雅詩蘭黛 (EL) 2004 Q3 法說會逐字稿

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

Today's call is being recorded and webcast.

For opening remarks and introductions, I'd like to turn the call over to the VP of Investor Relations, Mr. Dennis D'Andrea, please go ahead, sir.

Good morning.

Thank you for joining us.

On the call today are William Lauder, COO and Rick Kunes, SVP and CFO.

Some of our remarks today contain forward-looking statements which involve risks and uncertainties.

In addition to specific risks described on 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 10Q, which we expect to file also today.

Now I'll turn the call over to William.

Thank you, Dennis.

Good morning, everyone and thank you for joining us today.

As you know, our CEO, Fred Langhammer, announced on last quarter's conference call that it would be his last call.

It's my honor to follow him to take the lead on these calls.

Over the years, Fred has built a great deal of trust with you and I will look to build upon that what he established.

And now on to our third quarter results.

Our performance this quarter was better than we expected, due primarily to increased sales volume toward the end of the quarter.

For our third quarter, we turned in outstanding net sales growth of 15% to $1.42 billion from $1.23 billion last year.

Excluding the benefit of foreign currency translation, net sales grew a robust 10%.

Net earnings attributable to common stock from continuing operations for the quarter were up 27% to $100.1 million, compared with $79.1 million in the prior year quarter.

Diluted earnings per share for continuing operations rose a very healthy 28% to 43 cents, compared with 34 cents in the same period last year.

These are particularly strong results in light of the difficult comparison to last year's third quarter when EPS grew 79%.

In February, we sold our jane brand and had reflected their financial results as discontinued operations for the quarter and year to date.

In the U.S., retail sales picked up nicely and overall were quite strong.

Our international business remains strong with Europe growing 25% and Asia increasing 19%, including the positive effects of changes in foreign exchange rates.

A continued substantial recovery in the travel retail again helped drive sales this quarter as did double-digit growth from our retail stores around the world.

We had an across-the-board sales increase in every region, in every product category resulting in an outstanding performance.

The Company has performed very solidly for the first nine months of fiscal year, giving us the confidence to increase our previous full year guidance.

Growth in our top line is expected to be double digits on a reported basis and we are increasing our earnings per share expectations for the full fiscal year from continuing operations to a range of $1.59 to $1.62.

All product categories reported strong growth this quarter, led by makeup and hair care.

Our two biggest categories, makeup and skin care, also grew in every region.

In skin care, reported sales increased 10% to $559.1 million and grew 4% in constant dollars.

The Darphin product line, which is predominantly skin care, added incremental sales.

Our exclusive La Mer brand saw double digit growth in every region.

We had strong sales of Clinique's Repair Wear Day and Pore Minimizer as well as Estee Lauder's Hydra Complete and Idealist Micro-D and Re-Nutriv Intensive Lifting products from the Estee Lauder brand also reported a solid sales increase.

Sales growth in makeup was outstanding, increasing 22% to $591 million in dollars and rising 17% in local currency.

M.A.C. and Bobbi Brown's continued momentum was evident in their strong double-digit growth around the world, driven by new color stories and increased distribution.

Clinique launched a new foundation called Perfectly Real Makeup while the Estee Lauder brand introduced an exciting new lip cream called Electric Intense.

In fragrance, sales again grew this quarter.

Fragrance sales for the quarter increased 12% to $203.4 million on a reported basis and rose 5% over last year, excluding currency.

This growth came primarily from outside the U.S. along with strong travel retail fragrant sales.

As you know, this category continues to be challenging with industry sales in the U.S. growing modestly this quarter.

Estee Lauder's Beyond Paradise generated solid sales in the U.S. department stores ranking No. 3 in women's for the quarter and rolled out successfully to remaining countries this past quarter.

Aramis Life is now fully distributed and added to growth.

The new product for spring, with more visuals of Andre Agassi, has had a terrific effect on the buzz for this fragrance.

Clinique Simply, also performed well.

And incremental sales from our renewal license agreement with Michael Kors also helped the category.

Hair care rose 15% this quarter to $61.3 million on a reported basis and grew 13% in local currency.

Aveda and Bumble and bumble each had double digit increases this quarter from existing and recent product launches, existing door growth and new distribution.

Aveda opened additional Concept Salons worldwide and, as you know, Concept Salons sell Aveda products exclusively and have a more productive economic model.

Bumble and Bumble continued its salon expansion, opening 230 new salons over the period.

Let me now review our geographic regions.

In the Americas, sales for the quarter rose a better-than-expected 9% from the prior year to $783.1 million, aided by the improved retail environment in the latter part of the quarter.

We are pleased with the performance in this region so far this year with sales for the nine months up 7%.

Consumer traffic and spending picked up in the U.S., particularly later in the quarter, allowing most retailers to deliver robust same-store sales.

Most of our established brands posted higher sales along with growth from virtually all our developing brands, with most posting double-digit sales increases and in total, our free-standing retail stores generated double-digit growth with M.A.C. leading the way.

Fragrance was the only category that did not have increased sales this quarter in the Americas, coming off of last quarter's strong holiday results.

In Europe, the Middle East and Africa, net sales jumped 25% over the prior year to $453.1 million and grew 12% on a local currency basis.

Our travel retail business continued its recovery this quarter rising 18% in constant currency on top of the 30% growth reported in last year's third quarter.

Most countries reported growth, particularly Spain, Germany, the U.K. and Greece while Italy remained somewhat weak.

In Spain, the train bombings that took place in Madrid in the quarter tempered local department store traffic as well as air travel for a few days, but quickly came back to pre-event levels.

The European region also benefited from incremental sales from the addition of Darphin, which generates most of its sales in Europe.

In Asia Pacific, net sales grew 19% over the prior year to $185.4 million.

In local currency, sales were up 10%.

Local currency sales increased in every market, including Japan.

China, Taiwan, Thailand, Malaysia and Hong Kong all generated solid double-digit sales increases.

Now for the remainder of the fiscal year.

We will be introducing a full array of spring and summer seasonal products in makeup, skin care and fragrance as well as appealing gift ideas for Mother's and Father's Day.

Our new guidance supports our optimism about our business globally, despite pockets of softness in some countries.

Based on the current tone of our business, we now expect sales growth of approximately 13% on a reported basis and about 9% in local currency for the full fiscal year.

As I said earlier, we are now comfortable with increasing our estimate for fiscal 2004 diluted earnings per share from continuing operations to a range of $1.59 to $1.62.

Let me now give you a brief update on our Beauty Bank venture with Kohl's.

All aspects of this venture are progressing along as expected and on time.

On the product side, our new brands are getting some final touches and are looking good. while creative design and marketing are coming together, and I think you'll like what you will see.

We look to introduce the brands for the long leap print and select trade publications in late June with product shipment beginning in September for our fall launch.

Initially, some of the brands will be introduced in approximately 275 stores, this will be Phase I. Phase II, which will resume about next February, will ramp up those brands and roll out to all stores.

We're excited about this opportunity.

Bringing new brands into a new distribution channel brings on new challenges, but we have all the right elements to make this work and we're looking forward, together with Kohl's, to building a successful business.

Our financial estimates for Beauty Bank will be included as part of our fiscal 2005 forecast, which we will discuss with you during our year-end conference call in mid-August.

Now I'd like to switch topics.

You may have seen some comments in relation to the Company's future acquisition strategy.

Let me briefly touch on some key points on that subject.

We will continue with the notion of being opportunistic first; when a potential acquisition compliments our overall portfolio, second; where the acquisition can create value by leveraging our global distribution network and third; when the acquisition has the potential to result in substantial sales and profits.

Needless to say, as the company gets bigger, the opportunities will have to be more meaningful in terms of their potential size.

Our acquisitions are designed to compliment our existing portfolio, our product category strategy and our geographic strategy.

In these endeavors, we are committed to the upper segment of the market as well as multiple distribution channels.

As we have stated in the past, our basic philosophy is to make acquisitions that create value for our stockholders, not for the sole purpose of getting bigger.

Now I'd like to hand it over to Rick Kunes, our CFO, to take you through the third quarter financial details.

Rick?

Thank you, William and good morning, everyone.

Let me begin with a few reported results.

Reported net earnings attributable to common stock for the quarter rose 26% to $98.3 million, compared with $77.9 million in last year's quarter.

Reported diluted earnings per share were 42 cents or a 27% increase, versus 33 cents for the three months of last year.

As you know, during the quarter we sold the assets and operations of our jane brand.

All statement of earnings information for the periods reported have been restated to treat jane as a discontinued operation.

For your reference, restated historical financial information can be found in the investor information section of our corporate web site.

The remainder of my discussion today will focus on our continuing operations, as this is the way we evaluate and review our business performance.

Now some of the third quarter highlights.

The Company achieved third quarter operating income of $169.6 million, a 31% increase over the $129.3 million in the prior year.

This reflects an increase in operating margins of 140 basis points to 11.9%, due to both gross margin and operating expense improvements.

Our gross margin of 74.8% for the quarter increased 20 basis points over last year's 74.6%.

This reflects favorable supply chain initiatives of 60 basis points and lower cost from promotional activities of approximately 30 basis points.

The promotional expense reduction reflects a strategic shift from promotional spending to advertising spending, which was partially offset by a shift in the timing of certain promotions from our second quarter into our third quarter.

These benefits were offset by changes in foreign exchange rates, as well as a change in our mix of business, notably the continued recovery in travel, retail and higher fragrance sales.

Operating expenses, as a percentage of sales for the quarter, improved 120 basis points to 62.9% from 64.1% in last year's quarter.

The decrease as a percentage of sales reflects the higher rate of sales growth, continued tight management of operating costs and a delay of expenses related to certain product launches, partially offset by higher support spending.

Once again, we continue to strategically invest in advertising, sampling and merchandising expense, but at the same time are focused on reducing all other operating expenses as a percentage of sales.

For the nine months, we have reduced selling, distribution and administrative costs by 60 basis points.

Increased advertising, merchandising and sampling by 40 basis points while at the same time exceeding our financial performance objectives.

Looking at operating profits by category, skin care, makeup and hair care increased, primarily due to higher sales with each category growing strong, double digits.

Skin care increased $21.6 million to $96 million.

Makeup was up $35.1 million, to $96.1 million.

And hair care increased $1.5 million to $3.3 million, while our operating loss in fragrance widened to $27.6 million.

This decline in fragrance was due to the soft fragrance business in the U.S., increased support spending behind recent product introductions and their international rollout, particularly Beyond Paradise, as well as development costs for future fragrances and brands such as Michael Kors.

Turning to operating profits by region, we've seen some swings between quarters for both the Americas and Europe regions that have smoothed themselves out, resulting in operating income growth in the Americas and Europe of 30% and 19%, respectively for the nine months.

In the quarter, the Americas increased by $24.4 million, to $102.8 million, driven by the strong operating results in our makeup category, which performed exceptionally well this quarter.

In Europe, the Middle East and Africa, operating income rose $12.5 million to $57.2 million, versus last year, primarily due to the increase in the travel retail business and strong improvements in Spain, Germany and Italy.

Asia Pacific operating income increased $3.4 million to $9.6 million due to higher results in Japan, Singapore, Hong Kong and Malaysia.

At the same time, we continue to invest in the region in new brand expansion and business opportunities and developing markets like China.

Regarding our interest costs, we reported net interest expense of $6.9 million this quarter, versus $1.9 million last year.

The increase is due to the inclusion of the preferred stock dividend and higher average net borrowings, partially offset by a lower effective interest rate during the quarter.

The effective income tax rate for the quarter was 37.4%, versus 32.4% in the prior year.

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

We continue to expect our effective tax rate throughout fiscal 2004 to be approximately 37.4%.

This change, versus the prior year, reflects the first nine months results, revised estimates of our full year mix of earnings and the timing of certain tax savings initiatives.

Net earnings attributable to common stock from continuing operations for the quarter increased 27% to $101.1 million, compared with $79.1 million in the prior year.

As I mentioned earlier, we reclassified the preferred stock dividend as interest expense 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 from continuing operations and EPS both include the effect of the preferred dividend and are comparable in each period.

Diluted earnings per share from continuing operations for the quarter rose 28% to 43 cents from 34 cents in the prior year quarter.

Regarding our financial position, the Company's cash balance was $868 million at March 31, 2004, an increase of $340 million, versus last year.

During the nine months ended March 31, we generated net cash from operating activities of $551 million, a 31% increase over the $419 million in the prior year period.

The current periods cash flow from operating activities includes approximately $14 million of preferred stock dividends.

If you were to exclude the $14 million and then compare cash flows from operating activities, the increase is even greater.

During the nine months, we spent $98 million to repurchase approximately 2.5 million shares of stock onto our share repurchase program, bringing the total shares repurchased under the program to $16.3 million.

In the current quarter, we repurchased a total of 1.9 million shares.

We are increasing our expected cash flow from operations to approximately $650 million for the full year, with capital expenditures of approximately $200 million.

Let me now update you on our working capital.

At March 31, 2004, inventory was $575 million, an increase of $42 million, versus last March.

Inventory days were 147 at the end of the quarter, versus 150 days at last March.

While we continue to improve our inventory performance, as a company we will always carry more inventory than other consumer products companies due to our business model.

Regarding receivables, our DSOs of 50 days at March 31, 2004, improved by 4 days, versus last year.

And once again, our return ratios continued the trend of improvement we experienced last year.

Let me now update you on a few assumptions for the full fiscal year.

For the full year, we anticipate reported sales growth of approximately 13%, which includes approximately 4 percentage points of positive foreign exchange impact.

Sales in local currencies are forecast to grow about 9%.

While the weakening dollar benefits our reported sales, not all of that benefit drops to the bottom line, with the translation of operating expenses and losses on cash flow hedge contracts offsetting some of the benefits.

We expect gross margin to improve about 60 to 70 basis points for the fiscal year, from ongoing supply chain savings and strategically lower promotional activities.

We anticipate operating expenses to be between flat and a slight improvement.

This is due to the sales growth and tight cost controls in nonbusiness areas.

These improvements are expected to be partially offset by investment in the Beauty Bank initiatives of approximately $15 million for the full fiscal year, strategically higher advertising sampling and merchandising spending and the shift of a portion of our marketing investments from the promotional to advertising spending, which benefits our cost of sales, but increases operating expenses.

Operating margin is estimated to increase 60 to 80 basis points.

As you are all aware, our founder, Mrs. Estee Lauder, passed away on Saturday, April 24th.

Her passing has two immediate financial implications to the Company.

First, the international royalty that was paid to Mrs. Lauder, which is reported on our P&L as related party royalties, cease to accrue on April 24.

For the remaining two months of this fiscal year, we will not pay approximately $3.8 million of royalties or $2.3 million after tax, which translates to a benefit of about a penny per share for the fiscal 2004 fourth quarter and full year.

The eventual full year benefit of the terminated royalty payments will be approximately 6 cents per share.

Second, the $360 million of redeemable preferred shares may now be put to the Company by the holders.

Once they are put, we would have up to 120 days to pay for the shares.

In addition, about 80% of the preferred shares, which are currently held by the Estee Lauder 1994 trust, may now be called by the Company.

The call requires authorization from the board of directors and at least 30 days notice to the Estee Lauder 1994 trust.

The remaining approximate 20% of the shares, held by the LAL 1995 preferred stock trust, may not be called for redemption until May 24, 2005.

If the 1994 trust shares have been put or called and paid for, the dividend rate on the shares held by the LAL trust would drop from 4.75% to the tax-affected 6-month treasury bill rate, which is currently about .6%.

Although there can be no assurance, at this time we are expecting that the shares held by the Estee Lauder 1994 trust will be put to us or pending board approval will be called by us during this quarter.

For forecasting purposes we assume no change to interest expense for the current fiscal year.

When the shares are redeemed the net impact after considering financing costs is approximately 6 cents per share annually.

As William said earlier, for the full fiscal year we now anticipate diluted earnings per share of between $1.59 to $1.62.

This concludes our comments for today and we'd be happy to take your questions now.

Thank you.

The question and answer session will be conducted electronically today.

If you would like to ask a question, please press the star key followed by the digit 1 on your touch-tone telephone.

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

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

You may queue up again by pressing the star key and the digit 1.

We'll go to Andrew McQuilling of UBS.

Thank you very much and congratulations on a nice quarter.

William, question, the recovery in the Americas margin, it is very gratifying.

Is there any shift in marketing activity from the March to June quarters, just the timing of promotional activity?

Well, there's a 2 cent shift, Andrew.

And really when you talk about the qualitative issues, I think it's just general improvement in brands with good margin activity.

We're seeing a general trend in the stronger basic business, versus promotional business.

Now, if this trend can continue over the next few years, that's a very healthy mix change for us.

In addition, as we talked about, skin care and makeup are both growing at healthier rates than fragrance.

Again, this is a mix effect because skin care and makeup margins are better than fragrance margins.

Terrific.

And you mentioned that you saw double-digit sales growth in your retail stores?

Yes, we've seen a nice recovery ahead of the department store recovery.

And we tend to always see that, Andrew, actually.

The retail stores always tend to trend higher than the department stores on both sides of the trend.

They don't go down as much then they go up higher.

Now, is 15% too high?

I don't want to give you directional on the numbers.

All right, fair enough.

And I guess a question about the margin in the U.S. business, the U.S. retail stores, above the U.S. average, above the corporate average right now?

Generally, yes.

Nice to see.

Maybe one last one.

Since the makeup numbers were very impressive, M.A.C. door distribution growth year-over-year, can you talk about it?

You know, in North America it's not substantial, it's marginal.

M.A.C., most substantial growth is coming outside of North America, particularly in Asia.

They also seem to be refining their model and seem to be well on their way in Europe, too.

All right, terrific.

I will let somebody else.

Thank you very much.

We'll go next to Chris Ferrarra of Merrill Lynch.

Good morning.

I was wondering if you could talk a little bit about, sort of, a reconciliation between what looks like sell-in and sell-through that MPD is talking about, because it looks like your numbers in North America or the Americas were much stronger than MPD might have indicated.

Let me make a general comment on MPD.

I think you ought to be looking at MPD as a directional indicator.

If you look at the universe on which MPD pulls its data, it's only a partial universe from the universe in which we operate.

They extrapolate from that partial universe to estimate the rest and oftentimes those extrapolations are pretty good, but we would say that they're entirely accurate.

It can generally be said that there seems to be a much closer correlation between sell-in and sell-through, over the last nine month.

Most importantly there's a closer relationship, it's not necessarily a destocking, just is a closer relationship.

Retailer inventories are cleaner, our sell-in is cleaner and don't forget, MPD does not cover our own retail stores or the salon business.

So, for some of our brands, the retail store business is significant.

So, I think the general trend, you can say, is there's a good, close relationship, we like that.

Over 90% of our business in North America is on EDI, which gives us very accurate sell-through information, as well as giving us more accurate demand and supply information in the stores.

Got it.

And in Europe, I was wondering if you'd be willing to talk about what the business will look like X travel retail?

You know, we don't really usually break that out, but we can say travel retail, obviously, is performing quite nicely for us.

I mean it is double-digit growth on a year to date basis so we're happy with the recovery of travel retail and that continues.

And certainly it is helping the region, there is no question, but you know, there are markets within Europe that are doing quite nicely as well.

The U.K., Spain, there are several that are doing well.

We have a couple of markets in are not quite as strong.

Thank you.

We'll go next to Bill Schmitt of Deutsche Banc.

Good morning.

Good morning.

Is there a skin care problem at the Company?

I mean the MPD data showed you lacked some dermatological brands that are growing quickly.

I was wondering if you could just comment on that and what you guys are doing to combat that.

Well, first of all I think the dermatological brand trend is quite interesting.

As you know, we have recently acquired a brand called Rodan and Fields, which is created by two doctors in this dermatological category.

I think if you are to look at the total corporate share in skin care between Clinique and - - just the Clinique and Estee Lauder brands alone, you'd find those two brands combined have the dominant share in skin care.

As far as I understand, over the prior year, we had a 15.8% increase in skin care over last year, and that's really important.

We think that the dermatological business is very interesting but it's not yet a significant player in the total.

And the 15% or actually greater than 15% growth was last year's growth in the skin care market.

So, obviously we're up against a little bit of a tougher comp in this quarter.

But on a year to date basis, our skin care business is actually growing quite nicely.

Great, thanks, just one moe if I may?

About a year and a half ago you targeted a 13.5% operating margin by 2007, are you still on track to hit that number?

Yeah, we're still comfortable.

We said between 13 and 13.5% by the end of '07 and, yes, we're comfortable with that number.

I think we're on track with the projections we gave and in some respects a little bit ahead.

All right, thanks very much, it was a very good quarter.

Thank you.

We'll go next we go to Wendy Nicholson of Smith Barney.

Hi, just first, back on the M.A.C. question.

Can you tell us exactly how many stores are open now and kind of in your mind what's the right number over the long-term that you're hoping to get to?

In other words, how many more - -

M.A.C., in North America, M.A.C. operates approximately 80 of their own stores.

Okay.

And it's sort of a moving target on a weekly basis on the number of retail, you know, department store doors they're in, but I want to say it's approximately 200.

Okay.

And on a global basis they have slightly over 500 doors total, if I'm not mistaken.

Okay.

And the actual total, excuse me, forget me, on a global basis is 743, that's retail stores, as well as department stores, everywhere around the world.

There is no set target.

M.A.C.'s metrics are based on door by door productivity.

And so long as the brand demands and continues to increase in making gained individual door productivity, in other words, there's excessive demand for the brand, they will continue to look for expansion.

But the vast majority of the growth for M.A.C. is in comp door growth.

How many doors opened in the third quarter?

You know what?

I'm not really sure, but it was - - out of the population of 743 it was an insignificant number.

It wasn't, you know, 50?

No, no, no, no.

No, the growth in M.A.C. is comp door growth, for sure.

Okay.

Great.

And back to the guidance on both the royalty and the potential with the calling of the preferred, are you suggesting that we can add 12 cents to our '05 estimates or do you plan to reinvest a portion of that the same way you did with the royalty that rolled off a couple of years ago?

Well, Wendy, I think that the guidance that we give for fiscal '05 will incorporate the impact of the royalties and the dividends.

So we haven't really factored in final numbers, but for the most part, I think directionally you're correct, that it will be part of our numbers and reported earnings growth.

In other words, we can add a big piece of that.

Don't count on all of it.

We will continue to invest in growing our business to achieve all of our objectives and most importantly our bottom line objectives, but top line growth is what has always fueled the success of this company and will continue to fuel the success of this company.

Okay.

And then just following up on the Beauty Bank statement, in terms of kind of where your progressing, I think you said $15 million for fiscal '04.

How do you see that shaking out at this point kind on a quarterly basis?

With the third quarter spending similar to what the fourth quarter is going to be?

Is there going to be a ramp-up as we get toward the launch cycle?

I'm wondering kind of how we should factor in our numbers for the next couple of quarters in terms of the spending versus the benefit.

Right, the $15 million, Wendy, was more or less spread almost evenly throughout the quarter.

I mean it was a little bit less in the first quarter, it will be a little bit higher in the fourth quarter, but when in general it was almost spread evenly throughout the fiscal year.

For next fiscal year, we've said that Beauty Bank is pretty much a break even operation for us.

So, our initial sales and profits on those sales will cover the investments that we're making in the brand.

On a quarter by quarter basis?

On a quarter by quarter basis that may fluctuate a little bit.

I think you're asking for fiscal year guidance, not quarterly guidance.

We will give you fiscal year guidance at the end of the fiscal year.

We expect that the Beauty Bank operations would be neutral and on a quarter by quarter basis, we don't give you directional on business in quarters, we look at seasonals at best.

I'm sorry did you say that Beauty Bank would be neutral on a revenue basis, is that what you said?

In other words, the Beauty Bank operation in fiscal '05, we expect the expenses will be offset by its sales.

Okay.

And then can you quantify for us how much - - I mean 275 stores all at once to show up in the September quarter strikes me as maybe a big dollar amount of shipments.

Can you quantify that for us?

It will be part of our - - when we talk in August about our full-year guidance, it will be incorporated in our numbers.

But ,remember, these are initial shipments, but they happen over the course of time.

So 275 is really what happens in the Fall through Phase I, which ends in January.

And Phase II starts for the second half of the year.

Okay, thank you very much.

You're welcome.

Next we go to Amy Chasen of Goldman Sachs.

Thanks.

William, first of all, condolences to you and your whole family.

Thank you very much.

Just on the fourth quarter and I know you guys don't like to talk about the quarters, I just want to make sure that I understand the guidance.

It looks like if you back into it, that you're sort of a little bit less enthusiastic about the fourth quarter,r especially since that's going to include a penny benefit from the royalty.

I guess I'm a little bit confused about that given that I think you said that sales actually accelerated towards the end of the third quarter.

Can you just comment on that?

I think when you look at the fourth quarter, we're expecting - - and you will do just what you've done, which is back into the numbers, we're expecting a slight improvement in our gross margin, not quite to the extent we've seen on a year to date basis.

A there is some spending that William referenced that's shifting from the third quarter into the fourth quarter, related to some new product launch activities and developments spending.

So, that's about 2 cents that shifted into the third quarter from a profit perspective and comes out of the fourth quarter.

But we have factored in the penny in there.

And, you know, again, we give guidance on a half-year basis and we've taken the guidance up for the second half of the year and we are well in excess of where we started the fiscal year and fairly comfortable with where we are right now.

Okay, I'm sorry, I missed that 2 cent comment.

So.

That's actually a big deal.

Can you just tell us what that spending was for?

Yeah, sure, it was spending related to new product launches, in particular, and when those products launch.

That spending was supposed to happen toward the end of March and it actually spilled into April.

There was also some development spending that we anticipated happening for new brand activity and new productivity that was going to happen toward the end of the third quarter, which is now actually spilled into the fourth quarter, as well.

Okay, great, that's helpful.

Now, just, William again on the acquisition strategy, to follow-up and your comments were very helpful, but the article that was in the "Wall Street Journal" did mention that you guys would not rule out mass.

And I think many of us were surprised by that given that you just sold the jane business.

Can you flush that out a little bit?

I think, Amy, the best way I can comment is we're a $5 billion-plus company.

Most of our key competitors are three or four times our size, if not more, competing in a number of different segments.

And I would hate to be very equivocal about saying what we will or will not do, as much as to say we know what kind of company we are and what we're capable of.

Given our recent experience with jane, we really have no interest in jumping out of frying pan into the fire at this moment.

However, I wouldn't want to say I want to rule it out, absolutely, unequivocably, don't even talk to me about it, as much as to say let's pay attention to what the opportunity is and let's use our imagination to see if, or not, we have a capacity capability from a management standpoint to be competitive.

Honestly, we're not interested in the mass business right now.

That's not high in our priority.

What's high in our priority is taking advantage of the assets we have as part of our company now and making them as big as we possibly can.

Okay, that's great.

And last but not least, William, can you just comment on the state of the U.S. department store business?

Obviously, from a cyclical perspective it's picked up, but I'm curious whether you think on the secular basis it's still in decline or whether there's signs that maybe some of the pickup is more than cyclical?

Amy, I would challenge your statement that on a secular basis there still on decline.

If you look at the U.S. department store and its role in a consumption society like the United States, you'd see that it's unique role has always been as a place for aspirational brands.

It's always served that role in our economy and seems to recover more quickly than the most mass-oriented outlets, primarily because as the aspirational consumer with a higher disposable income feels free to spend, they choose and feel free to spend in the upper ends of the market before they choose to spend in the lower ends of the market.

What's really happened, if you look at the department store market over a period of time, is that they've given up the segments of the business for which they were known as a full lifestyle store and given that up to specialty stores.

It's very rare, except in certain department stores, that you see a full furniture, bedding and white goods department You really can't buy a refrigerator at Macy's anymore where 15, 20 years ago you could.

Now you must go to Sears or Circuit City to buy these kinds goods.

Essentially the department store has become the place for aspirational fashion-oriented merchandise, including cosmetics, accessories, jewelry and other fashion items and they are the place to go, still, and they are the place for brand-building.

Certainly in our segment, as you've seen, you've heard us talk about over the years, the growth in prestige cosmetics, in better department stores has been a far greater growth rate than that in the mass outlets.

We expect that to continue in stores like Saks, Nordstroms, Neimans, Bloomingdale's, have had a stronger recovery much earlier than even the next trunch down of department stores.

I think that's indicative of the overall state and health of this kind of retailing.

Obviously, right now our retailing partners in the United States are very happy with their trend in their business.

I think it's come from strong focus in discipline, in merchandising in every aspect of their business and they're continuing to refine their model and their appeal to their consumer and we've got confidence in their management abilities and on how we can continue to grow our business.

I guess what I'm asking is, you guys have laid out the pie chart of what the split of your business is and where you want it to be and obviously, you're still looking to broaden out your distribution because you see more growth in other areas.

So, I wasn't meaning to suggest that they were falling off a cliff, but other segments are growing faster.

I'm just curious whether that's still the view internally.

We feel there are other segments for which there are opportunities for us to expand our business at a greater rate than we can expand the department store business.

That being said, with such a significant portion of our business in the United States, coming from this sector, we devote the vast majority of our resources, our time and our efforts in growing the significant business, while also developing other businesses in other channels.

We feel very strongly on a philosophical basis that we have to make sure we bring our brands to where our consumer is shopping and is in the mind frame to buy our kind of product.

The vast majority of those situations for the consumer is in the department store, but as you've seen over the last 12, 14 years in our strategy in retail stores, we've been very successfully able to build a fairly significant business in what we can call an alternative retail channel that enhances brand equity, as well as creates demand.

In addition, we've been building our prestige hair care businesses salons with Aveda and Bumble and bumble.

Most of our brands have built a very significant presence on the Internet.

Again, these are all complementary means of building the brand equity that helps create the demand for our brands.

Okay.

Great.

Thanks a lot.

We'll go next to Linda Bolton Weiser of Oppenheimer.

Thank you.

William, on the Kohl's venture, I'm just sort of curious about how patient you intend to be with it.

For example, if it starts off slowly in terms of the sales at retail, but you think it still has promise, will you err more on the side of putting more investment behind it or will you kill it very quickly?

Linda, we are very experienced in brand building and the vast majority of the revenues that are part of our company today are from brands which we created and built from nothing.

We have a long, proud tradition and it's built deep into our D&A to build brands and have the patient to build the brands to be long-term effective players.

And we expect that our activities, the Beauty Bank and Kohl's, will be successful and we will continue to refine the model from a merchandising and marketing perspective to make sure it's successful, just the way we have done with our five core home built brands, Estee Lauder, Clinique, Aramis, Prescriptives and Origins.

Okay.

And secondly, it seems like the fragrance business in the U.S. is having quite a bit of difficulty.

Can you talk about maybe which brands are the ones that are declining the most?

And then if you have this ideas about how to kind of fix it overall?

Well, I think the general issue in the fragrance business is that the prestige fragrance business, done at full price in prestige department stores, is being highly challenged, for any number of reasons.

And the result has been that many marketers have been forced or feel compelled to look at other channels to grow their business.

We find that the whole overall fragrance market in the United States is challenged, it's only been at prestige.

Its hay day was about 30% of the total.

Even though it generates a great deal of attention, it has not generated as much of a share of the consumer's pocketbook.

Specifically on a grand by brand basis, there are different brands that are succeeding at different rates.

Suffice it to say that if you look at the MPD data and its directional implication, you'd see that three out of the top three fragrances in the department store market are part of our portfolio and some five or six out of the top ten are also a part of our portfolio.

And generally those brands are doing as well, if not better, than the market overall.

Do you think you will get involved with more designer brands in the future?

I think it's safe to say that we are looking very seriously at our fragrance business and trying to take advantage of opportunities we see in the marketplace on a global basis.

And that may mean relevant brands on a regional basis and those regions and channels where fragrance is a more significant segment as well as where we currently compete.

Okay.

Thank you very much.

We'll go next to Connie Maneaty of Prudential Equity Group.

Good morning.

Good morning.

Would you comment a little bit on your initial statement that sales picked up towards the end of the quarter?

If you could summarize it, how much ahead of, perhaps, your own budget did sales come in?

Well, Connie, the best way to look at it is the first half of the quarter, the first six weeks of the quarter, or more or less where we thought they would be, though they weren't really super duper.

And the back half of the quarter, the last six weeks, was certainly far stronger than we had anticipated given the first half, And, if you will, the velocity increased as we got closer to the end of the quarter.

You see the overall department retail numbers and the key number that's helpful is to look at just their traffic patterns and their traffic increased.

As the season, the February/March period went on and we benefit from strong traffic.

So, overall we were very pleased with the way the retail sales finished in the quarter and we expect that some of those that momentum will continue into the fourth quarter.

So, the pickup would be more department stores surprising you rather than a pickup say in travel retail?

Well, those are not necessarily comparable numbers because we see travel retail on a different frequency than we see department stores numbers.

We get reported numbers on department stores on a weekly basis for the previous week on sell-through information, as well as in our own retail stores.

Travel retail numbers, they don't come with the same frequency that we get in our own - - I'm really talking about U.S. now, where we have a great deal of accuracy and information for the vast majority of our distribution.

Shopping mall traffic has increased, our own retail stores we saw pickup ahead of the department stores, which as I mentioned earlier is usually the trend.

And in addition, the department store numbers came along in a very healthy manner, also.

That's helpful.

Thank you.

We'll go next to Andrew McQuilling of UBS.

Just a couple of quick ones.

William, did you mention Bumble and bumble, is it up to 230 salons or something about opening them?

No, we added 230 new salons in this fiscal year.

And I believe the number of salons that Bumble is in is over 2,000, if I'm not mistaken.

I'm not exactly sure of the exact number, Andrew.

And maybe another question on the hair care side.

You launched a big salon in Japan.

Are you willing to talk about the expense of doing that, understanding that you invest for growth?

Can you talk about the cost for doing that in fiscal '04?

I think the most important thing to say is that we made the investment in this salon in Japan for it to be a flagship for Asia for the building of Aveda to be the most significant prestige hair care brand in the region and this is our flagship.

And an you talk a little bit more about like what's the, you know, if there's a rollout scheduled for that Asia push?

How should we think about it?

Obviously they use a lot of hair care?

Obviously the single biggest hair care market in Asia is Japan.

And we are going to, if you will, fight the biggest one first, which is to gain traction in this market and the Japanese hair care business is one of the most competitive, but it's also the most directional for the rest of Asia, and we'll continue really starting in July to push the expansion of the brand beyond just our Aveda center in [INAUDIBLE] and we're looking to build a beach head.

As I made the comment earlier about brand building, we're going to start with something like 50 salons in Japan with a partner in 2005 and we will build this brand to be one of the more significant, if not one of the most significant, prestige hair care brand in the region.

And maybe just one more question.

Japan, what percentage of the hair care sales in Japan are moving through salon-like channels, salon-like product?

The ratio in Asia is slightly different than the ratio in North America.

The ratio in North America is, approximately, 30% goes through salon, prestige salons.

The number in Japan is approximately 6 to 8%.

Terrific.

All right, maybe one more, William, if I could.

Of course.

Travel retail, obviously the run rate looks great.

Is there any reason that June will, you know, June, now that we're lapping the Iraq and SARS issues from last year, any reason to think June's run rate can't be similar to March's in travel retail?

You know, Andrew, I have a hard enough time talking about a quarter.

For you to start asking me how I think the month is going to be, next you're going to ask me when am I investing yet in the market.

If I had that much of a crystal ball, I'd be sitting in your shoes or I'd be on the buy side on a beach somewhere putting my orders in by telephone. [ Laughter ] Instead of lipsticks and sell fragrances.

Maybe if I rephrase!

The trends that you're seeing in travel retail in the March quarter, is there anything unusual in the travel retail buying pattern or is that really take away?

As far as we can tell it's take away.

All indications are we would expect the trends to continue.

Obviously, we have to put the caveat in there, unfortunately, is that barring any unusual extraordinary events that may effect travel the way they have in the past, there's not any indicator that says all of a sudden, sometime in this next three months that people are going to stop getting on planes.

We certainly hope there will be no reason for that.

Terrific.

American Airlines hopes that, also.

Very helpful, thank you.

We'll go to Chris Farrarra of Merrill Lynch.

Hi again.

I wondered if you could talk about how much inventory is typically held by retailers and how you think that might relate to Kohl's or would Kohl's be at similar levels?

Well, the rule of thumb has been approximately three months on hand with two weeks rolling.

In the department store universe, which I've mentioned before, 90% our population is on EDI.

The general rule is its twice monthly replenishment and they're holding somewhere plus or minus not quite 12 weeks supply.

There are finer points to that.

High volume merchandise, you're holding a higher weeks of supply, lower volumes merchandise you're holding a lower, but it generally works out that way.

The numbers in Kohl's won't be too dissimilar, especially since we both do not have the statistical data on take away and demand to be able to measure or reasonably estimate what the demand will be.

It provokes both of us to make a more substantial investment in the inventory up front to have the inventory there to meet demand than to be stingy.

That being said, they are very efficient, effective retailer in managing inventories from a data standpoint.

We are very effective, efficient, brand marketer in our category in managing inventories.

Both of our technical IS teams have been working very closely together so that our systems can integrate effectively so we can understand what consumer take away is, right down to the shade level so we can more accurately forecast on a going forward basis the likelihood of our business underneath our inventory.

Great.

And, I guess, on a typical new product that you'd sell in, I guess what would sort of be the time frame of ramping inventory to the three months on hand level?

A new product launch, say Beyond Paradise, when we launch, essentially the sell-in into the market for the initial launch, almost six months on hand and we - - six months forecasted on hand and we will be manufacturing or have componentry on hand for the next six months.

And then depending on demand and how it's pulling, we will either continue to manufacture to meet excessive demand or we will not complete the manufacturing if the demand is not at forecast.

That's a general rule of thumb.

Great, thank you.

And once again, that is star 1 if you'd like to pose a question.

We will go next to Kathleen Reed of Stanford Financial.

Good morning.

Just a quick follow-up question on your comments on the U.S. fragrance category.

I think you noted that prestige fragrance is sold in prestige department stores are just kind of, you know, either down or facing you said some tough issues.

I just wondered if you could give us a magnitude of that and if there are any distribution areas where prestige fragrances are doing well?

And I actually have a follow-up.

Generally the overall prestige fragrance market is challenged in the prestige channel.

I wish we could pin point highlights or any specific lowlights.

It's overall in a challenging environment right now and I think some of that is due to - - it's hard, f you will, to look at fragrance in the manner that we have been traditionally able to look at it because there is a significant amount of prestige brands that is available in channels of retail that are not necessarily considered to be part of the prestige universe.

Yet the advertising that drives demand for these brands affects consumers who shop in all channels of distribution.

Okay.

So are some of the alternative channels, i.e. like the mass channel, is that what you're referring to?

You know, it's not just mass channels.

It's just general channels.

I wish I could put my finger on it and say here's the reason and develop an inoculation that would stimulate consumer from in the prestige channel.

There are certain brands that do have very nice businesses in the prestige channel.

The general rule of thumb is those are brands that have made connections with the consumer's interest on an emotional basis and are brands that have been able to keep a very right control over their distribution pattern.

Okay.

Great.

Thanks.

And just secondly, I guess with your positive comments about travel retail and it was up double digits this quarter, expected similar, I guess you're not seeing, is it fair to say not seeing any issues with the announcement from China this week that they confirmed another SARS death, the first since July of last year and they've quarantined hundreds of people?

We have not seen that yet, but as I mentioned to you earlier, the frequency of information from sell-through in travel retail does not come with the same speed that we get it in the United States.

Okay.

Great.

Thanks very much.

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