雅詩蘭黛 (EL) 2002 Q3 法說會逐字稿

Good morning everyone and welcome to the Estee Lauder Companies fiscal 2002 third quarter conference call. Today's call is being recorded and webcast. For opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Dennis D'Andrea. Please go ahead, sir.

Good morning everyone. Thank you for joining us to discuss our third quarter results. On the call today are Fred Langhammer, President & Chief Executive Officer and Rich Kunes, Senior Vice President & Chief Financial Officer. Some of our remarks today contain forward-looking statements, and actual results could differ from those we expect. In addition to factors described on this call, you'll find additional factors that could cause actual results to differ materially from these forward-looking statements in our press release today and in our latest 10Q. And now, I'd like to turn the call over to Fred.

Thank you Dennis. Good morning ladies and gentlemen. I am glad you chose to join us this morning. Let me bring you up to date on our business environments, retail sales over the last three months since I last spoke to you. First, a good news. Our results this quarter came in within the expected ranges we told you in our update in mid-March. Our international business remained strong with Europe growing 12 percent, excluding currency and traveler retail, and Asia rising 8 percent in local currency. All of these growth numbers are very impressive. We're very pleased with our overall international business, particularly strong results from our affiliates. The soft spots continue to be the weak retail in the United States and the difficult traveler retail as well as the fragrance business. Although the retail business has somewhat stabilized, traffic in malls, especially stores as well as our own retail shops, is down.

Now to our third quarter results. Net sales for the quarter increased 4 percent, excluding the impact of foreign currency translation, which cut our growth in half. On a reported basis, net sales increased 2 percent to 1.12 billion from 1.1 billion in the last year's quarter. Net earnings for the quarter were 50.7 million versus 65.1 million in the prior-year quarter, and diluted earnings per share decreased to 19 cents from 24 cents in the prior-year quarter. In product categories, sales comparisons were difficult with last year's quarter when skin care grew high single-digits in local currency and makeup rose in the - in the teens. Skin care had a good quarter with sales in local currency increasing 7 percent. On the reported basis, skin care increased 4 percent to 438.4 million. In these economic times, product newness counts heavily and where they're at the forefront. Advanced Night Repair Eye Recovery Complex in the Estee Lauder division and Turnaround Visible Skin Renewer in Clinique and A Perfect World White Tea Skin Guardian in Origins are just a sample of some of the successful new products that contributed to the positive sales this quarter. Geographically, skin care grew in all regions with the strongest increases coming from Europe, which is very pleasing to us. We continue to take market share in Europe. In makeup, sales increased 3 percent in local currency, while reported sales rose 1 percent to 470.5 million. Noteworthy new products that helped drive sales included Moisture Sheer Lipstick, Ingenious Foundation, and Illusionist Mascara, in the Lauder division. MAC and Bobbi Brown, which are predominantly makeup brands, each had worldwide double-digit sales increases in the quarter owing to new product introductions and additional distribution. Fragrance continues to lag behind. Fragrance sales declined 8 percent in local currency while reported sales fell 10 percent to 156.5 million. Last quarter's tough holiday season, which was particularly difficult for fragrance, left our retailers with residual fragrance inventory and less [indiscernible] orders in the third quarter. This category continues to be directly affected by the shortfall in traveler retail, which is substantially fragrance driven. As a result, most fragrances are trending down. On a positive side, contributions came from T from Tommy Hilfinger as well as Cashmere Mist from Donna Karan. In the hair category, sales increased 24 percent to 49.6 million. Hair care growth came from strong increases in the Aveda and Bumble and bumble, as well as growth in Clinique's Simple Hair Care System. Aveda had solid double-digit growth and good takeaway at retail. Bumble and bumble also turned in double-digit growth. We're very pleased with the steps we've taken in this category, and the progress we've made.

Let me now review our geographic regions. In the Americas region, sales increased 1 percent from the prior year's quarter to 696.5 million. While this is a modest increase, it is nevertheless a welcome sight compared to what we've seen in the US in the last few quarters. However, we're not celebrating it. Store traffic trended soft in January and February and picked up a little in March. We continue to face the reality of a soft retail environment. As a result, I believe it's prudent to err on the -- on the side of caution. In the region, hair care growth was very strong, and makeup and skin care had gains, which [shall] offset weakness in fragrance. In particular, the industry fragrance business in the department stores was off 8 percent for the quarter at retail. On the positive side, most of our newer brands posted double-digit sales growths. In Europe and Middle East and Africa, net sales increased 6 percent over last year on the local currency basis. Excluding the shortfall in travel retail, local currency sales increased an outstanding 12 percent. You will recall that also last year we had double-digit growth in Europe. So this is almost the -- -I believe the third year in a row where we're enjoying double-digit growth, which is strong market share growth. Our travel retail business is still suffering from the reduction in worldwide travel, particularly in Asia. However, we've seen the business come back a little this quarter, particularly in Europe -- down 14 percent compared to 40 last quarter. We expect travel retail to continue to be adversely affected by lower international travel, particularly in Asia for the remainder of this fiscal year. Again, this quarter we had a very strong performance at the affiliate level, particularly the UK, Spain, and South Africa. Our new affiliate in Greece also contributed strong sales. In Europe, several brands including Clinique, Origins, Bobbi Brown and MAC posted strong double-digit gains, while Estee Lauder brand grew high single digits.

Paris Howard]:

If anybody knows how to affect the strength of the dollar, give me a call after this call. Thank you. Asia Pacific had an impressive 8 percent growth over the prior year on a local currency basis. Sales were up in most markets with exceptional increases in Korea and Thailand. Sales in Japan in local currency were favorable this quarter increasing low single-digits. In this region, the Yen continued to weaken further, and we have given back 8-percentage points of growth due to foreign currency this quarter. On a reported basis, Asia Pacific net sales increased slightly to 133.9 million.

Let me now turn towards the future. Our company's legacy is based on a commitment to grow. Although we'll continue our uninterrupted sales growth record this year with an increase of 1 to 2 percent, this necessitates adjusting our cost base and our cost structure in order to align ourselves with our future profit objectives. With this in mind, we're addressing the following areas to achieve cost reductions: Internet, supply chain, globalization and distribution. The objective is to size opportunities for greater efficiency, sustained growth, and lower our cost base. As a result of this effort, in our fiscal year 2000 fourth quarter, we will take a special pre-tax charge of approximately 108 million for restructuring and repositioning certain businesses. After tax, the charge will total approximately 78 million -- equal to about 32 cents per diluted share. Approximately, 45 million of this charge are cash related, which is expected to reduce costs about 43 million annually.

Now, let me tell you the rationale behind these special charges, and I'll begin with the Internet. When we announced our Internet strategy two years ago, our objectives were to build a strong customer database and create attractive marketing opportunities for our brands, as well as provide a convenience for our customers to purchase direct. We accomplished this, and the two million registered users and eCommerce sales we generated so far are in line with our expectation. Our plans included a multi-brand site and we acquired gloss.com to provide the platform and technical expertise for this project. Two years later, as you know, the Internet environment changed completely, and we find it now much more cost-effective to outsource the technical platform, maintenance, customer service, as well as fulfillment. In the next fiscal year, we will outsource future Gloss platform development and maintenance to outside third-party providers who can provide these functions more cost-effective. Outsourcing will allow us to cut costs more rapidly and more rapidly add brands and less expensively offer advanced site features to attract customers and enhance the experience.

A key aspect is that we will retain creative and marketing control. Thus assuring that the overall objectives of the site, enhancing the brand's position, building a powerful customer database, and creating marketing opportunities stay intact. This means Gloss will close its San Francisco offices and consolidate a substantially reduced operation in New York. As a result of these actions, we will record a charge of $24 million for severance costs and asset write-offs. We'll also take a $20 million charge to write off the related acquisition goodwill. Of the total 44 million charge, approximately 5 million are cash items and will generate about 12 million of annual savings.

Next is supply chain. Last year we told you that within our supply chain, there were opportunities to improve efficiencies and operating margins and that we are refining our strategy -- strategic direction related to our supply chain. We have looked across the board at our various operations, departments in the US, Canada and Europe and identified areas where enhanced efficiency and cost reductions can be realized. This phase includes the restructuring and streamlining of certain manufacturing, distribution, R&D, information systems, and quality assurance areas. This restructuring will result in a $16 million charge. These initiatives are indicative of the opportunities ahead. We're currently working on additional distribution supply chain and systems optimization initiatives that will help drive our gross margins, and we'll be sharing with you in the future. This is particularly important because we're too dollar-centric in our production and sourcing activity. Given the strength -- the continuous strength of the US dollar, which obviously puts enormous pressures on the cost of our products. These initiatives will require time, effort, attention, detailed planning, logistical moves, and ultimate effective execution. Having said that we believe the goals we've set in the areas are attainable.

Third, globalization: Last May we announced a global brand structure where we consolidated domestic and international businesses of the various brands under a common leadership. The intent is to have a brand operate globally with a single unified vision. To date, the transition has proceeded successfully without business interruption and benefited each brand through shared ideas, faster decision-making and improved speed to market. We've now taken the next step which has identified overlapping functions and responsibilities that will simplify our organization, including SKU reductions, etc. As a result, we will take a 23 million charge associated with this effort, and we will continue to be aggressive in identifying efficiencies that will further strengthen our global organization. Future programs will focus on aligning our processes and systems with a new global organization to drive down operating expenses.

And now, for the last topic, distribution. As you know, we are in seven distribution channels with some of our brands in over 1,200 -- 12,500 points of sale around the world. We continuously evaluate productivity levels of stores and markets we are in to determine if they meet our financial objectives. We will focus our resource on the most productive sales channels. Given the present circumstances in Argentina and limited prospects in the foreseeable future, we have decided to reconfigure our business in Argentina. Additionally, we decided to close our remaining tommy's shops so that we can focus on traditional department stores, perfumes and travel retail outlets and focus our resources on the fragrance side, which we have successfully stabilized. We will take a $25 million provision for these actions. We believe these are strategically sound steps to strengthen our business by placing resources to drive growth and improve profitability.

To summarize, we're confident in the strength of our company and the soundness of our strategies. We will [indiscernible] for growth but at the same time aligning our cost structure to achieve our operating margin objectives. In the short term, given the reality of the current retail climate, we remain cautious and prudent. And at this point, for the full year we reiterate our sales growth expectation of 1 to 2 percent in constant currency and EPS range from $1.10 to $1.15. We'll update you as the coming quarter unfolds. Now, I would like to hand it over to Rick Kunes, our Chief Financial Officer, to take you through the financial details.

Thank you Fred, and good morning everyone. Turning to our third quarter operating profitability, the company achieved operating income of $81.1 million versus the 105.3 million reported last year. This reflects the decline in operating margin of approximately 2 percentage points to 7.2 percent due to lower gross margin and a planned increase in operating expenses. A gross margin of 71.6 percent for the quarter decreased 140 basis points versus last year's 73 percent, driven by three factors due in part to our efforts to reduce inventory. They were lower production levels and associated overhead absorption, an increase in promotional activity versus the prior-year quarter, and lower than anticipated savings from reduced raw material purchases. This was partially offset by the ongoing benefit of our supply chain initiatives. As of January 1st, we adopted a new accounting regulation, the ITF 14, which relates to the classification of promotional expenses and related revenue. The overall impact increases historical full-year net sales by about 1 to 2 percent and decreases gross margin approximately 5 to 6 percentage points with a corresponding decrease in operating expenses. In the quarter, the incremental effect of this new rule increases sales and cost of sales by 20 basis points and 30 basis points respectively. There is no impact on the value of reported operating income. However, there will be greater volatility in gross margins and operating expenses due to the timing of our promotional calendars. This rule has been applied retroactively for comparability. And on April 16th, we issued a press release reflecting the classified P&Ls for the previous fiscal quarterly results for this year and last year, as well as full-year results for the past four years. Operating expenses as a percentage of sales increased 90 basis points to 64.4 percent, reflecting investment in new distribution channels and sales generating activities in spite of a soft retail environment.

Flavia Rayo]:

Turning to operating profits by region, the Americas decreased $19.6 million to 37.7 million. The decrease was primarily due to soft sales and continued investment behind their brands to drive future growth. In Europe, the Middle East, and Africa, operating income for the quarter declined 2.3 million to $37.3 million versus last year due to the lower results from our travel retail business. Partially offsetting these results were strong growth in several markets led by Spain and the UK Asia Pacific operating income decreased 2.3 million to $6.1 million, primarily due to lower operating income in China, Hong Kong and Malaysia. In Japan, lower planned operating expenses as a percentage of sales led to a higher operating income this quarter. The effective income tax rate for the quarter was 34.5 percent versus 36 percent in the prior year. At this time, our expected effective tax rate throughout fiscal 2002 before nondeductible restructuring charges is approximately 34.5 percent. Net earnings for the quarter were $50.7 million compared to 65.1 million in the prior year. Diluted earnings per share for the quarter declined to 19 cents from 24 cents in the prior-year quarter. Turning towards our financial position, the company's cash position was 469 million at March 31st, an increase of 85 million versus last year. During the nine months ended March 31st, we generated net cash from operating activities of 366 million versus 245 million in the prior year. These funds were used for capital expenditure, dividend repayments, and the repurchase of 1.5 million shares of stock under our share repurchase program.

Now let me brief you -- update you rather on our inventories. At March 31st 2002, inventory was 515 million, a decrease of $115 million versus June 30th 2001, and 26 million higher than last March.

You will recall our inventory was $126 million over last year at the end of this fiscal year'sfirst quarter. At this point, our inventory month's cover is at a similar level to last year, which reflects our efforts to reduce our inventory balances. While month cover is our primary performance measure, our days-to-sell inventory improved to 146 days at the end of March, compared to 146 days at the end of March last year. The debt-to-capital ratio improved to 18 percent at March 31st, 2002, compared to 20 percent last year. Let me now briefly recap the financial impact of the strategic initiatives Fred discussed that will occur in our fiscal fourth quarter. The initiatives focused on several areas including the Internet, supply chain, globalization, and distribution. The aggregate pre-tax charge will be approximately $108 million while after tax it will total approximately 78 million. This will equal about 32 cents per diluted share. Approximately, 45 million of the charges are cash related, which is expected to save about $43 million annually. That concludes my comments for today, and we'll be happy to take your questions now.

Thank you gentleman. Today's question and answer session will be conducted electronically. If you would like to ask a question, please press the star key followed by the digit "1" on your touchtone telephone. Again, that's star "1" on your touchtone telephone. To ensure that everyone has the opportunity to ask a question, we will limit each person to one question and a related follow up. Time permitting, we will return to you for additional questions. Again, that's star "1" to ask a question. We'll pause for just one moment to assemble the roster. And our first question will come from Carol Wilke of Merrill Lynch.

Thanks. Good morning. You saw some nice sequential improvement in the US business that -- you know -- the sales were up. Are you expecting that to pick up even more in the June quarter? Have you see more improvement in April than March?

You know, I'd like to comment as follows. First of all, the calendar was a little different this year. As you know, Easter was earlier and that favored March somewhat. I think that the overall retail situation is still one -- it's good to be prudent from what I see. I don't see a great surge coming in retail. Quite frankly, what we are seeing is that the day-to-day business, the basic business we're doing quite well. In fact, I just discussed the year with the Lauder division, and there we're up 5, 6 percent the last few weeks in basic business. What's not as good is the promotional activity, and that applies not only to our brands but it's an industry issue right now. So there is -- that's based on less footfall in the distribution. That's a clear indicator. So I don't see a great resurgence of the retail climate to be that optimistic right now.

Okay.

Okay.

You know that -- those [who] are doing these gift-with-purchase promotions their transactions are down. So the average unit sale -- the average unit sale during a transaction is going up in value, but the transactions are down, which means less traffic in the stores. What we are seeing in the basic business is that the new introductions of the Lauder inventory and new products is moving in the right directions, generating growth on the normalized basis. So the gift-with-purchase periods, the promotional periods, are somewhat soft compared to last year.

Is that 5 to 6 percent increase in the base business a pretty significant improvement from what you saw last year?

That's a -- I would say that's about almost of a 3, 4 percent improvement.

And final question. Are you still seeing, you know, your take away, the several percentage points ahead of your sell-in on the US business?

No.

In total.

No. I think that's pretty well stabilized now. There is continuous pressure on inventories, of course, but I can tell you that there is additional de-stocking going on at this present time. I think the inventories pretty well approximate now sell through, unless there is a further crisis somewhere -- that the financial condition of a trading partner, demands cash flow issues and lower inventories, but generally, I think that at this juncture sales aresort of an approximate sell-in.

Thanks very much.

Okay.

I'll let Rick answer the financial question, but as far the fragrance is concerned, what I stated in my comments is that in the United States, which is the major fragrance market, that together with travel retail, as well as Europe and the continent -- when you look at the fragrance business at a whole, it's down. In the US, the fragrance business as an industry was down 8 percent at retail in this last quarter. That's what it looked like, and in the travel retail business, our business was down in the quarter roughly about 14 percent. That's an improvement from the 40 percent we had the previous quarter in the travel retail only. Fragrance in Europe is not as drastically down as in the United States, but the fragrance business is also soft there.

I would say so, but I do expect, you know, given the circumstances of last fall that we'll see some growth in the fragrance category in the second half.

Okay.

Flavia Rayo]:

And regarding the savings, Wendy, we'll probably see about 75 percent of those savings in the next fiscal year.

And do you think we'll start to see them kind of sequentially a little bit in the first, more in the second, more in the third, more in the fourth?

Flavia Rayo]:

I think that's a fair statement; but, you know, most of them -- the ones that will happen next year will happen, you know, in the first half of the year, let's say.

Okay, and the number?

Flavia Rayo]:

And the number will be about 75 percent.

Did you ever quantify the savings? I don't think you did last June when you took your first restructuring charge. I think at that point it was early to quantify the magnitude of the cost savings, but have you given us a number in terms of what savings you generated from that last charge, so we can know that, you know, taking charges is worth it?

Yes, I think, we - I think we've made that public, but we certainly, if you call Dennis after the call, he'll share with whatever information we have on that.

Got it. Thank you.

I just want to say this company here, when we go through these programs as you've heard in my comments, we are very meticulous. If there is no pay back in terms of cost reductions, I'm not interested in changing anything in the corporation. The only reason why we are changing things is because we see opportunities to extract cost from our cost structure in order to meet our overall objectives -- meaning that we allocate resource to get more growth and at the same time allocate some of these resources, [that'll]ever fall to the bottom line. So that's the only premise for restructuring or looking at operations.

And is it fair to say, I mean, I guess, the thing that's interesting to me is that last June, I think was the first restructuring charge in the company's history. So for 50 years, since you're going along fine, you didn't need a charge, and now, all of a sudden, we see two within 12 months. And I'm just wondering, you know, is it just the fact that, you know, you Fred are looking at a much more difficult operating environment on the top line, so you've become much more aggressive on the cost side? I just want to make sure that, you know, Estee isn't going to become a perennial, you know, restructuring charge taker and that the business is actually, you know, going to grow and fund itself in a nice high quality way.

Okay. Okay. I think I'd obviously like to respond to that, because there are several issues involved here. First of all, we have to remember and, you know, I don't want to sound defensive, but the fact is that, you know, we have given back $500 million in translation into US dollars alone. That equates roughly -- just on the pure mathematics that equates to about $90 million in profit. Okay? In addition to that, when we look at our cost structure today we're US dollar centric. That means that even after the currency adjustments, 45 percent of our international sales are a soft currency against the US dollar. Our supply base is -- close to 70 percent of our supply base is US dollar denominated. That means that the pressures have been enormous due to the strength of the US dollar, and quite frankly, when I look into the future, I don't see a great deal of relief in the form of the US dollar weakening against international currencies. Therefore, we need to look at our cost base from a longer term and say, look, if we are driving our business growth more in international than in the Americas, we need to align our cost structure to that currency phenomenon. If we don't, we're going to have difficulties achieving our operating margin goals. So this is what this is about, and whenever we see an opportunity to do that we're going to go after it and you'll see that also in the future.

Okay. You're welcome.

Moving on to Catherine Lewis of Morgan Stanley.

Good morning, just a followup on the restructuring. The timing of restructuring cash outlays, is that all '03 -- that the cash outlay portion?

Flavia Rayo]: There'll be some of the cash in the fourth quarter but not a great deal, and most of the cash will be in next year.

Okay and then you mentioned days inventory are 146 days; longer term with, you know, all these supply chain initiatives, where do you think that can go, you know, maybe looking out five years?

Well I don't know about the five years job. The -- the issue is, we're dealing in a hundred countries around the world, in 22,000 SKUs. That's basically our business structure; and the centralized warehousing, when we look at that for instance in Europe, there's no payback, okay?, Because of the relationship of the cost structure versus the inventory carrying costs. So, you know, there's a limit as to how far we're going to drive that and have a financial advantage. So I think that -- will there be further improvement in the inventories management side of it? Yes, there will be. Particularly, now that we've globalized the company and we have less divergence, less SKU proliferation. So I think there will be further improvements, but, you know, there's a limitation in terms of how far we go. We're not -- we're more like a pharmaceutical company in that context.

Okay and then just lastly Fred, when you look at the competitive landscape, you know, your makeup business, it seems like, you know, you've got some [likes of Mac] and some of the newer brands and then hair care, [specially has] to be some distribution expansion. What about skin care and fragrance. It looks like you know, skin care, you know, the Estee Lauder brand has been struggling a little bit and then fragrance, just broadly, your portfolio has been struggling, and what are your thoughts on this?

You know, I feel good about the skin care side. I think if you -- our skin care business has really been impacted by the currency issue in Asia. You know, as you saw this quarter, we had an eight percent growth in Asia, and we reported zero growth due to the currency. So the Asian being the strongest skin care market around the globe obviously has had some impact on us. But I feel very strong about our skin care business. We have hundreds of projects in our R&D, in development, and when I look at what's coming down the pipe, I'm very encouraged in that -- I feel very good about that. And the -- for instance the Night Repair For Eyes, a Lauder product that just won the product of the year award, is doing phenomenal. So I think you'll see some good movement there. I feel also strong about makeup. We are taking market share in Europe. On the local currency basis, we're doing great. The fragrance area, I'm a little more concerned about because that business is so proliferated, you know, nobody is really dominating it. I think if you have 10 to 12 percent market share, you dominate it in Europe, for instance, okay. In the United States, it's a little bit more concentrated based on the distribution channel scenario. But the fragrance business seems to be the toughest category right now. Will it turn around in the future? I think there's a good possibility that it will, but at the present time, it's a scenario where it's just somewhat soft.

Okay. Terrific. Thanks.

Okay.

Next is Amy Chasen of Goldman Sachs.

No, of course that's part of the activity, but I think what we'll do is, we'll layout to you. We're pretty well -- once we're finished with our plan cycle which should be sometime in June, we'll layout more specifically exactly what Ed's been working on and what some of the benefits are going down the road. We already are pretty well through that planning process. We're just finalizing it, and we'll share that more specifically with you. Obviously, part of this, what we're doing now, is part of that old program as well.

I'm sorry. So the 43 million is part of it?

Yes.

Okay. Can you talk a little bit about what you're doing internally to make sure that, you know, all of your senior management and actually even your non-senior management is on the same page in terms of really stepping up the focus on cost savings?

Well, you know. I tell you that -- you know, all the management down to the director level, you know, had their performance based on all -- largely on performance bonuses. So, you know, if you look at the senior group, down to the VP level, 50 percent of their income depends on how the company and how their brands are doing. So you know, there's no -- so, you know, their pocket book is directly affected in terms of how the company is performing. So, you know, you can rest assure that there's a -- the entire company is mobilized to focusing on every nickel in this corporation.

Okay. Just two more last questions. On the promotion, just this comment that you made about, you know, the gift with purchase and purchase with purchase not doing as well. That seems like a pretty significant statement, given that that's been a significant driver of your business in the past. Are you thinking about -- just kind of rethinking this whole thing and maybe doing something dramatic as we are in the industry to make sure that whatever types of promotions that you ultimately do are successful?

Scott Crafic]: Fred H. Langhammer: Well listen, I'll tell you something, we've seen this movie before. You know, gift and promotion activity is somewhat cyclical from time to time. You see one-year, sometimes the gifts are not as buoyant as others and then two years later, suddenly you see the gifts again growing 12, 15 percent. We've seen this movie before. There's a direct correlation to footfall in stores as a general. If you have a lot -- if you have buoyant environment with a lot of people in the malls, you're going to have a great promotional period, because you're going get a lot of impromptu people also buying into your product. If you have less footfall and when you control like 20 to 25 percent of the transactions of the department and you have 10 percent decline in traffic, you're going to feel it, whether you like it or not.

Well, I would've thought it would've been the opposite. I would've thought that the gift with purchase would've brought people into the stores and then it would've been the base business that would've been weaker.

Well no, but they do bring people into the stores, it's a question of how many. If we bring in 250,000 and then the following year you bring in 200, that's a substantial difference. So there's two components to it. Obviously, the promotional schedule of the store as well as our brands are not drawing as many customers today as they did last year. That is true to our competitors and it's true to us. But I wouldn't say that this is an indicator that the promotions are no longer important.

No, no. I wasn't -- I was just wondering whether you were rethinking the type of promotions that you do?

Well, I think we are, and we've already moved a lot of resources to special events and, you know, and also, you know, driving new product introductions for a longer period of time than traditionally is the case. So we already are reacting to this phenomenon. We're not sitting there, you know. Our belief in the basic principle is that doing the same thing over and over again and expecting different results is not going to work. So whatever the environment dictates, we're adjusting our overall strategy to achieve growth.

Okay. Last question. Given the fragrance environment, are you guys still going to do you know, big mega launches the way you've done in the past couple of years or are you going to, kind of, stay away from that?

No. We still got to do substantial launches that we have. Some great activity going on, you know, the -- one of the highlights of the fragrance scenario, if you were to ask any US retailer is the fact that the Donna Karan Cashmere Mist fragrance is going in the twenties even in this difficult environment, which is sensational. We're launching a new version, which is -- which is going to be substantial called Black Cashmere. Intuition is launching a men's fragrance, Tommy T is being introduced as we speak. So we'll continue to introduce fragrances and drive that category. As I said in previous calls, the fragrance category is the easiest way to bring new customers into your franchise and also is an important contributor to the travel retail business. So things will improve in the future, and we need to be in a position to make sure that we have production order.

Okay, thank you.

Moving on to Sally Dessloch of J. P. Morgan.

Yes, good morning. I wanted to ask a little bit about the company owned stores. If I heard the remarks correctly at the outset, it sound like traffic is a little bit light there, in addition to seeing light traffic in the department stores. So I wonder if you could tell what your saying store sales growth was for the quarter, and how it trended at the quarter progressed, and then, how the current environment might affect your strategy with regards to opening additional stores?

Flavia Rayo]:

Okay. Let me just share it with you what -- my thoughts on this is. When I said department stores, I didn't just isolate department stores. What I am saying is that the traffic in malls is down. That's the key. Now, -our own stores -- you know we enjoyed excellent retail sales [indiscernible], and that basically has now dropped down to -- if I look at the last month, down to about 4 percent growth. You know, we were trending at the single high-digit or double-digits depending on the brand. So that ofcourse has changed somewhat, and so that's slowed down as this is basically as a result of lower traffic in the malls generally.

And would you say that that accounts 4 percent run rate with consistent throughout the quarter or did it get better or did it get worse?

You know it was worse in January and February, and its gotten better in March, and I see it a little better as well in April.

Okay. And does this affect your strategy in terms of how rapidly you might want to open additional stores?

Flavia Rayo]:

Not at all, but, you know, we were around 400 etc., and our target was always about 500. There is nothing changed in the fundamentals of our strategy. We're committed to that strategy. It's working well for us, and I think even in this environment when you look at the there are a lot of the store operators out in the malls today - they have a 4 percent comp [door] increase, they would be extremely happy. So we're not ecstatic about the 4 percent growth, but given the environment, I would say, you know, I'm not - certainly not of a mind to change core strategy based on that.

Okay, great. And then, I think, Rick, in your comments about operating profit by category, I think you mentioned that one of the drivers of the makeup profit decline was less than expected sales. Could you just elaborate on that a little bit? Where did you run shy versus what you thought you thought you were going to do?

Flavia Rayo]: You know our overall plans for the year, I mean coming into this fiscal year, was a slower growth in the first quarter, but then -- you know a steadily increasing sales growth in ending of the year. You know, our original plans were growth of about 7 to 8 percent. I mean obviously, we're much lower than that. So, you know, the reference to lower than planned sales is applicable really to all categories, but in particular -- with that particular category, that's the only thing that 's really bad, and the gross margin erosion is the two things that's affected.

Okay.

Flavia Rayo]:

We're also against a very difficult comp last year as well.

Okay, great. And just one quick follow up question on the inventories. You know, the progress from the end of December to the end of March, I thought, was even a little better than what I might have expected. Could you comment on what happened with finished goods inventories, because I think that was the one place where we haven't seen a lot of progress so far?

Flavia Rayo]:

Well, what happens here is when you drive inventory down, you have to do it in a way that you don't affect your service level at the same time, because business is tough enough. You don't want to run into out-of-stock situations, and what you do is you certainly [prepare] yourself if inventories are lower generally, that you kind of respond quicker. Responding quicker, you can't with components, you have to do it in finished goods, and that's basically been the focus that we've managed to bring inventories down, at the same time, have maintained our service level in terms of shipping into the stores.

And yes, just specifically our finished goods inventory is about 25 million higher than March last year, but I mean that was -- in some respect, that's something that is expected, because we added -- we changed from affiliate to distributors, you know, which happened after the third quarter of last year. We also launched -- you know, expanded our inventory in Europe to support our newer brands. So -- I mean that number is kind of anticipated. So, you know, our finished goods inventory is pretty much in line.

I think it would be probably good for information when we do our next call. We 'll present inventory on a comparable basis versus last year, because obviously our activity of entering new distribution channels and expanding there are building some inventory areas, which are not comparable. So what we'll do is we'll present inventory based on a comparable distribution strategy from the previous year versus this year, so that you can have a better understanding.

That will be teriffic.

Thank you. It seems that in your fragrance business, it could be that new fragrances that are brought out are somewhat cannibalizing the sales of the existing fragrance. Is that what's happening, and if so, do you have any strategies planned that could help correct that?

Well, I think it always depends on the position. If you launch a fragrance that is close to an existing fragrance position or the family of the fragrance flavor, then you run the risk of cannibalizing your own business. You know, if you look at the Tommy fragrance for instance, when we launched Tommy T, we didn't put a major expenditure behind it. We spent against it, but not major; because we looked at it as almost as an auxiliary product, and it stabilized the business. Itcontributed something between 20 and 25 percent of the growth. So this is depending on the positioning you are taking. When you're launching a fragrance, which has a quite different position, when for instance Clinique launched Happy, it did not affect at all their Aromatics fragrance because it was totally different position, and there was nothing cannibalistic about it. In fact, the focus on fragrance enhanced also the Aromatics business. So it's -- you have to look at it as a case-by-case basis. In general however, I must tell you in the marketplace itself, new fragrance launches tend to cannibalize some of the older fragrances. That's a fact, particularly in a non-demonstrated environment meaning that if you're going to stores with an open wall, where fragrances are just displayed and you have demonstration, which is not aligned to a specific company. In that environment, newness drives the ball -- drives the gain.

Okay. And, do you have any target in mind for an operating margin for your fragrance business long term for several years? What could be the profitability long-term?

Well I have -- obviously I have one in mind, but I don't want to necessarily share that right now, because it's an intricate scenario. It involves the travel retail business, needless to say, and it involves also different cost structures within the various divisions, you know, because I look at the fragrance business, not purely depending on the brand, not purely on the economics. I also look at it as a traffic generator into the brand of getting new customers into the franchise. So, you know, it's more complete. It's not a black and white sort of a scenario.

You're welcome.

And I would like to remind today's telephone audience that if you do have a question it is star "1." Next we'll hear from Williams Steele of Banc of America Securities.

Thanks. Fred, you've mentioned that the promotional activities is somewhat cyclical.. I wonder if you could tell us in the March quarter what the promotional activity was year over year? Was it up in that 12 to 15 percent range?

Scott Crafic]: No. In the March quarter, the promotional activity was down anywhere from -- I would say 8 to 10 percent.

And how did that compare with the December quarter?

Scott Crafic]: In the December quarter. Well, December -- in the December quarter there is not that much promotional activity because it really is the Christmas period. I'm talking about -- you're talking about gift with purchase.

Yes.

Okay.

When you look at the gift-with-purchase activity in the January to March quarter that was down.

Okay, and as we go forward looking at the $43 million in cost savings, three quarters of it, Rick, that is in fiscal '03. How are you going to re-deploy those cost savings?

Well, some of them may -- I'll take that question, because Rick wants to put it all to the bottom line, but I'll be looking at this as opportunistic to invest in areas where we see growth opportunity, but at the same time, some of it obviously is going to improve our bottom line.

Okay. Thank you very much.

Yes. One thing on that Will is that the 43 million is not all related to , you know, extras gross margin improvements. You know, there's only a portion of that that's related to that, and the rest is related to regular operating expenses.

Okay. Helpful. Thanks.

Yes.

Thanks very much. The growth in the European region was terrific excluding travel retailing. Can you talk about what the growth in the prestige market overall is and how Estee Lauder is driving the growth. Is it new distribution outlets, or bigger shares within [Dublast Saphora]?

Well, the overall growth in the European is -- depending on the continent and UK is a little different. But you're looking at 4 to 5 percent. So, we have been outpacing that growth substantially. We have tremendous growth in the UK, and we're taking market share in the continent. You know, we've -- we're now, I believeas a company, we're the number one in make-up, and we are the number one in treatment in Europe -- as a company, number one or number two; close, okay; And in the fragrance category, we're distant. We are strong in the UK, and we're relatively weak on the continents. Okay. So that's where it is and we've been, as you know -- for three years running now, we have been growing double digit, and we're very pleased with our strategy -- it's primarily in the make-up and skincare sector, and we see more opportunities to come.

Terrific. In moving, you know, when changing from distributor -- well, from affiliate to distributor structure, does this affect regional sales at all?

That affects regional sales in Europe. I would say you're looking at probably a couple of points.

Just a couple of points. This really is great growth. How is the -- because it seems like -- is it fair to say that Europe -- Estee Lauder and Clinique are really the bulk of your European business?

That's correct.

And how is Estee Lauder's -- you mentioned high singles sales in the skin-care business. How is the overall brand franchise doing?

The Estee Lauder franchise is doing terrific in international. You know, we just came through our budget sessions for the fall for next year, and in fact, Estee Lauder brand is now the number one brand in Asia, and it's growing very well, and in Europe, it's also doing well. We have some new ideas in terms of how we present our skin-care products, that we're working on that, and that will even make us more competitive in the perfumery distribution channel. We are very strong in the traditional department store scenario, but we've -- under Patrick Bousquet-Chavanne's leadership, they've looked at maximizing their treatments strategy in Europe, and that requires a little bit of realignment of the product line-up to make it more consumer friendly in a non-demonstrative environment, and they've worked on that, and I think that's going to make a further impact to our market share gains.

Terrific, and just one last one. Can you talk about your experience in US department stores with out of stocks in, you know, December 2001-March '02 relative to '99-2000? Is it really much of an issue?

No, it's not that much of an issue, I must tell you. It's not that much of an issue. We've had, of course, some out of stocks, but by and large, I don't think it's been material to our performance.

No. Not at least with our out-of-stocks and the best performing SKUs is -- it doesn't -it hardly exists. I think we have some out of stocks involved in the peripheral [Marilou] slower moving categories. But, as I said, you know, I can't use out of stocks as an excuse not to achieve higher sales. That's not the case.

Terrific. Thank you very much.

Okay.

Good morning, Rick. In your comments, I think you talked about, on the gross margin line, lower than expected benefit from raw material costs. Could you just talk about which specific raw material's caused the variance, and how that changes your outlook going forward?

Yes. We have certain purchasing arrangements with our major suppliers, which are also based on achieving a certain volume of activity with them, and obviously, with the shortfall in sales and the resulting excess inventory that we had, we've cut back on purchases with some of those suppliers, and that affects, you know, our purchasing agreement. So we don't get quite the pricing that we would have had normally. So that's what I was referring to.

Okay. So it wasn't a difference in the spot rates for raw materials that were [different] [indiscernible]?

No, no. It wasn't to do with the spot rates. I mean, we do take forward cover to cover on our budgetary exposure on purchases. The issue, unfortunately, is that, you know, the dollar keeps strengthening, which makes that new contracts that we entered into a little different rate than the previous one.

There is another element here you have to be aware of, that when we have slow growth like we had -- it is the first time this year and at the same time we are reducing inventories, these two events obviously put enormous pressure on overhead absorption. They are not permanent, but they certainly -- temporarily, they put on enormous pressure. because when you take a $100 million out of inventory that means you are reducing a $100 million less, and the overhead absorption remains with the remaining production. So that obviously will affect us short term.

Great. Thanks very much.

Well, I'll like to go back and revisit your comments about the dollar-centricness in your production and sourcing. Could you tell us what your dollar-based production is and sourcing, and then, what those targets might be?

Well, look, right now, it's roughly 70 percent in US dollar denominated.

Both. So -- 30 -- you know, one is 68, the other one is around 70. So it's in that neighborhood. Our international business is about 45 percent of our business, okay. Soobviously, that is putting enormous pressure on. So the alignment obviously would be -- ideally, if you could have a 45-55, or even going the other way, 50-50 would be ideal. That depends on a couple of things. It depends first of all on your vendor's ability to supply you or have a supply base at the -- where you have your focus plant, number one and secondly, it also, of course, depends where you can source and manufacture -- and on your growth, for instance, if I shift production out of the United States on to a platform which is more advantageous out of existing business, you get an overhead absorption problem in your fixed asset base in the United States. So when you have growth and you shift that growth over there, then you can accomplish both things. You can -- you have your absorption in your existing facility -- your dollar-based facility, and the additional growth goes into areas to help you balance it out. So the thing -- you can't do it in one shot, but you have to work towards that, and that's what - that's what we're doing.

Okay, that's helpful. Just as a follow up. I believe you said that the gross margin erosion was offset to some extent by the supply chain initiative. Can you quantify the supply chain initiatives this quarter?

Well, here's what a -- you know, rather than quantifying from this quarter, I really prefer to lay out a whole comprehensive program for you, sort of towards the end of this fiscal year as to what the supply base activity is going to look like over the next three years and what we're working on specifically and what the associated, you know, opportunities are with it, and be more specific rather than giving a piecemeal.

Okay, great. I'll look forward to it.

Okay.

Thanks.

-Again, once again, it is star "1" to ask a question. Scott Crafic] of C.L. King has our next question.

No, I don't have them, but what's -- what's the purpose?

[Scott Crafic] - C.L. King

To see -- I mean you said that it is trending up, but I wanted to get an idea exactly where and how quickly?

Okay, I'll give you directionally a flavor of it, okay?

[Scott Crafic] - C.L. King

Yes.

Flavia Rayo]: 00:56:47

[Scott Crafic] - C.L. King

Yes.

Scott Crafic]:

[Scott Crafic] - C.L. King

Okay. And you -- so you said that the Japanese really hasn't bottomed out yet?

Well, I think it's pretty well bottomed out, but it has certainly not rebounded.

[Scott Crafic] - C.L. King

Okay. Okay, that's great. Thanks.

As the vacation time comes around, we'll get a better fix on it.

[Scott Crafic] - C.L. King

Okay.

[Paris Howard] of American Express has the next question.

Yes. For the quarter, we ended the quarter on a global average day sales that is anywhere about 46 days which was equal to last year on average for the -- for a 12- month period. For the quarter itself, we were about 46 days versus last year of 47 days. We're relatively stable. [Paris Howard], American Express And versus the December quarter, do you have that information?

I don't have the December quarter information in front of me, but certainly if you called Dennis , he can provide that to you. [Paris Howard] - American Express Okay, thanks.

And our next question comes from [Flavia Rayo] of Montgomery Asset Management.

[Flavia Rayo], Montgomery Asset Management.

[indiscernible] respect, can you be a little bit more specific with your questions. What is it you would like to know in regards to inventory?

[Flavia Rayo], Montgomery Asset Management

Where it ended at the 3Q, and how that compared to last year, and if you could tell us where you see it going in the next couple of quarters?

Scott Crafic]:

[Flavia Rayo] - Montgomery Asset Management

And going forward?

Going forward, as Fred referenced earlier, you know, we're putting together a program in a lot of areas, gross margin improvement and inventory improvement, but we're going to take inventory down. There is no question about that. The question is to what level.

Flavia Rayo]:

[Flabia Rayo], Montgomery Asset Management

Okay.

In a business climate, which was less than stellar.

[Flabia Rayo] - Montgomery Asset Management

Thank you very much.

Thank you.

I have two followups actually. First of all, Fred, can you tell us what your market share in Europe is, both total and also then in the channels that you are in?

I can give you some of these numbers. It's in --in Europe, in total it's about, I think, 12 percent.

And in the channels that you are in?

In the channels -- I mean, it's probably higher, and it differentiates between the UK and the -- I would say it's probably in the 30s in the UK and on the continent its probably in the -- its in the 20s.

Okay. I think that -- . okay. A few years ago, I remember -- I think the number was something like 21 percent. I was just trying to get a sense for where that is versus...

Oh, we can update the numbers and share them with you. Obviously, if you look at the -- if you looked at the 20 that was a combined UK and the continent. In the UK, at the time, we were in the teensin the UK in the 30s. Now we've gone into certainly the mid-higher 30s in the UK, and we're probably in the 20s on the continent. So we've been taking, as you know, we've been taking market share last three years running. So we -- I wouldn't be surprised if we haven't picked up 3, 4 points in total.

And, can you just talk a little bit about the hair care business? Not Aveda and Bumble and Bumble, because those seem to be doing well. But I think originally you had talked about expanding hair care, you know, to Clinique and then potentially to some of your other brands as this is going to be a big growth driver in the department stores. Have you backed off on that?

No we haven't backed off on it, but we are still trying to find the right environment in the department stores to get more focused on that whole category. We've put our foot in the water with Clinique. You know we're getting good response from the customers in terms of repeat business. We're in it in Origins, but overall in the department stores, it's not known yet for hair products. So we still have to work on the model that would -- and get basically also some -- probably some support from some of the salons, etc. So we are still working with that area. We have launched Clinique in some of the international markets, and they have picked up anywhere from 1 to 3 percent of the Clinique business. So that's pretty well in line. We're not complete with our strategy and the drive on that one.

Okay so that's something that -- it sounds like, in terms of a real growth driver, it's probably a couple of years out?

It's a work in progress.

Okay, great.

That does conclude today's question and answer session. Gentlemen, we'll turn the conference back over to you for any additional or closing remarks.

Thank you. If you weren't unable to join us for the entire call, a playback will be available between 2 p.m. Eastern Time today through Thursday May 2nd. To hear a recording of the call, please dial 888-203-1112, pass code 246-324. That concludes our call today, and I'd like to thank you all for participating.