LB FIRST QUARTER 2018 EARNINGS COMMENTARY MAY 23, 2018

Transcription

1 LB FIRST QUARTER 2018 EARNINGS COMMENTARY MAY 23, 2018 INTRODUCTION L Brands is providing this first quarter commentary ahead of its live earnings call scheduled for May 24 th at 9:00 a.m. We remind you that any forward looking statements made in this commentary are subject to our safe harbor statement found in our SEC filings. Our first quarter earnings release and related financial information are available on our website, Also available on our website is an investor presentation. Also, as you know, 2017 was a 53-week year. All of the sales dollars, margin and operating income results discussed in this commentary are on a reported basis (quarter ending May 5, 2018 versus April 29, 2017). Comparable sales are on a comparable calendar period (quarter ending May 5, 2018 versus May 6, 2017). Commentary Our first quarter earnings per share of $0.17 were at the midpoint of our initial guidance of $0.15 to $0.20, and benefitted from a favorable tax rate. Absent 1

2 the impact of the lower than forecasted tax rate, we delivered an earnings per share result at the low end of our range. Operating income declined by 26%. Our performance was mixed growth in operating income at Bath & Body Works versus last year and our forecast was more than offset by a decline at Victoria s Secret. We are not satisfied with this result and are very focused on improving performance at Victoria s Secret. To spend some time discussing Victoria s Secret As you know, after record performance in 2015, in March of 2016 we made a number of significant strategic changes to the Victoria s Secret business, including: o The exit of the non-core categories of swim and apparel, which had annualized sales of $525 million in 2015; o The discontinuation of the catalogue, with an annual circulation of nearly 250 million in 2015; o The substantial reduction of CRM and direct mail bra and panty promotional offers; o Organizational changes, including the integration of the direct business and a significant reduction in workforce; and o The reorganization of the business into 3 separate business units: Lingerie, PINK and Beauty. 2

3 We made these significant strategic changes in order to streamline the business and to focus our resources on our core categories to accelerate their growth. Any of these changes individually are significant. The cumulative impact of the exit of swim and apparel and the discontinuation of the catalogue and promotional offers drove a reduction in customer traffic, and the organizational changes were disruptive. The PINK business was also impacted by these changes, with sales growth decelerating. We also had sales and margin pressure in the business as a result of our efforts to grow the bralette, Sport and beauty categories through aggressive trial. We recognize that we have not been able to grow over the cumulative impact of these changes as quickly as anticipated. Victoria s Secret segment operating income has decreased $458 million, or 33%, since We are very focused on turning around the Victoria s Secret Lingerie business. In doing so, we have a number of assets to work with, including: o A strong brand which continues to lead the lingerie category in market share. o A large, profitable store base. Our stores provide us with the opportunity to personally interact with customers during nearly 400 3

4 million visits annually a key competitive advantage. We are investing in a more experienced, more qualified sales team that understands our assortment and can continue to provide customers with great service. 99% of our stores are cash flow positive and 80% of our sales are in the stores channel. o A very profitable, rapidly growing direct channel. Victoria s Secret Direct sales increased 23% in the first quarter, and the annual operating margin of this significant $1.5 billion business is more than 20%. We are increasing our investment in the Victoria s Secret Direct business, including a replatforming of the technology foundation that will roll out in o A large and growing customer file. While our customer file is down from our historical peak, over the last 12 months we have seen growth and continue to build back the high-spend customer segment. o Speed and agility in our supply chain. Over the last ten years, we have significantly reduced our lead times and increased our agility, which enables us to test, read and react to customer preferences. o And finally, a talented leadership team. CEOs Jan Singer and Greg Unis are coming up on 2 years in the business. They have both made significant changes to their teams. To close the overview on Victoria s Secret, the 2016 strategic changes to the business were significant, and we are still dealing with the impacts, particularly in negative store traffic trends and the resulting increase in promotional activity as we work to build the customer file. We are confident 4

5 in the strength of the brand and our ability to improve performance, but given the current trend of the business, we believe it is appropriate to take a more conservative view of the timing of the turnaround, and have adjusted our 2018 earnings guidance accordingly. Specifics related to Victoria s Secret first quarter performance and our guidance are detailed later in this commentary. Turning to first quarter results Net sales for the quarter increased 8% to $2.626 billion, and total comps increased 3%. The 5 point spread between comps and total sales was driven by square footage and international growth, the adoption of the new accounting standard for revenue recognition and the calendar shift resulting from the extra week last year. The gross margin rate decreased by 120 basis points to 35.9%, driven by a decrease in the merchandise margin rate. SG&A expenses deleveraged by 150 basis points, principally driven by the reclassification of Angel card income resulting from the new accounting standard and the incremental investment in wage rates announced last quarter. Operating income dollars decreased by $54.4 million, or 26%. 5

6 Turning to the balance sheet, inventories per square foot ended the quarter up 14% to last year and up 1% on a 2-year basis, in line with expectations. We repurchased 2.1 million shares of stock in the first quarter for $82.5 million. At quarter-end, we had $192 million remaining under our current $250 million program. Turning to our earnings guidance for the second quarter and the remainder of 2018, as mentioned earlier based on the current trend at Victoria s Secret we have taken a more conservative view of the timing for an improvement in that business. We have identified opportunities to reduce expenses in the business, and our guidance also reflects our current estimate of those reductions, as well as the previously announced investment in incremental wages of approximately $100 million. We forecast second quarter comps to increase in the low-single digit range. Sales in the second quarter are expected to be about 5 points higher than comps, driven by square footage and international growth, the adoption of the new accounting standard for revenue recognition and the calendar shift as a result of the extra week in We expect the second quarter gross margin rate to be down to last year, driven by a decline in merchandise margin rate. 6

7 We expect the SG&A rate to be up significantly versus last year, driven by the reclassification of Angel card income, the incremental wage investments, and the expense impact of technology projects, principally related to our digital channel. The wage investments will have a more significant impact than in the first quarter, driven by a full quarter impact versus only a partial quarter in the first quarter. We expect second quarter net non-operating expense, consisting primarily of interest expense, to be about $95 million and the tax rate to be about 27%. We expect earnings per share between $0.30 and $0.35 in the second quarter against last year s $0.48 result. We expect to end the second quarter with inventory per square foot up in the high-single digit range, or flat on a 2-year basis. For the full year 2018, we are projecting comps to be up low-single digits. Total sales growth is forecasted to be about 2 to 3 points higher than comps due to growth in square footage and international and the adoption of the new accounting standard for revenue recognition, offset by the extra week in We expect our full-year gross margin rate to be down to last year, driven by a decline in the merchandise margin rate. 7

8 We expect the full year SG&A rate to increase, driven principally by the impact of the incremental wage investments and the reclassification of Angel card income. Excluding these increases, the SG&A rate would be about flat. Non-operating expenses, consisting principally of interest expense, are projected to be about $375 million. We estimate our tax rate will be approximately 27% compared to 32.3% in We are forecasting weighted average shares of about 279 million in the second quarter and about 278 million for full year. Assuming all of these inputs, we expect adjusted earnings per share for the full year 2018 to be between $2.70 and $3.00. As you calendarize this forecast by quarter, note that our third quarter is our lowest volume quarter, and earnings per share are historically below that of our first quarter result. We are projecting 2018 capex between $675 and $700 million versus our previous guidance of $750 million. Victoria s Secret square footage in North America will remain flat, and Bath & Body Works square footage in North America will increase by about 4%, yielding a total company square footage increase of about 2%. 8

9 Turning to liquidity, we expect 2018 free cash flow of about $800 million. We remain committed to returning excess cash to shareholders through a combination of share repurchases and dividends. Our free cash flow and year-end cash balance of $1.5 billion, along with the additional availability under our revolving credit facility, result in substantial liquidity, which is more than sufficient to fund our working capital, capital expenditures, dividends and any other foreseeable needs. VICTORIA S SECRET First quarter results at Victoria s Secret were below our expectations. While comps improved to plus 1% in the first quarter versus a decrease of 1% in the fourth quarter, the merchandise margin rate was down significantly as we increased promotional activity to drive traffic and invested in resetting large bra franchises. While we continue to see positive signs from newer product launches and strong growth in our digital business, traffic levels in stores continue to be negative, as we continue to build back our customer base strength. First quarter sales for the Victoria s Secret segment increased 4% to $1.589 billion, and comp sales increased 1%, including a 5% decline in store comps. Total digital sales increased by 23%. The total segment gross margin rate decreased significantly, driven by a decline in the merchandise margin rate as mentioned above. 9

10 SG&A expense deleveraged, driven principally by the reclassification of Angel card income and incremental wage investments. Operating income declined 48% to $83.2 million, and the rate decreased by 520 basis points. In the lingerie business, first quarter comps were about flat and the merchandise margin rate decreased significantly. Lingerie bra comps decreased in total driven by a decline in the Body By Victoria franchise and sport bra performance and reset, lapping last year s deep discounts. Total bra AUR increased in the first quarter. Constructed bra comps were up as we continue to build back our core business of everyday bras. Examples include the launch of Sexy Illusions, accelerated growth of Dream Angels and reset of the T-shirt bra all of which continue to perform well and are bringing in new, younger customers. Panty comps were up in the mid-single digit range. The reset of 5 for, our largest panty category, continues to drive growth. We are applying the learnings from that work to the reset of our match back 3 for and singleticket panty businesses. We are also focused on continuing to develop adjacent categories like sleep, lounge and sport. Initial customer response to this focus is very good with sleep and sport apparel both showing strong growth, as well as driving attachment to bras. 10

11 We will continue to drive traffic, engagement and conversion with performance marketing. We are testing new ideas like the magalogue/catalogue we mailed this month, with early encouraging customer response. Above all, we are confident in our team and we are focused on delivering our plan for growth. Turning to PINK, comps decreased in the low-single digit range in the first quarter, driven by a decline in swim, which we are in the process of exiting. Excluding swim, PINK comps were about flat. The total PINK merchandise margin rate was down significantly. Total PINK comps in the lingerie category were about flat. The fourth quarter fashion misses that we experienced in the loungewear category continued to have a negative impact on the business in the first quarter. We have seen an improvement in loungewear results as we introduced new fashion into the business at the end of April. Beauty delivered a strong first quarter performance in sales and margin dollar growth comps increased in the low-double-digit range. The customer responded to focus, fashion and newness in the assortment and we remained agile, chasing into what s working. Total Fragrance sales increased in the low-double digit range fueled by the Bombshell franchise, and fashion in our mist collection business. 11

12 PINK Beauty is a priority for us in 2018 the new assortment launched in February and we are pleased with customer response, and initial growth within the category. BATH & BODY WORKS At Bath & Body Works, first quarter results exceeded our expectations on top of a difficult quarter last year. First quarter sales for the Bath & Body Works segment were $760.4 million, up 12% or $82.4 million to last year. Comps increased 8%; store only comps increased 5%. All three of our key businesses body care, home fragrance and soaps & sanitizers grew in the quarter with our home fragrance assortment leading the shop. The merchandise margin rate for the quarter was about flat to last year as promotional levels were relatively consistent year-over-year. The gross profit rate increased, principally driven by the impact of expenses related to our store investment program shifting from the first quarter last year to the second quarter this year based on the timing of real estate activity. This led to buying and occupancy leverage on the high sales growth. For the quarter, operating income was $123.7 million, up 21% versus last year. Our operating income rate increased by 130 basis points to 16.3% driven by expense leverage in SG&A as well as on buying & occupancy expenses as previously noted. 12

13 Focusing on our store investment program, during the quarter we opened or remodeled 33 additional stores in our fleet, bringing the net number of new concept stores to 466 by the end of the quarter. Our current projections are targeting approximately 640 stores in our new concept by the end of the year. We continue to be pleased with the overall results of these stores, both in a shop-in-shop or side-by-side format. Our ongoing store remodel initiative, as well as significant investments in direct distribution capabilities as mentioned in the prior quarter will place pressure on occupancy costs in the second quarter and into the foreseeable future. The investment in wages announced last quarter only partially affected first quarter results. The wage increases will fully impact SG&A expenses for the second quarter and the balance of the year. We continue to see strong performance in our BBW direct channel which grew net sales by 25% in the first quarter versus last year. Inventories were well-managed through the quarter and ended up slightly on a per selling square foot basis, below our sales growth. Regarding our assortment, we have been pleased with the level of product acceptance we have generated. We continue to be focused on finding the right balance of newness and innovation in our assortment and delivering the experience she is seeking. As we progress into the second quarter and our semi-annual sale time period, 13

14 we will continue to balance disciplined expense and inventory management with the overall need to drive sales growth in the business. INTERNATIONAL In our international business, we experienced good sales growth in all segments of the business except for the U.K., which continues to be very challenging for us. Net sales increased by 31% to $135.1 million. We opened 19 net new stores to end the quarter with 698. Operating income declined by $4.2 million, as increases in all of our partner businesses were offset by significant decline in the U.K., and by planned preopening costs in China. Our franchise businesses in VSFA, VSBA and BBW all performed well in the quarter. In China, we continue to experience strong growth in the Direct business and positive comps in our VSBA stores. The 7 full assortment stores continue to perform about in line with our expectations. We remain on track to open an additional 10 full assortment stores this year, including the Hong Kong flagship store in mid-july. We are obviously very focused on improving performance in our U.K. stores which continue to experience negative traffic. We continue to be confident about our prospects for growth in international markets and of course, we remain focused on the fundamentals: great execution of our brands wherever we go. 14

15 We invite you to join us for our live earnings call tomorrow morning at 9 a.m. Eastern by dialing (international dial-in number: ); conference ID