Limited brands

Limited brands 2006 ANNUAL REPORT EFTA00190141 EFTA00190142 EFTA00190143 ..-• • • . ri . • _ • ' r • . - . . ... ............. . 1._ . .... ... " • -.a 1 , 4.- ."' ' " .4 - °dr ril L • •• rr r-.. . . -- ........ . - - alc;' - -; • -.7 - . - -.1..r. . . _ _ :" . .. • :, -a, ....• „ , „ -...a. - ..A.. .._ , . ... :,.. _ .: ' • e - • - . - - - ....; • . llw r - • . .r . -ar iir ill , An •II, . . • • * .• ••.- • a '''' • • a .• • . .r et ,•• • ..., .. ''. ....."- • • • to • . . .. • . • • • • • • • dllib. '4." 4 • " • _ , - ._. • . . . ... • re .. •• • 41/ • - • . . • • • .7 • ..'. - 4•'• ' •• P d; 1 . a .0 • • '. • 40 ' • . magi • • . • •- Nil a .0 . • I NIP a '1 41 . •• • d. - j • di g' t 4 .I g 0 a • . ' • 4 . • dr 0 ; . • a . -'. - s. I - . . - SIP •,g, aft • JD a • . • dIP .,gr 4 g EFTA00190144 TNER 2006 was a good year for Limited Brands. A very good year. Our financial results indicate real progress — sales increased by 10% and operating income increased by 19%. Clearly, this past year's performance reflects a combination of skills, including brand builders' and shopkeepers' skills, real tactical ability. and execution. We kept our eye on the near-term and the long-term, achieving day-to-day results while building a foundation for sustained growth. In our business, everything begins and ends with the customer. We have to keep giving them what they want. To do that, we must be exceptional shopkeepers and really know our customers. For 44 years we have grown and evolved. Yet, we remain shopkeepers. Regardless of scale, we run our brands with the insights of a single shopkeeper in a single store. Single-minded focus. Up close and personal. No substitute for it. I began as a shopkeeper. I am still a shopkeeper. I see the world that way. In one store. In four thousand. Doesn't matter. It's all about knowing the customer, not from data or research alone, but knowing her like a friend. Intimately. Traditional market information is important, but it only confirms what has already occurred. Significant, but not an insight to the future...not a substitute for knowing in real time. If specialty retail was about technology and systems, it would be easy. Whoever had the biggest, fastest computer would win. But it's not. Mediocre ideas, executed efficiently and quickly, are still mediocre ideas. EFTA00190145 4 No, the race will never be won by the technocrats. It will be won by great shopkeepers. As, indeed, it always has been. Walt Disney constantly walked his theme parks and would stop to talk to any child about their experience. Charles Revson would interrupt a board meeting to talk to a woman calling about her nail polish. Ray Kroc ate in McDonald's every chance he got. Great shopkeepers, keeping their priorities straight. Does anyone doubt Steve Jobs knows his customer? And what of Starbucks' Howard Schultz? He recently sent an open letter to top management saying they had to reestablish the small, intimate, critical details that make up the Starbucks' experience. He worried they were getting lost as the business continued to grow. He wanted them back. Howard didn't learn that in the office. He learned it in the shop. I said earlier that our business has evolved for over 40 years. We started with a single brand and an assortment "limited" to sportswear. Today, we are focused primarily on lingerie and beauty, and have distorted our time and resources to categories which are demonstrating significant market opportunity. Victoria's Secret is our largest brand. I'm pleased to report that the Victoria's Secret megabrand surpassed $5 billion in sales in 2006, with nearly $1 billion in operating income. We intend to grow this remarkably powerful brand to $10 billion in sales in five years. EFTA00190146 EFTA00190147 EFTA00190148 EFTA00190149 EFTA00190150 As sales have grown, it has become obvious that Victoria's Secret needs larger stores. We have tested larger store formats for several years and the format is achieving very attractive returns. We are, therefore, resizing the average Victoria's Secret store by about 50%. In 2007, we will increase square footage by 8-10% through 125 to 140 store projects. The groundwork for this real estate initiative is laid on a foundation of proven sales growth, category expansion, new segments, the amazing success of PINK, Beauty growth, and growth in Intimissimi. The Victoria's Secret Direct channel (internet and catalogue) had a phenomenal year in 2006, with sales growth of 16%, and a significant increase in operating income. We are supporting the continued growth of the Direct business by investing in expanded distribution center capabilities and upgraded internet and catalogue support technology. The Direct channel is a great medium for the brand and an important part of the 360° access we provide to our customers. Our acquisition of La Senza adds Canada's number one lingerie brand to our intimate apparel group and gives us a greater international presence. La Senza has achieved very impressive growth in Canada and 34 other countries through its franchise operated stores. We have great confidence in La Senza's management team and look forward to working with them. 9 EFTA00190151 10 Importantly, La Senza also provides us with real knowledge of the Canadian market and international experience as we begin to think about growth beyond the U.S. for our brands. Victoria's Secret Beauty and Bath & Body Works together represent the fifth largest personal care and beauty company in the United States. Remarkable progress. We are now focused on becoming the fourth largest, and then the third and, well, you get the idea. Bath & Body Works surpassed $2.S billion in sales in 2006, and has plenty of room to grow through the reinvigoration of base products and new product introductions. We can expand into underdeveloped categories of personal care like haircare and dermatological skincare, where we've had great initial success with Dr. Patricia Wexler skincare. We can grow through new stores — about SO in 2007, mostly in non-mall locations. And we can grow through new channels, internet and catalogue, giving us substantial upside as we leverage our skills across the enterprise. The apparel businesses, Express and The Limited, also made significant progress in 2006, turning a 2005 operating loss of about $100 million to income of over $2S million in 2006. We are clearly on the right track for continued progress, with a well-defined view of our customer and merchandise assortments that reflect her wants and needs. EFTA00190152 IMMINIall EFTA00190153 I EFTA00190154 EFTA00190155 EFTA00190156 This is a great time to be a member of the Limited Brands family: We are an enterprise of shopkeepers We are building our brands, and incubating new ones We have focused on attracting and retaining best-in-class talent And we have invested in the infrastructure and technology necessary to support our growth The fact that we are growing is the most positive indicator that we are focusing on the right things. The customer, in the end, is the judge of our talent, our brand strategies and our infrastructure investments. They vote with their dollars, and they vote every hour. Much has changed. We will continue to change, adapt and grow. What will remain constant is who we are; our values, culture and thinking — an enterprise of shopkeepers, doing our best to know our customers, and always giving them what they want. Best regards, Leslie H. Wexner Chairman and Chief Executive Officer 15 EFTA00190157 EFTA00190158 FINANCIAL RESULTS EFTA00190159 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K (Mark One) ▪ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended February 3. 2007 OR K TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to Commission file number 1.8344 LIMITED BRANDS, INC (Evict name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 31-1029810 (I.R.S. Emplo)er Identification No.) Three Limited Parkway, P.O. Box 16000, 43216 Columbus, Ohio Code, (Address of principal executive offices) Registrant's telephone number, including area code (614) 415.7000 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock, $.50 Par Value The New York Stock Exchange Securities registered pursuant to Section 12(g) of the Ad: None. Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes EI No O Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes O No E Indicate by check mark whether the registrant (I) 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 shorteiperiod that the registrant was required to file such reports). and (2) has been subject to such filing requirements for the past 90 days. Yes EI No O Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained. to the best of registrant's knowledge. in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 0 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and 1 e accelerated filef in Rule 12b-2 of the Exchange Act. Large accelerated tiler E Accelerated filer O Non-accelerated filer Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes O No The aggregate market value of the registrant's Common Stock held by non-affiliates of the registrant as of the last business day of the registrant's most recently completed second fiscal quarter was: 48.506.244.312. Number of shares outstanding of the registrant's Common Stock as of March 23.2007: 399.639.580. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the Registrant's 2007 Annual Meeting of Shareholders to be held on May 21, 2007, are incorporated by reference. EFTA00190160 Table of Contents Page No. Part I Item I. Business 1 Item IA. Risk Factors 4 Item IB. Unresolved Staff Comments 8 Item 2. Properties 9 Item 3. Legal Proceedings 10 Item 4. Submission of Matters to a Vote of Security Holders 10 Part II Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 11 Item 6. Selected Financial Data 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 15 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 32 Item 8. Financial Statements and Supplementary Data 34 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 63 Item 9A. Controls and Procedures 63 Item 9B. Other Information 63 Part III Item 10. Directors, Executive Officers and Corporate Governance 64 Item II. Executive Compensation 64 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 64 Item 13. Certain Relationships and Related Transactions, and Director Independence 64 Item 14. Principal Accounting Fees and Services 64 Part IV Item 15. Exhibits, Financial Statement Schedules 65 Signatures 69 EFTA00190161 PART I ITEM I. BUSINESS. FORWARD-LOOKING STATEMENTS. The Company cautions that any fonvard-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained in this report or 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 are beyond our control. Accordingly, the Company's future performance and financial results may differ materially from those expressed or implied in any such fonvard-looking statements. Words such as "estimate," "project." "plan," "believe," "expect." "anticipate," "intend," "planned," "potential" and similar expressions may identify forward-looking statements. A number of important factors could cause the results of the Company to differ materially from those indicated by such forward-looking statements, including those detailed under the heading, "Risk Factors" in Part I. Item IA. GENERAL. Limited Brands, Inc. (the "Company" or "we") operates in the highly competitive specialty retail business. Our stores arc located primarily in the in the United States but we also have international operations. The Company sells women's intimate apparel, personal care and beauty products, women's and men's apparel and accessories. The Company sells merchandise at its retail stores, which are primarily mall-based, and through e-commerce and catalogue direct response channels. DESCRIPTION OF OPERATIONS. As of February 3, 2007, the Company conducted its business in three primary segments: Victoria's Secret, Bath & Body Works and Apparel. VICTORIA'S SECRET The Victoria's Secret segment sells women's intimate and other apparel, personal care and beauty products and accessories marketed under the Victoria's Secret and La Senza brand names. Victoria's Secret merchandise is sold through retail stores and direct response channels (e-commerce and catalogue). Through its e-commerce site, MOV.VictoriasSecretcom, and catalogue, certain of Victoria's Secret's merchandise may be purchased worldwide. In January 2007, the Company completed its acquisition of La Senza Corporation ("La Senza") for $600 million. La Senza is a Canadian specialty retailer offering lingerie and sleepwear as well as apparel for girls in the 7-14 year age group. In addition, independently owned La Senza stores operate in 34 other countries. The acquisition of La Senza supports our objective of enhancing our capabilities to pursue our strategic growth goals internationally. The results of La Senza are included in the Victoria's Secret segment. For additional information see Note 16 to the Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data. The Victoria's Secret segment had net sales of $5.139 billion in 2006 and operated 1.003 stores in the United States and 323 stores in Canada. BATH & BODY WORKS The Bath & Body Works segment sells personal care, beauty and home fragrance products marketed under the Bath & Body Works, C.O. Bigelow and White Barn Candle Company brand names in addition to third-party EFTA00190162 brands. Bath & Body Works merchandise is sold at retail stores, through its e-commerce site, msw.bathandbodyworks.com, and catalogue. Bath & Body Works, which also operates C.O. Bigelow and the White Barn Candle Company stores, had net sales of $2.556 billion in 2006 and operated 1,546 stores nationwide. APPAREL BUSINESSES The Apparel segment sells women's and men's apparel through Express and Limited Stores. Express is a specialty retailer positioned as a young. sexy and sophisticated brand for both work and casual wear among fashion forward women and men. Express had net sales of $1.749 billion in 2006 and operated 658 stores nationwide. Limited Stores is a mall•based specialty store retailer. Limited Stores' strategy is to focus on sophisticated sportswear for modem American women. Limited Stores had net sales of $493 million in 2006 and operated 260 stores nationwide. OTHER Henri Bendel operates two specialty stores in New York, New York and Columbus, Ohio which feature fashion and personal care products for sophisticated women. The business had net sales of S42 million in 2006. The Company also operates six Diva London stores which sell accessories to a target market of women ages 18 to 34. Additional information about the Company's business, including its net sales and profits for the last three years and selling square footage. is set forth under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation. For the financial results of the Company's reportable operating segments. see Note 16 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. The following chart reflects the retail businesses and the number of company operated stores in operation for each business at February 3. 2007 and January 28, 2006. Victoria's Secret Number of Stores February 3. 2007 January 28. 2006 Victoria's Secret Stores 1,003 998 La Senza (a) 323 Total Victoria's Secret 1,326 998 Bath & Body Works 1,546 1,555 Apparel Businesses Express Women's 195 327 Express Men's 69 113 Express Dual Gender 394 303 Total Express 658 743 Limited Stores 260 292 Total Apparel businesses 918 1,035 Henri Bendel 2 2 Diva London 6 Total 3.798 3,590 2 EFTA00190163 (a) As of February 3, 2007. the Company also has global representation through 339 independently owned "La Senza" and "La Senza Girl" stores operating in 34 countries under 12 license agreements. The following table shows the changes in the number of retail stores operated by the Company for the past five fiscal years: Fiscal Year Beginning of Year Opened Closed Acquired/ Disposed Businesses End of Year 2002 4,614 108 (174) (512)(a) 4,036 2003 4,036 24 (149) — 3,911 2004 3,911 39 (171) — 3,779 2005 3,779 50 (239) 3,590 2006 3,590 52 (169) 325(b) 3,798 (a) Represents New York & Company (formerly Lemer New York) stores at November 27, 2002. the date of sale to a third-party. (b) Represents the stores acquired in the La Senza acquisition on January 12, 2007. The Company also owns Mast Industries, Inc. ("Mast"), an apparel importer which is a significant supplier of merchandise for Victoria's Secret, Express and Limited Stores. The Company also owns Beauty Avenues ("Beauty Avenues"), a personal care sourcing company serving both Victoria's Secret and Bath & Body Works. Mast and Beauty Avenues also have $650 million of sales to third-parties in 2006 and their operating results are included in Other in our segment reporting. For additional information, see Note 16 to the Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data. During fiscal year 2006, the Company purchased merchandise from over 1,000 suppliers located throughout the world. In addition to purchases through Mast and Beauty Avenues, the Company purchases merchandise directly in foreign and domestic markets. Excluding Mast and Beauty Avenues, no supplier provided 10% or more of the Company's merchandise purchases. Most of the merchandise and related materials for the Company's stores are shipped to the Company's distribution centers in the Columbus, Ohio area. In connection with the distribution of merchandise, the Company uses a variety of shipping terms that result in the transfer of title to the merchandise at either the point of origin or point of destination. The Company's policy is to maintain sufficient quantities of inventory on hand in its retail stores and distribution centers so that it can offer customers an appropriate selection of current merchandise. The Company emphasizes rapid turnover and takes markdowns as required to keep merchandise fresh and current with fashion trends. 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 season, accounted for approximately one-third of net sales in 2006, 2005 and 2004. Accordingly, cash requirements are highest in the third quarter as the Company's inventory builds in advance of the holiday season. The Company and its products are subject to regulation by various Federal, state, local and international regulatory authorities. The Company is subject to a variety of customs regulations and international trade arrangements. The Company's trademarks and patents, which constitute its primary intellectual property, have been registered or are the subject of pending applications in the United States Patent and Trademark Office and with the registries of many foreign countries and/or are protected by common law. The Company believes that its 3 EFTA00190164 products and services are identified by its intellectual property and, thus, its intellectual property is of significant value. Accordingly, we intend to maintain our intellectual property and related registrations and vigorously protect our intellectual property assets against infringement. COMPETITION. The sale of intimate apparel, personal care and beauty products, women's and men's apparel and accessories through retail stores is a highly competitive business with numerous competitors, including individual and chain fashion specialty stores, department stores and discount retailers. Brand image. marketing, fashion design, price, service, fashion assortment and quality are the principal competitive factors in retail store sales. The Company's direct response businesses compete with numerous national and regional e-commerce and catalogue merchandisers. Image presentation, fulfillment and the factors affecting retail store sales discussed above are the principal competitive factors in e-commerce and catalogue sales. The Company is unable to estimate the number of competitors or its relative competitive position due to the large number of companies selling intimate apparel, personal care and beauty products. women's and men's apparel and accessories through retail stores, catalogues and e-commerce. ASSOCIATE RELATIONS. On February 3, 2007, the Company employed approximately 125,500 associates, 105.100 of whom were part- time. In addition, temporary associates are hired during peak periods, such as the holiday season. AVAILABLE INFORMATION. The Company's annual reports on Form 10-K. quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and code of conduct are available, free of charge, on the Company's website, www.LimitedBrands.com. These reports are available as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. ITEM IA. RISK FACTORS. The following discussion of risk factors contains "forward-looking statements," as discussed in Item 1. These risk factors may be important to understanding any statement in this Form 10-K, other filings or in any other discussions of the Company's business. The following information should be read in conjunction with Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation and the consolidated financial statements and related notes included in this report. In addition to the other information set forth in this report, the reader should carefully consider the following factors which could materially affect the Company's business, financial condition or future results. The risks described below are not the only risks facing the Company. Additional risks and uncertainties not currently known or that are currently deemed to be immaterial may also adversely affect the business, financial condition and/or operating results of the Company in a material way. The Company's revenue and profit results are sensitive to, and may be adversely affected by, general economic conditions, consumer confidence and spending patterns. The Company's growth, sales and profitability may be adversely affected by negative local, regional, national or international political or economic trends or developments that reduce the consumers' ability or willingness to spend, including the effects of national and international security concerns such as war, terrorism or the threat thereof. Purchases of women's and men's apparel, women's intimate apparel, personal care and beauty products and accessories often decline during periods when economic or market conditions are unsettled or weak. In such circumstances, the Company may increase the number of promotional sales, which would further adversely affect its profitability. 4 EFTA00190165 The Company's net sales, operating income and inventory levels fluctuate on a seasonal basis. The Company experiences major seasonal fluctuations in its net sales and operating income, with a significant portion of its operating income typically realized during the fourth quarter holiday season. Any decrease in sales or margins during this period could have a disproportionate effect on the Company's financial condition and results of operations. Seasonal fluctuations also affect the Company's inventory levels, since it usually orders merchandise in advance of peak selling periods and sometimes before new fashion trends am confirmed by customer purchases. The Company must carry a significant amount of inventory, especially before the holiday season selling period. If the Company is not successful in selling inventory, it may have to sell the inventory at significantly reduced prices or it may not be able to sell the inventory at all, which in each case may further adversely affect profitability. The Company may be unable to compete favorably in its highly competitive segment of the retail industry. The sale of intimate and other apparel. personal care products and accessories is highly competitive. The Company competes for sales with a broad range of other retailers, including individual and chain fashion specialty stores, department stores and discount retailers. In addition to the traditional store-based retailers, the Company also competes with direct marketers that sell similar lines of merchandise and who target customers through e-commerce and catalogue. Direct marketers also include traditional store-based retailers like the Company who am competing in the e-commerce and catalogue distribution channels. The Company's direct response businesses compete with numerous national and regional e-commerce and catalogue merchandisers. Brand image. marketing, fashion design, price, service, quality, image presentation and fulfillment are all competitive factors in both the store-based and direct response channels. Some of the Company's competitors may have greater financial, marketing and other resources available to them. In many cases, the Company's competitors sell their products in department stores that are located in the same shopping malls as the Company's stores. In addition to competing for sales, the Company competes for favorable site locations and lease terms in shopping malls. Increased competition could result in price reductions, increased marketing expenditures and loss of market share, any of which could have a material adverse effect on the Company's financial condition and results of operations. The Company may not be able to keep up with fashion trends and may not be able to launch new product lines successfully. The Company's success depends in part on management's ability to effectively anticipate and respond to changing fashion tastes and consumer demands and to translate market trends into appropriate. saleable product offerings far in advance of the actual time of sale to the customer. Customer tastes and fashion trends change rapidly. If the Company is unable to successfully anticipate, identify or react to changing styles or trends and misjudges the market for its products or any new product lines, the Company's sales will be lower potentially resulting in significant amounts of unsold finished goods inventory. In response. the Company may be forced to increase its marketing promotions or price markdowns, which could have a material adverse effect on its business. The Company's brand image may also suffer if customers believe merchandise misjudgments indicate that the Company is no longer able to identify and offer the latest fashions. The Company may lose key personnel. The Company believes that it has benefited substantially from the leadership and experience of its senior executives, including Leslie H. Wexner (its Chairman of the Board of Directors and Chief Executive Officer). The loss of the services of any of these individuals could have a material adverse effect on the business and prospects of the Company. Competition for key personnel in the retail industry is intense and the Company's future success will also depend on its ability to recruit, train and retain other qualified personnel. 5 EFTA00190166 The Company's manufacturers may be unable to manufacture and deliver products in a timely manner or meet quality standards. The Company purchases products through contract manufacturers and importers and directly from third-party manufacturers. Similar to most other specialty retailers, the Company has narrow sales window periods for much of its inventory. Factors outside the Company's control, such as manufacturing or shipping delays or quality problems, could disrupt merchandise deliveries and result in lost sales, cancellation charges or excessive markdowns which could have a material adverse effect on the Company's financial condition and results of operations. The Company relies significantly on foreign sources of production and maintains operations in foreign countries. The Company purchases apparel merchandise directly in foreign markets and in the domestic market, some of which is manufactured overseas. The Company does not have any material long-term merchandise supply contracts and many of its imports are subject to a variety of customs regulations and international trade arrangements, including existing or potential duties, tariffs or quotas. The Company competes with other companies for production facilities and import quota capacity. The Company also faces a variety of other risks generally associated with doing business in foreign markets and importing merchandise from abroad, such as: • political instability; • imposition of new legislation or rules relating to imports that may limit the quantity of goods which may be imported into the United States from countries in a particular region; • imposition of duties, taxes and other charges on imports; • currency and exchange risks; • local business practice and political issues, including issues relating to compliance with domestic or international labor standards which may result in adverse publicity; • potential delays or disruptions in shipping and related pricing impacts; and • disruption of imports by labor disputes. New initiatives may be proposed that may have an impact on the trading status of certain countries and may include retaliatory duties or other trade sanctions which, if enacted, would limit or reduce the products purchased from suppliers in such countries. In addition, significant health hazards or environmental or natural disasters may occur which could have a negative effect on the economies, financial markets and business activity. The Company's purchases of merchandise from these manufacturing operations may be affected by this risk. The future performance of the Company will depend upon these and the other factors listed above which are beyond its control. These factors may have a material adverse effect on the business of the Company. The Company depends on a high volume of mall traffic and the availability of suitable lease space. Many of the Company's stores are located in shopping malls. Sales at these stores are derived, in part, from the high volume of traffic in those malls. The Company's stores benefit from the ability of the mall's "anchor" tenants, generally large department stores, and other area attractions to generate consumer traffic in the vicinity of its stores and the continuing popularity of malls as shopping destinations. Sales volume and mall traffic may be adversely affected by economic downturns in a particular area, competition from non-mall retailers and other 6 EFTA00190167 malls where the Company does not have stores and the closing of anchor department stores. In addition, a decline in the desirability of the shopping environment in a particular mall, or a decline in the popularity of mall shopping among the Company's target consumers, would adversely affect its business. Part of the Company's future growth is significantly dependent on its ability to operate stores in desirable locations with capital investment and lease costs that allow the Company to earn a reasonable return. The Company cannot be sure as to when or whether such desirable locations will become available at reasonable costs. The Company may face labor shortages or increased labor costs which could adversely affect its growth and operating results. Labor is a significant component in the cost of operating the Company's stores. If the Company faces labor shortages or increased labor costs because of increased competition for employees, higher employee turnover rates, increases in the federal minimum wage or increases in other employee benefits costs, its operating expenses could increase and its growth could be adversely affected. The Company's success depends in part upon its ability to attract, motivate and retain a sufficient number of qualified employees. Increases in costs of mailing, paper and printing may affect the Company's business. Postal rate increases and paper and printing costs will affect the cost of the Company's order fulfillment and catalogue and promotional mailings. The Company relies on discounts from the basic postal rate structure, such as discounts for bulk mailings and sorting. Future paper and postal rate increases could adversely impact the Company's earnings if it was unable to pass such increases directly onto its customers or by implementing more efficient printing, mailing, delivery and order fulfillment systems. The Company's stock price may be volatile. The Company's stock price may fluctuate substantially as a result of quarter to quarter variations in the actual or anticipated financial results of the Company or other companies in the retail industry or markets served by the Company. In addition, the stock market has experienced price and volume fluctuations that have affected the market price of many retail and other stocks and that have often been unrelated or disproportionate to the operating performance of these companies. The Company may be unable to service its debt. The Company may be unable to service the debt drawn under its credit facilities and/or any other debt it incurs. Additionally, the agreements related to such debt require the Company to maintain certain financial ratios which limit the total amount the Company may borrow, and also prohibit certain types of liens on property or assets. The Company is implementing certain changes to its IT systems that may disrupt operations. The Company is currently implementing modifications and upgrades to the information technology systems for merchandise, distribution, e-commerce and support systems, including finance. Modifications involve replacing legacy systems with successor systems, making changes to legacy systems or acquiring new systems with new functionality. The Company is aware of inherent risks associated with replacing these systems, including accurately capturing data and system disruptions. The launch of these successor systems will take place in a phased approach over an approximate five year period that began in 2005. Information technology system disruptions, if not anticipated and appropriately mitigated, could have a material adverse effect on the Company's operations. 7 EFTA00190168 The Company relies significantly on its information technology systems. The Company's success depends, in part, on the secure and uninterrupted performance of its information technology systems. The Company's computer systems as well as those of its service providers are vulnerable to damage from a variety of sources, including telecommunication failures, malicious human acts and natural disasters. Moreover, despite network security measures, some of the Company's servers and those of its service providers are potentially vulnerable to physical or electronic break-ins, computer viruses and similar disruptive problems. Despite the precautions the Company has taken, unanticipated problems may nevertheless cause failures in the Company's information technology systems. Sustained or repeated system failures that interrupt the Company's ability to process orders and deliver products to the stores in a timely manner could have a material adverse effect on the Company's operations, controls and reporting. The Company's results can be adversely affected by market disruptions. Market disruptions due to severe weather conditions, natural disasters, health hazards, terrorist activities or the prospect of these events can affect consumer spending and confidence levels and adversely affect the Company's results or prospects in affected markets. The receipt of proceeds under any insurance the Company maintains for these purposes may be delayed or the proceeds may be insufficient to fully offset its losses. The Company's results may be adversely affected by fluctuations in the price of oil. Prices of oil have fluctuated dramatically in the past. These fluctuations may result in an increase in the Company's transportation costs for distribution, utility costs for its retail stores and costs to purchase product from its manufacturers. A continual rise in oil prices could adversely affect consumer spending and demand for the Company's products and increase its operating costs, both of which could have a material adverse effect on the Company's financial condition and results of operations. The Company's licensees could take actions that could harm our business or brands. The Company has global representation through independently owned La Senza stores operating under license agreements. Although we have criteria to evaluate and screen prospective licensees, we are limited in the amount of control we can exercise over our licensees and the quality of licensed operations may be diminished by any number of factors beyond our control. Licensees may not have the business acumen or financial resources necessary to successfully operate stores in a manner consistent with our standards and may not hire and train qualified store managers and other personnel. Our brand image and reputation may suffer materially and our sales could decline if our licensees do not operate successfully. ITEM 1B. UNRESOLVED STAFF COMMENTS. Not applicable. 8 EFTA00190169 ITEM 2. PROPERTIES. The following table sets forth the location. use and size of the Company's distribution, corporate and product development facilities as of February 3, 2007: Location Columbus, Ohio New York, New York Kettering, Ohio Rio Rancho, New Mexico Paramus. New Jersey Hong Kong Montreal. Quebec, Canada Various foreign locations Use Corporate. distribution and shipping Office, sourcing and product development Call center Call center Research and development and office Office and sourcing Office, distribution and shipping Office and sourcing Approximate Square Footage 6,118,000 778,000 93,000 75,000 38,000 68,000 276,000 102,000 United States The Company's business is principally conducted from office, distribution and shipping facilities located in the Columbus, Ohio area. Additional facilities are located in New York, New York; Kettering. Ohio; Rio Rancho, New Mexico; and Paramus, New Jersey. The distribution and shipping facilities owned by the Company consist of seven buildings located in the Columbus, Ohio area. These buildings, including attached office space. comprise approximately 6.1 million square feet. As of February 3, 2007, the Company operates 3,475 retail stores in the United States, located in leased facilities, primarily in malls and shopping centers. A substantial portion of these lease commitments consist of store leases generally with an initial term of ten years. The leases expire at various dates between 2007 and 2022. Typically, when space is leased for a retail store in a shopping center, all improvements, including interior walls, floors, ceilings, fixtures and decorations. are supplied by the Company. The cost of improvements varies widely, depending on the design, size and location of the store. In certain caws, the landlord of the property may provide a construction allowance to fund all or a portion of the cost of improvements serving as a lease incentive. Rental terms for new locations usually include a fixed minimum rent plus a percentage of sales in excess of a specified amount. Certain operating costs such as common area maintenance, utilities, insurance and taxes are typically paid by the Company. For additional information, see Note 8 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. International Canada The Company's international business is principally conducted from owned and leased office, distribution and shipping facilities located in the Montreal, Quebec area. Additional leased office facilities are located in Toronto, Ontario. The distribution and shipping facilities owned by the Company consist of two buildings located in the Montreal area. These buildings, including attached office space, comprise approximately 276,000 square feet. Additionally, the Company leases additional office facilities in the Montreal area comprised of approximately 100,000 square feet. As of February 3, 2007, the Company operates 323 retail stores located in leased facilities, primarily in malls and shopping centers throughout the Canadian provinces. A substantial portion of these lease commitments consist of store leases generally with an initial term of ten years. The leases expire at various dates between 2007 and 2020. 9 EFTA00190170 Other International As of February 3, 2007, the Company also has global representation through 339 independently owned "La Senza" and "La Senza Girl" stores operating in 34 countries under 12 license agreements. The Company also operates small sourcing-related office facilities in various foreign locations. ITEM 3. LEGAL PROCEEDINGS. The Company is a defendant in a variety of lawsuits arising in the ordinary course of business. Plaintiffs may seek to recover large and sometimes unspecified amounts or other types of relief and some matters may remain unresolved for several years. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT. Set forth below is certain information regarding the executive officers of the Company. Leslie H. Wexner, 69, has been Chairman of the Board of Directors of the Company for more than thirty years and its Chief Executive Officer since he founded the Company in 1963. Leonard A. Schlesinger. 54, has been a member of the Board of Directors of the Company since 1996 and became Vice Chairman and Chief Operating Officer of the Company in February 2003. Mr. Schlesinger was Executive Vice President and Chief Operating Officer from March 2001 until February 2003 and Executive Vice President, Organization. Leadership and Human Resources from October 1999 until March 2001. Martyn R. Redgrave, 54, has been Executive Vice President and Chief Administrative Officer of the Company since March 2005. In addition, Mr. Redgrave has been Chief Financial Officer of the Company since September 2, 2006. Sharen J. Turney, 50, has been the Chief Executive Officer and President of Victoria's Secret Megabrand and Intimate Apparel since July 16, 2006. Ms. Turney was previously Chief Executive Officer of Victoria's Secret Direct from May 2000 to July 2006. Jay M. Margolis, 58. has been Group President of Apparel for the Company since January 2005. Mark A. Giresi, 49, has been Executive Vice President, Retail Operations. since May 2005. Mr. Giresi was Senior Vice President and Chief Stores Officer from December 2001 until May 2005 and Vice President, Store Operations from February 2000 until December 2001. Jane L. Ramsey, 49, has been Executive Vice President, Human Resources, of the Company since April 30, 2006. Ms. Ramsey was previously Vice President, Human Resources Intimate Brands Corporation from July 1999 to April 2003 and Senior Vice President, Chief Talent Officer from April 2003 to May 2004. In addition, Ms. Ramsey was Senior Vice President, Enterprise Integration from May 2004 to April 2006. All of the above officers serve at the discretion of the Board of Directors of the Company and are members of the Limited Brands Executive Committee. 10 EFTA00190171 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. The Company's common stock ("LTD") is traded on the New York Stock Exchange. On February 3, 2007, there were approximately 70,000 shareholders of record. However, including active associates who participate in the Company's stock purchase plan, associates who own shares through Company-sponsored retirement plans and others holding shares in broker accounts under street names, the Company estimates the shareholder base to be approximately 205,000. The Company's quarterly market prices and cash dividends per share for 2006 and 2005 were as follows: Fiscal Year 2006 Market Price Cash Dividend Per Share Low Fourth quarter $32.60 $26.16 $0.15 Third quarter 29.74 24.21 0.15 Second quarter 28.48 23.54 0.15 First quarter 25.95 22.80 0.15 Fiscal Year 2005 Fourth quarter $23.85 $19.50 $0.15 Third quarter 25.50 18.81 0.15 Second quarter 24.76 19.30 0.15 First quarter 25.26 21.51 0.15 11 EFTA00190172 The following graph shows the changes, over the past five-year period, in the value of $100 invested in Common Stock, the Standard & Poor's 500 Composite Stock Price Index and the Standard & Poor's 500 Retail Composite Index. The plotted points represent the closing price on the last day of the fiscal year indicated. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* AMONG LIMITED BRANDS, INC., THE S&P 500 INDEX AND THE S&P RETAIL COMPOSITE INDEX •51130 INVESTED IN STOCK OR IN INDEX AT THE CLOSING PRICE ON 212102 - INCLUDING REINVESTMENT OF DIVIDENDS. Comparison of Cumulative Five Year Total Return 200 D 0 L L 100 A R 50 1 50 .... .. • - - ''''' 0 2/02/02 2/01/03 1/31/04 1/29/05 1/28/06 2/03/07 —•—Limited Brands, Inc.- - • - - S&P 500 Index -A- - S&P 500 Retailing The following table outlines the Company's repurchases of its common stock during the fourth quarter ended February 3, 2007 (thousands, except per share amounts): Period Total Number or Average Price Shares Paid Per Purchased(I) Share(2) Total Number of Shares Purchased as Part of Publicly Announced Programs(3) Maximum Number or Shares (or approximate Dollar value) that May tel Be Purchased(3) November 104 $29.81 97 $63.540 December 22 29A8 - 63.540 January 158 27.58 147 59.498 Total 284 $28.54 244 459.498 ( I ) The total number of shares repurchased primarily includes shares repurchased as pan of publicly announced programs, with the remainder relating to shares repurchased in connection with (i) tax payments due upon vesting of employee restricted stock awards, and (ii) the use of the Company's stock to pay the exercise price on employee stock options. (2) The average price paid per share includes any broker commissions. (3) In February 2006. the Company's Board of Directors authorized the repurchase of an additional $100 million of the Company's common stock. During August 2006. the Company completed this program having repurchased 4.0 million shares of its common stock at an average price per share of approximately $25.09. In June 2006. the Company's Board of Directors authorized the repurchase of an additional 4100 million of the Company's common stock. Through February 3. 2007. 1.5 million additional shares have been repurchased under this program at an average price of $27.11. 12 EFTA00190173 ITEM 6. SELECTED FINANCIAL DATA. (Millions except per share amounts, ratios. store and associate data) 2006(0)(6) 2005(c) 2004 2003 2002(d) Summary of Operations Net sales $ 10,671 $ 9,699 $ 9,408 $ 8,934 $ 8,445 Gross profit $ 4,013 $ 3,480 $ 3,394 $ 3,255 $ 3,094 Gross profit as a percentage of net sales 37.6% 35.9% 36.1% 36.4% 36.6% Operating income (e) $ 1,176 $ 986 $ 1,027 $ 963 $ 838 Operating income as a percentage of net sales 11.0% 10.2% 10.9% 10.8% 9.9% Income before cumulative effect of changes in accounting principle (f) $ 675 $ 666 $ 705 $ 717 $ 496 Income before cumulative effect of changes in accounting principle as a percentage of net sales 6.3% 6.9% 7.5% 8.0% 5.9% Cumulative effect of changes in accounting principle (b)(c) 1 $ 17 Net income (f) $ 676 $ 683 $ 705 $ 717 $ 496 Per Share Results Net income per basic share: Income before cumulative effect of changes in accounting principle $ 1.71 $ 1.66 $ 1.50 $ 1.38 $ 0.97 Net income per basic share $ 131 $ 1.70 $ 1.50 $ 1.38 $ 0.97 Net income per diluted share: Income before cumulative effect of changes in accounting principle $ 1.68 $ 1.62 $ 1.47 $ 1.36 $ 0.95 Net income per diluted share $ 1.68 $ 1.66 $ 1.47 $ 1.36 $ 0.95 Dividends per share (g) $ 0.60 $ 0.60 $ 1.71 $ 0.40 $ 0.30 Weighted average diluted shares outstanding 403 411 479 526 522 Other Financial Information Total assets $ 7,093 $ 6,346 $ 6,089 $ 7,880 $ 7,246 Return on average assets 10% 11% 10% 9% 8% Working capital $ 1,062 $ 1,209 $ 1,233 $ 3,045 $ 2,347 Current ratio 1.6 1.8 1.9 3.2 2.9 Capital expenditures $ 548 $ 480 $ 431 $ 293 $ 306 Long-term debt $ 1,665 $ 1,669 $ 1,646 $ 648 $ 547 Other long-term liabilities $ 520 $ 452 $ 447 $ 444 $ 455 Debt-to-equity ratio 56% 68% 70% 12% 11% Shareholders' equity $ 2,955 $ 2,471 $ 2,335 $ 5,266 $ 4,860 Return on average shareholders' equity 25% 28% 19% 14% 13% Comparable store sales increase (decrease) (h)(i) 7% (1%) 4% 4% 3% Stores and Associates at End of Year Number of stores (i) 3,798 3,590 3,779 3,911 4,036 Selling square feet (Thousands) (i) 15,719 15,332 15,801 16,038 16,297 Number of associates 125,500 110,000 115,300 111,100 98,900 (a) Fifty-three week fiscal year. (b) On January 29, 2006. the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)"), which requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors based on estimated fair values on the giant date. See additional discussion in Note 13 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplemental), Data. 13 EFTA00190174 The cumulative effect of adopting SFAS No. 123(R) was $0.7 million, net of tax of $0.4 million, and was recognized as an increase to net income in the Consolidated Statement of Income as of the beginning of the first quarter of 2006. (c) During the fourth quarter of 2005, the Company changed its inventory valuation method. Previously, inventories were principally valued at the lower of cost or market, on a weighted-average cost basis, using the retail method. Commencing in 2005, inventories are principally valued at the lower of cost or market, on a weighted-average cost basis, using the cost method. See additional discussion in Note 2 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. The cumulative effect of this change was $17 million, net of tax of $11 million. This change was recognized as an increase to net income in the Consolidated Statement of Income as of the beginning of the first quarter of 2005. In addition to the $17 million cumulative impact recognized as of the beginning of the first quarter. the effect of the change during 2005 was to decrease net income by $4 million, or $0.01 per diluted sham. (d) As a result of its sale on November 27, 2002, New York & Company's (formerly Lerner New York) operating results have been reflected as discontinued operations. Accordingly. New York & Company's results are excluded for 2002. In 2002, New York & Company's reported net income was $6 million, or $0.01 per diluted share. (e) Operating income includes the effect of the following items: (i) In 2006, $26 million in incremental share-based compensation expense related to the adoption of SFAS 123(R). See additional discussion in Note 13 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data; (ii) In 2005, $30 million related to initial recognition of income related to unredeemed gift cards. See additional discussion in Note I to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data; (iii) In 2004, a $61 million charge to correct the Company's accounting for straight-line rent and the depreciation and amortization of leasehold improvements and certain landlord allowances. See additional discussion in Note I to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data; (iv) In 2002, a $34 million charge for vested stock awards related to the Intimate Brands Inc. ("IBI") recombination. (1) (g) In addition to the items previously discussed in (e), net income includes the effect of the following items: (i) In 2005, a favorable one-time tax benefit of $77 million related to the repatriation of foreign earnings under the provisions of the American Jobs Creation Act and pretax interest income of $40 million related to an Internal Revenue Serivice tax settlement. See additional discussion in Note 10 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data; (ii) In 2004, pretax non-operating gains of $90 million related to New York & Company and $18 million related to Galyan's Trading Company, Inc. ("Galyan's"). See additional discussion in Notes I and 4 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data; (iii) In 2003, pretax non-operating gains of $208 million related to Alliance Data Systems Corporation ("ADS"); (iv) In 2002, pretax non-operating gains of $6 million related to Charming Shoppes, Inc. In 2004, dividends per share include a special dividend of $1.23 per share. See additional discussion in Note 12 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. (h) A store is typically included in the calculation of comparable store sales when it has been open 12 months or morc and it has not had a change in selling square footage of 20% or more. Additionally, stores of a given brand are excluded if total selling square footage for the brand in the mall changes by 20% or more through the opening or closing of a second store. (i) Company operated stores (excludes independently owned La Senza stores). 14 EFTA00190175 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. The following discussion and analysis of financial condition and results of operations is based upon the Company's Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. This should be read in conjunction with these statements and the notes thereto which are included in Item 8. Financial Statements and Supplementary Data. Executive Overview Limited Brands, Inc. (the "Company" or "we") operates in the highly competitive specialty retail business. The Company sells women's intimate apparel, personal care and beauty products, women's and men's apparel and accessories. The Company sells merchandise at its retail stores, which are primarily mall-based, and through direct response channels (e-commerce and catalogue). Strategy The Company's strategy centers on its mission to build a family of the world's best fashion retail brands whose well-told stories create loyal customers and deliver sustained growth for our stakeholders. The strategy will be executed using differentiated capabilities including merchant vision, retail experiences, portfolio management, open innovation, talent management and enterprise infrastructure that allows the Company to deliver quality products to the customer cost-effectively and efficiently. The Company is focused on offering emotionally engaging shopping experiences driven by a differentiated and relevant assortment of product brands. Our brands represent a multi-dimensional portfolio competing across multiple categories, channels, customer segments and geographies. To execute the strategy. the Company is focused on six key strategic imperatives: 1) Growth of core retail brands in current channels and geographies, focusing on growth through comparable store sales increases and sales productivity gains within our current footprint. In addition, we will continue to close unproductive Apparel stores and convert Express single gender stores to dual gender formats. 2) Expansion of core retail brands into new channels and geographies, seeking to expand the Company's presence beyond its current footprint by increasing store count and square footage at Victoria's Secret and Bath & Body Works and through international expansion. Based on favorable returns from larger Victoria's Secret store formats, in 2007 we will begin implementing a plan to increase the square footage of our average Victoria's Secret store by about 50%. Specifically, the Company plans to open 35 new stores and remodel another 105 stores to the new larger store design. We anticipate total square footage will increase between 8% and 10% in 2007. At Bath & Body Works, we plan to open approximately 55 new stores in 2007, resulting in a square footage increase of approximately 3%. The 2006 acquisition of La Senza extends the Company's presence into Canada and provides an international network in 34 other countries as the Company begins to contemplate international expansion for our other brands. We plan to open 32 new La Senza stores in 2007, resulting in square footage growth of 12%. 3) Incubation and growth of new concepts, including PINK. Intimissimi, White Barn Candle Company, C.O. Bigelow and accessories at Henri Bendel and Diva London. 4) Investment in infrastructure to support future growth, focusing on two primary initiatives: • The enterprise-wide multi-year project to standardize and upgrade our technology in three areas: shared services, customer relationship marketing and supply chain management; Construction of a new distribution facility and development of new front-end technology to support the growth of our direct businesses. IS EFTA00190176 5) Attracting, developing and retaining talent across all disciplines. 6) Proactive management of our capital structure, focusing on the continued return of excess free cash flow to our shareholders through dividends and share repurchases, while also making incremental investments back into the business to support all of the previously described imperatives. Summary of 2006 Results The Company's operating results are generally impacted by changes in the overall U.S. economy. and therefore, management monitors the retail environment using, among other things, certain key industry performance indicators such as the University of Michigan Consumer Sentiment Index (which measures consumers' views on the future course of the U.S. economy), the National Retail Traffic Index (which measures traffic levels in approximately 250 malls nationwide) and National Retail Sales (which reflects sales volumes of 5,000 businesses as measured by the U.S. Census Bureau). These indices provide insight into consumer spending patterns and shopping behavior in the current retail environment and assist management in assessing the Company's performance as well as the potential impact of industry trends on its future operating results. We utilize the retail calendar for reporting. As such, the results for fiscal years 2006. 2005 and 2004 represent the fifty-three week period ended February 3.2007 and the fifty-two week periods ended January 28. 2006 and January 29, 2005, respectively. The 2006 fourth quarter consists of a fourteen week period versus a thirteen week period in 2005. The extra week accounted for approximately $171 million, or 5%, in incremental sales in the fourth quarter. For the fifty-three week year ended February 3, 2007. operating income increased 19% primarily due to a significant improvement in operating income at Express. Operating income also increased at Victoria's Secret and Bath & Body Works. For the fourth quarter ended February 3, 2007, operating income increased 5% due to increases in all operating segments. Victoria's Secret's increase in sales and operating income for the year and fourth quarter were driven by continued sales growth in the PINK sub-brand and new bra launches that featured the Secret Embrace and Infinity Edge technologies. Sales growth outpaced operating income performance as the brand focused on initiatives to drive customer trial, increase customer loyalty and increase market share. Bath & Body Works' increase in sales and operating income for the year and fourth quarter were driven by increases in newly introduced Signature Collection fragrances and expense leverage across all categories. Although Apparel experienced decreases in sales in the year and fourth quarter. its operating income improved significantly during the year and fourth quarter driven by a significant improvement in gross profit at Express. Express reasserted itself with its customer by offering a more fashionable merchandise assortment with appropriate price points. 16 EFTA00190177 Financial Data by Segment The following summarized financial data compares reported 2006 sales and operating income results to the comparable periods for 2005 and 2004: % Change Net Sales (Millions) 2006 2005 2004 2006 vs. 2005 2005 vs. 2004 Victoria's Secret Stores $ 3,700 $3,222 $3,113 15% 4% La Senza (a) 23 — — nm nm Victoria's Secret Direct 1,416 1,226 1,119 16% 10% Total Victoria's Secret 5,139 4,448 4,232 16% 5% Bath & Body Works 2,556 2,285 2,169 12% 5% Express 1,749 1,794 1,913 (3%) (6%) Limited Stores 493 545 577 (10%) (6%) Total Apparel businesses 2,242 2,339 2,490 (4%) (6%) Other(b) 734 627 517 17% 21% Total net sales $10.671 $9.699 59.408 10% 3% . . Operating Income (c) Victoria's Secret $ 958 $ 886 $ 799 8% 11% Bath & Body Works 456 403 400 13% 1% Apparel 27 (92) 16 129% nm Other(b) (265) (211) (188) (26%) (12%) Total operating income $ 1,176 $ 986 $1,027 19% (4%) (a) Includes the results of La Senza from the date of acquisition, January 12, 2007. (b) Other includes Corporate. Mast, Beauty Avenues and Henri Bendel. (c) 2006 and 2005 results are reported on the cost method of accounting for inventory valuation. 2004 results are reported on the retail method. nm not meaningful The following tables compare 2006 comparable store sales and store data to the comparable periods for 2005 and 2004: Comparable Store Sales 2006 2005 2004 Victoria's Secret 11% 1% 9% Bath & Body Works 10% 4% 12% Express (1%) (8%) (8%) Limited Stores (4%) (2%) (5%) Total Apparel businesses (2%) (6%) (7%) Henri Bendel 1% (12%) 9% Total comparable store sales 7% (1%) 4% 17 EFTA00190178 Store Data 2006 2005 2004 eh Change 2006 vs. 2005 2005 vs. 2004 Sales per average selling square foot Victoria's Secret Stores (a) $ 731 $ 653 $ 648 12% 1% Bath & Body Works $ 697 $ 637 $ 611 9% 4% Apparel $ 352 $ 333 $ 331 6% 1% Sales per average store (Thousands) Victoria's Secret Stores (a) $3,698 $3,224 $3,097 15% 4% Bath & Body Works $1,613 $1,453 $1,367 II% 6% Apparel $2,296 $2,087 $1,989 10% 5% Average store size (Selling square feet) Victoria's Secret Stores (a) 5,111 5,011 4,863 2% 3% Bath & Body Works 2,331 2,296 2,266 2% 1% Apparel 6,541 6,497 6,081 1% 7% Total selling square feet (Thousands) Victoria's Secret Stores (a) 5,126 5,001 4,868 3% 3% Bath & Body Works 3,604 3,570 3,556 1% 0% Apparel 6,005 6,724 7,340 (11%) (8%) (a) Victoria's Secret Stores data does not include the results of La Senza, which was acquired on January 12. 2007. Victoria's Secret Bath & Body Works Apparel Number of Stores (a) 2006 2005 2004 2006 2005 2004 2006 2005 2004 Beginning of year 998 1.001 1,009 1,555 1,569 1.604 1,035 1,207 1,297 Opened 24 15 13 20 17 10 2 18 15 Closed (21) (18) (21) (29) (31) (45) (119) (190) (105) Acquired (b) 325 End of year 1,326 998 1.001 1.546 1.555 1.569 918 1.035 1.207 (a) Excludes Henri Bendel store locations (2 in 2006, 2005 and 2004) and Diva London store locations (6 in 2006). (b) Represents stores acquired in the La Senza acquisition on January 12, 2007. Net Sales Fourth Quarter 2006 compared to 2005 Net Sales Fourth Quarter 2006 vs. 2005 (Millions) Increase (decrease) Victoria's Secret Bath & Body Works Apparel Other Total 2005 Net sales $1,581 $1.049 $746 $166 $3,542 Comparable store sales 115 92 8 — 215 Sales associated with new, closed and non-comparable remodeled stores, net 70 18 (10) — 78 La Senn 23 — — — 23 Direct channels 75 16 — — 91 Mast third-party sales and other — — — 76 76 2006 Net sales $1,864 $1,175 $744 $242 $4,025 18 EFTA00190179 At Victoria's Secret, the 10% increase in comparable store sales and in total sales was driven by growth in the PINK sub-brand as well as growth in sleepwear, core lingerie and beauty categories. The growth in PINK was driven by loungewear, panties and accessories, while the growth in core lingerie was driven by bras. The growth in the bra category was driven by new products featuring the Secret Embrace and Infinity Edge technologies. Growth in beauty was the result of continued momentum of the Dream Angles Desire fragrance and the Beauty Rush color line. Victoria's Secret Direct achieved an 18% increase in sales driven by double digit growth in intimate apparel and clothing. At Bath & Body Works, the 9% increase in comparable store sales was primarily driven by increases in the Signature Collection due to the introduction of new fragrances as well as strong sales performance during the semi-annual sale which was extended into mid-January. Incremental sales from the Temptations product line and continued growth of the Dr. Wexler product line launched during the third quarter of 2005 also contributed to sales growth. At the Apparel businesses, the I% increase in comparable store sales was driven by a 3% increase at Express. The increase at Express was primarily due to increased sales in sweaters and woven tops, a strong clearance event and a favorable response to early Spring merchandise. Limited Stores experienced a 4% decrease in comparable store sales, primarily driven by significant declines in woven tops and sweaters, offset partially by increases in jackets, skirts, woven shirts and dresses. The net increase in sales in other was primarily driven by an increase in Mast sales to third-party customers. 2005 compared to 2004 Net Sales Fourth Quarter 2005 vs. 2004 (Millions) Increase (decrease) Victoria's Secret Bath & Body Works Apparel Other Total 2004 Net sales 51.470 $1.006 $713 $139 $3,328 Comparable store sales 36 12 28 — 76 Sales associated with new, closed and non-comparable remodeled stores, net 22 1 (9) — 14 Direct channels 53 14 — — 67 Gift card breakage — 16 14 — 30 Mast third-party sales and other — — — 27 27 2005 Net sales $1,581 $1,049 $746 $166 $3,542 At Victoria's Secret, the 3% increase in comparable store sales and in total sales was driven by growth in the PINK sub-brand and in the bra and body care categories. partially offset by declines in panties, prestige fragrance and sleepwear. The growth in the bra category was driven by the Body by Victoria Bra event in December and the launch of the Angel's Secret Embrace Bra. Victoria's Secret Direct achieved a 15% increase in sales driven by growth in intimate apparel. beauty and sleepwear. At Bath & Body Works, the I% increase in comparable store sales was primarily driven by incremental sales from the launch of the American Girl and Breathe Body Care product lines during 2005. as well as by products launched last year, including C.O. Bigelow and Le Couvent des Minimes. Declines in the fragrant body care and home fragrance product lines partially offset its sales increase. An increase in gift-with-purchase and purchase- with-purchase promotions also partially supported the sales increases. At the Apparel businesses, the 4% increase in comparable store sales was driven by a 6% increase at Express. The increase at Express can be primarily attributed to increased sales in denim and knit tops as the focus shifted to a more balanced offering between casual and wear-to-work, with appropriate price points. Decreases in pants and sweaters partially offset these increases. Limited Stores experienced a 1% decrease in comparable store sales, primarily driven by significant declines in pants and woven tops. 19 EFTA00190180 The Company issues gift cards which contain no expiration dates or inactivity fees. The Company recognizes income from gift cards when: (i) the gift card is redeemed by the customer; or (ii) the likelihood of the gift card being redeemed by the customer is remote and it is determined that there is no legal obligation to remit the unredeemed gift cards to relevant jurisdictions (gift card breakage). During the fourth quarter of 2005, the Company recognized $30 million of net sales and operating income ($0.04 per share) related to gift card breakage at Bath & Body Works ($16 million) and Express ($14 million). The amount of gift card breakage recognized was based upon analysis of historical redemption patterns and represents the portion of remaining balance of gift cards for which the Company believes the likelihood of redemption is remote. The fourth quarter of 2005 is the first period during which the Company has recognized gift card breakage. Therefore, the amount recognized includes the breakage income related to gift cards sold since inception of the gift card programs at Bath & Body Works and Express. The Company will recognize gift card breakage at its other divisions once adequate historical data has been accumulated. The net sales increase in other was primarily driven by an increase in volume of Mast sales to third•party customers versus the fourth quarter of 2004. Net Sales Full Year 2006 compared to 2005 Net Sales 2006 vs. 2005 (Millions) Increase (decrease) Victoria's Secret Bath & Body Works Apparel Other Total 2005 Net sales $4,448 $2,285 $2,339 $627 $ 9,699 Comparable store sales 335 205 (36) — 504 Sales associated with new, closed and non-comparable remodeled stores, net 143 26 (61) — 108 La Senza 23 — — — 23 Direct channels 190 40 — — 230 Mast third•party sales and other — — — 107 107 2006 Net sales $5,139 $2,556 $2,242 $734 $10,671 At Victoria's Secret, both the increase in comparable store sales of 11% and the increase in total sales were driven by growth in all categories, including core lingerie, beauty and the PINK sub-brand. The sales were supported by several bra launches throughout the year, including the Angels Secret Embrace. Body by Victoria IPEX Wireless, Very Sexy Infinity Edge Push-up and Secret Embrace Demi. The increase in the beauty category was primarily driven by continued growth in the Garden body care line and incremental sales from beauty launches, including Very Sexy Make Up, Beauty Rush Lip Gloss and Eye Shadows and Dream Angels Desire fragrance. The 16% increase in sales at Victoria's Secret Direct was driven by growth across all major categories. At Bath & Body Works, the 10% increase in comparable store sales was primarily driven by increases in the Signature Collection due to the introduction of new fragrances more frequently throughout the year. Additionally, incremental sales from the Temptations product line and continued growth in the Dr. Wexler. Antibacterial and Breathe Body Care product lines contributed to sales growth. At the Apparel business, the 2% decrease in comparable store sales primarily resulted from declines during the first three quarters of the year. At Express, these results reflect the impact of the significant promotional and clearance activity that occurred in 2005. The 4% decline in Limited Stores comparable store sales was driven by declines in pants, sweaters and woven tops, partially offset by increases in dresses, jackets and skirts. The net sales increase in other was primarily driven by an increase in volume of Mast sales to third•party customers versus 2005. 20 EFTA00190181 2005 compared to 2004 Net Sales 2005 vs. 2004 (Millions) Increase (decrease) Victoria's Secret Bath & Body Works Apparel Other Total 2004 Net sales 54.232 $2,169 $2,490 $517 $9.408 Comparable store sales 25 73 (135) - (37) Sales associated with new, closed and non-comparable remodeled stores, net 84 12 (30) 66 Direct channels 107 15 122 Gift card breakage 16 14 30 Mast third-party sales and other 110 110 2005 Net sales $4,448 $2,285 $2,339 $627 $9,699 At Victoria's Secret, the increase in comparable store sales of 1% and the increase in total sales were driven by growth in the PINK sub-brand and the bra and body care categories, partially offset by declines in the sleepwear, panty and prestige fragrance categories. The growth in the bra category was driven by sales of the IPEX and the Very Sexy bra sub-brand. The 10% increase in net sales at Victoria's Secret Direct was driven by growth in almost all product categories, including woven tops, bras, knit tops and beauty. At Bath & Body Works, the 4% increase in comparable store sales was primarily driven by incremental sales from new product lines, including Tutti Dolci, C.O. Bigelow, Le Couvent des Minimes, Breathe Body Care and American Girl and recognition of gift card breakage in the fourth quarter, partially offset by declines in the fragrant body care and home fragrance product lines. This result was supported by a successful semi-annual sale during the second quarter and purchase-with-purchase promotions. At the Apparel businesses, the 6% decrease in comparable store sales primarily resulted from significant declines at Express related to the product assortment issues during the first three quarters of the year. All major Express categories experienced declines as compared to last year except for knits and denim. These results reflect a continuation of sales declines at Express which began in the Fall of 2004. Express' product assortment failed to meet customer preferences both in terms of fashion selection and price points. The 2% decline in comparable store sales at Limited Stores was primarily driven by declines in sweaters, skirts and jackets, partially offset by growth in denim, pants and accessories. The net sales increase in other was primarily driven by an increase in volume of Mast sales to third-party customers versus 2004. Gross Profit Fourth Quarter 2006 compared to 2005 For the fourth quarter of 2006. the gross profit rate (expressed as a percentage of net sales) decreased to 40.1% from 40.8% in 2005 driven by a decline in merchandise margin partially offset by buying and occupancy expense leverage. At Victoria's Secret, the gross profit rate decreased primarily due to a reduction in merchandise margin rates, partially offset by an improvement in the buying and occupancy expense rate. The reduction in merchandise margin rate was driven by increased markdowns due to the clearance of selected merchandise that missed sales expectations and increased levels of promotional direct mailings to drive an increase in market share. The merchandise margin rate also declined partially due to a shift in the mix of business from core lingerie and beauty to PINK, loungewear and sleepwear and the expansion of the Company's multiple pricing offers for panties. Additionally, buying and occupancy expense was leveraged on a 10% increase in comparable store sales. 21 EFTA00190182 At Bath & Body Works, the gross profit rate decreased compared to last year driven by a decrease in merchandise margin rate partially offset by leverage in buying and occupancy. The reduction in merchandise margin rate to last year was driven by a mix of promotional transaction driving activity and better than expected performance of the semi-annual sale. Additionally, buying and occupancy expense was leveraged on a 9% increase in comparable store sales. At the Apparel businesses, the gross profit rate increased due to improvement in merchandise margin at Express. The improvement in merchandise margin rate was driven by lower product costs and reduced markdowns. Additionally. buying and occupancy expense was leveraged on a l% increase in comparable store sales. 2005 compared to 2004 For the fourth quarter of 2005. the gross profit rate (expressed as a percentage of net sales) increased to 40.8% from 39.1% in 2004 driven by a decrease in the buying and occupancy rate primarily related to a $61 million lease related accounting charge in the fourth quarter of 2004 and the Company's initial recognition of gift card breakage of $30 million (as previously discussed). At Victoria's Secret, the gross profit rate increased due to improvement in the buying and occupancy expense rate, partially offset by a reduction in merchandise margin rates. The reduction in the merchandise margin rate was driven by the change to the weighted-average cost method of accounting for inventory valuation and lower margins at the beauty business. The declines at the beauty business were driven by lower margin gift set sales in December and increased markdowns during the semi-annual sale, primarily in the color product line. Buying and occupancy expense was higher in 2004 as compared to 2005 due to the one-time lease accounting correction. Additionally, buying and occupancy expense was leveraged on a 3% increase in comparable store sales. At Bath & Body Works, the gross profit rate increased due to improvement in the buying and occupancy expense rate, partially offset by a reduction in the merchandise margin rate. The reduction in the merchandise margin rate was due to higher markdowns and purchase-with-purchase promotions to stimulate traffic, partially offset by the Company's initial recognition of gift card breakage. Buying and occupancy expense was higher in 2004 as compared to 2005 due to the one-time lease accounting correction. Additionally, buying and occupancy expense was leveraged on a I% increase in comparable store sales. At the Apparel businesses, the gross profit rate increased over last year due to improvement in the buying and occupancy rate, partially offset by a reduction in the merchandise margin rate at Express. The reduction in the merchandise margin rate was driven by the change to the weighted-average cost method of accounting for inventory valuation that more than offset an increase in merchandise margin due to lower markdowns and initial recognition of gift card breakage at Express. The buying and occupancy expense was higher in 2004 as compared to 2005 due to the one-time lease accounting correction. Additionally, buying and occupancy expense was leveraged on a 4% increase in comparable store sales. Gross Profit Full Year 2006 compared to 2005 In 2006. the gross profit rate (expressed as a percentage of net sales) increased to 37.6% from 35.9% in 2005 driven by an increase in the merchandise margin rate at the Apparel brands offset partially by a decline in the merchandise margin rate at Victoria's Secret. The buying and occupancy expense rate improved across all operating segments driven primarily by leverage achieved at Victoria's Secret and Bath & Body Works on double digit comparable store sales increases at both brands. At Victoria's Secret, the gross profit rate decreased due to a reduction in the merchandise margin rate driven by markdowns associated with strategic marketing activities designed to drive trial, build brand loyalty and increase market share. The reduction in the merchandise margin rate was partially offset by buying and occupancy expense leverage achieved on a 1I% increase in comparable store sales. EFTA00190183 At Bath & Body Works, the gross profit rate was flat compared to last year. The buying and occupancy expense rate improved, but was offset by a reduction in the merchandise margin rate. The reduction in the merchandise margin rate was due to increased promotional activity to drive transactions and the performance of the semi- annual sale events. Buying and occupancy expense was leveraged on a 10% increase in comparable store sales. At the Apparel businesses, the gross profit rate increased significantly over last year driven by lower product costs and reduced markdowns at Express. Additionally, buying and occupancy expense was leveraged despite the 2% decline in comparable store sales. 2005 compared to 2004 In 2005, the gross profit rate (expressed as a percentage of net sales) decreased to 35.9% from 36.1% in 2004 driven by a decrease in the merchandise margin rate at the Apparel brands. This decline was offset by a decrease in the buying and occupancy expense rate (primarily related to a $61 million lease related accounting charge across the enterprise in the fourth quarter of 2004), the Company's initial recognition of gift card breakage of $30 million and expense leverage achieved at Victoria's Secret and Bath & Body Works on sales increases of 5% at both brands. At Victoria's Secret, the gross profit rate increased due to improvement in the buying and occupancy expense rate, partially offset by a reduction in the merchandise margin rate. The slight reduction in the merchandise margin rate was driven by markdowns in panties and beauty. Buying and occupancy expense was higher in 2004 compared to 2005 due to the one-time lease accounting correction. Additionally, buying and occupancy expense was leveraged on a 1% increase in comparable store sales. At Bath & Body Works, the gross profit rate was flat compared to last year. The buying and occupancy expense rate improved, but was offset by a reduction in the merchandise margin rate. The reduction in the merchandise margin rate was due to higher markdowns on gift sets and purchase-with-purchase promotions to stimulate traffic. Buying and occupancy expense was higher in 2004 due to the one-time lease accounting correction. Additionally, buying and occupancy expense was leveraged on a 4% increase in comparable store sales. At the Apparel businesses, the gross profit rate decreased over last year due to a decrease in the merchandise margin rate, partially offset by an improvement in the buying and occupancy rate at both Express and Limited Stores. The decrease in the merchandise margin rate was driven by significantly higher markdowns through the first three quarters to clear slow-moving inventories across many product categories. Buying and occupancy expense was higher in 2004 due to the one-time lease accounting correction, offset by the inability to leverage expenses due to a 6% decline in comparable store sales. General, Administrative and Store Operating Expenses Fourth Quarter 2006 compared to 2005 For the fourth quarter of 2006. the general, administrative and store operating expense rate (expressed as a percentage of net sales) increased to 22.0% from 21.2% last year, driven by incremental spending on technology and process initiatives to support future growth, higher incentive compensation which is tied to improved performance for the Fall season, and incremental stock option expense related to the adoption of SFAS No. 123(R). 2005 compared to 2004 For the fourth quarter of 2005. the general, administrative and store operating expense rate (expressed as a percentage of net sales) increased to 21.2% from 20.2% last year, driven by an increase in investments in new 23 EFTA00190184 growth concepts, increased spending on technology and process initiatives to support future growth and an increase in marketing expense. The increase in marketing spending related to the Victoria Secret's fashion show, PINK, Express television media and advertising and marketing programs at Bath & Body Works to support new product lines. These increases were partially offset by an $8.5 million favorable litigation settlement with respect to merchant fees previously paid to Visa and MasterCard. General, Administrative and Store Operating Expenses Full Year 2006 compared to 2005 In 2006. the general, administrative and store operating expense rate increased to 26.6% from 25.7% in 2005. The increase was primarily driven by: I) increased marketing expenses primarily at Victoria's Secret; 2) increases in incentive compensation expense due to improved performance; 3) investments in technology and process improvement initiatives to support future growth; and 4) incremental stock compensation expense related to the Company's adoption of Statement of Financial Accounting Standards No. 123 (R). 2005 compared to 2004 In 2005. the general. administrative and store operating expense rate increased to 25.7% from 25.2% in 2004. The increase was primarily driven by investments in new growth concepts, increased spending on technology and process initiatives to support future growth, and incremental expenses associated with the Victoria Secret's fashion show and PINK. The increases were offset by decreases in incentive compensation and an $8.5 million favorable litigation settlement with respect to merchant fees previously paid to Visa and MasterCard. Interest Expense The average daily borrowings and average borrowing rates for the fourth quarters and years ended February 3. 2007, January 28, 2006. and January 29, 2005 were as follows: Fourth Quarter Year (Millions) 2006 2005 2004 2006 2005 2004 Average daily borrowings $1,776 $1305 $1.474 $1.711 $1,666 $863 Average borrowing rate 5.9% 5.7% 5.6% 5.9% 5.5% 6.1% In 2006, the Company incurred interest expense of $28 million and $102 million for the fourth quarter and the year, respectively, compared to $25 million and $94 million for the same periods in 2005. The fourth quarter increase was driven by an increase in average borrowings and the average borrowing rates partially offset by a reduction in the bank facility fee from 0.15% to 0.10% of the committed amount per year. The increase in average borrowings resulted primarily from the issuance of commercial paper. The full year increase resulted from an increase in average borrowings and the average borrowing rate (see Note II to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data). In 2005, the Company incurred interest expense of $25 million and $94 million for the fourth quarter and the year, respectively, compared to $21 million and $58 million for the same periods in 2004. The fourth quarter increase was driven by an increase in average borrowings and the average borrowing rate. The full year increase resulted from an increase in average borrowings, partially offset by a decrease in average effective borrowing rates resulting from the addition of the Company's 5.25% $500 million notes during the third quarter of 2004 and $500 million variable rate term loan during the fourth quarter of 2004 (see Note II to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data). 24 EFTA00190185 Interest Income In 2006, interest income was $4 million and $25 million for the fourth quarter and the full year, respectively, compared to $49 million and $62 million for the same periods in 2005. The decrease in both the fourth quarter and the year was primarily the result of a $40 million tax settlement in 2005 (see Note 10 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data) and decreases in the average invested cash balances. In 2005, interest income was $49 million and $62 million for the fourth quarter and the full year, respectively, compared to S7 million and $30 million for the same periods in 2004. The increase in both the fourth quarter and year was driven by interest of $40 million related to a tax settlement. Other Income (Loss) In 2006. other income (loss) for the fourth quarter and the year was $2 million and $(2) million, respectively, compared to S4 million and $3 million for the same periods in 2005. In 2005, other income (loss) for the fourth quarter and the year was S4 million and $3 million, respectively, compared to S4 million and $99 million for the same periods in 2004. The full year decrease primarily relates to gains in 2004 of $90 million related to the early collection of the New York & Company note receivable, New York & Company's purchase of its warrants held by the Company and additional proceeds from the New York & Company initial public offering (see Note 4 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data). Gains on Sale of Investees' Stock During the second quarter of 2004, the Company sold its remaining ownership interest in Galyan's Trading Company, Inc. ("Galyan's") for $65 million, resulting in a pretax gain of $18 million. Prior to the sale of Galyan's shares, the Company accounted for its investment using the equity method. Provision for Income Taxes In 2006, the Company's effective tax rate for the fourth quarter and the year was 37.7% and 38.5%, respectively, compared to 28.0% and 30.4% for the same periods in 2005. The rate increase for both 2006 periods was primarily due to a favorable one-time tax benefit of $77 million related to the repatriation of foreign earnings that occurred in 2005 under the provisions of the American Jobs Creation Act. The 2006 fourth quarter and annual effective tax rate from on going operations decreased due to the resolution of certain state tax matters. For additional information, see Note 10 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. FINANCIAL CONDITION Liquidity and Capital Resources Cash generated from operating activities provides the primal), resources to support current operations, growth initiatives, seasonal funding requirements and capital expenditures. In addition, the Company has funds available from an unsecured revolving credit facility (the "Facility") as well as a commercial paper program which is backed by the Facility. In the fourth quarter of 2006, the Company issued commercial paper under the Facility for the short-term funding of the Company's peak working capital needs. The average balance during the quarter was $99 million. The Company repaid the commercial paper within the fourth quarter. In conjunction with the acquisition of La Senza, the Company entered into a $400 million bridge facility (the "Bridge Facility") which expires January 2008. The Company did not draw on the Bridge Facility during the year ended February 3, 2007 25 EFTA00190186 or during the period from February 3, 2007 through March 23, 2007. The Company financed the acquisition of La Senza with cash on-hand as of the January 12, 2007 acquisition date. In addition to the facilities described above, the Company has available a shelf registration statement under which up to $1 billion of debt securities, common and preferred stock and other securities may be issued. As of March 23, 2007, no securities have been issued under this registration statement. 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, accounted for approximately one—third of net sales in 2006, 2005 and 2004. Accordingly, cash requirements are highest in the third quarter as the Company's inventory builds in anticipation of the holiday period. The holiday period then generates a substantial portion of the Company's operating cash flow for the year. A summary of the Company's working capital position and capitalization as of February 3, 2007, January 28, 2006. and January 29. 2005 was as follows: Working Capital Position and Capitalization (Millions) 2006 2005 2004 Cash provided by operating activities $ 600 $1,081 $ 933 Working capital $1,062 $1,209 $1,233 Capitalization Long-term debt $1.665 $1.669 $1,646 Shareholders' equity 2.955 2.471 2,335 Total capitalization $4,620 $4,140 $3,981 Additional amounts available under long-term credit agreements $1,000 $1,030 $1,000 The Company considers the following to be relevant measures of liquidity and capital resources: Liquidity and Capital Resources 2006 2005 2004 Debt-to-equity ratio 56% 68% 70% (Long-term debt divided by shareholders' equity) Debt-to-capitalization ratio 36% 40% 41% (Long-term debt divided by total capitalization) Cash flow to capital investment 109% 225% 216% (Net cash provided by operating activities divided by capital expenditures) Operating Activities In 2006, the decrease in net cash provided by operating activities compared to 2005 was driven primarily by an increase in inventories. The Company deliberately increased inventory levels during the year to meet the following objectives: I) at Victoria's Secret, increases related to new product launches in core lingerie and beauty, initiatives to increase market share and build brand loyalty and an initiative to improve in-stock inventory positions; 2) at Bath & Body Works, increases related primarily to investments in safety stocks of seaconless basics in anticipation of the supply chain system conversion that occurred mid-year as well as an initiative to improve in-stock inventory positions. In 2005. the increase in net cash provided by operating activities compared to 2004 was primarily driven by an increase in net income (excluding the non-cash 2004 gains related to New York & Company and Galyan's Trading Company, Inc.) and changes in working capital. 26 EFTA00190187 Investing Activities In 2006, investing activities primarily included $548 million in capital expenditures (see "Capital Expenditures" section) and $572 million related to the acquisition of La Senza. In 2005, investing activities primarily included $480 million in capital expenditures (see "Capital Expenditures" section), $22 million related to strategic investments in several personal care companies and $4 million related to non-operating real estate investments. Financing Activities In 2006, the Company had the following financing activities: (i) cash payments of $193 million related to the repurchase of 8 million shares of common stock during the year at a weighted-average price of $24.98 under the Company's November 2005, February 2006 and June 2006 share repurchase programs, (ii) quarterly dividend payments of $0.15 per share, or $238 million and (iii) repayment of long-term debt of $7 million. These uses of cash were partially offset by proceeds from the exercise of stock options of $153 million and excess tax benefits on share-based compensation of $46 million. In 2005, the Company had the following financing activities: (i) cash payments of $380 million related to the repurchase of 17 million shares of common stock during the year at a weighted-average price of $22.49 under the Company's February, May, August and November 2005 share repurchase programs and (ii) quarterly dividend payments of $0.15 per share, or $242 million. These uses of cash were partially offset by proceeds from the exercise of stock options of $64 million and a $30 million draw on a line of credit at Mast (see discussion below). The Company has available a $1 billion unsecured revolving credit facility (the "Facility"), none of which was used as of February 3, 2007. The Facility is available to support the Company's commercial paper and letter of credit programs, which may be used from time to time to fund working capital and other general corporate requirements. Borrowings outstanding under the Facility, if any. are due in March 2011. Fees payable under the Facility are based on the Company's long-term credit ratings. and, at February 3, 2007, were 0.10% of the committed amount per year. The Facility also requires the Company to maintain certain specified fixed charge and debt-to•earnings ratios and prohibits certain types of liens on property or assets. The Company was in compliance with the covenant requirements as of February 3. 2007. In connection with the acquisition of La Senza and expanding internationally, the Company entered into a $400 million bridge facility (the "Bridge Facility") in January 2007. Borrowings under the Bridge Facility, if any, are due in January 2008. There were no borrowings outstanding as of February 3, 2007. Fees payable under the Bridge Facility are based on the Company's long-term credit ratings, and are currently 0.10% of the committed amount per year. Interest on borrowings from the Bridge Facility is calculated at LIBOR plus a credit spread. In January 2006, Mast Industries (Far East) Limited, a wholly-owned subsidiary of Limited Brands, Inc., entered into a $60 million unsecured revolving credit facility (the "Mast Credit Facility"). During 2006, $30 million was drawn on the facility while the remainin