Bath & Body Works, Inc. (BBWI) Earnings Call Transcript & Summary

Good morning, and welcome to Day 2 of the High Yield Conference. I'm Carla Casella, I cover consumer products, food and retail at JPMorgan. And we are pleased to have with us our first presentation of the day from L Brands. We have with us Stuart Burgdoerfer, the company's CFO; Tim Faber, SVP of Treasury; and Amie Preston, SVP of Investor Relations and Corporate Affairs. So without further delay, I turn it over to Stuart for a presentation. [Operator Instructions] Thanks so much for being here, everyone, and I'll turn it over to Stuart.

Good morning, and thank you, Carla, and thank you to JPMorgan for hosting the conference and for everyone's participation. We're going to use a presentation as you're familiar. And you would expect, I would call out before we start, that on Page 2 of that presentation, you'll note our safe harbor statements that relate to this presentation and that are inherent in our discussion this morning are important context for our discussion this morning. So again, good morning. And Tim and I -- or Tim and Amie will join me for the Q&A at the end. So using the document that we have, Page 4 summarizes how we think about our company. Again, for those not familiar with L Brands, we own 2 major retail businesses, Bath & Body Works, the leader in its space; and Victoria's Secret. For some, the better known of the 2 businesses, but these -- both these businesses are longstanding components of the company, and each of them enjoy leadership positions in their segments of retailing. So that's just an orientation to the business. Second point, and again, many hopefully heard or read the transcript from our earnings call last week, but we are committed to establishing Bath & Body as a pure-play company. We're doing that to ensure that it's appropriately valued in the equity markets and related in the debt markets as well, and so we are taking all the necessary steps to separate these 2 businesses. We engaged JPMorgan and Goldman Sachs in August to help us with that, August of 2020. And coincidentally, we're committed to working a dual path process, meaning both pursuing the opportunities associated with the spin-off, as its own public company in a sale, should that be the better course and working to get to a conclusion on either of those 2 paths in the August 2021 time frame. Both businesses have significant digital capabilities, presence, scale. We'll talk about that through the slides and the remarks. We do have good store base for physical retailing in each, and we'll overview where we are with respect to those footprints. The liquidity and cash flow of the business are in very good shape, and we'll touch on the management team and some changes at the Board level as well. So that's Page 4. We then move to Page 5. It was quite a year for all of us, for you as well, I'm sure. Whether it was in what each of us were experiencing personally or what we're experiencing in our professional or business lives. With respect to LB and actions taken, they're summarized on Page 5. And we did a lot, and you can read it, but our stores were closed for a significant period of time during the first half of the year. We took various actions to mitigate those effects from a cash flow and overhead and expense standpoint. We did flex our digital businesses significantly. And you see at the top of Page 5 the direct business of Bath & Body was up about a little more than 100% and Victoria's Secret direct sales were up about 30% in 2020. As disclosed last week and we had some releases through the fourth quarter, public releases, we had a very good fourth quarter, an extraordinary result at Bath & Body Works and a strong improvement at Victoria's Secret with EBIT and operating income up a little more than 100% in that business. We did take a lot of actions, again, as summarized on Page 5 to improve the cash flow of the business and the cash position of the company, suspension of the dividend and repurchase activity, a pullback on CapEx, work on our revolver and conversion of that to an asset-backed facility. We issued notes on a couple of occasions, and we reduced our near-term maturities. We also worked -- developed and worked hard a profit improvement plan. We're on track to meet or exceed the benefits of that, which were a goal that $400 million number on an annualized basis. And for the first half of that, the last 6 months of fiscal 2020 in line or slightly ahead of that goal. And I already mentioned our work done on the separation. If we then go to Page 6, you'll see the details of our profit improvement plan. We've been asked in the market about this. So things to improve, merchandise margin rates at Victoria's Secret. Work on store selling costs, again, also focused on Victoria's Secret. Substantial action to rationalize the real estate portfolio in the Victoria's Secret business. Addressing U.K. and China operating losses through a partnership with Next in the U.K. and work that we did in China in terms of new stores, and then a rationalization of that overhead. And then lastly, and a difficult thing to do in one that should get and does get a lot of consideration in terms of its -- the need to do it and the importance of doing it, but balanced with the impact on our teams and their families that made a difficult decision to have a reduction in force of about 850 people, about 15% of our home office headcount, which was implemented in August. Page 7 has some graphical representation of the Bath & Body Works business at the top and the Victoria's Secret business at the bottom half of the page. We see the Bath & Body revenue for the year increasing from about $5.4 billion to about $6.4 billion, an increase of $1 billion in a year. You see the operating income result increasing a little more than $600 million from $1.2 billion to $1.8 billion. And then you see the Bath & Body operating income results by quarter. In the most recent quarter, the one we just reported last week, with op income of $914 million versus for that same period a year ago at $664 million. And you see the third quarter at $494 million, nearly $500 million versus the $209 million the year prior. In the second quarter, at $349 million versus the $184 million in the second quarter of '19. So this extraordinary results, you see the percentages growth year-on-year at the bottom of that table, so plus 90, plus 137 and on a bigger base of plus 38 in the fourth quarter. The same information is displayed for the Victoria's Secret business. So a business that is rationalizing its size, but improving its profitability. So in 2018, this business generated revenue a little more than $8 billion. And in 2020, obviously impacted by the pandemic, generated revenue of $5.4 billion. You see the annual operating income in the next panel over with the 2020 result at $174 million, pretty consistent with 2019. But importantly, of note without a significant effect of the pandemic and with the benefits of the profit improvement plan that I just outlined, that was implemented beginning in August, you see the Q3 result of 2020 at $115 million comparing to the loss of $70 million in the prior year in the far right panel. And then you see in the fourth quarter of '20 operating income of $403 million versus $194 million the year prior. So in the back half of the year, a substantial pickup, again, not being adversely impacted by the closure of stores in the first and second quarters. I'm referring to the back half and also, again, benefiting from a series of actions that I outlined earlier to improve the results of the business. So we are pleased with the progress on the turnaround at Victoria's Secret. And as mentioned on Thursday, we're managing at this point an operating income rate of between 10% and 15%. Right now, we're at the lower end of that range, but profitability at about that 10% level at this point with an opportunity to further improve that and begin growing the business. On Page 8, some additional information about Bath & Body on the left and Victoria's Secret and PINK at the right are provided. You can read it, and it's familiar for those that follow the business. But in the middle of the page, you see some #1s in terms of leadership positions in segments of retailing in which we participate. If you go to Page 9, a lot of people wonder how does Bath & Body do it? I don't really understand this business. Why does it do so well? And one way to better be responsive to that curiosity is we think about it as a business that is category dominant from the top half of Page 9 in these categories of body care and fragrance, home fragrance and soaps and sanitizers, and that combined with what we bring to the business in terms of fashion and that comes really from the fashion history of almost 60 years at L Brands that everyday use aspect of Bath & Body and then the giftability that the business enjoys through providing positive consumer experiences for a long period of time and just the positive perceptions that people have about the brand in terms of the fact that it's special and admired broadly in the marketplace underlie -- or help with the giftability of what we sell. So it's the combination of that category dominance along with the fashion aspects, the everyday use aspects and giftability that we really think provide the consumer-facing dynamic that has been very powerful for the business for a long period of time. Bath & Body, in terms of its real estate composition, is summarized on Page 10. Importantly, and we're really trying to make sure that we're clear in our communication to this. If you see the second bullet there, 45% of Bath & Body stores are not in enclosed shopping malls -- not in enclosed shopping malls. And we very actively manage the fleet and believe that we're proactively ensuring that the fleet is healthy. If you look at sales per foot, very strong and the annual amount of $916 only impacted really only going down because of the impact of the pandemic in the first part of the year. So this real estate portfolio is in very, very good shape. On Page 11, this is a chart of comps, comparable store sales over a long period of time. The information stores and direct is at the table below and then stores only, the last row numerically. And really, the point of the chart were two. One is that the business is consistently positive and the second is in periods where there has been some relative softness in the business, the business has been able to correct quickly in terms of resuming a more appropriate rate of growth. So long record of success here really dating back to the Great Recession in '08 and '09 and demonstrative of the fact of the business through its overall set of capabilities, including a short-cycle supply chain is able to respond quickly, if it has a relative soft period. Page 12 provides some information about the digital side of Bath & Body, I think, underappreciated. And obviously grew a lot, lower left at Page 12, the business grew -- last year, it was at about $1 billion, $958 million, and it more than doubled to about $2 billion this year. So a significant online business and one that obviously grew at a very healthy rate in 2020. Victoria's Secret, some basic information on Page 13. In terms of the Victoria's and PINK brands, it is a scale business. It is a very well-known business. It's composition of revenue, and going to the right side of the page, in '20 was about 40% direct and about a little more than half -- 44% direct, 56% revenue in stores, and it remains the leader in inner apparel. The same format of information in terms of what we use for the BBW business on Page 14 for VS. So the digital scale of the business summarized at left. The revenue trend online, at the bottom of Page 14, you see growing from about $1.7 billion to about $2.2 billion online. You see the profile of real estate on page -- on the right side of the page, pardon me. And then, again, impacted by COVID. $4.6 million is not a normal annualized number, but one significantly impacted by the pandemic. For LB in total, Page 15 provides a series of information. Upper left revenue, upper right EBITDA, you see the growth from $1.8 billion to $2.3 billion. Operating income, lower left, at $1.8 billion, and the CapEx reflective of our conservative actions that we took in the face of the pandemic at about $200 million in 2020 versus the higher amounts in the preceding years. Page 16 summarizes liquidity at the top of the page. We ended the year with $3.9 billion in cash, plus amounts available under the asset-backed facility. And then the free cash flow of the business, you see, was $1.782 billion, reflective of the strong operating result and the pullback in CapEx. The maturity profile is shown on Page 17. Tim and team, a lot of people helping lawyers, Amie, Wendy Arlin, a lot of folks on the team, legal folks helped do this. But Tim has done a lot of financings in his time and in his role with the company and more activity in 2020. I'm appreciative of all he's done for the business over a long period of time and he was busy again this year. And you see that the maturity profile of the business we think is sound and took steps in the March-April time frame to amend that revolving facility to an ABL facility. If you go to Page 18, you see our calculations of leverage ending the year on an adjusted basis at 3.1x. Page 19 provides some profile about the management team and the business in terms of some of our key people. Obviously, at the beginning of the year, Les Wexner, founder of the business, longtime CEO of the business, stepped back from his role as CEO and Chair of the Board. And Andrew Meslow, upper left on this page, assumed the CEO role for L Brands, along with his responsibilities at Bath & Body. The Board asked me to run Victoria's Secret beginning in May, the 4th of May, which I did through February. And now Martin Waters is running that business. Importantly, Julie Rosen was brought in to the Bath & Body team this year. She has got a long record and a very positive record in specialty retail. Chris Cramer been with our business a long time, elevated to COO on the team. Greg and Amy had been with the business a meaningful period of time. Amy a long time with Bath & Body and then coming to PINK a few years ago. Dein Boyle being elevated to COO in connection with our organizational work back in the summertime. And Jamie Bersani has run real estate for the company for a long time, and he and his team had an extraordinary year this year doing what they did in negotiating with our landlord partners what was a very important set of concessions and rent relief driven by the pandemic. So that's some overview about the leadership team. Martin, now running again Victoria's Secret NewCo, assuming that in February. And he's been with our business a long time. He brings a lot of capability to that role and the team is excited about what he's going to do in our next chapter for that business. So with that, those are our remarks. I hope this has been helpful. I think we're going to open up the mic, Carla. And Tim and Amie will join me because if I can't remember something, they'll help me out and they will join the conversation, and we're happy to take your questions. Thank you.

Great. Thank you, Stuart, and as always, a great presentation. We actually have a question from the line that I'm going to begin with. Given the stabilization this year of the Victoria's Secret business, how do you view the debt capacity or appropriate capital structure for that business longer term?

Yes. We'll be looking at it, and I'm not going to go into detail about it. Obviously, as reflected in your question, the business has some capacity for that we want to be careful about it. I have had a more volatile result or more variability in its performance. So it has that capacity, but on a spectrum, we want to be careful to ensure that we're not putting too much leverage on that business. So I realize that that's a qualitative set of remarks versus here is our target, but we want to be careful.

All right. That's great. Understood. So you showed in your slides and talked about how much growth you've seen this year from digital and e-com games. Is there -- do you have a sense is there a way to know how much of that is repeatable or ongoing versus the world revert after the pandemic?

It's a really hard question, Carla. So a lot of people, if we think about a lot of curiosity that's existed about the Bath & Body business, even from a category standpoint, apart from the channel question that you're asking, it's hard to know about how people's behavior will revert or moderate back to more historic norms. Carla, before this conversation, we were talking about where do we all work from, right? And is that going to -- is everybody having go back into the office 5 days a week and so on. So whether it's about where people work, and how they commute or how people shop and how that plays through, it would be reasonable to expect some reversion back to where we were. But I also think that people have very much enjoyed some of the benefits that were forced on us or triggered through the pandemic. So we believe that the digital part of our business is both of them, will be significant. Obviously, both grew at an extraordinary level. As we think about the Victoria's business, very clear minded that, that's a 50%-ish, maybe a little more online business. In the Bath & Body business, with $2 billion of revenue online, that honestly really struck us. But that business continues to do -- the digital channel continues to do well. And another belief that people have that -- and it's a reasonable belief that the actual behaviors have been different. People think about the Bath & Body online business as only a [ replan ] business. But as we actually look at it, we find a lot of people are experimenting with new fragrances and new items brought into the assortment. And I think that's reflective of the fact that there is a lot of trust in the Bath & Body name and those that run the Bath & Body site, whether it's through the visual imagery or the narrative descriptions, do a great job describing what it is that we're offering. And so we're optimistic about ongoing growth in both businesses in the direct channel.

Okay. And I'm not sure -- you have talked about this on your last call. So maybe you could just refresh us if any comments you've made about the potential appropriate capital structure for Bath & Body. How much debt can that business support? Is there a range where you would like to keep the leverage of that business as a stand-alone?

So we're doing deep work on it now, Carla, as you would imagine, in connection with the expected -- although it's still subject to actually doing it, but the expected separation. So we're doing work in that regard. And we're looking at leverage. We're looking at return of excess cash. We're looking at how might we think about dividends and share repurchase activity and reduction of debt. We do believe as a general matter that we want to reduce our debt levels a bit, we do. And we're also carrying a lot of cash, and we -- after reducing debt levels in an appropriate way, we'll be thinking about -- we are thinking about. So all these subject to review with the Board. No decisions have been made. But we'll be thinking about also dividend policy and share repurchase activity. So we're looking at all of it. We're getting good advice from 2 very well-known institutions, and we'll continue those reviews with the Board. So we're looking at all of it. And as you would expect, we ended the year with $3.9 billion of cash. We really -- we're concerned at the beginning of the year. We all think back to what was happening because a few months ago or 8 or 9 months ago in March, April, May, we were quite concerned. And we took extraordinary actions to deal with that, and the business performed really well on a relative basis. So we have built up a lot of cash, and we want to be very thoughtful about how we deal with it in terms of that excess cash, and then the ongoing management of the capital structure, as you asked. So short answer, we're looking at all of it, and we don't have specific announcements of it.

Okay. And if I remember correctly, there aren't a lot -- there are not a lot of hard assets there we could do sale leasebacks of either business.

Yes, the distribution centers and the underlying land in those distribution centers have home office facilities attached to them. There are some -- there is some asset value there that we own. But apart from that, you're right, Carla, that is not [indiscernible].

Okay. And then right now, the way -- we really appreciate that you've broken out the 2 businesses in your segment reporting. There is a big corporate -- not huge, but there is a corporate allocation as well that's not been allocated to the businesses. Is that business -- is that the corporate headquarters that would probably stay with the Remainco? Or would you be able to split some of the corporate expenses in the event of the split?

We've split a lot of it already. So when we did our restructuring work, the things that one could reasonably split, we did. But things like certain corporate HR or certain corporate finance, if you thought about audits and CFO stuff and tax and treasury and financial reporting, certain other corporate functions, there is still some that is shared. But where we could reasonably split it, we did that in connection with the work that we did over the summertime. But there will be some deleverage of that cost as the companies go their own way. Amie, you can keep me -- keep us honest here. We've -- if we've provided any broad guidance on this subject that Carla is asking about, we could repeat that broadly. But if we haven't, I would say, Carla, there -- as a general point, there will be some deleverage in that number as we move forward because there are certain things that need to be -- we need to have a second instance of -- particularly if VS ends up being a public company. Anything you'd add, Amie?

No. I think that other segment that's remaining that has unallocated corporate overhead in it, it's currently annualizing at a run rate of about 1% of sales. So that's what would you think -- yes?

Yes. And I know, Tim, help me up over this question after the call, but I think I've gotten the question from the investors on the rent. How much of your rent right now is Victoria's Secret versus Bath & Body Works? If we look at this split on the rent there, if we want to try and do it -- separate it out in our models.

I don't know that we've -- I don't know. Tim, that -- I would just be thoughtful in [indiscernible].

Just variable terms.

Yes, just in a broad, it's about 2/3, 1/3, but...

Yes. That's helpful. So you have exposure to really almost every mall and definitely every good mall in the U.S. So I'd love to get your thoughts on when traffic might return? Or what you're seeing in a state that's more open versus that's more closed? Are people yet returning to the malls? And I have a few more mall questions.

Well, the first thing is, Carla, I would say, and you recognize it as you [indiscernible] the question, we'd like to think that we're in every good mall in the United States. There are a lot of malls in the United States. And again, importantly, and I'm just emphasizing it because it's important to us, remember that 45% of Bath & Body's locations are not in enclosed shops. What I would say is that what we have observed is the traffic pattern in what many would refer to as A-malls, that's actually where the traffic patterns have been the weakest year-on-year. They're starting to normalize or moderate a little bit, but traffic has been down meaningfully. What I would also say, though, and it's fascinating, as we reported last week, using the Victoria's data point, our dollars per foot stuff, we're up 75%. So there is this notion of lookers versus buyers, right? So I'd like to think that the executive that runs the field organization for Victoria has made all of that 75% up and she's terrific, and she did a great job, and our store teams did a great job selling. But the other aspect of this is, Carla, that maybe people don't talk as much about because it gets complicated and speculative is just this whole notion of lookers versus buyers. And clearly, while traffic was down meaningfully, the nature of that traffic was different. And so that would be, maybe the additional perspective I might add is that not all traffic is graded equal. And while traffic trends overall are down year-on-year, again, the previous position of somebody to buy. Like if she's overcome any concerns that she might have about her health and safety, she's now in a mall, it is what's her mindset. She's like, no, I'm going to go even though it's a little bit of a hassle, and I got to feel a little worried about health and safety. Her state of mind is probably, she is pretty motivated by it, right? So it's complicated, complicated. What we also would say is that our traffic patterns off mall. So Bath & Body does have this big presence off mall. And the traffic year-on-year phenomena there is not as pronounced -- not as pronounced as you -- as we observe in enclosed shopping malls.

So you mentioned in your last release that you have completed some of your negotiations or discussions around rent. Are the structures of mall rents changing? And can you give us any more detail on kind of what you were able to accomplish there? Was it more store closures, relocations? Was it rent, term changes or other changes?

Yes. What it was predominantly was relief related to the pandemic. So let's just like -- let's just start with why did we have these conversations and why was it appropriate to have these conversations, right? It started with just the fact that stores were closed, out of our control, and we needed to partner in that economic effect. So that's what gave rise to it. Why was there more benefit for Victoria's Secret than there was for Bath & Body because Victoria's Secret is more concentrated in enclosed shopping malls and Victoria's Secret, frankly, was just in a more challenged position. Were there -- if one thought about every material economic aspect of a lease where all of those things in one way or another discussed, and in some cases, modified with respect to our leases, they were. So it was a holistic kind of discussion, but again, the concentration of the discussion was around relief related to the pandemic. And incremental, numerically, we said what we want to say in our transcript last week in our circulated remarks. So beyond that, financially, we provided we think the disclosure that we're comfortable with and that's appropriate. But in terms of kind of the nature of it, it really started with the effect of the pandemic. But as you would imagine, once you talk to somebody, you're going to talk to them about all material aspects of our relationship, and there were intensive discussions, and both parties probably walked away a little bit unhappy in any given discussion because that's what a good negotiation is. And the relationships are important, that doesn't mean that we weren't tough minded and aggressive in our discussions, but you got to put yourself in their shoes, too. They got to put themselves in our shoes, and we got to put ourselves in their shoes. And through that, we had spirited discussions, but we feel good about the outcomes we've got.

That's great. We are just up for time, and I've cleared the question board. So we want to thank you for taking the time to be with us and for doing some group meetings later as well. We appreciate you being here. We really hope that next year it's in Miami.

Well, Tim and Amie will enjoy that.

Yes. You want to tell me the special appearance, maybe by the pool.

Thank you. Appreciate it. Thank you, guys.

See you there.

Thanks, Carla.

Thank you.

Thank you, Carla.