Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I'd like to welcome everyone to the L Brands Second Quarter 2015 Earnings Call. .

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

Thank you. Good morning, and welcome to L Brands' second quarter earnings conference call for the period ending Saturday, August 1, 2015. 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, lb.com. Also available on the website is an investor presentation, which we will be referring to during this call..

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'll be available to take your questions for as long as time permits. [Operator Instructions].

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

Thanks, Amie, and good morning, everyone. We delivered solid second quarter results as we continued to deliver sales growth, merchandise margin rate improvement and sound inventory management. Earnings per share increased 8% to $0.68 versus $0.63 last year. Excluding the $0.02 negative impact from foreign exchange rates, earnings growth was 11%. .

To take you through the second quarter results as detailed on Page 4 of the presentation. Net sales for the quarter increased 3% to $2.765 billion and comps increased 4%. Foreign currency negatively impacted our sales growth by about 1 point.

The gross margin rate increased by 130 basis points to 40.3%, driven by an increase in the merchandise margin rate..

Buying and occupancy expense deleveraged, driven by our investments in real estate. SG&A expenses deleveraged by 70 basis points, primarily driven by our investment in store selling to improve the customer experience. Operating income dollars increased by 7%, and our operating income rate improved by 50 basis points.

Earnings per share increased 8% to $0.68. Foreign currency negatively impacted our second quarter EPS result by about $0.02. .

Turning to the balance sheet on Page 8. Retail inventories per square foot at cost ended the quarter flat versus last year. Inventories were clean and we are well positioned. We repurchased 1.5 million shares of stock in the second quarter for $131.2 million.

At quarter end, we had $197.8 million remaining under our current $250 million repurchase program..

Turning to Page 11 of the presentation. Our forecast for 2015 reflects actions we are taking to grow our business. Growth in square footage increased selling payroll, driven by our efforts to improve the customer experience and investments in international expansion.

It also reflects an estimated negative impact resulting from foreign currency exchange rates and a higher tax rate. Our third quarter earnings forecast reflects a low single-digit comp increase.

We expect the third quarter gross margin rate to increase, driven by an improvement in the merchandise margin rate, offset by buying and occupancy expense deleverage. We expect the SG&A rate to delever, driven primarily by an increase in store selling costs..

We expect third quarter net nonoperating expense, consisting primarily of interest expense, to be about flat to last year at $80 million. We expect earnings per share between $0.40 and $0.45 in the third quarter against last year's $0.44 result. This forecast includes a negative impact from foreign exchange of about $0.03.

We are also lapping approximately $35 million in sales of non-go-forward apparel at Victoria's Secret Direct. We expect to end the third quarter with inventory per square foot of low to mid-single digits to last year..

For the full year, we are projecting positive low single-digit comps. Total sales growth will be about 1 point higher than comps due to growth in square footage in our international business. Foreign currency translation is expected to negatively impact sales growth by about 1 point..

We expect our full year gross margin rate to be up and the SG&A rate to be slightly up to last year. Net nonoperating expenses, consisting principally of interest expense, are projected to be about $315 million, roughly flat to last year. Before any discrete items, we estimate our tax rate will be approximately 37.5% versus 36.3% in 2014.

The higher projected tax rate in 2015 will negatively impact earnings per share by about $0.07. .

We are forecasting weighted average shares of about 296 million in the third quarter and 297 million for the full year. Assuming all of these inputs, we expect adjusted earnings per share for the full year 2015 to be between $3.58 and $3.73. This estimate includes an estimated negative impact from foreign exchange of about $0.12.

We are projecting 2015 CapEx between $800 million and $850 million. As you know, about 70% of our CapEx budget is for real estate and stores. The remainder relates to investments in technology, logistics and facilities..

As detailed on Page 12 of the presentation, Victoria's Secret square footage in North America will increase by about 4% this year, driven by expansions of existing Victoria's Secret stores and 25 net new openings. Bath & Body Works square footage in North America will increase by about 3%, driven by 28 net new openings and 83 remodels.

Total company square footage will increase by about 3.5%. .

Turning to liquidity. We expect 2015 free cash flow of between $700 million and $800 million. 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, dividend and any other foreseeable needs..

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

Thank you, Stuart, and good morning, everyone. In the Victoria's Secret segment, we were able to grow sales and earnings versus our record performance last year. We were able to drive growth in sales while improving margin rates. .

Comps increased 3% on top of 3% last year, reaching $1.8 billion in total sales for the second quarter. Operating income of $298 million was up $5 million or 2% to last year. We had hoped to do even better, but remain committed and focused on the fundamentals. We recognize that we must keep getting better to win..

Included in our results are the exit of apparel and makeup last year or $65 million in sales. Excluding these items, our segment sales growth would have been up mid-single digits and comps would've been about 1 point higher. We had solid performance in bras and panties with positive double-digit growth and increased margin rate.

In addition, we remain pleased with the growth and strong customer response to our PINK loungewear business..

We were disappointed in the performance of swim and beauty, which were both below our expectations and were the primary drivers of our miss in operating income. We finished the quarter with inventory levels up low single-digits per foot to last year and in line with our expectations. .

Now let's turn to the specific channel performance, starting with stores. Sales for the quarter increased 5% to $1.4 billion and comps increased 3% on top of 3% last year. Sales growth was driven by strength in PINK, along with growth in lingerie, bras and panties.

Our beauty business was down to last year, reflecting the impact of exiting the makeup category and softness in gifting. Swim was also down to last year, driven by fashion misses during the second quarter.

Merchandise margin dollars increased versus last year, but the rate was about flat as strength in full-price selling was mostly offset by increased swim clearance and unfavorable FX impact in our Canadian business.

Expenses, including buying and occupancy and SG&A, delevered in the quarter versus last year, driven by investments in store real estate and higher store selling costs. Operating income dollars were about flat to last year. Excluding the impact of exiting makeup, earnings would have been up mid-single digits versus last year. .

Now turning to the direct channel. Our strategy to distort to core categories with our best growth opportunities is working, and we were pleased with the results in our direct channel. Second quarter sales were down 4%, as we anniversaried roughly $45 million of non-go-forward apparel.

Operating income dollars and rate improved, driven by the increase in merchandise margin and decrease in expenses. Collectively, sales in go-forward categories were up over 10%. Swim also missed expectations in the direct channel. The merchandise margin rate in dollars were up to last year during the quarter as we continued to distort to the core..

bras, panties, lounge and fragrance. We started August with the Body by Victoria and Wear Everywhere Bra launches. We prepared for a strong back-to-school season with our second annual PINK Friday. We are entering the season with well-positioned inventory, enabling us to be agile and respond with speed.

We will continue to be up against the exit of non-go-forward apparel, which represents roughly $35 million in sales in the third quarter last year. In addition, we are continuing to invest in real estate, store selling and digital enhancements to create a more seamless shopping experience for our customer.

These are the right investments for the long-term growth of our business, but will pressure rate in the third quarter. We are continuing to test and learn for holiday in order to set ourselves up for success in the fourth quarter. .

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

Thanks, Sharen, and good morning, everyone. At Bath & Body Works, we were pleased with our second quarter results, where we were again able to grow sales and increase earnings versus our record performance last year.

We were able to drive growth in sales while improving margin rates and continuing to maintain inventory levels -- manage inventory levels down..

our Signature Collection product line, the soap and sanitizer business and our home fragrance assortment. .

We were able to pull back in promotional activity versus last year. We reduced clearance selling throughout the quarter and we were able to effectively leverage product newness in our semiannual sale.

We were very pleased with our customers' continued positive reaction to our brand, our product assortments and our storytelling as well as our in-store experience..

For the quarter, operating income was $138 million, up 20% versus last year. Our operating income rate improved by 210 basis points to 18.4%, driven by improvement in gross profit and SG&A expense leverage.

We continue to see strong performance in our BBW Direct channel, which grew sales by 15% and operating income significantly in the second quarter versus last year..

We ended the quarter with inventory down to last year, well positioned heading into the third quarter and flexible enough to react to customers' preferences. We remain focused on disciplined expense management but will continue to make appropriate investments to drive growth in the business..

Looking ahead to the third quarter of 2015. We will continue to leverage the strength of our read-and-react capabilities and provide a world-class, in-store experience by constantly delivering differentiation within visual display and maintaining a strong customer service focus.

We begin the quarter focused on our Welcome to Wine Country theme, featuring new and seasonal fragrances in our 3 key businesses, and we'll transition to our fall floor set in September time period..

With that, I'll turn the discussion over to Martin Waters. .

Thanks, Nick, and good morning, everyone. As in previous calls, I shall give you a brief overview of our progress in our international businesses.

As we all know, our opportunity for international growth is significant, and 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..

As detailed on Page 13 of your presentation, we opened 64 gross international locations so far this year, 35 in the second quarter, to end the quarter with 453 stores in the segment. Revenue increased 12% in the quarter to $88.7 million and operating income increased 19% to $20.2 million. The operating income rate increased 140 basis points to 22.8%.

The revenue growth deceleration versus the first quarter was driven by timing shifts in the shipment of product to our wholesale partners in the VSBA business. These timing shifts will smooth out over a longer period of time..

Importantly, retail sales growth in the international business continues to be strong and has been consistent over the last several quarters. At Victoria's Secret International, we are pleased with performance of our full-assortment stores..

In the U.K., we continue to be very pleased with our 10 stores. We opened the Bond Street expansion in May, and we will open another 4 stores in the U.K. later this year. In the Middle East, we now have 14 Victoria's Secret stores and 3 PINK stores. We continue to be very pleased with the results there and will open a few more stores later this year..

Staying with Victoria's Secret. Our Victoria's Secret Beauty and Accessories business continues to progress well with 325 locations opened at the end of the quarter, about 1/3 of which are in airports. We've opened 12 VSBA stores in China and are pleased with the results. We will open about 100 or so VSBA stores across the globe by the end of 2015..

Turning to Bath & Body Works International. We now have 101 BBW stores outside of North America, and we continue to be very pleased with their performance. We expect to open another 30 or so BBW stores in the balance of the year..

great execution of our brands wherever we go. .

And with that, I'll say thank you and turn the discussion back over to Amie. .

Thank you, Martin. That concludes our prepared comments. And at this time, we'd be happy to take any questions you might have. [Operator Instructions] Thanks, and I'll turn it back over to Stephanie. .

[Operator Instructions] Your first question comes from Kimberly Greenberger with Morgan Stanley. .

A very nice quarter here. My question's for Stuart. Stuart, you guys have been investing in store selling payroll for a number of years now, testing different wage structures and such. I'm wondering -- it sounds like the 70 basis points of pressure in SG&A this quarter was largely higher store selling payroll.

As you look at the competitive landscape and what both Victoria's Secret and Bath & Body Works need to do in order to stay competitive and an employer of choice, what further changes are you anticipating in making in those structures as we go into 2016? And maybe just give us an update on the evolution of your strategies over the last 3 years. .

Kimberly, thanks for the question. In the most summary sense and the way that we commented on it in our prepared remarks, we're investing to improve the customer experience. And we're doing a number of things to improve that experience, some of which relate to compensation, but there are other things that we're doing. And we're learning a lot.

We -- it will be an ongoing journey, if you will. But again, our focus is on improving the customer experience. We obviously see that as an opportunity to deliver incremental sales growth over time. And we've got a number of initiatives within Victoria's and Bath & Body Works pursuing that agenda. We're not speaking in a lot of detail about it.

But at the end of the day, it's about investing in the customer experience to drive sales growth, to improve the customer experience over time, both at Victoria's and Bath & Body Works. .

Thanks, Stuart. Thanks, Kimberly. .

Your next question comes from Tom Filandro with Susquehanna Financial. .

So a question for Martin. Can you help us understand the timing shift in deliveries at the VSBA locations? Like what's driving that shift? And how should we think about the underlying growth of the business? And I'm going to slip in one for Nick.

How's the White Barn test going?.

Yes, thanks, Tom. So you're right. There was deceleration in growth in Q2, and that is all driven by timing shifts in the wholesale proportion of the VSBA business. So a good chunk of the VSBA business works on retail royalty. But the balance, which is somewhere between 30% and 40%, is wholesale.

And that does experience lumpiness as we go through the year. We do expect it to level out over time, Tom. Importantly, most important of all, retail sales have been strong, and we continue to see about the same level of growth that we've seen in each of the previous 4 quarters. .

Thanks, Martin.

And Nick, on White Barn?.

Hey, Tom. Well, we're very encouraged with the initial results. But I really want to preface that. We're in the early stages and still very much in a learning curve. This is really about leveraging our strength that we currently have in the home business. We're very much at the early end of that. We'll continue to read the results and react appropriately.

.

Great. Thanks, Nick. Thanks, Tom. .

Your next question comes from Omar Saad with Evercore ISI Group. .

I wanted to ask a question about the bra category. I know you had strong growth there again. But I was wondering if you're seeing any kind of changes and continue -- subtle changes in consumer behavior in that category, shifts within the business. And there's some talk about the athleisure trend seeping into the more traditional bra category.

I would love to see how you see that category evolving currently and into next year. .

Omar, thank you very much. We're very excited about the bra category. And as with any category, we are going to see shifts, and we're very prepared for those shifts. We're very excited about the low double-digit growth that we have in our bra category. We continue to look at the -- our landscape and thinking about the segments of the business.

We entered into the sport bra business about 2, 3 years ago. It is a major focus and doing quite well. I believe that is going to be part of the bra business as we go forward. So I think that we are well positioned. We're very excited about our position as we go forward, and we continue to see double-digit growth across all of our bra categories. .

Thanks, Sharen, and thanks, Omar. .

Your next question comes from Brian Tunick with Royal Bank Canada. .

I guess, first one for Stuart.

Maybe as we think about the gross margin composition going forward from here, if you think about the buckets of the markdown improvement, the buying and occupancy deleveraging, and then maybe even AUC on what's happened to cotton, how should we think about the drivers going into next year, really? I mean, do you still need a 5% to 6% comp next year to get the OW [ph] leverage? Are there just ways you're thinking about -- I know we're getting ahead of ourselves, but does the model change at all next year on the gross margin composition? And then maybe for Sharen on PINK.

I think last year, back-to-school, you had a very strong PINK business, said you were off to a good start.

Are there any categories that you're either lacking or you're introducing that you're most excited about in PINK?.

So Brian, there's a lot in that question, and that's okay, because we're in an interesting business. As we think about merchandise margin, as you know, it starts with the product. And what I mean by that is the -- how consumers react to our product.

And when we get it right, as you know, we got a lot of pricing power with the Bath & Body Works and Victoria's Secret brands. So it really does start with getting the product right, which as you know, is one of the key reasons or rationales for all the work that we've done and that we continue to do on our speed agenda.

When you combine that with inventory management and discipline, those things in combination get to merchandise margin rate improvements that we've realized over time, including year-to-date in 2015. With that said, you also know that we try to be smart about the trade-off between rate and dollars.

And we really think a lot about reinvesting in our product and driving dollar volume at the end of the day, trading off price levels, promotions, opening price points, et cetera, to get the best merchandise margin dollar result.

And then as you move into occupancy, the other component of the gross profit rate, frankly, we are very enthused and bullish about the opportunity that we have to reinvest in our store fleet.

And as we report out regularly at our annual investor meeting, those investments, certainly in aggregate, have been paying off very well in terms of investment returns, driving sales growth, profit dollar growth and very importantly, setting our business up for the next 5 or 10 years with a store environment that's very compelling to consumers.

And so reflecting those investments, I would expect that we'll continue to see some deleverage in the occupancy line over time. But again, view that very favorably because of how that contributes to the long-term health and growth potential for this business. So big subject.

I think that reflects our views, and we'll be careful about managing rate versus dollars. Thanks. .

Brian, it's Sharen. PINK. We are so pleased with the PINK business. That team has just done a terrific job, really staying focused on just product categories and speed. The biggest investment that is different this year versus last year for PINK is in the bra category. We did a lot of testing in some districts last year.

We ended up rolling out a brand-new fixture package and capacity for our bra business. So that is where we have our largest growth category as we go into back-to-school that is different from last year. .

Great. Thanks, Sharen. .

Your next question comes from Mark Altschwager with Robert W. Baird. .

Just wanted to ask about swim for a moment.

Can you just comment a bit more about what drove the weakness there, primarily a fashion issue or something else going on? And then, could you also comment on your supply chain test-and-respond capabilities for that category in particular? Just wondering if there's anything structurally different about that category that may limit your ability to respond to demand in season.

.

Thanks, Mark. Swim has been my biggest disappointment, and we did it to ourselves. We had a great first quarter. We changed, instead of reacting into the things that were working, we said, "Oh, let's land a brand-new fashion delivery," which we did, and it was a big misstep. It affected both the store channel as well as the direct channel.

When I think about our supply chain in swim, it was one of the first to go on a speed model. One of the other things that we did is we designed really complex swimsuits with macramé, all of those kinds of details that were much harder to chase into. So the whole swim thing is something we did to ourself. The business is there to have. We messed it up.

We didn't follow our own fundamentals, and it's been my biggest disappointment. .

Thanks, Sharen. And thanks, Mark. .

Your next question comes from Dana Telsey with Telsey Advisory Group. .

Sharen, as you think about holiday for 2015, how are you planning marketing? And what do you think the difference will be this year versus last year? And also, on the Bath & Body Works side, how do you think of holiday this year versus last year? What should we be seeing? And is there margin opportunity for holiday for both businesses?.

Dana, as you know, we're taking a pretty conservative view for fourth quarter holiday this year. Our marketing plan, we actually are adding a bra launch in the first week of December, which will be different this year versus last year. We're continuing to test early so that we can identify bigger opportunities.

Our promotional activity is basically planned slightly down, but we have contingencies in place that if we need to balance out responding to traffic or driving to traffic as we protect the brand. I think for the PINK business, obviously, it's a good indicator for us about how holiday can be.

We really tore holiday apart last year to think about how to approach things differently and to maximize that time frame between Thanksgiving and Christmas Day, because we all had known that, that has been declining for the industry over time, and we're just trying to make sure that we can get more of our fair share. So we're positioned well.

Inventories are under control. We're doing a lot of testing. We've got a new bra launch that's happening. PINK has actually got some -- we're very fortunate that we're in a backpack cycle right now, which is just perfect for PINK.

Our beauty business, we are in the throes of repositioning that beauty business because we want it to be more elevated and in line with the lingerie category. So we have introduced body care for the August time frame. We're repositioning Fantasy, which is a big chunk of that business, in October, and as we continue to elevate our fine fragrance.

So I think that we're prepared, but we're also being very cautious in terms of going into holiday. .

Dana, so for us, we really want to leverage our fortunate position of being very much a destination during the holiday period. So obviously, that means we've got to be as giftable as we possibly can.

So things that spring to mind for us will be, obviously, the notion of distorting to the things that we know are really, really critical at that time frame as well as making storytelling as powerful as we possibly can. So we'll continue to heavily invest in that side of it.

Obviously, newness at that time frame is important and how we mix of that with the things that she really expects to get from us. We have a rich heritage set of products that she really expected to get. So the mix is important there.

From a margin perspective, obviously, we'll plan that flat and then leverage the speed capabilities that we have to be able to react to what's working and what's selling, which should give us, hopefully, some upside. But the real plan there is to be flat.

I think the most important thing for us during holiday is to make sure we go into it with the highest amount of flexibility we possibly can, both from an inventory perspective as well as obviously, how we're flowing goods, et cetera. .

Great. Thanks, guys. .

Your next question comes from Anne-Charlotte Windal with Bernstein. .

A question for Martin on the Victoria's Secret full-assortment stores. Could you give us a little bit of an update and a little bit more color around what's working or not working? And in general, how well the basic U.S. lingerie product is translating internationally. .

Thanks.

Martin?.

Anne-Charlotte, yes, thanks for the question. We always say that the VS business is a replication model of what we do in North America. And so it proves to be wherever we take it. I can say with confidence that the offer is well received.

I can tell you that the bestsellers are, by and large, the bestsellers, the best colors -- are usually the best colors. We see a very high degree of similarity in most cases. Obviously, in certain countries where there are particular cultural norms, for example, Saudi Arabia, we see slight distortions.

But honestly, not that much greater than the distortions that we would see across the enormous country that is the United States of America. So all in all, very, very pleased with the VSBA business and broadly consistent with what we see in the U.S. and excited about growth in lots of new areas of the world in 2016. .

Thanks, Martin. And thanks, Anne-Charlotte. .

Your next question comes from Howard Tubin with Guggenheim Securities. .

Sorry, this is Paula [ph] calling in for Howard. I was just wondering if you could talk to us a little bit about the performance of your sport business this quarter and plans on the go forward in terms of rolling it out to more stores. .

Thanks. Our sport business performed very well, and actually, to our expectations. We are rolling out to about 200 more stores, probably about 100 this year and 100 in early spring. So we feel good about this category. It is a growth category for us. It will be dominated by the bra category. So we look forward to seeing even more growth as we go forward. .

Thanks, Sharen. .

Your next question comes from Susan Anderson with FBR & Co. .

I was wondering if you could maybe touch a little bit more on the gross margin. I know you talked about the outlook for next year and kind of the drivers, which I assume are very similar in the back half.

But maybe just directionally, given merch margin kind of started to improve last year in the back half, how should we think about the upside there starting in the third quarter now? And then also, if you can maybe talk about just the direct business, which seems to be converging a bit more with the stores.

And any more focus on omni-channel?.

It's Stuart. On the merchandise margin question, to be honest, I don't have a lot more to add beyond what I already commented on in response to Brian's question. We've realized some improvement. There's the potential to realize a bit more.

As I mentioned, we make a lot of judgments within the season, ultimately thinking about what will resonate best with customers and drive the best sales and margin dollar outcome.

But again, with all that said, when we get the product right, leverage our speed tools really well, continue to stay disciplined on inventory, there's some opportunity for further improvement. But we're always going to balance it against reinvesting in the product and driving dollar growth. .

Thanks, Stuart.

And Sharen, on direct?.

Yes, I'm really excited about our direct business as we continue to reposition Victoria's Secret and edit out the peripherals and really focus on our core businesses.

And when you think to the direct business over the last 12, 18 months, walked away from $280 million and basically, are replacing a lot of that with the core categories, just bodes well for the customer and for the brand.

As I think about omni-channel, I think Victoria's Secret, because we've been in the catalog business so long, because we moved to the Internet business, we've been an omni-channel business. We're just getting stronger and stronger. We're engaging more with our customers. Our customers are buying more with us.

They're becoming -- they're not attriting at a -- they're attriting at a slower rate for us. So I think that from a brand perspective and from a direct perspective, we're moving in the right direction. We're going to continue to elevate our catalog.

We're going to continue to think about that, shifting a lot of our emphasis to mobile because that's where the engagement model happens and that's where our -- we're investing in our technology. So I feel very good about where we are and what our capabilities are. .

Thanks very much, Sharen. [Operator Instructions].

Your next question comes from Lorraine Hutchinson with Bank of America. .

Martin, just wanted to follow up on the international commentary.

Is it fair to assume that the growth rate internationally will reaccelerate in the back half? And can you talk about any successes and challenges in opening the numbers of new stores that you've planned in the first half of this year and the back half?.

Thanks, Lorraine.

Martin, yes?.

Sure, yes, happy to take that question. Yes, happy to take that question, Lorraine. Thanks for asking. As we look forward into the back half of the year, I think we're very well positioned across all of our markets.

To be honest, we focus less on trying to predict exactly what that growth rate will be and more on solid execution and getting the stores open that we have in our plans. We have over 100 stores to open in the back half, and getting them opened on time and getting them opened well is mission critical.

So I'm more focused on that than predicting precisely what the rate will be. But I will tell you that there's been a great deal of consistency in our growth rates across each of the last 4 quarters in terms of retail sales. Highs and lows in terms of things most pleased with, I would say China is an area of real excitement for us.

We've opened 12 stores, VSBA stores. We have another 7 or 8 to open in the balance of this year. We're well positioned to open full-assortment stores in China in 2016, so particularly excited about that. If I had to pull out one big challenge that we face, it's really delivering the right real estate.

We've made a strategic choice not to go at a pace that means that we need to compromise on our retail real estate. If we want the best real estate in any mall, sometimes we have to wait for it. So there's a frustration in getting the right real estate as quickly as I would like it.

But by and large, we work our way through that and continue to stay focused on solid execution. .

Great. Thanks, Lorraine, and thanks, Martin. .

Your next question comes from Marni Shapiro with The Retail Tracker. .

I was curious, one just clarification. The sport business at Victoria's Secret, are those bras categorized into your bra business or into your sport business? I just want to clarify that. And then, Sharen, I think you said the bra and panty business was up double digits, which is very impressive.

Was that driven primarily by PINK? Because you did also call out PINK bra and panty business being very strong and a focus -- one of the changes in the back half of the year versus last year. .

the VSL bra business grew, the PINK bra business grew and the sport bra business grew. Obviously, from an increase, you saw more growth from a percentage in the sport category as well as the PINK category because they're coming off a much smaller bases. VSL has a huge base, over $1.3 billion in terms of bras, so they're coming off of a big base.

And that business grew high single digits. .

The core VS business. Great. .

Yes. .

Thanks, Sharen. Thanks, Marni. .

Your next question comes from Richard Jaffe with Stifel. .

Just a couple of thoughts, one about real estate and one about the direct business. Just want to know about the VS growth.

Is it new stores or bigger stores? How is that balancing out? And how many stores are still not rightsized, still not been expanded? And then, given the direct business and its success, is there further investment to be anticipated, whether it's mobile shopping or ship from store, pickup in store, some of these features we've been seeing other retailers add?.

So in terms of the Victoria's Secret growth, basically, our growth has -- and in terms of the 4% real estate growth that we have, part of that is new stores, where we're actually taking PINK and segmenting out of the Victoria's Secret stores. So then, therefore, you'll have a free-standing PINK store and a free-standing Victoria's Secret store.

The other piece is just making our stores larger and having PINK be side-by-side. We still have, when we look at it, probably 50% to 60% of our fleet still cannot hold all of our assortments. And that's just going to take time because, first of all, you want to get the right real estate.

And as I think from a Limited Brands perspective, that we do an outstanding job managing that real estate fleet because we have very few stores that don't make money.

So one of the things as I think about our real estate as well, is that how do we -- our dominant real estate, is it actually more leveraged to our core categories? That is -- takes a repositioning in adjacencies with -- inside our store. That is one piece that we're working on as well. We have proven that we can actually pay for these.

It gets a very high 20% over return in the first year, which is great from our real estate. So I think that we're on the right track and excited about where we're going. And it's still a lot of opportunity that we have left on the table.

When I think about the direct business, we've already shifted probably, I think, 52% -- or about 52% of our business is coming through mobile. So that is something that we are -- have been focused on and that -- continue to focus on and continue to leverage.

In terms of the omni-channel work, we actually have -- where you can buy online, return in store -- buy online and return in store. If we're out of stock, we can buy -- from store out of stock, you can buy online. We haven't done the pickup yet, and it's something that we're continuing to think about.

But we have already put all those other things in place and have had those things in place over 2 years now. .

Thanks, Richard. .

Your next question comes from Betty Chen with Mizuho Securities. .

I was wondering if Sharen and Nick can talk about the second half opportunity, whether that's mainly going to come from conversion or traffic or perhaps on AUR. And then just a clarification for Sharen.

With the swim business struggling a little bit in second quarter, just want to make sure that we're exiting the quarter clean in terms of any swim clearance product.

Or is there any sort of residual that we should see in the third quarter?.

Thanks, Betty.

Nick, you want to start?.

Sure. Betty, I think the way we're thinking about the second half is we still believe we have a tremendous business opportunity in our core businesses. We'd like to think there's opportunities still remaining within the Signature business as we come up against last year. We've got an awful lot of newness flowing.

And we continue to see a very healthy customer ship against that core business of Signature. The other side of that is our home business continues to be very strong and our investments in the home business will maintain as we think about holiday.

And really, the second half is the time that our home business typically grows, outpaces its first half results.

So those are the really the 2 big opportunities for us really, and underpinning all of that is again, wanting to make sure that we have enough flexibility by leveraging the speed model that we have that really provides us the best opportunity to chase into the right business and drive first-quality selling. .

Great. Thanks, Nick.

Sharen?.

Yes, you guys, I'm sorry. I want to clarify something. The -- our direct mobile business grew 72%. It's 25% of the business, not 52%. I reversed my numbers. So I apologize for that. When I think about the growth opportunity in -- the next question was swim. We actually cleaned up swim. And that's what you saw in the second quarter that hit our gross margin.

So we do not have residual that will go forward into the fall season within that swim category. .

Thanks, Sharen. .

Your next question comes from Simeon Siegel with Nomura Securities. .

Just a follow-up on a prior question. Sharen, I think you mentioned expense deleverage in the stores.

Maybe without going into the qualitative details of the initiatives, can you just talk about the right way to think about store-level SG&A growth? And then how you think about the long-term VS operating margin level?.

Thanks, Simeon.

Sharen?.

We are, as Stuart had talked about earlier in terms of being the best place to work and the best place to experience, are investing in terms of selling as well as in terms of investing in terms of the stores. Where I see that investment, we're going to continue work on getting the return on that.

I think that will probably happen more in the latter part of 2016 as we continue to test and learn. Excited about some of the things that we're seeing. The operating margin improvement and the operating income improvements, obviously, every year, we always set a target that we would like to grow and continue to grow somewhere between 10% and 15%.

I mean, that -- those are our goals. We're not there this year for many reasons in terms of some of the investments we're making, in terms of getting out of the product categories. I think it's about $350 million in total product categories that we walked away from.

But I think all of this does is to set us up for a lot of success and growth opportunities, both on the top line and the bottom line going forward. .

Great, Sharen. Thanks, Simeon. .

Your next question comes from Oliver Chen with Cowen and Company. .

Stuart, you guys have been really exceptional at the inventory management over time with the fast-turning programs and also, kind of balancing getting the right product at the right place at the right time.

Just where are you in this inning? Are you feeling comfortable? There's been different times in your history when you felt like you could have even bought more. I'm just curious about what we should expect there and maybe how your assortment will evolve with the fast-turning items as a percentage of total. .

Yes, Oliver, there's not a lot of new news to report, if you will. Our thinking is pretty consistent, which is actually, first and foremost, we sell high-margin stuff, and we want to be in stock. So that -- we never get confused about that.

With that said, we've been pursuing strong inventory management through what I call basic disciplines in pursuit of that speed agenda now for 3, 4, 5 years. Our numerical goal, if you will, is to continue to grow inventory slightly slower than sales, to have some spread.

But with that said, we want to be careful about it because you go back to point #1, which is we want to be in stock and we want to be well positioned to pursue business. But there's not any major change in our thinking. It's a fundamental part of our business. We managed inventories well in the spring. Our inventories are very clean.

As I mentioned in my prepared remarks, we expect inventory per foot, store inventory per foot to be up low to mid-single. You might be curious about the mid-single digit. When you look at things on a 2-year basis, fall inventories will actually be down a little bit more or pretty consistent with the inventory changes in spring.

And there's a lot of moving pieces to it. But again, our overall thinking and our overall goals are very consistent, and we'll manage it with discipline. .

Great. Thanks, Stuart. Thanks, Oliver. .

Your next question comes from Matthew Boss with JPMorgan. .

So on capital allocation, any change in mindset as we think about the consistency of share repurchase versus special dividends and the total return algorithm going forward? And then higher level, what type of comp is needed to actually leverage fixed cost this year versus next year and beyond as we do lap some of the selling initiatives?.

Thanks, Matt. We'll go to Stuart. .

Yes. So on capital allocation, the thing that is very consistent for us is that any excess cash that we generate, and we generate a lot of excess cash through the profitability and the operating cash flow of the business, we're going to, first and foremost, reinvest in our business.

And as you know, we are reinvesting meaningfully in our business to grow it and doing so, we think, in a very profitable way. And then to the extent that we have free cash flow after that, we're very clear minded again about returning that to shareholders.

And as you know, first and foremost, is a regular dividend that we want to be very compelling and appropriate for our shareholders. And we've increased that regular dividend very materially or very significantly over the last several years, including a very significant increase over the last 12 months.

Then in terms of the interplay between special dividends and share repurchases, we use our judgment. And we use our judgment about our sense of the desire of shareholders and our sense of relative opportunity in the marketplace. One component of that thinking is we do want to generally offset dilution from equity awards with share repurchases.

But beyond that, we'll be, what we believe to be opportunistic, obviously, thinking about our view of the intrinsic value of the company.

So again, first and foremost is invest in the business; second, any excess coming back to shareholders; third, compelling regular dividend; and then, fourth, some swing between repurchase and specialist, depending on facts and circumstances at the time. .

Great. Thanks, Stuart. I'm sorry. .

And then in terms of leverage point. It's okay. In terms of leverage point, we've mentioned that we're -- and you said on fixed cost and then you mentioned selling expenses. I mean, selling expenses, to some degree, are fixed, and to some degree, you would appreciate that they're variable.

So if we put the selling expenses off to the side for a second and really more so think about occupancy expenses, as we've mentioned pretty consistently, we're investing in our business. And that percentage increases, depending upon the business and the period of time, 6%, 7%, maybe in some periods, 8%.

But again, that's because we're investing in the business. So that -- on that part of the expense structure, that's kind of the breakpoint in terms of total sales growth. That's not comp, but total sales growth. And then the selling expense will be in season, in annual management.

And as you've heard, we're investing in that part of our business to improve the customer experience. And thus, right now, we're seeing some deleverage in that part of our P&L. .

Thanks, Stuart. I think we can take a couple more questions. .

Your next question comes from Adrienne Yih-Tennant with Wolfe Research. .

Stuart, I think this is for you.

Can you talk about a number of the input variables that are going in cotton, oil, the devaluation in the yuan from a sourcing perspective and the impact on AUC? When could we see those and of what magnitude, if you can help us out there?.

Sure. Importantly, and again, consistent in our thinking, while we do think about -- and certainly, I would want you to know that we don't want to overpay for anything. First and foremost, in our mind, as we think about the business and manage the business is creating compelling product that commands very strong retails.

And that's where our dominant emphasis is on driving dollars and margin rates. With that said, you mentioned a number of items that do have the potential to drive some favorability in product cost. But I wouldn't describe them as, in aggregate, material.

And again, our bigger opportunity is to minimize markdowns and drive compelling product and flow with speed and innovation and quality in our product. And importantly, we will continue to reinvest in the spec and the quality of our products, whether it's in intimate apparel or personal care and beauty, so a lot of moving parts.

We're not a cost-driven company as it relates to merchandise or store environment, particularly. And the bigger drivers of margin rate opportunity for us are some of the things we've commented on earlier in the call. .

Thanks, Stuart. .

Your last question comes from Janet Kloppenburg with JJK Research. .

Sharen, I hope you could comment on the beauty category. And I'm wondering how confident you are that the improvement in that business -- if we will see improvement in that business in the back half.

And if beauty can contribute to improvement in 2H '15?.

Janet, I think with the repositioning that we're doing and the exits that we're doing, that I would tell you, I would be very cautious about the beauty business in the back half. I am more optimistic as we go forward. I think we're doing a lot to trade out, a lot of moving pieces going on, and so I would approach it very cautiously. .

Thanks, Janet. That concludes our call this morning. We appreciate your interest in L Brands. Thank you. .

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