SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended July 31, 2004
OR
For the transition period from to
Commission file number 1-8344
LIMITED BRANDS, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Three Limited Parkway, P.O. Box 16000,
Columbus, Ohio
Registrant’s telephone number, including area code (614) 415-7000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x No ¨
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, $.50 Par Value
Outstanding at August 31, 2004
TABLE OF CONTENTS
Item 1.Financial Statements
Consolidated Statements of Income Thirteen and Twenty-six Weeks Ended July 31, 2004 and August 2, 2003
Consolidated Balance Sheets July 31, 2004, January 31, 2004 and August 2, 2003
Consolidated Statements of Cash Flows Twenty-six Weeks Ended July 31, 2004 and August 2, 2003
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Item 2.Management’s Discussion and Analysis of Results of Operations and Financial Condition
Item 3.Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Item 1.Legal Proceedings
Item 2.Issuer Purchases of Equity Securities
Item 4.Submission of Matters to a Vote of Security Holders
Item 6.Exhibits and Reports on Form 8-K
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SAFE HARBOR STATEMENT UNDER THE PRIVATE
SECURITIES LITIGATION ACT OF 1995
The Company cautions that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained in this Quarterly Report on Form 10-Q (“Report”) or otherwise made by the Company or management of the Company involve risks and uncertainties and are subject to change based on various important factors, many of which may be beyond the Company’s control. Accordingly, the Company’s future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements. Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend,” “planned,” “potential” and similar expressions may identify forward-looking statements. The following factors, among others, in some cases have affected and in the future could affect the Company’s financial performance and actual results and could cause actual results for 2004 and beyond to differ materially from those expressed or implied in any forward-looking statements included in this Report or otherwise made by the Company or management: changes in consumer spending patterns, consumer preferences and overall economic conditions; the potential impact of national and international security concerns on the retail environment, including any possible military action, terrorist attacks or other hostilities; the impact of competition and pricing; changes in weather patterns; political stability; postal rate increases and charges; paper and printing costs; risks associated with the seasonality of the retail industry; risks related to consumer acceptance of the Company’s products and the ability to develop new merchandise; the ability to retain, hire and train key personnel; risks associated with the possible inability of the Company’s manufacturers to deliver products in a timely manner; risks associated with relying on foreign sources of production; and risks associated with the possible lack of availability of suitable store locations on appropriate terms. Investors should read Exhibit 99.1 to the Company’s Annual Report on Form 10-K, as well as the Company’s other filings with the Securities and Exchange Commission, for a more complete discussion of these and other factors that might affect the Company’s performance and financial results. The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.
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PART I— FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
LIMITED BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Thousands except per share amounts)
(Unaudited)
July 31,
2004
August 2,
2003
Net sales
Costs of goods sold, buying and occupancy
Gross income
General, administrative and store operating expenses
Operating income
Interest expense
Interest income
Other income (loss)
Gain on investees’ stock
Income before income taxes
Provision for income taxes
Net income
Net income per basic share
Net income per diluted share
Dividends per share
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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CONSOLIDATED BALANCE SHEETS
(Thousands)
Current assets:
Cash and equivalents
Accounts receivable
Inventories
Other
Total current assets
Property and equipment, net
Goodwill
Trade names and other intangible assets, net
Other assets
Total assets
Current liabilities:
Accounts payable
Accrued expenses
Income taxes
Total current liabilities
Deferred income taxes
Long-term debt
Other long-term liabilities
Shareholders’ equity:
Common stock
Paid-in capital
Retained earnings
Less: treasury stock, at average cost
Total shareholders’ equity
Total liabilities and shareholders’ equity
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Gain from early collection of long-term note receivable
Gain on sale of third party warrants
Stock compensation
Gain on sale of investees’ stock
Loss on sale of joint ventures
Debt extinguishment costs
Change in assets and liabilities:
Accounts payable and accrued expenses
Income taxes payable
Other assets and liabilities
Net cash provided by operating activities
Investing activities:
Capital expenditures
Collection of long-term note receivable
Proceeds from sale of third party warrants
Proceeds from sale of investees’ stock
Other investing activities
Net cash used for investing activities
Financing activities:
Repurchase of common stock
Dividends paid
Repayment of long-term debt
Proceeds from issuance of long-term debt
Proceeds from exercise of stock options and other
Net cash used for financing activities
Net decrease in cash and equivalents
Cash and equivalents, beginning of year
Cash and equivalents, end of period
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation
Limited Brands, Inc. (the “Company” or “Limited Brands”) sells women’s intimate apparel, personal care products and women’s and men’s apparel, under various trade names through its specialty retail stores and direct response (catalog and e-commerce) businesses.
The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Investments in unconsolidated entities over which the Company exercises significant influence but does not have control are accounted for using the equity method. The Company’s share of the net income or loss of unconsolidated entities is included in other income (loss).
The consolidated financial statements as of and for the thirteen week and twenty-six week periods ended July 31, 2004 and August 2, 2003 are unaudited and are presented pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s 2003 Annual Report on Form 10-K. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments (which are of a normal recurring nature) necessary for a fair statement of the results for the interim periods.
Due to seasonal variations in the retail industry, the results of operations for any interim period are not necessarily indicative of the results expected for the full fiscal year.
Certain prior year amounts have been reclassified to conform to the current year presentation.
2. Shareholders’ Equity and Earnings Per Share
At July 31, 2004, one billion shares of $0.50 par value common stock were authorized, 523.9 million were issued and 470.2 million were outstanding. At January 31, 2004, 523.9 million shares were issued and 518.1 million were outstanding. At August 2, 2003, 523.8 million shares were issued and 518.5 million were outstanding. In addition, ten million shares of $1.00 par value preferred stock were authorized, none of which were issued.
In April 2004, the Company completed a modified “Dutch Auction” tender offer under which the Company repurchased approximately 50.6 million shares of its outstanding common stock for $1 billion, or $19.75 per share.
In May 2004, the Board of Directors of the Company authorized the repurchase of $100 million of the Company’s common stock. As of July 31, 2004, the Company had repurchased approximately 3.0 million shares of its common stock for $57.4 million at an average price per share of approximately $19.35, of which $6.1 million was settled in August 2004 and, accordingly, was reflected in accounts payable as of quarter end. The remainder of the $100 million repurchase was completed in August 2004.
In August 2004, the Board of Directors of the Company authorized the repurchase of an additional $250 million of the Company’s common stock.
In January 2003, the Board of Directors of the Company authorized the repurchase of $150 million of the Company’s common stock. Through August 2, 2003, the Company had repurchased approximately 6.8 million shares of its common stock for $98.5 million at an average price per share of approximately $14.57. During the third quarter of 2003, the Company completed the $150 million repurchase by acquiring approximately 3.1 million shares of the Company’s common stock for $51.5 million at an average price per share of approximately $16.18.
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Earnings per basic share is computed based on the weighted average number of outstanding common shares. Earnings per diluted share includes the weighted average effect of dilutive options and restricted stock on the weighted average shares outstanding.
Weighted average common shares outstanding (thousands):
Common shares issued
Treasury shares
Basic shares
Dilutive effect of stock options and restricted shares
Diluted shares
The quarterly computations of earnings per diluted share exclude options to purchase 2.3 million and 20.3 million shares of common stock for the thirteen weeks ended July 31, 2004 and August 2, 2003 and the year-to-date computation of earnings per diluted share excludes options to purchase 2.0 million and 22.8 million shares for 2004 and 2003, because the options’ exercise prices were greater than the average market price of the common shares during those periods.
3. Stock-based Compensation
The Company recognizes compensation expense associated with stock-based awards under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and related interpretations. Under APB No. 25, because the exercise price of the Company’s employee stock options is generally equal to the market price of the underlying stock on the date of grant, no compensation expense is recognized. Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” establishes an alternative method of expense recognition for stock-based compensation awards based on fair values.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123:
Thirteen Weeks
Ended
(thousands except per share amounts)
Net income, as reported
Add: Stock compensation cost recorded, net of tax
Deduct: Stock compensation cost calculated under SFAS No. 123, net of tax
Pro forma net income
Earnings per basic share, as reported
Earnings per basic share, pro forma
Earnings per diluted share, as reported
Earnings per diluted share, pro forma
4. Other Income (Loss)
In March 2004, the Company recognized a $44.9 million gain resulting from (i) the early repayment of New York & Company’s (formerly Lerner) $75.0 million subordinated note held by the Company plus accrued interest of approximately $10 million (scheduled maturity was November 26, 2009) and (ii) New York & Company’s $20.0 million purchase of warrants representing approximately 13% of New York & Company’s common equity. The note and warrants were part of the consideration received by the Company for the sale of New York & Company in November 2002, and had a carrying value, including accrued interest, of $60.1 million.
In connection with the agreement to purchase the note and warrants (the “Agreement”), New York & Company has agreed to make an additional payment to the Company in either cash or a combination of cash and shares if (i) New York & Company completes an initial public offering pursuant to a registration statement filed on or before December 31, 2004 or is sold pursuant to an agreement entered into on or before December 31, 2004 and (ii) the implied equity value of New York & Company based upon one of the above transactions exceeds $156.8 million. The additional payment would be equal to 6.38% of the implied equity value in excess of $156.8 million and would result in the recognition of a non-operating gain by the Company at the time one of the above transactions is completed. On May 24, 2004, New York & Company filed an initial registration statement with the SEC in connection with a
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proposed initial public offering (the “Proposed IPO”). With respect to the Proposed IPO, the Agreement was amended on August 5, 2004 to (i) require New York & Company to pay the additional payment in cash, and (ii) reduce the additional payment by $4.5 million, provided that the Proposed IPO is completed.
In addition to the $44.9 million gain relating to the New York & Company note and warrants, other income (loss) for the twenty-six weeks ended July 31, 2004 also included $0.6 million and ($3.7) million, respectively, which represents the Company’s share of net income (loss) associated with its unconsolidated entities.
For the thirteen weeks ended August 2, 2003, other income (loss) primarily included $0.6 million of income related to the Company’s share of net income associated with its unconsolidated entities. Other income (loss) for the twenty-six weeks ended August 2, 2003 was primarily comprised of a $6.9 million loss related to the sale of certain Mast joint ventures and a $1.3 million loss representing the Company’s share of net loss associated with its unconsolidated entities.
5. Gain on Investees’ Stock
In July 2004, the Company sold its remaining ownership interest in Galyan’s Trading Company, Inc. (“Galyan’s”) for $65.3 million resulting in a pretax gain of $17.6 million. Prior to the sale of Galyan’s shares, the Company accounted for its investment using the equity method.
During the first quarter of 2003, the Company sold approximately one-half of its ownership in Alliance Data Systems Corporation (“ADS”) for $130.7 million resulting in a pretax gain of $79.7 million. During the third quarter of 2003, the Company sold its remaining interest in ADS for $192.9 million resulting in a pretax gain of $128.4 million. Prior to the sale of ADS shares, the Company accounted for its investment using the equity method.
6. Inventories
The fiscal year of the Company and its subsidiaries is comprised of two principal selling seasons: spring (the first and second quarters) and fall (the third and fourth quarters). Inventories are principally valued at the lower of average cost or market, on a weighted average cost basis, using the retail method. Inventory valuation at the end of the first and third quarters reflects adjustments for estimated inventory markdowns for the total selling season.
7. Property and Equipment, Net
Property and equipment, net consisted of (thousands):
Property and equipment, at cost
Accumulated depreciation and amortization
8. Trade Names and Other Intangible Assets, Net
Intangible assets, not subject to amortization, represent trade names of $411.0 million as of July 31, 2004, January 31, 2004 and August 2, 2003.
Intellectual property assets and other intangibles, subject to amortization, were as follows (thousands):
Gross carrying amount
Accumulated amortization
Intellectual property assets and other intangible assets, net
The estimated annual amortization expense for intangibles is approximately $8 million each year through 2006 and approximately $5 million in 2007, at which time intangible assets will be fully amortized.
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9. Income Taxes
The provision for income taxes is based on the current estimate of the annual effective tax rate. Income taxes paid during the twenty-six weeks ended July 31, 2004 and August 2, 2003 approximated $296.3 million and $270.9 million, respectively. Income taxes payable included net current deferred tax liabilities of $69.7 million at July 31, 2004, $69.7 million at January 31, 2004 and $55.4 million at August 2, 2003.
The Company’s effective tax rate has historically reflected and continues to reflect a provision related to the undistributed earnings of foreign affiliates. Since 1995, the Internal Revenue Service (“IRS”) has assessed the Company for additional taxes and interest for the years 1992 to 2000 relating to the undistributed earnings of foreign affiliates. In September 1999, the United States Tax Court sustained the position of the IRS with respect to the 1992 year and, in connection with an appeal of that Tax Court judgment and related IRS assessments for subsequent years, the Company paid $122 million in taxes and interest for the years 1992 to 2000 that reduced deferred tax liabilities.
In March 2002, the U.S. Court of Appeals for the Sixth Circuit ruled in favor of the Company, reversing the previous Tax Court judgment relating to the 1992 year. This ruling also applied to years 1993 and 1994. In the third quarter of 2003, the Company reached an agreement with the IRS regarding the computation of interest and recognized interest income of $30 million related to the Company’s appeal of the 1992 through 1994 years, of which $28 million was collected in the fourth quarter of 2003; the remaining balance reduced deferred tax liabilities.
The Company is pursuing additional actions to obtain any refunds related to the 1995 through 2000 years although there can be no assurance as to the outcome of those actions.
10. Long-term Debt
Unsecured long-term debt consisted of (thousands):
6.125% $300 million Notes due December 2012, less unamortized discount
6.95% $350 million Debentures due March 2033, less unamortized discount
In the first quarter of 2003, the Company issued $350 million of 6.95% debentures due March 1, 2033 under a 144A private placement. The Company exchanged the privately held securities for securities registered with the SEC with identical terms through a non-taxable exchange offer. $0.5 million of securities were not exchanged and remain privately held.
Also in the first quarter of 2003, the Company redeemed its 7 1/2% debentures due 2023 at a redemption price equal to 103.16% of the principal amount, plus accrued interest through the call date. The early redemption of these securities resulted in a pretax charge of $13.4 million, comprised of the call premium and the write-off of unamortized deferred financing fees and discounts. This charge was included in interest expense in the Consolidated Statements of Income.
The Company has a shelf registration statement, under which up to $500 million of debt securities, common and preferred stock, and other securities may be issued. To date, no securities have been issued under this registration statement.
The Company currently has a 5-year $750 million unsecured revolving credit facility (the “Facility”). The Facility was reduced from $1.25 billion at the June 25, 2004 expiration of the Company’s $500 million 364-day agreement which the Company chose not to renew. Borrowings outstanding under the Facility, if any, are due July 13, 2006. The Facility has several borrowing and interest rate options. Fees payable under the Facility are based on the Company’s long-term credit ratings, and is currently 0.125% of the committed amount per year.
The Facility requires the Company to maintain certain specified fixed charge and debt to capital ratios. The Company was in compliance with these requirements at July 31, 2004.
The Facility is available to support the Company’s commercial paper and letter of credit programs, which are used from time to time to fund working capital and other general corporate requirements. The Company did not issue commercial paper or draw on the Facility during the twenty-six weeks ended July 31, 2004. In addition, no commercial paper or amounts under the Facility were outstanding at July 31, 2004.
Cash paid for interest during the twenty-six weeks ended July 31, 2004 and August 2, 2003 was $23.7 million and $34.9 million, respectively.
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11. Commitments and Contingencies
In connection with the disposition of certain subsidiaries, the Company has remaining guarantees of approximately $442 million related to lease obligations of Abercrombie & Fitch, Too Inc., Galyan’s, Lane Bryant and New York & Company under the current terms of noncancelable leases expiring at various dates through 2015, unless extended or renewed. These guarantees include minimum rent and additional payments covering taxes, common area costs and certain other expenses and relate only to leases that commenced prior to the disposition of the subsidiaries. In certain instances, the Company’s guarantee may remain in effect if the term of a lease is extended. The Company believes the likelihood of material liability being triggered under these guarantees is remote.
Also, in connection with the Company’s investment in Easton Town Center, LLC (“ETC”), the Company has guaranteed $25 million of ETC’s $210 million secured bank loan.
Additionally, in June 1999, the Company issued a $31 million standby letter of credit, on which the City of Columbus, Ohio (the “City”) can draw solely to pay principal and interest on public bonds issued by the City for infrastructure development at Easton. The Company does not currently anticipate that the City will be required to draw funds under the letter of credit.
The Company is subject to various claims and contingencies related to lawsuits, income taxes, insurance, regulatory and other matters arising out of the normal course of business. Management believes that the ultimate liability arising from such claims or contingencies, if any, is not likely to have a material adverse effect on the Company’s results of operations, financial condition or cash flows.
12. Segment Information
The Victoria’s Secret segment derives its revenues from sales of women’s intimate and other apparel, personal care products and accessories marketed under the Victoria’s Secret brand name. Victoria’s Secret merchandise is sold through its stores and direct response (catalog and e-commerce) businesses. The Bath & Body Works segment derives its revenues from the sale of personal care products and accessories and home fragrance products marketed under the Bath & Body Works and White Barn Candle Company brand names. The Apparel segment derives its revenues from sales of women’s and men’s apparel through Express and Limited Stores.
Segment information for the thirteen and twenty-six weeks ended July 31, 2004 and August 2, 2003 follows (thousands):
Thirteen weeks:
Operating income (loss)
Twenty-six weeks:
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To the Board of Directors and Shareholders
of Limited Brands, Inc:
We have reviewed the consolidated balance sheets of Limited Brands, Inc. and its subsidiaries (the “Company”) as of July 31, 2004 and August 2, 2003, the related consolidated statements of income for the thirteen and twenty-six week periods ended July 31, 2004 and August 2, 2003, and the consolidated statements of cash flows for the twenty-six week periods ended July 31, 2004 and August 2, 2003. These financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the consolidated interim financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Limited Brands, Inc. and subsidiaries as of January 31, 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated February 26, 2004 (except for Note 16 as to which the date is March 16, 2004), we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of January 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
August 19, 2004
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Executive Overview
Limited Brands, Inc. (the “Company”) operates in the highly competitive specialty retail business. The Company sells women’s intimate apparel, personal care products and women’s and men’s apparel through its retail stores (primarily mall-based) and direct response (catalog and e-commerce) businesses.
Strategy
In the second quarter of 2004, the Company continued to focus on its core brands and leveraging its talent and strong financial position to drive increased growth. The focus on core brands, as described below, includes investment in the Company’s stores to move its brand positioning forward, investment in new product opportunities and the pursuit of new products through third parties.
The Company’s strong financial position enabled it to continue its strategy of enhancing shareholder value by returning capital to its investors through two recent actions. In May 2004, the Company announced that its Board of Directors had authorized a $100 million share repurchase program, under which an additional $57.4 million of its common stock has been repurchased as of July 31, 2004. In August 2004, the Company announced that its Board of Directors had authorized an additional $250 million share repurchase program.
From an operating perspective, the Company’s strategic agenda is to continue to focus on brands, talent and capability.
Brands
In the second quarter of 2004, the Company continued to see positive results from brand building product extensions, including the Victoria’s Secret Pink product line, Henri Bendel Home Fragrance at Bath & Body Works and the Express Design Studio. In the second quarter, we continued to expand the distribution of these products, most notably through the national rollout of the Pink product line, which was available in a total of 846 Victoria’s Secret Stores as of July 31, 2004, and through the full scale rollout of the Express Design Studio.
The Company continues to concentrate on brand building activities by improving in-store marketing and visual elements and implementing a more focused promotional strategy. Accordingly, during 2004, the Company has eliminated most of the promotional activity that discounts the entire store and has shifted its focus to more targeted product promotions combined with quarterly sale events. We believe these brand building activities have contributed to improved growth and profitability in the second quarter of 2004.
Talent
One of the Company’s key imperatives is to develop, retain and attract talent on a continuing basis. This talent pool is critical to enable the Company to develop and implement a wide range of ideas that are essential to its continued growth. Accordingly, the talent initiative continues to be a major focus of the Company and involves identifying and building the capabilities required to manage the business today and just as importantly, to manage the business the Company anticipates in the future.
Capability
The Company is focused on a number of initiatives to develop and improve operational capabilities, including: a Center-based creative team focused on new products and product extensions; the implementation of a new human resources system throughout the business in 2004; an enterprise-wide focus on the procurement of non-merchandise goods and services; and store operating initiatives which are intended to drive sales and labor productivity. The Company is also in the early stages of standardizing and upgrading our capabilities in the areas of merchandise planning and allocation, finance and customer relationship marketing.
Second Quarter 2004 Results
In the second quarter of 2004, key economic indicators including GDP Growth, the unemployment rate and initial jobless claims continued to show signs of improvement over last year, while consumer sentiment remained largely unchanged. The Company’s second quarter operating results may have been impacted by this continued improvement in the external economic environment.
In the second quarter of 2004, net sales increased approximately 10% or $197 million, comparable store sales increased 9%, and operating income increased approximately 34% to $227 million compared to the second quarter of 2003.
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For the twenty-six week period ended July 31, 2004, net sales increased approximately 9% or $333 million, comparable store sales increased 8%, and operating income increased approximately 24% to $346 million compared to 2003.
The following summarized financial and statistical data compares reported results for the thirteen week and twenty-six week periods ended July 31, 2004 and August 2, 2003:
Net Sales (millions):
Victoria’s Secret Stores
Victoria’s Secret Direct
Total Victoria’s Secret
Bath & Body Works
Express
Limited Stores
Total apparel businesses
Other (a)
Total net sales
Segment Operating Income (millions):
Victoria’s Secret
Apparel
Total operating income
Comparable Store Sales (b):
Henri Bendel
Total comparable store sales increase
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Segment Store Data:
Retail sales per average selling square foot:
Retail sales per average store (thousands):
Average store size at end of quarter (selling square feet):
Selling square feet at end of quarter (thousands):
Number of Stores:
Beginning of period
Opened
Closed
End of period
Express Women’s
Express Men’s
Express Dual Gender
Total Express
Total apparel
Total stores and selling square feet
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Net Sales
The change in net sales for the second quarter of 2004 compared to 2003 was as follows:
(Millions) Increase (decrease)
2003 Net sales
Comparable store sales
Sales associated with new, closed and non-comparable remodeled stores, net
Mast third party sales and other
2004 Net sales
At Victoria’s Secret, the 7% increase in comparable store sales was primarily driven by the rollout of the Pink product line to the majority of Victoria’s Secrets stores by July 2004, by the continued success of the Angels bra sub-brand and by the Beauty business. Growth in the Beauty business was primarily driven by the continued success of the Very Sexy for Her and Him II and Breathless fragrances, as well as the launch of the Forbidden Fantasy fragrance in the Garden product line. The 14% increase in net sales at Victoria’s Secret Direct was driven by growth in swimwear, wear-to-work clothing and bras, most notably the Body by Victoria shaping full coverage bra.
At Bath & Body Works, the 20% increase in comparable store sales was primarily driven by continued sales growth for the Pure Simplicity, Home Fragrance and Anti-bac product lines, primarily during the semi-annual sale period. The success of the semi-annual sale was supported by increased direct marketing and in-store promotional activities.
At the apparel businesses, the 3% increase in comparable store sales at Express was driven by sales increases in the women’s wear-to-work category, primarily pants, and by success in men’s woven shirts and dress pants, partially offset by declines in women’s shorts, knits and casual bottoms categories. This result was supported by the rollout of Express Design Studio to all stores by July 2004 and the success of our end-of-season sale. At Limited Stores, the 2% decrease in comparable store sales was primarily driven by the exit of dress categories and decreased incentive marketing activities.
The net sales increase at Mast was primarily driven by an increase in volume of third party customer sales versus the second quarter of 2003.
The change in net sales for the twenty-six weeks ended July 31, 2004 compared to August 2, 2003 was as follows:
Sales associated with new, closed and non-comparable remodeledstores, net
At Victoria’s Secret, the 11% increase in year-to-date comparable store sales was driven by growth in the bra category, particularly the Angels and Very Sexy sub-brands, the national launch of the Pink product line and the continued growth of the Beauty business. The 14% increase in net sales at Victoria’s Secret Direct was driven by growth in swimwear, wear-to-work clothing and bras, most notably the Body by Victoria shaping full coverage bra.
At Bath & Body Works, the 14% increase in year-to-date comparable store sales was primarily driven by the second quarter comparable store sales increase described above and continued sales growth in the Pure Simplicity, Home Fragrance and Anti-bac product lines.
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At the apparel businesses, the 2% increase in comparable store sales at Express was driven by sales increases in the women’s wear-to-work category, primarily Express Design Studio’s Editor pant, and men’s woven shirts, dress pants and knits categories, partially offset by declines in women’s dresses, shorts and knits categories. At Limited Stores, the 1% decrease in comparable store sales was primarily driven by the exit of the dress category and decreased incentive marketing activities, partially offset by increases in pants and woven tops.
The net sales increase at Mast was primarily driven by an increase in volume of third party customer sales since the second quarter of 2003.
Gross Income
For the second quarter of 2004, the gross income rate (expressed as a percentage of net sales) increased to 36.1% from 34.9% for the same period in 2003 primarily due to a slight increase in merchandise margin at Victoria’s Secret and Express and leverage in buying and occupancy expense at Bath & Body Works.
The increase in merchandise margin rate at Victoria’s Secret was primarily driven by improved performance in the swimwear category at Victoria’s Secret Direct and the merchandise margin rate increase at Express resulted primarily from decreased markdowns related to men’s dress pants and woven shirts. Leverage in buying and occupancy expense at Bath & Body Works was primarily driven by a comparable store sales increase of 20%.
The year-to-date gross income rate increased to 35.2% from 34.1% in 2003. The increase in the year-to-date gross income rate was primarily driven by decreased markdowns at Victoria’s Secret Stores, improved performance in the swimwear category at Victoria’s Secret Direct and a decrease in the buying and occupancy expense rate. The decrease in the buying and occupancy expense rate was achieved through leverage at Bath & Body Works on a comparable store sales increase of 14% and a reduction in buying and occupancy costs at the apparel brands resulting from a decrease in rent and depreciation expense.
General, Administrative and Store Operating Expenses
For the second quarter of 2004, the general, administrative and store operating expense rate (expressed as a percentage of net sales) decreased to 25.8% from 26.4% last year. The decrease in the general, administrative and store operating expense rate was primarily driven by the ability to leverage store selling expenses, the Company’s largest expense category, across all operating segments. The rate improvement was partially offset by an increase in incentive compensation costs.
The year-to-date general, administrative and store operating expense rate remained relatively flat at 26.9% compared to 26.8% in 2003. The rate improvement resulting from the ability to achieve leverage on store selling expenses was offset by a reserve related to legal matters in the first quarter and an increase in incentive compensation costs.
Interest Expense
Average borrowings (millions)
Average effective borrowing rate
The Company incurred interest expense of $12.0 million for the second quarter of 2004 compared to $11.4 million for the same period in 2003. An increase in average borrowing rates contributed to the increase.
Year-to-date interest expense decreased to $23.7 million in 2004 from $38.4 million in 2003. The decrease in interest expense occurred because 2003 included a one time $13.4 million charge associated with the retirement of the Company’s $250 million 7 1/2% notes due in 2023. A decline in average borrowing rates also contributed to the decrease.
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Other Non-operating Items
For the second quarter of 2004, interest income of $8.5 million was relatively flat compared to $8.1 million in 2003. Year-to-date interest income decreased to $16.4 million from $17.3 million in 2003. The decrease primarily relates to a decrease in the average invested cash balance and in the average effective interest rate.
For the second quarter of 2004, other income (loss) was $1.0 million compared to $0.9 million for the second quarter of 2003. Year-to-date other income (loss) was $41.9 million compared to ($7.6) million in 2003. The year-to-date improvement in other income compared to 2003 primarily relates to a $44.9 million gain related to the early collection of a long-term note receivable and the sale of third party warrants (related to the sale of New York & Company as further discussed in Note 4 to the Consolidated Financial Statements). The loss in 2003 was primarily driven by a $6.9 million loss on the sale of certain Mast joint ventures.
Gain on Investees’ Stock
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Adjusted Data
Adjusted income information provides non-GAAP financial measures and gives effect to certain significant transactions and events that impact the comparability of the Company’s results in 2004 and 2003. Specifically, adjusted income excludes certain non-operating items which do not relate to the core performance of the Company’s business and affect the comparability of current period results. Accordingly, the following table adjusts net income for such transactions and events in determining the adjusted results, and reconciles the adjusted results to net income reported in accordance with accounting principles generally accepted in the United States of America.
Management believes that the adjusted results provide useful information as to the Company’s underlying business performance and assessment of ongoing operations. The adjusted income information should not be construed as an alternative to the reported results determined in accordance with generally accepted accounting principles. Further, the Company’s definition of adjusted income information may differ from similarly titled measures used by other companies.
Reconciliation of Adjusted Income Information for the thirteen weeks ended July 31, 2004 and August 2, 2003 (thousands except per share amounts):
Other income
Weighted average shares outstanding
Notes to Reconciliation of Adjusted Income Information:
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Reconciliation of Adjusted Income Information for the twenty-six weeks ended July 31, 2004 and August 2, 2003 (thousands except per share amounts):
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FINANCIAL CONDITION
Liquidity and Capital Resources
Cash generated from operating activities provides the primary resources to support current operations, projected growth, seasonal funding requirements and capital expenditures. In addition, the Company has funds available from an unsecured revolving credit facility as well as a commercial paper program which is backed by the credit facility. The Company did not issue commercial paper or draw on the credit facility during the twenty-six weeks ended July 31, 2004 and August 2, 2003. However, changes in consumer spending patterns, consumer preferences and overall economic conditions could impact the availability of future operating cash flows.
A summary of the Company’s working capital position and capitalization follows (millions):
Working capital
Capitalization:
Shareholders’ equity
Total capitalization
Additional amounts available under credit agreements
The Company’s operations are seasonal in nature and consist of two principal selling seasons: spring (the first and second quarters) and fall (the third and fourth quarters). The fourth quarter, including the holiday period, typically accounts for approximately one-third of net sales for the year. Accordingly, cash requirements are highest in the third quarter as the Company’s inventory builds in anticipation of the holiday period, which generates a substantial portion of the Company’s operating cash flow for the year. The Company regularly evaluates its capital needs, financial condition and possible needs for and uses of its cash.
Net cash provided by operating activities was $154.4 million for the twenty-six weeks ended July 31, 2004 versus $86.5 million for the same period in 2003. The increase in cash provided by operating activities relates primarily to an increase in net income, as well as an increase in accounts payable due to timing of payments and inventory receipts, partially offset by higher inventory balances in 2004 primarily related to new product launches at Victoria’s Secret and Bath & Body Works.
Net cash used for investing activities of $82.5 million for the twenty-six weeks ended July 31, 2004 primarily included $238.1 million in capital expenditures, partially offset by cash inflows of $75.0 million from the collection of a long-term note receivable, $20.0 million from the sale of third party warrants and $65.3 million from the sale of investee’s stock. Net cash used for investing activities of $10.7 million for the twenty-six weeks ended August 2, 2003 primarily included $146.8 million in capital expenditures, partially offset by cash inflows of $130.7 million from the sale of approximately one-half of the Company’s investment in ADS.
Net cash used for financing activities of $1.1 billion for the twenty-six weeks ended July 31, 2004 primarily included (i) the repurchase of 50.6 million shares of common stock for $1.0 billion through the Company’s modified “Dutch Auction” tender offer in April 2004, (ii) cash payments of $51.3 million related to the repurchase of 2.7 million of the 3.0 million shares of common stock repurchased during the second quarter under the Company’s $100 million share repurchase program, and (iii) quarterly dividend payments of $0.12 per share or $119.1 million. These uses of cash were partially offset by proceeds from the issuance of stock options. Net cash used for financing activities of $98.2 million for the twenty-six weeks ended August 2, 2003 included the issuance of $350 million in long-term debt, which was more than offset by the redemption of $250 million in debentures, quarterly dividend payments of $0.10 per share or $104.5 million and the repurchase of 6.8 million shares of common stock for $98.5 million.
In August 2004, the Company completed the $100 million share repurchase program and announced that the Board of Directors of the Company had authorized the repurchase of an additional $250 million of the Company’s common stock.
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Capital Expenditures
Capital expenditures amounted to $238.1 million and $146.8 million for the twenty-six weeks ended July 31, 2004 and August 2, 2003, of which approximately $210 million and $115 million, respectively, were for new stores and for the remodeling of and improvements to existing stores. Remaining capital expenditures were primarily related to information technology.
The Company anticipates spending between $500 and $550 million for capital expenditures in 2004, the majority of which relates to the remodeling of and improvements to existing stores. The anticipated increase in capital spending in 2004 is primarily driven by remodeling activities related to key initiatives including (i) our mall remodel strategy focused on high performance stores in the top markets, (ii) the introduction of the Pink product line at Victoria’s Secret and (iii) the Express Design Studio, a new wear-to-work assortment at Express. The Company expects that 2004 capital expenditures will be funded principally by net cash provided by operating activities.
Contingent Liabilities and Contractual Obligations
The Company’s contingent liabilities include approximately $442 million of remaining lease and lease related guarantees related to the divestiture of several former subsidiaries, as well as a $25 million guarantee and a $31 million standby letter of credit related to the Company’s investment in Easton Town Center, LLC. These contingent liabilities are discussed further in Note 11 to the Consolidated Financial Statements.
The Company’s contractual obligations primarily consist of long-term debt, operating leases, purchase orders for merchandise inventory and other agreements to purchase goods and services that are legally binding and that require minimum quantities to be purchased. Except as noted below, there have been no significant changes in the Company’s contractual obligations since January 31, 2004, other than those which occur in the normal course of business (primarily changes in the Company’s merchandise inventory related purchase obligations, which fluctuate throughout the year as a result of the seasonal nature of the Company’s operations).
During 2004, the Company entered into two four-year telecommunication contracts related to national and international service which together require minimum spending of approximately $20 million per year through May 2008.
Impact of Inflation
The Company’s results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, the Company believes the effects of inflation, if any, on the results of operations and financial condition have been minor.
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Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements. On an on-going basis, management evaluates its estimates and judgments, including those related to inventories, long-lived assets and contingencies. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. Management has discussed the development and selection of the Company’s critical accounting policies and estimates with the Audit Committee of the Board of Directors and believes the following assumptions and estimates are most significant to reporting the Company’s results of operations and financial position.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The market risk of the Company’s financial instruments as of July 31, 2004 has not significantly changed since January 31, 2004. Information regarding the Company’s financial instruments and market risk as of January 31, 2004 is disclosed in the Company’s 2003 Annual Report on Form 10-K.
Item 4. CONTROLS AND PROCEDURES
Explanation of disclosure controls and procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report (the “Evaluation Date”), have concluded that as of the Evaluation Date, our disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities.
Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred in our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II—OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is a defendant in a variety of lawsuits arising in the ordinary course of business.
In May and June 1999, purported shareholders of the Company filed three derivative actions in the Court of Chancery of the State of Delaware, naming as defendants the members of the Company’s Board of Directors and the Company, as nominal defendant. The operative complaint generally alleged that the rescission of the Contingent Stock Redemption Agreement previously entered into by the Company with Leslie H. Wexner and The Wexner Children’s Trust (the “Contingent Stock Redemption Agreement”) constituted a waste of corporate assets and a breach of the board members’ fiduciary duties, and that the issuer tender offer completed on June 3, 1999 was a “wasteful transaction in its own right.” On February 16, 2000, plaintiffs filed a first amended consolidated derivative complaint (the “amended complaint”), which made allegations similar to the first complaint but added allegations apparently intended to show that certain directors were not disinterested in those decisions. Defendants moved to dismiss the amended complaint on April 14, 2000 and, on March 27, 2002, the Court granted the motion in part and denied the motion in part. On May 10, 2002, the Company’s Board of Directors appointed a special litigation committee composed of directors Donald B. Shackelford and Raymond Zimmerman and granted that committee the authority to investigate the claims asserted in the amended complaint and to determine the Company’s response to them. On October 31, 2002, the special litigation committee (“SLC”) filed a motion on behalf of the Company to dismiss the action on the basis that pursuit of the claims was not in the best interests of the Company. On February 25, 2004, the parties agreed to a settlement of the litigation. Under the terms of the settlement, Mr. Wexner, his immediate family members and affiliated entities agreed not to tender any shares in the issuer tender offer commenced by the Company on February 27, 2004 and not to sell any shares of Limited Brands common stock for a period commencing February 25, 2004 and ending six months after completion of the tender offer. In addition, Mr. Wexner agreed to contribute to the Company an amount equal to one half of plaintiffs’ counsel fees and expenses awarded by the Court, with Mr. Wexner to contribute more than one half to the extent necessary to limit the Company’s contribution to $3 million. Such contribution may be effected through the forfeiture of stock options, the payment of cash or other consideration. The Company, Mr. Wexner and the other defendants agreed not to object to aggregate plaintiffs’ counsel fees and expenses of up to $10 million. On August 10, 2004, the Court of Chancery entered a judgment approving the settlement and awarding to plaintiffs counsel fees and expenses of $7 million, over the objections of two alleged shareholders of the Company. This judgment is subject to appeal through September 9, 2004.
Although it is not possible to predict with certainty the eventual outcome of any litigation, in the opinion of management, the Company’s legal proceedings are not expected to have a material adverse effect on the Company’s financial position or results of operations.
Item 2. ISSUER PURCHASES OF EQUITY SECURITIES
The following table outlines the Company’s repurchases of its common stock during the second quarter ended July 31, 2004:
Period
Average PricePaid PerShare
(2)
Total Numberof SharesPurchased asPart of PubliclyAnnouncedPrograms
(3)
MaximumNumber of Shares(or approximateDollar value) thatMay Yet BePurchased
May
June
July
Total
On August 19, 2004, the Company announced that its Board of Directors authorized an additional $250 million share repurchase program.
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Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Stockholders on May 17, 2004. The matters voted upon and the results of the voting were as follows:
Name
Shares
Voted ForElection
Eugene M. Freedman
V. Ann Hailey
David T. Kollat
Leslie H. Wexner
In addition, directors whose term of office continued after the Annual Meeting were: E. Gordon Gee, James L. Heskett, Donna A. James, Leonard A. Schlesinger, Donald B. Shackelford, Allan R. Tessler, Abigail S. Wexner and Raymond Zimmerman.
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Item 6. EXHIBITS AND REPORTS ON FORM 8-K
15.
31.1
31.2
32.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ V. ANN HAILEY
Executive Vice President and
Chief Financial Officer*
Date: September 9, 2004
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