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Good morning. My name is Missy, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Victoria's Secret & Co. Second Quarter 2021 Earnings Conference Call. Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to turn the call over to Mr. Jason Ware, Vice President, Investor Relations at Victoria's Secret & Co. Jason, you may begin.
Thank you, Missy. Good morning and welcome to Victoria's Secret & Co.'s Second Quarter Earnings Conference Call for the period ending July 31, 2021. As a matter of formality, I need to remind you that any forward-looking statements we may make today are subject to our safe harbor statement found in our SEC filings and in our press releases. Joining me on the call today are CEO, Martin Waters; CFO, Tim Johnson; and EVP Finance, Brad Kramer. All of the 2020 results we discuss on the call today are adjusted results and exclude the special items described in our press release. Also, as a reminder, our results are on a carve-out basis and include the Victoria's Secret segment and a portion of the unallocated overhead costs as part of L Brands. Thanks. And now I'll turn the call over to Martin.
Thanks, Jason. Good morning, everyone. We're excited to have launched Victoria's Secret & Co. as a stand-alone public company. And on behalf of the management team and the Board, I'd like to extend our sincere appreciation to all associates who worked so hard on the successful spin-off. I'm 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 of course, we wish the Bath & Body Works business and their associates well as they embark on their journey as a stand-alone public company. Turning to our second quarter performance. We delivered very strong results, exceeding expectations and delivering our most profitable spring season in 5 years. We reported second quarter earnings of $1.71 per share compared to an adjusted loss of $0.97 per share last year.
Sales growth of 51%, combined with significant growth in merchandise margin and disciplined expense management, drove these results. Compared to 2019, sales decreased 10%, reflecting the net closure of about 240 company-operated stores since the second quarter of 2019. However, comparable sales increased 5% compared to 2019.
Operating income in the second quarter was $203 million, an increase of $314 million compared to last year and an increase of $197 million compared to 2019. Second quarter operating income on a historical segment reporting basis as part of L Brands totaled $233 million, significantly exceeding our previously communicated guidance of more than $200 million. As shared in our written commentary, given the COVID-19-related uncertainty in our base of supply, we're only providing guidance for the third quarter of 2021. We believe the supply chain headwinds may impact merchandise flow and the promotional cadence of the business. Operating income for the third quarter on a historical segment reporting basis as part of L Brands and before standup and separation costs is expected to be in the range of $110 million to $120 million, which is broadly in line with last year's results of $115 million. Thank you, and that concludes our prepared comments. At this time, we'd be happy to take any questions you may have.
[Operator Instructions] Our first question comes from Matthew Boss from JPMorgan.
So maybe a 2-part question. Martin, first, what inning do you see AUR expansion here today in terms of moving forward? And with that, do you see merchandise margin levels exiting this year as sustainable or any giveback that we need to consider? And Tj, on SG&A reinvestments that I know are embedded in the mid-teens margin plan, is it best to think about investments from here as linear over the 3- to 5-year plan? Or any timing to consider as we would think about on an annual basis next year relative to the back end of the plan?
Thanks, Matt. Appreciate the question and your interest in the business, as always. So on AUR, yes, we've made great progress on AUR. We feel very happy with where we are. Is there more room to go? Probably, a little bit, as we develop better merchandise and improve our assortments and lean more into the core categories of bras, particularly our best at bras, there may be some more expansion of AUR. So if you had to push me for a number, I'd say we're probably in the sixth innings. As it relates to merchandise margin, do I think our current position is sustainable? Absolutely. Our goal is to focus on profitable sales. I have 4 priorities on the back of my hand. One of those priorities is profitable sales. It's not a market share game for us. It's not a volume game for us. It's about ensuring we deliver high-quality merchandise, high emotional content, and that comes with high margins. And hopefully, if we can manage with the discipline of our buying process so that we start the season light and read and react and chase into winners and cancel losers, then we can continue to build on that margin growth that we delivered during 2020 and into the first half of this year. Tj?
Yes. Thanks for the question, Matt. In terms of the forward look that we talked about on the Investor Day and the mid-teens operating margin, our desire to continue to invest in the business, we would think of that more as a linear discussion and not just a point in time. So specifically, our investments will likely be focused in stores, in technology and in digital. Each of those time lines may look a little bit different. So for instance, we talked about a store in the future test here in fall and potentially a handful of stores next year in 2022. When successful, 2023 and beyond is where you would likely see us build that out in a more meaningful way. So again, kind of a linear approach to stores. Technology may look a little bit different. Upon separation, I think we've talked about from an LB perspective, $200 million to $300 million of investment, the majority of that being in technology. We would think of that as more consistent over a period of time. And then from a digital perspective, Martin's desire to be digital-first, we'll continue to look at opportunities to invest there. So I think when you look at the components or when you look at it in total, it will likely be more linear and focused. Having said all of that, ROI and profitable sales, as Martin mentioned, will be the priority when we think about reinvesting in the business. So hopefully, that helps clarify how we're thinking about investment in the long-term operating model.
Our next question comes from Roxanne Meyer from MKM Partners.
Congrats on a solid quarter and a successful separation. My question is around third quarter, the start to third quarter. You provided some guidance. I'm just wondering if you could give us a little bit more color about the start, and in that context, talk about the new bra launch last week, which is exciting to see, a new recent athletic launch. How impactful and needle-moving can launches like this be to sales? And then just as a follow-up, as we appreciate the supply chain disruptions that are out there, how should we think about what percentage of your sales are historically chased in the second half? How to think about what could be left on the table and capped, if there are indeed disruptions?
Thanks, Roxanne. I'll take that one, and thanks for the question. I hope you're well. So we are excited about the start of the third quarter. The momentum we saw in Q2 has continued. We're only 2.5 weeks in, but we're happy with how we've started, and thank you for raising the new bra launch, which is very, very important to us. So the Bare Infinity Flex Bra launch was our first big launch in a long time. And when this business was at its best, we were launching 2 new bra frames a year. We stopped doing that during the period of execution missteps. We are getting back on the habit of doing that, and we now have a pipeline of new bras coming that I can see out 24 months into the future. So very excited about the bra launch. The results were overwhelmingly positive, significantly exceeded our expectations. And we didn't put that much marketing behind the bra and she found it. And that's a great indicator that customers are coming back to this brand. They're finding us and they're excited for new merchandise. We also had a couple of other really exciting proof points in the first quarter. One was PINK Friday, where Amy Hauk's team did an amazing job of launching the back-to-school campaign with PINK Friday and that again exceeded our expectations. And in the Beauty business, Greg's team really knocked the ball out of the park with the Crème Cloud fragrance launch in the Tease franchise, which was really, really outstanding. So 3 great launches to start the quarter. and there's lots more to come. So very excited about where we are. Are they needle moving? Of course. I think they're essential to the pipeline of being a full-price operator in a fashion-forward business that is not chasing discounted sales and overly promotional, that is focused on newness. Having those kind of launches is essential. You asked about the ability to chase. So I've said publicly that when this business is at our best, we would buy and commit to about half of the season, and we would leave half of our dollars to read and react and chase, and that is our long-term objective. Given the problems that there are in our base of supply right now, that would be folly going into the fall season. It is not safe to only place 50% or 60% of our merchandise and hope that the base of supply will be able to read and react. So we're going to break from our normal cadence, the cadence that we reestablished in the spring and the fall of last year, and we're going to commit a little harder than I would like. And I think that is prudent based on all the challenges that we see. But going forward, we should get back to that cadence of booking about 50%, 55% of merchandise at the start of the season. I hope that helps, Roxanne.
Our next question comes from Ike Boruchow from Wells Fargo.
Just 2 questions for me. On the revenue guide for the quarter, the mid- to high single, I'm just kind of curious of the component of the direct and store should direct remain negative, given you still have some pretty robust compares. Just curious on that mix. And then maybe Martin, just the 7% dilution from the 88 million shares, I'm just kind of -- I'm trying to understand what exactly is driving that? And then is there an expectation of that to go even further or higher over the next quarter or so? Or is 93 million kind of the right way to be?
Yes. Thanks for the question. I think on the first question on sales, I think it's really important to reiterate for everybody that if we think about sales and the progression that's happened here so far in the business in 2021, we put out a 9% comp in the first quarter and a 5% comp in the second quarter. Please remember the 9% comp in the first quarter did have the benefit of stimulus. So without that, it was more in the low to mid-single-digit range. So we saw nice comp progression from first quarter to second quarter on a 2-year basis. Even the months within the second quarter, we were very pleased with May, June and July as all 3 months were either in line or slightly better than our internal plans that we measure against. Additionally, all 3 lines of business performed, as Martin mentioned, all 3 businesses are off to a great start in third quarter as well. So we feel very good about the progression of how the business has performed from a top line perspective in the first 2 quarters and here in the start to August. We haven't necessarily provided guidance between the 2 different channels that you mentioned, Ike, only to say that we are continuing to see the business shift in terms of mix as stores start to reopen, as we start to be -- more able to open parts of the store to the customer that weren't necessarily open in the front half of the year. We are seeing some shift from digital into stores, which, again, we think is also very healthy for the business and very healthy as we reopen. So we feel very good about the progression of sales in the guide here into August from a trend standpoint.
And the shares, the share dilution?
Yes. So Ike, this is Jason. On the shares, so the 88 million is the basic at the time of the separation. The 93 million is the dilutive share expectation moving forward.
Our next question comes from Kimberly Greenberger from Morgan Stanley.
Great. Just, if my math is correct here, it looks like the exit rate coming out of the second quarter actually accelerated maybe relative to what you had been trending at previously. It's possible that I'm off here, but it looks like maybe running low to mid-teens on a year-over-year basis. And I'm looking at the Q3 guide, it just looks like maybe you're embedding a little bit of deceleration for third quarter in the mid- to high single-digit range compared to that double-digit exit rate. Am I doing the math there correctly? And if so, Martin, are you thinking that there may be a little bit of inventory supply delays that could be impacting Q3 sales? And so are you just trying to position the expectation a bit conservatively in the event that you actually do encounter some delays in receipt?
So Kimberly, why don't I take the second part of that question first, and then I'll throw it back to Tj on your question about deceleration. So are we being conservative in our guidance for Q3? Maybe. I don't know. What I do know is that there is definitely pressure in the base of supply. Most of that pressure will impact Q4, but some of it will impact Q3. How does that pressure show up? Well, there are 3 parts to it. One is the cost of freight coming into the country will increase significantly as we move from some plan C into air. Secondly, there will be delays that will push merchandise sales out. And in some cases, those delays will be so extreme, we may end up canceling merchandise, again, more a Q4 than a Q3. And the third part is what I mentioned earlier, which is our inability to read and react in the way that we would like to because we're just going to have to place our bets because of the uncertainty around production going forward. So are we being conservative? I think we're being prudent. I think we're being transparent in acknowledging that the base of supply has some black clouds ahead of it. But all aspects of the business as they sit today are in a very healthy shape. So Tj, why don't you pick it up on that?
Yes. Kimberly, great question on the trends here in the second quarter. I think it's important to note, internally, the business made a decision on semiannual sale and the timing of semiannual sales. So that had a bigger benefit in the month of July and a little bit of a hurt in the month of June.
So that's why it's important that we look at how did the business trend against our original expectations month to month to month, and we were very pleased with that. So we do not see August as a deceleration. Actually, we see it as a continuation of a broader trend and an encouraging one because it is merchandise based, as Martin mentioned, and some of the newness and new programs.
Next question comes from Omar Saad from Evercore.
I wanted to ask for maybe a little bit of update on the brand evolution that you guys have been undergoing for a while, how that's resonating with consumers. Any thoughts on what that means for product and category mix, growth and profitability, if it does play out in terms of the products and categories that you sell most?
Great. Thanks, Omar. Thanks for asking the question. We are very happy with where we're sitting in terms of the brand revolution. As I think you know, we started this journey back in January, but we're relatively quiet about it in terms of just getting on with changing the imagery that we put forward and the way we talked about the brand and the language we used in the brand. It wasn't until the middle of the year, around June when we came out publicly and said, "This is a brand revolution. We're dramatically changing the positioning of the brand." And we already knew by that point that there were significant proof points to be seen. The good news is that since those announcements, and specifically the announcement of the VS Collective, we've gone from strength to strength. What do I mean by that? Well, I look at our daily sales, and I see evidence of success there. I look at the 3 launches I mentioned earlier, some of the best launches we've seen in recent years, success there. I look at the growth of the customer file, which has been terrific. I look at the response to the reopening of the Fifth Avenue store in New York, which, again, has just been terrific. The Live, Flow, Sweat, On Point in the active space that we launched. Really, really excellent momentum there. So all around the business, we see positive proof points, and we see that showing up in our social media as well. We also run a customer panel that keeps us close to the voice of our consumer, and we test all of the things that we're putting out with that panel. And the indicators are very positive, particularly as it relates to body diversity, to inclusivity and to showing up in a way that is culturally relevant. What does it mean for our product category mix going forward? Well, you remember that slide that I showed at the investor conference that the #1 thing for us to focus on is growth from the core. The area where this business lost the most sales and profit is in the bra category. It's -- we're a bra business. The #1 objective for this company is to be best at bras. That means world-class, nobody better than us at bras. So all roads lead to bra innovation and successful bra launches. That's the most important. Beyond that, are other growth opportunities in categories that we're excited about? There are. And they all happen to be very close to the core, adjacent to the core. So I'm thinking about areas like maternity that are strategically important.
We launched the maternity bra within the last month but very quietly, no marketing, barely any in-store signage, had to find it deep on the website. We sold 100,000 units in a week. The customer is rooting for us. Shapewear, very important category for us. Size expansion, very important. Swim, as you know. We entered that category and building back sales with a very good franchise that's close to the core. And I think there are other opportunities as well, particularly in aggregating third-party content. So wherever we look around the business, there is grounds for optimism, Omar, and we're very pleased with how the customer is responding. So thanks for asking, and I hope that helps.
Our next question comes from Janine Stichter from Jefferies.
So wanted to ask a bit more about the On Point active launch. We noticed in stores, it seems like a pretty big departure from what you've done in active before. So maybe just elaborate on the opportunity for that category, what you're seeing in the initial uptake and the broad strategy for active just knowing it's gone through some fits and starts over the years.
Yes, I'll take that, Janine. So the Live, Flow, Sweat launch was very successful. And I don't know if you saw the campaign, but we had Eileen Gu as one of the members of our Collective representing for us. And the imagery was absolutely stunning and very representative of how Victoria's Secret should show up going forward. So very pleased about that. The activewear category is an important one for us, but I must say that the basis of us being in the activewear category is its adjacency to bras. What do I mean by that? It's about sports bras. Sports bras, sports bras, we're underweight in sports bras. We've been underweight for many years. It's a key part of all women's bra wardrobe, and we have to get better at it. Now one of the ways you get better at being in the sport bra business is by having really good leggings and other components of activewear. They're fashion forward and they help complete the outfit, and they're very relevant to what young women are wearing out there in the market at large. So it's a very important category for us, but you must remember that its adjacency to the core, that is the reason that we're doing it. I hope that helps.
Our next question comes from Simeon Siegel from BMO Capital Markets.
Congrats on the separation and the ongoing progress of the business. How are you guys thinking about long-term gross margin from here? Maybe how you're benchmarking your opportunity? And then just given all the successful initiatives you've done last year, could you share the occupancy dollars you'd expect on an annualized basis at this point?
Yes. I think, Simeon, I'll start and certainly, Brad and Martin can weigh in here. I guess from our perspective, from a margin rate perspective, we know that we are still trailing our peak margin rates. We're seeing improvement in full-price selling. We're seeing improvement in lower promotional selling through the inventory management and inventory disciplines that have been put into the business. We know we're running down meaningfully on a per square foot in terms of inventory. So I think we feel very good about the progress that we've made, and we feel very good that there's still opportunity in front of us given we're well off of our peaks still. So hopefully, that helps from a margin perspective. I guess from an occupancy standpoint, Brad?
Yes. What I would add on occupancy side is that a lot of the fleet rationalization work is behind us, and we believe we have rightsized the fleet and reset the store count. We don't anticipate meaningful changes in the fleet count going forward. Obviously, we'll read the business year-over-year and look at store performance trends, but we would believe the occupancy, as stated in our trailing 12-month performance, is a good proxy for ongoing rates.
Our next question comes from Susan Anderson from B. Riley.
Nice job on the quarter. I guess maybe if you could talk a little bit about PINK. Maybe if you could talk about the growth in the second quarter and what did well between loungewear and lingerie. And then also the start to back-to-school, what trends you're seeing there so far?
Susan, I think you asked about PINK as the first part of the question? What was the second part?
Just the start to back-to-school and the trends that you're seeing there for PINK.
Yes. Got it. Thank you. We're very pleased with the PINK business. The PINK business is patterning very closely with the VSL business and showing growth in all of the 3 pillars. So the 3 pillars of the business are lingerie, which had its highest penetration, I think, in history, certainly in recent history, approaching 60% of the business. So that's really, really important for us as a lingerie business. Second pillar is logo. That's an indicator of the health of the business. And that is also approaching peak levels and has seen double-digit growth in the last year. And the third pillar is active, where we've seen very strong performance there as well. So all 3 pillars of the business doing well.
PINK Friday was a very strong event for us. We saw good momentum. We were starting to see earlier in the season that back-to-school would be later than we've seen in previous years, and we were hoping that it would come through strong, but we weren't sure. And it did. So back-to-school happened. It just happened a little later than it has done previously. We've also seen great customer advocacy in PINK from initiatives like Mental Health Awareness in May, where we launched a very exciting program that had great resonance with customers. And similarly, our initiative with Chloe x Halle that Amy and her team have launched has been absolutely terrific for us. So very pleased with the progress that we're making in the PINK business all around. Thanks for asking, Susan.
Our last question comes from Oliver Chen from Cowen.
This is Jonna on for Oliver today. We just had a question about the international business, just what you're seeing quarter-to-date and if you're seeing any improvement in the travel retail. And as we look towards second half, how are you thinking about the international segment?
Thank you. And please give our regards to Oliver. So the international business is 5 businesses in one, as you probably know. The franchise business is rebounding relatively well. The direct-to-consumer business that we run from North America has been very strong, seeing exceptional growth and continues to be very profitable. China and the U.K., China has been okay, not fully rebounded by any stretch of the imagination but okay, and we're making progress on our restructuring in that market. The U.K. has been very good for us, considering all of the troubles that there have been in COVID. We've restructured our business. We have an amazing partner in Next. We have a really strong direct-to-consumer business and the stores business is starting to reopen and come back. So we feel very good about that. Travel retail, as you mentioned, is the area that has been the slowest to respond, perhaps for obvious reasons. There are airports around the world that are back up and running and fully functioning, and our business there is good. But equally, there are parts of the world that are just closed out. And so it's very much a mixed bag in travel retail, but Arun and his team are doing a great job of rebuilding steadily. The main thing to look for in our international business is not the top line growth, given that in the restructure in the U.K., we've changed the accounting there. But also, it's more about a profit story.
And the swing that you will have seen year-over-year in Q2 is very real and very meaningful. And we expect that to continue into the back half of the business, with all parts of the business showing profit with the exception of China, where we're getting close to cash breakeven, but we still have a bit of work to do in the back half to get that to flat. So hope that helps. And thank you, everybody, for your interest in the business and your continued support. We appreciate it very much. Jay, do you want to close it out?
No. That's perfect. Martin. Thank you, everyone.
That does conclude today's conference. You may disconnect at this time, and thank you for joining.