Macy’s, Inc. (M) Q2 2021 Earnings Call Transcript

Macy’s, Inc. (NYSE: M) Q2 2021 earnings call dated Aug. 19, 2021

Corporate Participants:

Mike McGuire — Head of Investor Relations

Jeff Gennette — Chairman and Chief Executive Officer

Adrian V. Mitchell — Chief Financial Officer

Analysts:

Matthew Boss — J.P. Morgan — Analyst

Chuck Grom — Gordon Haskett — Analyst

Kimberly Greenberger — Morgan Stanley — Analyst

Jay Sole — UBS — Analyst

William Reuter — Bank of America Merrill Lynch — Analyst

Carla Casella — JPMorgan — Analyst

Steph Wissink — Jefferies — Analyst

Omar Saad — Evercore ISI — Analyst

Dana Telsey — Telsey Group — Analyst

Presentation:

Operator

Good morning, and welcome to Macy’s Second Quarter 2021 Earnings Conference Call. [Operator Instructions]

I would now like to turn the call 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 second quarter 2021 results. With me on the call are Jeff Gennette, our Chairman and CEO; and Adrian Mitchell, our CFO. Jeff and Adrian have prepared remarks that they’ll share after, which we’ll provide time for questions. Given the time constraints and the number of participants, we ask that you please limit your questions to one. Along with our press release, we have posted a slide presentation on the Investors section of our website macysinc.com.

In addition to information from our prepared remarks, the presentation includes additional facts and figures to assist your analysis of Macy’s. Also note that given the pandemics impact on 2020 results, unless otherwise noted the comparisons that will speak to you this morning will be versus 2019 as we feel that benchmarks our performance more appropriately. We noted in our press release this morning that on Thursday, September 9th at 7:30 AM Eastern Time, Jeff and Adrian will be participating in a fireside chat at the Goldman Sachs Annual Global Retailing Conference. This event will be webcast on our Investor Relations website, so please mark your calendars.

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

In discussing the results of our operations, we will be providing certain non-GAAP financial measures. You can find additional information regarding these non-GAAP financial measures, as well as others used in our earnings release and our presentation on the Investors section of our website. And 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 and Chief Executive Officer

Thanks, Mike, and good morning everyone and thank you for joining us. Macy’s Inc., continue to build momentum in the second quarter. Our business results across our three nameplates exceeded our expectations on both top and bottom lines. The Polaris transformation our blueprint to bring Macy’s back to growth is working. Our results this quarter demonstrate the power of an omnichannel model with a robust offering of categories, brands and price points.

We delivered a comparable owned plus licensed total sales increase of 5.9% and nearly 16 point trend improvement versus the 10% decrease we saw in Q1 of 2021. Adjusted diluted EPS was a $1.29 significantly exceeding our prior guidance. Total digital sales penetration, which continues to outperform expectations was 32% and we saw a meaningful improvement in our stores business, which was up 18 percentage points versus the first quarter trend.

Gross margin for the quarter improved by approximately 180 basis points, driven by tighter inventories, as well as initiatives focused on pricing and promotion. Total company AUR was up more than 12% across all three nameplates. Adrian will cover this improvement in more detail.

We are generating a significant amount of cash and this financial flexibility allows us to simultaneously invest in our business and pursue significant actions to return capital to shareholders. We are reinstating our quarterly dividend and our board has authorized a $500 million share repurchase plan. And earlier this week we used cash to repay our $1.3 billion secured senior notes. Putting us right on track to be below our target leverage ratio with an investment grade financial profile by the end of the year.

Our results in the quarter were strong across Macy’s Inc., as many people return to in-person shopping, while still continuing to shop online. From off-price to luxury, we are emerging from the pandemic a stronger company than we were before it began. In the second quarter, we attracted nearly 5 million new customers to Macy’s, which is a 30% improvement versus 2019. Average customer spend in the quarter was up 10%, compared to 2019 and up 2 points, compared to the trend in Q1 of 2021.

We saw continued strength in dressy apparel, fine jewelry and fragrance as our customers prepared for in-person social events and back-to-school. We saw enthusiasm for newness with a pent-up desire to feel fresh and look current at gatherings and occasions in school and on social media. We had strong gifting business for Mother’s Day, Father’s Day and Graduation with customers making up for lost time and missed milestones with gifts, a fine jewelry, fragrances and accessories.

Throughout the quarter we seized every opportunity to capitalize on rapidly changing consumer demand, analyzing shopping and spending patterns and adjusting purchasing and allocation strategies. I’m proud of our teams who made sure that when consumers were ready to spend again we were ready to deliver across all channels.

Comparable sales for the Macy’s brand were up 5.2% on an owned plus licensed basis a nearly 16 point improvement to last quarter. Our e-commerce conversion was up 10% and traffic was up 22%. Our stores also exceeded expectations with both existing and new customers returning to in-person shopping. Our Macy’s Backstage store-within-store locations open more than one year continued to outperform, up 28 percentage points, when compared to the full line stores and our freestanding backstage locations also deliver positive results on a comparable basis.

The Bloomingdale’s business was strong online and in stores. Comp sales on an owned plus licensed basis were up 11.5% and nearly 19 point trend improvement versus the first quarter. Performance was driven by strength of elevated designer products across all categories with the majority showing double-digit growth. Results also reflected better sell throughs at full price and improvement in average unit retail.

The Bluemercury business also showed a trend improvement versus the first quarter, with comp plus licensed sales up 2.2% and nearly 18 point improvement to last quarter. Loyalty, customer performance improved across all tiers of our Star Rewards program. The combined platinum, gold and silver average spend per customer increased by 15% and average spend per visit increased by 11%. The Bronze tier of this program saw average spend per customer increased 15% and average spend per visit increased 19%. The Bronze tier is one of our best customer acquisition vehicles with approximately 26% of members under 40% and 56% ethnically diverse.

Loyalty program members are important to our omnichannel business comprising approximately 65% of our total Macy’s brand comparable owned plus licensed sales for the first half of 2021. And our omnichannel customers shop with us more often, make 3 times as many trips as single channel customers purchase across 2 times to 3 times more product categories and spend 2.5 times to 3.5 times more. They are our most productive and most valuable customers and we are working to ensure that their experience with us is outstanding.

We also want to maintain a best-in-class digital experience, as we continue to make investments, in foundational improvements to keep our online platform current and differentiated digital experiences that provide greater service, discovery and value for our customers. We made advancements in enterprise-wide data and analytics capabilities to improve inventory placement, pickup and delivery options, boosting speed and convenience for online orders. And these omnichannel investments are showing strong results. We saw customer spend increases across both new and retained customers.

We are effectively serving customers with new more contemporary products across all categories and we continue to add new categories and brands as we look to unlock additional opportunities with our future core customer, who is under 40 and increasingly diverse. In some cases, we’re expanding upon current brand partnerships or investing more in our private brands or launching entirely new private brands such as And Now This, a contemporary men’s and women’s apparel line of elevated basics and sophisticated styles that we introduced in the second quarter. Younger customers are reacting positively. We’re seeing consistent full price sell throughs both online and in stores and we’re confident that the exploration will unlock opportunities for us with younger customers.

We are building upon our expertise in the home category with brands such as hotel to launch Oak a new private label home and textiles brand for our more socially conscious customers. Oak will be featured on a new site led that launches in a few weeks, which will make it easier for customers interested in Macy’s full range of environmentally conscious products to see those brands and merchandise in one place. We’re taking this approach based on the success of our contemporary site led, which we has already drawn younger customers to macys.com. We’re also applying a physical expression of this strategy in 160 of our stores, where these contemporary boutiques will sit near front entrances for maximum visibility.

We also seek to gain market share from younger consumers by attracting them, retaining the millennial mom, who we know shops for back-to-school, holiday, year around gifting and for herself. The breadth of our offering creates a unique opportunity to make Macy’s for go to and most satisfying convenient one-stop shop. A great example is the growth of our toy business during the pandemic, which we saw was a category that helped us attract millennial parents. And then also lead them to higher margin products in apparel and accessories.

Today, I’m pleased to announce that Macy’s has entered into an exclusive omnichannel partnership with Toys “R” Us to help us more fully realize the toy category. More information on this relationship can be found in the press release we issued this morning. By offering a wide assortment of categories, products and brands from off-price to luxury, we’re able to meet the needs and flex to the demands and preferences of a broad diverse range of customers.

For example, during the second quarter, casual and home categories continue to see the strong demand levels they experienced during the height of the pandemic, while categories that required during the same period such as traditional wear-to-work and dressy showed increases. As a department store, with our breadth of offering we were able to analyze data to drive cross category shopping within our ecosystem. Think about exposing our significant customer base in fragrances to all the newness we have in Denim or connecting with that millennial mom, when she is in a store for back-to-school apparel. She can also pick up new sneakers at finish line, Toys for when the homework is done and cosmetics for herself and if she is enrolled in Star Rewards, she has Star Money to make her feel like she’s not only checked everything of her [Phonetic] list, but has also been a savvy shopper.

Our commitment to delivering a dynamic seamless omnichannel experience across the customer shopping journey has never been stronger and that journey increasingly begins with research and initial exploration online. We have a fully integrated business with a portfolio of product categories and brands that allow us to meet our customers based on who they are and how they want to engage with us.

To me, it is clear that a comprehensive retail ecosystem with physical stores in the best malls and the most productive off-mall locations integrated with the best-in-class e-commerce offering is a powerful combination and is moving us forward as a strong digitally led omnichannel business. With all this said the pandemic is, of course still very much a reality as we move into the back half of the year, and we’ll keep a watchful eye on headwinds. We’ll pay close attention to the COVID variants and make decisions with the health and safety of our colleagues and customers in mind.

We’ll continue to mitigate supply chain shortages and other disruptions through surgical buying, close collaboration with our key brand partners and reduce reliance on manufacturers without transnational capabilities. We’ll also continue to chase inventory to help us achieve higher sell throughs, turnover and AUR. I’ll also mention that our scale has allowed us to provide support for our brand partners, because we were able to take on more of their inventory. And we’ll navigate the labor shortages and intense competition for talent through multifaceted recruitment strategies, including incentives for our hourly colleagues to make referrals.

And now let me turn it over to Adrian, who will walk you through the financial details.

Adrian V. Mitchell — Chief Financial Officer

Thank you, Jeff and good morning everyone. As you’ve already heard the second quarter exceeded our expectations. In addition to the market recovery, our positive results benefited from the effective execution of our Polaris strategy and the strong performance of our teams.

Lean inventories, the expanded application of pricing science and better sell throughs led to healthier gross margins and our expense leverage continue to improve. Our results over the last three quarters have strengthened our business and helps us achieve many of our financial targets much earlier than we had anticipated. They have also given us the opportunity to more quickly advance the additional initiatives intended to profitably grow our top line sales. We are testing and scaling several of these initiatives and have pilots in place that are showing promising results. And with the excess cash we generated, we have taken additional actions to delever the balance sheet and return capital to shareholders.

As I summarize our results, I’ll focus on the metrics that are most important to value creation: sales, gross margin, inventory productivity, expense management and capital allocation. First, top line sales exceeded 2019 sales levels with a larger digital business and approximately 10% fewer stores. Net sales increased by $101 million or 1.8% in the quarter to $5.6 billion and our comps were solidly positive. We saw strength in each of our nameplates across all merchandising categories driven by new customer acquisitions and the reactivation of dormant customers.

Digital sales grew 45% in the quarter accounting for 30% of Q2 net sales. Meanwhile, more customers were back in stores significantly improving the stores owned plus licensed comp store sales sequentially by about 18 percentage points to down just 5.5% to 2019 levels. Our 150 [Phonetic] Macy’s growth doors outpaced non-growth doors by nearly 7 percentage points in the quarter and we saw improved trends across all regions with particular strength in the South East and South West regions.

While our urban doors continue to be negatively impacted by the lack of international tourism and the continued fluid state of remote and hybrid working, the re-opening of borders and the return to a more normalized work environments are expected to be tailwinds for our business once they occur.

Shifting to improving gross margins. The momentum we built in the first quarter continued in the second as our gross margin rate expanded 180 basis points from Q2 2019 to 40.6%. We’re making headway on our commitment to achieving sustainable margin expansion, which remains one of our top priorities and this level of margin expansion combined with the sales outperformance is a significant achievement for us.

Our progress on merchandise margin has been the most notable, improving by 350 basis points during the quarter to 44.9% as a result of consistent improvements in inventory productivity and lower markdowns driven by three factors. First, healthier inventory levels, which I’ll expand upon in a few minutes. Second, 100s of POS pricing test in our stores that resulted in $85 million of margin improvement from the optimization work such a significant marketing calendar changes, simplified pricing and reduced promotions. And third, location level pricing initiatives that resulted in a benefit of $25 million. Location level pricing achieved scale across 500 departments in the quarter and together with POS pricing tests, these initiatives drove about 45% of the improvement in merchandise margin, compared to 2019.

For the Macy’s brand our initiatives contributed to full price sell through improvement of 500 basis points, while full price AURs increased 11%. As digital penetration increased the related rise and delivery expense partially offset the improvement in merchandise margin. Delivery expense was 4.3% of net sales, 170 basis points higher than the second quarter of 2019. We made good progress with our initiatives to improve delivery expense management, but we continue to have work to do.

With regard to inventory productivity, market dynamics combined with our own initiatives led to inventory levels that were down 14.5%, compared to the second quarter of 2019. Our sales to stock ratio is healthy, and we remain focused on leveraging our data and analytics tools to most efficiently plan, place and price our inventory. Inventory churn for the trailing 12-months improved by 15%, while for the trailing six months inventory churn improved by 18%. Of course, inventory productivity has benefited from constrain supply as a result of global supply chain disruption.

While we’ve been successful in meeting most customers needs, reduced supply is ultimately detrimental offering them a more limited selection. We anticipate improvements in many of these constraints by no earlier than mid-year 2022, after which we expect inventory levels will normalize and at healthier levels than they were before the pandemic in order to sustain margin benefits. However, our inventory strategy is still focused on chasing sales and exercising very disciplined buying behavior. In fact, even with the current constraints, we have been able to source more supplies and plan to successfully chase sales.

Moving on, we continue to show strong expense management discipline. Our next value creation metric. SG&A expenses of $1.9 billion improved by about 13% or $279 million from the second quarter 2019 levels. As a percent of net sales, SG&A expenses were 33.6%, a significant improvement of 570 basis points, compared to the second quarter of 2019. This was primarily driven by the $900 million in annual expenses we removed from our cost base last year through Polaris.

Macy’s Media Network also contributed. The partners that joined in 2020 have invested more heavily this year as they have recognized its ability to drive results. At the same time, there are more vendors investing, resulting in increased expectations of more than $75 million of net revenue this year. Additionally, as mentioned earlier, labor shortages contributed. However, while expense levels were aided by the shortages, we are diligently working to fill open positions in order to best serve our customers. The contribution of expense savings from the tight labor market is not sustainable over the long-term.

We generated $197 million in credit card revenues during the quarter, up $21 million from the second quarter of 2019 and ahead of what we expected. They were also ahead as a percent of net sales increasing by 30 basis points to 3.5% and trending ahead of our prior annual guidance. Strong customer credit helped resulting in lower bad debt levels continue to be a benefit in the second quarter. Given our strong performance across these key areas, we generated positive unadjusted EBITDA of $753 million and adjusted EBITDA of $836 million.

Notably, adjusted EBITDA margin of 14.8% exceeded the margin in Q2 of 2019 by 760 basis points on the strength of our expense management and gross margin expansion. After accounting for interest and taxes collectively, these results helped to generate quarterly adjusted net income of $411 million and adjusted diluted EPS of $1.29 versus $88 million and $0.28, respectively in 2019. Our final value creator is capital allocation and we generated meaningful cash flow in the quarter, ending the quarter with $2.1 billion of cash and cash equivalents and leaving our credit facility untapped.

Year-to-date through Q2, we generated $769 million of free cash flow with capital expenditures of $230 million. Combined with the momentum from our Polaris initiatives, our ability to generate these levels of cash gives us the runway to increase our prior expectations and further invest in profitable sales growth.

Over the next couple of years, we expect our capital spend to increase from $650 million this year to approximately $1 billion annually. These dollars are and will continue to be heavily focused on strengthening our omnichannel capabilities with investments in digital shopping experiences, data and analytics, technology infrastructure and more efficient fulfillment capabilities all supporting profitable growth. In fact, we expect these types of investments to represent around three-fourth of our total capital spend over the next two years.

We are now well positioned to focus not only on deleveraging the balance sheet, but also returning cash to shareholders as Jeff mentioned. First, we redeemed our $1.3 billion secured bonds earlier this week in cash. This action, along with our planned repayment of $294 million of unsecured debt due in January 2022 is expected to result in a year-end leverage ratio of no more than 2.5 times. All in, it saved us more than $6 million on a cash basis versus call on the debt in June of next year. This is a significant step towards our goal of returning to investment grade metrics this fiscal year, which would be far earlier than we originally expected.

Second, we are reinstating our dividend our first cash dividend since the start of the pandemic, which allows us to return approximately $95 million of cash to investors this year. Starting with $0.15 a quarter, we expect to grow this dividend over time subject to board approval, which will depend upon market and other conditions. And third, our Board of Directors authorized a $500 million share repurchase program, which we intend to exercise to opportunistically buy back shares. We are very excited about the momentum we created coming out of the second quarter.

So what does this does all mean for the rest of the fiscal year. While we incorporated a healthy amount of conservatism into our prior guidance, our performance in the second quarter combined with a relatively more confident outlook in the macro environment has led to a material increase in our full-year guidance. There are still headwinds, we continue to face, the supply chain constraints, the tight labor market, elevated levels of holiday shipping surcharges and potential unforeseen impacts of the COVID variant. And so we built our expectations for these headwinds into the low-end of our guidance, which still doesn’t contemplate a return to government mandated shutdowns should they prove necessary.

But at the same time, today’s economic data reveals that consumers have money to spend and are confident in spending it even when stays with possible restrictions. All of this combined with the ongoing success we’ve seen from our Polaris initiatives, which is growing and expected to contribute more to our performance leads us to believe that back half of 2021 will be strong.

You can refer to our slide presentation for the complete full-year guidance metrics, but here are the highlights. Full-year net sales expectations increased by more than $1.7 billion with positive comps versus 2019 in the back half of the year driving the majority of the increase. Gross margin rate expectations improved by 100 basis points. Notably, now only slightly below 2019.

SG&A expense as a percent of sales is expected to be up to 250 basis points better than 2019 also a significant increase from our prior guidance. Adjusted EBITDA expectations have also improved and the margin is now expected to be as much as 2 percentage points better than 2019.

And the midpoint of adjusted diluted EPS expectations is nearly 2 times higher than that of our prior guidance reflecting the better outlook and lower interest expense. It does not include any impact from the repurchase of shares for which we will provide quarterly updates.

We plan the remainder of the year significantly higher than when we first [Technical Issues] our targets back in February. The back half is expected to be solid as our Polaris initiatives continue to take hold, but we are also coming off a quarter that benefited from a very healthy response to the reopening of the country and our range is also reflect the headwinds I mentioned earlier.

So for the third quarter, we expect net sales to be between roughly $5.0 billion and $5.2 billion with adjusted diluted EPS in the range of $0.17 to $0.26. We’re increasing our long-term adjusted EBITDA margin target to remain in the low double-digits beginning next year. This reflects the confidence we have in our ability to sustain healthy top line and bottom line growth, while at the same time getting back to investment grade metrics and returning cash to shareholders all sooner than expected.

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

Jeff Gennette — Chairman and Chief Executive Officer

Thanks, Adrian. We had a strong first half of the year as we executed our Polaris strategy, while operating in a better environment. We have come through what I hope will be the worst of the pandemic and emerged even more focused, more determined and more strongly positioned to succeed in the future. I want to thank and recognize all my colleagues across Macy’s Inc., for their contribution to our performance and who are working every day to serve our customer and transform our business.

The Macy’s Inc., portfolio is digitally led, because there is no doubt that consumers expect us to do this exceptionally well. We are robustly omnichannel, because stores and sites and mobile apps are stronger together than anyone is alone. We are well represented from off-price to luxury, because we know consumers participate in more than one tier of the market. We are well balanced across categories products and brands.

Because we know our customers look to us for all expressions of fashion and style and we are proud of our department store routes, because we believe in the relevance, appeal and opportunity of a trusted brand name bringing forth a breadth of offering. Our results are clear, the Polaris strategy is working not only to improve the fundamentals of our business and our balance sheet, but also to build a bolder, brighter and stronger Macy’s for the future.

Thank you. And we’re now going to open up the line for questions-and-answers.

Questions and Answers:

Operator

Thank you. [Operator Instructions] We will now take our first question from Matthew Boss from J.P. Morgan. Please go ahead.

Matthew Boss — J.P. Morgan — Analyst

Great, thanks and congrats on the nice quarter. So Jeff, maybe with the business improving to positive mid single-digit comps versus pre-pandemic this quarter. It’s really two questions: first, what you attribute the magnitude of the improvement, particularly with tourism, I imagine which is still a headwind?

And then second, what have you seen from August and back-to-school that provides you confidence in mid single-digits continuing in both the third and the fourth quarter, which I think is the high-end of your forecast?

Jeff Gennette — Chairman and Chief Executive Officer

Hey, Matt. Thanks for your question. So when you look at the, kind of, the beat of our business in the second quarter. I think, it comes from a couple of place, certainly, kind of, the economic tailwinds. And when you think about the new jobs, the stimulus with the child’s tax credit continuing just a lot of pent-up demand that when customers were kind of re-emerging from the pandemic and resuming life. So when you look at our business, I would tell you that really the Polaris strategy is taking hold, and you look at the 16 points that we were better when you compare it to 2019 between the quarters and what happened in our business. The stuff that was working for before it just continues to be quite strong. So our digital business, very strong on a two-year stack, you look at the home categories, fine jewelry, you look at fragrance.

What happened in the quarter that was unique was these dormant categories, the dress up categories like dresses, men’s clothing, one of the biggest beats was our luggage business as the domestic tourist business is starting to rev up. We also want new categories that we brought in during the pandemic and expanded it in department store you would expect us to do that. So you look at one of the VDF categories, Toys, which we announced this morning to broaden our relationship there has been a home run for us, getting into really looking at categories that respond best in this under 40 customer we’ve been really hard at work at that and getting lots of good results there.

So, look, that’s really what happened in the second quarter when you — to your question about tourism. We don’t expect international tourism, which as you know is about historically about 3% to 4% of the entire Macy’s Inc business that’s not coming back in ’22. So those are potential tailwinds that we’re going to see in ’22 and ’23, that’s good news for us that’s coming. When you think about the third and fourth quarter of this year. I’d start with back-to-school, so it’s been a strong start and we’re well into it right now, high single-digit improvement versus 2019. And it really is across the board, you look at it in girls and boys, it’s certainly the categories of denim and Tees, uniforms active of all been strong. When you look at kind of the Gen Z areas of men’s and women’s, young men’s and juniors sometimes called, you know,. really the brands are doing extremely well there.

So when you look at the Levi brand, the Armani brand, Gas all really strong, Denim has been a standout and then you look at the categories like back to dorm in the home categories, you look at backpacks just huge increases. So, high single-digits, that is a — that’s been obviously a chunk of our business in the third quarter.

And then to the last part of your question about, kind of, fourth quarter, obviously that’s the gifting time frame of the holiday time frame is where Macy’s and Bloomingdale’s shine. So we’ve got a great lineup. We’re going to be ready. We expect that it’s going to be a very strong holiday season with customers coming back together maybe for the first time in a couple of years.

Operator

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

Chuck Grom — Gordon Haskett — Analyst

Hey, great results guys. You know, your sales guide for the year implies sales per square foot of around $225, which I think if my model is right is the highest ever. Adrian, I’m curious when you think ahead to maintaining the low double-digit EBITDA guide, which is really the big surprise in the print today in my opinion. I’m curious what you’re assuming for that sales outlook going forward?

Adrian V. Mitchell — Chief Financial Officer

Chuck, it’s great to be with you this morning. So a couple of things, when we think about the topline sales for the business. We’re looking at not only the sales within our stores, which we expect to continue to be highly productive, but we’re also looking at digital sales as well. And so we’re very pleased with the strength of the digital business that we’re seeing, we’re very pleased with the recovery that we’ve also seen in our stores.

As it relates to the margin profile in terms of low double-digit, adjusted EBITDA, it’s really pushing on three key things: the first piece is really around our merchandise margins. We’re being much more disciplined about the depth of promotions, making sure we’re having more full price sell throughs, and so we’re really pleased with the health of our merchandise margin in order to help achieve that margin expansion. We do have work to do on delivery expense. We are very much benefiting from the pace of digital acceleration, which is actually increasing our delivery expense rate as you saw in our performance in the last quarter particularly relative to 2019. But we have work to do to reduce split shipments, increase the number of orders that are actually picked up from our stores by our customers, and just the number of things that we’re doing to really mitigate that.

We’re very deliberate about our SG&A expenses as well. So we did have a lot of improvement partially driven by the $900 million of permanent improvements, based on the restrictions we did last year in SG&A. So I think all in all, as we think about the performance in terms of low double-digit performance going forward, it’s really pulling those key levers recognizing that we still have work to do, but given the traction that we’re seeing with Polaris, we feel that we have real confidence and achieving those goals as we look forward into 2022 and beyond.

Operator

We will now take our next question from Kimberly Greenberger from Morgan Stanley. Please go ahead.

Kimberly Greenberger — Morgan Stanley — Analyst

Okay, great thank you so much. I wanted to know, Jeff, if you could just touch a little bit more on the Toys “R” Us partnership and how you’re thinking about that both heading into this holiday season and in the future? And then if I could just dig a little bit more into the gross margin and the co-operative advertising comments that you made. Gross margin I think, Adrian, you’ve indicated would be a touch below 2019 levels on a full-year basis, but it’s sort of nicely above 2019 levels here in the first half of the year. So, are there some pressures you’re anticipating in the back half of the year that would, sort of, push down your expectations?

And then on cooperative advertising, I think, you indicated that levels are running above historic — about history, how sticky is that, sort of, I guess it’s a contra SG&A account? How sticky is that? And if you have any quantification of that? That would be helpful.

Jeff Gennette — Chairman and Chief Executive Officer

So, Kimberly, let me — good morning. Let me start with Toys “R” Us, and so we’re obviously excited about this partnership and it really started just based on how we sort of have, kind of, the toy business in backstage and it was one of the stand-out categories for us. We did have it to a limited degree during the gifting time frames at holiday in the full-line store. Got huge increases really over the past couple of years and our market share in toys is quite small.

So it was an opportunity for us to look at, hey, what’s the entry category for Toys “R” Us kids that are now millennial parents and opportunity for us part of our under 40 strategy to go after this category with a lot more bigger and recognizing that those footsteps or those eyeballs will translate into other purchasing, you know, as — if we do all of our offer engines right. So and that’s really was the impetus of starting out with how did we want to do that. So we’ve gotten into this partnership with them, you go to our website, it’s now live on that — that’s the beginning.

You will see in 2022, you’ll see it to a limited degree in 2021, but in 2022 there will be 400 stores that will have full out shops. We will have access obviously to their private brands. We’re going to expand the categories. We will do lots of marketing together, you will see them in the parade as an example. There — we’re embedded now for a category that we think we can quintuple the size of the business. And so it’s a big growth factor for us. It’s actually at pretty decent margins and obviously those footsteps, eyeball to be able to translate into other categories is the big win. So this is the beginning of our relationship and we have lots of opportunities to expand it both online and in our stores.

And Adrian, do you want to take on the gross margin question?

Adrian V. Mitchell — Chief Financial Officer

Yes, absolutely. Good morning, Kimberly. So with regards to the gross margin, what we would say is that we’ve had great performance so far this year. A lot of that is driven by the health of our merchandise margin and our efforts to mitigate as much our delivery expense. But the reality is that we’re heading into our peak season and in our peak season we tend to have our highest level of digital penetration, which puts pressure on gross margin.

In addition to anticipated surcharges that we’re expecting given the demand that’s happening in the marketplace in the back half of this year. So some of that conservatism and that measured approach to our guidance with regards to the gross margin is really around the delivery expense metric there.

With regards to Macy’s Media Network, we continue to see some real gains here. We had originally forecasted about $60 million in revenue from Macy’s Media Network in our previous guidance. We’re now guiding that, that’s going to be more around $75 million and the good news here is that this will be an offset to our SG&A based on how we think about the Macy’s Media Network within the context of our marketing efforts.

Operator

We will now take our next question from Jay Sole from UBS. Please go ahead.

Jay Sole — UBS — Analyst

Great, thank you so much. Jeff, wanted to ask you about some comments that some of the off-price retailers have made recently about increasing prices going forward. How does that impact your strategy? Does that allow you to take price as well especially if there’s going to be more inflation next year? Or do you see there is an opportunity to improve your value proposition, I’d love to know about that.

And then secondly, just if you could elaborate on your expectations for adjusted EBITDA margin remaining in the low double-digits in ’22 and beyond. Could you just elaborate a little bit on what gives you the confidence in that given some of the inflation pressures that are out there and lapping stimulus and some of things of the market is talking about? Thank you.

Jeff Gennette — Chairman and Chief Executive Officer

Hey, Jay. So let’s start with where we’re going with in terms of — kind of inflation. So we already have, you know, when you look at some of the home categories we have been working on ticket prices and that has been going on over the past number of months. And where we have a number of levers that we’re playing. When you look at what’s going on with our gross margin retail expansion, as well as our AUR improvements, as well as our regular price selling improvements. I think it starts, when you think about where we are with margin, it starts with having a very healthy inventory base that we’re building on.

So if you look at being down about 15% on a two-year stack in inventory and we massively exceeded our sales plan in the second quarter and we were able to secure a lot of additional inventory to fuel those sales. We’re buying much closer to the disciplines of lag. If you look at our turnover being up almost 20% on the year, those are really healthy scenarios for us to really play with our pricing and promotional strategies. And so you can see that we have reduced the amount of promotion, the amount of overlap, we’ve reduced the amount of couponing and we’ve reduced the amount of the depth of our POS discounts.

So when we take a price increase, sometimes we don’t raise the ticket, because we’re just reducing the amount of POS discounting and obviously playing with thousands of tests every week to see how the customer responds to that both in line and in stores. There are some categories in which while we can [Phonetic] raise the ticket price and we have, and we use the same kind of promotional tactics to get to a higher AUR. So the devil’s in the details, but I would say the difference between our brands from where we were a year ago is just the degree of sophistication that we have on pricing science, and how we’re applying that not only an allocation, but all of our promotional ladders, all our seasonal content.

And so the other thing I’d say is that there are some categories in which we’re really playing we’re putting more make into the good more fashion, more content and that commands a higher retail. So we’re able to kind of massage some of those price increases. And there are some categories in which the customer rejects price increases and we might take a shorter margin, but it’s compensated from all of the expansion that we’re getting in the other areas. So, look inflation is happening right now, but I think we’ve got a very solid plan to drive it within the strategies that I just articulated.

Adrian V. Mitchell — Chief Financial Officer

And so Jay, it’s great to be with you this morning. Just with regards to your question around the adjusted EBITDA and maintaining low double-digits EBITDA, over time. We kind of look at this in three pieces: the first piece is around the merchandise margin and Jeff spoke to a bit of this a bit earlier, which is we’re really making real progress around the pricing and promotional science within our business. And so whether it’s having higher regular price penetration, reducing and simplifying the depth and of our promotions, looking at location level pricing to reduce the portion of our mark down sales. These are all, a lot of the science that we’re putting into our business to be able to sustain those behaviors.

In addition, we’re actively chasing sales, which allows us to manage our sales to stock ratio. So that as we go forward we’re relatively lean on inventory so that we can maximize the full price sell through. As it relates to delivery expense, this is an area we are continuing to work towards, we’re continuing to make a lot of investments in, but the kinds of things that we’re pursuing is increasing the percent of digital orders picked up by customers at the store, that delivery expense is free for the customer and free for us. We’re also looking at ways to improve allocations to reduce the distances that packages travel, because there’s a high correlation between distance and cost of parcel shipments. We’re also looking at our operation and saying look if we can improve the way we allocate our inventory, we can do a much better job of reducing splits, which is just an extra package and much more costly to us and that’s something that we can pass on to the customer. So we do see a lot of improvement and I think from a gross margin standpoint really attacking that delivery expense piece is going to be an important dimension for us.

As we think about the SG&A piece, we have a lot of benefits. We talked a bit earlier with Kimberly about the offset of the Macy’s Media Network, we also recognize at increasing digital penetration with our business is really a leverage — sales leverage point for our SG&A and we’re constantly looking at ways for our sales teams in our stores or selling team in our stores to find ways that would be even much more productive, while maintaining that our stores are at brand standard. So those are the kinds of things that we’re doing, but I think it all adds up to traction in the Polaris strategy. Our tests are working, we’re scaling things that are working and yet we have a portfolio of strategic initiatives that we’re implementing later this year and implementing into next year. So that’s what gives us confidence. It’s just that traction and the fact that the full portfolio in our toolkit is not fully deployed yet.

Operator

We will now take our next question from William Reuter from Bank of America. Please go ahead.

William Reuter — Bank of America Merrill Lynch — Analyst

Hi, I just have one, you mentioned that you are going to be achieving the investment grade credit metrics earlier than you previously expected later this year. Is it a goal to actually attain investment grade ratings? Or more or less are you just going to be focused on those metrics, which you believe should be representative of investment grade?

Adrian V. Mitchell — Chief Financial Officer

Good morning, Bill. Thanks for your question. You know, we’re just very pleased with the health of the business in the fact that our plan with the $1.3 billion pay down that we did earlier this week. In addition to the payment at maturity of the upcoming node in January that we expect to end the fiscal year at less than 2.5 times. And the purpose of this is really a combination of not only investing in the highest return investments in our business, deleveraging the balance sheet and returning capital to shareholders. That’s very much our balanced strategy.

But all of that really speaks to just a healthy business and a healthy business gives us flexibility to compete, to invest in initiatives and opportunities that come up that may be a bit unplanned and so for us achieving an investment-grade profile is really critical just because it really speaks to the health and resiliency and sustainability of Macy’s Inc.

William Reuter — Bank of America Merrill Lynch — Analyst

Thank you.

Adrian V. Mitchell — Chief Financial Officer

Thanks, Bill.

Operator

We will now take our next question from Carla Casella from JPMorgan. Please go ahead.

Carla Casella — JPMorgan — Analyst

I actually have a follow-up on that one. So [Indecipherable] $1.3 billion your biggest tranche of secured debt, you have a few other smaller tranches of secured debt. Do you think that, that you needed to address those before you can get to investment grade?

Adrian V. Mitchell — Chief Financial Officer

Well we do have about $361 million of additional secured lean, we do not anticipate paying that at this point in time, we are very much paying the towers that are maturing over the next several years. And so that’s really very much our focus. But again, we’re very much focused on the financial health and flexibility of the business, and we feel that given our current leverage ratio and what we anticipate for the end of the fiscal year. That brings us into a healthy position and gives us a lot of flexibility to think about further investments in the business, returning capital to shareholders and really having a balanced capital allocation strategy.

Operator

We will now take our next question from Steph Wissink from Jefferies. Please go ahead.

Steph Wissink — Jefferies — Analyst

Thank you. Good morning everyone. I’d like to ask a question about the 5 million new customers that you added to your profile. I think you mentioned 40% came in through digital and up 40% were in the Bronze tier of your loyalty programs. May be just talk a little bit about those merchant categories where they’re shopping? Does that give you any validation on some of your merchandise strategies? Or even identify some opportunities where you think you might be able to expand over the next several years? Thank you.

Jeff Gennette — Chairman and Chief Executive Officer

Thanks, Steph. So when you look at the 5 million new customers that came in, you hit some of the headlines. So they are younger, they’re more diverse. You have a little over 40% came in via digital and they came in through a lot of the categories that we have great strength and they came in for fragrances. They come in through some of the millennial categories that we’re building out. They come in for denim and it gives us the opportunity for that first purchase to then okay, what’s their behavior in that first purchase. How do we see it and get a second and the third purchase with them.

So one of the stats that we’re really focused on is what percent of the customers that come in one quarter and are they shopping with you the second quarter. So as an example, if we look at the first quarter will be brought in 4.6 million customers in, we’re really measuring, okay, how many of them came back during the Mother’s Day, Father’s Day, gifting in the second quarter. And that percentage is continuing to build with us. So our personalization techniques or data analytics capabilities is really coming to the [Indecipherable] and it’s really helping us seed additional messaging. We’re obviously making a great incentives for them to come into our loyalty program.

But what we find is those categories that we have the highest market share is generally where the customers — the new customers are coming in and our opportunity to give them new content, new categories and new offers is seeding long-term behavior, and many of them moving up our royalty chain. So we have the younger customer very much in mind. And when you look at the 5 million customers that came into the brand for having not seen the bulk of them before is very encouraging.

Steph Wissink — Jefferies — Analyst

Thank you.

Operator

We will now take our next question from Omar Saad from Evercore. Please go ahead.

Omar Saad — Evercore ISI — Analyst

Good morning, thanks for taking my question and thanks for all the color. You guys mentioned a couple of interesting trends that I’d love to hear you guys explore a little bit more both the dynamic that you’re seeing customers return to stores and still shopping online. And you also mentioned that pandemic categories and the recovery categories are both showing signs of strength here. So maybe if you look through the customer data and the profiles you’re seeing and this activity maybe could talk about. Is this the same customers returning the stores? The younger customers that you attracted online? Are you seeing them shift to stores or is this the old existing customers kind of reactivating and coming back in the stores and same thing on the categories? Does the same customers buying across both pandemic and recovery categories or is it different customers? Thanks.

Jeff Gennette — Chairman and Chief Executive Officer

So, Omar. It’s different depending on what part of the country you’re in. So, but what I would first say is that the customer is just increasingly omnichannel, and it’s really hard to tease out their behavior. It used to be like five years ago, you would have two touch points for our customer before they would consummate a transaction. It’s now at six, so you’ve got customers are going to stores that are buying later online or on their device. They’re doing research, they’re getting inspiration in the social channels. We’ve got our colleagues in stores that are basically doing virtual selling. So there is a — but I would say in general, what you’re seeing in the second quarter, we’ve got a lot of our core customers that were basically not shopping and they were not comfortable going into a store. They have — they kept — they had shifted their behavior during the pandemic to online purchasing you saw some of that shift back into the stores.

The younger customer was shopping in both channels with vigor. So there is a — and then the categories that you know that we saw come back strongly were those that was really about wearing occasion and gifting occasion. So those were categories that those younger and our core customers were responding to. So I hope that answers your question. But what we’ve seen is that when you look at the southern parts of the country that business came back more strongly. There are still pockets of the country where the stores business to our average is off and it’s not correlated to vaccination rate. It’s really kind of the psychology of those customers and many of those customers are not buying online or in-store. And so we believe that we will get a recovery with those customers over time that will come into ’22 and beyond.

Operator

[Operator Instructions] We will now take our next question from Dana Telsey from Telsey Group. Please go ahead.

Dana Telsey — Telsey Group — Analyst

Good morning, everyone and nice to see the progress. Jeff, can you give any comment on what you’re seeing in urban area stores versus suburban, Manhattan for example, is it still the same cadence of what it had been? And then, Adrian, on the delivery expense, how are you planning that going forward? And how do you see the digital business where you took up the sales for the year? Is there any more efficiencies that you see perhaps of in-store pickup that we should be monitoring as we go into the holiday season? Thank you.

Jeff Gennette — Chairman and Chief Executive Officer

Hey, Dana. So I’ll take your first question about urban versus suburban. Definitely our city stores are still our most challenged and when you think about, kind of, the three buckets of shoppers in those stores. You’ve got your resident of those cities and we’re engaged with them very strongly and we’ve got our colleagues are hyper-motivated to make sure that we’re building out all of those customers in their business.

You then have the second bucket, which is playing out right now, which is kind of back to office and you’ve got these office workers which were really strong customers for us in normal times during the lunch hour and after work. And as you see with all the delta variants those reengagement on to back to office are always shifting. So we haven’t seen the impact of that yet. And that will certainly affect all of our city stores as that plays out.

And then the third bucket is really Tourism and in particular international tourism and that has dried up. I don’t see, there is certain signs of life in certain countries. But I would tell you on balance all of our city stores are still suffering from a lack of that traffic in that historical volume. So again, that will be a tailwind for us in the future as the variants play out.

So urban stores are still dramatically lower we’ve got many suburban stores that are comping ahead of 2019 levels and they could be like if you look at the Manhattan timeframe or the Manhattan, you could look at a Herald Square, you look at the 59th Street, but then you go out to Long Island, you look at the Roosevelt Field and it is a hopping center and we’re all benefiting from that. So there definitely is a different psychology with suburban and the urban customers right now.

Adrian V. Mitchell — Chief Financial Officer

Good morning, Dana. As it relates to delivery expense, your instincts are right, we do want to continue to focus on delivery expense especially given the momentum and the pace of digital sales growth, as well as digital penetration. As it relates to in-store pickup we do identify that as an opportunity, and so we’re doing a number of things to try to encourage our customers to take advantage of that service, it’s quick, it’s convenient, it’s easy, it’s free. And so those were the kinds of things that we have to continue to work on in terms of increasing our pickup in our stores.

In addition this fall, we’re actually planning to rollout a number of tests that would actually help complement this. So we’re taking a small population of our stores. We’re looking at ways to improve the productivity and efficiency of all the store fulfillment activities and that also includes putting in stores varying levels of automation to support pick up, speed, efficiency and also ship from store capabilities. So delivery expense is definitely something we’re looking at, we’re working actively, test this fall, doing the kinds of things that will allow us to really get after the delivery expense and get that much more under control as we think about our ambition going forward.

Operator

As there are no further questions in the queue. I would like to turn the call back to your speakers for any additional or closing remarks.

Jeff Gennette — Chairman and Chief Executive Officer

Thanks everybody have a great day.

Operator

[Operator Instructions]