Good morning, and welcome to the Macy's Inc. 2nd Quarter 2018 Earnings Conference Call. Today's hours long conference is being recorded. I would now like to turn the conference over to Monica Koehler, Vice President, Investor Relations and Finance. Please go ahead.
Good morning, and welcome to the Macy's, Inc. Conference call scheduled to discuss our Q2 earnings and outlook for the remainder of the year. Joining us on the call today are Jeff Gennett, Chairman and Chief Executive Officer and Paula Price, Chief Financial Officer. Any transcription or other reproduction of the statements made in this call without our consent is prohibited. A replay of the call will be available on our website, mayesinc.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 net income and adjusted diluted earnings per share amounts that exclude the following: the impact of impairment and other costs, settlement charges associated with our defined benefit plan and losses or gains on the early retirement of debt. You can find additional important information regarding these non GAAP financial measures as well as others used in our earnings release and during this call on the Investors section of our website.
We look forward to taking your questions after our prepared remarks. With that, I'll turn the call over to Jeff.
Thank you, Monica. So good morning, everybody, and thank you for joining the call. First, I want to introduce Paula Price. Paula joined Macy's Inc. As the Chief Financial Officer in early July.
Paula is a strong addition to the team and she has hit the ground running. I also want to thank again Karen Hogay for all that she is doing to help make this a smooth transition before her much deserved retirement. Karen has been a great partner to me and an exceptional leader for Macy's Inc. And for the industry. So, this morning, I'm going to share perspective on the Q2, then Paul will take you through the details of the quarter as well as updated guidance, and then we'll open up the line for your questions.
As you saw in this morning's press release, Macy's Inc. Had another strong quarter. This was our 3rd consecutive quarter of comparable sales growth and reflects ongoing improvement in the business that we saw first in the Q4 of 2017. It is early innings, but I feel about feel good about the progress that we've made, the focus and energy of the team and the positive response our customers have to our strategy. Before we get started, I want to note, as we said in our press release, last week's or last year's 53 week calendar caused some shifts in our 2018 promotional calendar.
Today and in my comments and in those of Paula, we will provide you with both 2nd quarter and first half views where we think it is helpful. So this is how we're gauging the strength of the business and we want to give you the same level of detail. For the Q2, comparable sales were up 0.5% on an owned plus license basis. But when adjusted for the friends and family shift from the 2nd quarter to 1st, comparable sales were up 2.9% on an owned plus license basis for the quarter. For the first half of the year, comparable sales on an owned plus license basis were up 2.3%.
We delivered adjusted EPS results of $0.70 per share for the Q2 and $1.19 per share for the first half of the year. Based on the first half performance, our strong execution and the anticipation of continued healthy consumer spending, we are raising both sales and earnings guidance for the year. Paul will give more detail around guidance, but to sum it up, we are raising annual comparable sales guidance for own plus licensed to 2.1% to 2.5%. We are also raising EPS by $0.20 and anticipate that annual EPS will be in the $3.95 to $4.15 range. Overall, I'm feeling good about where we are today and I'm encouraged by the momentum we have heading into the back half of twenty eighteen.
At the heart of our improved performance is a consistent focus on the customer. The North Star strategy is built around improving our customer journey every step of the way, taking out points of friction and dialing up the things that she loves about Macy's. As I've said before, our recipe for success stores, a robust e commerce business, and a powerful mobile app. Our customer wants a great experience anytime and anywhere she shops with us. It's especially encouraging to see another quarter of trend improvement for our brick and mortar business.
This improvement was led by the growth 50 stores, but we also saw trend improvement across much of the fleet. Our digital business clocked another quarter of double digit growth, including a very strong July. And we continue to see increased engagement with Macy's mobile app. Sales are up more than 50% on our app in the first half of the year versus last year. We continue to emphasize and edit an elevated assortment with a heightened focus on fashion through our merchandising initiatives and our customers are responding well.
Average unit retail was up nearly 5% in the first half of the year. And operationally, we continued to improve execution in the quarter. It was encouraging to see the organization flex and respond to drive additional sales throughout the quarter. All of this activity laddered up to a strong performance across all families of business, every geography and all three of our brands, Macy's, Bloomingdale's and Blue Mercury all turned in a strong second quarter performance. At Bloomingdale's, we saw particular strength in men's, handbags and cosmetics.
And like the Macy's brand, we're seeing good regular price sell through through on all of our fall trends and that's really across all categories. The newly renovated shoe floor at Bloomingdale's 59th Street flagship has continued to gain momentum after the Q1 opening. Across the store renovated areas are performing in total above expectation and we look forward to the completion of the renovation by year end. New Yorkers and tourists alike love the vibrancy of this iconic store. Blue Mercury continued to perform well and we are pleased to see comparable sales growth in both freestanding stores and the Blue Mercury shops within Macy's stores.
We're now going to turn to the Macy's 5 strategic initiatives. 1st, we're very pleased with the loyalty program that we launched last year. There has been a meaningful positive change in behavior at the Platinum tier, which are our best customers. We've hit a rhythm with the exclusive experiences we're able to offer our Platinum members. Access to VIP sections of the New York Fireworks, exclusive cooking classes with local chefs in Miami, LA and San Francisco, a preview of Broadway shows.
These are just a handful of examples of the unique experiences we can offer the Platinum customer. And at the bronze tier level, that was the tender neutral offering that we launched last quarter. We now have more than 1,000,000 new members. These are new customers to Macy's. So, within the loyalty program, our best customers are spending more and new customers are coming into the program.
We will continue to expand and refine the Star Rewards program throughout the year. Next, our Backstage expansion is continuing at pace. We opened 47 Backstage stores in the 2nd quarter for a total of 65 opened in the first half of the year. We are now on track to complete 120 openings this year. This includes the expansion of Backstage to the West Coast and to some of our premium doors.
Opening a Backstage store within the Macy's is a significant operation since we need to relocate departments to carve space and then construct and merchandise backstage. This process does create a ripple effect in the store and to date the teams have been handling it very well with minimal disruptions and all work will be complete by the end of Q3. Based on the ongoing sales lift we see from 20 16 and 2017 Backstage locations, we feel good about our on mall off price strategy. Adding Backstage makes existing stores more productive, gives our customers an exciting new experience, and will bring new customers into the brand. Next up is vendor direct or the expansion of our online offerings.
It is also on track. By Q4, our customers on macys.com will have access to a significantly expanded assortment. This includes more selection of products from great national and private brands that Macy's is known for, plus the addition of new brands and categories that we know our customers will love. We're building on our merchandising strengths and adding selection where our customer has already signaled interest. Next is the expansion of our store pickup program.
This is doing well. This includes buy online, ship to store, what we call BOSS, and buy online, pickup in store, which we call BOPS. BOSS expanded to 50 stores in the 2nd quarter and will be in almost every store by the end of the 3rd quarter. We're also refining BOPs to improve the customer experience. And to support those programs, we are nearly complete with the rollout of the Atcher service stations in every store to make pickup easy and quick.
Our 5th strategic initiative in 2018 is the Growth50. And I'm pleased to report that our Growth50 stores are performing as we had expected and lead the improved trend in brick and mortar in the first half of the year. We also see an outside improvement in customer satisfaction scores in the Growth fifty, which tells us that our customers are noticing and appreciating the changes that we are making. The investment we're making in these 50 stores is paying off and supports our thesis that with the right talent and investment, our stores can be vibrant, productive and profitable shopping destinations. I have visited almost every Group 50 store over the past few months and I'm very encouraged by what I see.
The stores look great, the merchandise is right, customers are engaged and the teams are committed to win. The early performance of these stores is strong enough to give us confidence to line up the next batch of stores that will get the Growth50 treatment in 2019. While we have this intense focus on the Growth50, we're also making investments in stores across the fleet to improve the customer experience. As mentioned, that your service centers and mobile checkout are going to be in almost every store. Stores are receiving more fashion, a more edited assortment and they're being allowed more localization.
We're also activating 60 virtual reality furniture locations in the 3rd quarter. VR significantly increases transaction size and reduces returns. And importantly, it allows us to put big ticket in roughly half the amount of space. We are committed to bringing excitement and fresh new experiences to our stores on a regular basis. In the Q2, we announced our investment in beta, a technology powered retailer that allows us to scale the market at Macy's faster.
We're excited by the impact of the market and we'll be opening up 2 new markets in the fall, 1 in Atlanta and 1 in Los Angeles. Between the market in Macy's and STORY, which we acquired in the Q1, we feel good about our opportunities to bring new content and experiences to our stores. We also had a good start to the back to school season at the end of the second quarter. Our integrated marketing campaign Time to Shine has resonated with customers. The merchandising strategy is solid and our kids business is thriving.
By brand, by category, by geography, we see improved performance and momentum in the business, which we will carry into the Q3. We wouldn't have this momentum without the effort and support at our teams. I want to say thank you to all of our colleagues who are more engaged in the business than ever. Their hard work is paying off, both in our results and in our customers' attitudes towards the brand. Year to date, we've improved our Net Promoter Score by 7 full points versus last year with our Growth 50 stores almost up almost over 10 points.
That's a big improvement and I'm proud and grateful to the 130,000 colleagues who are motivated and dedicated to serving our customers every day. And all that work is paying off for our people too. For the Q2, nearly 80% of our colleagues will receive a payout in the path to growth incentive plan. That's part time, full time, seasonal, every colleague has a role to play and a stake to win in our success. We are still early in our journey, but as I look at the progress we've made on merchandising, our strategic initiatives, the reengineering of our marketing machine and our company culture, I feel good about the work that's underway and optimistic about Macy's Inc.
Future. And with that, I'm going to turn the call over to Paula to discuss our financial performance.
Thank you, Jeff. I am so pleased to be a part of the Macy's, Inc. Team and I'm looking forward to updating you on the financial progress of our journey. I too would like to congratulate Karen on her retirement and to thank her for the effort that she has put into making sure that I have a great beginning at Macy's Inc. I truly appreciate her support.
As Jeff mentioned, I will provide some detail on the Q2 and also offer some perspective on how we're thinking about the year. And then I will share a few of my very early observations on the business. I remind you that my commentary includes certain financial measures adjusted for the impact of impairment and other costs, settlement charges associated with our defined benefit plans and losses or gains on the early retirement of debt. Sales in the Q2 were $5,570,000,000 up 50 basis points over last year on an owned plus license comparable basis, which was better than we expected. The quarter was negatively impacted by the shift of friends and family promotional event into the Q1 of this year as compared to the Q2 last year.
Excluding the 2 40 basis points of negative impact due to this shift, comparable sales on an owned plus license basis increased an estimated 2.9% in the 2nd quarter. Due to the materiality of the friends and family shift, which impacted the Q1 positively and the 2nd quarter negatively, as Jeff mentioned, we are providing first half metrics where appropriate to facilitate a more meaningful comparison to the prior year. For the first half of the year, sales were up 1.1% in total and up 2.3% on an owned plus license comparable basis, much stronger than we expected at the start of the year. Comparable sales on an owned basis were up 1.9% for the first half of the year. Our North Star strategy and strong execution are driving our improved performance.
Our brick and mortar business continued the positive momentum that began in the Q4 of 2017 and our digital business continued to grow double digits. We are also benefiting from strong consumer confidence in spending, including growth in international tourist spending. In the 2nd quarter, our international tourist sales were up 3% over last year, less than the 10% increase seen in the Q1, in part due to the friends and family shift. For the first half of the year, we saw a 6% increase in international tourist sales. Macy's, Bloomingdale's and Blue Mercury all delivered strong sales.
Sales were also strong across all geographies with top performing market spread across the country. The strength in our categories was also broad based across fine jewelry, fragrances, active dresses, kids, men's, luggage and furniture, while our performance in mattresses was lower than expected. For the first half of the year, total transactions were up 50 basis points. Average units per transaction were down 2.6%. Average unit retail was up 4.6%.
These metrics reflect strong regular price selling helped by our disciplined inventory management. Credit card revenues in the quarter of $186,000,000 was 11% higher than last year due to higher balances and an increase in card usage driven by the enhanced Star Rewards loyalty program. The penetration or usage rate of our proprietary cards was 46.6%, up 60 basis points from last year. This is in line with the goals that we set for the new loyalty program. And as Jeff mentioned, we are pleased with the heightened engagement of our best customers and healthy growth of our credit portfolio.
Gross margin in the quarter was $2,250,000,000 or 40.4 percent of net sales, 80 basis points higher than last year, benefiting from our much improved inventory position this year as well as our strong sales performance. We ended the quarter with inventory down 40 basis points on a comparable basis. This year over year decline in inventory is less than it was in the Q1 as we cycled the clearance of excess inventory during the Q2 of 2017, creating a more difficult comparison. Additionally, we were 1 week deeper into the back to school season this year due to the 53rd week calendar shift and therefore needed fresh merchandise to capture those sales. The calendar shift will have a greater timing impact on our receipt flow at the end of the Q3 when in fact we expect inventory to be up on a comparable basis versus last year as we prepare for the holiday season.
By the end of the fiscal year, however, we expect inventory to be down again. We continue to be disciplined about managing positively to fresh merchandise receipts. SG and A expense in the quarter was $2,160,000,000 or $3,000,000 higher than last year. On a rate basis, SG and A expense was 38.8% compared to 38.4% last year. We continue to invest in our strategic initiatives to accelerate our growth and our lower taxes continue to help fund these investments.
Asset sales gains in the quarter were $46,000,000 $3,000,000 higher than last year, including continued recognition of the deferred gain from the Brooklyn transaction that we closed in 2015 and other property sales that we closed during the Q2. For the first half of the year, asset sale gains were $70,000,000 as compared to $111,000,000 last year. Proceeds from asset sales were $88,000,000 year to date, compared to $150,000,000 last year. We booked approximately $17,000,000 in restructuring, impairment and other costs, which included the impact of changes we made to our China business, which we shared last quarter. Benefit plan income in the quarter was $11,000,000 compared to $14,000,000 last year.
And we also booked non cash pension settlements of $50,000,000 in the quarter, which is approximately the same amount as last year. Consolidated EBIT in the quarter was $264,000,000 compared to $245,000,000 last year. Adjusted EBIT of $331,000,000 was 12% higher than last year. Excluding asset sale gains as well, EBIT of $285,000,000 was up 13% in the quarter. In Danda's same basis, EBIT for the first half of the year was $529,000,000 compared to $417,000,000 last year, a 27% increase.
Interest expense in the quarter was $62,000,000 compared to $79,000,000 last year. This excludes debt premium charges of $5,000,000 associated with the $344,000,000 of debt repurchase completed in the open market in the quarter. Tax expense in the quarter was $33,000,000 or 17 percent of pre tax income. This compares to $60,000,000 or 36% last year. We also benefited in the quarter from the resolution of certain state tax examinations.
Net income in the quarter was $166,000,000 compared to $111,000,000 last year. Adjusted net income was $219,000,000 This is $78,000,000 or 55% higher than last year. For the first half of the year, net income adjusted on this basis was $369,000,000 compared to $221,000,000 last year. Excluding asset sale gains as well, adjusted net income of $316,000,000 in the first half of the year was more than double the adjusted net income of $152,000,000 last year. Diluted earnings per share were $0.53 in the quarter compared to $0.36 last year.
Adjusted earnings per share were $0.70 in the quarter compared to $0.46 last year. When excluding asset sale gains as well, adjusted earnings per share were $0.59 in the quarter compared to $0.37 last year. And on this same basis, earnings per share were $1.02 for the first half of the year compared to $0.50 last year. Cash flow from operating activities of $544,000,000 for the first half of the year was consistent with prior year. We also had $36,000,000 more invested in capital expenditure and $62,000,000 less received in proceeds from asset sales compared to prior year.
We ended the 2nd quarter with $1,100,000,000 in cash, $286,000,000 more than last year. As you heard from Jeff, we are very pleased with the performance of our key strategic initiatives, the Growth 50 stores, Backstage, store pickup, the enhanced Star Rewards loyalty program and the growth in our vendor direct assortment. As a result of the strong first half sales and earnings performance, we have again raised guidance for the year. We are gaining traction earlier than we expected and this combined with a healthy consumer spending environment gives us the confidence to increase our outlook. Our assumption for total sales for the year is now flat to up 0.7% with 2017 having had one extra week of sales.
Comparable sales on an owned plus license basis is now expected to be up 2% to 2.5% for the back half of the year, which translates to 2.1% to 2.5% for the full year. This is consistent with the strong growth seen in the spring, but also considers that we are cycling a very strong 4th quarter from last year. Adjusted diluted earnings per share are now expected to be $3.95 to $4.15 up from our previous guidance of $3.75 to $3.95 Key assumptions behind our revised full year guidance include the following. We expect our gross margin rate as a percent of sales to be slightly up for the year. This means that the gross margin rate is assumed to be slightly below last year in the fall.
This is because we expect the increase in fall 2018 merchandise margins to be smaller than the increase we experienced this past spring as we cycled a strong the anticipated increase in fall 2018 merchandise margins will not fully offset the increase in delivery expense associated with our fast growing digital business, which ramps up in the second half at a higher penetration. Further, since we launched our enhanced loyalty program in October 2017, we anticipate more delivery expense impact on our gross margin rate in the Q3 of this year compared to last. SG and A dollars for the year are expected to be higher than last year due to our investments in the business and in support of the expected sales growth. We expect it to be more pronounced in the Q3 than in the Q4, because the Q4 benefited from 1 less week than last year. Credit card revenue is now expected to be $720,000,000 to $735,000,000 on the strength of performance to date.
Interest expense, excluding any debt premium charges associated with debt repurchases, is now assumed to be approximately $245,000,000 which is lower than prior guidance due to the acceleration of our debt reduction. Our expected annual effective tax rate is now expected to be 23%, which is 25 basis points lower than prior guidance. The other assumptions provided in May remain unchanged. While we are pleased with the strong start to the year and our ability to capture benefits from our strategies earlier than we expected, we know that we have a lot of work ahead of us. Nonetheless, it is great to enter the back half of the year well positioned for growth.
Before I hand it back over to Jeff, I want to share a few of my early observations about what I see at Macy's Inc. I see growth. Our strategic initiatives are gaining traction and the financial results are showing up consistently and positively in our stores, online and through our mobile app. I see potential. We have cost and productivity opportunities that are already beginning to be unleashed by analytics and technology.
Our business generates strong cash flows. We have a healthy balance sheet and these all give us the flexibility that we need to fund our future and reinvest in our business. And I see my highly motivated colleagues throughout the organization who are aligned on one path to restore this iconic company to sustainable profitable growth. I look forward to meeting many of you over the coming weeks. And with that, I'll turn it back over to Jeff for some closing remarks.
So, thanks, Paul. So, before we open up the line for questions, let me sum things up. We are delivering strong operational performance, which is amplified by a healthy consumer spending environment. Our brick and mortar business has shown meaningful improvements and our digital business continues with strong consistent growth. The North Star strategy strategic initiatives are gaining traction and drove the 3rd consecutive quarter of comparable sales growth.
We have momentum heading into the back half of the year. And with that, we'll open up the line and Paul and I will take your questions.
Thank We will now take our first question from Matthew Boss, JPMorgan. Please go ahead, sir.
Thanks. So Jeff, can you
help us break down the improvement in first half same store sales maybe between the stronger underlying consumer you're seeing and your company specific initiatives? And just also how you're thinking about back half international tourist sales given I think you mentioned a roughly 700 basis point sequential slowdown versus what you saw in the Q1?
So, I think Matt that certainly the trend of the business in the first half was buoyed with a strong consumer sentiment and good spending across all of retail. And so, I think that's a piece of our trend. But when you look at Macy's performance to general market in 2018 versus what we were in 20 17, you definitely see a big narrowing. And I believe that gap, that narrowing of gap is really related to our strategies. And so, our strategies are really related to how we are going to take care of a customer and that's across any way that she shops with us.
So, really happy with the strong digital growth. We continue to invest there. We're getting double digit growth there both in the first and the second quarter, putting a lot of investment into mobile. And we're going to pass in 2018 $1,000,000,000 in mobile sales, but it's much more than that. You know how the customer really uses that for really understanding the brand, checking out customer reviews, navigating a store, mobile checkout.
Mobile app is a real gateway for us and we're going to continue to strengthen that. But the part of the strategy that I'm most excited about is the firming up of brick and mortar trends. And really across the fleet, it is we saw improvement and that's the big difference in our business in 2018 versus 2017 is what's happening in brick and mortar. So, very excited about that. And I expect that to carry us into the back half of twenty eighteen.
To your international tourist question, I think we have to also look at what happened in 2nd and first quarter. What happened in international tourism is what happened to Macy's customers at large that there was a shift as a result of the international tourism excuse me, of friends and family. And so, what we want to look at is really the first half performance of international tourism, which is up about 6% when you look at the Macy's and the Bloomingdale's plates. So, we expect that international tourism will remain up in the back half of the year around that spring level.
Great. And then, just a follow-up on the P and L. On the expense front, I guess as your offensive initiatives accelerate into next year, should we be thinking about also a step up in SG and A as we think about next year on the expense front or do you see continued operational efficiencies to offset
this? We're looking at that right now. We haven't finalized all of our 2019 planning, but we're obviously looking at where are those inefficiencies that we have in our overall strategy that the customer doesn't value and making sure that we're making those appropriate cuts because there's a lot of opportunities that the voting on that we want to make sure we're fueling. But I just would remind you that we're good at cost control. We've done a great deal with getting out extraneous expense.
We're a much linear organization than we were even last year and we're totally focused on doing what's right to drive profitable sales and taking care of a customer that expects that of us.
That's great. Best of luck.
Thanks, Matt.
We will now take our next question from Paul Trussell, Deutsche Bank. Please go ahead, sir.
Good morning. I wanted to inquire about the EPS revision higher for the year. If you can just walk through all of the components that led to the increase, Certainly, we see your confidence on the top line. And I think you also mentioned a higher credit revenue expectation. But if you could just walk us through all the puts and takes as we think about asset sales and kind of below the line items, just so we have a full understanding of what's led to the incremental rates?
Okay. So, our sales and earnings guidance for the full year reflects our strong performance in the first half as well as our increased confidence in our fall expectations. And so our sales guidance for fall is up 2% to 2.5% on a comparable owned license basis. And this is fairly consistent with our strong performance in the first half where we performed better than we expected, but it also considers that in the fall we're cycling a very strong quarter from last year. We also guided our credit revenue up.
Our asset sale gains continue to be the same at $300,000,000 to 3.20 $5,000,000 for the year and we're making progress against that. And our interest expense is down and that's based on the debt repurchase that we did earlier than we expected. So we're already seeing that effect. And so as we stated at the beginning of the year, we are investing in the business and we're continuing to do so in the fall season. For example, in our enhanced loyalty program and in our strategic initiatives.
And fall SG and A will be impacted by in our strategic initiatives, while our fall gross margin will be impacted due to increased delivery expense for our most loyal customers. And then gross margin will also be impacted by our growing digital business, which ramps up in the fall season. And this, along with our reduction in our tax rate, is all reflected in our guidance for the year.
That's helpful color. Thank you. And as we just think about the composition of the comp, AUR was up meaningfully. If you can just discuss the drivers of that gain and how you think about or how we should think about transactions in UPT over the balance of the year as well?
So, I'd say on that, Paul, is that our inventory is in great shape. And so, when you look at the first half of the year, as Paula mentioned, we brought in a lot of residual inventory in 2017 from the holiday season of 2016 that didn't sell. So, I would tell you that the AUR in spring of 2017 reflected that. We had to liquidate a lot of inventory. We came in really clean in 2018.
So we were cycling we didn't cycle through that. So that gave us the option of really making sure that by making sure that our stock was in parity with the sales that would follow it, we call lack receipts, that we could stay really close to the customer in terms of what she was expecting of us, which she loves tasting new fashion that we put in front of her. And so that's what we did. So what we found is that we're really farther along in pricing analytics than ever. We're able to gauge customer demand.
We're able to make a lot more out of regular price and first markdown selling. And that's what you saw drove the AUR increase of almost 5% in the first half of the year. So, keeping our inventories in line, keeping it completely synced to customer demand and seasonal changes, selling more regular price, selling more fashion, that's where you saw the beat there and what I expect to take into the balance of the year.
Thank you. Best of luck.
Thank you.
We will now take our next question from Lorraine Hutchinson of Bank of America. Please go ahead.
Thank you. Good morning. You spoke on the call about earlier inventory receipts to address an extra back to school week in the Q2. How much did that extra week benefit your comp in 2Q?
We think it's a slide, Lorraine. I think what's important is just to understand what happened in the month of July just in general. So, July was definitely our strongest month from a comp performance of the quarter. And so, we certainly wanted to accelerate back to school receipts be ready because we had a lot of customers that were going back earlier and just because of the calendar shift, we were there and ready with all back to school receipts. We obviously had a strong digital business.
Black Friday in July played well for us, but we had great strength in some of the other businesses where we were in a much better inventory position with fresh goods. So, when you look at fine jewelry, you look at dresses, men's, certainly kids as mentioned. So, had a good performance in the July season and a lot of that is because we had the inventory and freshness there for our customer.
Thank you. And when you're thinking about the Growth fifty, were these stores completely up and running throughout the entirety of the second quarter or was that one of the drivers in July that could persist through the back half?
Yes. What happened with Growth50 was we made a lot of changes in the beginning of the year. I give the stores organization a great deal of credit for what they did with talent. And when you look at the management talent and you look at the focus on that frontline colleague talent, all of those efforts went into play all the way through the spring season. We've got good traction from that.
The things that are coming on right now in Growth50 is the capital expenses. So, we've improved lighting levels, surface levels, restrooms, all that. That really came in, in the second quarter. But with respect to what we're doing with furniture and what we're doing with Backstage, those are changes that are coming online right now. That's going to happen really in the Q3.
We're looking to mitigate the disruption that that's going to cause in our Q3 business in those particular stores. We're going to do as much of that work at night as possible. But all those changes are coming in. But I will tell you that we're getting better traction out of the Growth50 anticipated in the first half of the year as well as many of our other initiatives. But we do think there's some that will continue into the back half of the year, but also with new capital that is going to also help us with the 4th quarter business.
Great. Thank you.
We will now take our next question from Brian Tunick, Royal Bank of Canada. Please go ahead, sir.
Great. Thanks very much. I was hoping maybe you could give some perspective around the Growth50 and the Backstage stores. Maybe talk about even on the first half basis, how they performed versus the balance of the chain, just curious. And then maybe if you could help us understand how much digital penetration grows in Q4 versus the 1st 9 months of the year, just so we have an understanding of how much delivery pressure there should be on gross margins in the Q4?
Thank you very much.
So Brian, let me just take a bunch of your questions. And so the first thing on Growth50. So just to go back that I think the Macy's competitive moat is robust digital growth, healthy brick and mortar and a great mobile app. And so, I felt buckets 13 there, we had an investment strategy. We're winning in both of those categories, continue to see us do well there.
It was really how we would solve brick and mortar and very happy with the early testing that we did in 2017 and then what we're learning from the Growth50 strategies. So, all of our Growth50 strategies, it's a 5P approach. It's focusing on product and value. It's focusing on presentation. It's focusing on process, it's focusing on promotion, but the most important one is focusing on people.
And with all the efforts that we put against that, we're very satisfied with the results we're getting. To your question about trend change, our trend change in brick and mortar has been marked since 2017 and it's even more marked when you look at growth 50 versus the balance of brick and mortar. We expect to carry those trends into the back half of the year. The other thing that's important to note about Growth50 is how the customer is responding to the changes that we're making. And while what Paula quoted in terms of our net promoter score is up 7 full points in Growth 50, it's up almost 10.
So, the customer is really liking what we're doing with respect to that. With respect to your question, we don't break out digital growth. Digital growth is a more penetrated piece of our business in the Q4. Business in the Q4. When you think about Cyber Monday, you think about Black Friday, that fuels a great deal of volume that we're doing as well as what we're doing with Vendor Direct.
So when you think about Vendor Direct, it's one of our 5 initiatives. We're basically almost doubling the amount of SKUs that we had in our inventory in the back half of twenty seventeen and where we're going to be by the going into the Q4 of 2018. So, that's a lot of sales that we're banking on. It's going to be digital. It's digital growth and then there are shipping costs that are accorded to that.
So, that's how I'd respond to digital.
And I think just my question on Backstage, what you're
seeing in the first
half in those stores that now have it, seeing in the first half in those stores that now have it versus a year ago, what kind of comp lift are you seeing in either year 1 or year 2 now?
So, in Backstage, this has been a good story for us. We came into the year with an investment thesis. We're now executing that. So, as we said in our comments, we've got 65 doors that we've opened in Backstage in the first half of the year. We've got another 60 or so that are coming in by the end of the third quarter.
So, we'll have about 120 that we will have added in 2018 added to the 40 some that we had in prior. So, that's all making our plans right now. We're going through a lot of adding this, a lot of construction, a lot of making the openings in each of the stores, building that out and we're satisfied with our results there. I think one of the things that I talked about on previous calls was how would Backstage perform in its 2nd full year. And so, one of the things we watch very carefully are those doors that were opened in 2017 2016 and how are they lapping that 1st year's business.
And I'm pleased to say that we're getting positive growth in the balance of those doors. So, this is clearly a strategy that's resonating with our customer and really having the only off price, full price store that's on mall is a competitive advantage we believe. And our history and our progress with Backstage is giving us further confidence on that subject. So, as mentioned, we're going to be bringing Backstage to the West Coast. West Coast, we had some ads in the Q2 and we're starting to put it into some of our premium doors.
So, this is an evolving story of Backstage at Macy's.
Great. Thanks and good luck guys.
Thank you.
We will now take our next question from Chuck Grom, Gordon Haskett. Please go ahead, sir.
Hey, thanks. Good morning. Just Paul, on the guide, your front half of the year comps are up about 2%. You're basically guiding to that level in the second half, which is a little bit different than your form review, which I think was the second half greater than the front half. Any reason for that change?
And then just on the just any early reads on back to school? I know it's early for you guys, but any update on the trend there?
So I'll take the first part. The performance in our first half was really quite strong. And so when we look to our second half, it's still very strong. So we are continuing with that momentum into the second half, but we are performing basically on the early delivery of all of our strategic initiatives. And so that gives us confidence about the second half.
But our first half was really very strong. In the second half, we are also cycling a very strong 4th quarter. And so, we are considering all of that in our fall guide.
And then Chuck on the back to school question, it started out well. So to Lorraine's earlier question, we were in a good position with back to school receipts. And so the customer that was in our stores really and starting in June for some of our southern markets as well as the entire month of July, we're getting great traction. And our kids business is one of the strongest in the entire store and that's across boys and girls, that's not just active, that's uniforms, that's sportswear, very strong. We also repositioned denim in our millennial world.
So, that's really juniors and some of the price points in Missy sportswear And that denim area is doing quite well, which is triggering back to school business. So, happy with how it has started.
Okay. That's great. And then, there was a lot of talk here about Backstage. I think you said going to go into 125 stores this year. And obviously, the Growth 50 is going to be in 50 stores this year, but you have about close to 700 stores.
When you think out to 2019 2020, do you think it's what do you think that the pipeline looks like for a deeper rollout of both Backstage and Growth50 into more doors down the road?
Well, first off, I'd say is that we're happy right now with our portfolio. And we like where our brick and mortar is positioned know, but we're also looking at what are the opportunities that we have in each of our buildings. So at your service, mobile checkout, really what we're doing with merchandise and value and all the other doors. But think about Backstage is really Backstage really went into some of the lower tier stores in 2,000 and really for the full roll out. We would continue with that.
So when you look at some of the doors that are not our top doors, Backstage has been many of those. We're now starting to experiment with Backstage in our most premium doors. And so that's coming online right now and in the beginning of Q3. So we'll be measuring that very carefully. So then with respect to Growth50, we're learning a lot.
What we wanted to make sure that in Growth50 is that we had a scalable investment. What we were testing could be scaled into a lot more doors. And so we're learning from what is working, what the customer is voting on, what they want to see more of and that which they're not as excited about. So we're learning from all of that. We expect to continue with those learnings through the back half of this year and be ready with the right level of investment in more doors in 2019.
That's great. And just, Paul, just real quick on guide. You guided last quarter asset sales to $300,000,000 to I think $325,000,000 Just want to make sure that that view is unchanged on that line item.
Yes. We are sticking with our guidance for the full year of $300,000,000 to 3 $25,000,000 for the annual guidance. And EyeMagna, we're expecting sometime in the 4th quarter, in case you're curious.
Great. That's helpful. Thanks.
And just to make that clear, Chuck, is this the size of the Imagnan, that's the bulk of that $325,000,000 $325,000,000 is iMagna. So, we expect that to go through in Q4.
Okay. Great. Thanks for clarifying.
We will now take our next question from Bob Drbul of Guggenheim Securities. Please go ahead, sir.
Good morning. Just a couple of questions for me. First, when you look at the traffic trends, excluding the shift in the Q2 that you had, can you just talk to that briefly, adjusted when you move the friends and family out and speak for the extra week. Just wondering if you could talk to that first. The second question is on the credit card income, can you talk in the $720,000,000 to $730,000,000 assumption, what's your assumption on the penetration rate going forward?
And then third question I have is just on the beauty categories. I wonder if you could talk to ex Blue Mercury, the beauty category at Macy's, the promotional levels that you're seeing and the margins that you're in that category? Thank you.
So, Bhavan, I'm going to take 1 in 3 of your questions and Paula will take credit. But let me just talk about transactions. So, I think the number that Paula was quoting is a really good sign for us. So, the fact that transactions were up in the first half to last year is a very good sign for us. And then once they're on our site or in our buildings, I feel good about our ability to convert them at deeper levels with the right merchandise and the right services.
So, we're tracking with that. So, we expect that to continue into the back half of the year. When you think about how many customers we have in our building and how many we convert on, we always have opportunity with that. And with the right service levels, the right content, the right values, I like our chances there. I'll talk about beauty and then let Paula take credit.
But on the beauty category, look, what I love about beauty is that it's fairly broad. It's our front door, it's color, it's treatment and it's fragrances. And you've heard us talk about fragrances is one of our strongest categories in the front half of twenty eighteen. We're banging on all cylinders with respect to the fragrance business. We've got all the launches.
We've got exclusive product. We're selling jumbos which is the bigger size. Our customer loves that. So, our fragrance business and we expect that to continue into the back half of the year. We're also winning in a number of our color and treatment lines.
We're really migrating our strategy from a brand centric to a customer centric strategy and really like the leadership of our team and how we're approaching that. Our Growth50 stores is a laboratory for that. We had early testing that went into our Woodbridge store. So, you will have a dedicated beauty advisor by line, but then they're cross trained against other lines. Our customer is liking that.
The customer service score, the net promoter score is way up in beauty as a result of the service that we're providing and we're also going to more open sell. So, we're able to get more content and more newness into more doors as a result of all of those measures. So, we're still working through color and treatment. We've got some formidable competition and we're very focused on taking care of our customer. So, fragrances will continue and we're continuing to work on everything we're doing in beauty.
And so, Bob, on the credit revenue, we are guiding up to $720,000,000 to $735,000,000 as I mentioned. And that business continues to perform in a very healthy way. We had 46.6 percent of penetration, up 60 basis points from last year. And so we're expecting that business to continue to perform in a healthy way. And so that's what is reflected in our guidance.
Okay, great. Thank you very much.
We will now take our next question from Dana Telsey of Telsey Advisory Group. Please go ahead.
Hi, good morning everyone and welcome Paula. Thank you. Can you talk a little bit more on delivery expense? How that's progressing? How you see that expense developing going forward?
And then Jeff, you mentioned about the vendor direct offering. Where are we in that? How many SKUs? How many categories should it be? And lastly, just anything more detail on category performance, what's doing well, what didn't do as well?
Thank you.
So, let me take the last 2 and then we'll talk about delivery after that. So, we talk about category performance. So, it's what we put in the press release on that, Dana. Really men's and kids standouts in the front half and really across all categories. When you look at some of the fine jewelry business was very strong.
I mentioned fragrances have been strong. Women's shoes was strong. Big ticket furniture was quite strong. Home categories are performing well beyond our expectation. Parts of ready to wear the dress business active across the entire store has all been good.
So, happy with that.
Yes, sure. So, we are seeing the benefits of our loyalty program. It shows up in our increased retail sales and it also shows up in our credit income and it shows up in our higher delivery expense. And so as we mentioned, we expect that our digital business and loyalty business to ramp up in the second half of the year. So we'll see a progress, a progression over the second half of the year.
And also in the third quarter, we're launching the recycling the launch of our Star Rewards loyalty program, which comes with extra shipping, which our customers greatly appreciate, but that will impact our delivery expense as well and will impact our gross margin. And so, again, there are 2 factors. 1 is that in the in versus October in Q3, we are launching we are cycling the launch of the Star Rewards program and we're expecting to see the impact of our digital business, which naturally ramps up in the back half of the year.
And then, Dana, to your question about Vendor Direct, we're in the early innings of this, but we're making great progress. We're at our target of new vendors that we are adding. Just to remind everybody that we had about a 6:one ratio of the number of SKU units that were online versus an average store, where that is low compared to virtually every one of our multi channel competitors. And so, we were adding significant amount of new content. And this is really we looked first at what the customer said.
Where did we have failed searches? Where do we have great brands that are in our portfolio that we could add more assortment based on what they offered on their own sites, what are categories that customers expect of Macy's that we could and should add. So, we're in the beginning stages of all of that, but we're well on track. So, we've added we're on track to basically almost double the amount of SKUs by the end of October and we're already seeing early signs of customers responding to that amount of content. So, the way we look at it is that we curate for customers in store, she curates for herself online.
And so, having a wide assortment or endless style just makes us competitive. Customers expect more content from the Macy's brand and this is the right strategy for us.
Thank you.
We will now take our next question from Michael Binetti of Credit Suisse. Please go ahead, sir. Your line is open.
Hey, good morning. And let me add my welcome, Paula.
Thank you, Michael.
If you can help us straighten out something for the modeling, just so there's no confusion coming after this call. I think you helped tell us that gross margins will be a little lower for a few reasons in the fall and we would characterize that as Q3. But I think a lot of the same drivers and dynamics that you just described through Q and A should continue into 4Q. So can you just help us just clarify whether you think, you see gross margin expanding or contracting relative to 4Q last year when we get to the Q4 this year?
So we expect the Q4 overall to be down in terms of gross margin. We expect it to be down more in the Q3 than in the Q4. Again, we're cycling the launch of the Star Rewards loyalty program last year. And so that's sort of the dynamic for the half year. But for the full year, we expect gross margins to be up slightly.
So, Michael, just I would add to what Paul has said. As we expect that merchandise margin is going to continue to increase versus last year in both Q3 and Q4. It's just the offset of the increased delivery that we're getting from the new loyalty program and then the highly penetrated digital business that's growing at a double digit rate in the back half of this year. So, again, we will be up slightly in overall gross margin on the full year, but we're going to give back some of the increase that we had in spring based on where shipping is going and how much traction we're getting in this loyalty program. So, this is all good.
It's all factored in our guidance to you and we feel good about our strategy here.
Great. Okay. So, then, I guess, more fairly thinking multi year, I think the dynamics that you mentioned in merch margin and then how that rounds up to the gross margin. I think we'll look back at this year and say gross margins for you and for the industry have been a catch up year after some inventory cleaning in 2017. But as you look out to 2019 on a multiyear basis on a more apples to apples comparison for your business and consider those initiatives, do you think gross margins continue to expand into 2019?
Or do those dynamics like the growth of digital, loyalty, backstage, I mean the blended gross margins are more of like flat to down based on the business mix change that you see?
So, let me take it in a couple of parts. I would expect the delivery expense is going to continue to rise just based on the momentum that we're getting in digital and what's going on with our loyalty program. So, I would expect that's going to be a rise. But I also expect merchandise margin to go up as well. So, when you think about our path to getting great product for our customers and our ability to control that in many cases, we're moving towards a 40% exclusive mark with our content.
So, I would expect that when you look at our private brands and you look at our exclusive brands and capsules that we can get more margin growth in those as an offset to some of the increased expenses that we're getting on the shipping line. So, too early to tell you exactly where we're going to land in 20 19, but we're working on both those ends.
Okay. Thanks a lot guys.
We will now take our next question from Brian Kallen of Bank of America Merrill Lynch. Please go ahead.
Hi, good morning. Thank you. Paula, in terms of thinking about the back half and debt reduction relative to your comment about this quarter's acceleration of debt reduction. I guess, how are you thinking about leverage relative to your target range now? And then separately, is there more proactive debt reduction to occur or sort of how do you manage that against thinking about your credit ratings?
So thank you. Let me just take a step back and talk about our capital allocation strategy, which is what I think you're getting at here. Our capital allocation strategy has not changed and we continuously make our capital deployment decisions consistent with the strategy as our business results unfold. And so our priorities for deploying capital continue to be 1st, investing in our business to fuel profitable growth. And for example, in 2018, we intend to invest $1,050,000,000 in capital expenditures.
2nd, maintaining our healthy balance sheet for financial flexibility. We want to be prepared for both opportunities as well as a potential economic downturn and our target leverage ratio continues to be 2.5 times to 2.8 times. And 3rd, returning excess free cash flow to our shareholders in the form of dividends, which we are doing and or share buybacks. And so at this point, we're still anticipating debt reduction being the use of excess cash in 2018.
John, anybody else?
Apologies, sir. Hello? Yes. Can you hear me? We will now take our next question from Paul Lejuez of Citi.
Please go ahead, sir.
Hey, thanks guys. Can you maybe talk about the comp performance during the friends and family promotion lined up against the same promotion last year versus how comps trended outside of that promotion in the first half? Then second, I just want to make sure I understood something that you said in response to Lorraine's question. I think you said July was the strongest month. But I want to make sure when you guys talk about July, are you including the 1st week of August in this year's July versus last year when it did not have the 1st week of August.
I just want to make sure I understand the calendar impact in terms of how you gave that answer. And maybe if you could just provide the first half comp on a lined up basis, that would be helpful. Thanks.
So, Paul, friends and family was the increase we had when you look at the event is consistent with the increase that we got in the full first half. So, it was about the same penetration as we had in the balance of the business. So, satisfied with that. With respect to that last week of July versus the 1st week of August at Macy's is not a big difference. So, it had a slight effect on the Q2, slight negative effect on the Q3, but it's very slight.
So, for us, it was just it's the mix of the business. It's being ready for the back to school businesses. It's having your inventory in place and ready for that. So, that's how I would say that. And then, your last question, the last question?
I think it had to do with
1st half comp lined up.
Yes. Our first half comp is lined up 2.3% for the first half. It neutralizes the friends and family promotional shift.
It neutralizes the friends and family, but you also gained the week of August and the week of February. So was that Yeah,
it's a small we mentioned
it's a slight change to Q2, it's a slight change to Q3, it's not meaningful. Yes.
Got you.
Thanks guys. Good luck.
Thank you.
We will now take our next question from an Oliver Chen of Cowen and Co. Please go ahead.
Thanks so much. Thanks, Jeff and Paula. Regarding the curation factor, there's a lot of great initiatives. What are your thoughts on speed and test read and react? And also, I know you've made some really innovative steps in terms of utilization of data.
How will you partner data with buyers because the whole buying function and the merchandising function is rapidly shifting and a lot of newer competitors are using coding attributes as well as customer interactions to drive decision making and speed. Would love your thoughts there.
So, we're definitely operating with more speed. As we have mentioned in the past, Oliver, really the structure has changed dramatically in our merchandise organizations. So, you have the speed to decision making is significantly shorter than it used to be. So, if you were to talk to our vendors, they would all tell you that Macy's is operating with more speed than ever. And because we've got so much liquidity in our receipts to be able to respond to customer needs, we were able to respond in getting more customer wanted products, the wanted trends into our stores faster.
We're definitely working on supply chain with our own private goods to shorten those cycles. We're definitely using our consumer panels to help define what is the bright assortment and right trends for us to get into. We have a very developed fashion office and trend forecasting. It's working with consumer panels. We've got a style crew, which are colleagues of ours that advise us on that, that are out there in their own social space, getting information on that.
So, we're a dramatically leaner organization and we're operating with more agility and we're much more customer centric in how we're responding to their needs and desire for trend. As it relates to analytics, what we did over a year and a half ago of consolidating analytics into one center of excellence that serves the business is really paying off for us, not only in all pricing decisions and really looking at outdate and expected sell through and dividing what we want to do with point of sale discounts as well as markdown pricing cadence of that helping us improve our churns margin and sales. But also what it means in terms of seeding customer demand over a longer view, what it means for what you need in the South in January, what you need in the North in February and making sure that we're getting those analytics built into our buy plans just based on history and forecasting. So, we're in the early innings of this, but we have appetite to continue to use science really married with the art of a retail fashion business. And it's that art and science that I think is what our formula is going to be at both Bloomingdale's and Macy's.
That's really helpful. Just a follow-up on the long term story, what do you think is key to driving sustainable positive traffic and transactions? And as you speak to a lot of the initiatives throughout this call, how would you reorientate them in the context of ensuring that you're attracting a younger customer as well and balancing your appeal to millennials and Generation Z? Thank you.
I think long range, it's really the combination between robust digital growth, you better be online and you better be in a way that you're top of mind for your customer. Your mobile app is going to be incredibly important in the future. And so, when you think about how the mobile app is being used as wallet and all transactions need to go through that, how it needs to be done as kind of their guide to a store in all product categories and then how it gives them access to services or stylists or a style crew. Your mobile app has got to play all three of those buckets effortlessly and at the same time removing friction in the customer journey between offline and online. So, I would give that a and then when you marry that with a healthy brick and mortar fleet, so strong digital, really strong mobile app and healthy brick and mortar, that's Macy's and other multi channel retailers' competitive moat and that's what we're really focused.
As that relates to the younger consumer, it's interesting when you look at the Macy's brand, we're very attracted to a younger consumer in certain businesses and we have opportunity in others. We know where that is, we know what we need to do and that's what we're working on. If you look at men's clothing as a great example, we are one of the headlines in terms of the men's clothing business and it's amazing when you look at the amount of younger customers that are entering our store through a men's clothing alienating the customer that's already in our tent. And so, when you look at our alienating the customer that's already in our tent. And so when you look at our payment terms and loyalty, if you think about the bronze program, you think about what we're doing with Backstage, Better Direct, those are all initiatives that will broaden our customer profile to get to younger customers.
Really helpful. Thanks a lot for the details. Best regards.
Thank you. Thank you.
That concludes today's question and answer session. At this time, I'd like to turn the conference back to you for any additional or closing remarks.
Thank you, everybody. Appreciate everybody's time and attention. Thank you, everyone.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.