Bath & Body Works Inc (BBWI) — Q1 2019 Earnings Call Transcript

Thank you. Good morning, everyone, and welcome to L Brands' First Quarter Earnings Conference Call for the period ending Saturday, May 4, 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 first quarter earnings release, additional commentary, and earnings presentation are available on our website, lb.com. Stuart Burgdoerfer, EVP and CFO, and I will handle the call today. Thanks. And now I'll turn it over to Stuart.

Thanks, Amie, and good morning, everyone. Our first quarter earnings per share of $0.14 were above our initial guidance of about breakeven, principally driven by a strong performance at Bath & Body Works and some favorability in income taxes. Performance at Victoria's Secret Lingerie, PINK, Victoria's Secret Beauty and International were largely in line with our forecast. Our performance continues to be mixed. Substantial growth in operating income at Bath & Body Works and an improvement in the other segment as a result of the sale of La Senza and the closure of Henri Bendel was offset by a decline at Victoria's Secret. Turning to our outlook for the remainder of 2019. At Bath & Body Works, an aligned experienced leadership team and strong customer response to our merchandise assortments are contributing to another solid year. We also remain highly focused on improving performance in the Victoria's Secret and PINK businesses. John Mehas and Amy Hauk, CEOs at Victoria's Secret Lingerie and PINK, respectively, are focused on getting closer to our customers and improving our merchandise assortments. We look forward to our assortments benefiting from their input beginning in the fall season, and our earnings guidance assumes gradual improvement in the Victoria's Secret segment performance as we move through the remainder of 2019. You will hear more from John and Amy as well as other business leaders at our Investor Day, which is scheduled for September 10. Thanks, and over to you, Amie.

Thanks, Stuart. That concludes our prepared comments. At this time, we'd be happy to take any questions you might have. [Operator Instructions] Thanks. And I'll turn it back over to the operator.

Can we just touch on Victoria's Secret in terms of where you saw some positive signs in the first quarter? And just give us a better sense of what you expect in the second quarter. Clearly, the guidance does still suggest some real improvement in the second half.

Sure, Paul. So in terms of where we see strong consumer response and what we're focusing on, it's where we're delivering significant fashion and elevation in the assortment. It's a big focus for us, and that's where we're seeing the strongest consumer response. The incredible bra launch did well. But as a general theme, it's where we have fashion that resonates with the consumer. Again, John is particularly focused on that and jumped right in. Frankly, he's been with our business now for 13 weeks, hit the ground running in a very good and intense way, and is very busy at work to impact fall assortments. For Lingerie, it's about delivering compelling fashion in the major categories of bras, panties and sleep and loungewear. In the PINK business, there has been strong performance in intimates and good volume results in sport bras, particularly on the intimate side of the business with strong value for the consumer. The PINK business is focused on really continuing to advance the assortment in bras and panties and is doing important work to reposition the apparel assortments as well. For Victoria's Secret Beauty, this business continues to do well. It's where we had good fashion in a higher-priced fragrance business, leading to strong consumer response. So, when we're delivering strong fashion, differentiated merchandise with emotional content, the consumer responds positively and we achieve healthy margins, unit volume, average unit retail increases, and overall positive results. That's what the Victoria's leaders—John, Amy, and Greg—are focused on, and the same applies to the team at Bath & Body Works. When we perform well, we are rewarded. When our assortments are off-target or too basic, that's when we tend to encounter trouble.

I guess, Stuart, just a high-level question for you. There was some news that came out a week or two ago about potentially reevaluating the fashion show and being on TV. With respect to Victoria's Secret right now, how much of the changes should be more strategic in terms of merchandising versus more substantial changes, like changing the marketing approach, evolving the brand, and looking at the international business? Just trying to understand what we might expect to hear from you at the Analyst Day in September.

Thanks, Ike, for the question and your research on the business. We've consistently said for around six or nine months now, everything is on the table when it comes to evaluating the Victoria's Secret business, and that isn't just a throwaway phrase. We are taking a fresh, hard look at all aspects of the business. This is not a one-time exercise; it's an ongoing process that begins with the realization that the ultimate profit results aren't consistent with our expectations or the potential of the business. Thus, we are assessing everything thoroughly. With Amy and John coming into the business, it's clear that we must start, not limited to, but must start with the merchandise we're selling. As I mentioned earlier, Amy is very intensely focused on understanding the target customer and reworking the assortments at PINK. John, now 13 weeks in, has hit the ground running and is contributing a lot of great experience from his prior retail life. We're closely examining merchandise and implementing substantial changes that are already showing impact starting in the fall season and increasing as we progress through the year. We are also closing more stores to rightsize square footage in 2019 than we have historically, as an example of this ongoing evaluation. In terms of marketing and the fashion show, we are reassessing how to best reinforce the equities and strengths of the Victoria's Secret business. The changes in merchandise will dictate how we effectively market those changes. We will share specifics publicly as we finalize them, including any significant actions regarding the fashion show. Everything is under consideration, with no constraints—only a time frame—when evaluating the international business aspects.

I was wondering if you can provide some color on the gross margin as the year progresses. I know you're expecting growth in merchandise down for the year, but are you anticipating any improvement at all as we go into the back half? What are the drivers for that?

Thanks for the question. The simplest way to respond is that we are expecting improvement in merchandise margin. As we report, gross margin includes buying and occupancy costs, but we expect to see an increase in the Victoria's Secret business. Both Lingerie, PINK, and Beauty are expected to see improvement in merchandise margin rate and dollar result as we move through the year. This was our view going into the year, and it remains unchanged due to the efforts John, Amy, and Greg are focusing on in refining the merchandise assortment.

I wanted to follow up on the margin front. There was a comment in the prepared remarks about the Victoria's Secret Q1 operating margin benefiting from last year's credit and sourcing actions. As we move through the year, especially since you've mentioned you expect merchandise margin to improve, how should we think about the EBIT margin rate progression relative to the 300 basis point decline in Q1? And could you clarify the investment plans at Victoria's Secret versus Bath & Body Works?

Thanks, Mark. Regarding the progression of margin rates and EBIT rates throughout the year, despite various factors at play, including last year's benefits from our proprietary credit card and sourcing-related advantages, we expect to see sequential improvement. Even with those prior benefits and the pressure from the list 3 tariff increase from 10% to 25%, we expect a movement towards improved margin rates and operating income results for Victoria's segment. Regarding buying and occupancy dollar increases, Bath & Body Works' growth is driven by healthy investment in store remodels and sales mix shifting toward direct-to-consumer. While Bath & Body Works is successfully growing both in-store and online, the online growth is outpacing total sales. This means that the required sales growth to drive leverage is in the high single-digit to low double-digit range. In contrast, Victoria's Secret's sales growth needed to achieve leverage is flat or slightly less than flat due to reduced investment levels and limited growth in square footage.

Regarding the digital business at Victoria's Secret, you have mentioned past investments in this area, including a relaunch. Can you confirm if this relaunch is coming this year and what it will entail?

Yes. We went live in the first quarter with a new technology platform for victoriassecret.com. This was a result of over a year’s work on a substantial IT project to replatform the website. This new base platform is critical and has gone live without significant adverse startup issues, which is a significant development. Moving forward, we will need to invest further to implement capabilities like buy online, pickup in store—alongside the RFID project underway to ensure we have accurate inventory management, particularly important given our extensive assortments. We plan on expanding our digital efforts to international markets while investing in fulfillment capacity. Online business at L Brands is currently running at around $2.4 billion to $2.5 billion, growing at a healthy rate overall and being highly profitable.

Stuart, I want to ask another question about margins at Victoria's Secret. Despite the company's success in cost-cutting, sales remain over $7 billion, yet margins have declined. What opportunities exist for further cost-cutting without closing stores, and what is the path to profitability for the business in China?

Regarding managing expenses in the Victoria's business, as we analyze the P&L, the largest contributor to expense costs is store payroll, which is crucial for adequate store coverage and traffic conversion. While we prioritize competitive compensation for our associates, significant cuts are challenging. In terms of occupancy costs, adjustments can be made by reducing investment in store remodels and closing stores. This year, we closed more stores than in prior years; and while we invest in new stores, it's mainly in Bath & Body Works and selected international markets. We've also scrutinized marketing expenses, reducing our spend significantly over the last 9 to 12 months. Furthermore, substantial reductions were made in our home office workforce in 2016, and we have been managing growth in expenses since. Overall, the greatest improvement potential lies in achieving healthy sales growth at robust margin rates. Regarding our operations in China, improving profitability largely depends on increased sales volume in existing stores, new openings planned for 2019, and careful expense management to ensure satisfactory returns.

Stuart, regarding PINK, could you remind us of the merchandise mix between intimate apparel and loungewear? Additionally, can you share insights on what's not working in apparel and discuss the impact of swim elimination?

Currently, the merchandise mix between intimates and apparel is about 50-50, meaning bras and panties together account for roughly 50% of sales. We believe our greatest competitive strength is in intimate apparel, so we intend to speed up its growth compared to apparel, leading to a potential shift beyond that 50-50 mix in the coming year or two. With respect to the apparel category, Amy will discuss these aspects further during our session on September 10. She is actively assessing various elements, including price points, fabric quality, and design, and is testing several ideas to gauge consumer responses. We're optimistic that as we progress through the year, particularly in the fall, we'll stabilize and see positive growth in both sales and margin for PINK. Regarding the swim category, we have indeed reentered it, particularly through third-party brands, allowing for an athleisure crossover. This encompasses light offerings, although it won't be a key focus for this year. We'll continue to monitor how it develops in future years.

We had questions related to the innovation that you foresee at Victoria's Secret. Some survey feedback we've gathered points towards fit and comfort, as well as customer segmentation across the store. What are your thoughts on that?

Oliver, the issues you've highlighted are precisely what John and his team are concentrating on—evolving the assortment to account for customer preferences. While customers sometimes express their needs directly, other times it requires a leading brand to drive innovation and market demand. We see significant opportunities to elevate our offerings in terms of fashion, focusing less on basic commodities that are easily available elsewhere. As we've conducted consumer research, we've identified key attributes such as comfort that are critical for our customers. John is dedicated to this process and is supported by a capable team working on substantial assortment changes expected to unveil in August. Full elaborations on John’s insights and strategies will be available in September during our investor meeting.

I have a follow-up question regarding feedback on customer service and store navigation. Could you provide insights into these areas and their importance moving forward?

Absolutely, Oliver. We agree there is an opportunity to simplify store layouts and enhance interactions between associates and customers. This is part of John’s and Amy’s objectives to focus on improving store navigation and services while advancing our overall customer experience.

[Operator Instructions]

Could you discuss the swim launch at Victoria's Secret, its impacts on the business, and customer responses to e-commerce traffic? What can we expect regarding pricing and product changes?

As we have communicated, the swim reentry was part of an initial test launched late last year. The financial outcomes to date align with expectations; it is performing well but isn't significantly impacting the overall business due to the nature of the test. However, we’ve received positive feedback on the wider array of price points offered, particularly at higher price ranges. We’ll continue to learn and evolve from this testing process.

Can you share John Mehas' perspective on the legacy bra platforms at Victoria's Secret? Do you think older products are hindering recovery in the Lingerie category, and will we see changes in legacy platforms or greater fashion innovations?

Janet, our company has a long history in the retail sector, and fundamentally, this business is about fashion. We're not in the business of selling the same basic products year after year. John is fully aware of the opportunities that lie in reworking the assortment. Our focus is strong on increasing the fashion element, which is essential for compelling sales. John will detail his insights on opportunities in the assortment during our September 10th meeting. We're optimistic about making meaningful improvements.

You've indicated that substantial changes are forthcoming in August on the product side at Victoria's Secret. Has John made progress on marketing changes as well? Regarding swim, have you seen success through third-party brands here, and are there opportunities for partnerships in the lingerie assortment?

To answer your question directly, yes, there will be changes in marketing to accompany the merchandise changes. However, we won't provide specifics right now as we are still formulating strategies. Regarding expanding partnerships with third-party brands in swimwear, we've seen positive outcomes and will continue to assess our swim offerings as well as third-party collaborations in the lingerie category. Recognition of the existing partnerships and their performance will guide further decisions.

What trends in the Bath & Body Works business excite you about sustaining momentum for the remainder of 2019? Also, how are you balancing top-line and bottom-line objectives with increased inventory investment?

What excites the Bath & Body Works team is strong growth paired with healthy margins in key categories, including home fragrance, hand soap, and body care. This excitement stems from regular introductions of new offerings, such as recent launches in their body care that have received impressive consumer responses. The team has been managing inventory effectively for over a decade, with improvements leading to strong sales and margin performance. We're making strategic inventory investments ahead of major holiday periods to ensure we capitalize on potential sales opportunities, enhancing stock positions while avoiding past mistakes of being too lean.

Thanks. And thanks, everyone, for joining us this morning. I hope everybody has a happy Memorial Day weekend. Bye.