LandBridge Co LLC (LB) 2009 Q2 法說會逐字稿

Good morning, my name is [Sauday] and I will be your conference operator today. At this time I would like to welcome everyone to the limited brands second quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After speakers' remarks, there will be a question and answer session. (Operator Instructions)

Thank you, I would now like to turn the call over to Ms. Amie Preston, Vice President Investor Relations. Please go ahead ma'am.

Thank you, good morning, everyone and welcome to Limited Brands second quarter earnings conference call for the period ending Saturday, August 1, 2009. As a matter of formality, I need to remind you that any forward-looking statements we may make today are subject to the safe harbor statements found in our SEC filing. Our second quarter earnings release and related financial information are available on our web site limitedbrands.com. This call is being taped and can be replayed by dialing 1-866-NEWS-LTD. You can also listen to an audio replay from our website. Martyn Redgrave, EVP and Chief Administrative Officer, Stuart Burgdoefer, EVP and CFO, Sharen Turney, CEO Victoria's Secret and Diane Neal, CEO at Bath and Body Works, are all joining us today. After our prepared comments, we will be available to take your questions for as long as time permits. So that we can speak with as many callers as possible, please limit yourself to one question. Thanks and now I'll turn the call over to Martyn Redgrave.

Thank you, Amie and good morning everyone. Our second quarter performance was generally consistent with the first quarter. As was the case in the first quarter, our overall second quarter comp result and promotion levels within each of our businesses, were generally from line with your guidance and we were able to deliver earnings upside versus our guidance through our continued focus on expense management.

As we look ahead to the third quarter, we are continuing to manage the retail fundamentals of the business very conservatively. Therefore, we remain laser focused on inventories, all expenses and capital spending. We expect to deliver strong free cash flow results and to maintain a very strong balance sheet. Overall, we continue to believe that we're in the right businesses. Our brands lead their categories and offer high emotional content at accessible prices. As Sharon and Diane will further describe in just a few minutes, we are aggressively focused on bringing compelling merchandise assortments, marketing and store experiences to our customers, in order to maximize sales and margins, and we're continuing to be very opportunistic in this difficult environment.

We continue to be on track with our technology initiatives and the Victoria's Secret direct distribution center. As you've heard on earlier calls, we implements the new supply chain systems at Victoria's Secret stores in June and I'm happy to report that the post implementation and stabilization processes, are progressing as expected.

On the international front, we continue to be very pleased with the performance of the six new BBW stores that we opened in Canada in 2008 as well as the eight additional stores opened so far this year. These stores continue to deliver outstanding performance. And we plan to open approximately 17 more BBW stores this year as well as the first four new PINK stores in Canada. In addition, we opened four new Victoria's Secret Travel and Truism shops this quarter. In Sal-Palo, Buenos Aires stores, JFK Airport and Dubai. These stores are owned and operated by various partners. They range in size from about 600 square feet to a 1,000 square feet, and they carry an assortment of beauty, PINK, panties, accessories and gifts. The early response to these stores has been phenomenal. And we believe that this is a clear indication of the strength of our brands outside the United States. I will be opening another location in Barbados in September and we are very excited about the potential for future growth in these Travel and Truism shops. We are also continuing our test the success of our Henri Bendel accessory stores in the United States and are planning to open six new locations this year to reach a total of ten stores for this new concept pilot.

Now, before I turn it over to Stuart, I'd like to make some comments on La Senza's second quarter performance. As you may know, the Canadian retail market has been very negatively impacted by the global economic crisis just like the United States. Second quarter sales for La Senza were $109.1 million and comps were down 11%. Operating income dollars and the operating income rate were both down to last year. A significant decline in SG&A expense resulted in a known improvement in the overall SG&A rate despite the negative comp result. Now, under the leadership of our new La Senza President, Joanne Nemeroff, we are testing a new store layout, with reduced SKU counts and a new assortment plan that distorts focus to our best bra and panty styles -- very encouraging early results. So, with that, thanks and now I'll turn it over to Stuart.

Thanks, Martyn and good morning, everyone. So, turning to our second quarter performance, we reported adjusted earnings of $0.19 per share versus $0.27 last year. Which excludes significant items of $0.04 per share in 2009 and $0.02 per share in 2008. The 2009 significant item of $0.04 per share relates to a gain associated with the divestiture of a non-core joint venture and a 2008 item of $0.02 per share relates to a gain from a cash distribution from Express. All results discussed on this call exclude these significant items in both years.

As Martyn mentioned, our second quarter result exceeded our guidance of $0.11 to $0.16 per share. Our comp, merchandise margin and SG&A expense results, were roughly in line with our guidance. The upside was primarily a result of a decline in buying and occupancy expense versus our expectation, driven by lower home office costs recorded in the B and O line, lower occupancy costs and lower and catalog and fulfillment costs.

To take you through the second quarter results in more detail, net sales were $2.067 billion versus $2.284 billion last year and comps were down 9%. The gross margin rate decreased 100 basis points to 32.3%, driven by buying and occupancy expense deleverage. The merchandise margin rate was roughly flat and benefited by about a 100 basis points from the decline in lower margin rate MAST sales. Sales in the other segments which consists principally of MAST declined 13%. SG&A dollars declined by $55.9 million or 10% and the SG&A rate was flat, primarily driven by our expense reduction efforts and to a lesser extent a decline in marketing.

Total operating income decreased $36.5 million or 20% to $148.6 million. By segment, the Victoria's segment decreased by $56 million to $126.4 million, the Bath & Body Works segment increased by $3.5 million to $44.2 million and the other segment operating loss improved by $15.9 million to 21.9 million. Interest expense in the second quarter totaled $57.8 million and included about $5 million of incremental costs related to our $500 million mid-quarter ten-year bond offering. Retail inventories per square foot at cost ended the quarter down 6% versus last year and down 24% on a two-year basis in line with our expectations. Capital expenditures in the second quarter were $46 million and depreciation and amortization was $93 million.

So, as we think of the upcoming quarter, we think its very important to remind that the third quarter is a very challenging quarter for us as it's difficult to leverage fixed costs on the low sales volume. Additionally versus the first quarter, where we had similar volume, overall gross margin rate is lower due to a number of factors, including the higher percentage of MAST sales and we incurred incremental expense in the third quarter related to holiday, including marketing, packaging, training, and distribution costs which total approximately $25 million. We are forecasting third quarter comps down in the mid single digit range which reflects an updated August comp estimate as down mid single versus our guidance of down high single digits. We anticipate a decline in the gross margin rate, a result of buying and occupancy expense deleverage partially offset by an improvement in the merchandise margin rate. We expect SG&A dollars will decline by roughly 5%. This decline is below the (inaudible) as we begin to (inaudible) cost initiatives from the previous and have planned for some incentive compensation this year versus basically none in Fall 2008. We are projecting third quarter loss per share between $0.07 and $0.12.

Turning to the full year, we anticipate a comp decline in the mid to highs single digits. We expect the sales decline at Victoria's Secret direct of roughly 15% and a sales decline at MAST of roughly 20%. Our merchandise margin rate is difficult to forecast. And although inventories are well-controlled and we are planning them conservatively, we expect that the environment will remain very promotional and customers are reluctant to pay full price. We will stay very flexible in response to traffic trends and we will adjust our promotional plans accordingly. We also expect to achieve benefits from reductions in cost of goods in the Fall season. We will also continue to recognize that sales mixed benefit on the merchandise margin rate as a result of the decline due to lower margin MAST sales.

So, taking all of this into account, our current view is that the full year gross margin rate will be about flat to last year driven by buying and occupancy deleverage offset by an improvement in the overall merchandise margin rate. With respect to expenses, as we said on our last call, we are focused on a number of initiatives to reduce costs with areas including home office, non-merchandise spending, marketing and other discretionary costs. We remain on track to deliver $150 million in cost savings this year. We expect the full year SG&A expense rite to increase slightly from last year due to the negative comp. We expect interest expense to be approximately $58 million per quarter for the remainder of the year reflecting the increased interest rate of the amended term loan, the amortized portion of other fees and costs, the interest from the recent $500 million bond offering offset by a reduction in the interest from the 2012 maturities that we expect to repurchase or repay. Interest income and other income will not be significant in total for the full year. Our tax rate will be approximately 38% and weighted average shares will approximate 325 million. So, assuming all of these inputs, we expect adjusted earning per share for the full year to be between $0.75 and $0.90 per share.

We continue to aggressively manage capital expenditures and are projecting 2009 CapEx at about $225 million down from $479 million in 2008, and $749 million in 2007. The $25 million dollar increase versus our previous projections of about $200 million, relates to increased investments in our store locations in both the US and Canada. Approximately 70% of our total 2009 capital spending will be focused on real estate reflecting investments in key US centers and significant growth for Bath & Body Works in Canada. In the US, total square footage is expected to be about flat while square footage in Canada is expected to grow by 5% for a total company square footage growth of about 1%. More specifically in 2009, we plan to open 60 new stores, down from 145 new stores in 2008. In terms of store reconstructions, we are planning 54 reconstruction in 2009, down from 153 reconstructions in 2008.

Turning to liquidity we ended the last year with $1.2 billion in cash and we expect to generate free cash flow at the high end or our previous estimate of between $350 million and $450 million. Our free cash flow and cash position along with additional availability under our $1 billion revolving credit facility, results in very strong liquidity, which is more than sufficient to fund our working capital, capital expenditures, dividends and any other foreseeable needs. To date, we have used $433 million of the proceeds from our $500 million dollar June bond issue to repurchase about $108 million of our 2012 bonds and prepaid $325 million of our bank term loan which is also due in 2012. We intend to use the remaining $67 million to retire additional debt. We have substantial cushion under our renegotiated term loan through revolver financial covenants and have no debt maturities until 2012. We do not anticipate having to borrow under our additional $1 billion in available credit facility in 2009. So, thank you and now I'll turn the discussion over to Sharen.

Thank you, Stuart. And good morning, everyone. I'd like to begin with four key messages that I will discuss this morning. First, although Spring was difficult, the insight we've gained will benefit us in the Fall. Second, we had reacted to these insights with speed to affect the third quarter. Third, we are more confident in the balance of fashion and price points within our assortments to forward. And finally, we are focused on maximizing sales and margins. So, with that, as an introduction, let me turn to our second quarter results.

The consumer environment remained challenging throughout the second quarter. This is evidenced by continued declines in traffic, higher (inaudible) that CRM offers and increased promotional selling. In an effort to drive more traffic to our stores, we utilized targeted promotions and limited time pricing in the quarter. We achieved a higher than expected response rate to these actions which drove unit growth over last year. However, the result in decline in average unit retail negatively impacted our sales in margin rate.

Turning to our overall financial results, in the second quarter, sales for our total segment, including La Senza, decreased 11% to $1.0306 billion. Comp store sales were down 12%. Total segment operating income decreased $56 million to $126.4 million.

Turning to performance by channel, Victoria's Secret stores comp declined by 12% and total sales decreased 8% to $837.7 million. All three businesses, intimates, PINK and beauty experienced comp declines in the quarter and while we focused on managing expenses and inventory levels, we were not satisfied with this sales performance.

Turning to sales performance by merchandise category, intimates experienced softness in bras and panties, particularly basics, in addition to the soft traffic trend and the decline in AUR already discussed. There are two other notable issues I would call out related to performance in our core intimates category. First, we were (inaudible) a very strong (inaudible) performance last year in a very challenging environment. In addition, in light of the environment, we deliberately planned our launches conservatively. Although each launch met or exceeded our expectations, we did not maximize our opportunities. The second issue that impacted intimate sales was that at our Spring color palate (inaudible) variety was too muted and serious. Trends improved as we landed new bright colors in July. This was particularly evident in the lacy panties and in our new cotton undies, which we introduced late in the second quarter. Both continued to perform well.

Turning to beauty, the decline in sales was primarily driven by a decline in fine fragrance. We were anniversarying the exit of two fragrances last year, so our red line selling in this category was down significantly. Additionally, fragrance has been a challenging business in this environment across the industry. While this did have a positive impact to our beauty margin rate, it was more than offset by the liquidation of discontinued makeup products in advance of the launch of our new line this month. The decline in PINK sales was driven by a decline in the apparel category, which was somewhat offset by (inaudible) in bras. Swim wear, which was in all stores for the first time this season, exceeded our expectation. Our merchandise margin rate was down significantly to last year driven by targeted promotions to drive traffic across all categories and the clearance of discontinued makeup products that I mentioned earlier. Buying and occupancy (inaudible), deleveraged on the negative 12% comp. Despite the negative comp results, we leveraged SG&A expense as a result of our focus on expenses. Our credit income dollars and (inaudible) were both down significantly to last year.

Now, I'd like to spend some time discussing our plans to address our Spring hindsight and change the trends into the Fall. We are focused on three things. First, now that we've completed the systems implementation that Martyn mentioned earlier, we can be more purposeful and directed behind our inventory positioning for our Fall launches. We have supported these launches, including the current new Body by Victoria bras with a more robust inventory position and the early results are promising. Second, we are focused on introducing compelling fashion (inaudible) products with brighter color schemes. Our bra launches, including new product introductions in Bio-Fit and Perfect One, will include brighter more youthful colors. In the panty category we will build on the momentum that we are seeing in products that we launched in the second quarter, including cotton undies, lacy panties and cheeksters in PINK. Beauty is introducing several important new collections this Fall, most note worthy is the launch of the new Very Sexy makeup line which began in early August and is off to a strong start. In PINK, we will introduce new styles in (inaudible) new fashion in bras, panties and apparel. And third, as we look at our pricing architecture, we believe we have an opportunity to attract an incremental customer by increasing our product offerings in opening price points. In June, we introduced cotton bras at 2 for $40. Performance has exceeded our expectation. And we will continue building on this momentum in the Fall. We will also introduce a new Everyday Bra collection in September at $29.50 price point. Also in September, PINK will introduce the Wear Everywhere bra at a price point of 2 for $32.

Now, let's turn to the direct business. Sales for our web and catalog business were $359.4 million, down 15% from last year. We experienced declines across all merchandise categories, particularly clothing. Although women's apparel has been challenging across the industry, we also had fashion misses within our assortments. The merchandise margin rate declined in the quarter, driven by incremental promotional activity to drive demand. Inventory has been tightly managed and is down significantly to last year. We reduced expenses versus last year. However, the SG&A rate deleveraged (inaudible) [lowest] sales volume. Productivity in the new distribution center improved partly enabling leverage in B&O. With the decline in sales and margin operating income dollars and rates were down to last year.

Looking to the third quarter, we have taken action to improve our Fall merchandise assortment by adding newness, fashion and brighter colors and prints. Of course, we will leverage the bra launches mentioned earlier. In addition, like in the store stores, our lacy panty has been a bright spot in the direct assortment demonstrating how much our customers like fun, bright fashion. We have also positioned our assortments in important Fall categories like sleep wear and sweaters to give the customer a balanced offering at all price points.

So, in summary, I'd like to leave you with three things that we are focused on. First, driving incremental business by offering a compelling assortment across all price points, including an expanded offering at opening price points. Second, increase the level of newness, fashion and color across our assortment, we will build on the second quarter successes and momentum we have in our bra launches, items such as as the Lacy panty and our cotton selection and new launches in beauty. And finally the continued conservative management of inventory and expenses while continuing to focus on speed and efficiency in all operations. So, thank you and I will turn it over to Diane.

Thank you, Sharen. And good morning. As I highlighted at the end of the first quarter, at Bath & Body Works we're focused on driving the performance of our top three categories, our signature collection product line, the (inaudible) business and our home fragrance assortment. These three categories delivered (inaudible) results versus last year. Our conversion was up significantly versus last year helping to partially offset traffic decline. Additionally, the retail environment continued to be heavily promotional and our customers are increasingly responsive to our promotional vehicle. So, with that back drop, let me take you through our financial results for the quarter.

Bath & Body Works second quarter comps were down 5%. Total sales for the quarter were $534 million, down 4% or $20 million from last year. For the quarter our operating income was $44 million, which was up $4 million to the second quarter of last year. The increase and operating income was a result of continued disciplined expense management. Specifically SG&A expense was down significantly the last year. And despite the negative comp results, we were able to leverage total expenses versus last year.

Gross margin rate was roughly flat to last year. Our focus on inventory management helped us delivered a merchandise margin rate that was up slightly to last year. The merchandise margin rate improvement was offset by deleveraged and buying and occupancy expense. Buying and occupancy dollars were down, slightly deleveraged to last year, due to a negative sales growth.

Another outcome of our focus on inventory is that we finished the quarter with inventory levels down to last year. Which was enabled by our technology infrastructure implementation that happened two years ago. This the ninth consecutive quarter that inventories were down year-over-year, while our in-stock positions continued to improve. The Bath & Body Works direct channel continues to deliver strong growth and beat our expectations for the quarter. We continue to view the direct channel as both a revenue generator and marketing vehicle for our brands and sub brands.

I now want to give you a preview of what our customers can expect in the third quarter and beyond. We are currently in on annual hand soap event, which focuses on our antibacterial hand soap, including the new collection of kitchen fragrances. We are seeing strong anti-bac performance and are well positioned for the upcoming Fall flu season. We also recently introduced the home fragrance scent plugs, which is an innovative oil defuser. In late August we moved to stock-up event and will follow that up in early September with the launch of P.S. I Love You, which is the newest signature collection fragrance. In September, we will continue to drive the home fragrance category with the introduction of this season's perfect autumn home fragrance collection. Also in September, our aromatherapy category gets a new stress relief blend called lemon grass (inaudible). And in October we will introduce exciting new forms from the signature collection line, including improved formulas for our body and shower creams as well as new seasonal moisturizing forms. We will also introduce our holiday (inaudible) gift, home fragrance and seasonal (inaudible) collections.

In addition to the launch of exciting new products, I just described, our other priorities remain maintaining focus and growth strategies around our signature collection, home fragrance and anti-bac categories. We are well positioned to take advantage of upside opportunities in all three of these categories in the Fall season. Optimizing our segmentation strategy through tiered assortments, continuing to manage our expenses and inventory levels and executing a successful holiday season. So, despite the softness in consumer spending I want to reiterate that we will continue to drive results by offering newness, responding to business trends, testing new products and promotional strategies to drive traffic and gain share. And with that, I'll turn this discussion back over to Amie.

Thanks, Diane. That concludes our prepared comments and we'd be happy to take any questions that you might have at this time. Again, just a reminder, we want to get to as many of you as we can, so please limit yourself to one question. And I'll turn it back over to the operator.

(Operator Instructions) Your first question comes from John Morris of BMO Capital.

Thank you, good morning, everyone. I wanted to -- I guess dive a little deeper on the marketing plans looking ahead for the back half. Stuart, you talked about marketing, it sounds like being planned down. Can you quantify how much it would be down and tell us -- give us a little color by division in particular I'm wondering for Victoria's Secret if it's down as well, where is it coming from? Is it print, is it TV and your thoughts about the fashion show this year. Thanks.

Thanks, John. We'll go to Stuart for a little bit of the numbers and then go back over to Sharen.

In terms of the marketing dollars, John in the balance of the year, I wouldn't describe it as a key driver of decline for the balance of the year. Or as a key -- a key (inaudible). There's some reduction in the third quarter and some in the fourth quarter as well, so we are working hard as we talked about to insure that we are getting the maximum return on those investment dollars and there is some decline in the back half of the year, but I wouldn't describe it as a major change, particularly on a rate basis. And as it relates to the specific plans of getting some color on that, Sharen and Diane are in the best place it provide that.

Right.

From a Victoria's Secret perspective, we have marketing plans slightly down at end of Fall season, primarily cutting unprofitable PRN and actually optimizing the mailings. The other opportunity that we have is shifting some of the marketing into on-line, which has been very beneficial for us and we're very excited about that. The other question that you had was in terms of the fashion show. We are having the fashion show. We just announced our partnership with CBS, which will be held in New York this year.

And just Sharen, briefly, does that come out of TV, is TV down as well in the back half?

TV is slightly down in the back half in one month particularly.

Okay. And, Diane, thanks. Diane?

Sure. Marketing expense at BBW is actually pretty minimal. Most of our marketing expense in the back half of the year is through CRM and that basically flat year-over-year.

Thanks, guys. Good luck for Fall.

Thanks, John. Next question.

Your next question comes from Kimberly Greenberger of Citigroup.

Great, thank you, good morning. My question is for Sharen. Sharen, does it feel like the bra business at at Victoria's Secret might be turning and do you think that the issues in the first half of the year in the intimates business were just the economy and color palate or did you really need to reprice the assortment or lets say, adjust the mix across the pricing sector? Thanks.

We are seeing as we have gone into our launch this Fall season with Body by Victoria and improvement in our bra business. I think the first half of the year that we did have problems with our fashion assortment in in terms of color. The other piece, I do believe that the opportunity for us to attract new customers as we balance our good, better, best pricing has proven that we can actually gain an incremental customer versus trading for down so that we are optimistic about our bra business as we go forward.

Thanks, Sharen. Kimberly, you good?

Yes, thank you.

Okay, next question, please.

Your next question calms from Todd Slater of Lazard Capital Markets .

Hello, guys, it's actually Jennifer in for Todd. Congratulations on a good quarter. I was wondering if you could talk a little bit Sharen, if you feel that Victoria's Secret has gotten too promotional are you taking share at the expense of margin, and what do you think the right average -- or the right average ticket price is? Thanks.

The Spring season we were promotional for a couple of things. One is, is that we actually game out of Fall with a little bit of heavy inventory, so to get the inventory in line, we were promotional. The second thing, as we already talked about in terms of the color palate that as we went through our systems implementation, we had to pull some deliveries up and therefore weren't as quick to react as we possibly could be and that would -- in my remarks that now that we have gone through that implementation that we're able to react to the assortment. I think that as we go forward in how we're looking at our promotion is that we are looking to be less promotional this year versus last year in the Fall season. We're obviously prepared if the economy turns on us that we will engage in more promotions. I think that when we look at our average unit retail, that we're not looking at our average unit retail going down. We're actually looking at it being basically flat.

Thanks, Sharen. Next question.

Your next question comes from Paul Lejuez of Credit Suisse.

Thanks, hello guys, Paul Lejuez. Sharen, on that last comment, how is it that AUR's are going to be held flat? Where's the offset to some of the price reductions that are taking place? And also wondering, Sharen, if you feel like you're getting adequate returns on the Victoria's Secret apparel business on the direct side? A lot of pages dedicated to apparel and just wondering if you're happy with the returns on that business. Thanks.

In the -- the first question about how do we see our AUR not declining, I think the big -- the main reason is we will have less clearance this Fall versus last year. And in our strategy and intent, not only are we adding things at the opening price points, we're also adding things on the top end of the spectrum as well which then as you think about that in terms of selling balancing out, one of the examples in terms of a higher price point is our Bio-fit 7-way bra launch, which actually far exceeded our expectation, which is a $50 bra. So, I do believe that we're in well-positioned to balance our AURs and again, the primary reason is less clearance.

Can I get just one follow up to that, I guess if we're thinking outside of markdowns, thinking just about initial selling prices, if we talk just on that basis, how long do you foresee, you know, pressure in terms of initial selling prices? Is that a one-year adjustment that we're just beginning to through now or is this a multi-year process?

I think that it's really kind of hard to foresee that. I think that, number one, is that we are -- I think it's just good retail practice to always look at your assortment and thinking about them from a good, better, best perspective as well as from a fashion perspective. And I think this is something that we will continue rigor around as we go forward.

And then, Sharen you also had a question about apparel at (inaudible)

Going back to the apparel. We are very profitable in our apparel business in the direct channel. This Spring season, we were obviously disappointed in the return that we got from apparel. Apparel was the hardest hit category and we're making some adjustments in terms of the (inaudible) allocation as we go forward in the Fall season. But having said that, the apparels business is very important to that direct channel.

Thanks a lot.

Thanks, Paul. Next question.

Your next question calls from Tom Filandro of FIG.

Tom Filandro, hello everyone. Question is, I guess Stuart -- Martyn -- you guys have done an amazing job on the cost side of the equation. And obviously we're seeing the comparisons get a little more challenging. Maybe Stuart, could you help us better understand long-term how we should think about the operating expenses as a percent of sales? It does appear that you're starting to track close to historic lows. Thank you.

Yes, Tom. Thank you for the question and good to hear from you. What I would say is we remain focused on growing expenses, lower than sales, thats the long term prospective. But as we've talked about in lots of forums over the last year or two, we are very focused on improving the operating margin in the business that's going to come through some comp growth, thats going to come through merchandise margin rate improvement. It's also going to come through an ongoing focus on growing expenses, lower sales. So, we do believe that there is more opportunity, we are focused on it as it relates to the near term. As I outlined in the remarks, getting the 10% reduction in pure dollars quarter-after-quarter, gets more challenging as the quarters play through, then we start to anniversary some of the (inaudible) we took last Fall. But on a longer term basis, very focused on growing expenses, lower than sales and it will be a component of getting our operating margin to the 15% level that we're targeting over time.

Great thanks Stuart, thanks Tom, next question.

Your next question comes from Michelle Clark of Morgan Stanley.

Yes, good morning. And congratulations. A question on the comp guidance, you look at your comp guidance and implies an acceleration in the two-year com trend, just have a question as to what is driving that degree of optimism? And then on the August comp, you guys had mentioned running down mid-single digits versus previous guidance is down high-single digits. Any color there by segment? Thank you.

Yes, probably not wanting to give the color by segment at this point just to get to the second half of your question and as we look at the back half of the year, in terms of comps there is some level of "acceleration" when viewed on a two-year basis. Obviously we don't foresee the type of economic shock that occurred last Fall, and we're working hard as we've been outlining -- Sharen and Diane have been outlining to drive the best sales an margin dollar outcome, so some combination of not seeing an economic shock like we did a year ago and thinking through the -- the expected results from the work we're doing at a merchandising level, marketing level, we see some as viewed on a two-year basis improvement in the business in the back half of the year.

Great, thank you.

Next question please.

Your next question comes from Loraine Hutchinson of Bank of America Merrill Lynch.

Thank you. For Victoria's Secret, I was hoping you could just discuss the margin implications of some of the lower price products. Have you been able to source into these at your historical margin? Will these dilute your overall profitability over the long run?

We -- I'm happy to tell you, that we have sourced into these and that we will be maintaining the same kind of mark-up that we get in our better price point businesses, so we are -- we do not see an erosion within our IMUs within these lower price points.

Thanks, Sharen. Next question.

Your next question comes from Jennifer Black of Jennifer Black and Associates.

Good morning. My question is for Sharen. Regarding the lacy panty, it's clear that you've gone after Hanky Pankey. And I wanted to know are you planning any other lace extensions to lacy? Hanky Pankey has expanded their offerings and it seems like a big opportunity. Thank you.

We are very confident in our lacy assortment and you will see a row bust expanded assortment starting now and as we continue into the future. So, we're excited about the lacy opportunity that we have and the expanded assortment

Great, thanks, good luck.

Thanks, Jennifer. Next question.

Your next question comes from Brian Tunick of JPMorgan.

Thanks, my question for Diane, maybe if you can you give us a sense if you think the Bath & Body Works either comps or more importantly the merchandise margins might have been bottomed in July, I guess, as you've cleared most of the signature product or are you sourcing better? Maybe just give us your perspective on those two things.

Well we're definitely sourcing better and getting better costs and we have since cleared all of signature, so as we head into Fall season and our top three categories are our higher margin categories and we're seeing those trending all the way through Spring season, so we feel pretty confident that will maintain through the Fall and holiday.

Thanks, Sharen -- or sorry, Diane. Next question.

Your next question comes from Laura [Sampine] with [Cohen].

Good morning it looks like your free cash flow guidance, Stuart, assumes that you four have pretty impressive inventory turn performance. Am I looking at that right? And what gives you confidence that you can drive better turns in Q4?

Well, the first thing that I would say is that if you look at the (inaudible) in the business over the first six months, its substantially improved versus a year ago in terms of free cash flow. Largely obviously a product of the reduction in capital spending but also getting some good outcomes on the working capital line. What gives us confidence that we're at the higher end of that have $350 million to $450 million range is we've had some improvement in income from the beginning of the year, and we're doing a good job managing working capital, including inventory. I don't sense a dramatic change in inventory turn in the fourth quarter versus our prior quarters this year. So, I would just attribute the confidence in being at the higher end, one, higher income, and two, just good working capital management through the year.

Thank you.

You're welcome.

Thank you. Next question.

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

Good morning, everyone. Can you talk a little bit about as you're thinking about the margins, would the infusion of newness and color at Victoria's Secret and the improvements that we've seen at Bath & Body Works, what do you see as the key drivers to move that gross margin higher? And lastly, how are you feeling about the consumer today versus the beginning of the year? How is it different or the same? Thank you.

Thanks Dana. We'll go to Diane first because the microphone is over there.

I think as I just mentioned on the last question, we expect our margin rates to maintain as we have our higher margin categories continue to outperform, so we're pretty excited how that looks for the back half of the year. We have -- even though our traffic is down, we are getting significant improvements in our conversions so we're feeling pretty good about once we get people in the stores that they are liking what they see of our newness, so we feel pretty confident that consumer spending will (inaudible) our benefit in the back half of the year.

Thanks, Diane. And Sharen?

We in Victoria's Secret will have less clearance, so I think that our margin will be flat or slightly up, so we are looking at having -- as we walk through this Fall and holiday season a lot less clearance than last year. In terms of the consumers reaction, again as (inaudible) said, our conversion is well -- is up slightly as we have landed the fresh new products, we are seeing our conversion even go up more than we experienced in the first and second quarter and so that we are very excited about the opportunities in front of us.

Thanks, Sharen. Next question.

Your next question comes from Richard Jaffe of Stifel Nicholas.

Thank you very much guys. A couple of questions I guess about assets on both your real estate strategy in terms of rationalizing your store count and store size particularly in the case of Victoria's Secret. Are there stores that need to be managed to a smaller footprint? And then are there other assets within the portfolio that might be sold over the next couple of quarters, whether it's real estate or brands, that sort of thing?

Thanks, Richard. We'll go to Stuart.

Sure. Richard, as it relates to store -- store closings and store sizes, on -- we -- even with reductions in sales volumes over the last year and a half to two years, even with those reductions, our sales productivity is really as a result of that our (inaudible) economics are just very good for both Victoria's Secret and Bath & Body Works. We literally have a handful of stores that don't make profit and generate good cash flows. So, we don't (inaudible) other than natural -- what I call natural openings and closings, we don't have a situation where there's a big opportunity or a need to close stores. Or to resize stores. So, that's where we are on that. And we feel good about that. And then as it relates to monetization of assets, as you know, having (inaudible) coming for a long time, we've made a lot of different moves. We feel very good about the businesses that we're in strategically and we don't see any particular opportunity at this time to make any material changes as it relates to the composition of the business or the (inaudible).

Thanks, Stuart. Next question?

Your next question comes from Randy Konik of Jefferies and Company.

What about the other part?

Great, thanks, a question for Sharen. Sharen just thinking about in the Summer, the semi-annual sale is I guess, is below expectations and you -- I think you spoke about the basics business here being somewhat weak. Are there any -- you talked about maybe fashion not being right but are there any other competitive factors that we're seeing here? Because it just seems like on the low end on the pricing end -- there -- just -- you're starting to see some weakness here. I'm just trying to get a better sense of your thought process on what you're seeing.

The major semi-annual sale lower volumes this year versus last year, primarily was the fast that we went in with a lot less inventory both in the beauty category as well as the PINK category, so that was the big piece around the semi-annual sale. Right now I think that our assortments in terms of especially us looking at our good, better, best pricing strategy, if there was any competition drain from us, I think that we will have course corrected and real address that as we go forward, but in looking at our malls and looking at where our competition is, is that we continue to have the better market share within those markets versus the competition, so we're not seeing that happening today.

Just follow-up, on the high end though is that where you're still seeing most of the high end stuff and the low end is where you're seeing the weakness right now in the bra category?

No. On the low-end stuff, I don't know what you mean in terms of the low end.

Like in terms of pricing strata, on the lower end of the pricing strata is that where you're seeing the most weakness and the higher end pricing strata within the bra category, is that where most of your incremental strength is right now?

No, were we're seeing -- where we saw the weakness in the Spring season within our basic assortment and not -- not about the price points. So, where the weakness was in the Spring season was just in the basics.

Great. Thank you.

Thanks, Randy. Next question.

Your next question comes from Stacy Pak of ST Research.

Thanks. Diane, I was wondering if you could talk a little bit more about what happened in your perspective in July when there was such big upside to -- to the guidance for BBW, particularly with regard to the top 3 signature home fragrance and anti-bac and why that improvement should be stainable? Help us kind of understand that. And then just an understanding point to Sharen, can you just comment other than the better inventory positions impact on AUR, how will the AUR in Fall compare to last year? Thanks.

As l look at July, I actually look back on our entire Spring season and our categorying thing, which I mentioned before signature, home fragrance, antibacterial soap, are all trending above our expectations for the season. June was a little bit of a blip with our semi annual sale we ran down significantly, part that was that we made some decisions not to as deep on our core categories as we did in previous years. So, I think when you look at the beginning of the year up through May as well as July, those results have been more consistent with those three categories which is one of the reasons why I've had the (inaudible) confident in going forward. As well as all the newness within those three categories, we have much more newness it the back half of the year in those three categories versus last year, as well as the additional fragrance launches.

Thanks, Diane. And then Sharen?

Our expectations for AUR will be flat.

Okay, thank you.

Thanks, Stacy. Next question.

Your next question comes from Howard Tubin of RBC Capital.

Thanks, guys. Can you tell us how you're thinking about square footage expansion for next year particularly on the stores that will be opened outside the US?

Yes. Stuart?

Well, in total, Howard, we're thinking about square footage expansion conservative, we covered that. So, as we think about going forward, we will be taking a more conservative posture, particularly in the United States in relation to square footage expansion. Obviously we're in the process of finalizing our plans for the 2010 (inaudible) and we're in the middle of working on that. As it relates to expansion outside the United States, obviously as we've talked about as far as highlighted -- the success in Canada has been very good with Bath & Body Works and we're testing PINK and Victoria's up there as well. And you know, those locations are doing very well. And we will -- we are and we will pursue aggressive growth in Canada, the returns are outstanding and we will pursue that pretty aggressively. But we haven't finalized our 2010 (inaudible).

Thank you.

The other -- Howard, the other clarification I just added is Canada is clearly our focus for company-owned expansion. For both obviously -- La Senza is more about right sizing it, but the growth in BBW, PINK coming in the Fall and Victoria's Secret will be introduced into Canada in the Spring of next year. Outside of Canada, and I mentioned this T&T concept what we call T&T, travel and tourism, and franchising and other things that we've talked about before, and we are still very focused on expansion through those mechanisms, through those business models but not on a company-owned basis.

Great. Thanks.

Do you think we'll see any franchise stores in Europe next year?

I can't really comment on specifically where you're going to see the stores. You know, this pilot that we're running in the travel and tourism arena is giving us a lot of very interesting learnings about taking Victoria's Secret brand to the rest of the world and what I call a very low risk format, more of a wholesaling and the travel and retail format for now. And that's going to teach us a lot about the brand going to the rest of the world and then we'll leverage off that have learning to decide when and where we would be expanding with partners in the rest of the world.

That's great, thanks.

Thanks Howard. Next question.

I have no further questions at this time. Do you have any closing remarks?

Great. I don't think so. We just would like to thank everybody for joining us today and for your interest in Limited Brands. Thanks.

This concludes today's conference call. You may now disconnect.