Bath & Body Works, Inc.: Form 10-Q for the period ended Oct 28, 2023

The following discussion and analysis of financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as codified in the Accounting Standards Codification. The following information should be read in conjunction with our financial statements and the related notes included in Part I, Item 1. Financial Statements in this Quarterly Report on Form 10-Q.

Executive Overview

In the third quarter of 2023, Net Sales decreased $42 million, or 3%, to $1.562 billion compared to the third quarter of 2022, primarily due to a decrease in both average dollar sale and total transactions. In our stores and direct channels, Net Sales decreased 1% to $1.168 billion, and 8% to $317 million, respectively. In our international business, Net Sales decreased 5% to $77 million.

In the third quarter of 2023, Operating Income increased $19 million, or 9%, to $221 million, from $202 million in the third quarter of 2022, and the Operating Income rate (expressed as a percentage of Net Sales) increased to 14.1% from 12.6%. These increases were primarily due to a 200-basis point increase in our merchandise margin rate, driven by approximately $40 million of deflation in our cost structure, lower product costs and reduced transportation costs, and General, Administrative and Store Operating Expense and rate (expressed as a percentage of Net Sales) improvement resulting from our cost optimization work (discussed below).

For additional information related to our third quarter 2023 financial performance, see “Results of Operations.”

Cost Optimization

We are enhancing our operations and efficiency by targeting an aggregate of $200 million of planned annual cost savings across both Gross Profit and General, Administrative and Store Operating Expenses. Our cost optimization work delivered benefits of approximately $45 million in the third quarter of 2023, and we expect to deliver approximately $50 million of cost savings in the fourth quarter of 2023 and $150 million of total cost savings in fiscal 2023. We expect to realize the remaining benefits in fiscal 2024.

Outlook

We anticipate continued macroeconomic uncertainty, soft customer spending and category normalization following the COVID-19 pandemic in our candles and sanitizers categories to pressure Net Sales in the fourth quarter of 2023 and potentially continuing into fiscal 2024. We expect our merchandise margin rate to improve in the fourth quarter of 2023 compared to the fourth quarter of 2022, driven by anticipated deflation in our cost structure and expected reductions in expenses resulting from our cost optimization work, partially offset by our continued investment in product formulation and packaging upgrades. General, Administrative and Store Operating Expenses are expected to deleverage in the fourth quarter of 2023 compared to the fourth quarter of 2022, as we expect higher marketing spend and technology investments. We are investing in a brand campaign and personalized marketing to activate new programs to drive customer awareness, acquisition and retention. Following the information technology (“IT”) separation from Victoria’s Secret that we substantially completed in the second quarter of 2023, we expect technology investments to remain elevated to drive future growth. We anticipate continued cost deflation and the benefits of our cost optimization work to support our operating income rate in fiscal 2024.

Adjusted Financial Information

In addition to our results provided in accordance with GAAP above and throughout this Quarterly Report on Form 10-Q, provided below are non-GAAP measurements which present Net Income and Net Income Per Diluted Share for the third quarter of and year-to-date 2023 on an adjusted basis, to remove certain special items recorded in 2023. We believe that these special items are not indicative of our operations due to their size and nature. We did not make any adjustments to our results in the third quarter of or year-to-date 2022. We use adjusted financial information as key performance measures for the purpose of evaluating performance internally. These non-GAAP measurements are not intended to replace the presentation of our financial results in accordance with GAAP. Instead, we believe that the presentation of adjusted financial information provides additional information to investors to facilitate the comparison of past and present operations. Further, our definitions of adjusted financial information may differ from similarly titled measures used by other companies.

The table below reconciles the third quarter of and year-to-date 2023 GAAP financial measures to the non-GAAP financial measures:

(in millions, except per share amounts)

Reconciliation of Reported Net Income to Adjusted Net Income

(a) In the third quarter of and year-to-date 2023, we recognized pre-tax gains of $12 million (after-tax gain of $9 million) and $28 million (after-tax gain of $21 million), respectively, related to the repurchase and extinguishment of outstanding notes. For additional information, see Note 7, “Long-term Debt and Borrowing Facility” included in Part I, Item 1. Financial Statements.

Company-Operated Store Data

The following table compares Company-operated U.S. store data for the third quarters of and year-to-date 2023 and 2022:

(a) Sales per average selling square foot and sales per average store, which are indicators of store productivity, are calculated based on store sales for the period divided by the average, including the beginning and end of period, of total selling square footage and store count, respectively.

The following table represents Company-operated store data for year-to-date 2023:

Partner-Operated Store Data

The following table represents partner-operated store data for year-to-date 2023:

Results of Operations

Third Quarter of 2023 Compared to Third Quarter of 2022

Net Sales

The following table provides Net Sales for the third quarter of 2023 in comparison to the third quarter of 2022:

(in millions)

(a) Results include royalties associated with franchised stores and wholesale sales.

The following table provides a reconciliation of Net Sales for the third quarter of 2023 to the third quarter of 2022:

(in millions)

For the third quarter of 2023, Net Sales decreased $42 million, to $1.562 billion, compared to the third quarter of 2022. Net Sales decreased in the stores channel by $10 million, or 1%, due to a decline in average dollar sale, partially offset by Net Sales from new store growth. Direct Net Sales decreased $28 million, or 8%, due to a decline in orders, which was partially due to our customers continuing to select our buy online-pick up in store (“BOPIS”) option (which is recognized as store Net Sales) as we completed our rollout of BOPIS capabilities to our U.S. stores in the first quarter of 2023. International Net Sales decreased $4 million, or 5%, due to lower orders and shipments, partially offset by new stores opened by our partners.

In terms of category performance, Net Sales in candles and sanitizers both declined compared to the third quarter of 2022 driven by category normalization following the COVID-19 pandemic. Both soaps and wallflowers increased compared to the third quarter of 2022. Body care was approximately flat compared to the third quarter of 2022, as growth in our men’s business and fine fragrance mist was offset by declines in wellness and travel.

Gross Profit

For the third quarter of 2023, our Gross Profit increased $4 million to $682 million, and our Gross Profit rate (expressed as a percentage of Net Sales) increased to 43.6% from 42.2%. Gross Profit increased due to a 200-basis point increase in our merchandise margin rate driven by approximately $40 million of deflation in our cost structure, lower product costs and reduced transportation costs, partially offset by our continued investment in product formulations and packaging innovation. The improvement in merchandise margin was partially offset by increased Buying and Occupancy Expense primarily due to new store growth.

The Gross Profit rate increase was driven by the increase in the merchandise margin rate due to the factors discussed above, partially offset by the Buying and Occupancy Expense deleverage due to lower Net Sales and increased occupancy expenses.

General, Administrative and Store Operating Expenses

The following table provides detail for our General, Administrative and Store Operating Expenses for the third quarter of 2023 compared to the third quarter of 2022:

(in millions)

(in millions)

(in millions)

For the third quarter of 2023, our General, Administrative and Store Operating Expenses decreased $15 million to $461 million, and the rate (expressed as a percentage of Net Sales) decreased to 29.5% from 29.7%. Our Selling Expenses decreased primarily due to our cost optimization work related to efficiency in store labor and selling productivity, reduced expense as we optimized our call center and the decline in Net Sales. Our Home Office Expenses increased primarily due to higher technology expense, principally related to IT separation costs as well as strategic investments to drive future growth, partially offset by severance and related charges of approximately $6 million recognized in the third quarter of 2022.

The General, Administrative and Store Operating Expense rate decreased primarily due to the benefits of our cost optimization work related to Selling Expenses, partially offset by our investments in technology as well as deleverage on lower Net Sales.

Other Income and Expenses

Interest Expense

The following table provides the average daily borrowings and average borrowing rates for the third quarters of 2023 and 2022:

For the third quarter of 2023, our Interest Expense was $84 million, compared to $86 million in the third quarter of 2022. Our lower average daily borrowings, which were driven by the repurchase and early extinguishment of outstanding notes, were partially offset by a higher average borrowing rate.

Other Income

For the third quarter of 2023, our Other Income was $22 million, primarily due to pre-tax gains of $12 million associated with the repurchase and early extinguishments of outstanding notes and interest income on cash balances.

Provision for Income Taxes

For the third quarter of 2023, our effective tax rate was 25.3% compared to 23.3% in the third quarter of 2022. The 2023 third quarter rate was consistent with our combined estimated federal and state statutory rates. The 2022 third quarter rate was lower than our combined estimated federal and state statutory rates primarily due to the resolution of certain tax matters during the quarter.

Results of Operations

Year-to-Date 2023 Compared to Year-to-Date 2022

For year-to-date 2023, Operating Income decreased $135 million to $589 million, from $724 million year-to-date 2022, and the Operating Income rate (expressed as a percentage of Net Sales) decreased to 13.0% from 15.5%. The drivers of the year-to-date Operating Income results are discussed in the following sections.

Net Sales

The following table provides Net Sales for year-to-date 2023 in comparison to year-to-date 2022:

(in millions)

(a) Results include royalties associated with franchised stores and wholesale sales.

The following table provides a reconciliation of Net Sales for year-to-date 2023 to year-to-date 2022:

(in millions)

For year-to-date 2023, Net Sales decreased $155 million, to $4.517 billion, compared to year-to-date 2022. Net Sales decreased in the stores channel by $53 million, or 2%, due to a decline in average dollar sale, partially offset by Net Sales from new store growth. Direct Net Sales decreased $104 million, or 10%, due to a decline in orders, which was partially due to our customers continuing to select our BOPIS option (which is recognized as store Net Sales) as we completed our rollout of BOPIS capabilities to our U.S. stores in the first quarter of 2023. International Net Sales increased by $2 million, or 1%, primarily due to new stores opened by our partners.

In terms of category performance, Net Sales in candles, sanitizers and soaps declined compared to year-to-date 2022 driven by category normalization following the COVID-19 pandemic. Though total body care Net Sales decreased slightly compared to year-to-date 2022, Net Sales in our men’s business increased during the period.

Gross Profit

For year-to-date 2023, our Gross Profit decreased $107 million to $1.899 billion, and our Gross Profit rate (expressed as a percentage of Net Sales) decreased to 42.0% from 42.9%. Gross Profit decreased due to the decline in Net Sales and an increase in occupancy expenses primarily associated with store growth. These decreases were partially offset by an increase in our merchandise margin rate driven by deflation in our cost structure, lower product costs, reduced transportation costs and slightly increased average unit retails, partially offset by our continued investment in product formulations and packaging innovation.

The Gross Profit rate decline was driven by increased occupancy expenses and Buying and Occupancy Expense deleverage due to lower Net Sales, partially offset by the increase in the merchandise margin rate due to the factors discussed above.

General, Administrative and Store Operating Expenses

The following table provides detail for our General, Administrative and Store Operating Expenses for year-to-date 2023 compared to year-to-date 2022:

(in millions)

(in millions)

(in millions)

20

For year-to-date 2023, our General, Administrative and Store Operating Expenses increased $28 million to $1.310 billion, and the rate (expressed as a percentage of Net Sales) increased to 29.0% from 27.4%. Our Home Office Expenses increased primarily due to higher technology expense, principally related to IT separation costs as well as strategic investments to drive future growth, and other corporate expenses. Our Selling Expenses decreased primarily due to our cost optimization work related to efficiency in store labor and selling productivity, reduced expense as we optimized our call center and the decline in Net Sales.

The General, Administrative and Store Operating Expense rate increased primarily due to our investments in technology as well as deleverage on lower Net Sales, partially offset by the benefits of our cost optimization work related to Selling Expenses.

Other Income and Expenses

Interest Expense

The following table provides the average daily borrowings and average borrowing rates for year-to-date 2023 and 2022:

For year-to-date 2023, our Interest Expense was $259 million, compared to $262 million for year-to-date 2022. Our lower average daily borrowings, which were driven by the repurchase and early extinguishment of outstanding notes, were partially offset by a higher average borrowing rate.

Other Income

For year-to-date 2023, our Other Income was $68 million, primarily due to interest income on cash balances and pre-tax gains of $28 million associated with the repurchase and early extinguishments of outstanding notes.

Provision for Income Taxes

For year-to-date 2023, our effective tax rate was 24.9% compared to 21.9% for year-to-date 2022. The 2023 year-to-date rate was consistent with our combined estimated federal and state statutory rates. The 2022 year-to-date rate was lower than our combined estimated federal and state statutory rates primarily due to the resolution of certain tax matters during the period.

FINANCIAL CONDITION

Liquidity and Capital Resources

Liquidity, or access to cash, is an important factor in determining our financial stability. We are committed to maintaining adequate liquidity. Cash generated from our operating activities provides the primary resources to support current operations, growth initiatives, seasonal funding requirements, future common stock and debt repurchases, and capital expenditures. Our cash provided from operations is impacted by our net income and working capital changes. Our net income is impacted by, among other things, sales volume, seasonal sales patterns, success of new product introductions and product expansions, profit margins, income taxes and inflationary pressures. Historically, our sales are higher during the fourth quarter of the fiscal year due to seasonal and holiday-related sales patterns. Generally, our need for working capital peaks during the summer and fall months as inventory builds in anticipation of the holiday period. Our cash and cash equivalents held by foreign subsidiaries were $79 million as of October 28, 2023.

During year-to-date 2023, we repurchased and extinguished $373 million principal amount of our outstanding senior notes for an aggregate price of $343 million. Additionally, we also repurchased 2,765 thousand shares of our common stock for $100 million. We may, from time to time, repurchase, or otherwise retire, additional debt or shares of our common stock, as applicable.

We believe that our current cash position, our cash flow generated from operations and our borrowing capacity under our asset-backed revolving credit facility (“ABL Facility”) will be sufficient to meet our liquidity needs, including capital expenditure requirements, for at least the next twelve months.

Working Capital and Capitalization

The following table provides a summary of our working capital position and capitalization as of October 28, 2023, January 28, 2023 and October 29, 2022:

(in millions)

(a) The January 28, 2023 amounts represent a fifty-two-week period, and the October 28, 2023 and October 29, 2022 amounts represent thirty-nine-week periods.

(b) As of both October 28, 2023 and October 29, 2022, our borrowing base exceeded the aggregate commitments. Our borrowing base was $525 million as of January 28, 2023. We had outstanding letters of credit, which reduce our availability under the ABL Facility, of $10 million as of October 28, 2023, and $16 million as of both January 28, 2023 and October 29, 2022.

Cash Flows

The following table provides a summary of our cash flow activity during year-to-date 2023 and 2022:

(in millions)

Operating Activities

Net cash provided by operating activities for year-to-date 2023 was $28 million, including net income of $299 million. Net income included depreciation of $199 million, share-based compensation expense of $29 million and pre-tax gains on extinguishment of debt of $28 million. Other changes in assets and liabilities represent items that had a current period cash flow impact, such as changes in working capital. The most significant items in working capital were the seasonal changes in Inventories (and related increases in Accounts Payable), as we build our inventory levels in anticipation of the holiday season, which generates a substantial portion of our operating cash flow for the year, and Income Taxes Payable due to seasonal tax payments.

Net cash provided by operating activities for year-to-date 2022 was $67 million, including net income of $366 million. Net income included depreciation of $162 million and share-based compensation expense of $26 million. Other changes in assets and liabilities represent items that had a current period cash flow impact, such as changes in working capital. The most significant items in working capital were the seasonal changes in Inventories (and related increases in Accounts Payable), as we build our inventory levels in anticipation of the holiday season, which generates a substantial portion of our operating cash flow for the year, and Income Taxes Payable due to seasonal tax payments.

Investing Activities

Net cash used for investing activities for year-to-date 2023 was $239 million, primarily related to capital expenditures. The capital expenditures included approximately $125 million related to new, off-mall stores and remodels of existing stores, approximately $75 million for various IT projects primarily supporting the separation of our IT systems from Victoria’s Secret and approximately $35 million related to distribution and logistics capabilities.

Net cash used for investing activities for year-to-date 2022 was $252 million related to capital expenditures. The capital expenditures included approximately $130 million related to new, off-mall stores and remodels of existing stores. The remaining capital expenditures were primarily related to our new Company-operated direct channel fulfillment center and IT projects.

We continue to plan for approximately $300 million to $350 million of capital expenditures in 2023, focused on investments to support long-term growth. We are prioritizing investments in select remodels to the White Barn store design and new off-mall store openings. We are also investing in our technology, distribution and logistics capabilities to better serve our customers.

Financing Activities

Net cash used for financing activities for year-to-date 2023 was $609 million, primarily consisting of $343 million for open market debt repurchases, dividend payments of $0.60 per share, or $137 million, $99 million for share repurchases and $10 million of tax payments related to share-based awards.

Net cash used for financing activities for year-to-date 2022 was $1.499 billion consisting of $1.312 billion in payments for share repurchases, including the payment of $1 billion related to our accelerated share repurchase program, dividend payments of $0.60 per share, or $140 million, and $32 million of tax payments related to share-based awards.

Common Stock and Debt Repurchases

Our Board of Directors (our “Board”) will determine share and debt repurchase authorizations, giving consideration to our levels of profit and cash flow, capital requirements, current and forecasted liquidity, the restrictions placed upon us by our borrowing arrangements as well as financial and other conditions existing at the time. We use cash flow generated from operating and financing activities to fund our share and debt repurchase programs. The timing and amount of any repurchases will be made at our discretion, taking into account a number of factors, including market conditions.

Common Stock Repurchases

2022 Share Repurchase Program

In February 2022, our Board authorized a $1.5 billion share repurchase program (the “February 2022 Program”). Under the February 2022 Program, we repurchased the following shares of our common stock during year-to-date 2023:

(in millions)

(in thousands)

(in millions)

The February 2022 Program had $88 million of remaining authority as of October 28, 2023. There were share repurchases of $1 million reflected in Accounts Payable on the October 28, 2023 Consolidated Balance Sheet. Subsequent to October 28, 2023 through December 1, 2023, we repurchased an additional 569 thousand shares of our common stock for $17 million under the February 2022 Program.

Dividend Policy and Procedures

Our Board will determine future dividends after giving consideration to our levels of profit and cash flow, capital requirements, current and forecasted liquidity, the restrictions placed upon us by our borrowing arrangements as well as financial and other conditions existing at the time. We use cash flow generated from operating and financing activities to fund our dividends.

We paid the following dividends during year-to-date 2023 and 2022:

(in millions)

In November 2023, we declared our fourth quarter 2023 ordinary dividend of $0.20 per share payable on December 1, 2023 to stockholders of record at the close of business on November 17, 2023.

Long-term Debt and Borrowing Facility

The following table provides our outstanding Long-term Debt balance, net of unamortized debt issuance costs and discounts, as of October 28, 2023, January 28, 2023 and October 29, 2022:

(in millions)

Repurchases of Notes

During the third quarter of and year-to-date 2023, we repurchased in the open market and extinguished $174 million and $373 million principal amounts of our outstanding senior notes, respectively. The aggregate repurchase prices for these notes were $161 million and $343 million for the third quarter of and year-to-date 2023, respectively, resulting in pre-tax gains of $12 million and $28 million, net of the write-off of unamortized issuance costs, during the third quarter of and year-to-date 2023, respectively. These gains are included in Other Income in the 2023 Consolidated Statements of Income.

The following table provides details of the outstanding principal amount of senior notes repurchased and extinguished during the third quarter of and year-to-date 2023:

(in millions)

Subsequent to October 28, 2023 through December 1, 2023, we repurchased in the open market and extinguished $93 million principal amount of our outstanding senior notes for an aggregate repurchase price of $86 million.

Asset-backed Revolving Credit Facility

We and certain of our 100% owned subsidiaries guarantee and pledge collateral to secure our ABL Facility. The ABL Facility, which allows borrowings and letters of credit in U.S. dollars or Canadian dollars, has aggregate commitments of $750 million and an expiration date in August 2026.

In the second quarter of 2023, we amended our ABL Facility to replace the LIBOR-based rate with a SOFR-based rate as the interest rate benchmark on U.S. dollar borrowings. This amendment made no other material changes to the terms of the ABL Facility.

Availability under the ABL Facility is the lesser of (i) the borrowing base, determined primarily based on our eligible U.S. and Canadian credit card receivables, accounts receivable, inventory and eligible real property, or (ii) the aggregate commitment. If at any time the outstanding amount under the ABL Facility exceeds the lesser of (i) the borrowing base and (ii) the aggregate commitment, we are required to repay the outstanding amounts under the ABL Facility to the extent of such excess. As of October 28, 2023, our borrowing base was $1.169 billion, and we had no borrowings outstanding under the ABL Facility.

The ABL Facility supports our letter of credit program. We had $10 million of outstanding letters of credit as of October 28, 2023 that reduced our availability under the ABL Facility. As of October 28, 2023, our availability under the ABL Facility was $740 million.

As of October 28, 2023, the ABL Facility fees related to committed and unutilized amounts were 0.30% per annum, and the fees related to outstanding letters of credit were 1.25% per annum. In addition, the interest rate on outstanding U.S. dollar borrowings was the Term SOFR plus 1.25% and a credit spread adjustment of 0.10% per annum. The interest rate on outstanding Canadian dollar-denominated borrowings was the Canadian Dollar Offered Rate plus 1.25% per annum.

The ABL Facility requires us to maintain a fixed charge coverage ratio of not less than 1.00 to 1.00 during an event of default or any period commencing on any day when specified excess availability is less than the greater of (i) $70 million or (ii) 10% of the maximum borrowing amount. As of October 28, 2023, we were not required to maintain this ratio.

Credit Ratings

The following table provides our credit ratings as of October 28, 2023:

Guarantor Summarized Financial Information

Certain of our subsidiaries, which are listed on Exhibit 22 to this Quarterly Report on Form 10-Q, have guaranteed our obligations under the 2025 Notes, 2027 Notes, 2028 Notes, 2029 Notes, 2030 Notes, 2035 Notes and 2036 Notes (collectively, the “Notes”).

The Notes have been issued by Bath & Body Works, Inc. (the “Parent Company”). The Notes are its senior unsecured obligations and rank equally in right of payment with all of our existing and future senior unsecured obligations, are senior to any of our future subordinated indebtedness, are effectively subordinated to all of our existing and future indebtedness that is secured by a lien and are structurally subordinated to all existing and future obligations of each of our subsidiaries that do not guarantee the Notes.

The Notes are fully and unconditionally guaranteed on a joint and several basis by certain of our wholly-owned subsidiaries, including certain subsidiaries that also guarantee our obligations under our ABL Facility (such guarantees, the “Guarantees”; and, such guaranteeing subsidiaries, the “Subsidiary Guarantors”). The Guarantees of the Subsidiary Guarantors are subject to release in limited circumstances only upon the occurrence of certain customary conditions. Each Guarantee is limited, by its terms, to an amount not to exceed the maximum amount that can be guaranteed by the applicable Subsidiary Guarantor subject to avoidance under applicable fraudulent conveyance provisions of U.S. and non-U.S. law.

The following tables set forth summarized financial information for the Parent Company and the Subsidiary Guarantors on a combined basis after elimination of (i) intercompany transactions and balances among the Parent Company and the Subsidiary Guarantors and (ii) investments in and equity in the earnings of non-Guarantor subsidiaries.

(in millions)

(a) Includes amounts due from non-Guarantor subsidiaries of $596 million and $589 million as of October 28, 2023 and January 28, 2023, respectively.

(b) Includes amounts due from non-Guarantor subsidiaries of $40 million as of January 28, 2023.

(c) Includes amounts due to non-Guarantor subsidiaries of $1.860 billion and $1.987 billion as of October 28, 2023 and January 28, 2023, respectively.

(in millions)

(a) Includes net sales of $248 million to non-Guarantor subsidiaries.

(b) Includes a net loss of $14 million related to transactions with non-Guarantor subsidiaries.

Contingent Liabilities and Contractual Obligations

Lease Guarantees

In connection with the spin-off of Victoria’s Secret and the disposal of a certain other business, we had remaining contingent obligations of $267 million as of October 28, 2023 related to lease payments under the current terms of noncancelable leases, primarily related to office space, expiring at various dates through 2037. These obligations include minimum rent and additional payments covering taxes, common area costs and certain other expenses and relate to leases that commenced prior to the disposition of these businesses. Our reserves related to these obligations were not significant for any period presented.

Contractual Obligations

Our contractual obligations primarily consist of long-term debt and the related interest payments, operating leases, purchase orders for merchandise inventory and other long-term obligations. These contractual obligations impact our short-term and long-term liquidity and capital resource needs. Other than the repurchase of $373 million principal amount of our outstanding senior notes through year-to-date 2023, there have been no material changes in our contractual obligations subsequent to January 28, 2023, as discussed in “Contingent Liabilities and Contractual Obligations” in our 2022 Annual Report on Form 10-K. Certain of our contractual obligations may fluctuate during the normal course of business (primarily changes in our merchandise inventory-related purchase obligations which fluctuate throughout the year as a result of the seasonal nature of our business).

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

We did not adopt any new accounting standards year-to-date 2023 that had a material impact on our consolidated results of operations, financial position or cash flows. In addition, as of December 1, 2023, there were no new accounting standards that we have not yet adopted that are expected to have a material impact on our consolidated results of operations, financial position or cash flows.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with GAAP requires management to adopt accounting policies related to estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements. On an ongoing basis, management evaluates its accounting policies, estimates and judgments, including those related to inventories, valuation of long-lived store assets, claims and contingencies, income taxes and revenue recognition, including revenue associated with our loyalty program. Management bases our estimates and judgments on historical experience and various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates.

There have been no material changes to the critical accounting policies and estimates disclosed in our 2022 Annual Report on Form 10-K.

Market Risk

The market risk inherent in our financial instruments represents the potential loss in fair value, earnings or cash flows arising from adverse changes in foreign currency exchange rates or interest rates. We may use derivative financial instruments like foreign currency forward contracts, cross-currency swaps and interest rate swap arrangements to manage exposure to market risks. We do not use derivative financial instruments for trading purposes.

Foreign Exchange Rate Risk

Our Canadian dollar denominated earnings are subject to exchange rate risk as substantially all our merchandise sold in Canada is sourced through U.S. dollar transactions. Although we utilize foreign currency forward contracts to partially offset risks associated with our operations in Canada, these measures may not succeed in offsetting all the short-term impact of foreign currency rate movements and generally may not be effective in offsetting the long-term impact of sustained shifts in foreign currency rates.

Further, although our royalty arrangements with our international partners are denominated in U.S. dollars, the royalties we receive in U.S. dollars are calculated based on sales in the local currency. As a result, our royalties in these arrangements are exposed to foreign currency exchange rate fluctuations.

Interest Rate Risk

Our investment portfolio primarily consists of interest-bearing instruments that are classified as cash and cash equivalents based on their original maturities. Our investment portfolio is maintained in accordance with our investment policy, which specifies permitted types of investments, specifies credit quality standards and maturity profiles and limits credit exposure to any single issuer. The primary objective of our investment activities is the preservation of principal, the maintenance of liquidity and the maximization of interest income while minimizing risk. Our investment portfolio is primarily composed of U.S. government obligations, U.S. Treasury and AAA-rated money market funds, commercial paper and bank deposits. Given the short-term nature and quality of investments in our portfolio, we do not believe there is any material risk to principal associated with increases or decreases in interest rates.

All of our Long-term Debt as of October 28, 2023 has fixed interest rates. We will from time to time adjust our exposure to interest rate risk by entering into interest rate swap arrangements. Our exposure to interest rate changes is limited to the fair value of the debt issued, which would not have a material impact on our earnings or cash flows.

Fair Value of Financial Instruments

The following table provides a summary of the principal value and estimated fair value of our outstanding Long-term Debt as of October 28, 2023, January 28, 2023 and October 29, 2022:

(in millions)

(a) The estimated fair values are based on reported transaction prices and are not necessarily indicative of the amounts that we could realize in a current market exchange.

As of October 28, 2023, we believe that the carrying values of our Accounts Receivable, Accounts Payable and Accrued Expenses approximate their fair values because of their short maturities.

Concentration of Credit Risk

We maintain cash and cash equivalents and derivative contracts with various major financial institutions. We monitor the relative credit standing of financial institutions with whom we transact and limit the amount of credit exposure with any one entity. Our investment portfolio is primarily composed of U.S. government obligations, U.S. Treasury and AAA-rated money market funds, commercial paper and bank deposits. We also periodically review the relative credit standing of franchise, license and wholesale partners and other entities to which we grant credit terms in the normal course of business.

Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective and designed to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission (“SEC”) rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred in the third quarter of 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The risk factors that affect our business and financial results are discussed in Item 1A. Risk Factors in our 2022 Annual Report on Form 10-K. We wish to caution the reader that the risk factors discussed in Item 1A. Risk Factors in our 2022 Annual Report on Form 10-K and those described elsewhere in this report or other SEC filings could cause actual results to differ materially from those stated in any forward-looking statements.