BBWI

Business Context and Reporting Period

This Form 10-Q covers the thirteen-week period ended April 30, 2005, for Limited Brands, Inc. (parent company of Bath & Body Works, Victoria's Secret, Express, and Limited Stores). The company operates specialty retail brands selling intimate apparel, personal care, beauty products, and apparel through mall-based stores and direct response channels. The fiscal year is seasonal, with the first quarter representing the Spring selling season.

Key Financial Metrics

Cash Flow: Net cash used for operating activities was $213.2 million. Net cash used for investing activities was $140.1 million (primarily $134.1 million in capital expenditures). Net cash used for financing activities was $121.2 million (including $82.4 million in stock repurchases and $61.2 million in dividends).

Material Changes vs. Prior Period

• Revenue: Total net sales remained flat year-over-year. Victoria's Secret sales increased 5% and Bath & Body Works increased 6%, offset by a 17% decline in the Apparel segment (Express and Limited Stores).
• Profitability: Operating income decreased 60% to $48.3 million. This was driven by a significant decline in the Apparel segment, which swung from $10.7 million operating income in 2004 to a $68.5 million loss in 2005 due to poor fashion assortment and heavy markdowns.
• Debt: Long-term debt increased significantly from $648.3 million to $1,646.7 million following the issuance of $500 million in notes and a $500 million term loan in late 2004 to fund a $2 billion tender offer and a $500 million special dividend.
• Comparable Store Sales: Total comparable store sales decreased 5%. Victoria's Secret was flat (0%), Bath & Body Works increased 5%, while Express declined 21% and Limited Stores declined 6%.

Guidance, Outlook, and Risks

Management Commentary: Management attributed the poor results primarily to the Express brand, where the fashion assortment did not meet consumer preferences regarding style and price points. Conversely, Bath & Body Works saw an 89% increase in operating income due to successful new product introductions (e.g., C.O. Bigelow, Le Couvent des Minimes). Victoria's Secret growth was driven by the IPEX bra launch and the PINK sub-brand.

Outlook and Capital Allocation: The company anticipates capital expenditures of approximately $600 million for fiscal 2005, an increase from $431 million in 2004, driven by system upgrades and store remodeling. The Board authorized an additional $100 million stock repurchase program in May 2005.

Risks and Contingencies:

• Tax Matters: The company is pursuing a potential refund of up to $85 million plus interest related to foreign earnings repatriation for years 1995-2000. A tax benefit of up to $70 million could be realized under the American Jobs Creation Act if a qualifying reinvestment plan is implemented.
• Guarantees: The company holds approximately $344 million in guarantees related to leases of divested subsidiaries (e.g., Abercrombie & Fitch, Dick's Sporting Goods), though management believes the likelihood of material liability is remote.
• Accounting Changes: The company plans to adopt SFAS No. 123R (Share-Based Payment) in the first quarter of 2006, which will impact reported net income.

Investor Verification Checklist

• Verify the extent of inventory markdowns and the resulting impact on gross margins for the Express brand in subsequent quarters.
• Monitor the resolution of the IRS tax dispute regarding foreign earnings (1995-2000) and the potential $70 million tax benefit.
• Track the performance of new product launches at Bath & Body Works and Victoria's Secret to ensure they offset apparel weakness.
• Review the company's ability to service its increased debt load ($1.65 billion) given the decline in operating cash flow.
• Assess the impact of the upcoming adoption of SFAS No. 123R on future earnings per share.