Business context and reporting period
The supplied filing is L Brands, Inc.’s Form 10-Q, not a Bath & Body Works standalone filing. It covers the 13 weeks ended July 29, 2017, and the 26 weeks ended July 29, 2017; comparisons are to the corresponding 2016 periods. Bath & Body Works is one of L Brands’ reportable segments, alongside Victoria’s Secret and Victoria’s Secret and Bath & Body Works International.
L Brands operates specialty retail stores and direct channels in intimate apparel, personal care, beauty and home fragrance. The interim financial statements are unaudited and were reviewed by the independent accounting firm.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Year to date 2017 | Year to date 2016 |
|---|---|---|---|---|
| Net sales | $2,755 million | $2,890 million | $5,192 million | $5,504 million |
| Gross profit | $1,028 million | $1,113 million | $1,931 million | $2,156 million |
| Gross margin | 37.3% | 38.5% | 37.2% | 39.2% |
| Operating income | $301 million | $408 million | $510 million | $732 million |
| Operating margin | 10.9% | 14.1% | 9.8% | 13.3% |
| Net income | $139 million | $252 million | $233 million | $405 million |
| Diluted EPS | $0.48 | $0.87 | $0.81 | $1.39 |
- Q2 comparable sales declined 8% overall and comparable store sales declined 6%. Year-to-date comparable sales fell 9% and comparable store sales fell 7%.
- Cash from operations was $221 million year to date, versus $508 million in 2016. Capital expenditures were $372 million, leaving cash flow after capital expenditures negative $151 million. Cash and equivalents fell $574 million from fiscal year-end to $1.36 billion.
- At July 29, 2017, total debt was $5.768 billion, including $64 million current; long-term debt, net of current portion, was $5.704 billion. Cash exceeded current debt, but shareholders’ equity was a deficit of $914 million.
- Working capital was $1.199 billion. The $1 billion revolving facility had no borrowings outstanding and $992 million of stated availability after letters of credit. The company reported compliance with its financial covenants and a debt-to-EBITDA ratio below 3.00x.
- Interest expense was $101 million in Q2 and $201 million year to date. Average borrowing rates were 7.02% for Q2 and 6.99% year to date.
- Year-to-date dividends paid were $344 million ($1.20 per share); share repurchases were $132 million. After quarter-end, the company repurchased another 2.4 million shares for $90 million.
Material changes and segment results
- Victoria’s Secret was the principal source of weakness: Q2 sales fell 12% to $1.646 billion, comparable sales declined 14%, and operating income fell 35% to $183 million. Year-to-date sales declined 12% to $3.179 billion and operating income fell to $342 million from $515 million.
- Bath & Body Works performed better: Q2 sales rose 7% to $860 million, comparable sales increased 6%, and operating income rose 5% to $156 million. Year-to-date sales increased 5% to $1.539 billion, while operating income was $258 million versus $260 million.
- International segment Q2 sales increased 14% to $114 million, but operating income decreased to $2 million from $8 million. Year-to-date sales rose 11% to $217 million, with operating income of $1 million versus $21 million.
- Management attributed Victoria’s Secret sales declines to exiting swim and apparel, reduced direct mail and promotions, lower average unit retail in core bras, and weakness in panties and beauty during category repositioning. PINK, sport and beauty provided offsets. Bath & Body Works growth reflected home fragrance and body care, product newness, and higher average unit retail and dollar sales.
- Consolidated Q2 sales fell 5%, while operating income declined 26%; year-to-date sales fell 6% and operating income declined 30%. Gross and operating margins contracted in both comparisons.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or sales guidance. 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.
- Q2 2016 included a $108 million pre-tax gain from an Easton Town Center distribution and a $36 million pre-tax loss on debt extinguishment. These items make the prior-period comparison of other income and net income less representative of recurring results. Q2 2017 included $20 million of pre-tax gains from Easton investment distributions year to date.
- The company identified consumer spending, mall traffic, competition, fashion and product acceptance, international expansion, foreign exchange, sourcing and shipping, labor, information security, debt service, dividends and credit ratings among its risks. It uses currency and interest-rate derivatives but cautioned that hedges may not offset all currency effects.
- The company reported various ordinary-course claims and lawsuits; management did not expect current matters to have a material adverse effect. Lease-related guarantees included $12 million associated with disposed businesses, for which no liability was recorded because payment was not considered probable, and $104 million of residual-value guarantees, with a liability below $1 million recorded.
- Adoption of the revenue-recognition standard was planned for fiscal 2018 using the modified retrospective method, with a cumulative retained-earnings adjustment; impacts were still being evaluated. The company expected adoption of the lease standard in fiscal 2019 to materially increase reported assets and liabilities.
- Management stated available capital resources were sufficient for foreseeable requirements. The May 2017 amendment extended the $1 billion revolver to May 2022. This liquidity assessment should be considered alongside substantial debt, negative equity, and ongoing dividends, repurchases and capital spending.
Important facts for investors to verify
- Whether Victoria’s Secret sales and comparable-sales trends stabilize, and whether Bath & Body Works can sustain growth and margins.
- How much of the operating and cash-flow decline reflects recurring business performance versus working-capital timing, investment spending and nonrecurring items.
- Debt maturities, interest costs, covenant headroom, and the company’s capacity to fund dividends and buybacks while maintaining liquidity.
- The eventual financial-statement effects of revenue-recognition and lease-accounting changes, including the retained-earnings adjustment and lease liabilities.
- Any developments in legal matters, lease guarantees, foreign-exchange exposure, and international operations that could materially change the company’s risk or cash-flow profile.