Victoria's Secret & Co

NYSE:VSCO

Earnings Call Analysis

Victoria's Secret posts strong Q2 due to new collections and cost control.

Victoria's Secret exceeded expectations for Q2 2024 with $1.4 billion in sales, a slight 1% decline from the previous year, but at the higher end of expectations. Operating income grew year-over-year for the first time since 2021, driven by successful launches like the Dream Bra collection and improved traffic, especially during events such as PINK Friday. Strong expense management led to an 80 basis point improvement in gross margin. For the full year, sales are expected to be down around 1%, with adjusted operating income forecasted between $275 million and $300 million. The company is optimistic about continued growth in international markets and the impact of upcoming events like the Victoria's Secret Fashion Show.

A Promising Quarter

Victoria's Secret & Company reported results for the second quarter of 2024, which largely exceeded expectations across key financial metrics. Notably, this marked the first year-over-year growth in quarterly operating income since 2021. The company generated $1.4 billion in sales, resulting in a modest decline of 1% from the previous year. However, this figure is considered a positive outcome, falling at the better end of guidance expectations.

Sales Performance and Market Trends

Encouragingly, the sales trends in North America showed consistent improvement, with the fourth consecutive quarter of sales growth in both physical stores and digital channels. This growth coincided with successful product launches, including the Victoria's Secret Dream Bra collection and events like PINK Friday’s Back to Campus. Notably, foot traffic in stores also outperformed overall mall traffic, reflecting a positive reception to the new merchandise and promotional events.

Operational Efficiency and Margins

The company's gross margin improved by 80 basis points year-over-year due to effective inventory management and cost control. During this quarter, both buying and occupancy costs decreased, helping to alleviate pressure on overall expenses. Looking ahead, though transportation rates are expected to shift from a tailwind to a headwind, the management remains optimistic about maintaining margin improvements into Q3.

Guidance for the Future

For the remainder of 2024, Victoria’s Secret revised its annual sales guidance to a decrease of approximately 1%, acknowledging sequential improvements in North American sales alongside a strong international business. Adjusted operating income is now projected between $275 million and $300 million, an increase from the earlier forecast of $250 million to $275 million. Additionally, free cash flow is anticipated to range between $200 million and $225 million, as opposed to the previous guidance of $175 million to $200 million.

Looking Ahead to Q3

For the third quarter, Victoria's Secret expects low single-digit sales growth with a possible increase from down 1% to approximately 2% due to calendar shifts benefitting from earlier holiday sales transitions. The results for Q3 are expected to be propelled by new product launches and events, including the anticipated return of the Victoria's Secret Fashion Show on October 15, which management believes will enhance customer engagement and sales.

Challenges and Competitive Landscape

Despite the positive trends, the company acknowledges ongoing challenges in the broader retail environment, particularly the competitive promotional landscape. An increase in discount rates was noted, driven more by efforts to generate traffic rather than liquidation of underperforming inventory. Management indicated their strategy may involve more promotional activities in the near term, aiming to drive trial of new products while hoping to stabilize promotional levels as the year progresses.

Strong Customer Loyalty and International Growth

Victoria's Secret's loyalty program has seen great success, boasting over 32 million members responsible for roughly 80% of weekly sales. This program is a cornerstone for driving customer engagement. Internationally, the company also reported high single-digit sales growth driven by franchise and travel retail markets, although challenges persist in certain areas like China due to softened consumer demand.

Final Thoughts

Overall, Victoria's Secret is navigating a transitional phase with a mix of renewed sales momentum, effective operational strategies, and a focus on innovation in their product offerings. With strong guidance revisions and strategic marketing initiatives set for upcoming quarters, the company positions itself favorably against ongoing market challenges.

Earnings Call Transcript 2025-Q2

[Operator]

Good morning. My name is Amanda, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Victoria's Secret & Company's Second Quarter 2024 Earnings Conference Call. Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to turn the conference over to Mr. Kevin Wynk, Vice President of External Financial Reporting and Investor Relations of Victoria's Secret & Company. Kevin, you may begin.

[Kevin Wynk, executive]

Thank you, Amanda. Good morning, and welcome to Victoria's Secret & Company's Second Quarter Earnings Conference Call for the period ended August 3, 2024. As a matter of formality, I would like to remind you that any forward-looking statements we may make today are subject to our Safe Harbor statements found in our SEC filings and in our press releases. Joining me on the call today is: CFO and Interim CEO, Tim Johnson. We are available today for up to 45 minutes to answer any questions.

Certain results we discussed on the call today are adjusted results and exclude the impact of certain items described in our press releases and our SEC filings. Reconciliations of these and other non-GAAP measures to the most comparable GAAP measures are included in our press release, our SEC filings and the investor presentation posted on the Investors section of our website.

Thanks, and now I'll turn the call over to TJ.

[Timothy Johnson, executive]

Thanks, Kevin, and good morning, everyone. I'm pleased to report that second quarter results exceeded or met our expectations for the quarter on all key financial metrics, and we delivered year-over-year quarterly operating income growth for the first time since 2021. We were encouraged by the continued sequential improvement in quarterly sales results in North America for the fourth consecutive quarter as sales trends improved in both our stores and our digital channels. Our customers responded to new merchandise deliveries and events with particular success in the launch of our Victoria's Secret Dream Bra collection, in apparel with our PINK Friday's Back to Campus event in late-July, and through consistent, steady improvement of VS Sport as we introduced the Featherweight Max Front-Close Bra and a broader assortment of merchandise flow to stores in digital.

Sales for the second quarter 2024 were $1.4 billion, a decrease of 1% to last year and at the better end of our expectations for the quarter. In North America, the improvement in sales trends was evident in both our stores and in our digital businesses. Momentum experienced at the end of first quarter in April continued into the month of May. As anticipated, sales performance during our semiannual sale period in the June time frame was lower than last year, driven by fewer units on sale, particularly in PINK apparel. We saw strength in July, driven by the introduction of product newness with Victoria's Secret Dream Bra collection in apparel with our PINK Friday Back to Campus event and consistent steady growth of VS Sport.

From a Stores perspective, we experienced improvement in traffic, which outperformed the balance of the mall for the quarter and with meaningful outperformance in late July during PINK Friday. In terms of our Digital business, traffic levels improved in the quarter and were up compared to the second quarter last year, while conversion was down in the quarter, in particular during the semiannual sale period when year-over-year, we had fewer units on sale in our digital channels.

From a Market perspective, third-party market data indicates the sales trend in the overall Intimates market in North America got a little bit softer in the second quarter than what was reported in the first quarter. Our combined Victoria's Secret and PINK market share in the Intimates category remained at 20%. We were encouraged to see our digital market share increase in both bras and panties, along with an overall increase in our Sports Bra market share for the second consecutive quarter. This was partially offset by a slight decrease in market share in the stores channel where value or low price points appear to be gaining share.

From a Merchandise Category perspective for Victoria's Secret, our Beauty business continues to be our best performing category with year-over-year growth for the fourth consecutive quarter, followed by stronger acceptance of VS Sport as merchandise available for sale grew throughout the quarter in anticipation of an important event in Q3. In Bras and Panties, newness and innovation sold well and several older legacy styles were exited or down-trended during the -spring season.

PINK's sales trend overall improved in the quarter, both in total and in most major categories. Specifically, in apparel, we were encouraged by the improving customer response to product newness during our PINK Friday Back to Campus event in late-July as we ended the quarter. This strength continued into August to start the third quarter as the Back to Campus event continued in stores and online.

In addition to improving trends for Victoria's Secret and PINK, we experienced sales growth in the high single-digits for both our international business and Adore Me. International sales in the second quarter were driven by year-over-year growth with our franchise and travel retail partners, our performance with our partner Next was also strong in the U.K., and we grew profitability in China, where our top line trends were challenged by the overall market and economic softness in the country. We're optimistic about sales, profit and growth opportunities for all of our partners around the world.

The retail environment in North America was challenging and the promotional environment remains competitive, but improving product acceptance and disciplined inventory management led to adjusted gross margin dollar growth and 80 basis points of adjusted gross margin rate expansion year-over-year in the quarter. Adjusted SG&A dollars were down in the quarter, leveraging 20 basis points compared to last year and coming in better than our guidance due to disciplined and proactive expense management initiatives to drive incremental efficiency within our operating model.

You may recall at our Investor Day, we committed to transforming the foundation of our company and established a $250 million 3-year goal, and we are on track to exceed that goal. I believe we have demonstrated our commitment to focusing on efficiencies within our model and improving the cost structure of our business.

Aside from the financials over the last 90 days, we've executed several key actions in support of our strategy and brand positioning for the long term, including in July, we introduced newness with the launch of the Victoria's Secret Dream collection, a collection of bras, panties and sexy sleep that combines the ultimate experience in beauty and everyday comfort. Also in July, we added a new style to our top-selling Sports Bra with the launch of the Featherweight Max Front-Close, where maximum support meets maximum comfort now with an easy Zip-front closure.

Additionally, within the VS brand, we launched the Tease Sugar Fleur Beauty Collection, a limited edition version of our fan-favorite Tease. We continue to create meaningful and memorable connections with our customers, including the return of PINK Friday, the last weekend of July as our collegiate customers get ready to head Back the Campus and with the celebration of National Underwear Day in early August. You may have heard that Victoria's Secret Fashion Show is returning on October 15 in New York City, with an amazing cast of talented women.

The show's return will deliver precisely what our customers have been asking for: Glamour, Runway, Fashion, Fun, Wings, Entertainment, all through a powerful modern lens reflecting who we are today. And we continue to further develop our understanding of our Victoria's Secret and PINK customer through our multitender loyalty program, which has now been active for just over a year. We have 32 million members who drive about 80% of our sales on a weekly basis. Through insights and data, we are focused on turning our understanding of our customers into world-class seamless customer experiences.

As we look forward, we're encouraged our North America business trends have continued to improve as we've moved through August and the start of the third quarter. Early customer feedback on fall assortments is encouraging for both the Victoria's Secret and PINK brands. And our Beauty business has continued solid performance and is driving traffic to our stores. Strategically, we have several exciting events planned for the balance of third quarter, including a major VSX Sport launch and the return of our Victoria's Secret Fashion Show to kick off the all-important holiday season.

While we're optimistic about the positive signs we're seeing in our business, we recognize that consumer environment remains challenging, and our customer is pressured economically. We remain focused on what we can control, which is leveraging our market position in Intimates and delivering on multiple initiatives to drive growth in our business over the longer term.

Today, for fiscal 2024, we are raising our financial forecast to reflect Q2 and spring outperformance to our original expectations and also some level of modest improvement in our fall assumptions. For the year, we now expect sales to be down approximately 1% to a comparative 52 weeks from fiscal 2023, compared to prior guidance of down low single-digits. This forecast reflects sequential improvement in North America, along with continued strength in our international business and tracks in line with the positive trajectory we've been discussing throughout 2024.

At this forecasted level of sales, we expect our adjusted operating income in 2024 to be about $275 million to $300 million compared to prior guidance of $250 million to $275 million. We also now forecast our adjusted free cash flow in 2024 to be approximately $200 million to $225 million compared to prior guidance of $175 million to $200 million. For the third quarter of 2024, we're forecasting sales to increase low single-digits compared to sales in the third quarter last year. And at this level of sales, we are forecasting a third quarter adjusted operating loss in the range of $40 million to $60 million.

And finally, we're sure [ you also ] our recent announcement regarding the appointment of Hillary Super as our next CEO effective September 9. Once again, we want to thank Martin for his time with the company and his support, and we're excited for Hillary to take us into our next chapter.

Thank you. That concludes our prepared comments. And at this time, we'd be happy to take any questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Ike Boruchow with Wells Fargo.

[Irwin Boruchow, analyst]

TJ, congrats on the results. 2 from me. Just first, real quick on the model. You talked about international up high singles. It sounds like you're confident there. Can you just tell us what you're expecting from the international segment in the back half of the year?

And then could you just elaborate further on the promo environment that you're seeing and what you're basically baking into your plan? I'm most curious what kind of promo/gross margin outlook you can maybe share with us for the fourth quarter specifically.

[Timothy Johnson, executive]

Yes. Thanks for the question, Ike. First off, we continue to be very, very excited about our international business really all around the world. As I mentioned in our prepared remarks, both the Travel Retail as well as Franchise businesses were the strongest in second quarter. We continue to do very well with our partners in the U.K. And the one area of the international business that softened a bit is in China, which is, I don't think, unique to our business. There does appear to be a more pressured consumer there in that country at the moment.

As we look forward, I would expect more of the same from our Travel Retail and Franchise partners in the third quarter as well as our partners in the U.K. I do think there's some timing on promotional events in China and some events that are more national in nature from an e-commerce perspective that will likely get pulled into the third quarter because of the calendar shift. So third quarter for our international business might be a little bit better than fourth. But I think that's largely due to calendar shifts in and around the China business.

From a promo perspective, as we look at third quarter and fourth quarter, our guidance assumes much of the same that we've incurred here in the front half of the year. We do think it will continue to be promotional. We're prepared to be more promotional, if need be in the third and fourth quarter to drive our outcomes. I think what the business has gotten much, much sharper with is, utilizing key areas of the business. I mentioned the Beauty business as a traffic driver. You've seen us be very successful leveraging our Panty business as a traffic driver.

Clearly, the size and growth of our loyalty program is also supporting level of traffic growth. We're seeing that customers inside our loyalty program, now we have some annual data, are actually shopping more year-over-year and spending more year-over-year. That's a really good sign for us in terms of product acceptance and how we're reaching them. So I do think each of the 3 of those items I mentioned, have the opportunity to drive traffic in our business and might lead to a little bit more promotion here in the fall season.

But coming back up to a high level, I think the most exciting part about our business is really the early merchandise acceptance to newness, particularly in the VS and PINK brands. You'll recall that if you go all the way back to almost a year ago now, when we were in New York for our Investor Day and the team laid out some of the strategy from a merchandising perspective and the newness that would be coming and some of the adjacent category expansion work that would be coming, it's now starting to show up in stores here in July and August; and clearly, something is working. So we're excited about that. We think we're very early in that process. And again, merchandise product and newness, ultimately, we think will win the day in the back half of the year. Thanks for the question.

[Irwin Boruchow, analyst]

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

[Timothy Johnson, executive]

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

[Operator]

Our next question comes from Alex Straton with Morgan Stanley.

[Alexandra Straton, analyst]

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

[Timothy Johnson, executive]

Yes. Thanks for the question, Alex. I think raising the sales guide for the year was predominantly this spring outperform, coming in at the better end of the range 2 quarters in a row, obviously pushed the year up a little bit in terms of dollars.

I'd say, generally speaking, that the sales estimates for the balance of the year are largely unchanged. Where the model probably got a little bit stronger, would be below the sales line and some of the margin elements or particularly from an expense standpoint, the teams continue to do a great job managing costs in -- and managing inventory and cash. I think from a -- what am I kind of most encouraged by, I'll just reiterate what I mentioned, that product acceptance early in both the Victoria's Secret and PINK brands has been very encouraging.

As I mentioned, we've been waiting for this inflection moment here in July and August for a long period of time, and the newness that we were expecting, both in Intimates and adjacent categories to intimates has shown up and is doing well. I think that's the single most encouraging part of what we're seeing in the business, and the team that has been working on that tirelessly has done a really, really good job.

I think from a promo color and kind of back half of the year or just general discounting levels, it is true our discount rate is up a little bit year-on-year. I think, it's also true that we don't believe that we should be at this discount rate forever and ever. I think this is a reflection of the environment. It's a reflection of where we are in terms of the evolution of the merchandising assortments and making sure that we're getting enough customers across the lease line or to our site for trial of the newness that the teams have delivered. But coming out of the holiday season and going into next year, I think we would all like to believe that we could be a little less promotional as a brand, and I'm sure we'll be working towards that.

I do think it's important to highlight, and I've mentioned this on previous calls, that we do have a fair amount of testing rigor around promotionality. And what I mean by that is we do have test and control groups or holdout groups where we are less promotional. And in the current environment, what we're seeing is that promotions matter. Promotions matter to the customer. They're accretive to sales and accretive to margin dollars. So again, for the moment, and where we are in the evolution of merchandising and where we are with the customer, we think the promotions make sense. Longer term, I think we would all like to be a little less promotional than we are today.

[Operator]

Our next question comes from Corey Tarlowe with Jefferies.

[Corey Tarlowe, analyst]

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

[Timothy Johnson, executive]

Yes. Thanks for the question, Corey. And it's -- we've been looking forward to talking about the PINK business in a positive light because there's been a tremendous amount of work to get us here. I think in summary, tees, tanks, dresses continued to start off well for the business in July, in August around the PINK Friday event. And as we deliver more and more newness in capsules to the front of the store, we're seeing good customer response.

If you think about what you see on the front table, particularly end of July and early August, a fair amount of stores had sellout activity, but tees, tanks and dresses were some of the early good winners for the business. You might have seen some denim shorts on the front table here in the third quarter, different types of pant inventory available for sale. And I'd be remiss if I didn't mention the Wink bra that delivered early in the season that has continued to sell through well. So I think there are a number of different category examples, Corey, that give us optimism as we move into the back half of the year, but there's more opportunity to come with PINK.

For Back to School, I'd be remiss if I didn't mention -- that we actually had backpacks this year to drive customers to the store and to get that basket started and use it as a promotional item. So backpacks for Back to School is a pretty novel idea, and the teams have done a good job executing against that, and it's been very well received.

I think maybe one of the most encouraging parts if you were -- and I know you're in stores almost every day, if not every day, but for those that are in store, particularly end of July and for Back to School, seeing a younger customer return to the PINK side of the store was very encouraging for our stores team and our merchant team. So getting back to that younger customer in that 18- to 22-year-old age demographic, you saw significantly more of that type of foot traffic in our stores in late-July and August than maybe you have in prior seasons. So a lot to like about what's happening so far in PINK, but more to come.

[Operator]

Our next question comes from Simeon Siegel with BMO Capital Markets. You may need to unmute yourself.

All right, I'll go to the next question. Our next question comes from Brooke Roach with Goldman Sachs.

[Brooke Roach, analyst]

I was hoping you could speak to the drivers of the better SG&A cost control that you saw in the quarter. Could you provide a few examples of where you're finding those efficiencies?

And then as you look ahead, how are you thinking about the cadence of SG&A dollar growth in the back half of the year? And any additional levers that you might be pulling there?

[Timothy Johnson, executive]

Yes. It was a little soft, but I think you were asking about cost opportunities and kind of what drove the outcome in the second quarter and our outlook for the balance of the year. I think, that's what the question was. Brooke, there were a number of different areas within the business. I wouldn't want you to think that it was any one big thing that drove the cost outperformance in the second quarter. I think the best way to think about it is the teams have rallied around keeping costs under control as we've kind of come into this inflection point, and they understand that driving profitability is important, while we're in this inflection moment and keeping costs under control is one thing that we can do to help in that regard.

So there are a number of different areas throughout the business, whether it's closely monitoring travel and headcount or whether it's really looking at our ship commitments and promise dates and how we deliver to the customer differently from a digital and distribution standpoint or whether how we're managing our store payroll or what we're expecting of our stores in terms of changes and frequency of change and kind of monitoring that closely. There are a number of different areas throughout the business where we were able to keep costs in check here in the second quarter, [ we ] have every expectation that will continue on into the third quarter.

You've probably worked through your model at this point and the leverage that we're guiding to on the sales, we're guiding to has SG&A dollars relatively flat year-over-year. And I'd expect there will probably be a little bit of growth in SG&A dollars potentially as we move into the fourth quarter, when you account for the extra week last year. That growth in fourth quarter, candidly, is probably as much about the good start to the season and the expectation that we will be providing for more incentive compensation in the back half of the year than last year than anything else. We're not doing anything differently or adding cost to the business in the fourth quarter differently than we have in any prior years. So I feel very good about the cost outlook.

And maybe again, most importantly, I just want to underline that this is something that the teams have rallied around. It's not always the most fun part of what we do, but it's necessary in the environment that we're in. And this has been a multiyear journey. This isn't something that's been new to VS&Co., in just the last quarter or 2. This has really been something we've been after for a while. So we feel very good about how the teams are managing cost and managing inventory.

You didn't necessarily mention, but I'll mention it anyway. We do have costs that sit inside of the gross margin component in the business, buying and occupancy costs, and those costs were down year-over-year. And I expect they would be flat-to-down as we move through the balance of year. So again, much the same disciplines around all areas of the business plus some pretty meaningful positive movement from a -- I'll call occupancy costs, meaning lower rents, working on locations and getting better terms on a go-forward basis. Looking at things like co-tenancies as anchors have gone out and things like that, so really, there's no stone unturned right now from a cost perspective to keep things heading in the right direction.

[Operator]

Our next question comes from Mauricio Serna with UBS.

[Mauricio Serna Vega, analyst]

I wanted to ask about the third quarter guidance. It calls for a sequential improvement. I just want to understand like from a business, from a segment standpoint, what is -- like what segments are driving that improvement? Is it like across the board or anything in particular?

And then like as you think about that improvement, just focus on the North America Intimates market, you were mentioning that it got softer -- kind of slightly softer in the second quarter. What are your expectations for like the industry growth of the Intimates -- North America Intimates industry growth for the second half of the year?

[Timothy Johnson, executive]

Yes. Thanks for the question, Mauricio. When we think about third quarter, if I could just maybe stay at a high level for a moment and use big round numbers, we were down 1% in Q2 as a business on the top line. We've guided to low single-digit growth in the third quarter. So 1% to 3% is how we define low single-digits. So if I just take the midpoint of that at plus 2%. So really, what we're talking about is going from down 1% to plus 2% in the third quarter.

In our prepared remarks, we talked about the retail calendar shift that is happening for us and all retailers this year. And as it relates to the third quarter, that's about 2 points of positive impact. So really that plus 2%, in my example, without the retail calendar shift would be more like flat. So on an apples-to-apples basis, you might be talking about going from down 1% to flat. Again, on a reported basis will be from going from down 1% to plus 2% because of the calendar shift. And again, to be clear, the calendar shift is really about we move a week -- of the first week of November last year into the third quarter this year. First week of November, as you know, is a big holiday week or holiday volume starts to ramp in our business, you can kind of hopefully visualize the positive impact there.

To the heart of your question, what's going to drive that? From our view, we're already seeing some of that in our business in the month of August. I would expect the month of August will be positive in the low single-digits, if not a little bit better, based on the strength of PINK Friday and National underwear day to start off the month, and then just better core business here as we're finishing the month. So feel good about August. And what's driving that and what we anticipate will drive the third quarter is all about newness and product, product acceptance, major VSX launch coming in September, kick-off at the fashion show, which will be commercialized this year -- live and commercialized this year to drive, hopefully, positive results from a sales perspective and really kick-off the holiday season for us in a major, major way. So that's what we anticipate will drive from a product perspective.

We do think that North America, PINK -- Victoria's Secret and PINK, the brands in North America. Again, business gets sequentially better from second to third quarter. Again, that would be the fifth quarter in a row I do think North America in total will get closer to flat in the quarter or maybe down slightly, but again, sequential improvement year over -- quarter-over-quarter for the fifth quarter. And then, we have every expectation the international business and our partners at Adore Me will continue to grow in the high single-digits or better. So those are kind of the building blocks of third quarter, but I think it's important to understand the calendar shift does need to be accounted for there.

On the last part of your question as it relates to the domestic market share -- coming into the year, we had to make some assumptions on the domestic Intimates market and performance. We said at that time, we expected the market to be softer here in the front half of the year and then stabilize in the back half of the year. I guess that's as good of an assumption as any, still. Maybe it continues to be a little bit softer in the back half of the year, I'm not quite sure. But what I am confident in is here in the second quarter, where the market was tougher, our business has still got better in North America.

And even if in the third quarter, the domestic Intimates market is difficult, I'm seeing our business get better in the month of August and we have every expectation and it will get better in September and October. So while we prefer it to be a tailwind, we just have to kind of keep our heads down and push through it with all of the newness, innovation and initiatives that we're launching in our business. So we feel comfortable with where we are to start the Q3 time frame, and we'll see how we do in September and October.

[Mauricio Serna Vega, analyst]

Got it. And just a quick follow-up on gross margin. One of the things I noted in the commentary provided for Q3, as you called out transportation costs on ocean, air. Maybe you could elaborate a little bit more, like what kind of impact are you expecting in Q3 gross margin, if that's only like a onetime thing? Or is this should -- if -- or is this something that we should be maybe considering for Q4 and maybe going into fiscal year '25?

[Timothy Johnson, executive]

Yes. I wish my crystal ball was that clear on forecasting transportation rates. I can only see for sure, a month or a few weeks out, Mauricio. But what we really saw was that transportation rates were down significantly as we exited 2023 and in the front part of 2024. And those transportation rates were being down or what rolled through our margin and was a tailwind in the spring season.

As we started to work through second quarter in the June, July time frame and even here in August, what we've seen is that transportation rates, whether it's ocean or air start to spike in the spot market for a number of different reasons, some capacity-related, some movement between East Coast and West Coast related. But regardless, we're seeing the overall rate environment pick up here over the last few weeks and the last couple of months.

Our expectation and our guidance is that likely continues through the balance of the year. So what was a tailwind will likely be a little bit of a headwind as we move into the fall season and potentially even a little bit more than that as we move into fourth quarter. Where it goes next year? Your estimate might be as good as mine. But here in the near term in our guidance, we've assumed that transportation rates are a bit of a headwind in the back half of the year.

[Mauricio Serna Vega, analyst]

Got it. Very helpful. And that's also why you think like merchandise margins in Q4 might be down a little bit?

[Timothy Johnson, executive]

It's certainly an element that is new and different. I mean last year, transportation rates were probably close to a historical low level. And as I mentioned, since they've been spiking here off-late, we do think it likely continues through the fourth quarter. So that's probably one change from maybe our beginning of year expectation to where we are currently.

I think the other piece that I'd be remiss if I didn't mention, and you'll recall, fourth quarter last year is when we started seeing meaningful cost of goods sales -- cost of goods sold reduction or reduction in average unit cost. And that's something that the teams had been working on production sourcing merchant teams and others had been working on. It's something that's part of our "Transform the foundation" goal.

You may recall us talking about an annual opportunity of probably $130 million to $140 million or more in the form of lower unit cost that kicked off last year in the fourth quarter. And obviously we'll have our full 12 months here wrap-up in third quarter of this year. So we will start to go up against that. But in terms of year-over-year change, if the transportation rates is probably the one piece, Mauricio, that's certainly different. So going from historic lows last year in fourth quarter to a spiky market here in the fall season, we've tried our best to reflect that in the fourth quarter guide.

[Operator]

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

[Simeon Siegel, analyst]

Hope you had a nice summer and congrats on some really nice improvement. I apologize, I got disconnected. So if you already answered any of these just disregard, and I'll get it from the transcript. Sorry about that.

All right. So could you quantify the puts and takes behind the gross margin improvement this quarter and how you're thinking about those drivers going forward? What do you expect buying and occupancy dollars to look like going forward? Recognizing the comment from this past quarter.

And then with the fashion show returning, how are you thinking about marketing dollars this year? So if you said any of those before, I'll get them again. And then just higher level -- or I'll get them from the scripts, you don't have to say them again.

And then just higher level, the EBIT dollar growth was great. So that was really encouraging. Could you speak to your comfort in continuing that inflection going forward? Is this the beginning of that turn?

[Timothy Johnson, executive]

You made up for lost time there, Simeon. We got -- I think I got 3 or 4 things. I'll try to address all of them, but the puts and takes here in second quarter from a margin perspective, as I just mentioned with Mauricio, significantly up to last year from a rate perspective up about 80 basis points. Gross margin dollar growth in excess of sales activity so good performance in the quarter. The teams managed inventory -- inventories ended down 2% in line with our guidance, so everything is seemingly moving in the right direction.

The positives here in Q2 were mostly about the cost of goods sold, work that I mentioned in lower average unit costs because of the lag and how kind of things sell through from a margin perspective, and how we recognize cost of goods. We still did have some favorable transportation activity from the front half of the year flowing through in the second quarter. Again, it gets more challenging as we move forward. Those were probably the 2 good guys in the quarter from a margin perspective.

And then a third good guy would be just overall for the second quarter buying and occupancy dollars were actually down year-over-year and again that helped flatten out the B&O impact on a -- down 1% sales number. The one item going the other way is it was a promotional quarter across our category and across retail. I mentioned earlier our discount rate was up a little bit year-over-year. We did our best to try to target that discount rate in a couple of key areas, namely Beauty, namely Panties, so this discount was not about liquidating poor performing inventory at all. This was about trying to drive trial and traffic.

As we look forward from a margin perspective, guiding the margin rate up year-over-year and third quarter. Again, cost of goods sold would be the primary driver there and lower average unit costs. We'll start to see transportation rates turn from a tailwind to a bit of a headwind in Q3. And then I'd say from a promotion standpoint, probably pretty similar year-over-year or maybe slightly more promotional in our guide. So just same sort of elements just moving slightly one way or the other.

From a buying and occupancy standpoint, I would expect dollars to continue to be flat or down here in the third quarter and likely in the fourth quarter as well. Again to Brooke's question earlier, we manage all costs in our business, not just the ones that show up in SG&A, and the team is doing a great job in that. So I feel good that on a low single-digit sales increase will leverage B&O with B&O dollars being down. So those are kind of some of the puts and takes from a margin perspective.

You might not have picked up on, I think Mauricio's last question on Q4. We talked about the margin rate in Q4 likely being down a little bit as we anniversary last year's cost of goods sold work, but probably more importantly, and just some of the expectation that transportation rates could remain elevated for the balance of year.

Your question on marketing? I'd say we're spending an appropriate level of marketing from our view. Yes, our marketing dollars in total were elevated a bit last year with the World Tour, this year with the Fashion Show. The fashion show is not the same cost as the world tour. It's lower than the world tour. So overall marketing dollars will likely be down year-over-year. But again, from our view, still an appropriate budget. When we look to the third quarter, we're really excited to see what type of -- not just positive sentiment. We've already got a pretty good indicator on that based on yesterday's instagram post of announcing the date and a couple of key people associated with the program. So very positive sentiment.

Customers are super excited about it. We're really looking forward to seeing what we can do to generate new customer trial through the fashion show and through the launch of VSX Sport here in third quarter. So a lot to like about what's coming from a marketing perspective, and I think I lost the last question.

[Simeon Siegel, analyst]

Just the idea on EBIT dollars we're growing, [ they're ] inflecting. So just comfort in that continuing this being the beginning of a trend? Because that's obviously very encouraging.

[Timothy Johnson, executive]

Yes. So [ Simeon ] you say EBIT, we speak in operating dollars since a lot of our incentive programs are tied to operating profit dollars. Yes. The inflection point for the first time since really Q3 of 2021. I think you caught it right in your note this morning was the last time operating income dollars were up year-over-year. Our guide for Q3 suggests that should continue into this quarter. And fourth quarter is a little bit tough to look at because of the extra week year-over-year, which we did quantify, that drove about $20 million of operating income last year due to the extra week. So we've got some work to do to get fourth quarter back to last year's first -- fourth quarter from an operating income perspective. But there's a lot of dollars at play there from a volume perspective.

You'll note in squeezing the model a little bit, our sales expectation for Q4 is a little bit lower from a growth perspective than Q3. Again, Q3 being aided by the calendar shift. The calendar shift kind of works against you in Q4 again that November week 1 moves into Q3 and you replace it with a February week, and those volumes are not the same. So we've got a little bit of work to do yet on Q4. But I think the biggest opportunity there for us is the such strong early acceptance of new products on both the VS and PINK side really is where the opportunity sets to drive better sell-through, higher sell-through, better margin, lower promotion or all of the above. So lots of like about how we're positioned for the balance of this year.

[Kevin Wynk, executive]

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

[Operator]

Our last question comes from Jonna Kim with TD Cowen.

[Jungwon Kim, analyst]

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

[Timothy Johnson, executive]

Yes. Thanks for the question, Jonna. In the Adore Me business, I think most people know there are actually 2 brands which sit inside the Adore Me business as we report it. There's the Adore Me brand, which focuses primarily on intimates but does present other categories. And then there's a second business called Daily Look, which also features a home try-on model, but more focused on the apparel side.

In the last couple of quarters, we've seen outsized growth in the Daily Look business, that's driving the growth in total or overall at Adore Me. So having 2 different businesses, 2 different brands inside of that business gives the team the opportunity to toggle investment dollars from a marketing perspective into what's trending, what's working best. And I think they're doing a really, really good job of doing that. So putting the investment where the customer is in the near term. So the Daily Look or Apparel side of the business is driving the majority of the growth there.

Having said all of that, they're managing to -- the total business to high single-digit growth on the top line and pretty meaningful growth here in the second quarter from an operating income perspective. Looking forward, I'm comfortable that they have growth plans here for the third quarter. You may recall that they actually are on a 1-month lag to our business, so we report them on a 1-month lag. So we've already seen really the first half of their third quarter and the business is off to a good start and is on forecast to not only grow in the top line, but be profitable in the quarter again. So happy with where we are in the near term in the Adore Me business.

[Kevin Wynk, executive]

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

[Timothy Johnson, executive]

Thank you.

[Operator]

Thank you for participating in the Victoria's Secret & Company's Second Quarter 2024 Earnings Conference Call. That concludes today's conference. Please disconnect at this time.