LandBridge Co LLC (LB) 2007 Q3 法說會逐字稿

Welcome to the Limited Brands third quarter earnings conference call. All participants will be in a listen-only mode until the question and answer portion. (OPERATOR INSTRUCTIONS) Today's conference is being recorded. If you have any objections, you may disconnect at this time. I will now turn the meeting over to Mr. Tom Katzenmeyer, Senior Vice President, Investor and Media and Community Relations. You may begin.

Thank you, and good afternoon, everyone. Welcome to Limited Brands third quarter earnings conference call for the period that ended Saturday, November 3, 2007. As always, 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 statement found in our SEC filings. Our third quarter earnings release and related financial information are available on our website, LimitedBrands.com. The call is being taped and can be replayed by dialing 1-800-337-6551, followed by the pass code 583. You can also listen to an audio replay from our website.

Martyn Redgrave, EVP and CAO; Stuart Burgdoefer, EVP, Chief Financial Officer, Sharen Turney, CEO of Victoria's Secret; Diane Neal, CEO of Bath and Body Works; and Amy Preston, Vice President of Investor Relations are all joining us today. After our prepared comments, we'll be available to take your questions for as long as time permits and, again, so we can speak with as many callers as possible, it's important that you limit yourself to one question and I will remind you about that later. And now I would like to turn the call over to Martyn.

Thanks, Tom, and good afternoon, everyone. Since we just held our investor update meeting about a month ago, I'm not going to spend a lot of time this afternoon discussing our strategic initiatives. However, I do want to reiterate that we remain very focused on our opportunities for growth, including the following things. Expanding the average Victoria's Secret store size by roughly 50%, resulting in an 8 to 10% square footage growth per year for the brand over the next five years; opening new BBW stores, primarily in non-mall locations, which will result in BBW's square footage growing at about 6% per year over the next five years; our continued expansion of La Senza in Canada, which will result in square footage growth his year and total company-owned stores of roughly 15%. The continued testing and expansion of our new concepts, including VSX, our new sport initiative for Victoria's Secret, Intimissimi, accessories, and BBW direct. And finally, the further development of our plans to expand internationally, including the opening of five to ten new BBW stores in Canada next year.

Now, as we reviewed in some detail at the investor update meeting, all of these initiatives are on track and meeting our expectations in terms of timing and performance. As you know, we've also been investing in our operational capabilities to support the growth of our brands. Over the past three years, we have successfully implemented new systems and capabilities in a number of areas, including our PeopleSoft implementation for payroll and HR capabilities, our SAP core financial systems implementation, our terra data, customer data warehouse and customer relationship marketing systems, and the creation of our finance, HR, and procurement shared services organization.

In addition, last year, we implemented new supply chain systems at Bath & Body Works. We spent the past year stabilizing those systems and training our associates in how to fully utilize the new capabilities delivered by these systems. We believe we will begin to see the benefits from these new capabilities in the fourth quarter and more completely next year. We are also investing in a new distribution center and new front end technology to support the growth of our Victoria's Secret direct business. As you know, we opened the new distribution center for Victoria's Secret Direct in early August. As we described in our October sales call, it has taken us longer than we had anticipated to ramp up this new DC to full capacity. This has had a negative impact on our third quarter results, and we now expect that it will have an even more negative impact on our fourth quarter results. Stuart and Sharen will discuss the financial impact more specifically, but I thought it would be helpful to provide you with an overview of this situation.

The former direct distribution center was built back in 1992 when the business was doing less than $400 million in volume. The business is now $1.4 billion, and we have been experiencing capacity issues in the last two holiday seasons. As a result, we recognize that we could not support the growth of the direct business with the existing DC. When we planned the new DC that would support the growth of our direct business for the next decade, we invested in a new physical facility, systems, material handling equipment and processes, that represent the best practices that are being used in direct distribution.

While many of the systems and processes we are using in the new DC have been employed before in other centers, the way in which these systems are integrated is a unique combination, due to the high unit velocity and the range of SKU diversity in our direct business. The fact is that the hard change over the new integrated processes, mechanical equipment, and IT systems is taking us longer than expected to stabilize. We appear to have hit a limit on how much we can process through the new center and we need to be able to substantially increase our throughput to serve the volumes that we expect for holiday and January's semi annual sale.

Direct demand at Victoria's Secret remains very strong and we want to ensure that we don't disappoint our customers. Therefore we have taken actions to constrained the volume of orders we will take, including reducing catalog circulation, which will significantly reduce fourth quarter direct demand and sales. Now, getting the direct DC up to full capacity is without question the most significant operational priority that we have. We have our best internal people, as well as outside vendor experts and independent experts evaluating the situation, and we are looking at a range of options to make changes.

As we have previously discussed, we also have two other significant technology projects under way. As a result of the challenges that we've experienced with both the implementation of the supply chain systems at Bath & Body Works and the new direct distribution center, we are reevaluating the approach and timing of the supply chain systems rollout to Victoria's Secret and Mast and the development of the new front end technologies systems at Victoria's Secret direct.

Our number one business priority is to remain very focused on executing the best possible fourth quarter and holiday. Although we anticipate that the external environment will remain challenging and we will be negatively impacted by the issues at the Victoria's Secret direct distribution center, we do believe that our brands are very strong and that we are very well positioned with respect to our assortment, our inventory levels and expense discipline. Thanks, and I'll now turn it over to Stuart to do the financial update.

Thanks, Martin, and good afternoon everyone. Turning to our third quarter performance, we reported earnings of $0.03 per share, $0.04 of which represented gains from the sale of Corporate Aircraft in connection with the disposition of the apparel businesses and our review of Corporate overhead. Our earnings miss versus our original expectation was driven by Victoria's Secret direct and the issues that Martyn discussed related to the distribution center. Sharen will discuss this in more detail.

Although we did experience softness in the stores channels of our brands as reflected in the negative 3% comp for the quarter versus our expectation for a flat comp, we were able to offset the earnings impact of this sales miss through greater than anticipated expense savings. The negative 3% comp for the quarter was driven by negative traffic levels and we believe is more the result of a tough environment versus specific assortment issues. It is also worth noting that our comp was up 13% in the third quarter when viewed on a two-year basis.

Gross margin decreased 400 basis points to 31.9%. As we discussed on the second quarter call, over half of the basis point decline is the result of the net impact of the recognition of Mast sales to Express and Limited stores, partially offset by the elimination of the lower margin apparel business. The remaining decline is the result of a significant decline in the gross margin rate at Victoria's Secret direct and to a lesser extent deleverage in buying and occupancy at Victoria's Secret stores. Importantly the merchandise margin rate at Victoria's Secret stores was roughly flat and BBW's merchandise margin rate improved versus 2006.

The SG&A rate improved by 410 basis points, again, consistent with our guidance. Key drivers of the rate improvement include, first, the net impact of the recognition of Mast sales to Express and Limited stores, partially offset by the elimination of the apparel businesses, which drove over half the rate improvement. Second, the benefit of the aircraft gains. Third, the benefit of home office, marketing, and other expense reductions. And fourth, an offset due to the impact of lower sales volume and incremental expenses at Victoria's Secret Direct. Total operating income declined $5 million to $61.1 million. By segment, the Victoria's Secret segment declined by $52.3 million to $77.7 million. The Bath & Body Works segment declined by $2 million to a loss of $1.1 million, and the other segment improved by $47.7 million to a loss of $15.2 million.

Our capital restructuring activities, including the impact of the additional debt and the share repurchases were about $0.02 dilutive in the third quarter. Retail inventories ended the quarter down 14% per square foot at cost, in line with our targets. We continue to target retail inventory per square foot to be down roughly 20 to 25% to 2006 levels by year end. On a two-year basis, retail inventory growth per foot in the fall will be below our sales growth per foot. We repurchased 14.6 million shares of stock in the third quarter for $335.6 million. At the end of the third quarter, we had 96.4 million remaining in our current $250 million program. Additionally, our Board has authorized an additional $250 million repurchase program.

Now, turning to our earnings outlook for the fourth quarter, we expect fourth quarter earnings per share between $0.90 and $1.05 versus our previous estimate of $1.18 and $1.08 last year. Last years earnings per share include about $0.04 attributable to the 53rd week. The decline versus our previous estimate is primarily attributable to a reduction in our projections for Victoria's Secret direct. As Martyn mentioned, we have taken steps to reduce demand and sales in the fourth quarter in order to protect the customer experience. We believe that these measures could reduce Victoria's Secret direct sales in the fourth quarter by roughly 150 million versus last year. We are also incurring additional expenses related to the distribution center.

Our revised estimate also reflects a decline at Victoria's Secret stores and Bath & Body Works versus our prior estimates in recognition of the difficult environment and negative traffic trends. Our revised comp estimate for November is a negative midsingle digit comp and for the fourth quarter is a negative low single-digit comp versus flat guidance for both periods previously. This would represent a two-year comp result for the fourth quarter in the high single digits. Versus last year, our operating income dollars will be most impacted by a significant decline at Victoria's Secret Direct, a decline at Mast driven by lower sales to Victoria's Secret and Abercrombie, partially offset by a reduction in Corporate overhead related to our head count reductions. We estimate that total sales in the fourth quarter will decline by roughly 15 to 20% driven by the sale of the apparel businesses and the decline at Victoria's Secret Direct, partially offset by an increase in Mast sales of roughly 70 million. We estimate that the fourth quarter gross margin rate will be roughly flat. And we expect that the fourth quarter SG&A rate will increase versus last year driven by the same factors that drove the third quarter rate improvement.

It is important to note that the net impact of the incremental Mast sales and the elimination of the apparel businesses will not be as significant on a rate basis as it was in the third quarter due to the higher sales volume in the fourth quarter. We expect that interest expense will be about $50 million in the fourth quarter and that the total of interest income, other income, and minority interest will be around $15 million. We continue to estimate that 2007 capital expenditures will be between 765 million and $790 million.

As we've discussed previously, over 60% of our capital expenditures relate to the investments in remodeling and expanding existing stores, as well as opening new stores. This investment relates to the real estate growth for Victoria's Secret and Bath & Body Works, as well as the capital spending at La Senza, which is incremental for 2007. About 20% of our CapEx budget relates to investments in technology initiatives and the expansion of our direct distribution center, and this investment level is roughly flat year-over-year. The remainder of our CapEx budget relates to home office and other investments, including the consolidation of the majority of our New York offices to one location.

Before I turn it over to Sharen, I would like to make some comments on La Senza's third quarter performance. Third quarter sales at La Senza were $117.3 million and comps were down 2%, which was below expectation. Although operating income dollars were slightly lower than expectation due to the sales miss, the operating income rate was in line with our plan. Victoria's Secret beauty products were rolled out to all La Senza stores in October and we are encouraged by the response to date. Thanks, and now I'll turn the discussion over to Sharen.

Thank you, Stuart, good evening. The total Victoria's Secret segment sales including La Senza increased 9% in the third quarter to $1.077 billion. Comp store sales decreased 4%, but were up 13% on a two-year basis. Total segment operating income declined $52 million to $77.7 million, a decline of 40%. The total segment operating income decline was primarily driven by decline at Direct. A decline in operating income at Victoria's Secret stores was largely offset by La Senza's operating profit during the quarter.

Turning to the individual business performance, Victoria's Secret store comps declined by 4%, and total sales declined 1% to $735 million. Operating income dollars declined and the operating income rate declined by just over 200 basis points driven by buying and occupancy deleverage. The merchandise margin rate was roughly flat and SG&A leveraged as a percent of sales due to a decline in marketing spend. Comp store sales for the quarter were below expectation, as our performance was hampered by the continued overall economic environment and consequential softness in mall traffic.

During the third quarter, our core bra, panty, and sleepwear business was down to last year, while our PINK and beauty business posted year-over-year growth. For the fourth quarter, we are focused on executing the best holiday possible, continuing to introduce and launch new and innovative product, and executing our real estate strategy.

As our customer insight work tells us at the beginning of the holiday season, our customer is primarily focused on self purchase. Therefore we began the holiday season with this focus in mind, featuring the launch of the new Very Sexy Ways with lace bra, a fresh PINK assortment and the new Supermodel fragrance launch in beauty. In order to deliver our holiday plans, we are focused on executing our planned strategy, executing call to action marketing to drive additional traffic to our stores and increase conversion, and we continue to proactively manage inventory levels while providing customers with required levels of newness. We are also continuing to develop key drivers of growth for the holiday.

Some of our plans include a shift from self purchase to gifting during key holiday timeframe, including lingerie, PINK and beauty gifting. We expanded our giftable and impulse purchase assortment to include fun items, such as panty pops, panty candy, gift card holders that also serve as luggage tags, along with other highly giftable items that we think will sell this holiday.

We plan a celebration of the first-ever Supermodel PJ party, featuring a fun, fabulous colorful collection of sleepwear that is perfect for self purchase or gifting. We are continuing to build the Intimissimi line of intimate apparel, which represents a strong opening price point proposition, and an escalated frequency of fashion, Intimissimi will be in roughly 240 stores by the end of this year. Testing VSX, our new line of sports bras and apparel in about 30 stores and finally we continue to focus on and be excited about our overall real estate strategy. In this third quarter, we opened 17 new stores and remodeled 52 stores with plans to open or remodel a total of 145 stores by year end. Make sure you watch the fashion show, which will air on December 4, at 10:00 p.m. on CBS. This year's show features the kickoff of the World Union tour of the Spice Girls.

Now, turning our attention to the Direct channel, as Martyn and Stuart mentioned, our results at Direct were negatively impacted by the delays in shipping out of our new distribution center. Demand for the brand, as evidenced by our orders from the catalog and the Internet channel, remain very strong, but sales at Direct declined 7% in the quarter, due to the increased ship times and operating income decline significantly. The decline in operating income was a result of sales and related shipping and handling revenue decline. The loss of higher margin, expedited shipping options and incremental labor hired to staff the DC and work on fixing the issue. We are obviously disappointed that we've had to take steps to reduce this demand in the fourth quarter. However, protecting the customer experience and her satisfaction with the brand is of paramount importance. As Martyn said, this is our most significant operational priority and we are working very hard to bring the DC up to full capacity and maintain customer satisfaction. Thank you, and I'll now turn it over to Diane.

Thank you, Sharen, and good evening. Bath & Body Works comp decreased 3% in the third quarter, against a 15% increase last year. Although sales for the quarter increased $16 million over last year, sales were below our expectations. For the quarter, operating income versus last year declined $2 million to a loss of $1 million. The operating income result was driven by increases in sales and margin dollars, primarily driven by real estate activity and a margin rate improvement. That was offset by deleveraging of fixed buying and occupancy expenses and startup costs associated with new store real estate activity, and consistent with prior quarters, higher SG&A costs due to ongoing supply chain system support costs.

Overall, third quarter sales and margin were below expectations driven in part by lower than expected customer traffic. Throughout the quarter, we experienced a downturn in customer traffic, which has been consistent with mall traffic decline. Both merchandise margin and gross margin rates were up to last year driven primarily by mix and improved product costs, partially offset by increased promotional activity to clear seasonal fragrances and gift sets. During the quarter, performance of our e-Commerce business met expectations. We continue to view the direct channel as both a revenue generator and marketing vehicle for our brand and collection of subbrands.

In August, we ran our annual hand soap event, which focused on our anti bac and Aromatherapy hand soaps and featured the launch of three new hand soap fragrances, Midnight Pomegranate, Japanese Cherry Blossom, and Central Amber from our Signature Collection line. In early September, we launched our fall fragrance theme, featuring the new Irresistible Apple fragrance from our Signature Collection, and our Perfect Autumn home fragrance collection. In late September, we moved to our home fragrance theme, but continued to focus on our Perfect Autumn and Halloween Home fragrance collections and new fragrances from our Temptations body care line. In October, we launched our fall home fragrance theme, featuring Perfect Autumn and Halloween Home fragrance collections. We then moved to our Happy Falladays theme which was a more transitional holiday set. Happy Falladays featured the launch of new fragrances, Velvet Tuberose, Blackberry Amber from our Signature Collection line, as well as our Perfect Autumn home fragrance collection.

In November, we moved to the perfect Christmas theme, which featured holiday gifts, home fragrance, and toiletry collections. This year's Black Friday promotions will be similar to last year, featuring an Eau De Toilette gift with purchase and wall flower promotion. December themes will continue to focus on our holiday collections. New for this year, we will feature exciting activities to drive traffic each day during the last 12 days leading up to Christmas.

Holiday is off to a softer start than we had planned, but we believe our assortment is fresher than last year and inventories are appropriate balanced in total and also by store, driven primarily by our system implementation benefits. We also have additional inventory support in our key volume drivers, that we feel was a missed opportunity from last year. We are cautiously optimistic that we will deliver a successful holiday and fall season. With that, I will turn the discussion back over to Martyn.

Well, thanks, Diane. Before we take your questions, I would just like to emphasize three main points. First, we have very strong brands that lead the industry in their categories. Second, we are reevaluating the timing and approach to our ongoing technology initiatives in order to minimize the disruptions to our business in 2008. And finally, we're very focused on managing the key basic operational elements of our business. Our assortments, inventory levels, expense controls, and operating execution. Thanks, and I'll now turn it back over to Tom for questions.

Thanks, Martyn. That concludes our prepared comments. At this time, we would be happy to take any questions you might have. Again, I want to remind you, we would like to limit everyone to one question, so I would like to turn it back over to Josh for the first question. Operator?

Thank you. At this time, we are ready to take questions. (OPERATOR INSTRUCTIONS) Our first question is from Mr. Jeff Black of Lehman Brothers.

Thanks, good afternoon, everybody. I guess just a question on the magnitude and depth of the problem at the DC. I mean is this a full reengineering effort we have to undertake here? And what are the chances this extends beyond 4Q and into spring, would be, A. Then on the Victoria's Secret systems implementation, assuming you probably don't want to do that next fall, is that going to slip into '09? Thank you very much.

Thanks, Jeff. We're going to go to Martyn Redgrave with your question.

Jeff, in terms of the distribution center operation, just to step back and give you a little bit more perspective, because I'm sure this will be a source of a number of questions, the first thing I think you need to understand is in opening the center in August, we had expected a slow ramp up. We did in fact ramp up at about the pace that we were expecting to ramp up at, to about the end of September and into October. We saw a noise, if you will, in the operation of the center, but we didn't see an inability to break through the volume levels that we need to break through to service holiday.

Over the last four weeks, as we've evaluated the performance of the center, we've concluded that there are some issues there that are going to cause us to have to limit the capacity of the center -- that will limit the capacity of the center as we enter into holiday. The center itself obviously is a new operation for us. For instance, it utilizes a number of new capabilities that we've not had in our other distribution centers before, things like the high pay reserve storage capabilities that are not in our other centers. We're using a dynamic location picking system, which is very different than the static location picking systems that our traditional centers have used. We're using new high speed multiple stage conveyor systems, new handheld and laser reading scanning technologies. All of this is kind of new to us, not necessarily new to the world in terms of the way it's been utilized in other large scale distribution centers, but are just taking us longer than we had expected to kind of burn in these new processes, these new systems, and make sure that our associates in our distribution center fully understand how to utilize the new processes and systems.

Another point that I would give you as perspective is that the center right now is operating at about 70 to 75% of our targeted capacity. In other words, the capacity we would need to be at to fully service holidays. So that gives you a sense of the gap. And the last thing I would say, and I would be happy to answer more questions about this, is that we are obviously focused on stabilizing the systems, the processes, and the, and ensuring that our people are properly trained to operate these new systems and processes. We're working on all aspects of that on a very realtime basis with internal and outside experts, and at this stage, it's premature to say how long it's going to take to fully stabilize the center and whether or not it's going to have an impact on the spring. We do expect it will have some impact, though.

Martyn, he had a follow-on question about the systems at Victoria.

Well, as I mentioned in the scripted remarks, we're evaluating the timing of the limitation of the supply chain systems for Victoria's Secret stores. It's important to distinguish that on one hand we're talking about the Victoria's Secret Direct business, that's the distribution center. On the other hand, which is a completely separate organization and operation, is our store's operation, which is scheduled to implement the supply chain systems next year. As I indicated, we're reevaluating the timing of that implementation, particularly as we look at the other priorities that we have to deliver against and it is probable that we will change that timing in order to not disrupt the Victoria's Secret Stores business in 2008.

Without belaboring it, the system as it stands now and with the 70% capacity could handle spring volume or no?

Could handle spring volume, but not semi annual sales peak volumes.

Okay. I'll turn it over to the rest of the callers. Thanks.

Thanks, Jeff. Next question, please.

Our next question is from Ms. Michelle Clark of Morgan Stanley.

Thanks, guys, and good evening, everyone. Can you break out for us what the year-over-year change in operating margin rate would have been at Victoria's Secret ex the impact of the direct business? And then secondly, if you could discuss square footage growth plans at VS, I mean any plans to scale back there, given continued struggle in the business, or what would get you to scale back square footage growth at VS? Thank you.

Thanks, Michelle. We're going to go to Stuart Burgdoefer for those questions.

So on the question about excluding the effect of Direct from the Victoria's Secret results, operating margin rate would have been down, or it was down in the third quarter, driven by B&O leverage. As I mentioned in my remarks, merchandise margin, merchandise margin was basically flat, but there is some deleverage in buying and occupancy costs related to our real estate initiative. As we've talked about over the last several quarters, the effect of real estate in the first three quarters does not drive earnings growth. It will drive earnings growth in the fourth quarter, so the real driver of operating margin decline at Victoria's Secret stores in the third quarter is the effect of the incremental real estate cost, but again, that will become additive to earnings in the fourth quarter and in 2008. On real estate specifically, we are monitoring real estate closely. As we shared with the investment community a few weeks ago, we are very encouraged by the results that we've seen, but we are monitoring it very closely and we will evaluate it once we have a view -- the holiday sales results in in terms of seeing what the results look like post-holiday.

Thanks, Stuart. Next question, please?

Our next question is from Mr. Brian Tunick of JPMorgan.

Thanks. Good afternoon. I guess my question is, I guess from a big picture, it sounds like marketing spend is down, inventories are down, promotions are down. So I guess the question, how do you think about comping better than mall traffic and holding market share between the two brands, with all those things that are down versus last year?

Thanks, Brian. I think we'll start with Stuart on that question.

I mean and Diane and Sharen can add to this, but Brian, we've looked at things on a two-year basis. So as you would imagine, we look at our sales trend in a lot of different ways. As you are aware and certainly we're aware, our comparisons ease up quite a bit in the fourth quarter. So we've assessed our sales expectations. We've certainly worked to factor in what we know at this point, and we're comfortable with the guidance we're providing, obviously, and that's kind of how we settle out. And maybe Sharen or, and Diane could comment further as it relates to BBW and VS.

Hi, this is Sharen. On the marketing dollars, yes, our marketing dollars for the third quarter were significantly down to last year. Our marketing spend as we're looking at going into the fourth quarter, both in terms of looking at what we're doing and our lineup around holiday are flat, primarily flat to last year. We were investing those marketing dollars are truly around gifting product, as I said earlier around our Supermodel PJ party that we're looking at, a launch of a holiday fragrance, which is very gifting, and looking at our gift card strategy. So all the marketing dollars this year are primarily focused on true gifting opportunities for this holiday season, which I do believe gives us the opportunity to continue to drive our market share as well as to drive the holiday.

And at Bath & Body Works, hi, this is Diane, Brian, at Bath & Body Works, we launched Tuberose as a -- Velvet Tuberose as a fragrance in October, so we did not launch a fragrance last year, so we have that to anniversary in December. Also, last December, I've mentioned before that our in-stocks and our top key fragrances within our Signature Collection were about 50%. We are in unbelievable shape now, not to mention our balance of inventory by store is much better than it has ever been. We are actually in a much better position by store and total inventory at BBW than we have been in years, so I'm pretty excited about our balance. Then the other piece of it really is the last 12 days leading up to Christmas, that was a big miss for us last year and we've got a lot of great different activities happening every day I think will add additional volume for us.

Terrific. Very helpful. Good luck.

Thanks, Brian. We'll go to our next question, please?

Our next question is from Kimberly Greenberger of CitiGroup.

Great, thank you. I was hoping that the brand presidents could just talk about the margin direction at each Victoria's Secret and Bath & Body Works. We've seen sort of degradation throughout the year and based on the fourth quarter guidance I have to assume we'll see down margins again in each of those divisions in the fourth quarter. Is the '08 outlook for some recovery there, or if you could just give us any sort of directional help with that, that would be great. Thanks.

Hey, Kimberly. Why don't we start with Stuart there again.

Kimberly, for both BBW and VS, our expectation is basically for a roughly flat margin result in the fourth quarter, so that's our expectation. We're working on our views for 2008. We realize what we're lapping in terms of the spring of '07, but we're still developing those views, but with respect to the fourth quarter, our expectation is a roughly flat result.

And Stuart, could you just address the Victoria's Secret Direct sales shortfall in the fourth quarter and how you get through the excess inventory that that sales shortfall creates?

So as you would imagine, we're very focused on that. We have estimated the inventory impact and we're adjusting receipt flow appropriately to minimize the negative aspects of that, but it's a pretty fluid dynamic situation, as you can imagine, and it relates to an assessment of where we are in the distribution center and how we want to manage through spring, but our fourth quarter guidance in terms of earnings does contemplate or estimate any margin effect from our inventory position at the end of the year.

Thanks.

Kimberly, did we get all your questions answered?

That's helpful. Thanks, Tom.

Next question, please?

Our next question is from Mr. Jeff Stein of KeyBanc Capital Markets.

Okay. Well, this question's probably a little premature, but I'm just kind of curious how you go about ramping a business, or ramping back up a business like Victoria's Secret Direct after slowing it down. In other words, do you envision a steep ramp or are you, or once you get the business stabilized, will you be more inclined to try to produce a soft ramp?

Jeff, we're going to go to Sharen Turney for that.

Basically this timeframe, this is when we really peak the business, around the holiday and semi annual sale. As we've come out of semi annual sea, the normal business subsides down to, all the way until we get back into semi annual. The piece that we feel very confident in terms of the product. The product demand has been very strong at Direct. We continue to see that opportunity in the spring season. The one caution that you have is the fact that we won't be driving the file and the growth of the file as we have in the past. We're being very strategic with the contact strategy. We're just not contacting the customers as frequently as we had in the past, and in our Spring plan is around a contact strategy and going back out to those customers at a more frequent basis, both by catalog, as well as an e-mail strategy.

Sounds like it's kind of a soft ramp, would that be correct?

Well, I don't -- the thing about it is, you're not really having to ramp up because you're coming out of a peak timeframe, where it, normally the volume drops. So because the volume drops, that distribution center will be able to handle that volume. It's just, it's like can we get the labor corrected within that from a profit flow-through perspective.

Got it. Thank you.

Thanks, Jeff. Next question, please?

Ms. Lauren Levitan of Cowen and Company, you may ask your question. Please check your mute button. We'll move on to the next question. Our next question is from Eric Miller of Lehman Brothers.

Yes, good evening. Thank you for taking the question. My question relates really to your balance sheet and your share repurchase programs that you have had in place for sometime. Could you just talk a little bit about, as your operating performance has deteriorated, and obviously we're seeing your stock at a multiyear low. Can you talk a little bit about your commitment to maintaining a strong balance sheet as we face a tougher economic environment and where you stand in terms of your commitment to an investment grade debt rating? Looks like you're on the path to heading below investment grade, your debt spreads have now doubled over the last two months or so and I was curious what the Company's commitment is to maintaining the financial flexibility as we enter 2008. Thank you.

Thanks for your questions. This is Stuart. So we are committed to retaining financial flexibility, as you put it. As we've talked about before, we really are, we try to be very thoughtful about our operating performance, the credit environment, our estimates of cash flow, et cetera, in making decisions about capital structure, including share repurchase, so that we balance the interest between equity holders and debt holders appropriately. We believe that based on our operating performance and our announced programs that we will retain the financial flexibility that you speak of and we review that specifically.

With respect to credit spreads, they are up really for almost all retailers, so we do look at that as well and we've looked at them recently and ours are up, but the credit spreads for a number of other retailers and really the retail category segment is up as well. So the net of it is we are committed to flexibility. We are committed to balancing the interests, and we are in appropriate contact with the rating agencies on those points.

Could you just answer the question in terms of whether or not investment grade ratings are something that you're committed to?

We are committed to those.

And is there a specific debt to EBITDA metric that you're measuring your business by? I mean you're approaching 4 times adjusted debt to EBITDAR when you look at your lease adjusted leverage, which is significantly higher than it's been in some time, is there a specific number that we should look to that you are going to manage the business by?

We're not focused on any one metric. We're focused really on the goals that were implicit in your question and in our view of it. And as you know, it's a function of many different variables, including operating performance trends as well. So we don't focus on one particular metric, but we are certainly familiar with the ratios the agencies use.

Thanks, Eric.

Thank you for the question.

Next question, please?

Next question is from Ms. Lorraine Maikis of Merrill Lynch.

Thank you, good evening. You've mentioned before that the SG&A rate would be up in the fourth quarter. Can you just clarify and give us the reasons for that? And also do you think that you're putting the Victoria's Secret Stores business at risk by not updating the systems and can you still manage the inventory in the newly expanded stores without doing the upgrades immediately?

Lorraine, we'll go to Stuart for the first part of your question and then to Martyn for the second part.

For the, for the fourth quarter, we're estimating that the enterprise SG&A rate will be flat. In terms of the drivers of change in the SG&A rate, the impact of the Victoria's Secret Direct sales loss has a pretty meaningful effect on the SG&A rate, and that's really the most significant thing that I would call out beyond the effects of apparel and mass that we've talked about before.

And then to Martyn?

In terms of the systems implementations, VSS, the Victoria's Secret Stores and Mast our production and sourcing business, we probably will be proceeding with implementing part of those systems in 2008, particularly for the production and sourcing end of it, which is kind of the front end of those implementations when you think about the supply chain. The fact is that realizing the benefits from those systems is a medium-term, not long-term, but medium-term effort as evidenced by the implementation of these supply chain capabilities of BBW last year, it did take us longer to stabilize those systems at BBW than we had originally expected. We had expected around six months. It took us a full 12 months to stabilize the systems and start utilizing the way they are intended to be utilized, and now as Diane has mentioned, the business team is beginning to see the benefits and fully utilizing those systems. So we're consciously aware of the trade-offs, but feel that retiming the systems implementations will give the Victoria's Secret Stores team a chance to really focus on execution in 2008 and not go through a disruption in front of holiday as we have done with our Direct channel business this year and our BBW business last year and retiming it to a spring of '09 timing, which is what we're examining, would probably optimize all of the above pros and cons.

Lorraine, we're going to go back to Stuart for a clarification of something he just said.

Yes, excuse me, on the fourth quarter SG&A rate, it will be up somewhat for the reason described, which is the effect of the VSD sales loss is the main driver. So excuse me for that. I mentioned it in my script correctly, on Q&A incorrectly. Thanks.

Okay, thank you.

Thanks. Next question?

Our next question is from Lauren Levitan of Cowen and Company.

Thanks. Good afternoon. I want to go back to the Victoria's Secret Direct issue. I'm curious if you believe cutting circulation has any impact on Victoria's Secret sales, in so much as that marketing device might be driving people to the stores, and how you'll address that potential impact on traffic? And then I know you mentioned earlier in response to a question, Stuart, that you thought that inventory, you got ways to work through it, but it's our understanding that a significant portion of that inventory, or of those styles are not available in stores, so if you could help us get a better understanding of how that's going to flow through? And then related to that, expense control, obviously in the third quarter it looks like you found more ways to control expenses than the original set of expense cuts that you had talked about. Can you tell us, give us some sense of how much more opportunity you think there is to control expenses, particularly in light of this reduced outlook you're seeing, not just for Victoria's Secret Direct, but also in the core businesses relative to traffic? Thanks.

Lauren, we're going take your question and pass it around here a little bit. We'll go to Sharen first.

The first question is I believe was that by cutting the catalog circulation, what would that do to effected stores. We do know that when you mail a catalog, that you actually do -- it does drive some traffic to stores. What we're doing is actually just, we're actually just going back one contact. So what we've done is we've taken those names and have put in an e-mail strategy to over 14 million people on a weekly basis between now and the end of January, which is totally contacting those customers with a drive to store initiative. So that we do believe that we will be able to offset the catalog circulation by actually putting in a drive to store store-only event with those customers to try to offset a little of that demand, won't come nearly to be able to set all of the demand that the Direct business will lose.

I think one of the questions, if I -- I think, was about the inventory levels in Direct, about the non-purchased, things that are not in the store. What we've done is we've actually resorted the catalogs, as well as the e-mails and home pages to truly seasonal merchandise, whether it be in our apparel categories or be in our sleepwear categories. So therefore, the categories that are more long-life categories are not as prevalent in the catalogs or online. Therefore, selling through those that have shorter lives. We also are taking some inventory from Direct to the Stores, of which we need it, to actually drive our key bra business, as well as some opportunities within the sleepwear category. So I do believe that we have done everything that we can to mitigate the risk that we do have within the inventory. There are still some, and as Stuart has said, that we have addressed those within the guidance.

And Lauren, we're going to go back to Stuart for your question and observation about third quarter expenses.

In terms of the favorability on expenses versus previous view, we are just continuing fundamentally to scrutinize home office spending, and particularly project and IT-related spending, and so that's what really drove the favorability versus our initial view in the third quarter. As you can imagine, based on our operating performance, we are reevaluating just about everything in our operating P&L to drive consistent profit growth. So with respect to forward expectations, we'll be specific about that in February, but we're reevaluating all expense categories to drive efficiency.

That's helpful. One clarification. Did you say that you thought Victoria's Secret EBIT margins would be flat in the quarter and was that excluding the impact of Victoria's Secret Direct issues in the quarter?

In terms of the fourth quarter?

Yes.

What I said is they would be down in the fourth quarter, down somewhat driven by B&O, driven solely by B&O leverage on a rate basis.

I think, Lauren, we were talking about merchandise margin.

So merchandise margin will be roughly flat. Operating margin will be down somewhat driven by B&O deleverage.

Thank you very much.

Thanks, Lauren. Next question?

Our next question is from Paul Lejuez of Credit Suisse.

Hi, Sarah Lewis standing in for Paul. Just wanted to follow-up on the question about DC impact on the Victoria's Secret retail business. Is there any way you can quantify what type of impact it's had to the business thus far in the stores? And then also, can you just clarify what the number of bra launches will be in fourth quarter this year versus last year? Thanks.

Sarah, we're going to go to Sharen for both of us.

We didn't do anything with the circulation strategy in the third quarter, so we've seen no effect on the stores. I do believe, as I said earlier, I think that we have got a plan in place to, on the circulation, that we are pulling back to actually have a strong plan to drive to, to drive to store. And your other question was we have flat launch this is year versus last year in the fourth quarter.

Great. Thanks, Sarah. Next question, please?

Our next question is from Marni Shapiro of The Retail Tracker.

Hey, guys, good evening. If you could talk about, you said inventory was down about 14% per square foot. It sounds like that's a little bit more heavily weighted towards Victoria's Secret. If you could just break that out a little bit more clearly between the two brands?

Thanks, Marni. We'll go to Stuart actually for that.

It's down pretty consistently in both businesses, so there isn't a dramatic difference between the two businesses.

Oh, great. Okay. Thanks, guys.

Thanks, Marni. Next question?

Our next question is from Richard Jaffe of Stifel Nicolaus.

Thanks very much, guys. Just a couple of sort of mundane questions about tax rate for the quarter and for the year and what we should anticipate for next year in the new forum?

So this is Stuart. On that, you should expect about 39%. The phenomena that occurs in the third quarter is what I would call the law of small numbers, so you'll get a funny rate because inherently in the business and also in part due to performance the pretax income is low. So a forward modeling assumption of 39% is right. As you know, I trust there's more volatility today in a public company's tax rate due to the effects of FIN 48, but 39% is a good number. There will be some volatility quarter to quarter based on the settlement of particular issues, but 39% is a good number.

That's great. Just a quick question, could you provide inventory by division a little bit more detail?

What I would say is that we're focused on having the right amount of inventory obviously in all of our businesses. Our focus has been, in all the major businesses and the results in terms of declines in 2007 and being in balance on a two-year basis apply to both Bath & Body Works and Victoria's Secret Stores.

Thank you.

Thanks, Stuart. Thanks, Richard. I know we've been on the call for a an hour, but I think we would like to take a few more questions. There are still some folks in the queue.

Our next question is from Ms. Dana Cohen of Banc of America Securities.

Hey, guys. Thanks for taking the question. Starting with the other number, which moved about $47 million, can you just give us the pieces of that? Sort of like what were the big chunks to have such a big swing in the other number? My second question is on the Victoria's Secret number you just gave for operating profit to be down somewhat, that is just Victoria's Secret before the direct business? I just wanted to confirm that and also confirm that operating margins were down 200 basis points and that was just the Victoria's Secret business before La Senza?

Okay. We'll go to Stuart.

Okay. So on the -- and I'll repeat the second and third questions after the first one. On the first question, Dana, in terms of the key drivers within the other segment in terms of favorability, the gain on sale of corporate aircraft was the biggest driver. Expense savings that I mentioned related to home office, overhead, and IP-related project spending would be the next biggest driver of the favorability.

Just can you just -- okay. So obviously the gain is in there?

Yes.

Is there any other pieces to that that are not recurring?

Not -- there's nothing else that I would describe as significant and nonrecurring.

Okay, and then just the clarification?

And the clarification is on the operating margin for--?

Dana, when we were talking before, Stuart was only talking about Victoria's Secret Stores, not including Direct.

Question about the fourth quarter?

Both for Q4 guidance and for operating margins having been down 200 in Q3.

That was also only stores.

Perfect. Thanks so much.

Thanks, Dana. Couple more quick questions here?

Frank Henson of Bear Stearns, you may ask your question.

Yes, thank you very much for taking my question. Most of my questions have been answered, but I'm curious, as I look at your recent announcement of an additional $250 million share repurchase authorization, have you had a conversation with the rating agencies prior to announcing this additional increase in authorization?

So in answer to your very specific question, the answer is yes, we make sure that we are, we're not going to be surprised by anything and we have had the right conversations to ensure that we make an informed decision.

Okay. Thank you very much.

Thanks, Frank. Operator, let's try to take two more questions.

Our next question is from John Morris of Wachovia.

Thanks. Hi. Unless I missed it, did you quantify how much you plan on catalog circulation to be down in the fourth quarter? If you could give us that number. And then also just check with you, the inventory plan on a per square foot basis for Q4, if you can give me those metrics. Thanks.

John, we'll go to Stuart for that.

On the first one, you can appreciate why we want to be somewhat general from a competitive standpoint, but I would just say, to try to be helpful that the circulation would be down roughly in line with the sales impact that we described to you.

Okay, good.

Okay, and then the second question, I'm sorry, was?

Second question was just give us the inventory on a per square foot or per store basis that you're targeting for Q4. I think you said it, but I want to get it again.

At the end of the quarter, targeting a reduction of 20 to 25%.

Okay, and I think you said evenly across both the BBW and Vickie's divisions, right?

Yes.

Thanks.

Exactly the same, but in terms of, it's essentially the same.

Okay, thanks.

Operator, we're actually going take two more questions, the people left in the queue.

Okay. [Howard Kuben] of RBC Capital Markets, you may ask your question.

Oh, hey, thanks. Could you guys talk at all about the Mast business and what it will look like from a revenue basis next year in terms of business that you may be losing or business that you may be gaining?

Yes, in terms of '08 specificity, again, we would be more -- we'll be more prepared to do that and it will be part of our -- we'll cover that in the right way when we give guidance in February. As you can appreciate, recognition on an external basis of the Express and Limited sales will drive year on year growth, giving the timing of that, those transactions partway through 2006, and we have had some other changes in our third party business, some plus, some minus. But we'll try to give you more, more color on that in February.

Okay, thanks.

Thanks, Howard. One last question, please?

The last question is from Dana Telsey of Telsey Advisor Group.

Good afternoon, everyone, and thank you very much for getting me in. Just wanted from each of the brand Presidents, how do you look at the issues going on in each of your businesses? How much is external, how much is internal in terms of your product assortment or where you think you're off the mark or on the mark? And when do you think it gets back to where you want it to be? Thank you.

Dana, thanks. That's a great way to finish up today. Why don't we start with Diane.

I think as I mentioned before, I think we're pretty well put in place for fourth quarter -- for December as far as business. Going forward, our focus I had mentioned before is really around our proprietary brands and how we build those. So we are making genuine progress throughout the entire spring season, but I think for us to see complete impact of some of these changes will be fall of '08.

Okay.

I think as we look into the fourth quarter that we're very well positioned to try to optimize the holiday. I think our bra launches, as we look forward into spring, are stronger and more focused. Trying to do a few things well, and like Diane, I think you'll see the full results of that in fall of '08.

Thank you.

Sharon, Diane, Dana, thanks everyone for listening in and we wish you all a Happy Thanksgiving.