Good morning, and welcome to the Macy's Incorporated Third Quarter 2018 Earnings Call. Today's hour long conference will end promptly at 10:30 Eastern Time and is being recorded. In the interest of time, we ask that you please limit yourself to one question. I would now like to turn the call over to Monica Koehler, Vice President, Investor Relations and Finance. Please go ahead.
Great. Thank you. Good morning and welcome to the Macy's Inc. Conference call scheduled to discuss our Q3 earnings and outlook for the remainder of the year. Joining us on the call today are Jeff Ginnett, Chairman and Chief Executive Officer and Paula Price, Chief Financial Officer.
Any transcription or other reproduction of the statements made on this call without our consent is prohibited. A replay of the call will be available on our website, smakeysinc.com, beginning approximately 2 hours after the call concludes. 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 the company's filings with the Securities and Exchange Commission.
In discussing the results of our operations, we will be providing adjusted earnings before interest, taxes, depreciation and amortization, net income and diluted earnings per share amounts that exclude the impact of restructuring and other costs and settlement charges associated with our defined benefit plans. 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.
So thank you, Monica. It's a good morning, everybody, and thanks for joining the call. As you saw in our press release this morning, Macy's delivered a strong 3rd quarter with comparable sales up 3.3% on an owned plus license basis and earnings of $0.27 per share. We saw strong results across the Macy's Inc. Business with Macy's, Bloomingdale's and Blue Mercury all performing well in the quarter, which contributed to our solid top line growth.
Based on the 3rd quarter results, we are raising annual earnings guidance by $0.15 and adjusting the range of sales guidance. Paula will give you more details on the quarter and our remarks and our outlook in her remarks. So Macy's recipe for success is e commerce, healthy stores and a great mobile experience that ties it all together. It is our competitive moat. Our e commerce business just completed another consecutive quarter of double digit growth, driven by continued improvement to our online offering and experience.
We invested early in mobile and our mobile app just keeps getting better. We view the Macy's app as our customer's indispensable shopping companion and increasingly it's becoming a channel for transactions as well. This year we will hit $1,000,000,000 in mobile sales. The growth of our digital business goes hand in hand with the growth of our brick and mortar business. We've seen a trend improvement in our stores beginning a year ago, and we've seen steady quarter to quarter progress throughout the year.
This is important because healthy brick and mortar business is part of our strategy to build lifetime value with our existing customers and bring new customers into the brand. I'm going to give you a brief update on our strategic initiatives and then Paula will take you through the details of the quarter and then we're going to open up the line for your questions. So as we noted on our last call, the Q3 was an important time for us as we were laying the groundwork for our strategic initiatives. That work is complete and we're fully prepared for the critical holiday season ahead. As you know, we have 5 strategic initiatives in 2018, and let me touch on each of them.
Loyalty. We recently marked the 1 year anniversary of our new loyalty program and I'm pleased to say that the program is delivering the results we anticipated. Our Platinum customers, who are our best customers, are spending more with us and shopping more frequently. They like the simplicity and value of the new program. We've had a great response to the exclusive experiences that we've been able to offer the Platinum cardholders.
Because we have a well developed entertainment and events business, Macy's has a unique portfolio of experiences to pull from and to offer our platinum cardholders. This includes exclusive access to our iconic events like the upcoming Macy's Thanksgiving Day Parade, like concerts, fashion shows, cooking classes to name a few. While the first priority of our loyalty program is to take care of our existing best customers, we've now expanded the program with a new Tinder neutral tier, which we launched earlier this year. We call this the Bronze program. And the Bronze program is showing strong early results, and we have added nearly 2,000,000 new members to the loyalty program.
So overall, we're very pleased with the loyalty program. It's bringing new customers into the brand and increasing the lifetime value of our best customers. Number 2 initiative, Backstage. We've added 121 Backstage locations this year, including nearly 60 in the Q3. I'm proud of the work the team has done to deliver this expansion.
It is a testament to the speed and agility that we've emphasized across the company. We now have 166 Backstage in store locations. With this scale, we are now dialing up our marketing for Backstage with an emphasis on product that is off price, on trend and arriving daily. We expect the additional marketing, which launched last month, will increase awareness at Backstage and bring new customers into the store. And importantly, we continue to see a lift in sales across the entire store when we add in Backstage.
3rd initiative, Vendor Direct. So to understand the role of Vendor Direct, let's first take a step back to understand how we look at the role of curation. In our stores, we curate for our customer through a highly edited assortment that is localized to a specific market. Using our enhanced data and analytics, we're able to efficiently influence assortment down to the store level. But online, the customer curates for herself using search and personalization tools.
Vendor Direct allows us to offer our customer a vastly wider assortment online and the self curation tools direct through to products where she's shown the most interest. We have more than doubled our SKUs online since the launch of Vendor Direct in April. This includes an expanded assortment of great national brands that we already carry, as well as the addition of new brands and categories that we know our customer will love. Number 4, store pickup. In the Q3, we completed the expansion of our store pickup options.
As a refresher, with BOP's or Buy Online Pickup in Store, a customer orders online choosing from the merchandise available in a specific store where they can then pick it up within 2 hours or less. With BOSS or buy online, ship to store, customers have access to merchandise anywhere in the Macy system, including vendor direct, which is then shipped to their neighborhood store for pickup. BOSS is very popular with our customers and we are seeing greater than anticipated use. Our customers love having access to the full Macy's assortment, couple that with the security and convenience of pickup at their neighborhood store and BOSS has been a hit. To support fulfillment of both BOSS and BOSS orders, we completed the rollout of At Your Service to every store in the fleet.
At Your Service Centers are located at a high traffic door for quick and convenient pickups. At your service also handles returns, self checkout assistance and a variety of customer service activities. The success of BOPS and BOSS is a great example of how e commerce, our e commerce business, and our stores business grow together. Our last of our 5 initiatives is Growth50. And as we noted in the last call, the Q3 was when much of the construction work was underway underway for the improvements in the Growth50 stores, which represent, in what we'll talk about in a moment, our magnet stores.
I'm pleased to say that the teams were able to minimize the disruption in these stores. And even better, now that the work is complete, our customers have noticed the improvements and are responding well. The Growth50 stores are performing ahead of their peer stores and this improved performance gives us confidence to roll this treatment out to another 100 stores in 2019. This investment will help us continue the momentum of our stores business and drive the top line into the future. And while we put an emphasis on the Growth fifty stores, I do want to note that we've also invested in each of our stores this year.
Every store in the Macy's fleet has received improvements, including at your service centers, mobile checkout and elevated and localized merchandising assortment. To sum it up, we've turned into strong performance for the Q3 and we entered the Q4 fully focused on our customer. The holidays are where Macy's really shines, and I'm confident that we have the right strategies, the right merchandise and marketing, and the right experiences to win with today's consumer. Several things give me confidence in our ability to deliver the Q4. Consumer confidence and spending remains strong.
It's a great backdrop. Number 2, our e commerce business is humming and the dotcom penetration naturally increases in the Q4. 3, our stores are in good shape for the holiday and have momentum. 4, our strategic initiatives are up and running and we will feel their full weight in the quarter. And lastly, our colleagues across the business are engaged, aligned and rowing in the same direction.
And with that, I'm going to turn it over to Paula.
Thank you, Jeff, and good morning, everyone. In the Q3, we delivered $5,400,000,000 of sales, an increase of 3.3 percent on an owned plus license comparable basis. Overall, we were pleased with our operational and financial performance as sales, earnings and cash flow all exceeded our internal expectations. Through continued strong execution, the traction and scaling of our key strategic initiatives and the healthy consumer environment, we extended the positive momentum from the first half of the year into the third quarter. We delivered solid performance across all our channels, brands and geographies.
Our digital business maintained its steady double digit growth as we continue to significantly expand our assortment and enhance our personalization capabilities. And as Jeff mentioned, our brick and mortar business again demonstrated improved and very encouraging sales trends. Our channels also benefited from the successful rollout of the BOSS and BOSS fulfillment options. Macy's, Bloomingdale's and Blue Mercury all positively contributed to our performance in the quarter and each exceeded our internal expectations. And while we saw solid performance around the country, we delivered our strongest regional performance in the Northeast and North Central, which is primarily in the Midwest.
Turning to families of business. We delivered another strong quarter in men's and kids, fine jewelry, women's shoes, fragrances, coats and activewear, offsetting some underperformance in fashion watches and women's sportswear. We benefited late in the quarter from cold weather. Total transactions were up 3.8% in the quarter, reflecting strong customer demand both online and in stores. Average units per transaction were down 3.1% and average unit retail was up 2.6% driven by more regular price selling versus a year ago.
We generated net credit card revenues in the quarter of $185,000,000 up 28% from last year. On the strength of our new loyalty program, the corresponding penetration or usage rate of our proprietary credit cards increased 100 basis points to 48.4%. Our new loyalty program is not only delivering a more engaged customer as Jeff mentioned, but also stimulating higher credit sales and proprietary card balances, which yield higher credit card revenues and enhance our overall operating performance. We delivered gross margin in the quarter $2,200,000,000 Our gross margin rate of 40.3 percent of net sales was flat to last year. We achieved significant rate expansion in our merchandise margins through stronger regular price selling.
This merchandise margin rate expansion exceeded our internal expectations and fully offset higher delivery costs related to both our new loyalty program that launched in October of 2017 and our growing e commerce business. As planned, we ended the quarter with inventory up 50 basis points on a comparable basis. This is consistent with the expectation we set on our last earnings call as the calendar this year put us 1 week closer to the holiday season and had a timing impact on our receipt flow. We continue to expect our inventory to be down at the end of the fiscal year. We recorded $2,300,000,000 of SG and A expense in the quarter, dollars 67,000,000 higher than last year.
On a rate basis, our SG and A expense was 41.7% compared to 41.4% last year. As we have been discussing, this is due to investment in our strategic initiatives, including Backstage and our path to growth incentive that we use to align all our colleagues around our North Star strategy as well as to help us compete in a tight labor market. This will be our 3rd consecutive quarter with the incentives, which is open to all full time, part time and seasonal colleagues. And in the Q3, about 75% of our colleagues earned the incentive. Asset sale gains in the quarter were $42,000,000 23,000,000 lower than last year.
We delivered adjusted EBITDA of $407,000,000 which was 3.8% lower than last year. When excluding asset sale gains as well, EBITDA was up 2% in the quarter based on stronger sales, the strength of gross margin and higher credit card revenues. Our interest expense in the quarter was $59,000,000 compared to $74,000,000 last year as we accelerated our debt reduction by $744,000,000 over the past 12 months. Tax expense in the quarter was $12,000,000 or 16.2 percent of pretax income benefiting from the Federal Tax Reform Act and certain tax settlements. This compares to $10,000,000 or 27% last year.
We delivered adjusted net income of $83,000,000 versus $65,000,000 last year. When excluding asset sale gains as well, we more than doubled our adjusted net income to $52,000,000 compared to $25,000,000 last year. Our adjusted EPS was $0.27 in the quarter compared to $0.21 last year. When excluding asset sale gains as well, adjusted EPS was $0.17 more than double the EPS of $0.08 last year. Cash flow from operating activities was $429,000,000 year to date, $30,000,000 above last year.
We invested $127,000,000 more in capital expenditures related to our strategic initiatives and received $91,000,000 less in proceeds from asset sales. We returned $347,000,000 to our shareholders in the form of cash dividends. We ended the quarter with $736,000,000 in cash, which was above our expectations. We remain committed to using excess cash in 2018 to reduce debt to consistently achieve our target leverage ratios. We continue to believe that having a healthy balance sheet is key to maintaining both flexibility and durability.
Taking our strong Q3 performance into consideration, we are raising the low end of our annual sales guidance. Our new range is 2.3% to 2.5% on a comparable owned plus license basis. Our guidance for annual net sales growth is now 0.3% to 0.7%. As a reminder, fiscal 2017 had one extra week of sales. We are raising our full year adjusted diluted EPS guidance by $0.15 to a range of $4.10 to 4 $0.30 We are also raising our guidance for annual net credit card revenue to a range of $740,000,000 to $755,000,000 We are adjusting our annual effective tax rate slightly downward to 22.75%.
All of our other annual guidance assumptions for gross margin, SG and A, interest expense, depreciation and amortization, capital expenditures and asset sale gains, which include the anticipated sale of the former I. Magnin building in the 4th quarter remain the same. While we are cycling a strong Q4 from last year, we are confident in our Q4 plans. Our colleagues are aligned and engaged and poised to deliver the full year the full strength of our strategic initiatives over the holiday season. We have had a few inquiries related to our store segmentation strategy that some of you have read about yesterday.
So before we open the lines to your questions, I'll ask Jeff to make a few comments.
Thanks, Paula. So wanted to give everybody some color about our store segmentation strategy. And it's really based on the customer insights that we have and a deep understanding of how the customer what their shopping journey looks like across online and our stores platform. And we certainly know that our best customers, they shop with us cross channel, cross category and cross stores. So within a market, strong brick and mortar, I think everybody knows really amplifies our online sales.
And conversely, when we close stores, our online sales in that market decrease. So increasingly, our stores serve as fulfillment centers for shopping that is done online, and we see that in the popularity of our pickup options, which I mentioned as part of my Bob's and Boss update. So for some context, today over one half of our platinum and gold customers, which are our best customers, regularly shop online and at least 2 or more Macy's specific stores. So knowing this was very important for us to better understand their behavior, when and why does she choose one Macy's store over the other, what are her expectations in different types of Macy's stores and within the specific malls. And this exploration led us to our segmentation strategy.
So we have bucketed our stores into 3 segments. We call them our flagships, magnet stores and neighborhood stores. And you're going to hear more in more granular detail our segmentation strategy when we lay out our 2019 plans in the New Year, I did want to take a moment to give you a sense of how we're looking at these 3 buckets. So let's start with flagship stores. And this includes Herald Square as well as 10 regional flagships.
And these are some of the best retail properties in America and each of these eleven stores are the number one retail destination in their regional market. They have the best that Macy's has to offer. It's really an all senses engagement through fashion, service and experience. Our next bucket is what we call our magnet stores. And these are really represented by the stores that we currently have in our Growth fifty group.
And when we're looking for a Macy's store or a mall that offers the best of fashion, food and entertainment, this is what customers look to for magnet stores. Those are also where they go for magnet malls. Customers come to magnet stores for expanded selection, including special occasion, dress up for men's and women's, fine jewelry, an expanded gift assortment, a wider selection of home. And in 2018, we launched this Growth50 of these magnet stores. The investment approach, we now believe is a scalable formula that as we mentioned earlier will be rolled out to 100 additional stores in 2019.
And the last bucket is our neighborhood stores. These tend to be smaller. These stores are all profitable and each play an important role in how our customer experiences the Macy's brand. Customers visit their neighborhood store primarily for convenience, for fulfillment of online orders, as well as for basics things like skincare replenishment or casual wear. We're currently testing 4 different investment models for our neighborhood stores that are aimed at increasing shopping ease and convenience, including more self-service options.
And in 2019, we will test and iterate until we land on the right formula to scale the neighborhood stores in our fleet. So to sum up, a large percentage of our best customers already shop both their neighborhood store and their magnet store, and their shopping behavior feedback will inform our store segmentation strategy moving forward. So with that, we're going to open it up for questions.
Thank you. The question and answer session will be conducted electronically. We'll take our first question from Matthew Boss with JPMorgan.
Thanks and congrats on your 4th positive comp.
Thanks, Matt.
Jeff, so I guess along those lines to map out sustainable positive comps from here, I guess can you help us rank the initiatives that you have in place to improve store traffic? And then on the e commerce front, can you help break down vendor direct and just the magnitude of this opportunity? Okay.
So Matt, the I think when we look at the 4th quarter, we're obviously looking at a very strong environment that we're playing on along with our competitors. So that the consumer confidence is very strong, the spending is strong. I think the predictions when you look at of where consumer spending is going to be during the holiday season, it's a very good backdrop for us. So, if I was ranking to your question, I think our dotcom business, we expect that to continue to be very strong, certainly double digit growth. And it's a much higher penetration during the Q4, which really helps our comps in that particular quarter.
And I think one of the headlines on our dotcom business is that we've made significant improvements to the site navigation and content in 2018 and we're ready for the holiday season. I'd say the second piece of it is that our stores all stores are improving in their trend from where they've been and it's sequential improvement quarter to quarter. And now that all the investments that has been has really touched all stores, be it at your service or mobile checkout and certainly what we've done with the Growth50 initiatives, we're ready for all the gift traffic that we're going to get in the Q4. So we're bringing a store fleet that has momentum into it with us. When you look at our strategic initiatives, what I would say is that Backstage is a meaningful part of our comp.
And now that we've got in as many stores as we've got and we've got in as many parts of the country. So the opportunity to now market that in the Q4 is going to help comps there. Better direct, having doubled the amount of SKUs online to have broadened menus, new categories for our customers online is certainly going to be a piece of our comp. And then the radiated sales that come from both BOPS and BOSS is you're in the 20% to 25% range is an average on every one of those footsteps. We have a lot more activity going through the stores with the fulfillment options that converts digital demand to store traffic and radiated sales.
That's kind of how I would rank all of the options that we have going into the Q4. So I think that the last thing I'd say is just the momentum that the team has. And that when you think about everybody aligned against comp store growth, everybody knows that we're now going up against a 4th quarter that we had comp store growth last year, highly motivated to meet the customer, where I think that Macy's shines best, which is the Q4, and we're very motivated to put another positive comp on the board in Q4 this year.
That's great. I'm a big fan of the BOSS initiative.
And next we'll go to Paul Lejuez with Citigroup.
Hey, thanks guys. Just one housekeeping thing and then a follow-up. Since you don't wind up the comps, what was the impact if you can share with us from the calendar shift in 3Q? And then for 4Q, which weeks will your comp be based on and what weeks we line those up against versus last year? And then I just wanted to ask a little bit more about the magnitude stores and the incremental 100.
How should we be thinking about CapEx, the impact of the investment on these stores into 2019 versus 2018 in terms of overall CapEx levels? Thanks.
Okay. So I'll start. So it's important to keep in mind that we not only had a shift in the calendar, but we also shift our promotional events in order to better serve the customers. And as we said earlier in the year, had we reported our comparable sales on a shifted like for like week basis, we would have experienced a slight detriment to the comp in the spring and a slight benefit to the comp in the fall. And then your second question, we would use the same week that we used at the beginning of the year.
And Paul, to your second question about Growth 100, so we finally have a real scalable model in the amount of capital that we are spending. So it depends on what the store is, but just the average is really $2,500,000 to $3,000,000 that we've been spending. And that is giving us and depending on what the store is, that could be an investment in certainly all the customer amenities but then also putting new businesses like Backstage or Big Ticket into those buildings. We have that formula now set. Some of those initiatives are giving us a nice return on investment and some are watching right now, but we know we have the right formula to make the adjustments going into 2019.
So expect in the 100 stores that we're spending in that $2,500,000 to $3,000,000 range per store in order to get those next 100
right. Got you. And sorry, just to clarify, Paul, did you say the Q3 was helped or hurt by the calendar?
So what we said in the first time is that had we have shifted the comp, we would have had a slight detriment to the comp in the spring and a slight benefit to the comp in the fall. That's had we have done the shift it like for like.
Okay. Thank you. Good luck.
And we didn't comment by the way on the Q3. This is all with respect to the first half and second half.
Okay. And next we'll go to Chuck Grom with Gordon Haskett.
Hey, thanks. Good morning. A nice uptick here in the number of transactions. I think you said, Paul, 3.8%. Just wondering if you could unpack that for us and if you think that is sustainable here into 4Q?
And on the guide, I think you originally said gross margins in the 3rd quarter would be a little bit worse than the 4th quarter. Just wondering if you're still holding that guide?
So on the AURs, was it the AURs that you're asking for or the transactions? So transactions were up 3.8% in the quarter and that's basically due to our initiatives and our increased engagement from our loyalty customer. We especially our platinum customer, she's shopping more with us. And what was the second part of your question, Chuck?
Just on the gross margins, you originally expected the Q4 to be better than the Q3. Q3 came in better than you expected. So just wondering if you still feel that the Q4 could still be better? Yes.
So we're pleased with the strength of our gross margin in the Q3 as well as year to date and it gives us more confidence than we had at the start of the fall season in the annual guidance. And for now, we're sticking with our guidance of annual gross margin up slightly. We're not guiding the quarters, but I think you can back in.
Okay, fair enough. And then Jeff, on store segmentation, it sounds a little bit similar to sort of what Kohl's has done with their standard of small effort. Just wonder if you could frame out for us the opportunity over the next couple of years on inventory, labor, merchandise margins, all three of which Kohl's has seen a benefit from?
Yes. So, what I'd say is that there's we have a lot of economic models now at our disposal that really help on the inventory and the gross margin conversation. So, when you think about better direct, very little risk as you know in inventory there. When you look at what we're doing with lease or what we're doing with retail as a service, new economic models that really mitigate risk and just add a lot of experience and new content for the customer. What I'd say is there's a big difference in our store portfolio versus some of our competitors.
When you're looking at some of these flagships and the volume that they command and the bones of those particular stores, those are really unique experiences in retail today on both really the Bloomingdale's as well as on the Macy's side. And so let's take full advantage of those and we have a multi year strategy to really increase the interest in those particular buildings. On these magnet stores, really a magnet is a draw. So you've got these regional malls that draw lots of customers. And at the same time that we are really changing the chemistry and the content and experiences in these buildings, so are all our mall developers in these malls.
And so what you see them doing is they're remixing their square footage, they're pulling out more apparel and accessories, they're adding more entertainment and food and beverage, They're making these more destinations. We're doing the same thing within our buildings. And what we're finding is that when you get to the customer insights about whatever that particular major market is, how often they're going from a neighborhood store to a magnet store that really is informing what our long range strategy is within them. So that's how we're looking at it. We're looking at our neighborhood stores about how do we make them more efficient, what do we do with excess space, how we make that an additive experience for a customer, that's what we're focused on right now that we're in the testing phase with.
Great.
And as a reminder, we'd like to remind everyone to please limit themselves to one question to allow everyone an opportunity to ask a question. Next, we'll go to Paul Trussell with Deutsche Bank.
Good morning. On the top line, I think you mentioned that weather was a benefit toward quarter end. Could you just speak to the cadence of comps? Should we assume that they improved as the quarter progressed? And has that cold weather benefit continued quarter to date?
Or any other color you can provide on early November trends? And then just on the credit card revenue, again, a meaningful increase year over year and you've raised the outlook. I know loyalty is playing a factor, but just help us understand the magnitude of the gains. And is there anything else that we should keep in mind playing a role there?
So Paul, I'm going to take the weather question and then I'm going to let Paul take the loyalty question. But as it relates to kind of a traffic in the quarter, all 3 months were positive. October was the best of the 3 months and a lot of that was related to the cold weather snap that we had and that really is across all cold weather categories. So what Paula had said earlier about the Northeast and particularly the Midwest area all benefited from certainly cold weather on that. I can't comment about November and how that's starting.
But what I would say just in general is that with remarkable consistency when you look at a cold weather calendar and the business in the fall season, how you trend in the Q3 is a remarkably similar percentage of the overall fall business and cold weather. So we know that our cold weather business in the Q4 is not affected by earlier demand, if you will, that's pulled from the Q4. So we feel very comfortable in our cold weather business. We did have good increases of that in the 3rd quarter. We expect to have the same increases in the 4th quarter.
So I would say that our credit program is integral and fully intertwined with our overall retail strategy. It is the primary vehicle for delivering our enhanced loyalty program and nearly half of our sales occur on our proprietary credit card. Our loyalty program has been very effective as you heard earlier in improving engagement and spending with our best customers especially at the platinum tier and that also benefits the credit program. And our partnership with Citi has worked well and it's helped us to generate a revenue stream that continues to grow driven by higher credit sales and proprietary card balances. We are seeing slower payments on those card balances, but the quality of the credit balances continues to be good.
And in terms of what you can expect to see, we've guided $740,000,000 to $755,000,000 in the year that reflects the improvement that we're seeing. And so we expect that to occur over the Q4 and that's been reflected there. And
there. All
right. And next we'll go to Omar Saeed with Evercore ISI.
Thanks. Good morning. Thanks for all the information. Jeff, I wanted to follow-up on the BOPS and BOSS discussions you were having. Maybe help us with some examples or anecdotes how different customers are using those options, especially when we think about the underlying kind of traffic strength in your business and merch margin strength in your business, some of that getting depleted away for shipping and returns.
How do you think about the BOPS and BOSS dynamic maybe alleviating shipping and returns costs over time as you get customers into stores? And are you incentivizing the customers to come and the guests to come into the stores given the attachment rates when they come in to pick up these purchases? Have you toyed around with that given the attachment rates and the savings again on shipping and returns? Thanks.
Yes. Good questions, Omar. So the what I tell you is that to your last question, we have not. We've debated it. Do we need to do that?
Do we need to give them an incentive? And I would tell you that of the quarter, of all the initiatives that we have, BOSS has been a surprise about how quickly this has taken on and how big this business has become for us. The customers love the option. And I think a lot of it comes down to the store segmentation strategy. What you're seeing with BOSS and BOPS is that those neighborhood stores, those smaller neighborhood stores, they have a much higher penetration of their overall traffic being generated by fulfillment options, which I guess makes some sense because when you look at what we curate an individual store's assortment, you don't have the same breadth of assortment in a smaller door as you do in a magnet or a flagship.
So as a result of that now, you've got customers who are not either comfortable in shipping something directly to their home because they're not there, they're working or they want to feel it, they want to touch it by coming into a building. They're taking full advantage of BOSS. So which what we're seeing is that the radiated sales that come from a BOSS purchase and a BOSS purchase is pretty similar. So check that box, that part is good for us. We know what those footsteps do.
When you look at the average unit retail or the transaction that is coming with a BOSS order versus a BOPS order, it is lower. So that would basically say that customers that are not part of a gold or platinum level where they get free shipping, they're foregoing the need to pay for shipping by taking advantage of BOSS. But as people are getting more used to this, I think we're going to see where it goes. We're in the beginning stages of this. We really churn BOSS in full across the horn in the Q3, and we're still measuring all the results of it.
But so far very good. The dynamics of this are really strong. It's really helping us in our neighborhood store traffic and it's just a it's been very positive thus far.
Very helpful, Jeff. Thanks. Good luck.
Thank you.
And next we'll go to Kimberly Greenberger with Morgan Stanley.
Okay, wonderful. Thank you so much. Good morning. I had a quick question on following up Jeff on your comments about the sequential improvement in stores that you've seen here over the last four quarters. Are we back to positive traffic in stores?
The transaction growth this quarter was very strong, obviously. I'm just wondering if that's being largely driven by digital or are you seeing positive growth in stores? And then I just wanted to follow-up on Paul's question about the 4th quarter comp calculation. Understanding you'll compare 13 weeks this year to 13 weeks last year in Q4, does that comp calculation clock start on the 1st week of the quarter, November 4? Or do you exclude the 1st week of November from your comp calculation and start the clock with the week beginning November 11?
So I'm going to address the first one, Kimberly, which is really the kind of sequential improvement in stores. So all the stores are performing better in this year versus last year, and it has gotten progressively better. When you look at some of these stores, they definitely are have positive comps and some of them are getting quite healthy. So let's just talk about some of the individual parts. When you look at the Growth 50 stores, that's a very positive comp story when you look at those.
And some of those stores were negative comps in previous quarters before we put in the investment. When you look at what Backstage is doing, so Backstage is a separate part for those stores where Backstage has been open more than a year. The whole portfolio of those stores have high single digit comps. So that's good news. Obviously, we've got certain businesses that are positive comps in stores.
But the aggregate store, be it with Backstage as a subset or the full store that doesn't have Backstage, We've got a number of stores in our portfolio now that are demonstrably better than they were in the beginning of the year. They get better each quarter. We believe that trend is going to continue across all store types as we get into 2019. When you look at the profitability of those stores with many of those have fixed expenses, the profitability picture improves for the overall company when the stores comp gets better. So that's very healthy for us.
And then when you look at the economics of online and you look at a larger portion of the online demand being fulfilled through either Bob's or BOSS and the radiated sales that come from that, that also helps the profitability picture. But again, when we look at both online or stores and look at it as kind of a separate thing, it gets really murky. We really look at the full customer journey because she's shopping in all channels, in all categories, and in many cases, many stores. So we got to look at how one particular experience will have an effect on another experience or another transaction. We look at the full customer journey versus the individual pieces.
But in aggregate, stores are improving.
Kimberly, I would say that in terms of how we look at the comp in the Q4, it will be similar to how we've been looking at it in all the previous three quarters. We will exclude the same week from Q4 that we did last year. Thank you.
Okay. And next we'll go to Lorraine Hutchinson with Bank of America.
Thank you. Good morning. I just wanted to understand the dynamic behind the SG and A growth this quarter. The 3% dollar growth was the highest we've seen in some time. Is this the new run rate going forward or was there anything that was pulled into the Q3 that may not continue in 4Q in 2019?
So Lorraine, we in the Q4, we had elevated SG and A and that's due to the investments in our strategic initiatives. Particularly in Backstage, we rolled out 60 Backstages in the Q4 in the 3rd quarter. And so you're seeing the impact of that. In terms of what you can expect for the balance of the year, I would just look to the SG and A guide. We haven't changed it.
We are guiding that SG and A will be up slightly in dollars, but that our rate will be approximately the same.
And I understand you don't want to talk too much about next year, but I think it's important given that you do plan to roll out an incremental 100 Growth 50s, if we could get some sense of where you're thinking about SG and A or if there are offsets, that would be very helpful.
So again, we will continue to invest in the strategic initiatives that we know are working from our test iterate and scale approach. And we have a long track record of being very disciplined on expenses even while we're investing for growth. And so through the Funding Our Future point on our North Star strategy, we have a multiyear focus on managing expenses and that will help us to fund our strategic initiatives that are driving the improved sales growth that you're seeing. So we have already a number of cost savings and productivity
So look to hear more
about that later. Okay. So look to hear more about that later.
And next we'll go to Baum Drbul with Guggenheim Securities.
Hi. Just a question around competition. I just wondered if you could talk a little bit what you're seeing from the competition both online and the bricks and mortar, and if you're seeing any impact to your business from the Sears liquidation sales?
Well, obviously, Bob, we look at competition all the time both online and in our stores. And when you think about what we set out to do with the North Star strategy, it is really what is Macy's unique competitive advantage and how do we distort that in a more fulsome way. So we're really focused on when you think about the point of the star, it's about it must be Macy's, which is about what we're doing with really kind of localized but really exclusive content. We spend a lot of time with our manufacturing partners that create specific content for us as well as our own private brands. And when you look at that in the context of having a really strong mobile business and a really strong digital business, that is really where we know we can compete and compete well.
We're really focused now on experience as it relates to table stakes experience about removing the friction from the customer journey, but then also what do we add that Macy's can uniquely do. So that would be what we're doing with story, which we haven't announced yet, but what will story be within Macy's, what we're doing with the market at Macy's, all what we're doing with VR and AR, those are all pieces that we are putting a lot of initiative against. But then what are we doing with our in store colleagues in those businesses where that touch matters and what we're doing with special events and trunk shows, those are all things that increase the experience. When I look at the to your question about Sears, we've been dealing with Sears for a number of years as their businesses decline or as they've dropped out of particular malls. And as you would probably expect, we have very little customer overlap with Sears.
So I don't see that affecting us much. When I look at something like Bon Ton, when that goes out of the Midwest, that definitely affected us. So when you look at some of our strongest districts have been in those districts that competed against Bon Ton. And when you think about the arsenal of products that Bon Ton carry, the brands and the categories, Macy's, you would expect would be a recipient of that. So beauty business is some of the best brands that we would be the place where that customer would look for it.
So we've done a lot of outreach to those customers. We've done a lot of outreach to those stores that closed in terms of their great colleagues, their great management, making sure that we knew who they were. We brought them into our stores that were nearby and we've been aggressive about going after. So that customer wouldn't be disappointed with losing that competitor out of that market and figuring out this is a place where you can come and get continuation of either the sales colleague that you enjoyed when you were in another location or a brand that you were used to seeing. So that one did affect us and that is helping our overall Midwest business.
Great. Thank you very much.
Okay. And next we'll go to Alexandra Walvis with Goldman Sachs.
Good morning, guys, and thanks for the question. We wanted to ask another one about the new store segmentation strategy. As you think longer term about that strategy, what proportion of sales are you expecting to deliver through flagships, magnet stores and neighborhood stores? And then one clarification question on the magnet stores specifically. You've mentioned that you're going from the 50 growth growth 50 stores now and rolling out another 100 next year.
Will that be the total base of magnet stores or is there potential to make that a bigger group?
So, Alexandra, the first question is we're not going to break out what percent of our portfolio was in each of the 3 buckets, but all three of them are sizable is what I'd say. And the second part of your question, the next 100 magnet stores will not complete the list. There will be a slug of others that would go based on what we learn, what the return on investment of those are. So when we have the Growth 50 going to the next 100, there will be more that we would do in future years.
And next we'll go to Dana Telsey with Telsey Advisory Group.
Hi, good morning and nice to see the progress. As you think about the gross margin, it was impressive on the merchandise margin offsetting the delivery expense. Are you achieving scale or economies of scale and delivering expense that's allowing this to come through? And how do you think of the buckets of opportunity for that merchandise margin or reg price as compared to delivery expense? Thank you.
So we have been expanding our gross margin merchandise margin all year and that's been based on the discipline that we have with inventory management as well as using the data analytics to inform our various inventory decisions. And that's been helping us to sell more full price selling or merchandise and to price better. So we're looking at opportunities there. We'll continue to impact our merchandise margins. On delivery expenses, we're also looking at those very closely as well in terms of how we can be more efficient.
And we have a number of activities underway there, such as BOPS and BOSS that are helping on our delivery expenses. So we're focused on both of those two components and we're seeing progress in both of those two components.
And then just on tourism, what did you see on tourism? How did it differ from the Q2 and how you're planning it? Thank you.
So Dana, we saw you'll recall in the first half of the year, 6% improvement in our international tourism business. In the Q3, our tourism business was down 4.2%. So year to date, we're up 2.5%.
All
right. And next we'll go to Priya Auri Gupta with Barclays.
Hey, thank you so much for taking the call. Paula, I was just wondering if you could give us your thoughts on how we should think about where you plan to manage your leverage going forward? You're pretty comfortably within your range. Should we expect any further debt pay down over the remainder of the year, given your comments on deploying excess free cash flow towards debt pay down this year? Thanks.
Sure. We continue to target our leverage ratio of 2.5% to 2.8%. A healthy balance sheet is very important to us. And as we've said, we'll use excess cash, to pay down further debt and to get closer to our target ratios.
Okay. Next, we'll go to Brian Tunick with Royal Bank of Canada.
Thanks. Good morning. I was curious on your views about CapEx needs going forward. I guess talking and hearing from Jeff on these different initiatives for next year accelerating, Just curious how we should view CapEx maybe next year or the next couple of years? Have you guys figured out either a lower CapEx spend per store as you've done the Backstage or Growth50 initiatives?
Just generally, how should we be thinking about that? And then maybe, Jeff, on the vendor direct and the mobile numbers you've cited, have you changed your view of maybe how high e comm can mix at the company over the next few years? And are there any new distribution centers or other CapEx needs in order to maintain that growth? Thank you very much.
So look for us to continue to invest in our strategic initiatives next year and to have around a similar investment next year in terms of CapEx. And as a percent of sales, we're still well within line. And so around the same amount or a little bit more next year.
And what I'd say Brian on the just to add to what Paula just said about, I think what you can depend on from us is really a balanced investment strategy against maintaining where we're going with really robust digital growth, but also getting our brick and mortar fleet healthier. And we know that we can't do one without the other. So investing in digital and mobile is very important, but equally investing in stores. So as Paula said, the capital outlay for 2019 expect to see it the same as what we were in 2018, give or take. And then to your second question about where fulfillment or where the overall digital demand is going to go, we do see that continuing to build as a percentage.
But what I'd say is that there's so many more fulfillment opportunities for us outside of building mega centers. And so again, when you start to look at some of this excess space that we have in these neighborhood stores that are in every one of our major markets, there's opportunities to redeploy that square footage. So the opportunity basically with more economic models with hold and flow opportunities, we're going to be looking at lots of opportunities for us to take fuller advantage of data analytics and getting the most out of the inventory that we flow closer in need to where customers are and when they want to purchase something. So, we'll be giving you more detail on that as we outline all of our 2019 plans, but it's very much on our mind.
And next we'll go to Michael Binetti with Credit Suisse.
Hey guys, good morning. Thanks for taking our questions here. Just want to ask you first on the credit line. We're just trying to back out some of the math on the Q4. It looks like it's implied to be slightly negative in the Q4.
Obviously, the most recent trends have been better than that. But obviously, you're lapping loyalty, but I'm not sure how much of that is a one time step up in the Q3 or what it means for the next 12 months?
So in terms of our credit, we're guided at $740,000,000 to $755,000,000 So that would imply a range for it just doing the math versus where we were in Q3 of 207 to 227. And in terms of tell me the second question.
Well, I'm just curious since that's guided to slightly lower in the Q4 year over year, but you've been seeing such big gains lately. And I know you're lapping loyalty, but I'm just trying to think of how much the so should we assume that the Q3 growth we saw in credit was really one time or what we can extrapolate going forward multi quarter into next year on credit?
Have you contemplated a 53rd week?
Okay. So if we look at that, maybe you could just unpack what drove so much growth in the Q3 for us between the drivers of like interchange fees, higher balances, credit score changes. I know you said you gave a few comments earlier, but just if you could help us think about that, because you also mentioned that the quality of credit was quite high, but that the balances, it sounded like were going higher as well. I didn't know how to reconcile two comments.
Yes. The credit sales are higher, again driven by our loyalty program. The balances also are higher and that's driven by the sales, but also we're seeing slower payments. And that is just because our customer is deciding to pay slower. The quality of the accounts receivable continues to be high.
The other thing is we're seeing slightly lower fraud charges. So there are a lot of positives in there, but the biggest thing is credit sales in the higher corresponding balances.
Okay. That's helpful. And maybe if I could go back to Lorraine's question, just ask a different way. I think given some of the commentary you've given on the store plan for next year and the CapEx related to the Wall Street Journal story. I guess, how should we think about how that influences the P and L on the SG and A line next year?
You mentioned you have some cost containment plans that you've already told us about. I'm just wondering if that lets you and puts you in a position to lever SG and A as we look out multi quarter into next year given the growth plans that you mentioned?
So we're developing our plans for 2019 and we'll talk about those more on subsequent call. But again, we will be investing next year and we will also be mitigating our investments as best we can through cost savings. The other thing I should say is that to the extent that we have been investing, we're already seeing returns on those investments. So all of that will be helpful as well. Jeff Gannett for any
additional comments
or closing remarks. Thank you. Thank you. Thank you. Thank you.
Thank you. Thank you.
Thank you. Thank you. Thank you. Thank you. Thank you.
Jeff Gannett for any additional comments or closing remarks.
Thanks, everybody. Thank you. Appreciate all your questions.
And that does conclude today's conference. We thank you for your participation. You may now disconnect.