Bath & Body Works Inc (BBWI) — Q4 2018 Earnings Call Transcript

Thanks, Natalia, and good morning, everyone. Welcome to L Brands' Fourth Quarter Earnings Conference Call for the period ending Saturday, February 2, 2019. 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 statements found in our SEC filings. Our fourth quarter earnings release, additional commentary and the earnings presentation are all available on our website, lb.com. All the results discussed on the call today are adjusted results and exclude the significant items described in our press release. Stuart Burgdoerfer, EVP and CFO, is joining me on the call today. Thanks. And now I'll turn the call over to Stuart.

Thanks, Amie, and good morning, everyone. After reducing guidance in the middle of 2018, we beat those reduced forecasts in both the third and fourth quarters on an adjusted basis. That said, we have not met our own expectations for overall performance, and we are intensely focused on improving results. We have set guidance for 2019 that is pretty well-balanced for external purposes, reflects current trends early in the year and assumes improvement as we move through the year at Victoria's Secret Lingerie and PINK. In addition to the ongoing running of the business, I would want to highlight important decisions and events, including the closure of Henri Bendel, the sale of La Senza, reducing our regular dividend by half to normalize the payout and free up funds to reduce our near-term debt levels, the appointment of Amy Hauk to run PINK and the hiring of John Mehas to lead Victoria's Secret Lingerie, the continued proactive and disciplined management of inventory, expenses, real estate and capital structure, a heightened focus on the customer and our merchandise assortment at Victoria's Secret Lingerie and PINK, and finally, an ongoing mindset of everything is on the table for review and change. Thanks. And over to you, Amie.

Thank you, Stuart. That wraps up our prepared comments. We are now ready to answer any questions you may have. I will now hand it back to Natalia.

I would like to know your thoughts on the industry. The intimate category has clearly faced challenges for a while, not just within your company but also among department stores struggling in that area. Are you experiencing pricing pressure due to new competitors entering the market and becoming more price competitive? Additionally, there has been a surge in online competitors. While they may not be taking individual market share, do you think collectively they are impacting the industry and making it harder to gain market share, thus creating some pricing pressure?

Thanks for the question, Susan. Our thoughts on the intimate apparel category are that it's a great category. I think the one observation reflection I would have on others entering the category is they're doing so because it's an attractive category. It's got the opportunity for differentiation. It inherently, when it's intimate apparel versus underwear, has emotional content. And from that, a lot of economic value can be created for companies that are participants in the category. So we think it's a great category. In terms of recent developments, pricing pressure, commoditization, I mean, at the end of the day, it comes back to the merchandise. If the merchandise is special, unique, reflects fashion, has newness, has technical benefit, there are terrific opportunities in the category. So we feel very good about the category. And again, I would characterize the entrance of new participants, frankly, as a sign of that and that it's an attractive category. So with that said, are we meeting our expectations right now in the category? We're not. And we're obviously very focused on improving the trend of our business, and John Mehas and Amie, particularly, are most focused on improving the merchandise. So overall, we think it's a great category. Thank you.

Stuart, last quarter, in the prepared remarks, it really discussed everything, that you're looking at everything at VS. And today, you've announced the plan, the 3% reduction in VS square footage, speaking up to basically about the improved assortments later in the year. Just curious if there's any additional actions being contemplated or bigger-picture changes on the brand positioning, marketing plans, cost structure that you can speak to today just to give us a bit more perspective on the change that's happening within the brand. And then as a follow-up, specifically on the assortment, I'm wondering if you can help us contextualize what will be changing later in the year.

In regards to the changes at Victoria's Secret, the main focus for us is merchandise. John, Amie, and Greg are dedicating most of their time to understanding this area and our customers deeply. We will continually review all major aspects of the business, including marketing, online and in-store sales, customer experiences, cost structure, and real estate. We have initiated a thorough examination of these factors. This year, our plans for store closures have intensified, and we have notably reduced investments in new and remodeled stores over the past few years. Amy and John are still new to their roles and want to fully understand the situation before implementing significant changes. They are very engaged and focused on merchandise, but we are considering everything. We completed a thorough review of our real estate in the fourth quarter, which informed our capital spending plans for 2019, leading to a more active closure strategy than in previous years. The focus remains firmly on the customer and merchandise. Thank you.

This is Lauren Frasch on for Ike. Wanting to ask how you're thinking about promotions this year. What's the plan as of today? And how you're thinking about AUR versus last year? And how should we think about your inventory positioning in 2019 at VS versus 12 months ago?

I'll begin by discussing promotions at Bath & Body Works. It's a strong business within L Brands. I apologize for my lightheartedness, but this key part of our business was able to decrease promotional activity in 2018, especially in the fourth quarter. The promotional levels in these businesses are influenced by the quality of the merchandise and the disciplined operation of the business. When we get this right—by offering compelling and fresh merchandise—promotional levels decrease, average unit retails rise, margins remain healthy, and inventory turnover is strong. Bath & Body Works has a proven history of this and made additional progress in reducing promotions in 2018. For Victoria's Secret, the approach is similar; when the merchandise is more aligned with customer expectations, we can lower promotions. Significant changes to the assortment are expected to happen more in the latter half of 2019 rather than the first half. We've been more promotional than desired in recent years, but with a continued focus on improving the merchandise assortment and managing inventory effectively, we anticipate being able to reduce promotional levels in the future. However, this will take some time. I hope that addresses your questions. Thank you.

My question is about Lingerie. Over the past year and a half, it seemed to gain some momentum from new product launches in the latter half of 2017. Aside from the bralette business in the latter half of 2017 and the first half of 2018, it appeared to maintain some momentum due to those new introductions. However, in the latter half of 2018, it seemed to decline a bit. Stuart, please let me know if I've misunderstood anything. Have you had a chance to review and analyze what occurred so you can develop some strategies to improve that segment?

Thank you, Kimberly, for your question. I want to add to what you've framed regarding the situation. Some of our key franchises, especially Body by Victoria, experienced a slowdown in trend, with year-on-year pressure increasing throughout 2018. This decline in those core franchises, particularly Body by Victoria, contributed significantly to the pressures we faced as we progressed through the year. Ultimately, this issue relates to innovation. All products have a life cycle, and as they mature, it's essential to innovate and differentiate them. Unfortunately, we fell behind in updating some of these core bra franchises. John and his team are fully focused on addressing this challenge and seizing the significant opportunities that lie ahead. This will be a major priority as we enter 2019. To summarize, the change in performance was driven by the deceleration in some long-established sub-brands that lacked sufficient updates in fashion or innovation to maintain their strength.

I was wondering if we can dig in a bit more into the marketing side of the equation at VS. Could you just speak to any of the work you were doing to reexamine how you're communicating with the customer on the brand position? What were some of the learnings last year as you have evolved the positioning to more of a self-empowerment me day versus V day angle, for example? And what's the view on how that's evolving this year? And how do you see the fashion show fitting into all of that?

Sure. Well, as we've tried to be clear about, we are taking a fresh hard look at everything in the business. So that would be the first point to register. The second thing I would just articulate is that the dominant focus is understanding the customer and making significant improvement to the merchandise assortment. And we've taken a fresh look at all of the marketing. We don't have any specific announcements about the fashion show. We don't typically make announcements about the fashion show at this time of year, but we're looking at all aspects of the marketing of the business. And John's heavily involved in that as are other leaders in the business. And we're spending a lot of time taking a fresh hard look at all those things. And there'll be more to report as we move through 2019, but we don't normally comment on the fashion show at this time of year. But we're taking a fresh hard look at everything.

Great. And then if I could just follow up with one quick question on the first quarter guidance, negative low single digits. Could you speak to February trends, thus far? And I guess how should we contextualize that with the thought that swim is launching next month and also inventories are clean?

February has been somewhat inconsistent, likely due to the timing of tax refunds. This is generally recognized and discussed elsewhere. However, we won't go into further detail regarding February. As we mentioned in our recent commentary, we will transition to quarterly reporting of sales and results in response to shareholder feedback, aiming to reduce confusion and misinterpretations stemming from calendar shifts, holidays, and year-over-year promotional changes. We have outlined the key assumptions for our Q1 results. Overall, February has shown some volatility due to tax refund timing. Thank you.

Just two quick ones from me. The first one is can you just talk a little bit about your process for identifying the stores to close? What do you expect the financial impact of those closures to be? And this is just the first wave in terms of what you would expect over the next few years. And then second is I think in the past, you talked about relaunching digital for Victoria's Secret this year. Is that still on track? And when would that happen?

What's the last part of your question?

Relaunching digital.

Yes. Regarding store closures, I want to clarify that while you asked if this is the first wave, I would suggest that it’s more like the 50th wave. We consistently close stores every year as part of our business operations. Our approach involves analyzing current and projected performance, including sales, profit, and cash flow. We also consider the dynamics of the trade area and how opening or closing stores affects surrounding locations and, to a lesser degree, our online business. Based on historical and expected outcomes, not just for the store in question but for those nearby, we assess potential sales, profit, and cash flow results in relation to the costs of exiting a store. As a result, we regularly close stores each year at Bath & Body Works and Victoria's Secret, while also opening new ones. We're closing more stores now than we did in 2018 and anticipate further closures in 2019 due to Victorian’s performance not meeting expectations. This is a thorough, data-driven process. While we are indeed closing more Victoria’s stores than in the last few years, I want to emphasize that this is not done in waves but is a continual aspect of managing a multiunit business, whether in retail or food service. Our real estate agreements offer us significant flexibility, allowing us to exit vulnerable malls at minimal or no cost. Overall, our real estate portfolio remains in good condition, although we did recognize an impairment cost this year. We actively manage our real estate, which helps keep it in good shape. Regarding the relaunch of the Victoria's website, we have been working on it for several years, and the project is progressing well. We are currently conducting live tests of the new online platform and expect to fully transition around April, depending on the ongoing testing outcomes. If we encounter any issues during the transition, we can revert to the old system. Overall, this project is progressing well and will enable us to implement various customer-facing initiatives in the near future. Thank you.

We have a lot of people waiting to ask questions. Let's move on to the next one.

Just Stuart, in terms of everything being on the table, I wonder if we've already seen the major changes, like the swim line and store closures that we're discussing today. Are there still more significant changes expected for the Victoria's Secret brand from your perspective? Additionally, what are some of the major ideas that have already been considered and potentially rejected?

Yes. It will be dynamic, Paul, as it should be. So we'll learn more as time goes by, but we're not constrained in our thinking or in the options that could be considered or should be considered. And we're trying to make the best decisions possible in the running of the business starting with the customer mindset. Obviously, a mindset about producing the appropriate financial results for the business and for the shareholders of the business. But we aren't constrained and we're trying to use our best judgment, which certainly isn't perfect, there's no such thing, but pretty reasonable judgment. And our dominant focus has been clear through my remarks already this morning and through the script. The dominant focus is on the merchandise. With that said, we have and we will continue to take a hard look at everything. And we'll report along the way. But there are no constraints. We're not financially constrained. And we've got a lot of different things that we have and can consider. But I think it's also important to be very clear that our dominant focus, John's, Amie's, Greg's is on the customer and on the merchandise because that's what matters most. Thanks.

Right. And you're considering how to change. But have you thought about the aspects that you will definitely not change? Like the things that have already been ruled out?

There are truly no constraints, Paul. We know each other pretty well, having worked together for a while. The only constraint is determining what is the right thing to do. There are legal considerations to follow, but aside from what is legal, we are not limited. What matters to the customer is obviously important, but otherwise, we face no restrictions.

My question is on the comp guide for the business, the comps of low single digits. I wonder if you could give us some color on how you're expecting that to parse out between the two businesses. In particular, we're interested in Bath & Body Works and what's giving you the confidence that that business can continue to comp against what are some slightly tougher compares as we go into next year.

Yes. The most important thing in the guidance is the assumed progress for Victoria's as we move through the year. That's the most important judgment or the most important assumption in the 2019 guidance. And this is summarizing. But in terms of trying to headline it, in the early part of the year, we're assuming comps and margin dollar results for Victoria's Secret Lingerie and PINK particularly that are generally in line with the most recent trends, and then we're assuming improvement as we move through the year. That's the most important assumption. Separately, you're asking about can Bath & Body lap tough numbers and to what extent. Bath & Body is a very well-led business. It's in a very strong category of retailing in terms of personal care and beauty. And we believe it's reasonable that they can continue their success. Are we expecting the same degree fully, ultimately, in our operating income the same degree of success in '19 in OI dollars as they produced in '18? No, there's a little bit of moderation in the OI dollar results. But we have confidence that that business can continue to perform well. It's very well led. It's in a very good category of retailing. They've got good current results. So we think we've made reasonable assumptions with respect to Bath & Body Works. It won't be easy by any stretch, but it's a very well-led business and a great category retailing. And the recent results have been very good. The more fundamental assumption is the degree and rate of improvement for Lingerie and PINK. And we've tried to deal with that appropriately. But as you can appreciate, that's a hard judgment to make. Thank you.

As you think about the International business, how are you planning investments in International and expectations for International in 2019 as compared to 2018?

Yes. There are multiple components of the International business. When it comes to investment, we see this primarily through our company-owned businesses as well as franchise and partner-owned businesses. We expect to significantly grow our store count in the International business in 2019 by opening between 100 and 120 stores, combining both company-owned and partner-owned locations. This represents good growth. Additionally, similar to our company-owned business in North America, we will continue to close stores based on lease expirations or when opening full assortment stores nearby. There will be strong growth in the store count for International, although it is skewed toward partner-owned businesses as we are moderating our growth in China at this stage and not adding stores in the U.K. Overall, we anticipate solid growth in store numbers, approximately between 100 and 120 stores, along with continued growth in the digital sector of that business. We see a positive growth profile overall while adjusting growth in China as we better understand the appropriate store size and format there. There is also strong growth online in China for 2019. In the U.K., our current opportunity lies in driving more sales through our existing stores.

My question is on Victoria's Secret Beauty. It had a pretty strong comp in the fourth quarter, mid-single digits. But you did call out that it didn't meet expectations and perhaps it was more promotional. So just looking for some hindsight on Beauty and how you're thinking about it in 2019.

Yes. Beauty had a solid 2018 and was significantly stronger in the first part of the year compared to the fourth quarter. The focus for further improvement in that business is particularly on the prestige fragrance segment, which Greg and his team are dedicated to enhancing. A key area shaping our agenda for 2019 is to achieve greater success in the prestige business. As of now, we have four of the top 20 fragrances sold, either globally or in the United States. This gives us a strong starting point, and many people may not realize that we have four of the top 20. It's a robust business with a good margin profile, and in terms of growth potential, we see an opportunity to accelerate growth in that segment. Thank you.

Just dovetailing actually a little bit on what Roxanne asked, but different segment, though. Could you give us an update on Victoria's Secret sport? It's been a little up and down, and you've used it as a promotional vehicle to drive traffic. I guess what's the thinking there today? And what should we expect going forward from that part of the brand?

Yes. Thanks, Marni. So in the spirit of everything is on the table, John is taking a fresh, hard look at that part of the business, obviously, at leisure. And sport is a key category of apparel retail. And intimate apparel sport bras are an important part of that segment. But what I'm confident about is that John will take a fresh hard look at it. We don't have anything further to announce about it today, but it's an important segment. And I know John will be taking a fresh hard look at it.

I think we'll take one last question.

I wanted to just maybe get a few more details around the puts and takes on margins. Stuart, you mentioned that we continue to have incremental promotions at VS to maybe start the year, at least that's the expectation in the 1Q guide. Just help us maybe understand what you see as the opportunity to get some stabilization there or any other initiatives that will improve the rate of gross margin as the year progresses. And at the same on SG&A, what are the puts and takes here that are leading to the guidance of just an increase of low single digits?

Thanks, Paul. So the opportunity in margin rate at Victoria's, Lingerie, PINK and Beauty is a very substantial one. And we won't get all of that opportunity in 2019, but we would expect to make progress as we go through the year. But just to mention, the opportunity versus the record year of 2015, we're in the order of 5 or 6 percentage points versus 2015. So there's a very substantial opportunity. Am I, from that comment, suggesting we're going to get all of that in 2019? I am not. But through the focus on the customer and the focus on merchandise with ongoing disciplined management of inventories, there is a very substantial opportunity for margin in this business. And it starts and ends with that customer understanding and that strong management on the merchandise assortment. So that's the big-picture answer to your question or, in my view, the most important answer to your question. As we improve the merchandise assortment as we move through 2019, we would expect to see some improvement in year-on-year result on margin rate. But really, that's how I would address the question. Very substantial opportunity. Thanks, Paul.

Thanks, Paul. Thanks to all for joining us this morning, and thank you for your continuing interest in L Brands.