Bath & Body Works Inc (BBWI) — Q3 2015 Earnings Call Transcript

Thank you. Good morning, everyone, and welcome to L Brands' third quarter earnings conference call for the period ending Saturday, October 31, 2015. As a matter of formality, I need to remind you that any forward-looking statements we may make today are subject to our safe harbor statement found in our SEC filings. Our third quarter earnings release and related financial information are available on our website, lb.com. Also available on our website is an investor presentation, which we will be referring to during this call. The call is being taped and can be replayed by dialing 1-866-NEWS-LTD. You can also listen to an audio replay from our website. Stuart Burgdoerfer, EVP and CFO; Sharen Turney, CEO, Victoria's Secret; Nick Coe, CEO, Bath & Body Works; and Martin Waters, President of International are all joining us today, and Sharen is joining us remotely. After our prepared comments, we will be available to take your questions for as long as time permits.

Thank you, Amie, and good morning, everyone. We achieved record results for the third quarter, continuing our trend of sales growth, improved merchandise margin rates, and effective inventory management. Earnings per share rose 25% to $0.55 from $0.44 last year. Excluding the $0.04 negative impact from foreign exchange, our earnings growth was 34%. As Les mentioned in our press release, our brands stand out and evoke strong emotional connections, allowing us to offer new and engaging merchandise along with an exciting in-store experience. We remain committed to executing our strategies and being close to our customers. Our month-to-date performance is encouraging, and we are well positioned for the crucial part of the year ahead. Net sales for the quarter grew 7% to $2.482 billion, with comparable store sales also increasing by 7%. Foreign currency fluctuations reduced our sales growth by approximately 1 percentage point. The gross margin rate improved by 80 basis points to 41.6%, largely due to enhancements in merchandise margins and buying and occupancy leverage. SG&A expenses were leveraged by 70 basis points. Operating income in dollars increased by 19%, and our operating income rate improved by 140 basis points. Retail inventories per square foot at cost rose 7% year-over-year and declined 6% compared to two years ago. Our inventory reflects some early receipts at the quarter's end and is in good shape, positioning us well. We bought back 751,000 shares of stock during the third quarter at a cost of $61 million. At the end of the quarter, we had $137 million remaining under our current $250 million repurchase program. Turning to liquidity. We expect 2015 free cash flow of between $750 million and $850 million. We remain committed to returning excess cash to shareholders through a combination of share repurchases and dividends. Our free cash flow and cash position, along with the additional availability under our revolving credit facility, results in very strong liquidity, which is more than sufficient to fund our working capital, capital expenditures, dividend and any other foreseeable needs.

Thank you, Stuart, and good morning, everyone. The Victoria's Secret segment grew both sales and earnings during the third quarter. Total sales increased 8% to $1.6 billion, and comps increased 7% on top of 3% last year. Operating income of $211 million was up $19 million or up 10% to last year. Included in last year's results are approximately $36 million in apparel sales in the direct channel, which we have fully exited this year. Excluding this item, our segment sales growth would have been between 2 and 3 points higher. We began the quarter with successful Body by Victoria and Wear Everywhere Bra launches as well as a record back-to-school result in our PINK business. That strength continued throughout the quarter as customers responded to our newness and fashion, leading to double-digit growth in our bra, panty and loungewear categories. In regard to the Beauty business, we are in the process of a full repositioning of this category and remain committed to delivering an elevated Beauty business that is more consistent with the Victoria's Secret brand. Throughout this transition, we expect and are seeing Beauty results that are down to last year.

Thanks, Sharen, and good morning, everyone. At Bath & Body Works, we were pleased with our third quarter results. We were again able to increase earnings versus our record earnings last year. We were able to drive growth in sales while improving margin rates and continuing to manage inventory appropriately. Third quarter sales of Bath & Body Works North America was $705 million, up 7% or $46 million to last year, and comps increased 6% on top of 7% last year.

Thanks, Nick, and good morning, everyone. As in previous calls, I should give you a brief overview of progress in our international businesses. As you know, our opportunity for international growth is significant, and we're making good progress. We opened 93 gross international locations so far this year, 29 in the third quarter, to end the quarter with 480 stores in the segment. Revenue increased 16% in the quarter to $92.8 million and operating income increased 13% to $18.2 million. The operating income rate decreased 50 basis points to 19.6, driven by FX headwinds. Absent the impact of FX, OI rate would have been 3 to 4 percentage points higher.

Thanks, Martin. That concludes our prepared comments this morning. At this time, we'd be happy to take any questions you have. Now I'll turn it back over to the operator.

I was wondering, Stuart, if you could talk about just the gross margin composition going forward. Do you think there is opportunity still with markdown in the fourth quarter, especially given the environment around the holiday?

So a lot, Susan, in that question, and thanks for your remark about the third quarter. As we think about merchandise margin and related buying and occupancy expense, our thinking has been very consistent about this. We have some additional opportunity, probably not a lot in the merchandise margin rate. The most important thing is to get the product right. From that, obviously, we get full-price selling and all good things happen. There is a little bit more opportunity or some more additional opportunity as it relates to speed and the value that, that creates. But all of that is balanced against making sure that we're providing great value to customers.

As you grow in square footage in the U.S., can you talk about what's actually happening to rents in the new space that you get relative to existing space?

What I would say is as we renew leases generally, rents are increasing, as you would expect. Our lease terms are generally 10-year lease terms. And as we renew leases, the rents are higher. With that said, as we think about real estate, the most important thing is having a terrific location within a given shopping venue. So we're not looking to get the lowest rents, if you will. We're looking to get the right locations. We drive a lot of productivity in terms of sales per foot.

On the international front, we were surprised by the revenue growth in Q3, given some of the wholesale shipments that shifted into the quarter from 2Q. Can you walk through the puts and takes of growth during the quarter?

Sure. I'll take that. Retail sales in local currencies are up significantly to last year and broadly in line with the increases that we saw in the previous quarter. Those recorded revenues have been up significantly to last year but have been impacted by really three things. The first is FX headwinds, which had about 6 points of impact. The second is delays to some store openings versus the prior year. We still have over 50 stores to open between now and the end of January. The third is that the travel retail business globally has seen a little bit of slowdown.

I'm wondering if you can just give us the longer-term picture on the category. By recollection, Beauty has largely not grown here over the last 8 to 10 years. And as a result, the Beauty piece, the mix percentage of Beauty to the overall assortment, has declined.

Our Beauty business is about $1 billion business today. And you're right, it has not grown really over the last three years. We've continued to shrink the real estate in our Beauty business because we feel like it has the opportunity to be much more productive. We felt like the Beauty business was trading on the brand equity versus the opportunity to trade up.

Sharen, I wondered if you would talk about the bra category and the performance. Obviously, PINK we know had a great performance.

We're very pleased with our Victoria's Secret launch array bra business, seeing low double-digit growth. When I think about our total bra category, both from the Victoria's Secret lingerie perspective and a PINK perspective, we're seeing mid-double-digit growth, which is a very strong category.

Hey, Janet, on the spread. The short answer to your question is yes. What we expect for the spread in '16, '17, '18 is something we would typically expect because of square footage growth.

It's great to see how insulated the business has been relative to some of the other challenges we've seen from your peers in the mall. I'm curious if you could give us any perspective on whether you're seeing a difference across regions, across mall types.

We're not seeing any dramatic differences between either regionally and/or mall type. What we're really focused on is continuing to keep the store looking as animated and interesting as possible.

Sharen, a question for you. We've talked a little bit about it thus far. The store trending and incentive program, can you give us the status update and the progression there?

As we think about our selling organization, we're really focused on great experienced sales associates. We're testing and learning different programs. We are seeing positive results of our efforts, but there's still much for us to learn.

As we look across the holiday season for other retailers, a big theme is earlier promotions, the integration between online and stores and buy online, pickup in store. I just wanted to get your highlights about how you're competing in that context.

We're not looking to go earlier or later. I think we want to be in a position to fundamentally follow last year's pattern, but be in a position to react to the market and/or react to the customer in terms of the dynamics of that particular period.

Thanks, everyone, for joining us today, and we hope you all have a happy Thanksgiving.