Limited Brands, Inc. 1Q08 (Qtr End 5/3/08) Earnings Call Transcript

| About: L Brands, (LB)

Limited Brands, Inc. (LTD) F1Q08 Earnings Call May 22, 2008 9:00 AM ET


Amie Preston – Vice President Investor Relations

Martyn Redgrave – Executive Vice President, Chief Administrative Officer

Stuart Burgdoerfer – Executive Vice President, Chief Financial Officer

Sharen Turney – Chief Executive Officer Victoria’s Secret

Diane Neal – Chief Executive Officer Bath & Body Works

Tom Katzenmeyer - Senior Vice President Investor Relations


Paul Alexander - Merrill Lynch

Brian Tunick - J.P. Morgan

Neely Tamminga - Piper Jaffray

Paul - Credit Suisse

Lauren Levitan - Cowen and Company

Jennifer Black - Jennifer Black & Associates

Todd Slater - Lazard Capital Markets

John Morris - Wachovia Capital Markets, LLC

Dana Telsey - Telsey Advisory Group

Marni Shapiro - Retail Tracker

[Dana Tillen] - Banc of America

Richard Jaffe - Stifel Nicolaus & Company, Inc.

Kimberly Greenberger - Citigroup


Good morning. My name is [Kristi] and I will be your conference operator today. At this time I would like to welcome everyone to the Limited Brands first quarter 2008 earnings conference call. (Operator Instructions)

I would now like to turn today's conference over to Amy Preston, Vice President of Investor Relations. Please go ahead.

Amie Preston

Thank you, Kristi. Good morning, everyone, and welcome to the Limited Brands first quarter earnings conference call for the period ending Saturday, May 3, 2008.

As a matter of formality I need to remind you that any forward-looking statements we may make today are subject to our safe harbor statement found in our SEC filings.

Our first quarter earnings release and related financial information are available on our website, This call is being taped and can be replayed by dialing 1-866-NEWS-LTD. You can also listen to an audio replay from our website.

Martyn Redgrave, EVP and Chief Administrative Officer, Stuart Burgdoerfer, EVP and CFO, Sharen Turney, CEO of Victoria's Secret, Diane Neal, CEO of Bath and Body Works, and Tom Katzenmeyer are all joining us today.

After our prepared comments, we will be available to take your questions for as long as time permits. As a reminder, so that we can speak with as many of you as possible, it's important that you limit yourself to one question.

Thanks, and now I'll turn the call over to Martyn Redgrave.

Martyn Redgrave

Thanks, Amie, and good morning, everyone.

I'd like to begin our call today by providing an update on several of our strategies and initiatives, then Stuart will take you through our first quarter results and our outlook for the rest of the year. And then finally Sharen and Diane will discuss Victoria's Secret and Bath & Body Works in more detail.

As we anticipated, the retail environment continued to be very challenging in the first quarter. I'm sure I don't need to remind you about the price of gas, the mortgage and the credit crisis, or the recent negative trends in consumer sentiment. As I've said for the past year, these represent very strong headwinds that we are continuing to manage through.

Nevertheless, we are very pleased that we exceeded our earnings guidance for the quarter, and we continue to manage the business very conservatively with respect to inventory, expenses and capital investments.

At the same time, we are aggressively focusing on bringing compelling merchandise assortments, marketing and store experiences to our customers to maximize our upside, and we're continuing to be opportunistic whenever we see openings to move forward in this stormy environment. We also continue to execute against the strategy that we first laid out for you in the fall of 2006.

Today we're going to take a little bit more time with Sharen and Diane to really just dive into and discuss Victoria's Secret and Bath & Body Works, therefore I'm not going to go into all of the components of our overall strategy this morning, but I would like to highlight a few key things.

First, with respect to our real estate strategy, we remain committed to our initiatives to increase the footprint of our Victoria's Secret stores and open new Bath & Body Works stores. As you know, we have substantially slowed the pace and timing of this real estate expansion and have now reduced the total planned projects for 2008 by 35%. But we do continue to believe that the results and the size of the opportunity indicate that this should be an important part of our future plans.

We know that you're very interested in the rationale for and the results from this initiative, so Stuart is going to spend some additional time today taking you through this in a greater level of detail in his remarks.

Now, another major part of the strategy is our initiatives to support the growth of our business through enabling infrastructure and technology. As you know, we opened our new distribution center last August to support the growth of our Direct business. As we've discussed over the past six months, it took us longer than expected to get the new Direct distribution center up to capacity. This resulted in a significant incremental cost in the last half of last year and forced us to proactively take steps to reduce demand in the fourth quarter.

Now we're continuing to make significant progress in bringing the Direct DC up to speed. We're now able to fully meet the volume demands of the business, and we are operating it close to our targeted accuracy levels. At the same time, we are implementing expansions of our material handling and systems capabilities and are focusing on improving our overall efficiency and productivity within the DC throughout the balance of this year.

As a result, in the first quarter we were negatively impacted by higher costs associated with the lower accuracy levels, running the DC and implementing these improvements. We expect that those costs will continue to have a negative impact throughout the remainder of the year, although we do not expect them to have anywhere near as material an impact as they did last year as we continue to make further progress.

With respect to our technology initiatives, we implemented the new supply chain systems at MAST, our sourcing and production company, this past quarter. To date, this implementation has proceeded according to our expectations. We expect to implement these same systems at our Victoria's Secret stores business in 2009.

I'd like to conclude with an update on our plans for international expansion, another key part of our strategy. We continue to put a lot of effort into pursuing the international opportunity, evaluating markets, partners and our overall approach and laying the groundwork in the supply chain logistics and other areas that are required for us to take our brands to the rest of the world.

Our first area of focus is Canada, and we are on track to open six BBW stores in Canada this fall with another four opening in early spring 2009. We are also continuing to expand our international business through growth in our Victoria's Secret beauty business in the Middle East and duty free shops around the world, and our Direct channel business for all of our Victoria's Secret products and sub-brands.

Over the past couple of months we also continued to build our talent, with the addition of [Ralph Janssen] to our international team. Ralph will be joining us from Triumph International, where he was the Chief Operating Officer for Asia Operations for this global intimate apparel company.

Ralph will join with Martin Waters, who has now started work with us following his 17 years with Boots International, and our other key international leaders to take our brands to the rest of the world.

As we said on our February earnings call, we believe we will be putting actual deals in place this fall and laying the groundwork for stores to be opened in 2009.

Now before I turn it over to Stuart, I'd like to make some comments on La Senza's first quarter performance, which is part of our international business and one of my areas of responsibility.

Our first quarter results at La Senza were consistent with our expectations. First quarter sales were $112.1 million and comps were flat as the incremental growth from our Victoria's Secret beauty products in Canada offset declines in core lingerie and La Senza Girl.

Operating income dollars and rate were both up significantly to last year. The rate increase was primarily driven by a significant increase in the merchandise margin rate and SG&A rate leverage.

So with that, thank you, and I'll now turn it over to Stuart.

Stuart Burgdoerfer

Thanks, Martyn, and good morning, everyone.

Turning to our first quarter performance, we reported earnings of $0.28 per share versus $0.13 per share last year. This year's result includes a pre-tax gain related to the sale of a non-core joint venture of $128 million, or $0.24 per share, and a pre-tax charge related to the impairment of another noncore joint venture of $19 million, or $0.05 per share. Our earnings per share excluding these items was $0.11.

Although our comp result is at the low end of our expectations for the quarter, the sales miss was more than offset by a higher than anticipated merchandise margin rate and aggressive expense management.

First quarter net sales were $1.925 billion versus $2.311 billion last year, and comps were down 8% against a 3% comp increase, excluding apparel, last year.

Gross margin decreased 110 basis points to 33.3%. The net of the positive effect of the elimination of the lower-margin apparel business offset by the negative effect of the recognition of mass sales to Express and Limited stores was a negative impact of about 160 basis points. Gross margin excluding this impact was up roughly 50 basis points.

By segment, the gross margin rate at Victoria's Secret was down to last year as an improvement in merchandise margin was offset by buying and occupancy deleverage.

At Bath & Body Works, the gross margin rate was up, reflecting a significant improvement in the merchandise margin rate. It was partially offset by deleverage in the buying and occupancy rate.

The SG&A rate improved by 160 basis points. The net impact of the apparel divestiture, including the recognition of mass sales to Express and Limited stores, drove 170 basis points of improvement. Excluding this impact, the SG&A rate deleveraged by 10 basis points on the negative 8 comp.

Total operating income excluding the $109 million net gain from the two previously mentioned special items declined $8.1 million to $100.4 million. Excluding apparel operating income of $13 million last year, operating income increased by $4.9 million.

By segment, the Victoria's Secret segment increased by $16.9 million to $149.2 million. Bath & Body Works declined by $4.7 million to a loss of $5.6 million. And the Other Segment expense increased by $7.2 million to a loss of $43.1 million. This increase was the result of a decline in mass profitability that was partially offset by a decrease in corporate overhead costs.

Retail inventories ended the quarter down 28% per square foot at cost.

We repurchased 7.1 million shares of stock in the first quarter for $122.4 million. At the end of the first quarter we had 27.4 million remaining in our current 500 million program.

Now turning to our earnings outlook for the second quarter, we expect second quarter earnings per share of between $0.16 and $0.20 versus last year's adjusted $0.20 result. We estimate that the second quarter comps will be down in the mid to high single digit range on top of last year's positive 1 comp excluding apparel.

We estimate that the second quarter gross margin rate will be roughly flat. Consistent with the first quarter, the apparel divestiture, including the recognition of mass sales to Express and Limited stores, resulted in a negative impact to the second quarter gross margin rate. We expect merchandise margin rates to improve at both Victoria's Secret stores and Bath & Body Works.

We estimate that the SG&A rate will improve in the second quarter, driven by the impact of the apparel divestiture, including the recognition of mass sales to Express and Limited stores.

Inventory levels in the second quarter will continue to be down to last year, although the rate of decline will moderate as we lap last year's decreases. We expect to end the spring season with retail inventories per square foot down in the mid to high teens.

For the full year 2008, we are projecting earnings per share of $1.38 to $1.58 excluding the $0.18 of onetime items in the first quarter.

We have revised our full year comp guidance from flat to down low single digits, reflecting the current challenging

top line trends of the business. However, consistent with the first quarter results, we are working hard to maximize our opportunities with respect to merchandise margins, and we continue to aggressively manage expenses.

Therefore, for the full year versus last year's adjusted $1.21 earnings per share result, we expect an improved gross margin rate driven by improved merchandise margins at both brand segments and an improvement in the SG&A rate.

The impact of the apparel divestiture drives a negative impact to the full year gross margin rate and a favorable impact on the SG&A rate.

Now I'd like to spend some time reviewing our real estate initiatives. As we mentioned on the last earnings call, in light of the current difficult environment, at the beginning of this year we reduced the number of planned projects by roughly 25%. During the first quarter we continued to evaluate our plans with a view of focusing on the highest priorities and have further reduced the number of planned projects by about 12% for a total reduction of nearly 35%.

We are now projecting 2008 capital expenditures to be about $60 million below our previous estimate or between $515 and $540 million. 2008 total capital expenditures will be down more than $200 million from the 2007 actual.

Looking at our plans by brand, we now expect net square footage growth at Victoria's Secret of about 7% versus our prior estimate of 8%. About 60% of the gross square footage increase is driven by the opening of 43 new stores, and the remainder is the result of 66 remodels. The new stores, which generate strong returns, are primarily located in specialty centers and are an average size of 6,700 selling square feet.

We also plan to open four additional Victoria's Secret clearance stores, which will bring the total to six. These stores are located in the best outlet centers and provide an additional means of clearing excess inventory.

Of the 66 expansions, about 80% of those are located in top malls, and over 80% are occurring at least expiration. It is important to note that these stores are highly productive, with sales per square foot roughly 25% higher than the balance of stores in top malls. Because they are at the end of their lease terms, they are also earning higher returns on sales. We believe that investing in these stores to remodel to the current store design and to expand and to create the capacity for current and future category growth such as Pink, Beauty, Sport and Accessories, is the right thing to do for the long-term benefit of the brand.

In 2007, we expanded 112 stores by roughly 50%. While initially we were seeing an incremental sales growth from these stores of roughly 30%, that has since declined to just under 20%, consistent with the overall decrease in the total business. The projected investment returns continue to exceed our hurdle rates. As we have commented on previously, real estate activity will drive operating income dollar growth in 2008, but also will reduce operating margin rates in the near term.

At Bath & Body Works, we estimate net square footage growth in 2008 of about 4% versus our previous estimate of 5%. Ninety percent of the incremental growth in square footage is driven by the opening of 84 new stores. A little over a third of these stores are located in power strip centers, about a quarter are in specialty centers, and another quarter are in outlet centers. As with Victoria's, these new stores generate high returns.

We also plan to remodel 75 Bath & Body Works stores which are primarily located in top malls. Over 90% of the remodels are occurring at lease expiration. The majority of these stores are being remodeled to the newer design. The average size of the remodeled stores will increase modestly by about 300 selling square feet or 14%.

Our square footage growth in Canada is expected to increase by roughly 15%, primarily through the opening of 19 new La Senza locations and 6 Bath & Body Works stores.

So the sum of all this activity adds up to about 7% square footage growth for the total company in 2008. The majority of our capital spending budget, roughly 75%, is driven by this real estate activity. About 15% of the capital spending budget relates to investments in technology initiatives, and the remainder of our capital spending budget relates to home office and other investments.

Before I turn it over to Sharen, I would like to close by commenting on our liquidity and cash position. In addition to the $124 million in after-tax proceeds we received from the sale of the joint venture in the first quarter, we received a $41 million cash distribution from Express. We are projecting a year end cash balance in excess of $1.2 billion.

Our cash position, along with additional amounts available under our revolving credit facilities results in very strong liquidity which is more than sufficient to fund our working capital, our capital expenditures, dividends, share repurchases, and any other foreseeable needs.

Thanks, and now I'll turn the discussion over to Sharen.

Sharen Turney

Thank you, Stuart.

Before I get into the numbers for Victoria's Secret, I'd like to offer some thoughts about our overall performance in the quarter. Although comps were below our expectations, I think our performance in a tough environment this quarter shows the resilience of the Victoria's Secret brand.

In our last earnings call I had talked about continuing to affirm our brand heritage and our authority in bras and lingerie. Our brand tells a beautiful and empowered story, where women feel sexy, sophisticated, forever young and ultra-feminine. Delivering that story consistently remains our focus across the brand, acting as one brand. And we're making progress, but it's a long-term effort.

We are committed to improving performance this year, and to do that we have distilled our strategy down into specific actions we'll take in 2008. And I'd like to highlight them for you and talk a little bit about how we're progressing.

The first one is what we call growth from the core, which is about regaining sales momentum in our core categories  bras, sleepwear and panties - always innovating, always focusing on new. We're beginning to see increased levels of sophistication, quality and fashion leadership in the assortment, and there's much more newness in the pipeline.

To put even more emphasis on innovation, we also recently reorganized our design talent and added [Janie Schafer] as our Chief Design Officer, and we're very excited about that change.

We are testing a number of new concepts, including something we're calling bra authority. To talk a little bit about the traction that we're getting, we had two very strong bra launches, including BioFit, which was our best ever. However, we did not see growth in the total bra business, in part because we intentionally chose not to anniversary the heavily promotional activity of last year.

I feel good about where we are right now in reinventing sleepwear. You'll begin to see some of the results in the product beginning after our Semi-Annual Sale with the strength of the assortment building through holiday. And I would even say that in reinventing sleepwear, it's really about loungerie versus using the word sleepwear. And our work to gain new traction in panties is just starting, but even though it's early, there are positive signs.

Our second area is real estate and space optimization. We have a team solely dedicated to this work, which is about finding out how we get the most from existing fleet, how we optimize the space in our stores, and how we tier or segment our fleet, the right adjacent feet, the right assortment, the right inventory level, all to get the best return on our real estate investments and improve our comps. But there is still much to be done.

Our third area is assortment, product and financial architecture. Obviously, this is closely related to our real estate work. You all know that we have added new products and categories to our assortments over the years. Bras are expanding in terms of [frames]. Pink is expanding. VSX, which is the Sports line, is testing; Swim, [Accessories], just to name a few. So we are now taking a careful, very strategic holistic look at how we organize, plan, price and deliver that assortment so we can consistently maximize the incremental value and support our margin, controlling inventory and focusing on the few that produce the many.

Finally, we are focusing on regaining the sales momentum in Direct, and I'm very pleased with the progress in this area. The work has two parts - restoring the client file and improving shipping capacity, and both are doing well.

There are some specific ways we're turning our strategy into tactics that we believe will change business this year. I hope hearing about them provides some added context for the brand's direction.

As I look back at last quarter, I recognize we could have allowed external factors or the significant organizational changes we've undertaken to distract us, but we didn't. And I'm proud of that. We stayed close to our customer and committed to the fundamentals. That paid off in an increased merchandise margin, well-managed inventory and expense control.

Of course, there are still challenges. There was softness in the larger bra assortment, and Beauty continues to trend softer for the most part due to the lack of newness.

Even so, I believe difficult times rebuild the core strength of a business, and to me, Q1 provided that even if the economic environment is weak, our core is strong.

Let's talk about the numbers for the total Victoria's Secret segment, including La Senza.

Sales increased $46.5 million or 4% in the first quarter to $1.3 billion, driven by new and expanded stores and growth in the Direct channel. Comp stores decreased 6% against a 2% comp last year. Total segment operating income increased $17 million or 13% to $149 million and increased 90 basis points as a percent of sales.

Let's move to the view by Victoria's Secret channel. In Q1, Victoria's Secret stores comps were down 7%, slightly below our expectations. Our real estate activity drove incremental sales growth and total sales were down only 1% to $750.7 million.

As I mentioned, BioFit was a major success. It surpassed our expectations and confirmed what we believed about the sophistication of our customer. She wants new, but she also wants elevated and elegant products. BioFit clearly matched her aspirations. We were also pleased with the results of our [inaudible] Angel Bra launch, which met expectations.

At Pink, we saw strength in all top categories, Dresses and Accessories. We believe Pink is well positioned for the second quarter, including a compelling short promotion supported by an incremental [resemptive] print campaign.

In mid-February we began offering swimwear in 350 stores. We were pleased with the Swim performance in the stores and found it to be largely incremental to sales. And we are continuing to explore just how big an opportunity Swim can be and how far it can go.

VSX is performing to expectation, and we continue to be confident about its potential. We are testing a full line in 30 stores, and we are using the results to continue to evolve the concept.

Now we've seen some positive signs in Fragrances, launches like Ooh La La and Heavenly Kiss and in seasonal launches like Very Sexy Now. We continue to be disappointed in the overall Beauty performance.

A definite [inaudible] here about Beauty. You probably know that last quarter we brought in Shashi Batra as the new leader of Beauty. I believe most of you are familiar with Shashi's experience. He's an industry veteran, a true beauty merchant. Shashi is still on board, and so we're already feeling excited about the ideas and direction he and his team are beginning to establish for the Beauty business.

Let's go back to the Store channel results. Operating income increased in both dollars and rates for the quarter. We have chosen to be less promotional, and our inventories are down significantly to last year. We are managing this as a priority. As a result, we achieved a significant improvement in our merchandise margin rate versus last year.

[Inaudible] occupancy expense increased versus last year, driven by increased risk in occupancy charges associated with our real estate strategy. The increased expense drove rates to deleverage. As a result, the gross margin rate was roughly flat to last year.

Finally, for the Store channel selling, general and administrative expense dollars were down to last year and leveraged as a percent of sales, driven by a reduction in marketing expense. Overall, we continue to focus on and aggressively manage expenses.

Now let's move to the Direct channel. In Q1, sales at Victoria's Secret Direct were $381 million, up 11% to last year. Sales growth was diversified and driven by strength in bras and spring merchandise such as dresses and swimwear. Direct saw increases to last year in almost every merchandise category.

And in sales recovered from the fall of 2007, Direct experienced remarkable growth in the client file. We generated double-digit growth across the board, with a particular strength in the top-tier customer level.

Operating income dollars were up slightly to last year, and the operating income rate decreased as a percent of sales. The rate decline was driven by a decrease in the gross margin rate partly offset by SG&A expense leverage. The decline in the gross margin rate was a result of increased markdowns to clear the holiday seasonal product and increased costs related to the DC stabilization. That said, the results of the Direct clearance strategy exceeded expectations and led to inventory levels being down to last year.

You all know we've been working to improve our shipping capacity at our newest distribution center. We're very pleased with our progress, and as Martyn mentioned, we have built on gains we made in the fourth quarter. We are on track to reach our capacity milestones and are continuing to improve our productivity level, but we still have a way to go before we are hitting our holiday accuracy and capacity levels, so work continues.

Direct is also continuing its tradition of generating exciting new ways for the customer to connect with the brand, including testing mobile this spring season, which we're very excited about. So good news in the Direct channel.

That's Q1. And before I wrap up, I do want to share a couple of things we're excited about for the upcoming quarter. After Semi-Annual Sale, we'll show more of the ultra-feminine beautiful product I talked about earlier in our new fashion assortment. We are very excited about a program that we're working on for Pink that you will hear more about in the next month or so. Pink's presence on the Victoria' will increase in the coming quarters, too. And we anticipate international sales at Direct will continue to rise, and as a result, we plan to launch our website in Spanish. That's expected to happen in the next several months.

Those are just a few things we are looking forward to in the short term at VS. So thank you, and now we'll turn it over to Diane.

Diane Neal

Thank you, Sharen, and good morning, everyone.

Despite difficult economic conditions and unsatisfactory comp results this quarter, the details of which I will take you through shortly, Bath & Body Works remained focused on a few key priorities in 2008 to reinvigorate the brand, create more brand consistency, and change the current negative sales and traffic declines.

Specifically, we're focused on three key priorities. First of all, building and growing and creating more newness, innovation and excitement with our key brands and businesses - C.O. Bigelow, True Blue Spa, Aromatherapy, our Signature Body Care line and our Home Fragrance business. Even though we did not have success with - even though we did have success with some of our product launches in the first quarter, we did not have enough newness and excitement to drive traffic and total brand performance.

Our biggest decline in the first quarter has come from our core Signature product line. We have very exciting plans to reinvigorate this brand in the back half of the year, and we'll be able to share more detail on this as we get closer to that timeframe.

Starting in the fall, you will see a shift in sophistication levels of not only our new product launches but how they come to life in stores through updated graphics, in-store marketing, and [inaudible]. In addition, we will have a greater emphasis on accessory and products that animates all of our new product introductions. There will also be a significant increase in the amount of newness in the fall versus this spring and also last fall. This will start in August and will continue throughout the entire fall and holiday season.

And operationally, we are testing, analyzing and putting plans in place to segment our fleet by customer, market and specific product opportunities. The [inaudible] knowledge and infrastructures that we implemented last year will greatly aid in our efforts to achieve this segmentation initiative.

So at this time I would like to take you through our first quarter financial results.

First quarter comps at Bath & Body Works were down 11% versus a 5% increase last year. Total sales for the quarter were down 5% or $23 million versus last year. The 6% spread between comps and total sales represents sales from our new stores.

Sales were below expectations driven by continued softness in store traffic.

Despite the first quarter sales decrease to last year, the gross margin rate increased versus last year, driven by an increase in merchandise margin rate partially offset by deleveraging of fixed buying and occupancy fee expenses.

The increase in merchandise margin rate was primarily driven by improved end-to-end inventory management as our promotional levels were consistent with last year. Consistent with prior quarters, we continue to experience deleveraging of fixed buying and occupancy expenses associated with store real estate activity.

For the quarter, SG&A expenses were flat to last year on a dollar basis due to aggressive expense management, but deleveraged on a rate basis due to negative comp sale trends.

For the quarter, operating income versus last year declined $5 million to a loss of $6 million. Profit rate was down 120 basis points to last year, primarily driven by the expense rate deleverages on declining sales.

During the quarter, performance of our ecommerce business met expectations. We continue to view the Direct channel as both a revenue generator and marketing vehicle for our brand and collection of sub-brands.

Looking ahead, we have a cautious outlook on the second quarter driven by continued softness in traffic that we have seen for Mother's Day and general and macroeconomic conditions. We will continue taking proactive measures to manage discretionary spending and inventories to mitigate the top line softness.

We are currently in our Welcome to Summer theme, featuring our C.O. Bigelow brand at the front of the store, focusing on the new Bigelow Mentha and [inaudible] fragrance body care products. Other newness featured during this theme is the limited edition of Pop Culture Body Care, with fun summer fragrances and newcomer scents from our Slatkin & Co. Home Fragrance brand.

Beginning the first week of June, we launch our Semi-Annual Sale, which, as last year, is planned to run for five weeks. We wrap up the spring season with our post-sale [inaudible] featuring our Fresh Clean fragrance collection for body and home.

With that, I will turn the discussion back over to Amie.

Amie Preston

Thanks, Diane. At this time we'd be happy to take any questions you might have. And again, just a reminder, in the interests of time and consideration for others, please limit yourself to one question.

And with that, I'll turn it back over to Kristi.

Questions-and-Answer Session


Thank you. (Operator Instructions) Your first question comes from Paul Alexander - Merrill Lynch.

Paul Alexander - Merrill Lynch

Could you guys give us a little bit more color on the rationale behind the decision to slow store growth, and how much is that related to the economy or other factors?

Stuart Burgdoerfer

Well, what we're trying to balance is, as, was laid out now a year and a half to two years ago, we do have a strategy, as Martyn articulated, a strategy to grow square footage in the United States based on our view of the sales, the profits, the return potential associated with that square footage growth.

With that said, we're aware and mindful of the general economic trends, and we are, as we talked about in prior calls, very closely monitoring the results of the activity that we're investing in, so specifically around expansions for the most part but also new stores.

And so it's about balancing risk, risk taking, considering the trend in the business and the environment that we're doing business in. So we're trying to strike the right balance.


Your next question comes from Brian Tunick - J.P. Morgan.

Brian Tunick - J.P. Morgan

Sharen, I was wondering if you could maybe talk a little about how you think growing Pink versus the core foundation business - I think from the analysts meeting or before you said maybe the focus was too much on Pink  and sort of how you're going to regain that spot as the number one or I guess growing the foundation business.

Sharen Turney

Success would look like both businesses would both have great growth. I think the core continues to have growth, and speaking about the Pink business, what we're looking at is expanded square footage. As we take our stores from 6,000 to 7,000 square feet to 10,000 to 12,000 square feet in some stores, Pink is basically getting the majority of that expanded space. Where they may be under 1,000, now we're looking between 2,500 and 3,000 square feet.

When you think about Pink as well, the opportunity in terms of growing adjacencies, such as the Accessory business, which is a focus for us as we go into this fall season - and if you've been to any of the stores, you'll have seen some of the accessories and luggage pieces of business - we still believe that we have not tapped into the bra business as much as we should into Pink. We see that as a growth opportunity. We do have today four freestanding stores, and we're excited about the learns that we're getting from those stores. And then as we talked about, we will be announcing some future opportunities for us later in the summer.

So I do feel like that there's still plenty of growth opportunity in Pink, and what we're actually doing in terms of the core business is where we started to get younger and almost overlap with Pink, we're really saying this Pink is focused to the 19-year-old customer and the core business is really focused on the 26year-old customer and really being more definitive about those lines.

And I think you'll start to see that as we come out of Semi-Annual Sale going into the fall season.


Your next question comes from Neely Tamminga - Piper Jaffray.

Neely Tamminga - Piper Jaffray

Hey, Diane, I hope I didn't miss this, but could you talk a little bit more about the skew productivity that you've been doing? I mean, I think given your Target background, that's certainly been an area of strength that you bring to the table, and I'm just wondering, as it relates to the fall launch schedule, what could we be looking for more from this division with your new leadership talent in that regard.

Diane Neal

Yes, Neely, actually we have, as you know, ran last fall and continue to run this spring assortment optimization tests. And we've taken that learning and we have implemented those learnings into our fall [wall] set, which is really the end of September for next year. And we've also looked at our seasonal launches as far as what is more productive versus last year in some of the things that we've tested.

The other thing about the assortment optimization test, it has greatly informed our segmentation efforts as we look forward to our specific - how we segment our stores by brand and by customer. It has been an extreme learning for us in that regard.


Your next question comes from Paul - Credit Suisse.

Paul - Credit Suisse

As far as the DC issue last year, what was the impact, if you can remind us, in the third quarter and fourth quarter in terms of the additional costs incurred and the lost sales and operating profits you think you suffered?

Martyn Redgrave

Paul, what we've said, a couple of things. It's difficult to estimate the exact impact on demand and sales because it's hard to say what the customer might have done if we hadn't the issues that we had. But we have said that we estimate that the total of all of the extra costs of running the center and the disruption to the business was in the range of approximately $80 million.

Paul - Credit Suisse

That's in operating profit?

Martyn Redgrave

In operating income impact in the fall of 2007.

Paul - Credit Suisse

And how about between the third and fourth quarter?

Martyn Redgrave

We don't have that broken out in any specific way.

Paul - Credit Suisse

And just one quick follow up. Sharen, how do you view the maturity of the Direct business? What's the ultimate size? How much is international, if you could provide that percentage?

Sharen Turney

Sure. The international business today roughly is about 10%, heavily in Canada and then throughout the world.

I think that although the Direct business is $1.5 billion, it's the fastest growing channel. I think that we will continue to see growth out of that channel. What you're going to see, as I look forward, is within the catalog business. We probably won't mail as many catalogs or pages. It will still be a very heavily integrated web-based business. The community piece is continuing to build and how do you play within the community, which is a new marketing target for us.

I think also how do you think about step size, like VS - you know we have and how we're linking that back to the mother ship, and I think there's some exciting things there.

One of the hottest things, I mean, it's amazing. We started to test this mobile, what I call mobile commerce, and it's just beginning touching in the water so, you know, it may not be a great experience but you actually get on your mobile phone and you can actually place orders and through Catalog Quick Orders. And it is amazing how many people have already responded to that test. I was blown away.

And as you know, you're starting to see a lot of that in Japan. As our technology and zones continue to upgrade in the United States, I still think that there's some interesting opportunities there.

I see nothing but a bright future for the Direct channel today.

Martyn Redgrave

Paul, I just want to be a little bit more helpful. Obviously, with the demand spike in the fourth quarter, most of the costs that I referred to hit the fourth quarter of 2007. And just to add another kind of helpful piece of information, we are anticipating disruption costs. We are incurring disruption costs in the spring of 2008. We're estimating those to be in kind of the range of $25 to $35 million in the spring of '08, which would not have been in the spring of 2007 because we didn't open the center until the fall.

And for the fall of 2008, obviously we're expecting the center to be stabilized. But we are continuing to incur slightly higher costs from a productivity perspective, so we are estimating kind of a $10 to $15 million range of what we call out of the ordinary costs.

Paul - Credit Suisse

Above and beyond last year?

Martyn Redgrave

No, no, no. Relative to our targeted levels of productivity. So just making the numbers very clear, fall of '07 kind of the $80 million range of total disruption costs; in fall of '08, $10 to $15 million range of total disruption costs, so for an improvement of, you know, that's $70 to $65 million.


Your next question comes from Lauren Levitan - Cowen and Company.

Lauren Levitan - Cowen and Company

I'm wondering if both Sharen and Diane could update us on their thoughts for operating margin targets for the brands, both in the near term with some of the headwinds you're facing in terms of traffic as well as some of the specific brand initiatives, and then longer term, if you could update us on thoughts around operating margin targets. Thanks very much.

Amie Preston

Lauren, as you know, we don't really provide guidance down to the brand or segment detail. I'm going to ask Stuart if he can give us some kind of general thoughts about that.

Lauren Levitan - Cowen and Company

Maybe even relative to historical levels would be helpful.

Stuart Burgdoerfer

Understand. So, for Limited Brands, Inc., we would expect over the next two to three years to improve operating margins significantly. As you know, we've historically, if you kind of isolate unusual situations, we've run at about a 10% to 11% operating margin historically with the apparel business in those figures. And we as a management team believe that there are several hundred basis points of upside to that Limited Brands, Inc. operating margin rate over the next several years.

And that's really how we're working it, because otherwise you've got to get into discussions of how we're allocating corporate overhead and lots of different things. What we're focused on is driving operating margin improvement for Limited Brands, Inc. And again, we think there's several hundred basis points of opportunity over the next two to three years.


Your next question comes from Jennifer Black - Jennifer Black & Associates.

Jennifer Black - Jennifer Black & Associates

Sharen, this question is for you. I wondered if you could talk about your training program at Victoria's Secret for bra fitting. How long does it take? Are these people dedicated bra fitters only, or do they also roam throughout the store?

Sharen Turney

We are in the process of actually changing how we are actually training our specialists. Years ago we did have a training program. I think, for whatever reason and I can't speak to it, we got off of that. We're actually reintroducing, kind of under the headlines of bra sorting, a very robust training program, going to the University of Victoria's Secret.

They will only be bra specialists, and it won't just be the one person in the fitting room that's trained. The entire store will be trained. There will different levels of graduation. And this is something new, and we actually have piloted this program. It is now fully implemented in two stores today, which is Houston Galleria and [Tuttle].

And we have great training materials. We also have materials for the customer. We've actually [inaudible] in both of those stores fitting for customers who were invited to come in, and it was very successful.

So I think that what you'll see on a go forward basis is that we will have much more robust training so that we can really deliver on our promise.


Your next question comes from Todd Slater - Lazard Capital Markets.

Todd Slater - Lazard Capital Markets

I'd like to know when you start taking applications for Victoria's Secret University. This is a question for Martyn. You've been agonizingly patient in exploiting the international opportunity. I understand why you're careful given how large it is, and you said you'd see some deals hitting the tape or we should see deals this fall. My questions are: Do you see opportunities for all the businesses, VS and even the sub-brands, Pink, Beauty, and also BBW? Second, outside of Canada, what other geographies are you targeting and most excited about in the near term? And third, are you still pursuing the capital light, margin right type of structure?

Martyn Redgrave

I figured you might want to know a little bit more about international. I think in terms of the order of priority on the brands, the three that we're most focused on would be Victoria's Secret, Pink and BBW. And we actually do think there is an opportunity for Pink as a freestanding brand outside of the United States. It's a different assortment model, a different sizing model, and [Les] is very engaged with us right now in thinking that through.

Canada is our number one priority, both in terms of continuing to grow the La Senza business and its international franchise business as well as introducing BBW, and we're continuing to think from a 2009 perspective about Pink and Victoria's Secret.

Beyond Canada, the key priority for us and for me in particular has been to get a couple of partners on board who have what I call been there, done that experience in the rest of the world and in the product categories that we specialize in. So Martin Waters, in terms of personal care and beauty. We have an executive, [Sandra Heppinheimer], who runs our Victoria's Secret Beauty business outside the United States who's been on board for a number of years but has a deep beauty background and experience around the world. And now Ralph Jannsen, who has a deep experience in intimate apparel around the world, Martin being German and Ralph being, you know, Swiss German. I'm mean, I'm sorry, Martin being British - sorry - and Ralph German.

So we're building a team that has the kind of experience that I think gives us the credibility in terms of taking our brands to the rest of the world.

The geographic priorities, it's hard for me to comment. The rest of the world kind of sets itself up as very developed markets like Japan and the U.K., Continental Europe, and less developed from a competitive perspective markets, like the Middle East, Hong Kong, Singapore, China, Mexico, Brazil. Those are all places that we're spending time in and looking at.


Your next question comes from John Morris - Wachovia Capital Markets, LLC.

John Morris - Wachovia Capital Markets, LLC

My question is for Diane. Diane, direct mail marketing promotions on a year-over-year basis in terms of mailings and planned promotional level, can you tell us what that looked like this spring versus last year and what you're planning for the fall season in that regard? And then also just a lot of focus on newness, which is really admirable, the numbers of A and B launches this year versus last year? I know you don't want to go into specifics, but give us a little more flavor as you look into the back half.

Diane Neal

Overall promotional strategy for the spring has been about flat to last year. [inaudible] discount started out shallower in the beginning of the first quarter. We got a little bit deeper as we got to Mother's Day. The CRM activity is basically, the amount of mailings are down to last year but we hit a higher segment of return customers, so we feel the overall traffic generated is from that. It's probably flat to last year.

And also it'd be similar as we get into the fall. However, we are looking at opportunities for mailings to new customers as well as some of our lost customers, so we're looking at some other opportunities with our CRM activity.

And then as far as newness, without getting into specifics the only thing I can really tell you is that we've got about double the amount of newness in fall of '08 versus fall of '07, not only in product launches but some of the fashion accessories that we're buying.


Your next question comes from Dana Telsey - Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Can you talk a little bit about the gross margin and the opportunity given that I believe some of the inventory reductions are being anniversaried? And then on the SG&A front go forward with some of the improvements that you've been seeing, what are the levers for additional SG&A as you look at through the balance of the year?

Stuart Burgdoerfer

On gross margin, we would expect to continue to have merchandise margin rate improvement for the balance of the year, and offsetting that, as was the case in the first quarter, there is B&O - buying occupancy - deleverage, and that can be compounded based on, obviously, what our sales result is. So that's where we are on that, and certainly it's better management of inventory that's contributing meaningfully to that result.

On SG&A, as we've talked about in prior communications, we have taken tough action there last summer. A big contributor to the result this quarter was the ongoing disciplined management of expenses. And we do continue to look at additional opportunities in the form of home office headcount, technology related project spending, etc.

We don't intend to reduce expenses in a way that would lessen the customer experience, so we're focused on what we would call more discretionary overhead and project-related spending, and that focus will continue really for the foreseeable future.

Dana Telsey - Telsey Advisory Group

Any initial thoughts on 2009 expansion?

Stuart Burgdoerfer

No. No, we're working hard to deliver a good '08, and we'll get more focused on modeling assumptions for '09 as we move through the year.


Your next question comes from Marni Shapiro - Retail Tracker.

Marni Shapiro - Retail Tracker

Can you talk a little bit about the SG&A line? You've talked about managing the expenses very tightly, but certainly at Victoria's Secret it's a very high staff, customer service business and BBW is very skew intensive, so could you talk about where those cuts are coming from if not payroll.

Stuart Burgdoerfer

There was some decline in marketing, as Sharen outlined, in the first quarter for the Victoria's Secret business yearonyear. We managed that carefully, recognizing the trade-off with sales.

But again, we're really looking at home office spending, project-related spending is the areas of continued scrutiny and opportunity.

Marni Shapiro - Retail Tracker

It's not hitting the stores?

Martyn Redgrave

No. No, we're doing natural flex and that's it.


Your next question comes from [Dana Tillen] - Banc of America.

Dana Tillen - Banc of America

[break in audio] If you cut SG&A or marketing at Victoria's Secret in the first quarter, should we think that will continue going forward? And also, what comp does the business need to get leverage on buying and occupancy? And then lastly, can you just discuss in a little more detail the other, because I would have thought you would have seen more improvement in that line.

Sharen Turney

I think that what you're going to see in the VS marketing is that we'll probably be flattish in the second quarter, but we will be up in the fall season. The reason we'll be up in the fall season is we're adding another launch. So this year we are adding another launch to our calendar, so we will be looking at some increase in terms of advertising. We're also seeing just the cost of advertising going up, but we're trying to leverage that and be very specific. But you will see marketing go up slightly on a dollar basis as we go into the fall season.

Stuart Burgdoerfer

Dana, on the comp to leverage the B&O, it's more complex than what I'd call a normal analysis given our investment in real estate that we've talked about. In fact, we haven't penciled a precise number on that, but what I would tell you is that the comp necessary to lever B&O is higher than it would be in a steady state situation given the real estate strategy that we've articulated.

With respect to other, our overhead reductions were largely offset by a decline in MAST operating income related to the roll off - related to the Express and Limited stores roll off of business and the reduction in other third-party business concentrated on a particular customer.


Your next question comes from Richard Jaffe - Stifel Nicolaus & Company, Inc.

Richard Jaffe - Stifel Nicolaus & Company, Inc.

A follow up on the SG&A savings and the ad spend plan for this year by division, could you talk about year-over-year change in the ad spends and also in the channels you'll be advertising in for both those brands?

Stuart Burgdoerfer

I can help with some general direction. Marketing in total is going to be roughly flat in aggregate year-on-year for Limited Brands on a rate basis. So in terms of your overall question about our level of marketing investment, it's roughly flat year-on-year on a rate basis.

Richard Jaffe - Stifel Nicolaus & Company, Inc.

Is that the same for both divisions?

Stuart Burgdoerfer

We're not going to go quite that specific. I think Sharen gave you some color on Victoria's. So a Q1 reduction and relatively flat beyond that. But that's about all we're going to.


Your last question comes from Kimberly Greenberger - Citigroup.

Kimberly Greenberger - Citigroup

I was hoping, Stuart, that you could comment on the reduction in some of your real estate initiatives. Is it that you are raising the bar on the expected return of those projects or you're pushing more of them toward lease expiration? We're just trying to understand your thinking on this.

Stuart Burgdoerfer

Well, I think you've kind of hit on the key thing. So one aspect of it, an important aspect of it, is how many we do before lease expiration. And as I outlined, you know, the substantial portion of those are being done at lease expiration, but that is certainly one aspect of it that we look very closely at.

And then the other piece is really how large we make the stores and how much we invest in the stores is another piece.

And then the last is around new store project count, which we have also taken down, again, just managing relative risk trade-off there, a balance between the incremental sales and profits with the relative return of those new stores.

So those really are the variables.

Amie Preston

Okay, thanks, everyone. We appreciate your participation, and we thank you for your continuing interest in Limited Brands.


This does conclude today's conference call. You may now disconnect.

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