BBWI

Business Context and Reporting Period

Company: Limited Brands, Inc. (Parent of Bath & Body Works, Victoria's Secret, Express, and Limited Stores)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended February 3, 2007 (53-week period)
Business Overview: The Company operates in the specialty retail business, selling women's intimate apparel, personal care, beauty products, and apparel. Operations are divided into three primary segments: Victoria's Secret, Bath & Body Works, and Apparel. In January 2007, the Company acquired La Senza Corporation for $600 million to expand its international presence.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 10% to $10.67 billion, driven by a 16% increase in Victoria's Secret sales and a 12% increase in Bath & Body Works sales. The Apparel segment saw a 4% decline in sales.
• Profitability: Operating income rose 19% to $1.176 billion. This was primarily due to a significant turnaround in the Apparel segment (specifically Express), which moved from a loss of $92 million in 2005 to an operating income of $27 million in 2006.
• Comparable Store Sales: Total comparable store sales increased 7% in 2006, reversing the 1% decline in 2005. Victoria's Secret (+11%) and Bath & Body Works (+10%) drove this growth, while Apparel declined 2%.
• Cash Flow: Cash provided by operating activities decreased significantly to $600 million from $1.081 billion in 2005. Management attributed this to a deliberate increase in inventory levels to support new product launches and improve in-stock positions.
• Acquisition: The Company completed the acquisition of La Senza Corporation for $600 million in cash on January 12, 2007. Results are included in the Victoria's Secret segment.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• 2007 Capital Expenditures: The Company anticipates spending between $790 million and $815 million in 2007. This includes opening approximately 125 new stores (primarily Victoria's Secret and Bath & Body Works) and closing about 143 unproductive stores (primarily Express).
• Store Strategy: Plans include increasing the average square footage of Victoria's Secret stores by approximately 50% through new openings and remodels. Bath & Body Works plans to open approximately 55 new stores.
• Shareholder Returns: The Company continues to return excess free cash flow to shareholders through dividends and share repurchases. In 2006, the Company repurchased 8 million shares for $193 million.

Risks and Contingencies

• Seasonality: Approximately one-third of net sales occur in the fourth quarter. Inventory builds in the third quarter create high cash requirements.
• IT Systems: The Company is implementing a multi-year upgrade of IT systems (merchandise, distribution, e-commerce, finance). Disruptions during this transition could materially affect operations.
• Supply Chain: Reliance on foreign manufacturing exposes the Company to risks related to trade regulations, currency fluctuations, and shipping delays.
• Accounting Changes: The Company adopted SFAS No. 123(R) regarding share-based compensation in 2006, resulting in $26 million of incremental expense. The Company also expects to adopt FIN 48 in 2007, which may decrease retained earnings by up to $12 million.

Investor Verification Checklist

• Inventory Levels: Verify the impact of the $545 million increase in inventory on future gross margins and potential markdowns.
• Apparel Turnaround: Monitor the sustainability of the Express segment's profitability improvement following significant promotional activity in 2005.
• La Senza Integration: Assess the performance of the newly acquired La Senza stores and the success of international expansion strategies.
• IT Implementation: Track the progress of the enterprise-wide IT system upgrades to ensure no operational disruptions occur.
• Debt Covenants: Confirm continued compliance with financial ratios required by the $1 billion revolving credit facility and term loans.