Bath & Body Works Inc (BBWI) 2005 Q1 法說會逐字稿

Welcome to the Limited Brands incorporated first quarters earnings release conference call. [OPERATOR INSTRUCTIONS] Now we'll turn the meeting over to Tom Katzenmeyer, Vice President of Investor Relations.

Welcome to the Limited Brands first quarter earns conference call for the period ending Saturday, April 30, 2005. Before I begin, and as a matter of formality, I need to remind you that any forward-looking statements that we may make today are subject to our Safe Harbor statement found in our SEC filings. Our first quarter earnings release and related financial information are available from our website, limitedbrands.com. The call is being taped and can be replayed by dialing 1-800-337-6551. Followed by the pass code 583. You can also listen to an audio replay from our website.

This is who is with me on the call this morning. Len Schlesinger Vice Chairman and COO. Ann Hailey Executive Vice President and CFO. Grace Nichols CEO Victoria's Secret Stores. Mark Weikel COO Victoria's Secret Stores. Neil Fiske, CEO Bath & Body Works. Tom Fitzgerald, CFO Bath & Body Works. Ken Stevens CEO of Express. Paul Raffin President of Express. And Amy Preston, Vice President of Investor Relations. Len will open the call and we'll follow with a discussion of our financial performance and then Greg, Neil, and Ken will conclude with overviews of their brand.

After our prepared comments, we will be available to take your questions for as long as time permits. Since we will need to end today's call just prior to 9:00 in order to attend our annual meeting, it is important that you limit yourself to one question so that we can speak with as many callers as possible. As always, all results that we will discuss on this call are adjusted results. We believe this adjusted information helps in understanding our financial results. A reconciliation of GAAP to adjusted results is included in the press release and is also available from our website. Now I'll turn the call over to Len Schlesinger.

Thanks, Tom. Good morning, everyone. Obviously we're very disappointed with our first quarter performance. Bath & Body Works had a solid quarter and has great momentum. Victoria's Secret performance although solid against a record performance last year was somewhat below our expectations. We're embarrassed by the performance at Express. And I'd like to emphasize that we are very committed to returning the brand to better performance. The Express team, with significant input from Jay Margolis and the rest of the executive committee are working feverishly to move the business ahead. Ken Stevens will provide you with more detail later in the call.

Now I would like to briefly update you on several strategic initiatives throughout our business. First, within lingerie, in the fall we will begin testing an expanded Pink assortment in about 40 stores. Vic's' expansion will test and include new categories, such as accessories, sportswear and denim and new marketing and will serve as a precursor to the actual opening of freestanding stores in 2006. Second, as I mentioned on our last call, we determined it was important to integrate the Victoria's Secret lingerie and beauty sales forces in order to include the customer experience by creating a captivating and single brand store environment. This integration which began in the first quarter is proceeding extremely well. This activity resulted in a small net cost in the first quarter due to severance costs. And we expect that it will result in cost benefits in future quarters. And more importantly, a much better customer shopping experience.

Within personal care, we're close to finalizing an arrangement with technology and fulfillment partner for Bathandbodyworks.com and are prepared for an October launch. We believe the Web represents significant opportunity for this brand and we are hopeful that we will launch an E-commerce site prior to holiday, obviously in October and begin the process of establishing a full direct capability for Bath & Body Works that will include catalog as well in 2006. We're also pleased to announce the acquisition of New York based Slatkin and Company. An industry leader in the prestige home fragrance category.

Slatkin and Company will operate as a wholly owned subsidiary of Bath & Body Works and will maintain its existing home fragrance brands and separate distribution channels with department stores at specialty retailers such as Neiman Marcus, Sachs, Borgdorf Goodman, and Barney's. Harry Slatkin founder and President of Slatkin and Company will Hold the dual title of President of Slatkin and Co as well as the newly created position of President of Home Design for Limited Brands. He will report to Neil Fiske, Chief Executive Officer of Bath & Body Works. The acquisition is expected to contribute to the overall Bath & Body Works growth plan by helping to accelerate the innovation and brand development in the home fragrance category. Under the agreement Harry Slatkin will provide home fragrance and design expertise and resources to create new collections for Bath & Body Works, White Barn Candle Company and potentially other Limited Brands initiatives.

Finally, in personal care, we have finalized plans to open six new Bigelow stores this year. These stores will be opening in the Chicago, Boston, and New York markets in October of this year. Thanks and now I would like to turn the discussion over to Ann.

Thank you, Len. Good morning, everyone. For the first quarter, sales were roughly flat at $1.975 billion compared to $1.978 last year. Comps for the quarter decreased 5%. Gross margin declined 340 basis points to 30.8% primarily driven by a decrease in apparel merchandise margins. Total SG&A dollar spending increased by less than 1%. This result was an improvement versus our original expectations primarily as a result of management of store selling payroll. On a negative 5% comp, the SG&A rate increased slightly.

I want to reiterate Len's comments about our extreme disappointment with first quarter results. As first quarter operating income declined by $71.1 million. By segment, the results were Victoria's Secret operating income increased by $6.2 million. Bath & Body Works increased by $7.8 million. Apparel operating income declined by $79.2 million. And the other segment loss increased by $6 million. First quarter earnings per share were $0.06 compared to $0.13 last year.

Regarding our financial position, we ended the quarter with $686 million in cash. We have completed our $100 million share repurchase program buying a total of 4.3 million shares at an average price of $23.16 per share. We are pleased to announce that the Board has authorized an additional share repurchase program for 100 million. Both of these programs are part of our ongoing strategy to return value to shareholders. Inventory ended the quarter up 19% per square foot at cost, driven by funding for new product rollouts at Bath & Body Works and Victoria's Secret. Apparel inventories ended the month down 2% per square foot at cost. On a cost of goods available for sale per square foot basis, which measures our cash investment in inventory over the quarter, total inventories were up 19% in the first quarter. And apparel inventories were up 10% as we invested to support our successful wear to work pants business.

Turning to the second quarter, we expect that business at Express will continue to be disappointing. And as a result we are projecting earnings per share of $0.23 to $0.25 versus last year's $0.29 result. This second quarter estimate is based on roughly flat comps, a significant decline in the gross margin rate, and a slight increase in the SG&A rate. For the month of May, we are projecting low, single digit negative comps. For the full year 2005 we expect earnings per share to be about $1.41, which is flat to last year's result of $1.33 adjusted earnings per share plus the $0.08 per share one-time noncash lease accounting charge. This full-year estimate is based on a low single digit increase in comp store sales, a decrease in the gross margin rate and a slight increase in the SG&A rate as we fund investments and operational initiatives to support growth. We continue to estimate 2005 capital expenditures at approximately 600 million.

Before I turn the discussion over to Grace now, I would like to make a few comments about Limited Stores. Limited Stores made good progress in the first quarter. Better sell through of seasonal merchandise reduced overall clearance activity in the quarter resulting in an improved merchandise margin rate. This improved margin, combined with lower SG&A costs in the quarter resulted in a significant improvement in operating income. I'll now turn it over to the leaders of our other brands to discuss their results, beginning with Grace and Victoria's Secret Stores.

Thanks, Ann and good morning. For the first quarter Victoria's Secret stores including Beauty had a roughly flat performance in terms of comps and operating income dollars. Although this result was up against a record first quarter with 15% comps last year, it was below our initial expectations. And this was caused primarily by a result in panties and sleep wear. Victoria's Secret direct had a good first quarter. Sales increased 10% and operating income increased significantly driven by strength in bras, swim wear, woven, and knit tops. The Internet business continues to grow as a percent of total sales.

At stores, poor panty performance was primarily due to an assortment in balance with an overdistortion to V-strings and thongs and away from covered bottoms offerings. These assortment issues are being reworked to better position fall and holiday in response to customer demand. Beauty experienced modest growth with low single digit comps. Growth was driven by our body, color, and hair care categories. Which was primarily offset by a decline in prestige fragrance. Primarily in the very sexy and breathless sub brand. Sleep wear is performing in line with modest expectations. As you recall, we transitioned out of our older, more traditional sleep wear in spring of '05 to reposition to a younger, sexier sleep wear. In hindsight, the pace of the transition may have been too fast. We have been testing the younger, sexier sleep wear line and it has performed well. We are preparing to roll this out to all stores during the third quarter.

We just talked about key issues that were disappointing in the first quarter, but also want to share some highlights with you. While the low expectations, costs in the bra category were in the high single digits on top of double-digit growth last year, driven by the successful launch of the Body by Victoria IPEX. The IPEX Body by Victoria launch was the best launch in the brand's history, with comparable volume to last year's It bra on a fewer size offering. The Body by Victoria sub-brand continues to perform well post launch and is inventoried to continue to meet customer demand. The continue to be pleased with the performance of the Pink sub-brand which is performing in line with first quarter expectations. We have successfully integrated store operations for beauty and lingerie. And are continuing to enhance store management capability and product knowledge to provide a captivating single brand in-store experience.

Looking ahead to the second quarter, the stores are currently featuring the very sexy convertible plunge bra and the launch of the latest prestige fragrance So in Love. In June, we will feature a Sexy Little Things fashion presentation, a category that is doing very well for us in the lead up to the semiannual sale. In July, the back-to-school time period will focus on Pink. The floor set will begin on July 13 and will be supported by a Pink panty sampling and a Pink dog gift with purchase. Thanks and now I'll turn things over to Neil.

Thank you, Grace. Good morning, everyone. Bath & Body Works comps increased 5% in the first quarter and operating income increased by 86% or 200 basis points to $16.9 million. It was our eighth consecutive quarter of positive comps.

First quarter profit growth was driven by significant leverage in volume and occupancy and SG&A costs as spending was basically flat year-on-year. We're pleased with the progress we made in the quarter on several fronts. First, growth was driven by new product introductions. Tutti Dolci, C.O. Bigelow and Le Couvent des Minimes, all important signals to our customers of the brand's transition. Second, we delivered compelling stories for each scene which drove positive comps each month. During the blossom and Mother's Day themes, our most successful, we used fragrance and color with three new editions to our daily beauty ritual line. Cherry blossom, Violet, and Gardenia to lift the business. We launched our biggest ideas during the Bigelow and Le Couvent des Minimes themes with investments in product sampling, trial kits, and in-store testers to encourage new product trial. Lastly, as Len mentioned, we finalized our decision to make our Web E-commerce ready and hope to be ready in time for holiday this year. We believe this capability will further strengthen the dialogue with our customers and better meet their needs.

Turning to the second quarter, stores are currently featuring a summer fun theme focusing on preparing for summer. The theme showcases new fragrances in Tutti Dolci and daily beauty rituals as well as the introduction of our new Goldie color line. Semiannual sale begins June 6 and will run for four weeks. Consistent with last year. Our activities are planned to build on last year's very successful event. Finally in July, we will introduce, Breathe, a collection of mood-enhancing products with six fragrances and 11 skin nurturing formulas. The strategic goal of the Breathe line is to provide an accessible tradeup opportunity to the daily beauty rituals business by offering a modern alternative to everyday body care, upgraded sophistication, and performance. We believe we are well positioned to deliver strong growth for the season. With that, I'll turn the discussion over to Ken.

Thanks, Neil. Good morning, everyone. Express' first quarter financial performance was disappointing and well below our expectations. A significant decline in operating income was driven by negative 21% comps and a higher markdown rate year-over-year. Continuing the progress made last fall, stores and home office controllable expenses in the first quarter were down to last year. Progress and growth continued in pants. But was more than offset by declines in casual bottoms and knit tops. Selling on crop pants in the first quarter was well below our expectations driven by color and fit issues. We expect that the second quarter will continue to be challenging for Express. Although we are doing everything we can to optimize margin. Our priorities are clearing through underperforming merchandise and fixing our fashion issues by the fall season.

To further stimulate transactions in May and early June we are incorporating a series of merchandise specific bounce backs such as a free cotton T-shirt with any Editor or Correspondent pants purchase. To support our second quarter clearance sale in late June, we will use a combination of direct mail and E-mail announcements. In mid-July we will feature a four set focus on denim. We know that one of our timing misses last summer and fall was our launch of wear-to-work during a time period when our customers were focused on back-to-school and denim. This category is an integral component of our growing pants business and reinforces our return to a younger, sexier assortment. Thanks. And now I'll turn the discussion back over to Tom.

Thanks Ken, that concludes our prepared comments. At this time we'd be happy to take any questions you might have. Again I want to remind you in the interest of time and consideration of others please limit yourself to one question. And as a reminder, if you joined the call in progress our annual meeting begins at 9 and we will have to conclude the call just before that. Wendy, we're ready for our first question. o you're request, you may press star two.

[OPERATOR INSTRUCTIONS] Our first question comes from Brian Tunick. Please state your company name.

Thanks. JP Morgan. Grace, just was hoping you could talk about the ticket versus the transaction. Seems like there is still no resistance on your bra prices, but yet beauty was weak. Just trying to reconcile that.

Hi. Mark Weikel is here and I'm going to let him take that question.

Brian, thanks very much. Currently our first quarter transactions and traffic were up about 2%. As we look at the month of April, especially with the Body by Victoria IPEX bra launch, our AURs are up low double-digit increases. We see a continued ability to tradeup throughout the business with little resistance there.

Thanks, Mark. Next question, please?

Thank you. Our next question comes from Emme Kozloff. Please state your company name.

Hi, Sanford Bernstein. In terms of Express the division has already lost twice as much as it earned in all of last year. And '04 was less than half of what it was in '03. Given Q1 is typically the only quarter besides Q4 that's profitable, is there any way for you guys to make up the losses in the next three quarters to just get the business to break even? And from a high level, how much of the business weakness do you think came from just merchandising mistakes versus changing the promotional strategy, et cetera.

We'll divide that question between Ken and Paul. We'll start with Ken.

Yes, without obviously being specific in terms of the numbers for the full year, we are working our way back from a profit standpoint. And right now, we couldn't forecast that we would make that up.

Hi, it's Paul Raffin. As far as the attribution of what went wrong here, clearly our efforts at repositioning Express, employing a strategy aimed at a wear-to-work component of our assortment as well as trading our customer up through better quality and as a result higher average unit retail has clearly not worked. We got fashion wrong, we drifted older. We drifted more expensive. And in fact alienated a large percentage of our total customers. Our goal right now is to win those customers back. We're really focused on two primary components. Most importantly the product aesthetic. We believe Express' DNA has always focused on fashion, it's always focused on being young and sexy and delivering that experience to our customers. Also the assortment architecture has provided our customers with accessible price points.

First and foremost, wear to work, we're discovering can in fact be young and sexy. We're convinced that the integration of wear to work and casual, resulting in a much more balanced approach is the key to more effective repositioning. In our visual merchandising in the past, we've tended to look entirely too segregated. And appearing as though there was two separate brand approaches. We also know that in getting too old for our customers with a lack of excitement and sexiness we just simply turned a lot of our core customers off.

We're also discovering that stable pants need fashion-forward tops and they need them at accessible price points. So the new strategy and the new formula that's emerging is a predictable stable base of pants that have been in fact a successful component of this strategy. Paired with a total reassortment of fashion forward tops. Designed to turn extremely fast. And offer our customer newness on a continuing basis. In the pant category, we've also learned that color and pattern at times have not margined out. So we're being much more pragmatic about reducing both color and pattern and focusing in on some of the more black and neutral colors that our customer has clearly voted for.

Lastly, Express is really going to design with one eye. We have completed the integration of our two design offices into one comprehensive design team focused on a front-to-back cohesiveness that has clearly been lacking within the express stores. We feel as though we're going to -- we're working very hard at aiming at that for the fall launch and at maintaining quality with respect to that integration is going to be part of the effort going forward. Our denim focus floor set in July will be a true integration of lifestyles with all of the key elements of the assortment working together to tell the brand fashion story. It is young, urban, sexy and all about where Express has been.

Paul and Ken , thank you. That was very helpful. Wendy, we're ready for our third question.

Dorothy Lakner, you may ask your question. And please state your company name.

Thanks, good morning, everyone. Just following up on that question or questions on Express, I just wondered if you could define who exactly the customer is, what the age is, what kind of demographics you're looking at. And then also who you view as the competition in the mall likewise for the Limited Stores. Thanks.

Excuse me. Our primary target are men and women between the ages of 20 and 30. We know that approximately 70 to 80% of all these young people have jobs. We are interested in people who have a desire for fashion, who are into design, understand fashion when they see it. And want something that is a little more forward than they might get at some of the other mall competitors.

Where we generally don't talk about specific competitors, clearly market share has been going to brands who get their brand right. And that offer their customers a young, vibrant assortment. There is a tremendous success out there right now clearly with brands that are offering sexy bare tops on a continuous basis that engage their customer in newness. As well as jeans, there is a very strong secular trend in denim right now. In fact, that is one component of our assortment that is currently working. And we intend on amplifying that. Really it gets down to balance and providing that balance to our customers and taking back some of the share that we've advocated through a distortion strategy that hasn't worked?

We want to go to Ann Haley for the same question about Limited Stores.

Limited Stores target customer is slightly older, three to five, seven years than the Express customer. So the assortment is going to be slightly more skewed to a professional wear-to-work without losing the sexy elements, that's a fundamental part of our our apparel brand. And the competitors would be to some extent the same. But they would also include some things like Banana Republic, Ann Taylor, more so than would the Express competitive set.

Time for a new question.

Thank you. Dana Cohen, you may ask your question and please state your company name.

Two things. First of all, Ann, on the guidance for the back half of the year, can you just give us a sense of where you're cutting your expectations sort of by business? And then on Victoria's Secret, I guess I was impressed by the profitability in light of the comp miss, can you just talk about where the offsets were? I would have expected more margin pressure given the comps.

Why don't we go first to Mark Weikel for the question about Victoria's Secret, Dana, and then we'll go to Ann for the back half guidance.

This is Mark. Could you repeat your question. I would like to make sure I answer it directly.

You're basically taking about a nickel out of the back half of the year. I'm just trying to understand is it a specific business. Where are you cutting your expectations?

We're cutting our expectations -- this may be helpful before you get to the Victoria's Secret question. The cut in expectations is coming out of Express. It is not coming out of Victoria's Secret or Bath & Body Works. We expect they will continue to be growth engines in the second quarter and in the back half of the year. But the growth expectations are down in the second quarter and the fall for Express, although they are down more significantly in the second quarter than they are in the fall.

And then Dana, if you can repeat your question that was specific to Victoria's Secret in the second -- in the first quarter.

Well, just given the comp miss, I would have thought operating margins would have been down. You came in sort of flattish. I'm just trying to figure out where the offset was given the sales miss on the P&L.

Well, in the first quarter our gross margin is just slightly off. And primarily we managed our first quarter performance through driving basic performance. In the first quarter -- this may help a little bit. Our bra comps were in the high single digits. And that's on top of mid teens last year. The margin components related to that helped drive the business.

What about SG&A?

SG&A was up slightly. Slightly.

Thanks.

On an enterprise, basis, though, Dana -- this is Ann again. On an enterprise basis, we did have as I mentioned in my comments earlier, we did have a significant upside in selling expense as we were able to tailor our selling hours on the floor to the reduced sales comp. So that was part of the offset. That was a big offset against the gross margin decline on an enterprise basis.

Thank you.

John Morris, you may ask your question and please state your company name.

John Morris with Harris Nesbitt. Can you give us a little bit more color, excuse the pun, on Pink in terms of the growth, in terms of the category, what it is going to look like. Where -- how many stores you're thinking about doing this in. And then similarly, longer-term growth plans for Bigelow, what gives you the confidence that that can be successfully spun off into a separate division.

This is Len Schlesinger. I'll take both of those questions. First on Pink, we continue to be very encouraged with the sales of Pink and the evolution of Pink within the confines of the Victoria's Secret store and the stores organization. And continue to believe that Pink will always maintain some sort of role and presence in the Victoria's Secret store as constituted today. The major agenda we have over the next six months is to take what we affectionately call a solution set of about 40 stores and aggressively test a variety of merchandising and marketing ideas to maximize the learning we have about that customer. And the purchasing habits of that customer above and beyond the standard assortments that we're carrying today.

So as I said earlier, we expect to be able to test a variety of sportswear, a variety of bath leisure, wear a variety of accessories, a variety of pick-ups at the cash wrap and things of that genre. We also expect to begin to play with a variety of in-store marketing and execution ideas that are designed to not only continue to kind of grow that business within the confines of ES, but also as I was saying position us for being able to do free standing stores with a much more significant knowledge base and a much more expanded assortment going into 2006. Hopefully that addresses the issue on Pink.

As relates to the issues on Bigelow, we remain quite encouraged with both sides of C.O. Bigelow. The product assortment going out under the C.O. Bigelow label and the performance of the C.O Bigelow store at Easton. The major part of our test in the remainder of '05 as we go forward with six additional stores is to maintain the differentiation of a Bigelow store and Bigelow customer from a Bath & Body Works flagship store and flagship customer. As part of our test, we're looking at a variety of different configurations of Bigelow spaces alongside BBW spaces to be able to be ensuring that as we go into '06 that we have in fact found a different customer. A different market niche and a different position in the marketplace. We are acutely sensitive to those issues. That's a large part of the agenda for the rest of '05 as we open these six new stores.

Thanks, John. Next question.

Stacy Pak, you may ask your question and please state your company name.

Hi. It's Prudential. It is three, but they are very quick. Grace, why do you believe transactions have been negative for the last several months at VS? Ken, can you talk about how much pricing should be down in the fall? And then Len, could you perhaps address for us what is a realistic time frame to give Express before you would think of spinning it off or selling it off? How long do you give this turn? Thanks.

All right. We will take Stacy's three questions by going first to Grace.

Stacy, I'm going to have Mark answer is the transaction questions. Because he's got all the data sheets in front of him.

Stacy, in the first quarter, our transactions were up about 1% at the brand. The only month that our transactions were negative was in the month of April, which a portion of that was contributed by the Easter shift. So that's where we are in transactions. For the first quarter, our traffic was in line with mall traffic increase.

Stacy, this is Ken. Our -- as you probably noticed, our AUR on women's was up pretty significantly in the first quarter, almost 20%. And men's similar. And we saw basically an inverse relationship between this pricing and our transactions. So transactions were negative at about the same rate. One of the interesting things about our merchandise assortment is that we actually have demonstrated pretty significant pricing elasticity in the wear-to-work pant business relative to the other product categories. As you'll recall, several years ago before we introduced Editor, our average unit price on pants was probably between 20 and $30 and today it is between 50 and $60. When you include denim. In the other categories, however, we have not seen the same elasticity. As we go forward to fall, you will see a much greater percentage of entry price points, especially in the key categories of knits, sweaters, and denim.

Stacy with regard to the question about what constitutes a realistic time frame for performance at Express at this point. All of our energies are really going in to improving the profitability of the apparel segment as a whole and Express in particular. That's what is constituting both our strategic and our operational time and energy. At the moment we've indicated quite clearly that we have no plans to sell either of those businesses. That got reaffirmed in the context of Les' annual report letter. And while we have always in the past demonstrated our willingness to adjust the portfolio in the name of shareholder value and will always continue to do that, that doesn't drive us right now, having a specific time frame for the disposition of any of our businesses.

Thanks, Len. Operator, let's get to some more questions here.

Kim Greenberger you may ask your question and please state your company name.

Thank you. It is Smith Barney. Grace, can you, or Mark, can you tell us the incremental revenue that's been driven through the Pink business here over the last two or three quarters? And if we could also get the quarterly transaction metrics by brand. I think we have them for Victoria's Secret. If we could get the others that would be helpful. Thanks.

We'll go to Mark for the first part of that and then to Ann.

Kimberly, the Pink sub-brand over the course of the last 12 months has consistently driven probably 5 to 7 comp points. As you might remember, we rolled Pink out in three ways in spring 2004. We've just lapped the first wave. The second and third wave we will lap as we go through July of 2005.

And Ann, for the transaction metrics.

BBW was -- had transactions up 4%. Express combined was down 25%. Limited Stores was down 22%. But please note their profitability was improved. And that gave us a total transaction decline down for the enterprise of down 5%.

Next question, please.

Lauren Levitan, you may ask your question and please state your company name.

Thanks. Good morning. SG Cowen. My question is for Neil. I was wondering if you could give us some insights into your decision to outsource the BBW E-commerce business. Maybe give us some sense if that's a long-term strategy or a temporary one and what kind of profitability targets you would have for that business, both upon launch and over time.

Hey, Lauren, thanks. It is good to finally have a question for Neil here. We're going to divide this up though, we're going to let Len give an overview and then get Neil to talk about it also.

The decision to outsource the startup of BBW.com is driven especially by the fact that we want to get into the market quickly. As we look at our own capabilities, both in terms of distribution of fulfillment given the nature of the HAZMAT requirements associated with large amounts of personal care and the desire to have a substantially more flexible front end than we have right now for the Victoriassecret.com business, we made the conscious decision to start-up this business by outsourcing. It's not intended at this point to state a strategic direction for BBW.com or for Limited Brands direct in any way, shape, or form. It is recognition of the fact that this is far and away the best way to start up this business.

And Neil, to you for your further thoughts.

Thanks, Tom. Consistent with that, the way that we are thinking about this is really to take it in a couple of phases. Therefore the outsourcing decision that we've made is consistent with that phased scale-up approach. Phase one will really be focused this fall on getting our gifting position established on-line and making sure that this is a leverage point for us at holiday. And then at the beginning of next year, January or February kind of timetable, we'll look to start to expand the assortment, including not only our brands, but a number of specialty brands. And so clearly given that staged approach, we thought that the outsourcing road was really the best way we could get at this most economically and with the minimal amount of upfront investment. And we're confident having looked through the numbers that we can get to an operating and economic model that works for us.

Thanks, Neil. Operator we have about nine more minutes that we're able to take questions. Let's get to as many as we can.

Thank you. Mark Friedman you may ask your question and please state your company name.

Merrill Lynch. Good morning, everybody. Len, I was wondering if you could talk about the acquisition. You continue to sell to the various department stores you mentioned. What was -- the key driver obviously was to bring some new fragrance in-house. Just trying to fully understand how much of that mix will be between driving the wholesale and supporting the brands. And then on Pink, as you look to test some stores in '06, any color as to what you would replace that space in the Victoria's Secret stores?

Mark, thanks.

Let me first start with the slack in acquisition. The logic behind the slack in acquisition is consistent with everything we've been talking about over the last couple of years, which is under the name of open market innovation and open market sourcing. We've maintained a predisposition towards looking at great third party brands in the marketplace and being able to consider a variety of ventures with those third party brands up to and including equity participation. This one obviously represents the logical extreme of equity participation in the context of acquisition. Harry Slatkin has a very attractive business right now providing third party support to a variety of those vendors. And we expect for that to continue. It is not intended to signal a change in direction for Limited Brands. Although you would understand at this point we already have a reasonably significant third party business in the home fragrance business with the outsource distribution of the Bendels Candle that goes into sellages Aimen Wardy, Fred Siegel in California et cetera. So we look at that as very much consistent with what we have done in the past and clearly the major emphasis for the growth of the work that Harry Slatkin will be working on and focusing on will be on the opportunities that exist here at home at Limited Brands.

As relates to the question about Pink, I went to some pains to be able to kind of maintain a fundamental belief that we have that a Pink assortment will always right now be part of the Victoria's Secret store as we go forward. So realistically, what we expect to continue to see in the Victoria's Secret stores are reconfigrations of floor space that will reflect the changing emphasis of the varying sub-brands that exist in Victoria's Secret stores as well as the new sub-brands that come into that organization. So Pink represents again one of many opportunities for a reconfiguration of floor space at Victoria's Secret. And it doesn't require at this point any significant strategic work for replacing it there. There's plenty of product across the sub-brands that we have that it can adequately fill Victoria's Secret store. Hope that helps.

Thank you. Dana Telsey, you may ask your question and please state your company name.

Bear Stearns. Can you talk a little bit about inventory plans and for the balance of the year how you're looking at it? We also noticed that the tax rate was a bit lower in the first quarter. What are your expectations going forward? And given the consolidating financial systems that you're doing this year, when do you expect to see the benefit of that? Thank you.

Okay. I'm going to take them kind of in reverse order. The first wave of systems conversion for finance, for part of the enterprise doesn't even happen until August. So we need to successfully get through that. And I would not expect benefit streams to kick in until sometime in '06. So we won't see benefits from that this year. The tax rate question is the result of a state tax settlement. And we never know when those are going to settle. So for your models, you ought to just use the standard rate. Because they settle over time as we are able to get things through the legal system.

With respect to inventory, we expect for quarter two, the numbers to be up kind of middle to high single digits. That's driven by the same kind of factors that we've seen before with investment in the stores and Bath & Body Works driven by new products. The Victoria's Secret direct has some investment to stay in stock. And to fund their initiatives. And the pants business continuing to be funded at the apparel businesses.

Thanks, Ann. Next question?

Thank you. Neely Tamminga, you may ask your question and please state your company name.

Piper Jaffray. The question is really for Ken or Paul. Related to some of the sub-brands that you have in Express. Lilly Protruce is in the stores right now. Just wondering in how many stores you have it in, an update on how it is doing. Moving forward, for back-to-school and for fall. Are you planning to do any more designer sub-brands similar to what you did with Seven as well as Lilly Protruce? What can we be looking for on the horizon?

Yes, that's a great question. Actually the Lilly Tetris cobrand or third party strategy was a very small one aimed at top stores it's an expensive designer line from Italy that sits alongside of Balenciago or Dries van Noten. Clearly part of the exacerbation of the issue I spoke to previously, which was passing along, averaging a retail and price increases to our customer a lot faster than they were ready to absorb them. This trading up phenomenon, we need to go a lot slower. So strategies like that will not be seen in the near term in our assortment. We're getting back to the fundamentals of getting the core assortment at Express right. And that involves continuing to employ our efforts at being as important in the jeans wear side of it as we have been in the pants side of it. And most importantly getting our fashion tops business correct. And that's really the summary of where we stand. There really is no interest in pursuing additional third party relationships at this point.

We're also reviewing the pricing architecture. There are still too many items at both intermediate and higher prices and not enough at opening price points. So the tops business that I referred to, over 80% of that fashion tops business will be merchandised at what we call the good price point strata on our pricing pyramid. We think that that is a strategy to win our customers back.

Thank you Paul. Operator we have time for one last question.

Thank you. Our final question comes from Barbara Wyckoff. You may ask your question and please state your company name.

Hi, under the bell, Barbara Wyckoff, Buckingham Research Group. I guess for Neil, on the Slatkin acquisition, how long will it take to get up to speed and sort of product in the pipeline? Is it possible for holiday '05? And then in terms of Victoria's Secret beauty, how are the Victoria's Secret beauty international test stores doing? I believe they are in the London airports?

Barbara, we'll first go to Len for the question about the duty-free test at Victoria's Secret Beauty.

At this point we remain encouraged by the performance of the Victoria's Secret Beauty product at the three U.K. airports and are now actively considering expansion, both into Germany and Brazil over the coming months under the same conditions that we have in the U.K. It becomes for us a very powerful way to begin to internationalize the brand with our customers.

And to Neil.

Hi, Barbara. The good news on the Slatkin integration, is that it will happen very quickly. In fact it will begin this week. And we've already mapped out the ways in which his company will get integrated into ours. That's number one. Number two, we've been working actually with Harry for quite some time on a consulting basis. And have had sort of a trial run of this. And so, for example, you will see his hand and his influence on our holiday '05 assortment already. And we're just as pleased as we can be with the contribution that he's made. So I expect that we'll hit the ground running with his ability to contribute a wealth of ideas, creative ideas to our home fragrance business. And it will have a material impact beginning this year.

Thank you.

Barbara, thank you very much. Thank you all again for joining us this morning. Pleasure to host this call

Thank you. This concludes today's conference call. Thank you for your participation. You may disconnect at this time.