Limited Brands Q3 2007 Earnings Call Transcript

Limited Brands, Inc. (LTD)

Q3 2007 Earnings Call

November 20, 2007 5:30 pm ET

Executives

Tom Katzenmeyer - SVP of Investor, Media, and Community Relations

Martyn Redgrave - EVP and CAO

Stuart Burgdoerfer - EVP and CFO

Sharen Turney - CEO of Victoria's Secret

Diane Neal - CEO of Bath & Body Works

Analysts

Jeff Black - Lehman Brothers

Michelle Clark - Morgan Stanley

Brian Tunick - JP Morgan

Kimberly Greenberger - Citigroup

Jeff Stein - Keybanc Capital Markets

Eric Miller - Lehman Brothers

Lorraine Maikis - Merrill Lynch

Lauren Levitan - Cowen and Company

Sarah Lewis - Credit Suisse

Marni Shapiro - The Retail Tracker

Richard Jaffe - Stifel Nicolaus

Dana Cohen - Banc of America Securities

Frank Henson - Bear Stearns

John Morris - Wachovia

Howard Tubin - RBC Capital Markets

Dana Telsey - Telsey Advisory Group

Presentation

Operator

Welcome to the Limited Brands' Third Quarter Earnings 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, Media, and Community Relations. You may begin.

Tom Katzenmeyer

Thank you and good afternoon, everyone and 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 you to remind you that any forward-looking statements we may make today are subject to the Safe Harbor statements 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 Burgdoerfer, EVP and Chief Financial Officer; Sharen Turney, CEO, Victoria's Secret, Diane Neal, CEO, Bath & Body Works, and Amie Preston, Vice President of Investor Relations are all joining us today.

After our prepared comments, we will 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'd like to turn the call over to Martyn.

Martyn Redgrave

Thanks, Tom and good afternoon, everyone. Since we just held our investor update meeting about a month ago, I am 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 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 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 this year and total company owned stores of roughly 15%.

The continued testing and expansion of our new concepts including the VSX, our new sport initiative for Victoria's Secret, Intimissimi, our 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, if we review it in some detail of 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 have 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 [entire] data, customer data warehouse and customer relationship marketing systems, and the creation of our finance, HR and procurement services organization.

In addition, last year, we implemented new supply chain systems at Bath & Body Works. And 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 our 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 impacts 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 at $1.4 billion and we have been experiencing capacity issues in the last two holiday seasons. As a result, we recognized that we could not support the growth of this direct business with 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, there's a unique combination, due to the high unit velocity and the range of skewed diversity in our direct business. The fact of it is that the hard change over of the new integrated processes, mechanical equipment, and IP systems is taking us longer than expected to stabilize. We appear to have hit a limit in 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 in January 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 constrain the volume of orders we'll take including reducing catalogue circulation, which will significantly reduce fourth quarter direct demand and sales.

Again the direct DC up to full capacity is, without question, the more significant operational priority that we have. We have our best internal people as well as outside vendor experts and independent experts evaluating this 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 underway. 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 technology systems at Victoria's Secret Direct.

Our number one business priority is to remain very focused on executing the best possible fourth quarter in 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.

Stuart Burgdoerfer

Thanks, Martyn, 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 mix versus our original expectations 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 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 mix through greater than anticipated expense savings.

The negative 3% comp for the quarter was driven by negative traffic levels and we believe it 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 deleveraging, buying and occupancy at the 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 volumes 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 in the share repurchases were about $0.02 diluted in the third quarter.

Retail inventories ended the quarter down 14% per square foot at costs 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 year's 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 trend.

Our revised comp estimate for November is the negative mid-single digit count and for the fourth quarter is the negative low single digit count 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 headcount 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 the 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 the 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 $50 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 of 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 Sharon, I'd 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 mix] the operating income rate was inline with our plans. Victoria's Secret Beauty products were rolled to all the center stores in October and we are encouraged by the response to-date. Thanks and now I will turn the discussion over to Sharen.

Sharen Turney

Thank you, Stuart and 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%. And total segment operating income declined with a primary driven by a decline at Direct. A decline in operating income of Victoria's Secret stores was largely offset by the La Senza's operating profit during the quarter.

Turning to the individual business performance, Victoria's Secret store comp declined by 4% and total sales declined 1% to $735 million. Operating income dollars declined and the operating 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 decline in marketing stand. Comp store sales for the quarter were below expectations 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 a holiday season our customers' primarily focus on self purchase. Therefore, we began the holiday season with this focus in mind, featuring the launch of a new Very Sexy Wave with lace bra, fresh PINK assortment and a new Supermodel fragrance launch in Beauty.

In order to deliver our holiday plan, we are focused on executing our planned strategy, executing cost 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 gift things during key holiday timeframe, including lingerie, PINK and Beauty gifting. We expanded our giftable and impulse purchase assortment to include fun items such as [penny pop, penny candy, gift card holders] that also serve as luggage tagged along with other highly giftable items that we think will sell this holiday.

We planned 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 as 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 apparels in about 30 stores, and finally, we continue to focus on and be excited about our overall real estate strategy.

In the third quarter, we opened 17 new stores and remodeled 52 stores with plans to open a remodel -- a total of 145 stores by yearend. Make sure you watch the fashion show, which will air on December 4th at 10:00 pm on CBS. This year's show features the kickoff of the World Reunion Tour of the Spice Girls.

Now turning our intention 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 in the catalog and the Internet channel, remain very strong. But sales at direct declined 7% in the quarter due to the increase shipped time and operating income declined 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 option and incremental labor higher to staff a DC and work on fixing the issue.

We were, obviously, disappointed that we have had to take steps to reduce this demand in the fourth quarter. However, protecting the customer experience and their 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. Now I will turn it over to Diane.

Diane Neal

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 in margin dollars, primarily driven by real estate activity and a margin rate improvement. That was offset by deleveraging a fixed buying and occupancy expenses and start-up 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 margins 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 growth margin rates were up to last year, driven primarily by mixed and improved product costs, partially offset by increased promotional activity to clear seasonal fragrances in 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 sub brands. In August, we ran our annual hand soap event, which focused on our antibac and aromatherapy hand soaps and featured the launch of three new hand soap fragrances; Midnight Pomegranate, Japanese Cherry Blossom and Sensual 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 that 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 collection, we then moved to our Happy Falliday theme, which was a more transitional holiday set. Happy Falliday features 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 (inaudible) gifts with purchase, and [wildflower] promotion.

December themes will continue to focus on our holiday collection. New for this year, we'll seek to exciting activities to drive traffic each day during the last 12 days leading up to Christmas.

Holiday is off to softer [cycle] than we have planned, but we believe our assortments are fresher than last year and inventories are appropriately at balance in total and occupy stores driven primarily by our systems 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 in fall seasons.

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

Martyn Redgrave

Thanks, Diane. Before we take your question, I'd just like to emphasis three main points. First, we are 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.

Tom Katzenmeyer

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

Operator?

Question-and-Answer Session

Operator

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

Jeff Black - 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 that extends beyond 4Q and into spring, would be a? And then on 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

Tom Katzenmeyer

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

Martyn Redgrave

Jeff, in terms of the distribution at our operation, just to step back and give your a little bit more perspective, because I'm sure this could be a source of a number of question, the first thing I think you need to understand with opening a new centre in August we had expected a slow ramp-up. We did, in fact, ramp up the development pace as were expecting to ramp-up that throughout the end of September and into October. We say no ways, if you will, in the operation of the center, but we didn't see an inability to breakthrough the volume levels that we need to breakthrough the service holiday.

Over the last four weeks, as we have evaluated the performance of the center, we've concluded that that are some issues there that are going to cause us to have one of the capacity in center that will limit the capacity in center as we're entering a 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 the things like the High Bay reserve storage capabilities that are not in our other centers. So, we're using as a dynamic location picking system, which is very different then the static location for consistence that our traditional centers have used.

We are 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 necessary new to the world in terms of the way it's been utilized in other large scale distribution centers, but it is 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'd give you as perspective is that the center right now is operating in about 70% to 75% of our targeted capacity. In other words, the capacity we would need to be at before these 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're obviously focused on stabilizing the systems, the processes 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 real time 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.

Jeff Black - Lehman Brothers

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

Martyn Redgrave

Well, as I mentioned in the scripted remarks, we're evaluating the timing of the implementation of the supply chain systems for Victoria's Secrets 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 stores operations, which is scheduled to implement the supply chain systems next year.

As I indicated, we're evaluating 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 Secrets stores business in 2008.

Jeff Black - Lehman Brothers

But without belaboring the system, does it stands now and with the 70% capacity it can handle spring volume or no?

Martyn Redgrave

It handles spring volume but not semi-annual sales peak volumes.

Jeff Black - Lehman Brothers

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

Martyn Redgrave

Thanks, Jeff.

Martyn Redgrave

Next question please.

Operator

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

Michelle Clark - Morgan Stanley

Thanks guys and good evening everyone. Can you breakout for us what the year-over-year change in operating margin rate would have been at Victoria's Secret pacts 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 overall, what's getting you to Scale Back square footage growth at VS? Thank you.

Tom Katzenmeyer

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

Stuart Burgdoerfer

So on the question about excluding the effect of directs from the Victoria's Secret result, operating margin rate would have been down or was down in the third quarter driven by P&L leverage. As I mentioned in my remarks, merchandise margins was basically flat, but there is 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 margins declined at Victoria's Secret's stores in the third quarter is the effect of the incremental real estate costs. 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 the holiday sales results and in terms of seeing what the results look like post holiday.

Michelle Clark - Morgan Stanley

Thanks.

Tom Katzenmeyer

Thanks, Stuart. Next question please.

Operator

Our next question is from Mr. Brian Tunick of JP Morgan.

Brian Tunick - JP Morgan

Thanks. Good afternoon. My question is, I guess, from a big picture, it sounds like marketing spend is down, inventories were down, promotions are down, so, I guess, the question is: 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?

Tom Katzenmeyer

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

Stuart Burgdoerfer

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 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 have assessed our sales expectations. We've certainly worked to factoring what we know at this point and we are 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, VS.

Sharen Turney

Yeah. Hi. This is Sharen.

Brian Tunick - JP Morgan

Hi, Sharen.

Sharen Turney

On the marketing dollars, yes, our marketing dollars for the third quarter were significantly down since last year. Our marketing spend as we're looking at going into the fourth quarter are both in terms of looking at what we're doing and our lineup around holiday are primarily flat to last year.

We were investing those marketing dollars are truly around gifting products, as I said earlier, around are on supermodel PJ party that we're looking at, our launch of 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.

Diane Neal

And at Bath & Body Works sides. This is Diane, Bryan. At Bath & Body Works, we launched Velvet Tuberose as a fragrance in October. So we did not launch our fragrance last year, so we have that to anniversary in December.

Also, last December, I had mentioned before that our in-stocks and our top key fragrances within our Signature Collection were about 50%. We are at unbelievable fate now. Not to mention our balance of inventory by store is much better than it has ever been. We're actually in a much better position by starting to hold inventory at BBW, I think than we have done in years. So, I'm pretty excited about our balance.

And then the other piece of it really is those last 12 days moving up to Christmas, that was a big miss for us last year. And we've got a lot of great different activities happening everyday, I think will add additional volume for us.

Brian Tunick - JP Morgan

Okay. Terrific. Very helpful. Good luck

Tom Katzenmeyer

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

Operator

Our next question is from Kimberly Greenberger of Citigroup.

Kimberly Greenberger - Citigroup

Hi. Thank you. I was hoping that the brand President could just talk about the margin direction at each Victoria's Secret and Bath & Body Works. We've seen degradation throughout the year and based on the fourth quarter guidance, perhaps we'd assume it would 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.

Tom Katzenmeyer

Hey Kimberly, why don't we start with Stuart there again?

Stuart Burgdoerfer

Kimberly, for both BBW and VS, our expectation is basically for a roughly flat margin result in the fourth quarter. So that's our expectations. We're working on our views for 2008. We've realized 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.

Kimberly Greenberger - Citigroup

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

Stuart Burgdoerfer

Yes. 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 preclude, as dynamic situation as you can imagine, and it relates to an assessment of where we are in the distribution center and how we might want to manage through spring. But our fourth quarter guidance in terms of earnings does contemplate or estimate any margin affect from our inventory position at the end of the year.

Kimberly Greenberger - Citigroup

Thanks.

Tom Katzenmeyer

Kimberly, did we get all your questions answered?

Kimberly Greenberger - Citigroup

That's helpful. Thanks, Tom.

Tom Katzenmeyer

Next question please.

Operator

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

Jeff Stein - Keybanc Capital Markets

Hey, well, this question is probably a little premature, but I am 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 another words, do you envision a steep ramp or once you get the business stabilized, really will be more inclined to try to produce a soft range?

Tom Katzenmeyer

Jeff, we are going to get you Sharen Turney for that.

Sharen Turney

Basically, at this time and this is when we really peak the business around the holiday and semi-annual sale. As we come out of semi-annual sale, the normal business subsides down to all the way until we get back into semi-annual. We feel very confident in terms of the product. The product demand has been very strong at direct and 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 fire and the growth of the fire as we have in the past. We're being very strategic with the contact strategy. We are just not contacting the customers as frequently as we had in the past and our [selling] plan is around the contact strategy and going back after those customers at a more frequent basis both by catalogue as well as an e-mail strategy.

Jeff Stein - Keybanc Capital Markets

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

Sharen Turney

Well, the think about it is, you are not really having to ramp up because you are coming out of a peak timeframe where normally the volume drops. So, because the volume drops, that distribution center will be able to handle that volume, can we get the labor corrected within that from a profit flow perspective.

Jeff Stein - Keybanc Capital Markets

Got it. Thank you

Tom Katzenmeyer

Thank you, Jeff. Next question please.

Operator

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.

Eric Miller - Lehman Brothers

Yes, good evening. Thank you for taking the question. My question relates throughout your balance sheet and your share repurchase program that you had in place for sometime. Could you just talk a little bit about as your operating performance has deteriorated and obviously, we are seeing your stock at a multi-year row, 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 in investment grade debt rating? Because it looks like you are on the path 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.

Stuart Burgdoerfer

Thanks for your question. This is Stuart. So, we are committed to retaining financial flexibility as you put it. As we have talked about before, 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 looked at them recently, but the credit spreads of 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 interest. And we are in appropriate context with the rating agencies on those points.

Eric Miller - Lehman Brothers

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

Stuart Burgdoerfer

We are committed to those.

Eric Miller - Lehman Brothers

And is there a specific debt to EBITDA metric that you are measuring your business by? I mean you are approaching four times adjusted debt to EBITDA when you look at your least-adjusted leverage, which is significantly higher than it has been in sometime: is there a specific number that we should look to that you are going to manage the business by?

Stuart Burgdoerfer

We are not focused on any one method. We are 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 strength as well. So, we don't focus on one particular method, but we are certainly familiar with the ratios the agencies use.

Tom Katzenmeyer

Thank you for your question. Next question please

Operator

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

Lorraine Maikis - Merrill Lynch

Thank you. Good evening. You have 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 are 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 upgrade immediately?

Tom Katzenmeyer

So, then we will go to Stuart for the first part of your question and to Martyn for the second part.

Stuart Burgdoerfer

For the fourth quarter, we are estimating that the enterprise SG&A rate will be flat. In terms of the drivers that change in the SG&A rates, 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 will call out beyond the effects of the apparel and Mast that we have talked about before.

Tom Katzenmeyer

And then to Martyn.

Martyn Redgrave

In terms of the systems implementation, we assessed Victoria's Secret stores and Mast for 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 a front end, of those implementations when you think about the supply chain. The fact is that realizing benefits from those systems is a medium-term not long-term but medium-term effort as evidenced by the implementation of the supply chain capabilities of BBW the last year. It did take us longer to stabilize those systems in BBW than we had originally expected.

We had expected around six months. It took us for 12 months to stabilize the systems and [in trying to] utilizing the way they are intending to utilize now, as Diane has mentioned that this team is beginning to see the benefits in fully utilizing those systems. So, we are consciously aware of the trade [hawks] but feel that re-timing the system implementations will give Victoria's Secret or this 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 this year in our BBW business last year, and re-timing it to a spring of '09 timing, which is what we are examining and it would probably optimize all of the above pros and cons.

Tom Katzenmeyer

Well, [I'm really going] back to Stuart for a clarification of something we missed out.

Stuart Burgdoerfer

Yeah, excuse me on the fourth quarter SG&A rate, it will be up somewhat for the reason described which is the affect of the [VSP] sales loss is the main driver. So, excuse me for that, I had mentioned it in my script correctly and on the Q&A incorrectly. Thanks.

Lorraine Maikis - Merrill Lynch

Okay, thank you.

Stuart Burgdoerfer

Thanks.

Tom Katzenmeyer

Next question?

Operator

Our next question is from Lauren Levitan of Cowen and Company

Lauren Levitan - Cowen and Company

Thanks good afternoon, when I 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 and so much as that marketing device might be driving people to the stores and how you'll address that, potential impact on traffic. And I know you mentioned earlier in response to a question Stuart, that you thought that inventory, you've got ways to work through it that it's our understating that significant portion of that inventory or of those styles are not available in stores, if you could help us get a better understanding of how that's going to flow through and then we have made it to that expense [control] obviously in the third quarter, looks like you found more ways to control expenses than the original side of expense cuts that you had talked about.

Can you tell us, give us some sense as how much more opportunity do 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.

Martyn Redgrave

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

Sharen Turney

The first question is in the half I believe was that while cutting the catalog circulation. What would that do to Secret stores? We do know that when you mail a catalog that you actually do, it does drive some traffic through stores. What we are 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 slipped] in an e-mail strategy to over 40 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 circulations by actually putting in a drive-to-store, store only event with those customers who try to offset a little of that demand when it comes nearly to able to [sell all of the] demand that the direct business will [move].

I think one of the questions if I think was about the inventory levels in direct about the non purchase things that are not in the store. What we've done is we've actually re-sorted the catalog as well as the e-mails and homepages to truly seasonal merchandise whether it being our apparel categories or being our sleepwear categories. So therefore the categories that are more long life categories are not as, probably in the catalog or online, therefore, selling through those that have a shorter life. We also are taking some inventories from Direct to the stores of which we needed 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.

Martyn Redgrave

And Lauren we are going to get back to Stuart for your question on observation about third quarter expense.

Stuart Burgdoerfer

In terms of the favorability on expenses versus in our previous [year], we are just continuing fundamentally the scrutinized home office spending and particularly projects in 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.

Lauren Levitan - Cowen and Company

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

Stuart Burgdoerfer

In terms of the fourth quarter?

Lauren Levitan - Cowen and Company

Yes.

Stuart Burgdoerfer

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

Sharen Turney

I think, Lauren, we were talking about merchandise.

Stuart Burgdoerfer

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

Lauren Levitan - Cowen and Company

Thank you very much.

Tom Katzenmeyer

Thanks, Lauren. Next question?

Operator

Our next question is from Paul Lejuez of Credit Suisse.

Sarah Lewis - Credit Suisse

Hi. It's 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 anyway you could quantify what type of impact it 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 of this versus last year? Thanks.

Tom Katzenmeyer

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

Sharen Turney

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

Tom Katzenmeyer

Thanks. Next question, please.

Operator

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

Marni Shapiro - The Retail Tracker

Hi, guys. Good evening. If you could talk a little bit, you said inventory was down about 14% per square foot, it sounds like that 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?

Tom Katzenmeyer

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

Stuart Burgdoerfer

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

Marni Shapiro - The Retail Tracker

Great. Okay. Thanks, guys

Tom Katzenmeyer

Thanks, Marni. Next question.

Operator

Our next question is from Richard Jaffe of Stifel Nicolaus.

Richard Jaffe - 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 form?

Stuart Burgdoerfer

So, this is Stuart. On that, you should expect about 39%. The phenomenon that occurs in the third quarter is what I call the law of small numbers. So you'll get a funny rate, because inherently in the business and also in [prior dated] performance, the pre-tax income was low.

Richard Jaffe - Stifel Nicolaus

Right.

Stuart Burgdoerfer

So a forward modeling assumption of 39% is right. As you know, there is more volatility today in a public companies 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

Richard Jaffe - Stifel Nicolaus

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

Stuart Burgdoerfer

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 applies to both Bath & Body Works and Victoria's Secret stores.

Richard Jaffe - Stifel Nicolaus

Thank you.

Tom Katzenmeyer

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

Operator

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

Dana Cohen - Banc of America Securities

Hi, guys. Thanks for taking the question. Starting with the other number, which moved to 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, operating profit to be down somewhat, that is just Victoria's Secret booked for 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, where was that though?

Tom Katzenmeyer

Okay. We will go to Stuart.

Stuart Burgdoerfer

Okay. And I will repeat the same answer to questions as I stated on the first one. On that first question, Dana, in terms of the key drivers within the other segment in terms of favorability that gain on sale of corporate aircraft was the biggest driver. Expense savings that I mentioned related to home office overhead and IT-related project spending would be the next biggest driver of the favorability.

Dana Cohen - Banc of America Securities

Okay. Obviously, the gain is in there. Are there any other pieces to that that are not recurring?

Stuart Burgdoerfer

No. There is nothing out that I would describe as significant and nonrecurring.

Dana Cohen - Banc of America Securities

Okay. And then just the clarification?

Stuart Burgdoerfer

And the clarification is on operating margins for…

Sharen Turney

So Dana, when we were talking about for -- Stuart was only talking about Victoria's Secret stores not excluding direct.

Stuart Burgdoerfer

And we're talking about the fourth quarter.

Dana Cohen - Banc of America Securities

Both for Q4 guidance and for operating margins having (inaudible) 200 in Q3.

Sharen Turney

That was also only stores.

Dana Cohen - Banc of America Securities

Perfect. Thank so much.

Tom Katzenmeyer

Thank Dana. One more, quick question here.

Operator

Frank Henson of Bear Stearns. You may ask your question.

Frank Henson - Bear Stearns

Yes. Thank you very much for taking my question. Most of my question have been answered, but I am 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?

Stuart Burgdoerfer

An answer to your very specific question answer is yes. We make sure that we're not going to be surprised by anything and we have had the right conversations to ensure that we're making informed decision.

Frank Henson - Bear Stearns

Okay. Thank you very much.

Tom Katzenmeyer

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

Operator

Our next question is from John Morris of Wachovia.

John Morris - Wachovia

Thanks. Hi. Unless I missed it, did you quantify how much you plan on catalogue 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.

Tom Katzenmeyer

John, we'll go to Stuart for that

Stuart Burgdoerfer

John, on the first one and you can appreciate while we want to be somewhat general from a competitive standpoint, but I would just say that's hard to helpful that the circulation would be down roughly in line with the sales impact that we described to you.

John Morris - Wachovia

Okay. Good.

Stuart Burgdoerfer

And then, the second question, I am sorry was?

John Morris - Wachovia

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

Stuart Burgdoerfer

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

John Morris - Wachovia

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

Stuart Burgdoerfer

Yes. Exactly the same, but it's essentially the same.

John Morris - Wachovia

Okay. Thanks.

Tom Katzenmeyer

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

Operator

Okay. Howard Tubin of RBC Capital Markets. You may ask your question.

Howard Tubin - RBC Capital Markets

Hi. Thanks. Could you guys talk about the mass business and what it will look like from a revenue basis next year in terms of business that you maybe losing or business that you maybe gaining?

Stuart Burgdoerfer

In terms of '08 specificity, again, we would be more, we'll be more prepared to do that and be part of our, that will 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 those transactions part way through 2006. And we've had some other changes in our third-party business, some plus some minus. But we'll try to give you more color on that in February.

Howard Tubin - RBC Capital Markets

Okay. Thanks.

Tom Katzenmeyer

Thanks. Operator, one last question please.

Operator

Last question is from Dana Telsey of Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

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

Tom Katzenmeyer

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

Diane Neal

I think as I mentioned before, I think we're pretty put in place for December product business. Going forward our focus I mentioned before is really around our propriety 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 in fall of '08.

Dana Telsey - Telsey Advisory Group

Okay.

Sharen Turney

I think as we look into the fourth quarter, that we're very well positioned to, just trying optimize the holiday. I think our bra launches just we looked 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.

Dana Telsey - Telsey Advisory Group

Thank you

Tom Katzenmeyer

Sharen, Diane and Dana, thanks everyone for listening and we wish you all a happy Thanksgiving.

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