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Executives

Stuart Burgdoerfer - Chief Financial Officer

Tim Faber - Treasurer

Analysts

Karru Martinson - Deutsche Bank

L Brands, Inc. (LTD) Deutsche Bank 21st Annual Leveraged Finance Conference Call October 1, 2013 4:00 PM ET

Karru Martinson - Deutsche Bank

Good afternoon. My name is Karru Martinson. I am the consumer, retail, and food analyst here for Deutsche Bank. So, it’s my pleasure to introduce Stuart Burgdoerfer, CFO of L Brands; and Tim Faber, the Treasurer of L Brands as well.

Stuart Burgdoerfer

Thank you. Good afternoon. It’s good to be here. We have got about $4.5 billion of bonds outstanding in the marketplace, so it’s important for us to spend time with our debt investors. So, I appreciate you coming here today and spending some time with us.

We’ve got about 20 minutes where I am going to go through a lot of material quickly, and then Tim and I will take questions for about 15 minutes and cover whatever is on your mind about our company, so I am going to move pretty quickly through these slides.

So, in terms of key messages, our businesses Victoria’s Secret and Bath & Body Works, we have business called La Senza and another concept called Henri Bendel. But fundamentally, L Brands is comprised of Victoria’s Secret, the leader in intimate apparel in the United States with a lot of global opportunity.

And Bath & Body Works, the seller of personal care and beauty in the United States, Canada, and in other global locations as well, primarily in the Middle East, so that is our business.

Category leading brands, high emotional content generates good income, good cash flow. We have got a lot of additional growth in North America, second point on this chart. Obviously, a very substantial international growth opportunity that we are starting to pursue, and I will talk about that.

We've improved our operating income rate or operating margin pretty substantially over the last four or five years, and we believe there is potential for more improvement in the operating income results of the business both dollar growth and rate.

And obviously very important to us, to any business to have a strong cash and liquidity position, while maximum -- optimizing our capital structure and minimizing our cost-to-capital, and we will talk a bit about our thinking there.

Had been focused on fundamental things like managing inventory and expenses and capital spending with discipline, and have done that well. We have returned a lot of cash to shareholders and are focused on shareholder returns doing that in a balanced way, and we will touch on that also.

Quick page on shareholder returns, on a 3-, 5-, and 10-year basis. We are near the top of those list or at the top in one case and important for us to do. About a third of that return on a 5-year basis has come from distribution of cash to shareholders. But some good results as measured against some very good companies in the market more generally from a shareholder perspective.

We have grown earnings per share pretty substantially over this period of time. As I mentioned, we've improved the profitability of the business quite a bit in the fall of 2009. We announced the goal of getting operating margin of the business to 15%. We indicated we do that by 2012. We were very close a year early at 14.93% in 2011 and last year in 2012, the year that we said we’ll get it done, we reported an op income rate of about 16.3%.

What we have -- how we have been able to get those results is the quality of those two brands, I mentioned, Victoria's Secret and Bath & Body are the leaders in their categories, and from that you get pricing power and awareness and traffic and all kinds of good things. The intimate apparel and personal care and beauty categories had a lot of loyalty. Our difficult categories too compete in, and again we are the leader in those spaces.

We've been focused on fundamental things, if I was in your shoes and reading a list, it says, “oh, the company has been focused on customers,” I might laugh a little bit about that and say, wow that’s a novel management approach, you are actually focused on customers.”

But really being in her mindset and thinking about what she wants and needs and delivering that through merchandise and store experience and interaction with associates, doing that really well, obviously matters a lot, product matters a lot in retailing your merchandise and how compelling are styles and colors and fashion and details, flowing goods effectively to the stores is very important.

We've done a lot of work reducing our lead times in our business, which is very important to us economically, because it allows us to chase into things that are selling very well in short periods of time and allows us to order less quantity initially, so that we can read and react and adjust to the actual selling results of the merchandise.

Very focused on improving selling and operational effectiveness at the store level and you guys can be the judge of it from the outside in, but we do have a sound management team, an aligned management team, meaning we are all on the same page and that's pretty important to any business.

We have been driving good sales growth as shown by the graph, so 15 consecutive quarters of sales growth. We have been growing inventory slower than sales, which is a good thing in a retail business. You don't want to be out of stock obviously, so you want to balance that and be careful about it, but growing inventory slower than sales is an important thing to do to maximize full price selling and not be overbought in the business.

We have grown expenses slower than sales as depicted by these two lines, and over that period of time beginning in 2009 generated the equivalent of $539 million of expense savings, meaning expenses growing slower than sales over that time period.

The operating income of the business has grown pretty substantially. You can see in 2008 as many were struggling with results driven by the economic environment and some of our own opportunities, and the business generated just over $700 million in operating income, and this year based on the external guidance we put out to probably do about $1.8 billion or a little bit better, last year did over a $1.6 billion approaching $1.7 billion.

One of the most important things to evaluate in a retailer -- store-based retailer is the health in real estate, this pie chart we have been sharing with the marketplace for a number of years now, and the key takeaway is that 99%, a little more than 99% of our stores are cash flow positive.

So less than 1% of our stores don't generate cash, that’s a good place to be in that tells you that there is high sales per foot, there is high profitability, there isn’t a looming store closure, or lease-related issue in a business, so important aspect of evaluating our business.

As we think about our balance sheet, you can see here, we’ve got information beginning in the year 2000. And in that time frame, we had a lot of other businesses that we’ve since sold or disposed businesses like Lerner and Lane Bryant and Limited stores and Express and Structure and so on. And from 2000 through to today, we've increased the balance sheet debt as you can see on the page from $400 million to $4.5 billion, so a very substantial increase.

But you can also see that our lease related debt has gone down from [$6.7 billion] (ph) to $4.9 billion, again in connection with selling off those businesses that had a lot of lease-related debt and didn’t generate a lot of profitability. You can also see over this period of time that our EBITDAR increased from $1.8 billion to $2.8 billion.

The result of those three dynamics; more balance sheet debt, less lease related debt, growth in EBITDAR, is an adjusted debt to EBITDAR ratio that is in the mid-three’s. And we feel we’re not overly formulaic in terms of evaluating our capital structure. There are a lot of inputs into that as you would appreciate given what you do for a living but leverage in the mid-threes feels about right to us.

I’ll just take on a question now that’s probably a foreseeable question. It is not an explicit goal of ours to return to investment grade. In the current market environment, we’re borrowing on a very efficient basis, say that the margin today is just under 6%. So after-tax in the mid-threes and don't see a compelling reason to get back to investment grade. It doesn’t have any other effect on our business as it relates to work with our suppliers, our landlords or any other aspect of our business.

Our maturity profile is shown on this page as we look at it, it’s well timed or well spaced out. There is a maturity about a year from now, $213 million. As we continue to grow the business as we think about that maturity, we’ll evaluate whether it makes sense to put a little bit more debt on the business.

The business does generate a lot of cash flow, starting with operating cash flow, $1.3 billion to $1.4 billion per year. We are investing a lot in our business and we’re getting good returns on those investments, 25% to 30% IRRs, most of that investment -- more than 70% of that investment related to our stores in terms of remodeling and expanding stores, building new stores.

We did pay regular dividends. It’s gone from $0.60 several years ago to $1.20 per share. Share count has come down a bit. When you sold all that out, we have a remaining cash, retained cash, excess cash between $300 million and $400 million. Okay.

So that’s kind of a look back in terms of where we’re looking to, what we’re striving to achieve. One other things that we look at is we’re looking at other retailers, global retailers, Inditex, H&M, UNIQLO. We’re looking at their profitability. We think the best of those is Inditex. That’s a company that’s gone from about $10 billion five or six years ago to about $20 billion at an operating income rate just short of 20%.

And as we look at our business, we think we can get into that range. We've made a lot of progress, more to do. We believe there's a lot of growth in North America as depicted on the page driven by the positioning of our brands and the strength of those brands which I’ve talked about.

There is focus on speed that I’ve mentioned reducing lead times, focus on improving store selling, associate productivity, experience for the customer, some growth in square footage which I'll talk about, and we have great, very competitive direct businesses, online businesses, Victoria's Secret Direct is about $1.5 billion in volume, Bath & Body Works has a direct business that’s in excess of $200 million. Both of those businesses have operating income rates north of 20%.

In terms of speed and agility, reducing lead times allows us better opportunity to sell things at full price. If literally each of us could read yesterday’s sales report, what sold yesterday and for those goods from point of manufacture to the store today, how many people in this room think you could do that pretty well by reading the sales report, probably good right.

If it’s harder creatively, when you are trying to judge or trend or judge your fashion choice three months, six months out and we’re working hard to do with our suppliers is reduce those timeframes to allow us to have more flexibility and to have better information about what selling and what's not and again all that translates to more full price selling and fewer markdowns.

One way to judge speed is looking at inventory turn. This is that statistic for the company in aggregate. Obviously there's variability in this depending upon what category you look at but we have made pretty substantial improvement in the inventory turn in the business.

We’re not looking to maximize this matter at the cost of being out of stock. So you want to be thoughtful and balanced about it but the good progress in terms of productivity and freshness of inventory.

Another way to look at it and this is comparing 2008 and 2012 as we've grown sales, as you can see on the page about $2.4 billion. And we've done that with $128 million less inventory. So that's a pretty interesting way to dimension inventory productivity.

Store selling and execution, an opportunity to be more productive in the store have a better experience for the customer. As you can see on the left side of that page, it’s around having very aggressive goals, having the right talent and the right training in store, making sure our real estate and our store environment are optimized and making sure that the assortments is tailored to the store and that the merchandize is flowing appropriately day-to-day, week-to-week. Through that, we’re getting some very good results in terms of sales growth in the business.

We focus many of those things I just described on key markets and started that at Victoria’s Secret in 2009, Bath & Body Works a few years later. So this is focusing on key geographic markets, I think major MSAs. And today we’re now doing that work intensively in six markets for Victoria’s Secret.

And the sales differential, the growth in those markets focused on those things substantially above the balance of the company indicating that what one really gets execution done very, very well at the store level, you can get a differential sales result giving us confidence that there is a lot of growth in North America in addition to the merchandise ideas and real estate, I’ll talk about in a minute.

In terms of real estate, interestingly we run a lingerie business and only about 100 stores have the full lingerie assortments. So Victoria’s is operating about 1,050 stores in the United States. As you can see from the page, 950 don’t have -- do not have the full lingerie assortment. More than 800 don’t have the full Pink assortment. Pink is the sub-brand focused on the college-age customer.

We’ve got growth opportunities in these categories listed at the bottom of the page, sport and supermodel essentials and loungewear, swim business. I mentioned the expansions have been very profitable for us and that the IRRs are very healthy 25% to 30% IRRs.

In terms of square footage growth, one way to look at it and this is intentionally titled as rough math illustrative. The average store size for Victoria’s in the United States is about 6,000 feet as we think about what it should be in most malls, it should be about 8,000 feet on averaging. You multiply that by 750 malls and you get to an incremental growth opportunity of about 1.5 million feet. The business has about 6 million feet today. So that’s 25% growth opportunity, very productive. And we think we would achieve that over a four or five-year period.

We are investing in the business as I mentioned. The important thing to note here particularly from your perspective I would think is that our lean time on store-related CapEx which is the majority of our CapEx is normally about 12 months. And I’ve mentioned that because in 2009, as you can see on the page there based on performance, based on the environment, we pulled our CapEx back to $202 million.

And today we’re investing $700 million and I think the base going forward assuming strong business will be about $700 million. But maybe that -- again the most important thing to register here is that this is a variable that we can and will adjust quickly if conditions are such, performance is such that we need to. So if I were in your shoes that’s something I would want to know for sure.

We are increasing store counts. This is a detailed page maybe one of the highlights is we are doing more freestanding Pink locations and that’s because it's sometimes difficult to get additional adjacent space to the Victoria’s to expand the store.

Our preference is to have Pink be part of or side by side next to the Victoria’s store but there are times where we can’t get that at neighbor’s space. And so in those instances, we will go out and get a Pink freestanding location in the mall. Those stores are doing very well and the original Victoria’s store, the one that had Pink taken out of it is retaining substantially all of its sales volume. So a very good financial outcome for the business.

There is a big international opportunities. Anybody wonder if Victoria’s Secret and Bath & Body Works could do well internationally. I think there is a lot of confidence in that. Certainly on the equity side people if anything had been impatient with kind of our deliberate approach on this but there are lot of people that have done international poorly and have lived to regret it. So we’re trying to be pretty thoughtful about how we do it and at what pace.

So there is a big opportunity. We’ve got five stores in the U.K. We’ve got a number of stores in the Middle East with a franchise partner Alshaya. We’re doing a lot of Victoria's Secret Beauty and Accessories locations which are smaller format locations. Victoria’s locations focused on beauty and accessories as the name would suggest, they are about a 1,000 feet doing about a 1.6 million a year highly productive, good concept that can roll quickly.

Number one priority is to focus on growth in the United States and North America. We do have separate team focused on the international opportunities. So the U.S. team doesn’t get distracted with international because it has its own complexities and we have certainly been pursuing a test and learn approach.

We are doing work with franchisees in many markets. We’ve got good relationships and good strong contracts and a good royalty rate. We haven’t been public about the royalty rate but just trust me that it’s a healthy rate. We do have the option to buy markets back at a later date if we want to which others have done like Ralph Lauren and Coach. It’s a very good model and that we get revenue of the top. We don’t invest the capital. The margin is very high. The return on invested capital obviously is extremely high given the investments are very low, so a nice business for us. We are company-owned in the U.K. and basically franchised in all other key markets.

Some detail here as information about international growth by concept type. Again, a lot of activity in this beauty and accessories, concept, I think will end with about 200 stores this year in that format.

So I move quickly intentionally, Victoria’s Secret, Bath & Body Works in good categories not as intensely competitive as general woman’s apparel. Victoria’s and Bath & Body are leaders in this space. I’ve mentioned when I am over viewing the business in a setting like this.

This is not -- we are not in our Hertz, Avis, Coke, Pepsi, Home Depot, those kind of battles with another close competitor. We have a fair amount of distance between us and the next relevant competitor. I am not suggesting there isn’t competition in these categories, there is, but we are in a good spot.

We do have a lot of growth we believe in North America, further opportunity to improve the operating income rate in the business. We do believe that we should return excess cash to shareholders. We are comfortable with our leverage. We will continue to operate the business with discipline.

So I’d move quickly again by design. I think I basically hit the time here. Clock says 14:36 that’s pretty close to 15 minutes. So, Tim Faber is here. He has been -- he and I have been with the company about the same amount of time. So (inaudible) away with questions and we’ll be happy to address them.

Question-and-Answer Session

Unidentified Analyst

In terms of the retail environment, most retailers have talked about (inaudible) consumer, low spring, low summer, back-to-school, (inaudible) we did well, yet you guys are reporting markets and comp, what’s different about your consumer and the way that you spend versus the rest of the retail space?

Stuart Burgdoerfer

Yeah. Our comp has been -- that chart is total sales growth. Our comps have been positive, but not fully 5%. But we have been performing relatively well. We grew operating income 11% in the first half of the year, so the first six months for the year. So we have been doing pretty well.

But, I think, what’s -- the environment is a little choppy. I think money is flowing into housing and automobiles particularly, and there are some -- there are reasons to not be perhaps as confident as a consumer as one may want to be including some of the stuff going out in Washington at the moment.

But with that said, we are -- what we are focused on is what we can control, and we have got good brands and good categories and we have got an experienced aligned management team and through a combination of merchandizing ideas and selling more effectively in stores, and continuing to grow our direct businesses, we have been putting up good results. We don’t get it perfect every time by any stretch. But we are a performance oriented business and we have got a good platform to work from, and I think from that we have been putting up some good results and we are very optimistic about the growth potential for this business certainly over the near-term, the median-term, and the longer term, and we will keep working hard at that.

We were joking earlier in small group meeting, every Christmas that I have been associated with going in to the holiday season, I think people are kind of, oh, this is going to be the toughest Christmas ever, and it’s going to be more promotional than ever, and maybe that’s true, maybe that’s true.

But if you have got brands and categories where you can differentiate and what you sell is unique, that puts you in a pretty good spot to deliver pretty well. So, we are focused on the stuff we can control. Other questions? Yes.

Unidentified Analyst

(Inaudible)

Stuart Burgdoerfer

Yeah. I think we will stay steady, and we are being pretty aggressive than we were going to open about 100 Victoria’s Secret, Beauty & Accessories stores this year, I mean, that sounds pretty aggressive to me, adding 100 doors.

We will focus on particular geographies. So, we are not -- this is not about flag planting. You have one Victoria’s store in the most prominent city in a given country, but rather how do you establish real scale in key markets like the U.K., and so I wouldn’t expect that it’s from London to Paris to Milan to a city in Italy, it’s more about how do we really build a substantial business in the U.K.

Certainly, China is the big opportunity that many are focused on. We are all aware of the population there and the desire for western brands and the potential there. We have open three stores in Hong Kong there, Victoria’s Secret Beauty and Accessories stores. They are doing very well. So there is a various substantial opportunity there.

But I would say, we will be trying to be steady and thoughtful, and the business in the U.K has been good. The business in the Middle East has been very good. So, consumers are reacting well to what we are doing.

Unidentified Analyst

(Inaudible)

Stuart Burgdoerfer

It’s more likely that they will be licensed or franchised. The logic is that, where we have high, high confidence based on culture and familiarity, more likely to be company owned, where we really need to tap into local knowledge.

So (inaudible) recently in Kuwait and Dubai, I mean, those are different places than the United States. The Limited Brands was a U.S based retailer for its first 45 years. We just went into Hawaii around three years ago.

And so, I think we’re trying to be respectful of what we know and what we don’t know. And to work with partners where we really need local knowledge as it relates to real estate, hiring people, leading store associates, et cetera.

And certainly you know our experience in the Middle East with [L'Arche] (ph) has been a positive one where we partnered well with them to execute our business at retail. So I think we’re trying to be thoughtful of kind of what we know and what we don’t know and where there is more unfamiliarity in terms of culture and politics, environment, et cetera. Try to tap in the local knowledge there, and that is what most people do. Other questions?

Unidentified analyst

When we look at your platform in (inaudible), we know that areas where you feel that where you could perhaps you can accelerate that growth by division or do you feel that platform (inaudible)?

Stuart Burgdoerfer

Well, it’s a good question. We’re very confident, time will tell, but we are very confident in the growth opportunity for Victoria's Secret and Bath & Body Works and La Senza assuming we continue to see the progress that we have been seeing recently in Canada and those opportunities are very significant, and so we don’t see any need for any M&A activity.

One other things that we learn from having 12 or 13 brands 15 years ago is you really want to have leading brands and good categories and focus on those and really maximize the potential of those businesses versus spreading yourself to that. So it’s been a good strategy for us. We think there is a lot more growth in front of us. Other questions?

Unidentified Analyst

(Inaudible)

Stuart Burgdoerfer

Tim, do you want to take that?

Tim Faber

Sure. Essentially two things slightly better ratios than that, more importantly a commitment to remain investment grade -- to target remain investment grade.

Stuart Burgdoerfer

Other questions? Great. Thanks for coming. Appreciate it. Have a great conference and don’t forget to go shop in this fall. All right. Thank you.

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