keeping our customers at the heart of every decision. Their spirit and ingenuity drive us forward as we continue to navigate this dynamic environment. And with that, I'm going to turn it over to Adrian for additional color on our first quarter results and the outlook for the rest of the year.

Thank you, Jeff, and good morning, everyone. Driving shareholder value remains our top priority. And we're doing this by combining effective operational execution with the strategic deployment of capital. Our disciplined actions have improved the financial health of our business and have allowed us to successfully navigate today's volatile and uncertain operating environment. As Jeff said, we delivered first quarter sales as anticipated while our bottom line exceeded expectations. I'll highlight our successes as I walk through our results, focusing on our five value creation metrics: omni-channel sales, gross margin, inventory productivity, expense management, and capital allocation. First, omni-channel sales. We generated $5.3 billion in net sales during the quarter, up $642 million, or 13.6% versus last year. Comparable sales on an owned plus licensed basis increased by 12.4%. As you may recall, our first quarter last year did not fully benefit from the accelerated economic recovery and stimulus payments that were just beginning to drive macro trends in the market. These had a larger impact later in the year. Nevertheless, we are pleased with our performance, particularly in light of the channel and category dynamics that we’re navigating further. Now on to gross margin, where we saw another strong quarter of expansion that contributed to our outperformance. For the quarter, gross margin was 39.6%, up 100 basis points from the prior year period and above our expectations. Merchandise margin increased 50 basis points, benefiting from higher average unit retails. Our average unit retail performance was driven by three big factors: first, lower promotions, particularly on regular priced goods. This was driven by our pricing optimization work. Second, higher ticket prices. The big contributors here were fragrances, mattresses, textiles and fine jewelry. And third, category mix, driven largely by furniture and fragrances in addition to the increased penetration of occasion-based apparel categories. Full-price sell-throughs were down slightly in the quarter, impacted by the shift away from pandemic categories like activewear and soft home that I just discussed. However, full-price average unit retails increased 10% for the Macy's brand. Within gross margin, delivery expense accounted for 4.3% of net sales. That's 50 basis points lower than last year, reflecting the four percentage point decline in digital penetration. If we step back for a minute, we know that our ability to maintain margin depends on our understanding of customer demand within and across categories. To improve this understanding and better forecast demand in a highly uncertain environment, we're leveraging predictive analytics and data science. They also allow us to apply a few key tactics. First, we are shifting our promotional profile to be more personalized. Important here are the personalization efforts that Jeff spoke about earlier. Second, as we improve our ability to predict demand, we expect to improve the accuracy of our upfront buys and how we allocate inventory within and across markets. This should help us drive better sell-throughs and higher inventory productivity. Third is our use of pricing science. We utilize dynamic pricing to change the timing, cadence, and size of markdowns based on factors such as inventory availability, sell-throughs, and demand patterns. This leads me to inventory productivity. As Jeff discussed, we acknowledge that the dynamics around inventory are challenging, including those within the supply chain. The faster-than-expected shift away from pandemic categories resulted in higher inventories, largely within decelerating categories. At the same time, the loosening of the supply chain resulted in a higher percentage of receipts landing at our Macy's earlier than we expected. Despite this, we managed inventory as effectively as we could during the quarter and continued to deliver productivity gains. Our efforts resulted in an 18% improvement in turnover versus 2019 and even a 9% improvement compared to 2021, which had abnormally low inventory levels at the beginning of the year. Effective inventory management remains a strategic priority for us. We are working actively to get inventory metrics better aligned to actual sales trends by driving faster sell-through of our slow-moving merchandise and adjusting our buys to reflect the changing environment. The data science we have built into the business is key to the success of this work in helping to ensure we maintain strong margins. Next, expense management. In the quarter, SG&A expenses increased by $131 million or 7.5% to $1.9 billion. SG&A as a percent of net sales improved by 200 basis points to 35.1%. This was primarily driven by disciplined expense management in the face of sales growth. And we achieved this strong performance even with material wage inflation across the organization. Recall that we exited 2021's first quarter with a significant number of open positions due to the tightening labor market. Since then, we have made major progress on either filling or eliminating open positions. Today, our remaining open positions generally reflect the normal course of business or new positions we need for expanding operations such as those for marketplace and personalization teams. Additionally, as of May 1, all our colleagues in stores and distribution centers are now at a minimum wage base of $15 or above, depending on the legal minimum wage within the municipality. During the quarter, we also benefited from the growth of Macy's Media Network, which saw net revenue nearly doubled to $26 million in the quarter. Credit card revenues were $191 million, up $32 million from the first quarter of 2021. As a percent of net sales, credit card revenues were up 20 basis points to 3.6%. Our outperformance here benefited from three primary factors: one, continued low bad debt levels; two, higher credit sales; and three, greater co-brand credit card spending. Our better-than-expected bad debt levels continued to benefit credit card revenues as the consumer remains healthy. Our strong sales performance over the last couple of quarters also helped to drive higher balances within the portfolio. And lastly, we saw higher spending on the co-branded credit card where we benefit from usage outside of our own channels. While credit card revenues exceeded our expectations for the quarter, we continued to expect inflation to outpace wage growth and weigh on consumer health. We expect this to contribute to an increase in bad debt. Partially offsetting this will be the continued higher balances in the portfolio and higher spending on the co-brand credit card, both benefiting from the shift in consumer spend away from debit cards. This will be a reversal from last year when consumers were flushed with stimulus cash. As we look ahead to the rest of the year, we expect credit card revenues to rise more than we expected three months ago. I'll give more detail on that in a moment. Now for bottom line profitability. Adjusted EBITDA margin came in higher than expected at 12.8% or 270 basis points higher than 2021. This includes asset sale gains of $42 million, which were $36 million higher than the last year. This outperformance was driven by the better-than-expected results for gross margin and credit card revenues that I spoke of earlier. After accounting for interest, taxes, and the share repurchase, which I'll address in a moment, these results generated adjusted diluted EPS of $1.08, up from $0.39 in 2021, which leads me to our final value creation metric, capital allocation. The strategic deployment of our cash over the past year has been one of the most critical drivers of our transformation journey. And through our solid execution of our capital allocation priorities, we are now able to invest in the business and return capital to shareholders. Let me take you through this quarter's highlights. We generated $248 million of operating cash flow. This was driven by higher adjusted EBITDA and merchandise payables, and partially offset by an increase in merchandise inventories and a decrease in accounts payable and accrued expenses. Capital expenditures were $261 million and free cash flow was $60 million. Our continued capital investments remain critical, with a large portion geared towards growth investments focused on omnichannel investments, including the digital marketplace, automation, and data science capabilities. During the quarter, we also took significant actions to increase our financial flexibility. First, with the upgrade of our credit ratings in February, we were able to remove the collateral from our bonds so that now all our long-term debt is unsecured. Another action we took was amending and extending the term of our $3 billion asset-based credit facility by three years to March of 2027, further strengthening our financial flexibility and liquidity. As we've said before, we expect to use the credit facility periodically based on the needs of the business. The third move we took to increase financial flexibility was using cash on hand along with the proceeds from the issuance of $850 million in new longer-term maturity, unsecured notes due in 2030 and 2032, to redeem approximately $1.1 billion of debt that was maturing in 2023 and 2024. As a result, we have no material debt maturities for the next five years, giving us significant financial flexibility to invest further in our Polaris transformation. The debt maturities between 2027 of $71 million and 2028 of $206 million are very manageable. Lastly, we continue to return capital to shareholders. In addition to our dividend payment of $0.1575 per share or $45 million, we repurchased approximately 24 million shares for a total spend of $600 million during the quarter, leaving $1.4 billion of our $2 billion share repurchase authorization available. This represents 8.2% of our shares outstanding. Recall that our guidance did not include buybacks, and they contribute $0.03 to our outperformance in EPS. Turning to our full year outlook, we are reaffirming our sales guidance and raising our earnings guidance based on the strength of our credit portfolio and share repurchases. We acknowledge that the level of macroeconomic uncertainty is continuing to intensify. And we believe that this updated guidance appropriately reflects the associated risks we see. To highlight the changes within our net sales guidance of flat to up 1% versus 2021, we now expect digital sales as a percent of net sales to be approximately 35%, in line with 2021, down from our prior estimate of 37%. This reduction in digital penetration and associated increase in store penetration is the result of two primary expectations. First, the continuation of the shift in consumer behavior from online to in-store that we experienced this past quarter. And second, the accelerated shift to occasion-based apparel, which we know has a higher return rate than pandemic categories, such as home and beauty. During the quarter, we saw a higher-than-expected increase in returns on macys.com within the accelerating categories and have adjusted our outlook accordingly. Overall, we haven't changed our net sales expectations. We've only changed the contribution of each channel. Additionally, we now expect credit card revenues of approximately 3.1% of net sales, up from 2.9%. This is driven largely by the improvement in bad debt we were seeing compared to our original expectations, as well as balances within the portfolio trending higher than expected. As a result of this, adjusted EBITDA as a percent of sales is now expected to be between 11.2% and 11.7%. Our adjusted EPS for the year is now expected to be $4.53 to $4.95, which not only reflects the change in EBITDA, but also reflects the impact of buybacks completed in the first quarter. Note that this excludes any consideration for future buybacks. In the second quarter, we expect net sales to be between $5.5 billion and $5.6 billion. We expect the gross margin rate for the second quarter to be no lower than the second quarter of 2019. This reflects our anticipation of higher fuel costs within our supply chain network, from markdowns needed to correct inventory levels within overstock categories and the possibility of an elevated promotional environment given the high inventory levels we see in the industry. For adjusted earnings per share, we expect between $0.84 and $0.94 for the quarter compared to $1.29 in 2021. While we are pleased with our first quarter performance, we recognize that our work is certainly not complete. The world is changing rapidly. But our financial health provides us the capacity and flexibility to make the necessary investments and operational changes to keep up with the pace of change. With that, I'll turn the call back over to Jeff for some closing remarks.

Thanks, Adrian. In summary, we delivered a solid first quarter, despite the unprecedented macroeconomic environment, demonstrating our improved operational agility, driven by our Polaris strategy. As we move forward, we recognize this coming year presents unique challenges for both our business and our customers. Our strength is in our omnichannel ecosystem. We operate across the value spectrum, from off-price to luxury and have a balanced portfolio that can shift and flex with consumer demand. Our Polaris strategy has proved durable. And we have confidence that it enables us to weather any storm we may face in 2022 and in the future. And with that, let's begin the Q&A.

We will take the first question from Chuck Grom from Gordon Haskett. Please, go ahead.

Hey. Thank you. Good morning. And great results to the team. Jeff, I'd be curious on your comp performance during the quarter and into the month of May, but also by income cohort. You touched on a little bit in terms of the low versus the high. But given the wide range of customers you serve, can you perhaps share any color on that front? And then on Adrian, for the gross margins, how should we think about the puts and takes here in 2Q? I think you said no lower than the 38.8 you posted in 2019. But just trying to contextualize what we should think about the balance of the year for gross margins.

Hey, Chuck, let's first discuss the customers affected by the macro environment. One key point is that we saw an increase in customer count and spending across all income brackets this quarter. Customers earning under $75,000 annually were the most impacted, yet their spending and numbers went up. They are shifting towards categories supported by our Backstage brand. Looking at mid-tier and luxury customers earning above $150,000, their spending remained strong. Overall, we noticed a decline in spending in casual, active, and soft home categories compared to 2021, while dress-up categories, special occasions, and travel saw an increase compared to the fourth and first quarters. May has started off positively, and quarter-to-date performance can be attributed to three factors. First, strong Mother's Day gifting provides confidence for our gifting strategy in the second half of the year. Second, high-energy events, like one-day sales in May, have performed well. Lastly, we see positive developments in apparel, especially with our Own Your Style platform, as we sell complete outfits rather than individual items. Our customers are responding to both quality brands and competitive pricing, whether it's off-price or luxury. We aim to be a destination for gifting and special occasions, and we anticipate sustained demand. However, there is significant uncertainty, and we are approaching our outlook with caution.

Good morning, Chuck. Regarding gross margin, we're managing it quite carefully. One key point we've highlighted is the decline in digital penetration, which usually suggests an improvement in gross margin. However, as we look at the second quarter, it reflects the markdowns necessary to clear excess inventory in the slowing categories discussed by Jeff, along with the rising fuel costs associated with our delivery expenses. We talked previously about our delivery expense initiative, and we are starting to see the benefits of that. We're balancing the advantages with the challenges we're facing. We're noticing fewer packages per order, but we're progressing well with our fulfillment operations across 36 stores before the holiday season. We're also seeing an increase in orders being fulfilled from stores, reducing the distance packages travel to reach customers, which is positive. However, this improvement is countered by increased fuel costs. As we move through the year, we anticipate holiday surcharges and continuing fuel cost rises, which we've factored into our guidance for the remainder of the year.

Great. Thanks very much.

Thank you, Chuck.

The next question comes from Matthew Boss from JPMorgan.

Great. Thanks, and congrats on a nice sprint.

Thanks, Matt.

So, Jeff, maybe to elaborate on the shopping trends that you're seeing by category. How are you thinking about the duration of occasion spending for apparel? And then what's your comfort with current inventory on hand? And just how quickly can you pivot the assortments if trends shift across both apparel and hard goods as we think about maybe the back half of the year and into early 2023?

Yes, Matt, we are definitely transitioning and have already made changes. Let me provide more detail on what we're observing. Firstly, regarding the decline in the pandemic-related categories such as casual, active, and soft home, we experienced about a 20-point drop from the fourth quarter to the first quarter, which was more significant than we expected. Inventory levels in these categories have certainly increased. Our efforts in enhancing our pricing strategies are proving beneficial here, as we included this information in our second-quarter margin guidance. We have adjusted our upcoming orders accordingly, and we don't anticipate improvement, especially when comparing our inventory levels to those of competitors, which continue to rise and indicate a shift from customers. On the other hand, there has been significant growth in dress-up categories, which have increased by 10 points from the fourth to the first quarter and continue to improve in the second quarter. We are being very proactive with additional stock and have strong partnerships with our vendors, focusing on the right brands. As we look ahead for the second half of the year, I would categorize our focus into five areas. The first is the decline in pandemic categories, coupled with the growth in dress-up categories. The second is our gifting strategy, where we've achieved strong results for Mother's Day, Father's Day, and the upcoming holiday, offering competitive price points for a range of products. Next, we are focused on new categories, like Toys 'R' Us and our Marketplace initiatives, alongside premium brands such as Ralph Lauren, Pandora, and Prestige Fragrances, which present numerous growth opportunities. The fourth area is enhancing personalization and effective customer engagement. We are in the early stages but see potential for growth through relevant communications and content, which we expect to develop further in the second half of the year. Lastly, we are seeing a resurgence in our store performance. Improvement is evident, especially in urban flagship locations, attributed not just to international tourism but also to returning to work and celebrating special occasions. Backstage is becoming increasingly vital in our operations, with the addition of 300 stores enhancing our reach. The Own Your Style initiative continues to progress. Additionally, the Bloomingdale's brand is performing exceptionally well as we prepare for its 150th anniversary, which the team is gearing up for. We had a successful report from Bluemercury as it establishes itself as a premium beauty brand, meeting customer demand for eye and lip products as masks are being removed. New leadership at Bluemercury is having a positive impact.

Its great color. Best of luck.

We will now take the next question from Bob Drbul from Guggenheim. Please go ahead.

Hi. Good morning. Could you provide more information about the marketplace initiative? Specifically, I'm interested in the timeline, expectations, and the current status of its development. Additionally, could you share your insights on big ticket items and what you're observing in those segments of the business? Thank you.

We're excited to share that we will provide more details on the marketplace later this year. We're set to launch in the third quarter with plans to scale it in the latter half of the year. From the very beginning, we will focus on testing and learning. Our initial efforts will concentrate on categories where we see significant market share opportunities and where we currently lack developed businesses, either through vendor direct fulfillment or owned inventory. Expect us to launch in categories like pets, electronics, home improvement, gardening, and video games. Stay tuned for updates, as we will share more information in our next call regarding the marketplace.

Big ticket?

We're observing that the supply chain is beginning to ease, much like we mentioned during our last call. When examining the costs in these businesses, we noted previously that larger items or well-known brands can often pass some costs to consumers. However, we have to be cautious with pricing on items in lower price ranges, such as a $499 or $599 couch or an entry-level mattress. We are currently catching up with the demand from previous orders and carefully monitoring how customers are responding across different categories and price points, making necessary adjustments accordingly.

Great. Thank you very much.

You bet.

The next question comes from Dana Telsey from Telsey Group.

Good morning, everyone. Congratulations on the nice progress. Can you expand on the relaxed supply chain and what you're seeing there and how you see it moving to the balance of the year? And then just to touch on the AUR increase of 8%. How are you thinking about that for the rest of the year? Thank you.

Dana, let me address your questions. We didn't expect the improvement in order replenishment in the supply chain. Usually, we planned for about a 30% fallout on our orders, which was in line with what we saw in the latter half of 2021. Now, that fallout has decreased to around 20% in the first quarter, which is consistent across the board, although there are exceptions. Vendors are performing better with their shipments, but that doesn't indicate a complete relaxation in the supply chain. We anticipate some challenges ahead, especially related to the Shanghai port's situation. Currently, there are about 30 tankers at the L.A. port, down from roughly 120, and we expect that number to increase as freight from the Far East shifts. Our focus now is to safeguard our back-to-school and fourth-quarter operations, so we are maintaining the same lead times for our orders that we implemented during the pandemic and in 2021. The timing of goods arrival in the second and third quarters may vary, but we've factored that into our forecasts. We will be prepared for potential issues as we approach the season. Regarding the domestic supply chain, we are in a favorable position. Our forecasting for receipts and their allocation is significantly better than before, and we are placing a strong emphasis on logistics, especially with UPS for last-mile delivery. Concerning AUR, we recorded an 8% increase in the first quarter. During our previous discussion, we predicted AUR growth would be around 5% for the year, which I still believe holds true. We expect to see continued improvement in certain trending categories like dress-up, special occasions, and travel, although those pandemic-related categories where we and our competitors have built up inventory may see slower growth. So, the supply and demand dynamics are currently misaligned. We are applying our pricing strategies to address these issues, and our gross margin expectations reflect this outlook. Overall, we're looking at a mid-single-digit improvement for the year.

Thank you.

The next question comes from Omar Saad from Evercore. Please go ahead.

Thanks. Good morning. I appreciate you taking my question. I wanted to follow up on a few points. Regarding the pandemic categories versus the post-pandemic categories, could you elaborate on active, casual, and home? Are there specific segments within these categories that are performing better while others are declining more rapidly, or is the pullback consistent across all athletic, casual, and home goods? Additionally, are you noticing any signs of price sensitivity? You referenced lower-priced mattresses and couches. Are there any other areas in your business where customers are hesitant to pay higher prices? Thank you.

Yes, Omar, your questions are related, and it's essentially the same answer. In the casual active and soft home categories, we are definitely noticing some customers hesitating at certain price points, so we have made adjustments and I anticipate continuing those efforts. With our pricing science, we have the advantage of making changes at the store level, which helps us maintain higher margins. However, I do believe these categories will experience the most pressure. In terms of opportunities in other categories, let me provide some additional details. Within the Soft Home segment, the most impacted categories include textiles, tableware, and housewares. Conversely, categories like luggage are performing exceptionally well, aligned with the travel trend, showing very high double-digit growth. Although we had a strong performance in textiles, tableware, and housewares over the past two years, we are now adjusting our expectations for those categories. We are focusing on realistic average unit retails (AURs) and will emphasize categories that matter most to the customer, ensuring we deliver great value, even though their contribution to our business is expected to be less than in 2020 and 2021. Regarding the trending categories, we are seeing improvement in AUR across all our value bands, with over 50 different categories each telling a unique story. Certain brands, like Ralph Lauren, are experiencing significant AUR increases due to their premium positioning and reduced distribution. We have intensified our efforts to provide a comprehensive lifestyle portrayal of their content both online and in our stores. Additionally, in our fragrance business, we are observing more transactions involving larger sizes and value-added items like gift baskets, which help drive higher AURs that differentiate us from competitors. Each product offering presents its own narrative.

Got it. Thanks Jeff.

We will take the next question from Jay Sole from UBS.

Great. Thank you so much. Jeff, obviously, it was a strong quarter. And you're raising guidance in an environment where some of your off-price competition is doing the opposite. Weaker quarters, lowering guidance for the year. Do you think this difference is really just about the income demographics and maybe some of your off-price competitors are serving and maybe a little bit better execution on your part than their part of the quarter? Or taking a step back, do you see the company really closing the gap in terms of your competitive position versus those retailers where you feel like your ability to take share back from them is improving or at least maintaining shares improving? Thank you.

Yes, Jay. I believe the Polaris strategy is effective, addressing all aspects of your question. As a department store with 50 categories, we can influence customer preferences. Some competitors may have struggled because their focus is on categories that are currently less appealing to customers, which allows us to pivot towards those in greater demand. Regarding affluent customers, we are not observing any slowdown, which positively impacts some of Macy's businesses. This is a testament to the successful strategies being implemented at Bloomingdale's and Bluemercury. As for the middle-income customer, we are committed to offering a wide range of products to retain their loyalty. The Polaris strategy is indeed working and has helped us navigate the challenges from the fourth quarter into the first quarter. We are performing well this quarter and I have strong confidence in the second half of the year, thanks to the capabilities we've developed during the pandemic transformation. I am proud of the team's response, as they continuously focus on the customer with various tools at their disposal.

Got it. Thank you so much.

The next question comes from William Reuter from Bank of America.

Hi. I just have one. In terms of the share repurchases in the quarter which accelerated, can you talk about, given the large authorization that still remains, how you're thinking about that? And if you currently have a leverage target? Thanks.

Terrific. So thanks very much for your question. Good morning. As we think about share repurchases, in this dynamic environment, we're very much focused on flexibility. Flexibility is really our key priority. And that flexibility at this point in time is defining our ability to lean into those consumer demand trends that Jeff spoke about earlier, while at the same time, making sure that we maintain our commitment to a disciplined and healthy balance sheet as well as continued investments in the Polaris transformation, which Jeff spoke about. That's really working for us. The third commitment we've made is to return capital to shareholders. And as you pointed out, we did receive the $2 billion of authorization earlier this year. But it's been open-ended, which gives us the ability to be flexible in how we allocate our cash. And so we're just going to be very balanced in this pretty dynamic environment and continue to make sure that we are returning value to shareholders, but at the same time making sure that we’re making investments in the growth of the business. As we think about our leverage ratio, we really entered the year with a lot of strength. Our leverage ratio target last year was 2.5 times or below. We ended the year at 1.8 times, and we continued to pay down debt in the first quarter. We paid down an additional $300 million of debt. So very disciplined as it comes to the leverage ratio, very disciplined on the balance sheet. And we'll continue to be very thoughtful about how we allocate our capital.

Thank you.

You're welcome.

The next question comes from Stephanie Wissink from Jefferies.

Hi, good morning. It's Blake on for Steph. Thanks for taking our question. You've given a lot of good details so far. We just were curious on Macy's media network and how that's performing versus your expectations. And maybe how the conversations are going in this environment of increased uncertainty? It sounds like their growth is still pretty strong, but curious if there's any change in the conversation tone. And then maybe also, you talked about the category shifts. Wondering if that's maybe playing more into your strength in the conversations. Thank you.

Hi, Blake. Macy's Media Network continues to exceed expectations with ongoing growth in both the number of advertisers and the volume of campaigns. In the first quarter, we generated $26 million in net revenue, nearly double that of the previous year. To provide more insight, over 320 vendors have participated in the program so far, indicating strong interest. We anticipate continued growth in vendor and campaign counts as we expand our vendor base and prepare for the upcoming launch of Macy’s marketplace in the third quarter, which makes us quite optimistic. Regarding category shifts, categories where Macy's excels are certainly contributing to our success. Our omnichannel capabilities give us a significant advantage, as customers may begin their shopping journey online, conducting research and price checking, but often make their purchases in-store. The channel shift has shown a slight decline from 37% to 35% in mobile commerce, yet we still maintain a robust digital business. The success of specific categories and our ability to leverage analytics and pricing engines to respond to trends has been crucial. We believe we’ve managed this well, ensuring we remain strong in our margins and are equipped to adapt to changing trends. Our flexible model allows us to effectively follow customer behavior.

We will take the next question from Oliver Chen from Cowen. Please go ahead.

Thank you. Hi Jeff and Adrian, in your remarks, you mentioned intensification of uncertainty. Just would love for you to elaborate on those factors that you're paying attention to from the consumer and what indications may be leading? And then as you think about promotions, it sounds like you're prepared for promotions. How will you execute those in a customer right manner just to preserve brand equity and your relationships with customers to ensure that you're executing them against the competitive environment, yet balancing what's right for the business? Thank you.

Hi Oliver, regarding your first question on economic indicators, we have a chart that outlines the tailwinds, neutral factors, and headwinds. Looking at the tailwinds, the labor market and tourism are improving, which is promising. Historically, about 3% to 4% of Macy's Inc. business has come from international tourism, and that is beginning to recover. The return to office dynamics are interesting as many companies adapt to hybrid work models, creating a need to refresh wardrobes, which we're observing. Categories like blazers, dresses, and dress-up accessories are benefiting from this trend. Neutral factors include personal disposable income and the current savings rate, which, while still good, are not as favorable as they were a year ago. Consumer credit remains strong, and consumers are still willing to spend, but we are closely monitoring their sentiment and spending habits. For promotions, we consider it neutral because we're not increasing promotions but are more strategic with the ones we do offer. In terms of headwinds, we are definitely facing inflation with factors such as housing and gas prices, potential interest rate changes, and geopolitical issues all under close watch. These are all incorporated into our estimates. To address how we communicate our great values, we adapt our approach depending on the free on board (FOB) terms. A clear price point resonates well with our customers, especially in declining casual and active categories, which typically include key items with strong inventory support. When we establish straightforward pricing, it helps ensure customer understanding without confusion. We're also actively monitoring competitors' prices as frequently as every hour to make necessary adjustments. We are confident in managing our inventory effectively and making the right changes for future stock based on these observations.

Regards. Thank you.

Thanks, Oliver.

As there are no further questions, I would like to hand the call back over to your host for any additional or closing remarks.

Thanks, everybody. Appreciate listening, and everybody have a great day.

Thank you. That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.