Good morning and welcome to the Macy's Inc. Second Quarter 2018 Earnings Conference Call. Today's conference is being recorded. I would now like to turn the conference over to Monica Koehler, Vice President, Investor Relations and Finance. Please go ahead.

Good morning, and welcome to the Macy’s Inc. conference call scheduled to discuss our second quarter earnings and outlook for the remainder of the year. Joining us on the call today are Jeff Gennette, Chairman and Chief Executive Officer; and Paula Price, Chief Financial Officer. Any transcription or other reproduction of the statements made in this call without our consent is prohibited. A replay of the call will be available on our website, www.macysinc.com, beginning approximately two hours after the call concludes. Keep in mind that all forward-looking statements are subject to the safe harbor provision 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 the company’s filings with the securities and exchange commission. In discussing the results of our operations, we will be providing adjusted net income and adjusted diluted earnings per share amounts that exclude the following. The impact of impairment and other costs, settlement charges associated with our defined benefit plans and loss or gains on the early retirement of debt. You can find additional important information regarding these non-GAAP financial measures, as well as others used in our earnings release and during this call on the investors section of our website. We look forward to taking your questions after our prepared remarks. With that, I’ll turn the call over to Jeff.

Thank you, Monica. Good morning, everybody and thank you for joining the call. First, I want to introduce Paula Price. Paula joined Macy’s Inc. as the Chief Financial Officer in early July. Paula is a strong addition to the team and she has hit the ground running. I also want to thank again, Karen Hoguet for all that she is doing to help make this is a smooth transition before her much deserved retirement. Karen has been a great partner to me and an exceptional leader for Macy’s Inc. and for the industry. So, this morning I’m going to share a perspective on the second quarter, then Paula will take you through the details of the quarter, as well as updated guidance, and then we’ll open up the line for your questions. As you saw in this mornings press release, Macy’s Inc. had another strong quarter. This was our third consecutive quarter of comparable sales growth and reflects ongoing improvement in the business that we saw first in the fourth quarter of 2017. It is early innings, but I feel about feel good about the progress that we’ve made, the focus and energy of the team, and the positive response our customers have to our strategy. Before we get started, I want to note as we said in our press release, last weeks or last year's 53-week calendar caused some shifts in our 2018 promotional calendar. Today, in my comments and in those of Paula, we will provide you with both second quarter and first half views where we think it is helpful. So, this is how we’re gauging the strength of the business and we want to give you the same level of detail. For the second quarter, comparable sales were up 0.5% on an owned plus licensed basis,…

Thank you, Jeff. I am so pleased to be a part of the Macy's Inc. team and I’m looking forward to updating you on the financial progress of our journey. I too would like to congratulate Karen on her retirement, and to thank her for the effort that she has put into making sure that I have a great beginning at Macy's Inc. I truly appreciate her support. As Jeff mentioned, I will provide some detail on the second quarter, and also offer some perspective on how we're thinking about the year. And then, I will share a few of my very early observations on the business. I remind you that my commentary includes certain financial measures adjusted for the impact of impairment, and other cost, settlement charges associated with our defined benefit plans, and losses or gains on the early retirement of debt. Sales in the second quarter were $5.57 billion, up 50 basis points over last year and an owned plus licensed comparable basis, which was better than we expected. The quarter was negatively impacted by the shift of Friends and Family promotional event into the first quarter of this year, as compared to the second quarter last year. Excluding the 240 basis points of negative impact, due to this shift comparable sales on an owned plus licensed basis increased an estimated 2.9% in the second quarter. Due to the materiality of the Friends and Family shift, which impacted the first quarter positively and the second quarter negatively, as Jeff mentioned, we are providing first half metrics where appropriate to facilitate a more meaningful comparison to the prior year. For the first half of the year, sales were up 1.1% in total, and up 2.3% on an owned, plus licensed comparable basis, much stronger than we expected at…

Thanks, Paula. So, before we open up the line for questions, let me sum things up. We're delivering strong operational performance, which is amplified by a healthy consumer spending environment. Our brick-and-mortar business has shown meaningful improvements and our digital business continues with strong consistent growth. The North Star Strategy strategic initiatives are gaining traction, and drove the third consecutive quarter of comparable sales growth. We have momentum heading into the back half of the year. And with that, we’ll open up the line and Paula and I will take your questions.

Thank you. [Operator Instructions] We will now take our first question from Matthew Boss, JPMorgan. Please go-ahead sir.

Thanks. Jeff can you help us break down the improvement in first half same-store sales, maybe between the stronger underlying consumer you are seeing and your company specific initiatives? And just also, how you're thinking about back half international tourist sales given, I think you mentioned a roughly 700 basis points sequential slowdown versus what you saw in the first quarter?

So, I think Matt that, certainly the trend of the business in the first half was buoyed with a strong consumer sentiment and good spending across all of our retail. And so, I think that’s a piece of our trend, but when you look at Macy's performance to general market, in 2018 versus what we were in 2017 you definitely see a big narrowing. And our, I believe that gap that narrowing of gap is really related to our strategies. And so, our strategies are really related to, how we're going to take care of a customer and that’s across anyway that she shops with us. So, really happy with the strong digital growth. We continue to invest there. We're getting double-digit growth there, both in the first and the second quarter. Putting a lot of investment into mobile. And we're going to pass in 2018 $1 billion in mobile sales, but it’s much more than that. You know how the customer really uses that for really understanding the brand, checking out customer reviews, navigating the store Mobile Checkout, mobile app is a real gateway for us, and we're going to continue to strengthen that, but the part of the strategy that I’m most excited about is the firming up of brick-and-mortar trends. And really across the fleet it is we saw improvement and that’s the big difference in our business in 2018 versus 2017 is what’s happening in brick-and-mortar. So, very excited about that. And I expect that to carry us into the back half of 2018. To your international tourist question, I think we have to also look at what happened in second and first quarter, what happened in international tourism is what happened in Macy's customers at large that there was a shift as a result of the international tourism or excuse me of Friends and Family, and so what we want to look at is really the first half performance of international tourism, which is up about 6% when you look at the Macy's and Bloomingdale's plates. So, we expect that international tourism will remain up in the back half of the year around that Spring level.

Great. And then just a follow-up on the P&L. On the expense front, I guess as your offensive initiatives accelerate into next year, should we be thinking about also a step-up in SG&A as we think about next year on the expense front or do you see continued operational efficiencies to offset this?

We're looking at that right now. We haven't finalized all of our 2019 planning, but we’re obviously looking at, where are those inefficiencies that we have in our overall strategy that the customer doesn't value, and making sure that we're making those appropriate cuts like there’s a lot of opportunities that the customer is voting on that we want to make sure we're fueling, but I just wouldn't remind you that we’re good at cost control. We’ve done a great deal with getting out extraneous expense. We’re a much linear organization then we were even last year, and we’re totally focused on doing what’s right to drive profitable sales and taking care of a customer that expects out of us.

That’s great. Best of luck.

Thanks Matt.

We will now take our next question from Paul Trussell, Deutsche Bank. Please go-ahead sir.

Good morning. I wanted to enquire about the EPS revision higher for the year, if you can just walk through all of the components that led to the increase? Certainly, we see your confidence on the top line and I think you also mentioned a higher credit revenue expectation, but if you could just walk us through all the puts and takes as we think about asset sales and kind of below the line items, just so we have a full understanding of what’s led to the incremental raise [ph]?

Okay. So, our sales and earnings guidance for the full-year reflects our strong performance in the first half, as well as our increased confidence in our fall expectations. And so, our sales guidance for fall is up 2% to 2.5% on a comparable owned licensed basis. And this is fairly consistent with our strong performance in the first half where we performed better than we expected, but it also considers that in the fall we’re cycling a very strong quarter from last year. We also guided our credit revenue up and our asset sale gains continued to be the same at $300 million to $325 million for the year, and we’re making progress against that. And our interest expense is down, and that’s based on the debt repurchase that we did earlier than we expected. So, we’re already seeing that effect, and so, as we stated at the beginning of the year, we are investing in the business and we’re continuing to do so in the fall season. For example, in our enhanced loyalty program and in our strategic initiative. And fall SG&A will be impacted by investments in our strategic initiatives, while our fall gross margin will be impacted due to increased delivery expense for our most loyal customers. And then gross margin will also be impacted by our growing digital business, which ramps up in the fall season and this along with our reduction in our tax rate is all reflected in our guidance for the year.

That’s helpful color. Thank you. And as we just think about the composition of the comp, AUR was up meaningfully, if you can just discuss the drivers of that gain and how you think about or how we should think about transactions in UPT over the balance of the year as well?

So, I would say on that Paul is that, our inventory is in great shape and so when you look at the first half of the year, as Paula mentioned, we brought in a lot of residual inventory in 2017 from the holiday season of 2016 that didn’t sell. So, I would tell you that the AUR in the Spring of 2017 reflected that. We had to liquidate a lot of inventory. We came in really clean in 2018. So, we were cycling – and cycle through that. So that gave us the option of really making sure that by making sure that our stock was in parity with the sales that would follow it, we call lag receipts. We can stay really close to the customer in terms of what she was expecting of us, which she wants tasty, new fashion that we put in front of her, and so that’s what we did. So, what we found is that, we’re rarely farther along and pricing the analytics than ever, we're able to gauge customer demand, we’re able to make a lot more out of regular price, and first markdown selling, and that’s what you saw drove the AUR increase of almost 5% in the first half of the year. So, keeping our inventories in line, keeping completely sync to customer demand and seasonal changes, selling more regular price, selling more fashion that’s where our AUR, you saw the beat there, and what I expect to take into the balance of the year.

Thank you. Best of luck.

Thank you.

We will now take our next question from Lorraine Hutchinson of Bank of America. Please go ahead.

Thank you, good morning. You spoke on the call about earlier inventory receipts to address an extra back-to-school week in the second quarter, how much does that extra week benefit your comp in 2Q?

We think it’s slight Lorraine. I think what’s important is just to understand what happened in the month of July just in general. So, July was definitely our strongest month from a comp performance of the quarter. And so, we certainly wanted to accelerate back-to-school receipts and be ready because we had a lot of customers that were going back earlier, and just because of the calendar shift we were there and ready with all back-to-school receipts. We obviously had a strong digital business. Black Friday in July played well for us, but we had great strength in some of the other businesses where we were in a much better inventory position with fresh goods. So, when you look at fine jewelry, you look dresses, men’s, certainly kids as mentioned. So, had a good performance in the July season and a lot of those because we had the inventory and freshness there for our customer.

Thank you. And when you’re thinking about the Growth50, where these stores completely up and running throughout the entirety of the second quarter or was that one of the drivers in July that could persist through the back half?

Yes, what happened with Growth50 was we made a lot of changes in the beginning of the year. I give the stores organization a great deal of credit for what they did with talent, and when you look at the management talent, and you look at the focus on that frontline colleague talent, all of those efforts went into play all the way through the spring season and we got good traction from that. The things that are coming on right now in Growth50 is the capital expenses. So, we've improved lighting levels, surface levels, rest rooms all that, that really came in in the second quarter, but with respect to what we’re doing with furniture and what we’re doing with backstage, those are changes that are coming online right now. That’s going to happen really in the third quarter. We’re looking to mitigate the disruption that that’s going to cause in our third quarter business and those particular stores, we’re going to do as much of that work at night as possible, but all those changes are coming now. But I will tell you that we’re getting better traction out of the Growth50 that we initially anticipated in the first half of the year, as well as many of our other initiatives, but we do think there is some, that will continue into the back half of the year, but also with new capital that is going to also help us with fourth quarter business.

Right, thank you.

We will now take our next question from Brian Tunick, Royal Bank of Canada. Please go ahead, sir.

Great. Thanks very much. Was hoping maybe you could give some perspective around the Growth50, and the backstage stores. Maybe talk about even on the first half basis, how they performed versus the balance of the change? Just curious. And then maybe if you could help us understand how much digital penetration grows in Q4 versus the first nine months of the year. Just so we have an understanding of how much delivery pressure there should be on gross margins in the fourth quarter? Thank you very much.

So, Brian, let me just take both your questions. So, the first thing on Growth50, so just to go back that – I think the Macy’s competitive mode is robust digital growth, healthy brick-and-mortar, and a great mobile app. And so, I felt buckets one and three there, we have an investment strategy, we're winning in both of those categories continue to see us do well there. It was really how we would solve brick-and-mortar and very happy with the early testing that we did in 2017 and then what we’re learning from the Growth50 strategies. So, all of our Growth50 strategies is a 5P approach, it’s focusing on product and value, it’s focusing on presentation, it’s focusing on process, it’s focusing on promotion, but the most important one it’s focusing on people. And with all the efforts that we put against that, we’re very satisfied with the results we're getting. To your question about trend change, our trend change in brick-and-mortar has been marked since 2017, and it’s even more marked when you look at Growth50 versus the balance of brick-and-mortar. We expect to carry those trends into the back half of the year. The other thing that’s important to note about growth 50 is how the customer is responding to the changes that we’re making, and what Paula quoted in terms of our net promoter score is up seven full points in Growth50, it’s up almost 10. So, the customer is really liking what we're doing with respect to that. With respect to your question, we don't break-out digital growth. Digital growth is a more penetrated piece of our business on the fourth quarter. And when you think about Cyber Monday, you think about Black Friday that fuels a great deal of volume that we are doing, as well as what we're doing with vendor direct. So, when you think about vendor direct, as one of our five initiatives, we’re basically almost doubling the amount of skews that we had in our inventory, and at the back half of 2017, and where we’re going to be by the – going into the fourth quarter of 2018. So, that’s a lot of sales that we’re banking on that’s going to be digital, that’s going to be fulfilled by a vendor. We want to own the inventory until we consummate the sale, but that’s part of the digital growth and then there are shipping costs that are recorded to that. So, that’s how I’d respond to digital.

And I think just my question on backstage, you know what you're seeing in the first half in those stores that now have it versus a year ago, what kind of comp lift are you seeing in either year one or year two now?

So, in backstage this has been a good story for us. We came into the year with an investment thesis. We’re now executing that. So, as we said in our comments we’ve got 65 doors that we’ve opened in backstage in the first half of the year. We’ve got another 60 or so that are coming in by the end of the third quarter. So, we’ll have about 120 that we will have added in 2018, added to the 40 some that we had in prior. So, that’s all making our plans right now, we're going through a lot of adding this, lot of construction, lot of making the openings in each of the stores, building that out, and we’re satisfied with our results there. I think one of the things that I talked about on previous calls was how would backstage perform in its second full-year and so one of the things we watch very carefully are those doors that were opened in 2017 and 2016, and how are they lapping that first year's business. And I'm pleased to say that we’re getting positive growth in the balance of those doors. So, this is clearly a strategy that’s resonating with our customer and really having the only half-price full-price store that’s on mall, it is a competitive advantage we believe and our history and our progress with Backstage is giving us further confidence on that subject. So, as mentioned, we're going to be bringing backstage to the West Coast. West Coast we had some ads in the second quarter, and we’re starting to put it into some of our premium doors. So, this is an evolving story of Backstage at Macy's.

Thanks, and good luck guys.

Thank you.

We will now take our next question from Chuck Grom, Gordon Haskett. Please go-ahead sir.

Hi, thanks, good morning. Paula, on the guide, your front half of the year comps were up about 2%, you are basically guiding to that level in the second half which is a little bit different than your former review, which I think was a second half greater than the front half, any reason for that change and then just any early reads on back-to-school line, I know it is early for you guys, but any update on the trend there?

So, I’ll take the first part. The performance in our first half was really quite strong and so when we looked to our second half, it’s still very strong. So, we are continuing with that momentum into the second half, but we are performing basically on the early delivery of all of our strategic initiatives, and so that gives us confidence about the second half, but our first half was really very strong. In the second half, we are also cycling a very strong fourth quarter, and so we are considering all of that in our fall guide.

And then Chuck on the back to school question, it started out well. You know, to Lorraine’s earlier question, we were in a good position with back-to-school receipts, and so the customer that was in our stores really and starting in June for some of our southern markets as well as the entire month of July we’re getting great traction, and our kids business is one of the strongest in the entire store, and that’s across boys and girls that’s not just active that’s uniforms, that’s sportswear, very strong. We also repositioned denim in our millennial world. So, that’s really juniors and some of the price points in missy sportswear. And that denim area is doing quite well, which is triggering back-to-school business. So, happy with how it has started.

Okay, that’s great. And then, lot of talk here about Backstage, I think you said, going to go into 125 stores this year, and obviously the Growth50 is going to be in 50 stores this year, but you have about, close to 700 stores, when you think out to 2019 and 2020, what do you think that the pipeline looks like for our deeper rollout of both Backstage and Growth50 into more doors down the road?

Well, first-off, I would say that we’re happy right now with our portfolio and we like where our brick-and-mortar is positioned across the nation, and so every store has a role to play. And so, what you hear is we are not just investing in Growth50 or Backstage, but we’re also looking at what are the opportunities that we have in each of our buildings. So, At Your Service, Mobile Checkout, really what we're doing with merchandising value and all the other doors. But think about Backstage is really – Backstage really went into some of the lower tier stores in 2000 [ph] and really for the full rollout. We would continue with that. So, when you look at some of the doors that are not our tops doors Backstage is in many of those. We're now starting to experiment with Backstage in our most premium doors, and so that’s coming online right now and in the beginning of third quarter. So, we’ll be measuring that very carefully. So, then with respect to Growth50, we’re learning a lot. What we wanted to make sure of in Growth50 is that we had a scalable investment that all the testing could be scaled into a lot more doors. And so, we're learning from what is working, what the customer is voting on, what they want to see more off, and that which they’re not as excited about. So, we're learning from all of that. We expect to continue with those learnings through the back half of this year and be ready with the right level of investment in more doors in 2019.

That’s great. And just, Paula, just real quick on guide. You guided last quarter asset sales to $300 million to $325 million just wanted to make sure that hat view is unchanged on that line item?

Yes. We're sticking on our guidance for the full-year of $300 million to $325 million at the annual guidance, and I Magnin, we’re expecting some time in the fourth quarter in case you're curious?

That's helpful. Thanks

And just to make that clear, Chuck this is the size of the I Magnin. That’s the bulk of that 300 million to 325 million is I Magnin. So, we expect that to go through in the fourth quarter.

Okay, great. Thanks for clarifying.

We will now take our next question from Bob Drbul of Guggenheim Securities. Please go-ahead sir.

Good morning. Just a couple of questions for me. First, when you look at the traffic trends, excluding the shift in the second quarter that you had, can you just talk to that briefly, adjusted when you move the Friends and Family out, and I think for the extra week, so wonder if you could talk to that first. The second question is, on the credit card income, can you talk – in the 720 million to 730 million assumption, what’s your assumption on the penetration rate going forward? And then third question I have is just on the beauty category. I was wondering if you could talk to ex-Bluemercury the beauty category at Macy's, the promotional levels that you’re seeing and the margins that you're seeing in that category? Thank you.

So, Bob I’m going to take one and three of your questions, and Paula will take credit. But let me just talk about transactions. So, I think the number that Paula was quoting is a really good sign for us. So, the fact that transactions were up in the first half to last year is a very good sign for us. And then once they are on our site or in our buildings, I feel good about our ability to convert them at deeper levels with the right merchandise, and the right services. So, we are tracking with that. So, we expect that to continue into the back half of the year. You know, when you think about how many customers you have in our building, and how many we convert on, we always have opportunity with that and with the right service levels, the right content, the right values, I like our chances there. I’ll talk about beauty, and then let Paula take credit. But with the beauty category, what I love about beauty is that it’s fairly broad. It’s our front door. Its color, its treatment, and its fragrances, and you’ve heard us talk about fragrances as one of our strongest categories in the front half of 2018. We’re banging on all cylinders with respect to the fragrance business. We’ve got all the launches. We got exclusive product. You know, we're selling jumbos, which is the bigger size, our customer loves that. So, our fragrance business and we expect that to continue into the back half of the year. We’re also winning in a number of our color and treatment lines. We're really migrating our strategy from a brand centric to a customer centric strategy and really liked the leadership of our team, and how we're approaching that. Our Growth50 stores is a laboratory for. We had early testing that went into our Woodbridge store. So, you will have a dedicated beauty advisor by line, but then they are cross-trained against other lines. Our customer is liking that. The customer service score with a net promoter score is way up and beauty, as a result of the service that we’re providing and we’re also going to more opening south. So, we’re able to get more content and more newness into more doors as a result of all of those measures. So, we're still working through color and treatment. We’ve got some formidable competition and we're very focused on taking care of our customer. So, fragrances will continue and we’re continuing to work on everything we’re doing in beauty.

And so, Bob on the credit revenue, we are guiding up to 720 million to 735 million as I mentioned, and that business continues to perform in a very healthy way. We had 46.6% of penetration, up 60 basis points from last year and so we’re expecting that business to continue to perform in a healthy way and so that’s what it is reflected in our guidance.

Okay great. Thank you very much.

We will now take our next question from Dana Telsey of Telsey Advisory Group. Please go ahead.

Hi, good morning everyone, and welcome Paula. Can you talk a little bit more on delivery expense, how that’s progressing, how you see that expense development going forward? And then Jeff you mentioned about the vendor direct offerings, where are we in that, how many SKUs, how many categories should it be? And lastly, just anything more detail on category performance, what’s doing well, what didn't do as well? Thank you.

So, let me take the last two, and we’ll talk about delivery after that. So, we talked about category performance. So, it’s what we put in the press release on that Dana. Really men's and kid’s standard-outs in the front half and really across all categories. When you look at some of the fine jewelry business, it was very strong. I mentioned fragrances are being very strong, women's shoes was strong, Big Ticket furniture was quite strong, our home categories are performing well beyond our expectation. Parts have already went to dress business, active across the entire store has all been good. So, happy with that. You want to talk about vendor?

Yes, sure. So, we are seeing the benefits of our loyalty program. It shows up in our increased retail sales, and it also shows up in our credit income, and it shows up in our higher delivery expense, and so, as we mentioned, we expected our digital business and loyalty business to ramp up in the second half of the year. So, we’ll see a progress, a progression over the second half of the year. And also, in the third quarter, we’re launching the – we're cycling the launch of our Star Rewards loyalty program, which comes with extra shipping, which our customers greatly appreciate, but that will impact our delivery expense as well and will impact our gross margin. And so again, there are two factors, one is that in versus October in the third quarter, we are launching – we're cycling the launch of the Star Rewards program and we’re expecting to see the impact of our digital business, which naturally ramps up in the back half of the year.

And then Dana to your question about vendor direct. We’re in the early innings of this, but we are making great progress. We are at our target of new vendors that we are adding. Just to remind everybody that we had about a 6 to 1 ratio of the number of SKU units that were online versus an average store, where that is low, compared to virtually every one of our multichannel competitors. And so, we were adding significant amount of new content, and this is really, you know we look first at what the customers said. Where did we have failed searches, where did we have great brands that are in our portfolio that we could add more assortment based on what they offered on their own sites? What are categories that customers expect of Macy's that we could and should add? So, we’re in the beginning stages of all of that, but we’re well on track. So, we’ve added. We’re on track to basically almost double the amount of SKUs by the end of October, and we’re already seeing early signs of customers responding to that amount of content. So, you know the way we look at it is that we curate for customers and store. She curates for herself online and so having a wide assortment or endless aisle just makes us competitive, the customers expect more content from the Macy's brand and this is the right strategy for us.

Thank you.

We will now take our next question from Michael Binetti of Credit Suisse. Please go-ahead sir. Your line is open

Hi, good morning and let me add my welcome Paula.

Thank you, Michael.

Assuming you help us just straighten out something for the modelling, just there is no confusion coming after this call, I think you helped tell us the gross margins would be a little low for a few reasons in the fall, and we have characterized that as third quarter, but I think a lot of that seems drivers and dynamics that you just described through Q&A should continue in 4Q, so can you just help us just clarify whether you think, you see gross margin expanding or contracting relative to 4Q last year when we get to the fourth quarter this year?

So, we expect the fourth quarter, overall, to be down. In terms of gross margin, we expect it to be done more in the third quarter than in the fourth quarter. Again, we're cycling the launch of the Star Rewards loyalty program last year, and so that’s sort of the dynamics for the half year, but for the full-year we expect gross margins to be up slightly.

So, Michael, just – I would add to what Paula said. We expect that merchandise margin is going to continue to increase versus last year in both third quarter and fourth quarter. It is just the offset of the increased delivery that we’re getting from the new loyalty program and then the highly penetrated digital business that’s growing at a double-digit rate in the back half of this year. So, again, we will be up slightly on overall gross margin on the full-year but we're going to give back some of the increase that we had in Spring, based on where shipping is growing and how much traction we’re getting in this loyalty program. So, this is all good. It’s all factored in our guidance to you and we feel good about our strategy here.

Right. Okay. So, I guess more fairly, thinking multi-year, I think the dynamics that you mentioned in merchandise margin and how that rounds up to a gross margin, if, I think if you look back at this year and say gross margins for you and for the industry you are going to catch up year after some inventory cleaning in 2017, but as you look out to 2019 on a multiyear basis, on a more apples-to-apples comparison for your business and consider those initiatives, do you think gross margins continue to expand in 2019 or do those dynamics like the growth of digital loyalty backstage, I mean the blended gross margins are more of like a flat to down based on the business mix change that you see?

So, let me take it in a couple of parts. I would expect the delivery expenses going to continue to rise, just based on the momentum that we're getting in digital, and what’s going on with our loyalty program. So, I would expect that’s going to be a rise, but I also expect merchandise margin to go up as well. So, when you think about our path to getting great product for our customers, and our ability to control that in many cases, you know we're moving towards a 40% exclusive mark with our content. So, I would expect that when you look at our private brands and you look at our exclusive brands and capsules that we can get more margin growth in those as an offset to some of the increased expenses that we’re getting on the shipping line. So, too early to tell you exactly where we’re going to land in 2019, but we're working on both those ends.

Okay. Thanks a lot, guys.

We would now take our next question from Brian Callen of Bank of America Merrill Lynch. Please go ahead.

Hi, good morning. Thank you. Paula, in terms of thinking about the back half and debt reduction relative to your comment about this quarter's acceleration of debt reduction, I guess how are you thinking about leverage relative to your target range now? And then separately, is there more proactive debt reduction to occur or sort of how do you manage that against thinking about your credit ratings?

Thank you. Let me just take a step back, and talk about our capital allocation strategy, which is what I think you’re getting at here. Our capital allocation strategy has not changed, and we continuously make our capital deployment decisions consistent with the strategy as our business results unfold, and so our priorities for deploying capital continue to be first investing in our business to fuel profitable growth and for example in 2018, we intend to invest $1.05 billion in capital expenditures. Second, maintaining our healthy balance sheet for a financial flexibility. We want to be prepared for both opportunities, as well as a potential economic downturn. And our target leverage ratio continues to be 2.5 times to 2.8 times. And third, returning excess free cash flow to our shareholders in the form of dividends, which we are doing and our share buybacks. And so, at this point, we’re still anticipating debt reduction being the use of excess cash in 2018.

Okay. Thank you very much.

Thank you.

John, anybody else?

Apologies sir. We will now take our next question from Paul Lejuez of Citi. Please go-ahead sir.

Hi thanks guys. Can you maybe talk about the comp performance, during the Friends and Family promotion lined up against the same promotion last year versus how comps trended outside of that promotion in the first half? And then second, I just want to make sure I understood something that you said in response to Lorraine's question, I think you said, July was your strongest month, but I want to make sure, when you guys talk about July, are you including the first week of August in this year's July versus last year when it did not have the first week of August? I just want to make sure I understand the calendar impact in terms of how you get that answer. And maybe if you can just provide the first half comp on a lined-up basis that would be helpful? Thanks.

So, Paul Friends and Family was the increase we had when you look at the actual event is consistent with the increase that we got in the full first half. So, it was about the same penetration as we had in the balance of the business. So, satisfied with that, with respect to that last week of July versus the first week of August at Macy's is not a big difference. So, it had a slight effect on the second quarter, slight negative effect on the third quarter, but it is very slight. So, for us it was just, it’s the mix of the business that’s been ready for the back to school businesses, it’s having your inventory in place and ready for that. So, that’s how I would say that. And then your last question?

I think it had to do with…

First half comp lined up.

Yes, our first half comp is a lined-up. 2.3% for the first half it neutralizes the Friends and Family promotional shift.

It neutralizes the Friends and Family, but you also gain a week of August and lose a week of February. So, was a benefit to the [indiscernible]?

Paul, we mentioned there is a slight change to second quarter, it’s a slight change the third quarter. It’s not meaningful.

Yes.

Got you. Thanks guys. Good luck.

Thank you.

We will now take our next question from Oliver Chen of Cowen and Co. Please go ahead.

Thank you, so much. Thank you, Jeff and Paula. Regarding the curation factor, there is a lot of great initiatives, what are your thoughts on speed and test read and react? And also, I know you’ve made some really innovative steps in terms of utilization of data, how will you partner data with buyers because the whole buying function and the merchandising function is rapidly shifting and a lot of newer competitors are using coding attributes, as well as customer interactions to drive a decision-making and speed, would love your thoughts there?

So, we’re definitely operating with more speed as we have mentioned in the past Oliver, really the structure has changed dramatically in our merchandised organizations. So, you have, the speed of decision-making is significantly just shorter than it used to be. So, if you were to talk to our vendors they would all tell you that Macy's is operating with more speed than ever. And because we’ve got so much liquidity in our receipts to be able to respond to customer needs, we were able to respond in getting more customer wanted products the wanted trends into our stores faster. We’re definitely working on supply chain with our own private goods to shorten those cycles. We’re definitely using our consumer panels to help define what is the right assortment and right trends for us to get into. We have a very developed fashion office and trend forecasting it’s working with consumer panels. We’ve got our style crew, which are colleagues of ours that advises on that that are out there in their own social space getting information on that. So, we’re a dramatically leaner organization and we’re operating with more agility and we’re much more customer centric in how we’re responding to their needs and desire for trend. As it relates to analytics, what we did over a year and half ago of consolidating analytics into one center of excellence that serves the business is really paying off for us, not only in all pricing decisions, and really looking at out date and expected sell-through and defining what we want to do with point-of-sale discounts, as well as markdown pricing and cadence of that helping us improve our terms margin and sales, but also what it means in terms of seating – customer demand over a longer view. What it means for, what you need in the south in January, what you need in the North in February, and making sure that we're getting those analytics built into buy plans just based on history and forecasting. So, we’re in the early innings of this, but we have appetites to continue to use science really married with the art of a retail fashion business. And if that art and science that I think is what our success formula is going to be at both Bloomingdale's and Macy's.

That’s really helpful. Just a follow-up on the long-term story, what do you think is key to driving sustainable positive traffic in transactions and as you speak to a Lord of the initiatives throughout this call, how would you re-orientate them in the context of ensuring that you’re attracting younger customer as well, and balancing your appeal to millennials and Generation Z? Thank you.

I think long-range, it’s really the combination between robust digital growth, you better be online and you better be in a way that you are top of mind for your customer. Your mobile app is going to be incredibly important in the future, and so when you think about how the mobile app is being used as wallet and how transactions need to go through that, how it needs to be done is kind of their guide to a store and all product categories and then how it gives them access to services or stylists or a style crew, your mobile app has got to play all three of those buckets effortlessly, and at the same time removing friction in the customer journey between off-line and online. So, I would give that a, you know and then when you marry that with a healthy brick-and-mortar fleet, so strong digital, really strong mobile app, and healthy brick-and-mortar that’s Macy's and other multichannel retailer’s competitive moat, and that's where we are really focused. As that relates to the younger consumer, it’s interesting when you look at the Macy's brand. You know, we’re very attracted to the younger consumer in certain businesses and we have opportunity and others. We know where that is. We know what we need to do and that’s what we're working on. If you look at the men's clothing that’s a great example. We are one of the headlines in terms of the men's clothing business and it’s amazing when you look at the amount of younger customers that are entering our store through men's clothing purchase. So, we have – that’s a headline, we have others, but we are very focused on the customer of tomorrow. While doing that, we want to make sure that we're not alienating the customer that’s already in our tent. And so, when you look at our payment terms and loyalty, if you think about the bronze program, you think about what we're doing with Backstage, vendor direct, those are all initiatives that will broaden our customer profile to get to younger customers.

Really helpful. Thanks a lot for the details. Best regards.

Thank you.

Thank you.

That concludes today's question-and-answer session. At this time, I’d like to turn the conference back to you for any additional or closing remarks.

Thank you everybody. Appreciate everybody's time and attention.

Thank you, everyone.