Good morning, and welcome to Macy’s, Inc. Second Quarter 2022 Earnings Conference Call. Today’s hour-long conference is being recorded. I would now like to turn the call over to Mike McGuire, Vice President and Head of Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone, and thanks for joining us to discuss our second 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 you participants in the Q&A please limit their questions to one 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 impacts from the pandemic. I do have one housekeeping item to share with you this morning. On Thursday, September 8, at 8:05 a.m. Eastern Daylight Time, Adrian will be participating in a fireside chat at the Goldman Sachs Global Retailing 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. 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 of our website. 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. As you saw on this morning’s press release, our team put together another solid quarter on both top and bottom lines in the face of an increasingly challenging consumer environment. We generated quarterly net sales above our expectations at $5.6 billion, while comparable owned-plus-licensed sales decreased 1.6%. We also delivered earnings above our expectations with adjusted EBITDA of $616 million and adjusted diluted EPS of $1. We benefited greatly from the steps we’ve taken to transform our business through our Polaris strategy. We are quicker and more agile and more prepared for the challenges in the current environment. Over the past two years, as consumer demand rapidly switched between categories and channels and macroeconomic pressures intensified, our teams have taken disciplined actions and made tough decisions in order to ensure stability and health of our enterprise. We have fortified our model and strengthened our balance sheet all while delivering an easier and more convenient shopping experience for our customers across channels and the value spectrum. Before we dive into the full details, I’d like to take some time to review how the pressures of the macroeconomic environment are affecting consumer behavior and what that means for us. During the quarter, Macy’s brand customers across all income tiers slowed and shifted their spend, persistently high inflation drove higher prices and food and fuel and in turn led to higher interest rates than the softening market. As a result, overall consumer discretionary spending and sentiment weakened compared to the prior year. Constrained consumer spend also shifted from goods to services with more consumers choosing to spend on vacations, events and dining out. Despite the weakened environment for Macy’s, we continue to see strength in occasion-based categories, which include career and tailored sportswear, fragrances, shoes, dresses, and…

Thanks, Jeff, and good morning, everyone. As Jeff noted, we delivered second quarter results above our expectations. Our financial health, our talented team, and our continued investments in new capabilities, particularly those related to the use of data science and pricing have allowed us to thoughtfully navigate through this period of uncertainty. Looking ahead, we will continue to remain disciplined by focusing on further transformational investments yielding healthy returns, the effective execution of our Polaris initiatives and the efficient use of cash. We will do so while remaining financially healthy in order to emerge as an even stronger and more well-positioned business than we are today. At the same time, we remain committed to long-term sustainable and profitable growth, including low-single digit compound annual sales growth, and low-double digit adjusted EBITDA margins to maximize shareholder value over the long-term. With that, let me walk through our second quarter performance within our five value creation levers before discussing our outlook. First is omni-channel sales. We generated $5.6 billion in net sales during the quarter, a decline of 0.8% versus the prior year. Comparable sales on an owned plus licensed basis decreased by 1.6%, which was ahead of our expectations. As you may recall, the second quarter last year benefited from the accelerating economic recovery and government stimulus payments. Despite the absence of these benefits this quarter, 22% of omni-channel markets grew year-over-year with a large portion of those in our Western and Southern markets. The second value creation lever is gross margin. For the quarter, gross margin was 38.9%, down 170 basis points from the prior year period and consistent with our expectations. Merchandise margin decreased 160 basis points driven by a year-over-year increase in clearance markdowns within Macy’s. These markdowns were largely related to our pandemic categories, seasonal goods and…

Thanks, Adrian. Over the past two years, we have been thoughtful and measured in our decision making to better prepare us to confront the unprecedented challenges we faced while protecting our business. This would not have been possible without our talented team driving our durable strategy. While there is uncertainty ahead, our financial health and operational efficiencies bolster our confidence that we can effectively manage these difficult short-term pressures. At the same time, we feel confident that we can deliver on our long-term initiatives as part of our Polaris strategy. We firmly believe that we’ll be able to traverse the challenges ahead, grow market share and profitability and emerge from this uncertain period as an even stronger business than when we entered. And with that, I’ll turn it over to Q&A.

Thank you. [Operator Instructions] And our first question today comes from Oliver Chen of Cowen.

Hi, good morning, Jeff and Adrian. We’ve also noticed cautious trends in July, would love your thoughts on that month in terms of traffic and promotions and how that may interplay with your guidance, as well as the level of markdowns you’ll need to take. As you think about Macy’s as an ecosystem, just to follow-up on the marketplace and media, they sound like big opportunities. How should we think about how that may impact the financial model near or longer term? Thank you.

Hey, Oliver. Let’s talk about July. So the month of July, really since Father’s Day, we saw that the back half of the second quarter was about 5 percentage points lower than the front half. So we had a very strong Mother’s Day and Father’s Day as we quoted in the post. And that trend basically was – we took that all the way back through the back half of the year, which informed where we were going to be in terms of our guidance. We looked at the promotional levels. We looked at the inventory that was mounting in some of the pandemic categories as well as though looking at our holiday opportunity and the newness, the gifting opportunities that we have and how we experience gifting in Mother’s Day and Father’s Day. It’s all factored into our guidance. And I’ll tell you in the third quarter to date is basically conforming to our revised guidance. So when we’re seeing how back-to-school is performing and how the first three weeks of August are performing, so in line with that. I tell you that on marketplace, we’re excited about that opportunity, it launches over the next number weeks. We’ll give a lot of detail on that in future calls, but we definitely expect that to be number one, it’s going to give our customers lots more opportunities to transact at on the Macy’s brand, as well as the Bloomingdale’s brand in the future. And then with Macy’s Media Network, that one has been a standout for us. And so when you look at the numbers that Adrian was quoting in the past, $30 million of revenue in the second quarter. Most importantly, customers are really taking to it. And our brand partners are really enjoying the increased interaction that we’re providing based on all the traffic that we get on our sites.

Our next question comes from Matt Boss of JPMorgan.

The 8% category growth in occasion based categories that you cited versus the double-digit drag in the pandemic categories. I guess, maybe larger picture, how has your overall view of the health of the consumer changed relative to three months ago? How are you planning demand for lower income versus higher income cohorts? And then Adrian, just on the gross margin, when we incorporate the markdown actions that you have embedded in the third quarter. How do you anticipate the forward look on inventory as we exit the third quarter relative to the fourth quarter?

Hey, Matt, let me start. So basically when you look at the spend by tiers, it basically slowed it at that – basically the same rate. And so we’re not really seeing evidence yet of trade down going on between different buckets of income levels. What we saw was differences in engagement and obviously our most productive customers, our platinum customers and star rewards were highly engaged. And occasional shoppers were less engaged. To your question about occasion based, that is – those are just very healthy categories for us. So the AUR there was up about 13% and you just got real standouts there where you’ve got men’s clothing, AUR was up 29%, missy career which would be the equivalent of suiting and wear to work was up 20%, luggage was up 20%. So we expect those AURs to continue. As we get into those categories that we have excess inventory to supply, as well as where I would characterize the balance of the industry we expect those to be constrained. Certainly with pricing, a transparency, we’re seeing those sell-throughs were depressed really since Father’s Day. And so that’s what we factored in terms our gross margin, particularly the gross margin that we’re quoting for the third quarter of responding to that.

Matt, good morning. If I could speak first to the markdown question that you raised, and then I’ll go into the inventory. The big headline on the gross margin overall is that it really reflects the actions that we feel are necessary. Given some of the challenges that you highlighted as we look ahead to the back half of the year. But with regards to the gross margin, there are really three things that we’re managing through in the fall season. The first, as you pointed out is really taking the necessary markdowns to clear the age inventory, just spoke about the seasonal goods, the private brand merchandise, the slow moving pandemic categories. We want to work through those – that inventory and markdown appropriately to increase sell-throughs and position us better going into the next year, but we are also managing elevated supply chain costs. So I’d call that out as well. When you think about freight and delivery, fuel costs are currently trending down, but they remain elevated to what we saw earlier in the year. As you think about where we were last year, we saw raw materials like cotton prices increase and a lot of that is now flowing through this year, as we are receiving those receipts. The third thing I’d point to, in terms of margin is really just the pressures within certain categories that are experiencing increasing promotional intensity, as well as excess inventory across the retail industry. So as Jeff spoke about earlier, categories like sleepwear, men and women’s activewear, casual, sportswear, those are areas where we’re going to have to respond. And we want to make sure that our margin profile actually reflects that. In contrast, we’re also making sure that we’re going to be disciplined on our buys. We are supporting freshness for the holiday season, but we’re also very focused on inventory productivity and inventory health. And so our pricing sciences watching the selling patterns in terms of the demand and anticipating and quickly responding to those are going to be the kinds of things that we’re doing to manage our gross margin position. Now, if you think about the inventory, the inventory is an important piece to think through. As I mentioned earlier, we’re going to take the markdowns necessary. We’re going to flow the appropriate receipts to support strengthen the holiday season. But the important thing to keep in mind is, we will end this year with the appropriate level of inventory. Now we do expect relative to last year, our ending Q3 inventory to be at similar levels on a rate basis relative to the second quarter, but that’s really responding to the opportunity to be ready for holiday and have strength going into the back portion of the year. So that’s how we’re thinking about both the gross margin for the back portion of the year, as well as the inventory.

Our next question is from William Reuter of Bank of America.

Hi. I just have one question. In terms of the accelerated pace of asset monetization in the third quarter with this additional $30 million sale, does this say anything about the pace of monetization over the next couple of years? And if we were to think about what we might expect in terms of proceeds and aggregate over the next five years, do you have a sense for what that could be? Thank you.

Good morning, Bill, and thank you very much for your question. So as I highlighted a little bit earlier, we continue to be comfortable with our asset sale forecast for this year. We do anticipate having an additional asset sale gain in the third quarter. So that’s reflected in narrowing the range to $75 million to $90 million. That being said, we continue to remain very committed to our real estate monetization priorities. As we think about the kinds of factors that are outside of our control that we have to kind of look and manage, it’s really the interest rate environment and kind of any kind of slowdown that may exist on the horizon. But we continue to be very excited about the opportunity around real estate monetization. We’re watching the macro environment closely, and we’re continuing to develop programs to monetize assets across our network. We have not provided any guidance around what the next five years or three years may look like. We’ll certainly speak to what 2023 will look like in a couple of quarters, but we just know that we remain very committed to real estate monetization.

Our next question is from Lorraine Hutchinson of Bank of America.

Thanks, good morning. I was hoping just to get your views on your expected free cash flow profile for the back half of the year. And then also how you’re thinking about the buyback, understanding it’s not in guidance, but if you think that you will continue to repurchase shares with your excess capital in the back half.

Yes. So just to give a perspective on how we’re thinking about both the free cash flow profile and buybacks. In times of uncertainty, our number one focus is preserving cash and maintaining liquidity. That’s really paramount for us. So as we think about our free cash from what’s going to be driving it? One of the things that we’re very focused on are continued investments in the kinds of initiatives that’s going to drive margin expansion for us. We also want to preserve cash to maintain flexibility to support those fresh receipts that we spoke of earlier to really support the holiday season. And we want to make sure that we’re maintaining balance sheet health as we navigate these on certain times. Just know that we’ll end the year in terms of our cash position in a way that will allow us to support our business goals, but we continue to be committed to our dividend. We continue to be committed to the remaining balance of share repurchase, but keep in mind that our share repurchase is open-ended. So for us, just to kind of recap Lorraine, it’s all about preserving cash and liquidity in these uncertain times.

Our next question is from Omar Saad of Evercore Partners.

Good morning. Thanks for taking my question. I actually first just wanted to clarify and that kind of slowdown that occurred during the 5 point slowdown that occurred during the quarter. Did both the COVID winning categories, as well as the occasion based categories all slowdown that kind of same 5 point? And then I was also wondering if you could speak to the performance of your older consumers versus a lot of the younger consumers that you picked up during COVID, you talked about the platinum doing really well. Is that mostly a boomer type consumer? Thanks.

So Omar, let me start on the occasion based categories did not slowdown at the rate that the pandemic categories slowed down. And when you look at our older customers, they are – when you look at kind of over 40 and under 40, we basically saw about the same level of slow down between those demographics. And as mentioned, the same thing we saw in the income buckets would really characterize the activity was really their productivity level within the proprietary program. So the gold and platinum customers were retaining their spends and more of the less engaged customers are more occasion based or the less occasion based categories. Those customers downshifted.

Our next question is from Kimberly Greenberger of Morgan Stanley.

Great. Thank you so much. Good morning. I wanted to just make sure I’m doing the math right here on the comp sales in the first half of the second quarters compared to the second half. If I’m hearing you right, comps were actually around plus one in the first half of the second quarter and down around four. Is that right? Am I doing the math on that correctly?

Yes, you’re in the geography, right? Kimberly, yes.

Okay, great. That’s super helpful. And then Q3 to date has sort of continued at that minus 4% exit rate. It sounds like Jeff so far here during back to school.

It’s a little better than that, Kimberly, but yes, that’s in the same – it’s in the ballpark.

Okay, great. And then Jeff, I just wanted to ask about inventory, because obviously consumers spending trends are changing, they’re very dynamic as you’ve come through the last three or four months, you’ve seen the categories that consumers are spending on change in some cases dramatically. So I’m guessing that you along with the merchant team are sort of rethinking the inventory by going forward. If I know you’re sort of adjusting dynamically here through the fall season. But when in the future, did you have a blank slate where you could just rebuild the inventory sort of from the ground with a fresh forecast. In other words, when do you think the buy on the inventory is going to be optimally repositioned and you’ll have it sort of fully where you want it to be?

Yes. I think we’re in good shape on this subject. Obviously, we spent a lot of time and effort on this. So I would say that the buy for the fourth quarter onward and the stock levels that we will have entering into the fourth quarter are pretty much at the status that we would build from the ground up. So, there may be – that’s assuming the sell-throughs that we’ve been getting really since Father’s Day in some of the slower categories that they persist. We’re taking more aggressive markdowns to ensure that when we talk about the kind of sell-throughs that we got since Father’s Day and some of these pandemic categories in second and third markdowns that was off about a third from the rates that we were getting previously in the quarter, and then first markdowns were off about 0.5 point. So we’ve taken those kind of sell-throughs, we’ve applied it to being more aggressive on our hard markdowns in our POS on all those categories. But assuming that and you saw that in a kind of our guide on the 350 basis points, expectation – degradation of gross margin in the third quarter versus 2021 levels. So we believe that the stock to sales ratio are going to be close in the areas that are not trending. And we’ve been able – we’re already at status in those categories that are trending in both market and private brands. So we’re flowing those goods appropriately. As mentioned, we feel good about the receipts that we’ve got coming in for the fourth quarter. So we feel that the post that we’ll have in inventory at the end of the third quarter, as Adrian mentioned, similar to where we are right now, the second quarter, that’s appropriate to where we’re going into the holiday season. We expect the holiday buying still will be starting in the month of October as it did in the pandemic years. We want to be fully ready for that. And then as Adrian mentioned, we expect that our stock to sales ratio will be appropriate by category, by channel entering 2023.

Kimberly, if I could just add a few things and amplify one thing that Jeff mentioned, as a bit of context we are – when you look at our inventory productivity, we’re better than 2019 and relatively flat to last year when – effectively we were relatively lean, not only at Macy’s, but across the industry. And I think that speaks to just the processes and capabilities that we built around this topic of inventory productivity. But there’s kind of three things that we’re looking at as we look at the business going forward. One is just to Jeff’s point really improving the composition of inventory by category, by brand and by channel and doing that in a way while we’re still managing our vibes very efficiently. The other piece is really leveraging our pricing science. We recognize that we’re going to have to deliver competitive market prices in this environment, but we’re doing it in a way that’s going to improve our sell-throughs and improve relatively speaking our margins as well, based on what we’ve shared in our forecast. But the other piece is location level pricing. This is something that we’ve spoken about earlier, and we’re continuing to refine the mathematics and the technology around this, which just gives us much better precision around how we’re actually managing at a local store level or by channel the pricing that helps us to remain competitive in this marketplace. And then the last piece that we’re pretty excited about is really tapping into both the vendor direct and soon to be marketplace capabilities to really think about what channel or sub-channel we’re supplying those goods in the most profitable way. So those are some of the things that we’re doing to manage through the inventory dynamics that’s ahead of us as well.

And we can go to Steph Wissink of Jefferies.

Thank you. I have two quick clarification questions. The first Adrian is just on the inventory balance year-over-year. Could you help us think about what inflation is in that figure versus units? And then I think you mentioned cuts and inventory with some of your national brands. Can you share with us a little bit about some of the categories where you’re actually cutting inbound receipts? Thank you.

So I’ll start with the inventory and then I’ll hand it over to Jeff to talk a bit about the assortment. So from an inventory standpoint, we expect to end the year in a very healthy position or an appropriate position. As you look at the third quarter, what we do expect is that the increase relative to last year is going to be more in line with what we saw coming out of the second quarter. And this is really about making sure that we have the freshness going into the holiday season. As you can imagine last year, having the appropriate freshness and time for holiday was certainly a challenge within the industry. We feel that we’re much better positioned on that. As I mentioned a bit earlier, our input costs are higher. We’re managing through inflation with regards to both logistics of getting the product to us, as well as the raw materials that are going into the products that we sell. So what would be implied there is that we’re bringing in product at a higher cost, but on lower units to align with our unit velocity sell-through and our sales profile.

So Steph on the question on the kind of market brand. So, recognizing that we – when you talk about kind of the occasion based categories in the market brands, our demand is up when you looked at the second quarter up about 7% and inventories are up 5%. So that’s about the level that we want to see is having demand slightly outpace the supply assuming that the year-end question is, is the right base. And then when you look at the pandemic categories, if you look at our market brands, we’ve really been able to cut that back. So the demand there is down about 24% and supply was down about the same. So we were able to get those in status and I feel pretty comfortable across our brands that we’re in line with the categories that our customers are trending with. And we’re always working through tweaks, but we’re in pretty good shape there. And again, where we’ve got big opportunities in the third and the fourth quarters, I don’t expect issues in supply chain to be able to hamper our ability to flow those goods. So we’re working with all of our market partners. And we’ve been doing that obviously in first and second quarters to get the rate – get the receipt in line with demand. And we’re basically there now. And as we go through the back half of the year, we’re going to stay very disciplined in that view.

The next question comes from Gabby Carbone of Deutsche Bank.

Hi. Good morning and thanks for taking our question. Just wanted to dig into Backstage, so flat comps for the quarter, which outperformed your Macy’s full-line stores. Given kind of the excess inventory out there, do you think there is the opportunity to provide customers with even better value at Backstage moving ahead. And then it sounds like you aren’t seeing a trade down to Backstage from full-line stores. Is that correct?

Yes, that’s correct. So Gabby would – if you look at the – first off, Backstage is continuing to perform well for us, it definitely is a growth strategy for us. So we now have 308 locations opened in store-within-stores. We just opened State Street and Herald Square. When you look at – and just what we’ve seen all the way through our journey with Backstage since 2015, is that customers who shop Backstage in our individual stores that also shop the balance of the store are our best customers. We’re getting more frequent trips. They’re more profitable for us. Their spends are up quite strongly versus stores or just shopping in a particular channel. So, we have not seen a big shift in the difference when you look at the variance of the trends of those stores in Backstage versus the balance of the store during the second quarter versus what it was prior, not a difference. So we don’t see a down shift into the – where you’re seeing more customers from the full price going in the Backstage section. Just the customers that are shopping between them are very healthy customers.

We can go to Paul Lejuez of Citi.

Thank you. This is Tracy Kogan filling in for Paul. I know you noted earlier that you hadn’t yet seen the trade down customer in your stores. And I was wondering what you’ve seen in prior periods of consumer weakness, maybe in terms of early signs of the customer trading down, is it to your private brands? And then when you do get the trade down customer from other places to Macy’s. When have you typically seen that and where are they trading down from? Thanks.

Hi, Tracy. So, again, we have not seen a trade down as of yet. And I think it really – I just would characterize our business is really just the difference between the categories that they’re spending in right now. And so from the point of view of where you have an abundance of stock in certain categories you’re going to need to liquidate those with lower prices. We don’t operate in a vacuum. Our competitors are in the same boat, so customers are going to take advantage of that. Where we still have customer wanted categories, and there’s more scarcity of product with us and with the market, we’re getting the higher AURs. I mentioned some of those earlier, so that’s how I would characterize it right now. What I would talk about on the Bloomingdales, we’re not seeing any – we’re seeing our most affluent customers continue to spend at very strong levels. The 150,000 and above, we have not seen trade down at Bloomingdales’ either and their business continues to be quite robust. But nothing yet, and nothing that’s informing us from prior recessions, that’s going to suggest anything that we haven’t put into our guidance for the balance of the fall season.

Next question is from Chuck Grom of Gordon Haskett.

Thanks. Good morning. Adrian, on the credit front in order to get to 3.3% of revenues for the year implies a pretty big drop in the second half roughly 10% to 14% year-over-year. I guess, can you speak to, to what’s driving that assumption? Are you seeing a big change in credit quality bad debt? And then Jeff just geographically over the past six weeks, just wondering if you’re seeing any major trends across the country?

Good morning to you. With regards to the credit card revenue, I think the punch-line here is that we’re just taking a measured view on bad debts for the remainder of the year. We’re monitoring credit delinquencies, we’re monitoring payment rates. And so as we look ahead, there’re just a number of factors that from our perspective, just continuing to take that measured view. So when we look at the industry more broadly, we see that inflation about pacing wage growth. That’s just not sustainable for the consumer. We see that consumers are under pressure with regards to elevated gas prices, as well as double digit increase in grocery prices. So as we look at some of these different indicators, we’re just very thoughtful and very measured about what we believe bad debt will actually be. Now, that being said, we are seeing increased balances. We are seeing increased co-brand spend. So that continues to drive more of a healthy guidance of about 3.3% of credit card revenues as percent of sales, as we think about what the outlook will be for the year.

And then Chuck to your second question the Western and really the Southern markets are performing better than you saw in our – if you take a look at our slide deck, it’ll show you the 22% of our omni markets had increases in the second quarter. And what you’ll see there is the Southern markets definitely perform better. The other comment I’d make that within the quarter is the return of the downtown locations. Not so much as a result of tourism, but certainly a return to work. And so those return to work and getting the traffic around those buildings with more offices being filled, albeit, not certainly at levels that we were pre-pandemic, but certainly better than we were in the – against the quarter of comparison. And that’s really helping us. So when you look at like downtown, certainly here at Herald Square, Union Square, you look at downtown Boston and Washington D.C. Those are all – those locations are quite strong. So Southern markets and downtown locations would be how it characterize the geography question.

Our next question comes from Jay Sole of UBS.

Great. Thank you so much. We got three part question. First is Jeff, can you elaborate a little bit on the toys opportunity specifically in 4Q? I think you said that toys sales grew 3x over 2Q of 2021, and you see $1 billion opportunity. So what does that imply about maybe the opportunity in 4Q? And then secondly, thinking about Omicron last year and how that impacted comps and sales, what do you think about lapping that this year? What kind of opportunity would that create for December? And then lastly, during the quarter announced the acceleration of the growth of the off-mall, small-format strategy, so could you just maybe give us a little bit of an update there and tell us what you’re seeing and what the bigger picture opportunity is for the smaller format stores? Thank you.

You got it. Okay. Jay, so let’s just take it from the top on toys. The fair share opportunity would be if you take Macy’s percentage within these categories and you apply to the overall toy market, that’s how you get to the $1 billion. That’s not to suggest we’re going to get to $1 billion at the end of 2022, but that’s currently what we’re really pushing for. When we signed on with Toys“R”Us, and we decided to put the investment that we went against this, it was recognizing that we were had a very small toy business. It was in Backstage and online. We did not have a developed toy business. This is really putting us in the game. We do believe that Toys“R”Us offers us the most experiential omni-channel toy experience in America. When all is said and done, we’ll have 400 Toys“R”Us shops that will be constructed, including some flagships by October 15. So we’re well on our way on that. So we have nothing but growth ahead of us with toys over the coming years. With respect to Omicron, frankly, the Omicron really affected us more in the month of January. Obviously, our smallest month of the year than the month of December. It started to, we had a strong January last year. We had a tough January. So that’s incorporated in our guidance. And then with respect to off-mall small door format, we’re continuing here we have three formats there that we’re really playing with. The first one is kind of the backfill strategy. That’s where we’ve got high productive markets, omni-markets, and where there is Zip codes in which our digital business is not as high as the balance of the market and where there may be opportunities for us to put a…

The next question is from Bob Drbul of Guggenheim.

Hi, good morning. Just one question that I have as you think about the back half of the year, and even into 2023, there’s just been a lot of discussion around your vendors taking price increases. And I’m just curious if you’ve revisited any of the direction around the sales over the – since post Father’s Day? Thanks.

Hey, Bob. You kind of cut out in the middle of your question. So you were talking about vendors and say that again, ask that again, please.

I’m sorry though. The question that I have is just on price increases. Like there’s a lot of vendors that have talked about taking price in the back half of the year or into 2023, given the change in direction on the trends, are you revisiting some of these initiatives with your vendors and just trying to understand how you’re thinking about it going into the back half into next year?

Yes. So I think we’re – you’ve got a trending category and you have a price increase, what I say is that our manufacturing partners, market partners have done a great job of not just having a price increase, but in many cases, putting more quality into the goods, either more make or more trim, more quality, and that’s commanding a higher price point. And when you’re in a category that is, let’s say occasion based or other categories that are not pandemic in that particular flavor. We’re passing on those cost increases and the customers are responding quite well to it. So I mentioned that in like men’s clothing, I mentioned that in women’s clothing, as well as luggage, but there’s brands. I look at Ralph Lauren is a great example of that. Ralph Lauren has really improved their quality. We’re getting much higher AURs there. We’re fully aligned with that brand in terms of our strategy together. And that includes improving the customer experience both online as well as in-store. So if you’ve got a considered strategy about what you’re doing and there’s good value, and the price increases you’re making. Customers will transact quite well with that. So I think it depends on what category, what brand you’re in. But it’s a general comment, I think we’re fully aligned with our vendor partners on that strategy.

Our next question comes from Michael Binetti of Credit Suisse.

Hey guys. Thanks for taking all our questions here. I guess a lot of our questions have been answered. But I guess when you look at the year, you just guided us to and kind of step back, where do you think about where AUR will end the year, where units will end the year? And as you think about spring, I know there’s some parts to the assortments you have to start forming up plans a little earlier. So maybe at this point, just how you’re thinking about positioning the business for return to growth next year lapping, some of these AUR increases. Do you think about growth in terms of ordering units up as you look to spring to drive growth plans to recapture some level of full price selling against the guidance for more markdowns in the back half, maybe just help us think about how you early on think about driving the business for growth after year like 2022?

Okay. So Mike let me take the AUR and I’ll talk about how we’re thinking about kind of return to growth and let Adrian add anything on that question. So when you think about AURs, what we quoted in the beginning of the year pretty much stands where we are right now, which is we think we’re going to be up about 5%. That’s what we were up in the second quarter with kind of the ins and outs of again, you’ve got pandemic categories, which is a chunk of our business. You’ve got other, which is a chunk of our business. Then you’ve got the occasion based categories, which is a chunk of our business. And when you look at the blend of all of that, we’re in the ballpark of that kind of mid, single digit AUR improvement as we look at it versus 2021. As you kind of think about, where we really an answer to Kimberly’s question, we are really talking about just what we’re focused on in terms of inventory and ensuring we’ve got the right inventory by channel, by location and certainly by category and brand. And so we do believe that having a better status across all of that in a stock to sales ratio and making sure that you’ve got built in liquidity and just some reserve that is going on to be able to respond in season is really important. And so that’s a discipline that, and Adrian went through all the tools that we’re using. Once we get it in to make sure that we’re maximizing the profitability on the way out, but also on the way in and the buy in, you have that same level of rigor that goes into how we’re constructing it. So we want to retain flexibility. We’re not quoting yet what our guidance is for 2023, but just know that our inventory and our stock to sales ratios will be in line with those expectations.

And Mike, just to add to Jeff’s point, we remain committed to our long-term targets. And as you heard us speak to in prior calls, we’re committed to low single digit sales growth, as well as low double digit adjusted EBITDA margins. But as we think about where we are today, we have to see how the consumer shopping behaviors and how the macroeconomic trends really how they unfold for the balance of the year before we provide kind of a clear outlook for 2023. But that being said, as we think about longer-term targets, we remain committed. A demonstration of that conviction that we have is really in the actions that we can continue to invest in the near term. We’re continuing to invest in initiatives that we believe are high return initiatives, whether it’s strengthening our pricing capabilities, our Macy’s media network capabilities, which is our advertising agency, or even building new sales capabilities with things like marketplace. We’re being very disciplined on inventory management to position ourselves for healthy and profitable growth next year. So a lot of the inventory productivity and pricing initiatives that we’re referencing are really capabilities that we continue to lean into with strength. But I would also say that we’re investing in our talent as well. We’re investing in our talent to execute a strategy for Macy’s. That is an evolved Macy’s and it changed Macy’s relative to what we’ve been investing over the last several years. But I think the overarching punchline in terms of how we’re approaching it is to really do what’s necessary to strengthen our competitive position with a healthy balance sheet with new capabilities, with a talented team, so that we can take advantage of growth opportunities coming out of this uncertain period over the course of the next six to 12 months.

Kevin, we’ll take two more questions.

The next question comes from Dana Telsey of Telsey Group.

Dana, you’re up.

Telsey, your line is open.

Hi. Can you hear me? Okay.

Yes, we can hear you now.

Perfect. Can you expand on the magnitude of the digital returns, what you’re seeing there and is that in-store also, and just with the following up with the guidance adjustments, how you adjusting your holiday plans, including marketing spend given the current environment? Thank you.

Good morning. I’ll start with the topic of returns and then hand it over to Jeff to talk about our holiday plans. So if you look at returns, overall returns are higher than last year, but actually lower than 2019. So for example, on the digital side, in the second quarter, we saw returns were up about four percentage points higher than last year, but still two percentage points lower than 2019. So when you think about what’s driving the higher returns, it’s a lot of what you would actually expect. There has been a shift in the category mix towards apparel. So when you think about dressier, more tailored apparel categories, they tend to have a higher return rate than what we’ve seen in prior years with the demand around center core and home categories. And then if you compare it to kind of the trend that we’ve been seeing over the years, our digital penetration, for example, in the second quarter was eight percentage points higher than 2019. And as you know, the digital channel tends to have a materially higher return rate than the stores channel. So it’s a really a combination of mix, a combination of digital penetration. That’s really impacting how we think about returns this year versus last year, but we’re continuing to see favorability relative to our pre pandemic levels. And the category mix trends that I’ve just described, that’s all reflected in our outlook for the balance of the year. But that’s kind of how we would speak to the returns profile.

And then Dana on the marketing, marketing is definitely going to be commiserate with the sales expectations. We had a slide down shift and overall volume for the back half of the year. So when you think about the marketing that is going against those sales, pretty consistent to what you’ve seen in the first half of the year. What I talk about is some of the differences in marketing is that really our upper funnel tactics are really going to go to branding. So when you think about what we’re doing with own your style and being a gifting destination, that’s what you’re going to see on the upper funnel. And the lower funnel tactics, a lot of digital tactics are going to really be about item price and more promotion and opportunities with that. So – but we feel like we’ve got a good formula on that. It’s certainly fitting within our SG&A rate and it’s definitely tied to our expectations on volume trends for holiday.

Final question comes from Carla Casella of JPMorgan.

Hi. I’m wondering, just given your updates for your free cash flow and any change in your thoughts towards capital allocation and your leverage target?

We remain committed to our leverage target. We talked about two times or below. So that’s an important thing for us. If I take a step back for a moment, Carla, just really think about where we are from a cash standpoint. Coming out of the second quarter, we’re actually quite comfortable with our cash position. Just to put it in context, we did not tap our ABL. Our overall liquidity doesn’t compass a $3 billion asset based credit facility that we did not tap coming out of the second quarter. Inventory came in earlier than we expected because we were experiencing higher fill rates and the supply chain loosening. We managed through that. We’re managing through softing sales in the back portion of the quarter. Again, we managed through that. We have no debt maturities on the horizon. And so, from our perspective coming out of the second quarter, we really maintained our financial flexibility to respond to any potential changes that may be ahead of us. And the most important thing we want to be responsive to is the approach of holiday. That’s an important quarter for us, an important period for us, but also having the capacity to respond to any kind of macroeconomic scenario that may be on the horizon. So from a cash standpoint, we’ll continue to manage our cash efficiently and effectively. From a capital allocation priority, we were continuing to invest in high return initiatives within the business, return capital to shareholders. So we’re being very consistent with what we’ve shared in prior quarters as well.

And that does concludes the question-and-answer session for today’s call. I’d like to hand the call back to Mike McGuire for any additional or closing remarks.

Thank you, Kevin, and thanks everyone for joining us today and for your interest in Macy’s, Inc. If you have any questions, please feel free to reach out to Michelle Cassiere and myself in investor relations. Remember to keep your feet on the ground and keep reaching for the stars and have a great day.

And that does concludes today’s conference call. We thank you all for your participation and you may now disconnect.