Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended May 3, 2003

OR

For the transition period from                              to                             

Commission file number 1-8344

LIMITED BRANDS, INC.

(Exact name of registrant as specified in its charter)

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.

Table of Contents

LIMITED BRANDS, INC.

TABLE OF CONTENTS

2

Table of Contents

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,” 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 2003 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 including the impact in Asia and elsewhere of the recent outbreak of severe acute respiratory syndrome; 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 detailed discussion of these and other factors. 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.

3

Table of Contents

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

LIMITED BRANDS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Thousands except per share amounts)

(Unaudited)

The accompanying Notes are an integral part of these Consolidated Financial Statements.

4

Table of Contents

LIMITED BRANDS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Thousands)

The accompanying Notes are an integral part of these Consolidated Financial Statements.

5

Table of Contents

LIMITED BRANDS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Thousands)

(Unaudited)

In 2002, non-cash investing and financing activities included the issuance of 88.9 million shares of Limited Brands common stock valued at $1.6 billion in exchange for all of the outstanding shares of Intimate Brands, Inc. Class A common stock.

The accompanying Notes are an integral part of these Consolidated Financial Statements.

6

Table of Contents

LIMITED BRANDS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation

Limited Brands, Inc. (the “Company” or “Limited Brands”) sells women’s and men’s apparel, women’s intimate apparel and personal care products 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 including Intimate Brands, Inc. (“IBI” or “Intimate Brands”), an 84% owned subsidiary through March 21, 2002 and wholly-owned thereafter. On March 21, 2002, the Company completed a tax-free tender offer and merger, which resulted in the acquisition of the IBI minority interest (“IBI recombination”). The operating results of Lerner New York (“Lerner”) are reflected as discontinued operations for all periods presented through November 27, 2002 when it was sold to a third party (see Note 4). 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 from which the Company purchases merchandise or merchandise components is included in cost of goods sold. The Company’s share of the net income or loss of all other unconsolidated entities is included in other loss which amounted to $1.8 million and $1.0 million for the thirteen weeks ended May 3, 2003 and May 4, 2002, respectively.

In the first quarter of 2003, Mast Industries, Inc., a subsidiary of the Company, sold its interest in certain joint ventures for $8.0 million in cash and $5.1 million in preferred notes (net of a $1.9 million fair value discount) resulting in a loss of $6.9 million which is included in other loss.

Certain prior year amounts have been reclassified to conform to the current year presentation.

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.

The consolidated financial statements as of and for the thirteen week period ended May 3, 2003 and May 4, 2002 are unaudited and are presented pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s 2002 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, but are not necessarily indicative of the results of operations for a full fiscal year.

The consolidated financial statements as of and for the thirteen week period ended May 3, 2003 included herein have been reviewed by the independent public accounting firm of Ernst & Young LLP and the report of such firm follows the Notes to Consolidated Financial Statements. Ernst & Young LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for its report on the consolidated financial statements because that report is not a report within the meaning of Sections 7 and 11 of that Act.

2. Stock-Based Compensation

The Company reports stock-based compensation through the disclosure-only requirements of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure-an

7

Table of Contents

Amendment to FASB No. 123,” but elects to measure compensation expense using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). 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.

SFAS No. 123 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:

The above stock compensation cost recorded by the Company in 2002 and 2003 primarily relates to compensation expense resulting from the exchange of both vested and unvested IBI stock awards in connection with the IBI recombination. Stock compensation expense related to the IBI recombination was recognized in accordance with Emerging Issues Task Force (“EITF”) 00-23, “Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44.”

The weighted average per share fair value of options granted by the Company ($3.53 during 2003 and $5.31 during 2002) was used to calculate the pro forma compensation expense under SFAS No. 123. The fair value was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions for 2003 and 2002: dividend yields of 3.3% and 2.8%; volatility of 42% and 42%; risk-free interest rates of 2.4% and 3.0%; and expected lives of 4.2 years and 4.4 years.

3. Shareholders’ Equity and Earnings Per Share

At May 3, 2003, one billion shares of $0.50 par value common stock were authorized, 523.6 million were issued and 521.4 million were outstanding. At February 1, 2003, 523.5 million shares were issued and outstanding and at May 4, 2002, 521.1 million shares were issued and 519.5 million shares were outstanding. Ten million shares of $1.00 par value preferred stock were authorized, none of which were issued.

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.

8

Table of Contents

Weighted average common shares outstanding (thousands):

The quarterly computation of earnings per diluted share excludes options to purchase 25.3 million and 6.1 million shares of common stock at May 3, 2003 and May 4, 2002 because the options’ exercise prices were greater than the average market price of the common shares during the period.

4. Discontinued Operations

In the fourth quarter of 2002, the Company sold one of its apparel businesses, Lerner New York, to an investor group led by the business unit’s President and Chief Executive Officer and affiliates of Bear Stearns Merchant Banking. Under the terms of the agreement, the Company received $79 million in cash, a $75 million subordinated note and warrants for approximately 15% of the common equity of the new company. A $26 million fair value discount was recorded on the subordinated note, which will be accreted to income over the term of the note. The subordinated note bears interest at 10% to be accrued and added to the principal balance of the note. The subordinated note and related accrued interest are due on November 26, 2009. During the first quarter of 2003, the Company received approximately $38 million in additional cash consideration based on Lerner’s net working capital at closing.

The transaction resulted in an after-tax loss of approximately $4 million in the fourth quarter of 2002, which reflects transaction costs and a $12 million lease guarantee liability. The Company’s financial statements reflect Lerner’s operating results (including the transaction loss) as a discontinued operation for all periods presented in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

The Company will continue to provide certain corporate services to Lerner under a service agreement.

5. Special Item

In connection with the IBI recombination, vested IBI stock options and restricted stock were exchanged for Limited Brands stock awards with substantially similar terms. In accordance with EITF No. 00-23, “Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44,” the exchange was accounted for as a modification of a stock-based compensation arrangement. As a result, the Company recorded a pretax, non-cash special charge of $33.8 million in the first quarter of 2002.

6. Gain on Investee’s Stock

During the first quarter of 2003, the Company recognized a pretax gain of $79.7 million resulting from the sale of approximately one-half of its ownership in Alliance Data Systems Corp. (“ADS”) in a secondary offering. ADS is a provider of electronic transaction services, credit services and loyalty and database marketing services. Prior to the sale, the Company’s ownership interest in ADS was approximately 20%. As of May 3, 2003, the Company owns approximately 7.7 million shares of ADS common stock, representing approximately a 10% ownership interest. The Company will continue to account for its investment in ADS using the equity method as the Company has the right to nominate two Company designees for election to

9

Table of Contents

ADS’s Board of Directors and the Company continues to be a significant shareholder and the largest client of ADS.

7. Goodwill and Other Intangible Assets

The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” in the first quarter of 2002. Under SFAS 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized, but must be tested for impairment annually (or in interim periods if events indicate possible impairment). Other intangible assets will continue to be amortized over their useful lives.

Intangible assets, not subject to amortization, represent trade names that were recorded in connection with the IBI recombination and were $411.0 million as of May 3, 2003, February 1, 2003 and May 4, 2002.

Intellectual property assets and other intangibles, subject to amortization, were as follows (in thousands):

The estimated annual amortization expense for intangibles each year through 2006 is approximately $8.0 million.

There were no changes in the carrying amount of goodwill for the thirteen weeks ended May 3, 2003.

8. 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.

9. Property and Equipment, Net

Property and equipment, net consisted of (thousands):

10. Income Taxes

The provision for income taxes is based on the current estimate of the annual effective tax rate and, for the thirteen weeks ended May 3, 2003 and May 4, 2002, also reflects the nondeductible expense related to the exchange of vested IBI incentive stock options. Income taxes paid during the thirteen weeks ended May 3, 2003 and May 4, 2002 approximated $155.3 million and $269.6 million. Income taxes payable included net current deferred tax liabilities of $56.4 million at May 3, 2003, $55.7 million at February 1, 2003 and $20.0 million at May 4, 2002.

The Company’s effective tax rate has historically reflected and continues to reflect a provision related to the undistributed earnings of foreign affiliates. The Internal Revenue Service (IRS) has assessed the Company

10

Table of Contents

for additional taxes and interest for the years 1992 to 1998 relating to the undistributed earnings of foreign affiliates. On September 7, 1999, the United States Tax Court sustained the position of the IRS with respect to the 1992 year. In connection with an appeal of the Tax Court judgment, in 1999 the Company made a $112 million payment of taxes and interest for the years 1992 to 1998 that reduced deferred tax liabilities.

On March 29, 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 will also apply to years 1993 and 1994. However, the amount of any payment the Company may receive related to the 1992 through 1994 years has not been finalized and the Company is pursuing additional actions to obtain any refunds related to the 1995 through 1998 years.

11. Long-Term Debt

Unsecured long-term debt consisted of (thousands):

On February 13, 2003, the Company issued $350 million of 6.95% debentures due March 1, 2033 under a 144A private placement. In connection with a registration statement filed with the Securities and Exchange Commission (“SEC”), the Company exchanged $349.5 million of the privately held securities for $349.5 million of securities registered with the SEC with identical terms through a non-taxable exchange offer. The $0.5 million of securities that were not exchanged remain outstanding as privately held securities.

On March 28, 2003, the Company redeemed its 7 ½% 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 for the thirteen weeks ended May 3, 2003.

The Company currently has a $1.25 billion unsecured revolving credit facility (the “Facility”). The Facility is comprised of a $500 million 364-day agreement and a $750 million 5-year agreement. Borrowings outstanding under the Facility, if any, are due June 27, 2003 and July 13, 2006, respectively. 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 are currently 0.1% (for the 364-day agreement) and 0.125% (for the 5-year agreement) 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 May 3, 2003.

The Facility supports 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

11

Table of Contents

commercial paper or draw on the Facility during the first quarter of 2003. In addition, no commercial paper or amounts under the Facility were outstanding at May 3, 2003.

Interest paid during the thirteen weeks ended May 3, 2003 and May 4, 2002 was $25.0 million and $11.0 million, respectively.

12. Guarantees

In connection with the disposition of certain subsidiaries, the Company has remaining guarantees of approximately $534 million related to lease payments of Abercrombie & Fitch, Limited Too, Galyan’s, Lane Bryant and Lerner under noncancelable leases expiring at various dates through 2014. 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. The Company does not intend and is not required to renew its guarantees at the expiration of these leases. The Company believes the likelihood of material liability being triggered under these guarantees is remote.

In conjunction with the sale of Lerner, the Company recognized a liability of $12 million representing the estimated fair value of the Company’s obligation as guarantor in accordance with the provisions of SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” effective for guarantees issued after May 15, 2002.

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, the Company has issued a $30 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.

13. 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.

12

Table of Contents

Segment information as of and for the thirteen weeks ended May 3, 2003 and May 4, 2002 follows (in thousands):

14. Recently Issued Accounting Pronouncements

In November 2002, the EITF reached a consensus on two issues in EITF Issue No. 02-16 (“EITF 02-16”), “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor”. The first issue addresses the income statement classification of cash consideration received from a vendor. The second issue addresses the measurement and timing of recognition of cash rebates or refunds that are payable only if the customer completes a specified cumulative level of purchases or remains a customer for a specified time period. The consensus on the first issue is effective for fiscal periods beginning after December 15, 2002 and may be applied either retroactively or through a cumulative effect adjustment. The consensus on the second issue is effective for arrangements entered into after November 21, 2002. The Company has adopted EITF 02-16, which did not have a material impact on its results of operations or its financial position.

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” This interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Instruments,” establishes standards for determining under what circumstances a variable interest entity should be consolidated with its primary beneficiary. FIN 46 applies immediately to variable interest entities created after January 31, 2003. For variable interest entities acquired before February 1, 2003, this interpretation is effective in the third quarter of 2003. The Company is currently evaluating the effect of adopting FIN 46 on its results of operations, financial position and cash flows.

13

Table of Contents

15. Subsequent Event

On May 22, 2003, the Company filed a shelf registration statement that became effective on June 6, 2003, under which up to $500 million of debt securities, common and preferred stock, and other securities may be issued.

14

Table of Contents

Independent Accountants’ Review Report

To the Board of Directors and Shareholders

of Limited Brands, Inc.:

We have reviewed the accompanying consolidated balance sheet of Limited Brands, Inc. and its subsidiaries (the “Company”) as of May 3, 2003, and the related consolidated statement of income and cash flows for the thirteen-week period then ended. These consolidated financial statements are the responsibility of the Company’s management. The consolidated balance sheet of the Company as of May 4, 2002, and the related consolidated statement of income and cash flows for the thirteen-week period then ended were reviewed by other accountants whose report dated May 20, 2002 stated that they were not aware of any material modifications that should be made to those statements for them to be in conformity with accounting principles generally accepted in the United States.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the consolidated financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements at May 3, 2003, and for the thirteen week period then ended for them to be in conformity with accounting principles generally accepted in the United States.

The consolidated balance sheet of Limited Brands, Inc. as of February 1, 2003, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended (not presented herein) were audited by other accountants, and in their report dated February 27, 2003, they expressed an unqualified opinion on those consolidated financial statements. Based on our review and reliance upon the report of other auditors, the accompanying consolidated balance sheet as of February 1, 2003, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Ernst & Young LLP

Columbus, Ohio

May 19, 2003

15

Table of Contents

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

Results of Operations

Net sales for the first quarter of 2003 increased 2% to $1.842 billion from $1.799 billion for the first quarter of 2002. Comparable store sales decreased 1% for the quarter. Operating income increased to $109.1 million from $94.3 million in 2002. Net income increased to $97.5 million from $49.9 million in 2002, and earnings per share increased to $0.19 from $0.10 in 2002.

There were a number of items that impact the comparability of the Company’s reported results. See “Note 1 to the Consolidated Financial Statements (Unaudited),” the “Special Item,” “Gain on Investee’s Stock” and “Adjusted Data” sections for a discussion of these items and the impact on 2003 and 2002 earnings.

Financial Summary

The following summarized financial and statistical data compares reported results for the thirteen week periods ended May 3, 2003 and May 4, 2002:

N/M—not meaningful

16

Table of Contents

17

Table of Contents

Number of Stores:

18

Table of Contents

Net Sales

Net sales for the first quarter of 2003 increased 2% to $1.842 billion from $1.799 billion for the first quarter of 2002. The increase in sales was driven by Victoria’s Secret and Mast, partially offset by declines at the apparel businesses.

At Victoria’s Secret, net sales for the first quarter of 2003 increased 4% to $791.3 million from $762.0 million in 2002. The net sales increase was primarily driven by the net increase in sales associated with new, closed and non-comparable remodeled stores of $20.0 million and an increase in comparable store sales of 1% or $5.6 million. Net sales at Victoria’s Secret Direct increased 2% or $3.7 million driven by panty and sleepwear sales.

At Bath & Body Works, net sales of $321.4 million for the first quarter of 2003 were flat compared to net sales of $320.3 million for the first quarter of 2002. The net increase in sales associated with new, closed and non-comparable remodeled stores of $6.7 million was substantially offset by the decline in comparable store sales of 2% or $5.6 million. The decrease in comparable store sales was primarily driven by a decline in the core bath products line, partially offset by growth in the True Blue Spa product line and the home fragrance and gift set categories.

At the apparel businesses, net sales for the first quarter of 2003 decreased 4% to $615.6 million from $638.0 million in 2002. The net sales decline was due to the comparable store sales decrease of 3% or $15.2 million and the net decrease in sales associated with closed, new and non-comparable remodeled stores of $7.2 million. Comparable store sales at Express decreased 2% or $7.8 million driven primarily by the women’s business, where declines in sweaters, woven pants and denim were only partially offset by growth in knit pants, tops and dresses. Comparable stores sales at Limited Stores decreased 5% or $7.4 million due to declines in sweaters, casual pants and accessories, which were partially offset by growth in tops, jackets and wear to work pants.

The net sales increase at Mast was primarily driven by sales to Lerner which became a third party customer upon its disposition in November 2002.

Gross Income

For the first quarter of 2003, the gross income rate (expressed as a percentage of net sales) decreased to 33.2% from 34.6% for the same period in 2002. The gross income rate decline was principally the result of a decline in merchandise margin, driven by declines at Bath & Body Works, Express and Mast. These declines were partially offset by an improvement at Victoria’s Secret.

The increase in the gross income rate at Victoria’s Secret was driven by Victoria’s Secret Direct, resulting from lower markdowns as compared to last year. The decrease in the merchandise margin rate at Bath & Body Works was driven by additional direct mail programs and higher percentage of lower margin giftset sales. The decrease in the merchandise margin rate at Express was driven by higher markdowns to sell through underperforming sweater and denim styles in the women’s category. The decrease in the gross income rate at Mast was due in part to a decrease in joint venture income resulting from the sale of certain joint ventures since last year.

General, Administrative and Store Operating Expenses

For the first quarter of 2003, the general, administrative and store operating expense rate (expressed as a percentage of net sales) of 27.3% was about flat compared to 27.4% last year. The slight rate improvement was driven by improved expense leverage on store selling costs and a decrease in home office incentive compensation reflecting a decline in operating results.

19

Table of Contents

Special Item

In connection with the IBI recombination in March of 2002, vested IBI stock options and restricted stock were exchanged for Limited Brands stock awards with substantially similar terms. In accordance with Emerging Issues Task Force Issue No. 00-23, “Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44,” the exchange was accounted for as a modification of a stock-based compensation arrangement. As a result, the Company recorded a pretax, non-cash special charge of $33.8 million in the first quarter of 2002.

Operating Income

The operating income rate in the first quarter of 2003 (expressed as a percentage of net sales) was 5.9% versus 5.2% in 2002. Excluding the special charge of $33.8 million described above, the operating income rate decreased to 5.9% from 7.1% in 2002. The decrease in the overall operating income rate was due to the decrease in the gross income rate partially offset by the slight decrease in the general, administrative and store operating expense rate.

Interest Expense

The Company incurred $27.0 million in interest expense for the first quarter of 2003 compared to $9.2 million for the same period in 2002. The increase in interest expense was primarily due to costs of $13 million associated with the retirement of the Company’s $250 million 7 ½% notes due in 2023, which included the payment of a call premium and the write-off of unamortized discounts and fees. An increase in average daily borrowings, partially offset by a decrease in average borrowing rates, also contributed to the increase.

Other Non-operating Items

For the first quarter of 2003, interest income was $9.2 million compared to $7.6 million in 2002. The increase was primarily driven by an increase in average invested cash balances, partially offset by a decrease in average effective interest rates.

For the first quarter of 2003, other loss was $8.5 million compared to $0.5 million for the first quarter of 2002. The increased loss in 2003 was driven by a $6.9 million loss on the sale of certain Mast joint ventures.

Gain on Investee’s Stock

During the first quarter of 2003, the Company recognized a pretax gain of $79.7 million resulting from the sale of approximately one-half of its ownership in Alliance Data Systems Corp. (“ADS”) in a secondary offering. ADS is a provider of electronic transaction services, credit services and loyalty and database marketing services. Prior to the sale, the Company’s ownership interest in ADS was approximately 20%. As of May 3, 2003, the Company owns approximately 7.7 million shares of ADS common stock, representing approximately a 10% ownership interest.

20

Table of Contents

Adjusted Data

The adjusted income information provides non-GAAP financial measures and gives effect to the significant transactions and events that impact the comparability of the Company’s results in 2003 and 2002. The following table adjusts net income for such transactions and events (as described in the following paragraph) to determine 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 gain on investee’s stock in 2003 resulted from a transaction that does not relate to the core performance of the Company’s business. The IBI recombination and sale of Lerner are transactions that occurred in prior periods and, therefore, affect the comparability of current period results and also do not relate to the core performance of the Company’s business.

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.

21

Table of Contents

Reconciliation of Adjusted Income Information (thousands except per share amounts):