Bath & Body Works Inc (BBWI) 2016 Q3 法說會逐字稿

Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the L Brands third-quarter 2016 earnings conference call. I will now turn the call over to Ms. Amie Preston, Chief Investor Relations Officer for L Brands. Please go ahead.

Thanks, Heidi. Good morning everyone, and welcome to L Brands third-quarter earnings conference call for the period ending Saturday October 29, 2016. As you know, we released detailed commentary last night, which is available on our website. Since our opening comments are brief, we plan to end the call at 9:45.

As a matter of formality, I need to remind you that any forward-looking statements we may make today are subject to the Safe Harbor statement found in our SEC filings. Our third-quarter earnings release, additional commentary, and earnings presentation are available on our website, LB.com. Stuart Burgdoerfer, EVP and CFO; Nick Coe, CEO of Bath & Body Works; and Martin Waters, President of International are all joining us -- sorry Martin, who is off-site -- are all joining us today. Thanks, and now I will turn the call over to Stuart.

Thanks Amie, and good morning, everyone. While we delivered third-quarter earnings results that were within our beginning of quarter guidance, we are not satisfied with our overall results. Third-quarter EPS declined 24% to $0.42.

PINK and Bath & Body Works continued to deliver strong results, and the Victoria's Secret business continues to face headwinds related to changes we implemented in the business earlier this year. Results also reflect about $0.09 of pressure related to our investment in China; the Victoria's Secret Fifth Avenue flagship store, higher net non-operating expense, principally interest; and FX.

The changes we have made within the Victoria's Secret business were proactive, deliberate changes that will result in a more streamlined and efficient organization, and will accelerate growth in our core categories. We made progress in the quarter on the implementation of these changes, combining our store and direct channels, clearing through merchandise in the exited categories of swim and apparel, and making changes to our promotional approach.

Our brands are strong, and we are energized about our opportunities for growth. We will continue to leverage speed in the business, and be flexible and agile in our approach, in order to satisfy customers and maximize profitability. With that, I'll turn the discussion over to Nick.

Thanks, Stuart. Good start to our fall season. We grew sales and earnings against record results from last year. We continue to leverage and will continue to leverage our speed model to chase into proven winners across the business.

We have been able to keep inventory very well controlled, constantly monitoring our position, and maximizing our agility. We remain pleased with the results of our real estate activity, and we will stay in a read and react mode to ensure the investment and strategy are smart.

We are very focused on executing Christmas, and we are excited about the assortment. And we will continue to leverage one of our most important disciplines, which is obviously staying as close as we can to the customer, and read and reacting to her behavior. Thanks, and I'll turn it over to Martin.

Thanks, Nick, and good morning, everyone. As Amie said, I'm joining you from Singapore this morning, or this evening my time, where our latest and greatest Victoria's Secret full assortment store opens tomorrow morning. And earlier this week, I was in China with our team there.

As I said at our investor conference day a couple of weeks ago, we are very bullish about the opportunities for global growth, and continue to be confident about the strength and perception of our brands outside North America. I'd be happy to answer any questions you have, but in the meantime, I'll turn it back over to Amie.

Thanks, Martin. So that concludes our prepared comments this morning. And 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 Heidi.

(Operator Instructions)

Dana Telsey from Telsey Advisory Group.

Stuart, as you think about the Victoria's Secret business and the gross margin rate, as we go forward, how do you think about the declines in the merchandise margin before you see a balancing of the new business versus exiting the old business? How much should this gross margin decline of 190 basis points that we saw this quarter, how do you see that transitioning going forward? Thank you.

Dana, as we go forward, there will be some ongoing pressure in the fourth quarter, and probably to some degree into next spring. But as we look farther out, I would start with, we see Victoria's as a business that should be a high teens or better operating margin rate business, just based on the quality of the brand and the emotional content of the brand and good retail execution. A place where -- consistent with our overall corporate goals.

There will be some pressure in the fourth quarter, there will be some pressure on the rate, probably going into spring of 2017. But on a midterm basis, those things will level out, and we will have improvement in the gross margin rate, the merchandise margin rate and overall profit rate of Victoria's, after the first part of 2017. That's how I see it. Thanks.

Thank you.

Thanks, Stuart, and thanks, Dana. Next question please?

Omar Saad from Evercore ISI.

I wanted to ask about some of the things you discussed at the investor day especially around the sport and bralette categories, and any update in terms of your effort to really focus on market share in that category, to build up your business there? And any sort of effect that those efforts are and will have on the gross margin line? A little bit of follow-on from Dana's question.

Omar, it is Stuart. We are pleased with our results in the sport and bralette categories within the bra business. We drove a lot of unit volume growth, a lot of trial in those segments. For that reason, pretty pleased with the results.

What our Company has been able to do pretty consistently over a long period of time is to get to a margin rate, and an overall margin architecture that works well for the business over time. And I can think of numerous examples in the business over the years, including the PINK business five or seven years ago, that didn't have the same margin rate as the core lingerie business in Victoria's, where through understanding the customer well, great delivery of newness and fashion, and leveraging read-react capabilities and speed, we have been able to strike a right balance, an appropriate balance between dollar growth, dollar results and rate. And so we are pleased with our growth, extraordinary growth frankly in the bralette and sport bra business, intentionally driving trial and unit growth. And as I have mentioned, we're confident that over time, we will get the right balance as it relates to dollar growth and rate in those categories, and in the overall bra business for Victoria's.

Thanks, Stuart.

Thanks, Omar. Next question please?

Paul Lejuez from Citigroup.

Nick, at Bath & Body Works, can you talk about your comp performance by location type? I am just curious what types of locations are performing the best maybe on an absolute basis, but also where did you see the biggest acceleration, if you could talk about different types of location. A malls, B malls, C? Maybe street locations? Thanks.

Let me think here. We've actually seen pretty consistent results over the last number of years across our real estate, in general. And I could say probably the same regionally. We are not seeing any weird spikes by region, we are not seeing any weird spikes by location.

Obviously where we have put investment into the new real estate rather the remodel strategy, we continue to see very healthy lift in that business, consistent with what we have communicated in the past. And as you know, we will monitor that very, very tightly to ensure we continue to invest in the right locations, to get the right return. And that so far has been tightly monitored and that so far has yielded the results that we would want. So we will continue rolling out through the end of this year and into next year.

Great, thanks, good luck.

Thanks, Paul. Next question please?

Anna Andreeva from Oppenheimer.

Two quick ones for Stuart. A question on the fourth-quarter guide. A wider range of outcomes for EPS then we historically see from you. Maybe talk about what performance are you embedding at the high-end and at the low-end of the range?

And then secondly, at Victoria's Secret, I think you called out an increase in legal expenses. Maybe talk about what drove that, and should we expect that going forward? Thanks.

Thanks, Anna. With respect to the breadth of our range or our forecast, what I would say, what we would say is that the width of that range or the degree of that range has varied from time to time, as you look back in our history. And it reflects in the current situation just a wider range of outcome as we forecast the business.

And some of that is macro but more of that is just reflecting the number of changes we have made at Victoria's Secret, and we are trying to be thoughtful about how we run the business, and in addition to an EPS range that you are focused on, understandably, we are trying to make sure that within our thinking, it's a conservative mindset, so that we manage inventories and other aspects of our business appropriately, if we end up at the lower end of a range of outcomes.

So it's a big quarter obviously. A lot to play for. We believe we have good plans for the quarter, consistent with how we think about the business and run the business. We will read, react, and adjust week to week, and in some cases, day to day, depending upon what we are seeing, and the results of various tests that we always run. But we do have a little bit wider range than we've had in the last few years reflecting fundamentally a little less predictability, given the number of changes at Victoria's Secret.

With respect to the legal matters, that we -- or expenses that we referenced in our pre-circulated commentary, we would expect that those would not be of an ongoing nature. As you would appreciate, from time to time, businesses like ours have situations that are infrequent, and that's what that represented in the third quarter. Thanks.

Thanks Stuart, and thanks Anna. Next question please?

Kimberly Greenberger from Morgan Stanley.

Stuart, my question is on the EPS headwinds here in 2016, and how we should think about them in 2017. I'm wondering if you could just bucket them into two different broad buckets, if you have that detail available. The first, obviously the temporary or one-time ones like FX hits, the investment in China, pre-opening rent on Fifth Avenue, maybe there are others.

And the second, obviously there was EPS headwinds here in 2016 from strategic changes at Victoria's Secret, and ongoing real estate investments at Bath & Body Works, and just inventory management. I don't know if you have that level of detail with you, but I'm just wondering what are the pieces that were headwinds in 2016 that go away in 2017? And what were the headwinds in 2016 that you expect to continue going forward? Thanks so much.

Thanks, Kimberly. There will be pressure from the changes at Victoria's Secret, as I commented on at our Investor Day, that continue into the first half of 2017. And the specifics of that will provide the best update that we can, Kimberly, in February when we give our guidance for 2017.

The drag or the impact from China, we would expect will decline in 2017 versus the impact in 2016. Fifth Avenue obviously was a unique situation, so that should not recur. Based on what I see today, and what our thinking is at this point, I wouldn't see meaningful incremental borrowing in 2017, so it shouldn't be any additional interest drag which we had some of this year.

So the VS pressure will be there for the first half of 2017, some ongoing drag from China, but in the first part of the year, but we will lap that pretty quickly in 2017. And in terms of capital structure, shouldn't be anything meaningful, based on what we know at this point. Hopefully that gives you some flavor for it, and you have been following us for a long time.

As you know, we will do a lot of work as we get through this fourth quarter, which again is about 50% of the year, tightening up our views, and frankly also making operating decisions based on our results as we really get ready for 2017. But broad brush, that's how we see it at this point. Thanks.

Thank you.

Thanks Kimberly. Next question please?

Lindsay Drucker Mann from Goldman Sachs.

Stuart, I wanted to ask a bit about the margin outlook for the fourth quarter. And it seems as if you have some factors that should actually sequentially be helping you in Q4, whether it's opening the New York City flagship, or lapping the beauty relaunch, and also maybe some of the progress you have made in clearing out some of the excess inventory in structured bras that had been an overhang.

As you think about Q4 and why the outlook for margins isn't a little bit better, certainly versus what we contemplated even exiting the second quarter, what are the factors that are sustaining that pressure, despite some of the things I highlighted, that might be along for some improvement? Is this structured bra business, or the Victoria's business, the core business, is any aspect of that getting worse versus Q3, or maybe just helping me square those numbers? Thank you.

In answer to the last part of your question first, we don't have a point of view, Lindsay, that the core bra business at Victoria's is quote, getting worse, by any stretch. I would say what our guidance reflects, and again this is dynamic, and we manage it week to week and month to month, is the balance between driving trial and volume, particularly in these two new categories of bras that we've talked a lot about, sport bras and bralettes, and balancing that trial and margin rate pressure with growth in those categories. As you point out, the beauty pressure will diminish, and that will be a benefit in Q4.

But just as we laid out a view, and we will work hard to beat this view, trying to strike the right balance between ensuring that we end the season with clean inventory, and really striking a good balance between sales growth and rate. And as we add that up, there is some -- a little bit of improvement, slight improvement versus the third quarter, but still pretty dynamic in trading those factors off. And again, trying to take a conservative point of view about the rate. And we will work hard to beat that, and we'll see if we can.

Thank you.

Thanks, Lindsay. Next question please?

Paul Trussell from Deutsche Bank.

You made some comments regarding the impact of category exits, both for the fourth quarter, and the first half of the year. If you could just maybe elaborate a bit more in terms of detail, on how we should be thinking about that impact to the total P&L, and any offsetting factors to those category exits? Thanks.

Sure. So we did provide a little bit more perspective on the sales pressure that we estimate, related to the category exits in our prepared commentary that was sent out last night. But in terms of offsets, number one is, we are looking to drive accelerated growth in other categories.

And number two, as you are familiar with, and we talked about before, we took a fair amount of expense out of the business. Pretty meaningful reduction in expenses related to the catalog at Victoria's Secret direct, a reduction in overhead at Victoria's Secret, and rationalization of some other marketing activity at Victoria's Secret.

And so working hard to drive the volume in core categories and existing businesses, to offset that sales pressure. And again took meaningful expense out of the business as part of the changes that we began implementing in the spring season of 2016. So a big offset is on the cost side of the business. Thanks.

Thanks Paul, next question?

Janet Kloppenburg from JJK Research.

I just wanted to talk a little bit about the lingerie business, total bra and panties sales have declined a little bit year over year, and I think that is driven by AUR. So when you look at the business and consider the growth of the unlined bras and the bralettes, should we think that -- along with the sport bra business, should we think that the AUR declines you've been seeing could prevail, or do you think that the higher AUR structured bra business could gain some momentum, as we go from the fourth quarter next year? Thank you.

Janet, thanks for the question. I would start with the fact the bra business is absolutely core to Victoria's Secret, and a growing, healthy, very strong margin dollar growth bra business is among our highest priorities in our Company. So knowing that, you should know how we think about it, its importance, and what we will be working towards. There have been some important shifts in merchandise categories, but one of the other benefits we have that offset, at least in part, the lower AURs related to sport bras and bralettes is we were doing a lot of those $10 off a bra promotions, that as you know, we have stopped doing.

The timing and specifics of when do we get to meaningful dollar growth in the bra business, and the outcomes that are so important to us, we are working through some significant transitions right now. But we are very clear-minded about what the goals are, on a line point of view, through the organization. And at the end of the day, I'm highly confident that we will achieve that outcome. But it's a little dynamic right now, based on some of the changes in the merchandise assortment, and the proactive changes that we've made.

Thank you.

Thanks, Janet. Next question please?

Brian Tunick from Royal Bank of Canada.

Two quick ones. First, on the fourth quarter comp guide, I guess you are saying flat to positive low singles versus, November you are guiding low singles. Just curious how we should read into that? And is there any timing shifts on semiannual or anything we should think about?

And then Stuart, from a capital allocation or really special dividend question we have been getting from investors, you were able to cut your full-year earnings outlook, put the CapEx at the high end of guidance, but still maintain your free cash flow range. Just curious how you think about special dividend, when you rank your priorities of use of cash flow? Thanks very much.

Brian, on the first part of that, the pressure from category exits is a little greater in Q4 than it was in Q3, and most particularly, as it relates to the swim business and the non-go forward apparel business that we exited. So that pressure is a little greater for Victoria's in the fourth quarter than it is in the third quarter, so that's really the delta that you are asking about or observing in the comp question you asked.

As a relates to special dividend and return of cash, you have also been following us a long, long time. You know what our point of view is about that, which is, it's a very important source of return for our shareholders, and one that we are deeply committed to, in a balanced approach, between regular dividends, special dividends and repurchases, particularly as it relates to operating cash flow and CapEx and minimum cash levels.

We earn a lot of our cash in the fourth quarter, as you know, or generate a lot of our cash in the fourth quarter, and we will have the right discussions, as we always do with our Board, and work to strike the right balance between a lot of interest, and you should know that the planning of any of this stuff, including CapEx, is dynamic. We regularly review the performance of our business, and make judgments about how to best balance reinvestment in the business, and the results have been very strong to date, based on that reinvestment in real estate with IRRs of 20%, 25% or better, for both Victoria's and Bath and Body. That's where the substantial majority of the CapEx is going.

But we also take very seriously managing the business appropriately to ensure that we always have the right cash and liquidity in the business. We've got a strong balance sheet, and a very good maturity profile in our debt and a $1 billion revolver, et cetera. But it is dynamic, and a lot of cash generated in the fourth quarter, and we will have the right discussions with our Board as we go through the fourth quarter.

Thanks.

Thanks Brian. Next question please.

John Morris from BMO Capital Markets.

Just a quick clarification, Stuart, and then a question for Nick and Jan, if she is there. In the prepared pre-released transcript, and we touched on the impact, and thanks for pointing that out for Victoria's Secret for the first half, in terms of comps, potentially negative high single. Are we to think in terms of impact, are we to think, all things being equal, if your guide had been plus 2 to 3, or positive low singles, would that indicate negative mid-single? Or as far as we can see here is more like negative high single?

And maybe if we can just get a quick commentary from Nick, and/or Jan if she is there, about the outlook for holiday this year versus last year, and I know Jan wasn't there last year, but maybe what she is most excited about. What the differences are, what you are really most excited about. Thanks.

John, as you mentioned in your question, we are trying to be helpful and quantify where we can the effect of exits, including a preliminary view of the impact in the first half of 2017. But I really don't want to get ahead of ourselves, and start to provide full 2017 guidance, when we haven't really even started the fourth quarter in a meaningful way yet.

I understand your curiosity, and why you're curious about it, but again, I don't want to get ahead of ourselves and say, and provide L Brands total revenue or comp guidance at this stage. It is just premature. But we are trying to be helpful to you and others following the Company about the quantification or significance of the exits in the first half of 2017, but I don't want to go down a path here where we are now issuing 2017 guidance in early November or mid November of 2016.

Understood.

Jan isn't with us today, but the Victoria's team is very enthused about holiday, and we believe we have good plans for that business. And one thing that we are sure of is we will read and react and adjust, based on those plans, and we are enthused about having a very strong holiday result through a range of new items and key items and giftable moments, et cetera. And we will see how it unfolds, and Nick will comment about their plans for Bath & Body Works. Thanks, John.

Good morning John. Let's start with, I think we are in pretty good shape from an inventory perspective. So that sets us up well.

Most importantly, you know as well as we know, the backbone of our business is agility and so going into fourth quarter, and making sure we are leveraging those muscles so we can react appropriately, frankly, to her shopping trends and/or the environment. And we do know the levers that we need to pull, in the event that we need to drive traffic and/or drive units.

We very much like our Christmas floor set. I know you saw that when you were out here, and we continue to be comfortable with that. I think things that we are most excited about probably revolve around understanding how our real estate will continue to perform during that timeframe, what type of customer behavior we get, both in those side-by-sides, and in the shop-in-shops, as they're a slightly larger portion of our total fleet than they were this time last year.

And excited about the continuation of frankly a strong and healthy home business. And obviously, the newness that we have delivered, what will transpire from that, and we are excited about a fair chunk of the newness that is coming into the store, it should be setting us up well for next year.

Nick the assortment looks great, and that [Eastern] store looks terrific. Thanks.

Thank you very much.

Thanks John, next question please?

Matthew Boss from JPMorgan.

So at Victoria's Secret, what is the best way to think about the evolution of the promotional strategy from here, as we move into next year? What inning of change would you say we are in today? And how would you rank the underlying same-store sales opportunities to help offset the category drags into next year?

In terms of change in promotional strategy, and where are we in that journey, I would say we are still relatively early in that journey. So we have made some clear decisions to eliminate or reduce broad-based promotions, like the free panty and $10 off a bra promotion that drove a lot of activity in the history of the business.

Obviously made an important change in terms of the marketing and advertising of the business, you put in promotion as well, around as well how we communicate with customers with respect to the catalog. Have made very good progress on driving trial through pricing and promotion. In sports bras, bralettes, and certain of the Victoria's Secret Beauty categories.

But it's a big subject, as you are aware. And how do you think about loyalty and loyalty programs? How you think about proprietary credit? How you think about the best ways to communicate with customers over time, these various promotional ideas? And I think, and others more heavily involved in this, but I'm involved in it, I think we are still relatively early on. And as I think about that, I think that suggests a lot of opportunity for the business. So that would be my sense on that.

In terms of other things that can offset some of the drag, the most important thing for a business like ours, whether it is Victoria's or Bath & Body, or Bendel or La Senza, or any of them, is to have great merchandise. They have a very clear point of view about the customer, and to have compelling regular flow of new key items, that -- where she says, I just got to have that. That's the most important thing, and we've got a lot of talented people working on that in all the major categories of the business at Victoria's.

And then the other thing I would mention, because we believe strongly that it is a driver of sales growth and comp growth over time, is continuing to improve our in-store selling, and our in-store customer experience. And we have made some progress on that front.

We have been talking about it, as you know, for a number of years, and we have laid out our core ideas, if you will. But we would share with you that there is ongoing meaningful opportunity to drive sales growth through continued improvement in the customer experience for our business. That's just another category of opportunity for us.

And maybe lastly and Nick has spoken a lot about this but the corollary exists at Victoria's as well. When you get the store environment right, and Nick has talked about the results of a remodeled Bath & Body, and Victoria's has some pretty compelling store designs, that aspect of the experience is also very powerful in these categories. And another driver of sales growth in these businesses.

Great, best of luck.

Thank you. Next question please?

Ike Boruchow from Wells Fargo.

Stuart, just take quick one. Just looking through the segments in a little more detail. Can you help parse out some of the moving pieces in the other segment?

The losses, I think, came way down in Q2, and now they are higher again in Q3 this year. Just curious what exactly is driving those quarterly puts and takes and how to think about Q4? Not sure if that is La Senza, or what exactly is moving that around?

Thanks, Ike. The year-on-year driver in the other segment for the third quarter was the impact of a number of technology projects that are underway in the business, and the expense portion of those projects that is reflected in the other segment. So in terms of the key year-on-year driver, that's what it was, Ike, in Q3.

Got it, thanks.

Thanks, and I think we have time for one more question.

Oliver Chen from Cowen and Company.

As you do engage in the edits to the promotional strategies, which seem really prudent for the long-term brand equity, what is the interplay with that and just setting our expectations appropriately for traffic over the medium-term? And as we think about omnichannel for the long-term, Stuart, what are the features which will continue to integrate bricks and clicks, whether that be buy online, pick up in store and ship from store? What are the key opportunities you see that make sense for materially continuing to drive a big and relevant part of the business?

Thanks, Oliver. In terms of promotional strategies, and how they affect traffic, big subject, obviously. And as you appreciate, Oliver, a lot of things drive traffic.

And I would even start with, we believe - and I'm not trying to avoid your question, I will get to it, but trying to share with you how we think. We believe we have a lot of sales growth opportunity with the traffic that we have, with the steady state amount of traffic.

Even as strong as our conversion rates are, and I think they are among the best in specialty retail, the fact is, there a lot of people that come into our stores that for whatever reason we are not able to convert to buyers. And our conversion rates are very high, but there is more that we can do with the traffic that we have, so I would start there.

Separately, promotional strategies are about striking balance on a number of fronts, and certainly can and do drive traffic into the store. And through some of the promotional changes we have implemented at Victoria's, we are continuing to evaluate the interplay between driving trial in key categories, and the dynamic you are asking about, which is driving incremental traffic into the store. And I think we are learning more about that, and again we will seek to strike the right balance.

But the most important thing as it relates to promotional strategies, is to do things that are healthy for the brand, and don't damage the brand over time. But a lot of balances to strike in the short-term.

With respect to digital, Oliver, in terms of what is going to be new or different, as you know, we've got terrific digital businesses. The growth for both Victoria's, and Nick can comment about BBW, is very, very strong.

The biggest opportunity for us in digital, beyond continuing to grow the existing platforms well, that are primarily focused on North America, is to really go after the international opportunity for digital. As opposed to one or two additional features, for a consumer experience, the big opportunity for us in digital, beyond what we are already doing, is to more aggressively go after that business outside of North America.

Oliver, if I bring it up to a slightly higher level for us, we are constantly trying to figure out, and indeed we are, evolving the brand. The primary focus for us is, how we do we get the brand to next.

And on the assumption that we fundamentally have the identical assortment online, and in stores, and the identical pricing strategy, that allows us to really go back to basics, which is the number-one goal for us online, is to be able to market the brand, drive traffic, use it for storytelling, and really use it for launching and information sharing of new products, especially if you go back to the beginning, which is we're trying to continue to evolve this brand.

That doesn't negate our responsibility to figure out how to grow the business, and as you have been able to see, we have continued to see very, very healthy growth in there, and we will continue to invest in different formats, different models and different testing, to ensure that we can do both of those. So it's a really important channel, but it's very much a complementary channel and very much used to market the brand.

Thanks for the transparency. Best regards for holiday.

Thanks much, Oliver. That concludes our call for today. We want to wish everybody a happy Thanksgiving, and happy holidays. Thanks.

This concludes today's conference call. You may now disconnect.