Victoria's Secret & Co. (VSXY) FY 2023 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

We caution that any forward-looking statements (as such term is defined in the U.S. Private Securities Litigation Reform Act of 1995) contained in this Annual Report on Form 10-K or made by us, our management, or our spokespeople involve risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. Accordingly, our future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements. Forward-looking statements include, without limitation, statements regarding our future operating results, the implementation and impact of our strategic plans, and our ability to meet environmental, social, and governance goals. Words such as “estimate,” “commit,” “target,” “goal,” “project,” “plan,” “believe,” “seek,” “strive,” “expect,” “anticipate,” “intend,” “potential” and any similar expressions may identify forward-looking statements. Risks associated with the following factors, among others, could affect our financial performance and cause actual results to differ materially from those expressed or implied in any forward-looking statements:

•the spin-off from our Former Parent may not be tax-free for U.S. federal income tax purposes;

•we may not realize all of the expected benefits of the spin-off;

•general economic conditions, inflation, consumer confidence, consumer spending patterns and market disruptions including pandemics or significant health hazards, severe weather conditions, natural disasters, terrorist activities, financial crises, political crises or other major events, or the prospect of these events;

•the novel coronavirus (COVID-19) global pandemic has had and may continue to have an adverse effect on our business and results of operations;

•difficulties arising from turnover in company leadership or other key positions;

•our ability to attract, develop and retain qualified associates and manage labor-related costs;

•our dependence on mall traffic and the availability of suitable store locations on appropriate terms;

•our ability to successfully operate and expand internationally and related risks;

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•our independent franchise, license, wholesale, and joint venture partners;

•our direct channel business;

•our ability to protect our reputation and the image of our brands;

•our ability to attract customers with marketing, advertising and promotional programs;

•the highly competitive nature of the retail industry and the segments in which we operate;

•consumer acceptance of our products and our ability to manage the life cycle of our brands, keep up with fashion trends, develop new merchandise and launch new product lines successfully;

•our ability to realize the potential benefits and synergies sought with the acquisition of Adore Me;

•our ability to source, distribute and sell goods and materials on a global basis, including risks related to:

•political instability, environmental hazards or natural disasters;

•significant health hazards or pandemics;

•legal and regulatory matters;

•delays or disruptions in shipping and transportation and related pricing impacts; and

•disruption due to labor disputes;

•our geographic concentration of vendor and distribution facilities in central Ohio and Southeast Asia;

•the ability of our vendors to deliver products in a timely manner, meet quality standards and comply with applicable laws and regulations;

•fluctuations in freight, product input and energy costs, including those caused by inflation;

•our and our third-party service providers’ ability to implement and maintain information technology systems and to protect associated data and system availability;

•our ability to maintain the security of customer, associate, third-party and company information;

•stock price volatility;

•shareholder activism matters;

•our ability to maintain our credit rating;

•our ability to comply with regulatory requirements; and

•legal, tax, trade and other regulatory matters.

Except as may be required by law, we assume no obligation and do not intend to make publicly available any update or other revisions to any of the forward-looking statements contained in this Annual Report on Form 10-K to reflect circumstances existing after the date of this report or to reflect the occurrence of future events, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized. Additional information regarding these and other factors can be found in “Item 1A. Risk Factors” in this Annual Report on Form 10-K.

The following discussion and analysis of financial condition and results of operations are based upon our Consolidated and Combined 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 (“ASC”). The following information should be read in conjunction with our financial statements and the related notes included in Item 8. Financial Statements and Supplementary Data.

Our operating results are generally impacted by economic changes and, therefore, we monitor the retail environment using, among other things, certain key industry performance indicators including competitor performance and mall traffic data. These can provide insight into consumer spending patterns and shopping behavior in the current retail environment and assist us in assessing our performance as well as the potential impact of industry trends on our future operating results. Additionally, we evaluate a number of key performance indicators including comparable sales, gross profit, operating income and other performance metrics such as sales per average selling square foot and inventory per selling square foot in assessing our performance.

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Executive Overview

Victoria’s Secret & Co. is an iconic global brand of women’s intimate and other apparel, personal care and beauty products. We sell our products through three brands, Victoria’s Secret, PINK and Adore Me. Victoria’s Secret is a category-defining global lingerie brand with a leading market position and a rich, over 45-year history of serving women across the globe. PINK is a lifestyle brand for the collegiate-oriented customer, built around a strong intimates core. We also sell beauty products under both the Victoria’s Secret and PINK brands. Adore Me is a technology-led, digital first innovative intimates brand serving women of all sizes and budgets at all phases of life. Together, Victoria’s Secret, PINK, Victoria’s Secret Beauty and Adore Me support, inspire and celebrate women through every phase of their life.

Victoria’s Secret, PINK and Adore Me merchandise is sold online through e-commerce platforms, through retail stores located in the U.S., Canada and China, and through international stores and websites operated by partners under franchise, license, wholesale and joint venture arrangements. We have a presence in approximately 70 countries and we believe we benefit from global brand awareness, a wide and compelling product assortment and a powerful, deep connection with our customers.

We are committed to optimizing our performance by focusing on what is within our control, and we are confident in our strategic growth plan and remain committed to delivering long-term sustainable value for our stockholders.

Impacts of Macroeconomic Environment

Our operations and financial performance have been adversely impacted by deterioration in economic conditions in the United States and globally, which were caused in part by the COVID-19 pandemic. The current macroeconomic environment is characterized by record-high inflation, supply chain challenges, labor shortages, high interest rates, volatility in global capital markets and growing recession risk. Such macroeconomic conditions have and could continue to adversely affect our business, for example, by reducing consumer demand for our products and leading to decreased sales.

Information Technology Impacts of the Separation

Subsequent to the completion of the Separation, we have provided technology services and systems to our Former Parent under the transition services agreements while two independent information technology platforms are being created in support of two independent companies. We have incurred, and expect to continue to incur, costs consisting of internal and external labor, software licensing, networking, security and infrastructure required to separate the current information technology capabilities (systems and infrastructure) in support of two independent companies. We currently estimate that our total incremental expenditures will be at the lower end of our previous estimate of $100 million to $150 million over the transition period, with the majority of costs being incurred by the end of 2023, which is when the separation of our technology systems is expected to be predominately completed. Such estimates are subject to change as our work continues.

Basis of Presentation

Our financial statements for periods through the Separation date of August 2, 2021 are combined financial statements prepared on a “carve-out” basis, which reflects the business as historically managed within the Former Parent. The balance sheets and cash flows for the periods prior to the Separation include only those assets and liabilities directly related to the Victoria’s Secret business, and the statements of income (loss) include the historically reported results of the Victoria’s Secret business along with allocations of a portion of the Former Parent's total corporate expenses. Our financial statements for the period from August 3, 2021 through January 28, 2023 are consolidated financial statements based on our reported results as a standalone company. For additional information on the “carve-out” basis of accounting, see Note 1, “Description of Business, Basis of Presentation and Summary of Significant Accounting Policies.”

Growth Strategies

Our goal is to be the world's leading fashion retailer of intimate apparel. Our strategic growth plan is guided by our three key pillars: 1) strengthening our core; 2) igniting growth; and 3) transforming the foundation of our company. We are evolving the positioning of Victoria's Secret and PINK to drive profitable growth and are focused on strengthening the core of our business by leading with a customer-first approach and rewarding customer loyalty, advancing technology to improve and expand the customer experience, delivering best-in-class products across all categories and focusing on being “best at bras”. We will focus on igniting growth through maintaining an innovative product pipeline, evolving our store fleet of the future, and through channel expansion and international growth within existing and new markets. We continue to take actions to transform the foundation of our company by making foundational changes to modernize and make our operating model more efficient to help us deliver long-term sustainable value for our shareholders.

We have a multi-year goal to increase sales and operating income by focusing on these key business priorities:

•Invest in our brands, business and new opportunities to drive growth;

•Continue optimizing the customer experience through elevated and profitable company-operated stores;

•Drive penetration and growth in our digital channel and provide an enhanced omni-channel experience; and

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•Expand our international business.

The following is a discussion regarding certain of our key business priorities.

Invest in our Brands, Business and New Opportunities to Drive Growth

We continue to make significant investments in our iconic brands, our physical and digital business channels, our customer experience and our organizational capabilities in order to support the continued growth of our business. We believe our success is significantly enabled by frequent and innovative product launches, which include bra launches and new beauty fragrances. We are making targeted investments in technology related to our strategic initiatives to drive growth, including our new Victoria's Secret and PINK customer loyalty program, and to maintain our high digital penetration and to expand the omni-channel offering for our customers. We are also working to increase our distribution capacity and efficiency in order to make decisions close to market, deliver orders to customers more quickly and provide the best and widest assortment across product categories and sizes across all channels. Our management team is committed to a diverse and inclusive corporate culture and we have a world class team to support the execution of our growth strategies. Additionally, we will continue to search for new growth opportunities, including new brands we may develop as well as partnerships with existing brands that help us attract new customers and better meet the needs of existing ones.

Continue Optimizing the Customer Experience through Elevated and Profitable Company-Operated Stores

We believe we can further optimize our existing base of stores within North America to continue to deliver an elevated retail experience and to meet our customers’ evolving channel preferences. We believe our stores channel is important to engaging with existing and new customers and, accordingly, see it as a key part of our strategy and focus to provide flexibility and convenience to our customers through omni-channel capabilities. We are investing in our stores through refreshing existing stores and expanding our store of the future concept that will include smaller, more flexible space in off-mall locations with a unique dual-brand layout to meet the needs of our customer and accommodate shifting consumer preferences for omni-channel shopping. We also continue to focus on appropriate space allocation within the store and right-sizing the overall size of the North American stores, which we believe will lead to sales transference to other stores and our digital channel. In addition to our initiatives related to our physical stores, we plan to continue to invest in store talent and labor optimization. These initiatives are designed to increase productivity in our stores measured through improved sales per selling square foot, as well as overall store profitability.

Drive Penetration and Growth in our Digital Channel and Provide an Enhanced Omni-Channel Experience

Investing in our digital channel continues to be a key priority and we believe that our global brands and our scaled retail footprint in North America is a unique platform to grow our digital business. Omni-channel initiatives, including buy online pick-up in store, and an increased focus on mobile and application interactions will continue to provide flexibility and convenience to our customers. Our shopping and services initiatives are aimed at modernizing the customer’s digital shopping experience through features like digital selling guides, virtual try-on, digital appointments, improved checkout performance and alternative payment options. Further, with our customer at the core of our strategy, we are also increasing the personalization of our digital platforms through site experience and marketing designed for our customer. Our ongoing digital investments are designed to create a seamless shopping experience between online and offline and bolster our performance in the digital channel. In addition, we are scaling the distribution capacity of our digital business in order to support our growth and our omni-channel offerings. These strategies are aimed at increasing our digital channel mix and driving margin accretion.

Expand our International Business

Growing our international business is a key strategy. We plan to drive strong sales growth in franchise, travel retail and joint venture-operated stores through continued improved product offerings and adjusting assortments to better reflect local preferences. We plan to increase our international store count, enabled by a new store design, lower costs and flexible store formats, which are designed to provide a pathway to profitable growth. Additionally, we expect to continue investing in and growing the digital components of our international business, including through country-specific web platforms tailored to local languages and preferences and through additional regional expansion. We believe our joint venture partnership we entered into in 2022 with Regina Miracle in China will allow us to grow the China business through joint investment in product development, distribution and marketing, and also positively impacts the speed and agility of the business due to Regina Miracle's established production base in China.

2022 Overview

In 2022, our first full year as an independent, publicly-traded company, we continued to take strategic steps guided by our three key pillars in support of our strategy and positioning for the Company for the long-term.

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Despite a macroeconomic environment that remained challenging for our customers, including ongoing supply chain disruptions and inflationary pressures, we controlled what we could and delivered financial results that we believe demonstrate the stability of our business and progress of our brand repositioning, our domestic market share leadership position in the intimates category, and our new, more agile operating structure that allows us to deliver solid financial results in a challenging environment. Throughout the year, we have been focused on our revolution of our brand and our strategic growth plans, to provide long-term, sustainable value to our shareholders. We completed our acquisition of Adore Me which we believe will strategically position us for growth by allowing us to leverage Adore Me's expertise and technology to continue to improve the Victoria's Secret and PINK customer shopping experience and to accelerate the modernization of our digital platform. In 2022, we invested $250 million to repurchase 6.0 million shares of our common stock, and in January 2023, we announced a new share repurchase program providing for the repurchase of up to $250 million of our common stock.

In 2022, net sales decreased $441 million, or 6%, to $6.344 billion compared to $6.785 billion in 2021. Our North American store sales decreased 7%, or $285 million, to $3.909 billion compared to $4.194 billion in 2021, as an increase in traffic was more than offset by a decrease in conversion (which we define as the percentage of customers who visit our stores and make a purchase) and average unit retail (which we define as the average price per unit purchased). Our direct channel sales decreased by 13%, or $271 million, to $1.843 billion compared to $2.114 billion in 2021, primarily due to a decrease in average unit retail, traffic and conversion. Operating income for the full year decreased to $478 million compared to operating income of $870 million in 2021, and our operating income rate decreased to 7.5% compared to 12.8% last year. The operating income decrease in 2022 was primarily driven by a decrease in net sales and merchandise margin rate, and was partially offset by a decrease in general, administrative and store operating expenses.

For additional information related to our 2022 financial performance, see “Results of Operations – 2022 Compared to 2021.” For a discussion of our financial condition and results of operations for 2021 compared to 2020, refer to “Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended January 29, 2022, filed with the SEC on March 18, 2022.

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Non-GAAP Financial Information

In addition to our results provided in accordance with GAAP above and throughout this Annual Report on Form 10-K, provided below are non-GAAP financial measures which present adjusted operating income, adjusted net income attributable to Victoria's Secret & Co. and adjusted net income per diluted share attributable to Victoria's Secret & Co. in 2022, 2021 and 2020, which exclude the impact of certain items. We believe the presentation of these non-GAAP financial measures is useful for an assessment of our ongoing operations, and that the adjustments are not indicative of our ongoing operations due to their size and nature. We use non-GAAP financial information as key performance measures of results of operations 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 non-GAAP financial information provides additional information to investors to facilitate the comparison of past and present operations. Further, our definition of non-GAAP financial measures may differ from similarly titled measures used by other companies. Non-GAAP financial measures should not be used exclusively in evaluating our business or operations. The table below reconciles the non-GAAP financial measures to its most directly comparable GAAP financial measures.

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(a)In the first quarter of 2022, we recognized a pre-tax charge of $22 million ($16 million after-tax), included in buying and occupancy expense, related to a legal matter with a landlord regarding a high-profile store that we surrendered to the landlord prior to the Separation. For additional information, see Note 16, “Commitments and Contingencies” included in Item 8. Financial Statements and Supplementary Data.

(b)In the second quarter of 2022, we recognized a pre-tax charge of $29 million ($22 million after-tax), $16 million included in general, administrative and store operating expense and $13 million included in buying and occupancy expense, related to restructuring activities to reorganize our leadership structure. In the fourth quarter of 2022, we recognized a pre-tax charge of $6 million ($4 million after-tax), $5 million included in general, administrative and store operating expense and $1 million included in buying and occupancy expense, related to restructuring activities to continue to reorganize and improve our organizational structure. In the second quarter of 2020, we recognized pre-tax severance charges of $51 million ($40 million after-tax) related to headcount reductions as a result of restructuring activities. For additional information, see Note 6, “Restructuring Activities” included in Item 8. Financial Statements and Supplementary Data.

(c)In the fourth quarter of 2022, we recognized a $16 million charge ($12 million after-tax), $15 million included in costs of goods sold, buying and occupancy expense and $1 million included in general, administrative and store operating expense, for inventory and other costs related to restructuring actions associated with Happy Nation.

(d)In the fourth quarter of 2022, we recognized a $15 million charge ($14 million after-tax), included in general, administrative and store operating expense, related to professional services and other transaction-related costs associated with the acquisition of Adore Me. For additional information, see Note 2, “Acquisition” included in Item 8. Financial Statements and Supplementary Data.

(e)We recognized pre-tax impairment charges of $97 million ($72 million after-tax) and $117 million ($99 million after-tax) related to certain store and lease assets in the first and second quarter of 2020, respectively. For additional information, see Note 8, “Long-Lived Assets” included in Item 8. Financial Statements and Supplementary Data.

(f)In the second quarter of 2020, we recognized a net pre-tax gain of $36 million ($25 million after-tax) related to the closure and termination of our lease for the Hong Kong flagship store. For additional information, see Note 9, “Leases” included in Item 8. Financial Statements and Supplementary Data.

(g)In the third quarter of 2020, we recognized a pre-tax gain of $30 million ($27 million after-tax) related to the establishment of a joint venture for the U.K. and Ireland business with Next. For additional information, see Note 6, “Restructuring Activities” included in Item 8. Financial Statements and Supplementary Data.

(h)In the third quarter of 2020, we recognized a $44 million tax benefit related to a tax matter associated with foreign investments.

Company-Operated Store Data

The following table compares 2022 U.S. company-operated store data to the comparable periods for 2021 and 2020:

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(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 square footage and store count, respectively. As a result of the COVID-19 pandemic, all our stores in the U.S. were closed on March 17, 2020 with the majority having re-opened as of the beginning of the third quarter of 2020. As a result, comparisons of year-over-year trends are not a meaningful way to discuss our operating results for the periods impacted by the COVID-19 pandemic.

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The following table represents store data for 2022:

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(a)    Includes thirteen partner-operated stores at January 28, 2023.

(b)    For additional information, see Note 2, “Acquisition” included in Item 8. Financial Statements and Supplementary Data.

The following table represents store data for 2021:

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The following table represents store data for 2020:

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(a)    For additional information, see Note 6, “Restructuring Activities” included in Item 8. Financial Statements and Supplementary Data.

Results of Operations — 2022 Compared to 2021

The following information summarizes our results of operations for 2022 compared to 2021.

Operating Income

For 2022, operating income decreased $392 million, to $478 million, compared to operating income of $870 million in 2021, and the operating income rate (expressed as a percentage of net sales) decreased to 7.5% from 12.8%. The drivers of the operating income results are discussed in the following sections.

Net Sales

The following table provides net sales for 2022 in comparison to 2021:

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(a)Results include consolidated joint venture sales in China, royalties associated with franchised stores and wholesale sales.

The following table provides a reconciliation of net sales from 2021 to 2022:

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The following table compares 2022 comparable sales to 2021:

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(a)The percentage change in comparable sales represents direct and comparable store sales. The percentage change in comparable store sales represents the change in sales at comparable stores only and excludes the change in sales from our direct channel. The change in comparable sales provides an indication of period over period growth (decline). A store is typically included in the calculation of comparable sales when it has been open 12 months or more and it has not had a change in selling square footage of 20% or more. Closed stores are excluded from the comparable sales calculation if they have been closed for four consecutive days or more. Upon re-opening, the stores are included in the calculation. Therefore, comparable sales results exclude the closure period of stores that were closed for four consecutive days or more as a result of the COVID-19 pandemic. Additionally, stores are excluded if total selling square footage in the mall changes by 20% or more through the opening or closing of a second store. The percentage change in comparable sales is calculated on a comparable calendar period as opposed to a fiscal basis. Comparable sales attributable to our international stores are calculated on a constant currency basis.

Net sales in 2022 decreased $441 million, or 6%, to $6.344 billion compared to $6.785 billion in 2021.

In the stores channel for 2022, our North America net sales decreased $285 million, or 7%, to $3.909 billion, as an increase in traffic was more than offset by a decrease in conversion and average unit retail. Net sales in stores outside of North America increased in 2022 compared to 2021 driven by fewer COVID-19-related restrictions this year impacting international travel and traffic in our stores.

In the direct channel, net sales decreased $271 million, or 13%, to $1.843 billion, primarily due to a decrease in average unit retail, traffic and conversion.

Gross Profit

For 2022, our gross profit decreased $502 million to $2.258 billion, and our gross profit rate (expressed as a percentage of net sales) decreased to 35.6% from 40.7%.

For 2022, the gross profit decrease was primarily due to the decrease in merchandise margin dollars related to the decrease in net sales, increased promotional activity driven by the challenging economic environment during the last three quarters of the year and incremental supply chain and inflationary cost pressures in 2022 compared to last year. Partially offsetting these decreases was lower buying and occupancy expenses this year compared to last year driven by lower management compensation expense and lower depreciation expense.

The gross profit rate decrease was driven by a decrease in the merchandise margin rate reflecting the increased promotional activity, buying and occupancy deleverage on the decline in sales and the net impact of supply chain and inflationary cost pressures, partially offset by the lower management compensation expense and lower depreciation expense.

General, Administrative and Store Operating Expenses

For 2022, our general, administrative and store operating expenses decreased $110 million to $1.780 billion primarily due to lower store selling expenses driven by improvement in our labor model and our ongoing disciplined expense management initiatives, as well as lower management compensation expense. These decreases were partially offset by $21 million of restructuring charges in 2022 and $15 million of professional services and other transaction-related costs associated with the acquisition of Adore Me.

The general, administrative and store operating expense rate (expressed as a percentage of net sales) increased to 28.1% from 27.9% due to slight deleverage driven by the decrease in net sales.

Interest Expense

For 2022, our interest expense increased $33 million to $60 million compared to 2021, primarily driven by the increase in our outstanding debt due to the issuance of the 2029 Notes and the Term Loan Facility that we entered into upon the Separation in August 2021 and due to the borrowings from the ABL Facility during 2022.

Provision for Income Taxes

For 2022, our effective tax rate was 19.0% compared to 23.3% in 2021. The effective tax rate for both years was lower than the Company's combined estimated federal and state statutory rate primarily due to the recognition of excess tax benefits related to share-based compensation awards that vested in the respective periods.

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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 and capital expenditures. Our cash provided from operations is impacted by our net income (loss) and working capital changes. Our net income (loss) is impacted by, among other things, sales volume, seasonal sales patterns, success of new product introductions, profit margins and income taxes. Historically, 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.

Prior to the Separation, we generated annual cash flow from operating activities. However, we were operating within the Former Parent's cash management structure, which used a centralized approach to cash management and financing of our operations. As a result, a substantial portion of our cash was transferred to the Former Parent. This arrangement was not reflective of the manner in which we would have financed our operations had we been an independent, publicly traded company during the periods presented prior to the Separation.

The cash and cash equivalents held by the Former Parent at the corporate level prior to the Separation were not specifically identifiable to us and, therefore, were not reflected in the Consolidated Balance Sheets. The Former Parent's third-party long-term debt and the related interest expense were not allocated to us for any of the periods presented prior to the Separation as we were not the legal obligor of such debt.

Following the Separation from the Former Parent, our capital structure and sources of liquidity changed from the historical capital structure because we no longer participate in the Former Parent's centralized cash management program. Our ability to fund our operating needs is primarily dependent upon our ability to continue to generate positive cash flow from operations, as well as borrowing capacity under our senior secured asset-based revolving credit facility (the “ABL Facility”), which we rely on to supplement cash generated by our operating activities, particularly when our need for working capital peaks in the summer and fall months as discussed above. Management believes that our cash balances and funds provided by operating activities, along with the borrowing capacity under our ABL Facility, taken as a whole, provide (i) adequate liquidity to meet all of our current and long-term obligations when due, including third-party debt that we incurred in connection with the Separation, (ii) adequate liquidity to fund capital expenditures, and (iii) flexibility to meet investment opportunities that may arise. However, certain investment opportunities may require us to seek additional debt or equity financing, and there can be no assurances that we will be able to obtain additional debt or equity financing on acceptable terms, if at all, in the future.

We expect to utilize our cash flows to continue to invest in our brands, talent and capabilities, and growth strategies as well as to fund our share repurchase programs and to repay our indebtedness over time. We believe that our available short-term and long-term capital resources are sufficient to fund requirements over the next 12 months.

Working Capital and Capitalization

Prior to the Separation, we generated annual cash flow from operating activities to support our working capital needs. However, we were operating within the Former Parent’s cash management structure, which used a centralized approach to cash management and financing of our operations. As a result, a substantial portion of our cash was transferred to the Former Parent. This arrangement was not reflective of the manner in which we would have financed our operations had we been an independent, publicly traded company during the periods presented prior to the Separation. Based upon our cash balances and funds provided by operating activities, along with the borrowing capacity under our ABL Facility, we believe we will be able to continue to meet our working capital needs.

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The following table provides a summary of our working capital position and capitalization for the periods post-Separation as of January 28, 2023 and January 29, 2022:

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(a)For the reporting period ending January 28, 2023, the availability under the ABL Facility was limited by our borrowing base of $596 million, less outstanding borrowings of $295 million and letters of credit of $42 million. For the reporting period ending January 29, 2022, the availability was limited by our borrowing base of $564 million, less outstanding letters of credit of $41 million. There were no borrowings outstanding under the ABL Facility as of January 29, 2022.

The following table provides certain measures of liquidity and capital resources for the periods post-Separation as of January 28, 2023 and January 29, 2022:

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(a)Long-term debt divided by total capitalization.

Cash Flow

The following table provides a summary of our cash flow activity for the fiscal years ended January 28, 2023, January 29, 2022 and January 30, 2021:

Operating Activities

Net cash provided by operating activities reflects net income adjusted for non-cash items, including depreciation, share-based compensation expense and deferred tax expense, as well as changes in working capital. Net cash provided by operating activities in 2022 was $437 million, a decrease of $414 million compared to 2021. The decrease in net cash from operating activities in 2022 was primarily driven by lower net income and higher cash outflows associated with working capital changes. The most significant working capital driver resulting in the decrease in operating cash flows this year compared to last year is driven by payments related to the increased inventory levels throughout this year compared to last year. The increased inventory levels this year were primarily driven by modal mix changes and longer in-transit shipment times which we began to experience in the third and fourth quarter of 2021. The other significant working capital driver resulting in the decrease in operating cash flows this year is related to income taxes paid of $161 million in 2022 as compared to $56 million paid in 2021. In 2021, the income tax provision assumed the utilization of certain tax benefits that only existed on a “carve-out” basis from the Former Parent.

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Investing Activities

Net cash used for investing activities in 2022 was $555 million, consisting primarily of our $369 million cash payment, net of cash acquired, in connection with the Adore Me acquisition and capital expenditures of $164 million. The capital expenditures were primarily related to our store capital program, along with investments in technology, distribution and logistics to support our retail capabilities.

Net cash used for investing activities in 2021 was $169 million for capital expenditures. The capital expenditures were primarily related to our store refresh program and spending on technology and logistics to support our digital business and other retail capabilities.

We are estimating 2023 capital expenditures to be approximately $275 million. We are investing in our store capital program along with investments in technology related to our strategic initiatives to drive growth and technology investments relating to the Separation activities.

Financing Activities

Net cash provided by financing activities in 2022 was $58 million, consisting primarily of borrowings of $295 million from the ABL Facility and $55 million of cash received from Regina Miracle in connection with the joint venture agreement completed in the first quarter of 2022. Those proceeds were partially offset by $250 million of share repurchases and $42 million of payments for taxes on share-based compensation awards.

Net cash used for financing activities in 2021 was $527 million consisting primarily of net transfers to the Former Parent of $1.253 billion and $250 million for the accelerated share repurchase program, partially offset by $982 million of net proceeds from the issuance of long-term debt.

Common Stock Share Repurchases & Treasury Stock Retirements

Our Board of Directors determines share 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 and the Tax Matters Agreement with the Former Parent, as well as financial and other conditions existing at the time. We use cash flow generated from operating activities to fund our share 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.

January 2023 Share Repurchase Program

In January 2023, our Board of Directors approved a share repurchase program (“January 2023 Share Repurchase Program”), authorizing the repurchase of up to $250 million of our common stock. The $250 million authorization is expected to be utilized to repurchase shares in the open market, subject to market conditions and other factors. Shares acquired through the January 2023 Share Repurchase Program will be available to meet obligations under equity compensation plans and for general corporate purposes. The January 2023 Share Repurchase Program began upon completion of the March 2022 Share Repurchase Program and will continue until exhausted, but no later than the end of fiscal year 2023. We did not repurchase any shares of our common stock under the January 2023 Share Repurchase Program during fiscal year 2022.

Subsequent to the end of fiscal year 2022, we entered into an accelerated share repurchase agreement (“ASR Agreement”) with Goldman Sachs & Co. LLC (“Goldman Sachs”) to repurchase $125 million of our common stock. In February 2023, we made an initial payment of $125 million to Goldman Sachs and received an initial delivery of 2.4 million shares of our common stock. The final number of shares to be repurchased will be based on the volume-weighted average price of our common stock during the term of the ASR Agreement, less a discount and subject to adjustments pursuant to the terms of the ASR Agreement. The final settlement of the ASR Agreement is expected to be completed in the second quarter of 2023. The ASR Agreement is a component of the January 2023 Share Repurchase Program.

March 2022 Share Repurchase Program

In March 2022, our Board of Directors approved a share repurchase program (“March 2022 Share Repurchase Program”), providing for the repurchase of up to $250 million of our common stock. The full $250 million authorization was utilized in fiscal year 2022 to repurchase shares in the open market, subject to market conditions and other factors.

We repurchased the following shares of our common stock under the March 2022 Share Repurchase Program during 2022:

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In accordance with the Board of Directors' resolution, shares of our common stock repurchased under the March 2022 Share Repurchase Program were retired upon repurchase and were available to meet obligations under equity compensation plans and for general corporate purposes. As a result, we retired all the shares repurchased under the March 2022 Share Repurchase Program during 2022, which resulted in reductions of less than $1 million in the par value of Common Stock, $12 million in Paid-in Capital and $238 million in Retained Earnings.

December 2021 ASR Agreement

In December 2021, we entered into an accelerated share repurchase agreement (“December 2021 ASR Agreement”) with Goldman Sachs to repurchase $250 million of our common stock. In December 2021, we made an initial payment of $250 million to Goldman Sachs and received an initial delivery of 4.1 million shares of our common stock. The $250 million payment to Goldman Sachs was recognized as a reduction to shareholders’ equity, consisting of a $200 million increase in Treasury Stock, which reflects the value of the initial 4.1 million shares received upon initial settlement, and a $50 million decrease in Paid-in Capital, which reflects the value of the stock held back by Goldman Sachs pending final settlement of the December 2021 ASR Agreement. In accordance with the Board of Directors' resolution, we immediately retired the 4.1 million shares repurchased under the December 2021 ASR Agreement. The retirement resulted in a reduction of $200 million in Treasury Stock, less than $1 million in the par value of Common Stock, $8 million in Paid-in Capital and $192 million in Retained Earnings.

In February 2022, upon final settlement of the December 2021 ASR Agreement, we received an additional 0.3 million shares of our common stock from Goldman Sachs. The final number of shares received under the December 2021 ASR Agreement was based on the daily average of the volume-weighted average share price of our common stock over the term of the December 2021 ASR Agreement, less a discount and subject to other adjustments pursuant to the terms of the December 2021 ASR Agreement. The delivery of shares resulted in an immediate reduction of the outstanding shares used to calculate the weighted-average common shares outstanding for basic and diluted net income per share. In connection with the settlement of the December 2021 ASR Agreement, $50 million previously recorded in Paid-in Capital as of January 29, 2022, was reclassified to Treasury Stock in the first quarter of 2022. In February 2022, we immediately retired the additional 0.3 million shares repurchased in connection with the settlement of the December 2021 ASR Agreement. The retirement resulted in a reduction of $50 million in Treasury Stock, less than $1 million in the par value of Common Stock, less than $1 million in Paid-in Capital and nearly $50 million in Retained Earnings.

Dividend Policy and Procedures

We have not paid any cash dividends since the Separation. We cannot guarantee that we will pay a dividend in the future or continue to pay any dividends if and when we commence paying dividends. The declaration and amount of any dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend upon many factors, including our financial condition, earnings, cash flows, capital requirements of our business, covenants associated with our debt obligations, legal requirements, regulatory constraints, industry practice and any other factors the Board of Directors deems relevant. We would use cash flow generated from operating and financing activities to fund our dividends.

Long-term Debt and Borrowing Facilities

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

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Cash paid for interest was $52 million and $18 million in 2022 and 2021, respectively. There was no cash paid for interest in 2020.

Issuance of Notes

In July 2021, we issued $600 million of 4.625% notes due in July 2029 in a transaction exempt from registration under the Securities Act. The obligation to pay principal and interest on the 2029 Notes is jointly and severally guaranteed on a full and unconditional basis by certain of our wholly-owned subsidiaries.

On August 2, 2021, we used cash proceeds of $592 million, which were net of issuance costs of $8 million, from the 2029 Notes, to partially fund the approximately $976 million cash payment to the Former Parent in connection with the Separation. The issuance costs are being amortized through the maturity date and are included within Long-term Debt on the Consolidated Balance Sheets.

Credit Facilities

On August 2, 2021, we entered into a term loan B credit facility in an aggregate principal amount of $400 million, which will mature in August 2028. Commencing in December 2021, we are required to make quarterly principal payments on the Term Loan Facility in an amount equal to 0.25% of the original principal amount of $400 million. We made principal payments of $4 million and $1 million for the Term Loan Facility during 2022 and 2021, respectively.

Interest under the Term Loan Facility is calculated by reference to the London Interbank Offered Rate (“LIBOR”) or an alternative base rate, plus an interest rate margin equal to (i) in the case of LIBOR loans, 3.25% and (ii) in the case of alternate base rate loans, 2.25%. The LIBOR rate applicable to the Term Loan Facility is subject to a floor of 0.50%. The obligation to pay principal and interest on the loans under the Term Loan Facility is jointly and severally guaranteed on a full and unconditional basis by certain of our wholly-owned domestic subsidiaries. The loans under the Term Loan Facility are secured on a first-priority lien basis by certain assets of ours and guarantors that do not constitute priority collateral of the ABL Facility and on a second-priority lien basis by priority collateral of the ABL Facility, subject to customary exceptions. As of January 28, 2023, the interest rate on loans under the Term Loan Facility was 7.98%.

On August 2, 2021, we also entered into a senior secured asset-based revolving credit facility. The ABL Facility allows for borrowings and letters of credit in U.S. dollars or Canadian dollars, and has aggregate commitments of $750 million and an expiration date of August 2026. The 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, eligible accounts receivable, eligible inventory and eligible real property, and (ii) the aggregate commitment. Interest on the loans under the ABL Facility is calculated by reference to (i) LIBOR or an alternative base rate and (ii) in the case of loans denominated in Canadian dollars, Canadian Dollar Offered Rate (“CDOR”) or a Canadian base rate, plus an interest rate margin based on average daily excess availability ranging from (x) in the case of LIBOR and CDOR loans, 1.50% to 2.00% and (y) in the case of alternate base rate loans and Canadian base rate loans, 0.50% to 1.00%. Unused commitments under the ABL Facility accrue an unused commitment fee ranging from 0.25% to 0.30%. The obligation to pay principal and interest on the loans under the ABL Facility is jointly and severally guaranteed on a full and unconditional basis by certain of our wholly-owned domestic and Canadian subsidiaries. The loans under the ABL Facility are secured on a first-priority lien basis by our eligible U.S. and Canadian credit card receivables, eligible accounts receivable, eligible inventory and eligible real property and on a second-priority lien basis on substantially all other assets of ours, subject to customary exceptions.

During 2022, we borrowed $295 million from the ABL Facility, all of which remains outstanding as of January 28, 2023. As of January 28, 2023, the interest rate on the borrowings from the ABL Facility was 5.90%. We had $42 million of outstanding letters of credit as of January 28, 2023 that further reduced our availability under the ABL Facility. As of January 28, 2023, our remaining availability under the ABL Facility was $259 million.

On August 2, 2021, we used the net cash proceeds from the credit facilities of $384 million, which were net of issuance and financing costs of $10 million for the Term Loan Facility and $6 million for the ABL Facility, to partially fund the approximately $976 million cash payment to the Former Parent in connection with the Separation. The discounts and issuance costs from the Term Loan Facility are being amortized through the maturity date and are included within Long-term Debt on the Consolidated Balance Sheets.

Our long-term debt and borrowing facilities contain certain financial and other covenants, including, but not limited to, the maintenance of financial ratios. The 2029 Notes and the Term Loan Facility include the maintenance of a consolidated coverage ratio and a consolidated total leverage ratio, and the ABL Facility includes the maintenance of a fixed charge coverage ratio and a debt to earnings before interest, income taxes, depreciation, amortization and rent (“EBITDAR”) ratio. The financial covenants could, within specific predefined circumstances, limit our ability to incur additional indebtedness, make certain investments, pay dividends or repurchase shares. As of January 28, 2023, we were in compliance with all covenants under our long-term debt and borrowing facilities.

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Foreign Facilities

Certain of our China subsidiaries previously utilized revolving and term loan bank facilities to support their operations (the “Foreign Facilities”). The Foreign Facilities allowed borrowings in U.S. dollars and Chinese Yuan, and interest rates on outstanding borrowings were based upon the applicable benchmark rate for the currency of each borrowing.

Certain of these facilities were guaranteed by the Former Parent and certain of the Former Parent's wholly-owned subsidiaries (the “Secured Foreign Facilities”). The Secured Foreign Facilities allowed for borrowings and letters of credit up to $30 million. We borrowed $21 million and made payments of $126 million under the Secured Foreign Facilities during 2020. We had no borrowings or payments under the Secured Foreign Facilities during 2021. During the second quarter of 2021, with no borrowings outstanding, we terminated the Secured Foreign Facilities.

We borrowed $13 million and made payments of $63 million under the unsecured Foreign Facilities during 2020. During the second quarter of 2020, with no borrowings outstanding, we terminated the unsecured Foreign Facilities.

Long-term Debt due to Former Parent

During 2020, we borrowed $97 million from the Former Parent to pay down outstanding debt with external parties. This borrowing was due in September 2025 and had a variable interest rate based on the China Loan Prime Rate. As a result of the Separation, we no longer have this Long-term Debt due to Former Parent. Prior to the Separation, we recognized $2 million of interest expense during 2021 related to this borrowing.

Credit Ratings

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

Contingent Liabilities and Contractual Obligations

The following table provides our contractual obligations, aggregated by type, including the maturity profile as of January 28, 2023:

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(a)Long-term debt obligations relate to our principal and interest payments for our outstanding debt. Interest payments have been estimated based on the coupon rate for fixed rate obligations. For variable interest rate obligations under the Term Loan Facility, the interest payments have been estimated based on a LIBOR rate of 4.73% plus an interest rate margin of 3.25%. For variable interest rate obligations under the ABL Facility, the interest payments have been estimated based on an interest rate of 5.90%. For additional information, see Note 13 to the Consolidated and Combined Financial Statements included in Item 8. Financial Statements and Supplementary Data.

(b)Future lease obligations primarily represent minimum payments due under store lease agreements. For additional information, see Note 9 to the Consolidated and Combined Financial Statements included in Item 8. Financial Statements and Supplementary Data.

(c)Purchase obligations primarily include purchase orders for merchandise inventory and other agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transactions.

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(d)Other liabilities also include future estimated payments associated with unrecognized tax benefits. The “Less Than 1 Year” category includes $6 million of these tax items because it is reasonably possible that the payments could change in the next 12 months due to audit settlements or resolution of uncertainties. The remaining portion totaling $23 million is included in the “Other” category because it is not reasonably possible that the payments could change in the next 12 months due to audit settlements or resolution of uncertainties. For additional information, see Note 12 to the Consolidated and Combined Financial Statements in Item 8. Financial Statements and Supplementary Data.

Recently Issued Accounting Pronouncements

We did not adopt any new accounting standards during 2022 that had a material impact on our results of operations, financial position or cash flows. In addition, there are no new accounting standards not yet adopted that are expected to have a material impact on our 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, long-lived assets, claims and contingencies, income taxes and revenue recognition. Management bases our estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. Management has discussed the development and selection of our critical accounting policies and estimates with the Audit Committee of our Board of Directors and believes the following assumptions and estimates are most significant to reporting our results of operations and financial position.

Inventories

Inventories are principally valued at the lower of cost or net realizable value, on an average cost basis. We record valuation adjustments to our inventories if the cost of inventory on hand exceeds the amount we expect to realize from the ultimate sale or disposal of the inventory. These estimates are based on management’s judgment regarding future demand and market conditions and analysis of historical experience. If actual demand or market conditions are different than those projected by management, future period merchandise margin rates may be unfavorably or favorably affected by adjustments to these estimates.

We also record inventory loss adjustments for estimated physical inventory losses that have occurred since the date of the last physical inventory. These estimates are based on management’s analysis of historical results, operating trends and consumer behavior. Management believes that the assumptions used in these estimates are reasonable and appropriate. A 10% increase or decrease in the inventory valuation adjustment would have impacted net income by approximately $3 million for 2022. A 10% increase or decrease in the estimated physical inventory loss adjustment would have impacted net income by approximately $2 million for 2022.

Valuation of Long-lived Assets

Long-lived Store Assets

Long-lived store assets, which include leasehold improvements, store related assets and operating lease assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Store assets are grouped at the lowest level for which they are largely independent of other assets or asset groups. If the estimated undiscounted future cash flows related to the asset group are less than the carrying value, we recognize a loss equal to the difference between the carrying value and the estimated fair value, determined by the estimated discounted future cash flows of the asset group. For operating lease assets, we determine the fair value of the assets by comparing the contractual rent payments to estimated market rental rates. An individual asset within an asset group is not impaired below its estimated fair value. The fair value of long-lived store assets are determined using Level 3 inputs within the fair value hierarchy.

As a result of our store fleet rationalization executed during 2020 and the negative operating results of certain stores in 2020, we determined that the estimated undiscounted future cash flows were less than the carrying values for certain asset groups and, as a result, determined the estimated fair values of the store asset groups using estimated discounted future cash flows and estimated market rental rates. Long-lived store asset impairment charges are included within Costs of Goods Sold, Buying and Occupancy in the Consolidated and Combined Statements of Income (Loss).

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There were no long-lived store asset impairment charges in 2022 or 2021. The following table provides pre-tax long-lived store asset impairment charges included in the 2020 Consolidated and Combined Statement of Loss:

Our fair value estimates incorporate significant assumptions and judgments including, but not limited to, estimated future cash flows, discount rates and market rental rates. The use of different assumptions or judgments in our assessment could materially increase or decrease the fair value of our store assets and, accordingly, could materially increase or decrease any related impairment charge. Sustained declines in our business performance could result in a material impairment charge in a future period.

When a decision has been made to dispose of property and equipment prior to the end of the previously estimated useful life, depreciation estimates are revised to reflect the use of the asset over the shortened estimated useful life.

Goodwill

Goodwill is reviewed for impairment at the reporting unit level each year in the fourth quarter and may be reviewed more frequently if certain events occur or circumstances change. We have the option to either first perform a qualitative assessment to determine whether it is more likely than not that each reporting unit's fair value is less than its carrying value (including goodwill), or to proceed directly to the quantitative assessment which requires a comparison of the reporting unit's fair value to its carrying value (including goodwill). If we determine that the fair value of a reporting unit is less than its carrying value, we recognize an impairment charge equal to the difference, not to exceed the total amount of goodwill allocated to the reporting unit. Our reporting units are determined in accordance with the provisions of ASC 350, Intangibles - Goodwill and Other.

Claims and Contingencies

We are subject to various claims and contingencies related to lawsuits, taxes, insurance, regulatory and other matters arising out of the normal course of business. Our determination of the treatment of claims and contingencies in the Consolidated and Combined Financial Statements is based on management’s view of the expected outcome of the applicable claim or contingency. We consult with legal counsel on matters related to litigation and seek input from both internal and external experts with respect to matters in the ordinary course of business. We accrue a liability if the likelihood of an adverse outcome is probable and the amount is reasonably estimable. If the likelihood of an adverse outcome is only reasonably possible (as opposed to probable) or if an estimate is not reasonably determinable, disclosure of a material claim or contingency is disclosed in the Notes to the Consolidated and Combined Financial Statements included in Item 8. Financial Statements and Supplementary Data.

Income Taxes

We account for income taxes under the asset and liability method. Under this method, taxes currently payable or refundable are accrued, and deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are also recognized for realizable operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in income tax rates is recognized in our Consolidated and Combined Statement of Income (Loss) in the period that includes the enactment date. The Company treats the global intangible low-taxed income provisions enacted as part of the U.S. Tax Cuts and Jobs Act as a current period expense. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more likely than not that such assets will not be realized.

Significant judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities. In determining our provision for income taxes, we consider permanent differences between book and tax income and statutory income tax rates. Our effective income tax rate is affected by items including changes in tax law, the tax jurisdiction of new stores or business ventures and the level of earnings.

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We follow the authoritative guidance included in ASC 740, Income Taxes, which contains a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and for which actual outcomes may differ from forecasted outcomes. Our policy is to include interest and penalties related to uncertain tax positions in income tax expense.

Our income tax returns, like those of most companies, are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities. A number of years may elapse before a particular matter for which we have established an accrual is audited and fully resolved or clarified. We adjust our tax contingencies accrual and income tax provision in the period in which matters are effectively settled with tax authorities at amounts different from our established accrual, when the statute of limitations expires for the relevant taxing authority to examine the tax position or when more information becomes available. We include our tax contingencies accrual, including accrued penalties and interest, in Other Long-term Liabilities on the Consolidated Balance Sheets unless the liability is expected to be paid within one year. Changes to the tax contingencies accrual, including accrued penalties and interest, are included in Provision (Benefit) for Income Taxes on the Consolidated and Combined Statements of Income (Loss).

Revenue Recognition

We recognize revenue based on the amount we expect to receive when control of the goods or services is transferred to our customer. We recognize sales upon customer receipt of merchandise, which for direct channel revenues reflect an estimate of shipments that have not yet been received by our customer based on shipping terms and historical delivery times. Our shipping and handling revenues are included in Net Sales with the related costs included in Costs of Goods Sold, Buying and Occupancy in our Consolidated and Combined Statements of Income (Loss). We also provide a reserve for projected merchandise returns based on historical experience and recent information. Net Sales exclude sales and other similar taxes collected from customers.

We offer certain loyalty programs that allow customers to earn points based on purchasing activity. As customers accumulate points and reach point thresholds, they can use the points to purchase merchandise in stores or online. We allocate revenue to points earned on qualifying purchases and defer recognition until the points are redeemed. The amount of revenue deferred is based on the relative stand-alone selling price method, which includes an estimate for points not expected to be redeemed based on historical experience.

We sell gift cards with no expiration dates to customers. We do not charge administrative fees on unused gift cards. We recognize revenue from gift cards when they are redeemed by the customer. In addition, we recognize revenue on unredeemed gift cards where the likelihood of the gift card being redeemed is remote and there is no legal obligation to remit the unredeemed gift cards to relevant jurisdictions (gift card breakage). Gift card breakage revenue is recognized in proportion, and over the same period, as actual gift card redemptions. We determine the gift card breakage rate based on historical redemption patterns. Gift card breakage is included in Net Sales in our Consolidated and Combined Statements of Income (Loss).

Revenue earned in connection with our credit card arrangements is primarily recognized based on credit card sales and usage and is included in Net Sales in the Consolidated and Combined Statements of Income (Loss).

We also recognize revenues associated with franchise, license, wholesale and sourcing arrangements. Revenue recognized under franchise and license arrangements generally consists of royalties earned and recognized upon sale of merchandise by franchise and license partners to retail customers. Revenue is generally recognized under wholesale and sourcing arrangements at the time the title of merchandise passes to the partner.