雅詩蘭黛 (EL) 2004 Q1 法說會逐字稿

Good day, everyone, and welcome to The Estee Lauder Companies fiscal 2004 first quarter conference call.

All participants have been placed on a listen-only mode, and the floor will be open for questions and comments following the presentation.

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 today.

On today's call are Fred Langhammer, President and Chief Executive Officer, William Lauder, Chief Operating Officer, and Rick Kunes, Senior Vice President and Chief Financial Officer.

Also with us today is Dan Brestle, Group President with responsibility for many of our developing brands, Dan will be available for questions after our prepared remarks.

As a reminder, some of our remarks today contain forward-looking statements which involve risks and uncertainties.

In addition to specific risks described in this call, you will find additional factors that could cause actual results to differ materially from these forward-looking statements in our press release today and in our 10-Q which we expect to file later today.

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

Thank you, Dennis, and good morning, ladies and gentlemen.

I'm glad you could join us today to review our first quarter results.

We also look forward to sharing with you the strategy behind our announcements of our business venture with Kohl's.

First let's get right to the quarter.

We're off to a great start, continuing the momentum we generated during last year.

U.S. retail started to pick up nicely in June and carry into the first quarter, and it seems to be continuing.

In the first quarter, we turned in robust net sales growth of 9% to $1.35 billion, from $1.24 billion in last year's quarter.

Excluding the impact of foreign currency translation, net sales grew at 6%.

Net earnings attributable to common stock for the quarter were up 14% to $77 million, compared to $67.5 million in the prior year quarter.

Diluted earnings per share came in at 33 cents, compared to 28 cents in the same period last year, a very solid 18% growth, and once again meeting our own expectations.

Terrific performance from our strong new product pipeline.

Double-digit growth in our retail stores, overall, and salon channel, and a pickup in travel retail helped drive sales this quarter.

Let me take you through our product categories results.

In skin care we reported net sales increase of 10% to $462.9 million and grew 7% in constant dollars.

Behind this increase was some notable product, including Clinique's Repairwear line and 3-Step Skin Care System.

The Estee Lauder brand extended its Idealist concept with the launch of Idealist Micro-D, an over-the-counter alternative to microderm abrasion.

This product has exceeded our expectations so far, and we have ramped up production to meet demand.

Estee Lauder also continues to record strong sales of Perfectionist this quarter.

We benefited from addition of a few full quarter sales of Darphin, which is predominantly skin care.

Makeup.

Sales increased 6% to $494.1 million and rose 4% in local currency.

M.A.C. and Bobbi Brown continued their trend of strong double-digit growth, while makeup benefited from a host of new products in many sub categories, including powders, foundations, lips and mascaras.

Our fragrance category is seeing a lot of action, as we previously told you.

Our first quarter fragrance sales increased 12% to $331.1 million, on a reported basis, and rose 9% over the last year, excluding currency.

The category got a nice boost from the August launch of Estee Lauder's Beyond Paradise.

Our goal was to achieve a top-five ranking in the U.S. department stores.

We have been successful so far, ranking #1 in September and #4 for the quarter, and we're off to a great start, also, in the U.K.

Clinique Simply just launched in September, and Aramis Life had initial shipments.

Both of these launches should have a great impact on our second fiscal quarter.

Fragrance also includes sales from our new license arrangement with Michael Kors, and to a lesser extent, was positively affected by the improvement in the travel retail channel this quarter.

Hair care.

Hair care rose 9% this quarter to $54.8 million.

Both Aveda and Bumble and bumble saw double-digit growth this quarter.

Aveda introduced Detailing Mist, a new 3 SKU styling product, while Bumble and bumble experienced strong comp door growth and increased distribution.

In September, Aveda established a presence in the Japanese market with an opening of a state-of-the-art holistic center, a combination salon, spa and retail outlet in Tokyo.

The Japanese hair care market is approximately $4.5 billion, and we believe we have excellent prospects for long-term growth in the market.

Let me now review our geographic regions.

In the Americas, sales increased 9% from the prior year to $856.6 million.

This is very encouraging.

I'm very pleased with these results, owing to the momentum from existing products, very successful new entries, plus a pickup in retail takeaway.

Sales increases occurred in every product category, particularly in fragrance, with the introduction of three major launches.

Virtually all our developing brands had growth, with most posing double-digit sales increases, and our U.S. retail stores sustained mid-teen growth throughout the quarter, led by M.A.C..

Overall, a very healthy quarter for the region.

In Europe, the Middle East, and Africa, net sales increased 8% over the prior year to $327.8 million, and was flat on local currency basis.

In local currencies, the U.K. travel retail and Russia led sales growth, along with addition of Darphin, which generates most of its sales in Europe.

Our travel retail business this quarter came back nicely from the SARS-related softness.

These positives were offset by lower sales in many markets in the continental Europe, which suffered from the abnormal weather conditions in July and August.

The excessive heat hurt the retail environment and delayed orders and shipments.

Additionally we had lower sales orders during the quarter because one of our key customers changed its fiscal year and we were renegotiating trading terms with another customer.

We believe that with our strong programs we will recapture some of these sales throughout the year.

In Asia Pacific, net sales grew 11% over the prior year to $167.3 million.

In local currencies, sales were up 8%.

Low currency sales increased in every market except Japan, which was flat.

Korea, China, Australia, Thailand, and Taiwan all had solid double-digit sales increases.

That wraps up the first quarter.

Let's now look ahead.

At this time, I feel good about what I'm seeing in the U.S. retail, and I'm saying that the -- and I'm not saying that the economy has turned the corner completely.

But it is encouraging.

At the same time, it's prudent to remain somewhat cautious until we see sustained growth in the U.S. market.

Nevertheless, as we enter the holiday season, we have a solid lineup of new fragrances, attractive gift sets, and special holiday color offerings.

As always, we expect the height of the holiday business to occur in the last two weeks before Christmas.

Fragrances are a popular holiday gift item and we expect our three newest fragrances to have a terrific Christmas debut, and also our classic fragrances will perform well.

But it's not just about fragrances.

We have new product introductions that we've -- that we're excited about in our other categories, as well.

In fact, throughout the year, given our broad portfolio of brands, you will see strong product launch activity every month.

I also feel good about the continued recovery in our travel retail business.

After travel fear factor subsides, this profitable business, which makes up 6% of our total sales, is expected to grow nicely throughout the fiscal year.

On the international side, we're seeing a mixed performance.

In Europe, markets like the U.K., Spain, South Africa, we're maintaining momentum, while Germany and France remain tough, and Italy has turned somewhat soft.

In Asia, Korea is expected to remain the growth leader, and we're still forecasting a modest increase in Japan this year after experiencing a few challenging years there.

These international expectations, along with the improvements in the Americas, support one of our core strengths, geographic balance, which smooths out the rough edges around the globe, resulting in overall strong and consistent growth.

We're launching new products, opening new doors, investing in our brands, and working closely with our retail customers to ensure we have the right programs to drive sales, not only during the holiday period, but all year long.

Based on the current tone of our business, our first half top line growth expectations are between 8 and 10% on a reported basis, which translates to 6 to 7 in constant currency.

In line with what we said on our last call.

As for the bottom line in the first half, we are comfortable reiterating our previous EPS guidance in the range of 78 to 81 cents.

For the full fiscal year, we expect sales growth of between 7% and 9% on a reported basis, and 6 to 7 in local currency.

And we remain comfortable with our fiscal 2004 diluted earnings per share estimate in the range of $1.45 to $1.50.

Let me now switch to the day's other exciting news.

I hope you've all seen our press release this morning, announcing an alliance with Kohl's.

We're very excited with the opportunities this venture represents.

Later in the call, William Lauder will comment on the concept and rationale behind this venture.

Afterwards, both William and Dan and I will be -- will be fielding questions.

But first, let's have Rick Kunes, our CFO, take you through some of the finer details of the quarter.

Thank you, Fred.

Good morning, everyone.

The company achieved first quarter operating income of $128.4 million, a 12% increase over the $114.4 million in the prior year.

This reflects an increase in operating margin of 30 basis points to 9.5%, due to a continued strong improvement in gross margin, partially offset by a higher operating expenses.

Our gross margin of 72.9% for the quarter increased 160 basis points over last year's 71.3%.

This increase reflects favorable supply chain initiatives and lower promotional activities from a combination of timing and a strategic shift from promotional spending to advertising spending, as we have previously mentioned.

These improvements were partially offset by a change in our mix of business, notably higher fragrance sales.

Operating expenses as a percentage of sales for the quarter were up 130 basis points to 63.4%.

Operating expense improvements from selling efficiencies and cost containment were offset primarily by higher levels of advertising sampling and merchandising to support significant new product launches, to promote brand building and build momentum into the holiday season.

Operating expenses also reflect the incremental investment behind our BeautyBank venture, higher operating costs associated with newly acquired brands, and expenses related to compliance with new regulatory requirements.

Looking at operating profits by category, makeup increased $6.5 million to $44.2 million, and hair care was up $900,000 to $4.7 million, reflecting higher sales.

Fragrance operating income rose strong double-digits, increasing $10.5 million to $39.2 million, primarily due to major launch activities in the quarter.

Skin care decreased $6.4 million to $39.6 million.

This category was adversely affected by the soft retail environment experienced in continental Europe, resulting from the record heat, as well as our investments in the Far East, as a skin care-dominated region.

All categories included continued advertising, sampling and merchandising costs to promote new or recently-launched products.

Turning to operating profits by region, the Americas increased substantially by $52.7 million to $117.8 million.

The increase was primarily due to higher sales, restructuring benefits, and other cost reduction efforts, particularly as they relate to manufacturing.

This region's profitability reflects more historical first quarter levels, similar to fiscal 2000 and 2001, when the region wasn't affected by a slow retail environment in the U.S., as it has been for the last couple of years.

In Europe, the Middle East, and Africa, operating incomes declined $36.9 million to $7.7 million versus last year, due to the impact on sales of the adverse weather conditions in most of the region during the quarter that Fred mentioned.

Those conditions negatively impacted the retail environment, leading to the late receipt of certain orders.

This region's results were also impacted by lower sales orders resulting from one of our major customers changing its fiscal year, and renegotiating certain trading terms with another major customer.

In addition, advertising, sampling and merchandising costs were higher during the quarter.

Asia Pacific operating income decreased to $2.9 million.

This decrease reflects costs associated with the launch of Aveda in Japan and investments in new brand expansion and business opportunities in markets like China.

Regarding our interest cost, we reported net interest expense of $7.7 million this quarter versus $2.9 million last year.

The increase is due to the inclusion of a preferred stock dividend.

Let me remind you that effective this fiscal year, in accordance with a new accounting rule, the dividends on our preferred stock are now characterized as interest expense.

All other interest expense benefited from lower average net borrowings and a lower effective interest rate during the quarter.

The effective income tax rate for the quarter was 36% versus 33.5% in the prior year.

The increase was primarily due to the inclusion of the preferred stock dividend in interest, which is non-deductible, as well as the forecasted full year mix of global earnings.

At this time, our expected effective rate throughout fiscal 2004 is approximately 36%.

Net earnings attributable to common stock for the quarter increased 14% to $77 million, compared with $67.5 million in the prior year.

As I mentioned earlier, we reclassified preferred stock dividends as interest expense in the current quarter in accordance with the new accounting rule.

This rule does not allow restatement of prior years, so our period-over-period net earnings are not comparable.

However, our net earnings attributable to common stock and EPS both included the effect of the preferred dividend and are comparable in each period.

Diluted earnings per share for the quarter rose 18% to 33 cents, from 28 cents in the prior year quarter.

Regarding our financial position, the company's cash balance was $483 million at September 30, 2003, an increase of $126 million versus last year.

At the end of the quarter, we issued $200 million of 30-year senior notes to increase our financial flexibility.

For the quarter, net cash used for operating activities was $47 million, compared with net cash generated from operating activities of $3.1 million in the prior year period.

Historically in the first quarter, we experience net cash outflows which reflect seasonal working capital levels and generally will reverse in the next three months.

The current quarter's net use of cash also includes approximately $6 million of preferred stock dividend.

Last year's cash generation was somewhat unusual for us and reflected less cash use for certain working capital components.

During the quarter, we spent $12 million to repurchase approximately 400,000 shares of stock under our share repurchase program, bringing the total shares repurchased under the program to 14.2 million.

We continue to expect cash flow from operations to exceed $560 million for the full year and capital expenditures should reach between $190 and $200 million.

Let me now update you on our working capital.

At September 30, 2003, inventory was $628 million, an increase of $47 million versus last September.

Inventory days were 170 at the end of the quarter versus 165 at last September.

Our inventory days were impacted by the addition of Darphin, Michael Kors, and Rodan & Fields, the strengthening of foreign currencies against the U.S. dollar, and the trend toward later holiday ordering by our major customers, including the delay in receipt of orders in Europe, as previously mentioned.

Regarding receivables, our DSOs of 56 days at September 30, 2003, was unchanged from last year.

Our return ratios continued on the improving trends that we experienced last year.

At the end of September, we sold $200 million of 5 3/4 30-year senior notes, taking advantage of historically low interest rates.

We intend to use the proceeds for general corporate purposes, including the eventual reduction of our outstanding redeemable preferred stock.

I will now update you on a few assumptions for fiscal 2004.

Regarding our first half, we continue to anticipate a gradual economic recovery, particularly in the U.S.

We are also continuing to increase advertising sampling and merchandising spending to support major launch activities and to stimulate sales momentum ahead of the holiday season.

This combination will result in lower first half earnings growth compared with our second half.

We expect reported sales in this year's first half to go between 8% and 10%, including approximately 2% to 3% positive impact of foreign exchange.

In local currencies, we anticipate sales to grow between 6% and 7%.

We expect our gross margin to improve about 80 to 90 basis points for the first half.

Operating expenses are forecast to increase approximately 80 to 90 basis points as we continue to support our launch activity and build momentum in the holiday season.

As a result, operating margin for the first half is estimated to be relatively flat with the prior year.

Diluted earnings per share for the first half is expected to -- in the range of between 78 and 81 cents.

For the full year, we anticipate reported sales growth of approximately 7% to 9%, which includes approximately 1% to 2% of positive impact of foreign exchange.

Sales and local currencies are forecasted to grow 6% to 7%.

We continue to expect gross margin to improve about 70 to 90 basis points for the full fiscal year, with approximately half of the ongoing -- from ongoing supply chain savings, and half from strategically lower promotional activities.

We anticipate an increase in operating expenses of approximately 30 to 50 basis points.

This is due to the investment in BeautyBank initiatives of approximately $15 million, strategically higher advertising sampling and merchandising spending, and, as I just mentioned, the shift of a portion of our marketing investments from promotional to advertising spending, which benefits our cost of sales but increases operating expenses.

These increases are expected to be partially offset by sales growth, tight cost controls in nonbusiness building areas, and the benefit of prior restructuring.

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

As Fred said earlier, for the full year, we anticipate diluted earnings per share of between $1.45 and $1.50.

Now I'd like to hand it over to William Lauder, our Chief Operating Officer, to take you through our new business developments.

William?

Thanks, Rick.

On our last conference call, we informed you of our strategy to develop new brands in additional distribution channels.

This morning, we jointly announced, with the Kohl's Corporation, a strategic alliance to create a new cosmetics department for Kohl's department stores.

The department will consist of exclusive new brands being developed by a new division of our company, called BeautyBank.

Kohl's is a rapidly-expanding retailer with 542 stores in 36 states that has created a very loyal consumer following.

Extending our distribution into new channels has been a part of our growth strategy for several years.

Within that strategy, we have opened hundreds of our own free-standing stores, developed an online business, entered high-end salons, and grown our sales in the travel retail venues throughout the world.

Diversifying into Kohl's will allow us access to both a new consumer and a fast-growing channel with solid foot traffic.

This arrangement allows each party to do what they do best.

The Estee Lauder Companies will leverage its talent pool, technology and expertise in beauty to create brand, products, creative materials, public relations, and sales training, while Kohl's will create an attractive retail environment, providing merchandising, sales people, and advertising investment.

Our BeautyBank division is under the direction of Dan Brestle, Group President in charge of our specialty brands.

BeautyBank is in the process of developing new brands that will comprise a new cosmetics department in Kohl's nationwide and will be the sole provider of branded makeup and skin care for Kohl's.

These new brands are being developed with the Kohl's consumer in mind, appealing to multiple needs with differentiated positioning.

Kohl's will be offering the shopper selection and options which reflect the way she likes to shop.

Based on Kohl's extensive market research, the Kohl's customer would like have her fashion and beauty needs fulfilled in one location.

Currently, Kohl's offers a very limited selection of beauty products.

As previously mentioned, these initiatives require incremental investment of approximately $15 million in fiscal 2004 before we begin to see the benefits accrue in fiscal 2005 as the brands are launched.

The first brands will launch in the fall of next year and roll out into the vast majority of Kohl's stores within the first year.

We will give you more specifics as we get closer to launch.

We are thrilled to announce this exciting new development, which supports our strategies of product innovation and distribution diversification.

We have the experience, talent, and resources to carry out BeautyBank's mission and will work to ensure the success of our ground-breaking alliance with Kohl's.

We'll be happy to take your questions now.

Thank you.

The question-and-answer session will be conducted electronically today.

If you have a question, simply press the star key, followed by the digit 1 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 1.

Our first question today comes from Carol Wilke with Merrill Lynch.

Thank you.

Good morning.

Good morning.

A couple of questions on the announcement from this morning.

You mentioned that you will be the sole provider of cosmetics.

How long -- is there a contract for how long it will only be you guys?

Or is Kohl's, you know, available to -- to link up with other firms, as well?

Well, we're not going to talk about the specifics, but I'm going to let William answer this one.

The arrangement and understanding between ourselves and Kohl's is that through the fall of 2000-something we will have an arrangement that will allow to us be the sole provider.

And is The Estee Lauder Company name going to be anywhere on the products?

No.

No, in keeping with the strategy of our corporation and all of our brands, the only brand that has the name Estee Lauder on it is the Estee Lauder brand.

All the other brands in the -- as part of the Estee Lauder family do not have the name Estee Lauder on them anywhere.

And if I can ask one other question on this.

Is it going to be -- are the brands going to be sold at counters similar to your department store products?

I'm going to let Dan answer that question.

The Kohl's department will be smaller than a traditional department store, and it will be a hybrid between what you would commonly see in a specialty store like Sephora and a normal department store.

So, it's a hybrid type of presentation.

And, Fred, can I just ask one question, or somebody, on the European situation in the quarter?

Two of the events you talked about were pretty quarter-specific.

Were those Estee Lauder-specific events, as well?

Or did anyone who sells in the cosmetics area experience the impact from the shift in the year-end, as well as renegotiating?

I think everybody experienced that, too, in Europe.

And so do you expect -- especially for the change in the year-end, those sales to flow into the December quarter?

Yes, I think some of it, obviously, will flow into December in the second quarter, and -- and -- and, you know, however, having said that, you know, the retail environment for both -- for -- in Europe, were pretty soft in July and August.

And we -- we're pretty confident that we'll recapture most of it, but there's -- the fact is that there was some loss in the retail sales during that period for, you know, for fashion companies as well as -- as for -- for the cosmetics companies.

But seeing, so far, September and October, the retail environment has improved.

So we feel pretty good about it.

Thanks very much.

Okay.

And our next question comes from Andrew McQuilling with UBS.

Thanks very much.

I had a few more for Dan on the -- on the Kohl's.

Dan, can you talk about how many brand concepts you're planning initially?

And your sense for door productivity?

Is it going to be comparable to the base business?

Well, we're going to discuss the brand specifically after the first of the year, but it'll be a multiple brand presentation, so that the customer has the selection she needs and is comfortable with them.

We think that is key to the enterprise that we satisfy various needs at variation price points.

The productivity is a question mark as of this time, with estimates -- it's been estimated at a very conservative number, but we think there is a huge upside once the Kohl's consumer realizes the quality of the cosmetics she's being provided.

Andrew, you know, if you look at the traditional department stores, you know, you -- they have cosmetic sales anywhere from 12% to 15% of their total sales.

So, you know, you can figure out approximately what the universe potentially could be.

I'm not saying that that's what we're shooting for, but obviously there's an opportunity out there.

And Fred, I guess you mentioned -- or Dan, you mentioned that it's going to be a hybrid model.

In terms of, you know, how to think about profitability for the new -- for the new outlets, any thoughts there?

I'm assuming at least as good as the U.S. department store business?

Andrew, thank you very much for the question.

I'm not going to respond to it at this point.

Thank you.

Thank you.

Okay.

And we'll move on to Linda Bolton Weiser with Oppenheimer.

Thanks.

You know, I didn't catch a few -- did you go into the details regarding, you know, how your cost sharing is for fixtures and payment of sales commissions and anything like that?

We will not discuss details in regards to what the arrangement is at this -- at this juncture.

Okay.

And just to clarify, in terms of the rollout for the number of stores, are you saying that it will be roughly in almost all Kohl's stores, 500-plus, by fall of '05?

I'm going let Dan handle that one.

It will start rolling out next fall with -- with -- I think the initial number is somewhere around 272 stores, with some of the brands.

When -- by the time all of the brands roll out to all the stores, will be at least a year.

Okay.

And -- and just one more question.

How -- acquisitions total contributed what to sales growth in the quarter?

It was very small.

Yeah, it was very small.

The only one was really Darphin, and it contributed about 3% of the growth in the treatment category, but for the total company, you could do the math for that.

But it was very small.

Okay, thanks.

Our next question comes from Bill Schmidt with Deutsche Bank.

Hi, guys.

Hi, Bill.

What is in the $15 million cost for the channel expiration for Kohl's?

For the $15 million?

Yeah, what is that comprised of?

Well, you know, these are development costs, but again, I'm going to let William and Dan handle that one.

The $15 million is predominantly brand development, that is both the expenses themselves for the brand development activities, as well as the salaries for the people who are -- are in the process of doing that now, as well as product development and research and development.

Okay.

And then one more question, if I may?

How do you think Kohl's is different than JCPennys?

You know, obviously, Avon's foray with combining into JCPenney was a failure by all accounts.

And I was wondering what you saw differently in Kohl's?

Well, I think there are a number of different aspects that Kohl's has done an exceptional job in differentiating themselves from different department stores.

I would say the primary difference is, is that Kohl's position is a far-more focused position on a number of different areas.

First of all, they have a very clear position in their fashion position as far as value is concerned, as well as merchandising.

From a distribution position, they tend not to or almost exclusively are never in regional department stores -- in regional malls, they're always in strip malls or other more convenient locations for their consumer than traditional regional mall.

The format is smaller, it's all single level, they're all approximately between 60 and 100,000 square foot.

I think their standard model is 80,000 square feet, plus or minus.

And they have a far -- they have a more -- they really sort of bisected -- aimed themselves squarely between the discount stores, the Targets and the Wal-Marts, and the department stores, if you will, JCPennys, Sears.

And they have a very unique model that's been very effective, and we see them as a different retailer from the others.

In addition, I would say that you can't compare The Estee Lauder Companies and how we develop brands -- how we develop brands for a channel in any of our competitors.

We have a track record over 50-plus years, almost 60 years now, in developing brands that's unique in our industry.

And to look at how any of our competitors may or may not have done it successfully and compare it to us, is not right.

Okay, Dan, you want to add anything to that?

I'd like to just accent what William said, I think it's important.

The selection of a distribution channel is always the easy part of a process.

The development of brands is the more difficult process, and we think that we have an expertise in the area that has proven itself over and over again.

Another point of difference is the numbers of brands and the difference in price point and selection that we're offering.

So, we are very confident in this venture.

I'd just like to add one thing and that is, as you know, Kohl's is not competing within the shopping malls, whereas some of the other operators, like Pennys and Sears are in the malls competing with the traditional department stores.

So, I think that is, from a distribution point of view, that is also a differentiator.

Okay, great.

Thank you.

Thank you.

Wendy Nicholson with Smith Barney has our next question.

Hi.

My first question has to do with the guidance on operating margin expansion.

I think you said operating margins would be flat year-over-year for the first half, but still up 20 to 60 basis points for the year.

But given the seasonality of your profits, that means that operating margins in the second half have to be up, like, I think, well north of like 80 to 100 basis points.

And given that I'd assume that Kohl's investment spending is skewed to the second half, are there particular cost savings coming in from restructuring that are second-half loaded?

Or how am I not getting comfortable there?

Not really, because we're launching the fragrances in the first half.

That's obviously an investment period.

I think the benefits of that will come through -- what we anticipate excellent sales, retail sales in November and December, which will obviously carry into the new year with a lower cost base.

So, you know, you've seen that sort of executed in a different form last year and you will see it similarly again.

The other aspect you have to remember, that last year, in the last quarter, the European business was relatively soft in the fourth quarter, and I think we have all kinds of ammunition this year to have -- to expect a very good European and international business on it -- in that period.

So, we feel pretty comfortable about that.

Okay, fair enough.

And then just to clarify on the Kohl's thing, are we talking one primary brand or multiple brands that are all going to be launched at the same time?

Multiple brands, but we're not specific right now as to how many we launch and at what time, but it will be definitely multiple brand environment.

And the multiple brands being different positioning and different price points just like you have --

Exactly.

Okay.

And then before announcing this, did you talk about this with your other primary customers?

I guess, I mean, my concern would be if I'm federated, for example, I say, wait a minute, I want my own exclusive brand, too?

Look, our basic view is first of all, we have an inherent interest to drive our business with our existing customers.

We're committed to do that.

This is not a strategy to cannibalize our existing businesses in any form.

So, I think that this is a new format, a new idea, new concepts, which -- which, basically, competes in an environment where there's no competition today at Kohl's in the -- in the beauty business.

So, I think it's very difficult to compare that with the existing formats in the department stores, where a lot of different vendors are competing for the same pie.

So, that's where its at at this juncture.

We've explained our position and we're clear and committed to continue to drive our growth of our existing brands in the -- in the existing distribution.

And just the last question, I guess, is just in terms of '05 and the impact of the year-one advertising and all that kind of stuff is going to have, I mean, this Kohl's arrangement doesn't take you off of -- I mean, you're still committed to realizing your consistent annual EPS growth goals -- in that positive not going to take away from that?

Absolutely, in fact it should enhance it because we're going to have bigger volume and better overall absorptions, et cetera.

So I think it's going to enhance it rather than take away from it.

Excellent.

Okay, thanks.

Thank you.

We'll take our next question come Amy Low Chasen with Goldman Sachs.

One question on Kohl's, which is why are you not doing a test market?

Dan, you want to talk -- tackle that one?

Yeah.

Amy, you sound like you have a cold.

Just a sore throat.

We've done a lot of research there, Amy, suffice it to say.

Go on.

The test market and the investment in the product line, the concepts, the positioning, we didn't really see a benefit.

We have a confidence level of how we're going to execute this.

We have a terrific partnership with Kohl's.

They're as anxious to develop this concept as we are, and we were confident enough to just move forward.

We didn't feel that the investment in a test market would be worthwhile, nor did we want to delay the process two or three years evaluating results.

What type of metrics will you look at, say in, you know, year 1, to make sure that you're kind of achieving your goals?

And if you're not, you know, is this something that you'd be willing to pull the plug on?

Can I -- ?

Please.

We're going to treat this like a normal business, and we evaluate our success, it's not necessarily shipments, it's sellthrough to the consumer.

We will see the acceptance of the brands to the consumers.

If we see good sellthrough, we'll know we're on the right track.

We have built in time with our arrangements with Kohl's, and if something's not perfect, we have time to tweak it until it is perfect.

So it'll go through the normal course of any brand-building exercise, but it's all about retail sales.

We will see immediately whether there's acceptance.

Amy, if I could add one more point.

In -- as I mentioned earlier, we've got enormous experience and enormous track record, a very long track record, in brand building.

An one thing we know for certain is, is that you don't know whether a brand is a success or not in year 1, or even in the first 18 months.

The success of the brand is in years 3, 4, 5 and beyond, and we are marathon runners this this, and we're expecting to build a group of brands with a great retailer where we can talk about the success of this partnership 20 years from now, not just 18 months from now.

And Amy, let me just add a couple of things on process.

You know, when we're developing a brand like this, there's a lot of market research and -- and interaction with potential customers involved.

We have our own -- we have our own marketing group who does nothing but that, and market research group.

For instance, if -- the name of the brand is going to be tested extensively with potential Kohl's customers.

The -- the positioning, the pricing -- suggest a pricing strategy.

The packaging.

All of these things are being vetted before we get into the marketplace.

So, this is not a question of, you know, talking to ourselves here and then bringing it to the market.

I mean there's -- the whole process is, you know, there's a lot of hurdles which we -- which we test, doing the development process, so, we feel pretty confident about that.

Okay.

And just one last thing.

Does this reduce your desire for, you know, a -- a bigger acquisition, kind of outside of Kohl's or your core brands?

One has nothing to do with the other.

Everything is geared towards if there's value to be created for this Corporation, we have an open mind and the balance sheet to support that idea.

Okay, great.

Thanks a lot.

Okay.

Thank you.

We'll move now to Neal with State Street Global Advisors.

Hi.

Just two of the Kohl's questions, then I'd like to ask something about the, you know, the ongoing business now, as opposed to the future, but --

One of the goals from, I guess, a year or two ago when you had us all in New York, was the percentage of revenue that was going to come from America, Europe, and Asia.

I would assume this is going to change that expectation of getting to 54% of Americas, for example, and Europe to 30?

Yes, that will change it somewhat, but having said that, you know, the -- the currency, obviously, also plays into this whole shift, and we'll see what shakes out.

But needless to say, this activity we announced today will certainly enhance our North American percentage of sales to the total corporation.

Okay.

And then, within this department store itself, within the Kohl's store, are you going to be in the "filet mignon" space of the store?

Exactly.

And then, I'm also curious as far as the multi -- multiple brands, is there going to be a Kohl's brand?

Dan?

No.

There will not be a Kohl's brand.

Each brand will have its own -- will be -- will be named appropriately for its position, but there's no Kohl's brand, per se.

Okay.

And then, curious about the -- the quarter, the Americas sales of 9%, what was takeaway in the quarter?

Takeaway was in -- in our retail stores, we could obviously see it was in the double digits.

And -- and in the department store universe, I think it was around 3% or something like that, 3% to 4%.

Depending on the brands, it varies.

And if you, kind of --

-- there's a long business it would also double digits.

If you rolled it all up into one takeaway number for the Americas?

Hard to roll it all up, you know, and I don't want to get into that specific at this juncture.

I would say, probably, I would say in the neighborhood of about 6, 6-plus%.

Okay.

And then just lastly, did you -- did you say that your retail stores were up mid-teens --

Retail stores in the Americas was up in the mid-teens.

Okay, great.

Thank you.

Good quarter, by the way.

Thank you.

Thank you.

Next we have Bill Stelle with Banc of America Securities.

Thanks.

Good morning.

Regarding the Kohl's situation, I'm curious as to the product offering.

Are you going to be in hair care, skin care, and cosmetics?

And then secondly, would you potentially have a specific brand for a specific category, or would the brand encompass, you know, all the offerings?

The initial offerings will be in the makeup and skin care categories.

We will look further as the relationship develops, and -- any of those potential categories you mentioned could be -- could be undertaken.

Each brand will have its various assortments.

Some brands will be exclusive to a category, others will be a broader offering.

Okay.

Thank you very much.

Okay.

John with Founder's Fund.

Good morning, gentlemen.

Good morning.

Well, Rick or Fred, I was hoping that you guys might be able to give us a little more detail on travel retail, what type of growth you saw year-over-year?

Okay.

The travel retail -- the travel retail so far, you know, growth over year is only about 3, 4% or something like that.

But the encouraging news is -- the encouraging news is that the -- the order flow coming into us now in October is accelerating, so, we feel good about that.

And also, also, by the way, the fragrances, the Aramis Life with Agassi, and Beyond Paradise is impacting our travel retail business and is expected to impact it even more, because, you know, what we're seeing so far in the launch activity, these fragrances have tremendous acceptance.

U.K., the Aramis Life immediately came out of the starting gate tremendous, and here -- here also in the United States.

So, we think we have some upside potential there.

Great, thank you.

Okay.

Michael Exstein with Credit Suisse First Boston has our next question.

I'm just wondering how you communicated with your existing customers on the decision to broaden distribution and what their response has been?

Thanks.

Well, obviously, we have a very close relationship with our existing partners, and when we make an announcement such as this, we contact, of course, we're in contact and we then explain our position to ensure that there's no misunderstanding.

And our intentions and objectives are very clear.

Our objectives are, that to drive our existing business.

Nothing good will happen to drive one side of the business -- create a new business that cannibalizes your old business.

So, we've explained our positions in this and we will be doing some more work in this regard as we are -- as we are able to disclose more of this going forward.

And what was their response to that explanation?

They understand.

They understand that our success depends on their success.

Thank you so much.

Okay.

And we do have a follow-up question from Andrew McQuilling with UBS.

Thanks very much.

I guess two more.

First on Europe, Fred, can you quantify the drag in the September quarter on the two events, the change in trade terms and the change in year-end?

You know, Andrew --

Please?

Andrew, I really don't want to get into these quarterly things, you know.

I've gotten away from giving quarterly guidance, I really don't want to spend too much time on this, because I feel good in my comments to say that I think the majority of what took place in the first quarter in Europe, we'll be able to recapture throughout the year, and I think that's where we should leave it at.

And well then, just on a follow-up on that Europe question, you mentioned -- it sounds like in your write-up that Europe's going to lead the overall regions in terms of sales growth for the first half.

Is that how I should understand it?

Well, I think you'll see some positive growth still coming in Europe and -- if not for the first half, it certainly will be, I think the lead for the year.

Alright, and one more for Dan, if I could?

Dan, can you talk about the Kohl's customer, their current cosmetics and skin care purchasing behavior?

From -- from the research we've -- we've discussed with Kohl's, their consumer shops for cosmetics in multiple channels.

She's not specific to any one channel, much like she shops for the rest of her assortment.

So, you know, she comes from there, she comes from some prestige, she comes from direct, she comes from specialty store, she comes from all over, and she, coincidentally, shops Kohl's.

So, we're looking to address her at the price points with the assortment she likes.

Terrific.

Thank you very much.

And as a reminder to our audience, please press star 1 if you'd like to ask a question.

We'll take our next question come Janet Clautenberg with JJK Research.

Hi, Fred.

Hi, Janet.

Congratulations on a very good quarter.

Thank you so much.

I have a couple of follow-on questions.

When you said travel retail was only up 3% to 4%, that's to mean that's what it was about -- about what it was up in this quarter just reported?

I think as far as -- in fact, I think it probably was a little better than that.

It was between, I think, from what I understand, it was 5 to 6 overall.

Okay.

But that's -- to me, it's not that important.

I think what's important is the trend.

What I'm seeing in the trend of takeaway --

Well, it's a big improvement from what it was in the June quarter.

So, the trend looks good to me.

That's true.

So I'm looking for an acceleration in the trend here, okay?

Yeah.

And the Japanese business seemed flat, can you talk a little bit about the trends there during the quarter.

Did you see acceleration as the quarter ended up?

And do you see a positive direction in business there?

Well, it's a sort of a mixed bag.

You know, the overall market is only marginally growing if anything, 1% to 2% maximum.

Uh-huh.

And, you know, we have some brands that are -- they're doing very well, and some other brands are doing less well.

You know, it requires to do a lot of spending in the Japanese market, and I'm not sure that to drive sales and spending against that at this juncture is a wise investment.

I think that, you know, to -- to stay in the game and -- and grow your business is one thing, but to really go aggressively after, I'm not sure you get the payback at this juncture.

So, we're looking at our business there.

We see an opportunity for Aveda.

We've invested in.

We see the Lauder brand doing very well, in fact, amongst the largest ones, it's the fastest-growing one.

We're still struggling a little bit with Clinique, but it's getting better, and that's what it is.

So, and as you know, fragrance is not a factor in Japan, so, our fragrance ammunition is not going to play out as well as it does in the Angelo Saxon and European markets.

So, we will stay on the ball in Japan.

We have a leadership position there and we'll continue to do that, but, you know, we're prudent about it.

Okay.

And I have a question on operating margins.

I think you guys said you're looking for flat operating margins in the first half of the year.

Would that -- I guess that implies that the second quarter operating margins are to be down?

No gross margin improvement in the second quarter?

I'll let Rick respond to that.

Hi, Rick.

Hi, Janet, how are you?

Good, thank you.

That's true, yes, there'll be a slight decline in operating margins in the second quarter.

But, again, for the half, relatively flat, and for the --

Does that have to do with, not only higher operating expenses, but a lower gross margin, as well, Rick?

It has to do -- you know, there was a big improvement in the first quarter in cost of sales related to the timing of gift shipments.

Right.

And some of that timing, obviously, reverses itself in the second quarter.

So, that's a big impact.

And we had the spending going on for BeautyBank, and some other things, and some investment spending in advertising, merchandising, and sampling.

So, you know, it's not different than we had planned.

We said 78 to 81 cents, and we should be on that plan for the year.

And the second half is, obviously, as Fred mentioned earlier, tremendously impacted by the fourth quarter of last year.

We're up against a very weak fourth quarter.

So I think we're up in the second half related to that.

Okay.

And my last question is on -- is on the new venture with Kohl's.

I'm -- I'm guessing that initially the margins of the business will be lower, as they usually are when you deal with a discount channel.

I -- is the hope that as the volume gets up you're able to leverage the infrastructure and work on a lower gross margin, higher SG&A -- excuse me, lower gross margin, lower SG&A model?

Janet, your assumptions are not correct.

And I'm not going to explain and help you explain to improve your assumptions at this juncture, but at the right time, we'll certainly lay out a little bit more specifically with our partners, how this should be -- how this should be executed --

Let me just ask one question, Fred.

You don't believe that the investment it this business and the growth of it will deteriorate the overall company's operating margins?

Not at all.

Okay.

Thank you very much.

Okay.

Thank you.

Wendy Nicholson with Smith Barney has a follow-up question.

Hi.

I just wanted to go back to one of the comments you made about the product mix in Kohl's, and you said, I think, no fragrance to start.

That surprises me, because I think fragrance -- I think of fragrance as being very much impulse purchase and, you know, lots of brand diversification.

So, why not start with fragrance?

Dan?

Wendy, they -- they have a present fragrance assortment.

When we -- when we developed businesses, we thought it was a better strategy to go in with makeup and skin care.

It's not precluding our entry of fragrance long-term, but because they have an ongoing fragrance business there, that is not part of the original arrangement.

And the other thing I would say is, if you want to drive a fragrance, you really have to have a broader distribution.

You know, the arrangement with Kohl's is on an exclusive basis in terms of the brands we're building.

And on the fragrance side, you know, you really need to have a global distribution platform, you know, to make it economically viable.

Got it.

Thank you.

Thank you.

Moving now to Amy Low Chasen with Goldman Sachs for a follow-up.

I also want to follow-up on Kohl's.

Are you -- you discussed that for some period of time that you're the only cosmetics supplier to them.

But do -- what -- in the contract, what does it say about your ability to take these brands down the road to either other retailers or outside the U.S.?

Amy, we have an exclusive arrangement with Kohl's for North America.

These brands are our trademark brands and we have any -- we have any option we want to take these brands anywhere throughout the world where the distribution channel would provide adequate --

-- opportunity and return on the investments.

And so, can you discuss what your plans are with respect to that?

Our plans right now are to develop new cosmetic brands for Kohl's.

So, I guess, I'd read that to mean that that's your first priority, and kind of, in a year or two years down the road, you'll re-evaluate whether it makes sense to take them outside of the U.S.?

That's a great observation.

Okay, thanks.

We'll move now to Neal Goldner with State Street Global Advisors.

Hi.

Real quick.

Rick, I think you said cap ex would be 190 to 200.

My notes have that cap ex this year is going to be something closer to 2.25.

Are my notes wrong?

Or is cap ex actually going to be down --

Neal, I think your notes are wrong.

We -- right now we're around $190 to $200 million is the number we're looking for.

I think that's always been our number.

But your notes may come from, maybe, some guidance we were talking about last year, about what's a more normal level and at some point in time it might get up to that, but right now that's not what we're seeing.

Okay.

And I'm just looking at last year's fourth quarter, because it was commented about last year's fourth quarter being an easy comp.

Last year's fourth quarter, if I'm looking at this right, operating margins were up significantly -- yes, '02 was a low base, but still you had significant improvement in operating margins.

Are you suggesting that your June quarter this year is going to be closer to what used to be the normal?

Well, I think what -- when we were talking about a soft quarter, we were referring to the international part of it.

The international part of the -- of the business last year, we didn't have a lot of new activity and launches going on through that period, and I think we have a tremendous opportunity this year, in addition to that TR business last year was also negatively affected.

So, I think although the numbers were -- showed a big improvement in -- in the fourth quarter, overall as a company, the international business was really not performing that well in that quarter.

Okay, and then just a last question.

I don't want to nitpick, but the guidance you gave for '04 during the last conference call, as far in as in order of importance geographically, was basically Europe, European region, Americas, and Asia Pacific.

Now it's European region, Asia Pacific, and Americas.

Have the Americas and Asia Pacific -- have actually kind of flip-flopped a little bit.

Is there anything specific that about?

Especially since Japan is flat.

It's interesting that you would do that.

That's the full year numbers and you are correct, there is a flip-flop, but, you know, the numbers are so close, that, you know, a small change is just moving one ahead of the other, they're relatively close.

Great, thanks a lot.

Yep.

Linda Bolton Weiser with Oppenheimer has a follow-up question.

Thanks.

Do you have any sense for what inventory in the channel at the end of the quarter was in North America this quarter versus last year?

Similar.

Similar situation.

Inventory continues to be managed tight by the stores, and we're trying to manage it tightly, as well.

William, you want to add something to this?

Linda, in the United States, we -- 94, 95% of our retailers are on EDI with us.

So, it's a pretty transparent stocking process right now.

And, essentially, the inventory growth is -- is related to sellthrough and new productivity.

And, obviously, with the addition of the -- with the major fragrance launches of Beyond Paradise, Aramis Life, and Clinique Simply in the first haft of year, you will see inventories growing because fragrance is a big piece of the last piece.

And the retailers were all investing in the inventory to match our investment in A&P.

Okay, and if you look at the fragrance segment growth in the quarter, about how much was accounted for by those three big new fragrances?

Roughly.

I don't know --

It certainly was a major contributor, but I don't think we have that number readily available at the moment.

I think another way to look at it is, absent the major launches, I think you would have seen a different number in the fragrance business.

I don't -- I don't know if it's quantifiable.

Because it's a chicken and egg principle.

We're investing in new brands and some of that investment in new brands is offsetting investment we might have put into existing brands because we had the launches.

Okay, great.

Thanks.

And as a final reminder to our audience, please press star 1 at this time if you'd like to ask a question.

We will pause for a moment to give everyone an opportunity to signal.

And our next question comes from Andrew McQuilling with UBS.

Fred, you're sick of hearing of me, but one more.

You mentioned that travel retail trends are improving.

Can you mention what September month sales are up and how October others are doing?

No.

I'm not going to be that specific, but all I can tell you is that it's moving in a good direction.

And we -- we're getting some excellent orders in, particularly going into -- into the Christmas selling season, and because -- I think the word is getting around that these fragrances we've launched are really hitting a mark.

You know, the -- the Beyond Paradise could be the number one fragrance in September and -- you know, before -- you know, we haven't even geared up fully in terms of our promoting this brand, so, I think that's pretty impressive.

And the Agassi fragrance, the Aramis Agassi fragrance, is fabulous.

So, I think the word is getting around and the orders are flowing, so, we're pretty healthy.

But at the end of the day, it's about sellthrough and not sellin.

So, you know, I want to be prudent.

Terrific.

For what it's worth, I'm buying Beyond Paradise for my mother this Christmas.

You've got excellent taste!

And what about your wife?

Wife, too!

Go out and buy it for your wife!

For your wives that need Happy from Clinique!

You need to keep her happy.

Absolutely!

Okay.

Thank you.

And, gentlemen, it appears we have no further questions at this time.

Terrific.

That will conclude today's question-and-answer session.

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That concludes today's Estee Lauder conference call.

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

Thank you.

Thank you.