LandBridge Co LLC (LB) 2008 Q1 法說會逐字稿

Good morning. My name is Christie, 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. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (OPERATOR INSTRUCTIONS)

Now I would now like to turn the call easier to Amie Preston, VP of Investor Relations. Please go ahead.

Thank you, Christie. 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 statements found in our SEC filings. Our first quarter earnings release and related financial information are available on our website, Limited Brands.com. This call is being taped, and can be replayed by dialing 1-866-news-LTD. You can also listen to a replay from our website.

Martyn Redgrave, EVP and Chief Administrative Officer, Stuart Burgdoefer, EVP and CFO, Sharen Turney, CEO, Victoria's Secret, Diane Neal, CEO of Bath & 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 is important that you limit yourself to one question.

Thanks and now I will turn the call over to Martyn Redgrave.

Thanks Amie, and good morning everyone. I would like to begin our call today by providing an update on several of our strategies and initiatives, and 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 am 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 have 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. 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 are 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 are going to take a little bit more time with Sharen and Diane to really dive into and discuss Victoria's Secret and Bath & Body Works. Therefore I am not going to go into all 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 are 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 discussed over the past six months it took us longer than expected to get the new 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 next steps to reduce demand in the fourth quarter.

We are continuing to make significant progress in bringing the direct DC up to speed. We are now able to fully meet the volume demands of the business and we are operating at 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 lower accuracy levels, running the DC, and implementing these improvements. As a result in the first quarter we were negatively impacted by higher costs associated with 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 near as material an impact as they had 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 56 Victoria's Secret stores business in 2009.

I would like to conclude with 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 to us 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 Jansen 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.

Before I turn it over to Stuart, I would 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 in 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 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 will now turn it over to Stuart.

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 results includes a pretax gain related to the sale of a noncore joint venture of $128 million, or $0.24 per share, and a pretax charge related to the impairment of another noncore joint venture of $19 million, or $0.06 per share. Our EPS excluding these items was $0.11.

Although our comp results was at the low end of our expectation for the quarter, the sales mix 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 MAST 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 EPS 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 MAST 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 MAST 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 EPS of $1.38 to $1.58, excluding the $0.18 of one-time 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 margin, and we continue to aggressively manage expenses.

Therefore for the full year versus last year's adjusted $1.21 EPS 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 would 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 plan ,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 lease 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 them 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%. 90% of the incremental gross 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 projected to increase by roughly 15%, primarily through the opening of 19 new La Senza locations, and six 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 is 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 positions. 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 will turn the discussion over to Sharen.

Thank you, Stuart. Before I get into the numbers for Victoria's Secret, I would 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 a resilience of the Victoria's Secret brand.

In our last earnings call, I had talked about continuing to affirm our brand's [durancy], and our authority in bra and lingerie. Our brand held a beautiful and empowering 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 are making progress, but it is 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 will take in 2008, and I would like to highlight them for you, and talk a little bit about how we are progressing.

The first is what we call growth from the core, which is about regaining sales momentum in our core category, bras, sleepwear, and panties, always innovating, always focusing on new. We are beginning to see increased levels of sophistication, quality, and fashion leadership in the assortment, and there is much more newness in the pipeline. But even more emphasis on innovation, we also recently reorganized our design talent and added Jaime Schaffer as our Chief Design Officer, and we are very excited about that change.

We are testing a number of new concepts including something we are calling bra authority. To talk a little bit about the traction we are 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 will 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. I would even say that reinventing sleepwear is really about lingerie versus using the word sleepwear, and our work to gain new traction in panties is just starting, so even though it is 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 space, how we optimize the space in stores, and how we tier or segment our fleet, the right adjacencies, the right assortments, the right inventory levels, all to get the best return in our real estate investment, 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, PINK is expanding, VSX is the sport line we are testing, swim, accessories, just to name a few. So we are now taking a careful, very strategic look at how we organize, plan, price, and deliver that assortment, so we can consistently maximize the incremental value and support our margins, controlling inventory and focusing on the SKUs that produce the most.

Finally we are focusing on regaining the sales momentum we direct, and we are very pleased with the progress in this area. The work has two parts, restoring the client file, and improving the shipping capacity, and both are doing well. There are some specific ways we are turning our strategy into tactics, that we believe will change the business this year. I hope hearing about them provides an added context to the brands direction.

As I look back at last quarter, I recognize there are a lot of external factors that have significant organizational changes we have undertaken to distract us, but we didn't, and I am proud of that. We stay close to our customer and committed to the fundamentals. That paid off in increased merchandise margin, well managed inventory, and expense control.

Of course there are still challenges. It was the softness in the larger bra, and beauty continues to trend softer for the most part, due to the lack of newness. Even so I believe difficult times rebuild a core strength of the business, and to me Q1 provided that, even if the economic climate was 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. Comps stores decreased 6%, against 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 sales comps were down 7%, slightly below our expectation. 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 and 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 new Angel bra line, with 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 to fortify the incremental recent swim campaign.

In mid-February, we began offering swim wear in 350 stores. We were pleased with the swim performance in 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 expectations, and we continue to be confident about it's potential. We are testing a full-line in 30 stores, and we are using the results to continue to evolve the concept.

So we are seeing some positive signs in fragrances, launchings by ooh la la and Heavenly Kiss, and in seasonal launchings by Very Sexy Now, we continue to be disappointed in the overall beauty performance. Just an aside here about beauty, you probable know that last quarter we brought in Shashi Batra in as the new leader of Beauty. I believe most of you are familiar with Shashi's experience, he is an industry veteran, a true beauty merchant. Shashi is still on board and we are all 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 rate for the quarter. We have chosen to be less promotional, and our inventories are down significantly to the last year. We are managing this as a priority. As a result, we have achieved a significant improvement in our merchandise margin rate versus last year.

Volume occupancy expense increased versus last year, driven by increased risk and occupancy charges associated with our real estate strategies. The increased expense drove rates deleveraged, as a result the gross margin rate was roughly flat to last year. Finally for the store channel, SG&A expenses 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 of 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 swim wear. Direct saw increases to last year in almost every merchandise category. And in sales recovered from the fall 2007, direct experienced remarkable growth in client buy. 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 rates 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 the result of increased markdowns to clear some holiday seasonal products, and increased costs related to the DC stabilization. That said, the result of the direct clearance strategy exceeded expectations, and led to inventory levels being down to last year.

You all know we have been working to improve our shipping capacity at our newest distribution center, we are 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 levels, but we still have a ways 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 brands, including testing mobile this spring season, which we are very excited about. So good news in the direct channel. That is Q1.

Before I wrap up, I do want to share a couple of things we are excited about for the upcoming quarter. At the Semi-Annual Sale, we will show more of the ultra feminine, beautiful products I talked about earlier in our new fashion assortment. We are very excited about a program we are working on for PINK, and you will hear more of that in the next month or so. PINK's presence on Victoria's Secret.com 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 is 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.

Thank you, and now I will turn it over to Diane.

Thank you Sharen, good morning everyone. Despite difficult economic conditions, and unsatisfactory comp results in the quarter, the details of which I will take you through shortly, Bath & Body Works remains focused on future priorities in 2008, reinvigorate the brand, create more brand consistency, and change the current negative sales and traffic decline.

Specifically we are focused on three key priorities, first of all building and growing, and creating more newness, innovation and excitement with our key brands in the businesses, C.O. Bigelow, True Blue Spa, Aromatherapy, our Signature by Caroline, and custom fragrances. Even though we did have success with some of our product launchings 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 these brands in the back half of the year, and will be able to share more detail on that as we get closer to that timeframe. Starting in the fall we will make a shift in the sophistication levels of not only our new product launchings, but how they come to life in stores, through updated graphics, in-store marketing, and packaging. In addition, we will have a greater emphasis on accessory products that animate all of our new product introductions.

There will also be a significant increase in the amount of newness this fall versus this spring and also last fall. This will start in August, and will continue throughout the entire fall and holiday season. Operationally we are testing, analyzing, and putting plans in place, to segment our fleet by customer, markets, and specific product opportunities. With this knowledge and the infrastructure that we implemented last year, will greatly aid in our effort to achieve this segmentation and resource.

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 comp and total sales represents sales from our new stores. Sales was 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 expenses.

The increase in merchandise margin rates 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 that deleveraged on a rate basis, for the negative comp sales 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 rates leverage on declining sales. During the quarter performance of our e-commerce 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 our Mother's Day, and general macro economic 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 for the C.O. Bigelow brands at the front of the store, focusing on the new Bigelow merchandise, in particular fragrance body care products. Other newness featured during this phase is the Limited Edition of Pop Culture Body Care, with fun summer fragrances, and new summer scents from our flagship Company's Home Fragrance brand. Beginning the first week of June, we will launch our Semi-Annual Sale, which as last year is planned to run for five weeks. We wrap up the spring season with our wholesale phase featuring our Fresh spring fragrance collection for body and [inaudible].

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

Thanks, Diane. At this time, we would be happy to take any questions you might have, and again, just a reminder, in the interest of time and consideration to others, please limit yourself to one question, and with that I will turn it back over to Christie.

Thank you. (OPERATOR INSTRUCTIONS) Lorraine Maikis, Merrill Lynch.

Hi, this is Paul Alexander for Lorraine Maikis, can you give a little bit more color on the rationale behind the decision to slow the store growth, and how much of that is related to the economy, or other factors?

Thanks, Paul. I think we are going to go to Stuart Burgdoefer for that question.

What we are trying to do is balance as was laid out about 1.5 years or 2 years ago, we do have a strategy to grow square footage in the United States, based on our view of the sales, the profits and the return potential associated with that square footage growth.

With that said, we are aware and mindful of the general economic trends, and we are as we have talked about in prior calls, very closely monitoring the results of the activity that we are investing in. So specifically around expansion for the most part. But also new stores. And so it is about balancing risk, risk taking, considering the trends of the business, and the environment that we are doing business in. So we are trying to strike the right balance.

Thanks. Next question?

Our next question comes from the line of Brian Tunick of JPMorgan.

Thanks. Sharen, I was wondering if you could talk about how you think growing PINK versus the core foundation business? I think from the Analyst Meeting or before, you said maybe the focus was too much on PINK, and how you were going to regain that spot as the #1, growing the foundation business?

Success would look like that both businesses would both have great growth. I think the core continues to have growth. And speaking about the PINK business what we are looking at is expanded square footage. As we take our stores from 6,000 to 7,000 square feet, or 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 are looking between 2,500 to 3,000 square feet.

You think about PINK as well, the opportunity in terms of growing adjacencies, such as the accessories business, which is a focus for us as we go into this fall season. And if you have been to any of the stores you will 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 free standing stores, and we are excited about the learns that we are getting from those stores. As we talked about, we will be announcing some future opportunities for us later in the summer. So I do feel like that there is still plenty of growth opportunity in PINK, and what we are actually doing in terms of the core business, is where we started to get younger and almost overlap with PINK, we are really saying this PINK is focused to the 19 year old customer, and the core business is really focused on the 26 year old customer, and really being more definitive about those lines. And I think will you start to see that as we come out of Semi-Annual Sale going into the fall season.

Thanks.

Thanks, Brian, next question.

Your next question comes from the line of Neely Tamminga of Piper Jaffray.

Good morning, Diane, I hope I didn't miss this, but could you talk about the SKU productivity that you have been doing? I think given your target background that has certainly been an area of strength that you bring to the table, and I am just wondering as relates to the fall launch schedule, what could we be looking for more from this division with your new leadership talent in that regard?

Yes, Neely. Actually we have as you know, ran last Fall and continue to run this Spring assortment optimization tests, and we have 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 have also looked at our seasonal launches, as far as what is more productive versus last year, in some of the things we have tested.

The other things about these optimization tests it has greatly informed our segmentation efforts, as we look forward to our specific, how we segment our stores by brand and by customer, and it has been an extreme learning for us in that regard.

Thank you.

Next question, Paul LeJuez of Credit Suisse.

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

Thanks Paul, Martyn.

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

That is in operating profit?

In operating income impact in the Fall of 2007.

How about between the third and fourth quarter?

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

Just one quick follow-up, Sharen, how do you view the maturity of the direct business? What is the ultimate size? How much is international, if you can provide that percentage?

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 is the fastest growing channel, I think that we will continue to see growth out of that channel. What you are going to see as I look forward is within the catalog business it is still, we probably won't mail as many catalogs or pages, it will still be a very heavily integrated Web-based business.

So the community piece is continuing to build, and how do you play with it in community, which is a new marketing target for us. I think also is how do you think about sub sites like, we have VSPINK.com, and how we are linking that back to the mother ship, and I think there are some exciting things there.

One of the hottest things, it is amazing, we started to test what I call mobile commerce, and it is just beginning touching the waters, 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 order, and it is amazing how many people have already responded to that test. I was blown away.

And as you know you are starting to see a lot of that in Japan as our technology of phones continues to upgrade in the United States, I still think that there are some interesting opportunities there. I see nothing but a bright future for the direct channel today.

Great. Thank you.

We are going to go back to Martyn to follow up to his response.

Just, Paul, I just wanted 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 pieces of information, we are anticipating distribution costs. We are incurring disruption costs in the spring of 2008.

We are estimating those to be in the range of 25 to $35 million in the Spring of '08, which would not have been in the Spring of 200, because we didn't open the center until the Fall. And for the Fall of 2008, obviously we are 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.

Above and beyond last year?

No, no, no. Relative to our targeted levels of productivity. So just making the numbers very clear, for all of '07, kind of the 80 million range of just total disruption costs, in the Fall of '08 10 to $15 million range of total disruption costs. So an improvement of about 70 to 65 million.

Got you. Thank you and good luck.

Thanks, Paul.

Your next question comes from the line of Lauren Levitan of Cowen and Company.

Thank you. Good morning. I am 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 are 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.

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

Maybe even relative to historical levels would be helpful.

I 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 have historically, if you kind of isolate out unusual situations, we 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 Brand Inc. operating margin rate over the next several years. And that is really how we are working it. Because otherwise, you have got to get into discussions of how we are allocating corporate overhead and lots of different things, but what we are focused on is driving operating margin for Limited Brands Inc., and again we think there are some hundred basis points of opportunity over the next two to three years.

Thanks Stuart. Next question.

Next question comes from Jennifer Black, Jennifer Black & Associates.

Good morning, 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? Thank you very much.

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, I can't speak to it, we got off of that. We are actually reintroducing kind of under the headlines of bra authority, a very robust training program, going to the University of Victoria's Secret. There will own they will only be bra specialists, and it won't just be one person in the fitting room that is trained, the entire store will be trained, there will be different levels of graduation.

This is something new and we have actually piloted this program. It is now fully implemented in two stores today, which is Houston Galleria and Tuttle, we have great training materials. We also have materials for the customer. We have actually held 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 will see on a go forward basis, is that we will have much more robust training, so that we can really deliver on our products.

Thank you, Sharen. Good luck.

Thanks.

Next question, Todd Slater, Lazard Capital Markets.

Thanks very much. I would like to know when you start taking applications for Victoria's Secret University. Martyn, it is a question for Martyn, you have been agonizingly patient in exploring the international opportunity. I understand why you are careful given how large it is, and you said you will see deals hitting the table 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 a capitalized margin right type of structure? Thanks.

Thanks Todd. I figured you might want to know a little bit more about international. So I think in terms of the order of priority on the brands, the three that we are most focused on would be Victoria's Secret, PINK and BBW.

And we actually do think there is an opportunity for PINK as a free-standing brand outlet in the United States. It is a different assortment model, different sizing model and Les is very engaged with us right now on thing that through. Canada is our #1 priority both in terms of continuing to grow the La Senza business, and it's international franchise business, as well as introducing BBW.

And we are 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 Heppenheimer, who runs our Victoria's Secret beauty business outside of the United States, who has been on board for a number of years, but has a deep beauty background and experience around the world. And now Ralph Jansen, who has a deep experience in intimate apparel around the world, Martin being British, and Ralph German.

So we are 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. In geographic priorities, it is hard to me to comment that 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 are spending time in and looking at.

Thanks, Martyn. Next question?

Your next question comes from the line of John Morris of Wachovia.

Good morning, 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 are 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? Thanks.

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

And also it will be similar as we get into the Fall. However, we are looking at opportunities for mailings to new customers with, as well as to some of our last customers, so we are 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 we have got about double the amount of newness in Fall of '08 versus Fall of '07. Not only product launches, but some of the fashion accessories that we are buying.

Thanks.

Thanks, Diane. Next question?

Your next question comes from the line of Dana Telsey of Telsey Advisory Group.

Good morning everybody. 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 have been seeing, what are the levers for additional SG&A as you are looking through the balance of the year? Thank you.

Thanks, Dana. We are going to go to Stuart.

Good morning, Dana. So on the gross margins, 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 and Occupancy deleverage and that can be compounded, based on obviously what our sales result is. So that is where we are on that, and certainly the better management of inventories is contributing meaningfully to that result.

On SG&A as we talked about in prior communications, we have taken tough action there last Summer, a big contributor to the results 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, et cetera. We don't intend to reduce expenses in a way that would lessen the customer experience. So we are focused on what we would call more discretionary overhead and project related spending, and that focus will continue really for the foreseeable future.

Any initial thoughts on 2009 expansion?

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

Thank you.

Thanks, Dana. Next question?

Your next comes from the line of Marni Shapiro of The Retail Tracker.

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

Sure, Marni, again I think we will go back to Stuart for that.

There was some decline in marketing as Sharen outlined in the first quarter for the Victoria's Secret business year-on-year. We managed that carefully recognizing the trade-off with sales. But again, we are really looking at home office spending, project-related spending is the areas that continued scrutiny and opportunity.

It is not hitting the stores?

No, we are doing natural flex, and that is it.

Great.

Thanks, Marni. Next question?

Your next question comes from the line of Dana Cohen of Banc of America.

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?

Okay, so for the VS marketing question we are going to go to Sharen first.

I think that what you are going to see in the VS marketing, is that it will probably be flattish in the second quarter, but we will be up in the Fall season. The reason we will be up in the Fall season is we are 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 are also seeing just the cost of advertising going up, but we are trying to leverage that and be very specific, but you will see marketing going go up slightly on a dollar basis, as we go into the Fall season.

Thanks, Sharen. Then we are going to go to Stuart for the comp, the leverage, the B&O, and the Other segment results.

Dana, on the comp to leverage the B&O, it is more complex than what I call a normal analysis, given our investment in real estate that we have talked about. And frankly, we haven't pencilled a precise number on that. But what I would tell you is that the comp necessary to lever B&O, Is higher than what would be in a steady state situation, given the real estate strategy that we have articulated.

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

Got it. Thanks.

Thanks. Next question?

Next question, Richard Jaffe of Stifel.

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

Sure, Richard.

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 is roughly flat year-on-year, on a rate basis.

Is that the same for both divisions?

We are 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 is about all we will go into.

And, operator, I think we have time for maybe just one more question.

Your final question comes from the line of Kimberly Greenberger of Citigroup.

Good morning, I was hoping, Stuart, that you could comment on the reduction of some of your real estate initiatives, is it that you are raising the bar on the expected return of those projects? Or you are pushing more of them towards lease expiration? We are just trying to understand your thinking on this? Thanks.

I think you kind of hit on the key things. One important aspect of it is, how many we do before lease expiration. And as I outlined the substantial portion of those are being done at lease exploration, and that is 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 the last is around new store project count, which we have also taken down again, just managing a relative risk trade-off there, a balance between the incremental sales and profit with the relative return of those new stores. So those really are the variables.

Thank you.

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.