Filing summary
Period and entity: This is L Brands, Inc.’s unaudited Form 10-Q for the 13 and 39 weeks ended October 28, 2017. Although the request identifies Bath & Body Works and “2016 Q3,” the filing is for L Brands, the parent company, and reports third-quarter 2017; Bath & Body Works is one of its segments.
Financial performance
| Metric | Third quarter 2017 | Third quarter 2016 | Year to date 2017 | Year to date 2016 |
|---|---|---|---|---|
| Net sales | $2.618bn | $2.581bn | $7.809bn | $8.085bn |
| Gross profit | $989m | $1.025bn | $2.919bn | $3.181bn |
| Gross margin | 37.8% | 39.7% | 37.4% | 39.3% |
| Operating income | $232m | $284m | $742m | $1.015bn |
| Operating margin | 8.8% | 11.0% | 9.5% | 12.6% |
| Net income | $86m | $122m | $319m | $526m |
| Diluted EPS | $0.30 | $0.42 | $1.11 | $1.81 |
Bath & Body Works: Third-quarter sales rose 6% to $816m, while operating income declined 5% to $138m and operating margin fell to 16.9% from 18.9%. Comparable sales increased 4% and comparable store sales increased 1%. Year-to-date sales rose 5% to $2.354bn, while operating income declined to $396m from $405m. Management attributed sales growth mainly to home fragrance and body care; promotional activity, product mix, and higher occupancy costs pressured margins.
Liquidity, debt and cash flow: At October 28, cash was $735m, current assets were $2.930bn and current liabilities were $2.019bn; reported working capital was $911m. Debt was $5.785bn, including $80m current, and shareholders’ equity was a deficit of $1.121bn. Year-to-date operating cash flow was $138m, versus $411m; capital expenditures were $599m. Cash decreased by $1.199bn from the fiscal-year opening balance. The company paid $516m in dividends and repurchased $283m of stock during the period.
Material changes and management commentary
- Third-quarter consolidated sales increased 1%, but comparable sales declined 1%; operating income fell 18%. Year-to-date sales declined 3% and operating income fell 27%.
- Victoria’s Secret was a major source of pressure: third-quarter sales declined 3% and operating income declined 18%. Management cited category exits and repositioning, softer core bra and panties sales, and reduced traffic. Bath & Body Works sales growth partly offset this weakness.
- Management described the retail environment as uncertain, said it was taking a conservative approach to financial management, and emphasized retail execution, merchandise assortments, and store and online experiences. The filing provides no specific earnings or sales guidance.
- The company said it had sufficient capital resources for foreseeable requirements. Its $1bn revolving facility had no borrowings outstanding; $8m of letters of credit reduced availability. The company reported compliance with its financial covenants and a debt-to-EBITDA ratio below 3.00x.
- Unusual comparison items affected year-to-date 2016: a $108m pre-tax Easton investment gain, a $36m pre-tax debt-extinguishment loss, and $35m of Victoria’s Secret restructuring charges. Excluding these items, 2016 adjusted operating income was $1.050bn and adjusted net income was $500m; 2017 results were not adjusted for special items.
Risks, contingencies and other notable items
- Key disclosed risks include retail competition and consumer spending, mall traffic, brand and product acceptance, international expansion, sourcing and shipping disruption, foreign-exchange movements, information security, and the company’s ability to service or refinance debt and maintain its credit rating.
- The company reported $11m of lease-payment guarantees for disposed businesses, for which no liability was recorded because payments were considered not probable. It also had $104m of residual-value guarantees, with a recorded liability of less than $1m. Management did not expect current litigation to have a material adverse effect.
- Adoption of the revenue standard was planned for fiscal 2018 using the modified retrospective method; management identified changes to loyalty-point accounting, sales returns presentation, and Victoria’s Secret credit-card income presentation. Lease accounting adoption was planned for fiscal 2019 and was expected to materially increase reported assets and liabilities.
- After quarter-end, the company retired 36m treasury shares and repurchased a further 0.1m shares for $6m. The interim financial statements received an independent accountant’s review, not an audit.
Important facts for investors to verify
- Confirm the requested period: this filing covers 2017 Q3, not 2016 Q3, and is filed by L Brands rather than Bath & Body Works as a standalone issuer.
- Track whether Bath & Body Works can sustain sales growth while recovering operating margin amid promotions and occupancy costs.
- Assess the continued decline in Victoria’s Secret sales and the effect of category changes and lower traffic on consolidated results.
- Monitor operating cash generation, seasonal inventory needs, capital spending, and shareholder distributions relative to cash and debt levels.
- Review the impact of upcoming revenue and lease accounting standards and the risks associated with debt, foreign exchange, and retail demand.