Business Context and Reporting Period
This Form 10-Q covers the thirteen-week period ended May 4, 2002, for Limited Brands, Inc. (formerly The Limited, Inc.). The Company operates specialty retail stores and direct response businesses under brands including Victoria's Secret, Bath & Body Works, Express, and Lerner (New York & Company). A material event during the period was the March 21, 2002, acquisition of the remaining minority interest in Intimate Brands, Inc. (IBI), making it a wholly-owned subsidiary and resulting in the recombination of the two entities.
Key Financial Metrics
| Metric | Q1 2002 | Q1 2001 |
|---|---|---|
| Net Sales | $2,027 million | $2,127 million |
| Gross Income | $685 million | $671 million |
| Gross Margin | 33.8% | 31.5% |
| Operating Income | $104 million | $63 million |
| Net Income | $50 million | $31 million |
| Diluted EPS | $0.10 | $0.07 |
| Cash and Equivalents (End of Period) | $1,255 million | $289 million |
| Long-Term Debt | $248 million | $400 million |
| Working Capital | $1,472 million | $1,045 million |
Segment Performance: Victoria's Secret sales increased 8% to $762 million. Bath & Body Works sales were flat at $320 million. Apparel sales increased 5% to $866 million.
Material Changes vs. Prior Period
- Revenue: Reported net sales decreased 5% year-over-year. However, excluding the sale of Lane Bryant in 2001, net sales increased 7%, driven by a 4% increase in comparable store sales.
- Profitability: Operating income increased 65% to $104 million, and net income increased 61% to $50 million. This growth occurred despite a $34 million pre-tax, non-cash special charge related to the IBI recombination.
- Balance Sheet: Total assets increased significantly from $3.864 billion to $6.079 billion, primarily due to the $1.6 billion stock issuance to acquire IBI minority interest. Shareholders' equity rose from $2.325 billion to $4.471 billion.
- Cash Flow: Net cash used for operating activities improved to $65 million (from $142 million used in 2001). Capital expenditures decreased to $50 million from $104 million.
Guidance, Outlook, and Risks
Management Commentary: Management attributes the gross margin improvement to fewer markdowns at Victoria's Secret and tighter inventory management in apparel. The Bath & Body Works segment faced an 8% decline in comparable store sales, offsetting the impact of 152 new store openings.
Capital Expenditure Outlook: The Company anticipates 2002 capital spending to be at or below $430 million, primarily for new stores and remodeling.
Risks and Contingencies:
- Legal Proceedings: The Company is involved in lawsuits regarding labor practices in Saipan and shareholder derivative actions concerning the 1999 tender offer. Additionally, litigation regarding the IBI exchange offer has reached a settlement in principle pending court approval.
- Tax Matters: The Company won a U.S. Court of Appeals ruling regarding IRS assessments on foreign affiliate earnings for 1992, though the IRS may appeal to the Supreme Court. Management believes the ultimate resolution will not have a material adverse effect.
- Forward-Looking Risks: Risks include changes in consumer spending, competition, weather patterns, and the ability to retain key personnel.
Investor Verification Checklist
- Verify the impact of the $34 million non-cash special charge on adjusted earnings per share ($0.15 adjusted vs. $0.10 reported).
- Confirm the sustainability of the 8% comparable store sales increase at Victoria's Secret versus the 8% decline at Bath & Body Works.
- Review the status of the pending Supreme Court appeal regarding the IRS tax assessment on foreign earnings.
- Monitor the final court approval of the settlement regarding the Intimate Brands, Inc. shareholder litigation.
- Assess the Company's ability to meet the $430 million capital expenditure target while maintaining liquidity.