Bath & Body Works, Inc.: Form 10-Q for the period ended Aug 3, 2024

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 second quarter of 2024, consolidated Net Sales were $1.526 billion, which decreased $33 million, or 2.1%, compared to the second quarter of 2023. The decrease was driven by declines of $32 million and $4 million in our North American Direct and Stores channels, respectively, partially offset by a $3 million increase in our International business. Our second quarter Operating Income was $183 million, which decreased $5 million, or 3%, compared to the second quarter of 2023, and our Operating Income rate (expressed as a percentage of Net Sales) remained flat at 12.0%.

For additional information related to our second quarter 2024 financial performance, see “Results of Operations.”

Cost Optimization

We are enhancing our operations and efficiency by targeting an aggregate of $280 million of planned annual cost savings across both Gross Profit and General, Administrative and Store Operating Expenses, which is up $30 million from our previous expectations. We delivered approximately $150 million of annual cost reductions as part of this initiative in fiscal 2023, and now expect approximately $130 million in additional annual cost savings in fiscal 2024. Our cost optimization work delivered approximately $40 million and $80 million in cost savings in the second quarter of and year-to-date 2024, respectively.

Outlook

As we look ahead to the remainder of the year, we anticipate continuing pressures given the first-half sales trends and the choppier macroeconomic environment. We are focused on executing with precision, continuing to bring newness to customers and demonstrating our strong value proposition across our product assortment. Our strategic priorities remain our core categories, supported by newness and innovation, and extending our reach through new category adjacencies, including men’s, hair, lip, and laundry, and expansion of off-mall and international locations. We are continuing to invest in product and marketing to elevate value for our customers, and in foundational tools and systems enabling new capabilities that we believe will increase customer engagement and provide a more seamless and convenient shopping experience across channels. We also continue to focus on enhancing operational excellence and efficiency through the cost optimization discussed above, which will support our strategic priorities.

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 measures that present Net Income and Net Income Per Diluted Share for the second quarters of and year-to-date 2024 and 2023 on an adjusted basis to remove certain items. We believe that these items are not indicative of our operations due to their size and nature.

We use adjusted financial information as key performance measures for the purpose of evaluating performance internally. These non-GAAP measures 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 our GAAP financial measures to our non-GAAP financial measures:

(in millions, except per share amounts)

(a) In the second quarter of 2024, we sold our investments in Easton Town Center and Easton Gateway, resulting in an aggregate pre-tax gain of $39 million (after-tax gain of $25 million). For additional information, see Note 1, “Description of Business and Basis of Presentation” included in Part I, Item 1. Financial Statements.

(b) In the second quarter of and year-to-date 2023, we recognized pre-tax gains of $9 million (after-tax gain of $7 million) and $16 million (after-tax gain of $12 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.

(c) In the second quarter of 2024, we recognized a $44 million tax benefit related to the release of a valuation allowance on a deferred tax asset.

Company-operated Store Data

The following table compares Company-operated U.S. store data for the second quarters of and year-to-date 2024 and 2023:

(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 2024:

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Partner-operated Store Data

The following table represents Partner-operated store data for year-to-date 2024:

Results of Operations

Second Quarter of 2024 Compared to Second Quarter of 2023

Net Sales

The following table provides Net Sales for the second quarter of 2024 in comparison to the second quarter of 2023:

(in millions)

(a) Results include fulfilled buy online-pick up in store (“BOPIS”) orders.

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

For the second quarter of 2024, Net Sales decreased $33 million, or 2.1%, to $1.526 billion, compared to the second quarter of 2023. Direct Net Sales decreased $32 million, or 9.7%, driven by a decline in fulfilled orders, which was primarily due to our customers continuing to select our BOPIS option (which is recognized as store Net Sales) and a decline in website traffic. Stores Net Sales decreased $4 million, or 0.3%, due to a decline in total transactions as we have seen our customers become increasingly cautious in their spending. International Net Sales increased $3 million, or 2.2%, driven by increased product shipments.

Gross Profit

For the second quarter of 2024, our Gross Profit increased $4 million to $626 million, and our Gross Profit rate (expressed as a percentage of Net Sales) increased to 41.0% from 39.9% in the second quarter of 2023. Gross Profit dollars increased primarily due to a 130 basis point increase in the merchandise margin rate and slightly lower Buying and Occupancy Expenses, partially offset by lower Net Sales.

Gross Profit rate increased due to the increase in the merchandise margin rate, driven by a decline in our average unit cost, due to cost saving initiatives partially offset by product reinvestments and category mix, and an increase in average unit retail, driven by category mix.

General, Administrative and Store Operating Expenses

The following table provides detail for our General, Administrative and Store Operating Expenses for the second quarter of 2024 compared to the second quarter of 2023:

(in millions)

(in millions)

(in millions)

For the second quarter of 2024, our General, Administrative and Store Operating Expenses increased $9 million to $443 million, and the rate (expressed as a percentage of Net Sales) increased to 29.1% from 27.8% in the second quarter of 2023. Our Selling Expenses increased primarily due to increases in associate wages and store count, partially offset by the benefits of our cost optimization work. Increases in Marketing Expenses, primarily due to additional spend to drive customer acquisition, were nearly offset by decreases in Home Office Expenses, primarily due to discrete corporate expenses in the prior year.

The General, Administrative and Store Operating Expense rate increased primarily due to our investments in marketing and the increase in associate wages, partially offset by the benefits of our cost optimization work and lapping discrete corporate expenses in the prior year.

Other Income and Expenses

Interest Expense

The following table provides the average daily borrowings and average borrowing rates for the second quarters of 2024 and 2023:

For the second quarter of 2024, our Interest Expense was $77 million, compared to $86 million in the second quarter of 2023. The decrease was due to lower average daily borrowings, which were driven by the repurchase and early extinguishment of outstanding notes.

Other Income

For the second quarter of 2024, our Other Income was $47 million, compared to $25 million in the second quarter of 2023. The increase was primarily due a $39 million pre-tax gain on sales of certain Easton investments, partially offset by the recognition of a $2 million pre-tax loss on extinguishment of debt in the second quarter of 2024, compared to a $9 million pre-tax gain on the repurchase and early extinguishments of outstanding notes in the second quarter of 2023.

Provision for Income Taxes

For the second quarter of 2024, our effective tax rate was 0.9% compared to 21.9% in the second quarter of 2023. The 2024 second quarter rate was lower than our combined estimated federal and state statutory rates primarily due to the sales of Easton investments during the quarter, which resulted in the release of a valuation allowance on a deferred tax asset. The 2023 second 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 2024 Compared to Year-to-Date 2023

For year-to-date 2024, Operating Income increased $1 million to $370 million, from $369 million year-to-date 2023, and the Operating Income rate (expressed as a percentage of Net Sales) increased to 12.7% from 12.5%. 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 2024 in comparison to year-to-date 2023:

(in millions)

(a) Results include fulfilled BOPIS orders.

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

For year-to-date 2024, Net Sales decreased $45 million, or 1.5%, to $2.910 billion, compared to year-to-date 2023. Direct Net Sales decreased $51 million, or 8.4%, driven by a decline in fulfilled orders, which was primarily due to our customers continuing to select our BOPIS option (which is recognized as store Net Sales) and a decline in website traffic. We completed our rollout of BOPIS capabilities to our U.S. stores in the first quarter of 2023. International Net Sales decreased $22 million, or 13.1%, driven by a decline in wholesale shipments to our franchise partners, primarily in the Middle East, as they continue to manage their inventory levels. Stores Net Sales increased $28 million, or 1.3%, primarily due to new store growth, an increase in BOPIS fulfilled orders, and the benefit of the shifted fiscal calendar, partially offset by the decline in average dollar sale as we have seen our customers become increasingly cautious in their spending.

For year-to-date 2024, total North American Net Sales benefited by approximately 100 basis points from the shifted fiscal calendar resulting from the 53rd week in fiscal 2023.

Gross Profit

For year-to-date 2024, our Gross Profit increased $15 million to $1.233 billion, and our Gross Profit rate (expressed as a percentage of Net Sales) increased to 42.4% from 41.2%. Gross Profit dollars increased primarily due to a 120 basis point increase in the merchandise margin rate and slightly lower Buying and Occupancy Expenses, partially offset by lower Net Sales.

Gross Profit rate increased due to the increase in the merchandise margin rate, driven by a decline in our average unit cost, due to cost saving initiatives partially offset by product reinvestments and category mix, and lower transportation costs.

General, Administrative and Store Operating Expenses

The following table provides detail for our General, Administrative and Store Operating Expenses for year-to-date 2024 compared to year-to-date 2023:

(in millions)

(in millions)

(in millions)

For year-to-date 2024, our General, Administrative and Store Operating Expenses increased $14 million to $863 million, and the rate (expressed as a percentage of Net Sales) increased to 29.6% from 28.7%. Our Selling Expenses increased primarily due to increases in associate wages, BOPIS fees and store count, partially offset by the benefits of our cost optimization work. Increases in Marketing Expenses, primarily due to additional spend to drive customer acquisition, were nearly offset by decreases in Home Office Expenses, primarily due to discrete corporate expenses in the prior year.

The General, Administrative and Store Operating Expense rate increased primarily due to our investments in marketing and the increase in associate wages, partially offset by the benefits of our cost optimization work and lapping discrete corporate expenses in the prior year.

Other Income and Expenses

Interest Expense

The following table provides the average daily borrowings and average borrowing rates for year-to-date 2024 and 2023:

For year-to-date 2024, our Interest Expense was $159 million, compared to $175 million for year-to-date 2023. The decrease was due to lower average daily borrowings, which were driven by the repurchase and early extinguishment of outstanding notes.

Other Income

For year-to-date 2024, our Other Income was $61 million, compared to $45 million for year-to-date 2023. The increase was primarily due a $39 million pre-tax gain on sales of certain Easton investments, partially offset by the recognition of a $3 million pre-tax loss on extinguishment of debt for year-to-date 2024, compared to a $16 million pre-tax gain on the repurchase and early extinguishments of outstanding notes for year-to-date 2023.

Provision for Income Taxes

For year-to-date 2024, our effective tax rate was 12.1% compared to 24.7% for year-to-date 2023. The 2024 year-to-date rate was lower than our combined estimated federal and state statutory rates primarily due to the sales of Easton investments, which resulted in the release of a valuation allowance on a deferred tax asset. The 2023 year-to-date rate was lower than the Company’s 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 and market expansions, profit margins, income taxes and inflationary pressures. Our sales are highest 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 $124 million as of August 3, 2024.

We repurchased and extinguished $200 million principal amount of our outstanding senior notes for an aggregate price of $202 million during year-to-date 2024. Additionally, we repurchased 5.763 million shares of our common stock for $249 million during year-to-date 2024. 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.

Cash Flows

The following table provides a summary of our cash flow activity during year-to-date 2024 and 2023:

(in millions)

Operating Activities

Net cash provided by operating activities for year-to-date 2024 was $30 million, including net income of $239 million. Net income included depreciation of $142 million, impacts to deferred income taxes of $102 million, an aggregate pre-tax gain on sales of certain Easton investments of $39 million, and share-based compensation expense of $22 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, Income Taxes Payable, and Accounts Receivable, and the change in Accounts Payable, Accrued Expenses and Other.

Net cash provided by operating activities for year-to-date 2023 was $77 million, including net income of $180 million. Net income included depreciation of $129 million, share-based compensation expense of $18 million and pre-tax gains on extinguishment of debt of $16 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, Income Taxes Payable and Accounts Receivable, and the change in Accounts Payable, Accrued Expenses and Other.

Investing Activities

Net cash used for investing activities for year-to-date 2024 was $40 million primarily related to capital expenditures of $101 million, partially offset by aggregate cash proceeds of $50 million related to the sales of certain Easton investments. The capital expenditures included approximately $75 million related to new, primarily off-mall, stores and remodels of existing stores, approximately $15 million for various IT projects primarily to support the growth and profitability of our business, and approximately $10 million related to distribution and logistics capabilities.

Net cash used for investing activities for year-to-date 2023 was $176 million, primarily related to capital expenditures. The capital expenditures included approximately $85 million related to new, off-mall stores and remodels of existing stores, approximately $55 million for various IT projects primarily supporting the separation of our IT systems from Victoria's Secret and approximately $30 million related to distribution and logistics capabilities.

In 2024, our top priority remains driving sustainable, long-term, profitable growth through investments in the business. To support this, we are now planning for a total of $250 million in capital expenditures during the year, and our priorities remain investments in brick-and-mortar stores and in technology. Our capital expenditures guidance is down from our previous range of $300 million to $325 million, largely driven by cost savings in our real estate build outs and timing of multiyear supply chain investments.

Financing Activities

Net cash used for financing activities for year-to-date 2024 was $560 million, primarily consisting of $248 million for share repurchases, $202 million for open market debt repurchases, dividend payments of $0.40 per share, or $90 million, and $15 million of tax payments related to share-based awards.

Net cash used for financing activities for year-to-date 2023 was $343 million, primarily consisting of $182 million for open market debt repurchases, dividend payments of $0.40 per share, or $92 million, $48 million for share repurchases and $9 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 2024 and 2023:

(in thousands)

(in millions)

The February 2022 Program had no remaining authority as of May 4, 2024. There were share repurchases of $1 million reflected in Accounts Payable on the February 3, 2024 Consolidated Balance Sheet.

2024 Share Repurchase Program

In January 2024, our Board authorized a new $500 million share repurchase program (the “January 2024 Program”). Under the January 2024 Program, we repurchased the following shares of our common stock during year-to-date 2024:

(in thousands)

(in millions)

The January 2024 Program had $290 million of remaining authority as of August 3, 2024. There were share repurchases of $2 million reflected in Accounts Payable on the August 3, 2024 Consolidated Balance Sheet.

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 the first and second quarters of 2024 and 2023:

(in millions)

In August 2024, we declared our third quarter 2024 ordinary dividend of $0.20 per share payable on September 6, 2024 to stockholders of record at the close of business on August 23, 2024.

Long-term Debt and Borrowing Facility

The following table provides our outstanding debt balances, net of unamortized debt issuance costs and discounts, as of August 3, 2024, February 3, 2024 and July 29, 2023:

(in millions)

Repurchases of Notes

During the second quarter of and year-to-date 2024, we repurchased in the open market and extinguished $91 million and $200 million principal amounts of our outstanding senior notes, respectively. The aggregate repurchase price for these notes were $92 million and $202 million for the second quarter of and year-to-date 2024, respectively, resulting in pre-tax losses of $2 million and $3 million, including the write-off of unamortized issuance costs, during the second quarter of and year-to-date 2024, respectively. These losses are included in Other Income in the 2024 Consolidated Statements of Income.

During the second quarter of and year-to-date 2023, we repurchased in the open market and extinguished $115 million and $199 million principal amounts of our outstanding senior notes, respectively. The aggregate repurchase price for these notes were $106 million and $182 million for the second quarter of and year-to-date 2023, respectively, resulting in pre-tax gains of $9 million and $16 million, including the write-off of unamortized issuance costs, during the second 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 amounts of senior notes repurchased and extinguished during the second quarters of and year-to-date 2024 and 2023:

(in millions)

Asset-backed Revolving Credit Facility

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

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 August 3, 2024, our borrowing base was $661 million, 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 August 3, 2024 that reduced our availability under the ABL Facility. As of August 3, 2024, our availability under the ABL Facility was $651 million.

As of August 3, 2024, 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 Secured Overnight Financing Rate plus 1.25% and a credit spread adjustment of 0.10% 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 August 3, 2024, we were not required to maintain this ratio.

Credit Ratings

The following table provides our credit ratings as of August 3, 2024:

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 $610 million and $622 million as of August 3, 2024 and February 3, 2024, respectively.

(b) Includes amounts due to non-Guarantor subsidiaries of $1.411 billion and $1.905 billion as of August 3, 2024 and February 3, 2024, respectively.

(in millions)

(a) Includes net sales of $71 million to non-Guarantor subsidiaries.

(b) Includes a net loss of $5 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 & Co. and the disposal of a certain other business, we had remaining contingent obligations of $253 million as of August 3, 2024 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 $200 million principal amounts of our outstanding senior notes during year-to-date 2024, there have been no material changes in our contractual obligations subsequent to February 3, 2024, as discussed in “Contingent Liabilities and Contractual Obligations” in our 2023 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

In November 2023, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2023-07, Improvements to Reportable Segment Disclosures, that expands reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses and information used to assess segment performance, and applies to companies with a single reportable segment. The standard is effective for fiscal years beginning after December 15, 2023, and for interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. We are currently evaluating the impact of adopting this standard on our disclosures.

In December 2023, the FASB issued ASU 2023-09, Improvements to Income Tax Disclosures, that requires enhanced income tax disclosures, primarily related to standardization and disaggregation of rate reconciliation categories and income taxes paid by jurisdiction. This standard is effective for fiscal years beginning after December 15, 2024, with early adoption permitted, and may be applied either prospectively or retrospectively. We are currently evaluating the impact of adopting this standard on our disclosures.

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 2023 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 objectives of our investment activities are 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 outstanding debt as of August 3, 2024 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 debt as of August 3, 2024, February 3, 2024 and July 29, 2023:

(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 August 3, 2024, 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 second quarter of 2024 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 2023 Annual Report on Form 10-K. We wish to caution the reader that the risk factors discussed in Item 1A. Risk Factors in our 2023 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.