Good morning. My name is Lisa, and I will be your conference operator today. At this time, I'd like to welcome everyone to the L Brands' Second Quarter 2016 Conference Call. .

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

Thanks, Lisa. Good morning, everyone, and welcome to L Brands' Second Quarter Earnings Conference Call for the period ending Saturday, July 30, 2016. As you know, we released detailed commentary last night, which is available on our website. We will make some brief introductory comments in order to allocate more time to your questions..

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, additional commentary and earnings presentation are all available on our website, lb.com..

Stuart Burgdoerfer, EVP and CFO; Nick Coe, CEO, Bath & Body Works, who is off-site today; Andrew Meslow, COO of Bath & Body Works; and Martin Waters, President of International, are all joining us today..

All results that we discuss on this call are adjusted results and exclude the 2016 pretax gain of $108.3 million, $0.24 per share, related to a cash distribution from Easton Town Center; and the pretax charge of $35.8 million or $0.08 per share, related to the early extinguishment of our July 2017 notes. .

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

Thanks, Amie, and good morning, everyone. We're pleased that we were able to deliver a slight increase in operating income against last year's record result and a second quarter earnings result that was above our initial expectations, all in the midst of significant change in our business. .

We remain confident that the changes we are implementing at Victoria's Secret, which we discussed in detail on last quarter's call, will simplify the business and position us for accelerated future growth.

We made progress in the quarter on the implementation of these changes, combining our store and direct channels, clearing through merchandise in the exited categories of swim and apparel, and beginning to make changes to our promotional approach..

We are well positioned heading into the fall season. Our brands are strong, and we're energized about our opportunities for growth. We will continue to leverage speed in the business and be flexible and agile in our approach to -- in order to maximize profitability and deliver great experiences for our customers. .

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

Hey, thanks, Stuart, and good morning, everybody. Just a few additional comments before handing over to Martin. Overall, pretty pleased with our first half performance. We feel good about growing sales and earnings on top of the record performance that we had last year.

And we continue to leverage our speed model, which has really provided us the opportunities to chase and to win [ph] across the business, which is obviously beneficial from a top line and a bottom line perspective..

Once again, our inventory is well positioned. And clearly, we'll closely monitor that position to maximize our agility as we maneuver our way through the season. .

Finally, we remain very, very committed to one of our most important disciplines, which is all about staying very close to the customer and reacting to her behavior. This is something that allows us to feel confident as we work through the season with newness, floor sets and changes, et cetera. So it puts us in a pretty healthy position. .

Thank you. And I'll turn it over to Martin. .

Thanks, Nick, and good morning, everybody. As we mentioned in the preprepared notes, the pattern from Q1 really continued into Q2, with impacts from our investment in China, from FX and sadly, from weakness in our Victoria's Secret Beauty business. .

I'm actually just back from a long trip around the world. I went to the U.K, Dubai, Hong Kong, Macau, Shanghai. I just got back last night. And I would tell you that everywhere I went around the world, I thought the standard of execution was just fantastic in all markets. .

As it relates to China, I was particularly impressed with the talent that we've been able to recruit into that market with the leadership that we now have in place to take us forward. So feeling very excited there. I also saw some great real estate that's in front of us for China. So overall, feeling very optimistic. .

Over to you, Amie. .

All right. Thanks, Martin. So that concludes our prepared comments. And at this time, we'd be happy to take your questions. [Operator Instructions].

And I'll turn it back over to Lisa. .

[Operator Instructions] And your first question comes from the line of Lorraine Hutchinson from Bank of America. .

Stuart, I wanted to follow up on the Other segment loss, which was much better than we had expected.

Can you just give us a little bit of insight into the cost cuts there, how sustainable they are and then perhaps, an update on the Henri Bendel and La Senza pieces of that?.

Yes. In terms of the year-on-year improvement in the Other segment result, we certainly are working hard to manage corporate overhead and other expenses with discipline. We did have lower bonus payouts for the spring season, reflecting our results versus a year ago. Also, in the LY result, we had a few discrete expenses that didn't repeat in 2016.

All that said, we'll continue to manage corporate overhead with discipline, and we'll continue that mindset. In terms of the Bendel business, we remain optimistic about that concept and that brand, that business, that opportunity. They continue to drive sales growth in their stores and are developing a very nice online business as well.

And so we're optimistic we'll continue to work to get the best results this fall season and periodically think about how and when to best expand that business. But the focus right now is on driving further sales growth in the stores that we have, driving good results online, which we are, and improving the margin architecture of that business.

So -- but good overall trends for Bendel. .

Maybe a few comments on La Senza. Really good performance in La Senza. In fact, we've seen positive comps in each of the last several quarters in that business, really getting closer to the customer and sharpening up the proposition around young, sexy, obvious value positioning, and excited that our launch in the USA will take place later this fall.

So good progress in that business. .

Our next question comes from the line of Mark Altschwager from Robert W. Baird. .

I was hoping you could dig into the beauty repositioning a bit.

Just when do you begin to lap the more significant pressures on that business? And given the shorter lead times there and the aggressive clearance activity through Q2, just why wouldn't we expect to see a more significant inflection point in Q3? And then kind of separately, still on beauty.

On the international side, do you have any ability to make some shifts in the product or pricing given the learnings in the U.S. over the last few quarters? Just wondering if that might impact the timing of an inflection on the international side. .

Thanks, Mart -- Mark, sorry. We'll start with Stuart, and then go to Martin. .

So I think as you appreciate, maybe in order from our standpoint, we've got a new leader in the beauty business. He started in May. He's learning about L Brands and Victoria's Secret and is on-boarding, but now getting into the business of the business, if you will.

Second point I would probably register is that through promotional and other activity, changes in pricing and promotion, we certainly tried to and did drive a lot of trial in the second quarter, and we expect to continue that in the fall season.

So through pricing and promotional activity, driving trial in core categories of beauty to drive business, to drive results. And encouragingly, we're seeing some pretty good repeat -- customer repeat post-trial with some of those products.

The third thing I'd mention is Greg working with Les and others, developing a point of view and implementing a point of view about rationalizing or narrowing the assortment in a meaningful way this fall season.

And then lastly, as you teed up in your question, we, in terms of what we're lapping, the year-on-year pressure in '16 will moderate as we go through the fall season.

And maybe last, last is we all recognize the importance of speed in our business, and including, through the eyes of new leadership, really working to reduce lead times in that business, make further use of the beauty park that we have for personal care and beauty at Victoria's Secret Beauty.

And those changes are beginning, and we'll have some positive impact on the fall season. But -- so we'll see some year-on-year reduction in pressures certainly through fall. And it's such an important category.

It's such a strong category for us, that we're very committed to it and optimistic about the growth potential for that business over the next, call it, 12 to 24 months. .

Thanks, Stuart.

Martin, anything to add there?.

Yes, we see very similar patterns in the international business to the patterns that we see in North America. As you know, it's a replication model in international. So we sell the same merchandise that we have in the home market. So to that extent, not much opportunity to do things differently.

But as you suggested in the question, Mark, as it relates to pricing and promotions, we do have opportunity there. And we are taking the learning from North America, and we're flexing and adapting our plans in that respect. .

Our next question comes from Anna Andreeva from Oppenheimer. .

I guess, our question on SG&A. Stuart, leveraged pretty significantly here in the second quarter. What drove that? I think you're just starting to see lower home office costs.

And trying to understand the expectation for deleverage in the third quarter, why wouldn't we see some of those benefits continue?.

Sure. So our -- the management of the company is very focused on balancing our investments in the business, including those that hit the SG&A line, and doing that with discipline. In terms of the difference between the second quarter and the third quarter result, in Q3, we have a lower sales assumption.

Now we're going to work hard to beat that sales assumption. But just in terms of the math of it and the impact on rate guidance, we have a more conservative assumption about comp and total sales growth in Q3 versus Q2. Secondly, our investment in China and its impact on SG&A is more significant in the third quarter than it was in the second.

And then lastly, as I mentioned in the context of the Other segment, our spring and Q2 specifically, expenses related to short-term incentive comp provided benefit in Q2. And our going-in assumption for Q3 is that, year-on-year, the benefit won't be as significant in the third quarter. So those would be the highlights. .

Our next question comes from the line of Oliver Chen from Cowen and Company. .

Your core lingerie business growing at low single versus PINK double digits, could you just brief us on how you feel about core lingerie and how do you expect to impact the assortments? I was also curious about the averaging of retail across your core lingerie and how you feel about the mix between good, better and best in fashion versus core. .

Thanks, Oliver. It's Stuart. I'll respond to that. So in terms of core lingerie, there are some important trends going on in the business, and we're taking significant action to participate in and frankly, lead with respect to those trends.

And what I'm speaking about is the unconstructed or bralette trend as one and separately, the sport bra business as a second important development in the bra category.

And we've made significant progress and drove meaningful growth in both of those areas in the second quarter and intend to pursue those segments of the bra business very aggressively in the fall season.

One of the important things about the bralette business or unconstructed bra business, particularly as we do think it has a higher fashion element to us -- to it and we think that's a good thing for us, we've been a fashion specialty retailer for a long time, our abilities in terms of lead times and speed and read-and-react particularly play well into the bralette category.

And while the AUR in bralettes is below some of the other categories in bras, we believe that the unit volume or their frequency of purchase, given the fashion element to it, in part makes up for the lower AURs. So those are 2 important trends in the bra business.

Again, we drove very significant growth in both of those trends in Q2 and expect the same or even greater growth in the fall season. In terms of the average unit retail, in total, importantly, in connection with our promotional changes, we had a large number of offers in our history, in our base, that included $10 off a bra.

And we've substantially reduced or eliminated those offers. So that provides upside in the AUR. And kind of when you pull it all together, our non-redline AUR for the second quarter was pretty consistent with prior year or steady with -- compared to prior year.

So the combination of all those things, we didn't have a decline in AUR in non-redline categories of the business. PINK continues to also grow its bra business at a very healthy rate.

So some changing dynamics for sure, but we had good overall results in the bra business, driving sales growth and very optimistic about the fall season with respect to bras. .

Stuart, on the unconstructed bra comment, what would you say to skeptics that think that the marketing that you've traditionally done isn't necessarily conducive to the changes happening? Just curious on that. .

Well, we just -- in terms of promotional approach, we think the direct mail couponing that we were doing, we think there's just frankly a better way to market and promote the brand. And so we're pursuing different types of promotions, and we made good progress on that in the second quarter.

And we'll continue to learn about the most effective ways to promote within Victoria's Secret. But again, we've been doing a lot of direct mail couponing for a number of years, and we think there's a better way to drive business and build our brand going forward. .

Yes. And Oliver, I'd just add to that. In terms of the marketing, as it relates to image or television, advertising or anything like that, certainly, the same way we focus on speed within our merchandise assortment, I mean, we can take the same approach with respect to marketing. So I think we can be agile about that.

We have made changes in terms of our visual marketing, and so it's about fashion. We are a fashion business, and so that's constantly evolving. .

Our next question comes from the line of Richard Jaffe from Stifel. .

And if we could talk for a minute about PINK and obviously, with rapid growth, seems to be the winner in your portfolio.

I'm wondering, looking ahead your opportunity to invest in that space and to accelerate or expand line extensions, new products, I'm wondering what your thoughts are regarding investment, and if you can give us some visibility into the fourth quarter, in particular. .

Well, Richard, the first thing I would say is PINK is a very strong business within L Brands. The other business that's been consistently very strong for us is the Bath & Body Works business, and I wouldn't want that to be lost through our discussions. But with respect to PINK, it's been a terrific business.

And we see very substantial ongoing growth for that business, easy to say, hard to do. But the -- Denise Landman and the team there are very, very good at what they do. As you know, they have a clear mindset on their target customer. Their ability to execute their business in season and longer term is outstanding.

Their use of speed, read-and-react capability is terrific. So they have a very clear customer segment. They're executing very well. They have very deep and strong capabilities.

With respect to investing in that business, a lot of the square footage that we're adding and a lot of the capital that we're spending on real estate is positioning and supporting PINK growth.

And so as you know, Les Wexner and our company, we're not afraid to invest when we've got a trend and results and the payback, and we're investing record levels of CapEx in our business.

And not suggesting that all that money is going to PINK, but a lot of it is in terms of square footage growth of Victoria's, and again, a lot of that flowing to PINK. Denise is very optimistic about the fall season. It's off to a good start. And again, their ability to read, react and adjust within the season is very strong.

So great business, great second quarter result, very optimistic about the fall. And L Brands is investing very heavily in that business and getting very good returns. .

Our next question comes from the line of Paul Trussell from Deutsche Bank. .

Just wanted to ask a question on Bath & Body Works. There's been good momentum there. Maybe you can just give us a little bit more color on the products driving [ph] the growth as well as an update on the performance of the models. And then lastly, just your confidence on continuing to have merchandise margins up in the back. .

Thanks, Paul. So we're going to start with Andrew, and then -- since Nick is off-site, and if he has anything to add, he can jump in. .

Paul, thanks for the question. On the first part of your question, in terms of category performance and what's been driving our results, as you saw in our prepared remarks, we specifically called out our home fragrance business, which has been a consistent strong driver of our overall business now for the last several years.

In addition to that, obviously, we have our other product categories, such as our Signature Collection fragrant body care business and our soap and sanitizer businesses. And while we did not call those out explicitly in our prepared remarks, those businesses are also growing over the last year.

And so in total, I would say we continue to be pleased with our overall results and our overall portfolio of performance. I believe your second question was regarding our remodel strategy.

As a reminder, that remodel strategy is one that is focused on touching this year about -- we'll finish this year with about 250 stores in that new remodel that, again, includes both a remodeled Bath & Body Works store as well as a White Barn concept, either in a side-by-side location or a shop-in-shop format.

And again, our overall results are -- continue to be very positive. We continue to be very pleased with that performance, and we are committed to driving continued investment into that strategy, both for the balance of this year and well into the next several years. And then last, your question on go forward and our thoughts there.

Again, as you've heard Stuart say, read-and-react is a very, very important lever in our business. And so as we start any new season, we go in with a relatively conservative perspective. We then follow the trends of the business.

We're constantly testing, whether it's new product categories, whether it's new promotional strategies, whether it's new storytelling strategies in stores, and we use that read-and-react capability to chase to the upside.

So again, as we come into the back half of the year, which is, especially in the Bath & Body Works business, a very important time frame, we are still very confident in our ability to use that business model to chase to the upside. .

Our next question comes from the line of Kimberly Greenberger from Morgan Stanley. .

Stuart, my question is on the Victoria's Secret promotions. That brand has obviously been adjusting a number of the promotions used, as you mentioned, eliminating the $10-off coupon and instead, offering alternative kinds of promotions.

I'm wondering if you can share any of your learnings from that, and if you, at -- you're 3 months in, have a greater degree of certainty about how to guide the brand through lapping that $10-off coupon here in the next few quarters based on what you've learned so far. .

Thanks, Kimberly. What I would say is that we shifted our promotional strategy from that free panty, $10 off a bra direct mail coupon generally to promotions intended to drive trial. And that might be trial in beauty, as we've talked about.

It might be trial in sport or sharp pricing and promotions related to the bra business and particularly, the unconstructed bra business. I would say we absolutely have shown that we can drive trial in those important categories.

We are lapping a lot of this direct mail volume, and that amount of business that was driven is more significant in Q3 than it was in Q2. But again, our view is we really want to have purposed promotions that are brand-building and drive trial for merchandise that we think is terrific merchandise.

Again, whether it's in the beauty business or sport bra business or in the unconstructed or other parts of the bra business. So that's our mindset. I would say what we learned is that we can absolutely drive trial.

But I wouldn't suggest and you recognize implicitly in the question, do I think we have all of that figured out in the first few months of this? Would not represent that. But good progress on it in the second quarter. And I know we'll continue to learn more in the third quarter and the fall season. .

Our next question comes from the name of Ike Boruchow from Wells Fargo. .

On the international side, I guess, Martin, a question for you. Correct me if my math is off, but based on the remarks you gave in the script, it sounds like your China business might have contributed around $8 million in sales and about an $8 million loss in the quarter.

I guess, is that right? And is there a good way to think about sales and losses the next 2 quarters for that part of the business? And how would you characterize profitability and sales growth next year and maybe a time line to potentially breakeven there?.

Thanks, Ike.

Martin?.

Yes, thanks, Ike. I appreciate the question. I think the way you characterized the numbers is about right, $8 million of sales, about $8 million of loss. Sadly, it's hard to put those 2 things together because they reflect different parts of the business. So the sales reflect the VSBA stores that are up and running and are trading.

The loss represents the efforts that are going into building the full-assortment business, which will open in February of 2017. So those 2 parts are not related to each other. In terms of thinking forward and how do we project what's going to happen over the next several months, very, very difficult to do that.

What I would tell you is that we're on track to open 2 full-assortment stores probably towards the end of February 2017 and then another flagship store in Beijing around the middle of the year. And we'll continue to trade the VSBA business and add to that selectively, probably about 6 stores over the course the next 6 months.

And then in addition, there's a third part to the business, which is our direct-to-consumer business, where, later this fall, we will test a full Chinese-language, Chinese-currency site, which will initially be fulfilled out of the USA on a test basis, ready for full fulfillment out of China in the middle of '17.

So there's just so many moving parts, Ike, that it really is quite difficult to predict. We don't -- as you know, in terms of the way that we run the business, we don't spend that much time looking into the crystal ball to try and predict what will happen. We try and follow the pattern of test and learn.

The most important thing is to get the business stood up with the right brand presentation in the right way, see what happens, and then be flexible and agile and adapt as necessary. But I'll probably be able to tell you more when we get to our investor conference later in the fall. .

Our next question comes from the line of Janet Kloppenburg from JJK Research. .

Stuart, I just wanted to confirm my calculation to get to your SG&A guidance for the year that you should be able to get some SG&A leverage in the fourth quarter, even though I think your comp assumption for the fourth quarter is something around flat, using the guidance that you gave us last night in the summary.

I wondered if that was a correct calculation. And then, for Martin, I wondered if you could just tell us, in the core international business, ex the acquisition of China, how the traffic, the tourist traffic is trending and if you've seen any improvement versus prior months. .

Thanks, Janet. We'll start with Stuart for the SG&A question. .

So Janet, we're -- in terms of our current view, we -- as we talked about earlier in the context of Q3, we're expecting some deleverage in Q3, reflecting a more conservative sales assumption. With respect to the fourth quarter, we also have a pretty conservative sales assumption in our Q4 view.

And as a result, also some deleverage, not as much as the third quarter. And that gets us for the year to be -- for SG&A to be roughly flat to what it was a year ago. I think, as you know, you followed us for a long time, we'll work very hard to manage expenses with a tough mind and with discipline.

And we want to make the right investments in our business to deliver great experiences for customers, but we also want to make sure that, over time, we're growing expenses lower than sales. .

Thanks, Stuart.

Martin?.

Yes. So tourism does continue to be down slightly around the world. A couple of areas that I'd point out specifically, I think Russian tourists and Latin-American tourists are the 2 groups of that are most impacted, both out of those geographies and into those geographies. So that's one that I would call out.

The second is tourism to high-profile cities around the world is also down. So if I look at our business in the U.K., we think real strength outside of London, a little more difficult in London and areas where we are dependent on tourist traffic. So overall, about the same pattern in Q2 as we saw in Q1.

And I think that's probably the new normal for the balance of this year. .

Our next question comes from the line of Omar Saad from Evercore ISI. .

I wanted to follow up on the discussion around bralettes and sports bras. Wondering if you're seeing in your data, whether it's through the loyalty program, the Angel Card, kind of insights around behavior around the categories.

Are you seeing consumers kind of dapple in the new types of bras or are you seeing heavy adoption? And when they are buying bralettes and sports bras, does it tend to be incremental to their historical bra purchases? Any insight around the behavior, especially since you can probably get a lot of visibility through your -- through the data you get in your loyalty program, the Angel Card?.

Yes. Omar, thank you. The most significant insight that we've had, and this is, we think, a very important one for us, given how we think about what we do, is that the customer is absolutely a younger customer. And we think that's very important to our business.

We've always been about marketing to, segmenting, targeting customers certainly with a young mindset. And any time, any of our business, we feel like the customer is starting to not be in that target of a young mindset, we get concerned.

And the good news is through our efforts in unconstructed bras, bralettes, sport bras, we're absolutely seeing a shift to a younger customer, which we view very positively. We're seeing some good signs of repeat. But the data around that, not as clear. The data around younger is very clear and very compelling. .

Our next question comes from the line of Dana Telsey from Telsey Advisory Group. .

As you're making the changes, what progress have you seen in combining stores and direct? And what are the guideposts that we should look at going forward?.

Thanks, Dana.

Stuart?.

Yes, Dana, at a high level, and this might seem obvious, but it's important to maybe confirm the obvious.

The integration of how we're presenting product to the customer, the integration of pricing and promotion, the interplay in terms of driving business online versus to store, all of that is happening much more naturally today than it was 6 or 12 months ago.

And I wouldn't suggest from the comment that we've completely nailed that and we've completely figured it out and it's all perfect, it's not. But that coordination is more effective, more natural than it was 6, 12 months ago.

And we'll make, from time to time, deliberate decisions about driving business one way or the other in terms of the channels, obviously, with the customer in mind through all of that. So I'd say we made good progress on that, but certainly, more to do. .

Our next question comes from the line of Lindsay Drucker Mann from Goldman Sachs. .

Stuart, I wanted to follow up on the Victoria's brand and the changes in promo strategy. I was wondering if, now that you're a few months in, you could talk about how much you think the shift in promotional strategy is weighing on your sort of core lingerie business.

So from a comp perspective, what sort of order of magnitude drag it's been? It seems like it's probably been less of a drag than what you were initially thinking about when you talked to us after the first quarter.

And as you contemplate your guidance for the full year, what sort of an overhang you think that is to Victoria's into the back half? To the degree that 3Q had more of a year-over-year comparison, is that even more amplified in the fourth quarter?.

Sure. So we did drive a fair amount of volume in prior years, in 2015 and prior years, through that direct mail promotion that you're familiar with and that we've talked about.

With that said, and again, as I think you appreciate and we've talked about on the call, we've been able to replace a lot of that volume through our targeted promotions, particularly as it relates to the sport bras and bralettes.

The amount of direct mail volume that we're lapping is more significant in Q3 and Q4 in dollars than it was in the second quarter. But Q4, in relation to the total quarter, would be a little less than Q3.

Separately, one way that we were able to drive a lot of volume, and were committed to and did drive a lot of volume in the second quarter, was clearance activity. We wanted to make sure that we ended the season clean, and particularly, as it relates to exited categories.

And so that sales driver, if you will, or that source of sales that existed in the second quarter, we won't really have that opportunity in the third quarter. So able to replace some of the volume. Clearance was also a contributor in Q2.

It does represent pressure in Q3 and Q4, but you should know that we're of a mindset that we're going to offset that volume, whether that's every month or every week, and the right people involved in those discussions, including Les and other leaders the business.

We're working hard to replace that volume and do it in a way that's healthier for the brand and that drives trial and business in core categories. .

Our next question comes from the line of Paul Lejuez from Citigroup. .

Stuart, can you maybe give us the puts and takes on the Victoria's Secret merchandise margin? How much did the fewer promotional offers help versus the clearance of swim hurt, and I guess, weakness on the beauty side hurt as well, if you might be able to help us out there. .

Yes. Thanks, Paul. And in terms of the magnitude, the effect of clearance related to exits and just ensuring that we ended the spring season clean, that drag or that pressure, Paul, was the biggest impact of any of the impacts in the margin rate for Victoria's for the second quarter.

The other pressure that we had -- the next biggest pressure would be related to beauty. And so as you know, we restaged what we referred to as the fantasies business last fall. We believe we improved the product quality a lot, the packaging and so on, a fair amount, which drove some increase in costs, which we were fine with.

But as we've talked about previously, we needed to make some adjustment in pricing this spring to drive appropriate volume in that business. And so that combination of things, along with some use of beauty giveaways to drive business, bra business and other business, put pressure on the business.

And then going the other way, which you mentioned, but not as significant as the 2 things I just called out, was the benefit of the cessation of the direct mail couponing and promotional offers. So those would be the main drivers. .

Our next question comes from the line of Brian Tunick from the Royal Bank of Canada. .

I guess, 2 questions. One, on the exiting of the $525 million, I believe, Stuart, right, you're guiding for about 2 to 3 points of that headwind in the back half of the year. Just wondering if you've informed your view of what the first half of next year, what's the rest of that pressure look like, either is it in the Q1 or Q2.

Just if you have any viewpoints on the $525 million.

And then, I guess, outside of bralettes, can you talk about the core bra launch calendar? How do Les and Jan think about the biggest opportunities in the back half, particularly Q4, for the bra launch versus last year?.

Sure. So Brian, in terms the exits, there will be pressure in the first half of 2017. And we know what we sold in terms of business from those exited categories. And when we get closer to 2017, we'll probably get -- not probably, we'll get more specific about the calendarization of that.

But I think what you know, and you've known us for a long time and we commented about this on the last call, we're going to work like heck and we're optimistic that we're going to replace that volume with growth in other categories. And so we're going to prove that. We're going to do that.

But you should know that that's our mindset and we're taking specific actions to do that this fall. And certainly, we'll work to do that next spring. Does the math get harder next spring in terms the dollar impact of those exits? It does. But again, you should know that we'll be working hard to offset that volume.

With respect to the bra launch calendar and key drivers of bra growth in holiday, a couple of thoughts. You mentioned Jan. Jan hasn't started yet. She starts in early September. But that doesn't mean that we don't have a plan. We do have a plan.

But given competitive aspects, Brian, and so on, and I'm not trying to be, in any way, unhelpful, but we'll be close to the vest about our bra launch strategy for holiday, given where we are in the calendar. As helpful as I want to be to the competition, I'm not sure I want to be quite that helpful. So we'll keep that closer to the vest. .

Our next question comes from the line of Simeon Siegel from Nomura Securities. .

Stuart, just a follow-up on an earlier question.

Just given how much Victoria's Secret sales beat the initial guide this quarter, can you contextualize the beat maybe versus the original expectations? Did the promo reduction or category eliminations have less of an initial impact? How much did that extra clearance activity add to the guide? And then just maybe the corollary, are there any similar variables with the initiatives that could come up over the next few quarters that might impact your guidance?.

So Simeon, thanks for the question. Two things. One, the clearance activity did drive a lot of volume in the second quarter, and some of that was hard to estimate as we entered the quarter. But what we were very clear-minded about is how we wanted to end the quarter with respect to our inventory position. And that was dynamic within the quarter.

But headline answer to your question, some upside related to clearance. And then I would -- the second thought I would register, I'm being repetitive, but it's a theme through the dialogue, is that we drove some good volume in some of these emerging trends in the bra business.

So the bralette business and the sport business were very healthy for us and good growth in the second quarter. And the panty business, we've got some good results there as well. So that's what I would call out. And PINK continued to have a very nice business in the second quarter as well.

But in terms of what was really different, I would say clearance very strong and some good growth in these emerging categories within bras. .

Our next question comes from the line of Roxanne Meyer from MKM Partners. .

Great. One just quick follow-up on earlier comments on BBW. I'm wondering how you think about AUR as a lever in the second half, either through pricing or through mix. It's obviously been an important lever for you and a nice driver of comp over the past few years.

And second, as you think about the bralettes driving a younger, more fashionable customer, how do you think about the potential for increased cannibalization with PINK? I mean, obviously, it doesn't seem like you've seen it, given the strength in PINK.

But how do you think about that? Do you care if there's an increased overlap? And just how are you managing that?.

Thanks, Roxanne. We'll start with Andrew. .

Roxanne, thanks for the question. To your observation, AUR has been a strong driver of growth in sales for Bath & Body Works, both for spring 2016 as well as for the past couple of years. And to your point, some of that is driven by mix in business. So as we've talked about, the home fragrance business has been our strongest growing category.

And that is, in general, at higher retails relative to the balance of our assortment. So that certainly is a contributing factor. But then I would say the other maybe even more important factor is our ongoing, again, testing into how to get paid for investments that we continuously make into the product.

So obviously, one of the key levers in terms of driving our business is constant innovation, constant investment into newness across all product lines in our business. And when we do that, we do extensive testing around our ability to command higher retails that go along with that.

And that is an ongoing effort in our business, one that has proven to be successful again in our past and we would look to continue to be a driver in the future as well. .

Roxanne, with respect to bralettes, we believe that, that business is highly incremental to the bra business. Nothing is ever perfectly incremental, but we believe it's highly incremental.

With respect to how that category interacts or interplays with PINK, PINK has been in the bralette business for a long time and it has a very nice business there with good volume and good growth. We believe that the brand positioning and the customer segmentation in PINK vis-a-vis Victoria's is relatively clear to customers.

And while there's always a little bit of interplay, we believe again that the segmentation, the positioning is pretty clear between the 2 businesses. So I feel good about it. .

Your next question comes from the line of Susan Anderson from FBR Capital Markets. .

I had another question on BBW as it relates to White Barn.

So I guess, when you have a shop-in-shop, I'm just wondering, are the products performing similar to the BBW products? Or are there any differences in performance or price points? And then, also, do you think this is an additional purchase the customer is making? Or is it something that they're making instead of a BBW product?.

Susan, thanks for the question. So in terms of performance in the White Barn stores by category.

Again, in general, the remodels that we do that include a remodel of both the Bath & Body Works portion of the store as well as any addition of the White Barn component, whether it's in the shop-in-shop or side-by-side format, is driving total performance of the overall box.

And so we do see a lift in essentially all categories when we do one of those remodels. Under the covers, we do see a slightly higher growth rate in our home fragrance business associated with, again, that addition of a unique White Barn component. And so that is something that we do see as a result of that real estate strategy.

In terms of different products or new products in those stores, again, there are more home decor aspects in the White Barn portion of those stores, but that is not a larger material portion of the overall performance of those stores.

On your question of whether or not we're seeing that as an incremental purchase, we are absolutely seeing incrementality across all of the aspects of those remodel activities in terms of driving sales across all categories. So yes, we would definitely categorize that as incremental. .

It's Nick. I think the only thing I would add to what Andrew is talking about is, there's also 2 other components to it from a customer perspective. There is an acquisition side of it as we see new customers coming into the brand.

But there's also a renewal aspect of it as customers get reintroduced to Bath & Body Works as both sides of the store or both front and back of the store are completely remodeled. So we have additional benefit from that, too. .

Our next question comes from the line of Matthew Boss from JPMorgan. .

So can you just talk a little bit about the positioning of sport in the marketplace today for you guys? How has it been performing versus maybe your internal expectations? And then just with catalog costs now more in the rearview mirror, not as much pressuring buying and occupancy, what's the best comp to think about needed to leverage B&O for 4Q? And then where do you see that leverage point going next year and beyond?.

Okay. So with respect to the sport business and how we're doing and what's our assessment, it's obviously an important category in the bra business. We think we're well positioned today, generating very significant -- very substantial growth.

But we're working hard to accelerate that growth, and frankly, increase our position and our dominance in that space. And so you're seeing regular flow of new products. You're seeing relatively sharp price points. You're seeing promotion targeted to sport, and we're getting good results.

So we would grade our paper pretty well for the second quarter, with high ambition for the fall season in terms of growth of sport, and particularly sport bras.

In terms of the comp needed for -- to leverage buying and occupancy, given the benefit of the catalog lap there, low single digit would be the breakpoint, if you will, to get B&O leverage within gross margin net of the benefit of the catalog elimination. .

Our next question comes from the line of John Morris from BMO Capital. .

Question, I think, for Andrew, or if Nick wants to weigh in. Wanted to talk -- great operating margins, and we've talked a lot about the upside, the potential. A little bit of narrower gross margin expansion this quarter. And besides some of the things you talked about, I'm wondering if that's entirely due to the remodel program or mostly.

Maybe give us a feel for what to expect there going forward. .

John, thanks. As you saw in our prepared remarks, obviously, buying and occupancy is a growing expense associated with all the real estate remodel activity that we spent some time discussing today.

And if you're looking at the difference between second quarter 2016 versus first quarter 2016, it is that growth in buying and occupancy costs that was the driver of slightly lower total operating income growth in Q2 versus what we experienced in Q1.

And then when we look on a go-forward basis, that buying and occupancy growth we do expect to continue, not only in the back half of 2016, but frankly, into 2017, as again, we continue on this initiative. As I've mentioned earlier on the call, we obviously are seeing very good results associated with the real estate remodel strategy in general.

And so we remain very committed to those investments. But it does have the headwind, obviously, of that buying and occupancy growth. .

John, the only other thing I would just add, just even at kind of a higher level and we've talked about it and it's an additional view, is that Bath & Body Works' operating income rate is very high. And what we're looking to do is reinvest in that business for the long-term health of that business and to accelerate growth.

And whether that's through the investment in real estate that Andrew and Nick have remarked about or other things, we want to balance operating income rate with top line growth and dollar growth. And so the observation about the impact of real estate is there. But again, over a multiyear basis, it's a terrific business.

We want to keep it a terrific business and accelerate growth. And so we're going to invest in the business, and we are. .

Our next question comes from the line of Marni Shapiro from Retail Tracker. .

I have to say your Victoria's Secret fall line, the new colors really do look beautiful. It's quite a change from what we've seen over the last couple of years, and I think it looks fantastic.

Can you talk, Stuart, maybe a little bit about input costs, just where they've been trending, especially through the back half the year at VS and BBW? And can you update us on a couple of things, like wage costs and any pressures, any different pressures that you're seeing or an easing that you're seeing? And I know you pulled back the catalog, so any changes that we should expect to see in marketing at Victoria's Secret that you haven't talked about yet?.

There's a lot in that question, Marni, but that's okay. The most important point I want to register, frankly, in response to the question, and I mean this sincerely, but I think it's the most important thing for an investor to understand about us, is we're not trying to win by being the low-cost player. It's not what we do.

And so you're asking about cost inputs. And I understand, I mean, we're a big company and we do pay attention to costs, whether it's about product costs or other cost inputs in our business.

But what this management team is most focused on is delivering emotional content, great customer experiences, great store environments, great digital experiences, great interactions with store associates, et cetera, and we're willing to pay for that. And great product quality as well.

So are there material changes in input costs related to merchandise fall '16 versus fall '15? I would say no. Are there some changes related to mix? Yes, sure. But in terms of year-on-year cost input related to merchandise, no significant changes. We got a great sourcing organization that does terrific work.

But what they're most focused on is product quality and speed. They do manage cost, but no big changes. With respect to wage inflation, we are seeing that more in the United States, which is, at the end the day, probably a good thing.

As you know from prior conversations we've had, we want to make sure that we're attracting and retaining terrific associates, whether it's at the store level, in our distribution centers, in our home office. And so we're not looking to be the low-cost player in those spaces either.

We're looking to pay for terrific people, ensure that we're getting productivity from those people in terms of sales productivity in stores or other forms of productivity in other parts of our business. But in terms of cost pressures, the wage piece is affecting store selling.

But as you again heard us talk about over time, we believe that through sales growth and other levers that can come from more productive store associates, we don't -- we believe that we shouldn't have, over time, significant deleverage in store selling costs. Lastly, you mentioned the catalog. We did cease producing the catalog this spring.

A big cost in our business. I think, as part of that, you're asking, are there going to be changes in marketing at Victoria's Secret? There already have been and I'm sure there will continue to be more. And so -- and I don't mean that in an unsettling way, but that's just the dynamic aspect of our business.

And we've made some good progress in marketing in the second quarter, but there will be more change in fall. And I'm sure there'll be more change in 2017. .

Our next question comes from the line of Jeff Stein from Northcoast Research. .

Question for Stuart. First of all, Stuart, wondering if you could quantify the lift that the remodels at Bath & Body Works are having on the overall comp in Bath & Body Works.

And secondly, wondering on Victoria's Secret, if you can just give us some idea what percent of their revenues in the second quarter compared to third quarter are on the type of promotions that we've been discussing, such as the $10-off coupon. .

Yes. So when we remodel stores or most of our stores, Jeff, if we have a change in square footage, they're out of the comp base. So you may be asking about how does it contribute to sales growth. We are getting sales growth in those locations, as we've talked about, and we've provided some dimension of that last fall.

And I would say, in general, results have been pretty consistent. But specifically, as it relates to comp, those stores often -- if there's an expansion in square footage of more than 20%, those stores are going out of the comp base. With respect to your second question, it was about the magnitude of volume that we're lapping Q3 versus... .

I think the difference in direct mail Q2 versus Q3, how much... .

Yes, the Q3 dollars and proportion to the base, if you will, are more significant in Q3 than they were in Q2. .

Can you -- any way you can kind of quantify the dimension of that?.

Yes, I want to be helpful, Jeff, but don't want to get too specific, to be honest with you. It's some increase Q3 versus Q2. But as you know, we're going to work hard to offset that volume. .

Great. Thanks, Jeff. And that concludes our call this morning. We want to thank you for your continuing interest in L Brands. .

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