Macy’s Inc (M) Q1 2022 Earnings Call Transcript

Macy’s Inc (NYSE: M) Q1 2022 earnings call dated May. 26, 2022

Corporate Participants:

Mike McGuire — Head of Investor Relations

Jeff Gennette — Chairman & Chief Executive Officer

Adrian V. Mitchell — Chief Financial Officer

Analysts:

Chuck Grom — Gordon Haskett Research Advisors — Analyst

Matthew Boss — J.P. Morgan — Analyst

Bob Drbul — Guggenheim — Analyst

Dana Telsey — Telsey Group — Analyst

Omar Saad — Evercore ISI — Analyst

Jay Sole — UBS — Analyst

William Reuter — Bank of America Merrill Lynch — Analyst

Blake Anderson — Jefferies — Analyst

Oliver Chen — Cowen — Analyst

Presentation:

Operator

Good morning, and welcome to Macy’s Inc. Q1 2022 Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to Mike McGuire, Head of Investor Relations. Please go ahead.

Mike McGuire — Head of Investor Relations

Thank you, operator. Good morning, everyone, and thanks for joining us to discuss our first quarter 2022 results. As always, with me on the call today are Jeff Gennette, our Chairman and CEO; and Adrian Mitchell, our CFO. Jeff and Adrian have prepared remarks that they will share, after which we will provide time for your questions. Given the time constraints, we ask that participants in the Q&A please limit their questions to one, hopefully single part question. Along with our press release from earlier this morning, the slide presentation has been posted on the Investors section of our website, macysinc.com. In addition to information from our prepared remarks, the presentation includes supplementary facts and figures to assist you in your analysis of Macy’s. Also note that unless otherwise noted, the comparisons that we’ll speak to this morning will be versus 2021. Comparisons to 2019 are provided where appropriate to best benchmark our performance given the impact of the pandemic in 2020.

I do have one housekeeping item to share with you this morning. We noted in our earlier press release that on Tuesday, June 7 at 8 o’clock AM Eastern Daylight Time, Jeff and Adrian will be participating in a fireside chat at the Evercore ISI Consumer and Retail Conference. This event will be webcast live on our Investor Relations website. So please circle the date on your calendars and plan to tune in.

Now for the good stuff. Keep in mind that all forward-looking statements are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions mentioned today. A detailed discussion of these factors and uncertainties is contained in our filings with the Securities and Exchange Commission.

In discussing the results of our operations, we will be providing certain non-GAAP financial measures. You can find additional information regarding these non-GAAP financial measures as well as others used in our earnings release and our presentation on the Investors section. Finally as a reminder, today’s call is being webcast on our website. A replay will be available approximately two hours after the conclusion of this call and it will be archived on our website for one year.

With that, I’ll turn the call over to Jeff.

Jeff Gennette — Chairman & Chief Executive Officer

Thanks, Mike, and good morning, everyone. Thank you for joining us. The first quarter presented a unique combination of challenges across a highly dynamic and uncertain operating environment with mounting inflation, rising interest rates, a volatile stock market, COVID-19 lockdowns in Asia and the war in Ukraine. Nevertheless, I’m pleased to say that Macy’s Inc. delivered solid results, thanks in large part to the efficiencies we built into our business through the Polaris strategy.

Throughout the quarter, our team stayed focused on the customer and we executed on our plan for long-term growth. We’ve leveraged our transformation muscle and quickly pivoted to satisfy customers with what and where they wanted to shop. As a result, quarterly net sales were in line with our expectations at $5.3 billion, a 13.6% increase compared to the prior year. Comparable owned plus licensed sales increased 12.4% and average unit retail was up approximately 8%. We beat our earnings expectations. We generated $211 million more in adjusted EBITDA in the first quarter than in the same period in 2021 and our adjusted diluted EPS was $1.08 for the quarter, almost 3 times higher than the prior year’s $0.39.

Looking at each of our nameplates. Comparable sales for the Macy’s brand increased 10.1% on an owned plus licensed basis. We saw a notable shift in consumer shopping behavior between channels with better than expected sales in stores and lower than expected digital sales. This dynamic underscores the resilience of our omnichannel strategy, which I’ll talk about in a couple of minutes.

Macy’s sales were also affected by an accelerated category shift away from the popular pandemic categories such as casual and activewear as well as soft home and into more occasion-based apparel like dresses, women’s shoes, men’s clothing and furnishings. This shift accelerated faster than we expected. It contributed to an increase in store foot traffic as consumers are more likely to shop in-person for occasion-based apparel. We were pleased to see that our balanced assortment allowed us to meet the shift and capture sales.

Our Macy’s customer base remained healthy during the quarter. On a trailing 12-month basis, we now have 44.4 million active customers. That’s a 14% increase over where we were in the first quarter of 2021 and the highest active customer level in four years. We were also encouraged to see strong engagement by our most loyal customers. On a trailing 12-month basis, our 29.1 million Star Rewards program members made up 69% of Macy’s brand owned plus licensed sales. That’s up nearly 6 percentage points from the prior year.

Our Bloomingdale’s brand performed strongly, exceeding expectations both in stores and online as luxury consumer spending remained robust. Comp sales on an owned plus licensed basis was up 26.9%. This was driven by strong sales of dresses, men’s tailored, men’s and women’s contemporary and luggage. About 4 million people shopped the Bloomingdale’s brand for the trailing 12 months and in Q1. That’s a 21% increase compared to where we were as of the first quarter of 2021. Overall, this robust, broad-based performance is a testament to how the Bloomingdale’s team has evolved the product assortment to be relevant for new younger generations that is investing in both their wardrobes and their homes.

At Bluemercury, the team continued to build on its momentum and posted another improved quarter. Comparable sales on an owned plus licensed basis were up 25.2%. This was driven by an increase in store traffic coupled with better than expected growth in private brands. During the quarter, as mask restrictions lifted, Bluemercury saw the return of color, particularly in lip, face and eye categories.

Now let me circle back to the importance of our omnichannel strategy. Across our nameplates, it’s clear that our customers were changing how they shopped during the quarter and we were ready. As COVID-19 restrictions loosened in the U.S., people grew more comfortable returning to normal activities. They went back to the office at least a few days a week. They attended group events and celebrations and resumed in-store shopping. Our strong performance underscores the strength of our omnichannel ecosystem and our success in building a seamless shopping experience that accommodates changes in customer behavior. Notably, more than 88% of our omnichannel markets grew sales.

Breaking this down further between channels, growth in our digital channels slowed from last quarter, but sales remained elevated over ’21 and ’19 levels. Digital sales were up 2% versus 2021 and up 34% versus 2019. For Macy’s, which represents the lion’s share of digital sales, traffic was up 1% from the quarter of 2021. As consumer shopping behavior shifted from digital to in-person, we took steps during the quarter to increase traffic, including paid search and personalization, which helped to attract more visitors. At the same time, Macy’s saw conversion declined by 5% driven by consumers online shifting back to in-store purchases, which was partially due to the return of occasion-based apparel.

We know that the consumer shopping journey often begins online even when the ultimate purchase happens in the store. We’re continuing to drive traffic to our digital platforms with that in mind and further underscoring the benefit of our omnichannel ecosystem. We’re focused on personalization as an important growth engine and we continue to ramp up our capabilities to increase engagement, particularly with our highly engaged omnichannel shoppers, our best segments.

Today, we’re starting to see the results of this personalization work with revenue driven by personalized product recommendations, up 13% during the quarter. While we’re still in the early innings of these initiatives, we’re pleased with these results and we continue to test and iterate to find the best communication in channels, frequency, messages and offers. Our apps performance continue to be a standout with active customers increasing 14% to 7.4 million in the quarter and we continue to make progress in preparing for our new Macy’s Marketplace, which we’ll launch during the third quarter and we expect to scale it over the course of the second half. We’ll share more on this as we get closer to launch.

As I mentioned, sales in stores grew as consumer comfort levels rose along with our desire to return to in-store shopping. But these gains were also a result of the investments we made to make our stores a style destination through our new brand platform, Own Your Style. There are also benefits of our focus on trend merchandising, which enables our customers to shop for full looks rather than just items. We’re also investing in our customer service experience by enhancing At Your Service centers in every store.

Additionally, we continue to make progress scaling our smaller off-mall store formats like Market by Macy’s. These will be integral in supporting our digitally-led omnichannel ecosystem. During the quarter, we also benefited from international tourist traffic, particularly from Central and South America as well as Europe, aiding stores like our flagships at Herald Square in New York and Union Square in San Francisco along with many of our downtown locations. While our downtown locations continue to lag in performance versus 2019, we saw a year-over-year improvement in their sales trend with these locations outperforming the balance of the stores.

We’re also continuing to see strong performance from our Backstage store-within-store locations. These locations, opened more than a year, posted a high-single-digit comp increase versus last year driven by continued strong performance in kids’ apparel, men’s, dresses, missy sportswear and luggage as well as higher AURs. We’re also expanding this off-price presence in strategic spots that advance the Macy’s value spectrum strategy. During the quarter, we announced that we will open 37 new Backstage store-within-store locations nationwide. In the month of May, we opened our 300th Backstage location as well as our largest store-within-store location in our Herald Square flagship, both of which are significant achievements for our off-price portfolio. So in summary, we’re pleased with our results this quarter, particularly our ability to navigate the difficult macroeconomic environment.

Now I’d like to provide more details on how we’re dealing with the economic headwinds. First, I’d like to share some color on supply chain and inventory productivity. As I mentioned earlier, we saw a rise in consumer demand in occasion-based merchandise categories, while at the same time, we experienced a deceleration in casual active and soft home categories, both at a faster pace than we anticipated.

Simultaneously, supply chain constraints relaxed, resulting in a higher percentage of receipts than we expected. The combination of these factors created an imbalance in our overall inventory levels as well as by channel. The good news is that we were able to navigate these demand and supply trends, thanks to our underlying work to improve pricing science and our disciplined purchasing behavior, coupled with leaner inventories entering the year. As a result, we delivered strong improvement in both inventory turn and gross margin compared to both 2021 and 2019 levels.

At quarter end, our work resulted in inventories rising 17% from 2021 levels on the 13.6% increase in net sales. And this shift in consumer demand for more occasion-based categories like dresses and tailored clothing is a good thing for Macy’s. It is where we shine. With our broad assortment base, we are pivoting to those categories and building replenishment stock in our best sellers.

We are continuing to closely watch supply chain dynamics. While constraints loosened up in the first quarter, there is still a significant amount of uncertainty with the lockdowns in China and the ongoing labor negotiations in the LA Port. Factors like these drive us to continue taking a prudent and disciplined approach with our lead times and forecasting. We’re making adjustments as needed with ongoing communications with our partners to ensure that we can adapt to changing consumer demand and have the right inventory available at the right levels and at the right time.

We’re also closely monitoring evolving shopping behaviors relating to the ebbing of the COVID pandemic combined with mounting inflation and macroeconomic volatility. During the first quarter, all income tiers continue to engage with us, led by the higher income and middle income consumers. Luxury sales remained a standout for our business as shopping behavior among high income consumers has so far remained less affected by inflation. These trends show the benefit of our balanced portfolio across nameplates. We operate across the value spectrum from off-price to luxury. This coupled with our wide assortment of categories, products and brands, gives us the ability to flex with consumer demand.

Now I’ll pivot to our merchandising strategy for the Macy’s brand. We’re putting a lot of focus here as we look to engage more customers and grow market share. We are in the early stages of reimagining our private brand portfolio and realigning our private brand team under new leadership in partnership with our broader merchandising and sourcing teams. Our goal is to have a private brand portfolio that is differentiated, defendable and durable.

The team is developing original designs and distinctive brand identities, values and principles that foster brand love with a modernized size and fit approach so that all of our customers are empowered to own their personal style. This work is underscored by customer data and analytics to ensure that we have the right value equation and competitive pricing architecture. And while specifics at this composition are not yet ready to share, we’re considering all avenues, including the launch of new brands as well as a rethink and refresh of current brands, all centered around giving the customer what they want. I’m looking forward to sharing additional details on this work in the future.

Before I pass it over to Adrian, I want to thank our colleagues for their continued hard work and dedication. They are demonstrating tenacity and executing our strategy and building a seamless shopping experience, all while keeping our customers at the heart of every decision. Their spirit and ingenuity drive us forward as we continue to navigate this dynamic environment. And I want to acknowledge and thank them for that.

And with that, I’m going to turn it over to Adrian for additional color on our first quarter results and the outlook for the rest of the year.

Adrian V. Mitchell — Chief Financial Officer

Thank you, Jeff, and good morning, everyone. Driving shareholder value remains our top priority and we’re doing this by combining the effective operational execution with the strategic deployment of capital. Our disciplined actions have improved the financial health of our business and have allowed us to successfully navigate through these volatile and uncertain operating environment.

As Jeff said, we delivered first quarter sales as anticipated, while our bottom line exceeded expectations. I’ll highlight our successes as I walk through our results, focusing on our five value creation metrics; omnichannel sales, gross margin, inventory productivity, expense management and capital allocation.

First, omnichannel sales. We generated $5.3 billion in net sales during the quarter, up $642 million or 13.6% versus last year. Comparable sales on an owned plus licensed basis increased by 12.4%. As you may recall, our first quarter last year did not fully benefit from the accelerated economic recovery and stimulus payments that were just beginning to thrive macro trends in the market. These had a larger impact later in the year. Nevertheless, we are pleased with our performance, particularly in light of the channel and category dynamics that we’re navigating through.

Now on to gross margin where we saw another strong quarter of expansion that contributed to our outperformance. For the quarter, gross margin was 39.6%, up 100 basis points from the prior year period and above our expectations. Merchandise margin increased 50 basis points, benefiting from higher AURs. Our AUR performance was driven by three big factors. First, lower promotions, particularly on regular price goods. This was driven by our POS pricing optimization work. Second, higher ticket prices. The big contributors here were fragrances, mattresses, textiles and fine jewelry. And third, category mix, driven largely by furniture and fragrances in addition to the increased penetration in occasion-based apparel categories.

Full price sell-throughs were down slightly in the quarter, impacted by the shift away from pandemic categories like activewear and soft home that Jeff discussed. However, full price AURs increased 10% for the Macy’s brand. Within gross margin, delivery expense accounted for 4.3% of net sales. That’s 50 basis points lower than last year, reflecting the 4 percentage point decline in digital penetration.

If we step back for a minute, we know that our ability to maintain margin depends on our understanding of customer demand within and across categories. To improve this understanding and better forecast demand in a highly uncertain environment, we are leveraging predictive analytics and data science. They also allow us to apply a few key tactics. First, we are shifting our promotional profile to be more personalized. Important here are the personalization efforts that Jeff spoke about earlier.

Second, as we improve our ability to predict demand, we expect to improve the accuracy of our upfront buys and how we allocate inventory within and across markets. This should help us drive better sell-throughs and higher inventory productivity. Third is our use of pricing science. We utilized dynamic pricing to change the timing, cadence and size of markdowns based on factors such as inventory availability, sell-throughs and demand patterns.

This leads me to inventory productivity. As Jeff discussed, we acknowledged that the dynamics around inventory are challenging, including those within the supply chain. The faster than expected shift away from pandemic categories resulted in higher inventories largely within decelerating categories. At the same time, the loosening of the supply chain resulted in a higher percentage of receipts landing at our DCs earlier than we expected. Despite this, we managed inventory as effectively as we could during the quarter and continued to deliver productivity gains. Our efforts resulted in an 18% improvement in turnover versus 2019 and even a 9% improvement compared to 2021, which had abnormally low inventory levels at the beginning of the year.

Effective inventory management remains a strategic priority for us. We are working actively to get inventory metrics better aligned to actual sales trends by driving faster sell-through of our slow moving merchandise and adjusting our buys to reflect the changing environment. The data science we have built into the business is key to the success of this work and helping to ensure we maintain strong margins.

Next, expense management. In the quarter, SG&A expenses increased by $131 million or 7.5% to $1.9 billion. SG&A as a percent of net sales improved by 200 basis points to 35.1%. This was primarily driven by disciplined expense management in the face of sales growth. And we achieved the strong performance even with material wage inflation across the organization.

Recall that we exited 2021’s first quarter with a significant number of open positions due to the tightening labor market. Since then we have made major progress on either filling or eliminating open positions. Today, our remaining open positions generally reflect the normal course of business or new positions we need for expanding operations such as to those for marketplace and personalization teams. Additionally, as at May 1, all our colleagues in stores and distribution centers are now at the minimum wage phase of $15 or above depending on the legal minimum wage within the municipality.

During the quarter, we also benefited from the growth of Macy’s media network, which saw net revenue nearly doubled to $26 million in the quarter. Credit card revenues were $191 million, up $32 million from the first quarter of 2021. As a percent of net sales, credit card revenues were up 20 basis points to 3.6%. Our outperformance here benefited from three primary factors. One, continued low bad debt levels. Two, higher credit sales. And three, greater co-brand credit card spending.

Our better than expected bad debt levels continued to benefit credit card revenues as the consumer remained healthy. Our strong sales performance over the last couple of quarters also helped to drive higher balances within the portfolio. And lastly, we saw higher spending on the co-brand credit card where we benefit from usage outside of our own channels.

While credit card revenues exceeded our expectations for the quarter, we continued to expect inflation to outpace wage growth and weigh up consumer health. We expect this to contribute to an increase in bad debt. Partially offsetting this will be the continued higher balances in the portfolio, enhanced spending of the co-brand credit card, both benefiting from the shift in consumer spend away from debit cards. This will be a reversal from the last year when consumers were flushed with stimulus cash. As we look ahead to the rest of the year, we expect credit card revenues to rise more than we expected three months ago. I’ll give more detail on that in a moment.

Now to bottom line profitability. Adjusted EBITDA margin came in higher than expected at 12.8% or 270 basis points higher than 2021. This includes asset sale gains of $42 million, which were $36 million higher than the last year. This outperformance was driven by the better than expected results for gross margin and credit card revenues that I spoke of earlier.

After accounting for interest, taxes and the share repurchase, which I’ll address in a moment, these results generated adjusted diluted EPS of $1.08, up from $0.39 in 2021. Which leads me to our final value creation metric, capital allocation. The strategic deployment of our cash over the past year has been one of the most critical drivers of our transformation journey. And through our solid execution of our capital allocation priorities, we are now able to invest in the business and return capital to shareholders.

Let me take you through this quarter’s highlights. We generated $248 million of operating cash flow. This was driven by higher adjusted EBITDA and merchandise payables and partially offset by an increase in merchandise inventories and a decrease in accounts payable and accrued expenses. Capital expenditures were $261 million and free cash flow was $60 million. Our continued capital investments remained critical with a large portion geared towards growth investments and focus on omnichannel investments, including the digital marketplace, automation and data science capabilities.

During the quarter, we also took significant actions to increase our financial flexibility. First, with the upgrade of our credit ratings in February, we were able to remove the collateral from our bonds so that now all our long-term debt is unsecured. Another action we took was amending and extending the term of our $3 billion asset-based credit facility by three years to March of 2027, further strengthening our financial flexibility and liquidity. As we said before, we expect to use the credit facility periodically based on the needs of the business.

The third move we took to increase financial flexibility was using cash on hand along with the proceeds from the issuance of $850 million in new longer term maturity unsecured notes due in 2030 and 2032 to redeem approximately $1.1 billion of debt that was maturing in 2023 and 2024. As a result, we have no material debt maturities for the next five years, giving us significant financial flexibility to invest further in our Polaris transformation. And the debt maturities between 2027 of $71 million and 2028 of $206 million are very manageable.

Lastly, we continued to return capital to shareholders. In addition to our dividend payment of $15.75 per share or $45 million, we repurchased approximately 24 million shares for a total spend of $600 million during the quarter, leaving $1.4 billion of our $2 billion share repurchase authorization available. This represents 8.2% of our shares outstanding. Recall that our guidance does not include buybacks and they contribute $0.03 to our outperformance at EPS.

Turning to our full year outlook. We are reaffirming our sales guidance and raising our earnings guidance based on the strength of our credit portfolio and share repurchases. We acknowledged that the level of macroeconomic uncertainty is continuing to intensify and we believe that this updated guidance appropriately reflects the associated risks we see.

To highlight the changes within our net sales guidance of flat to up 1% versus 2021, we now expect digital sales as a percent of net sales to be approximately 35% in line with 2021, down from our prior estimate of 37%. This reduction in digital penetration and associated increase in stores penetration is a result of two primary expectations. First, the continuation of the shift in consumer behavior from online to in-store that we experienced this past quarter. And second, the accelerated shift to occasion-based apparel, which we know has a higher return rate than pandemic categories such as home and beauty.

During the quarter, we saw a higher than expected increase in returns on macys.com within the accelerating categories and have adjusted our outlook accordingly. Overall, we haven’t changed our net sales expectations. We’ve fully changed the contribution of each channel. Additionally, we now expect credit card revenues of approximately 3.1% of net sales, up from 2.9%. This is driven largely by the improvement in bad debt we were seeing compared to our original expectations as well as balances within the portfolio trending higher than expected.

As a result of this, adjusted EBITDA as a percent of sales is now expected to be between 11.2% and 11.7%. Our adjusted EPS for the year is now expected to be $4.53 to $4.95, which not only reflects the change in EBITDA, but also reflects the impact of buybacks completed in the first quarter. Note that this excludes any consideration for future buybacks.

In the second quarter, we expect net sales to be between $5.5 billion and $5.6 billion. We expect the gross margin rate for the second quarter to be no lower than the second quarter of 2019. This reflects our anticipation of higher fuel cost within our supply chain network, for markdowns needed to correct inventory levels within overstock categories and the possibility of an elevated promotional environment given the high inventory levels we see in the industry.

For adjusted earnings per share, we expect between $0.84 and $0.94 for the quarter compared to $1.29 in 2021. While we are pleased with our first quarter performance, we recognized that our work is certainly not complete. The world is changing rapidly, but our financial health provides us the capacity and flexibility to make the necessary investments and operational changes to keep up with the pace of change.

With that, I’ll turn the call back over to Jeff for some closing remarks.

Jeff Gennette — Chairman & Chief Executive Officer

Thanks, Adrian. In summary, we delivered a solid first quarter despite the unprecendented macroecononic environment, demonstrating our improved operational agility driven by our Polaris strategy. As we move forward, we recognized this coming year presents unique challenges for both our business and our customers. Our strength is in our omnichannel ecosystem. We operate across the value spectrum from off-price to luxury and have a balanced portfolio that can shift and flex with consumer demand. Our Polaris strategy has proved durable. And we have confidence that it enable us to weather any storm we may face in 2022 and in the future.

And with that, let’s begin the Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] We will take the first question from Chuck Grom from Gordon Haskett. Please go ahead.

Chuck Grom — Gordon Haskett Research Advisors — Analyst

Hey, thank you. Good morning, and great results to the team. Jeff, I’d be curious on your top performance during the quarter and into the month of May, but also by income cohort. You touched on it a little bit in terms of the low versus the high. But given the wide range of customers you serve, can you perhaps share any color on that sense? And then on Adrian, for the gross margins, how should we think about the puts and takes here in 2Q? I think you said no lower than the 38.8% you posted in ’19. But just trying to conceptualize how we should think about the balance of the year for gross margins?

Jeff Gennette — Chairman & Chief Executive Officer

Hey, Chuck, on — let’s talk first about the — when we talk about the customers and who were affected by whatever might be happening in the macroenvironment. I think what we — one of the headlines is that we saw the customer count and the customer spend across all of our kind of income buckets go up in the quarter. And when you look at the customer that’s under $75,000 annual income, they were the most affected, but they still — the spend was up, the comp was up and their shift is into those categories that when you’ve got a brand like a Backstage, it’s helping them.

When I look at kind of the mid-tier customer as well as the luxury customer, above $150,000, very healthy and spend levels were quite strong. I think when you think about just kind of aggregate comment about category, what we saw about the spend levels were definitely a downshift in the casual, active and soft home categories from the trends that we saw in 2021 and definite upshift in the categories versus fourth quarter and first quarter when you look at the dress-up categories, special occasion, travel categories.

I think when we look at the month of May, the month of May is it started out quite strong. And so we look at the kind of quarter-to-date, the performance really related to kind of three things. The first one was Mother’s Day gifting was very strong. And I think that gives us some confidence as we think about our gifting strategy for the back half of the year and what we learned in Mother’s Day. The second was these kind of high octane events like One Day Sales were very strong. And so we had one of those in the month of May thus far and good performance. And the last one and importantly is really what we’re seeing going on in the apparel areas, particularly as it is kind of serving our Own Your Style platform that we launched.

So when you look at men’s, women’s and kids’, those apparel businesses and the amount of linkage products we’re getting, so we’re selling full outfits versus just particular items, that is working for us. So our customers are responding to great brands and great values from off-price to luxury. We’re a gifting and special occasion destination. And we expect that demand to continue. But as we’ve said at the top, lots of uncertainty and we’re being prudent in our outlook.

Adrian V. Mitchell — Chief Financial Officer

Good morning. Excuse me. Good morning, Chuck. Just to speak to gross margins, kind of the big headline on gross margin is that we’re managing gross margin pretty tightly. One of the things that we signaled in on this call is the decrease in digital penetration which would typically imply that you will see some favorability in gross margin. But as we think about kind of what we’re working through in the second quarter, it really reflects the markdowns that we need to clear some of the excess inventory on those decelerating categories that Jeff spoke to in addition to the rising fuel costs that we do incur as part of our delivery expense. But we spoke about in the previous earnings call some of the work that we’re doing around our delivery expense initiative and we’re beginning to see some of those gains. And so we’re just really balancing the benefits in the headwinds.

We are seeing reduced splits or reduced packages per order. We are making good progress on placing larger fulfillment operations across 36 stores before holiday and that’s progressing well. And we’re also seeing that we are fulfilling more orders from stores up about 3.5 points versus the first quarter of last year, which is a good thing in terms of the distance that packages have to travel to get to the customer. But again, this is really offset by higher fuel costs. As we progress through the balance of the year, we typically have holiday surcharges as well as fuel costs continuing to rise is something that we’ve contemplated in our guidance for the balance of the year.

Chuck Grom — Gordon Haskett Research Advisors — Analyst

Great. Thanks very much.

Adrian V. Mitchell — Chief Financial Officer

Thank you, Chuck.

Operator

The next question comes from Matthew Boss from J.P. Morgan.

Matthew Boss — J.P. Morgan — Analyst

Great. Thanks, and congrats on a nice print.

Jeff Gennette — Chairman & Chief Executive Officer

Thanks, Matt.

Matthew Boss — J.P. Morgan — Analyst

So Jeff, maybe to elaborate on the shopping trends that you’re seeing by category, how are you thinking about the duration of occasion spending for apparel? And then what’s your comfort with current inventory on hand? And just how quickly can you pivot the assortments if trends shift across both apparel and hard goods as we think about maybe the back half of the year and into early ’23?

Jeff Gennette — Chairman & Chief Executive Officer

Yeah. So Matt, I think we were definitely pivoting and have pivoted. So I would — let me just characterize, give you a little more detail on what we’re seeing. So the first thing is really if we want to talk about kind of the downshift in the pandemic categories of casual, active and soft home, we had about a 20 point downshift from the fourth quarter to the first quarter and we didn’t anticipate it to be that extreme.

So those categories have or the inventory levels have certainly built up there. And this is where all the work that we’ve done in our pricing science tools has really helping us. And we, as Adrian talked about in his comments, we’ve incorporated that particularly in our second quarter margin guidance. So I think we’re — we’ve adjusted all of our go-forward orders. We don’t think that’s going to get better, particularly when you look at our inventory levels and that of the competition’s. That is building and customers have clearly signaled a downshift there.

Conversely, to the other part of your question on big acceleration in dress-up categories and those have gone up 10 full points when you look at where the trend was in the fourth quarter, in the first quarter and that’s getting even better in the second quarter. So we’ve been very aggressive with additional receipts. We’ve got very strong vendor partnerships. We’re working very closely with them on all the right brands. And as Adrian — as I mentioned, this is really where we shine.

As we think about kind of the trends that we’re looking at for the back half of the year, I kind of would bucket it into like five things. The first one is just this — the pull back on the pandemic categories, the acceleration of the dress-up, the things I talked about. The second is really the gifting strategy. And just based on where we did — what we did in the Mother’s Day, Father’s Day. What we’re planning in Father’s Day, the holiday. We’re planning gifting off-price to luxury, great price points, feel very good about that. We’re very focused on the new categories. So when you think about Toys “R” Us, you talk about Marketplace and just what we’re doing with premium brands. Brands like Ralph Lauren or Pandora or Prestige Fragrances, lots of growth initiatives coming there.

The fourth thing I’d mention would just be personalization and just the developing prowess there. We are in the early innings, but really following the customer with relevant communications and relevant content is a big opportunity for us that we’re starting to get some traction, some green shoots there, that’s just going to build in the back half of the year.

And then the last thing I’d talk about is the stores bounce back. And it really depends on what area of the country you’re in or what type of store it is. But what I’d say is that the downtown flagships are definitely a marked improvement. Not as much about international tourism, which is a piece of it, but a lot because of the return to work and the return to special occasion and then being really big destinations for that. Backstage is becoming an increasingly important piece in our fleet. The 300 stores we’ve opened gives us a good breadth up there and then the Own Your Style initiatives I talked about earlier.

The other thing I talked about in terms of the back half of the year is that on the Bloomingdale’s brand. That one is quite hot right now and we’re really banging on all cylinders. And we’re super excited about the 150th anniversary of the Bloomingdale’s brand and all the initiatives that the team is creating to be ready for the customer on that. And then also, we had a really good print on Bluemercury and just where that is going it’s kind of a premium beauty brand. And when you look at as the masks are coming off and you look at customers and their need for eye and lip and cheek needs, Bluemercury is a great destination for that. So new leadership there and making great traction with Bluemercury brands.

Matthew Boss — J.P. Morgan — Analyst

It’s great color. Best of luck.

Operator

We will now take the next question from Bob Drbul from Guggenheim. Please go ahead.

Bob Drbul — Guggenheim — Analyst

Hi, good morning. I guess, if you could, I think you talked about the Marketplace initiative. Is there any more information you can give us either a timeline or expectations or just development in terms of where it is today? And then the second question I have is, can you just talk a little about big ticket items and really what you’re seeing in those areas of the business? Thanks.

Jeff Gennette — Chairman & Chief Executive Officer

Hey, Bob. I’ll take both of those. So I think the headline here is that we’re going to provide more details on Marketplace later this year. We are very excited about this one. We’re launching in third quarter with the expectation to scale it over the second half and we’re going to be test and learn from day ones. What I can tell you about it is that our initial focus is going to be in categories that we have meaningful market share opportunities, categories that we don’t have developed businesses in either VDF or an owned inventory. So categories like pets, electronics which would include portable and home, home improvement, gardening, video games, those should be categories that you would expect us to launch with. So stay tuned. Do hope to have an update. Well, we will have an update for everybody when we next speak. So that would be — that’s on Marketplace.

Bob Drbul — Guggenheim — Analyst

Big ticket?

Jeff Gennette — Chairman & Chief Executive Officer

Big ticket is what we’re seeing in there is similar to what we talked about on the last call that the supply chain is starting to loosen up a bit there, definitely when you look at what’s going on in the costs in those businesses. What we talked about before was you can pass some of those costs on to the consumer, the bigger the item is or the more of a brand name it is. But when you were in a price point business like a 499 couch or a 599 couch or an opening price mattress, we’re very careful about what we’re doing with pricing there. So we’re catching up with all the demand that it’s now delivering from the previous orders. And we’re watching the environment carefully about how the customer is voting by category, by price point and we’re making those adjustments.

Bob Drbul — Guggenheim — Analyst

Great. Thank you very much.

Jeff Gennette — Chairman & Chief Executive Officer

You bet.

Operator

The next question comes from Dana Telsey from Telsey Group.

Dana Telsey — Telsey Group — Analyst

Good morning, everyone. Congratulations on the nice progress. Can you expand on the relaxed supply chain and what you’re seeing there and how you see it moving through the balance of the year? And then just to touch on the AUR increase of 8%, how are you thinking about that for the rest of the year? Thank you.

Jeff Gennette — Chairman & Chief Executive Officer

Dana, let me take those. So what I’d say is that what happened in supply chain, we didn’t anticipate the loosening of order replenishment on this. So generally, what we were getting on each of our orders was a fallout of about 30% that we kind of built into our estimates. And that was what we were getting in the back half of ’21. So — and that fallout has become more like 20% when you look at the first quarter.

So — and that really is kind of across the board. We’ve been getting — I mean, there’s certainly exceptions, but the vendors have been shipping better. That doesn’t mean that the supply chain is loosening. What we’re seeing is that there’s definitely some headwinds coming, particularly as you start to see about the Shanghai port, that’s how that’s going to affect. We have like 30 tankers right now that are in the LA Port down from about 120. We do expect that to build as some of that freight moves from the Far East.

And so the way we’re approaching it, we’ve got to protect back-to-school. We’ve got to protect the fourth quarter. So we’re going to ensure that some of the lead times that we did during the pandemic and certainly during ’21 were actually we’re moving that — those kind of the same lead times in terms of our orders. So it might be lumpy how we receive goods in the second and the third quarter. It’s all built into kind of our forecast that we shared with you earlier. But we will be ready for the customer based on what we anticipate to be issues.

When you think about kind of the domestic supply chain, I think we’re in pretty good shape. Obviously, when you look at our science in terms of forecasting receipts and the allocation of those receipts, we’re in much better shape than we’ve been in the past. We’ve got a great focus when I look at UPS and what we’re going to be doing for the last mile. So I feel good about that.

When you look at AUR and your question about, as you saw our posts that we were up 8% in the first quarter. You heard us when we talked about AUR and our expectation for the year on the previous call. We thought it would be in the 5% range. I’m still thinking about. I’m still forecasting about that amount. We do think that we’re going to continue to see great AUR improvement, particularly in those trending categories. So the dress-up, special occasion, the travel categories, those are going to continue to go up, but I do expect them to be more constrained and more flattish in those categories, those pandemic categories, where we have built up in inventories, and importantly, our competitors have built up in inventories.

So I think that supply is out of whack with the demand and I — we’re using all of our pricing science to deal with it. Our gross margin expectations are all incorporating where we expect that to go. And I think when you look at the blend of all of that, you’re looking at a mid-single-digit improvement for the year.

Dana Telsey — Telsey Group — Analyst

Thank you.

Operator

The next question comes from Omar Saad from Evercore. Please go ahead.

Omar Saad — Evercore ISI — Analyst

Thanks. Good morning. Thanks for taking my question. I wanted to follow-up on a couple of things. In terms of the pandemic categories versus the post-pandemic categories, maybe you could you dive in a little bit deeper on active, casual, home? Which — are there segments within these categories that are holding up better and others that are pulling back — you’re seeing the spend pull back faster or is it just very broad across all things, athletic, casual and home?And also, any other signs of some price sensitivity? You mentioned opening price point mattresses and couches. Any other areas of your business where you’re seeing the customer balk at higher prices? Thanks.

Jeff Gennette — Chairman & Chief Executive Officer

Yeah. So Omar, on the — your questions are related. It’s really kind of the same answer. In the casual, active and soft home categories, we’re definitely seeing some balk at some of the prices and we’re going to — we’ve made adjustments there. I would expect us to continue with those adjustments. With our pricing science, we have the opportunity to do that at a store level. And that obviously gives us more margin versus what it would be if we didn’t have that tool. But I do expect those are going to be the ones that are most under duress.

I think that when I look at the opportunities in the other categories — and let me give you some more color on that. When you look at soft home, the ones that are most affected would be categories like textiles, top of the table, housewares, typically where we would have a soft category, like luggage is off the hook. That really goes into our travel trend. So we are very, very high-double-digit increases there. But those categories which we had really good run for the last two years, textile, top of table housewares, they’re most affected. So we’re pulling down our expectations there. We are looking at realistic AURs.

We’re going to be — we’re going to play where it’s really important for the customer and those categories are important. We’ll be there with great values. But they are going to be less than the penetration of our business than what they were in ’20 and ’21. So that’s — when I look at — all the time we look at it. When you look at the trending categories, we’re getting AUR improvement across all of our value bands.

So we have over 50 categories. There’s a different story for each of them. Some brands carry real premium and we’re getting massive increases in AUR there. I look at Ralph Lauren where we’re enjoying big AUR increases, but that’s more of a premier brand. They’ve reduced their distribution. We’ve really ramped up our efforts to make sure that we’re giving a fulsome lifestyle presentation of that content, both online and our stores. We’re building. When I look at our fragrance business, you’re seeing more of our business go into like jumbos and building. The higher AUR, gift baskets, building value into things that we can uniquely create that drive higher AURs that might be different from our competitors. So each FOB has a different story.

Omar Saad — Evercore ISI — Analyst

Got it. Thanks, Jeff.

Operator

We will take the next question from Jay Sole from UBS.

Jay Sole — UBS — Analyst

Great. Thank you so much. Jeff, obviously, it was a strong quarter and you’re raising guidance in an environment where some of your off-price competition is doing the opposite, have weaker quarters, lowering guidance for the year. Do you think this difference is really just about the income demographics and maybe some of your off-price competitors are serving maybe a little bit better execution on your part than their part in the quarter or taking a step back, do you see the company really closing the gap in terms of your competitive position versus those retailers where you feel like that your ability to take share back from them is improving or at least maintain shares improving? Thank you.

Jeff Gennette — Chairman & Chief Executive Officer

Yeah, Jay. I think it’s — I do think the Polaris strategy is working, which incorporates all the kind of the contours of your question. I do think that as a department store and having 50 categories that we can really shift where the customer goes and you got some of our competitors that may not have had great posts that may be more — their business may be more focused and their penetrations may be higher in those categories where the customer is not signaling as much interest, it gives us the opportunity to really shift it into those categories that are.

And I do think that when you look at the affluent customer, we’re not seeing a slowdown there. And so that touches some of the Macy’s businesses, but it’s a real testament to the strategies that are working right now at Bloomingdale’s and Bluemercury. And when I look at that middle income customer, again, count up, spend up and we’ve got a real breadth of offering to be able to ensure that they stay with us.

So I would tell you that the strategy — the Polaris strategy is working. It definitely helped us with the headwinds increasing from the fourth quarter into the first quarter. And I think we’re having a good quarter right now and obviously have a lot of confidence as I look at the back half of the year based on the muscle that we’ve developed through kind of the pandemic transformation that we went through. So I think Polaris is working. I couldn’t be prouder of the team and how they’re responding. Always following the customer with a lot of tools to be able to do so.

Jay Sole — UBS — Analyst

Got it. Thank you so much.

Operator

The next question comes from William Reuter from Bank of America.

William Reuter — Bank of America Merrill Lynch — Analyst

Hi. I just have one. In terms of the share repurchases in the quarter which accelerated, can you talk about given the large authorization that still remains, how you’re thinking about that? And if you currently have a leverage target? Thanks.

Adrian V. Mitchell — Chief Financial Officer

Terrific. So thanks very much for your question, and good morning. As we think about share repurchases, in this dynamic environment, we’re very much focused on flexibility. Flexibility is really our key priority. And that flexibility at this point in time is defining our ability to lean into those consumer demand trends that Jeff spoke about earlier, while at the same time making sure that we maintain our commitment to a disciplined and healthy balance sheet as well as continued investments in the Polaris transformation, which Jeff spoke about. That’s really working for us.

The third commitment we’ve made is to return capital to shareholders. And as you pointed out, we did receive the $2 billion of authorization earlier this year, but it’s been open ended, which gives us the ability to be flexible in how we allocate our cash. And so we’re just going to be very balanced in this pretty dynamic environment and continue to make sure that we are returning value to shareholders, but at the same time, making sure that we’re making investments in the growth of the business.

As we think about our leverage ratio, we really entered the year with a lot of strength. Our leverage ratio target last year was 2.5 times or below. We ended the year at 1.8 times and we continued to pay down debt in the first quarter. We paid down an additional $300 million of debt. So we’re very disciplined as it comes to the leverage ratio, very disciplined on the balance sheet and we’ll continue to be very thoughtful about how we allocate our capital.

William Reuter — Bank of America Merrill Lynch — Analyst

Thank you.

Adrian V. Mitchell — Chief Financial Officer

You’re welcome.

Operator

The next question comes from Stephanie Wissink from Jefferies.

Blake Anderson — Jefferies — Analyst

Hi, good morning. It’s Blake on for Steph. Thanks for taking our question. You’ve given a lot of good details so far. We just were curious on Macy’s Media Network and how that’s performing versus your expectations and maybe how the conversations are going in this environment of increased uncertainty? It sounds like their growth is still pretty strong. But curious if there’s any change in the conversation tone? And then maybe also, you talked about the category shifts. Wondering if that’s maybe playing more into your strength in the conversations? Thank you.

Jeff Gennette — Chairman & Chief Executive Officer

Hi, Blake. So Macy’s Media Network, it continues to grow and it’s above expectations. So continuous growth in the number of advertisers, and frankly, the volume of the campaigns that we’re doing. So as you heard in our post, the first quarter net revenue was $26 million. That was nearly double the previous year. A little more color across Macy’s and Bloomingdale’s. We had more than 320 vendors that have participated in the program to date with just lots of pent-up interest for us. We do expect that that — the vendor and the campaign count is going to continue to grow as the company — as Macy’s and Bloomingdale’s, as we expand our vendor base and as well as with the upcoming launch of the Macy’s Marketplace, which is going to be in the third quarter. So we’re quite bullish on this.

As it relates to category shifts, yeah, I do think that when you have categories that are trending where Macy’s shine, that is certainly helping us. And when you think about there’s big benefits of us having the omnichannel engine that we have. So if you have a customer that’s shifting more to stores, we’ve got a great store base for them. They’re still starting most of their journey online. They’re doing lots of research, lots of price checking, looking at what influencers is saying. They may be looking online, but then purchasing in-store.

So the channel shift that we talked about are going from 37% in m-comm to 35% in where we’re now expecting it is still on a very healthy digital business. But the categories themselves, as I’ve mentioned in the answers to two other questions, I think is part of our success. And also having — when we’re dealing with those that are down trending of having all of the analytics and the pricing engines to basically respond accordingly. So we have — I think we’ve responded quite well with that. And that’s going to maintain exactly where we need to be in our margins and ensuring that we have all the receipts and the firepower to put against that which is trending. So we follow the customers and we’ve got a very flexible model to do so.

Operator

We will take the next question from Oliver Chen from Cowen. Please go ahead.

Oliver Chen — Cowen — Analyst

Thank you. Hi, Jeff and Adrian. In your remarks, you mentioned intensification of uncertainty. Just would love for you to elaborate on those factors that you’re paying attention to from the consumer and what indications may be leading? And then as you think about promotions, it sounds like you’re prepared for promotions. How will you execute those in a customer right manner just to preserve brand equity and your relationships with customers to ensure that you’re executing them against the competitive environment, yet balancing what’s right for the business? Thank you.

Jeff Gennette — Chairman & Chief Executive Officer

Hi, Oliver. So your first question about kind of economic indicators, we have a little chart that’s like, hey, what are the tailwinds? What’s neutral? What are the headwinds? And obviously, when you look at the tailwinds, the label market, tourism is a — we’re starting to see good seeds of that. And as we have talked about, 3% to 4% of Macy’s Inc. business historically has been in international tourism. That’s starting to come back, which is good news.

This return to office has been quite interesting. And when you look at a lot of companies now based on their kind of hybrid work environments there are wardrobes that need to be refreshed. We’re clearly seeing that. If you look at the blazer, if you look at the dress, if you look at all the dress-up categories as well as accessories that go with them, that is a great tailwind.

What’s neutral is when you think about the personal disposable income and what the savings rate looked like a year ago and what it is now, it’s still good, but it’s not as good as it was a year ago. So I call that a neutral. Consumer credit is still good. Their open to spend is still good. But we’re watching consumer sentiment very carefully to see how they want to spend it.

And then promotions, I would say, neutral because we’re not adding promotions. We’re just being more surgical on the ones that we do. When I look at the headwinds, clearly inflation. When you look at what’s going on with housing or gas prices, what might go on with the interest rates, geopolitical, those are all things that we’re watching carefully, but again, all factored into our estimates.

To your question about how are we going to talk about these great values, the team is — it’s a different story depending on FOB. But I would tell you is that a clear price point always works well for us. And when you start to think about those categories that are down trending, those casual categories and active categories, those lend themselves well. They’re generally key items. There’s got good depth behind them. They have good fixture fill, having a price point that’s really clear to the customer that they understand, that’s not too complicated is the way we’re going to approach it. So we want to make sure that with all of our online scrapes, we know where our competitors are going to be on an hourly basis. We’re making adjustments. We will get through that inventory. And we’ve made adjustments on future inventory in response to that.

Oliver Chen — Cowen — Analyst

Regards. Thank you.

Jeff Gennette — Chairman & Chief Executive Officer

Thanks, Oliver.

Operator

As there are no further questions, I would like to hand the call back over to your host for any additional or closing remarks.

Jeff Gennette — Chairman & Chief Executive Officer

Thanks, everybody. Appreciate the listening, and everybody have a great day.

Operator

[Operator Closing Remarks]