BBWI

Business Context and Reporting Period

Company: Limited Brands, Inc. (Parent of Bath & Body Works, Victoria's Secret, and Pink)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Thirteen weeks ended May 2, 2009 (First Quarter 2009)
Business Overview: The Company operates specialty retail stores in the U.S. and Canada, primarily mall-based, selling women's intimate apparel, beauty, and personal care products. The reporting period was significantly impacted by the global economic downturn, resulting in a defensive management stance focused on inventory control, expense reduction, and liquidity preservation.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 10% ($200 million) driven by a 7% decrease in comparable store sales. Victoria's Secret sales fell 10%, while Bath & Body Works sales increased slightly by 1%.
• Profitability Compression: Operating income dropped $144 million (69%). This decline is largely due to the absence of a $128 million pre-tax gain on the divestiture of a joint venture recorded in Q1 2008, partially offset by a $19 million impairment charge in 2008.
• Margin Pressure: Gross margin rate declined to 31.8% from 33.3% due to increased promotional activity to drive sales and lower merchandise margins, particularly in the Victoria's Secret segment.
• Expense Management: General, Administrative, and Store Operating expenses decreased $58 million (11%) due to enterprise cost initiatives, reduced marketing spend, and the elimination of costs related to the divested personal care business.
• Cash Flow: Net cash used for operating activities was $118 million, compared to $112 million in the prior year. Capital expenditures were reduced significantly to $51 million from $139 million in Q1 2008.

Guidance, Outlook, and Risks

• Management Commentary: Management maintains a defensive stance, prioritizing the management of inventory, operating expenses, and capital expenditures. They believe their brands are well-positioned due to high emotional content at accessible prices.
• Debt Covenant Amendments: On February 19, 2009, the Company amended its credit facilities. The leverage ratio covenant was relaxed to allow up to 5.0x through Q3 2010. The amendment increased interest costs and fees ($19 million total, $8 million expensed) and restricted dividends and share repurchases to $220 million annually.
• Credit Ratings: The Company faced downgrades from Moody's, S&P, and Fitch in early 2009, with outlooks set to "Negative." This increases borrowing costs and limits credit availability but does not accelerate debt repayment.
• Key Risks: Significant risks include the global economic crisis, consumer confidence, mall traffic dependence, foreign currency fluctuations (specifically the Canadian dollar impact on La Senza), and the ability to service debt.
• Unusual Items: The Q1 2008 results included a $109 million net gain on joint ventures, making year-over-year comparisons difficult. Q1 2009 included $10 million in debt amendment fees expensed.

Investor Verification Checklist

• Debt Covenants: Verify continued compliance with the amended fixed charge coverage (1.60x) and leverage ratios (5.0x) given the economic environment.
• Inventory Levels: Monitor inventory turnover and potential markdown requirements as the Company navigates reduced consumer spending.
• Credit Rating Impact: Assess the potential for further credit rating downgrades and the associated increase in borrowing costs.
• Comparable Store Sales: Track the trend of comparable store sales, which declined 7% in Q1 2009, to gauge the effectiveness of cost-cutting and promotional strategies.
• Dividend Sustainability: Review the $220 million annual cap on restricted payments (dividends and buybacks) imposed by the new credit agreement.