BBWI

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended November 2, 2002, and the thirty-nine weeks ended on that date for Limited Brands, Inc. (parent company of Bath & Body Works, Victoria's Secret, and Express). The filing reflects the completion of the acquisition of the minority interest of Intimate Brands, Inc. (IBI) in March 2002, resulting in IBI becoming a wholly-owned subsidiary. The company operates specialty retail stores and direct response businesses selling women's and men's apparel, intimate apparel, and personal care products.

Key Financial Metrics

Liquidity: The company maintains a $1.25 billion unsecured revolving credit facility with no borrowings outstanding as of November 2, 2002. Cash and equivalents decreased by $489.8 million year-to-date primarily due to operating cash usage and capital expenditures.

Material Changes vs. Prior Period

• Revenue: Third-quarter net sales increased 4% year-over-year. Excluding the sale of Lane Bryant in 2001, sales increased 6%, driven by a 3% increase in comparable store sales and the addition of 57 stores at Victoria's Secret and Bath & Body Works.
• Profitability: Reported operating income decreased significantly in the third quarter ($21.5M vs $153.5M) primarily due to the absence of a $170 million one-time gain from the Lane Bryant sale in 2001. However, adjusted operating income improved from a loss of $16.8 million in 2001 to $21.5 million in 2002.
• Segment Performance: Victoria's Secret operating income surged 256% to $57.3 million. Bath & Body Works operating income improved to $2.2 million from a loss of $0.8 million. The Apparel segment operating income declined to $1.4 million from $7.1 million.
• Balance Sheet: Total assets increased to $6.15 billion from $4.16 billion, largely due to the recording of $1.2 billion in goodwill and $411 million in intangible assets from the IBI recombination.

Guidance, Outlook, and Risks

• Capital Expenditures: Management anticipates 2002 capital spending to be $325 million or less, funded principally by operating cash flows. This is a decrease from the $299.8 million spent in the first three quarters of 2001.
• Subsequent Events: On November 27, 2002, the company sold the Lerner/New York & Company business for $78.5 million in cash, a $75 million subordinated note, and warrants. This transaction is expected to result in a fourth-quarter after-tax loss of approximately $7 million and will be reported as a discontinued operation.
• Debt Issuance: On November 25, 2002, the company issued $300 million of 6 1/8% debt securities maturing in 2012.
• Risks: Key risks include changes in consumer spending patterns, competition, pricing pressures, weather patterns, and the ability to retain key personnel. The company also faces ongoing litigation regarding labor practices in Saipan and shareholder derivative actions related to the IBI exchange offer (though settlements were reached for the latter).

Investor Verification Checklist

• Adjusted Earnings: Verify the "Adjusted Income" metrics provided by management, which exclude the $170M Lane Bryant gain (2001) and the $33.8M IBI stock award charge (2002), to assess core operational performance.
• Inventory Levels: Review the increase in inventories to $1.41 billion (from $966M at Feb 2002) and the associated cash outflow of $444 million, ensuring markdown reserves are adequate for the fall season.
• Goodwill Impairment: Monitor the $1.32 billion goodwill balance resulting from the IBI acquisition for potential future impairment charges under SFAS No. 142.
• Discontinued Operations: Confirm the accounting treatment and financial impact of the Lerner/New York & Company sale in the upcoming fourth-quarter filing.
• Cash Flow Usage: Analyze the $164 million net cash used for operating activities year-to-date to ensure it aligns with seasonal working capital requirements and tax payments.