Macy’s, Inc. (NYSE:M) Q2 2023 Earnings Call Transcript

Macy’s, Inc. (NYSE:M) Q2 2023 Earnings Call Transcript August 22, 2023

Operator: Greetings and welcome to the Macy’s, Inc. Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this call is being recorded. I will now turn the call over to Pamela Quintiliano, Vice President of Investor Relations. Pamela, you may now begin.

Pamela Quintiliano: Thank you, operator. Good morning, everyone, and thanks for joining us. With me on the call today are Jeff Gennette, our Chairman and CEO; Tony Spring, President, Macy’s, Inc. and CEO-Elect; and Adrian Mitchell, our COO and CFO. Along with our second quarter 2023 press release, a presentation has been posted on the Investors section of our website at macysinc.com. Unless otherwise noted, the comparisons discussed today are versus 2022. Comparisons to 2019 are provided, where appropriate, to best benchmark performance. All references to our prior expectations, outlook or guidance refer to information provided on our June 1st earnings call unless otherwise noted. 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 on the Investors section of our website. Today’s call is being webcast on our website. A replay will be available approximately two hours after the conclusion of this call. With that, I’m going to hand it over to Jeff.

Jeff Gennette: Good morning, everyone, and thank you for joining us. I’m going to begin today’s call with a review of our second quarter results, followed by a discussion on the macro environment and how that is informing our approach to the remainder of the year. Tony will then give an update on our five growth vectors and the merchandising strategy. From there, Adrian will provide additional detail on the second quarter and our third quarter and full year outlooks. He will also discuss opportunities under his expanded role as COO. Before we dig into the results, I want to acknowledge the devastating wildfires on Maui. We have accounted for all our colleagues on the island, but a few have been directly impacted by the destruction and loss caused by the wildfires.

We’re supporting those colleagues via our North Star Relief Fund and are engaged with the American Red Cross through our annual financial commitment and customer roundup campaigns across our Hawaii and Guam stores to support Maui residents. Turning to second quarter results. We achieved net sales of $5.13 billion, a gross margin rate of 38.1%, and an SG&A rate of 37.5%. Adjusted diluted EPS of $0.26 primarily benefited from better-than-expected sales, gross margin and SG&A. These factors more than offset lower-than-anticipated credit card revenues and a timing shift in the recognition of shortage. Taking a step back, we exited the first quarter with excess spring seasonal receipts at Macy’s due to lower-than-anticipated demand trends in the back half of the quarter.

On our earnings call, we committed to entering fall in a clean inventory position. Ultimately, we ended the second quarter with inventories down 10% to last year and down 18% to 2019. We were disciplined with our approach to inventory commitments and flex the cadence and depth of promotions and markdowns, utilizing our data-driven tools to reduce the length of seasonal clearance activity by several weeks. Promotional sell-throughs were better than expected and clearance markdowns were not as deep. Thanks to our cross-functional teams for being nimble, flexible and embracing new ways of working. Entering the third quarter, store floors and online are less cluttered and easier to navigate. Content is fresh and seasonally appropriate with open to buy and the ability to chase into areas of strength, all of which improves the omnichannel shopping experience.

At Macy’s, net sales declined 9.3% and comparable sales declined 8.2% on an owned-plus-licensed basis. Aged inventories were roughly 20% below last year’s levels and warm weather inventories were about 40% lower. Top performing categories include beauty, particularly fragrances and prestige cosmetics, women’s career sportswear, and men’s tailored clothing. We also continued to realize improvements in the soft home categories, including textiles and housewares. Active, casual and sleepwear remain challenged. We are working on solutions to improve trends in these categories. In the near term, active should benefit from the reintroduction of Nike men’s, women’s and kids’ online and in 75 doors in October and the rollout to more than 200 doors this spring.

This morning, we are also pleased to announce that select Under Armour men’s product will be available in 150 stores and online, beginning in February. The return of Nike and Under Armour speaks to the strength and reach of Macy’s and our ability to attract sought-after wholesale partners. Looking ahead, we’re working with both brands as well as potential new partners on how to expand further. Comparable owned sales for store-within-stores in our Macy’s off-price concept, Backstage, outperformed Macy’s full-line stores in which they operate by roughly 260 basis points. At Bloomingdale’s, net sales declined 3.6% and comparable sales were down 2.6% on an owned-plus-licensed basis. Beauty, women’s contemporary and designer apparel, and shoes were our best performing categories, while handbags, men’s and dresses were challenged.

Bloomingdale’s focus remains on being the winning option for multi-branded upscale retail. During the quarter, we introduced Hoka, a leading active shoe brand that is highly relevant to our consumer, and it has been selling out. Bloomingdale’s outlet outperformed full-line Bloomingdale’s locations by about 800 basis points. Later this month, we will be opening our 21st outlet, which will be located in Christiana, Delaware. At Bluemercury, net sales rose 5.6% and comparable sales increased 5.8%. Customers continue to respond well to our skincare and color cosmetic brands. While second quarter results largely exceeded our expectations, they were promotional and markdown-driven, which makes it difficult to decipher any potential shifts in consumer health.

As we plan the remainder of the year and we think about 2024, we remain cautious on the pressures impacting our customer, especially at Macy’s, where roughly 50% of the identified customers have an average household income of $75,000 or under. Over the last several quarters, we have seen the Macy’s customer more aggressively pull back on spend in our discretionary categories. They are not converting as easily and becoming more intentional on the allocation of their disposable income, with an ongoing shift to services and experiences. We cannot predict when macro pressures will ease and are focused on controlling what we can control. However, we believe our strong balance sheet, continued disciplined approach to inventories, and fortification of fundamentals position us well.

Today, we’re reading and reacting to shifting consumer preferences in real time. We have remixed category and brand level receipts, pulled back on what’s not working, and chased into areas of strength. As we look to the remainder of the year, we are confident in the thoughtful and strategic promotional calendar and offerings we have planned, and our ability to pivot to the right inventory at the right time and right value. We will continue to leverage our data science tools to refine inventory composition, breadth and depth on a weekly basis and to further streamline decision-making to efficiently find and execute compelling opportunities that had a positive impact, both near and longer term. At Macy’s, for back to school, we have a compelling mix of relevant national brands, including Jordan Kids, Levi’s and Ralph Lauren, and are also offering a better selection of everyday basics, including uniforms.

For holiday, we are further amplifying our strength as a gift-giving destination. We have elevated the quality of our products. We have built strong value across our categories from top market to private brands. In beauty and gifting are a more significant piece of our fourth quarter strategy, accounting for over 40% of Macy’s brand sales versus mid-30s during the rest of the year. We anticipate a strong holiday for toys and we will be offering a Disney 100th anniversary collaboration in-store and online. This is the start of a longer-term strategic partnership with Disney and Toys R Us that will have elevated differentiated products across categories, brought to life through engaging retail experiences. At Bloomingdale’s, this holiday season, we are partnering with many of our luxury brands to introduce high touch, unique experiences, events, and pop-ups, curated around the interests and shopping patterns of our best customers.

These activations have been designed to create animation and inspiration in our stores and strengthen our client relationships. And at Bluemercury, we have an expanded fragrance offering for holiday, and we will launch our newest proprietary brand, which is focused on body and bath products. We are excited for the back half in all the ways we will serve our customer. Adrian will discuss our full year guidance in detail shortly, but it is important to note that despite elevated headwinds for credit card revenue and asset sales relative to prior outlook, we are reiterating our full year adjusted diluted EPS guidance. Before turning it over to Tony, I want to congratulate our teams on several milestones. At Macy’s, we recently introduced our newest private brand, On 34th.

Its target demographic is the 30 to 50-year-old woman on the go. Commentary has been very positive with, approximately 80% of product reviews receiving four stars or above. At Bloomingdale’s, we soft-launched Marketplace in July. Customers have been discovering and responding well to the new categories and brands offer. And at Bluemercury, we moved our headquarters from Washington, DC to New York City. The team is energized by this important step in its growth trajectory, which places them in one of the major beauty centers of the world, brings cost efficiencies and allows them to further benefit from the existing infrastructure of Macy’s, Inc. Looking ahead, we believe that our improving underlying fundamentals, five growth vectors, and elevated customer experience are key components to relevancy and success as a modern department store.

With that, Tony is going to discuss our five growth vectors and his approach to merchandising.

Tony Spring: Thank you, Jeff, and good morning, everyone. I want to begin by recognizing our teams for their dedication and the innovative work they are leading. I have always believed that balance of tenured and newer colleagues working together brings the most thoughtful and fresh perspectives, and I see that coming to life across Macy’s, Inc. organization. Last week, we announced the arrival of Max Magni, our Chief Customer and Digital Officer. Max has over 20 years of experience at McKinsey, most recently as a senior partner, co-leading their NextGen Commerce and Consumer Growth Practices. We’re excited to have Max join us and look forward to his contributions. Over the last several years, Jeff and Adrian have improved the operational efficiencies and financial health of the company.

This has been a key enabler of our transformation and the advancement of our five growth vectors. These factors are intertwined with the overarching strategy of keeping the customer at the center of everything we do. Our first growth vector is Macy’s private brand reimagination. As Jeff mentioned, we recently launched On 34th, which has been informed by direct consumer research. Results are encouraging, with sales exceeding expectations, and we believe On 34th has the potential to become one of our biggest private brands. Our team has been thoughtful in both the development and planned rollout of our updated private brand strategy. The reimagination work has been built on three key pillars. First, brand stewardship; second, design with intention and execute with attention; and third, provide a meaningful value equation.

From sourcing to marketing to merchandising, the teams have worked together to reflect our customers’ wants and needs. They have considered life stages to create products and brands that authentically resonate with and capture the hearts of current and prospective customers. With the reinvigoration of a proprietary portfolio, we expect to further drive customer loyalty by complementing our national brand matrix with differentiated products, which should ultimately benefit sales and gross margin. Through 2025, we will be refreshing or replacing all existing brands in our portfolio and plan to introduce four new ones, including On 34th. As part of our updated private brand strategy, last year, we successfully refreshed women’s I.N.C. In the second quarter, momentum for this popular brand continued, as sales once again outperformed its broader apparel segment.

In September, we’ll be introducing the next phase of I.N.C.’s refresh. Our second growth vector is small store format. We are pleased with the performance of our 10 small-format locations, which include eight Macy’s and two Bloomies. Macy’s and Bloomies stores that have been opened over year had a positive comparable owned-plus-licensed sales growth. Last weekend, we opened our ninth small-format Macy’s just outside Chicagoland area in Indiana. And in September, we’ll open two more. One will be in Las Vegas and the other will be in Boston, which is our first smaller format in the Northeast. In November, we will open a location in San Diego. Bloomingdale’s is also adding to its small-format portfolio, with plans to open a third location in November.

The store will be located in Seattle, which is a new brick-and-mortar market for the brand. Our third growth vector is digital marketplace, which offers curated categories and brands that seamlessly integrate with the customer experience and have no inventory risk. At Macy’s, we’re approaching the one-year anniversary of our Marketplace launch. We now offer approximately 1,350 brands on the platform, up from 500 last fiscal year-end, and we grew gross merchandise value by over 116% from the first quarter. At Macy’s Marketplace, we continue to see significant cross-shopping, higher average order value, and higher units per order. As Jeff mentioned earlier, we recently introduced Bloomingdale’s Marketplace and are pleased with the early results.

Our fourth growth vector is luxury, which spans Bloomingdale’s, Bluemercury, and Macy’s beauty. At Bloomingdale’s, we continue to optimize our relationship with our customers and elevate our luxury shopping experience. On the trailing 12-month basis, our top-of-the-list loyalty customer base grew in both count and spend. We know this customer loves the Bloomingdale’s shopping experience, and we have remodeled the Bloomingdale’s doors with larger concentration of luxury brands and products. Improvements have focused on areas with higher luxury goods penetration, including beauty, fragrances, shoes, handbags, and fine jewelry. Thus far, we have remodeled five locations and believe there is opportunity for more. At our smallest nameplate, Bluemercury, we realized the 10th consecutive quarter of comparable sales growth.

Active customer count on a trailing 12-month basis rose 20%, driven primarily by new customers. Bluemercury’s consistently strong performance is a testament to the work the team is doing to evolve the brand and product mix to stay ahead of trends and offer a more exclusive experience to the luxury skincare, and beauty customer. At Macy’s beauty, we’re expanding our luxury offering with an emphasis on newness, freshness in our core market brands, and in-store service. As we prepare for the holiday, we will lean into our leading fragrance positioning across our omnichannel shopping experiences and will introduce six additional beauty remodels, bringing the total to 39 locations. Our fifth growth vector is personalized offers and communications.

It amplifies strategies across our business to increase customer lifetime value and loyalty by improving relevance of every interaction. Our digital and technology teams are in the early stages of implementing multi-step and multi-channel tests. We recently launched several new tools that will allow us to speak even more consistently to our customers across touchpoints, personalized conversations and increase the amount of behaviorally-driven marketing. I am confident that our five growth vectors should drive incremental sales growth beginning next year and I look forward to continuing to update you on our progress. Before turning the call over to Adrian, I want to provide a few thoughts on our overarching merchandise strategy. Over the last several months, I’ve been spending time with the Macy’s team discussing the right balance of private and market brands and the importance of curation.

We are working together to combine their ideas and my experiences at Bloomingdale’s. Currently, we are targeting two major opportunities. First, going after the right categories, brands, and products that excite our customers; and second, maximizing sales and market share opportunity in underpenetrated categories where customers have signaled demand. In addition, we’re exploring how we can further establish ourselves as a compelling wholesale partner for current and potential top market brands. The upcoming additions of Nike and Under Armour are two great examples. We are a business committed to transforming, even in an environment that’s unpredictable. Despite the macro conditions and challenges, we remain focused on satisfying our customers’ desire to shop, off-price to luxury, digitally, on-mall or off-model, and from private brands to up-and-coming and established national brands.

Within that framework, our multi-channel, multi-generational, and multi-category platform is an advantage to address changing demand. I have confidence in our strategy and the team’s ability to execute, which sets us up for success even in this uncertain environment. With that, let me turn it over to Adrian.

Adrian Mitchell: Thanks, Tony, and good morning, everyone. I want to start this morning by thanking my finance and real estate teams for their ongoing dedication and hard work. And to my colleagues in stores, technology, and supply chain, I am grateful to partner with you more closely. In our last call, I shared the three fundamental areas of opportunity that we identified to build a faster, more flexible and more efficient operating model. First, improving the end-to-end omnichannel shopping experience; second, optimizing our physical store footprint, while enhancing inventory flow, merchandise planning, and localized assortment capabilities; and third, further modernizing our supply chain and technology infrastructure. Over the last few months, I have continued to align with our teams on how to simplify our processes, while providing more consistent shopping experiences that engage and inspire our customers.

I look forward to sharing more on this effort in the future. Now, let’s talk through the second quarter performance for our five value creation levers. First, omnichannel sales. Net sales of $5.13 billion declined 8.4% versus the prior year, slightly above the high end of our outlook. Comparable sales on an owned-plus-licensed basis decreased 7.3%. Owned AUR rose 4.7%, driven by ticket increases and category mix. For the remainder of the year, we expect continued AUR improvement on ticket increases, lower markdowns and category mix. Other revenue of $150 million were 2.9% of net sales. Macy’s Media Network revenue was flat to last year at $30 million. Our long-term confidence in Macy’s Media Network is tempered by near-term caution in light of broader industry trends.

During the quarter, credit card revenues declined 130 basis points or $84 million year-over-year to $120 million and represented 2.3% of net sales. We experienced an increased rate of delinquencies within the credit card portfolio across all stages of aged balances. While we had expected delinquencies to rise as part of our normalizing credit environment, the speed at which the increase occurred for us and the broader credit card industry since our first quarter earnings call was faster than planned. This negatively impacted second quarter results and led to an increase in the portfolio’s bad debt outlook. As a reminder, credit card revenues for the quarter include the pro-rata recognition of the updated annual bad debt assumption. We will discuss our annual outlook inclusive of the updated bad debt assumptions within the credit card portfolio in just a few moments.

The second value creation lever is gross margin. Our gross margin rate was 38.1%, 80 basis points below prior year, but above our outlook. Merchandise margin was 130 basis points lower than last year. During the quarter, we leveraged our data-driven processes and tools to maximize margins and sell-throughs of excess spring seasonal receipts. We surgically implemented clearance markdowns and promotions, which, while above last year’s levels, were lower than forecasted in our prior outlook. Merchandise margin also impacted by unfavorable category mix shifts and a shift in the timing of shortage recognition, partially offset by better inbound freight charges from our cost savings efforts. In relation to shortage we added a June physical inventory count in certain categories with low RFID penetration.

This helped us better understand shortage trends and informed our outlook and approach to receipt planning for the remainder of the year. The count did not materially change our annual assumption, but it did provide actuals for the categories counted in the second quarter. As a result, we adjusted our shortage accrual shifting a portion of the recognition out of the fourth quarter and into the second and third quarters. Lastly, delivery expense decreased 50 basis points from the prior year, primarily due to improved carrier rates from contract renegotiations as well as lower fuel costs and lower vendor direct volume. Now, let’s turn to our third value creation lever, inventory productivity. End of quarter inventory was down 10% year-over-year and down 18% to 2019, which should represent a low point for the fiscal year.

Trailing 12-month inventory turnover was roughly flat for last year. Inventory management is a key tenet to further improve the omnichannel customer experience. We’re committed to having current and compelling product at the appropriate receipt levels, based on expected sales demand. Expense discipline is the fourth value creation lever. SG&A expenses of $1.98 billion were better than our expectations, declining $31 million, or 1.5%, from prior year. SG&A as a percent of total revenue was 37.5%, 300 basis points higher than last year, reflecting the decline in year-over-year sales. Second quarter adjusted diluted EPS was $0.26 versus $1 in 2022. Better-than-expected sales, gross margin, and SG&A were offset by credit card revenues and shortage, which negatively impacted EPS by $0.11 and $0.04, respectively, relative to the midpoint of our prior outlook.

Combined, this was roughly a $0.15 impact to EPS. Lastly, the fifth value creation, lever capital allocation. During the first half, we generated $271 million of operating cash flow versus $303 million last year. The change was primarily due to lower earnings, partially offset by lower merchandise inventories and merchandise accounts payable. We had $564 million of capital expenditures. Free cash flow, inclusive of proceeds from real estate, was an outflow of $261 million. And year-to-date, we paid $90 million in dividends. Regarding capital deployment, in times of uncertainty, liquidity and a healthy balance sheet remain top priorities. They provide us the flexibility to respond to changing consumer and competitive trends, while continuing to invest in our core business and growth vectors.

Now, let’s discuss the full year and third quarter outlook. To level set, we continue to have a cautious view on the consumer. In addition to the headwinds discussed on prior earnings calls, the expiration of student loan forgiveness beginning in October, higher interest rate levels, and lower new job creation are all new pressures on the consumer. While we had contemplated these factors when providing an annual outlook on our last earnings call, it is still unknown how consumers will respond to them, especially after so many months of increased pressures. As such, we believe it is prudent to maintain our cautious view on the consumer and their capacity to spend on the discretionary categories we sell. Even with this backdrop, there is much that remains in our control.

Entering the third quarter, inventories are clean, current, and fresh with an improved fashion and seasonless composition at compelling values that we believe appropriately reflects demand. Quarter-to-date sales results are in line with our expectations on reduced year-over-year promotions and clearance activity. Now, that I’ve provided the framework on how we are thinking about the back half, let’s walk through our updated full year expectations. Our full year outlook now contemplates reduced credit card revenues and asset sale gains, both of which are fully offset by better-than-expected second quarter results and favorable changes in interest expense and share count. Our outlook continues to include approximately $200 million of cost savings discussed on our last earnings call.

For fiscal 2023, we now assume net sales of $22.8 billion to $23.2 billion. Comparable sales on a 52-week owned-plus-licensed basis to be down about 7.5% to down 6% to last year. As a reminder, compares ease in the third and fourth quarters. Other revenue to be about 3.2% of net sales, with credit card revenues accounting for roughly 80% to 81% of that. The increased bad debt expectation for the credit card portfolio has resulted in a reduction in our annual forecast of roughly $80 million relative to our prior expectation. Given the magnitude of the credit card revenue impact, I want to take a moment to provide additional color. Credit card revenues are predominantly driven by the level and health of sales and receivables generated from our proprietary and co-brand credit cards.

While we have seen an increase in revenues as interest rates have risen, that has been more than offset by higher bad debt assumptions and write-offs. These bad debt assumptions and write-offs are the result of rising delinquencies, which leads to higher net credit losses over time and contributes to increased bad debt within the portfolio. We are working closely with our bank partner, Citibank, to mitigate the rising bad debt by adjusting underwriting strategies. We also remain focused on acquiring new customers and retaining our active customer base as we communicate future personalized value to our customers. But we are not assuming any benefits in the near term. Additionally, potential regulatory changes regarding late fees are still pending.

We’ll keep you updated as we learn more. Returning to the remaining line items, we are anticipating a gross margin rate of 38.3% to 38.6%, which is slightly better than our prior expectations of 38% to 38.5%. Our assumption for shortage, which impacts gross margin, remains materially unchanged. Shortage continues to be a headwind, and we are focused on a variety of mitigation strategies, including testing the use of advanced technology, reporting, and tools; moving high-theft product away from entrances in our stores, optimizing asset protection staffing to target high-risk areas and collaborating with external parties to advocate for legislative change. Now let’s turn to SG&A. SG&A as a percent of total revenue is expected to be 35.6% to 35.2%, or 36.7% to 36.4% as a percent of net sales, reflecting ongoing expense discipline efforts with additional risk on the low end, given the importance of protecting the customer experience.

Asset sale gains are now expected to be approximately $50 million, with nearly all the remaining gains anticipated in the fourth quarter. While the real estate market has become more challenging in light of higher interest rates, there is no change to our asset monetization strategies. We are confident in the value of our assets, have seen these cycles before, and we’ll be patient to ensure we receive the appropriate valuations for our properties. Fortunately, we have the balance sheet to do so. We expect to achieve adjusted EBITDA as a percent of total revenue of roughly 8.7% to 9.4%, or 9% to 9.7% as a percent of net sales. Interest expense is now expected to be approximately $160 million. After interest and taxes, we are maintaining our annual adjusted diluted EPS of $2.70 to $3.20, which reflects an updated annual diluted shares expectation of roughly 279 million shares.

There are lots of moving parts to our annual EPS outlook. To summarize, relative to our prior expectation, gross margin, SG&A, and shares are the primary benefits. When looking at the low and high end of our current outlook compared to what we discussed on our first quarter call, gross margin, inclusive of volume and mix, is positively contributing an incremental $0.14 to the low end and $0.06 to the high end of our prior outlook. SG&A is contributing an incremental $0.06 to $0.19. And together, lower share count and interest expense are contributing an incremental $0.04. These factors reflect solid execution in our core business and represents a $0.24 to $0.29 benefit relative to our prior outlook. On the flip side, reduced credit card revenues are a $0.21 to $0.22 drag on the low end and high end of our prior outlook, while lower asset sale gains are a $0.03 to $0.07 negative impact.

Combined, this also represents $0.24 to $0.29, essentially canceling each other out. Our adjusted diluted EPS guidance does not assume potential share repurchases. For the third quarter, we expect net sales of $4.75 billion to $4.85 billion, gross margin rate to be at least 140 basis points better than the third quarter of 2022. As a reminder, last year, Macy’s had elevated promotions and markdowns to clear excess receipts in warm weather seasonal goods and slower-moving pandemic-related categories, including casual apparel and soft home. Adjusted diluted EPS down $0.03 to up $0.02, inclusive of our updated credit card revenues outlook and the timing shift in the recognition of shortage. End of quarter inventories to be down low-to-mid single-digits to last year on a percentage basis as we begin to introduce Nike and further support On 34th and INC private brands.

Looking ahead, we remain committed to achieving low-single digit sales growth beginning next year and believe that improved underlying fundamentals and the early contributions of our five growth vectors will provide an offset to ongoing macro pressures impacting our consumer. However, we do have additional external factors that are more difficult to combat. If recent trends in credit card revenues, shortage, and asset sale gains continue, and late fee regulatory changes are passed, the ability to achieve low-double digit EBITDA margin in ’24 becomes more challenging. Now, to be clear, there have been no changes to the underlying assumptions and opportunities regarding the rest of our business. We’re actively working to offset headwinds, prioritize growth, and we’ll share more as the year progresses.

I’ll now turn the call back over to Jeff for some closing remarks.

Jeff Gennette: Thank you, Adrian and Tony. It has been exciting to watch you two collaborate on innovative ways of opportunity that reflect your unique lenses and backgrounds, and I am confident that you will lead Macy’s, Inc. to sustainable long-term profitable growth. Now, operator, we will now open it up for Q&A.

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Q&A Session

Operator: Thank you. The floor is now open for questions. [Operator Instructions] Today’s first question is coming from Oliver Chen of TD Cowen. Please go ahead.

Oliver Chen: Hi, Jeff, Tony, Adrian, good morning. 2Qs were — 2Q revenue and margins were encouragingly better. What was the driver behind that? And as we look at 3Q guidance being below Street, I assume it’s primarily the credit card delinquency, bad debt expense. AURs were also encouragingly up. What was the offset to that? We assume it could have been traffic. And a follow-up, as you think about longer term, the small-format opportunity, how are you dimensionalizing the addressable market there? Thank you.

Adrian Mitchell: All right. So, Oliver, good morning to you. It’s great to be with you. So look, despite the timing shift that we recognized with shortage, we achieved the gross margin rate in the second quarter ahead of our expectation. So, we were actually quite pleased with that. Now, while the second quarter was more promotional than last year as we worked to clear a lot of the seasonal product that we talked about, it was less promotional than we had anticipated. We leaned into a lot of our strategic and personalized promotions. We’ve been into our pricing science, as we’ve talked about prior. But look, leveraging the data-driven processes that we’ve had in place and been using for the last couple of years allowed us to really maximize our margins and sell-throughs as we actually exited the spring season.

Now, as we did in previous seasons, we’re actually able to clear through a lot of the seasonal product that we’ve spoken about several weeks ahead of schedule. So, we’re continuing to take these behaviors into the back half of the year.

Jeff Gennette: The other thing I’d add on that, Oliver, would be just our inventory is in a great position. So, exiting the third quarter, down 10%, we have been able to retain a lot of liquidity that will respond to customer interest. But our stock-to-sales ratios are good by category. The third quarter has started at expectation. We’re looking at the back-to-school read, as well as really all new fall fashion and how that’s performing. And we have confidence as we go into the fourth quarter on our strategies.

Adrian Mitchell: If I could just answer your last question, Oliver, with regards to small-format stores, we’re very excited about the growing impact of our small-format stores. As you know, we remain in the early stages of continuing to scale this opportunity, but we did announce that we’re opening up a number of stores this fall. Chicagoland, Boston, Las Vegas, San Diego are several locations where we’ll be opening up our small-format Macy’s stores. And in the Seattle market, we’ll be opening up a small format Bloomingdale’s. Last week, we did open up a store in Chicagoland. But as we think about the quality of experience for our customers, we continue to see positive signals in terms of the financial performance and the customer experience within these stores. So, we’re actively evaluating potential locations across the country that will enable us to accelerate growth at the appropriate time. So more to come on this topic.

Oliver Chen: Best regards. Thanks.

Adrian Mitchell: Thank you.

Operator: Thank you. The next question is coming from Matthew Boss of JPMorgan. Please go ahead.

Matthew Boss: Great. Thanks. So, Tony, could you just elaborate on the key strategic initiatives that you believe best positions Macy’s for a return to revenue growth next year? And then Adrian, any notable differences in topline by income cohort that you’re seeing today, maybe relative to three months ago? Any change in macro that you’re embedding for the back half of the year? And then just given the potential external changes that you mentioned, how best to think about a range of EBITDA margin outcomes for next year relative to the low double-digit target that you’ve laid out?

Tony Spring: Thanks for the question, Matt. Let me begin with the opportunities for growth. Just as a reminder, I’ve been a part of the Macy’s executive leadership team for the last few years and working closely with Adrian and Jeff and other senior leaders the last few months. And I remain bullish on the opportunities for the entire portfolio. And remember, Macy’s, Inc. is a portfolio company with, obviously, power in the Macy’s brand, Bloomingdale’s brand and Bluemercury brands. I believe that our opportunity remains in going off-price to luxury, multi-brand, multi-category. And these five growth vectors are designed to help us to amplify our business. They are designed around merchandise, which includes private brand and making sure that we are bringing the most important market brands to all of our portfolio.

The reintroduction of Nike and the announcement of Under Armour is a good example of that. It’s strengthening our marketing, but on a more personalized basis, with specific offers that are right for that customer, at the level of modernization in our marketing, it’s also making sure that our portfolio has the right number of stores in the right locations that include the quality malls that we’re in today as well as, as Adrian described, the right small-format locations that densify, replace existing stores that may not be as productive or allow us to enter new markets. The luxury business is a piece of the puzzle that we feel very strongly about. It underscores the importance of Bloomingdale’s and Bluemercury, but also gives us the opportunity to expand the Macy’s beauty business.