Business context and reporting period
This filing is L Brands, Inc.’s unaudited Form 10-Q for the 13 weeks ended August 1, 2015, with comparisons to the 13 weeks ended August 2, 2014; year-to-date figures cover 26 weeks. The request metadata says 2014 Q2, but the filing itself is for 2015 Q2. Bath & Body Works is a reportable segment of L Brands, not the registrant. L Brands operates Victoria’s Secret, Bath & Body Works and other retail businesses.
Financial results and liquidity
| Metric | Q2 2015 | Q2 2014 | YTD 2015 | YTD 2014 |
|---|---|---|---|---|
| Net sales | $2.765 billion | $2.675 billion | $5.277 billion | $5.066 billion |
| Gross profit | $1.114 billion | $1.044 billion | $2.170 billion | $2.026 billion |
| Operating income | $403 million | $376 million | $775 million | $712 million |
| Net income | $202 million | $188 million | $453 million | $345 million |
| Diluted EPS | $0.68 | $0.63 | $1.52 | $1.16 |
| Operating cash flow | Not provided separately | Not provided separately | $375 million | $446 million |
Q2 gross margin rose to 40.3% from 39.0%, and operating margin to 14.6% from 14.1%. YTD gross margin was 41.1% versus 40.0%; operating margin was 14.7% versus 14.1%. Q2 comparable sales grew 4% overall, including 3% at Victoria’s Secret and 5% at Bath & Body Works.
At August 1, 2015, cash and cash equivalents were $780 million, marketable securities $50 million, working capital $928 million, and long-term debt $4.759 billion. The $1 billion revolving facility had no borrowings outstanding; $981 million remained available after letters of credit. The company reported compliance with its financial covenants. Shareholders’ equity was a $648 million deficit. YTD capital expenditures were $358 million; dividends paid were $880 million and share repurchases were $295 million. Cash declined by $901 million to $780 million, primarily reflecting shareholder distributions and other financing outflows.
Material changes and unusual items
- Q2 sales increased 3% and operating income increased 7% year over year. Bath & Body Works sales rose 6% and operating income 20%; Victoria’s Secret sales rose 3% and operating income 2%.
- YTD reported net income included a $78 million pretax gain ($69 million after tax) from divesting the remaining interest in the third-party apparel sourcing business. Excluding this item, adjusted YTD net income was $384 million and adjusted diluted EPS was $1.29, versus reported $453 million and $1.52.
- YTD cash distributions increased materially versus 2014: dividends totaled $3.00 per share, including a $2.00 special dividend, versus $1.68 per share in 2014. The company repurchased $295 million of shares, compared with $48 million.
- Q2 gross margin improvement reflected stronger merchandise margins, including less promotional activity at Bath & Body Works. Higher store-selling, occupancy and online fulfillment expenses partially offset gains.
Outlook, risks and contingencies
The filing provides no quantified earnings or sales guidance. Management described the retail environment as uncertain and emphasized careful management, retail execution, compelling merchandise, marketing, and store and digital customer experiences. Management said available short- and long-term capital resources were sufficient for foreseeable requirements; interim results may be affected by retail seasonality.
Disclosed risks include consumer spending and mall traffic, competition and fashion execution, international expansion and foreign exchange, sourcing and shipping disruptions, debt servicing or refinancing, information security, regulatory and tax matters, and litigation. The company reported approximately $18 million of guarantees on former businesses’ leases, a maximum potential loss of $63 million on an Easton interest-rate-swap guarantee, and a $10 million estimated maximum guarantee exposure related to Easton Gateway construction financing. Sale-leaseback transactions included $66 million of residual-value guarantees, plus a further $29 million guarantee on a subsequent transaction. Management did not consider the estimated fair values of these newer guarantee obligations significant at quarter-end. The interim statements received an independent accountant’s review, not an audit.
Important facts for investors to verify
- Confirm the correct filing period: this is L Brands’ 2015 Q2 10-Q, not a 2014 Q2 filing or a standalone Bath & Body Works filing.
- Assess earnings quality by separating the $69 million after-tax divestiture gain from YTD reported results.
- Review the sustainability of dividends and repurchases in light of the $901 million YTD cash decline, $4.759 billion debt balance and deficit equity.
- Track Bath & Body Works and Victoria’s Secret sales, comparable-store trends, direct-channel performance and margin drivers.
- Monitor guarantee exposures, sale-leaseback obligations, covenant headroom and foreign-currency effects.