Victoria's Secret & Co. (VSXY) FY 2022 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 the Company, 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,” “planned,” “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;

•a loss of synergies from separating the businesses that could negatively impact our balance sheet, profit margins or earnings;

•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;

•the seasonality of our business;

•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 grow through new store openings and existing store remodels;

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

•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;

•our ability to maintain, enforce and protect our trade names, trademarks and patents;

•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 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, which could result in closed factories, reduced workforces, scarcity of raw materials, and scrutiny or embargoing of goods produced in impacted areas;

•duties, taxes and other charges;

•legal and regulatory matters;

•volatility in currency exchange rates;

•local business practices and political issues;

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

•disruption due to labor disputes; and

•changing expectations regarding product safety due to new legislation;

•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 ability to adequately protect our assets from loss and theft;

•claims arising from our self-insurance;

•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 service or refinance our debt and maintain compliance with our restrictive covenants;

•our ability to comply with laws, regulations and technology platform rules or other obligations related to data privacy and security;

•our ability to comply with regulatory requirements;

•legal and compliance matters; and

•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, 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.

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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.

Executive Overview

Victoria’s Secret is an iconic global brand of women’s intimate and other apparel, personal care and beauty products. We sell our products through two brands, Victoria’s Secret and PINK. Victoria’s Secret is a category-defining global lingerie brand with a leading market position and a rich, 40-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. Together, Victoria’s Secret, PINK and Victoria’s Secret Beauty support, inspire and celebrate women through every phase of their life.

Victoria’s Secret and PINK merchandise is sold online through our e-commerce platform, through company-operated retail stores located in the U.S., Canada and Greater China, and through international stores and websites operated by partners under franchise, license, wholesale and joint venture arrangements. We have a presence in over 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 continue to focus on opportunities for improved performance, driven by efforts to improve the cultural relevance of our brands, improved merchandise assortments, and disciplined inventory management focused on the quality, quantity and timing of merchandise receipts. While we believe our improvements in merchandise assortment and our brand repositioning strategies are attracting and re-attracting customers, we are also mindful of the cost challenges and disruptions in our supply chain.

Impacts of Victoria's Secret Spin-Off

The spin-off of Victoria’s Secret & Co. into an independent, public company was completed on August 2, 2021. We believe the spin-off will enable us to maximize management focus and financial flexibility to thrive in an evolving retail environment and deliver long-term profitable growth.

In connection with the Separation, we expect incremental, future capital and expense related to the implementation of new information technology platforms. We currently estimate that our total incremental expenditures could be $100 million to $150 million over the next several years. These estimated costs will consist of internal and external labor, software licensing, networking, security and physical infrastructure required to separate the current information technology capabilities (systems and infrastructure) in support of two independent companies. Such estimates are subject to change as our work continues. We will provide technology services to the Former Parent under the transition services agreements while independent systems environments are created, which we believe will help to minimize dis-synergies. The above estimates are preliminary in nature, are based solely on information available to us as of the date of this annual report and are inherently uncertain and subject to change.

Impacts of COVID-19

The coronavirus pandemic has created significant public health concerns as well as economic disruption, uncertainty and volatility. In 2020 and 2021, our operations and financial performance have been materially impacted by the COVID-19 pandemic. In the first quarter of 2020, all of our stores in North America were closed on March 17, 2020, but we were able to re-open the majority of our stores as of the beginning of the third quarter of 2020. Additionally, operations for our direct channel were temporarily suspended for approximately one week in late March 2020.

We adopted new operating models focused on providing a safe store environment for our customers and associates, while also delivering an engaging shopping experience. We remain focused on the safe operations of our distribution, fulfillment and call centers while maximizing our direct channel. There remains the potential for COVID-19-related risks of closure or operating restrictions, as well as risks related to delays or disruptions in our supply chain and related pricing impacts, which could materially impact our operations and financial performance in future periods.

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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 29, 2022 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

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

•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 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 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 are building 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 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 customer’s 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 working towards a store of the future 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 will continue to modernize 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 leadership 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.

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Expand our International Business.

Growing our international business is a key strategy. We plan to drive strong comparable sales growth in franchise 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 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 the joint venture partnership we entered into in 2020 with Next in the United Kingdom will allow us to leverage growth through the already existing and impressive Next digital presence. Further, we believe our recently announced joint venture partnership with Regina Miracle in China will allow us to grow the China business through joint investment in product development, distribution and marketing. We also expect our partnership with Regina Miracle will positively impact the speed and agility of the business due to Regina Miracle's established production base in China. We anticipate additional opportunities for growth in our travel retail channel as global travel begins to normalize following the COVID-19 pandemic.

2021 Overview

In 2021, we were able to achieve growth in all core categories. Our work to deepen our connection with the customer while improving our operational fundamentals continued to gain traction, and the customer responded positively to our brand transformation and our merchandising assortments. On August 2, 2021, we completed our spin-off into an independent, public company, and we began trading on the NYSE on August 3, 2021. Cash generated since the Separation allowed us to announce a $250 million accelerated share repurchase program in December 2021. Despite the supply chain and inflationary challenges impacting the third and fourth quarters, our net sales and operating income increased significantly in 2021. Net sales increased $1.372 billion, or 25%, to $6.785 billion compared to $5.413 billion in 2020. Our North American store sales increased 50%, or $1.399 billion, to $4.194 billion compared to $2.795 billion in 2020, primarily due to comparisons to the COVID-19-related store closures in 2020 and in the increase in comparable store sales, partially offset by the impact of the permanent closure of 241 stores in North America in 2020. Our direct channel sales decreased by 5%, or $109 million, to $2.114 billion compared to $2.223 billion in 2020, primarily due to a decline in traffic as direct sales last year were positively impacted by the COVID-19-related store closures. Sales and merchandise margin results were strong in 2021 as customers responded positively to our merchandise assortments. The merchandise margin rate improvement was driven by improved response to our merchandise assortments as well as strong selling execution in stores and online, partially offset by significant cost pressures in our supply chain particularly in the third and fourth quarter of 2021. Operating income for the full year increased to $870 million as compared to an operating loss of $101 million in 2020, and our operating income (loss) rate increased to 12.8% as compared to (1.9%) last year. The operating income increase was primarily driven by an increase in net sales and merchandise margin rate during 2021 and store asset and lease impairment charges of $214 million recorded in 2020.

For additional information related to our 2021 financial performance, see “Results of Operations – 2021 Compared to 2020.”

Adjusted 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 operating income (loss), net income (loss) and net income (loss) per diluted share in 2021, 2020 and 2019 on an adjusted basis, which remove certain special items. We believe that these special items are not indicative of our ongoing operations due to their size and nature. We use adjusted 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 adjusted financial information provides additional information to investors to facilitate the comparison of past and present operations. Further, our definition of adjusted financial information may differ from similarly titled measures used by other companies. The table below reconciles the GAAP financial measures to the non-GAAP financial measures.

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(a)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. We recognized pre-tax impairment charges of $218 million ($200 million after-tax) and $35 million ($30 million after-tax) related to certain store and lease assets in the third and fourth quarter of 2019, respectively. For additional information see Note 7, "Long-Lived Assets" included in Item 8. Financial Statements and Supplementary Data.

(b)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 5, “Restructuring Activities" included in Item 8. Financial Statements and Supplementary Data.

(c)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 8, "Leases" included in Item 8. Financial Statements and Supplementary Data.

(d)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 5, “Restructuring Activities" included in Item 8. Financial Statements and Supplementary Data.

(e)In the fourth quarter of 2019, we recognized a $690 million pre-tax goodwill impairment charge ($687 million after-tax) related to the North America reporting unit. In the third quarter of 2019, we recognized a $30 million goodwill impairment charge (no tax impact) related to the Greater China reporting unit. For additional information, see Note 9, "Goodwill and Trade Name" included in Item 8. Financial Statements and Supplementary Data.

(f)In the third quarter of 2020, we recognized a $44 million tax benefit related to a tax matter associated with foreign investments. For additional information see Note 11, "Income Taxes" included in Item 8. Financial Statements and Supplementary Data.

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2022 Outlook

We remain committed to our brand transformation focused on evolving our positioning and promoting inclusivity and diversity which we believe will allow us to attract new customers while also deepening our connection with existing ones. We will continue our advocacy for women, our commitment to being best at bras, and our focus on enhancing the customer experience. We plan to continue to enhance our omni-channel capabilities and personalization, increase our store of the future footprint and expand internationally into new markets while growing our digital presence. We will focus on assortment newness and product innovation, and will also continue to search for new growth opportunities, including new brands we develop as well as partnerships with existing brands that help us attract new customers and better meet the needs of existing ones. This will include continuing to partner and invest in women-led companies that are potential sources of growth, either in revenue or customer goodwill, or both.

We are mindful of the ongoing supply chain uncertainty, inflationary pressures, and federal stimulus benefit challenges facing us as we begin 2022. In the first quarter of 2022, we expect our operating performance to decrease compared to last year's first quarter, driven by incremental supply chain cost pressures in the first quarter of 2022 and federal stimulus benefits recognized in last year's first quarter.

For full year 2022, we are forecasting sales to be flat to up low-single digits compared to $6.785 billion in 2021. At this level of sales, we are projecting our operating income to be directionally in-line with 2021 results, with our Spring season below last year and the Fall season returning to growth. We believe the challenging supply chain environment will likely continue throughout the Spring season resulting in incremental supply chain cost pressures, in addition to the inflation of raw material costs throughout 2022.

We continue to focus on maximizing our performance and leveraging the strength of our brands and connection to our customers. We are confident in our opportunities and remain committed to delivering long-term sustainable value for our stockholders.

Company-Operated Store Data

The following table compares 2021 U.S. company-operated store data to the comparable periods for 2020 and 2019:

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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.

The following table represents company-operated store data for 2021:

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The following table represents company-operated store data for 2020:

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(a)    For additional information see Note 5, "Restructuring Activities" included in Item 8. Financial Statements and Supplementary Data.

The following table represents company-operated store data for 2019:

Partner-Operated Store Data

The following table represents partner-operated store data for 2021:

The following table represents partner-operated store data for 2020:

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(a)    For additional information see Note 5, "Restructuring Activities" included in Item 8. Financial Statements and Supplementary Data.

The following table represents partner-operated store data for 2019:

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Results of Operations — 2021 Compared to 2020

The following information summarizes our results of operations for 2021 compared to 2020.

Operating Income (Loss)

For 2021, operating income increased $971 million, to $870 million, compared to an operating loss of $101 million in 2020, and the operating income (loss) rate (expressed as a percentage of net sales) increased to 12.8% from (1.9%). The drivers of the operating income results are discussed in the following sections.

Net Sales

The following table provides net sales for 2021 in comparison to 2020:

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(a)Results include Greater China, royalties associated with franchised stores, wholesale sales and company-operated stores in the U.K. (before our joint venture with Next).

The following table provides a reconciliation of net sales for 2020 to 2021:

________________

(a)Includes the increased sales from period over period due to the 2020 COVID-19-related store closures.

The following table compares 2021 comparable sales to 2020:

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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.

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In the stores channel for 2021, our North America net sales increased $1.399 billion, or 50%, to $4.194 billion, primarily due to comparisons to the COVID-19-related store closures in 2020, partially offset by a net reduction of 37 stores in North America in 2021. The increase in comparable store sales was driven by an increase in store traffic and average unit retail (which we define as the average price per unit purchased), partially offset by a decrease in conversion (which we define as the percentage of customers who visit our stores and make a purchase). Sales related to our stores outside of North America also increased compared to 2020 primarily as a result of the COVID-19-related store closures in the prior year, partially offset by lower net sales in the U.K. driven by the change in accounting as a result of the joint venture arrangement entered into in the third quarter of 2020.

In the direct channel, net sales decreased $109 million to $2.114 billion primarily due to a decline in traffic as direct sales last year were positively impacted by the COVID-19-related store closures. The decrease in direct sales was driven by a decline in traffic, partially offset by an increase in average unit retail and conversion.

Gross Profit

For 2021, our gross profit increased $1.189 billion to $2.760 billion, and our gross profit rate (expressed as a percentage of net sales) increased to 40.7% from 29.0%.

For 2021, the gross profit increase was due to the increase in merchandise margin dollars related to the increase in net sales, and an increase in the merchandise margin rate driven by improved response to our merchandise assortments as well as strong selling execution in stores and online, all of which enabled us to reduce promotional activity during the year. Our merchandise margin dollar growth was partially offset by increased costs in our supply chain this year, due to market constraints and price increases driven by increased demand and inflationary pressures. Occupancy expenses were lower, driven by store asset and lease impairment charges of $214 million in the prior year and permanent store closures, partially offset by higher COVID-19 related rent concessions last year and a $39 million gain from the closure of our flagship store in Hong Kong in the prior year.

The gross profit rate increase was driven by an increase in the merchandise margin rate reflecting a meaningful reduction in promotional activity, partially offset by increased costs in our supply chain. The gross profit rate increase was also driven by buying and occupancy leverage on higher net sales and the store asset impairment charges in the prior year, which was partially offset by higher COVID-19-related rent concessions last year and a $39 million gain from the closure of our flagship store in Hong Kong in the prior year.

General, Administrative and Store Operating Expenses

For 2021, our general, administrative and store operating expenses increased $218 million to $1.890 billion due to an increase in store selling expenses as a result of the increase in net sales compared to the prior year, an increase in marketing expenses due to our new brand repositioning initiatives and the store closures in the prior year and the $30 million gain recognized as a result of the establishment of the U.K. joint venture in the third quarter last year. These increases were partially offset by severance and related costs associated with headcount reductions totaling $51 million in the prior year, and savings realized as a result of cost reductions and the impact of the permanent store closures.

The general, administrative and store operating expense rate (expressed as a percentage of net sales) decreased to 27.9% from 30.9% due to leverage on the significant increase in net sales.

Interest Expense

For 2021, our interest expense increased $21 million to $27 million driven by the increase in our outstanding debt during 2021.

Provision (Benefit) for Income Taxes

For 2021, our effective tax rate was 23.3% compared to 31.9% in 2020. The 2021 rate was lower than our combined estimated federal and state statutory rate primarily due to recognition of excess tax benefits related to share-based awards that vested during the year. The 2020 rate was higher than our combined estimated federal and state statutory rate primarily due to tax matters associated with our investments in the U.K.

Results of Operations — 2020 Compared to 2019

The following information summarizes our results of operations for 2020 compared to 2019.

Operating Income (Loss)

For 2020, our operating loss decreased $791 million, to an operating loss of $101 million, compared to an operating loss of $892 million in 2019, and the operating loss rate (expressed as a percentage of net sales) improved to (1.9%) from (11.9%). The drivers of the operating income (loss) results are discussed in the following sections.

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Net Sales

The following table provides net sales for 2020 in comparison to 2019:

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(a)Results include Greater China, royalties associated with franchised stores, wholesale sales and company-operated stores in the U.K. (before our joint venture with Next).

The following table provides a reconciliation of net sales for 2019 to 2020:

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(a)Includes the decreased sales from period over period due to the 2020 COVID-19-related store closures.

The following table compares 2020 comparable sales to 2019:

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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.

In the stores channel in 2020, our North America net sales decreased $2.317 billion, or 45% compared to 2019, to $2.795 billion. Store sales were negatively impacted by the temporary COVID-19-related closures, the permanent closure of 241 North American stores in 2020, occupancy restrictions and declines in store traffic. As a result of the COVID-19 pandemic, all stores in North America were closed on March 17, 2020, the majority of which were reopened by the beginning of August 2020. Occupancy levels in our stores varied over time as we reopened stores, but ultimately settled at approximately 30% capacity in August 2020. The decrease in comparable store sales was driven by a decline in store traffic which was down significantly since the beginning of the pandemic in March 2020, partially offset by a significant increase in conversion and average unit retail. Our partner-operated stores outside of North America were also impacted by temporary COVID-19-related closures, significant declines in store traffic and occupancy restrictions.

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In the direct channel, net sales increased $530 million, or 31%, to $2.223 billion despite a temporary suspension of operations in March 2020. The increase in direct sales was driven by significant increases in website traffic, conversion and average unit retail beginning with the closing of our stores in March 2020. Digital sales as a percentage of our total net sales increased to 41% in 2020 compared to 23% in 2019.

For both channels, lingerie comparable sales increased in all categories driven by merchandise performance. PINK comparable sales decreased, primarily driven by declines in sleepwear and tops. Victoria’s Secret Beauty comparable sales increased, principally driven by growth in PINK Beauty. Revenue earned in connection with our private label credit card arrangement decreased $59 million primarily driven by the decline in net sales in the U.S.

Gross Profit

For 2020, our gross profit decreased $492 million compared to 2019 to $1.571 billion, and our gross profit rate (expressed as a percentage of net sales) increased to 29.0% from 27.5% in 2019.

The gross profit decrease was due to lower merchandise margin dollars related to the decrease in net sales driven by the temporary COVID-19-related store closures and permanent store closures in 2020. This decrease was partially offset by improved response to our merchandise assortments driven by the disciplined management of inventory, as well as strong selling execution online, all of which enabled us to reduce promotional activity during the year. Additionally, occupancy expenses were lower in 2020 due to the store closures, COVID-19-related rent concessions totaling $90 million and a $34 million decrease in store and lease asset impairment charges recognized in occupancy expense.

The gross profit rate increase was driven by an increase in the merchandise margin rate reflecting a meaningful pullback in promotional activity. The merchandise margin rate improvement was partially offset by buying and occupancy deleverage on lower net sales. The deleverage on buying and occupancy as a result of lower net sales was partially offset by the rent relief, a decrease in store and lease asset impairment charges and a benefit from the penetration into the direct channel.

General, Administrative and Store Operating Expenses

For 2020, our general, administrative and store operating expenses decreased $563 million, or 25% compared to 2019, to $1.672 billion driven primarily by lower store selling and marketing expenses as a result of the temporary COVID-19-related store closures and our permanent store closures. These decreases were partially offset by severance and related costs associated with headcount reductions totaling $51 million, costs of $36 million associated with the terminated sale agreement of the business in the first half of 2020, a $31 million increase in marketing expenses in the direct channel, costs associated with employee retention arrangements and an increase in incentive compensation given company performance in the Fall season.

The general, administrative and store operating expense rate (expressed as a percentage of net sales) in 2020 increased to 30.9% from 29.8% in 2019 due to deleverage on lower net sales as well as severance and the other increased expenses mentioned above.

Impairment of Goodwill

In 2019, our goodwill impairment assessments concluded that the carrying values of our North America and Greater China reporting units exceeded their fair values. Accordingly, we recognized pre-tax goodwill impairment charges of $720 million.

Provision (Benefit) for Income Taxes

For 2020, our effective tax rate was 31.9% compared to 0.2% in 2019. The 2020 rate varied from our combined estimated federal and state statutory rate primarily due to tax matters associated with our investments in the U.K. The 2019 rate was impacted by the goodwill impairment charges which generated minimal tax benefit.

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.

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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 and Combined 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 dependent upon our ability to continue to generate positive cash flow from operations, and on our ability to maintain our debt financing on acceptable terms. Based upon our history of generating positive cash flows, we believe we will be able to meet our short-term liquidity needs. Management believes that our cash balances and funds provided by operating activities, along with borrowing capacity and access to capital markets, 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, there can be no assurances that we will be able to obtain additional debt or equity financing on acceptable terms 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 history of generating positive cash flows, we believe we will be able to continue to meet our working capital needs.

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

________________

(a)For the reporting period ending January 29, 2022, our borrowing base was $564 million and there were no borrowings outstanding under our senior secured asset-based revolving credit facility (the “ABL Facility"). We had $41 million of outstanding letters of credit as of January 29, 2022 that reduced our availability under the ABL Facility.

The following table provides certain measures of liquidity and capital resources as of January 29, 2022:

________________

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

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Cash Flow

The following table provides a summary of our cash flow activity for the fiscal years ended January 29, 2022, January 30, 2021 and February 1, 2020:

Operating Activities

Net cash provided by operating activities in 2021 was $851 million, including net income of $646 million. Net income included depreciation of $303 million and share-based compensation expense of $33 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 a decrease in operating cash flow of $247 million as a result of the increase in Inventories, primarily driven by higher cost of goods due to supply chain cost pressures, longer in-transit shipment times and our focused efforts to improve merchandise availability for customers, an increase in operating cash flow of $173 million associated with the increase in Accounts Payables, Accrued Expenses and Other, an increase in operating cash flow of $119 million associated with the increase in Income Taxes Payable and a decrease in operating cash flow of $156 million associated with Other Assets and Liabilities.

Net cash provided by operating activities in 2020 was $674 million, including the net loss of $72 million. Net loss included depreciation of $326 million, store and lease asset impairment charges of $254 million, deferred income tax benefits of $64 million, gain from formation of the U.K. and Ireland joint venture of $54 million, gain from the Hong Kong store closure and lease termination of $39 million and share-based compensation expense of $25 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 an increase in operating cash flow of $141 million associated with the decrease in Inventories and an increase in operating cash flow of $97 million associated with Other Assets and Liabilities.

Net cash provided by operating activities in 2019 was $315 million, including the net loss of $897 million. Net loss included depreciation of $411 million, goodwill impairment charges of $720 million, store and lease asset impairment charges of $263 million, share-based compensation expense of $38 million and deferred income tax benefits of $30 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 a decrease in operating cash flow of $118 million associated with the decrease in Accounts Payables, Accrued Expenses and Other and a decrease in operating cash flow of $57 million associated with Other Assets and Liabilities.

Investing Activities

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.

Net cash used for investing activities in 2020 was $123 million consisting primarily of $127 million of capital expenditures, offset by $4 million of other investing activities. The capital expenditures were primarily related to spending on technology and logistics to support our digital business and other retail capabilities.

Net cash used for investing activities in 2019 was $243 million consisting primarily of $225 million of capital expenditures. The capital expenditures were primarily related to spending on technology and logistics to support our digital business and other retail capabilities.

We are estimating 2022 capital expenditures to be approximately $225 million. We are investing in a store capital and refresh program, and we also plan to invest in technology, distribution and logistics capabilities and general infrastructure needs as we separate into a standalone company.

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Financing Activities

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.

Net cash used for financing activities in 2020 was $465 million consisting primarily of net transfers to the Former Parent of $407 million, $155 million of net repayments under our Foreign Facilities (as defined below), partially offset by borrowings from the Former Parent of $97 million.

Net cash used for financing activities in 2019 was $192 million consisting primarily of net transfers to the Former Parent of $197 million partially offset by $5 million of net borrowings under our Foreign Facilities.

Common Stock Share Repurchases

Our Board of Directors will determine 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.

In December 2021, we entered into an accelerated share repurchase agreement (“ASR Agreement”) with Goldman Sachs & Co. LLC (“Goldman Sachs”) to repurchase $250 million of our common stock. In accordance with the ASR Agreement, 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 final number of shares received under the ASR Agreement was based on the daily average of the volume-weighted average share price of our common stock over the term of the ASR Agreement, less a discount and subject to other adjustments pursuant to the terms of the ASR Agreement. The final settlement under the ASR Agreement occurred in February 2022 subsequent to the end of fiscal year 2021. At final settlement, we received an additional 0.3 million shares of our common stock from Goldman Sachs.

As of January 29, 2022, 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 ASR Agreement. The initial 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. The $50 million recorded in Paid-in Capital as of January 29, 2022 will be reclassified to Treasury Stock in the first quarter of 2022 in connection with the settlement of the ASR Agreement.

In March 2022, our Board of Directors approved a new share repurchase program ("March 2022 Share Repurchase Program"), providing for 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 March 2022 Share Repurchase Program will be available to meet obligations under equity compensation plans and for general corporate purposes. The March 2022 Share Repurchase Program will continue until exhausted, but no later than January 28, 2023. We have repurchased 0.8 million shares for $39 million through March 17, 2022 under the March 2022 Share Repurchase Program.

Treasury Stock Retirement

In December 2021, in accordance with the Board of Directors' resolution, we immediately retired the 4.1 million shares repurchased under the 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, subsequent to the end of fiscal year 2021, we immediately retired the additional 0.3 million shares repurchased in connection with the settlement of the ASR Agreement. The retirement will result 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 in the first quarter of 2022.

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.

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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 29, 2022 and January 30, 2021:

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.

Credit Facilities

On August 2, 2021, we entered into a term loan B credit facility in an aggregate principal amount of $400 million (the "Term Loan Facility"), which will mature in August 2028. Commencing in December 2021, we will make quarterly principal payments on the Term Loan Facility in an amount equal to 0.25% of the original principal amount of $400 million. During 2021, we made a principal payment of $1 million for the Term Loan Facility.

Interest under the Term Loan Facility will be calculated by reference to 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 will be 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.

On August 2, 2021, we also entered into a senior secured asset-based revolving credit facility (the “ABL 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 will be 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 will be 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 will accrue an unused commitment fee ranging from 0.25% to 0.30%.

For the reporting period ending January 29, 2022, our borrowing base was $564 million and there were no borrowings outstanding under the ABL Facility. We had $41 million of outstanding letters of credit as of January 29, 2022 that reduced our availability under the ABL Facility.

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.

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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 29, 2022, we were in compliance with all covenants under our long-term debt and borrowing facilities.

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 $117 million under the Secured Foreign Facilities during 2020 and 2019, respectively. Additionally, we made payments of $126 million and $103 million under the Secured Foreign Facilities during 2020 and 2019, respectively. 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 $50 million under the unsecured Foreign Facilities during 2020 and 2019, respectively. Additionally, we made payments of $63 million and $59 million under these unsecured Foreign Facilities during 2020 and 2019, respectively. 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 29, 2022:

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Contingent Liabilities and Contractual Obligations

The following table provides our contractual obligations, aggregated by type, including the maturity profile as of January 29, 2022:

________________

(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, the interest payments have been estimated based on the LIBOR floor of 0.50% plus an interest rate margin of 3.25%. For additional information, see Note 12 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 8 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.

(d)Other liabilities also include future estimated payments associated with unrecognized tax benefits. The “Other” category includes $10 million of these tax items because it is not reasonably possible that the amounts could change in the next 12 months due to audit settlements or resolution of uncertainties. For additional information, see Note 11 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 2021 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.

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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 $2 million for 2021. A 10% increase or decrease in the estimated physical inventory loss adjustment would have impacted net income by approximately $2 million for 2021.

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 fleet rationalization executed during 2020 and the negative operating results of certain stores in 2020 and 2019, 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).

The following table provides pre-tax long-lived store asset impairment charges included in the Consolidated and Combined Statement of Income (Loss) for 2021, 2020 and 2019:

Our fair value estimates incorporated 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. During 2019, we fully-impaired the goodwill at the North America and Greater China reporting units, resulting in pre-tax impairment charges of $720 million. Subsequent to these impairments, we no longer have any goodwill recorded on our balance sheet.

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Trade Name

The Victoria's Secret trade name is an indefinite-lived intangible asset. The trade name is reviewed for impairment 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 the indefinite-lived intangible asset is impaired, or to proceed directly to the quantitative assessment which requires a comparison of the fair value of the intangible asset to its carrying value. To determine if the fair value of the asset is less than its carrying amount, we will estimate the fair value, usually determined by the relief from royalty method under the income approach, and compare that value with its carrying amount. If the carrying value of the trade name exceeds its fair value, we recognize an impairment charge equal to the difference.

As of the end of the fourth quarter of 2021, we performed our annual impairment assessment of the Victoria's Secret trade name. To estimate the fair value of the trade name, we used the relief from royalty method under the income approach. The annual assessment concluded that the fair value of the trade name was in excess of its carrying value.

The use of different assumptions or judgments in our impairment assessment of our trade name, including with respect to the estimated future cash flows, the discount rate used to discount such estimated future cash flows to their net present value and royalty rates used for the relief from royalty method, could materially increase or decrease the fair value of our trade name. A 50% reduction to our assumed royalty rate would not have resulted in a material impairment charge in 2021.

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.

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.

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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 and Combined 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. 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 U.S. private label credit card arrangement 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 passes to the partner.