Bath & Body Works Inc (BBWI) 2012 Q2 法說會逐字稿

Good morning. My name is Tracy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Limited Brands second-quarter 2012 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.

At this time, I will turn the call over to Ms. Amie Preston, Chief Investor Relations Officer for Limited Brands. Please go ahead.

Thanks, Tracy. Good morning, everyone, and welcome to Limited Brands' second-quarter earnings call for the period ended Saturday, July 28, 2012. 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 filing.

Our second-quarter earnings release and related financial information, including any non-GAAP or adjusted financial reconciliation tables, are available on our website, limitedbrands.com. Also available on our website is an investor presentation which we will be referring to during this call. This call is being taped and can be replayed by dialing 1-866-NEWSLTD. You can also listen to an audio replay from our website.

Stuart Burgdoerfer, EVP and CFO; Sharen Turney, CEO Victoria's Secret; Nick Coe, CEO Bath & Body Works; and Martin Waters, President of International, 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.

Also, just a reminder that all of the results discussed on this call are adjusted results and exclude the one-time items that are described in our press release.

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

Thanks, Amie. Good morning, everyone. We reported adjusted second-quarter earnings per share of $0.50 against last year's $0.48 per share, or $0.46 per share excluding the earnings related to the sold third-party sourcing business. This year's result was negatively impacted by about $0.04 related to La Senza transition costs, investments in Victoria's Secret UK, and the timing shift of the Victoria's Secret marketing campaign. Operating income in our two core businesses, Victoria's Secret and Bath & Body Works, increased 12%.

To take you through the second-quarter results as detailed on page 4 of the presentation, comps increased 8% against 9% last year. Adjusting for the impact of the sourcing business sales, the gross margin rate decreased by about 30 basis points, as leverage in buying and occupancy costs did not fully offset the decline in the merchandise margin rate. The SG&A expense rate was about flat.

Turning to the balance sheet on page 8. Retail inventories per square foot at cost ended the quarter up 3% versus last year. Our inventories are clean and well-positioned as we head into fall.

We continue to be committed to returning free cash flow to shareholders. We repurchased 5.1 million shares of stock in the second quarter for $222.9 million. At quarter end, we had $60.5 million remaining under our current $500 million repurchase program.

Additionally, as previously announced, we will pay a special dividend of $1 per share, along with our regular quarterly dividend of $0.25 per share, on September 7 to shareholders of record on August 23.

Turning to page 11 of the presentation. For our forecast for 2012 we expect earnings per share between $0.15 and $0.20 in the third quarter against last year's adjusted $0.25 result, or $0.22 excluding the result of the sold third-party apparel sourcing business.

While we expect operating income growth in our two core businesses, we will continue to see an impact from our international business as we work to turn around La Senza and continue to invest to support future growth. We will also have a negative impact of about $0.02 from incremental interest expense in the quarter.

Our third-quarter earnings forecast reflects a low- to mid-single-digit comp increase. We expect the third-quarter gross margin rate to be up significantly as the sale of the sourcing business will benefit our gross margin rate by approximately 400 basis points.

Absent this impact, we expect the gross margin rate to be down, driven by a decline in the merchandise margin rate. The merchandise margin rate decline is primarily driven by a mix shift within the business as a result of an increase in masked sales to our international partners. We expect the merchandise margin rates at Victoria's Secret and Bath & Body Works to be about flat.

We expect the third-quarter SG&A rate to increase significantly, driven by a negative impact related to the sourcing business sale of about 370 basis points. Excluding this impact, the SG&A rate would increase as a result of investments in store selling, costs related to store openings and remodels, and marketing. These investments are supporting growth in our business. As a reminder, it is more difficult to leverage expenses in our lowest volume quarter.

We expect to end the third quarter with inventory per square foot up mid-single digits to last year. For the full year, we are projecting positive 3% to 5% comps. We expect our gross margin rate to be up significantly, again positively impacted by the sourcing business sale by about 250 basis points. Excluding this impact, our gross margin rate would still be up for the year, driven by a roughly flat merchandise margin rate and a slight improvement in the buying and occupancy expense rate.

We expect the full year SG&A expense rate to be up, negatively impacted by the sourcing business sale by about 170 basis points. Again, absent this impact, we expect the SG&A rate to be about flat. Before any discrete items our tax rate will be approximately 38.5%.

Assuming all of these inputs and others which are detailed in the presentation, we expect earnings per share for the full year 2012 to be between $2.73 and $2.88 per share. We continue to expect 2012 CapEx to be between $575 million and $625 million. The increase in CapEx versus last year is attributable to increased real estate investment at Victoria's Secret.

Turning to liquidity, we expect free cash flow in 2012 of about $700 million. We remain committed to returning excess cash to shareholders through a combination of share re-purchases and dividends.

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

Thank you, Stuart. Good morning, everyone. Our second-quarter results are detailed on page 15 of your presentation materials. Victoria's Secret had record sales and earned record operating profit in the second quarter, with segment operating income dollars up 8%. We continue to focus on our key priorities -- growing in our core categories, investing in select key growth opportunities, and emphasizing speed and agility.

In the stores channel, second-quarter comps were up 10% on top of a 12% increase last year, driven by strength across bras and panties, swim wear, PINK lounge, and fragrance. In the direct channel, second-quarter sales were up 3%, driven by strength in bras, panties, sleepwear, PINK, beauty, and swim, somewhat offset by softness in apparel.

Our second-quarter merchandise margin dollars were up and the merchandise margin rate was down versus last year in both channels. This is the direct result of decisions we made to ensure we ended the season clean in inventory and better positioned to chase into early fall winners.

In the store channel, the merchandise margin rate decline was primarily driven by three things. First, an increase in clearance merchandise sell-through; second, a timing shift in our marketing strategy to support our early August bra launch; and third, continued strong response rate to our gift-with-purchase and direct-mail offers, a trend we will expect will continue this fall. In our direct channel, the merchandise margin rate decline was driven by incremental promotion offers and lower pricing during the semi-annual sale.

Looking ahead to the third quarter, we will remain focused to grow our core categories of bras, panties, loungewear, and fragrance. We will continue to focus on providing our customer the best seamless experience across both channels through exceptional execution. We will also continue to make investments to main consistent growth in our business.

This includes real estate investments. This fall we'll open and remodel 40 stores, including our premier New York flagship at Herald Square; investments in customer-facing technology; store-related investments such as an enhanced training and development programs. We believe these types of investments improve the customer experience and have contributed to our strong increase in store conversion rate.

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

Thank you, Sharen, and good morning, everyone. At Bath & Body Works we delivered sales and operating income growth versus last year's strong performance in the second quarter. Comps increased 7% against a 4% increase last year, driven by continued newness in both form and fragrance in our three key categories -- our Signature Collection product line, the soap and sanitizer business, and our home fragrance assortment.

Operating income dollars were up 25% to last year and up 190 basis points as a percent of sales, driven by expense leverage and a slight merchandise margin rate improvement. The improvement in merchandise margin rate was primarily a result of less promotional activity, which offset logistics cost increases.

We're pleased with the success of the June semi-annual sale. The read-and-react nature of our business and strong customer response to the assortment throughout the spring season contributed to less clearance selling and more everyday selling during sale.

Looking ahead to the third quarter, we continue to introduce newness and innovation in both form and fragrance. In August, the shop moved to the From Paris with Love theme, creating a boutique shopping experience highlighting several new Paris-inspired Signature Collection fragrances. In addition, this month we will include the launch of our new Autumn in America soap collection and our new elevated White Barn Cider Lane home fragrance collections.

We're excited about the assortment and we'll continue to manage expenses and inventory conservatively, while continuing to focus on getting faster and providing our customers with a world-class in-store experience.

With that, I'll turn it over to Martin.

Thanks Nick, and good morning everyone. My comments this morning will focus on an update of our international businesses. We believe our opportunity for international growth is significant, given the leadership position and awareness of our brands and the success that we've seen from our early efforts.

We feel good about the strategic choices we made to be steady and purposeful, to pursue a test-and-learn philosophy that reflects the DNA of our Company. We made progress in the second quarter, and as detailed on page 14 of your presentation, we continue to be on track to open over 200 international locations this year.

At Victoria's Secret, we continue to be pleased with performance of our full assortment stores in Canada, and we'll open seven more stores this year. Our first full assortment store outside of North America opened on July 24 in London at the Westfield Mall adjacent to the Olympic Village. We're very happy with how that store is operating so far and we plan to open the Bond Street location in the coming weeks.

We'll also open three full assortment Victoria's Secret stores this fall in the Middle East under our franchise partnership with Alshaya. Our Victoria's Secret beauty and accessories business continues to progress well, with 73 locations open at the end of the quarter heading to about 130 by the end of the year. In Bath & Body Works we're now up to over 90 stores outside of the USA and project to end the year with about 120 stores. We're pleased with the performance of BBW in our own stores in Canada, as well as in our franchise stores in Turkey, the Middle East, and Russia.

Turning to La Senza, our Canadian business has been slower to turn around than we would have liked. La Senza comparable store sales in Canada decreased 3% in the quarter. As you know, we closed about 40 stores in the first half of the year, and we're encouraged by how the business is benefiting from that. We have plans to close about 30 more locations during the second half of 2012.

A portion of the costs related to these closures, $3.6 million, has been excluded from our adjusted second-quarter results. We also expect to incur some additional costs in the third quarter, which we intend to adjust as it reported results. Therefore, these costs are not included in our third-quarter earnings guidance. We believe La Senza is now right-sized at about 160 stores in Canada.

We continue to be encouraged by the repositioning work we're engaged in. We now have a distinct and compelling customer proposition that is globally appealing and highly scalable around the world. Our partners will open over 40 new La Senza stores this year.

So that's an update on international. As I know you know, we're not dependent on international for growth. Our over-arching priority is the strength of our brands in North America.

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

Thanks, Martin. That concludes our prepared comments and at this time we would be happy to take your questions.

As a reminder, please limit yourself to one question. We've got plenty of time, so if you've got a second question, you can queue back up. Thanks, and I'll turn it over to Tracy.

(Operator Instructions)

Dana Telsey, Telsey Advisory Group.

Good morning, everyone, and congratulations. As you think about the operating margins, both at Victoria's Secret and BBW, the strength of the BBW operating margin was very impressive. How do you see operating margin trends going forward as you break it down between gross margin and SG&A, both at Victoria's Secret and at BBW, especially given that Victoria's Secret the influence of PINK continues to gain traction, and that's also impressive? Thank you.

Thanks, Dana. We'll go to Stuart for that question.

Dana, obviously the different businesses are in somewhat different positions, but as we think about Victoria's Secret in the United States and Bath & Body Works in the United States, we believe that they have similar potential on an operating income rate basis.

As we look at it today, obviously, the operating income rate at BBW is higher, but as we think about the opportunity over the next two or three years, we see that Victoria's had significant opportunity to continue to improve its operating income rate. As you know, it's significantly improved its rate over the last two or three years, and we see potential for further improvement in that OI rate.

Thanks, Stuart. Is that good for you, Dana?

Yes, thank you.

Okay, thanks. Next question, Tracy.

Janet Kloppenburg, JJK Research.

Good morning, everyone, and congratulations on a great quarter. For Stuart, I was wondering if you could talk about your guidance for an improved merchandise margin in the core business for the year; I think implies an improved merchandise margin in the fourth quarter. Maybe you could talk about that by brand and what factors are leading to a change in the gross margin direction?

For Sharen, was wondering if you could just talk at all about beauty initiatives that you're taking to help that business firm up? Thanks so much.

Thanks, Janet. We'll go to Stuart first.

Thanks for your kind words about the quarter. With respect to the merchandise margin rate, for the whole year -- as I indicated in the prepared comments, for the whole year we expect the merchandise margin rate for the business in total to be about flat. As Sharen outlined, some pressure in Q2 at Victoria's, expect the rate to be about flat in Q3. But again, on a whole-year basis, expect merchandise margin rate to be about flat and we expect some leverage on the B&O line, which is in gross margin.

For the fourth quarter merchandise margins would be flat as well?

We would expect merchandise margins to be up in the fourth quarter.

And can you talk about what would drive that, Stuart, please?

It's going to be a function of a lot of things as you would understand, Janet, but certainly the year-on-year cost impact will be a contributor. Also, as we continue to control inventories well and read and react and maximize full-price selling, we would expect that those will also be key drivers in improving the merchandise margin rate.

Will the gift-with-purchase merchandising be as high or equal to last year in the fourth quarter?

Hi, it's Sharen.

Hi, Sharen.

Right now we're planning the same amount of circulation, but what we've been seeing in terms of the reaction that we're getting is very high, and we continue to see that as we go forward. Our gift-with-purchases continue to get stronger and stronger from a quality perspective from the reaction to the customer, and we do see them as brand-building.

Thanks, and on beauty?

I'm very excited about the work that we're doing to reposition our beauty business. You'll see more of that in spring 2013. As we continue to focus on our fine fragrance business, which has been growing at double-digit rates, as we actually last year restaged Fantasy, and then we have some other interesting concepts that will be coming out in beauty.

Thanks so much.

Thanks, Janet. Next question.

Erika Maschmeyer, Robert W. Baird.

Thanks and good morning. You mentioned, Sharen, increased clearance rate sell-through and an increased response rate to your direct mail. Could you talk a little more about what you're seeing and what you're doing to kind of work around this? Do you think that consumers are becoming increasingly sensitive, given the economy? Do you think weather was a factor on the apparel side? I guess if you could talk a little bit more about that. Thanks.

Sure. As you know, Victoria's Secret actually has only two all-storewide sales a year and that one happens to be our semi-annual sale, which happens in the second quarter. This year, because of our clean, fresh merchandise, and the fact that we actually re-launched Very Sexy Bra in the month of March, the old Very Sexy Bra we actually held and cleared in the month of June and July at our semi-annual sale. So that drove the response rate through that opportunity.

When I think about -- as we continue to be very fast, we're still -- when you have 1,000 stores, we still have great fresh merchandise that people are responding to in that clearance opportunity. The same time, as we talked earlier about the question about beauty, as we are restaging beauty we actually exited our beauty rush at the cash wrap, which we restaged that also within the semi-annual sale.

I think that from a weather impact, I don't really think that that hurt us. Maybe a little bit in PINK in terms of the fleece, but our back-to-school business has been strong in PINK and so we're very excited about that.

Thanks. Next question, please.

Paul Lejuez, Nomura Securities.

Hi. Thanks, guys. Stuart, as you think about next year and even longer term, how are you thinking about SG&A relative to sales? Is that a line where we should expect leverage, or will international growth weigh on SG&A leverage for years to come? Just wondering how we think about that over the long term? Thanks.

Good morning, Paul, and thanks for the question. We're crystal clear about how we think about it, and I realize why you might be asking the question, but we will grow expenses slower than sales.

The recent quarters' expenses have been growing in line with sales, but our clear long-term commitment, and we'll figure out the ways to make this happen, are that expenses will grow slower than sales. Certainly the international business, while there is investment happening today and pressure on the expense lines today, we expect that that business will be a significant driver of profit and at an equal to margin rate -- operating income rate as the overall business or better.

Thanks, good luck.

Thanks a lot, Paul. Next question, please.

Kimberly Greenberger, Morgan Stanley.

Great, thank you. Great second quarter here. I just wanted to follow up on Paul's question about the SG&A. Are there some factors happening in the third quarter that are driving that increase in SG&A rate relative to last year? Are there items in there that are not specifically tied, for example, to your sales volume?

Secondarily, I just wanted, Stuart, to know if you could talk about masked sales to third party. I assume that's for your international franchise business. Is this -- given the rate of growth in that business, is this likely to be a sort of mild headwind going forward to the gross margin rate?

Clearly, I would guess it adds gross profit dollars, but if you could just help us understand the sort of magnitude there. Is it 5, 10, 20 basis points or is it a little more significant? Thanks.

Good morning, Kimberly. Thanks for the question. On the Q3 expense rate, in terms of anomalous costs or things that may not be recurring or ongoing, we do have a bit more cost related to store remodels and pre-opening costs than I think we'll have in typical quarters. I would comment on that as a somewhat unusual item.

The second point that I would share is that as you know, and as I commented on in the prepared remarks, the third quarter is our lowest sales volume quarter, and we're making investments ahead of the holiday selling season. And so I would comment on that as really the second item.

Then, as we've been talking about for the last probably 18, 24 months, we are making meaningful investments, particularly in store selling-related activities at Victoria's Secret, that we absolutely believe are driving very strong conversion rates. And that's certainly part of the expense story in Q3 as well.

With respect to your second question, Kimberly, about the effect on merchandise margin rate of product-related sales to franchisees, that we are opening three stores in the Middle East as you know later this fall. We will continue -- obviously we expect a significant international business with franchise partners.

Have we fully modeled that out and its effect? We haven't, to be frank with you. Will it present some headwind as you indicated in your question? Somewhat. But we've got some more modeling to do there, and again, we believe that there's further opportunity in our core businesses over time to improve the merchandise margin rate. I think it will all settle out. But we've got more to model there, and we'll obviously give you more visibility to that in February when we give 2013 guidance.

Thanks, Stuart.

Sure.

Thanks, Kimberly. Next question, please.

Lorraine Hutchinson, Bank of America.

Thank you, good morning. The VS Direct business has been growing a bit slower than the stores' business and it seems that apparel is the reason for that. Do you consider this business core to your strategy? If you could just highlight any efforts you've made to try to turn that business around. Thanks.

Hi, it's Sharen. We do not think that the apparel business in Victoria's Secret Direct is core to the strategy. As we've continued to expand our assortments into our lounge business, such as SME, our PINK business, we will actually be putting more emphasis in the direct businesses on those core categories offsetting that apparel business, really transforming that apparel business into total brand categories.

Thanks, Sharen. Thanks, Lorraine. Next question.

Jennifer Davis, Lazard Capital Markets.

Hi, guys. Let me add my congratulations. Stuart, my question is on third-quarter merchandise margin guidance. I'm sorry I missed it, if you said about -- if you said down slightly or about flat at Victoria's Secret and Bath & Body Works?

Yes, Jennifer, good morning and thanks for your comment about the second quarter. The merchandise margin rates at Victoria's and at Bath & Body Works in Q3 we expect to be roughly flat.

Okay. I was just kind of wondering shouldn't you get a little bit of a benefit of lower input costs in the third quarter and at Victoria's Secret, shouldn't you get some of the benefit from the timing shift in that marketing event? I guess I'm a little bit curious about why you would expect flat merchandise margins, or is that just conservatism? Then, also, is beauty still impacting that as the sales of that higher margin business are a little bit lower?

In the third quarter, although we are shifting the marketing, as we are going through these new store openings in terms of touching 40 stores and the expansion of PINK, you will see an increase in expense from a visual perspective for the windows and the POS within our stores.

The other piece of it is we do believe that based upon the strength of the fashion in lingerie and PINK still outpacing the beauty business will be a reality for the third quarter. The beauty business actually gets stronger going into the fourth quarter, but the apparel businesses and the lingerie businesses are much stronger in the third quarter.

Okay, great. Sharen, I've seen several of the new expanded stores and they look great. Congratulations and best of luck for fourth quarter.

Thank you very much.

Thanks, Jennifer. Next question, please.

John Morris, BMO Capital Markets.

Thanks. Really nice quarter, guys. Good work.

Question for Nick, actually, on Bath & Body Works. Saw real nice improvement, real step up there in your overall profitability and margin rates looking at the operating margin line. I think you touched on it briefly; could you go a little bit deeper in terms of where you're getting that pick-up?

I'm wondering -- I don't think you touched on it. I'm wondering if you're getting better cost advantages there as well, perhaps from plastic coming down, if that's the case. Then, if you can, I guess both divisions, Vicki's and Bath & Body Works, just talk a little bit about the opportunity for holiday by division in terms of product and execution for the fourth quarter? Thanks.

Sure. Well, thanks for the kind words, John. So really this came from what we've really been trying to focus on, which is full-price selling. So less about cost and more about full-price selling and having less markdowns on the floor that really led us to a very healthy sale where we were moving more everyday full-priced selling, and that's really what's driven the margin rate.

In terms of what do we see for holiday, we'll continue to focus on flowing newness and innovation in the products, focusing on our three core businesses to make sure that each one of those has got enough newness, excitement, and innovation coming into it. And that's really what's been driving the business and what we would expect to continue to drive the business as we go into holiday.

For Victoria's Secret, we're very excited about our holiday assortments. We have a lot of newness as we go into holiday. We are continuing to focus on our core; our bra launches are exciting. Our gifting, I believe, has never looked better, so we have a lot of optimism as we look forward to the holiday season.

Great. Thanks, guys. Next question, please.

Barbara Wyckoff, CLSA.

Hi, everyone. Reiterate good job on 2Q. Question for both Sharen and Nick. How do you see social media driving sales into the holiday period?

We have -- as you know, we are very much into our social media strategy. I think that today we have about 18 million followers on Facebook in Victoria's Secret and about another 13 million in PINK. As we think about our mobile that we are working towards, we are already starting to see unbelievable response rates in terms of mobile.

We think that there's a great opportunity. We know that this is where our customer likes to engage with us and we will continue our strategy as we go forward. As you know, we've had a very strong initiative to tie our direct channel and our store channel together, and part of that will be within the mobile range.

We've done a lot of things in social and have gotten a lot of reaction, especially with our PINK Nation within PINK. So we see that continuing to get stronger and stronger.

Pretty much a similar story. We'll continue to leverage different parts of social media to drive it. I think really the big win for us is we continue to build the brand and build our businesses, really trying to link the story-telling between what stories we're telling in store, what stories we're telling marketing-wise, and then what stories we're telling online so that it's picked up the correct way in social media. So we're really one simple, compelling story about the brand across all those mediums.

Will you have the mobile capability fully functional by holiday?

Which brand?

Both.

Mobile in which aspect? If you're talking about mobile today, we have that. If you're talking about mobile commerce, we have that today as well as building upon it.

Our platform, we're actually changing our platform to get stronger in the month of October. Today we have iPads in the stores so that we are fully utilizing the iPads. We're actually doing a test, a technology test, that we want to roll in spring, which makes that even an easier transaction to do at the POS.

So there's a lot of technology that we're working on to go cross-channel and mobile is a huge piece of that.

Right, and Nick?

Obviously you can continue to purchase through mobile into our website. We don't necessarily have a separate app to do that, but the customer is able to really make the purchase happen through the phone if they want to. What we're really seeing is more activity in terms of reading what's going on about the brand, the business, et cetera, on the mobile phone, and then seeing most of the -- the majority of the transactions happen online.

Great. Thank you.

Thanks, Barbara. Next question, please.

Evren Kopelman, Wells Fargo Securities.

Thank you, good morning. Can you give us an update on the Beauty Park initiative, how quickly maybe the time line of that initiative can impact sales and margins? Also, where do you see sourcing costs going over the next 12 months? Thanks.

Thanks. We're going to go to Nick for Beauty Park.

Yes. Thanks for the question. We're beginning to see it come on line really in the back half of this year, and so it's going to be an opportunity for us to really read that during the back half of this year. It's more significant for us in the back half than it has been, and then it ramps up more aggressively as we go into the first half of next year. It'll be -- we'll start to see it, the impact of it now, and we'll be monitoring it and leveraging it as we go into next year.

Thanks, and we'll go to Stuart for the question on sourcing costs.

Our perspective on sourcing costs is that there will be moderate or modest inflation in sourcing costs related to wage rates, fundamentally. We think about -- our personal care and beauty products are largely made in the United States, our intimate apparel items are made largely overseas, but there is wage inflation in various regions as you're familiar with. As you've heard us talk about -- so in answer to your question, I'd say there's going to be moderate inflation in cost over time.

But what we've also conveyed to you, and hopefully you appreciate, is what this Company is all about is delivering emotional content, differentiated merchandise, special selling environments, whether it's in the store or online, a maniacal focus on increasing full-price selling through speed, through chase, through read-and-react. And so there will be some pressure on sourcing costs. But with that said, we see opportunity in merchandise margin rates over time through the things that I just described, and that's really what the Company's all about.

Thanks. Next question, please.

Brian Tunick, JPMorgan.

Thanks, morning, everyone. I guess Martin first. Congrats on getting the first UK store open. And we were just sort of wondering what is the right way we should be thinking about the pace of UK or European openings, what metrics you'll be looking at, and maybe what's the overall potential size -- I know it's early -- of what you think the UK or Europe could be for Victoria's Secret stores?

Then for Sharen, I was curious, when you look at the categories that have really been driving your comp growth the last couple years and you think about PINK, what can be the ultimate size of the PINK business? How big can it get? Then how is the brand evolving as other retailers seem to be expanding in the loungewear and dorm wear categories, as well? Thanks very much.

Thanks, Brian. We'll go start with Martin.

Hi, Brian, thanks for the congratulations. Yes, we're thrilled with the opening of the first store in the UK. Customer reaction has been really terrific. We're very pleased with the way the delivery of the customer experience has taken place.

But it is only our first store; we've only been open for three weeks. The second store at Bond Street will open in a couple of weeks. I think it's a little premature to go public on what we think the end game will be in the UK.

One step at a time, cautious, test and learn, and when we know more we'll tell. I would expect that when we talk more in 2013, we'll be able to give a fuller update. But for now, steady as she goes and pleased with the response.

Thanks, Martin. Sharen?

When I think about the PINK business, it's really three pieces of the PINK business. There's the bras and panties part of the PINK business; the lounge business, which does have some of the collegiate, NFL, MLB pieces of that; as well as the beauty and accessory. We think about the PINK business, we see that we will have the capability to double that business based upon our real estate strategy and the strength of the balance of all three of those product categories.

Thanks a lot, Sharen. Next question, please.

Omar Saad, ISI Group.

Thanks, good morning. Wanted to ask a follow-up question on La Senza. I think in the prepared remarks you made some comments that its -- the turn is maybe taking a little bit longer than you expected, but that there was also some kind of underlying positive themes there. That you feel like you're getting closer to reaching a point where you're laying the foundation for a great kind of brand fit for global growth.

How are you thinking about the positioning of that brand, especially how it fits into the portfolio of brands, your existing brands? When you use the word global what are we talking about? Are we talking about the continued franchisee expansion? Are we talking about outside of Canada, moving south of the border? Would love to hear your thoughts. Thanks.

Thanks, Omar. We'll go to Martin.

Thanks, Omar. Glad you asked the question. As a reminder, at La Senza we've changed just about everything about the brand. We've changed the positioning. We've changed the category focus. We've changed the assortment, the store design. We've really changed everything; relocated the team from Montreal to Columbus.

It's almost like starting a complete new business. Yes, it's heavy going. It's taken longer to see the results in Canada than we would have liked, but we're definitely gaining traction.

To the point specifically about the positioning, we see a sweet spot for La Senza around a young, sexy, obvious value positioning that fits very neatly alongside VS and alongside PINK. We're very optimistic about the positioning for the brand. We're definitely starting to see some traction.

In terms of where we go next, well, we've got 535 stores open right now, about 160 in Canada, moving towards 375 internationally, and I continue to see our international partners wanting to open more stores all around the world. We would love to bring La Senza to the USA, just think it's premature to talk about that right now. Our priority is to get Canada sorted and get it fixed and see the kind of business results that we see across our other two core brands.

Thanks, Martin, good luck.

Thanks, Omar. Next question, please.

Richard Jaffe, Stifel Nicolaus.

Thanks very much, guys, and great quarter. A follow-on question, I guess, regarding the direct business, both the merging of direct and store businesses at Victoria's Secret, the -- and I know you've talked about efforts to allow returns to stores and to keep the product and pricing identical. And then similarly, the opportunity to build a more robust direct channel for Bath & Body Works. So if you could each take one of those, thank you.

Thanks, Richard. We'll start with Sharen.

We are continuing our journey to have a seamless experience for the customer. We believe that the customer should be able to experience Victoria's Secret at the same price anywhere, any time that she chooses. That is our strategy, and we are making progress.

We do allow returns in stores from the direct channel. That has been going on for about six to seven months now and has been rolled through the chain. We're excited about that opportunity. We continue to see that as we move our customer file to more of a cross-channel it is just nothing but opportunity and growth for Victoria's Secret.

Thanks a lot, Sharen. Nick, for BBW.

Yes, thanks, Richard. We already take returns at the stores and it's a really small part of the business, so it's less -- sorry, the returns are a small part of the business, so it's less important.

I think the bigger picture for us is continue to drive what has been very healthy growth in that business, make sure we continue to drive that, and continue to try and, as I said earlier on, get as much alignment in terms of the brand story-telling. One single message to the customer that is consistent between what we're doing online and what we're doing in the stores, which I'm happy to say is currently happening. And we'll continue to try and leverage that.

Great.

Thank you.

Thanks, Richard. Next question, please.

Carla Casella, JPMorgan.

Hi. My questions are related to traffic versus ticket. Are you seeing any major changes in either mall or travel retail traffic? Then also, on the direct side of the business, is that business expected to remain lower margin, or is that something where you think you can narrow the margin gap between that and the stores?

Carla, okay, just to comment on the direct margins, I'm not sure, our direct business margins are actually several hundred basis points higher than stores, so there might be a misconception there. But in terms of traffic patterns versus ticket, we'll go to both Sharen and Nick for what they're seeing there.

We're seeing about 1 to 2 points better than mall sometimes in traffic and our AURs are up over last year.

Okay. I guess on the direct, you had commented in the results that they were -- I'm sorry, the direct channel was lower I guess than year-ago.

AURs, I think, in direct were down slightly.

Oh, okay. Great, thanks.

Okay, Nick?

Traffic for us, we continue to be in line or slightly better than mall traffic.

Then, Martin, anything on travel retail?

Our business in -- our Victoria's Secret beauty business in travel retail is very strong. We've had a very good half-year. Our partners in travel retail are telling us that overall global travel is down slightly year over year.

Thanks, and thanks, Carla. Next question, please.

John Kernan, Cowen & Company.

Good morning, guys. Thanks for taking my question. Stuart, how's the capital budgeting process lining up for next year? Should we expect the same type of closures, remodels, and reconstructions? Then within that, how does CapEx look relative to this year? And within the closures are you noticing any meaningful sales recapture, whether it be online or directly in the stores? Thanks.

Okay, so with respect to capital spending, as I -- first starting with 2012, the range or guidance that we put out there is $575 million to $625 million. Probably be at the higher end of that range. The increase versus the prior year reflects investment, or an increase in investment, I should say, at Victoria's Secret. So that's about 2012.

With respect to 2013, obviously we continue to work on those plans, and we'll give a definitive view in February. But what I would say is I would expect that levels will be similar to 2012, reflecting continued investment at Victoria's Secret in the United States.

We invest in a lot of things, obviously, but I would expect our investment at Victoria's in the US to continue because we're getting really good results. As you know, our productivity's high and we've got an opportunity to expand space to present a full lingerie assortment, a full PINK assortment, et cetera, in remodeled stores.

That would be a view on -- an initial view on 2013 CapEx. Was there another aspect --?

Store closures and transfers.

Oh, yes, thank you. So in terms of store closures, we close a certain amount of stores every year, and we think that that's the healthy thing to do in this business. We do it consistently, 40-ish stores, 40 to 50 stores a year, and we would expect that that will continue. Typically, those are at the end of lease term in the United States and are in malls that are more marginal malls, C malls.

What I would say definitively about kind of the economics of those closures is that the productivity of new space tends to be substantially higher than the productivity of the space that we're closing. So we do see economic opportunity in terms of the composition of square footage, which has been roughly flat to up slightly for Victoria's and Bath & Body in the United States. We are seeing some sales transfer related to the La Senza closures in Canada, which we expected, but as you appreciate, that's a more significant, more concentrated closure program than the activity that is typical in the United States.

Great, thanks.

Thanks, John. Next question, please.

Laura Champine, Canaccord Genuity.

Good morning, guys. My question's on inventory levels. I appreciate the guidance for the end of Q3 on a per-square-footage basis, but what's the plan for this holiday in terms of units and inventories?

Thanks, Laura. Stuart, Sharen, Nick?

Our general approach, Laura, as you know, is to grow inventory slower than sales. We've been doing that now for more than four years. Each of the businesses have plans and Sharen and Nick can comment on it more specifically. Each of the businesses have plans to continue to improve already significant improvement in inventory turn.

So we would expect to have some unit growth in inventories, but at a slower rate than sales growth. I am speaking in an overall sense. We'll continue to manage inventories in a controlled, disciplined manner, focused on the read-react-chase activity that we've talked about.

In terms of getting specific about units versus dollars, it varies so much, frankly, depending upon the business and the category. I don't think it's helpful, frankly, to get into that detail. But as you would imagine, some of those aspects vary quite a bit by category. Overall, we will have unit growth and we would expect it to be at a lower rate or slower rate than our sales growth in units.

Thanks, Stuart. Thanks, Laura. Next question, please.

Marni Shapiro, The Retail Tracker.

I got a quick off-the-topic kind of conversation for Sharen, if you wouldn't mind. Can you give us an update on the apparel side of VS Direct? What percentage of sales is it today, and is it meaningful to the profits of Victoria's Secret Direct? And if you can talk a little bit about plans for the back half of the year, because I know it's been a little bit less of a consistent business for you.

Yes, the apparel business is a big piece of the Direct business today, and there's many different variables within the apparel business. As I mentioned earlier, our goal is, as you think about it today, with any apparel business we have a big yoga business, we have a big fleece business, we have a big lounge business. And as we're growing, the PINK fleece business, the PINK yoga business, as well as getting into Supermodel Essentials, we see trading out that private label business so-to-speak into our branded categories. We'll look at that business as being more flat as we go into holiday and as we go through this transition.

By branded, do you mean your own brands --

Yes.

-- or would you also consider bringing in third-party denim brands and things like that?

No, there's no third party today. It's all -- there's some third party in shoes, but no, we do not -- we are not going after a third-party business. We believe the opportunity is to tell the same story across both channels, therefore, growing the lounge business, the yoga business, both through PINK and Supermodel Essentials. And there may be some key items that we may continue to run in direct only.

It will be a journey that we'll be on. It is something that we've already reorganized internally in terms of moving all the apparel business under one design team, the same that designs both sport, lounge, PINK, so that we are on that journey in terms of transforming that business.

Could I just ask you one more follow-up? Over time, should things like denim and sweaters and outerwear become less of a conversation when it comes to apparel for you guys, or will you look to brand or re-brand denim as something important for your brand?

It will become less important over time. If there is a key item or a key category that may be a seasonal piece, you may see that from us. But it is not going to be something that we're looking at taking Victoria's Secret into the denim business, no.

How does that affect the related accessories, whether it's shoes or belts or anything like that?

I think that today we don't really have an accessory business in the Direct channel from a belt perspective. We do think there is an opportunity for Victoria's Secret accessories. We already sell them today in our Victoria's Secret beauty and accessory area, so we do think that that is an opportunity for us to grow. And then we do have a shoe business that we think that will probably just be flattish over time.

Excellent. Thank you so much, guys. Best of luck for the back half of the year.

Thanks a lot, Marni. Next question, please.

Jeff Stein, Northcoast Research.

Got a question for both Stuart and Sharen. Wondering -- you talk about the investment you're making in your selling organization at Victoria's Secret stores. And I'm wondering if you could just give us some guidance in terms of how much the conversion rates are going up and how much you believe the retraining and improved staffing is contributing to the comp store sales increases we've been seeing this year.

Jeff, I can take that. With our initiatives in terms of our training and development for our sales associates, we are seeing conversion continue to go up 4 to 5 points on an annual basis, so we've been very pleased with that.

As we have put those initiatives -- I meant, sorry, percent. As we put those initiatives into place, what we're seeing also it's creating loyalty and return of customer to that store. So we believe that this investment is an important investment to make.

I think what the other important factor is we have lower turnover rate within the stores as we continue to develop our talent, and put them on more predictable schedules. Therefore, the store managers are not focused on recruiting, but actually focusing on servicing the customer.

Great. How much is it contributing to the comp? What would you estimate that to be, Sharen?

Wow. That's a hard one to really look at in terms of -- there's not just one thing that actually turns into a comp. I think when you think about with the right assortments, with the right selling team, with the right store, that combination is where we're seeing the differentiation in terms of the comp growth.

Got it. Okay, thank you.

Thanks, Sharen. Next question, please.

Roxanne Meyer, UBS Securities.

Great, thanks. Let me add my congratulations on a terrific quarter. Just wanted to ask what inning do you think you're in in terms of investing in that store payroll? Obviously, you've been doing it for a while and it has been paying dividends.

Then separately, on La Senza are you seeing a significant difference in performance between your Canadian stores and your franchise stores around the world? If La Senzas around the world are doing much better, I guess, what is the key difference between those and the ones in Canada in terms of merchandise or customer acceptance?

I'll take the first one. We're in the first inning of the selling -- of selling. We're just in the first inning.

Great.

And, Martin, La Senza?

Yes, on the La Senza business, I think performance per store is broadly similar around the world. We declared that the Canadian business was down 3% on a comp basis and international business was slightly better than that, but the picture is broadly similar. We offer the same proposition.

I think the reason we're growing our store count internationally is because there is relatively little competition globally in the intimate apparel sector, and we start from a relatively low base. We don't have a mature market position in more than one or two markets around the world, so there is plenty of scope for new store growth there.

We're going to try to squeeze in two more questions here.

Jennifer Black, Jennifer Black & Associates.

Let me add my congratulations as well. Sharen, I wondered if you could talk about the Body by Victoria launch with lace. It seems like the price point range is wider than anything we've seen in the past, and I wondered how people are responding to the lower price points versus the higher price point.

I can see with the bra you just launched it looks like today, Amazing and your Very Sexy collection, those also have wide price points. Then I also wondered are the margins different at both ends of the spectrum. Thanks so much.

The Body by Victoria launch was extremely successful for us. And when we think about the good, better, best strategy in terms of that the smooth bras are at a lower price point versus the lace, versus the lace with embellishment. All of them have similar margin characteristics and I think it's important for us to be able -- they each one have a different function.

If you want a smooth bra without lace, there's that opportunity. If you want the lace bra, there's that opportunity. Therefore, getting people to buy more than one. But all of them have similar margin characteristics.

The selling, it's very interesting; our sell-throughs are really much faster on the higher-end fashion piece of it, but we also buy probably fewer than we do in our solid programs.

Thanks a lot. One more question, Tracy, thanks.

Neely Tamminga, Piper Jaffray.

Just under the wire, hi. Just wondered if, Sharen, you could talk a little bit more about Jeff Stein's question on this whole idea, the in-store implementation on the training modules? What I'm trying to get a sense of is you've made some learnings, you've deployed aspects of it. Is there a major launch and redeployment of an overall overhaul on the training on in-store going in, and when would that be?

And I guess related to that, any thought to maybe changing or weighting differently some of the in-store compensation metrics to continue to drive the goal? Thanks.

I think that we have been on a steady path of what we're learning about our training. We have picked a specific market to go in and do a lot of our training in to see what is really working and resonating, and then we obviously will go market by market in terms of rolling that out.

We're on a constant learning path as we think about how we want to train our associates. When you want to have experienced sales associates, you do have to think about the compensation that goes along with that, of which we are.

Thank you, good luck.

Thanks a lot, Neely. Thanks, everyone, for joining us today and for your continuing interest in Limited Brands.

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