Victoria's Secret & Co. (VSXY) Q2 2024 Earnings Call Transcript

Good morning. My name is Amanda, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Victoria's Secret & Company’s Second Quarter 2024 Earnings Conference Call. Please be advised that today's conference is being recorded. All parties will remain in a listen-only mode. I would now like to turn the conference over to Mr. Kevin Wynk, Vice President of External Financial Reporting and Investor Relations of Victoria's Secret & Company. Kevin, you may begin.

Thank you, Amanda. Good morning, and welcome to Victoria's Secret & Company's second quarter earnings conference call for the period ended August 3, 2024. As a matter of formality, I would like to remind you that any forward-looking statements we may make today are subject to our Safe Harbor statements found in our SEC filings and in our press releases. Joining me on the call today is CFO and Interim CEO, Tim Johnson. We are available today for up to 45 minutes to answer any questions. Certain results we discuss on the call today are adjusted results and exclude the impact of certain items described in our press release and our SEC filings. Reconciliations of these and other non-GAAP measures to the most comparable GAAP measures are included in our press release, our SEC filings, and the investor presentation posted on the Investors section of our website. Thanks. And now, I'll turn the call over to T.J..

Thanks, Kevin, and good morning, everyone. I'm pleased to report that second quarter results exceeded or met our expectations for the quarter on all key financial metrics and we delivered year-over-year quarterly operating income growth for the first time since 2021. We were encouraged by the continued sequential improvement in quarterly sales results in North America for the fourth consecutive quarter, as sales trends improved in both our stores and our digital channels. Our customers responded to new merchandise deliveries and events with particular success in the launch of our Victoria's Secret Dream bra collection, in apparel with our PINK Friday back-to-campus event in late July, and through consistent steady improvement of VS sport as we introduce the Featherweight Max front-close bra and a broader assortment of merchandise flowed to stores and digital. Sales for the second quarter 2024 were $1.4 billion, a decrease of 1% to last year and at the better end of our expectations for the quarter. In North America, the improvement in sales trends was evident in both our stores and in our digital businesses. Momentum experienced at the end of the first quarter in April continued into the month of May. As anticipated, sales performance during our semi-annual sale period in the June timeframe was lower than last year, driven by fewer units on sale, particularly in PINK apparel. We saw strength in July driven by the introduction of product newness with the Victoria's Secret Dream bra collection, in apparel with our PINK Friday back-to-campus event and consistent steady growth of VS sport. From a store's perspective, we experienced improvement in traffic, which outperformed the balance of the mall for the quarter and with meaningful outperformance in late July during PINK Friday. In terms of our digital business, traffic levels improved in the quarter and were up compared to the second quarter last year, while conversion was down in the quarter, particularly during the semi-annual sale period when year-over-year we had fewer units on sale in our digital channels. From a market perspective, third-party market data indicates the sales trend in the overall intimates market in North America got a little bit softer in the second quarter than what was reported in the first quarter. Our combined Victoria's Secret and PINK market share in the intimates category remained at 20%. We were encouraged to see our digital market share increase in both bras and panties, along with an overall increase in our sports bra market share for the second consecutive quarter. This was partially offset by a slight decrease in market share in the stores channel, where value or low price points appear to be gaining share. From a merchandise category perspective for Victoria's Secret, our beauty business continues to be our best performing category with year-over-year growth for the fourth consecutive quarter, followed by strong acceptance of VS sport as merchandise available for sale grew throughout the quarter in anticipation of an important event in Q3. In bras and panties, newness and innovation sold well and several older legacy styles were exited or down trended during the spring season. PINK's sales trend overall improved in the quarter both in total and in most major categories. Specifically in apparel, we were encouraged by the improving customer response to product newness during our PINK Friday back to campus event in late July as we ended the quarter. This strength continued into August to start the third quarter as the back to campus event continued in stores and online. In addition to improving trends for Victoria's Secret and PINK, we experienced sales growth in the high-single digits for both our International business and Adore Me. International sales in the second quarter were driven by year-over-year growth with our franchise and travel retail partners. Our performance with our partner Next was also strong in the U.K. and we grew profitability in China, where our top line trends were challenged by the overall market and economic softness in the country. We're optimistic about sales, profit, and growth opportunities for all of our partners around the world. The retail environment in North America was challenging, and the promotional environment remains competitive. But improving product acceptance and disciplined inventory management led to adjusted gross margin dollar growth and 80 basis points of adjusted gross margin rate expansion year-over-year in the quarter. Adjusted SG&A dollars were down in the quarter, leveraging 20 basis points compared to last year and coming in better than our guidance due to disciplined and proactive expense management initiatives to drive incremental efficiency within our operating model. You may recall at our Investor Day, we committed to transforming the foundation of our company and established a $250 million three-year goal, and we're on track to exceed that goal. I believe we have demonstrated our commitment to focusing on efficiencies within our model and improving the cost structure of our business. Aside from the financials, over the last 90 days, we've executed several key actions in support of our strategy and brand positioning for the long term, including in July, we introduced newness with the launch of the Victoria's Secret Dream collection, a collection of bras, panties, and sexy sleep that combines the ultimate experience in beauty and everyday comfort. Also in July, we added a new style to our top-selling sports bra with the launch of the Featherweight Max front-closed where maximum support meets maximum comfort now with an easy zip front closure. Additionally, within the VS brand, we launched the Tease Sugar Fleur beauty collection, a limited edition version of our fan favorite Tease. We continued to create meaningful and memorable connections with our customers, including the return of PINK Friday the last weekend of July as our collegiate customers get ready to head back to campus, and with the celebration of National Underwear Day in early August. You may have heard the Victoria’s Secret Fashion Show is returning on October 15 in New York City, with an amazing cast of talented women. The show's return will deliver precisely what our customers have been asking for: glamour, runway, fashion, fun, wings, entertainment all through a powerful modern lens reflecting who we are today. And we continue to further develop our understanding of our Victoria's Secret and PINK customer through our multi-tender loyalty program, which has now been active for just over a year. We have 32 million members who drive about 80% of our sales on a weekly basis. Through insights and data, we are focused on turning our understanding of our customers into world-class seamless customer experiences. As we look forward, we're encouraged our North America business trends have continued to improve as we move through August and the start of the third quarter. Early customer feedback on fall assortments is encouraging for both the Victoria's Secret and PINK brands, and our beauty business has continued solid performance and is driving traffic to our stores. Strategically, we have several exciting events planned for the balance of the third quarter including a major VSX sport launch and the return of our Victoria's Secret Fashion Show to kick off the all-important holiday season. While we're optimistic about the positive signs we're seeing in our business, we recognize the consumer environment remains challenging and our customer is pressured economically. We remain focused on what we can control, which is leveraging our market position in intimates and delivering on multiple initiatives to drive growth in our business over the longer term. Today for fiscal 2024, we are raising our financial forecast to reflect Q2 and spring outperformance to our original expectations, and also some level of modest improvement in our fall assumptions. For the year, we now expect sales to be down approximately 1% to a comparative 52 weeks from fiscal 2023, compared to prior guidance of down low-single digits. This forecast reflects sequential improvement in North America along with continued strength in our International business and tracks in line with the positive trajectory we've been discussing throughout 2024. At this forecasted level of sales, we expect our adjusted operating income in 2024 to be about $275 million to $300 million compared to prior guidance of $250 million to $275 million. We also now forecast our adjusted free cash flow in 2024 to be approximately $200 million to $225 million, compared to prior guidance of $175 million to $200 million. For the third quarter of 2024, we're forecasting sales to increase low-single digits compared to sales in the third quarter last year. And at this level of sales, we are forecasting a third quarter adjusted operating loss in the range of $40 million to $60 million. And finally, we're sure you also saw our recent announcement regarding the appointment of Hillary Super as our next CEO effective September 9. Once again, we want to thank Martin for his time with the company and his support, and we're excited for Hillary to take us into our next chapter. Thank you. That concludes our prepared comments. And at this time, we'd be happy to take any questions.

Thank you. Our first question comes from Ike Boruchow with Wells Fargo. Your line is open.

Hi. Good morning, TJ. Congrats on the results. Two – I think two from me. Just first real quick on the model, you talked about International up high singles, it sounds like you're confident there. Can you just tell us, what you're expecting from the International segment in the back half of the year? And then could you just elaborate further on the promo environment that you're seeing and what you're basically baking into your plan? I'm most curious what kind of promo/gross margin outlook you can maybe share with us for the fourth quarter specifically? Thanks.

Thank you for the question, Ike. We're very enthusiastic about our International business globally. As I mentioned earlier, both our travel retail and franchise sectors were particularly strong in the second quarter. We've had great success with our partners in the U.K. However, we have seen a slight decline in China, which seems to be a broader issue affecting consumers there right now. Looking ahead, I expect our travel retail and franchise partners to perform well in the third quarter, along with our partners in the U.K. There are some timing issues with promotional events in China and certain nationwide e-commerce initiatives that we anticipate will shift into the third quarter due to the calendar change. This might make the third quarter a bit stronger than the fourth for our International segment, largely influenced by those calendar shifts in China. Regarding promotions for the third and fourth quarters, our guidance reflects an expectation of similar promotional activity as we experienced in the first half of the year. We are ready to increase our promotional efforts if necessary to achieve our goals. We have become more strategic in leveraging key business areas, such as the beauty sector as a traffic driver, and our panty business has also been effective in attracting customers. The growth of our loyalty program is contributing to an increase in customer traffic, with members now shopping and spending more year-over-year, which is a promising indicator of product acceptance and our ability to connect with them. I believe the three areas I mentioned have the potential to enhance traffic in our business, possibly leading to more promotions this fall. On a broader scale, the most thrilling aspect of our business is the positive reception of new merchandise, particularly in the VS and PINK brands. Nearly a year ago during our Investor Day in New York, we discussed our merchandising strategy and the upcoming new products and category expansions. We're now seeing those efforts come to fruition in our stores this July and August, which is encouraging. We're optimistic about this process and genuinely believe that our new merchandise will lead to success in the latter half of the year. Thank you for the question.

Could you say gross margins will be up or down in the fourth quarter?

Gross margins are guided to be up in the third quarter. I'd say embedded in the model is the rate might be down a little bit in fourth quarter principally because you'll recall we had an extra week in our results last year and obviously an extra week of selling and leveraging B&O has a pretty meaningful impact on margin rates. But I would suggest from a merchandise margin rate when we think about the fourth quarter compared to last year, it might be down a little bit. But the gross margin rate being down is more about the B&O rate than anything else.

Perfect. Thank you.

Yeah.

Thank you. Our next question comes from Alex Straton with Morgan Stanley. Your line is open.

Great. Thanks so much. I just have a couple for you both. So just on the sales guidance raised for the year, I know you said you did have that embed the back half outlook being slightly better than previous. Can you just talk to us about where you've grown more optimistic either by banner or geography or category, just so we understand that a little bit more? And then just a quick follow-up on your promo color that you just gave, which was super helpful. I'm just wondering bigger picture, do you feel like you guys are at the right promotional levels or is it still too elevated compared to what you think of as like a steady-state level for the brand? Thanks a lot.

Thanks for the question, Alex. Raising the sales guidance for the year was mainly due to strong performance this spring, which has exceeded expectations for two consecutive quarters. This has positively impacted our revenue projections. Generally, the sales estimates for the rest of the year remain steady, but we have seen some strengthening in areas below the sales line, particularly in margin and expense management. The team has been effective in managing costs, inventory, and cash flow. What I'm particularly encouraged by is the strong product acceptance in both the Victoria's Secret and PINK brands. We have been anticipating this inflection in July and August for some time, and the new offerings in intimates and related categories are performing well. This is the most encouraging aspect of our current business. The team has worked diligently on this and has done an excellent job. Regarding discounting, while our discount rate has increased slightly year-over-year, we believe this should not be a long-term strategy. This reflects the current market environment and our merchandising evolution as we aim to attract more customers to try the new products. As we move out of the holiday season and into next year, we hope to reduce our promotional levels. It's important to note that we have a structured approach to testing promotions, including control and holdout groups, where we implement less discounting. In the current environment, promotions are effective—they resonate with customers and contribute positively to sales and margins. Therefore, given our merchandising evolution and customer dynamics, we believe that promotions are currently necessary. However, we would like to transition to a less promotional stance in the long run.

Great. Good luck.

Thanks, Alex.

Thank you. Our next question comes from Corey Tarlowe with Jefferies. Your line is open.

Great. Thanks, and good morning. So TJ, I wanted to ask about PINK because you highlighted an improvement there and I know that you've infused a fair amount of newness in that segment. Could you talk a little bit about what you feel is working with that segment and what you think the trajectory might look like into the back half? Thanks so much.

Thank you for the question, Corey. We have been eager to discuss the PINK business positively because a lot of effort has gone into reaching this point. In summary, our tees, tanks, and dresses have performed well in July and August, particularly around the PINK Friday event. As we introduce more new items to the front of the store, we are seeing a positive customer reaction. During late July and early August, many stores experienced sell-out situations. The tees, tanks, and dresses stood out as early successes for the business. You may have also noticed denim shorts and various pant styles available for sale this quarter. Additionally, I must highlight the Wink bra, which launched early in the season and has continued to perform well. There are several encouraging examples that give us hope as we move into the latter half of the year, suggesting there is more potential ahead for PINK. For back-to-school, we introduced backpacks to attract customers to the store and kickstart their shopping experience as a promotional item. The backpack idea has been successful and well-received. One of the most promising signs, especially for those who visit our stores frequently, is the return of younger customers, aged 18 to 22, to the PINK section. There was a noticeable increase in this demographic's foot traffic in our stores during late July and August compared to previous seasons. There is much to be excited about regarding PINK, and we believe there is more to come.

Great. Thanks so much and best of luck.

Yeah. Thanks.

Thank you. Our next question comes from Simeon Siegel with BMO Capital Markets. Your line is open.

Thanks, everyone. Good morning. I hope you had a pleasant summer, and congratulations on the improvements made. I apologize for getting disconnected earlier. If you’ve already covered any of these questions, please disregard them, and I'll catch up through the transcript. Can you quantify the factors influencing the gross margin improvement this quarter and how you see those drivers evolving? What are your expectations for buying and occupancy dollars moving forward, given the comments from this past quarter? Additionally, with the Fashion Show making a return, how are you planning to allocate your marketing dollars this year? Just overall, the growth in EBIT dollars was impressive, which is encouraging. Can you share your confidence in maintaining that growth trend moving ahead? Is this the start of a turnaround? Thank you.

You made up for last time there, Simeon. I think I have three or four points to address. The margin perspective in the second quarter showed significant improvement compared to last year, up about 80 basis points, with gross margin dollar growth exceeding sales activities. It was a strong performance during the quarter. The teams effectively managed inventory, which ended down 2% in line with our guidance, indicating that everything is moving in the right direction. The positives in Q2 were primarily due to work on the cost of goods sold, leading to lower average unit costs. Although we still benefited from favorable transportation activities from the first half of the year, this will become more challenging moving forward. The two main positives from a margin perspective were the cost of goods and the fact that buying and occupancy costs were actually down year-over-year, which mitigated the impact of a decrease in sales. However, it was a promotional quarter across our category and retail in general. Our discount rate was slightly up year-over-year, but we targeted it in key areas like beauty and panties, which was more about driving trial and traffic than liquidating underperforming inventory. Looking ahead, we expect to guide the margin rate upward year-over-year in the third quarter, with cost of goods sold being the main contributor, as well as lower average unit costs. Transportation rates will shift from a beneficial to a challenging factor in Q3. Promotions are likely to remain similar to last year or may be slightly more aggressive. I anticipate that buying and occupancy costs will continue to be flat or decrease in the third and fourth quarters. We manage all costs in our business, not just those reflected in SG&A, and the team is doing an excellent job in that area. I feel confident that with a low-single digit sales increase, we will leverage B&O, even with B&O dollars decreasing. Regarding Q4, as Mauricio pointed out, we expect the margin rate to decline slightly due to last year's cost of goods sold work and the expectation that transportation rates could stay elevated for the remainder of the year. In terms of marketing, we believe our spending is at an appropriate level. While our marketing budget was elevated last year with the World Tour, this year's Fashion Show costs are lower. Overall, marketing dollars will likely decrease year-over-year, but we still see it as a suitable budget. As we approach the third quarter, we're eager to see the positive sentiment, which we already have a good indication of from yesterday's Instagram post announcing the date and notable participants. Customers are excited, and we're looking forward to generating new customer trial through the Fashion Show and the launch of VS sport in the third quarter. Overall, there is much to anticipate from a marketing standpoint. I think I missed the last question.

Hey, Amanda. We're running up on time here. Let's go with one more question, please.

Thank you. Our last question comes from Jonna Kim with TD Cowen. Your line is open.

Thanks for taking my question. Just a quick one for me. You mentioned Adore Me grew high-single digits this quarter. Just curious what were the drivers behind it and what you're assuming for the back half for the brand? Thank you.

Yeah. Thanks for the question, Jonna. In the Adore Me business, I think most people know there are actually two brands which sit inside the Adore Me business as we reported. There's the Adore Me brand which focuses primarily on intimates, but does present other categories. And then there's a second business called Daily Look, which also features at Home Try-On model, but more focused on the apparel side. In the last couple of quarters, we've seen outsized growth in the Daily Look business that's driving the growth in total or overall at Adore Me. So having two different businesses, two different brands inside of that business gives the team the opportunity to toggle investment dollars from a marketing perspective into what's trending, what's working best. And I think they're doing a really, really good job of doing that, so putting the investment where the customer is in the near term. So the Daily Look for the apparel side of the business is driving the majority of the growth there. Having said all of that, they're managing to the total business to high-single digit growth on the top line and pretty meaningful growth here in the second quarter from an operating income perspective. Looking forward, I'm comfortable that they have growth plans here for the third quarter. You may recall that they actually are on a one month lag to our business, so we report them on a one month lag. So we've already seen really the first half of their third quarter, and the business is off to a good start and is on forecast to not only grow in the top line but be profitable in the quarter again. So I'm happy with where we are in the near term in the Adore Me business.

Thank you.

All right. Thank you, everyone. That concludes our call for this morning. We appreciate your interest in VS. Have a great day. Thank you.

Thank you.