Good morning. My name is Danielle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Bath & Body Works Fourth Quarter 2022 Earnings Conference Call. Please be advised that today's conference is being recorded. I will now turn the call over to Ms. Heather Hollander, Vice President, Investor Relations at Bath & Body Works. Heather, you may begin.

Thank you, Danielle. Good morning, and welcome to Bath & Body Works Fourth Quarter and Fiscal 2022 Earnings Conference Call. Today's call may contain forward-looking statements related to future events and expectations. Please refer to this morning's press release and the Risk Factors in Bath & Body Works 2021 Form 10-K for factors that could cause the actual results to differ materially from these forward-looking statements. Today's call may contain certain non-GAAP financial measures. Please refer to this morning's press release for important disclosures regarding such measures, including reconciliations to the most comparable GAAP financial measure. Joining me on the call today are Gina Boswell, Chief Executive Officer; Julie Rosen, Brand President; and Wendy Arlin, Chief Financial Officer. All of the 2021 results we will discuss today are adjusted and exclude the significant items detailed in our press release. Additionally, the results represent results from continuing operations and exclude the discontinued operations related to Victoria's Secret in 2021. I'll now turn the call over to Gina.

Thank you, Heather, and good morning, everyone. Thank you for joining us. First, let me say how thrilled I am to be here at such a dynamic time. It is an honor to lead Bath & Body Works and the more than 55,000 associates worldwide. I look forward to working with this team, our leadership, and our Board to capitalize on the tremendous opportunities that I see for the business and for creating long-term shareholder value. On today's call, I'm going to talk about why I joined Bath & Body Works, discuss some of my early observations, and then outline my initial areas of focus to drive growth and profitability. But before I dive in, I'd like to first thank the team. Their efforts enabled us to deliver fourth-quarter sales at the high end of our guidance range and EPS that exceeded expectations. This was despite a challenging macroeconomic environment. As to share a bit about why I chose to join Bath & Body Works through nearly three decades in the consumer industry, I have developed a true love for beauty, personal care, and fragrance where customers are passionate and engaged, and quality and innovation are critical. And I was immediately drawn to Bath & Body Works as a company with its history of superior growth and a highly differentiated business model. This is a company truly positioned at the intersection of consumer goods and retail. The company is a market leader and innovator with leading share in its major categories of home fragrance, body care, soaps, and sanitizers, and we have a top position in the U.S. in 10 forms. This includes body lotions, shower gel, three-wick candles, and soaps and hand sanitizers. And we have also been significant share in the men's category. These are all growth categories with a long runway ahead in large addressable markets. As one of the premier fragrance companies in the world, we deliver customers their favorite fragrances in multiple forms and categories with industry-leading speed and innovation. We bring affordable luxuries in personal care and home fragrance to life like no other. Our strong relationships with our domestic vendor partners and fragrance houses enable us to continually deliver newness and meet the demands of an omnichannel customer. We manage every touch point throughout the customer journey to deliver a highly differentiated shopping experience. As I was visiting stores, I was also struck by the fact that Bath & Body Works offers products for the whole family and we're part of so many people's lives, we estimate that our products are in 40% of American households. And in my first three months, I've immersed myself in the business, visited our stores and distribution centers, and met with our supplier network at Beauty Park. I've also had an opportunity to engage with customers and store associates across the country as well as talk with investors to hear their perspective. I've conducted detailed business reviews with each of our functional leaders, and I've been impressed with the talent in our company and how engaged, knowledgeable, and dedicated our associates are. This holiday season, I saw firsthand how our passionate sales force brings our seasonal storytelling to life in our stores. I've seen the strong connection customers have with our brand, which is underscored by our best-in-class brand engagement and loyalty. And I'm excited to see customers celebrate our events. I was delighted to learn that many customers consider our Candle Day a national holiday. Overall, I'm pleased with the reach of Bath & Body Works with top brand awareness in our industry and customers indicating a strong propensity to recommend our brand. During the pandemic, our integrated and predominantly domestic supply chain positioned the company to meet elevated customer demand, which enabled us to drive significant growth in 2020 and 2021. In 2022, the company continued to grow unit share across our three major categories of body care, home fragrance, and soaps and sanitizers. This team has demonstrated remarkable innovation capabilities, delivering a pipeline of newness in fragrance and product forms that powers our deep customer connections. Our product offering serves multiple customer occasions, including gifting, replenishment, and self-purchase. We also connect with customers across touch points by telling stories through our fragrance and packaging. And finally, I've witnessed the company's key competitive advantage in bringing products to market with industry-leading speeds. Our vertically integrated supply chain allows us to respond quickly to changing customer and macro trends. So my early days at Bath & Body Works have reinforced why I joined the company and reaffirm the opportunity that we have to strengthen our position as a leading global omnichannel home and personal care brand. At the same time, there are areas where we can improve to drive top-line growth and increase profitability. Looking forward, key areas of focus for us will be driving growth by expanding our customer base, delivering effective personalized marketing, optimizing our product offering, expanding our international reach, advancing our digital capabilities, and unlocking the potential of our omnichannel model, all while focusing on improving profitability. So just starting with the customer. We have a large loyal customer base, and we have diversity across income levels, age groups, and ethnicity. I see a significant opportunity to acquire new customers, increase spend, and further diversify the space. As you know, our loyalty program launched nationwide in August, and we've seen great early results. Our enrollment speed is one of the fastest in the industry. And just last week, Newsweek named us one of America's best loyalty programs. We've enrolled a total of 33 million members to date and more than 80% of these are active. This is a testament to our customers' passion for our brand. Our loyalty sales represent approximately two-thirds of our U.S. sales since launch, and our loyalty customers also have higher spend, greater retention rates, and make more trips. And while these results are certainly impressive, we are still only in the early innings of the program, we're confident that more opportunity lies ahead. For example, we can drive more value and attract more customers to the program by increasing engagement through personalization by fully integrating our loyalty program across social, physical and digital interactions and making future program enhancements like tiered accelerators and flexible rewards. We also have an opportunity to leverage data and analytics to build deeper customer connections and deliver more personalized marketing and a more targeted promotion strategy. As Wendy will explain, relative to 2019 product cost inflation has exerted over 500 basis points of pressure on our operating margin. And though we've taken price increases to offset a portion of that pressure, in 2022 customers became increasingly price-sensitive. I believe we can grow our customer base, increase engagement, and drive incremental trips, all while decreasing our reliance on broad-based promotions. We can capture this opportunity by implementing a more targeted marketing approach that is rooted in advanced analytics and customer segmentation. Our product offering and assortment strategies are key to elevating our brand as well as increasing our pricing power and extending our reach. We're focused on leveraging our core strength in fragrance and innovation to extend our product leadership into categories such as men's and wellness, both of which currently represent a small portion of our total business today. And Julie is going to speak in a bit about our product and marketing strategy. We also have an opportunity to drive significant growth in our international business, which on a reported basis is approximately 4% of our sales. This business leverages a partnership-based asset-light model. In 2023, we expect our international business to continue to accelerate with double-digit top-line growth and operating margins that are accretive to our overall business. We're committed to expanding our reach and strengthening our position as a leading global brand through market expansion, new stores, and digital growth. Beauty and personal care category customers value a true omnichannel experience. And to that end, we have a strong fleet of profitable stores, both off-mall and in-mall, and these position us close to the customer. We also have a strong digital business. We see a significant opportunity to better connect our stores and e-commerce platform to deliver a seamless experience and increase our customer lifetime value. As an example, dual-channel customers spend three times more than single-channel customers, but dual-channel customers represent less than 15% of our customer base. So increasing penetration by just one percentage point could drive up to $50 million in sales. Technology is a key enabler of our growth. And as the team has shared, we are in a process of separating our IT systems from Victoria's Secret, and we expect to complete that transition this summer. But we're also assessing and investing in the foundational tools and systems that we'll need to support the company's future growth. We're focused on building out incremental capabilities to enhance the customer experience, evolve our loyalty program, support advanced analytics, and deliver more personalized marketing and strengthen our omnichannel capabilities. We also remain committed to driving margin expansion and cost savings through effective management of pricing and promotions, along with finding additional ways to operate more efficiently. Following my functional business reviews, I see meaningful opportunities to reduce expenses and improve operating efficiency. I'm mindful that we've increased revenue 40% since 2019. And while our team has done an excellent job accommodating that growth while separating from Victoria's Secret, we now have an opportunity to position the business for margin expansion and efficiency. To that end, we are targeting $200 million of annual cost savings across the company. We expect to realize over half of those savings in 2023 and a substantial portion of the remaining savings in 2024. We've engaged external advisers to assist in a top-to-bottom review of the business. As we pursue opportunities for both growth and margin expansion, we are prioritizing actions which we believe will create durable value for our shareholders. While we're focused in the near term on optimizing the core business, we'll continue to explore longer-term opportunities, such as adding new adjacent categories. With respect to 2023, we expect that ongoing macroeconomic challenges will continue to impact customer spending. At the same time, we expect that we will continue to see inflationary pressure on our input costs in the first quarter before beginning to see some relief as we move through the year, and we are pleased to enter this year in a clean inventory position. Regarding SG&A, the technology investments we're making to separate our systems and develop critical capabilities will help to reinvigorate growth and support the long-term success of the business. This will, however, create cost pressure in 2023. We're focusing on what we can control, and we're taking aggressive actions to drive profitable growth in the future. And despite near-term macroeconomic pressures, I am very optimistic about our future and our ability to reach our $10 billion sales target and deliver industry-leading operating margins of 20%. We look forward to updating you on our progress as we work to realize the full potential of our omnichannel model and profitably grow our business and deliver long-term shareholder value. So with that, I will turn the call over to Julie, who will review our brand and category performance.

Thank you, Gina. In the fourth quarter, customers responded well to our holiday assortment which included both Christmas favorites and cozy new fragrance additions. We are an affordable luxury brand with covetable gift offerings, and a key tenet of our holiday strategy was offering gifts at all price points. We drove a strong gifting business in the fourth quarter, exceeding our expectations and last year's results with record high gift-set sales and particular strength in overall gifting that last week before Christmas. The season was led by our iconic holiday traditions and top fragrances such as Winter Candy Apple and Vanilla Bean Noel. We brought back these customer favorites in new packaging that spans multiple categories and forms. Offering our customers' favorites in multiple forms is really a competitive differentiator for us, and we find that it drives customer loyalty and purchases. Our cross-category assortment is the key reason for our customers to come back and visit us each year. We saw success with our ability to tell cohesive and compelling fragrance stories across the shop, which continue to resonate with customers who want to enjoy our fragrances for both body and home. The fragrance stories that performed well during the quarter include core fragrances, such as Champagne Toast, returning holiday favorites such as Fresh Balsam, and new fragrances, such as Strawberry Snowflakes. Our men's business continues to be our fastest-growing category in body care as we test new forms and merchandising ideas. In the fourth quarter, for the first time, we launched a new single fragrance launch for the men's business, After Dark. The response to this launch exceeded our expectations. And we will leverage the significant insights we gained from it to guide future innovation. Soaps continued to perform well, outpacing the total shop. Our new packaging and holiday scents met the customer's mindset during this time of year and really drove demand. We continue to expand our formulation that's made without paraben, sulfate, or dyes. Our relaunch of our gel soap has performed well, and we see opportunities for meaningful future growth through this form. We've been able to maintain our strong market leadership position in the sanitizer business. Though as expected, we continue to see a shift out of this category, which we know surged during the pandemic. Body care outperformed in the fourth quarter, led by body lotion and cleansers. Our customers continue to show their affinity for our body care collection as our unit sales exceeded last year's fourth quarter. Travel also outpaced other categories as customers continue to increase their mobility post-pandemic. Home fragrance was down compared to last year as expected. However, we achieved the most successful Candle Day in our history as customers continue to come and celebrate one of their favorite holidays. Innovation and newness are key drivers of our business and we look ahead to spring; we are focused on delivering fresh and compelling new scents, such as our new Among the Clouds and Coco Paradise. We also have some exciting new product expansions to our Gingham fragrance portfolio coming from Mother's Day as well as additional launches later in the year. As part of our continued focus on delivering innovation and newness, we've rolled out men's antiperspirant deodorant to our entire chain, and we are seeing very promising results. We look forward to further expanding our men's portfolio later in the year. We recently also launched a new signature tumbler in candles which rounds out our candle portfolio and offers a burn time of 30 to 50 hours. We continue to increase our assortment of scent control Wallflower heaters that offer customers choice and how much scent to enjoy in each room of the house. We're also expanding our wellness collection that is geared toward elevating our customers' daily wellness routine with curated collections for body and home. And we will continue our sustainability initiatives. Later this year, we're excited to be offering cartons that enable our customers to refill their soap containers and minimize waste. The customer is always at the center of our innovation process, and we will continue to add new compelling products and packaging as we work to expand our brand's global potential. We're also building capabilities to better connect with our customers and drive margin expansion through more personalized marketing initiatives and more targeted promotions.

Thank you, Julie. Starting with our fourth-quarter results, we were glad to exceed our initial guidance for the quarter. We generated earnings from continuing operations per diluted share of $1.86, surpassing our guidance of $1.45 to $1.65 per share. This was largely due to a better-than-expected margin rate, primarily driven by improvements in transportation costs and a favorable inventory situation that led to reduced clearance activity, as well as lower SG&A expenses than anticipated. Net sales for the quarter totaled $2.9 billion, down 5% year-over-year due to declines in both transactions and average dollar sale, as our customers remained price-sensitive amid macroeconomic pressures. However, fourth-quarter net sales rose 29% compared to 2019. In our U.S. and Canadian stores, fourth-quarter sales were $2.08 billion, representing a 5% decrease from the prior year. Store sales were up 19% compared to 2019. Fourth-quarter direct sales were $716 million, marking a 6% decline year-over-year but a 66% increase from 2019. Our customers are increasingly utilizing our buy online-pick up in store, or BOPIS, option, often adding to their in-store purchases. BOPIS sales are counted as store sales. We expanded BOPIS capabilities to over 800 additional stores in 2022, and we currently have BOPIS available in more than 1,300 stores. For the fourth quarter, international sales reached $95 million, a 30% increase compared to last year. Our international operations mainly operate through franchise, license, and wholesale partners, and our recognized sales include royalties and wholesale product sales. Total international system-wide retail sales were approximately $250 million in the fourth quarter and $700 million for the full year of 2022. The gross margin rate for the fourth quarter declined by 480 basis points to 43%, primarily due to a significant drop in merchandise margin rate and deleverage from buying and occupancy expenses, mainly stemming from lower sales and higher labor costs in our distribution and fulfillment network. The decrease in merchandise margin rate was largely attributable to rising product costs from ongoing inflation in raw materials, transportation, and labor, as well as increased promotions to stimulate sales. Inflationary impacts were around $60 million in the fourth quarter. Our average unit retail decreased in the low single digits for the quarter, performing slightly better than expected and compared to the third quarter. We maintained a focus on disciplined expense management in light of sales trends and economic uncertainty, which resulted in lower-than-expected SG&A expenses for the quarter. Total SG&A deleveraged by 190 basis points, with technology expenses responsible for about 100 basis points of pressure. Additionally, increased store wage rates led to a further 70 basis points of deleverage as we raised wages for customer-facing associates to remain competitive while managing labor hours in line with sales expectations. Factoring all this in, the total company operating income for the fourth quarter was $653 million, or 22.6% of net sales. Turning to the balance sheet, total inventories at the end of the quarter were flat compared to last year, outperforming expectations due to effective inventory management. Finished goods retail units were down 5% compared to last year, which was also better than anticipated. The balance between flat dollar values and a 5% unit decrease was mainly due to inflationary pressures on product costs but was somewhat mitigated by a reduction in component inventory compared to last year. Our inventory is in good shape, and we're well positioned as we head into the new year with flexibility in our supply chain. Importantly, our overall real estate portfolio remains robust, with approximately 99% of our store fleet being profitable, and our stores continuing to significantly outperform pre-pandemic levels, especially in non-mall locations. In 2022, we permanently closed 48 stores, mainly found in malls, but we opened 95 new off-mall stores in North America, resulting in net square footage growth of about 5% for the year. For our international operations, we saw record store growth through our partnership model, ending the year with 427 stores. Before discussing our fiscal '23 guidance, I'll provide an overview of our core performance from 2019 to 2022 to give you a clear view of our progress moving forward. I encourage you to check the supplemental slides on our Investor Relations website for more details. Starting with 2019, baseline revenue for Bath & Body Works was $5.4 billion, with a gross margin of 44% and an operating margin of 19.2%. Sales in 2022 increased 40% from 2019, with contributions from both unit growth and increased average retail. While we’re forecasting lower sales in 2023, we remain confident in reaching our $10 billion sales target. Although operating margin has decreased by 100 basis points compared to 2019, we achieved a 32% increase in operating income dollars. The drop in margin rate was primarily due to over 500 basis points of cost inflation, along with 140 basis points of technology and transition expenses related to our separation from Victoria's Secret and 70 basis points from higher store wages. We did manage to offset some of the inflation impact through pricing, but similar to other retailers, we observed increased price sensitivity among customers in 2022, which hindered our ability to raise average retail prices. As Gina mentioned, we are focusing on developing more targeted, personalized marketing strategies to expand our customer base and increase foot traffic while reducing reliance on broad promotions, which should enhance our merchandise margins. We anticipate that cost inflation will begin to ease after the first quarter of this year. Regarding technology expenses, our IT initiatives and investments are concentrated on finalizing our separation tasks through the summer. Post-separation, we plan to build new capabilities to stimulate profitable sales growth, including enhancements to our loyalty program, supporting advanced analytics, refining our marketing strategy, and advancing our omnichannel capabilities. Our strategy assumes ongoing technology costs at current levels as we phase out separation-related expenses and invest in the establishment of our standalone capabilities and teams. As Gina mentioned earlier, we are collaborating with external advisors to thoroughly assess our cost structure and implement measures to counter ongoing pressures in both gross margin and SG&A, as well as fund our strategic investments. We are early in this journey but are aiming for $200 million in annual cost savings, with over half projected to impact our 2023 outlook, mainly in the second half of the year. We expect to realize a significant portion of the remaining savings in 2024. Our initiatives cover a wide range, with opportunities in transportation, product margins, store operations, home office expenses, and indirect spending. We've recently initiated this work and look forward to providing updates in the upcoming quarters. As we move beyond recent challenges and capitalize on our profit optimization initiatives, we’re targeting industry-leading operating margins of 20% along with a gross margin of around 45% and an SG&A rate of about 25%. Now, turning to our fiscal '23 financial outlook, we are sharing our guidance for 2023 along with comparisons to 2022. It's important to note that fiscal '23 will include a 53rd week, meaning the fourth quarter will comprise 14 weeks. Our outlook factors in the effect of this week, estimated at $0.07 per diluted share. The forecast considers ongoing macroeconomic uncertainty and anticipated consumer sentiment. For the entire year, we project flat sales to a mid-single-digit sales decline, which assumes first-half performance will mirror fourth-quarter trends with moderate improvement in the latter half of the year as we anniversary past softness in sales. Adapting to changing business trends quickly is ingrained in our operations. We will leverage our vertically integrated supply chain and agility to maximize sales and accommodate demand. Additionally, we aim to promote growth through our loyalty program, as these customers tend to visit more frequently and spend more than other customer types. Our current customer segmentation strategies are intended to lead to more effective and efficient marketing. Our international segment is expected to continue providing healthy growth with margin benefits; we anticipate double-digit growth in international net sales for 2023. We expect the full-year gross margin rate will be approximately 42%, with inflationary pressures lingering in the first quarter before easing as the year progresses. We are forecasting average unit retail to remain relatively flat, but will actively seek opportunities to increase AUR and enhance margins through targeted, data-driven marketing efforts. We also expect buying and occupancy expenses to face deleverage due to lower sales and investments in direct fulfillment capabilities aimed at promoting future omnichannel growth, which will be partially counterbalanced by our profit optimization initiatives. Our plan anticipates a full-year SG&A rate of around 26%, primarily affected by rising store wage rates and technology expenses, but also offset by the gains from our cost optimization strategies. We expect full-year net nonoperating expense of approximately $320 million, an effective tax rate of about 26%, and approximately 231 million weighted average diluted shares outstanding. Taking all these factors into account, we project earnings from continuing operations per diluted share to fall between $2.50 and $3 for the full year. Regarding capital expenditures, we are forecasting about $300 million to $350 million in 2023, focusing on investments that support future growth. Our plans include continued investment in selected remodels and the opening of new off-mall stores, along with enhancements to our technology, distribution, and logistics capabilities to foster growth. About $35 million of planned capital expenditures relate to costs shifted from 2022 to 2023. This year, we plan approximately 115 real estate projects, including around 90 new off-mall stores and 25 remodels of the White Barn store design, offset by approximately 50 mall closures, resulting in a total square footage growth of around 4%. We expect to generate free cash flow between $600 million and $700 million in fiscal '23. Now, let’s look at our first-quarter '23 outlook. We expect low to mid-digit sales declines for the first quarter. The forecast for the first-quarter gross margin rate is around 41%, with the decline from the previous year mainly driven by expected lower merchandise margin rates and deleverage in buying and occupancy. We anticipate slight declines in AUR adjusted for mix, given ongoing price sensitivity among customers. Our forecast includes approximately $20 million in additional inflation-related costs for the first quarter, covering raw materials, wages, and transportation. Buying and occupancy expenses are also expected to face deleverage as a result of the sales decline and the ramping operations at our new direct-to-consumer fulfillment center during the first and second quarters. We predict that our first-quarter SG&A rate will be around 30% of sales, with the increase mainly due to technology investments and the rise in store associate wages. We expect first-quarter net nonoperating expenses to be approximately $80 million, with a tax rate around 27%, and weighted average diluted shares outstanding expected to be approximately 230 million. With all these factors, we forecast first-quarter earnings from continuing operations per diluted share to range from $0.17 to $0.27. Our outlook for the first quarter reflects current softer demand trends and heightened inflation and wage pressures, but we believe this does not accurately represent our expectations for the entire fiscal year, as we anticipate that some of these headwinds will ease in the second half. Regarding inventory, we began 2023 with a very healthy inventory position. We expect to conclude the first quarter with a slight reduction in both inventory dollars and units as compared to the first quarter of 2022. Concerning capital allocation, we are dedicated to a balanced and disciplined approach. Our top priority is investing in the business to drive profitable growth by significantly enhancing the customer experience, advancing existing and new product categories, investing in new off-mall locations and remodels, improving fulfillment capabilities, completing our IT separation, and implementing essential new technology capabilities. We are committed to returning cash to our shareholders as well. Our plans include maintaining an annual dividend of $0.80 per share, with intentions to increase it over time as our earnings grow. Discussing our capital structure, we conclude the year with a gross adjusted debt-to-EBITDA leverage ratio of 3.1x, above our target of approximately 2.5x; on a net basis, our leverage ratio stands at 2.4x. Although we are above our target, we are confident in our ability to return to the intended range over time. We have no debt maturities until 2025 and about $600 million due over the next four years. Comparatively, in 2022, we generated over $600 million in free cash flow after our regular dividend payments. We believe we are starting the year with $700 million more cash than needed to cover our anticipated working capital requirements. We will explore the best uses for our cash throughout the year as we gain clearer insights into macroeconomic trends, contemplating options like debt repayment and share repurchases. In preparing for the year, we recognize the ongoing macroeconomic challenges affecting our customers and their spending behaviors, as well as the current business trends. We aim to outperform our forecast by utilizing our agile vertically integrated supply chain to meet demand and developing capabilities to drive future profitable sales growth while working with external advisors on a thorough review of opportunities to support our profit expansion. Taking a refreshed view of our core business will empower us to confidently pursue growth opportunities. That concludes our prepared comments.

Thanks, Wendy. Before we start the Q&A, we want to briefly address the recent disclosure by Third Point. We issued a response last night. The Board will respond to Third Point at the appropriate time. That said, today's call is focused on discussing our fourth quarter and fiscal year results, so we ask you to keep questions related to those results. We'll now move to the Q&A session. Danielle?

Our first question comes from Jay Sole with UBS.

I guess what I'm curious about is some of the cost inflation and maybe what's been incremental that you've seen over the last 90 days. Just help us understand sort of the difference between the margin outlook for this year compared to the margin outlook for last year?

Thank you, Jay, for your question. Regarding inflation, we previously discussed three main areas affecting us: raw materials and components, transportation, and wages. First, regarding raw materials, one key raw material for us is candle wax. We have observed some improvement in costs for candle wax, bringing us back to 2022 levels, although we are still above pre-pandemic costs. We are seeing some positive signs. As for our other raw materials, the market is generally stable, and while we hope for continued decreases, we are not currently anticipating significant deflation in these components. Moving on to transportation, we notice that volume remains down, which is beneficial as it creates excess capacity and offers us more options with carriers. In terms of trucking, we are in the midst of our annual bidding process with our partners, and initially, we're observing a year-over-year decline, which is favorable and provides us with deflation in line haul starting in the second quarter, and this has been incorporated into our guidance. For parcel transportation, we've seen a decline in surcharges, but the base rates are rising, resulting in a generally flat situation year-over-year. Lastly, for Final Mile transportation, we continue to face pressures primarily due to labor. Overall, we expect some deflation beginning in Q2, driven by line haul, which is included in our guidance.

And if I can just ask one more. I think you mentioned you're still targeting 20% EBIT margin. Did you put a time frame around that? Around when you believe the company will get back to that level?

Yes, we believe that a 20% EBIT margin is best-in-class and the right target for us. While we don’t want to restrict ourselves to just 20%, we think this rate allows us to balance our investments in the business while maximizing returns for our shareholders. It's hard to specify a time frame, but we are working diligently to improve margins and will continue to strive to reach that goal as quickly as possible.

Our next question comes from Alex Straton with Morgan Stanley.

Great. Congratulations on a strong quarter. I wanted to follow up on the 20% EBIT margin target. It seems like quite a significant jump from where we are now, but you have achieved this in the past. Can you explain how you plan to close the gap from approximately a 16% margin this year to 20% in the long run? What are the main factors we should consider in this transition?

Sure. As we look ahead, our primary focus is on increasing net sales and we're dedicated to enhancing our top line performance. The challenges we're experiencing in 2023 are largely due to the negative sales guidance, which creates leverage issues. Achieving sales growth is crucial for us to return to that 20% margin. Additionally, we are constantly exploring ways to grow Average Unit Retail (AUR) positively for our customers. We have a culture of testing and learning in our business, and we experiment with pricing strategies every weekend to understand how to effectively increase AUR while maintaining customer satisfaction. Historically, we've managed to achieve AUR growth in the low to mid-single digits pre-pandemic, and we believe innovation and a compelling product assortment will drive AUR growth over time, which is essential for attaining that 20% target. On the margin front, our merchandise margin rates are currently below pre-pandemic levels. While we've discussed inflation, we expect some deflation this year, and ideally, we hope for a bit more improvement, which will coincide with AUR increases to boost profit rates. Lastly, regarding expenses, we are conducting a thorough review of our organization and indirect spending, aiming to optimize our expenditures in line with the size of the business. We are highly focused on reaching that 20% margin goal as part of our strategy to enhance the organization and our spending profile.

Great. Maybe just one quick follow-up. It feels like part of the bigger SG&A guide this year is really related to kind of tech spending. So can you just walk us through sort of what the shortcomings you feel are there? Or what exactly you're trying to improve? Just so we have a better sense.

Certainly. I would say that from the beginning of the year through the end of summer, our focus is on separating from Victoria's Secret. The majority of our spending is directed towards that goal. Additionally, we are in the process of establishing our own organization and team. This focus will continue into the first part of the year. We are looking forward to completing that separation because it will enable us to pursue future opportunities. We've identified numerous areas for investment, particularly in marketing, such as loyalty programs and customer outreach strategies. We're also excited about the potential of using data analytics to enhance our marketing and promotions. Our investments will concentrate on customer-facing initiatives as we move into the latter half of the year.

Our next question comes from Matthew Boss with JPMorgan.

Great. So maybe dual-part question, Gina, could you elaborate on the cadence of business trends maybe as the fourth quarter progressed. Any notable change in business that you've seen post holiday here in January or February? And then Wendy, on AUR, where have you seen customers the most price-sensitive across categories? And just how best to think about your AUR plan for the first half of the year maybe relative to your back half expectation?

Thank you, Matt, for your question. Let's begin with the fourth quarter and how it unfolded. Our weakest month during the quarter was November, which was noted by other retailers as well. The first three weeks of November were the most challenging for us, similar to others in the industry. However, as we moved into December, we observed an improvement in trends, particularly in traffic. Julie highlighted Candle Day at the start of December, which was a positive event for us. Specifically, we experienced strong sales during the fourth and fifth weeks of December, meaning the weeks leading up to and following Christmas were particularly robust. January remained strong, especially during the initial two weeks as we kicked off our semiannual sale. In summary, December and January were strong months for us, while November posed significant challenges. Regarding Average Unit Retail (AUR), as mentioned in our prepared remarks, we anticipate a slight decrease in AURs for the first quarter. Our promotional strategy in Q1 will be similar to last year's, but we expect AURs to decline slightly. For the entire year, we forecast AURs to remain roughly flat. We are actively working to enhance this outcome and will consider increasing prices and reducing promotions without jeopardizing margin dollars, which is our overall strategy. Now, I’ll turn it over to Julie for additional insights.

Yes. I want to highlight that we have been gradually raising our prices this spring, and our everyday pricing strategies have been performing well. For instance, we are now selling soaps at 5 for $27 instead of 5 for $25, and wallflowers follow the same pricing adjustment. We are not experiencing any pushback on these price increases from our customers. Additionally, we have implemented price increases across various products using a good, better, best strategy, which we believe will be beneficial. However, we have noticed some sensitivity regarding our promotional pricing. In the short term, we are working to maintain strong customer engagement while also seeking to raise prices, supported by an agile operating model that allows us to adjust promotional activities effectively based on results. I want to remind everyone that our average unit retail prices have increased by nearly 20% since 2019. As Wendy mentioned, we have a history of successfully raising our AURs in the low single digits, and we aim to continue this trend. Our guidance anticipates that promotional levels will remain mostly unchanged from last year, and we will be responsive to maximize our performance.

Wendy, just one follow-up. On the 20% operating margin target, I know that's relative to low to mid-20s in your previous plan. Is the change in the long-term operating margin target driven by a lower gross margin assumption longer term?

I would like to point out a few things. In the past two years, we have experienced significant increases in input costs, particularly labor. As we have worked on our separation and considered the future, we've recognized that certain areas of our business, like technology, need more investment to support future growth. Therefore, we aim to invest while also acknowledging the substantial inflationary pressures we are facing. This balanced approach allows us to invest in the future while also providing a return to our shareholders.

Our next question comes from Kate McShane with Goldman Sachs.

We were curious to hear a little bit more detail about what role the loyalty program played in the fourth quarter and what you're assuming the lift could be from loyalty in Q1 and your overall 2023 sales guidance?

I think Julie, but I can provide additional details.

Yes. So we are very pleased, very pleased with our enrollment in the program. We projected to be about 30 million members by the end of the fiscal year, and we enrolled 33 members with more than 75% of those members having shopped with us in the last 12 months. And as we've discussed on other calls, we all know that loyalty members outperformed non-loyalty in spend, trips, retention, and cross-channel shopping behavior. So I think that we have a huge opportunity. We think about '22 as the year of enrollment, and we're thinking about '23 as our year of engagement. So our strategic path forward is to really capitalize on the very high rate of data collection that allows us to both identify and market to enrolled customers. So with customer segmentation and advanced analytics work that will allow us to customize our loyalty offering to maximize enrollment and engagement. We can also attract more customers by fully integrating our loyalty program across social, physical, and all of our digital interactions. We want to test and try to influence member behavior by leveraging points-based incentives to drive incremental trips, trial of new products, and we will be pivoting to more member-only events, content, and engagement as we have seen our sneak peaks and our exclusives be very successful.

Thank you, Julie. In response to your question, I want to add that we previously conducted a test of our loyalty program before the nationwide launch in August. We measured performance in several markets during the test period. We experienced a moderate lift in the fall season based on our pre and post-analysis, which is encouraging. However, what excites me most in terms of financial potential is that now we have the program and a substantial number of members. This presents us with opportunities to leverage data collection to enhance our marketing strategies and drive transactions with these customers, which I believe holds significant promise for the future.

Our next question comes from Paul Lejuez with Citi.

This is Kelly Crago on for Paul. I wanted to dig a little further into your kind of longer-term framework around the top line. I think you mentioned you believe you can sort of grow AURs low single digits over the longer term. I guess when we think about it, top line, does that assume the coming units flattish and we should sort of take low single-digit top line growth, comp growth? And then maybe a couple of points square footage. Just curious if you could provide a little bit more color on that.

Yes. As we consider a multiyear model, our focus remains on achieving comparable sales growth. We believe we can achieve this in the low single digits over time, but we are always aiming for mid-single digits or higher. Over the past few years, we have balanced our growth through both unit sales and average unit retail (AUR). By successfully growing both units and AURs, we can reach low to mid-level comparable sales growth while maintaining our focus on both areas over multiple years. Regarding square footage, we anticipate experiencing growth in that area in the low single digits over time, which will serve as a crucial driver for our store revenue growth in the long term. We've also discussed opportunities in international markets. Although this segment is currently a small portion of our business, we find it exciting because it has significant potential for meaningful double-digit growth as we expand globally. This will be an essential aspect of our growth strategy moving forward.

Wendy, you mentioned that in the first quarter, cost inflation would impact gross margins by $20 million, but that's expected to change moving forward. Will it shift from a negative to a positive impact in the second quarter, or will it simply be less of a negative? Additionally, how should we view the progression of gross margins throughout the year?

Yes. It turns to a tailwind in Q2. I would say the tailwind right now is about $10 million in Q2, but we will, of course, chase that. Hopefully, it's a bigger number.

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

I wanted to follow up on the gross margin guidance for the year. It does sound like after the first quarter, most of the inflationary pressure has actually flipped to positive, yet your guidance assumes a flattish gross margin for the rest of the year after the first quarter. Can you just bucket the pressures that you're expecting in those quarters two through four to offset these benefits from inflation and transport flipping?

Yes, for the full year, we continue to face some challenges with product margins and profit and loss leverage. Our average unit retail prices are largely stable. We anticipate a slight growth in average unit costs, which is creating some pressure. Additionally, we are experiencing pressures in buying and occupancy costs. The investments we have made in our stores are beneficial and yielding returns, but they also lead to some negative impacts in a declining comparable store sales environment. Furthermore, we are seeing some elevated costs in buying. Our focus remains on improving all areas of the profit and loss statement to achieve better results, which includes looking for increased opportunities in product margins.

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

Gina, I was hoping just higher level, maybe what you think about the right price versus 2019 architecture should be. Just curious how you're thinking about maybe the right balance between revenues and gross margin? Clearly, you guys got a lot of really nice AUR, you got great brand equity. You also may have had a little bit of over purchasing through the pandemic. So just any thoughts there on how to balance revs and gross margins.

Thanks for the question, Simeon. Gina, maybe if you want to start off with the focus on how we're growing sales in '23. And then Wendy, if you want to follow up with some detail there.

So just to clarify, are you asking about the balance between revenue and gross margin in 2023?

Yes. Yes, you guys earned a lot of price and a lot of brand equity. So I'm just curious how you're thinking about promotions versus units just thinking about the balance there.

Yes. You likely heard in our discussions about promotions and our approach. Julie mentioned testing various strategies. Our focus is on broad-based promotions, which can be somewhat imprecise. We're aiming to use data and analytics to better target our promotions where they are needed the most. Since joining, I've been dedicated to developing our marketing infrastructure. We're conducting exciting customer segmentation that aligns with our loyalty program. This capability is enabling us to create more effective and efficient promotions. This gives me confidence in how we can enhance our margins and average unit retail, supporting both top-line and merchandise margins. It’s an important focus area for us that we haven’t previously prioritized, and we anticipate seeing progress in the latter half of the year as we continue to build this capability. That covers the promotional aspect, but Wendy, you had a longer-term comment as well.

That answer your question, Simeon?

Yes, that's helpful. Gina, as you consider the company and reflect on how 2019 compares to our current situation, that perspective is really valuable. Wendy, may I follow up on the previous question? Do you happen to know the implied occupancy and other fixed cost deleverage included in the full year revenue guidance?

Our occupancy expense for the full year is forecasted to increase by 5%, which translates to approximately 50 to 60 basis points of deleverage.

We want to thank you for joining today's call. A replay will be available for 90 days on our website. Thank you for your interest in Bath & Body Works.

That concludes today's conference. Thank you all for participating. You may disconnect at this time.