Business context and reporting period
This is Limited Brands, Inc.’s unaudited Form 10-Q for the 13 weeks and 39 weeks ended October 27, 2012. The company operated Victoria’s Secret, Bath & Body Works, La Senza and other businesses. Bath & Body Works is reported as a segment; this filing does not provide standalone financial statements for Bath & Body Works.
Key financial metrics
| Metric | Third quarter 2012 | Third quarter 2011 | Year to date 2012 | Year to date 2011 |
|---|---|---|---|---|
| Net sales | $2.050 billion | $2.174 billion | $6.603 billion | $6.849 billion |
| Gross profit | $825 million | $785 million | $2.669 billion | $2.530 billion |
| Gross margin | 40.2% | 36.1% | 40.4% | 36.9% |
| Operating income | $187 million | $186 million | $785 million | $597 million |
| Operating margin | 9.1% | 8.6% | 11.9% | 8.7% |
| Net income | $74 million | $94 million | $342 million | $491 million |
| Diluted EPS | $0.25 | $0.31 | $1.15 | $1.55 |
Cash flow and liquidity: Year-to-date operating cash flow was $75 million, versus $94 million; investing cash outflow was $471 million, including $491 million of capital expenditures. Financing cash flow was $7 million, and cash declined $388 million to $547 million. Working capital was $973 million. Cash held by foreign subsidiaries was $317 million; repatriation could trigger additional taxes.
Debt and capitalization: Total debt carrying value was $4.535 billion, including $57 million current and $4.478 billion long-term, up from $3.538 billion at January 28, 2012, mainly following issuance of $1 billion of 5.625% notes due 2022. Shareholders’ equity was a deficit of $515 million, versus positive equity of $137 million at fiscal year-end, following substantial repurchases and dividends. The company reported $980 million of remaining revolving-credit availability after letters of credit, no revolver borrowings, and compliance with financial covenants. Debt fair value was estimated at $5.073 billion.
Material changes versus prior period
- Comparable sales rose 5% in the quarter and 7% year to date, while reported sales declined 6% and 4%, respectively. The comparison reflects the 2011 sales of the third-party apparel sourcing business divested in November 2011 ($259 million in the prior-year quarter; $689 million year to date).
- Victoria’s Secret quarterly sales increased 5% and operating income increased 5%; Bath & Body Works sales increased 7% and operating income increased 42% to $58 million. Bath & Body Works year-to-date sales rose 7% to $1.652 billion and operating income rose to $206 million from $165 million.
- Higher gross margins reflected, among other factors, reduced promotional activity and favorable input costs at selected businesses, as well as removal of lower-margin sourcing sales from the mix. Quarterly operating expenses increased $39 million; year-to-date expenses decreased $49 million, chiefly because the prior-year period included $163 million of expense for the Express share contribution.
- Net income and EPS fell despite higher operating income. Interest expense increased with higher average borrowings; the effective tax rate was 42.4% in the quarter versus 22.6%, and 40.1% year to date versus 24.1%. Prior-year other income included substantial Express-related gains.
Outlook, risks and unusual items
Management described the retail environment as uncertain, said it was taking a conservative approach to financial management, and emphasized retail execution, merchandise, marketing, and store and online customer experience. The filing provides no specific earnings, sales or margin guidance. Management stated that available short- and long-term capital resources were sufficient for foreseeable requirements; results remain seasonal, with holiday sales important to annual performance.
- La Senza store resizing continued: 34 of 41 stores in the second closure program had closed by October 27, with the remainder expected to close by the end of first-quarter 2013. The quarter included $13 million of restructuring charges; year-to-date charges were $16 million in cost of goods sold and $1 million in operating expenses.
- The company paid a $1.00-per-share special dividend in September, in addition to ordinary dividends; total year-to-date dividends were $507 million. It repurchased $616 million of stock year to date. A new $250 million repurchase authorization was approved after quarter-end.
- A jury awarded $9 million in a patent infringement case for alleged infringement through 2011. The company intended to appeal and could not estimate possible losses for future infringement through patent expiration in 2015.
- Approximately $60 million of lease guarantees related to disposed businesses remained; management said payments were not probable and recorded no liability for those guarantees other than the separately recognized $3 million fair value obligation. The company cited ordinary-course litigation and risks including consumer demand, competition, seasonality, international expansion, sourcing, currency, debt service and legal matters.
Important facts for investors to verify
- Reconcile reported sales declines with comparable-sales growth and the sourcing-business divestiture; assess the ongoing performance and costs of La Senza.
- Review inventory growth to $1.446 billion and the seasonal cash-flow pattern, alongside capital spending and holiday-period cash generation.
- Assess higher debt and interest burden against liquidity, covenant headroom, credit ratings and substantial shareholder distributions.
- Examine the sustainability of margin improvement, the elevated tax rate and the contribution of nonrecurring or investment-related income.
- Track the patent appeal, lease guarantees, restructuring execution and post-quarter repurchases and sourcing-business dividend.