BBWI

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended August 2, 2008, and the year-to-date period for Limited Brands, Inc. (parent of Bath & Body Works, Victoria's Secret, and Pink). The company operates specialty retail stores in the U.S. and Canada. The reporting period reflects the post-divestiture structure following the sale of the Express and Limited Stores apparel brands in mid-2007.

Key Financial Metrics

Operating Cash Flow (YTD): $247 million provided by operating activities in 2008, compared to $36 million used in 2007.

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 13% in Q2 2008 and 15% YTD 2008. This is primarily due to the absence of the Apparel segment (Express and Limited Stores) which was divested in 2007. On a comparable basis, Victoria's Secret sales grew 3% while Bath & Body Works sales declined 2%.
• Comparable Store Sales: Total comparable store sales declined 7% in Q2 2008 and 7% YTD 2008. Victoria's Secret stores saw a 7% decline, while Bath & Body Works saw an 8% decline, attributed to soft traffic and a challenging economic environment.
• Profitability: Operating income decreased significantly year-over-year due to the loss of Apparel segment revenue and one-time gains recorded in 2007 (divestiture gains). However, operating income rates improved for both Victoria's Secret and Bath & Body Works due to better merchandise margins and cost controls.
• One-Time Items: Q2 2007 included a $230 million net gain from apparel divestitures and a $100 million gain from an Easton Town Center distribution. Q2 2008 included a $13 million gain from a cash distribution from Express.

Guidance, Outlook, and Risks

Management Commentary: Management noted that the decline in comparable store sales was driven by a challenging economic environment, less promotional activity, and insufficient innovation in product assortments (specifically beauty at Victoria's Secret). Gross profit rates improved due to better inventory management and reduced promotional activity.

Liquidity and Capital: The company maintains strong liquidity with $978 million in cash and $1.3 billion available under credit facilities. Capital expenditures for YTD 2008 were $272 million, focused on new store openings and technology.

Risks and Contingencies:

• Guarantees: The company retains approximately $215 million in guarantees for lease payments of divested businesses (including Express and Limited Stores). A $34 million standby letter of credit from Express mitigates a portion of this risk.
• Market Risks: Exposure to foreign currency fluctuations (primarily Canadian dollar) and interest rate changes, managed through hedging instruments.
• Operational Risks: Dependence on mall traffic, consumer spending patterns, and supply chain disruptions.

Investor Verification Checklist

• Verify the sustainability of the improved merchandise margin rates at Victoria's Secret and Bath & Body Works given the decline in comparable store sales.
• Monitor the $215 million in lease guarantees for divested apparel brands and the status of the $34 million standby letter of credit from Express.
• Assess the impact of the 7-8% decline in comparable store sales on future revenue growth projections.
• Review the $109 million net gain on joint ventures included in YTD 2008 operating income to understand its non-recurring nature.
• Confirm the company's ability to service its $2.9 billion long-term debt load amidst a challenging economic environment.