Bath & Body Works Inc (BBWI) 2005 Q4 法說會逐字稿

Welcome to Limited Brands Inc. fourth quarter earnings release conference call. All participants have been placed on a listen-only mode until the question and answer session. [OPERATOR INSTRUCTIONS] Today's conference is being recorded. If you have any objections you may disconnect at this time.

I would like to introduce Mr. Tom Katzenmeyer, Senior Vice President of Investor, Media, and Community Relations. Sir, you may begin.

Thank you. Good morning, everyone, and welcome to the Limited Brands fourth quarter earnings conference call for the period ending Saturday, January 28th, 2006.

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 fourth quarter earnings release and related financial information are available on our website, limitedbrands.com.

Also, this call is being taped and can be re played by dialing 1-800-337-6551 followed by the passcode 583. You can also listen to an audio replay from our website.

This is who's with me this morning: Len Schlesinger, our Vice Chairman and COO; Martin Redgrave, EVP and CAO; Ann Hailey, EVP and CFO; Grace Nichols, CEO, and Mark Weikel, COO at Victoria's Secret stores; Neil Fiske, CEO, and Tom Fitzgerald, COO at Bath & Body Works; and Ken Stevens, CEO of Express are all here, as is Amy Preston.

After our prepared comments we will be available to take your questions for as long as time permits. Again, we plan to run the call for one hour, until 9 a.m.. So that we can speak with as much callers at possible, it is important that you limit yourself to one question. I will remind you about that again later.

And now I will turn the call over to Ann Hailey.

Thank you, Tom. Good morning, everyone.

Overall we were pleased that we exceeded our initial earnings per share guidance of $1.00 for the fourth quarter by $0.05. In addition to the $1.05, we delivered upside totaling $0.23 per share, bringing our reported results to $1.28 per share.

First, we recorded a favorable one-time tax benefit of 77 million or $0.19 per share related to the repatriation of foreign earnings under the provisions of the American Jobs Creation Act. This repatriation was enabled by final approval of our negotiated agreement with the IRS. This matter has been previously disclosed in our SEC filings. Also, in conjunction with the settlement we recorded interest income of $40 million or $0.06 per share.

The second item during the fourth quarter was that we recognized $30 million of revenue and operating income, or $0.04 per share, related to gift card breakage at Bath & Body Works and Express. The gift card breakage amount recognized was based upon analysis of historical redemption patterns and represents the gift card balances which we believe are unlikely to be redeemed. This is the first period in which we've recognized gift card breakage. Therefore, the $30 million breakage income related to gift cards relates to the cards sold since the inception of the gift guard programs at Bath & Body Works and Express. We will recognize breakage at our other divisions once we have adequate historical data.

Finally, in connection with our conversion to new merchandise systems this year, we elected to change our inventory valuation method from the retail method to the weighted average cost method during the fourth quarter of 2005. Under the retail method, we recorded a charge to cost of goods sold for all inventory on hand based upon actual and estimated permanent reductions in retail selling prices for the season.

Under the cost method, we do not recognize any impact of reductions in retail selling price until the merchandise is actually sold to the customer or until we expect to sell the merchandise below original cost. We believe that the cost method will improve the organizational focus on the actual margin realized on each merchandise sale. Just as importantly, as we have shifted our business focus to intimates, beauty, and personal care, we believe the cost method better reflects the characteristics of these businesses and is consistent with the practices of our competitors.

Our conversion to cost accounting has a number of impacts on our results. First, the cumulative effect of the change of $0.04 per share will be recorded as of the beginning of 2005.

Second, while the change has only a penny per share impact to our full year results, the timing differences in mark-down recognition shifts earnings between quarters. This timing difference results in a decrease in fourth quarter earnings per share of $0.06. The details of the impact to the remaining quarters are included with our press release and are available on our website.

Finally, the change results in a $22 million increase to inventory at the end of 2005.

In order to improve your understanding of our results and to improve comparability of financial information from period to period, all historical results that I am getting ready to talk about on this call are under the retail method for inventory valuation. They also exclude the three 2005 significant items that I just discussed, as well as the 2004 fourth quarter adjustments of the lease accounting charge of $0.09 per share. So the numbers I am about to give you are on a basis consistent with the fourth quarter guidance that we provided to you on our third quarter earnings call.

So those numbers are: fourth quarter earnings per share were $1.05 compared to $0.96 per share last year. Comps increased 3% and total sales increased 5% to 3.511 billion. Gross margin increased 60 basis points to 41.5%, primarily driven by buying in occupancy expense leverage. The merchandise margin rate was roughly flat. Total SG&A dollar spending increased by 11%. Incremental spending was driven by marketing costs and store selling expenses.

Fourth quarter operating income increased by 17.7 million. By segment, the results were: Victoria's Secret operating income increased by 20.9 million. Bath & Body Works decreased by 22.4 million. Apparel results increased by 17.6 million, and the other segment lots improved by 1.6 million. Inventories ended the quarter down 1% per square foot at cost. Apparel inventories ended the quarter down 4% per square foot at cost.

During the quarter we completed 158 million of our $200 million share repurchase program, which brings the year-to-date total share repurchases to 390.7 million and 17.4 million shares. We have since completed the balance of the $200 million program and are pleased to announce that our Board of Directors has authorized an additional $100 million share repurchase program.

That concludes my comments on the fourth quarter and so I will turn it over to Martin to talk about 2006.

Thanks, Ann. Good morning, everyone. As you know, Ann will be transitioning to a new role, but only after she certifies our 2005 financial statements, so I would like to just take a moment to express the Company's tremendous appreciation to her for all of other achievements as CFO over the last almost nine years. I am also very happy that we will be able to continue our relationship with Ann as she moves into her new role as the Head of Corporate Development.

Now turning to go our outlook for 2006, first to avoid any confusion, our basis of comparison for our 2006 guidance is 2005 results on the new cost basis of accounting for inventories and excluding the tax and gift card items in the fourth quarter. More specifically, for 2005, numbers for comparative purposes, the numbers are $0.16 per share in the first quarter, $0.19 per share in the second quarter, a penny per share in the third quarter, and $0.98 per share in the fourth quarter and a total of $1.33 per share for the full year.

Now, in the first quarter we're projecting roughly flat earnings per share versus $0.16 per share last year. This estimate is predicated on low to mid-single digit comps, an increase in the gross margin rate, and an increase in the SG&A rate. It also includes an estimated cost of a penny per share for implementation of the new stock options expense accounting.

For the full year 2006 we're projecting earnings per share of between $1.40 per share and $1.50 per share versus the $1.33 per share last year.

Now, excluding the estimated 2006 stock option expense of $0.05 per share, this projection represents 9 to 17% earnings growth over 2005. This estimate is predicated on low to mid single digit comps, an increase in the gross margin rate, and an increase in the SG&A rate. And as I said, it also includes an estimated cost of $0.05 per share for stock option expense.

We estimate that 2006 capital expenditures will be about 600 to $650 million versus 2005 expenditures of $480 million. Roughly $100 million of the increase relates to investments to support the growth of our direct business, including technology investments and the building of a new distribution center for that business.

We expect that inventories in the first quarter on a cost of goods available for sales basis will be roughly flat versus last year.

Now I will turn it over to our brand leaders to discuss their results, beginning with Grace and Victoria's Secret stores.

Thanks, Martin, and good morning, everyone. Victoria's Secret store sales, including Beauty, slightly exceeded fourth quarter expectations, but were certainly disappointing. Comps increased to 3% and operating income was slightly below last year. Operating income missed expectations, primarily due to a decrease in Beauty merchandise margin.

Our marketing campaign drove incremental traffic through direct marketing and gift-with-purchase programs. The increase in media increased traffic and lifted brand awareness and total sales.

We were pleased to reintroduce the Victoria's Secret fashion show as a brand building aspect of our holiday season this year. Customers responded favorably to holiday gifting assortment, particularly PINK sleepwear. PINK continues to exceed our expectations and in its first full year achieved almost $500 million in sales. We were pleased with the 43 store test of the expanded assortment and will be growing the number of stores in the test to between 90 and 95 stores in the spring season.

Bra sales were also above last year, driven by the Body by Victoria event in December, week five, and the introduction of the Angels Secret Embrace bra.

Holiday sales in sleepwear, although below last year, met our expectations, as we work to rebuild the casual sleepwear category. We continue to introduce new lounge-inspired casual sleepwear and were encouraged by the early results.

We continue to be disappointed with our dressy panty performance. We have addressed issues related to Silhouette and we are currently testing fabric and price. Semi-annual sales results were in line with our expectation.

Now going forward, in March we're up against our most successful bra launch ever. Our March bra launch will focus on the Body by Victoria Ipex family and will be introducing a new bra to this family, the Body by Victoria wireless bra. This will be supported by direct marketing and media and our marketing position is similar to last year.

We're pleased as well to announce that our Ipex technology was recently patent approved. Our spring plan is more heavily weighted to the end of the first quarter with the launch of the new Very Sexy Infinity Edge bra in April.

Thanks, and now I will turn things over to Len.

Thanks, Grace.

For today's call I am going to be talking about Victoria's Secret Beauty, Victoria's Secret Direct, and Limited Stores.

Victoria's Secret Beauty's comps increased slightly in the fourth quarter. Our merchandise margin rates were below our expectations as a result of gift set promotions in December and aggressive mark-downs on color during the semi-annual sale.

We were pleased with the performance of our Dream Angels fragrance line, especially Heavenly, the number one fragrance in America. We did sorted in-store marketing to Heavenly and introduced a Heavenly fragrance commercial in December, which drove incremental sales in the month after its airing. Other winners this quarter were Garden, our successful daily body care line, and our deluxe fragrance coffret.

However, the strength in Dream Angels, Garden, and our coffret, was offset by disappointing results in other fragrances, primarily because we did not anniversary last year's Basic Instinct fragrance launch.

This spring we're focused on distorting proven winners and introducing a great deal of newness, including Beauty Rush, a new cosmetics line, Bare Bronze Body Care, and Very Sexy Now, a new seasonal woman's scent.

Shifting to Victoria's Secret Direct, they had a tremendous fourth quarter. Sales increased 15% and operating income increased significantly. Performance was above our expectations, driven by strength in intimate apparel and sleepwear.

Beauty also achieved especially strong sales growth over last year as we continue to invest and grow this category on a direct channel basis.

For the first quarter, Victoria's Secret Direct is planning continued growth with a large part of the growth coming from our new offerings in Beauty and continued strength in Intimate Apparel, particularly in sleepwear and bras.

Limited Stores' fourth quarter comps decreased 1%. However, merchandise margins improved significantly over last year and as a result, operating income more than doubled year-over-year.

Looking to the first quarter, shorter pant lengths will continue to be a dominant trend, and Limited Stores is positioned to take significant advantage of it. We're also focused on shortening lead times for a more wear now focus in cut and sew tops.

Thanks, and let me turn over the discussion to Neil.

Thank you, Len, and good morning, everyone.

Bath & Body Works comps increased 1% in the fourth quarter against a 12% increase last year. We were disappointed with our fourth quarter performance. Excluding the gift card breakage adjustment from this year and the lease accounting charge from last year, our operating income decreased by 7% or 22.4 million, driven by a combination of lower merchandise margin rate and investments in the brand.

We believe our miss in the holiday time period was driven primarily by four factors: First, we set our holiday theme too early with a look that was too overtly Christmas. Many of our customers told us that they were simply not ready to start thinking about or shopping for their holiday buying.

Second, we put too much of our best merchandise out immediately and didn't have enough staged newness over the course of a long holiday season. By November and December our stores looked largely the same to the customer. We learned that we need to have more phases to our holiday assortment and get customers in more frequently and to have more of a sustained holiday build.

Third, we tried a different direct mail strategy this year that focused less on generating transactions and more on generating dollars per transaction. We missed our plan significantly.

Going forward, we will refocus our strategy on generating traffic in transactions, letting our store associates build the sale.

Finally, we looked too similar to last year in our major merchandising programs. In an effort to anniversary the big wins we had in 2004, we ended up with an assortment that lacked big newness or big enough evolution year-over-year.

We were also disappointed in our overall performance during the semi-annual sale in January. We tried a new look to the store and a mix of merchandise that did not perform as favorably as we had hoped. We were also short of inventory on some key products and programs.

As a result of the softness in holiday and sale, our operating income was down 22 million in the fourth quarter. Roughly half of the decline was driven by a lower merchandise margin rate which was a result of unplanned mark-downs to stimulate traffic.

The second big factor in our earnings decline was investments we made in the brand, including marketing, store visuals, store labor, and training.

Given our recent performance, we have a cautious outlook on the spring season. We are reassessing our plans and adjusting our inventory levels.

We began spring with a focus on Valentine's day. The Love Is theme featured new products from our Tutti Dolci and Breathe lines, as well as a lip event featuring lip plumpers from Goldie and Patricia Wexler, MD. We also launched the trial kit for the Wexler line in all stores.

We continue to be very encouraged by the response to the Pat Wexler, MD line. Full size versions of the products in the trial kit were launched in all stores on February 16th and exceeded our expectations.

The current store theme, Cure for the Winter Blues, features fragrances in our Spa, Aromatherapy, and Breathe lines, as well as the launch of Aquatanica, a collection of marine spa treatments. Next month we will feature our Blossom theme, with several new additions to our successful Cherry Blossom business: White Cherry Blossom, Hair Blossom, and Japanese Blossoms, from the Daily Beauty Ritual line, and Orange Blossom from the Le Couvent Des Minimes line.

As a final point, the fourth quarter was the first full quarter of operations for BBW Direct. We are encouraged by our performance to date as the site welcomed over 1 million visitors per week in the height of the holiday season.

We will continue to build on our learnings throughout the spring season and believe that multi-channel retailing is an important platform of our future growth.

With that I will turn the discussion over to Ken.

Thanks, Neil. Good morning, everyone.

Express's fourth quarter results exceeded our expectations. Comps were up 6% and operating income increased significantly to last year.

We focused on winning customers back with a casual, youthful, sexy sensibility at appropriate price points and a self-purchase or wear now approach to the holiday.

November began with an "I Wish" theme and focused on going out and party wear. The Thanksgiving weekend was particularly strong, driven by Black Friday and other [pulsed] promotions.

In December, focused promotional and selling efforts during key high volume days of the month generated a substantial sales increase to last year. Higher than expected holiday sales resulted in much less clearance inventory being carried into January. Therefore, we did not need to run our clearance sale as long as last year, contributing to our higher margin performance this year.

We set the first spring floor set the last week of January. We are encouraged by our customers' initial response. Increases in transactions are more than offsetting the lower average unit retail of this year's assortment. Pants, knit tops, and sweaters in particular are performing well.

In addition, we launched Slimmer Fits, with the introduction of the Skinny jeans and the Stylist pant. Initial indications are very positive.

In the first quarter, we will continue our emphasis on casual life styles with particular focus on being the customers' first choice for all of her legs purchases and winning her over with our knit assortment. Operationally, we will continue to focus on quicker reaction time to trends, to customer needs, and optimizing merchandise flow while maintaining prices that are aligned with our customers; expectations.

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

Thanks, Ken. Operator, we're now ready for the question and answer portion of the call. Again, we intend to run the call until 9 a.m. We'd like get to as many questions as possible. If you can tee them, I'll help on this end by moderating.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Barbara Wyckoff. You may ask your question, and please state your company name.

Hi, everyone. Buckingham Research.

This is a question for Grace regarding PINK. Can you talk about plans to expand PINK, perhaps into its own stores, based on the success of the additional classifications? Do you have any stand-alone stores at this point? What has been the performance and are there any changes between those stores versus the in-store shops?

Barbara, we're going to go to Mark Weikel for that question.

Okay.

Barbara, today we've been very pleased with the expanded assortment that we provided to the 43 additional stores in fall of '05, and we'll expand that assortment to a total of about 90 to 95 stores in spring of '06. Based on that learning, we hope to consider a freestanding option in fall of '06, beginning the exploration there.

Thank you.

Next question.

Thank you. Lauren Levitan, you may ask your question, and please state your company name.

Thanks. Good morning. Cowen and Company. My question is for Neil.

Neil, you commented that the plans for spring incorporate some changes in your inventory and marketing plan. I am wondering if you could elaborate on those and maybe give us some sense as to what metrics we should be watching for as indications of improvement and how long you think it might take to bring the kind of newness and marketing plans to restore operating profitability growth for BBW. Thank you.

Thanks, Lauren. Just to be clear, our investments for the spring are not so much in inventory levels but marketing programs designed to support our next brands.

Overall as we look forward to the spring season, we're really doing two things simultaneously. First, building on our proven winners in lines like Daily Beauty Rituals, Aromatherapy, and True Blue Spa, while, secondly, adding to and building upon the new lines that we believe will take our customer to a new place, which includes C. O. Bigelow, Pat Wexler, as kind of two primary marquis next brands. So as we look forward to the spring season, you will see more direct marketing, focused on building those programs, driving traffic into the store, and let our sales associates build the sale.

You'll also see hopefully the first launch of the BBW catalog in late spring, which we believe will be a very important marketing vehicle for us for the brand, not just to position the master brand but to tell the stories of all these great sub brands we're bringing to market. And really, the first major step into becoming a true multi-channel retailer. And we believe that multi-channel retailing through the web, through e-mail, through catalog, is one of our best marketing and growth platforms.

Thanks, Neil. Next question, please.

Brian Tunick, you may ask your question, and please state your company name.

Hi. Thanks. J.P. Morgan.

I guess for Neil again, maybe some color on the results of the C. O. Bigelow stores you opened last year versus the flagship BBW stores that have been running for a little while, and then maybe just as far as the core BBW stores, are you happy or are you still tweaking the mix between the private label and the third party brands? Thanks.

Okay. First on the question of the Bigelow stores, overall we're very happy with the performance of the Bigelow stores and are particularly encouraged by their performance in the best malls in the best locations, where historically our performance has not been up to par. So in the downtown urban centers like Copely Plaza and Water Tower in Chicago, we are running well ahead of where a BBW store would have traditionally run, including the BBW flagship store. So I think the results from those Bigelow openings in those downtown urban locations are very encouraging and suggest to us that Bigelow's position as a modern urban apothecary is right on the mark and clearly we can improve the concept, but I think the initial indications are quite good.

With respect to the core stores and third party brands, we really have kind of three classes of brands. One class is those that are identified as Bath & Body Works brands, like Daily Beauty Rituals or Aromatherapy.

Second class are brands that look to our consumer like third party brands but are really BBW-controlled brands. And those would include C. O. Bigelow, Le Couvent, and Pat Wexler.

And then the third category is true third party brands that we don't own and control, and in the core stores you will see very little true third party brands. Most of what you will see are the brands that look to the consumer like third party brands but are in fact are controlled destination brands that have more favorable margins that first explore us.

Great. Thanks. I think we're ready for the next question.

Thank you. Dana Cohen, you may ask your question, and please state your company name.

Banc of America. Two quickies. One, Neil, I guess I don't understand. If I look at the issues that hit the fourth quarter, most of them are fourth quarter issues. I guess I don't quite understand what are the issues now into the first quarter and when that gets resolved.

And then second, on the SG&A, Ann, or whoever, if someone could talk about why SG&A is going to go up as a percent of sales on a low to mid-single digit comp, what is driving that?

Thanks, Dana. First we'll go to Neil and then to Martin for the SG&A question.

Dana, I think the biggest question coming out of the fourth quarter and challenge for us is really building traffic and walking our customer through this next phase of the BBW transformation, and clearly one of the things that we learned last year is that we have to walk, not run, that we have to migrate her carefully to the new product lines that we're bringing in. And so for spring our marketing programs are really designed to drive traffic, first of all, and then secondly, to build trial in the new programs. But I think traffic, stimulating traffic, is our number one objective at this point.

Thanks, Neil. We'll go to Martin Redgrave for the SG&A question.

Yes, Dana, there are a couple of things to look into SG&A, both for the first quarter and the full year. First of all, I think it is important to understand that we are very strongly holding the line on home office department spending, as we did in the fall, and I think Ann had talked about in our fall call. So that's consistent into 2006.

We are also, though, continuing to invest incrementally in marketing and new systems capabilities to enable and drive our growth. In particular for 2006 we'll be continuing to invest in the new technology initiatives for our supply chain management systems, and as I mentioned in my comments also for Victoria's Secret Direct, which is a new investment. And finally, in terms of just year-over-year numbers, our 2006 actions include full incentive compensation, expenses which 2005 unfortunately did not include, and also the incremental stock option expense which, as I said, is about a penny per quarter and $0.05 in total for the year.

Great. Thank you.

Thanks, Dana.

Thank you. Tom Filandro, you may ask your question and please state your company name.

Susquehanna. Thanks.

Neil, can you provide a better understanding of the impact you're seeing from the introduction of e-commerce as well as sort of the selling experience there, maybe store [inaudible], particular in product selling via the web and maybe even some new to file customer reach. If you have any data on that, that would be great. Thank you.

Yes, I think that the short answer would be so far we've seen limited impact one way or the other, both in terms of leveraging the web as a marketing vehicle for the stores and for our best customers. Certainly we've seen absolutely no evidence of any cannibalization from the web in the stores.

Looking forward, one of our big objectives will be to build our e-mail file, which, as of this date, is only about 2.5 million customers versus our direct marketing file, which is over 25 million customers. So if we can have the same kind of success in collecting and building our e-mail database, we believe that this is an incredibly effective way to market the brand.

The limited e-mail campaigns that we have done so far with a limited number of names have proven highly effective, both in stimulating web traffic and in drive to store, and one of the things that we know from our sister division as well as our benchmarking of other competitors is that the multi-channel shopper is worth two to three times a single channel shopper is worth, and that's why we're so optimistic about multi-channel retailing as really an engine of growth for us that is totally additive and totally incremental.

Great. Thanks, Tom. Next question, please.

Stacy Pak, you may ask your question, and please state your company name.

Thanks. I was hoping that you guys could tell us why you're looking for a flat first quarter now. Is it BBW's operating income is supposed to be down again and the others not? Or just -- sort of help us there.

And then also, how are you going to measure whether Express's turn is a success? Is there a particular operating margin or metric, sales per square foot by a a certain time frame, et cetera, that we should be looking for? Thanks.

Stacy, first we'll go to Martin Redgrave for your question about first quarter guidance.

Stacy, as you know, we don't provide segment guidance. But in terms of what our outlook is for the first quarter, we are expecting substantially improved performance in apparel, especially at Express. We're looking for continued consistent growth at Victoria's Secret and as you've heard, we have a very cautious view of performance at BBW, and my comments about SG&A would also affect Q1.

And we'll go to Len for the follow-up on Express and the metrics we're watching.

Stacy, relative to the Express question, I think our desired and goaled metrics haven't changed one bit for the brand since we articulated them awhile ago, which is that we are looking for and we are running a business to generate returns in the mid-teens in terms of earnings as a percentage of sales. So that hasn't changed at all and that is the target we're shooting at.

Is there a date?

When we talked about -- obviously, when we talked about the brand a year ago, we talked about a process, okay? A process where we were looking for directional progress in the brand, and we weren't goaling that directional progress, quite honestly, in end-run financials. We were looking for return of the customer, we were looking for positive comps, we were looking for improvements in margin. The reality of it is we've experienced all of those things. The last thing in the world we would do at this point is call for a turn.

What we see are a lot of positive indications. We see improvements in profitability and we're quite positive about all of that. I think the issue becomes one of we are goaling ourselves to have continuing progress in this business, and without continuing progress in this business, we would be less than satisfied. So is there a specific date for a specific turn, the answer is no.

Okay. Thank you.

Thanks, Stacy.

Thank you. Jeff Black, you may ask your question, and please state your company name.

Hey, guys. This is actually Kelly Chen calling in for Jeff Black. Kind of another question on apparel. Margins were up significantly in 4Q. It looks like you guys recovered nearly three fourths of what you lost last year. I'm just kind of wondering if you can give us a little bit more clarity: how much of it was driven by better margins through lower markdowns than better inventory management? And can we expect to see that sort of margin recovery rate, that 75%, through 2006? Or what would prevent us from seeing that? Thanks.

Kelly, I think we'll go to Ken Stevens. I will assume you're just mostly referring to Express, in term of your questions.

Yes.

In terms of the margin improvement in the fourth quarter, it was a combination of fewer markdowns, better management of pricing, and frankly, just better selling at regular price, which to us is basically an indication that the customers were much more receptive to what we were putting in front of them.

Our average unit retail in the quarter was down significantly, as was our average unit cost, and so you combine that with the attractiveness of the product to the customer, and you can see what happened.

The other thing is I think we were a lot smarter in terms of how we managed pricing in the brand during the fourth quarter and didn't hold onto a lot of goods and then try to blow them out at incredibly low prices in January, but rather as time went along in the fourth quarter, made appropriate pricing moves that resulted, as I mentioned in my prepared remarks, a lower inventory level in January that you would have to clear at low margins. So as a result, January is always a loss and our January was significantly better because of that.

Thanks, Ken. Next question, please?

Richard Jaffe, you may ask your question, and please state your company name.

Thank you very much, I'm with Stifel Nicolaus.

Can you guys talk about advertising and marketing efforts, particularly on the apparel side but also Bath & Body Works, both in terms of dollars and new initiatives we should look for this year?

Thanks, Richard. First we'll go back to Ken Stevens and then we'll go to Neil.

Good morning. Our main focus in terms of advertising dollars is in direct mail and direct to specific customer communication, and we have upped our circulation of those programs substantially and have a program that is basically tied to each new floor set, and we segmented our customer base so we have specific communications and in some cases offers to specific customer segments.

We are building our customer database at the rate of a little over 200,000 people per month, and so this is becoming a much more valuable tool for us as we've gone forward.

And then to Neil for the same question.

I think there are kind of two parts to our answer on this. The first is the series of investments that we'll make around what we call the destination brands, the best example of which is Pat Wexler skin care, and you will see for each of these destination brands a customized marketing mix that is suitable to build that brand and suitable for what the product is. So, for example, with Pat Wexler, we are experimenting with infomercials, with QVC, with forms of advertising that really have a revenue stream associated with them and therefor are much easier for us to ramp up quickly. We had very positive results when we put Pat Wexler on QVC. She was scheduled for an hour, she sold out in 50 minutes and far exceeded their expectations and ours. So we believe there is something in that direct television channel for the Pat Wexler line, a helpful advertising vehicle. For us in exploring print and other traditional advertising vehicles for Pat Wexler and for C. O. Bigelow, but we don't have have plans as of yet we can commented on.

And then the second broad direction is continue to maximize the power that we have as a direct marketer. With 25 million names we believe we're just scratching the surface in the ways in which we can communicate directly with our customer. And given the fragmentation of media and the rising cost of media exposures, we believe that direct marketing is our most powerful, highest return marketing investment, and that includes the multi-channel strategy that we've undertaken.

Thanks, Neil. Next question, please.

Thank you. Paul Lejuez, you may ask your question, and please state your company name.

Hey. Credit Suisse. Just given the accounting change from retail to cost, can you talk about the level of markdowns coming out of the fourth quarter by brand? That's versus last year, of course.

Paul, we'll go to Ann Hailey for that comment.

For the fourth quarter, before we abandon the retail method of accounting and move to cost, the overall [NMU] for the brand, which is comprised, of course, of the IMU and then the markdowns, was down about 20 basis points. So we were roughly flat. The markdown levels were the largest at -- the highest change at Victoria's Secret, followed by BBW, and then there was a big improvement in markdown levels at the apparel brand. So we were about 100 basis points of deterioration in markdowns versus the fourth quarter of last year.

Hey, Paul, this is Amy. Is that what you were asking? Does that answer your question?

Yes, it does. I am just trying to get a sense of just the markdowns, just to make sure I am understanding, the markdowns that are in-store at the end of the fourth quarter would actually under the cost method have exposure to first quarter margins, is that right?

So you're asking, currently in stores at the end of the fourth quarter, how much of a percentage of the inventory was --

Right. Like the depth and breadth of markdowns this year at the end of the fourth quarter versus last year at the end of the fourth quarter.

Okay. It was very comparable. Essentially, we moved into the first quarter on a very clean inventory basis. We set our spring floor sets at the end of January, so there really wasn't any significant level of markdown in the stores.

What I would add is, that has been a consistent practice. We clean out our -- we don't box things up. We clean out our inventory at the end of the every season. We mark them out of stock. And so -- and in particular the quarterly sales we've added at the apparel brands have -- and the big sale, both at Victoria's Secret and Bath & Body Works on a semi-annual basis, we have a pretty disciplined process of things. We're not going into the next season with bad inventory.

Great. Thank you.

Thanks, Paul. We have about ten more minutes, so let's get to some more questions.

Mark Friedman, you may ask your question, and please state your company name.

Merrill Lynch. Good morning.

Grace, I was wondering if you could talk about the performance of some of the third party brands, Intimissimi, Chantal Thomass, in the fourth quarter. Could you also give an update as to what you have planned for them in '06 and any other new brands you're looking to add. Thanks.

Grace, we'll let Mark start with Intimissimi first.

Mark, just a quick update: the Intimissimi agreement that we have is an exclusive licensing agreement in the United States covering all channels, and Intimissimi is the leading retailer of lingerie in Italy. So next year, in '07, we also intend to begin the distribution of Intimissimi beauty products. So -- wasn't sure if we had mentioned that to you before.

We've been very pleased with the results of the 26 store-in-store tests that we have with Intimissimi and we plan on expanding that by the end of 2006 to about 160 to 165 store-in-stores. We've been very pleased with that, and a couple of things from the customers perspective, they've really responded favorably to the weekly flow of fashion and also to the breadth of assortment, and I think as you know, Mark, we opened last fall one Intimissimi freestanding location here at Easton and have been pleased with what we've learned from that and continue to -- will continue to learn from that in the spring of '06.

And we'll go out to Grace for some commentary on the other third-party brands.

Yes, I am out here in New York, so that's why we're having a little trouble trying to coordinate with one another, but we're very, very excited about Intimissimi and do have the plans that Mark outlined going forward.

As we looked at the balance, the primary balance of our third party effort, it was primarily an upscale designer fashion assortment. The conclusions that we've drawn is we had good response to those ventures in urban markets, not unlike the Bigelow story, very sophisticated markets, so as a result, going forward into '06 we're really going to consolidate our efforts in terms of trying to understand what the market potential is in our most sophisticated urban markets. Chantal Thomass is certainly a part of that, Roberto Cavalli, Dolce Gabana, Betsey Johnson, we just went to Salon d'Lingerie. So we have a much better articulated plan as -- based on the learnings that we had in '05 going into '06.

Finally, the other really significant success story in third party brand was the -- will be in the second quarter, the introduction of a new sport bra program that we're co-branding with Shock Absorber. We tested that last year in the March, April, May period in Los Angeles and based on the results of those tests it is going to be an important part of our total spring season marketing plan.

Thanks, Grace. Next question.

Dana Telsey, you may ask your question, and please state your company name,

Good morning. TAG. Telsey Advisory Group.

Can you please talk a little bit about Express, the mix of basic versus fashion? Where are you in the evolution and where would you like to be? And on Victoria's Secret, I think the marketing budget has been increased in the fourth quarter with the TV commercial and all. What should we expect going forward? Thank you.

Thanks, Dana. First we're going to go to Ken Stevens for the Express question.

Right. Good morning, Dana. We have -- you can kind of think about our product assortment in sort of two key areas. One is what we're now calling Legs, which by used to call pants but we've expanded it some to include anything -- any bottoms, basically. That, I think, you could categorize then further in Denim, Wear-To-Work, and Casual. And in each of those categories there will be a layer that is primarily Basic, then, with frequent in and out fashion. And depending on the category, Denim will have a relatively small layer of fashion and mostly basic. Casual will be mostly Fashion and the wear-to-work, the Editor in particular will obviously be mostly Basic with shots, actually, on almost a monthly basis.

On tops, we would have a smaller layer of Basics and a much higher proportion of Fashion, and so this combination, what we're finding is taking the fit-critical pants, which are really driving loyal customers to repeat purchases, combined with Fashion tops, which are really what drives a lot of impulse buying and a lot of getting people to turn their heads and actually walk into the store, gives us a pretty powerful combination.

Thanks, Ken. We're going to go to Mark Weikel for the Victoria's Secret marketing question.

We'll continue to focus our marketing effort on both brand building and traffic driving activities. Specifically in the first quarter our major bra launches will be supported by a level of media consistent with the major launches last year. Secondly, we'll also continue to have an increased investment in customer relationship marketing, which is really about driving traffic to the stores.

Thanks. We have time for a couple more quick questions.

Thank you. Margaret Mager, you may ask your question, and please state your company name.

Hi. It's Margaret Mager at Goldman Sachs. And first of all, Ann, congratulations on your new job. We will miss on you the conference call.

Thank you very much. I'll miss you, too, but I won't be a stranger.

Okay. And what is corporate development? What will you be working on? [Laughter.]

And then I do have a couple of financial questions. On the capital expenditures, can you go over besides the extra hundred million that you will be spending on Victoria's Secret Direct, can you just talk about the major buckets of CapEx, what was spent in '05 and what you'll be spending in '06 and how -- as you look at the guidance of the 140 to 150, will the overall corporation's operating margin be trending up, down, flat and how do you think about the stepped up CapEx in the context of return on capital? So if you could address all of that, that would be great, as your last financial question.

Actually, here is what we're going to do, Margaret. We're going to go to Martin for your questions and then we'll go back to Ann for a final comment.

Okay. Thank you.

Okay. Let me try -- Margaret, let me try to address the multiple parts there and I will -- in terms of our overall CapEx spending for 2006, it's reasonably consistent with 2005 in a couple respects. Over half of our spending will continue to be dedicated to new real estate investments, either for new stores or reconstruction of existing stores or refixturing of existing stores. It was a little bit higher percentage in 2005.

As I mentioned, in 2006 we have continued investment in new technology platforms. That was around $100 million in 2005. It is going to be around 120 in 2006.

Then the other major variable year-over-year is this new distribution center that we're building for our Victoria's Secret Direct business, and that's going to require about $80 million of capital in 2006 which was not being spent in 2005.

I think that gives you the pretty good breakdown on year-over-year and the components of 2006.

From a return on capital perspective, as we always have, I think the Company has an excellent discipline around demanding the kinds of return on cost of capital that we've consistently delivered, and we have, I think, a very enviable track record in terms of return on capital on new store and reconstruction projects, which is where most of our capital is going.

We obviously anticipate that the new technology platforms that we're building will enable growth and enable speed and allow us to be even more efficient at scale and therefore should produce very strong return on capital as well.

Thanks, Martin. We'll go back to Ann for Margaret's question about what kinds of projects she might be working on after she signs off on the financials.

Well, I was going to say that my current priorities right now are the year-end earnings, finishing up the financials, making sure we issue a quality 10-K and certify the financials under Sarbanes Oxley.

Once that's done I will move to new responsibilities and those will be in the area of what we would probably call offense, and we've talked a number of times about a few years ago we moved from defense, closing things, closing stores, splitting, spinning, to trying to grow offensively and realized that we don't have enough resource to devote to those kinds of projects because just the running of the day-to-day business is very time-consuming. So I will work on a variety of things that we would call new initiatives offense.

Sounds like fun. Congratulations.

Thank you very much.

Thanks, Margaret. I know it is about 9:00 and people have other earnings calls to get to. But let's take one more question, please.

Thank you. Kimberly Greenberger, you may ask your question, and please state your company name.

Great. Thank you. Citigroup.

My questions are for Neil. Neil, it seems as though the Pat Wexler line is somewhat production constrained here in the near term. When do you think you can get the production ramped up on that?

And secondarily, with Bath & Body Works seeing a sales increase in fourth quarter with gross margins flat, it would seem that the lion's share of the decline in operating profit would be due to higher SG&A, and I know you talked about a couple of other factors, but if you could just comment on -- be a little more specific about the pressures in SG&A and whether those are expected to continue into '06, that would be helpful. Thanks.

Kimberly, this is Amy. Just to clarify, there is a difference between the information in the financial package and what we actually discussed on the script because of the lease accounting adjustment last year. So if you take out the lease accounting adjustment from last year's results, Bath & Body Works' gross margins were actually down in the quarter, and I think Neil talked about roughly half of the operating income decline is due to that decline in gross margin. So I just wanted to quick clarify that before we went to Neil.

Great. Thanks.

Okay. And so, on the first part the of the question, Kimberly, the good news and the bad news of beating our expectations on the Pat Wexler line is that we are inventory constrained. We don't expect that it will take us more than eight to ten weeks to get back fully in stock. But we're kind of running at a level that's more than twice our expectations of what we would be selling. So I think it is a good news problem to have, and it won't take us that long to get back into stock in the scheme of things. And I think we don't know how high is high yet on this line, so we'll continue to experiment with how big we can make it.

Then very specifically on the SG&A question, the other thing that I would say on that besides Amy's comment is that a lot less of it is structural and more of it in the fourth quarter was discretionary investments that we chose to make in trying to build a brand that we can or can't -- we have the discretion making going forward depending on where we are in the brand evolution and our need to do so in the future.

Great. Thank you, Neil. That concludes our call. I want to thank everyone for limiting their questions. This was a good call for us. We were able to get to a lot of questions and I hope we were as thorough as possible for you and I also hope it helps that we crossed our financials last night so you could get a little bit of a head start on this today. So thanks, everyone, for tuning in today.

Thank you. This concludes today's presentation. Thank you for your participation. You may disconnect at this time.