Karen Hoguet - CFO

Lorraine Hutchinson - Bank of America Merrill Lynch Lauren Cassel - Morgan Stanley Matthew Boss - JPMorgan Oliver Chen - Cowen & Co. Priya Ohri-Gupta - Barclays Capital Charles Grom - Sterne, Agee & Leach, Inc. Paul Trussell - Deutsche Bank Jeff Stein - Northcoast Research Michael Binetti - UBS Bernard Sosnick - Gilford Securities Stephen Grambling - Goldman Sachs Joan Payson - Barclays Bob Drbul - Nomura Securities Stacie Rabinowitz - Consumer Edge Research Matt McGinley - Evercore ISI Dana Telsey - Telsey Advisory Group David Glick - Buckingham Research Group Richard Jaffe - Stifel Nicolaus Michael Exstein - Credit Suisse Wayne Hood - BMO Capital Markets Laurent Vasilescu - FBR Capital Markets Todd Duvick - Wells Fargo

Good morning, and welcome to the Macy's, Incorporated Second Quarter Earnings Release Conference Call. Today's conference is being recorded. I would now like to turn the call over to your host, Karen Hoguet. Please go ahead ma'am.

Great. Thank you. Good morning and welcome to the Macy's conference call scheduled to discuss our second quarter earnings. I am Karen Hoguet, CFO of the company. Any transcription or other reproduction of the statements made in this call without our consent is prohibited. A replay of the call will be available on our website www.macysinc.com beginning approximately two hours after the call concludes. Please refer to the Investor Relations section of our website for discussion and reconciliations of any non-GAAP financial measures discussed this morning. Keep in mind that all forward-looking statements are subject to risks and uncertainties that could cause the company's actual results to differ materially from the expectations and assumptions mentioned today due to a variety of factors that affect the company, including the risks specified in the company's most recently filed form 10-K and other SEC filings. Today, we announced second quarter earnings as well as two additional initiatives that should help to enhance shareholder value and build for our future. On this morning's call, I will cover three topics, starting obviously with second quarter earnings, then the other two announcements made this morning, and conclude with our outlook for the remainder of the year. I will then open the call as always for your questions. So let's get started. In the second quarter, we reported earnings per share on a diluted basis of $0.64, which is 20% below last year. While we had expected earnings to be below last year in the second quarter, this was below what we had expected. Our performance in the first half of the year was not as strong as we had hoped, but we are cautiously optimistic about our ability to improve the sales trend in the fall season. We'll talk about that later in the call, but know that we remain confident in our strategies and in our team's ability to execute them. Total sales in the second quarter were $6.1 billion, down 2.6% versus last year. On a comp, owned plus license basis, sales were down 1.5%. Remember that last year comp sales on an owned plus licensed basis were up 4% in the second quarter. So, on a two-year basis, comp sales increased 1.2% per year in the second quarter, which is stronger than the first quarter decline of 0.4% per year on the same basis. We would highlight the following four major factors in no particular order that contributed to our sales weakness in the quarter. Two of these are the same as we mentioned last quarter. The first is our decision to no repeat a friend and family event that we had last year in the second quarter. We had hoped that we would be able to preserve the sales with other promotional events, but that turned out not to be the case. Two, continued weakness in the international tourist business. We estimate this hurt comp growth by approximately 1% as it did in the first quarter. Three, slower growth in some key center core categories. These businesses are still growing well above the total company, but just not at the same level as they had been growing. And four, the continued challenges with the consumer. The overall growth in the economy is modest at best and we are seeing customers gravitating to restaurants, recreational services, healthcare, and electronics rather than to traditional general merchandize apparel and furnishing category. Last quarter, we also spoke about the West Coast ports, which had a lingering albeit smaller effect in the second quarter as we predicted. The weather effect in the first quarter no longer impacted sales in the second quarter. We also had mentioned last quarter that there was a steeper than expected learning curve as our new Omni channel merchandizing, planning, and marketing teams learn how to maximize business in their new roles. This is still a factor, but doesn’t rise to the same level as it did when the new organization launched in the first quarter. Interestingly, two of our best performing categories in the quarter were in the center core areas; handbags and fragrances. We also had strong sales performance in active, furniture, and mattresses. The weaker categories included fashion jewelry and watches, petites and large size women's apparel, men's tailored clothing, house wares, and table top. Our Omni channel strategies are working well as customers increasingly shop and buy across multiple channels. We believe that our new organization structure is helping to accelerate digital growth, which continued to be very strong in the quarter. Geographically, we continue to see relative strength in the Southern markets, but the best performance came this quarter from the entire West Coast, and our worst performance was in our major tourist doors and markets. In the second quarter, average unit retail was down 1.3%. The number of transactions was down slightly in the quarter and units per transaction, up slightly. The gross margin rate in the quarter was 40.9%, down 50 basis points from last year. We told you at the end of the first quarter that gross margin rate would be below last year due to the impact of the delayed receipts from the port slow down earlier in the year. However, with the weaker sales, we took additional markdowns needed to keep our inventory fresh, and as a result the gross margin rate was lower than we had expected. Remember though the margin rate was up versus last year in the first quarter. So for the spring season or the first half of the year as a whole, the gross margin rate was down 30 basis points. Inventory at the end of the quarter was up 3.8% or a 2.9% increase on a comp basis. This is higher than one would expect in part because we brought in merchandize earlier than last year to get better set for back-to-school, which by the way has started off well. SG&A in the quarter was $2,058 million, up 1.7% over last year, which is similar to the increase in the first quarter, and as a percent of sales, it was 33.8%, a 150 basis points above last year. The biggest increases in expense relative to last year related to our growth investments. Our Omni channel strategies, a full quarter of Bluemercury expense and the start-up expense associated with the back stage pilot. In addition, we were negatively impacted in the quarter by higher medical benefit expense. Depreciation and amortization was $261 million, which is $7 million higher than last year. These increases were offset in large part by the cost reduction resulting from the yearend Omni channel restructuring as well as higher credit income. In the second quarter, credit income was $195 million, which is $12 million above last year. Penetration or usage of our proprietary credit card in the quarter was 47.8%, up 190 basis points over last year. This great result was in large part due to the launch of our new Plenti Loyalty Program and also the impact of the lower international tourist business. Operating income in the quarter was $436 million, down 24% from last year. Interest expense was $93 million, tax expense $126 million with a 36.7% effective tax rate. Net income in the second quarter was $217 million, average share count on a diluted basis was 341 million shares, which is 6.7% below a year ago and as I said earlier, earnings per share on a diluted basis was $0.64, 20% below last year. Cash flow from operating activities was $398 million, $338 million below last year, due primarily to a $106 million of lower net income and $154 million from higher inventory net of payable. Net cash in investing activities was about the same as last year apart from this year’s acquisition of Bluemercury and year-to-date we utilized $937 million to purchase 13.9 million shares of our stock. In addition to the second quarter earnings we also made two announcements this morning. The first relates to our entry to China through the formation of Macy's China Limited, a joint venture with Fung Retailing Ltd. The joint venture will be based in Hong Kong and is 65% owned by us and 35% by Fung Retailing. This venture will start with an eCommerce pilot initiative on Tmall Global later this fall. Macy’s China Limited will be led by Kent Anderson, a longstanding Macy’s Executive who was the Founder and long time President of Macy’s.com. No physical stores are planned for China at this time, but maybe considered in the future based on our experience in eCommerce. Together with Fung Retailing, we're expected to invest approximately $25 million in these operations over the next 18 months and our share will obviously be 65% of that. The entry is expected to have an immaterial impact on our earnings this year and in 2016, we expect the joint venture to generate sales of approximately $50 million. We're very excited to be working with such a great partner to being to build a business in one of the world’s largest and fastest growing consumer marketplaces. Our game plan is to start small and use a test and learn approach as we move forward. We also believe that by increasing the presence of Macy’s in China, we will actually help our business here as well both with the Chinese tourists as well as Chinese residents. We also announced this morning a transaction that takes advantage of the value inherent in our Brooklyn real estate. As you know our strategy has been to maintain a mix of both owned and leased stores and this approach has worked extremely well for us keeping our cost low and providing us with the flexibility to adapt to changing economic conditions. As part of this strategy, we continuously review our portfolio and take action where we see opportunity to enhance value. In this case, we were able to monetize part of what we owned in Brooklyn and frankly weren’t using productively while creating what we expect to be a stronger, more productive retail store in this terrific market. We have been studying our options for this location as well as for other properties for quite some time. As you read Tishman Speyer is purchasing our Brooklyn parking garage facility as well as the top five floors and air rights above the existing Macy store for approximately $170 million in cash. Tishman Speyer will convert the space into first class office space. They will contribute an additional $100 million that will be used toward the total rebuild and remodel of our Macy store. This transaction is expected to close in the fourth quarter and is expected to result in a gain of approximately $250 million. This transaction had not been assumed when we provided earnings guidance at the start of the year. The good news is that in addition to monetizing the space that was unproductive, we're going to be able to reinvent the store to create a true fashion hub combining the best of Macy's with Brooklyn's local flavor. We see enormous opportunity to better serve the Brooklyn customer. We currently operate 378,000 square feet on eight floors in this store and in the future, we will be operate more productively in 310,000 square feet on five floors. The remodel is expected to start in the spring of 2016 and be completed by the fall of 2018 and the good news is that the store will remain open through this period. While on this subject of real estate, I want to take a moment to touch on the work we're doing on a real estate portfolio. We have regularly considered ways to realize the value of our own real estate over the years, but each time we did not see enough meaningful economic benefit to justify the added cost and lower flexibility that would come from doing so. With that said though real estate values clearly are nearing all time highs and so over the past few months, we have been intensely studying this subject again. We have brought on specialized real estate advisors as well as financial, legal and tax advisors to look at a wide range of alternatives from financing to structural that have the potential to create value. As part of this thorough effort we are working through a number of very complex issues relating to everything from property type to taxes, to debt covenants. It is too early to tell what the results of this will be as the work is still underway, but we plan to come back to you as soon as we complete this work. Let's now move on and talk about the back half of the year and some of the good things happening that should help accelerate our sales growth profitably. Last quarter, I spoke about our mom's strategy still being core to what we're doing. My Macy's, Omni channel and magic selling that is still the case and last quarter we highlighted seven new initiatives about which we are still excited. Let me just quickly give you an update on each of these. One was Bluemercury. There are now 66 stores open and we expect to have another 10 by yearend. We're working hard to improve the digital experience and strengthen the Omni channel capabilities and we're also opening this fall four Bluemercury stores within Macy stores including one on our Union Square Store in San Francisco. Two, Plenti has launched very successfully. Macy's now has over seven million customers enrolled and we expect to generate incremental sales from these customers as well as new customers who enrolled in this program through other companies as points begin to accumulate and customers understand the value inherent in this loyalty program. Three, the execution of our top door strategy continues and we said last quarter, we hope to see results beginning this fall. This will include enhanced product offering, upgraded shopping environment, incremental special events and additional sales associates with greater product knowledge. The fourth initiative we mentioned last quarter as All Things Wedding. Since the last conference call we announced our partnership with Men's Warehouse to open licensed tuxedo rental shops within 300 Macy stores with the first open opening this fall. This is an important capability added to what we offer for these customers. The fifth was outsized growth categories. One new initiative here is a pilot of a new strategy for jewelry and watches that includes an intensified selling effort, elevated product, improved physical environment and added marketing. We also are continuing to drive growth in the categories such as active, dresses and other parts of center core Six was Backstage, our off-price pilot. We’re getting ready for a grand opening in the first stores in a few weeks. We are very excited about how these stores are shaping up. And seven was International and obviously our China announcement that I just discussed is the big news in this arena. So as you can see, we are making progress in all of these fronts and staying focused on what we believe will drive our business. Our expectation for fall sales is now a 1% comp growth on an owned plus license basis with own comp about 50 basis points lower. Total sales are expected to be flattish versus last year. Total sales are growing slower than comp because of a significant reduction in the sales of private label goods to third parties. We’re opening two new full line stores in the fall, a Bloomingdale's and Honolulu and a second Macy store in Puerto Rico. Plus we're opening the ten Bluemercury locations, six Macy’s back stage off price stores and a very exciting new Bloomingdale’s outlet store on the upper Westside of Manhattan. Now as you model sale by quarter, I should note that we're expecting sales growth to be stronger in the fourth quarter than in the third as we begin to year around on the weakness in the international tourist sales. The gross margin rate is expected to be flattish in the back half of the year and SG&A dollars are expected to be below last year as a result of the large gain expected from the Brooklyn transaction. With that Brooklyn, SG&A is expected to be in the range of last year. And as you model the quarters know that the third quarter SG&A will be negatively impacted by the timing of asset sales this year relative to last year and additionally, the third quarter expense will be negatively impacted by a slight reduction in credit income in the quarter due to the cost associated with the EMV card reissue for our cobranded cards. So because of the sales assumption and the SG&A comparisons to last year, operating income is assumed to be below last year in the third quarter but in the fourth quarter operating income is expected to be above last year without the benefit of the Brooklyn gain and obviously with the Brooklyn gain higher still. Interest expense is expected to be $80 million in the third quarter lower than what we have been running year-to-date, due to a gain associated with the debt we're calling at par next week. But in the fourth quarter, interest expense is assumed to be back at the levels experienced in the first two quarters of the year. In the third quarter, the tax rate is expected to be higher than last year because last year's rate benefited from one-time tax settlements that happened during the quarter and was only 33%. We are still expecting our annual effective tax rate to be approximately 37%. So with these assumptions for the fall, the annual earnings per share on a diluted basis is expected to be 470 to 480 including the gain on the Brooklyn transaction. Now the good news as we head into the third quarter is that there are many things working in our business and we are following through on the plans we previously announced to initiate and develop growth avenues for the future both organic and with new businesses. The overall economy didn’t do us any favors in the first half of the year. We look forward to the effects of the stronger dollar beginning to year around in the fourth quarter and to consumers replenishing their closets as their wardrobes require updating heading into the fall and holidays. At a Management meeting two weeks ago, we updated each other on the many items on our to-do list, to generate sales growth from existing operations in the back half of the year. Some of them are mentioned earlier in this call today. As is often the case, success isn’t going to come from a big bang, but from a disciplined execution of strategic and well planned ideas, that genuinely serve the emerging needs of our consumers. Layer on top of that, the upcoming opening of Macy’s Backstage stores, our eCommerce launch in China and the growing presence of Bluemercury. The picture you see is of a strong and progressive retailer that is Omnichannel in nature and intent on continuing our success. Make no mistake about that the fact that we're focused on growing and driving this business and in creating shareholder value on all fronts. We’ve already returned more than $7 billion to shareholders over the past four years in the form of dividends and share repurchases. We have consistently outperformed the market in most of our major competitors on both the top and bottom lines. We're committed to maintaining the foundation of innovation and financial strength that have brought us this far. We continue to build our business in new and exciting directions and we appreciate your interest and support going forward. So let’s move on now to whatever questions you may have.

Thank you. [Operator Instructions].And we’ll take our first question from Lorraine Hutchinson with Bank of America.

Thank you. Good morning, Karen.

Good morning.

As you consider real estate monetization above and beyond maybe the single-store transactions, how do you think about the best use of proceeds from those transactions?

Well, as with everything, we’re looking at balancing growing the business and making the investments needed to do so along with obviously returning cash to the shareholders. So I think it would be similar to how we look at the cash flow that we generate just from the business.

Great. And it seems like you've been able to generate a lot of this -- these new initiatives without spending a lot of incremental capital, so would you consider a larger share repurchase here if you were to get further proceeds?

Absolutely, we would consider anything, but remember all of you who follow retail know that it’s fundamentally a cyclical business. So we do want to ensure that we have the financial flexibility and access to the capital markets in all conditions. So we’ll obviously balance how we use that cash with maintaining a strong balance sheet.

Thank you.

And we’ll take our next question from Kimberly Greenberger with Morgan Stanley.

Good morning, Karen. This is Lauren Cassel on for Kimberly. Just going back to the real estate strategy, it sounds like you are a bit more open to that subject today than in prior years. Is that a fair statement? And then you announced Brooklyn and Pittsburgh recently, so it seems like you are more open to opportunistically monetizing assets. But is there anything, other than all-time high real estate values, that has changed your thinking there?

I think that's the biggest issue. We've looked at this for many times over the years and also obviously how we can monetize assets like Pittsburgh like Brooklyn, particularly to increase the retail operation at the same time. So I think it’s really the value enhancement and some of the transactions that have been announced this year that were interesting. So I think between real estate values being high in some interesting transactions, we are taking a deeper look at the subject.

Great, thanks.

And we will take our next question from Matthew Boss with JPMorgan.

Hey good morning, Karen.

Good morning, Matthew.

So if you back out tourism, and we try our best to back out the friends and family, we calculate flattish to slightly positive same-store sales in the quarter. But then, in light of some of your comments on the consumer and maybe some of their changes in spending patterns, I guess as we look forward, is it more fair to think about consumer spending in department store category as more in the 0% to 1% comp run rate versus maybe 2% to 3% historical thought process or just any help you can give me around that would be great.

I’m stepping back for a second. I think the real answer Matt is that we see opportunities of generating more sales from our consumers. It is clearly getting harder. As I said, there is a lot of competition for the dollar in categories other than what we sell, but we have confidence in our team to develop -- deliver the sales that we've talked about and continue to be a market leader here.

Great. And then as we think about back stage and the potential rollout, if the fall test hits all your metrics, what options would you consider for growth next year and beyond, I guess both on an organic basis or would you also consider growing by acquisition?

Yes, I think we have to see how the test goes, but there is lots of ways that we could grow Backstage whether it would be organic, acquisition within Macy stores, there’s lots of ideas floating, but I don't want to get ahead of our test either.

Okay. Great. Best of luck.

Thank you.

And we'll take our next question from Oliver Chen with Cowen & Co.

Thanks a lot Karen. In your comments on back-to-school, it sounded like you're encouraged. I just was curious about categories or things that were driving that momentum and also when you did mention the slower growth in center core, which categories are you referring to?

Well in terms of back-to-school, it's way too early to claim victory. So we do feel good based on the early start. Obviously there has been a lot of talk about denim, and we see a lot of opportunity unfolding there for back-to-school, but also for the fall season in total, but it's too early to really talk fully about back-to-school, In terms of the slower growth categories, some categories are just growing slower than they had, but still growing very rapidly, but we did mention weakness in the fashion jewelry and watch category in the quarter.

Okay. And Karen on the -- regarding your helpful statements on real estate, I just had a question about the bigger picture characteristics you're thinking about in terms of really maintaining your operational excellence, maintaining investment grade, thinking about your margins, and thinking about how comps are not necessarily that predictable with external circumstances. What are the constraints that you're evaluating just to ensure that you optimize any potential transaction?

Well as I said earlier to Lorraine, the key here is maintaining financial flexibility, so that if the business hits a bump, we would still have the access to the financial markets that we need to operate the business as a proxy for that. That is why we talk about remaining investment grade as being so important to the company because we want to be a strong retailer for many years to come, and so we do need to have that flexibility for the speed bumps that do happen or the cyclical nature of retail. So those are all being factored into the arithmetic as we look at opportunities.

And just a final question, your comment on expanded markets and same day, it sounds really competitive and really focused on thinking about fulfillment, in what inning would you say you're there and what's ahead for us to think about how you'll continue your leadership in thinking about apparel online.

Yes I think that I have no idea what inning it is because I think the game keeps getting extended. So I think we will be investing and growing this business forever, which is the exciting news and I think at the end of the day, fulfillment is really important, but it's also having the right assortment and I think our team is so good in combination with our vendor partners including private brand as having the right assortments and offering to the customer that that combined with the fulfillment opportunities, I think is going to make us a leader in this arena.

Thank you. Best regards.

Thank you.

And we'll take our next question from Priya Ohri-Gupta with Barclays. Priya Ohri-Gupta: Thank you for taking my question and thank you so much for all your comments around the end points of investment grade and maintaining balance sheet flexibility, Karen, can you talk specifically within the IG context about how important maintaining access to the commercial paper markets for you in terms of ongoing funding needs, whether you could operate service of Tier 3 issuer comfortably or whether you would prefer to have the cushion that Tier 2 provide. And then just an administrative question, can you remind us where you need your cash balance to be at a minimum level. It looks like your cash is low as it’s been since October of 2010. So just wanted some guidance on how we should think about that going forward? Thank you.

Yes, I think the key thing is having access to commercial paper is a great thing and obviously gives you flexibility and lower borrowing cost and accessing our bank facility, but we could access the bank facility should we not have access to the commercial paper market. So I can't tell you today that maintaining access is critical for the company going forward, but we’d obviously like to keep that capability because again for a highly seasonal business that becomes very important. Priya Ohri-Gupta: And then just cash balance question.

Yes, I don’t know how to answer that. So I think I’m just going to deflect that question. Priya Ohri-Gupta: Okay. Thank you.

And we’ll take our next question Charles Grom with Sterne, Agee CRT.

Good morning, Karen.

Good morning, Charles.

On the tourism headwind, could you just remind us when that started last year and are we close to cycling that headwind? And I guess, in conjunction, how were trends at Bloomingdale's in the quarter?

Yes, it’s started really in December maybe late November. So it’s really the fourth quarter that we should begin to have easier comparisons. I don’t know that the international tours will get better. That’s the year rounding effect and Bloomingdale's had a disappointing quarter as well and they’re actually more impacted by the tourist slowdown as you might imagine given where the stores are then is Macy’s.

Okay. Great. And then just throughout the quarter just any sense for have comps trended by month and any early read on August.

Obviously I’m not going to comment on the early August. So that is just too early to judge and there really wasn’t much change. We obviously had a tough June given friends and family but we expected it although it was worse than we had expected.

Okay. Thanks and good luck.

And we’ll take our next question from Paul Trussell with Deutsche Bank.

Good morning, Karen.

Good morning.

You've touched on it a little bit, but if you can give any more detail, get a little bit more granular for us to help us make -- be more comfortable with your second-half guidance, which I believe includes a return to positive comps, flattish gross margin, and in-line SG&A dollars year over year, if I heard you correctly. Just given your prior comments regarding the consumer's preference to shopping restaurants and travel, what we already know about the promotional environment, as well as your focus on shipping and same-day shipping expansion, as well as some of the challenges you mentioned around credit card changes that will impact SG&A, healthcare, and other factors.

You’re full of doom and gloom Paul. Look we’ve tried to layout in a release and also in my comments earlier today that some of the things that give us comfort that there will be some improvement in the fall starting with all that's going on in the Omnichannel world. We think it will be very important as we go into the fall. The top door strategy that I talked about, go back and listen or read the transcript from today, but all of those things do give us the comfort that we're going to be able to deliver the fall results.

Thank you. And just going back to comments you made back in February, you spoke about entering phase three, which obviously included a focus on the growth initiatives and innovation, but also doing that at the 14% EBITDA level. Has industry conditions changed in terms or your positioning changed in terms of expectations to maintain that level? Or do you still believe that is doable?

I think that level is an attainable level, obviously this year we're taking a step backwards if we take out the Brooklyn gain as you can tell from our guidance, it's obvious from the math. So you can see that, but that doesn’t mean we don’t think it's the right level to get back to and we still think that that's achievable even accelerating our growth through these new initiatives.

Thank you and good luck.

We will take our next question from Jeff Stein with Northcoast Research.

Karen, a couple questions on the real estate transaction. Again, thank you for taking the question. So explain how you get a $250 million gain with $170 million of proceeds. I'm wondering if you're also including the $100 million that your partner is going to be contributing over the next three years. And can you quantify the EPS effect of the $250 million gain? Are you considering any tax strategies to try to minimize that and so forth? Thank you.

Well there is two different questions, yes the accounting is such that it's the $270 million, which gets you to the $250 million gain, which is approximately $0.46 a share. We are working on tax strategies vis-à-vis the cash taxes, but the book taxes would lead to the $0.46 a share impact roughly on the year.

Got it, got it. And I am wondering in the second quarter, did you see any boost from loyalty customers that were seeking the use of their point balances due to the transition to the Plenti program?

No, I think it too early and we didn't really expect it. I think it takes time to accumulate the points and see the value and remember we just launched it in early May. So it is going to take time. Our hope is that as the year goes on, we begin to get the benefit, but it does take time for those points to accumulate. The good news is, the good news is that we've had lots of customers far more than we had expected sign up. So at least they're interested in the program and hopefully they’ll get engaged and learn how to maximize their points and use them.

But what I was referring to, I am sorry if I wasn’t clear, the old Star Rewards program, I guess those points had to be used by the end of May.

Correct.

So if you had any balance left over, you would lose those or a customer for example where they were trying to build up points and get certificates to use before they lost everything. That's kind of what I was referring to.

I don't think that that happened. I think we did a very good job communicating with those customers, but I don't think it helped sales in the quarter.

Okay. And one real quick one, I am a joint venture with China, the $25 million investment your share, does that comprised or is some of it going through the P&L?

No, Jeff as I said, there is an immaterial impact on earnings in the quarter, sorry, in the fall.

Okay. Great. Thank you very much.

And we'll take our next question from Michael Binetti with UBS.

Hey, good morning, Karen. Could you help us talk a little bit about I think you commented that and I apologize if I missed anything that you're getting it back to flat gross margins in the second half. Just seems like as eCommerce gets bigger and the inventories are a little high, you got new initiatives like same day delivery and then slower sales to tourists or at least your third quarter, which I am assuming has a low return rate. Are some of the underlying drivers on the gross margins helping you to get back to flat that you can maybe point out to us?

Yes, just we believe that that's doable given the mix of the business and what we expect to happen. eCommerce is not a negative to gross margin. So yes, delivery expenses, but again we think we've planned it properly and we'll see.

Okay. So on the -- if we just tried around some of the math on Brooklyn it looks like it was about a $0.45 listen in the numbers, maybe I am off on that, but that's a pretty significant reduction excluding Brooklyn on a smaller sales adjustment. Can you tell us about the SG&A from here in the second half and how flexible the planned spending is in the second half if there is another downside scenario for you there or the industry or for you? Will there be a similar level of deleverage on sales in the back half?

Well, we're always trying to reduce expense when we see sales decline and SG&A was not up that much this year. So I am not quite sure what you're referring to. Obviously if sales are down, you are going to deleverage, but we're always looking if sales aren’t materializing to trying to offset or minimize the impact of that with expense and I think that will continue into the back half of the year.

Okay. And then just one final one, you've been helping us with your comments on real estate for several quarters now. I was just wondering if you with your longevity in the industry, can you talk about even though real estate values are peaking now, what any hesitations you may have at this point as you dot the eyes on how you're looking at anything you may do as you maybe look at what kind of financial obligations it will create for the retail business longer term, thanks?

Well I don't know that the word is hesitation. I think it's just making sure that the total fixed cost that we put on the business whether it would be interest expense or rent expense is appropriate given EBITDA that we expect to generate through all cycles. So I wouldn't use the word hesitation. It just has to all work together.

Thank you.

And we'll take our next question from Bernard Sosnick with Gilford Securities.

Yes Karen, mention was made about consumer spending on all the categories that are sold in department stores and of course Macy's has made adjustments through the addition of athletic footwear, you're bringing in tuxedos. But the one thing that you mentioned just a while ago was perhaps a licensee for electronics, could you speak about what the options are for bringing in a categories that are more in the forefront of consumer spending especially among young shoppers?

Sure. We're continuing to look at options for that. So that’s clearly on the radar screen. We're also trying to bring in products. So for example wearable tech is something that we're bringing in. Products like Fitbits and things like that. So we are trying to bring products into our assortment that fit that need and also still explaining opportunities vis-à-vis license partners.

Thank you. The second question that I have is in regard to the expense control. Of course sales were down in comps in the second quarter, which was a surprise, but in the first quarter you said that you were surprised by the weakness of sales but didn't have as much option to play with expense levels as you might have in the second quarter. Of course there was the addition of Bluemercury. But I didn't see as much adjustment in expenses as I thought might have occurred, given your prior history of making such adjustments quickly.

Well, remember we are also investing in Omni channel, which we think is critical and obviously sales -- digital sales are growing quite rapidly. So it would be wrong to start making that investment. We also obviously have to start-up expense associated with Backstage. So those are things that would be wrong to stop doing. We obviously could have, but not the right answer for the business over the long term.

And finally in the first quarter you said that the decline in tourism hit comp store sales by about 50 basis points.

No, we said a point

A point, okay. I'm glad you corrected that. What would be the impact in the second quarter?

A point it's about the same.

Which, to me, implies that tourism was down around 20% tourists sales. Is that a reasonable estimate?

We’re not giving that number.

Okay. Thank you very much.

You bet.

And we’ll take our next question from Stephen Grambling with Goldman Sachs.

Hi, good morning.

Good morning.

Good morning. So following up on Matt's earlier question on off-price, I'm just curious what are some of the learnings that you are getting from the pilots that is giving you confidence in the further expansion? And then kind of as a secondary question…

Well they haven't opened yet. So there is really no learning yet.

I guess I was just referencing the comments in the press release. But I guess the other question is just on the supply chain side. What would potentially have to change to support additional stores? Is there any thought process on additional CapEx needed to support that expansion as it relates to next year?

Obviously if we’re going to expand it, we will obviously map out the investment needed and plan accordingly.

Okay. And then I guess the second would be a follow-up on Jeff's question on the Plenti sign-ups. What are you seeing from those customers relative to the Star Rewards?

What do you mean relative to the Star Rewards?

I guess do you see incremental spending on certain categories or how are they responding?

Well I think the key thing is we talked about the fact that proprietary penetration is up in part because of the Plenti program taking hold. So I think that's a good sign.

Okay. Thanks so much.

And we will take our next question from Joan Payson with Barclays.

Hi good morning, Karen. You mentioned the acceleration in inventory growth earlier. Is there any way to quantify how much of that growth is the early pull-forward of that new seasonal product?

No it’s actually hard to do so, I was trying to do the same thing last night because I thought somebody might ask. So I don’t know the answer. It is the good chunk of it over and above the sales expectations are as we go into the spring season -- I’m sorry, into the fall season.

Okay, great. And then, with some of the categories that you are investing in the most right now, including active wear and dresses, could you talk about how those are performing versus other categories? And also is that more of a this year focus or is it also a long-term investment?

No it’s a long-term investment and we talked about them as being strong categories. I guess didn’t call out dresses this quarter, but it has been in prior quarters and still does well. So we think it’s long-term and not just something that's happening this fall season. And so we’re investing more and more in the whole health environments arena. You'll see us do more in that and obviously dresses plays into the wedding strategy in addition to just social dresses in total, junior dresses relating to prom, all kinds of things as we're building more business with the Millennial customer.

Okay. Great.

They are long-term as well as short term.

Thanks. And my last one is just about the upcoming openings of those off-price stores. Are there any changes that are going to be made to the surrounding or overlapping full-price stores in the same markets, either in terms of assortments or promotional activity?

Not anticipated at this time.

Great, thank you

And we’ll take our next question from Bob Drbul with Nomura Securities.

Hi Karen. Good morning.

Hey Bob.

Just a couple of questions from me. The first one is are you seeing any change -- when you look at the consumer interest in the branded national brands versus private brands, is there any change within your mix on that standpoint? And when you look at the overall sales results, are competitive pressures impacting your business at all any differently than they have over the last several quarters?

Actually in terms of the change in mix and consumer view towards national versus private brands we are really not seeing anything in that arena. And in terms of competitive activity, the answer really is no. We're really sticking to our playbook and don’t think that that’s had a big impact. Obviously we're reporting first. So we'll learn a lot more over the next couple of days and next week. On the Bloomingdale side, I would say the upscale world has gotten a lot more promotional. So for Bloomingdale the competitive activity as probably a bigger fact then it would have been in the case of Macy’s.

Got it. And in the back half of the year, is the credit income level expected to continue to be higher?

Yes just not the third quarter.

Okay. And then last question I have is you called out a medical benefit expense. Can you just elaborate a little bit what's going on there? I think that's the first time you've called that out.

Well there is two things happening. One is I think we’ve talked for a long time about the pressure of higher medical cost which I think is probably impacting most companies/ What’s different about this year is we’ve gone to a consumer directed plan and as part of that and this is probably more detail than you need. We've helped to fund the HSA accounts for our employees and so there was more expense in the second quarter than it would have been last year. So part of it is timing, but we also expect a big increase in medical expense for the full year as well.

Thank you very much.

And we’ll take our next question from Stacie Rabinowitz with Consumer Edge Research.

Good morning. I actually had two, if you don't mind. The first was just with the AUR decline you saw this quarter; is that coming from -- what portion of it is coming from the markdowns due to the ports, a potential mix shift?

It’s mostly due to the clearance activity, again mostly driven by the ports as well as the weaker sales earlier in the year.

Okay. And then my second question was actually around the Bluemercury openings in the Macy's stores. Are there any plans to put in some of the spa and services businesses?

I don’t believe so in the first four, but we are absolutely considering that.

Great. Thank you so much.

And we will take our next question from Matt McGinley with Evercore ISI.

Good morning, Karen. My first question is on the SG&A. I just want to make sure I have this right. Ex Brooklyn, your SG&A in the back half should be at around the same rate or the same dollar basis as you had last year?

I was doing it on dollars.

Okay, good. Then in the second quarter and you listed all the growth drivers and obviously there was a lot of spend in this quarter as it related to that. But was that spend more heavily weighted in the second quarter than we would see in the third and fourth quarter that would have caused more deleverage in this quarter versus other quarters this year?

Well Backstage opens. So that would obviously be less of a factor as they are beginning to generate sales and margins. Bluemercury would be similar and the Omni channel investment is going to continue through the year.

And then I think last quarter in the fourth quarter you said that there was a renewed focus on these top 150 stores in the platinum 30. Was there any real difference that you saw in terms of the comp rate in the quarter between the top 150 and all of the other stores?

Well there is a complicating factor if you're relating to the tourist stores. So a lot of those top stores are impacted by the declines in international tourist. So if you take the tourist impact, I think the answer would be yes, but obviously with the tourist impact, those stores are getting hit harder.

Okay. Great. Thank you.

And we will take our next question from Dana Telsey with Telsey Advisory Group.

Good morning, Karen.

Good morning, Dana.

Can you give us an update on the single view of inventory and how the progress is being made there? And lastly, on the weakness in jewelry and watches that you had mentioned, do you think of that as related to tourism, related to product trends? How would you describe that? Thank you.

Yes, in terms of single use of the inventory I would say it's progressing. As I mentioned earlier there has been a steeper learning curve on that subject as well as the restructure than we had expected. So I don't think we're getting the full benefit of having that single view of the inventory, which again for people who aren’t as close to the details is that we merge the inventories that is in the warehouses for a direct to consumer business plus the stores so that our planners are able to better allocate merchandize across warehouses and stores. It has helped us to begin to improve turnover as well as obviously help margin and more importantly get goods closer to the consumer. Having said that I would say we're in the early innings of maximizing the opportunity there. So I think that's still ahead of us as we go forward. In terms of the weakness in watches and jewelry, I think it's sort of all of those things and as you recall and as we talked earlier we've actually started a test where we're trying to intensify our business not only in the fashion jewelry and watches, but also find that we think may address some of this weakness as we go forward.

Thank you.

And we'll take our next question from David Glick with Buckingham Research Group

Thank you. Good morning, Karen. Most of my questions have been answered. Had a couple follow-ups. How do you -- with the additional proceeds from the sale of the Brooklyn store, how do you look at the buyback for this year in terms of what you are anticipating? Obviously, your EBITDA projection is lower today as well, but how do we think about the buyback for the year? And then, secondly, didn't talk a lot about some of the other categories. You mentioned some of the strong and weak, but in general you talked about center core. But how about ready-to-wear, home, and men's in terms of how they are trending and what the prospects are going forward? Thank you.

In terms of the buyback as with every year we look at our cash flow and look at what's the appropriate leverage ratios and we utilize our cash appropriately. Obviously with this transaction happening at the end of the year, unlikely to have a big impact on the buyback in '15 more likely beginning of '16, but obviously that's incremental cash that can be used to buyback more stock. In terms of the other categories, ready to wear continues to be tough with exceptions of areas like active, denim doing better, dresses doing a little bit better. Men's, I would say was mixed, but with a lot of strength in some parts. Home we talked about the big ticket areas being very strong furniture and mattresses and actually we've started a pilot of a new approach to soft home, which appears to have a lot of promise. So we feel good about the prospects for that business as we move forward into the fall season.

Then just a quick follow-up. Obviously the EBITDA projection down this year. How do you look at that shortfall and how quickly you can recover that going forward? Obviously some of the headwinds this year are transitory, some are not. But as you look at your EBITDA level coming out of the year, how quickly are you looking at making up that operating shortfall?

That's a big question of the day. We're looking at that as we're speaking today. So I don't know the answer to that yet.

Thank you very much. Good luck in the second half.

Thanks David.

And we'll take our next question from Richard Jaffe with Stifel Nicolaus

Thanks very much and I'm really excited about the opportunity in China and the initiative. I'm just wondering about the magnitude, that is to say the size of the offerings, the breadth, the depth, where the inventory is going to kept. Will you be doing fulfillment in China? And will the online experience be very similar to what we see here, or are you creating a unique experience for the folks in China?

I think those are all the questions we're still trying to answer. For this fall it will be relatively limited assortment and the goods will be in Hong Kong, but over time, assuming it works well, the idea would be to have the goods house in China hopefully at some point and see how much of the website we need to modify to fit the consumer in China. We're not going into this thinking we know all the answers and that's why we're taking sort of a test and learn approach because we know the Chinese consumer is different both in terms of merchandized taste but also how they interact online and so again we're going in with an open mind and not assuming we know all the answers. The good news is with Ken Anderson running it, who as I mentioned earlier was the founder of macys.com and has been there since up until the last couple of months. I think we're in very good hands for trying to switch through how to build this business appropriately.

I think so, too. What will Fung Retail's contribution be in this process, either dollars or expertise?

The dollars obvious, but there is a great deal of expertise. They obviously understand the Chinese customer in ways that we don't yet and they are terrific business people. So we're really very excited about the partnership and think that they're going to add a lot to the strategy and also helping us execute. They have great capabilities as I think you all know, not through Fung Retailing but through Lee and Fung, which will also have access to in logistics HR and all of these subjects that are going to be so important to the success of this venture.

I look forward to it. Thank you.

And we'll take our next question from Michael Exstein with Credit Suisse

Thank you, Karen. Two quick questions. Number one, can you talk about the decision to eliminate the friends and family in the quarter? And are you going to add one in the second half of the year to offset it? Secondly, in terms of the gross margin decline, was there any mix shift impact on your gross margin, or was it just purely clearance more inventory at the end of the quarter?

So in terms of the margin, it was not a mix shift. It was purely clearance of inventory. And in terms of the decision to eliminate the friends and family, obviously in hind side, I am not sure it was a good one, but we're not adding an event to offset it.

Okay. Thanks so much.

And we'll take our next question from Wayne Hood with BMO Capital Markets

Yes Karen, I just had two real estate questions and then a working capital question. I guess on the real estate side, on the Brooklyn transaction, does that preclude you from eventually vending the owned piece into a REIT with a joint venture partner at some point in the future?

No, it does not. We still own the part of the store that we're operating.

Okay. So that's still a potential outcome. The second I guess for you, and the Board and Terry, as you think about what's going on with real estate today, there's an element of surfacing the value the way you've done, but there's also throwing it in to or entering into a joint venture relationship with a JV partner that could grow. And I'm wondering as they think about that, broadly speaking, does it not to provide a growth silo for you eventually by partnering with a joint venture partner that could not only monetize your real estate, but go out and buy other assets to grow buy. And you could lever off of that in a way that you were not able to create a silo in the past.

I think the answer is we've said as we're looking at all options, obviously that's one of the options that we're looking at.

Okay. And the last question I guess is on working capital. You mentioned a little bit about inventory. Can you talk a little bit about where you think inventory will be at the end of the third or fourth quarter? And maybe if you can dive into where you think working capital might be by the end of those periods, if at all.

I think on a comp basis, I think it will be up at the end of the year, but less than it is right now, but I can't give you a forecast at this point precisely.

Okay. Great. Thanks Karen.

And we'll take our next question from Laurent Vasilescu with FBR Capital Markets

Good morning. Following upon Joan's question, can you provide a bit more color on how your athletic business is doing? Was there a pickup on -- over the first quarter? And are you seeing any particular strength in footwear versus apparel, men's versus women's, and any call outs on particular brands?

We don't discuss particular brands and I would say the whole business has done very well first quarter and second quarter, men's, women's apparel, footwear etcetera. So we feel very good about that business.

Okay, great. And then, with the resurgence in denim sales are you seeing consumers trading away from any other categories?

Well obviously if you're buying denim, you're probably not going to buy the same bottoms that you had been buying. The good thing for us is that denim comes at a higher AUR and also requires different tops and footwear to go with it. So it could be a really good trend for us assuming it continues

Okay, great. Best of luck.

Thank you.

And we'll take our next question from Todd Duvick with Wells Fargo.

Karen, good morning. Appreciate you getting us in. Just a follow-up to several of the previous questions. As you look at real estate opportunities or potential real estate opportunities, does your too forward of 2000 publicly stated lease adjusted leverage that's still hold or could that potentially change?

It does still hold. Could it potentially change, I guess so, but remember as I said repeatedly, financial flexibility and access to capital markets is really critical for us. So that will obviously always be a factor.

Got you. Thank you very much. Appreciate it.

And we have no further questions. And I would now like to turn the conference back over to Karen Hoguet for any additional or closing remarks.

No, I just want to say thank you everybody for your interest, your support and if you have further questions, obviously let me know, let Matt know and we'll do our best to get back to you as quickly as we can. Thank you.

And this concludes today's conference. Thank you for your participation. You may now disconnect.