Good morning. My name is Cedric, and I will be your conference operator today. At this time, I would like to welcome everyone to the Bath and Body Works Second Quarter 2021 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to turn today's call over to Ms.
Wendy Arlen, Chief Financial Officer at Bath and Body Works. Wendy, you may begin.
Thank you. Good morning, and welcome to Bath and Body Works' 2nd quarter earnings conference call for the period ending July 31, 2021. I'm excited to be with you today on my first earnings call as the Bath and Body Works' CFO. As a matter of formality, I need to remind you that any forward looking statements we may make today are subject to our Safe Harbor statements found in our SEC filings and in our press releases. Joining me on the call today are CEO, Andrew Meslow and SVP of Investor Relations, Amy Preston.
All results we discuss on the call today are adjusted results and exclude the 2020 special items described in our press release. Our Q2 results include the Victoria's Secret business. Consistent with our previously disclosed intention to reduce debt debt by up to $500,000,000 This morning, we announced a tender offer to purchase $500,000,000 of our 2023, 20252027 outstanding notes, which commences today. Thank you. And now I'll turn the call over to Andrew.
Thanks, Wendy, and good morning, everyone. Welcome to our first earnings call as a stand alone public company. We are thrilled to have reached this milestone and to launch Bath and Body Works as a stand alone company. Innovation remains at the foundation of Bath and Body Works. And with our leadership positions across key product categories, strong performance across channels and a highly loyal and growing customer base, We are poised to continue our track record of industry leading growth and profitability.
On behalf of the management team and the Board, I'd like to extend our sincere appreciation to all the associates who have worked so hard on the successful spin off of Victoria's Secret. I am grateful to all of our associates for their contributions to the success of our business as we look forward to capturing the opportunities ahead, and we wish the Victoria's Secret Business and associates well as they embark on their journey as a stand alone public company. Turning to our Q2 performance, we delivered record results, and we could not have done so without the continued hard work and commitment of all of our associates and partners. We'd like to express our deep appreciation for their dedication and efforts. We reported record 2nd quarter earnings of $1.34 per share compared to adjusted earnings of $0.25 per share last year.
These bottom line results were driven by continued strong sales and better than expected margin rates at both Bath and Body Works and Victoria's Secret. At Bath and Body Works, we continue to deliver record results with sales growth of 54% compared to 2019. All categories achieved solid growth and strong sales demand continue to allow us to pull back on promotional activity versus 2019. The Bath and Body Works segment operating income in the 2nd quarter was $431,000,000 an increase of 135% or $247,000,000 compared to 2019 and an increase of 24% or $82,000,000 compared to last year. Our operating income rate for the quarter of 25.3 percent increased 8 70 basis points compared to 2019, driven by merchandise margin rate expansion and leverage in both buying and occupancy and SG and A on the high sales growth.
We expect that the remainder of 2021 will not be easy as the world, the regional environment and our business continue to evolve and as we lap extraordinary 2020 results. We are optimistic about our fall and holiday product assortment and our continued ability to execute against our plans in stores and online. Risks related to COVID do persist, and we will continue to operate both of our channels in a safe manner for our customers and our associates. With continued smart and disciplined management of the business, I know we can proactively accelerate to our next phase of growth. Thank you very much and I'll turn it over to Amy Preston.
Thanks, Sandra. That concludes our prepared comments. At this time, we'd be happy to take any questions that you might have. We plan to end this call shortly before 9:30 in order to allow you to join the Victoria's Secret earnings call. In the interest of time and consideration to others, please limit yourself to one question.
Thanks. And I'll turn it back over to the operator.
Thank you. And our first question comes from Kimberly Greenberger with Morgan Stanley. Your line is open.
Okay, great. Very nice quarter here and congratulations on the separation. I wanted to ask about
the sort of
Look forward, if we could, into Q3 and Q4, and how we should think about, If you have any way for us to think about the standalone business and the financials, and any comment you've got about how Q3 started, That would be very helpful.
Thanks, Kimberly. We'll go to Andrew.
Hi, Kimberly. Thanks for the question. So, to the second part of your question, in terms of how the quarter has gotten started and our guidance for the Q3. As we said in our prepared remarks, the 1st couple of weeks of August, We've been very satisfied with, and those results are incorporated in our forecast. Again, those 1st 2 weeks, we've seen momentum that's quite similar to the performance we were seeing in the 2nd quarter.
So that will potentially imply upside to the up 40% to 45% that we've guided the quarter to. But again, those are 2 weeks out of 13 weeks and relatively small weeks relative to the overall quarter. So again, that guidance that we've provided of up 40% to 45% on a 2 year basis for Q3 is a forecast that we feel very good about at this point. I wasn't sure if the first part of your question you had questions around the financial structure of the business go forward?
Just now that we're getting past the separation, any additional color you could give us on The incremental overhead or the sort of all in SG and A burden and interest expense of the stand sorry, of the standalone company, that would be great.
Sure. So we'll go to Wendy for that, Kimberly.
Yes. So as we talked about in our remarks, the go forward company will have 2 pieces. We'll have the Bath and Body Works operating segment that we've reported extensively historically. And also as we've disclosed, we'll have about $25,000,000 per quarter of corporate overhead expense that was previously reported in the other segment. The vast majority of that $25,000,000 is SG and A, so it will be included in SG and A.
But the guidance we shared last night is all inclusive of those two pieces, so the BBW segment and the corporate overhead. The other point I would make go forward is we've also disclosed that as we look to separate the 2 businesses, one of the key areas of focus is in the technology area. We do anticipate over a multiyear period that we will incur $100,000,000 to $150,000,000 of costs That will be both capital and expense. That will be a multiyear period, and we'll be working with Victoria's to make sure that we separate the technology in a way that doesn't disrupt either business and minimizes the deleverage, but that will be incorporated into our guidance as we go forth into 2022.
Great. Great color. Thanks, Rich. Thank you. Next question please.
Our next question comes from Matthew Boss with JPMorgan. Your line is open.
Great. Thanks and congrats on a nice quarter. So Andrew, on the top line and as we think about the consistency and trend that You continue to show. I guess my question is beyond this year, is there anything preventing revenue growth that you outlined mid to high single digit revenue growth algorithm as we think about next year and beyond. And then Wendy, just more near term on gross margin, what have you embedded from a promotional backdrop and the gross margin guidance for the Q3 and back half of the year.
Thanks, Matt. We'll actually go to Andrew for both of those questions.
Thanks, Matt. So on the top line growth aspect. Again, we feel very comfortable with those 3 to 5 year targets that we provided as part of the investor meeting and roadshows over the last month or so. Obviously, 2022, much like 2021 will be an interesting year as we lap extraordinary results. So it's a little hard to predict exactly what quarter to quarter might look like next year.
But again, we feel very comfortable in those long term mid to high single digit revenue growth rate targets that we provided. On the promotional side, what I would say there is consistent with how we plan every season, We go into a season with what we hope is a conservative plan, intending to essentially anniversary similar promotional activity from prior year. And then we use our in season read and react capability around testing and constant analysis of our results to determine whether or not we need to increase or have the opportunity to decrease levels of promotion. As you remember, in the back half of last year, we were in chase mode for the entire time frame and had very little promotional activity, record low levels of promotional activity and that's what we're lapping. So our forecast does assume both a return to a slightly more promotional environment than what we would have experienced last year.
And as we delineated in our prepared remarks, we are also seeing some inflationary pressures that will impact Our margin as well, both of those factors are embedded in our guidance.
Great. Thanks, Matt. Next question, please.
The next question comes from Steph Wintzeck with Jefferies. Your line is open.
Hi, good morning. This is Sydney on for Steph. My question is regarding Bath and Body Works. I'm just wondering kind of how the rebalancing of spend across stores versus digital that we saw in the Q2 results compared to internal expectations. And then just as a follow-up, Could you provide some color on what's assumed in the guidance in terms of sales for the core sanitization categories?
Thank you.
Thanks, Sydney. Andrew?
Yes. So to your question on channel mix within The Q2 versus our expectations, again, our total sales performance for the quarter was slightly above our expectations with, I would say, direct more or less in line or digital more or less in line with our expectations and stores continuing to perform slightly above our expectations. But again, strong results out of both. As a reminder, our digital business In the Q2 on a 2 year basis was up 128% to 2019. That was actually slightly better and the performance it saw in Q1 and our stores were up around 39% in Q2, very close to what we achieved in Q1.
In terms of the soap and sanitizer business, as we think about that, As we mentioned in our prepared remarks, it did decline on a 1 year basis in Q2 of this year. However, On a 2 year basis, it's continued to be up strongly, up 58% to 2 years ago, which was higher than the total business at up 54% to 2 years ago. Again, as expected, it declined year over year where last year it was experiencing explosive growth. Our forecast Go forward, let's assume that we'll continue to see some softening in that business. On a year over year basis, As we talked about at the end of last year, substance sanitizer in total had gotten to be about 20% of the total business, up from roughly 14% of the business in the prior 5 year time frame.
We would expect that it will normalize somewhere in the mid teens, and that's consistent with what we've seen here through the 1st 2 quarters of the year. But again, what I would highlight is we were very pleased that even as that business, As expected, softened year over year, we were able to more than overcome that, offset that with strong growth out of our other categories leading to the total growth that we articulated.
Great. Thank you, Sydney. Next question, please.
The next question comes from Roxanne Meyer with MKM Partners. Your line is open.
Great. Good morning. And Let me add my congratulations on a really strong quarter and congrats on the separation. My question is on free cash flow. I'm just wondering if you could give us a sense What the free cash flow that just Bath and Body Works alone has thrown off over the past few years, How much you expect it to generate and how you're looking to deploy excess cash going forward?
Obviously, you've got the debt buyback announced today, but just generally what you're thinking about? Thank you.
Thanks, Roxanne. Wendy?
Hi, Roxanne. Yes, you're talking about cash flow. I mean, you know our business well. We are a seasonal business. And so typically as This business looks to Q3.
It's a period of cash usage for us as we build our inventory going into the 4th quarter. The Q4 is extremely important to us in terms of cash flow generation. And I'm not sure history It's the best guide here just given that the business has grown so much as you look at it over a multiyear basis. So I'd say what we're planning to do is we'll get through the important 4th quarter period to generate cash. We as we flip the calendar to 2022, we will look at our cash flow and we'll think about allocation and what that means going forward.
In terms of our plans for the fall season, we as we announced today, we're executing a tender offer for the $500,000,000 In addition, we have about $770,000,000 remaining on our 1.5 $1,000,000,000 authorization that we announced in July. So our intent is to execute that $770,000,000 over the fall season in a balanced way. And again, as we get to the end of the holiday period, we'll work with our Board of Directors to determine capital allocation prospectively.
Great. Thanks, Brett, Sam. Next question, please.
Yes. Our next question comes from Omar Saad, Evercore. Your line is open.
Good morning. Thanks for taking my question. I wanted to follow-up on the category discussion, maybe get a little bit more detail around home fragrance, Some of the consumer trends you're seeing in that business, obviously, if soaps and sanitizers are down, that's doing really well. Especially any signs on what the new customers at the franchise attracted, how they're continuing to shop in the home fragrance category, especially as back to school and return to office and the world reopens as that customer staying sticky. Thanks.
Thanks, Omar. Andrew?
Thanks, Omar. So on the category side, you're right to infer that Home Fragrance continues to be Strong. And in the Q2 where we saw the decline in subs and sanitizers, obviously, that was true. I do think it's important to point out though that Body Care Our other big category are actually seeing very strong year over year growth as well as on a 2 year growth basis as well, which really gets, I think, to the heart of your question around what have we seen in terms of the customers that we've gained through the pandemic and how is their behavior compare relative to our prior to pandemic existing customer base. And I think the good news there is a couple of points.
So one, after seeing a year in 2020 where we actually We saw fewer customers than we had in the prior year because of the 90 day closure of all of our stores in the first half of twenty twenty. We have now seen 4 quarters in a row of customer growth. And so on a rolling 12 basis, We're now up in customers pretty significantly to where we had finished the year in 2020. And in terms of the behavior and the profile of those customers, I would say the good news is the new customers that we've gained along that journey. While early in their spending habits with Bath and Body Works, do appear to be performing very similarly to historical new customers.
And our existing customers, as we've talked about on prior calls and in our Investor We've continued to see improvement in their engagements in terms of both their willingness to shop across Our 2 channels, digital and in the store as well as to shop across all three of our major categories. So again, we continue to see higher and higher ratios of our customers performing in those two ways. And when that occurs, as we've shared, customer spend is significantly higher than either a single channel or a single category customer. So very pleased with what we've been able to see so far in terms of The customer behavior that we're experiencing here as we move into through 2021.
Great. Thanks, O'Hare. Next question please.
Yes. Our next question comes from Susan Anderson with B. Riley. Your line is open.
Hi, good morning. Thanks for taking my question. I was wondering if maybe you could talk about product category expansion at BBW, particularly as it relates to Beauty, when you would expect to maybe start expanding more into beauty and then also any other categories. And then also I'm not sure if you mentioned AUR versus unit sales in the quarter?
Thanks, Susan. Andrew?
Yes. So on the first part of your question, Yes. As we talked about pretty thoroughly in our Investor Day, as we laid out our multiyear path to driving Bath and Body Works to become a $10,000,000,000 business over the next 3 to 5 years. We're really not all that reliant on seeing a yet to be determined category emerge as a strong driver of growth. That said, we have lots of different ideas in the pipeline that we will be looking to test over the next several years.
And from a testing standpoint, different than where we may have done things historically, which would have been small cells of store groups. We'll also be looking to test new product categories in our online digital business as well. As we've talked about, Those ideas run the gamut from potentially getting into the skincare business, getting into the haircare business, looking at further line extensions within the home business, whether that's into cleaning products or laundry products, etcetera. So lots of different ideas that are, again, in the pipeline. We will be testing those, As we had discussed prior in both an organic internal development way as well as partnering with third party brands to sell in our stores to understand which of those categories might emerge as something that the Bath and Body Works customer has the most interest in.
So Again, lots of different things in the pipeline. Most of those tests that I'm describing will be ramping up a little bit more in the back half of this year, but much more in 2022 and beyond. In terms of your question on AUR, so AUR on a 2 year basis for the business, up over 20% and units up a comparable amount on a 2 year basis. On a 1 year basis, we did see more expansion out of units with obviously the stores having been closed Last year AUR was still up slightly to last year, but more similar in line on
a 1 year basis. Hopefully that helps. Thanks. Next question?
Yes. Our next question comes from Ike Borja, Wells Fargo. Your line is open.
Thanks for taking the question. 2 quick ones. The cost inflation guided for the $40,000,000,000 to $60,000,000,000 I'm just curious, are you embedding are you kind of just flowing those costs into the P and L or are you embedding any kind of offset on pricing or anything? I'm just kind of curious how you're planning of the business from a margin perspective. And then Wendy, just the $600,000,000 cash in escrow, can you just explain exactly what that is and what's going on there?
Thank you. Okay. Thanks. We'll go to Andrew first.
Thanks, Ike. So on the inflation forecast range. Part of the reason why it's a range is We're working hard to obviously mitigate and offset as much of that pressure as we can, but there will be there are and will be real cost increases that the business faces and they run the gamut from product input costs to wage pressure to transportation pressure to supply pressure. On the product input portion, As you know, we work very hard on our ticketing strategy and our promotional strategies historically to try to offset cost increases, and we'll certainly try to do that again this quarter and the rest of this year. I think it's important to understand though that the base from which we're coming is one where there was so much less promotional activity in the history last year already that curtailing even more promotional activity will be that much more challenging.
So long winded way to say that our margin forecast do assume that quite a bit of that inflationary pressure will actually come through to the bottom line.
Thanks, Sandra. Wendy?
Yes, the $600,000,000 So as Victoria's Secret has disclosed, they issued $1,000,000,000 of debt, $600,000 of it was actually issued and completed prior to the spin and prior to quarter end. So it's essentially if you look at our reported consolidated balance sheet, it's essentially a gross up. So we have the cash from the proceeds of the issuance sitting in escrow on a restricted basis and then the offset is down in long term debt. Both at those Both items went to Victoria's Secret as part of the spin, but since we had the cash and the bank, so to speak, at the quarter end, It's sitting on the consolidated balance sheet. Great.
Thanks. Unfortunately, that's all the time we have this morning, but we'd like to thank you for your continuing interest in Bath and Body Works.