Bath & Body Works Inc (BBWI) — Q3 2019 Earnings Call Transcript

Thank you. Good morning, everyone, and welcome to L Brands Third Quarter Earnings Conference Call for the period ending Saturday, November 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 and in our press releases. Our third quarter earnings release, additional commentary and the earnings presentation are available on our website, lb.com. All of the results discussed in today's call are adjusted results and exclude the significant items described in our press release. Stuart Burgdoerfer, EVP and CFO, and I will handle the call today. Thanks, and now I'll turn the call over to Stuart.

Thanks, Amie, and good morning, everyone. Our third quarter earnings per share result of $0.02 was within our forecasted range of between a loss of $0.05 and earnings of $0.05. Bath & Body Works exceeded our expectations for the quarter and continues to deliver strong results, with a 9% comp increase and a 10% increase in operating income. Outperformance at Bath & Body Works was offset by Victoria's Secret results that were at the low end of our expectations. Looking to the fourth quarter, we are forecasting earnings per share of about $2. New CEOs, John Mehas and Amy Hauk, are very focused on getting close to our customers and making improvements to our merchandise assortments, marketing and customer experiences in stores and online. We have more work to do, and we recognize that it will take some time to see improvement in the business. Also, as mentioned earlier, we are up against aggressive promotions from last year and the time period between Thanksgiving and Christmas is 6 days shorter than last year. Therefore, our fourth quarter guidance assumes a Victoria's Secret merchandise margin dollar decline in the high single-digit range, which is consistent with our third quarter result. We expect continued strong performance from Bath & Body Works. We're very focused on executing a successful holiday. We will continue to rely on the strength of our agility, and we will continue to test pricing and promotion strategies, react to customer preferences, and chase proven product winners to drive results. 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. In the interest of time and consideration to others, please limit yourself to one question. Thanks, and I'll turn it back over to the operator.

I wanted to follow-up on PINK. It's nice to see the sequential improvement in the comp there. I was wondering if you could talk about the strong performance in intimates and how it outperformed so well versus Victoria's Secret intimates. And on the lounge side, it does sound like you're seeing some improvement in some products. How should we think about that for holiday? Do you expect more of the newness to flow in for holiday? Or should we think about spring as maybe increasing that better mix?

Thanks, Susan. So in terms of the PINK results in intimates, Amy and her team have made product improvements and have also developed an assortment architecture that has very sharp price points that make the intimate offerings very accessible to the PINK consumer. So very strong unit growth results and a strong sales result. Again, a rebalancing of the mix there to really distort to sharp price points and highly accessible from a retail positioning for intimates in PINK, and the consumer has reacted well to that, driving a strong overall result. With respect to improvements that the team is making in apparel and particularly in the tops business, obviously, there are adjustments happening on an ongoing basis. There is some strength in the apparel assortment, as was highlighted in our pre-circulated remarks. The business will continue to advance the assortment in the fourth quarter. However, as you recognized in your question, more to come in 2020 in terms of change in the apparel assortment to drive the results we're looking for there. Thanks.

I also wanted to dig into Victoria's Secret for a moment. There are some cross-currents on the merchandise margin line with average unit retail being planned up with lingerie, but down at PINK, given the different strategies there. To the extent that you hit your plans for each division, how should we think about the net impact on merchandise margin in the near term? And then separately, you cautioned that Victoria's Secret lingerie is up against a heavier promotional period from last year. Just overall, how are you thinking about the balance of capturing your fair share of traffic during the competitive holiday period versus holding firm on the product and average unit retail elevation strategy?

Sure. So in terms of the average unit retail positioning for lingerie and for PINK, it starts with a point of view that John and Amy communicated back at the Analyst Day in September, which is the businesses are going after different target customers that are in different stages of their life and otherwise just have some distinction. As a result of that, as you know, John is pursuing developing, pursuing offering more elevated products, more glamor, more fashion, a lot of emotional content. Over time, we expect that we'll get paid for that work through average unit retail and margin rates. Amy and her team have also done customer work. They assessed that they really want to make sure that our offerings to that customer, again, a younger customer, are highly accessible from a pricing standpoint. So, there's a natural delineation in average unit retails. As it relates to margin rate with the context I just provided, over time we would expect that both businesses, including the bra business should earn healthy margin rates consistent with those strategies. As for the second part of your question about promotion and how we will manage through the holiday period, obviously, we're trying to get paid for our work to have an appropriate amount of promotion. However, we need to ensure we start 2020 with a healthy inventory stance overall.

I wanted to go back into Victoria's Secret lingerie and talk about the pricing strategy there. You've pulled back on promotions in the bras business and raised prices there. What's going on with panties, apparel, and other categories within that business? And maybe one quick follow-up on that inventory point, inventory is up on a per foot basis at both Victoria's Secret and Bath & Body Works. Is that what was planned? It seems like a high-growth rate, given the shorter holiday season.

Yes. So I'll start with the second part of your question first. Inventory is in line with our expectation. To be clear, we are making important investments, particularly in the sleep and lounge category in the Victoria's Secret lingerie business. Additionally, there's some timing and investment related to the Bath & Body Works business that we believe is appropriate. Regarding pricing in panties and apparel for lingerie, John is also working in those categories, given the quality of the brand and the opportunity in offering differentiated merchandise that has significantly more emotional content. He is shifting the panty business to include a lot more single ticket panties that are matched back to come at higher average unit retails. In the sleep and lounge business, there's a significant investment in the product in terms of quality of fabrics, hand feel, quality of fashion and design aesthetic, and we believe we will get paid for that work. So we have a strong view that there's an opportunity to elevate product quality and emotional content across all categories in Victoria's Secret Lingerie, and over time, we believe we'll be rewarded for that effort.

I'll just add, too, that in the third quarter, we did see strong growth in that single-ticket panty category, including items like the Brazilian panty, which is more of a higher fashion item. Thanks, Alex.

Looking at the full year guidance, I think you had been expecting comps to be up low single digits and now expecting flat to down slightly. Can you just talk about really what changed throughout the course of the third quarter to cause that adjustment in the guidance?

Well, Victoria's was at the low end of our expectations, fundamentally. We've got good results and strength entering the fourth quarter in the Victoria's Secret beauty business, but both in lingerie and PINK were at the lower end of the range of outcomes or expectations. As a result, we adjusted our fourth quarter and thus the full year guidance.

Amie and Stuart, two questions for you, Stuart. Here's number one on the dividend, could you just comment on your confidence and your ability to sustain the dividend payment given the trajectory of the business? Just curious about your thoughts there. And then second, I know you've stated that you are looking at all options regarding the business, but my question is, the more Bath & Body Works outperforms and Victoria's Secret either underperforms or comes in at the low end of expectations, does that compel you to look at this potential optionality deeper?

Sure. So two different subjects, Ike, but one important aspect of both, and that is that those subjects are evaluated by the Board. Regarding the dividend, the Board regularly reviews our policy and on a quarterly basis approves the payment. On the other subject, the persistence of differences in performance between Bath & Body Works and Victoria's does raise questions like yours. We have a long history of managing our portfolio of businesses to drive value for shareholders, which includes splits and spins and sales. The Board periodically evaluates those opportunities to increase shareholder value over time and does receive input from outside financial advisers regarding those subjects.

My question is on Bath & Body Works. Curious about that 5% store comp; there was a call out in the prepared commentary around strong response during some key days. Curious what the traffic was behind that 5% number? And also, if you can just speak to maybe monthly cadence or at least the consistency in traffic during the quarter? It just feels like across the industry, the highs get higher around some of these key days and the lows get lower. Just curious what you keep meaning around some of these bigger events to compare the comp? And then secondly, Stuart, can you just speak to the nature of the impairment that you took in the China business overall in the quarter? That would be helpful.

Okay. If I've sifted through your question, if I missed something, come back at me. But with respect to traffic levels and comp at Bath & Body, what I would call their retail math, which includes traffic, conversion, average unit retail growth is all healthy and relatively stable. Their traffic is up low single digits, and their retail metrics are healthy across all meaningful periods of time. That would be my response to your first question regarding retail metrics for Bath & Body. Regarding the impairment, we believe that based on historic results, projections, and the passage of time required by accounting standards it was appropriate based on a complicated set of analysis and judgment to take an impairment charge related to many of our stores at full assortment stores in China.

Stuart, can you just talk a little bit more about inventory? I'm wondering, as the Victoria's Secret Lingerie business works to take average unit retail up and comps have come in lower, can you just talk about where inventory within that business is? I understand that it's up for Victoria's Secret overall, but are you planning for those comps to get worse as average unit retail goes up? Or how are you thinking about that?

We're not planning for comparable store sales to be down as average unit retail goes up. Obviously, we're highly motivated to grow the top line in our business and add healthy margin rates to stabilize, then get the business back to where it has been and should be. So our strategy is about finding the right pricing structure for the assortment, good, better, and best, getting paid for our work. In the case of lingerie, this is expressed in earlier Q&A, average unit retail increases based on the quality of the product. That's all intended to have a healthy balance between units and pricing over time. But we certainly don't have a strategy to raise prices to drive sales declines. In the short term, there may be some volatility in units, while in the PINK business units are up dramatically with average unit retails down. So there are significant shifts in the unit average unit retail architecture.

Regarding Victoria's Secret, would love your thoughts on the holiday season as we approach it, on this year versus last year? Any thoughts on segmentation and using your customer list in a more segmented manner just to drive traffic and balance healthy promotions? Also, there's been more talk about lower productivity malls and also underperformance and C&D locations at different retailers. What are your latest thoughts on the healthier store base, and how you're evaluating that question you get so often?

Yes. In terms of promotional approach, Oliver, segmentation, customer file. We engage with our customers in numerous ways -- through email, through direct traditional mail communication, through social media, etc. We certainly employ different views of segmentation in each of those and other contact strategies. So we have done that historically, and we continue to work to improve over time. About our general views on promotion during key periods, I would say, apart from not anniversarying some very significant intimate apparel promotions, we're not expecting significant changes from last year apart from fewer, simpler, more impactful offers. Regarding our store base, it's a critical aspect of our business. We open and close stores regularly, and on a net basis, we have opened more stores than we've closed. We believe strongly in the relevance and opportunities associated with the store-based business, while we also recognize the significant online business at both Bath & Body Works and Victoria's Secret. We're proactively managing our real estate, closely assessing performance metrics. Overall, we've increased investment in Bath & Body Works given its results while managing Victoria's Secret more conservatively due to its performance.

Lastly, if you could just help us understand what's next with digital or things we should focus on, whether that be inventory management between channels or buy online, pick up in store, would love your thoughts?

Sure, yes. Thank you, Oliver. As outlined, we completed in the spring season a multiyear technology project to re-platform the victoriasecret.com website. It's up and running and supporting the business. That work continues to support our international online business outside the United States. We're investing in foundational capabilities for initiatives such as buy online, pick up in store, ensuring inventory accuracy, and we're pursuing that through a project to have RFID information from our stores to ensure that we have appropriate visibility to inventory so that we don't disappoint customers due to misinformation. We have broad assortments, and so we want to ensure that our information is accurate so we can effectively execute buy-online-pick-up-in-store. You can expect developments along that line over the next couple of years, depending on timing and priority. We recognize the opportunity presented and will evaluate how to proceed as we close this year and engage in the next.

My question is on Victoria's Secret. It looks like there was sequential improvement in PINK, with comps getting better relative to the second quarter. Merchandise margin also seems to have improved relative to the second quarter. The last piece is the tops business, which seems like it needs to turn. Can you talk about Amy's strategies regarding tops? And regarding the core lingerie business, it seems the initial reception to the new strategic direction that John has laid out has not been particularly favorable. I'm wondering if he is course-correcting, understanding that he hasn't affected the full assortment at this point.

Yes. On PINK, we recognize the progress made in the intimate apparel side of the business, bras and panties, and the overall sequential trend improvement, still not where we want it to be. Margin dollars in the third quarter for PINK overall were down, but up in bras and panties, and down in the apparel categories driven by tops, as mentioned. In terms of what Amy is doing about that, she and her team are leveraging our testing and speed and agility capabilities to provide more new offerings to the consumer in that space, especially in sport and seamless apparel. It’s not just a matter of improving historical offerings but looking for new opportunities with a focus on sport and seamless apparel. There are some signs of success, but the overall result is not what we want it to be in apparel, and it's a significant part of our business. The team is very focused on it. Regarding Victoria's Secret Lingerie and the initial offerings that John has introduced into the assortment, it's still early to draw any conclusions. Some offerings have had a strong customer response, such as the match-back panty categories at higher average unit retails, along with sexy sleep and loungewear offerings that resonated well with customers. However, the progress observed is not yet enough to overcome year-on-year declines in other categories within the intimate apparel and sleep and lounge segments. We're aware that this business has faced challenges for several years, and stabilizing it will take time.

My question is on two things. The La Senza charge, or payment for this quarter on the guarantees, is there any residual guarantee on La Senza or future cash flows out for that? And then just your comfort level with leverage, target leverage? And if the rating agencies are looking at it anywhere different? And does that BB rating matter to you?

Sure, thanks, Carla. The La Senza charge is a noncash charge related to potential liabilities that we may have concerning leases and credit support we provided during the transition of sourcing to a third party. It's essentially a noncash reserve for potential cash exposure in future periods tied to leases and credit support. Regarding our leverage and credit ratings, as we announced a year ago, the company is taking steps to reduce its leverage. We've made some headway in debt reduction. These steps include cuts in capital expenditures and changes in the dividend policy announced a year ago. The management team works on improving cash flow, which ties into the operating improvements we are pursuing in lingerie and PINK, particularly. By the end of the year, we expect to have about $1.4 billion in cash, and our debt maturity profile is healthy and well spaced out.

I'm curious about Victoria's Secret on the marketing side as you enter the holiday season. Over the last years, you've had a fashion show driving many impressions. Have you contemplated how that would impact the brand itself? You’ve been very quiet, and as we come into the holiday season, nothing much seems to have changed from prior years. Can you discuss your thoughts there?

Well, we have certainly thought about it. It’s important to evolve the marketing of Victoria's Secret, which is something that is happening. I think there will be more developments as we evaluate it further. The most important thing is the quality of the merchandise itself, the execution in stores and online, but we acknowledge that the brand's communication and emotional content is crucial as well. I expect we will see an evolution in those aspects over the next six to twelve months. While some may have viewed the fashion shows as a significant driver of sales, we did not observe a material short-term sales impact tied to their airing.

But nothing for this holiday season, is that correct?

We'll be communicating to customers, but nothing of the scale we'll focus on. We'll ensure communication occurs through various channels, including social media and other contemporary platforms.

This is Tiffany Kanaga on for Paul. You've alluded to it, but could you discuss the pricing architecture rebalancing at PINK in detail? Specifically, who the targeted customers are that the lower price points are attracting, where you believe they previously shopped, and your long-term plans for moving them to higher price points and enhancing their purchases?

Yes, we invest significant time in understanding our target consumers. Amy and her team leverage the Campus Rep program, which is vital in this regard. As any good retailer would, we adopt a good, better, best framework—a pricing pyramid with a range of price points across major categories. The business will continue to balance its offerings, results, and communication using this foundational principle. We won't always get it exactly right, but this customer engagement is fundamental for us, along with our merchandising strategies and supply chain capabilities, allowing for quick adjustments.

Thanks, everyone. Thank you for your continuing interest in L Brands. We hope you all have a happy Thanksgiving.