LandBridge Co LLC (LB) 2010 Q3 法說會逐字稿

Good morning, my name is Sarah and I will be your conference operator today. At this time, I would like to welcome everyone to the Limited Brands third quarter 2010 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. I would now like to turn the call over to Ms. Amie Preston, Chief Investor Relations Officer. Ms. Preston, you may begin.

Thanks, Sarah. Good morning, everyone, and welcome to Limited Brands' third quarter earnings conference call for the period ending Saturday, October 30, 2010. As a matter of formality, I need to remind you that any forward-looking statements we may make today are subject to our Safe Harbor statement found in our SEC filings.

Our third quarter earnings release and related financial information, including any non-GAAP or adjusted financial reconciliation tables, are available on our Web site, limitedbrands.com. This call is being taped and it can be replayed by dialing 1-866-NewsLTD. You can also listen to an audio replay from our Web site.

Martyn Redgrave, EVP and Chief Administrative Officer; Stuart Burgdoerfer, EVP and CFO; Sharen Turney, CEO of Victoria's Secret; and Diane Neal, CEO of Bath & Body Works, are all joining us today. After our prepared comments, we will be available to take your questions for as long as time permits.

So that we can speak with as many callers as possible, please limit yourself to one question. Thanks, and now I'll turn the call over to Martyn Redgrave.

Thanks, Amie. Good morning, everyone. I'd like to start by saying that we continue to be very pleased with our performance and also the progress that we've made so far this year. As you've seen in the third quarter, our comps increased 10% and our operating income increased by 153% or 420 basis points as a percentage of sales.

Our earnings per share of $0.18 exceeded our initial expectations of $0.03 to $0.08. We also have taken further actions in our ongoing program of returning cash to shareholders with our announcements of a $3 per share special dividend and a new $200 million share repurchase program. Stuart will take you through and discuss those elements further in his remarks.

This very strong performance in the quarter was the result of our intense focus on execution, staying close to our customers and increasing speed and agility. Our entire organization is aligned and focused on these key priorities as we enter the all-important holiday season. In addition, we've raised our full year earnings guidance to reflect the third quarter beat. With respect to the third quarter, we are continuing to manage the business conservatively in light of the uncertain environment. Inventories and expenses are well controlled and we continue to pull back on our promotional activity.

We are laser focused on delivering the best possible holiday result. As some of you saw on our store tours last week, our product assortments are compelling and include a significant number of new items. We are also enthusiastic about the opportunity for growth of our businesses outside of the United States. We continue to execute against our six-point agenda for international growth.

Now Martin Waters presented an update of our progress at our update meeting in October, so I won't spend time reviewing all of this this morning. Since that meeting, though, we have opened our first three BBW Middle East stores in Dubai and Kuwait City under our Alshaya franchise agreement. While it's still very early, we are encouraged by the performance of these stores.

Turning to our La Senza business, comps in the third quarter increased 1% and sales declined 9% to $89.8 million, primarily as a result of the closure of La Senza Girl businesses at the end of 2009. Canadian mall traffic levels continue to be negative. And La Senza's traffic is lower still as we have positioned the business to a younger customer and have significantly reduced sleepwear inventory in order to focus more on bras and panties.

We are encouraged by the growth of our bra and panty categories and by the significant increase in conversion in the business, however, we still need to lap these traffic declines before we will see meaningful progress. Merchandise margin rate was roughly flat in the quarter and expenses deleveraged on the sales decline due to the costs associated with the repositioning of the business. Operating income dollars and rate were down the last year. Thanks, and I'll now turn it over to Stuart.

Thanks, Martyn, and good morning, everyone. Turning to our third quarter performance, our earnings per share increased to $0.18 a share from adjusted earnings per share of $0.02 last year. Our 2009 reported result was $0.05 per share. As detailed in our press release, last year's reported results included an income tax benefit primarily due to the resolution of certain tax matters of $8.8 million or $0.03 per share. All prior year results discussed on this call excluded this significant item.

Taking you through the third quarter results in more detail, net sales were $1.983 billion versus $1.77 billion last year and comps increased 10%. The gross margin rate increased 440 basis points to 36% driven by a significant increase in the merchandise margin rate and significant leverage on buying and occupancy expense. SG&A expense increased by $61.3 million or 12% and the SG&A rate deleveraged by 10 basis points.

The major drivers of expense growth are as follows. Approximately 40% of the dollar increase in SG&A was driven by increased store selling costs which leveraged as a percentage of sales. About 15% of the increase was driven by an increase in marketing costs. A little over 10% of the dollar increase was due to a change in an estimate used to calculate our stock compensation expense.

About 10% of the increase was driven by an increased fall season incentive compensation accrual versus last year as our third quarter performance has exceeded our season to date targets. And the remainder of the increase was driven by individually insignificant items including expenses to support our international growth, expenses to support technology initiatives at Victoria's Secret Direct, and increased payroll expense for merit increases. Year-to-date, sales dollars are up 11% and SG&A dollars are up 7%. We remain very focused on growing expenses slower than sales.

Total operating income increased $90.2 million or 420 basis points as a percentage of sales to $149.1 million or 7.5% of sales. By segment, the Victoria Secret segment increased by $69.2 million or 540 basis points as a percent of sales to $123.2 million or 10.4% of sales. Bath & Body Works increased by $16.1 million or 320 basis points as a percent of sales to $31.7 million or 6.8% of sales. In the Other segment, operating loss declined by $4.9 million to $5.7 million. Total non-operating expenses were roughly flat at $47.6 million as the loss of income from Express and Limited stores was offset by a decline in interest expense.

Turning to the balance sheet, retail inventories ended the quarter down 2% per-foot at cost, down 11% on a two-year basis. Turning to our earnings outlook for the remainder of the year, we are forecasting earnings per share between $1.02 and $1.17 for the fourth quarter. This forecast reflects a low-single-digit comp increase in Q4. We expect to see Other segment sales growth of between $90 million and $100 million driven by the change in accounting for [math] sales to Express and Limited stores and growth from our BBW and Victoria's Secret Canada stores.

We expect the gross margin rate to be roughly flat to last year and the SG&A rate to improve versus last year. We expect total non-operating expense of approximately $47 million consisting principally of interest expense. Before any discrete items, our tax rate will be approximately 39.5% and weighted average shares will approximate 332 million in the fourth quarter.

We expect that inventory per square foot through the fourth quarter will be up slightly. In particular, our November and December end-of-month balances will be impacted by an expanded mid-December floor set at Victoria's Secret and a later start to the Victoria's Secret semiannual sale. We continue to manage inventories conservatively and with discipline.

For the full year, we are projecting a mid-single-digit comp increase. We expect sales growth in the Other segment on a full year basis between $225 million and $235 million. We estimate that the full year gross margins will be up significantly to last year. We expect the full year SG&A expense rate to improve versus last year. Further, we expect full year interest expense of about $210 million, down over $25 million from last year as a result of our reduction in debt in 2009 and the repayment of our term loan this year.

We are projecting total Other income including interest income of roughly $30 million. Assuming all of these inputs, we expect earnings per share for the full year 2010 to be between $1.82 and $1.97 per share. We are now projecting 2010 CapEx of about $275 million or less with roughly 70% of this spending on real estate in stores. We generated over $970 million in free cash flow last year and we now expect to generate approximately $800 million this year.

As you know, we have been and remain committed to returning excess cash to shareholders. Accordingly, our Board of Directors has authorized a special dividend of $3 per share and a new share repurchase program of $200 million. With this distribution, we have returned $10 billion to shareholders since 2000. The special dividend will be paid on December 21, 2010 to shareholders of record at the close of business on December 7, 2010. The newly authorized $200 million repurchase program includes $53 million remaining under the Company's previous $200 million repurchase program.

Our free cash flow and cash position along with the additional availability under our revolving credit facility results in very strong liquidity which is more than sufficient to fund our working capital, capital expenditures, dividends and any other foreseeable needs. After the payment of the special dividend, we expect to end the year with approximately $750 million in cash. We repurchased 2.9 million shares for $78 million in the third quarter. We are confident in our ability to deliver substantial growth in our business and to generate significant free cash flow and we will continue to return excess cash to shareholders through a combination of ongoing regular dividends, share repurchases and special dividends. Thanks, and now I'll turn the discussion over to Sharen.

Thank you, Stuart, and good morning, everyone. We are pleased to report that the past quarter represented record Q3 sales and profits for Victoria's Secret. We believe this performance is a result of three key priorities we have been talking to you about over the last few quarters. First, is our continued focus on our core categories, bras and panties, coupled with an emphasis on speed and agility.

Second, is our purposeful approach to managing the business with a balance between optimism and conservative management as inventories and expenses. And, third, is bringing all of our work into a well-told brand story across channels and telling that story through innovative products, steady newness with the right fashion and outstanding in-store execution. As with the first two quarters of the year, we did this with leaner inventories relative to sales and, again, achieved record conversion rates in our stores, an indication of our assortment strength, our deep customer connection and our continued strong field performance.

Let's move to a review by channel. In Victoria's Secret stores, our comps for the quarter were up 14% with total sales increasing 15% to $842 million. Our results were driven by improvement in all three business units, Lingerie, Beauty and especially our Pink business. Throughout our business, customers continue to respond favorably to the new, fresh and fashion-right assortments we are providing.

Our third quarter launches, including the Incredible Bra and the Biofit Push Up were strong. Pink bras and the loungewear assortment continue to perform well. Panties were strong and a number of our innovative beauty products including the Bombshell fragrance exceeded our expectations. This, of course, all builds upon other newness we've introduced this year.

Importantly, we are continuing to accomplish our top and bottom line results while being less promotional than last year. A key example of this in the third quarter is that we did not repeat last year's fall sale. Fewer promotions, our assortment strength and well managed inventories all contributed to our merchandise margin rates expanding significantly versus last year. Our third quarter SG&A expense rate leveraged slightly versus last year and we delivered operating income that more than tripled last year's results.

Now, let's review performance at Direct. Third quarter sales increased 3% to $257 million driven by strength in bras, Pink, beauty, swim, dresses and active. The gross margin rate increased significantly driven by an increase in the merchandise margin rate as the strength of assortment and our conservative inventory position enabled us to drive more business at regular price. Additionally, total expenses leveraged to operating income dollars nearly doubled and the operating income rate was up significantly to last year.

Looking ahead to the fourth quarter, we will continue the discipline that served us well throughout the year. In terms of marketing, we are prepared and excited about Black Friday and our plans for the entire holiday timeframe. We are again distributing Secret Reward cards this month for redemption in December and the fashion show will air on November 30 with Katy Perry, and Akon performing as our musical entertainment. We are expanding on last year's new mid-December floor set and we will be bringing in fresh goods to support selling before and after Christmas.

We are continuing our focus on full price selling. We see particular opportunity on this front in Direct and believe we can lower promotion while expanding both margin dollars and rates. Finally, we will continue to manage the business with speed and agility, staying close to our customer and working each day to read, react, drive sales and manage inventory. To close, we feel good about the business and are prepared to win. So thank you and now I'll turn it over to Diane.

Thank you, Sharen, and good morning. At Bath & Body Works we are very pleased with the results of the third quarter. We were able to deliver sales growth and significant operating income growth versus last year. We continue to deliver improved results versus last year by maintaining focus on our three key categories, our Signature Collection product line, the antibacterial soap and sanitizer business and our home fragrance assortment.

Improved performance in our Signature Collection was driven by the launch of our new Signature Collection fragrance, Dark Kiss, and the relaunch of our already successful fragrance, Twilight Woods. We are also encouraged by the performance of our men's line which was relaunched in the second quarter of this year. The antibacterial business continued its strong growth trajectory driven by growth in our hand sanitizer business as well as performance in our new seasonal collection like Halloween and Perfect Autumn.

Our Home Fragrance sales were up from last year and continues to be driven by strong candle performance and seasonal fragrances like Leaves and Sweet Cinnamon Pumpkin, as well as the introduction of new forms and novelty in our diffuser category. Transactions were up versus last year driven by growth in traffic while maintaining our high conversion rate. Customers also spent more per transaction versus last year.

So with that backdrop, let me take you through the financial results for the quarter. Bath & Body Works' third quarter comps were up 6%. Total sales for the quarter were $468 million, up 7% or $29 million versus last year. For the quarter, our operating income was $32 million, up $16 million and doubling our third quarter operating income from last year.

Operating income as a percentage of sales was 7% in the quarter and up significantly to last year driven by strong top line sales, improvements in the merchandise margin rate and leveraging our expenses. Improvements in our merchandise margin rate continues to be driven by cost reductions and lower promotional activity. We also finished the quarter with inventory levels down to last year. This is our 14th consecutive quarter with inventories down year-over-year while our in-stock positions continue to improve.

The BBW Direct channel delivered strong sales and operating income growth. We continue to view the Direct channel as both a revenue generator and marketing vehicle for our brand. So, with that in mind, in the fourth quarter we will continue to introduce newness and innovation in both form and in fragrance. This month we began our holiday theme with animation in the windows and front-of-shop focus on our holiday toiletry collection, home fragrance items and gifts.

The shop will be focused on new fragrances, updated giftable packaging on our core, great seasonal gifts, and the launch of our newest Signature fragrance, Secret Wonderland, throughout the November and December holiday timeframe. We are excited about the assortment and the visual appeal of our stores. In addition to our focus on product and fragrance launches, we will continue to test and read the results of new product offerings and promotional strategies, maintaining flexibility in our inventory to react quickly to our customers' needs and manage expenses and inventory conservatively. With that, I'll turn the discussion back over to Amie.

Thanks, Diane. That concludes our prepared comments. Before we take your questions, just a reminder to please limit yourself to one so that we can get to as many people as possible. Thanks, and now I'll turn the call back over to Sarah.

(Operator Instructions) And your first question comes from the line of Paul Lejuez from Nomura Securities. Your line is open.

Hi. Hey, guys, Paul Lejuez. Just wondering if you can maybe give us an update on the performance of your Canadian stores, both on the Bath & Body Works side and Victoria's Secret, maybe if you can frame it for us in terms of productivity relative to the US stores? Thanks?

Okay, Paul, thanks. We will go to Martyn for that question.

Good morning, Paul. As you know, we are targeted to have around 60 BBW stores opened in Canada by the end of this year. We have now opened four Victoria's Secret stores in Canada and we will have eight Pink stores, free-standing stores, open by the end of the year. And I think while we are not commenting specifically on sales results or productivity, it's fair to say, as we've said before, that all of those stores in the aggregate are exceeding our expectations and performing at a level that is significantly higher in terms of sales productivity than our equivalent US stores.

Okay. Thanks, guys. Good luck.

Thanks, Paul. Next question?

Your next question comes from the line of John Morris from BMO Capital Markets. Your line is open.

Thanks, good morning. Congratulations on a great quarter and good start to the fourth quarter, I guess. Stuart, question for you on SG&A. Thank you for that breakdown. I think that was pretty helpful.

Of those items that you mentioned, or anywhere within SG&A, is there anything that is tracking a little bit higher than you would have planned, a little ahead of where you would have wanted it to be? It looked a touch higher to us, and what will you be looking to do specifically to focus on controlling those expenses go forward? Thanks.

Sure. Thanks, John. Our commitment, which we have been very clear about and we have achieved through 2010 year-to-date is that expenses are going to grow slower than sales and we are very committed to that.

With respect to anything that, quote, may have been a surprise or additional color on what drove the outcome in the third quarter, the only thing I would really put in the category of, quote, surprise is we did revise our estimate related to stock comp expense which reflects, frankly, better than expected stability in the business. As you may be aware, you estimate that expense based on assumptions about forfeiture rates and so on.

And as we've talked in a business context, we've really had very good stability in the business which is great. But one of the outcomes of that is it drives some additional stock comp expenses, as you look at the input assumptions. That would be the key. Then there is a little bit of IC, year-on-year incentive comp, fall season incentive comp, to be more specific, year-on-year, and that reflects the much stronger performance in the season to date than we would have expected. So I think that is also a good news story.

Great, thanks. Good luck for holiday.

Thank you.

Thanks, John. Next question?

Your next question comes from the line of Kimberly Greenberger from Morgan Stanley. Your line is open.

Great, thanks. Good morning. I will add my congratulations as well. Stuart, I'm wondering -- I'm looking at your third quarter gross margin up 440 basis points and your guidance for fourth quarter gross margin to be flat. I'm wondering if you can just talk about the puts and takes in fourth quarter gross margin and if you can sort of characterize your view of the guidance as conservative, or if it's actually you think really quite appropriate? And, lastly, you mentioned, I think, the Victoria's Secret sales shifting. Does that move business between months in December and January? Thanks.

So on gross margin expectations for the fourth quarter, the most important thing in our mind and that I would want to convey -- and we've talked about this over the last several calls and our other interactions -- is, as you know, we have generated very substantial improvements in merchandise margin rates over the last year, year and a half. And specifically in the fourth quarter last year, that merchandise margin rate was up between 500 and 600 basis points.

It's very important to understand what we are lapping. As we think about our Q4 expectation, we continue to think we are making progress in the business. We can always get better and we are working hard to get better, but what it really reflects is we are now anniversarying, beginning in Q4, a very substantial improvement in merchandise margin a year ago, and so the guidance reflects that. With respect to the timing of semiannual sale for Victoria's Secret, it will, in terms of sales, have a negative impact on December and a positive impact in January.

Great, thanks. Good luck for the holiday.

Thanks.

Next question?

Your next question comes from the line of Jeff Stein from Soleil Securities. Your line is open.

Question for Stuart. Just curious what the thinking was behind the size of the special dividend and what you think the appropriate capital structure for the business is going forward given your expansion plans internationally?

Great, thanks, Jeff. Our perspective -- a lot of it is reflected in the prepared remarks and in our press release -- but to put a little more color on it and to reiterate it, the reality is we have accumulated a significant amount of cash before the announcement of this dividend. Absent this special dividend, we would have ended the year with $1.7 billion or more versus our target level of about $700 million. You know we have talked at length about, our actions reflect that we are very committed to returning excess cash to shareholders. We are -- and we wouldn't want this action to be misunderstood -- we are very confident in the growth opportunities for our business and our ongoing ability to generate significant free cash flow. We're also very comfortable with our capital structure and our balance sheet.

By way of reminder, we have reduced our debt by $400 million and we proactively managed our maturity profile such that there is very little debt due before 2017. With all that, some additional color, management, the Board of Directors, determined that the special dividend and a new repurchase program were the best actions, the most efficient and effective method to return significant cash to shareholders and generate return for all shareholders.

With respect to the capital structure just as a general point and how it relates to international expansion, as we've talked about, this business generates a lot of cash. We have no concern about our ability to fund growth opportunities and, again, the debt profile and so on, extremely comfortable with. And as we've talked about also with respect to international, certainly a large aspect of what we do internationally will be with venture partners, franchise partners, reflecting a less capital intensive growth strategy. So we are very comfortable with this action and we're, frankly, really pleased to generate clear and indisputable return for all shareholders. So we're feeling good about it.

Got it. Thank you.

Yes.

Thanks, Jeff. Next question?

Your next question comes from the line of Todd Slater from Lazard Capital Markets. Your line is open.

Hi, good morning. It's actually Jennifer for Todd. Let me add my congratulations. Quick kind of follow-up back to gross margins, I think, Sharen, if I heard directly, you said that you feel confident that you will be able to expand merchandise margins and rate in the fourth quarter. But since gross margins are planned flat, does that mean we should assume that margins will be down at Bath & Body Works? And then, kind of along those same lines, could you both, Sharen and Diane both, touch on sourcing costs with higher cotton prices and oil prices and petroleum at BBW and cotton and freight at VS? Thanks.

Let me take a quick crack at it on an overall basis and then Sharen and Diane may want to fill in with some color. With respect to gross margins for the Company, our indication of roughly flat is obviously our view. There is some differentiation by business and there will be some slight improvement in the Victoria's Secret segment and also slight improvement at Bath & Body with a little bit of offset going the other way in the Other segment.

And just an overall comment about input costs and then, again, Sharen and Diane may want to comment further. It's important to remember three or four things. The first is that our biggest priority with respect to sourcing is on speed and quality and innovation. Those are our key priorities.

With that said, we have a great sourcing team or teams, I should say, that have great relationships with suppliers. We've talked about that. Also importantly cotton for us, as you know, is a lot less significant than it is for a straight up apparel company. With that said, it does have an impact, particularly in the Victoria's Secret business. We don't expect a big impact this fall. You might see some beginning in the spring.

But again, for the overall Company, not a big impact as compared to some others. Sharen, Diane, I don't know if you want to add anything to that in terms of input costs or how you're seeing it.

No, I think you answered that very nicely.

Yes, agreed.

Thanks, Jennifer. Next question?

Your next question comes from the line of Lorraine Hutchinson from Bank of America. Your line is open.

Thank you, Good morning. Just looking at your free cash flow guidance of $800 million, it's quite an increase from your original expectations. I was just hoping that you could walk us through some of the surprises, aside from maybe higher net income that you saw throughout the year?

Well, earnings has been, as you mentioned, we certainly substantially outperformed on an earnings basis our beginning of year view. We are managing capital tightly as we talked about. We started the year with a view of about $300 million. As I updated today, we'll be at $275 million or a little less.

And we continue to manage inventories and working capital in a very disciplined way. And we are getting upside there as well. So those would be the major drivers.

Thanks, Lorraine. Next question?

Your next question comes from the line of Emily Shanks from Barclays Capital. Your line is open.

Hi, good morning. Great quarter, guys. I had a question as we look into next year. I believe -- I wanted to refresh my numbers -- that the $250 million to $350 million CapEx run rate is fair and was just wondering if there was any elevated store growth, systems implementations or any one-time spends we should keep in mind as we look into next year?

It's Stuart. We are working on our 2011 plans. We obviously have views today, but we'll continue to work on those views over the next few months. We give our 2011 guidance in February, so that's when we'll be more, quote, definitive about it. In the spirit of working to be helpful. I think we will be $300 million to $350 million on CapEx would be our sense. But, again, we are still working those details.

Okay. Thanks.

You're welcome.

Next question please?

Your next question comes from the line of Janet Kloppenburg from JJK Research. Your line is open.

Thanks so much. Congratulations on a great quarter. Stuart, I was a little surprised by the SG&A ratio as well. I was just wondering, I know you expect to leverage SG&A in the fourth quarter, but I'm wondering if selling expenses plan to be up again in the quarter as it was here in the third quarter? And for Sharen and Diane, if you could just discuss, I know you are being less promotional, does that policy stand for this Black Friday weekend versus last year as well? Thanks so much.

Janet, on selling expense specifically, we did lever selling expenses in the third quarter, and in Q4 we think, it will depend on the ultimate comp outcome obviously, but our overall view is that SG&A in Q4 will be between low- and mid-single-digits in terms of a percent increase and obviously selling costs are the biggest component of that. We think we will be in good shape in terms of managing selling costs in Q4.

Yes, Janet. In terms of -- this is Sharen.

Hi, Sharen.

Hi, how are you.

Good.

In terms of Black Friday this year, we are very well prepared. We have some exciting PWPs and GWPs. We will be promotional on Black Friday as we were last year. We are expecting a big day and are very well prepared for it.

Lots of luck.

And, Janet, this is Diane. Our promotional strategy for Black Friday is basically flat to what we did last year.

Great. Thanks, Janet.

Thank you.

Next question?

Your next question comes from the line of Michelle Tan from Goldman Sachs. Your line is open.

Great, thanks. Hey, Stuart, thanks so much for all the color that you have given so far on SG&A. I was just wondering if you could, without giving a total line, help us think about the puts and takes that you are expecting for next year, the incentive comp side, the international growth and some of the other areas that are offsets that you can lever?

It's a little premature, Michelle, to be honest with you, beyond our clear views, it's not just a nice thing to say, it's a management commitment. We will grow expenses lower than sales period. But in terms of going through the details of 2011, the reality is we are still working those plans, those trade-offs, those choices. We will give more color on that in February. But our end goals are very clear.

Great, thanks.

Sure.

Thanks, Michelle. Next question?

Your next question comes from the line of Brian Tunick from JPMorgan. Your line is open.

Thanks. Good morning, and congratulations as well. I think the Company has talked a lot about systems and processes that are going to help you guys get to your 15% margin goal. I was just wondering if Sharen and Diane can give some examples of how the systems impacted their Q4 thoughts, whether it's lead times, or planning, or mark down thoughts?

Okay. Brian, we will go to Sharen and Diane.

Just to start, I think that when you think about your systems, they really are an enabler. The merchandising decisions are what really drive the business. That's where we are really focused. But having said that, what really -- an example of where the systems have benefited us is better store-by-store view of inventory that we are able to actually maximize where we didn't have that view as extensively as we do today.

This is Diane. I would just piggyback on that. The systems have really just allowed us to balance inventory store-by-store, replenish based on what stores are actually selling versus pushing. That is something we have been working on for a few years. And really, the whole process and success is really about shortening our lead times and reacting to what our customers are buying.

Great. Thanks, guys. Are you good, Brian?

Yes. Thanks, Amie.

Okay. Next question?

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

Good morning. I was just wondering if you guys could apply a little bit for us some of the learnings you've had out of Chicago in terms of how we would looking to next year? If you were to apply some of the learnings that you've had in some of your respective brands in that Chicago area test, would we see a lift in comps, conversion, margins, better store payroll? I'm just trying to get a sense of what that might positively impact next year. Thanks.

Thanks, Neely. That has primarily been a focus for Victoria. So we're going to go to Sharen for that.

We have really been pleased with the ability for us to learn within our Chicago initiative. We have been able to understand our selling force better, training, inventory, inventory availability, fixture [specification] as well as floor spacing. And we have gotten a nice return on that investment. We are planning to take those learns strategically and surgically into other markets as we go forward into 2011.

Thanks, Sharen.

Thank you.

Thanks, Neely. Next question?

Your next question comes from the line Randy Konik from Jefferies. Your line is open.

Yes, great, thanks. Stuart, just two things if possible, is there any kind of guidance you can give us on how you are thinking about spring inventories? I know you gave us the color for fourth quarter. And then just looking at it a little bit further than that, if we get the change on FASB with operating leases having to go on the balance sheet, does that impact any way your thinking about the capital structure, any type of way of paying down debt early? Do you even think about that? Just trying to get your sense around that? Thanks.

Thanks, Randy. In terms of spring inventory plans, again, still working on that. What my general expectation would be is that inventory will be up low-single-digits in aggregate, would be my expectation. But, again, we are continuing to work those plans.

With respect to the leases, in the spirit of humor, the first thing I would express is annoyance because it's quite annoying and it doesn't add a lot of value, as we would see it anyway. But we will send in our comment letter and see what happens. With respect to how it would affect how we manage the business, the answer is it's not going to affect how we manage the business at all. This is -- we are talking about accounting here versus cash economics.

And as you know, users of the financials today capitalize the leases at six or eight times to understand the leverage aspect of that. And in some ways it's no more complicated than that. But certainly they're going to make it more complicated than that. But, again, it doesn't affect cash economics at all, and as such, I don't expect that it will have any impact on how we manage our capital structure or any other aspect of the business.

So just to read it clearly then, it would not impact any sort of way you are thinking about future special dividends, dividends, et cetera, right?

I don't know how to be more clear, Randy. It has no effect on cash. So I'm not sure why it would affect those things. No, it won't affect those things.

All right. Thanks.

You're welcome.

Thanks, Randy. Next question?

Your next question comes from the line of Jennifer Black from Jennifer Black & Associates. Your line is open.

Thank you. Let me also add my congratulations. This question is for Diane. I know you have been experimenting with a loyalty program and you said last quarter that you might have more information this quarter. So I wondered what your findings are at this point in time and when will you make a decision if you roll it out? Thank you.

Sure. Hi, Jennifer. We are doing more extensive testing into the fourth quarter for the loyalty program. We have a lot more customers in our store in the fourth quarter than we do throughout the remainder of the year. So as soon as we get through the fourth quarter, we will kind of solidify our plans as far as what we're planning to do next spring.

Thanks a lot. Good luck.

Thank you.

Thanks, Jennifer. Next question?

Your next question comes from the line of Roxanne Meyer from UBS. Your line is open.

Great, thanks, and let me add my congratulations. My question is on conversion. You have been both leveraging mall traffic and driving conversion all year. And I'm just wondering how do see the opportunity to continue to improve conversion into next year and how far off-peak you are on your conversion rates? Thank you.

Hi, this is Sharen. I will talk about Victoria's Secret first. Our conversion rates are at our peak. So we have record conversion rates and have continued to increase them over this last year. We still believe and are striving to get better and better and want to continue to see our conversion rates improve. And we are doing that with -- many ways, in terms of some of our strategic initiatives such as inventory availability in the stores, better selling associates, better training. And then also it just depends on your product and the fashion and the newness that we continue to deliver. So we are expecting and would like to see even more improvement in conversion.

Hi, Roxanne. This is Diane. And at Bath & Body Works we also are at our peak in conversion and we run a fairly high conversion rate overall. But for us it's really about more about more fashion, more newness, more introductions than we had the previous year. And that is what is really driving our business.

Great, thanks, and best of luck.

Thank you.

Thanks, Roxanne. Next question?

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

Congratulations, everyone, and good luck for holiday. You mentioned, though, the Victoria Secret sale was going to start a little bit later. I was curious if there was any change in the Bath & Body Works sale as to either length or timing? And I was also curious if you run the same events at La Senza and if you are planning on running the same types of sales as you roll out internationally at Victoria's Secret?

Hi, Marni. This is Diane. The Bath & Body Works semiannual sale will be basically the same as last year. As you remember, last year we shortened it significantly so we're not lapping that.

Okay.

And, Marni, it's Amie. La Senza does run a semiannual sale, a post holiday sale. I'm not sure of the timing on that. I can get back to you on it.

It's very similar to the US calendar and cadence with the exception being that Boxing Day, for instance, in Canada is a very big day, it's almost like a Black Friday, so to speak. So it's a little different but similar.

And internationally?

Thanks, Marni, next question?

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

Hi, good morning, everyone, and congratulations. As you think about international and obviously it's a focus of growth, over the long term, how do you see the product assortment being the same or different and could the operating margins be at or above those of the US level? Thank you.

Thanks, Dana. We will go to Martyn for that question.

Well, Dana, as you know, we are in the process of kind of building a portfolio of business opportunities outside the United States, starting with our first priority being Canada and the BBW, VS and Pink expansions in Canada. And then beyond that we are working very hard on repositioning La Senza and repositioning our business with our La Senza franchisees around the world.

We are also introducing BBW through the franchise system in the Middle East as I commented on before. And we're also testing and learning around this new travel and tourism concept. And finally, the flagship store in London that we've described and Martin Waters updated a couple weeks ago. A lot of things in the works, and in addition to that, our Victoria's Secret Direct business continues to be a very important and growing business outside the United States.

So as we look at that portfolio of opportunities, we are learning a lot. It's all very much a work in progress for us, and while we understand the economics of each of those pieces of the portfolio, what we are trying to do is build a portfolio of businesses that generates the kind of sales and productivity that we experience in the United States and profitability in terms of the off-operating income rates that we experience in the United States.

As you understand, it will be a blend of Company-owned operations, franchise operations, which has a fundamentally different kind of P&L characteristic to it in terms of royalty income versus retail sales. And wholesale operations, which is more in the T&T, the travel and tourism category, which, again, has a different set of economics. But the headline would be sales and productivity equal to or greater than in the United States and targeting to get to operating income rates that are equal to or greater than in the United States.

Thank you.

Thanks, Martyn. Next question?

Your next question comes from the line of Laura Champine from Cowen and Company. Your line is open.

Good morning, guys, and congratulations. So, Stuart, this is the seventh consecutive quarter that Limited has beaten guidance and I'm wondering if there is a specific element that you are being systematically conservative on and if you are similarly conservative in your Q4 guidance?

Well, what we think the most about is how we are running the business internally and how we are running the business internally is on a conservative basis with respect to inventories expenses, CapEx, cash liquidity, all that stuff. But as it relates to your question, our mindset operationally is one of conservatism as we enter a season.

Then as we get feedback from customers in terms of what is working and what is not, we are working hard to chase those opportunities. But as we've talked about some before, we may give up a little bit on the upside reflecting that conservative mindset. That is the mindset from which we are running the business and our views that we discuss externally reflect that mindset.

The only other thing I would add to it is, as we start lapping better results, and as you'll remember from an earlier question, particularly as it relates to merchandise margin rates, the level of flow-through and the level of margin rate improvement is kind of, as we would all, I think, understand, is going to moderate as we lap better results. So that is what is reflected.

Got it. Thank you.

You're welcome.

Thanks, Laura. Okay, I think we're going to have time for two more questions.

Your next question comes from the line of Carla Casella from JPMorgan. Your line is open.

Hi, I may have missed this if you said it. But did you give a leverage target that you are comfortable just given the dividend and the share buybacks, if we can get a sense for how high you would be comfortable taking leverage?

The short answer to your question is we are not formulaic about it nor do we have a specific numerical guideline. So we are very comfortable with the balance sheet as it is for reasons we have described in terms of the cash generation of the business, the maturity profile, et cetera. We are very comfortable where it is now, but there are a lot of inputs into judging the appropriateness of a capital structure. And, again, we're not formulaic about it, we do review it with our Board regularly, get good perspective from them, and, again, we are very comfortable where we are.

Great, thanks.

Thanks, Stuart. And final question?

And your last question comes from the line of Erika Maschmeyer from Baird. Your line is open.

Thanks, just snuck in here. My question is about Pink. Given the strong results that you've seen there, could you talk about your thoughts and strategy around expanding the square footage for that brand in existing stores compared to stand alone?

Sure. The Pink business has had great performance and we're very excited about the growth opportunities that we see in Pink. We definitely have a strategy to expand the square footage in Pink. Our first initiative would be to be able to find the square footage, that we would have side-by-sides to Victoria's Secret. Where we don't have that luxury of getting the right amount of square footage, we'd still believe in the free-stranding strategy. The leverage of the customer on the side-by-side is greater than the free-standing but both work very well for Pink.

Great. Thanks, Sharen. And thanks to everyone for joining us this morning and for your continuing interest in Limited Brands.

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