Business context and reporting period
L Brands, Inc. (the parent of Bath & Body Works) filed this unaudited Form 10-Q for the 13 weeks ended May 3, 2014, compared with the 13 weeks ended May 4, 2013. The filing reports consolidated L Brands results; it does not provide standalone financial statements for Bath & Body Works. L Brands operates Victoria’s Secret, Bath & Body Works and other businesses. The interim statements received an independent accountant’s review, not an audit.
Key financial results
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $2.391 billion | $2.268 billion |
| Gross profit / margin | $982 million / 41.1% | $941 million / 41.5% |
| Operating income / margin | $336 million / 14.1% | $311 million / 13.7% |
| Net income | $157 million | $143 million |
| Diluted EPS | $0.53 | $0.48 |
| Interest expense | $84 million | $79 million |
| Net cash used in operating activities | $89 million | $120 million |
Sales rose 5%, operating income 8%, and net income approximately 10%. Comparable-store sales increased 2%, versus 3% in the prior-year quarter. The effective tax rate was 38.5%, compared with 39.3%.
Segments
Victoria’s Secret sales were $1.604 billion, up 4%, and operating income was $278 million, up 5%. Bath & Body Works sales were $582 million, up 4%, and operating income was $80 million, up 9%. International segment sales were $71 million, up 78%, and operating income was $15 million, compared with $4 million. “Other” reported a $37 million operating loss, versus a $31 million loss. Segment results were recast following a reporting-segment change; consolidated results were unaffected.
Financial position, cash flow and capital allocation
At May 3, 2014, cash and cash equivalents were $912 million, down from $1.519 billion at fiscal year-end. Working capital was $1.070 billion. Total debt carrying value was $4.972 billion, including $214 million classified as current; shareholders’ equity was a deficit of $609 million. The company reported $5.509 billion estimated fair value of debt. Cash used in investing was $135 million, including $150 million of capital expenditures. Cash used in financing was $383 million, primarily reflecting $392 million of dividends and $43 million of share repurchases. The quarter’s dividend included a $1.00-per-share special dividend and a $0.34 ordinary dividend.
A $1 billion revolving facility had no borrowings outstanding; $992 million remained available after letters of credit. The company stated it complied with its financial covenants and had no default. Approximately $213 million principal on 5.25% notes was due in November 2014. Long-term debt was largely fixed-rate, though swaps convert $400 million of notes to floating-rate exposure. Cash held by foreign subsidiaries was $162 million and repatriation could result in additional taxes.
Management commentary, outlook and risks
Management cited an uncertain retail environment and said it would manage conservatively while focusing on merchandise, marketing, store and online execution. It emphasized newness and innovation as drivers at both major brands. Victoria’s Secret Direct sales were roughly flat as the company reduced apparel styles and inventory and refocused on lingerie, PINK and beauty. Gross margin declined 0.4 percentage points, primarily reflecting brand- and channel-specific merchandise and occupancy pressures; operating expense leverage helped lift the operating margin.
The filing provides no numerical full-year earnings or sales guidance. Management said available short- and long-term capital resources were sufficient for foreseeable requirements, while noting seasonal working-capital needs and the importance of operating cash flow. Principal disclosed risks include consumer demand and mall traffic, competition and fashion trends, international expansion and foreign exchange, sourcing and shipping disruption, debt service or refinancing, information security, labor costs, and legal and tax matters. The company reported approximately $38 million of lease guarantees related to previously divested businesses, with no liability recorded for guarantees it judged not probable. Its estimated maximum exposure relating to Easton Gateway was $45 million, including a $10 million estimated guarantee exposure. A patent case remained on appeal; management expected the appeal to be granted after the patents at issue were found invalid in a separate proceeding, but the plaintiff continued the appeal process.
Important facts for investors to verify
- Confirm the filing is for L Brands consolidated results, not Bath & Body Works standalone performance, and review the recast segment definitions.
- Assess whether the 41.1% gross margin and 2% comparable-store-sales growth were sustained in subsequent periods.
- Review liquidity and refinancing plans for the November 2014 note maturity, alongside the company’s substantial debt and negative equity.
- Evaluate the sustainability of dividends and repurchases given negative quarterly operating cash flow and the special dividend.
- Track the Easton Gateway guarantees, divested-business lease guarantees, patent appeal and any subsequent developments.
- Consider that fiscal-quarter results are seasonal and management supplied no numerical full-year guidance in this filing.