Bath & Body Works Inc (BBWI) 2011 Q3 法說會逐字稿

Good morning. My name is Matthew, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Limited Brands third-quarter 2011 earnings 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) Thank you.

Chief Investor Relations Officer Amie Preston, you may begin your conference.

Thanks, Matt. Good morning, everyone, and thank you for joining us today. 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 third quarter earnings release and related financial information, including any non-GAAP or adjusted financial reconciliation tables, are available on our website, www.LimitedBrands.com. Also available on our website is an investor presentation, which we will be referring to during this call. This call is being taped, and can be replayed by dialing 1-866-NewsLtd. You can also listen to an audio replay from our website.

Joining us today are Stuart Burgdoerfer, EVP and CFO; Sharen Turney, CEO of Victoria's Secret; Nick Coe, CEO, and Andrew Meslow, CAO at Bath & Body Works; and Martyn Redgrave, EVP and CAO. 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 permit yourself to one question.

Thanks, and now I will turn the call over to Stuart.

Thanks, Amie, and good morning, everyone. We are pleased with our third-quarter performance. Our adjusted earnings per share increased 39% to $0.25 per share versus $0.18 last year. Our reported result was $0.31 per share versus $0.18 last year. This year's reported third-quarter results include an income tax benefit primarily due to the resolution of certain tax matters of $16.7 million or $0.06 per share. All results discussed on this call exclude this significant item.

To take you through the third-quarter results as detailed on page 3 of the presentation, net sales were $2.173 billion versus $1.983 billion last year. And comps increased 9%. The gross margin rate increased 10 basis points to 36.1%, as leverage on buying and occupancy expense offset a decline in the merchandise margin rate. As expected, our third quarter merchandise margin rate was negatively impacted by increased costs. We continue to focus on managing total expense growth at a rate that is slower than sales. Total expenses, the combination of buying and occupancy, and SG&A, increased by 5% and leveraged as a percent of sales.

SG&A dollars increased by $34 million or 6%. And the SG&A rate leveraged by 90 basis points. A significant portion of our SG&A is variable, and we will continue to manage that proactively throughout the quarter in response to our sales trends. Principally all of our SG&A expense growth in the third quarter relates to investments that we made in store selling to support and drive sales growth. These investments include higher selling payroll related to the growth in sales, increased investment in training, and investment in other store initiatives including technology.

Turning to operating income on page 5 of the presentation, total operating income increased $37 million or 25%, and 100 basis points as a percent of sales, to $186.1 million or 8.6% of sales. By segment -- the Victoria's Secret segment increased by $25.6 million or 90 basis points as a percent of sales, to $148.8 million or 11.3% of sales. Bath & Body Works increased by $8.9 million or 130 basis points as a percent of sales, to $40.6 million or 8.1% of sales. And the Other segment operating loss improved by $2.5 million to $3.3 million, driven by improved profitability at Mast. Total non-operating expenses increased by $16.6 million, driven by increased interest expense associated with the $1 billion bond issuance.

Turning to the balance sheet on page 9. Retail inventories per square foot at cost ended the quarter up 2% versus last year. We repurchased 4.8 million shares of stock in the third quarter for $172 million. We completed our previous $500 million share repurchase program, and the Board authorized a new $250 million program on November 3.

Turning to page 10 of the presentation, for our forecast for 2011, we expect adjusted earnings per share between $1.28 and $1.43 in the fourth quarter against last year's record $1.26 results. This forecast reflects a low single-digit comp increase.

Also, as we previously announced, at the beginning of November we sold a 51% interest in our third-party sourcing business. We retain 100% ownership of our intimate apparel, and personal care and beauty sourcing business. We received $125 million in net pretax cash. And we expect to recognize a pretax gain of approximately $115 million in the fourth quarter. This gain is not included in our guidance. We have included a schedule [on raw] materials on page 11, which describe the anticipated impacts of this sale on our reported results. Essentially, we will no longer consolidate results related to the third-party sourcing business, and will account for our 49% ownership under the equity method of accounting.

Sales and profits related to the third-party sourcing business will come out of the Other segment. As you know, the third-party sourcing business is a lower-margin business at approximately a mid single-digit operating margin rate. So, our gross margin rate and the operating income rate will be positively impacted, while our SG&A rate will be negatively impacted. The transaction will have a dilutive impact of roughly $0.03 per share in the fourth quarter, which is reflected in our guidance.

We expect the fourth quarter merchandise margin rate to be up significantly as the sale of the third-party sourcing business will benefit our merchandise margin rate by approximately 300 basis points. Absent this impact, we expect the merchandise margin rate to continue to be down, negatively impacted by cost increases. We expect the buying and occupancy rate to increase slightly, driven by the negative impact of the sale of the third-party sourcing business. Excluding this impact, buying and occupancy cost would leverage on a low single-digit comp in the high-volume fourth quarter.

We expect the gross margin rate to be up significantly, given the merchandise margin and buying and occupancy result I just discussed. This sale will favorably impact our gross margin rate by about 250 basis points. And again, absent this impact, our gross margin rate would be down slightly.

We expect the fourth-quarter SG&A rate to increase, driven by a negative impact related to the third-party sourcing business sale of about 150 basis points. Excluding this impact, the SG&A rate would leverage on low single-digit comps. The sale of the third-party sourcing business will favorably impact our fourth-quarter operating income rate by about 100 basis points.

Moving to inventories, we expect to end the fourth quarter with inventory per square foot roughly up low- to mid-single digits to last year. The end of quarter forecast includes a full [quarter] of inventory related to the timing of Chinese New Year this year, which had an impact of approximately 4 percentage points per foot. For the full year, we're projecting mid to high single-digit positive comps. We expect our gross margin rate to be up, driven roughly equally by an improvement in the merchandise margin rate, and buying and occupancy leverage. The third-party sourcing business sale will benefit our full-year gross margin rate by roughly 70 basis points. Excluding this impact, our gross margin rate would still be up for the year. We expect the full-year SG&A expense rate to be roughly flat, negatively impacted by the sale by about 50 basis points.

Nonoperating expenses are projected for the year at about $250 million, consisting principally of interest expense. Before any discrete items, our tax rate will be approximately 38%. We are forecasting weighted average shares of about 306 million in the fourth quarter, and 315 million for the full year. So, assuming all of these inputs, we expect adjusted earnings per share for the full-year 2011 to be between $2.38 and $2.53 per share. Versus our previous guidance, this forecast reflects our third quarter [beat], less the dilutive impact of the third-party sourcing business sale. We are projecting 2011 CapEx of about $425 million.

As detailed on page 12 of the presentation, we plan to open roughly 40 stores this year, and close roughly 55 stores. We will end the year with total square footage roughly flat to last year.

Turning to liquidity, we expect free cash flow in 2011 of about $700 million. And we remain committed to returning excess cash to shareholders through a combination of share repurchases and dividends. Our free cash flow and cash position, along with the additional availability under our revolving credit facility, result in very strong liquidity, which is more than sufficient to fund our working capital, capital expenditures, dividends, and any other foreseeable needs.

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

Thank you, Stuart, and good morning, everyone. The Victoria's Secret segment achieved both record sales and profits in the third quarter, a result of which we are proud. This morning, I'll share with you the key drivers of our success. I'll then review third-quarter financial results, and end by briefly discussing how we're thinking about fourth quarter. Let's begin with what we've been doing to deliver our results.

We continue to stay focused on our core categories -- bras and panties, supported by a culture that emphasizes getting faster and more agile everyday. We've remained purposeful in our balanced approach between managing the business with optimism and conservatism. We brought this together in a well-told brand story across channels. We told that story through innovative products, steady newness, the right fashion, and excellent in-store and online execution. And finally, critical to our success is our customer connection. We work everyday to stay close to her, and deliver an emotional and positive experience with every interaction.

Now, turning to our store financial performance. Our third-quarter results are detailed on page 13 of your presentation materials. In the Victoria's Secret store channel, third-quarter comps were up 13%. And total sales were up 12%, increasing to $942 million with a two-year comp of 27%. This result was driven by strength across the assortment. Customers continue to respond favorably to the fresh and fashion-right assortment that we are providing. Examples of our third-quarter launches that contributed to this include the Showstopper bra, the PINK Heartbreaker bra, the Unforgettable bra, and our Gorgeous bra. All launches were strong, and met our expectations.

We found success by complementing our bra launches with the beauty fragrance launch. A great example is the Gorgeous fragrance, which landed concurrently with our September launch of the Gorgeous bra, driving sales up for both the bra and fragrance business to last year. As with prior quarters, in-store execution has been critical to our sales growth. And we again achieved record conversion for the quarter. This is the ninth consecutive quarter we have achieved record conversion.

The third quarter merchandise margin rate was down significantly to last year. Margin rate was impacted by cost pressures in PINK and positive response to our customer marketing program, including different purchase offers. We leveraged buying and occupancy, and SG&A expense. And this, combined with our top line growth, drove our operating profit up over 15% versus last year.

Now let's review performance at Direct. Third-quarter sales increased by 8% to $277 million with a two-year sales growth of 11%. Top line growth was driven across the assortment, with particular strength in PINK, sleepwear, panties, and knit clothing. The merchandise margin rate declined with the product cost increases and increased used of shipping offers. Total expenses leveraged in the quarter, so operating income dollars increased by over 30%. And the operating income rate improved.

Now, let's discuss the fourth quarter. We've been preparing for holiday, and are ready. We are looking forward to Black Friday and the balance of fourth quarter. Our assortments continue to be fashion-right, and are coupled with excellent in-store and online execution. We are cautiously optimistic. Following the all-important Black Friday weekend, we are very excited about the Victoria's Secret fashion show, which will air on November 29 with Kanye West, Nicki Minaj, and Maroon 5 performing as our musical entertainment.

We will not lose focus on our bra and panty business. Nor will we lose focus on our robust gifting options such as beauty and sleepwear. These categories are our primary investments heading into the all-important holiday time period. We will maintain maximum agility to chase what is working. We will stay balanced in our approach by managing our inventory and expenses to grow at a rate slower than sales. And we will chase aggressively where appropriate.

In closing, we are pleased with our performance, but continue to see opportunities for improvement. We will stay close to our customer, and work to drive sustained profitable growth as our top priority.

Thank you, and now I'll turn the discussion over to Nick.

Thank you, Sharen, and good morning, everyone. At Bath & Body Works, we're pleased with the results of the third quarter. We delivered sales and operating income growth versus last year's strong performance. We continued to deliver improved results by maintaining focus on three key categories -- our Signature collection, the anti-bac soap and sanitizer business, and our home fragrance assortments. The customer also responded well to the increased presence of seasonally relevant fragrances and forms.

Performance improved versus last year at Signature collection, driven by the successful launch of a new fragrance, Paris Amour. The anti-bac business delivered growth in our soap and pocket-back collections by increasing novelty and fashion newness in our seasonally relevant fragrances. Home fragrance performance continues to be driven by candles and new seasonal fragrances, as well as growth in forms and novelty in our diffuser and Scentportable categories. Transactions were up versus last year, driven by traffic and continued improvement in our conversion rate.

So, with that backdrop, let me take you through the financial resorts for the quarter as detailed on page 15 of your materials. Bath & Body Works third-quarter comps were up 9%. Total sales for the quarter were $504 million, up 8%, or up $36 million versus last year. For the quarter, the operating income was $41 million, up $9 million or 28% from last year. Operating income as a percentage of sales was 8% in the quarter, and up to last year. Gross margin rate in the quarter was flat to last year. Merchandise margin rate declined somewhat, but was offset by leverage on buying and occupancy expense. The decline in merchandise margin rate was driven primarily by increasing costs, and we were able to leverage SG&A expenses versus last year.

We also finished the quarter with inventory levels down to last year. We continue to drive inventories down year over year while maintaining high in-stock positions. The BBW Direct channel also delivered strong sales and operating income growth versus last year.

Looking ahead to the fourth quarter, we will continue to introduce newness and innovation in both form and in fragrances. This month we began our holiday theme with animation in the windows, our front-of-shop focus on our holiday collections, home fragrance items and gifts. Throughout the month, the shop will be focused on new fragrances, great seasonal gifts, and the launch of our newest Signature collection fragrance, Be Enchanted. We're excited about the assortment and the visual appeal of our stores. Our overall focus continues to be about getting faster, and better understanding and satisfying our customer needs, while providing them with a world-class in-store experience. In addition to focusing on products and fragrance launches, we will continue to test and read the results of new product offerings and promotional strategies, while maintaining flexibility in our inventory to react quickly to our customers' needs.

With that, I will turn the discussion over to Martyn.

Thanks, Nick, and good morning, everyone. As most of you know, Martin Waters covered a complete update on our overall international strategy, including our accomplishments to date and our plans for 2011 and 2012 at our October investor update meeting in New York. So, today I will just hit the highlights.

One of those highlights is that we, along with our partners, continue to be on track to open approximately 120 stores this year outside the United States. Taking a look at each of the businesses, let's start with our Victoria's Secret international business. In the third quarter, we opened three Victoria's Secret full-assortment stores, and one PINK store in Canada. Bringing the total in Canada up to nine Victoria's Secret stores and eight PINK stores. These stores continue to do very well for us. And we plan to open another two locations in the fourth quarter of this year.

Our partners opened eight Victoria's Secret Beauty and Accessories stores in the third quarter, bringing the total to 32 stores. In addition, our partners plan to open another 27 stores by the end of the year, for a total of 59 stores at year end. Sales productivity in these stores continue to be very impressive. We also continue to be on track to open our new Bond Street store in London next summer. Along with another two to three full-assortment mall-based stores in the UK. And as we announced at the update meeting, we also plan to open three mall-based full-assortment stores in the Middle East in late 2012. So in summary, all of our Victoria's Secret stores outside the United States continue to perform very well, and we are enthusiastic about the growth opportunities for this brand.

Turning to BBW, we opened three stores in Canada in the third quarter, bringing our total to 65. These stores continue to achieve sales volumes well above our US average. In fact, our most recent opening in Newfoundland broke the record for opening week sales across the chain. As a result, we plan to open another four stores over the remainder of the year. We opened another six BBW stores under our partnership with Alshaya in the Middle East in the third quarter, bringing the total to 14. These stores also continue to do very well. Our partners will open another six stores in the Middle East and Turkey in the fourth quarter. And we are on track to open in Russia in early 2012.

Turning to La Senza, you will recall that this brand operates through Company-owned stores in Canada, and under a franchise partnership model in the rest of the world. Although the business is not significant to our overall results, our Canadian business has been slower to turn around than we would have liked. It is also being impacted in part by a very challenging Canadian retail environment. La Senza's comparable store sales decreased 4% in the quarter. The La Senza international business has been strong, with retail sales up significantly in the quarter. Our partners opened another five stores in the third quarter, bringing the total to 267 stores. And our partners plan to open another 30 stores in the remainder of the year, for a total of almost 300 stores. Total La Senza operating income was about flat to last year in the quarter, and remains at about breakeven. So, overall we are very pleased with our progress towards developing the foundation for a sustainable international business model, with outstanding long-term growth potential for all of our brands.

In closing, I want to reiterate that we also continue to be very pleased with the Company's overall performance, which has been driven by an intense focus on fundamentals, coupled with an orientation to getting faster and more agile, and of course, staying close to our customers. We remain focused on what we can control. And we will continue our disciplined and conservative approach to managing the business, while also aggressively pursuing every opportunity to get even better.

Thanks, and now I'll turn it back over to Amie.

Thanks, Martyn. That concludes our prepared comments. And at this time, we're happy to take any questions you have. Again, as a reminder, please limit yourself to one question. I will turn it back over to Matt.

(Operator Instructions) Erika Maschmeyer, Robert W. Baird.

Could you talk a little bit more, Sharen, at Victoria's Secret about your good, better, best pricing architecture, where you've added quality and raised price? And have you been seeing customers gravitate towards your best price points? And then also just update us on what you're seeing from an AUC perspective in Q4 and into next year. Thanks.

Sure, thank you. We do have a good, better, best strategy. And the offering is very balanced in the good, better, best. And at each one of those levels we are getting actually better sell-throughs this year versus last year. So whether it the good price point, the better or the best price point. So it is very balanced. You will hear us talk about in the best price point because the fashion and the details we're putting into the bras are actually anywhere from $42 to $98. It is not a distorted amount of units that are going into that better price point. But we are seeing very good sell-through. So the key message is, yes, we are pushing the best price point, but the offering is still very balanced, the sales are still very balanced, and the sell-throughs are very balanced in the good, better, best price points.

As we think about AUC, do not see much change going into the fourth quarter, nor the first quarter in terms of the costumes.

Brian Tunick, JPMorgan.

The question is for Stuart. On the expenses growing slower than sales over the past year and so, is there anything we should think about regarding next year, the Victoria's Secret international store rollout, that would change your opportunity to continue to grow expenses slower?

Brian, we are still working on our 2012 models and plans but our commitment to grow for the enterprise expenses slower than sales is just what I would call a foundational commitment. And so we're going to work very hard to do that, but do it in a way, obviously, that doesn't negatively impact experiences for our customers and so on. But that commitment at an enterprise level is a strongly held one, and we're going to continue to work hard to achieve that. But we continue to work our '12 plants and ranges and scenarios, and obviously we will provide more information about that in February when we provide 2012 guidance. But the commitment remains.

Lorraine Hutchinson with Bank of America.

Just wanted to follow-up on the sale of the sourcing business. It doesn't look like you have too much equity income coming into your guidance in the fourth quarter or next year. So I was just curious how the profit sharing would work there. And also if there is a possibility for a quicker deployment of that cash in terms of a share buyback to offset some of the dilution.

Thank you for the question. Stuart. In terms of the ongoing business, we'll own 49% of the business. We'll account for it on the equity method. The view at this point about income contribution from that stake is that it won't be material. And the reason for that is the new business, the newly formed business, will have some debt and related interest expense. And there will also be recognition of intangible assets and other step-up in basis that will drive more depreciation and amortization. So all those details are still getting sorted out a bit but at this point we don't judge it to be material to any particular period. So that is why that is.

With respect to deployment of that cash, I hope that you recognize what we do over time, which is we are very committed to returning excess cash to shareholders. We try to be very thoughtful and balanced about that. We work with our board, et cetera. As you know, we did just announce a new share repurchase program in early November. And again, our commitment to return cash to shareholders is as strong as ever.

Stacy Pak with Barclays Capital.

I was hoping you could talk a little bit more about Canada. My sense is mall traffic improved in Canada in October. What you're seeing there. And more fundamentally, why is La Senza strong in the rest of the world and not in Canada? What's the road map to getting that fixed? And what was the La Senza impact on EPS?

Good morning, Stacy. As I said in my prepared remarks, La Senza in Canada delivered a negative 4% comp in the quarter. This was driven by a bit more of a promotional activity in what I would characterize as a very tough retail environment. From what we can see in terms of reported results for Canada, the Canadian market in general remains very difficult. We see mall traffic down 10% in the quarter, and most retailers in Canada reporting negative comps. So it is a tough environment. That said, we continue to be very conservative about our plans for the business. We are applying learnings as we go to make sure we're positioning the business for success in the future. Our inventories are very clean as we enter holiday. And we're optimistic about the prospects for La Senza in the fourth quarter.

Your question about the international side of La Senza is interesting. The different retail markets distributed across the world, and as I said our La Senza international franchise business continues to show very good growth for us. And even more indicated by the fact that our partners are continuing to aggressively open new stores across the globe. A total of 55 stores this year alone. And a lot more to come next year. So we're very happy with the progress in international.

The last part of your question, Martin said in his prepared comments that La Senza was about breakeven in the quarter.

Janet Kloppenburg with JJK Research.

Stuart, I just had a question on the SG&A. The leverage in the third quarter was much better than I expected. And yet in the second quarter on the same level of comp, or close to it, your SG&A ratio actually was flat. So I was wondering what drove that difference. Maybe there were some investments in the second quarter that benefits the third quarter. And what factors may have affected that change. Thanks.

Janet, it obviously varies from quarter to quarter. And you have to also obviously look at the comparisons, as well. Again, last fall in the third quarter we started to invest a bit more in customer-facing expenses, and so that affects the comparison a bit.

Does that answer your question, Janet?

I just was wondering, is what you're saying, Stuart, that you've anniversaried that investment in payroll that you had started to do last year so perhaps --

That is part of it, Janet. And then the other thing, in the spirit of being helpful, in the fourth quarter, just moving to the fourth quarter, as we called out last year on the fourth quarter call, we did have some one-time expenses last year in the fourth quarter related to stock comp and the write-off of a trade name. So that affects our view of the fourth quarter, as well, in terms of our guidance.

So, were there some one-time items in last year's third quarter that perhaps I wasn't paying good enough attention to?

Not as significant as the fourth quarter but there was a little bit of one-time in last year's Q3 as well.

Paul Lejuez, Nomura Securities.

Could you maybe talk about what selling the main stake in Mast does for that organization that maybe could not be done under your umbrella? And just to be clear, I just want to understand what changes that brings to your sourcing organization by business, and even within the Victoria's Secret business. Is there any change to the PINK sourcing organization versus the folks that are sourcing on the lingerie side? Thanks.

Paul, in terms of thematically what we think is most important with respect to that sale of the third-party sourcing business, it's about focus. And so an ongoing focus for us related to the sourcing of intimate apparel and personal care and beauty is obviously very important and foundational to what we do. The new entity focusing on apparel sourcing, and only apparel sourcing, will be effective and helpful to that organization. So really the underlying rationale for it is one of focus. And that is the most significant effect of the sale of the third-party sourcing business. That will benefit us and that will benefit the ongoing new entity.

We will go to Sharon about the PINK and intimate sourcing structure.

All of the intimate and sourcing structure in what we call our loungewear, some people call it apparel, in PINK, in Victoria's Secret lingerie, as well as Rex will remain with the mass global organization and not the third-party sourcing. The only thing, and it's only pieces of the category that will go from the direct apparel business into the third-party sourcing, such as coats and shoes, things that are outside of our core. All of our core, including the lounge/apparel business and PINK stay with Mast Global and Victoria's Secret.

Michelle Tan with Goldman Sachs.

Sharen, I was wondering if -- and maybe this is a question for you, as well, Nick -- I think you guys have been calling out monthly some stronger response to promotional events. It feels like it is the first time we've heard that in a while from you. So I was just curious what you're seeing in terms of consumer behavior that might be changing and how you guys are thinking about playing into that or managing to that.

Hi, Michelle, this is Sharen. Basically when we've talked about our promotions, it is really around our gift-with-purchase or maybe our PWPs. And we have a philosophy of how do we surprise and delight our customer with really branded kinds of products. An example of that was our coats. That would be oversized coats in the fall season. Very high response to. An example of the spring season was the Victoria's Secret beach towel for the December timeframe. So as we think about really having her have an ownership of the brand, as well as surprising and delighting her, these are the things that we are really going after. And that's, when we talked to the higher response that we are getting to the GWPs and PWPs are what we are responding to.

Nick, do you want to add to that?

Sure. We're fundamentally running about flat in terms of promotions to last year. We continue to plan that down. And at the same time we obviously monitor customer behavior help us decide what we're running. But for all intents and purposes, we're running roughly flat to last year.

Jennifer Davis with Lazard Capital.

I was hoping you could talk a little bit about your promotional plans for fourth quarter. Nick, you touched on this a little bit. Are they going to be similar to last year? Are you planning them down at all? Will there be any timing changes in terms of the semiannual sale? And then also, if I can squeeze in another, I was hoping you could talk a little bit more about your thoughts on pricing and the cost increases. I feel like you guys have a lot more pricing power than most other specialty retailers. And just curious why you're not taking up prices a little bit more. Thanks.

Thanks, Jennifer. Let me reiterate. So we've been running pretty much flat promotionally and that does not change as we look forward. We continue to actually play with prices in terms of testing different pricing scenarios, both up and down, to understand what makes the most sense for the brand. And where it works, we'll continue to push that forward. And we don't see a change in terms of either the timing or the size of the sale as we come out of the end of holiday.

Great, thank you. Sharen, do you want to add?

Our promotional activity, if you're calling promotional pricing activity, is actually down to last year. We obviously are very prepared for Black Friday. We do have contingencies but today we are viewing that, our promotional -- and that means pricing -- activity will be down. We will continue our surprise and delight with our GWP through the holiday season. Not that it is a lot incremental to last year, but it is slightly up. When you think about, as we really think about our costings, there's really three key priorities. It's about quality, speed and innovation. And we know staying really focused and agile makes us better able to read, react and make big bigger. The top line benefit we get from that mindset and really strong execution, outweighs any downside in the increase in cost of raw materials.

Kimberly Greenberger with Morgan Stanley.

Sharen and Nick, I'm wondering if you can talk about how you are seeing traffic trends in your store. It seems to me that throughout the third quarter you have been bucking the mall traffic trends. What do you attribute that to? And if you can talk about the specific strategies you have employed and how you expect to drive those through the holiday season, that would be great.

The mall traffic is interesting. It has been erratic. We have been performing probably 80% of the time slightly above the mall traffic. And I really attribute that from us being able to deliver compelling emotional storey, really staying focused on our core. As we talked about also within the stores, the higher selling staff and training we're doing, which actually really tends to drive more conversion. And then the surprise and delight strategy that is tied back into our powerful bra launches. And in the fact that we've actually had better alignment with our fragrance business and our bra business putting power on power. We will not change that strategy as we go forward into the holiday timeframe. We're actually even trying to make our story even more emotional and more fashion right. And those that had the opportunity to see the holiday stores, I would hope that you agreed with me.

It'll be consistent with what we've been doing all year which is really making sure we are flowing units on a regular basis to the customer that she can emotionally connect with. I think it's really important that we're staying as close as we possibly can to the customer to understand her behavior so that we can have the right inventory there, so that we can win with her. And making sure that our story, our windows tell great stories of that product and of that newness. And that is really what has been helping us drive the traffic.

Marni Shapiro with The Retail Tracker.

I was curious, Sharen, you just said that mall traffic has been erratic. I was curious what you guys are seeing online. Is the traffic online more consistent or is it also a little erratic? Is it tied more to product launches and promotions or is it more a day-in, day-out business? And I'm curious across BBW and VS.

I'm glad you asked me about Direct because my last remarks about what's happening is the power, too, of our direct channel and our social media strategy with our store strategy. The traffic on the web is up. And it is up in the double digits. And it has been consistently up throughout the quarter.

By the way, thanks for the complements, Marni. We continue to see good solid, consistent performance in traffic online. And obviously we utilize our online business to help sell the overall brand story as much as we can.

Roxanne Meyer with CBS.

Congratulations on a solid quarter. I just had a question on Victoria's Secret Direct. The performance there, obviously, was really impressive. But we noticed that you didn't call out bras and beauty, like in your stores, some of the standout categories. I'm just wondering, is it just more of a relative performance or is there something that's keeping those a little bit softer on the Direct side? And just thinking about that, how do you feel how you're positioned online for beauty for holiday? Thanks.

Thank you very much. In terms of the Direct channel, and the bra business, when we call out the categories, and it may be a little bit misleading, it's that those categories are just so extraordinarily strong. Our bra business was slightly below the store channel in terms of its comps, but still comped itself. The panty business was up in the double digits in terms of the direct business for third quarter. I do believe that we have a lot of momentum within the core categories. And one of the strategies for the brand is how do we get even stronger among the categories that are shared categories between the direct channel as well as the store channel. Our goal is to have one seamless experience from the customer point of view. And we've done a lot there year, and very excited about the progress we're making towards that goal.

Dana Telsey, Telsey Advisor Group.

Good morning everyone and congratulations. As you think about the new sourcing arrangement, is there a long-term benefit to gross margin Victoria's Secret versus BBW? And also is PINK at all different from Victoria's Secret that way? Thank you.

Hi Dana. I don't think that the new sourcing agreement will affect the margins. Obviously, every day we continue to strive to get better and better, but there is nothing really changing in those sourcing agreements with Victoria's Secret and [Mast Global]. I look at it as all one and the same. I think the benefit that the Victoria's Secret Mast Global people will have is that they won't be distracted. They'll have more maniacal focus on Victoria's Secret.

Hi Dana. It would be consistent story for us, as Sharen just articulated.

And Dana, financially the effects are all in the other segments.

Christian Buss with Credit Suisse.

Could I ask a longer-term question? Can you talk a little bit about the levers you have to drive productivity ahead of prior peaks at both Victoria's Secret and Bath & body Works? And then if you could articulate some of the longer term targets there, that would be very helpful.

When we think about the levers that really drive productivity, if I take it from a store channel perspective, one of the things that we really believe, there's probably five levers. One is about being a brand that is really a well-told story. And having the right amount of compelling assortment. Number two would be the compelling assortment, focused on our core categories. Being able to tap, read, react into the right fashion at the right time. One of the key pieces that we have is really our selling and service models, that we are really trying to improve on every day within the stores. So when you think about how do we train our people, how do we really think about doing things differently than we have in the past, which also we're seeing great results in terms of driving that productivity.

We also believe that as we continue to move to have a seamless interaction between store channel and direct channel, such as buying online, returning in stores, which we have rolled that out for this fall season, it is also another opportunity for us to continue to improve in productivity. Nothing works as well as our speed and agility, constant flow, constant newness, but I believe that we are just at the beginning of the beginning on this journey as we go forward.

For us it will be a continued focus on our big three businesses. We have fantastic franchises in each of those three categories. And therefore there's an opportunity for us to further profit from those. When you think about different adjacencies that we might be able to manage. Secondarily, behind that, when we look at what is the optimum assortment from the store, there's still opportunity to continue to refine and define what that would look like. As well as standing back from the business and just thinking about what other categories might we be able to plan, just given the overall strength of the brand.

Howard Tubin with RBC Capital Markets.

Maybe just a question for Sharen. When you talk about being agile and nimble in the fourth quarter, maybe you can just give us some more detail on what ability you have to chase strong performers at this point in the season.

Sure. I'll just give you one quick real live example. So we have, let's say beauty, which is a category that relates so loudly as we go into the holiday season. We actually in our new beauty part, put componentry there that we actually can assemble and put together our gift set and actually get them out within two weeks. This is something we've never been able to do before. So we're able to read what is actually working and now we can actually push goods after the Black Friday, which then we can get the store to selling them, that have gone through this very quickly, back into business as we go into holiday. So that is a quick example in terms of agility. The other piece that I would like add, too, on the speed and agility work, it's really also about a mindset. It is about how we just think about it differently and how do we keep open to buy, to react, and to make quicker decisions. It has also been a cultural change as we've gone down this path to think about being more agile and to think about speed differently.

Richard Jaffe with Stifel Nicolaus.

A question regarding the beauty business and the ability to shift that business through to the direct channel. Obviously small average price points and small product. Wondering how effective that is compared to Victoria's Secret as a direct business. Or is it really more of a relationship builder and we shouldn't look for that as a high-volume direct channel?

The beauty business, both in Bath & Body Works Direct as well as Victoria's Secret Direct, which I had the privilege of launching, is a very strong business and a highly profitable business. And when you think about really, you're not selling really single items but then how do you really get your average order size really up, which makes it more profitable. Yes, as you think about the postage, it does cost more. But because of the efficiency of prepacking and the effectiveness of that, there really is a nice business model. And we have enjoyed very strong growth, especially in the Bath & Body Works Direct in beauty. I would the Victoria's Secret still has a bigger opportunity, that we've probably been more focused on our bras and panties and sleep. So that the opportunity to continue to grow the Victoria's Secret beauty business is very, very big.

Hi, it's Nick. When we think about the different channels that she shops, the opportunity to engage with her, multiple channels is a terrific way of building the brand. It's a great way of telling the brand story. It's a great way for us to emotionally connect with her in more than just bricks and mortar. So it is a good consistent opportunity for us.

John Morris with BMO Capital Markets.

Good morning and nice, nice work everybody. Question, one for Sharen. Talk a little bit about, just to jump ahead, Valentine's Day is such an important holiday for you guys. Give us a sneak peek what your thoughts are, strategy there, what might be a little bit different this year to help drive that business. I know that you always think that there is more and more opportunity there. So I would love to hear a little bit about your thoughts with that regard. And at Bath & Body Works, Nick or Andrew, some of the costs that have been creeping a little bit higher, we know about freight and things like that. But what else is in there that is pushing the costs higher? Perhaps petroleum, perhaps the package products? A little bit of understanding there. And how far out into next year would we continue to see those costs come into play? Thanks.

Right now I am really maniacally focused on delivering holiday. Absolutely, Valentines is another very important part of Victoria's Secret. We will have a lot of surprises. We have one of the best bra launches I think ever. So I'm excited about that. But right now I really want the team to be focused on delivering its holiday time frame.

Primarily for us, outside of cost, our real focus is on making sure we're focused on full-priced selling because that's where, obviously, we're going to get the benefit. Our costs, traditionally it's been around [resin] prices and fuel. And we see a similar impact looking forward for the next quarter or so. But it's really about us continue to maximize on full-priced selling.

Thank you, Nick. And that concludes our call for this morning. And we want to thank you all again for your interest in Limited Brands.

Happy Thanksgiving.

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