Good morning. My name is Dorothy, and I will be your conference operator today. At this time, I would like to welcome everyone to the L Brands Second Quarter 2017 Earnings Conference Call. I will now turn the call over to Ms. Amie Preston, Chief Investor Relations Officer for L Brands. Please go ahead. .

Thank you, and good morning, everyone. Welcome to L Brands' second quarter earnings conference call for the period ending Saturday, July 29, 2017. As you know, we released detailed commentary last night, which is available on our website..

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..

Denise Landman, CEO of PINK, who is joining us from another location; Jan Singer, CEO of Lingerie; and Greg Unis, CEO of Beauty..

As a reminder, all results that we discuss on the call today are adjusted results and exclude the 2016 special items outlined in our press release..

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

Thanks, Amie, and good morning, everyone. Second quarter earnings per share decreased 31% to $0.48 per share, exceeding our initial guidance of $0.40 to $0.45. The earnings upside was delivered through expense control and nonoperating income gains. The comp decline of 8% was below our initial forecast for a mid-single-digit decline..

Looking forward to the remainder of 2017, we expect continued solid performance at PINK and Bath & Body Works and continued improvement versus our first half results at Victoria's Secret Lingerie and Beauty.

Given our below expectation second quarter sales result, our comp forecast for the third quarter is a more conservative low single-digit decline versus our previous view of up low single digits..

We have strong brands that lead their categories with post connections to our customers. While store traffic, particularly at Victoria's Secret, has been challenging, we believe a large part of the decline is related to the exit of Swim and a pullback in promotional activity versus last year.

Our online businesses continued to be strong with 11% growth in go-forward categories at Victoria's Secret and 16% growth at Bath & Body Works..

Our stores have high sales productivity and 99% of our stores are cash flow positive. We have confidence in our upcoming product launches, and we will continue to leverage our speed and agility capabilities to read, react and fix. We will also continue to manage inventory, expenses and capital spending with discipline..

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

Good morning. My name is Denise Landman, I'm the CEO of PINK, and I've had the privilege of leading this brand since 2002. This morning, I have some brief comments regarding our recent performance..

Building off of a successful spring '17, led by bra and panty performance, the PINK brand management is currently focused on delivering a world-class experience, both online and in stores, for all of our back-to-campus shoppers. Back to campus, one of PINK's perennial milestones as a brand, really exists for multiple reasons.

Number one, it's an opportunity to build an on-trend wardrobe of intimates, lounge and accessories for collegiate girls across America. It's a critical brand engagement opportunity, fortifying our customer's affinity for the brand.

We leverage our agility and read and react, which is a core competency of PINK, enabling us to assess based on current performance those opportunities that are scalable and mitigate any risk. This is of particular importance as we look forward to the holiday season.

I would assert that we remain enthusiastic about the brand's relevancy and its forward performance potential. .

Those are my comments this morning. And I'd like to turn it over to Jan Singer, CEO of Victoria's Secret Lingerie. .

Thanks, Denise. Hi. It's Jan Singer, CEO of Victoria's Secret. It's really great to be on the call today.

Coming into L Brands and to Victoria's Secret with 15 years in beauty, over 10 years in sports and most recently in intimates, I'm really excited to bring Victoria's Secret Lingerie, my passion for the consumer and the customers that we have, the insights that they bring, understanding of innovative, aspirational product creation and their really close understanding of supply chain and agility.

In addition to that, brand programs that are authentic and engaging and will continue to build loyalty and conversion for our existing and new customers into the business..

The vision going forward is that there are many ways to run this offense, and I am on the offense to mine for long-term sustainable growth with 4 clear filters. Number one and always first is knowing her.

Putting the consumer at the center, deeply knowing her today, what she expects from products and experiences that speak sexy to her, not just to him. Number two, solving her sexy, which means really strengthening the core of our business with bras that are our best at in design, innovation, fit and finishing.

Bras with the benefits and key adjacent categories that also bring fashion and fantasy for her are the focus. Thirdly, serving her, where she wants to shop, when she wants to shop in an elevating, engaging, brand-accretive way, all powered by building a high-performing team and culture of diversity and inclusion.

That culture is what breeds innovation. Innovation is what helps us build the best at bras and when we do, we get paid for that work..

My focus right now and for this past year has been on the deep consumer connection, literally beginning the experience with working in stores and being in the market every week since day 1. The consumer connection we have with millions of women is a competitive advantage every day.

From that, we build product in the most excellent, innovative form, resetting how we, as a team, optimize our merch, design, planning, supply chain teams for speed, relevance and innovation is a new way of working and one that I'm excited to bring and lead the team on.

And with the team, we are in -- on the offense of building world-class high-performing talent. We have a balance of undeniable internal experience from L Brands and a balance of new team members that bring a lens of innovative thinking to the mix. That chemistry and competency is job one in building a high-performing team..

This quarter, it begins with bras. The #1 job was balancing the assortment, making sure that we have choices of sexy for her. We have a cornerstone in the business of the push-up bra, and we went to the bralette business and now we're finding a lot of sexy in the middle.

Balancing that assortment and bringing sexy solutions as well as fantasy and fashion in constructed bras is the way to go for us going forward. We're also resetting the panty architecture for the mix business, when she just want cheap and cheerful, fast fashion as well as disruptive single-ticket pinnacle product.

In addition to the time this quarter, we are obsessing holiday. Holiday is an everyday conversation for us, and we plan on coming into the quarter with holiday plans dialed..

Transitioning the team has been our focus this quarter and also, learning from last Retail 101 so that we can write the future together. I'm most excited to see the deep, deep consumer engagement that we have as a team, given the access to the customers. I'm excited to see the reset and return of the right level of loyalty.

We have an incredibly loyal customer today, and building new loyals is a mission for us and reactivating our existing customers has also been a focus..

I'm excited for the future ahead, and it's a pleasure and an honor to be at the brand at this time. I'm now going to turn it over to Greg Unis. .

Good morning, everyone. I'm glad to be here with you this morning. It's been a little over a year since I joined Victoria's Secret, and I'd like to begin this morning with sharing a few thoughts about what we've been focused on in Beauty..

So last fall, we began a journey to create a clear point of view for our brand and for our customer, most importantly, about what we stand for as a beauty business. We narrowed our assortment offering by 40%, and we saw significant increase in our productivity.

That decision allowed us to focus on fewer, more powerful launches within our prestige fragrance business and to create fashion and newness in categories where we can leverage our speed model through the Beauty Park..

So moving on to Spring 2017. We were focused on laying the foundation for healthier businesses across all product lines. Within Q2, by focusing the assortment, we made big bigger and best-selling fragrances are up year-over-year in both stores and digital.

We layered in fashion and newness in our mist collection, lip and accessories businesses, which the customer is responding to. We reduced lead times and continued to get faster. Overall, I'm confident we are headed in the right direction with positive sequential growth..

So looking forward to fall, to this coming fall, we will continue all key strategies, continue to lay the foundation of a healthy business to set up for growth in the future. We will build upon what's working, making big bigger, leveraging our speed model to infuse fashion and newness and testing and learning new ideas..

Thank you for joining this morning. I will now hand it over to Nick Coe to share his opening thoughts. .

Thanks, Greg, and good morning. I'd like to just add really just a couple of words of color to go with the black and white script that we sent out, where we -- you can see we continue to grow the business and the operating income on top of a pretty solid last year..

So I'd like to start by stating the obvious, and that's -- it really goes without saying, our most valuable assets is our brand. And our focus in assets in the last 6 months have been a critical part of us of moving the business forward.

So what's really not visible in the script, so the major investments we've made in 2 really critical areas to help move both the top line and the bottom line, and we've been able to do that at the same time as growing the business..

So during the last 6 months, the last couple of quarters, we've significantly increased the amount of newness, new product categories and new product testing. And that's a pretty big change versus recent history. I'm really referring to newness that isn't just seasonal updates on new fragrance launches. It's significant new newness for the store.

And this has been invaluable for us because it's provided us with some critical insights that will really help us define what's important to keep the brand relevant and remain category dominant..

Secondly, we've continued our disciplined approach in investing in the fleet, making sure the stores are updated, making sure the stores are exciting and obviously, interesting for the customers shopping. And that investment will bring us to the end of the year to about 420 stores, and the investment should continue as we go forward..

And as you know, we talk a lot about the importance of the customer experience, the store experience and how frankly that obviously translates into sales. And I really both of these 2 initiatives contributes significantly to us building the health of the brand, which, once again, is our most valuable asset and really sets us up for success.

So in summary, I think it's important to note, we've pushed hard on these 2 initiatives, and we've done it in a manner that has allowed us to drive top line and bottom line at the same time..

And with that, I'll hand it over to Martin. .

Thanks, Nick. Good morning, everyone. In the international business, we experienced similar overall trends as those that we saw in the first quarter, including softness in Beauty, difficult market conditions in the Middle East, some pressure in the U.K. market, and of course, we continue to make investments in China..

We did see some improvements in our Victoria's Secret franchise and travel retail businesses as well as continued strength in the Bath & Body Works International business.

We continue to be pleased with the first 2 full assortment of Victoria's Secret stores in Mainland China, and we successfully transitioned to the Tmall domestic digital platform with in-country fulfillment back in July. We continue to be very bullish about our growth opportunities in China and around the world.

And 2017 will be an exciting year for us as we continue to establish our business in China and build on our footprint in other geographies globally.

Amie?.

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

[Operator Instructions] Your first question comes from the line of Susan Anderson with FBR Capital Markets. .

I was wondering if you can maybe just give some more color on the lowered guide for the year. It sounds like it's pretty much all traffic related and just lower expectation for sales in the back half. But then also, it sounds like you feel that the Swim exit did impact traffic in second quarter.

So maybe just your thoughts on how you see traffic playing out in the back half.

And then also, on the merch margin front, do you expect it to improve in third quarter from second quarter?.

Thanks, Susan. So it's Stuart. In terms of the guidance, as outlined, we just reduced our assumptions around sales versus what we'd forecasted earlier in the year, so that is the driver. And with that said, we're -- this team is going to work very hard to maximize our opportunities this fall.

As you know, we try to run the business conservatively as it relates to the management of inventory expenses, capital spending. And so we try to be thoughtful about our sales assumption in managing those things. And that same conservative mindset plays through to our guidance.

We did beat the Q1 guidance that we put out and we're on the Q2 guidance as well. But the takedown, if you will, is sales related. With respect to your question or further perspective on traffic, at the end of the day, traffic is within our control.

And we believe, based on brand and product and experiences in stores and online, that we have the opportunity to impact traffic, and we do when we're performing at our best. And so we'll be focused on getting the best result in the back half. But in terms of the takedown, it is sales driven fundamentally. Thanks. .

And just on the merch margin front, do you expect it to sequentially improve from second quarter to third quarter? Or do you feel like you'll have to promote more to drive the traffic?.

We had some merchandise margin rate improvement in Q2, as we reported, and we would expect to have some improvement in Q3 and Q4 as well. .

Your next question comes from line of Kimberly Greenberger with Morgan Stanley. .

Stuart, and I'm not sure if anyone at Victoria's Secret wants to address this as well. But traffic, obviously, seems to be the #1 kind of key ingredient that's missing to drive the go-forward business. You mentioned that you're increasing marketing selectively in the third quarter.

I'm wondering if you can talk about the goal of driving traffic is your new targeted direct mail, pointing you in the right direction.

And are there any other levers that you've got at your disposal to try to drive traffic as we go through the back half of this year and into 2018?.

Kimberly, it's Jan Singer. Thanks for the question. I think that when we use the marketing strategically in a brand-accretive way, we have the opportunity to engage existing customers and make her aware of the new product that's coming.

In addition, we have the opportunity to engage new customers that we believe would really have a great experience with the brand. So the idea is to make sure that what we're doing is brand accretive, inspiring and drives traffic and conversion. So yes, that's a strategy for us. .

And then I would add from a PINK perspective that we enter into a season with a very holistic point of view regarding how we're going to reach out, inform and touch the customer through all relevant digital platforms in addition to pieces that we might mail.

I think above and beyond just trend-right product in the moment, our event strategy, our movable bus tour, which visits college campuses, continues to drive interest in the brand and traffic into the store. .

Thanks, Denise.

Kimberly, did that do it for you?.

I'm just wondering what kind of response you're seeing to the targeted direct mail efforts? Is it helping -- or initially, in those test markets, is it helping to drive traffic to the stores?.

Short answer is yes. We're getting good results. We've learned a lot, Kimberly, as we've talked about over the last 6 to 12 months, and we're seeing pretty strong response to the direct mail activity that we've been pursuing. Thanks. .

Your next question comes from the line of Paul Lejuez with Citi. .

Is there any more detail you can give in the comp breakdown between Victoria's Secret and Bath & Body Works embedded in your third quarter and fourth quarter guidance? So just how you think about each from a transaction versus ticket perspective that's built into the second half. .

Thanks, Paul. So we'll go to Stuart for that question. .

Yes, Paul. As you know, we don't get too granular about guidance by segment because there's variability even at the company level and obviously, further variability as you break it down into parts.

With that said, as we think about it and trying to be somewhat responsive to your question, we would expect stronger results in the businesses that have had stronger recent trends. So that might be an extremely obvious point. But we would expect a continuation and further improvement in all of our businesses.

But in terms of absolute traffic and comp results, the businesses are in different places, as described. We're expecting improvement through the fall season across the Victoria's businesses and a continued strong performance at Bath & Body Works. So that'd really be the color.

But in terms of getting details about traffic for PINK versus Beauty and all that, it just gets so granular. I'm not sure that it's helpful. We plan the business conservatively. We're optimistic about the fall. Bath & Body Works had a strong spring season. PINK had a strong spring season.

And Lingerie and Beauty made a lot of progress as well, and we believe we've got improvement opportunity across the portfolio. Thanks. .

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

We had a question related to panty sales below expectation.

Could you clarify what happened here? Was it an interplay with some of the bra launch performance there? And on that topic of targeted direct mailing and returning to that, what was your framework for thinking about that decision? And what will be different about the program in terms of being brand appropriate in a brand accretive way this time versus in the past?.

Thanks, Oliver. So we'll go to Jan. .

Thanks for the question. On panties, I think there's a few things in play. Number one is we moved from highly promotional free panty conversation into resetting the line and the architecture and making sure that we have content on a couple of different levels beginning.

On the 5-for business, which is our entry price point, the content needs to be absolutely on point, which requires a fast fashion model. We fortunately have speed. So resetting that proposition and getting on our existing speed model is job one.

Number two is we've had some success and we need to build on it in what we call the single ticket and the more elevated panties where we disrupt the marketplace. Our job is to push the edge and bring new sexy silhouettes to the market. And when we do, she comes in and she transacts. So we're resetting that opportunity.

We think that's a part of the -- of, clearly, the growth for panty future. In addition, yes, there's attachment rate to bras as well. And as we bring new product and we bring the logical balance to that business, we'll see that traction in panties. So I'm very confident in the architecture go forward.

I'm confident in using the fast fashion model as well as the more elevated. And I think we'll see a healthier panty business with more loyals going forward. In terms of the mailing, brand accretive offers mean that we're offering an opportunity to trial in a way that we are proud of and we continue to get repeat purchasing at.

And we offer direct connection with the customer in a segmented way that shows to her that we know her and show her new products that are for her. When we do that, it feels personal, and it is, and she comes in and checks out the business. And I think that's what we're trying to build on when we say brand-accretive product marketing. .

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

Jan, I was just hoping to get some clarification on the panty price architecture.

So are you saying that you'll be taking opening price point for panties lower? And if that's the case, how are you thinking about overall AUR for panties going forward? What kind of impact that might have on the business? Would you expect for the panty category to flatten out in coming quarters? Or is this a category that's likely to be a drag as this transition takes shape?.

No, let me just clarify. Thanks for the question. It -- we did not talk about lowering price point on panties at all. In fact, we think there's more opportunity in the upward motion than the down. The 5-for business is the 5-for business, and we've been aggressive about making sure that we're on a price value.

The opportunity I'm talking about is making sure that our team is as fast as possible on content and that the conversation we're having with the customer through the design of that panty is current. We're doing a lot of things to reset, make sure we put more value in those panties but not take price down. In addition, what I -- sorry. Yes, go ahead. .

Okay.

I guess, I was going to ask, will you be changing -- to the degree that panties were often offered as a promotional lever, free panties or panties discounted, do you expect to be further discounting promotional activity on panties, whether standalone or as part of a broader lingerie package promo? And will you be doing anything on your kind of entry price point panties to change the average unit cost? Or should we be expecting overall merchandise margin in panties to be flat or maybe even up?.

I think that when we talk about panties and promotions, it's a balance and we have to be selective. Do I want new customers to know what we have? Yes. Is there a brand-accretive way to do that without giving away panties to everybody that walks in the store? I do believe so. So for me, panties are our business. They're not just a marketing tool.

And we'll be continuing to build that business and getting paid for that work. And we'll balance that with trial when we think that we can get a conversion from that conversation. .

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

Just a follow-up on the conversation we're already having. Can you be a bit more specific on thoughts around units versus AUR in lingerie in the third and the fourth quarter and what the drivers are of that growth given what the comparisons are from a year ago? And then also, just a bit more detail on Bath & Body Works.

Obviously, a good overall quarter, but certainly a slowdown at the end of the period. Just dig a little bit deeper into what exactly what happened in July and what we should expect as we move into August in the second half of the year. .

It's Jan Singer. So I would say, on your first question, as we go to balance out the assortment, especially on bras, from a bralette predominant conversation, we expect to see AURs go up, of course, because constructed bras are bras with benefits and we get paid for that work. So in terms of that AUR conversation, that's our intention. .

Great. And we'll go over to Nick for the Bath & Body Works question. .

I think July for us was really about a transitional month. I talked earlier on a lot about the amount of change, the amount of product testing that we've put in, the amount of differentiated assortment. I mean, July is pretty transitional anyway as we exit sales and start thinking about being in the fall season.

So I really look at that slower slowdown in performance pretty much through the lens of it was transitional and it was about a lot of changes and some very interesting changes under the covers in terms of mix, assortments, et cetera. Thanks. .

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

I guess, my question, first, for Jan. I guess, this T-Shirt Bra launch last month was your first big launch, I think, since you've been at the company. So curious about any learnings you had there.

And as we look into the fall season, how should we be thinking about any big launches at any timing for VS launches versus last year? And then maybe Stuart can talk about the inventory guidance at the end of this quarter.

Is that a bullish viewpoint about the holiday season? Or is that more about timing versus last year's inventory position?.

Okay. So let's start with Jan, T-Shirt Bra. .

All right. Thank you for the question and the opportunity to talk about that for a bit. Yes, we were able to -- actually, a couple of interesting things I'll share.

We actually reduced the assortment in that collection by 30% and made plan in comp last year's 2 different collections with the one assortment, which the assortment was a mix of a few bras, the refresh and 3 new bras. And we saw our product deliver plan -- really on plan.

The most exciting thing about that product was that we brought new customers into the mix and new customers for us in an exciting, fresh way that the silhouettes that are new, not necessarily the existing. So I was really pleased with the execution of that launch, and I was pleased with the results.

And more importantly, the engagement with the customer was exciting. In addition to that, the engagement on social media with the customer about the bra itself was exciting. So I think that was a leading indicator that when we build the business that -- in a way that connects with her and fits and feels good, she will come.

So it's the beginning of the beginning. .

Great.

And Stuart, on inventory?.

Yes, Brian. With respect to inventory, you've been following us for a long time, you know what our commitment is, which is to grow inventory in line with sales. We've done that very consistently for a long period of time. There's nothing that's changed about that point of view.

With that said, we want to make sure that we're in stock and appropriately positioned to have a good fall. In terms of the guidance about the third quarter, I would describe it as consistent with that thinking. It is up a little bit but not significantly, and there's a little bit of timing involved.

But our commitment to manage inventory in line with sales was as strong as ever. And some of this is what we're lapping and cycling. But again, it's a pretty conservative position. We ended the spring season very clean. We've got a lot of agility, which is great. And we'll manage inventory in line with the sales trend. Thanks. .

Your next question comes from the line of Anna Andreeva with Oppenheimer. .

Question on the August guide. Should we still expect comps to be down low to mid-single digits this month? And as we think about 3Q guide for flat to down low singles, maybe talk about which month do you expect to see the biggest improvement to reach that level. And then, secondly, just priorities for cash.

I think you bought back a bit more stock during the quarter. Maybe talk about opportunity for bigger buyback, especially given the stock at these levels. .

Anna, it's Stuart. On the August comp guidance, when we began the month, we said down low to mid. We don't have further comment on that today. The back-to-school period for PINK is an important one. They had a good back-to-school result. But we're not commenting beyond that for August. We report every month, as you know, but no significant update to that.

With respect to cash and -- sorry, sequentially, through the quarter, the biggest change through the quarter will be, as we've described, the diminishing effect of the non-go-forward exit. And so sequentially, that will become less and less as we go through the fall season, including by month in the third quarter.

So that's the additional color we'd provide on the comp. With respect to cash, as you know, we are -- we have a very strong record and commitment to returning excess cash to shareholders, and we had spoken a lot about that. You're familiar with it. We are executing under our share repurchase authorization.

We're also paying a very healthy regular dividend, as you're aware, right now, given recent earnings results at a very high payout ratio and a very attractive yield to shareholders. But we remain committed to returning excess cash to shareholders using regular dividends through repurchase programs and from time to time, with special dividends.

We consult with our board about that, as you would expect. And we'll continue to execute against our authorized programs. So that's kind of where we are on that. Thank you. .

Your next question comes from the line of Ike Boruchow with Wells Fargo. .

I thought I'd try to get Martin involved. I guess, for the back half of the year, I think you guys commented that comps ex China were down in Q2.

What's kind of baked into the back half assumptions in the top line for the international business? And then maybe any update on the operating loss you expect this year from China, given all the investments and how you expect that to scale maybe as you move into next year. .

Great. Thanks, Ike. We'll obviously go to Martin. .

Yes. Thanks, Ike. Thanks for bringing me in. I appreciate it. So yes, the driver of negative comp really in the international business is really all coming out of the U.K. where we're seeing a couple of things happening.

One is the same patterns of business that we see in North America, particularly around the exit of Swim and Apparel and also, the lower AUR in bras. That said, we have seen significantly, I mean really significantly higher unit sales of bras in the U.K. So we are winning share of drawer, which is obviously a positive.

I think the other thing in the U.K. that we're seeing is just generally somewhat of a malaise, and most retailers are reporting that traffic is down, not helped by the terrible incidents around tourism and so on and so forth. So that's really the big story in Victoria's Secret International.

There is some softness in Beauty, but nothing that I would see as being particularly significant. And as we head into Q3 and Q4, we certainly expect to get back into positive comp territory. So feeling optimistic about that. The area where we have seen positive comps in Victoria is in China.

And I think what you should expect to see is that we grow stores in the third and fourth quarter. We have 2 full assortment stores open now. We have 4 more in production. Those are a good and a bad thing, in that we have preopening costs associated with them, which means we have to live with more loss. But of course, getting them open gets us to trade.

We then have 10 to 12 more full assortment stores coming in 2018. In terms of how the loss will be impacted, Q3 and Q4, you should expect to see somewhat of an increase in losses year-over-year in both of those quarters. But the scale of that increase will moderate and will moderate significantly as we get into Q1 '18. .

Your next question comes from line of Omar Saad with Evercore ISI. .

I wanted to ask a follow-up to -- I think it was a comment that Jan made about reactivating some of the Victoria's Secret customers.

Maybe you could kind of talk through what you think some of the reasons are that maybe drove a deactivation, if you will, and what the strategies are -- what caused the deactivation of some of those customers relative to the brand and what the strategies are to engage some of those lost customers. .

Thanks, Omar.

Jan?.

Yes. So I think that I wasn't here more than a year ago, but my understanding getting here was that we had a dramatic shift in our marketing programs, and we needed to do that for a very good reason, so we could reset to get to the right customers at the right level. So perhaps that pause had a conversation with our engagement.

No matter where we are now is really understanding who's in our file and how to reach her best. So we have had almost as much as 40% engagement with customers that we haven't talked to in quite some time. And that's a very positive reconnection for us and an important one to make. .

Got it. So it's really digital engagement.

That's how you're speaking to those customers in leveraging the, I guess, data from your loyalty program?.

That's correct. .

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

This is for Jan.

Jan, as you think of the progress of the new bra launches, how is it developing in your mind and where do you see the penetration of the lower AUR bralettes and sports bras going to or stabilizing at? And then as you think of the new product, store environment, do you see that at all changing in terms of either look or brand?.

Thanks, Dana, for the question. I think I'll take it a little bit high and then go detailed for you where I can. Theoretically, having a push-up bra constructed business is a really important part of the mix. Giving her choices of sexy with bralettes was a good do.

Finding the balance between those businesses with the constructed bras that provide options of silhouette for her is an important, important part of the future. So I think it's important to say that bralettes and unconstructed bras have a place in the assortment, but they trend up and down. And so we're in the business of building bras.

And I think that you and I probably know, if you've worn a bralette for more than a day, trying to wear them from the rest of your life is probably not your best option. So we're in the business of building bras at that have a lot of make and benefit in them, and we're in the fashion business.

So when bralettes trend and they're important, we will have them in the mix, as we do right now. So I think it's about choices and making sure that we have balance in there. And we -- when we start to roll launches forward, like we did with T-Shirt, we see her responding and really excited and the launch is going forward is the same. So it's a balance.

In terms of the stores, what I'm really passionate about is the balance of our selling, being able to be where she wants to shop. So we have a healthy digital business. And bra fitting happens in person.

And as a person who spent 3 months in the store, 6 days a week for over 10 hours a day and became certified as a bra fit specialist for Victoria's Secret, we offer a very life-changing experience in that fitting room, and I'm very serious about that. It can only happen in person. It's a really important part of our experience.

And when you have a retail store that offers an environment with an experience that's elevating, aspirational, brand right, she comes in. So I think when we have a product like bras and we have a place like our stores and we have specialists like our associates, we have a reason to drive engagement in that space. .

Your next question comes from of the line of Matthew Boss with JPMorgan. .

On the margin front, can you just help quantify the level of gross margin decrease and SG&A increase in the third quarter? Help us to think about some of the puts and takes for the fourth quarter.

And then just larger picture, as we move to next year, what revenue growth do you need to leverage SG&A? And is it reasonable to think about SG&A expense leverage next year?.

So it's Stuart. I'll take the second part of that question first. As a general matter, low to mid-single comp, which gets to a mid-single revenue growth, typically will allow us to have slight leverage in our business in a normal period of time, which -- implicit in your question.

You recognized '16 and '17 haven't been normal given the volume declines related to the category exits in the China investments that you're familiar with. So 3% to 5% comp, mid-single revenue gets to slight leverage would be how we think about it.

With respect to the back half of the year, in comparison to the first half of the year, we are making significant investments in real estate. We've moderated those, as you know, in our updated script or our commentary in the script. We took our CapEx guide down $50 million additional recently. So at $800 million versus $850 million.

But with that said, we're making, we think, very important and as Nick commented on, successful investments, particularly in Bath & Body Works and otherwise in real estate. And so it's driving pressure in the occupancy line.

What's different about the back half versus the first half is we're going to have volume increases, dollar volume increases in the back half of the year versus the declines in the first half. And so on a dollar basis, we'll have some variable expenses that run with that.

So on a dollar increase, there'll be more in the back half than there was in the first half driven by volume and again, the percent growth in expenses, including some pressure related to the CapEx and the occupancy. Thanks. .

Your next question comes from the line of Adrienne Yih with Wolfe Research. .

My question is for Jan.

I want to know how many new bra launches do you have kind of scheduled for the next, for the back half of this year versus last year? And then the penetration of bralettes in the third quarter, or actually, the back half this year versus last year and whether you're seeing the AUR lift? And then, Stuart, for you, can you just talk about rent reduction opportunities? What percent of your leases come up for action in the next 3 years and then your longer-term view of the number of stores you should have at each brand?.

Thanks, Adrienne. It's Jan. So in terms of launches, I mean, the edict, I think, if you're in this business, is constant newness. So we will continue to flow constant newness faster than most due to our speed model. So there's a difference between newness in launches, and I recognize that.

We will have the appropriate amount of launches that bring bras that have the right build in them. And when you cadence those correctly, I think that we can create spikes that matter for the business. In terms of the mix, it's less than 5% of bralettes as we go forward.

Again, I think anybody can make a bralette and that was a moment that will come and go and it will come again. But for us, we make constructed bras best. And when we do, even in our bralette business, bralettes that have more construction in them, we get paid for that work. .

Stuart?.

Yes. Adrienne, with respect to the real estate, stores, rent reductions, our thinking has been pretty consistent. Now we review the facts and the data on a very regular basis and take appropriate action and as I mentioned before, reducing our plans in 2017 significantly a couple of times.

But to reiterate our philosophy on it and to be very clear about it, including the example that Jan spoke about a minute ago in terms of that in-store experience in bra fitting, the store part of our business is critical, whether it's fragrance at Bath & Body Works or bra fittings at Victoria's Secret Lingerie or Victoria's Secret PINK or fragrance at Victoria's Secret Beauty.

The in-store experience is a critical part of our brands, our customer experience, et cetera, just inherent in the categories of business that we're in.

Secondly, as you know, our sales productivity, our financial results, our metrics related to our store fleet are very, very strong on the selling foot basis with productivity over $800 a foot in total and continuing at 99% of our stores being cash flow positive.

An additional point I would make is that we are opening and closing stores literally every year. And so based on performance and consumer experience, we very actively manage our real estate fleet. With respect to the number of stores that we should have for the business, at the end of the day, that will be performance based.

Again, a store-based experience, we believe, is foundational to our major brands and it'll be performance based to go. And we see the opportunity for some additional square footage in North America and obviously, significant expansion internationally.

We have a lot of flexibility in the CapEx, and we have a lot of flexibility with respect to our situation in the lower tier malls with co-tenancy and named tenant provisions in our leases and a meaningful number of stores with very short lease term or even month-to-month lease provisions that contribute to our ability to close them when it makes sense.

So with respect -- lastly, with respect to rent reductions, to be frank, it's not a key part of our real estate strategy. You know what they say about real estate, it is about location, location, location.

And the biggest priority or the highest priority that we have with respect to our relationship with our developer partners is to get terrific locations that provide great experiences for customers, a lot of footfall, a lot of sales productivity, a lot of revenue, a lot of profit. And so that's our dominant focus with the major developers.

With that said, we've got a very experienced real estate team and we're not looking to overpay, and we don't believe that we do. But it's not our key real estate strategy to figure out how to get rent reductions.

Our key real estate strategy is to ensure that we're in the right location with compelling store designs that set us up well currently and for the future. So hopefully, that answers your question. .

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

Just a follow-up to Adrianne's question for Jan. What do you think is going to be the bigger game changer, new bra launches or the opportunity to improve existing categories? And then I'm just wondering, obviously, there are many sub-brands within the structured bra business.

I'm just wondering, what percentage of the assortment have you been able to reposition for fall? What do you think you're going to be able to touch for holiday? And then just longer term, how you think about what percent of the assortment needs to evolve?.

Okay. Thanks, Roxanne, for the question. In terms of category, it's a great question. Clearly, we're going to be strong at the core with bras and panties, our best at -- and win that categories. But it's not lost on us, the key adjacent categories matter that we're in.

The sleep business and the sexy lingerie business are categories that have higher velocity at fashion and churn. I think right now, as you can see in trend, lingerie worn on the street, pajamas as apparel is a thing, a real thing. And we are taking our fair share of that business.

It's a fast fashion model, and we're optimizing our speed to get there, brings her back to the store more often than we have at our core, which then gets our core stronger. So I think we have to be really focused on the core and cognizant of the appropriate adjacent categories and how to grow them.

In terms of the changes, I look at it from the beginning. When you walk in the door, it's all yours, team player, all-in day 1. So when -- in the conversation of the product that I personally am affecting, as much as I can, as fast as I can, as ready as they are.

So there's percentage of change that you're feeling right now that I've clearly been focused on from upstream innovation to product creation and assortment. And you'll feel more as the holiday season comes and then again, into '18, it's just a build. But I think starting fall forward, it begins. .

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

I'm curious, Les has talked about, when things were trending downward in the bra business, that the sizes were going up and this was an indication that the customer was getting older. And as you brought bralettes back in, that starts to reverse. So I'm curious of a couple of things.

Are you still seeing that trend? Are you getting your younger customer back in? And then importantly, when she's coming in, you've talked a lot about AUR and the bralettes and the active business.

Is she only buying the bralettes? Is she more price sensitive than she used to be? Or is she buying around the store? And is there any pushback on the pricing of your structured bras?.

Thank you, Marni, for the question. I think we're seeing -- I know we're seeing our new customers come in, and the average age of that customer, in both our existing business, like a BBV Demi and the new businesses of T-Shirt, the customer, we have the demographics of who she is and she is younger.

That's very exciting for us because everybody wants to fill the file with the new as well as engage our important existing high-value customers. So it's not -- a bra is not a barrier of entry for her. When the bra fits and it feels like it's changing her expectation of what it should do in a good way, she's coming in.

And I was more impressed with that when I worked in the fitting room personally. And I will tell you, for instance, the BBV Demi, which is our tried and tested and most famous bra, she is opting into. So that's exciting. I don't see not having a high penetration of bralettes equaling not having a new customer, quite the opposite. .

And then the pricing question?.

In terms of, Marni, one more time?.

Is there a barrier on price or if it fits, she doesn't care what it costs?.

No, it -- there is no barrier for price. And again, what's interesting is the bra itself has a price, but then what she builds her basket to is always much higher.

When you have a bra and we know this, that fits and helps you feel confident, sexy, whatever your goal is, there is really no barrier to price on that, especially one that will work with your body, feel comfortable. I think we've seen time and again, especially from the younger customer.

It doesn't seem to be a barrier at all on our side of the business in terms of constructed bras, no. .

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

Jan, I was just wondering, given some of the softness in panties and sleepwear and the rebuild on bras, if you expected the lingerie comp to match that of the brand, of the Victoria's Secret brand in the second half of the year or if we should expect that to continue to trail as these adjustments are made.

And Nick, I was wondering if you could talk about the newness level in August, and if you felt that you had brought in enough innovation in the month so that we'd see a change from the July trend. .

Thanks, Janet. We're going to go to Nick first. .

I think you're really going to start to see the newness around, more specifically as we get into September, October, November. So a lot of the learnings that took place during the first half of the year has started to impact the assortment more aggressively as you get later on into the year. So I'm looking forward to September.

There's an awful lot of change in newness coming in from there that builds all the way into holiday so that we're sitting in the peak period of the year with probably the most amount of change. .

And Stuart?.

Janet, if I understood your question right, you're asking about the relative level of sales growth for lingerie, PINK and Beauty, if I understand the question completely. .

Actually not. The lingerie business missed comp, underperformed. I think the plan in the second quarter had -- and may have impacted your overall comp performance. So I'm wondering how we should think about the lingerie comp in the third and fourth quarter relative to the overall Victoria's Secret comp. .

Yes, we would -- we believe that with respect to the overall Victoria's Secret comp, we would expect that PINK would have the strongest result and that Beauty and Lingerie, in terms of absolute level of comp, would not be at the same level, but will improve through the fall season. .

Okay.

And can you talk about performance at Sport, Stuart, how that's going?.

I think Jan can speak to it, can provide a perspective on it. Thanks, Janet. .

Sure. Janet, yes, happy to talk about it. I think in general, we're very excited about the sport business. You can see our trajectory over time has been a growth driver, and it is a growth opportunity for the business. At the end of the day, the center of the business is around the sport bra. And we know, no sport bra, no sport for her.

So that's an important part of our business. And again, we're excited with new launches that are coming in that space. Our bottoms business has also been a rapid growth driver for us. The more that we come out with our core, core fashion and then really provocative sport, I like to say, when we're more girl than grrr, we win.

So we have a unique position to be in this space relative to bras and bras and sport having to perform. And the second thing about really sport sexy is strong, and we're on the business of fashion and sexy and we tie those 2 things together. She's coming in. We're also seeing a high penetration of new customers to the business.

In addition, I'm most excited about the repeat customer that's coming in as well. So we're building loyal. It's an exciting category. .

Can you give us a margin outlook there on Sport?.

Janet, it should be very healthy over time. So we would expect, in any major category of business that we have, and sports certainly is one today and we'll have substantial growth potential, but it will has a very healthy margin rate over time. .

Your next question comes from the line of Simeon Siegel with Nomura Instinet. .

Jan, just for perspective, could you quantify how much the aggregate bra AUR is down versus last year? And then just to be clear, your expectation for the moderating lower AUR bra penetration, is that a function of lapping the increased penetration from last year? Or are you expecting Sport and bralette units to decline in the back half? And then, Greg, I know it's quiet on your end this morning, but if you're still there, nice results at Beauty.

Could you help quantify the top and bottom line benefits you'd expect Beauty to contribute to the consolidated back half results and then maybe the margin implications?.

So Simeon, I'm going to take the first part of the question. We actually said in the script that bra -- lingerie bra units were up mid-single digits and total lingerie bras were down high single. So I think based on that math, you can get back to the AUR result in the business. And with that, let's go to Greg for the Beauty question. .

Yes. As I said earlier, we're seeing nice -- we saw in the second quarter nice sequential growth.

And as we think forward to fall, similar to the way that Jan spoke about the evolution of the Lingerie business, in fall, we're really -- we're very excited about what's to come and have learned a lot over the last year and making nice impacts in the business there. .

Simeon, did you have another question in there?.

Yes. Sorry, Amie. So what I meant in the first part was just thinking through the go forward.

So the penetration, the moderating penetration, is that because you're lapping the increased penetration in the lower AUR bras? Or do you actually see the growth in constructed offsetting that?.

It's both, actually. This is Jan. I mean, by nature of that not over assorting the line, something goes in, something comes out. So the mix is changing into constructive bras. By staying close to the customer, we see the demand for that.

So yes, by nature, it's actually both things on purpose, right?.

Your final question comes from the line of John Morris with BMO Capital Markets. .

Nick, if you can give us a little bit more color directionally on the improvement that you're seeing from the store renovations, if you can share any productivity metrics, that'd be great. What the store learning -- what the learnings are there from a traffic perspective, ticket perspective, et cetera.

And then, Jan, I guess, if you can briefly -- I think this really would be from your perspective, I'd be curious to hear a little bit more about your take on the Victoria's Secret marketing.

As you've gotten familiar with it now, thought given to any innovation in the positioning, including the fashion show, et cetera, but just, overall, the brand positioning and how you feel about it go forward, should we expect any changes? But your take on that?.

A couple of thoughts on that. So as usual, we get a pretty wide range of performance from the new real estate. But in general, it continues to meet our expectations that allows us to continue to make those investments. So we see a pretty solid ROI, very consistent with what we've seen, frankly, over the past -- course of the past 3 years.

So we continue to be pretty happy with that. I think the biggest thing is around customer-ship, John. So we see a high degree of new customers coming into the store because it's a better experience, it's a new experience. We see, obviously, overall traffic is up in those stores, which is a key driver to the success behind it.

And I think at the end of the day, the real value in there is it's an opportunity to introduce the brand in its best format and its most exciting format and the opportunity to introduce the newest products in the best format. So we continue to -- in summary, I think we continue to be excited with the performance.

The performance has been consistent, and we'll continue to invest in those stores over the course of the next couple of years until we find out otherwise. .

John, it's Jan. Thanks for getting in under the wire. That's awesome. Number one, most of the time, as I mentioned earlier, but I want to make sure I'm really clear about it, is that the focus is deep customer connection and making great product, job one. So I've spent this year really up in the value chain, way up into innovation, product creation.

Our supply chain, ensuring speed and agility as well as our merchandising assortment. So I'm deep into that space. And without that, I can't market anything. So I'm really excited about the time spent there.

That said, we know the marketing space in total for the universe is changing, and it's about performance marketing and we are embracing that notion. We have the mission of attracting, engaging and converting new customer as well as engaging our existing. Our new CMO will be joining the brand in September, this fall on boarding.

So that is important for the VSL business. And you mentioned the show, though I can't say too much about it, what I will say is Greg and I are deeply connected into this event to make sure that it actually ticks and ties to the business, and we're excited about what that means for our activity and traffic and conversion for holiday. .

Thanks, John. That concludes our call today. Thanks, all, for joining us and for your continuing interest in L Brands. .

Thank you. Ladies and gentlemen, that concludes today's conference call. You may now disconnect..