Bath & Body Works, Inc. (NYSE:BBWI) Q2 2023 Earnings Call Transcript

Bath & Body Works, Inc. (NYSE:BBWI) Q2 2023 Earnings Call Transcript August 23, 2023

Bath & Body Works, Inc. beats earnings expectations. Reported EPS is $0.4, expectations were $0.33.

Operator: Good morning. My name is Ted, and I will be your conference operator today. At this time, I would like to welcome everyone to the Bath & Body Works Second Quarter 2023 Earnings Conference Call. Please be advised that today’s conference is being recorded. [Operator Instructions] I will now turn the call over to Ms. Heather Hollander, Vice President, Investor Relations at Bath & Body Works. Heather, you may begin.

Heather Hollander: Thank you. Good morning. And welcome to Bath & Body Works’ second quarter 2023 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’ 2022 Form 10-K for factors that could cause the actual results to differ materially from these forward-looking statements. Today’s call contains certain non-GAAP financial measures. Please refer to this morning’s press release and supplemental materials 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, President, Retail; and Eva Boratto, Chief Financial Officer. I will now turn the call over to Gina.

Gina Boswell: Thank you, Heather, and good morning, everyone. Thank you for joining us today. Before I discuss our performance and progress in the quarter, I’d like to thank our teams for consistently delivering terrific service to our customers, remaining agile in a dynamic environment and executing on our strategic initiatives. We are also very pleased to have welcomed Eva Boratto as Bath & Body Works new CFO at the beginning of this month. She is a seasoned executive with over three decades of financial, operational and retail experience, and she’s already hit the ground running. You will, of course, hear from Eva on today’s call. Now moving on to our second quarter results. Net sales were in line with our expectations, declining 3.6% compared to the prior year.

Adjusted diluted earnings per share of $0.40 were better than planned, with the majority of the outperformance driven by the benefits of our cost optimization initiative, increased average unit retail or AUR and improved merchandise margin. In fact, year-over-year merchandise margin rate increased modestly for the first time in nine quarters. I continue to be very pleased with our team’s ability to drive efficiency in the business while building the capabilities to drive future growth. In the second quarter, we once again showcased our exceptional innovation capabilities. With the completed rollout of our new hand soaps, all of which are formulated a paraben, sulfates and dyes, continued delivery of newness through our genome fragrance collection, the addition of grooming to our men’s offering, the successful limited launch of our new fragrance haircare line in July, which has received a very positive response from our customers, and finally, the launch of hand soap refill cartons in July, providing our customers with a convenient sustainable solution.

We were also pleased with our Mother’s Day results and executed well in our June semiannual sale, delivering merchandise margin rates above our expectations. From a category perspective, in the second quarter, our body care sales increased versus the prior year. Home fragrance and soaps and sanitizer sales declined as expected, driven by post-pandemic normalization. Importantly, year-to-date, we have increased unit share across these product categories. As expected, we continue to see some pressure on basket size during the quarter. To be clear, we aren’t seeing any trade down in our business, but we have observed that the customer is carefully managing their spending against the backdrop of a challenging macroeconomic environment. As we look ahead to the remainder of the year, we remain focused on delivering innovation and building capabilities to position our company for above industry growth when our categories normalize.

Our revenue is approximately 40% above 2019 levels and we have diverse opportunities and multiple initiatives designed to deliver long-term topline growth and margin expansion. We are making progress on the five key areas that I outlined on our last call; first, elevating the brand through innovation and upgrades to our forms, packaging and merchandising; second, extending our reach through adjacencies and international growth; third, engaging with our customers by fully leveraging the strength of our loyalty program, enhanced technology and more personalization; fourth, enabling a seamless omnichannel experience by advancing our digital platforms and connecting them with our stores; and finally, enhancing operational excellence to drive efficiency.

Julie will speak to our progress in brand elevation and extending our reach in a moment, but I’d like to dig a little deeper on the other three, returning to our work to better engage with our customer. We are deepening our connection across the customer journey, building on our history of connecting with the customer through fragrance, outstanding products and a terrific shopping experience, whether online or in-store. Our customer segmentation analysis identified the customer groups that represent our biggest growth opportunities and has given us a better understanding of their unique needs and motivations. These insights are now informing our innovation, merchandising and marketing, and enabling us to be more effective and efficient in reaching our target customer segments.

We are also building our technology capabilities to implement a more personalized targeted approach the marketing and promotions rooted in data and analytics. Through this work, we plan to increase trial of new products, encourage cross-channel and cross-category shopping, build the customer’s basket and drive incremental trips. Now that we have successfully completed the vast majority of our IT separation from Victoria’s Secret, we will begin testing personalized marketing and optimize promotions this fall, that apply these capabilities more broadly and derive more value from them at the beginning of the year. Our loyalty program continues to be a key component of customer engagement. This August, we anniversaried the national launch of our loyalty program and we remain pleased with our enrollment of nearly 38 million members, with loyalty sales representing approximately three-quarters of our U.S. sales since launch.

While we will continue to build on our impressive enrollment, our primary focus is on increasing engagement. For example, in the second quarter, we not only of our loyalty members to both for the featured fragrances in our laundry product, we then gave them exclusive access to a previous sample event. Next, we gave our loyalty members a sneak preview of our Halloween collection and an exclusive to early Halloween shopping event prior to the national launch. We have more benefits planned and we are excited to test new capabilities such as accelerators in the third quarter. Beyond that, we are focused on fully integrating our loyalty experience throughout our channels. We are still in the early innings of our loyalty program and we are confident in our ability to drive more sales and improved merchandise margins, while attracting more customers to the program.

Moving to the next area of focus, which is enabling a seamless omnichannel experience. Although we have a strong profitable digital business, our digital assets are largely transactional. As we move to more experiential integrated platforms, we plan to drive higher sales, more discovery and larger baskets through personalized landing pages, immersive content and product recommendations. In the second quarter, we introduced personalized recommendations on our website and mobile app. This month, we will begin to deliver personalized e-mail content. Later in the third quarter, we plan to test immersive video content on our website and mobile app with a broader launch plan for the fourth quarter. As you know, we completed our national rollout of Buy Online, Pickup In Store, or BOPIS in the first quarter.

BOPIS orders increased 25% in the second quarter as customers are increasingly choosing this convenient option and approximately 30% of BOPIS customers made an additional purchase in store when they picked up their order, which is a testament to the power of the outstanding in-store experience delivered by our talented associates, iconic fragrances and compelling assortments. Delivering a seamless omnichannel experience will allow us to convert more single channel customers to dual channel customers, which, on average, increase spend threefold. Finally, we are enhancing operational excellence and efficiency through $200 million of planned annual cost savings across the company. We are on track to deliver approximately $150 million of those savings in 2023 and Eva will share additional detail on plans for the second half of the year shortly.

Eva will also provide an update to our fiscal 2023 guidance, which reflects our bottomline outperformance in the second quarter and sales expectations for the second half of the year. As I touched on earlier, the customer has been cautious in managing their spending amidst the softer macroeconomic backdrop. However, they are still responding to newness, innovation and our compelling seasonal events. We are taking action to deliver innovation and build the capabilities that will allow us to better serve our customers, drive above industry growth and deliver margin expansion. Bath & Body Works has a highly differentiated business model, positioned at the intersection of consumer goods and retail, and a strong fleet of profitable stores with off-mall and in-mall that position us close to the customer.

We have a vertically integrated supply chain, which allows us to respond quickly to changing customer and macro trends, along with a strong balance sheet and a history of superior growth and free cash flow generation. As we navigate macroeconomic pressures, I am confident that we have a diverse set of opportunities to profitably grow the business and create value for our shareholders, built a strong foundation that exists today. With that, I will turn the call over to Julie.

Julie Rosen: Thank you, Gina. We started the second quarter with a strong Mother’s Day, delivering newness with our Gingham all back of collection and a strong gifting assortment. As you know, our vertically integrated supply chain allows us to read and react to trends quickly and we have leveraged this capability as we chased winners and delivered additional inventory to meet customer demand. As Gina mentioned, we executed well in our June semiannual sale and we are pleased to deliver merchandise margin rates above our expectations. We were very intentional in structuring this year’s event to drive early interest by offering compelling price points on sale products and introducing full price new summer season product alongside the event.

We then took fewer markdowns over the course of the event and delivered better-than-expected merchandise margin rate. Turning to category performance. Second quarter body care sales increased slightly versus last year, a sequential improvement from the first quarter. Body care was propelled by growth in Fine Fragrance Mist, Travel, as well as our men’s business, which posted a double-digit sales increase this quarter and remains one of our fastest growing product lines as we add new forms and merchandising ideas. At the beginning of the quarter, we launched Men’s Grooming, which performed well and exceeded our expectations. We are very excited about the growth of our men’s business as it is bringing in new customers to our brands and also garnering the attention of younger customers.

The home fragrance and soaps and sanitizers categories both declined versus last year, as expected driven by continued industry-wide post-pandemic normalization trends, which we have discussed previously. Sales for the home fragrance and soap and sanitizer categories collectively represent just over half of our business. We remain market leaders in these categories and have gained unit share year-to-date even as the categories experienced pressure at the industry level. We remain focused on innovating and positioning for future growth in these categories. For example, wallflowers once again outperformed candles as customers are spending less time at home. We are leaning into the demand by increasing our assortment of in-control wallflower heaters and offering decorative innovations such as the projection wallflowers in our Halloween collection, which illuminate and project festive images.

Turning to our strategic initiatives. As Gina mentioned, I will provide some detail on how we are making progress in elevating our brand and extending our reach to accelerate growth. This quarter, we continued to deliver innovation in product and merchandising. This was visible and our refreshed core hand soap offering, including the completed rollout of our new formulation made without paraben, sulfates or dyes. Additionally, we have rolled out foaming hand soap refill and recyclable paper cartons to all U.S. stores, allowing customers to conveniently refill their soap containers and minimize waste. Beyond soap, we are innovating and elevating our product and packaging while staying true to the brand heritage. For example, this month, we brought back fan-favorite purpose spraying water [ph], a new and elevated packaging and formulations.

We also added a sensitive skin product with colloidal oatmeal. This ingredient-led collection is an exception of our wellness category and intended to provide the additional moisture, hydration and sensitive skin solutions that our customers are seeking. And within merchandising, we are evolving our storytelling to broader inspirational brand storytelling, including recommendations for selecting and using the product, as well as creating the perfect gift. We demonstrated elements of this within our Gingham offering, which was designed to be an immersive shopping experience. This included new fragrances in Gorges, Fresh, Vibrant and Gingham Legend for Men across multiple forms, as well as front of store and digital takeovers and beautiful gifting options.

As we work to extend our reach, we are leveraging our core strength in fragrance and innovation to expand into adjacent categories, including fragrance haircare, men’s, wellness and laundries. We are also building on the success of our international business. As I mentioned, this quarter, we expanded our men’s product portfolio to include grooming. The first stage of our expansion focused on face and beard care and launched in the advance of Father’s Day. In September, we are expanding in men’s hair and shaving. As part of our ongoing innovation cycle, we tested fragrance haircare products last summer, and we are very pleased with the customer response to our fragrance led positioning. In the second quarter, we launched haircare in approximately 560 stores and online with shampoo and conditioner in five of our signature scent and dry shampoos in three.

The launch has exceeded our expectations, and we plan to complete the rollout to all U.S. stores next spring. This month, we are excited to Elevate the Mundane with the launch of our laundry line, including many of our best-selling fragrances across a limited number of stores and online. Initial customer feedback from our previous sample event has been very positive with customers noting that our laundry detergent is an exciting new way to add another layer of their favorite scent to their daily routine. As we work to broaden our customer base and attract a younger customer, we know that lift products represent an important opportunity. Therefore, we are upping expanding and relaunching our in-store assortment and visual presentation of our lift products across a limited number of stores this fall with additional expansion to follow early next year.

With the addition of fragrant haircare, laundry and lift, we are now able to offer our iconic fragrances across as many as 22 product forms. We are also committed to extending our reach geographically and continue to evaluate opportunities to build on the success of our international business and drive significant growth through further market expansion, new stores and digital growth with our partnership based model. As we look ahead to the third quarter, we are very excited about the launch of Halloween. We launched Halloween one week later this year to better align with the customer mindset. For the first time, we are placing this assortment at the front of our stores to give it additional prominence and we are expanding our most loved spend such as Vampire Blood across categories.

For our fall assortment and scents, we have listened to the customers and are bringing back our iconic fall scents such as Leaves and Pumpkin Pecan Waffles in new and elevated packaging. And for Hispanic Heritage Month we are featuring a consumer series celebrating Patty Hidalgo and her longstanding contribution to our fragrance portfolio, including customer favorite Strawberry Pound Cake. Bath & Body Works is an outstanding beloved brand and we are excited about what’s ahead as we continue to deliver new compelling products and capitalize on opportunities for profitable global expansion. In closing, I’d like to thank our teams for their dedication to delivering industry-leading innovation and service and delighting our customers. And with that, I will turn it over to Eva.

Eva Boratto: Thank you, Julie, and good morning, everyone. I am excited to join you today and honored to be part of this outstanding company. Over the past several weeks, I have spent my time immersing the business, while engaging with the executive leadership and finance teams. I have also had the opportunity to participate in the financial planning process and observe the progress the teams have made on the company’s strategic initiatives. The last few weeks have reinforced my belief that Bath & Body Works is on the right path to capitalize on the tremendous opportunities ahead and create significant long-term value for shareholders. Today, I will start by reviewing our second quarter financial results, then I will provide an overview of our guidance for the third quarter and fiscal year 2023.

Starting with the second quarter results. we generated adjusted diluted earnings per share of $0.40, exceeding our guidance range of $0.27 per diluted share to $0.32 per diluted share. Our adjusted results exclude the gain on the early extinguishment of debt associated with the debt repurchases in the second quarter. We were pleased with our second quarter operational outperformance resulting from the benefits of our cost optimization initiative, increased AURs and improved merchandise margins. EPS also benefited from interest expense favorability in part associated with the repurchase and retirement of debt in the second quarter and tax rate favorability, resulting from the resolution of certain discrete tax matters related to the Victoria’s Secret spin-off.

Net sales for the second quarter were $1.6 billion, in line with our expectations. The year-over-year decline of 3.6% was driven by a decrease in both transactions and average dollar sale. In U.S. and Canadian stores, second quarter sales totaled $1.1 billion, a decrease of 1% versus the prior year. Second quarter direct sales of $329 million decreased 10% compared to last year. Adjusted for BOPIS, direct demand decreased 6% in the second quarter. As a reminder, BOPIS sales are recognized as store sales and we completed the BOPIS rollout to U.S. stores in the first quarter. International sales were $86 million and declined 4% versus last year. Note, on a year-to-date basis, international sales increased 4%. There are two components to our international net sales.

Royalties collected off franchise retail sales and wholesale revenue generated by the product we sell to our franchise partners and while wholesale revenue declined in the second quarter due to lower orders and shipments, total international system-wide retail sales posted a double-digit increase, propelled by new store openings and strong sales for the June semiannual sale event. Our guidance for the back half of the year assumes that our international sales returned to growth. Our gross profit rate for the second quarter decreased by 90 basis points compared to prior year Q2, representing a year-over-year sequential improvement of 255 basis points from the first quarter. Merchandise margin rate improved modestly year-over-year for the first time in nine quarters.

This improvement was driven by deflation benefit, increased AUR and reduced transportation costs, partially offset by continued investment in product formulations and packaging innovation. Improvements in merchandise margins were offset by buying and occupancy expense deleverage primarily due to lower sales and increased occupancy expense from new store sales growth — sales. Total SG&A deleveraged by 200 basis points, representing a year-over-year sequential improvement of 90 basis points in the first quarter. Technology expense was the biggest driver of deleverage, reflecting our IT separation costs, as well as strategic investments to drive future growth. As expected, we partially mitigated the impact of technology investments with our cost optimization work, which produced efficiency in store labor hours and home office expense.

All said, our cost optimization work produced benefits of approximately $30 million in the quarter across gross profit and SG&A. Second quarter total company operating income was $188 million or 12% of net sales. Turning to the balance sheet. We repurchased $115 million senior notes principal for $106 million in the quarter. We remain focused on disciplined inventory management and ended the second quarter with total inventory dollars down 16% compared to last year. Heading into the second half of the year, our inventory levels are well positioned. Our overall real estate portfolio remains very healthy, with 99% of the fleet profitable and store significantly outperforming pre-pandemic levels. In the second quarter, we continued to increase our off-mall penetration opening 30 new off-mall North American stores and permanently closing 17 stores, principally in malls.

Our international business, our partners opened 16 new stores in the second quarter, ending the quarter with 444 stores. Now turning to our fiscal 2023 guidance. We are providing our 2023 guidance with comparisons to 2022. And as a reminder, fiscal 2023 includes the 53rd week, so the fourth quarter of fiscal 2023 will consist of 14 weeks. The impact of the 53rd week reflected in our guidance is estimated at $0.07 per diluted share and our guidance excludes the impact of any further debt or share repurchase activity. With that as context, we are updating our fiscal year guidance to reflect Q2 performance, narrowing our sales range, raising our gross profit expectations and factoring in the benefits of the debt and share repurchases through the second quarter, resulting in an increase to our EPS guidance.

Now let me provide some additional color on these changes. For the full year, we now expect sales declines of 1.5% to 3.5%, reflecting our year-to-date performance, continued macroeconomic uncertainty, judicious consumer spending and post-pandemic category normalization across the industry. For the first two quarters of the year, our sales were in line with the midpoint of our projections. Factoring in year-to-date performance and improved visibility, we are narrowing our sales range around the midpoint of our prior guidance. The company is very adept at quickly reading and responding to changing business trends and we plan to leverage that agility to chase demand and maximize sales. We are enhancing our operational excellence and efficiency and plan to deliver approximately $100 million in cost savings in the second half of the year.

Approximately 30% of the savings are related to reduced transportation expense, with the remainder reflecting other benefits of our program, including efficiency in store labor and selling productivity as we better align staffing hours to traffic, reduced expense as we optimize our call center, home office expense efficiency and decreased indirect spend. Gross margin exceeded our expectations in the first half of the year and we are now raising our forecast for the full year gross margin rate to approximately 43%. We continue to expect year-over-year merchandise margin rate to improve in the second half of the year supported by greater deflation benefits and efficiency produced from our cost optimization work. These benefits are partially offset by investments in formulation and packaging upgrades to reinforce our competitive position.

Overall, we expect merchandise margin rate to expand by approximately 100 basis points in the second half of the year versus prior year, resulting in improved merchandise margin rate for the full year. We still expect buying and occupancy expense to deleverage for the year, driven by sales levels and increased expense from new store growth, with less deleverage for the remainder of the year, as our new direct-to-consumer fulfillment center ramps. Our guidance still assumes a full year SG&A rate of approximately 26% with deleverage driven by lower sales levels, technology expense and increased store wage rates, partially offset by the expected benefits of our cost optimization work. We now expect full year adjusted net non-operating expense of approximately $295 million, reflecting interest expense favorability from debt repurchases through the end of the second quarter.

We still expect an effective tax rate of approximately 26% and weighted average diluted shares outstanding of approximately $230 million. For the fiscal year 2023, we are increasing our adjusted earnings per diluted share guidance range to $2.80 to $3.10, we continue to plan for $300 million to $350 million of capital expenditures in 2023 and we now expect to generate free cash flow of $675 million to $725 million in fiscal 2023. Turning to our third quarter 2023 outlook, we are forecasting sales decline of 2.5% to 4% versus the prior year, we expect gross profit rate of approximately 42% and an SG&A rate of approximately 31% of sales. We expect net non-operating expense of approximately $75 million and a tax rate of approximately 26% and weighted average diluted shares outstanding of approximately $229 million.

Considering all these factors, we are forecasting third quarter earnings per diluted share of $0.30 to $0.40. Looking now at our capital allocation. Our first priority is investing in the business to drive profitable growth. We are also committed to returning cash to shareholders. In the first six months of the year, we paid $92 million in dividends and we plan to continue paying an annual dividend of $0.80 per share with an intention to increase the dividend over time as earnings increase. In the second quarter, we also repurchased 1.3 million shares for $50 million in the open market. In addition to returning cash to shareholders, we are committed to returning to our target leverage ratio of approximately 2.5 times gross adjusted debt to EBITDA over time.

We ended 2022 with a leverage ratio of 3.1 times and through the second quarter of the year, we have repurchased $199 million principal amount of our senior notes in the open market. We will continue to take a balanced approach to capital allocation, considering options such as additional debt and share repurchases. In conclusion, I am excited about the future of our business and we are focused on taking the necessary actions to drive profitable growth and generate value for all stakeholders. At this time, we would be happy to take your questions and I will turn it over to Heather for Q&A.

Heather Hollander: Thanks, Eva. For our Q&A session, we ask that participants limit their responses to one question and one follow-up. We will now move to the Q&A session. Operator?

Q&A Session

Operator: Yes. [Operator Instructions] The first question in the queue is from Kate McShane with Goldman Sachs. Your line is open.

Kate McShane: Hi. Good morning. Thanks for taking our questions. It was really encouraging to see that you grew AURs in the quarter. We wondered if you could talk to us a little bit more about this and what role it plays in your updated guidance today?

Julie Rosen: Yes. So from an AUR perspective — this is Julie, by the way. Thank you for the question. We actually, as you know, semiannual sale plays a huge role in our Q2 and we took a very balanced approach to driving sales and improving merchandise margins. So our semiannual sales event sales were below last year’s event, but in line with our expectations. We executed well, we offered compelling price points on sale products, while also introducing full price new summer season product alongside the event. Customers responded very favorably to our event. They continue to carefully manage their spending in light of macroeconomic conditions, which had an adverse effect on the impact of the number of items added to the basket.

Ultimately, we took fewer markdowns over the course of the event and delivered better-than-expected merchandise margin rate. I would also say that AUR increased slightly this quarter and remains significantly elevated since 2019. And as a note on pricing, we have taken price increases in spring 2023, we have created more differentiated assortments to drive pricing power. As a reminder, our AUR has increased slightly this quarter but significantly compared to 2019 and we do have a long track record of AUR growth in the positive low single-digit levels prior to the pandemic.

Eva Boratto: And Julie, if I could just add, as it pertains to our guidance, we are assuming flat AURs in the back half of the year and we will continue to test for opportunities to increase AURs, as Julie has just explained and expand margin through more data driven targeted marketing efforts.

Kate McShane: Thank you. And then if we could just follow-up with a question on the candle, soaps and sanitizers. Can you talk what — about what that category looks like on stack or versus 2019 and just how it performed also versus Q1?

Julie Rosen: Yes. Thank you for that question. So though the home fragrance and soaps and sanitizers categories are normalizing post-pandemic. We have gained unit share year-to-date and we are a market leader in these categories and plan to build on that position. We do continue to innovate and position for growth in these categories. For example, wallflowers, as I mentioned, continue to outperform. So we are leaning into that demand. We also recently refreshed our core soap offering, including the completed rollout of our new formulation made without carbon sulfates and eyes and additionally rolled out our foaming hand soaps and recyclable cartons. So we are absolutely focused on our core businesses and innovating in them to drive growth. To 2019, all categories are up significantly in the double digits. So no category is below.

Heather Hollander: All right. Thanks, Kate. We will take the next question please.

Operator: Next question in the queue is from Alex Straton with Morgan Stanley. Your line is open.

Alex Straton: Great. Thanks so much for taking the question. I have got two for you, one on guidance and then one on the longer term outlook. So on guidance, it seems like the full year update implies a deceleration in quarter over growth in the fourth quarter and I think a little bit lower sales than there. So what’s driving that more conservative view on the fourth quarter. And then, secondly, on the long-term, I know you guys have that 20% EBIT margin target out there. What do you view as the key factors holding you below that rate right now and how do you think about the time line to getting back to that goal in the future? Thanks a lot.

Eva Boratto: Alex, this is Eva. I will start with your question as it pertains to the Q4 guidance. As you look at our back half of the year guidance first, right, in our full year guidance. What we have done is we have narrowed our sales range to the midpoint of what we had previously provided and that really reflects our performance that we have seen in the first two quarters that were in line with our performance. And it also reflects the cautious consumer and while we haven’t seen trade downs in our business, we are seeing the consumer be more thoughtful at the overall basket size. So as we have this visibility, there’s a lot of macro uncertainty, that’s how we thought about the topline in the back half of the year.

Gina Boswell: And as it relates to — it’s Gina. As it relates to your question around the 20% operating income margin long-term, there’s a few things we feel very comfortable that as a long-term target, that’s the right one, 20% is the best-in-class operating income rate for our sector and we don’t want to limit ourselves to 20%, but we do think that, that number over time, best balances the investment in the business to drive future growth while maximizing shareholder return. Clearly, in the last couple of years, there have been step function increases in input costs and labor and certain parts of our business like technology, they require additional investments to fuel our growth and those are very important as we evolve our marketing program, our loyalty and our omnichannel.

But I am pleased with the track that we have on our initiatives. I am pleased with what we expect in terms of margin recovery and a very disciplined approach to expenses. So very comfortable with that.

Alex Straton: Okay. Thanks.

Heather Hollander: Thanks, Alex. We will take the next question.

Operator: Next question is from Ike Boruchow with Wells Fargo. Your line is open.

Ike Boruchow: Hey. Good morning, everyone. I guess I wanted to ask a question around costs, your AUC more so into next year. Can you comment about some of your key raw materials, primarily soy what those costs look like today, how they should flow into the P&L come next year? Just curious for some high level thoughts over the next 12 months there? Thanks.

Eva Boratto: Hi, Ike. This is Eva Boratto. From a deflation perspective, we saw — we experienced about $20 million of deflation in the Q2 and we expect $30 million in Q3. We expect that benefit to increase throughout the remainder of this year. As you look at raw materials, I will just add a few comments. Overall, we did see most prices peak in 2022 with expected deflation in 2023. Wax has been outlier with significant price volatility up and down year-to-date. We saw a spike in soy over the past 60 days with some concerns over dry weather impacting the crop. We have seen an impact being smooth via commodity risk mitigation processes and I think they are the key things that I would highlight. I think it’s premature to comment on what we expect in 2024 and will certainly come back as we are ready to provide our 2024 outlook.

Ike Boruchow: Great. Thank you.

Heather Hollander: All right. Thanks, Ike. Next question please.

Operator: Next question is from Dana Telsey with the Telsey Group. Your line is open.

Dana Telsey: Hi. Good morning, everyone. As you think about the new products that you are introducing, Julie, and what the gross margins could look like on some of the new products, is there any difference from the core gross margin to the business overall? And then the loyal members, any more color on the loyalty members and their acceptance of the new products and what statistics you are looking to hit for loyalty members by the end of the year? And then just lastly, on the off-mall stores, anything you are seeing at all in terms of productivity rates, anything with what we have heard with organized crime and shrink in what you are doing? Thank you.

Julie Rosen: Thanks. Thanks, Dana. Nice to hear your voice. So starting with the new products, we have launched a lot of adjacencies that we are starting to test, optimize and roll. So I just want to review them very quickly and then I will talk to your margin question about them. So in men’s, as you know, in the second quarter, we successfully launched Men’s Grooming and in September, we are following with Men’s Hair and Shave. We continue to focus on APDO as it is the number one form in the men’s market and men’s continues to be our fastest growing category in body care. The men’s margin is commensurate with the shop. So we are very excited about that. Fragrance haircare in the second quarter was launched to 560 stores and online in July, and the launch has exceeded our expectations and we expect to complete that rollout to all stores next spring.

We also have lift as we work to broaden our customer base and attract a younger customer. We are upgrading, we are expanding and we are relaunching our in-store assortment and visual presentation of our lift products across limited number of stores in the third quarter. Additional expansion will happen next year. And then finally, of course, there’s laundry, which we are very excited about to be launching this month across a limited number of stores and online. So initial customer feedback from our preview sample event has been very positive with customers noting that our laundry detergent is an exciting way to add another layer of their favorite sent to their daily routines. So some of those adjacencies are commensurate was shot from a margin perspective.

Others are not quite there yet, but we have a longstanding history here at Bath & Body Works. As you have seen with wallflowers and tree works [ph] over the years, that with scale, we have no doubt that we will get there. So I will skip to the straight question, if that’s okay, and then I will have Gina come back to your loyalty question, if that works. So as is the case with the retailers, we have seen external pressures adversely impacting our shrink rate and it has gotten worse this year. That being said, the impact has been factored into our guidance and we are working with our stores, with government and community partners to achieve lower loss rates over time. So I will let Gina talk to loyalty.

Gina Boswell: Thank you. So loyalty is — as you know, we are very proud of one of the best rollouts in Bath & Body Works’ history in terms of the enrollment speed among the fastest in the industry. So we are very pleased with the enrollment to-date. And as I mentioned, we are early stages of deriving the value from the program, but some of the things that Julie had mentioned in terms of the previews that we have used, whether it’s the laundry or the sneak preview of Halloween, we absolutely use the loyalty platform in ways to build the excitement around some of the launches and we will continue to do that. The benefits that we have planned going forward on new capabilities like accelerators, which you may see in other programs, that’s happening in the third quarter, so that’s sort of become.

And then this — actually this month, we have our first annual member appreciation event, because we are celebrating the one-year anniversary. So you will be seeing a lot of surprise and delight product drops, you will see first looks, exclusive offers to reward our loyal customers. So lots going on in loyalty and with the 38 million members strong, that’s a lot to work with. So we are excited on the go forward there. And I think you may have had a question around off-mall as well and actually we are quite pleased Julie can chime back in, but we are quite pleased with the traffic, both in-mall and off-mall, and the off-mall sales performance exceeds the in-mall, but the traffics are actually quite good. Julie, did you want to add anything about in-mall…

Julie Rosen: No. I think that you have absolutely answered that question. We do have opportunities with new stores as they continue to drive a great return for us.

Dana Telsey: Thank you. Great.

Heather Hollander: Thank you. Next question please.

Operator: Next question is from Matthew Boss with JPMorgan. Your line is open.

Matthew Boss: So, Gina, could you speak to categories of relative improvement that you saw throughout the second quarter? And then maybe as you just assess the performance of some of the new category launches and early feedback, maybe relative to the normalization curve that you spoke to around candles and soaps and sanitizers, just trying to put together or maybe bridge the path forward. Any way to think about a time line to return to low-to-mid single-digit same-store sales and the multiyear long-term target?

Gina Boswell: Sure. We can talk to normalization as well. Julie, you might want to start with the home fragrance and soap…

Julie Rosen: I actually, why don’t I talk to you about category performance relative to overall performance, just to give you a gauge of what’s happening in our business and then talk to you about how we are thinking about the back half. So body care was our top performing category this quarter and with positive sales propelled by Fine Fragrance Mist Travel and double-digit growth in the men’s business. I think the exciting thing about Fine Fragrance Mist is we just came out of Mother’s Day and that is what we hope to sell during Mother’s Day. Our frag — our home fragrance performed below the shop with declines driven by pressure in candles as was expected. We know this is an industry-wide trend as the category continues to normalize post-pandemic.

Wallflowers performed above the shop and better than handles, because we are seeing people fragrance their homes in different ways. I do want to mention we are still the market leader in this category and we continue to gain unit share in — versus mass, even as the category experiences broader pressure. And then from a soaps and sanitizers perspective, just tearing those apart, I just want you to know that soaps performed in line with shop. We completed our rollout, as I said, of our new formulations, as well as our new foaming refill — foaming hand soap refills. It was sanitizers that performs well below shop as that category continues to normalize and this is a broader industry issue and we continue to gain unit share versus mass in both soaps and sanitizers.

So our back half is really assuming similar trends and we are not really speaking to 2024 right now, no.

Gina Boswell: Yeah. I was — Matt, thank you for the question. I was only going to say that we are not speaking to 2024. We did see normalization we have based on continued normalization into the back half of the year and as well as the macro pressures, too. Our intent and our strategies that we undertake are absolutely building the capabilities to build above industry growth going forward. We are pleased with gaining unit share in the categories that we have as they decline, and quite frankly, we are leaning into some of the pandemic trends that we believe will endure, right? So there’s areas like wellness and healthcare. We can have categories contract, but we can take our fair share or more and then hang on to the ones that sort of we can grow further from there.

And given our track record, I feel comfortable that we will continue to do that, gaining market share and building the capabilities for future growth. So that when our categories normalize and our macroeconomic backdrop improves, we will have the customer that are frequent, as you know, they come in, they replenish and that’s why from a personal perspective, I think, unit share is a wonderful way to measure our performing.

Matthew Boss: Helpful color. Best of luck.

Gina Boswell: Thank you.

Julie Rosen: Thank you.

Heather Hollander: Thanks, Matt. Next question please.

Operator: Yes. The next question is from Lorraine Hutchinson with Bank of America. Your line is open.

Lorraine Hutchinson: Thank you. Good morning. The new guidance implies a nice year-over-year improvement in the fourth quarter gross margin. Can you talk about your expectations for the promotional environment over holiday and also the sustainability of these gains into next year? Thank you.

Julie Rosen: So — hi, Lorraine. It’s Julie. From a promotional, sorry, from a promotional perspective, we are actually looking at promotions being in line with last year. As you know and have seen, we are incredibly, incredibly agile in our promos. So when we need to add something and we do and when we need to pull something out, we do. So we see it actually in line.

Eva Boratto: Lorraine, this is Eva. I will add a little more color on the back half of the year trends and sequentially Q3, Q4, how we are looking at things. So as you look at the back half of the year, as you mentioned, we are seeing margin improvement and that’s coming from a few places. One, our Q3 and Q4 merch margin both quarters we expect to improve 100 basis points versus LY due to our continued efforts around supply, as well as price. We are also getting a benefit as our B&O deleverage improves, particularly in Q4, it’s a greater impact in Q4, obviously, we get the ramp of the sales line, but also the ramp of our new customer fulfillment center as we — as that ramps through the period. Finally, I will say our SG&A deleverage improves in the back half and sequentially Q3 to Q4, again, a sales increase, greater impact from our cost optimization and Q3 has cost — elevated costs related to staffing in the seasonality of our business that we experience each year.

So hopefully, that provides you some additional color there. And in terms of durability, while we are not commenting to 2024 here today, right? From our cost initiatives, we continue to target $200 million of annual cost savings and we will continue to strive to achieve more. We are focused on our margins, reducing cost, but also driving the topline.

Lorraine Hutchinson: Thank you.

Heather Hollander: Thanks, Lorraine. We are ready for the next question please.

Operator: Next question is from Adrienne Yih with Barclays. Your line is open.

Adrienne Yih: Great and congratulations on the progress. It’s very nice to see the merch margins. So I guess I will start there with the merch margin. First time it’s up in nine quarters. So can you talk about, Eva, I think, this is for you. Can you talk about that merchandise margin relative to pre-pandemic? And then Gina, if you see the new packaging and the elevation in Julie as well. Can you talk about sort of how you think about weaning the business off of some of these promos that kind of come out semiannual, et cetera, as you make your way toward kind of a more elevated product in particular categories and how you think about price — further price appreciation, price taking in that higher elevated category? Thank you very much.

Julie Rosen: Yeah. So I will start, Adrienne, with the merch margins since pre-pandemic. It is still downside slightly from pre-pandemic given the inflation that we have experienced over the last couple of years.

Gina Boswell: Yeah. And your question around when can we expect, I mean, I think, everybody is clear on our strategies around how we elevate the brand and the product and the way we have been, and Julie explained well, in terms of what we do with semiannual sales, right, to sort of have the price is sort of adjust and so that we can eke out the margin that we had. I think from a longer term point of view and it’s not so long-term, because we are building those capabilities as we speak is, how do we move from broad-based promotions into more personalized and that has been something that we are now doing, because we have successfully completed the vast majority of our separation from Victoria’s Secret. So with that in the rearview mirror, we have been putting tests in place, and so as an example, we introduced some personalized recommendations to our website and our mobile app and it was a small initial test, but we see the conversion rates, people engaging with personalized content to a greater degree and that is the toolkit really to start targeting our promotions more effectively driving efficiency there and we will start to see those for sure in the quarters that follow, but we are testing that right now.

And beyond that, the way we read, react, respond as it relates to where the customer is that is really a strength of this organization. So wherever we can get average unit retails without impacting. We basically have an analytical approach to drive elasticities like I have never seen at very real-time dynamics here. So I think when we have both testing, as well as week-to-week where is everybody at, we can drive the merch margin.

Julie Rosen: Yeah. Just one final point on that is just promos will still be a traffic driver for our business. But I do believe, as Gina has said, by sharpening our approach with the right technology in place, we are going to really leverage that data and analytics deliver that more personalized targeted messages to our customer and what the hope is and what we know will happen is that we will increase trips, spend and engagement, while reducing our reliance on those broad-based promotions.

Adrienne Yih: Fantastic. Great to see the progress.

Gina Boswell: Thank you.

Heather Hollander: Thank you. And Operator, we have time for one more question, please.

Operator: Okay. The last question is from Olivia Tong with Raymond James. Your line is open.

Olivia Tong: Great. Thanks and good morning. I want to ask you two questions. First, about trends exiting the quarter, your view in terms of back-to-school. You mentioned in earlier remarks, your expectation to provide AUR in second half. If you could talk about what’s driving that given that it had improved in Q2 and if that maybe factoring loan repayment is a piece of that. And then I also wanted to touch on your approach reacted to the core in terms of the new categories, whether it’s bringing in any new customers or expanding the share of wallet existing just where that consumer is coming from? Thanks so much.

Eva Boratto: Sure. Hi, Olivia. I will — this is Eva. I will start with trends exiting the quarter. Sitting here today, as we look at our August performance for the first half of the month, it’s right in line with the expectations that we provided today. If your question was more asking about second quarter, our second quarter sales normalizing for timing of events that we have performed right in line with our expectations and there were no trends to really — there were no trends month-to-month to call out.

Julie Rosen: As far as customers go, Olivia, we do know from the data that men’s is bringing in new customers and more customers who identify as mail and now customers also you younger, we know that from our data. The other thing we are starting to see that these are early stages is that our lift product is also engaging a younger customer. So as we roll out hair and laundry and lip and continue to test, optimize and work with men’s, we will grab the data and continue to let you know how we are tracking.

Gina Boswell: Yeah. And I was simply going to say you mentioned the magic word for me, which is it is really about the core and more and so — and as much as we talk about how the customer develops around reaction to lift or men’s and younger and more diverse. There are certainly opportunities and our customer segmentation work is indicating that. The core categories are also supportive of our customer expansion and we think there’s equal amounts there that we can believe, so.

Eva Boratto: And you had one additional question for me about flat AURs in the guidance. You are correct, we are assuming flat AURs in the back half of the year and we will continue to test for opportunities to increase the AUR and expand margin through data driven initiatives, targeted marketing efforts, et cetera. But flat is our guidance assumption.

Olivia Tong: Thank you.

Heather Hollander: All right. Thanks, Olivia. 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 Bats & Body Works. Have a great day.

Operator: This concludes today’s call. Thank you for your participation. You may disconnect at this time.