Bath & Body Works Inc (BBWI) 2013 Q2 法說會逐字稿

Good morning. My name is Sarah and I will be your conference operator today. At this time I'd like to welcome everyone to the L Brands second-quarter 2013 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.

I will now turn the call over to Ms. Amie Preston, Chief Investor Relations Officer for L Brands. Please go ahead.

Thank you, Sarah, and good morning, everyone. And welcome to Limited Brands second-quarter earnings conference call for the period ending Saturday, August 3, 2013.

As a matter of formality, I need to remind you that any forward-looking statements we may make today are subject to our Safe Harbor statement found in our SEC filings. Our second-quarter earnings release and related financial information 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. The call is being taped and can be replayed by dialing 1-866-news-ltd. You can also listen to an audio replay from our website.

Stuart Burgdoerfer, EVP and CFO; Sharen Turney, CEO of Victoria's Secret; Nick Coe, CEO of 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 of you as possible, please limit yourself to one question. All results discussed on this call are adjusted results, and exclude the one-time 2012 item that is described in our press release.

Thanks. And I'll turn the call over to Stuart.

Ask, and good morning, everyone. Our second-quarter comp increase of 2% was in line with our guidance. And we are pleased that we were able to deliver earnings upside through disciplined management and execution in the business. Which resulted in better than expected results in expenses and merchandise margin. Second-quarter earnings per share increased 22% to $0.61, $0.06 above the high end of our guidance. Total sales increased 5% to $2.516 billion. And comps increased 2% on top of an 8% increase last year. Our gross margin rate declined by 10 basis points, as a slight increase in the merchandise margin rate was offset by buying and occupancy deleverage. As we've mentioned previously, buying and occupancy expense is increasing as we invest in real estate expansion for Victoria's Secret and international. These investments continued to deliver very strong returns.

We focus on expense discipline across the enterprise. And SG&A expense dollars declined slightly, and leveraged by 140 basis points. Operating income dollars increased by 16%, driven by improvements in all three segments. And the rate increased by 130 basis points.

Turning to the balance sheet on page 8, the retail inventories per square foot at cost ended the quarter up 6% versus last year, in line with our expectations. We're very comfortable with our inventory position. They are clean and in good shape. The increase at the end of the quarter versus our previous trend was primarily driven by the Body by Victoria bra launch, both new product and the previous products, which will be sold in the January semi-annual sale. We expect inventories to continue to build through the third quarter to support significant planned launches at both Victoria's Secret and Bath & Body Works. We are also making targeted investments to support in-stock levels at Victoria's Secret. Inventory at the end of the third quarter is expected to be up in the high single-digit range. We do plan to end the fall season with inventories back in the mid-single-digit range. We continue to manage inventories thoughtfully and with discipline.

Turning to page 11 of the presentation, for our forecast for 2013, we expect earnings per share between $0.23 and $0.28 in the third quarter against last year's adjusted $0.26 results. A couple of things are negatively impacting our third-quarter earnings by a total of about $0.02 to $0.03 per share. First, due to the calendar shift related to the 53rd week, Victoria's Secret will lose the high-volume August week one and gain the lower volume November week one. Second, La Senza is implementing new merchandise systems, the same ones we rolled out to Victoria's Secret and Bath & Body Works in the 2006 to 2009 time period. We are also moving La Senza's distribution center from Montreal to Columbus. These actions will put expense pressure on the business in the near term.

Our third-quarter earnings forecast reflects a low single-digit comp increase, consistent with our first-half trend. We expect the third-quarter gross margin rate to be down to last year, driven primarily by buying and occupancy deleverage related to our increased real estate investments. As you know, it is more difficult to leverage expenses in our lowest volume quarter. We also anticipate a slight decline in our merchandise margin rate. We expect the third-quarter SG&A rate to decrease versus last year driven by our continued focus on expense management.

For the full year, we are projecting positive low single-digit comps. Total sales growth on a 52 to 52-week basis will be about 2 to 3 points higher than comps due to growth in square footage and our international business. We expect our full-year gross margin and SG&A rates to be down to last year. Non-operating expenses for the year are projected between $290 million and $295 million, consisting principally of interest expense. Before any discrete items, our tax rate will be approximately 38%.

We are forecasting weighted average shares of about 295 million in the third quarter and the full year. Assuming all of these inputs, we expect adjusted earnings per share for the full year 2013 to be between $3.06 and $3.21 per share. We now expect 2013 CapEx of about $700 million. The increase in CapEx versus last year is attributable to increased real estate investment at Victoria's Secret, primarily to increase square footage for PINK. As we've previously noted, only about 20% of our current stores carry the full PINK assortment.

As detailed on page 12 of the presentation, Victoria's Secret square footage in the United States will increase by just under 4% this year, driven by expansions of existing Victoria's Secret stores and the opening of about 50 new PINK stores. Total Company square footage will increase by just under 3%. Turning to liquidity, we expect free cash flow in 2013 of about $650 million to $750 million. And we remain committed to returning excess cash to shareholders through a combination of share repurchases and dividends. Our free cash flow and cash position, along with the additional availability under our revolving credit facility, results in very strong liquidity, which is more than sufficient to fund our working capital, capital expenditures, dividends, and any other foreseeable needs.

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

Thank you, Stuart, and good morning, everyone. Our second-quarter results are detailed on page 14 of your presentation materials. In the Victoria's Secret segment, our business results were in line with our expectations, as operating income increased $15 million, or 6% from last year. Merchandise marketing dollars and rate for the segment increased in the second quarter. We continue to manage our investment in real estate, technology, and store labor that we are confident will enable future growth.

In the stores channel, second-quarter sales increased 6%, and comps were up 1% on top of a 10% increase last year. Our growth in sales came from both lingerie and PINK. While we continued to see less traffic in the quarter, we focused on providing our customers with the best experience. As a result, we had another quarter of record conversions and higher average dollar sales. Our bra launches met expectations during the quarter. Total bra sales, while up to last year, did not meet our expectations, as new product introductions did not fully offset exit products from last year. As we move forward and anniversary these exits, we are confident that our current traction in newness and fashion will lead us in the right direction.

As mentioned earlier, both merchandise margin dollars and rate increased in the quarter. This is primarily the result of higher pricing in our semi-annual sale, which is a result of entering sales with fewer units than last year. Additionally, we benefited from calendar-related shifts in the second quarter. Buying and occupancy expenses decreased due to our investments in real e, tate and deleveraged slightly on sales. However, total expense leveraged versus last year as SG&A expenses held relatively flat to last year. The store channel saw record operating income during the quarter, up double digits to last year.

Our overall inventory is in good shape. As mentioned earlier by Stuart, we are carrying over previous Body by Victoria products that have been removed from the floor which will result in a higher inventory positioning in Q3. The merchandise will be cleared during our January semi-annual sale. We also continue to invest in a balanced, disciplined way in more key item depth and fashion.

In the direct channel, second-quarter sales decreased 6% as a double-digit decrease in apparel sales more than offset high single-digit growth in lingerie, PINK, and beauty. As we reminded you last quarter, we are transitioning our apparel business, while at the same time distorting our marketing resources to the core business of the brand -- bras, panties, PINK and beauty. We plan the apparel business to be down in Q2, with a 16% reduction in styles and a 25% reduction in inventory. The sales results were below our expectations, down in the mid teens.

As we move into fall, our styles and inventory will be more in line with the previous year. And combined with improved assortment, we are expecting improved results. Our direct channel second-quarter merchandise margin rate was down to last year, driven by increased promotional offers. Merchandise margin dollars decreased on the combination of the sales and rate declines. Operating income dollars declined as the decline in merchandise margin dollars more than offset a reduction in SG&A expenses.

Looking ahead to the third quarter, we feel good about our fall product assortment and our upcoming bra launches. We recently launched our new Body by Victoria bras, which have been well-received by our customers. In addition, we've coupled this launch with our new fragrance, Victoria. Although still early, we're encouraged by the successful start of both.

We will continue to manage both inventory and expenses with the appropriate conservatism to optimize our business. In closing, we continue to focus on providing our customers with world-class emotional brand experiences, both in-store and online that will consistently exceed their expectations. To achieve this, we know where we need to get better, and are focused on these areas. We have the right fashion and newness across our channels. And we will continue to leverage our speed and agility to drive our results.

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

Thank you, Sharen, and good morning, everyone. At Bath & Body Works we remain committed and focused on the fundamentals we do well. And that led to record sales and operating income growth in the second quarter. Comps increased 3% on top of 7% last year. Customers responded to 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.

Traffic levels were down during the quarter, but we were able to improve upon our already high conversion rates, while also driving higher average dollar sales. We were pleased with our decision to use July to combine newness and selected sharper price points in the highly promotional marketplace. Total sales for the quarter were $630 million, up 3%, or $21 million versus last year. For the quarter, our operating income was $102 million, up $14 million, or 16% over last year. Operating income as a percentage of sales was 16% in the quarter, and was up 180 basis points to last year. Gross margin rate in the quarter was about flat to last year. And SG&A expenses leveraged versus last year. The BBW direct channel also delivered strong sales and operating income growth versus last year in the quarter. We finished the quarter with inventory levels down to last year.

Looking ahead to the third quarter, we will continue to introduce newness and innovation in both form as well as fragrance. In August, the shop features our newest signature fragrances, Sweet & Sexy. We also introduced four inspired view with our fresh-picked collection featuring newness in both form and fragrance across all three key categories. We are excited about the assortments, and we will continue to manage our expenses and our inventory conservatively.

Our overall focus continues to be about getting faster and better at understanding and satisfying our customers' needs, while providing them with a world-class in-store experience. In addition to focusing our product and fragrance launches, we will continue to test and reap the results of new product offerings and promotional strategies, while maintaining flexibility in our inventory to react quickly to our customers' preferences.

Thank you. And with that, I'll turn the discussion over to Martin.

Thanks, Nick, and good morning, everyone. My comments this morning will focus on an update of our international businesses. We continue to believe that our opportunity for international growth is significant, given the leadership position and awareness of our brands, and the success we've seen to date. We made a lot of progress in the second quarter, with all of our international businesses showing improvements. Growth in our international business was the primary driver of the $62 million sales growth and $20 million profit improvement in the other segments during the quarter.

Starting with Victoria's Secret International, we continued to be pleased with performance of our full assortment stores. We now have 27 stores in Canada and we'll open another 7 stores during the balance of this year. In the UK, we continue to be very pleased with our store on Bond Street and with the London Stratford store. We opened stores in Manchester and Sheffield earlier this month with great success. And we will open in Leeds later this month. Elsewhere in the world the three Victoria's Secret full assortment franchise stores in the Middle East under our partnership with Alshaya, continued to do very well. And we've committed to open another store in Dubai this year, and several more stores in the Middle East region in 2014. Our Victoria's Secret beauty and accessories business continues to progress well. And we ended the quarter with 143 stores open, and we're on track for about 200 by the end of 2013. Importantly, the three VSBA stores in Hong Kong continue to trade well.

In Bath and Body Works International, we are now up to 77 stores in Canada, and 45 stores under our franchise partnership with Alshaya in the Middle East and Eastern Europe. We continue to be very pleased with the performance of BBW outside of the USA. In the first half, we opened 6 Canadian BBW stores and we'll open another 2 stores in the fall. In our Alshaya business, we opened 7 in the spring, and we'll open another 10 to 15 during the fall.

Turning now to La Senza, we continue to see signs of progress within the business. Comps in Canada increased 4% in the second quarter and 9% in July. That's seventh consecutive month of positive comps. And our merchandise margin rate is up significantly to last year. As Stuart mentioned earlier, we are implementing new merchandise systems in the third quarter, which will benefit the business go forward. We continue to be encouraged by the repositioning work we're engaged in, creating a distinct and compelling customer proposition that is globally appealing and highly scalable around the world. Our franchise partners operate about 350 stores around the world. We still have a ways to go to get the La Senza brands to an acceptable performance, but we're encouraged by recent results.

So that's an update of our international businesses. As I know you know, we are not dependent on international for growth. Our over-arching priority is the strength of our brands in North America. And with that, I'll say thank you, and turn the discussion back over to Amie.

Thanks, Martin. That concludes our prepared comments for this morning. And at this time we'd be happy to take your questions. Again, please, as a reminder, limit yourself to one question. Sarah, I'll turn it back over to you.

(Operator Instructions)

Matthew McClintock, Barclays.

I was just wondering if we could focus a little bit on the market intensification efforts that you're doing in Victoria's Secret. It sounds like the investments that you're making in customer service are driving improved results there. And then I was wondering if you could actually talk a little bit about, I believe, the test for similar efforts at Bath & Body Works. I believe that you said you've been testing that for at least a year now, in potentially Chicago. Thank you.

Hi, Matthew. This is Sharon. Thanks for the question. We're very pleased with what's happening with market intensification. We are in six markets today. And the performance in these markets continues to be about the Company average. We're very optimistic about the increases we're getting in sales, the increases that we're getting in productivity, and in our customer service forward, and in the conversions within those markets.

Thanks, Sharon. Nick?

We have a similar story in terms of what's going on there. We are a little bit behind, I think, in some of the learnings from the Victoria's Secret business, but similar results. We are pleased with not only the customer reaction but also the quality of the sales that are going through and the improved productivity. So, all in all, pretty good.

Barbara Wyckoff, CLSA.

I have a question for Sharon. Could you recap the big bra launches last year, and what your plans are to offset those numbers?

Sure. Today in our plans we are going to have one incremental bra launch that we had this year versus last year. Most of the bra launches that we had last fall were more about relaunching versus new introductions. We have a much bigger balance of new introductions for this fall season. So very confident about what we've seen in our early retests and within our testing. So I'm very optimistic of our growth outcomes for our launches.

Kimberly Greenberger, Morgan Stanley.

Congratulations on a really fine second quarter. My question's for Sharon on Victoria's Secret. Sharon, I'm wondering if you can talk to us about the way you're thinking about inventory management, more broadly speaking. As you've seen challenges here in the first half of the year, replacing some of the volume in exited bra styles, does that suggest perhaps a different inventory management strategy going forward?

As always, Kimberly, we are really maniacally focused on our inventory and really trying to take a very conservative approach. One of the things that we're looking forward to in this fall season is how do we make sure that we are invested within the bra launches that have tested well. And do we have enough inventory and can we be in stock. And I think that the checkmark to that is yes. I believe this year, as well, we are making investments in certain key items that we know that we have less business on the table. We still have lots of open to buy. We will continue to use our speed and raw material position to help us to do that. I do not believe that the offset of the bra launches is really the best way that we control our inventory. I think that was just about exiting way too much for what we had in the pipeline.

Jennifer Black, Jennifer Black & Associates.

Let me add my congratulations. I think this question is for you, Sharon. I was curious to know if you have early reads from the catalog that just dropped, the fall trend edit. And the website, the catalog, everything looks amazing. And then also it looks like you rebranded the footwear and we were wondering if you had changed manufacturers. Thank you.

Today is the big day to actually get a read in terms of all of the new catalog, as well as the new website before that particular catalog goes up. We have rebranded, we have redesigned the shoe business but we have not changed manufacturers. We've put more emphasis on quality and so we feel good about that. But today's the big day to really -- because it officially launches today.

Great. It looks fantastic.

Thank you. Keeping our fingers crossed.

Janet Kloppenburg, JPMorgan.

I wanted to ask Sharon about the focus that's been given to PINK and the greater value message I think that's going out to the customer there. I wondered if you could talk about it and the strategy there. And I'm wondering if that at all could inhibit margins for that brand going forward. And also I wanted to -- I wondered if you'd comment on the performance of sport. I think it looks great and I'm wondering if you'd consider celebrating the rollout of that product category. Thank you.

Thank you, Janet. Let me take the first one. PINK is really focused on a good price point in terms of our bra business. We think it's very important as part of our strategy, as graduating that bra customer into Victoria's Secret lingerie. We continue to increase prices in our bras. And, in fact, the Date Bra and now the Wear Everywhere Bra are doing very well. There's comparable pricing in the panty business. We do have a good, better, best reach strategy in the apparel business, so I think it's very well balanced. And so I think we are constantly looking at the opportunities that we have there. And there are no inhibitors in terms of the margin by our pricing strategy. We are seeing some success in sport, especially within the bra category. We are rolling the sport bras to 300 additional stores that we started basically in July and into August.

Thanks, Sharon. Good luck.

Brian Tunick, JPMorgan.

First one for Nick. Maybe outside of the big three categories, have you done any research, or identified maybe a fourth or fifth big category that you think can drive the BBW business in the future? And then maybe Sharon can talk about the beauty business. It's been a hot topic. Whether you want to discuss the margin impact for the first half or the product flows for the second half, but maybe just give us an idea of where you think we are in the spectrum from the beauty business being incremental to Vicky's. Thanks very much.

Brian, we're always looking at and testing different ideas outside of those three core categories. But I think the real interesting thing for us is looking at all three of them we see an awful lot of productivity gains to be gotten within them. Especially when I look at the home business and some of the things that we've added in there, whether that's decorative accessories or just the continued growth of new fragrances, et cetera, that we launched within that. So I think as we continue to look for ways to elevate the brand, look for ways to reinvent the brand, I think we'll be doing it very focused in those three categories because, once again, I feel like there's an awful lot of productivity gains to be gotten still left in the three key ones.

Hi Brian, it's Sharon, in terms of the beauty question. We feel like beauty is just such a natural adjacency to both the Victoria's Secret business as well as the PINK business. And as we've gone into the fall season, really focusing on going after the fun fragrance business with the first Victoria launch. If you haven't seen it, you should. And really have been very pleased with the response that we have gotten. As we continue to build in terms of that all-important holiday time frame, you will see more launches this year versus last year. Really more of an emphasis on gifting as we go into the holiday season. And then we also came off of last year repackaging the PINK beauty business and have seen good results from that effort, as well.

Ike Boruchow, Sterne Agee.

Congrats on a great quarter. Stuart, my question is on the expense line. There were several initiatives that you took during Q1 that seemed to have flowed into Q2. And expenses were managed very well. Just curious how that's going to flow through the next 9 to 12 months, and how we should be thinking about SG&A going forward.

We have intensified our focus on expenses. We talked about that at the beginning of the year. Saw some benefit in this quarter, as we reported. And we're going to continue to be focused on it. With that said, we're going to do so in a balanced way. The success for Limited Brands is not to be the world's best cost cutter. It's to have good top-line growth and brands with emotional content and great service experiences for customers in stores and online. But with that said, we're managing expenses with discipline. I would expect that we'll continue to have some leverage in the back half of the year. That's what's implicit in our guidance. And we'll continue to work it. But again, we'll do so in a balanced way. And it's broad-based so we're seeing that benefit across all the major parts of the business, and particularly in the home office area. So, it's an important part of what we're doing. But, again, the most important thing we're doing is working hard to drive top-line growth and good merchandise margin rate results.

Okay, thank you.

Paul Lejuez, Wells Fargo.

A question for Nick. BBW margins have been heading steadily higher. Just wondering what are the opportunities from here to continue to drive margins higher? Is it just productivity gains or are there opportunities on the gross margin line, as well? Thanks.

Thanks, Paul. I think a good answer to that, slightly differently, one of the goals that we're really looking at is to continue to figure out how to really evolve the brand. And figure out ways to get the right price and meet the right customer expectations. So, that being said, we continue to invest into the products. So, a lot of the product launches that we've done have taken on incremental cost increases. But we've been in a position that we've been able to charge the appropriate price. So, for me it's going to be less about continued gross margin gains and more about are we able to continue to reinvent the brand, continue to elevate the brand. And then work closely with the customer to make sure that we're not letting retail prices get too far ahead of us, which is probably looking more at a sustained gross margin rate.

John Kernan, Cowen and Associates.

The other segment had really nice improvement year over year in the first half in terms of operating income. Can we expect similar improvements in the back half or will some of the investments in La Senza systems offset that? Or will the continued growth in the international business help to offset some of those investments in La Senza? Thanks.

John, it's Stuart. I appreciate the question. The benefit in the second half and particularly in the third quarter related to the other segment will not be as great as it was in the first half. And it's for the reason you mentioned, which was in our prepared remarks about the systems project and related investments at La Senza. It also, frankly, relates to some of what we were anniversarying in the first half of the year. As an example, the pre-opening costs and rents related to Victoria's Secret UK we are anniversarying. And now, as we enter the fall, the store was opened last fall and obviously they're open this fall. Very good results in the first half. Shouldn't expect that level of contribution in the third quarter in the second half. With all that said, obviously very optimistic long term about our international business. But in terms of quarterly impact, not as significant.

Thank you.

John Morris, BMO Capital Markets.

My congratulations to everyone, as well. A question for Sharon and Nick, if I may, on rolling ahead and looking at holiday. You guys are very good at talking about where you see the opportunity in terms of product category versus last year. Where do you see that opportunity? If you can take a minute and just talk a little bit about that.

Let me just approach it in terms of what will change. I think what we learned at Victoria's Secret from last year, and really hope to not make the same mistake, is we understand the need to drive traffic in both channels, especially in those first weeks of December. So, fashion, beauty and gifting all play a big role in that. And I feel great about what we have to offer. We'll stay focused on the fundamentals and ensuring excellent execution.

Thanks, Sharon. Nick?

Thank you. A couple of things. One for us is going to be just based on our performance last holiday, which was strong. The big learning for us was how deep our planning went in terms of ensuring that we have various options available to us to maximize it. We're also going to look at, knowing that it's a condensed period. We're also going to look at the real peak opportunities and how do we really maximize those peak opportunities when we know the traffic is absolutely going to be there versus some of the softer periods. We'll obviously continue to test different promotional ideas to make sure that we've got ideas in our back pocket as we go into holiday, in case we need to pull them. We spent a lot of time looking at gifting and trying to figure out how to continue the improvements in that business. And then, at the end of the day, a lot of holiday for us will be about the right newness flowing at the right time and, again, maximizing our flexibility in terms of how we flow that newness so that we can be as close to the customer as possible.

Thanks, good luck.

Omar Saad, ISI Group.

I wanted to see if you guys could maybe comment on your customer base, Sharon, in the Victoria's Secret franchise. Older versus younger -- we're hearing a lot of noise in that, quote/unquote, teen or younger consumer space. Are you seeing something, whether it's along the lines of PINK, or your younger consumer in the Victoria's Secret side of the business? Is there something going on with that customer maybe? Any insight you could provide there would be super helpful. Thanks.

I think that when you look at Victoria's Secret and PINK, our real target is the 18 collegiate customers and upwards. And I think, so we're not so much focused on the teen customer. That's not who we target to. Because of the strength of the PINK brand being aspirational for the teen customer, she obviously trades up into PINK. But our real focus has been in the collegiate 18-year-old and up for the Victoria's Secret and PINK brands.

So you're seeing no disparity between your younger consumers and then older consumers, if you will -- under 18, maybe over 18?

No, we are not.

Thanks, guys.

Laura Champine, Canaccord Genuity.

This is a big picture question. I understand the issues with expenses for La Senza and the calendar changes. But it sounds like there's a lot for Victoria's Secret, in particular, to be excited about. And you've got great momentum coming out of Q2. Why not increase guidance for the back half today?

Laura, it's Stuart. We work hard internally as we think about the business and run the business. We found it very important to plan our business conservatively -- inventory, expenses, et cetera, mindset. And then read, react and chase where there's business to be done. And that mindset, that approach, that thought process, has served us very well. And we will continue to run the business that way. It's how we've run it the last four or five years. It's served us very well. And that's how we think about and run the business.

Jeff Black, Avondale Partners.

A question for Sharon. On the direct business can you remind us when the transition will be fully made to the supermodel essentials versus the apparel? And then as we look ahead, also remind us what the profitability characteristics are going to be when you look at a business that has supermodel essentials against what was formerly a lot of apparel in the mix? Thanks.

As we reposition the apparel business, it's going to be bigger than just the lounge piece of supermodel essentials. I just wanted to make sure that we were understanding that. I think that the transition, hopefully as we come out through 2014, that we will be 90% through that transition. The marketing characteristics are very strong, and are high double-digit margins. I think that we are learning a lot. This fall will teach us a lot. As I say, we're just launching some of the new catalogs as we speak. So we're being cautiously optimistic as we go forward.

Great. Thanks. Good luck.

Oliver Chen, Citigroup.

This is Nancy Hilliker filling in for Oliver Chen. Thanks for taking my question. We're wondering if you have any updates in terms of supply chain initiatives, if there's any more room for improvement there, and potential upside for margins in the second half or into next year.

This is Stuart. I'll speak generally about it and Sharon and Nick may want to comment further on it. In terms of supply chain we think about it more in terms of our sourcing and how we flow goods, and read and react. We've been talking about the initiatives around speed in our business for the last several years. And that continues to be one of the most critical things that we focus on as it relates to how we work with our suppliers and flow goods. And we've made a lot of progress in that area and we're continuing to do work there. We're doing more work in the beauty part as it relates to personal care and beauty. Again, Sharon and Nick may want to comment on it further, but we've made good progress on speed, and furthering our relationships with key sourcing partners. But there's more to do that, again, Sharon or Nick may want to comment on.

Nancy, I would just reiterate what Stuart said. We have great partnerships. We always are looking to get better and better. And we have not unlocked all of our potential. I think that we have baked in upside -- we've already baked in, in our margins, that I think there's even more upside in margin as we go forward. I think we've already baked that in for this fall season.

Nancy, it's Nick. I think we've pretty much got speed, and therefore read and react in our ability to stay close to the customer pretty embedded into the business now almost as a standard. I would agree with Sharon, it's pretty baked in.

Okay. Thanks, everyone.

Lorraine Hutchinson, Bank of America Merrill Lynch.

It looks like you took the CapEx guidance up by about $50 million. So I was just curious what that related to. And then you also maintained your free cash flow guidance. So, what the offset was there.

The increase in CapEx versus the prior forecast relates to real estate, and specifically Victoria's Secret real estate. One aspect of it is some additional CapEx that will be on '13's books but relates to 2014 projects. The effect of that is greater this year than it normally is. But fundamentally it's about real estate and Victoria's Secret. And, again, we remain very bullish about those projects and the sales results we're getting, and the profit results we're getting, and the returns that it is generating for shareholders. So just some movement there. With respect to the free cash flow forecast, as you would imagine, there's a wide range of inputs there in terms of all the components of that. And, again, remain comfortable with the broad range that we've given. As you appreciate, a lot of our cash is generated in the fourth quarter. So, there's a lot of moving parts there. But, again, the business has very strong free cash flow properties. And there's a reasonable range of outcome there. But it will be a strong year for cash flow.

Jennifer Davis, Lazard Capital.

Congratulations, especially, as it turns out, this quarter is looking like it hasn't been good for most retailers. A couple of clarifications on earlier questions. First, Sharon, on the bra launches, on the new introductions, are there any new technologies coming out? And, Nick, on the market intensification efforts, are you only in Chicago right now? And then just a general question on Henri Bendel. I know it's a very small piece. Just wondering for an update there. Thanks.

Yes, there are new technology launches in the fall season for Victoria's Secret.

Jennifer, yes, we are still in Chicago. But please remember, we are a year or so behind Victoria's Secret in taking on the initiative. So we're continuing to see nice productivity there, and continuing to invest in that marketplace.

On Bendel -- it's Stuart -- we're obviously optimistic about that category. We added a number of stores to the business over the last few years. We've got a team there that's working hard to drive growth in sales and margin and so on. They're making progress. And we think it's a great category. And we're seeing progress in the business this spring, and optimistic that that business will deliver further sales growth and margin improvement in the fall.

Great. Thanks and best of luck.

Dana Telsey, Telsey Advisory Group.

Good morning and congratulations. Bath & Body Works had terrific improvement in the operating margin. And certainly some of the new product initiatives seems to be working very well. What is the potential for the long-term operating margin of BBW? And how do you see pricing and product newness evolving there? Thank you.

Thanks for the compliments. In terms of long term what do we see, our goal will be to -- we're seeing very nice traction in terms of our ability to charge the right price for the customer. Where we've elevated the brand, she's gone into more prestigious products, more trade up products. This is really allowing us to maintain that margin position. So, again, as I mentioned earlier, we'll continue to look at improving the products. That's, in some cases, taking costs up. I think the bigger opportunity for us is to really say, what's the sales growth opportunity, more than the margin rate or margin growth opportunity as the brand moves forward.

Marni Shapiro, Retail Tracker.

Congrats on a great quarter and best of luck for fall, if I don't remember. Stuart, I actually have a bigger picture question here. Victoria's Secret is obviously a huge brand, a big brand in the direct business. You have a solid business there away from some ups and downs in apparel. At what point should we be thinking about either an investment, or will you guys start to seriously think about omni-channel, or even a situation where returns aren't getting mailed back to the DC? And I'm curious if you guys have the systems in the DCs to support this kind of shift. Or is this something that would have to be a multi-year investment in technology and your distribution systems?

Marni, I'm going to take that question for Stuart. This is Sharon. We have had what we have called omni-channel, really, in our size, and have been working on it and investing in it for the last two years. We are so encouraged. What we call it -- give her what she wants. So, now we have the systems in the stores to take the direct channel returns. We also have the systems in the DC to take those returns. So it is working very well for us. The customers have been very excited about the customer service that we have been able to provide. What it's allowing us to do now, are people that hadn't bought from direct before, because if you're out of stock in something in the store, they can buy it from direct and we'll have it there the next day. And now what we're seeing is moving more customers slightly to being dual channel customers, which we know dual channel customers spend more with us. But it's really about the customer service model that Victoria's Secret is after. It's making sure that we're servicing every single customer.

Are you able to take advantage of it from an inventory perspective, if somebody comes into a store or goes online to ship it from -- if somebody returns something to a store that is not a store item, rather than ship it back to the DC can you then reship it out to a customer who ordered it online? Or are you still shipping inventory back to the DC and then repurposing it and then sending it out?

We're shipping it back to the DC.

My question is, at what point will you start to think seriously about moving off of that model? Because there's a lot of cost savings and inventory implications that comes along with that. And so I'm curious at what point -- do you have the systems to move off of that model to the next step? And are you thinking about doing that any time soon? Or is this a big investment and a big multi-year project on top of what you've already done?

Marni, we probably, if we wanted to ship from the stores today, that one particular item, we could. It's a little bit more complicated than that, Marni, in terms of most of the orders and people that are coming in from the DC are really looking at multi category. So we do have the capability, it's just not something that we're turning on at this moment. But are always curious to learn about it.

One other thing I would add, quickly -- it's Stuart -- is the number one thing that our store associates are focused on is selling to customers that are there. And to the extent that we start doing some things that other retailers are doing, you start turning your stores into little mini DCs. And at the end of the day we're focused on selling in our stores.

Got it. Thanks, guys. Best of luck for the back half.

Richard Jaffe, Stifel Nicholas.

Just a question on merchandise margins. In both divisions I'm seeing that, albeit very modest pressure on margins, I'm wondering if there's an opportunity on the flip side with the introduction of beauty with better sourcing, with mix changes, to see merchandise margin improvement in the balance of this year and into 2014?

Richard, it's Stuart. The guidance that we've given is, in the third quarter, down slightly -- and we mean down slightly. The business is always working to get to the right merchandise margin rate. But we think the guidance is about right. And to your point, there are a lot of pluses and minuses. And, believe me, we are first and foremost focused on dollars. We have all heard the expression -- you don't take rate home to the bank. And things like more work on full-price selling, speed, and so on. But we think the guidance for the remainder of the year is about right. And you can be sure that the business is going to be focused on getting the maximum number of dollars that they can get. And part of driving that can be opportunity there in rate. But we think the guidance is about right.

Just a follow-on question about the Victoria's Secret direct business and its shift away from apparel. I'm wondering at what point do we see a new equilibrium established?

I think we're starting to see it. But, as I said earlier, we're really looking at 2014.

And what will that balance be?

The balance should be as we enter into the 2014, the core businesses, or the shared businesses, will be about 75%, and the remaining will be in the apparel category.

That's great. Thank you very much.

Susan Anderson, FBR.

Good job on the quarter, guys. I was wondering if maybe you can give us an update on the swim business and how that performed this summer. And then also if you could provide some color on the sports business and trends you're seeing there.

Sure, Susan. This is Sharon. We were very pleased with our swim business. We will have about a $450 million swim business this year. We still see growth opportunity. We're still not in 1,000 stores. It is still a big category for direct and has much more opportunity. And is a natural adjacency to our apparel business. The sport category still has a lot of upside potential. I think the one thing in the sport category is just making sure that we can get the real estate, and the right real estate, as we go forward. And that is something that we're working through year after year, because the first priority is to make sure we have the right space for the Victoria's Secret lingerie and PINK and then sport.

Great. Thanks.

Thanks, everyone, for joining us today and for your interest in Limited Brands.

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