Filing identity and reporting period
Important metadata discrepancy: The supplied filing is L Brands, Inc.’s Form 10-Q for the 13 and 26 weeks ended August 4, 2018—not a Bath & Body Works 2017 Q2 filing. Bath & Body Works is one of L Brands’ reported segments. Comparatives are the periods ended July 29, 2017. Financial amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Year to date 2018 | Year to date 2017 |
|---|---|---|---|---|
| Net sales | $2,984 | $2,755 | $5,610 | $5,192 |
| Gross profit | $1,059 | $1,028 | $2,003 | $1,931 |
| Operating income | $228 | $301 | $383 | $510 |
| Net income | $99 | $139 | $147 | $233 |
| Diluted EPS | $0.36 | $0.48 | $0.52 | $0.81 |
| Gross margin | 35.5% | 37.3% | 35.7% | 37.2% |
| Operating margin | 7.6% | 10.9% | 6.8% | 9.8% |
- Q2 sales increased 8%, while operating income fell 24% and net income fell 29%. Year-to-date sales increased 8%, while operating income declined 25% and net income declined 37%.
- Q2 comparable sales rose 3% overall, but comparable store sales fell 1%. Victoria’s Secret comparable sales declined 1% (stores down 5%); Bath & Body Works comparable sales rose 10% (stores up 7%).
- Bath & Body Works Q2 sales were $964 million, up 12%, and operating income was $169 million, up 8%. Victoria’s Secret sales were $1,725 million, up 5%, but operating income fell 38% to $114 million. International segment sales rose 28% to $145 million, while the segment moved to a $9 million operating loss.
- Q2 gross profit increased $31 million, but gross margin contracted 1.8 percentage points. Management cited Victoria’s Secret promotions and lower merchandise margin, as well as channel mix and distribution costs. Higher selling expenses and wage investments also weighed on operating margin.
Cash flow, debt and liquidity
- Year-to-date operating cash flow was $212 million, versus $221 million. Capital expenditures were $345 million, making operating cash flow less capital expenditures negative $133 million. Cash declined $672 million to $843 million.
- Cash uses included $335 million of dividends, $186 million of share repurchases and $345 million of capital expenditures. The company paid $1.20 per share in dividends during the first half.
- Total debt, including current debt, was $5.777 billion; cash was $843 million. Current debt was $65 million and long-term debt was $5.712 billion. Shareholders’ deficit was $1.124 billion.
- Working capital was $859 million. The $1 billion revolving facility had no borrowings outstanding, with $991 million available after letters of credit. The company reported compliance with its financial covenants and a debt-to-EBITDA ratio below 3.00x; the facility’s maximum covenant ratio was 4.00x.
- In June 2018, L Brands exchanged portions of its 2020, 2021 and 2022 notes for $297 million of 6.694% notes due 2027 and $52 million cash, including a $24 million exchange premium. It reported average borrowing rates of 6.8% for Q2 and 6.6% year to date.
Changes, outlook and risks
- Accounting comparability: L Brands adopted ASC 606 in Q1 2018 using the modified retrospective method; 2017 results were not restated. Private-label credit-card income shifted from a reduction of expenses to revenue, increasing reported sales and expenses by $48 million in Q2 and $73 million year to date. Adoption also reduced opening retained earnings by $28 million, primarily from deferring Victoria’s Secret loyalty-point revenue.
- Management described retail conditions as uncertain and emphasized retail execution, merchandise assortments, marketing, and store and online customer experiences. The filing provides no specific full-year sales or earnings guidance.
- Victoria’s Secret faced lower traffic and average unit retail, promotional pressure, and weakness in certain bra and PINK categories. Bath & Body Works benefited from product innovation, higher average dollar sales and conversion.
- Subsequent to quarter-end, S&P downgraded L Brands’ ratings and changed its outlook to negative; Fitch withdrew its ratings and also issued lower final ratings. These developments heighten the importance of monitoring refinancing costs and debt capacity.
- The company expects adoption of the new lease standard in Q1 2019 to materially increase reported assets and liabilities. Other stated risks include competition, mall traffic, consumer demand, international operations, foreign exchange, sourcing and shipping disruptions, and the ability to service or refinance debt.
- Management said ordinary-course litigation was not expected to have a material adverse effect. Disclosed guarantees included $8 million of lease guarantees for which no liability was recorded because payment was not considered probable, and $104 million of residual-value guarantees with a $3 million recorded liability.
Most important facts for investors to verify
- Confirm the intended issuer and period: this is L Brands’ 2018 Q2 filing, not a standalone Bath & Body Works filing or 2017 Q2 report.
- Assess whether the sales growth is translating into sustainable earnings, given falling operating income and margins, particularly at Victoria’s Secret.
- Separate ASC 606 presentation effects from underlying sales trends; the prior-year figures were not recast.
- Review the company’s capacity to fund dividends, repurchases and investment while cash declined and debt remained about $5.8 billion; consider the subsequent credit-rating actions.
- Check the timing and terms of foreign-facility maturities, the impact of future lease accounting, and developments in disclosed contingencies.