雅詩蘭黛 (EL) 2003 Q3 法說會逐字稿

Good day and welcome to the Estee Lauder Companies fiscal 2003 third quarter conference calm.

Today's call is being recorded and web cast.

For opening remark and introductions I'd 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 H. Langhammer, President and Chief Executive Officer, William P. Lauder, Chief Operating Officer, and Richard W. Kunes, Senior Vice President and Chief Financial Officer.

Some of our remarks today contain forward-looking statements and actual results could differ from those we expect.

In addition to risks describe 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 and in our 10-Q which we expect to file later today or tomorrow.

And now I'll turn the call over to Fred.

Thank you, Dennis.

Good morning ladies and gentlemen.

Thank you for joining us today.

Needless to say, I'm very pleased to report on our strong third quarter performance.

Particularly following the excellent results we posted last quarter.

In line with our plans to discuss with you at the beginning of the year, we have seen momentum build from quarter to quarter as our brand-building investment strategies and cost-saving initiative are coming to furation.

Sales again grew in all geographic regions, and major product categories despite negative consumer sentiment in the U.S. and uncertainty around the globe.

Our international business remains strong.

With Europe and Asia growing 8% and 7% respectively in local currency.

Travel retail continue to recover nicely from its year low a year ago.

As did our fragrance business.

While the Americas grew this quarter, the retail environment in the U.S. continued to be a soft spot for us.

However, business trends and our growth through the first nine months of this fiscal year were very encouraging and we are very pleased with our overall performance under the circumstances.

Let me give you some details.

Net sales for the quarter on a reported basis increased 10% to 1.24 billion from 1.12 billion in last year's quarter.

Before the impact of foreign currency translation sales rose a healthy 5%.

Net earnings for the quarter rose 65% to 83.8 million.

Compared to 50.7 million in the prior year's quarter.

I repeat, 65%.

Reflecting strong gross margin improvements as well as productivity gains in selling, general administration expenses, and general overhead.

At the same time, we invested more in advertising and sampling and in-store activities.

Diluted earnings per share came in at 33 cents compared to 19 cents in the prior year's quarter an outstanding 79% increase.

All major product categories have growth this quarter.

In skin care reported sales increased 16% to 507.8 million and grew an impressive 9% in constant currency.

Some primary drivers of this growth were Clinique's Repair Wear, Estee Lauder's Perfectionist and Origins Perfect World products.

These are all terrific products and we expect them to continue to generate sales growth.

Makeup sales increased this quarter by four % to 491.4 million on a reported basis.

And increased 1% in local currency.

New products continue to be the driving force and two of our biggest makeup launches this quarter were Color Search Lipstick from Clinique and Magnascopic Mascara from Estee Lauder.

These new products will continue to contribute positively to sales growth in the future quarters.

MAC once again had a strong quarter.

I'm very pleased to tell that you MAC has now had double digit sales growth for 17 of the last 18 quarters.

Offsetting these increases were all our sales in certain existing products.

Fragrances again grew this quarter.

Our fragrance business increased a strong 16% to $181.6 million on a reported basis and rose 9% excluding currency translation.

This category continued to be positively affected by the rebound in the retail channel this fiscal year.

On the product side, our strongest contribution came from the recent introductions of Clinique Happy Heart and Estee Lauder's Pleasures Intent and T-Girl from Tommy Hilfiger.

Donna Karan Cashmere Mist continues to shows strong retail sell through performance.

Estee Lauder Beautiful and Pleasure contribute nicely to this category.

Hair care rose 7% this quarter to 53.2 million, both Aveda and Bumble and Bumble are major hair care brands continue to make substantial progress in their product development, salon refinement, and distribution expansion.

At Aveda, we're seeing strong growth both domestically and international markets, new products and increased contribution.

Bumble and Bumble's growth reflects increased distribution and a positive influence of product education offered through salons.

These increases were partially offset by lower sales of Clinique's hair care products.

On a geographic basis, in the Americas region, sales increased 4% from the prior year's quarter to 721.5 million.

This is a terrific performance which means we outperform substantially the general retail environment.

In this region we had sales increases across product categories reflecting the success of new and recent product launches.

Virtually all developing brands had growth with most posting double digit sales increases.

Additionally our distribution diversification strategy is having the desired effect.

As our own retail stores grew high single digits on a global basis and the Internet business jumped 25% in the quarter.

Revitalization efforts in the Estee Lauder brand are continuing with positive results.

The brand is gaining share in the U.S. department stores, in skin care and makeup.

What has dedicate much of its new product activity.

We're confident that the upcoming launch this fall Beyond Paradise, Estee Lauder's new major fragrance that we just announced will add to this momentum.

Europe in the Middle East and Africa continued its strong pace.

Net sales rose 24% over the prior year's quarter to 361.5 million an increase in impressive 8% in locally currency.

Our travel retail business again rebound there quarter leading the region's growth with 30% increase over the prior year's quarter.

Which was depressed by a reduced travel volume last year.

While we continue to be encouraged by the recovery of the European travel, we are concerned about the effects of the SARS epidemic as it relates to the Asian travelers.

Our business, again, was very strong in most markets, particularly in the U.K., Spain, Greece and South Africa.

Most of our developing brands in Europe turned in double digit growth while Estee Lauder and Clinique reported growth in the high single digits.

In Asia Pacific net sales grew 17% over prior year to 156.4 million in local currency.

Sales were up an excellent 7%.

We had exceptional sales increases in Korea, China, Thailand and Australia.

Also posted strong gains.

In Japan, overall retail continues to be a challenge.

Department store sales in general in March recorded their 12th straight monthly decline.

Our sales in Japan were also lower this quarter, although we experienced very positive results from the Estee Lauder brand which turn in mid single digit growth.

Let me now discuss the balance of the fiscal year.

As you know, when we presented our plans for the fiscal year, they were based on the assumption that economic conditions would improve in the second half of the year.

This has not materialized so far.

The economic and retail environment in the U.S. and in certainly international markets continues to be challenging.

The conflict in Iraq and the emergence of SARS has created an adverse retail environment in the travel retail business and in certain local markets in Asia such as Hong Kong, Singapore and China.

Given these circumstances, and the uncertainty that is expected to exist for the next few months, we are factoring in to the best of our ability the potential impact of these issues on our future performance.

On this basis, we turn to the full year outlook.

We expect sales growth of approximately 7% on the reported basis which is -- which translates into approximately 4% increase in constant currency, slightly below our previous guidance.

We continue to expect our sales growth estimates coupled with productivity gains in our operating units and supply chain will still generate diluted earnings per share in the range of 128 to 133 in line with our previous guidance guidance.

Let me now update you on the acquisitional stuff that I discussed last quarter.

I'm pleased to say just this morning we closed on this acquisition.

The brand market's high, skin care products, independent pharmacies in Europe and specialty stores worldwide giving us access to some of the fastest growing channels of distribution in Europe.

We're also keenly interested of building our portfolio to where it's the demographic of aging population and skin care is a particular component that helps us to take care of these opportunities.

We're excited to add this brand to our portfolio and are eager to begin developing its business.

To summarize, we've built strong sales and earnings momentum throughout this fiscal year and I couldn't be more pleased with the results.

Despite the periodic disruptions we face in the business environment, we have remained focussed on our mid and long-term objectives.

This is the way we run our company.

While recent world events create new challenges, that will not distract us from our goals.

We are hopeful the disruptions will be short-lived and we are confident that the steps we are taking to realize our goals are the right ones.

Now I'd like to hand it over to Rick, our Chief Financial Officer to take you through the financial details.

Rick?

Thank you, Fred.

And good morning everyone.

Turning to our third quarter operating profitability, the company achieved operating income of $127.8 million, compared with 81.1 million reported last year.

This reflects a healthy recovery in operating margin of 310 basis points to 10.3%.

Due to a strong improvement in gross margin, combined with benefits from restructuring and discipline cost containment.

Our gross margin of 74.4% for the quarter increased 280 basis points over last year's 71.6%.

You will recall that we mentioned the anticipated significant improvement in gross margin on our second quarter conference call.

The increase reflects lower promotional activities, the absence of the overhead absorption issue from the prior year, favorable supply chain initiative including improved inventory management, and the favorable impact of foreign exchange rates.

These improvements were partially offset by a change in our mix of business.

Notably the recovery of travel retail and higher fragrance sales.

Operating expenses as a percentage of sales decreased 30 basis points to 64.1%.

Reflecting planned restructuring savings, selling expense efficiencies and general cost containment.

In particular, in those areas which are non-sales generating.

For the quarter, advertising, sampling and merchandising spending in value, and as a percentage of sales increased.

To support our business building initiatives.

Looking at operating profits by category, skin care rose 15.5 million to $74.4 million.

Makeup climbed 18 million to $59.5 million and hair care increased 1.2 million to $1.8 million, primarily due to the strength of our new or recently launched products.

Fragrance operating loss decreased 13.3 million to $7.6 million, primarily due to the improved results from our travel retail business.

Operating results in the fragrance category in our fiscal third quarter are typically softer, due to the seasonality of sales and lower corresponding expense leverage.

Turning to operating profits by region, the Americas increased 39.2 million to $76.9 million, the increase was primarily due to higher sales and restructuring benefits and other cost containment efforts.

Particularly as they relate to the manufacturing and distribution costs.

This region's improvement in particular reflects the impact of timing of some of our support spending which was skewed towards the beginning of this fiscal year .

In Europe, the Middle East and Africa, operating income for the quarter rose 7.4 million to $44.7 million versus last year, with our travel retail business posting the most significant increase.

As Fred mentioned our travel retail business, which has among the highest margins saw a sharp recovery this quarter against the backdrop of last year's negative events.

Operating results improved in a number of markets led by the UK and Greece.

Asia Pacific operating income increased lightly to $6.2 million with higher operating income in Korea and Australia being offset by lower results in Japan.

Regarding our interest cost, we reported net interest expense of 1.9 million this quarter versus 2.6 million last year.

The decrease is primarily due to lower outstanding borrowings partially offset by a higher effective interest rate.

The effective income tax rate for the quarter was 32.6 versus 34.5 in the prior year.

We expect the effective tax rate throughout 2003 to be approximately 33.2%.

The improvement was primarily due to ongoing tax planning initiatives and the reduction of the overall tax rate relating to foreign operations.

Net earnings for the quarter rose 65% to $83.8 million, compared to 50.7 million in the prior year.

Diluted earnings per share for the first quarter increased 79% to 33 cents versus 19 cents in the prior year quarter.

Turning towards our financial position, the company's cash position was $528 million at March 31, 2003 an increase of 59 million versus last year.

During the nine months ended March 31th, we generated net cash from operating activities of 416 million, a 14% increase over the 366 million in the prior year period.

The favorable change over the prior year period reflects increased earnings and improvements in certain working capital components and other assets.

And an increase in accrued advertising sampling and merchandising costs which corresponds to a higher level of spending and the type and timing of these activities.

In the first nine months of this fiscal year we made contributions to our U.S. defined pension plan totaling $46 million, which was 23 million more than in the comparable prior year period.

During the nine months we spent $216 million to repurchase approximately 7.2 million shares of stock under our share repurchase programs bringing the total shares we purchase under the program to 9.7 million.

Funds were also used for capital expenditures, the repayment of commercial paper, and dividend payments.

Our capital expenditures through the first nine months are approximately $33 million lower than last year as we have reevaluated certain projects and spending in light of current economic conditions.

Conversely our dividend payments through the nine months were 23 million higher than last year as a result of the change in our common stock dividend policy effective in January, from a quarterly to an annual basis.

Looking briefly to the remainder of the year we anticipate reducing our outstanding commercial paper further lowering our debt also by the end of the fiscal year, we may make additional pension contributions to further enhance our funding levels provided they qualify for a full tax deduction.

However, we still expect a very positive cash flow for this fiscal year.

Let me now update you on our working capital on March 31, 2003, inventory was $532 million, a decrease of 12 million versus June 30, 2002 and 17 million higher than last March.

We remain committed to ongoing efforts to lower our inventory balances.

Our inventory days were 148 at March 31, 2003, versus 151 at March 31 of last year.

Regarding receivables at March 31, our receivable balance was $733 million, a 56 million increase compared to last year due to the higher sales.

DSO's of 53 days at March 31, 2003 improved from 54 days a year ago.

Debt to capital ratio was 17% at March 31, 2003, compared to 18% last year.

As part of our ongoing capital structure and financing evaluation project, last month we filed a shelf registration statement with the SEC to sell debt securities in one or more offerings up to a little to of $500 million.

Shelf recommend registration gives us the flexibility to tap into the public debt markets when appropriate to take advantage of more favorable interest rates.

Proceeds from any sales of securities may be considered as a pre-funding of a portion of the 360 million redeemable preferred stock and/or for general corporate purposes, including locking in access to long-term liquidity at historically low interest rates.

We will keep you apprised of any financing activities.

Let me now update you on a few assumptions for fiscal 2003.

For the full year, as Fred said, we anticipate reported sales growth of approximately 7%.

Our reported sales are expected to be positively impacted by foreign exchange by approximately 3 percentage point which translates into 4% growth in local currency.

We expect gross margin to improve about 50 to 70 basis points for the fiscal year, benefiting from ongoing supply chain savings, more normal production levels and strategically lower promotional activities.

We anticipate a slight increase in operating expenses of approximately 10 to 30 basis points.

Reflecting the benefits of restructuring and tight cost controls offset by the sudden decline in sales and the remainder of our fiscal year from the issues Fred mentioned.

Operating margin is expected to increase 20 to 60 basis points.

As I've said in previous calls, in times of unit certainty, we need to be opportunistic and maintain flexibility in using advertising or promotion vehicles to drive business which may affect the mix of our gross margin and operating expense improvement.

I'd like to reiterate achievement of our forecast is sensitive to economic, political and other destructions which can impact desire of consumers to travel and shop and adversely affect our performance.

That concludes my comments for today and we'll be happy to take your questions now.

Thank you.

Ladies and gentlemen, the question-and-answer session will be conducted electronically today.

If you have a question, you may simply press the star key followed by the digit one on your touch-tone telephone.

To ensure everyone has the opportunity to ask their questions, we will limit each person to one question and a-related follow-up.

Time permitting, we will return to you for additional questions.

Just queue up again by pressing the star key and the digit one.

Our first question will come from Andrew McQuilling with UBS Warburg.

Thank you and congratulations on a great quarter.

Thank you.

Fred, with one quarter left to go, when you look at the Asian business and the travel retail, can you talk about the trends that you've seen in April and I guess the range of outcomes that you could potentially see for travel retail in the Asian sales?

Well the Asian markets are of course quite substantially impacted by the SARS situation because obviously people are a little spooked out there.

You have particularly Hong Kong and Singapore and China.

Things seem to be settling down a little bit.

I think the domestic market in Japan is less affected and Korea is less affected.

However, having said that, it is clear from the trends of the travel of the Japanese that the traveling really has come to a halt.

I think there was hundreds of thousands of people less in travel to Hawaii during the golden week.

So the overall TID, I don't know that we can't tell right now exactly how much it's going to be down, but certainly it's going to be affected in the Asian Pacific area.

Having said that, to our surprise, the European, inner European travel , is holding up very nicely, irrespective Iraq.

That's the positive side.

Generally, I think the Asian Pacific situation concerns us somewhat.

But, you know, I'm a little encouraged by what I've heard the last couple of days that the things are starting to come under control and if that continues, then I think it's not going to be -- it's going to be more short-lived.

Terrific.

And maybe one follow-up.

Your operating margins in March were frankly spectacular, the best of the historical series.

Is a lot of this, I understand the restructuring activities that you've taken.

Is there anything that we should look at as one time in terms of the absolute level of margin March?

Because it is very impressive.

I don't think it was a one-time scenario, I think it was morally in line with what we had planned at the beginning of the year.

We said at the beginning of the year this is the way it was going to shape up, that we're going to invest in trying to keep the momentum of the company going and we're going to be very strict on operating costs, et cetera.

And, you know, the only one aspect in the third quarter, which was favorable, which is obviously not repeatable, is the overhead absorption which we got hit last year because of the downturn of not only sales, but also we lowered inventory substantially last year.

So you had an overhead absorption which was of course much more favorable for this year.

That was a bit of a one-time scenario which affected gross margins.

Understood.

Thanks.

I repeat, congratulations.

Thank you very much.

Bye.

We'll take our next question from Carol Wilke with Merrill Lynch.

Thanks, I have a couple of quick questions.

Just you mentioned, Fred, in your dialog that what the Estee Lauder brand sales did in Japan and directionally in Europe, and I was curious if you could give us some indication in terms of the U.S. if they were up and if so, you you know, up more than they were the December quarter.

Yes, to continue to build momentum here in the United States.

In fact, from the three largest brands, the best performers right now, and they seem to be taking market share.

It's a little hard to see exactly, we're having very good number here in April, but as you now, Easter was shifted so March and April comparisons are a little distorted, so its hard to say.

We're very comfortable where the Lauder brand is going.

I was at a meeting yesterday down in Florida with a lot of people from the sales organizations from around America, and I got a very favorable impression in that regard.

And just one other quick one.

When you look on a local basis for the fourth quarter, are you still expecting every region to be up?

Even with the Asian potential impact?

Tough to say right now.

Really tough to say right now.

You know I think that probably Europe will show growth, the U.S. will show probably some growth, I don't know exactly, and Asia, outside of Japan, I think will certainly show some growth.

Thanks so much.

Okay.

We'll take our next question from Linda Bolton Weiser with Fahnestock.

Thank you very much.

Can you just talk about, at your analyst meeting you had talked about your long-term goal of trying to better align your production capacity with your sales geographically.

Are you proceeding with that given where the dollar is relative to foreign currencies, or are you changing your plan a little bit right now with regard to that?

No.

You know, the majority of our cost, if you look at our cost of goods, comes from components.

Components and ingredients are the biggest expense.

Labor and overhead is relatively small.

So that means that we will continue to drive for advantageous purchasing by going into Mexico, by going into China, by resourcing from the far east.

That's an ongoing program.

We still see substantial benefits coming you are way in this regard.

Okay.

And just on the cash flow performance in the quarter, it looks like from what you said that operating cash flow is down about $50 million in the quarter.

What would be the reason for that?

In this quarter, we had slower improvements in the reduction of our inventory.

You remember that we were coming off a very high inventory base last year so the cash generated by reducing our inventory was much greater last year than it is this year.

And the other is that we've slowed down a little bit in some of our other work capital components improvements versus the year before and we made the additional pension contribution this quarter as well.

Okay.

Thank you very much.

We'll take our next question from Wendy Nicholson with Smith Barney.

My first question has to do with the gross margin expansion which was obviously terrific.

And I'm just trying to understand, I guess back to Andrew's question about how much of that was sort of one time in nature.

Because it sound like from your guidance for the fourth quarter, you're not looking for that much gross margin expansion.

I'm wondering why that would be.

Whether there were things in the third quarter that don't repeat, whether it's a foreign exchange assumption.

I'm not sure I understand what's going to change.

Maybe you're just being extra conservative to the fourth quarter.

We're trying to be conservative for the entire year.

But having said that, Fred put his finger on the biggest issue, the overhead absorption.

We mentioned during the second quarter conference call we would anticipate a huge improvement in our gross margin this quarter and it was mostly-related to that.

In addition, we have strategically shifted our marketing programs, if you will, somewhat from promotional activities to more advertising-based.

And so there is an ongoing trend of lower gifts and GWP-type activity which is now classified in cost of sales which is also helping our gross margin.

And that will continue.

There was also sourcing initiatives ongoing.

If you look at the split for the quarter, just to give you an idea of the improvements, 150 basis point improvement in gross margin was related to supply chain activities, including the overhead absorption issue, about 110 basis points was related to lower gift and GWP activity and 20 basis points was all other, which includes mix and foreign exchange benefits and those sorts of things.

I would encourage you to look at the performance over a longer period of time.

The quarter-to-quarter not really representative, you need to look at the direction, the trend, and the directionally, the trend will continue and I think that's the important factor.

Is the lower amount -- I mean, that's more than 100 basis points from the timing, I guess, of fewer promotions.

Was that because Easter was shifted into the fourth quarter?

Because that's something, I would think that would carry through the next couple of quarters.

No, I've said from the overall strategic point of view the company is moving slowly but surely into more direct communication with the consumer via advertising and product innovation versus promotion in the distribution channel.

And the reason for that is if the channel distribution and the shopping malls have less traffic, and we spend most of our resources in an environment that has less traffic, where's the growth going to come from?

So with our new innovation drives we need to speak out to a broader audience and attract new customers.

And this is the overall strategy and this will continue over the next few years.

That leads me to my second question which is on the distribution diversification initiatives you said they were working well.

Can you give you makes in terms of what your growth, how that looks in department stores versus other classes of trade?

Similarly, we've seen in some of the Sephoras a broader array of Clinique products.

Is that a change in your distribution strategies that you are going to be selling more and more not just selected [inaudible], but the full line of Clinique for example?

First of all, I'm not going to break down exactly where the growth comes from, we're not going to get into that one, but I'll let William respond to the Sephora Clinique question.

I think perhaps you may be seeing a few stores in the New York metropolitan area that may be distorting your look at the Clinique distribution in Sephora.

Sephora is experiencing nice growth, but Clinique in Sephora is not material to our numbers in any way, shape or form to Clinique and/or to the overall company.

Sephora is a good partner of ours.

Suffice it to say, for existing brands we are pursuing alternative distribution opportunities and we're pursuing alternative distribution opportunities we expect in the long-term will be quite meaningful to the company, but at the moment, with -- for the larger brands, Clinique and Estee Lauder, it's safe to say that alternative distribution is not meaningful.

Okay.

And then the very last question, and you can move on: We've heard thoughts that maybe Kohl's would be thinking about putting Estee Lauder into distribution.

Any comment on that?

I don't think we can comment on what retailers may be considering in selling our brands.

All I can say is that we are always looking at alternative distribution opportunities.

But we will not comment and won't comment on anything that retailers may say.

Okay.

We'll take our next question from Amy Chasen of Goldman Sachs.

Rick, there were two things that you said that you glossed over pretty quickly, but I found to be pretty intreging.

One was this notion of bringing down, I guess, your capex, if you could talk a little bit more about what your new estimate is for the year and what's driving that.

And then on the preferred stock and this shelf registration, if you could flesh that out a little bit more.

You went pretty quickly, and I think I just missed it.

Sure.

Regarding capex, yes we are and we continue to, you know, through last year and into this year, in being very tight on where we spend our money and making sure it is very focussed on anything that builds our business so the controls we put in last year kind of spilled over and continue into this year Amy and we expect our capital to be around probably around 190 million this year, which will be about 25 million less than last year.

Regarding the preferred shares, as you know, the preferred shares are mandatorily redeemable at the end of fiscal 2005.

Interest rates are at, I think, 40 or 50-year lows right now for long-term debt, and it seems prudent from our perspective to lock in some long-term liquidity or access to long-term liquidity in anticipation either and redeeming that preferred stock at the end of 2005 and other business supporting activities.

That's the reason we filed the shelf and we're still determining what is the best mix and use of any additional debt.

But that's the reasoning behind it.

Got it.

Okay.

And then also on the working capital, I also noticed that the rate of change in this quarter was a little bit less than prior quarters.

Should we expect that this rate of change will continue or was there something aberrational in this quarter that accounted for the slowdown in the improvement?

Certainly will slow down a little bit Amy because inventory was so high, that's the biggest driver.

It was so high that the rate of improvement was greater earlier in the year.

As well at the end of our third quarter, we began to feel a little bit of the effects related to the slowdown in the U.S. business activity and some of the GRD-related business.

So that had a little impact and slowdown at this particular point in time our inventory improvement.

But we're committed to continuing to improve inventory levels as well as focus on receivables so it will continue going forward.

Last but not least, can you tell us what the FX impact on EPS was in the quarter?

Of what, I'm Sorry.

The currency impact in the quarter on an EPS basis?

How much did it help you?

Yes, in the quarter, about 1 1/2 cents benefit in the quarter from exchange.

Okay.

Great.

Thank you.

and once again, ladies and gentlemen, press "star 1" to ask a question.

We'll go next to Janet Coltenburg with JJK Research.

Good morning and congratulations.

Thank you, you're so kind.

Nice job.

I have a couple of questions.

I'm impressed with the gross margin growth and I think in the Americas it probably -- you're probably benefits from the reduced promotional levels.

And I'm wondering if you feel that that is having an effect on traffic in the Americas right now, given what's going on in U.S. retail? and if there will be any shift in policy?

I'm sorry, give me that point again?

Well, I think you're being less promising well your gift purchases.

I think that's probably great for the gross margin.

But maybe affecting traffic levels as well.

Can you comment on that?

No, really what we're doing is two things: First of all in the Estee Lauder brand, being an aspirational brand, we felt we have to restrict promotional activity a little more in order the make it desirable.

Okay.

So we're running out of stock when you're on promotion in terms of the promotional vehicle, to me, is not a bad thing.

Okay.

It creates desirability, okay.

So I think we've gotten -- we've put more discipline into the promotions.

The other thing is what we've done is we've got to make sure the promotion cycles run as planned.

In other words, they run for two weeks, so we're not allowing it to run for three weeks and things like that.

So we have more discipline into the promotional cycle.

Thirdly, we find that our day-to-day business and the events we're driving with our new products are showing fabulous growth.

In most cases double digit growth.

In fact, it's the gift business which has become more difficult over the last two, three years for all the major brands.

And, therefore, I think it's prudent and smart to shift somewhat of the resources into innovation of product and driving more communication into the marketplace.

That's generates new customer traffic for us.

And I think that's the way we're going about it and it's starting to work.

Great.

Also, I think that there's a revitalization effort going on with the Clinique brand, perhaps with a focus on the Japanese market and I wondered if you could talk about that level of success there.

Yes.

Well, you know, this is an ongoing program.

As you know, the dynamics of the Japanese market have changed quite a bit.

In fact, 45% of the treatment business now is in the whitening category.

I mean, that whitening category was one product 10 years ago which was a whitening essence.

Now 45% of the whole treatment category is in whitening.

So we had to respond the that and we're working very much.

And new technologies evolving that regard every year.

So we're on the case there and in addition to that, we also are working different concepts in terms of communication strategy in the far east and that's moving along.

You know, there's not going to be a quick fix on that, but directionally, I feel good about it.

Will we see some changes in the U.S. market with Clinique as well, Fred?

You will see a few changes in the U.S. as well, yes.

Okay.

Let me just mention one thing because I'd like to take this opportunity, now that you mention the U.S., you know, there's always people always beating up on department stores.

Quite frankly, we're in the shopping malls.

We're in the best location of the shopping mall.

We're in a space where 75% of the people going into the mall go by where we are.

That's why the cosmetic department tends to outperform the department stores.

I just looked at the Neilson's report for the last twelve weeks in the mass market.

Now, the mass market in cosmetics was down 6.8%.

Right.

Okay?

So people continue to tell us what happens in the rest of the business, et cetera.

Except the mass market is not performing as well as the department stores and the cosmetic departments we're operating in.

On that note, given the quarter that you just reported, had many effects, including a tough weather scenario and a war.

Would there be a more optimistic outlook for the Americas here in this quarter?

Well, look, what I said is basically, look, we went into the assumption at the beginning of the year that the economic situation was going to turn around in the third and fourth quarter.

Obviously we didn't anticipate the war in Iraq and the economic picture quite certainly with that uncertainty out there.

And the high ratings of some of the television station watching the events has not helped shopping.

I you're you know we're prudent here.

I don't expect that there's going to be a dramatic change to that pattern.

That's the way we're looking at it.

If things get better, we'll be very happy.

But for the time being, I don't see a quick fix.

I think for the next year or two, when you look around the globe from an economic point of view, I think we're probably in a more low-growth environment.

You know, there's still a lack of-over all consumer confident and couple that with the erosion of wealth based on the declines of the stock market in the last two, three years, that does not exactly back drop where there's going to be b buoyancy from one month to the next.

Great, and my last question if for Rick.

Did the tax rate change have a positive effect on the EPS.

It did, but about a half a penny.

Many thanks.

We'll take our next question from Andrew McQuillin with UBS.

Thanks very much.

One I quick one.

Rick, what was the share repurchase in the quarter and what are your thoughts on that going forward?

We repurchased 1.8 million shares in the quarter and as we have said, previously, we intend to continue to be opportunistic and purchase shares from time to time.

We have authorization in total of 18 million shares and we've purchased 9.7 million to date.

Terrific.

Thanks very much.

I'll go next to Neil Goldmer with State Street Global.

A quick question on the working capital, maybe it's for Rick.

You seem to be getting beaten up on the working capital side.

Your day's payable is down significantly which had a negative impact on your working capitol.

I'm curious, from a working capital management perspective why that's happening.

Are you getting better terms or is this just another easier kind of a strange comp. of the last year?

There's two things in this quarter, but it's interesting that you mention it, there's two things in this quarter happening.

One is kind of a timing of receipt of bills.

And you see that our accruals have increased rather significantly, other accrued liabilities, that's related to as I mentioned, the accrued advertising promotional and merchandising type activities.

Year-over-year those have gone up quite a bit.

Normally what happens is when those invoices appear, they then go into accounts payable and then eventually get paid.

So there's a little bit of a timing issue related to that.

Also here in the U.S., the cutoff of the month and the timing of when we actually print checks was such that we just that month then did our normal check-printing type of operation versus last year, you know, that had an impact as well.

So some of that.

We've always said that payables is a bit of a wild card.

Occasionally we'll negotiate better terms, better material purchase prices which show their benefit up in cost of goods.

That gets offset by our payroll balance because we may pay those vendors a little bit quicker to negotiate a better price and we do an economic analysis that says whether that makes sense or not from our perspective.

Okay.

And if I could ask you a question on I guess the fourth quarter gross margin, if I'm doing the math right and if I'm not, I'm sorry, but it looks to me like you're guiding to a down gross margin year-over-year in the fourth quarter.

A, is that right? and B, why would that be?

Yes, you are correct, it's going to be relatively flat or slightly down gross margin.

And again, it depends on the level of promotional activities that we do is the biggest driver of that.

Because some of that is timing where we did a little bit less in the third quarter.

While we continue to do less, there's are there may be a slight swinge from third quarter to fourth quarter.

The second is that those types of activities are in a sense more fixed in nature so when sales drop a bit, but we're still doing the promotional program that we intended to do, it has an effect of decreasing gross margin.

And, you know, that's basically it.

But as Fred mentioned, we really look at the long term trend for cost of goods and improvements we're making and I think if you look back and forward, our gross margin is and will continue to improve at a pretty good pace.

I think it's much more meaningful if you look directionally on this over a year period because there's going to be shifts of promotional activity which will affect this number.

I think if you look at it as a directional over an annual basis, I think you're better served.

Agreed and the numbers are great.

Fred if I could ask you one quick question.

Makeup and I think skin care, it was one sentence that said basically the sales in both categories are partially offset by lower sales of certain existing products.

And I guess it's to be expected.

Is there any way you can capture the data to find out whether you're getting existing customers to step up and trade up to newer products or you're actually getting new customers into the store to buy these new products?

We're getting both.

I'm going to let William talk to that a bit because he's in and out in the market a great deal.

The best way to answer it, the holey grail for us is to actually know who our customers are on a transactional basis.

We're in a constant push-pull between our sell -- it's a triangular relationship between ourselves, the consumer and the retailer in capturing that data.

With the trends towards desire for privacy, it's not often easy to capture that information from the consumer on an involuntary basis.

And capturing that information on a voluntary basis can be somewhat time consuming.

So we with either infer or understand that information if the consumer chooses to participate in certain programs, either loyalty programs driven by brands or loyalty programs driven by the store or use of a captive store credit card system.

Those three forms we are able to capture some information if they are a repeat loyal consumer.

If you don't fall into those categories and/or you pay cash, we may know inferentially that yes, they are a consumer because we've had them registered, we recognize them, but we cannot capture the information on a broad macro basis.

I think we can infer there are certain brands that are gaining market share and growing at a greater rate than the overall market and we are assuming that they are gaining new consumers.

Those brands that are growing marginally are with the market, we are assuming they are trading they're netting out with new consumers and existing consumers on a relatively equal basis.

But unfortunately, the actual quantitative scientific measure of that is quite difficult because the retailers are only capturing so much and we're only able to capture so much of what they're capturing.

What he is basically saying is back of the envelope, we have a pretty good idea, we have some intuition and salespeople who give us feedback, but scientifically, as William just pointed out, it's difficult to capture that.

Great.

Okay?

One more question, I'm sorry: A topic two years ago, that nobody cares about any more is Internet sales.

I'm curious, I know what you've done on a cost side, how's it going on a demand side?

Surprisingly, the demand online has held up quite nicely compared to normal real four-wall retail.

And the trend I've now -- is now up 35% year on year, which we think is excellent.

Another way to look at it is look at the existing brands that have been online more than a year, their growth online is really quite nice and it's held up better than existing retail.

Great, thank you very much.

We'll take our next question from Bill Steele with Bank of America.

Thanks, good morning.

Rick, could you comment on the restructuring savings efforts for fiscal '03?

Are you still on track for about $35 million?

We are, Bill and in the quarter it was about $10 million.

10 million pre-tax.

And how much of that fell to the bottom line or did you reinvest it all back behind the brands.

Our profits actually grew well in excess of that, so, you know, it's difficult and I'm always interested in how people decide whether the savings went to reinvestment and we saved money in other areas but it all goes into the pot and the results certainly improved much greater than the $10 million in savings.

To give you a benchmark, in the quarter we increased A and P by more than 1% of sales over the prior year.

So if -- it's 1.3 percentage points or something like that.

So if you look at 1.2 billion or 1.3 billion in sales, you can tell we invested in a additional 10 to $15 million in A and P.

That's very --

and even with that, even with that you saw our earnings performance.

That's a perfect answer.

Rick, cash flow from operations for the full year, what would you be targeting?

Uhm, Bill, about $550 million cash flow from operations.

What we'll do is when the year is over, we will do that with and without unusual items like the incremental, if we do it, the incremental pension contribution so you can have a year-over-year comparison.

Okay.

So 550.

And then last question for Fred: Given the fact that the fourth quarter you're one month through the quarter, you still have kind of the same variance for the full year, a nickel, that you did at the beginning of the year.

What are you concerned about?

What should we be concerned about over the next two months?

The concern basically was the Asian scenario, how serious it's going to be, how long it's going to last.

Quite frankly, as you know, the Asian markets, particularly the Hong Kong, Singapore, et cetera, are high profit margin areas.

The travel retail is high profit margin.

So we have some concerns there.

But the benefit compared to 2002 is of course that the impact is for one quarter whereas in 2002 the September 11 was in our first quarter.

So we got hit basically for three following quarters whereas this year is happening basically in the last quarter.

Okay.

Thank you very much.

Okay.

We'll go next to Amy Chasen of Goldman Sachs.

I just have two follow ups.

The currency benefit in the third quarter was much higher than I thought so basically the local currency was a little bit short of what we thought.

Can you talk about regionally where things came in on a local currency basis below your expectations?

What are you talking about?

Sales.

Sales, I just said that we had sales 7% in Asia and I think it was 8% in Europe in constant currency.

No, no, I understand.

I'm trying to get a sense for which regions were above or below your expectations on a local currency basis.

That was pretty well in line with what we had expected in terms of growth.

I think you had said -- I think your guidance had been a currency would benefit you by two to three points in the third quarter.

Am I mistaken.

No I think we said that for the year, and it's about three points for the year we said again today.

The currency effect in the quarter was greater than that.

And second half guidance, I think possibly is where you might be confused, the only guidance that we gave at the end of the last quarter was for the second half.

We didn't give quarterly guidance to start with.

Okay.

All right.

Well then can you just.

And by the way, that will continue.

We're not going to give quarterly guidance, I made that clear the last quarter.

Let me shift gears then.

Just on the hair care business in department stores, you mentioned that Clinique was down.

For a while, you've talked about sort of revamping that strategy.

How are you thinking about that strategically?

Can I make one comment.

The hair care business in department stores is an extraordinarily marginal, really I am material piece of our total strategy.

Hair care in the salon business with Aveda and Bumble and Bumble continues to be a more credible piece.

The Clinique hair care strategy has not been as successful as we would like; however, it really truly is immaterial for the total.

We are focuses our efforts in revamping that to make it more important but it will it will continue to be marginal at best compared to the salon side of the hair care business.

It's going to be more hair and scalp treatment oriented then sort of generic hair care products.

We're moving in that direction.

I think we're going to get some good response.

But William is right, in the overall scheme, particularly in the somewhat difficult environment, we focus on what drives materially the success of the Clinique and that's skin care and makeup.

We're not going to play on something I am material and put resources in it in a climate where it's more important to keep the brand momentum going.

Okay.

Great.

Thank you.

Okay.

We'll take our next question from Carol Wilke, Merrill Lynch.

I was curious about something, about the response that you have seen in the market to the new spokesperson for the Estee Lauder brand.

I know it's gotten favorable press, but being out of the field William maybe you can comment what you've seen on the floor, or excitement, et cetera.

Tremendous excitement about this, by the way.

It's really from first of all when we presented it to -- we have 10,000 consultants out there.

Beauty advisors and we obviously have a sales organization who supervises those.

When we presented that strategy in our meetings, our global meetings in San Francisco and then the meeting in Florida, the house nearly came down, there was so much excitement in that regard.

And the retailers are thrilled.

And I think it's going to be very positive.

We'll take our next question from Linda Bolton Weiser with Fahnestock.

Thank you.

I know it's early talk about this, but in thinking about FY '04 do you think that you'll kind of still shoot for this 5% local currency sales growth?

What are your current thoughts, just generally?

Well, first of all, I'm going to, you know, lay out our directional thinking for the fiscal '04 in the August conference call.

And that's when we're going to do it.

I'm not going to comment exactly how the next year plan is going to shape up, we're in the mid-of the process of putting all other plans together, both for international and the domestic companies.

So we're in that process right now, it's not going to be complete until about the middle of June.

I think once we get into August, we have the experience of the last quarter and what kind of momentum and what kind of issues are around the globe and we'll give direction in terms of '04.

We'll take our next question from Gladamire Velco with Two Door Investments. recollection.

Hi.

You mentioned a little bit about the shift away from promotions to advertising.

One.

And two, is just more focussed promotions, I guess.

Can you elaborate a little bit on those two issues strategically and near term.

I'll give you the overall strategy in this regard.

When we look at our A and P and we look at what -- how much of the A and P is commercializes the brand, i.e. promotion inside the store and how many how much drives communication and innovation.

When market conditions are the way they are in terms of footfall not growing or, in fact, declining, due to promote within the declining framework, puts you in a position where growth is very difficult to come by.

Therefore, you need to have a combination between innovation, communication, and promotional activity.

So this is not a major shift, but this is a gradual shift.

So what you will see the company do over the next few years because we put such emphasis on product innovation and new ideas, that you will see that we will be more aggressive in communicating those in the marketplace, stimulating new traffic to our brands and at the same time, we will continue to promote.

But it's a question of balance.

We'll take our next question from Rob Nye with PAW Partners.

My question's been answered thank you.

We'll take our final question from Andrew McQuillin with UBS.

Thanks, sorry to come back.

Just one question on Aveda.

Fred, how much did changing and distribution outlets in Aveda impact the sales numbers in the quarter?

How are same-store numbers doing for the Aveda business, the focussed salons?

The salons continue to do very well, most of them are growing double digit.

When we've taken over some of the salons for a distributor, it usually means that we're cleaning up the place.

So initially the first six, nine months usually you have a bit of a downturn and then the rebuilding process takes place.

And once we clean it up, the existing salons tend to grow between high single digit to even to the 20s.

So that continues.

And then once we're through with that process, then we start building some new salons as well in addition to.

So that's basically going on and it's doing very well in the salon business.

You know, we're investing in Aveda obviously in some of the international markets at this point.

We're building an educational center in Japan, and will be launching there this fall which obviously requires some resources and we're also building an educational center in Berlin.

For the German market.

So those are the two investment areas we have in the cards right now.

Our experience in the U.K. is very positive.

We're already profitable, moving nicely.

And we're making a very good impact.

So the model working in the U.K. and we're going to transport it into other markets but not wholesale, we're going step by step.

And could you mention how big the international business for Aveda is now?

How that's changed from acquisition?

It's really outside of the U.K., it's still marginal.

In Japan, will be launched in September.

But this is a slow-build initially, and then once you have it right, it starts moving quicker.

But, you know, it's a slower build because you have to commit to the opinion leaders, the salon orders, it's a different dynamic.

Perfect, thank you.

Thank you.

And ladies and gentlemen, that does conclude today's question-and-answer session.

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That concludes today's Estee Lauder Companies conference call.

I would like to thank you all for your participation and wish you all a good day.

Thank you.

Thank you.