Good morning. My name is Heidi, and I will be your conference operator today. At this time, I'd like to welcome everyone to the L Brands Third Quarter 2016 Earnings Conference Call. I will now turn the call over to Ms. Amie Preston. Chief Investor Relations Officer for L Brands. Please go ahead.

Thanks, Heidi. Good morning, everyone, and welcome to L Brands' third quarter earnings conference call for the period ending Saturday, October 29, 2016. As you know, we released detailed commentary last night, which is available on our website since our opening comments are briefly planned to end the call at 9:45. As a matter of formality, I need to remind you that any forward-looking statements we may make today are subject to the safe harbor statements found in our SEC filings. Our third quarter earnings release, additional commentary and earnings presentation are available on our website, lb.com. Stuart Burgdoerfer, EVP and CFO; Nick Coe, CEO, Bath & Body Works; and Martin Waters, President of International, are all joining us -- sorry, Martin, who is off-site, are all joining us today. Thanks, and now I'll the turn the call over to Stuart.

Thanks, Amie, and good morning, everyone. While we delivered third quarter earnings results that were within our beginning-of-quarter guidance, we're not satisfied with our overall results. Third quarter EPS declined 24% to $0.42. PINK and Bath & Body Works continue to deliver strong results, and the Victoria's Secret business continues to face headwinds related to changes we implemented in the business earlier this year. Results also reflect about $0.09 of pressure related to our investment in China; the Victoria's Secret Fifth Avenue flagship store; higher net nonoperating expense, principally interest; and FX. The changes we've made within the Victoria's Secret business were proactive, delivery changes that will result in a more streamlined and efficient organization and will accelerate growth in our core categories. 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 making changes to our promotional approach. Our brands are strong, and we are energized about our opportunities for growth. We will continue to leverage speed in the business and be flexible and agile in our approach in order to satisfy customers and maximize profitability. With that, I'll turn the discussion over to Nick.

Thanks, Stuart. So a good start to our fall season. We grew sales and earnings against record results from last year. We continue to leverage and will continue to leverage our speed model to chase into proven winners across the business. We've been able to keep inventory very well controlled, constantly monitoring our position and maximizing our agility. We remain pleased with the results of our real estate activity and will stay in the read-and-react mode to ensure the investment and the strategy are smart. We're very focused on executing Christmas, and we're excited about the assortment. And we will continue to leverage one of our most important disciplines, which is, obviously, staying as close as we can to the customer and read and reacting to her behavior. Thanks, and I'll turn it over to Martin.

Thanks, Nick, and good morning, everyone. As Amie said, I'm joining you from Singapore this morning or this evening my time, where our latest and greatest Victoria's Secret full assortment store opens tomorrow morning. And earlier this week, I was in China with our team there. As I said at our Investor Conference Day a couple of weeks ago, we're very bullish about the opportunities for global growth and continue to be confident about the strength and perception of our brands outside North America. I'd be happy to answer any questions you have. But in the meantime, I'll turn it back over to Amie.

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

[Operator Instructions] Your first question comes from the line of Dana Telsey from Telsey Advisory Group.

Stuart, as you think about the Victoria's Secret business and the gross margin rate, as we go forward, how much -- how do you think about the declines in the merchandise margin before you see a balancing of the new business versus exiting the old business? How much should this gross margin decline of 190 basis points that we saw this quarter, how do you see that transitioning going forward?

Dana, as we go forward, there will be some ongoing pressure in the fourth quarter and probably, to some degree, into next spring. But as we look farther out, I would start with we see Victoria's as a business that should be a high-teens or better operating margin rate business just based on the quality of the brand and the emotional content of the brand and good retail execution, a place where -- consistent with our overall corporate goals. So there will be some pressure in the fourth quarter. There'll be some pressure on the rate probably going into spring of '17. But on a midterm basis, those things will level out and will have improvement in the gross margin rate, the merchandise margin rate and the overall profit rate of Victoria's after the first part of '17. That's how I'd see it.

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

I wanted to ask about some of the things you discussed at the Investor Day, especially around the sport and bralette categories. And any update in terms of your effort to really focus on market share in that category to build up your business there? And any sort of fact that those efforts are and will have on the gross margin line? I guess a little bit of a follow-on from Dana's question.

Omar, it's Stuart. So we're pleased with our results in the sport and bralette categories within the bra business. We drove a lot of unit volume growth, a lot of trial in those segments. And for that reason, pretty pleased with the result. What our company has been able to do pretty consistently over a long period of time is to get to a margin rate and an overall margin architecture that works well for the business over time. And I can think of numerous examples in the business over the years, including a PINK business 5 or 7 years ago that didn't have the same margin rate as the core lingerie business in Victoria's, where through understanding the customer well, great delivery of newness and fashion and leveraging read/react capabilities and speed, we've been able to strike a right balance, an appropriate balance between dollar growth, dollar results and rate. And so we're pleased with our growth, extraordinary growth, frankly, in the bralette and sport bra business intentionally driving trial and unit growth. And as I've mentioned, we're confident that over time, we'll get the right balance as it relates to dollar growth and rate in those categories and in the overall bra business for Victoria's.

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

Nick, at Bath & Body Works, can you talk about your comp performance by location type? I'm just curious what locations -- what types of locations are performing the best maybe on an absolute basis. But also, where did you see the biggest acceleration? If you could talk about different types of location, A malls, B malls, C, maybe street locations.

Paul, let me think here. So we've actually seen pretty consistent results over the last number of years across our real estate in general, and I could say probably the same regionally. So we're not seeing any weird spikes by region. We're not seeing any weird spikes by location. Obviously, where we have put investments into the new real estate strategy -- or rather the remodel strategy, we continue to see very healthy lift in that business consistent with what we've communicated in the past. And as you know, we will monitor that very, very tightly to ensure that we continue to invest in the right locations to get the right return. And that so far has been tightly monitored and that's monitored, and that so far has yielded the results that we would want. So we'll continue rolling out through the end of this year and into next year.

Your next question is from Anna Andreeva from Oppenheimer.

I guess 2 quick ones for Stuart. A question on the fourth quarter guide. Wider range of outcomes for EPS than we historically see from you guys. Maybe talk about what kind of performance are you embedding at the high end and at the low end of the range. And then, secondly, at Victoria's Secret, I think you called out an increase in legal expenses. Maybe talk about what drove that. And should we expect that going forward?

Thanks, Anna. So with respect to the breadth of our range or our forecast, what we would -- what I would say -- what we would say is that the width of that range or the degree of that range has varied from time to time as you look back in our history, and it reflects in the current situation just a wider range of outcome as we forecast the business. And some of that is macro, but more of that has just been, frankly, reflecting the number of changes we've made at Victoria's Secret. And we're trying to be thoughtful about how we run the business. And in addition to an EPS range that you guys are focused on, understandably, we're trying to make sure that within our thinking is a conservative mindset so that we manage inventories and other aspects of our business appropriately if we end up at the lower end of a range of outcomes. So it's a big quarter, obviously. A lot to play for. We believe we have good plans for the quarter consistent with how we think about the business and run the business. We will read, react and adjust week to week and in some cases, day to day depending upon what we're seeing. And the results of various tests that we always run, that we do have a little bit wider range than we've had in the last few years, reflecting fundamentally a little less predictability given the number of changes at Victoria's Secret. With respect to the legal matters that we -- or expenses that we referenced in our precirculated commentary, those -- we would expect that those would not be of an ongoing nature. As you would appreciate, from time to time, businesses like ours have situations that are infrequent, and that's what that represented in the third quarter. Thanks.

From Kimberly Greenberger from Morgan Stanley.

Stuart, my question is on the EPS headwind here in 2016 and how we should think about them in 2017. I'm wondering if you could just bucket them into 2 different sort of broad bucks if you have that detail available. The first, obviously, the temporary or onetime ones like FX hits, the investment in China, preopening rent on Fifth Avenue, maybe there are others. And the second, obviously, there was some EPS headwind here in 2016 from strategic changes at Victoria's Secret and ongoing real estate investments in Bath & Body Works and just inventory management. So I don't know if you have that level of detail with you, but I'm just wondering, what of the -- what are the pieces that were headwinds in 2016 that go away in 2017? And what were the headwinds in 2016 that you expect to continue going forward?

Yes. Thanks, Kimberly. So there will be pressure from the changes at Victoria's Secret, as I've commented on at our Investor Day that continue into the first half of 2017. And the specifics of that, we'll provide the best update that we can, Kimberly, in February when we give our guidance for 2017. The driver or the impact from China, we would expect, will decline in 2017 versus the impact in 2016. Fifth Avenue, obviously, was a unique situation, so that should not recur. Based on what I see today and what we -- what our thinking is at this point, I wouldn't see meaningful incremental borrowing in 2017, so shouldn't be any additional interest drag, which we had some of this year. So the VS pressure will be there for the first half of '17, some ongoing drag from China, but -- in the first part of the year, but that -- we'll lap that pretty quickly in '17. In terms of capital structure, it shouldn't be anything meaningful based on what we know at this point. So hopefully, that gives you some flavor for it as -- and you've following us for a long time. As you know, we'll do a lot of work after we get through this fourth quarter, which, again, is about 50% of the year, tightening up our views and frankly, also making operating decisions based on our results as we really get ready for 2017. But broad brush, that's how we'd see it at this point. Thanks.

From Lindsay Drucker Mann from Goldman Sachs.

Stuart, I wanted to ask a bit about the margin outlook for the fourth quarter. And it seems as if you have some factors that should actually sequentially be helping you in 4Q, whether it's opening the New York City flagship or lapping the beauty relaunch and also, maybe some of the progress you've made in clearing out some of the excess inventory in structured bras that had been an overhang. So can you -- as you think about 4Q and why the outlook for margins isn't a little bit better certainly versus what we contemplated even exiting the second quarter, what are the factors that are sustaining that pressure despite some of the things that I highlighted that might be along for some improvement? Is the structured bra business or the Victoria's business, the core business, is any aspect of that getting worse versus 3Q? Or maybe just helping me square those numbers.

Yes. So an answer to the last part of your question first. We don't have a point of view, Lindsay, that the core bra business, Victoria's is "getting worse" by any stretch. I would say what our guidance reflects. And again, this is dynamic, and we manage it week to week and month to month, is the balance between driving trial and volume, particularly in these 2 new categories of bras that we've talked a lot about, sport bras and bralettes, and balancing that trial and margin pressure -- margin rate pressure with growth in those categories. As you point out, the beauty pressure will diminish, and that will be a benefit in Q4. But just as we laid out a view -- and we're going to work hard to beat this view, obviously, trying to strike the right balance between ensuring that we end the season with clean inventory and really striking a good balance between sales growth and rate. And so as we add that up, there is some -- a little bit of improvement, slight improvement versus the third quarter, but still pretty dynamic in trading those factors off. And again, trying to take a conservative point of view about the rate. And we'll work hard to beat that and we'll see if we can.

Paul Trussell from Deutsche Bank.

You made some comments regarding the impact of category exits both for the fourth quarter and the first half of the year. If you can just maybe elaborate a bit more in terms of detail on how we should be thinking about that impact to the total P&L and the -- any offsetting factors to those category exits.

Sure. So we did provide a little bit more perspective on the sales pressure that we estimate related to the category exits in our prepared commentary that was sent out last night. But in terms of offsets, number one is we're looking to drive accelerated growth in other categories; and number two, as you're familiar with and we've talked about before, we took a fair amount of expense out of the business. So pretty meaningful reduction in expenses related to the catalog at Victoria's Secret Direct, a reduction in overhead at Victoria's Secret and rationalization of some other marketing activity at Victoria's Secret. And so working hard to drive volume in core categories and existing businesses to offset that sales pressure and again, took a meaningful expense out of the business as part of the changes that we began implementing in the spring season of this -- of 2016. So a big offset is on the cost side of the business.

Your next question is from Janet Kloppenburg from JJK Research.

Stuart, I just wanted to talk a little bit about the lingerie business. Total bra and panty sales declined a little bit year-over-year. I think that's driven by AUR. So when you look at the business and consider the growth of the underlying cost in the bralette, should we think that -- along with the sport bra business, should we think that the AUR declines that you're seeing could prevail? Or do you think that this higher AUR structured bra business can gain some momentum as we go through the fourth quarter next year?

Yes. I guess, Janet, thanks for the question. I mean, I would just start with the fact that the bra business is absolutely core to Victoria's Secret. And a growing, healthy, very strong margin dollar growth, bra business is among our highest priorities in our company. And so knowing that, just -- you should know how we think about it, its importance, and what we'll be working towards. There have been some important shifts in merchandise categories. But one of the other benefits is we have -- that offset, at least in part, the lower AURs related to the sport bras and bralettes is we were doing a lot of those $10 off a bra promotions that, as you know, we have stopped doing. And so the timing and specifics of when do we get to meaningful dollar growth in the bra business and the outcomes that are so important to us, we're working through some significant transitions right now. But we're very clear minded about what the goals are, and that's on the line point of view through the organization. And at the end of the day, I'm highly confident that we'll achieve that outcome. But it's a little dynamic right now based on some of the changes in the merchandise assortment and the proactive changes that we've made.

Your next question is from Brian Tunick from Royal Bank of Canada.

Two quick ones. First, on the fourth quarter comp guide. I guess you're saying flat to positive low singles versus, I guess, November, you're guiding low singles. So just curious how we should read into that. And is there any timing shifts on semiannual or anything we should think about? And then, I guess, Stuart, from a capital allocation -- or really, special dividend question we've been getting from investors. You were able to cut your full year earnings outlook, put the CapEx at the high end of guidance, but still maintain your free cash flow range. So just curious how you think about special dividend when you rank your priorities of use of cash flow.

Brian, on the first part of that, the pressure from category exits is a little greater in Q4 than it was in Q3 and most particularly, as it relates to the swim business in the non-go-forward apparel business that we exited. So that pressure is a little greater for Victoria's in the fourth quarter than it is in the third quarter. So that's really the delta that you're asking about or observing in the comp question that you asked. As it relates to special dividend and return of cash, you've also been following us a long, long time. You know what our point of view is about that, which is it's a very important source of return for shareholders and one that we're deeply committed to in a balanced approach between regular dividends, special dividends and repurchases, particularly as it relates to operating cash flow and CapEx and minimum cash levels. We earn a lot of our cash in the fourth quarter, as you know. We generate a lot of our cash in the fourth quarter. And we'll have the right discussions, as we always do, with our board and work to strike the right balance between a lot of interest. And you should know that the planning of any of this stuff, including CapEx, is dynamic. And so we regularly review the performance of our business and make judgments about how to best balance reinvestment in the business, and the results have been very strong to date based on that reinvestment in real estate with IRRs of 20%, 25% or better for both Victoria's and Bath & Body. And that's where the substantial majority of the CapEx is going. But we also take very seriously managing the business appropriately to ensure that we always have to the right cash and liquidity in the business. We've got a strong balance sheet and a very good maturity profile in our debt and a $1 billion revolver, et cetera. But it's dynamic. And a lot of cash generated in the fourth quarter, and we'll have the right discussions with our board as we go through the fourth quarter.

And your next question is from John Morris from BMO Capital Markets.

Just a quick clarification, Stuart, and then a question for Nick and Jen if she's there. In the prepared pre-released transcript -- and we talked -- we touched on the impact, and thanks for pointing that out, for Victoria's Secret for the first half. In terms of comps, potentially negative high -- negative high single. Is -- are we to think -- in terms of impact, are we to think, all things being equal, if your guide had been plus 2% to 3% or possibly singles it's been, would that sort of indicate negative mid-single? Or as far as we can see here, it's more like negative high single. And then maybe if we can just get a quick commentary from Nick and/or Jen if she's there about the outlook for holiday this year versus last year. And I know Jen wasn't there last year, but maybe what she's most excited about, what the differences are, where the -- what you're really most excited about.

So John, as you mentioned in your question, we're trying to be helpful and quantify where we can the effect of exits, including a preliminary view of the impact in the first half of 2017. But I really don't want to get ahead of ourselves and start to provide full 2017 guidance when we haven't really even started the fourth quarter in a meaningful way yet. So I understand your curiosity and why you're curious about it. But again, I don't want to get ahead of ourselves and say, okay, so -- and provide L Brands' total revenue or comp guidance at this stage. It's just pretty immature. But we're trying to be helpful to you and others following the company about the quantification or significance of the exits in the first half of '17. But I don't want to get -- go down a path here where we're now issuing 2017 guidance in early November or mid-November of 2016. Jen isn't with us today. But the Victoria's team is very enthused about holiday, and we believe we have good plans for that business. And one thing that we're sure of is we'll read and react and adjust based on those plans. And we're enthused about having a very strong holiday result through a range of new items and key items and giftable moments, et cetera. And we'll all see how it unfolds. And Nick will comment about their plans for Bath & Body Works. Thanks, John.

Let's start with path. I think we're in pretty good shape from an inventory perspective. So that sets us up well. Most importantly, you know as well as we know, the backbone of our business is agility. And so going into fourth quarter, making sure we're leveraging those muscles so we can react appropriately, frankly, to her shopping trends and/or the environment. And we do know the levers that we need to pull in the event that we need to drive traffic and/or drive units. We very much like our Christmas floor sets. I know you saw that when you were out here, and we continue to be comfortable with that. I think things that we're most excited about probably evolving around understanding how our real estate will continue to perform during that time frame, what type of customer behavior we get both in those side-by-side and in the shop in shops as they're a slightly larger portion of our total fleet than they were this time last year. I think we're excited about a continuation of, frankly, a strong and healthy home business. And obviously, the newness that we've delivered, what will transpire from that, we're excited about a fair chunk of the newness that's coming into the store that -- which should be setting us up well for next year.

Nick, the assortment looks great, and that Easton store looks terrific.

Thank you very much.

Your next question is from Matthew Boss from JPMorgan.

So at Victoria's Secret, what's the best way to think about the evolution of the promotional strategy from here as we move into next year? What inning of change would you say we're in today? And then just how would you rank the underlying same-store sale opportunities to help offset the category drags into next year?

So in terms of change in promotional strategy and where are we in that journey, I would say we're still relatively early in that journey. So we have made some clear decisions to eliminate or reduce broad-based promotions like the free panty and $10 off a bra promotion that drove a lot of activity in the history of the business. Obviously, made an important change in terms of -- the marketing advertising of the business you put in promotion as well around how we communicate with customers with respect to the catalog have made very good progress on driving trial through pricing and promotion in sport bras, bralettes and certain of the Victoria's Secret Beauty categories. But it's a big subject, as you're aware. And how do you think about loyalty and loyalty programs, how do you think about proprietary credit, how do you think about the best ways to communicate with customers over time, these various promotional ideas. And I think -- and others are more heavily involved in this, but I'm involved in it. I think we're still relatively early on. And as I think about that, I think that suggests a lot of opportunity for the business. So that would be my sense on that. In terms of some other things that can offset some of the drag, the most important thing for a business like ours, whether it's Victoria's or Bath & Body or Bendel or La Senza, any of them, is to have great merchandise. They have a very clear point of view about customer and to have compelling regular flow of new key items that -- where she says, "I just got to have that." So that's the most important thing, and we got a lot of talented people working on that and all the major categories of the business at Victoria's. And then the other thing I would mention because we believe strongly that it is a driver of sales growth and comp growth over time is continuing to improve our in-store selling and our in-store customer experience. And we've made some progress on that front. We've been talking about it, as you know, for a number of years. And we laid out our core ideas, if you will. But we would share a view that there is ongoing meaningful opportunity to drive sales growth through continued improvement in the customer experience for our business. So that's just another category of opportunity for us. And maybe lastly, and Nick has spoken a lot about this, but the corollary exists at Victoria's as well. When you get the store environment right, and Nick has talked about the result of a remodeled Bath & Body, and Victoria's has some pretty compelling store designs, that aspect of the experience is also very powerful in these categories and another driver of sales growth in these businesses.

Your next question is from Ike Boruchow from Wells Fargo.

I guess, Stuart, just a quick one. Just looking through the segments in a little bit more detail. Can you help parse out some of the moving pieces in the other segment? Just -- because the losses, I think, came way down in Q2 and now they're higher again in Q3 this year. So just curious what exactly is driving those quarterly puts and takes and how to think about Q4. Not sure if that's La Senza or what exactly we should -- is moving that around.

Thanks, Ike. The year-on-year driver in the other segment for the third quarter was the impact of a number of technology projects that are underway in the business and the expense portion of those projects that's reflected in the other segment. So in terms of the key year-on-year driver, that's what it was, Ike, in Q3.

Your final question is from Oliver Chen from Cowen and Company.

As you do engage in the edits to the promotional strategies, which seem really prudent for the long-term brand equity, what's the interplay with that? And just setting our expectations appropriately for traffic over the medium term. And as we think about omnichannel for the long term, Stuart, what are the features which will continue to integrate bricks and clicks, whether that be buy online, pickup in store and ship from store? And what are the key opportunities you see that make sense for materially continuing to drive a big and relevant part of the business?

Yes. Thanks, Oliver. In terms of promotional strategies and how they affect traffic, big subject, obviously. And as you appreciate, Oliver, a lot of things drive traffic. And I -- we even start with, we believe -- and I'm not trying to avoid your question, I'll get to it, but just trying to share with you how we think. We believe we have a lot of sales growth opportunity with the traffic that we have, if you will, with the steady state amount of traffic even as strong as our conversion rates are. And I think they're among the best in specialty retail. The fact is there are a lot of people that come into our stores that, for whatever reason, we're not able to convert to buyers. And again, our conversion rates are very high. But there's more that we can do with the traffic that we have. So I would start there. Separately, promotional strategies are about striking balance on a number of fronts and certainly, can and do drive traffic into the store. And through some of the promotional changes that we've implemented at Victoria's, we're continuing to evaluate the interplay between driving trial in key categories and the dynamic you're asking about, which is driving incremental traffic into the store. And I think we're learning more about that. And again, we'll seek to strike the right balance. But the most important thing as it relates to promotional strategies is to do things that are healthy for the brand and don't damage the brand over time. But a lot of balances to strike in the short term. With respect to digital, Oliver, in terms of like what's going to be new or different, as you know, we've got terrific digital businesses. The growth for both Victoria's, and Nick can comment about BBW, very, very strong. The biggest opportunity for us in digital beyond continuing to grow the existing platforms well in -- that are primarily focused on North America is to really go after the international opportunity for digital. So as opposed to 1 or 2 additional features for consumer experience, the big opportunity for us in digital beyond what we're already doing is to more aggressively go after that business outside of North America.

Hey, Oliver. So if I bring it up to a slightly higher level for us, we're constantly trying to figure out and indeed, we are evolving the brand. And so the primary focus for us is how do we get the brand to next. And on the assumption that we fundamentally have the identical assortments online and in stores and the identical pricing strategy, that allows us to really go back to basics, which is the #1 goal for us online is to be able to market the brand, drive traffic, use it for storytelling and really use it for launching an information sharing of new products, especially if you go back to the beginning, which is we're trying to continue to evolve this brand. That doesn't negate our responsibility to figure out how to grow the business. And as you've been able to see, we've continued to see very, very healthy growth in there and will continue to invest in different formats, different models and different testing to ensure that we can do both of those. So it's a really important channel, but it's very much a complementary channel and very much used to market the brand.

Thanks much, Oliver. That concludes our call for today. We want to wish everybody a happy Thanksgiving and happy holiday. Thanks.

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