Good morning. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Bath & Body Works Third Quarter 2021 Earnings Conference Call. Please be advised that today's conference is being recorded. I will now turn the call over to Ms. Wendy Arlin, Chief Financial Officer at Bath & Body Works. Wendy, you may begin.

Good morning. Welcome to the Bath & Body Works Third Quarter Earnings Conference Call for the period ending October 31, 2021. 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 statement found in our SEC filings and in our press releases. Joining me on the call today are CEO, Andrew Meslow; and Senior Vice President of Investor Relations, Amie Preston. All results we discuss on the call today are adjusted results and exclude the third quarter loss on extinguishment of debt in both years as described in our press release. All results we discuss today represent the continuing operations of the Bath & Body Works business as the Victoria's Secret business has been classified as discontinued operations due to its spin-off on August 2, 2021. Thanks, and now I'll turn the call over to Andrew.

Thanks, Wendy, and good morning, everyone. Turning to our third quarter performance. We delivered strong results, and we could not have done so without the continued hard work and commitment of our associates and partners in stores, distribution and fulfillment centers, call centers, at our vendors, and our offices. We'd like to express our deep appreciation for their ongoing dedication and efforts. We reported adjusted third quarter earnings from continuing operations of $0.92 per share compared to $0.83 per share last year. This result significantly exceeded our third quarter guidance for earnings per share between $0.55 and $0.60. The upside versus our guidance was driven by better-than-forecasted sales and a higher merchandise margin rate. We continued our strong momentum in the third quarter. Net sales were $1.681 billion, a decline of just 1% versus last year's exceptionally strong results and a 53% increase compared to 2019, which was consistent with the 2-year growth we delivered in the first half of the year. Performance was strong across all months of the quarter as we saw good customer response to our fall seasonal and Halloween merchandise. We also launched 2 new fragrances in the third quarter, Fairytale and Open Sky, both of which exceeded our expectations. We are satisfied with our inventory position as we head into the holiday. While we are better positioned than most retailers due to our primarily domestic supply chain, we are not immune to challenges. We have proactively managed production and promotions throughout the third quarter and did not experience significant out of stocks. Furthermore, we do expect our assortments to be full and abundant for the holidays. We are partnering closely with our vendors to support production needs in order to continue to meet customer demand. In terms of our product offering and marketing stories, we invite you to watch a video showcasing our holiday assortment, which we posted to our website this morning. Inflationary pressures in raw materials, wages, supply chain, and transportation costs negatively impacted our third quarter results and will put even more pressure on our fourth quarter as we described in the commentary, which we released yesterday evening. We will continue to proactively manage pricing and promotion with the goal of offsetting as much of this cost pressure as possible. We are forecasting fourth quarter sales and earnings per share growth over last year and significant growth versus 2019. Specifically, we expect fourth quarter earnings per share between $2.10 and $2.25 compared to earnings per share from continuing operations of $1.96 in 2020 and $1.41 in 2019. Additionally, we expect sales growth in the mid- to high single-digit percent range compared to last year. We are well positioned as we go into the important holiday season and fourth quarter. We have confidence in our merchandise assortments. Although it is very early, customers are responding positively, and quarter-to-date sales are in line with our expectations. Risks related to COVID persist, and we will continue to operate both of our channels in a safe manner for our customers and our associates. With continued smart and disciplined management of the business, I believe we can deliver a strong holiday and fourth quarter.

Thanks, Andrew. That concludes our prepared comments. At this time, we'd be happy to take any questions you might have. Thanks, and I'll turn it back over to Julie.

Our first question comes from Ike Boruchow with Wells Fargo.

Congrats on the sustained growth. I guess, Andrew, I'm sure someone is going to ask this, so I'll just be the one. I mean, your margins were very elevated last year. You guys really were a key beneficiary. But you're really sustaining those levels of profitability in a way that I think most people did not think was likely. Can you give us an update? Are we still thinking that this is a low 20s margin business? I mean, you're going to be above the mid-20s this year. Just kind of curious like structurally, how are you seeing things evolve? I would love some higher-level perspective from you if that's okay.

Yes, sure. Thanks for the question, Ike. So yes, we've said pretty consistently on earnings calls and in investor meetings that we believe that an operating margin in the low to mid-20 range is appropriate for this business because we think it affords us the right balance of investing in our products, our customer experience, and our capabilities while also generating a very high return on sales. As we've also talked about, really the driver of the breadth of that range from low to mid is going to come down to how we're able to maintain the merchandise margin improvement that we've realized here over the last 18 months. I would say that our confidence on that from a promotional and pricing power standpoint remains high. As we've seen in each of the first 3 quarters of this year, we've been able to keep promotion levels at or below where we were in 2020 and meaningfully below where we were in 2019. That's a combination of all the different levers we use, including more full-price selling, less clearance, fewer days of traffic driving promotions, higher prices when we do run promotions, selective higher tickets, and fewer shop-wide discounts. However, the wild card that has come into play last quarter, Q3, and moving forward is around inflationary pressure. Looking at our margin improvement in Q3 relative to Q2, it was not as much as it was in the first half of the year, and that difference was primarily due to inflationary pressures, which include raw materials, transportation, and wage rates. We believe those costs will only go up further in the fourth quarter and this is a short-term situation. Moving beyond that, it will come down to how much merchandise margin pricing power we can sustain. Right now, we're still very confident in our ability to do that. Did I address your question, Ike?

Yes. Appreciate it.

No, my pleasure.

Great. Thanks, Ike.

Our next question comes from Lorraine Hutchinson with Bank of America.

Andrew, can you talk a little bit about some of the pricing actions that you have taken and what the consumer response has been? And then also, if you'll continue to adjust pricing and promotions on a go-forward basis to offset some of these supply chain issues?

Yes. Thanks, Lorraine. Again, as I highlighted in the prior answer, we have lots of different levers at our disposal around pricing and promotions, including ticket price increases and the frequency of promotions. On the ticketing front, as we started to get line of sight to the inflationary pressures, we made select ticket changes. For instance, we increased the ticket price on our big 3-Wick candle business by $1, and selectively raised prices in our body care key forms as well as in some of our wallflower heaters. More importantly, because the majority of our sales come from everyday promotions, we've also been gradually raising the promotional price level across all categories over the last 12 to 18 months. That's something we've done every day, and it's even more important with these inflationary pressures. To date, we have not seen negative customer reactions to our pricing and promotional changes, and we will continue to implement them. However, as we move into the fourth quarter, it is a more promotional time frame. We historically rely more on key promotional days that drive volume, traffic, and customer acquisition. While we will still utilize our read-and-react capability, we are expecting promotional activity to align more with last year, both in frequency and depth.

Great. Thanks, Andrew. Thanks, Lorraine.

Our next question comes from Kimberly Greenberger with Morgan Stanley.

Okay. Great. Really nice results here. Andrew, I wanted to ask about the sort of degree of magnitude that you're considering or contemplating for the fourth quarter gross margin. You talked about having the fourth quarter down compared to last year. If you could just help us understand order of magnitude? And your margins, as I said, have been really outperforming expectations this year. I'm wondering if you can talk about the puts and takes around your gross margin forecast for the holiday season? And what could cause that gross margin or the overall operating margin in Q4 to come in a bit better than you're currently forecasting?

Okay. Kimberly, we're going to go to Wendy.

Kimberly, as we look forward to Q4 and our gross margin, the primary driver of our gross margin decline is the inflationary pressure we discussed earlier. We are forecasting merchandise margin rates to be down significantly compared to Q4 of last year due to inflation. Of the inflation we called out, roughly half of it is raw material cost increases. The other part is driven by transportation, wage pressures, and general supply costs. A significant pressure on our AUCs is occurring in Q4, combined with the fact that we plan to maintain a similar promotional strategy as last year.

And then Andrew, do you want to talk about potential upside to the forecast?

Sure. The opportunity from a margin standpoint is really about whether we can be a little less promotional than last year. Our current guidance is a very similar approach to last year, so if we can be more aggressive with our pricing, that could yield some upside. Additionally, if we perform at the higher range of our forecast, we could achieve leverage since some costs are fixed.

Thanks, Kimberly.

Our next question comes from Simeon Siegel with BMO Capital Markets.

Congrats on the ongoing results, really well done. So the AUR is great; it feels pretty well understood at this point. I think in the script, you said you saw a low double-digit increase in UPTs as well. If I got that right, can you just speak to that growth? I don't know if there's any new shopping tendencies with higher bundling you're seeing versus pre-COVID, if that's something you think will last or if there's a one-time COVID lap? So just trying to think about the UPTs going from here. And then lastly, if you can speak to the $90 million to $100 million increase in forecasted costs, if you can break that down between raw materials, supply chain, and transportation at all, that would be really helpful.

Okay. So let's start with Andrew.

Thanks for the question, Simeon. I just want to clarify. The first part of your question was specific to the digital business or to the overall business?

I thought you pointed out a pretty nice growth.

2-year basis, yes. When we think about the business on a 2-year basis, the growth we've seen in stores has been phenomenal. It began with the reopening trend from last year in July, August, September, and from there, we continued to see strength throughout the year. In the third quarter versus 2 years ago, we saw traffic, conversion, and transactions all up significantly. On average, the dollar sale has increased meaningfully on a 2-year basis. The driver behind that is both UPTs and AUR. The AUR is influenced by our previous pricing and promotional strategies. On the UPT side, customers have been purchasing from multiple categories. We have enhanced our assortments to encourage this trend, resulting in a growth from about 55% of our customers purchasing multiple categories 2 years ago to now close to 60%. This shift has had a significant positive impact on UPTs and average dollar sales.

Great. And we'll go to Wendy for the question about cost.

Thanks. On inflation, regarding the guidance, about half of the increase we mentioned in our prepared remarks relates to raw materials. We're experiencing pressure throughout the components used in our business, including wax and other product parts. Roughly 25% of the pressure comes from transportation, which includes both inbound, outbound, and parcel shipping. The remaining portion primarily relates to wages, whether at our vendors producing our products or at our distribution and fulfillment centers where we are also facing wage pressure. That’s how it breaks down.

Thanks, Wendy. Thanks, Simeon.

Congrats, guys. Best of luck for the holiday.

Thank you.

Our next question comes from Matthew Boss with JPMorgan.

Congrats on another great quarter.

Thanks, Matt.

Andrew, can you speak to growth in the customer files that you've seen during the pandemic? How do you think this translates to market share opportunity by category going forward? And then a question that I just had in terms of the P&L. So you're guiding fourth quarter sales up mid to high single digits against 22% growth a year ago. As we think about the algorithm, mid- to high single digits going forward, obviously, compares will ease over time. Does that provide potential upside as we think multiyear about your ability to lap against these material compares and what it may mean going forward?

Thanks, Matt. Andrew?

Yes. In terms of the customer growth, we saw a decline in our customer file in 2020, primarily due to store closures for 90 days. Fortunately, the first half of 2021 and Q3 have shown a strong trend of absolute customer growth, now up low double digits over the past 2 years. We are also seeing strong customer engagement metrics that are up in the high 20% range compared to 2 years ago. This translates to category market share growth as we are seeing nice growth on a 2-year basis across all categories. Customers purchasing across multiple categories are spending over 3x more than those who purchase only one category. Additionally, dual-channel customers account for a growing percentage of our business now in low teens, up from high single-digit two years ago, and these customers also spend around 3x more than single-channel customers. Thus, we have effectively gained valuable customers during the pandemic and our retention rates are stronger than pre-pandemic levels.

Great. Matt, did we hit all your questions?

Yes, the second question was about Q4 guidance.

Yes. On Q4 guidance, our longer-term growth algorithm still anticipates total sales growth in the mid to high single digits over time. It's vital to note that we are lapping capacity restrictions from Q4 of last year, meaning we won't encounter that in future years.

Great. Thanks, Matt.

Our next question comes from Grace Menk with Jefferies. This is Grace Menk on for Steph. I'm wondering if you could talk about the trends that you're seeing in sanitization and the outlook for that part of the business going forward?

Thanks. Andrew?

Yes. We looked at the soap and sanitizer business together and it’s performed relative to pre-pandemic levels. In 2019, soap and sanitizer made up around 14% of our total business, while last year it spiked to almost 20%. This year, we expected it to moderate and stabilize in the mid to low teens percentage. Our Q3 results were in line with this expectation. While there was concern about the ability to anniversary the high soap and sanitizer sales last year, we experienced strong growth in the body care, home fragrance, and gifting/accessories segments that mostly offset the decline in soap and sanitizer sales. Looking ahead, we expect this segment to return to pre-pandemic levels but certainly not as high as in 2020.

Great. Thanks.

Our next question comes from Roxanne Meyer with MKM Partners.

Congrats on the improved sales and full-price selling in the third quarter. My question is on White Barn. You still have a nice runway for growth in your remodels. Can you remind us of the productivity of these, how much more productive they are than your stores without an attached White Barn and how you see the path for growth over the next year and few years? And then as a follow-up on the flat promotional strategy for Q4, I know that last year, you adjusted your approach to promos just given your capacity constraints. For example, running your candle day for multiple days. How are you going to implement strategies like that this year?

Thanks, Roxanne. Andrew?

Thanks, Roxanne. I appreciate the question on the White Barn strategy. Before the pandemic, we were excited about the half of our stores that underwent a White Barn remodel and the high teens to low 20% productivity increases we saw. After a pause in activities during 2020, we ramped up renovations in 2021, and the performance of these remodels has remained strong and consistent with pre-pandemic levels. By the end of this year, we'll have about 1,000 locations in the White Barn format, and we'd like to eventually extend this remodel to all stores. The question will be how many we replace in vulnerable mall venues versus transitioning to different off-mall locations. Regarding the promotional strategy for Q4, we are planning campaigns similar to last year. Last year's strategy included extending key promotional days, such as candle day, across multiple days instead of one. Likewise, our Black Friday deal will also spread over the entire Black Friday week again this year.

Great. Thanks, Roxanne.

Our next question comes from Jay Sole with UBS.

Great. I guess, Andrew, I have a question about hand sanitizer, about the market in general. What's your sense of how the hand sanitizer market overall across the U.S. has performed? Can you compare that to your business to help us understand the trends within Bath & Body Works versus the broader market? And then secondly, could you also address some of the constraints online last year?

Thanks, Jay. Andrew?

Thanks, Jay. So on sanitizers, the market saw explosive growth in 2020 due to the pandemic. This led to many companies entering the market, but many also exited in 2021 due to decreased demand, likely resulting in deep price promotions. We remain pleased with our hand sanitizer business, which continues to be considerably more profitable than the broader market. While sales for sanitizer have decreased year over year due to comping against last year's growth, we still tap into a very lucrative market that has changed customer behavior in ways that benefit us long-term. The second part of your question regarding online constraints. Last year, Bath & Body Works' online business doubled unexpectedly. Our team did an excellent job increasing fulfillment capacity, but last year's demand still constrained online order fulfilment. As a result, lead times for shipping exceeded our preferences. This year, we are much better positioned with adequate fulfillment capacity and improved inventory levels. We anticipate shorter shipping windows and hope to extend our cutoff for holiday orders.

Thanks, Andrew.

Our next question comes from Paul Lejuez with Citi.

Just one quick short term and one longer term. Short term, were there ticket changes that were taken for the fourth quarter this holiday season that had not taken effect in 3Q? So just curious if you've made any changes recently. Then just longer term, I'm just kind of curious, Andrew, what do you look at as the lowest-hanging fruit as you think about that mid-to-high single-digit top line growth over the next several years? Any new categories or opportunities that you see as low-hanging fruit as we look out to next year and beyond?

Thanks, Paul.

Yes, thanks, Paul. On your first question regarding Q4 ticket changes compared to Q3, the short answer would be no. The ticket adjustments made are accounted for in Q3. So we’re not implementing any new ticket changes in Q4. Regarding long-term opportunities, our business plan includes further expansion in existing core categories and entering adjacent categories. I believe the lowest-hanging fruit still involves key item opportunities for growth in categories we already excel in, such as adding new forms in candles, additional body care offerings like bar soaps and antiperspirant deodorants, and increasing our soap forms and sanitization product lines.

Thanks, Paul. I think we have time for one last question.

Our last question comes from Marni Shapiro with Retail Tracker.

Andrew, I was actually so happy to see the bar soap back. So thank you for that. I'm curious, as you guys have raised prices a little bit and pulled back on promotions, are you seeing a stronger reaction when you do put promotions in place? How should we think about your post-Christmas traditional sale this year?

Thanks, Marni. Good question. The very short answer to the first part is yes. As we've increased ticket prices or made everyday promotions less aggressive, we have seen a strong positive customer response when we launch deeper promotional events, like our try-it-to-believe-it days. Regarding our semiannual sale, we ran one last year but at shallower discounts than historical norms. The 2022 sale will return to a more traditional format with deeper offers and a higher penetration in clearance merchandise, as those details are embedded in our guidance.

Excellent.

We do enjoy a frenzy, as long as we're all safe and socially distanced.

Thanks, Marni. That concludes our call today. Thanks for your interest in Bath & Body Works. We wish you all a healthy and Happy Thanksgiving. Thanks. Bye.

Thanks, everybody.

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