雅詩蘭黛 (EL) 2005 Q4 法說會逐字稿

Good day, everyone.

And welcome to the Estee Lauder Companies' fiscal 2005 fourth quarter and year-end conference call.

Today's call is being recorded and Webcast.

For opening remarks and introductions, I would like to turn the call over to Vice President of Investor Relations, Mr. Dennis D'Andrea.

Please go ahead, sir.

Good morning, everyone.

We have on today's call William Lauder, President and Chief Executive Officer, and Rick Kunes, Executive Vice President and Chief Financial Officer.

Malcolm Bond, Executive Vice President of Operations is here to discuss some strategic operational initiatives, and Dan Brestle, our Chief Operating Officer is also here and he will be available for the Q&A session.

Since many of our remarks today contain forward-looking statements, let me refer you to our Press Release today where you will find factors that could cause actual results to differ materially from these forward-looking statements.

And I will turn the call over to William now.

Thank you, Dennis.

Good morning and thank you for joining us.

Before we begin, a few critical housekeeping notes.

Our discussion today will focus on our results from continuing operations and also exclude the effects of a one-time tax charge of $27.5 million, which equates to $0.12 per diluted share relating to the repatriation of foreign earnings under the American Jobs Creation Act.

Today's call will have a slightly different format.

I will highlight our 2005 results.

However, for further details, I refer you to the Press Release which you received this morning.

The focus of this morning will be our objectives for the coming year that support our continued position as a growth company.

For the full year, we turned in a solid performance.

Net sales increased 9% to 6.34 billion, from 5.79 billion last year.

We are very excited about reaching a new milestone of exceeding $6 billion in sales.

Excluding foreign currency, net sales rose 7%, which is at the high-end of our stated long-term annual objective of 6 to 7% organic sales growth.

And we delivered diluted earnings per share of $1.90, a 17% increase, compared to $1.62 in the prior year.

I'm very pleased that EPS came in within our original guidance, and that EPS growth, again, exceeded our long-term annual target of 12 to 15%.

During the year, we took many actions that strengthened our Company, positioned us for future growth, and increased stockholder value.

Let me recap some of them.

We continued our record of strong innovation, garnering numerous awards for innovative products and packaging.

We launched three new brands from our BeautyBank division, American Beauty, Flirt!, and Good Skin with 550 products and 1800 gondolas into 600 doors in a new channel Kohl's Department Stores.

Additionally, we trained 2,500 beauty advisors and recently launched the fourth brand Grassroots.

This project was the biggest launch in the history of our Company, and I am tremendously proud of our BeautyBank team for their seamless execution.

We also expanded our portfolio with the addition of new Designer brands.

The Missoni license, which we expect will strengthen our European fragrance profile and our travel retail business, and the Tom Ford alliance with the Estee Lauder brand.

We expanded the use of popular celebrities in our brands to take advantage of the current trends in this area, which I will discuss shortly.

On the international front, we continued our expansion in China with the launch of our La Mer brand and we increased distribution there of the Clinique and Estee Lauder brand.

At the end of the fiscal year we opened M.A.C in India.

We strengthened our Board of Directors with the addition of Mellody Hobson and Aerin Lauder, who each bring a unique and valuable perspective to our governance.

We expanded our share repurchase program by 20 million shares for a total authorization of 48 million.

We raised our annual dividend by 33% and we announced our intension to repatriate an additional $500 million in foreign earnings under the American Jobs Creation Act, providing a cost-effective source of capital for our domestic growth initiatives.

Now, to get a closer look at our operational performance, first, foremost, and most importantly, we grew sales in each major product category and in each region.

Fiscal 2005 sales growth in constant currency was led by strength in makeup, hair care and skin care, followed by less buoyant growth in fragrance.

In our skin care category for the full year we reported sales of $2.35 billion, a 10% increase and grew 7% in constant dollars.

We remain at the forefront of innovation and technology.

For example, the Company developed poly peptide technology for the repair segment of skin care product leveraging its use across four brands.

Additionally, our La Mer brand continued its strong growth in key products in the Estee Lauder Clinique and Origins brands helped drive the category also.

Makeup sales of 2.42 billion rose 13% in dollars and an impressive 11% in local currency.

Our makeup artist brands turned in very strong sales gains led again by M.A.C and Bobbi Brown.

We saw solid increases in certain foundation, eye, mascara, and lip gloss products from Clinique and Estee Lauder, and Flirt! and American Beauty, two of our newer brands, also provided incremental sales in this category.

Fragrance sales increased 3% to $1.26 billion on a reported basis, and was up less than 1% excluding currency.

In the fall we launched DKNY Be Delicious, which has been a hit with consumers and retailers far exceeding our expectations.

And in the spring, the men's version of Be Delicious also witnessed a successful consumer reception following its global launch.

We remain very excited about the potential of this master brand fragrance.

In hair care, sales rose 10% this year to 273.9 million on a reported basis and grew 9% in local currency.

Aveda had a good year benefitting from new shampoo, conditioner, and professional color product, as well as its continued success in Japan where it launched almost two years ago.

Bumble & bumble sales growth was very strong, benefitting from the success of new and existing products, and new salon openings.

Geographically, sales in the Americas grew 7% from the prior year, to $3.38 billion.

New and recently launched products contributed to growth in all major product categories, and we generated strong combined sales growth from our makeup artist brands.

In Europe, the Middle East, and Africa, net sales rose 13% over the prior year to $2.12 billion and increased 7% on a local currency basis.

Local currency sales gains were led by travel retail, the U.K., Spain, and Portugal.

Travel retail rose double-digits this year, coming off of a 30% increase last year, as this channel's growth normalized to a more sustainable pace.

In Asia/Pacific, net sales this year grew 8% over the prior year, to 8. -- $835.5 million.

In local currency, sales were up 4%.

Our business in China nearly doubled this year, and we increased distribution of our core brands into 23 cities.

The local currency increase also reflects very strong double-digit gain in Hong Kong, Taiwan, and Malaysia.

Partially offsetting the increases were sales declines in Japan and Korea.

Overall, our performances this year reflects the tremendous balance we enjoy from our diverse brand portfolio, channels of distribution, geographic mix, and new product focus.

Our strategy has proven to be successful, delivering the kind of consistent sustainable quality growth we all desire.

That being said, I believe the future holds even greater promise.

Looking ahead, there are a few main questions we ask ourselves.

First, how do we continue to create value for our stockholders?

Second, what will it take to continue growing our Company at or above our targeted goal?

And third, how will we maintain our leadership position or even better, enhance it?

The fundamental strategies that have made us successful in the past will continue to drive us well into the future.

But the focus and emphasis have shifted with the changes in the industry, the retailing environment, and of course, the consumer's needs and desires.

As such we have five strategic imperatives that we are confident will drive our growth and enhance our leadership in prestige beauty.

They are -- optimizing our brand portfolio, strengthening our product categories, strengthening and expanding geographic presence, diversifying distribution, and achieving operational and cost excellence.

Let me briefly talk to the actions in each one.

First, to optimize our brand portfolio, we will increase investment behind our high-growth, high-profit brands, such as, M.A.C, refining the criteria for prioritizing investments across brands and geographies.

The investments will broadly cover research and development, distribution expansion, and advertising and promotion.

Thus, as part of this more rigorous process, we are reviewing the milestones and requirements for brands performing below our operational and financial expectations, and evaluating either substantial adjustments to their business model or divestiture.

We will only consider acquisitions that fulfill an unmet consumer need or solidify a position in a category, distribution channel or geography.

As we've said before, in identifying new opportunities, we are not interested in just buying large short-term sales, but rather, consistent long-term growth.

Within our portfolio, we have two core brands, Estee Lauder and Clinique, that are very important to our overall growth objectives.

In recognition of this fact, we are stepping up the revitalization of the Estee Lauder brand, building on its strong heritage of quality, beauty, and excellence.

Over the past few years, we've made a good start in this effort by modernizing advertising, point of sale imagery in counters and uniforms, as well as accelerating new product launches and improving gifts.

More must be done and we will see the positive impact of the extraordinary management team we've just installed.

We've announced an alliance with Tom Ford and signed Gwyneth Paltrow as a new spokes model, both of whom will enhance the image and the beauty authority of the brand.

At the same time, Estee Lauder will reallocate its advertising and promotional mix more to skin care and makeup from fragrance.

The success of the Clinique brand is also critical to the Estee Lauder Companies.

The brand has a powerful and relevant global concept which leverages current market trends, consumers gravitating to simplicity, personal service, custom fit options and brands they can trust.

Globally, Clinique is investing in a focused number of new products and supporting its key franchises, such as, 3-Step, Repairwear, and our foundation.

Clinique is also reinforcing its long-term dedication to skin expertise and skin health with a partnership with Weill Cornell Medical College.

In North America, where Clinique has the number one position in prestige cosmetic, it will be reaching out to new consumers further cultivating relationships with its most loyal customers and involving its gift program.

Clinique has a tremendous opportunity internationally to increase market share both in Europe and Asia.

In addition to its positioning, Clinique's entry-level prestige pricing makes it a natural favorite in markets where prestige is emerging.

Our second strategic imperative is strengthening product categories.

We will continue to build on our strength in skin care, with focused investments on technologies that drive innovative products based on local consumer needs.

Strong consideration will be given to global demographics, cultural preferences, and ethnicities.

We are establishing a more local R&D presence in select countries, developing centers of excellence to further understand and respond to local consumer needs.

For example, as we speak, our new R&D center in China is coming on stream.

In fragrance, our focus is on substantially improving profitability.

We have programs in place that we expect will improve the product mix, reduce cost of sales, and examine the effectiveness of promotional spending.

Newness and excitement has always been a main stay in fragrances, and we need to be relevant in this category, but not at the expense of profitability.

We have several clear fragrance successes among our brands that will support appropriately and we should be able to raise our fragrance profitability to that of our peers.

In makeup, we will focus on expanding our leadership through aggressive rollout of high-growth brands and product innovations.

Clinique, M.A.C, Bobbi Brown, and Estee Lauder combined have a commanding share of prestige makeup units sold in the U.S., which we will continue to support.

We are pursuing further leadership in foundations and our R&D efforts are focused on creating breakthroughs in mascara, lipstick, and powders.

In concert with this, we will continue to leverage the full range of our brands to include colors and shades for a more diverse array of skin types.

We see tremendous potential in hair care with our strong brands of Aveda and Bumble & bumble through increased distribution and geographic reach.

The launch of Aveda in Japan, one of the largest hair care markets, has been very successful and we continue to open new salons there.

New styling products and natural ingredient products are under development as is the focus on the hair color segment and we will continue to be opportunistic in seeking additional hair care brands that compliment our portfolio in this category.

The third strategic imperative is strengthening and expanding our geographic presence.

We have over 20 brands at different stages of development around the world.

This gives us enormous opportunity to expand into new countries and further penetrate those we are already in.

To solidify and build on our leadership we must reinforce the position of both our more established brands and our high-growth brands in highly, influential markets, such as, France and Japan.

We will also strengthen our presence in long-term strategic markets where we have identified strong potential, including China, India, Russia, Brazil, and select Central European countries, as well as Turkey and Vietnam.

As an example, within the last month, M.A.C opened its first door in India where it is doing three times our expectations, as well as opening in China.

M.A.C, with its positioning of all races, all sexes, all ages, is our first brand to enter India allowing us to explore potential opportunities to bring other brands into the market.

We are evaluating how and where best to introduce our BeautyBank brands, in fact, we're currently exploring a pilot program in Mexico.

We will pursue retailers that have new distribution channels for us to maximize the potential of these terrific new brands.

Fourth, our strategic imperative is diversifying distribution.

A critical distribution development is the Federated and May Department Store merger.

We have experienced this situation previously with the absorption of Broadway on the West Coast by Macy's, and the closing of Eden's in Canada.

Long-term, the impact on our business should be positive, having a strong nationwide retailer operating with fewer name places as our largest customer will increase the efficiency of our training, sales, promotion and advertising, and logistical support.

Most importantly, our experience bears out that our strong brands speak directly to consumers who will still have access to our brands at their favorite shopping venues.

Our distribution mix will continue to evolve and become more balance over time as new prestige channels grow faster than our more established channels.

We will continue to invest behind the high-growth travel retail channel where we have significant opportunity to grow share and introduce more of our brands.

In the independent pharmacy channel in Europe, we have begun distribution of Origins' products into several locations in France.

We are just scratching the surface of this high potential channel and believe we have ample opportunities for growth beyond our current position.

Finally, our fifth strategic imperative, achieving both operational and cost excellence.

We clearly have a number of opportunities to wring cost from our structure and improve our operations without sacrificing either our product quality or our sales growth objective.

The first and most critical method for achieving this is continuously reinforcing a cost conscious mind-set throughout our organization and this starts with a strong commitment at the top, beginning with me.

Every member of our executive committee, the leadership of every element of the Company is on board, leading the cost containment charge within their respective areas.

Let's review the main components of this cost reduction effort.

Under Malcolm Bond's leadership we will continue to reduce costs through distribution consolidation and procurement of our raw materials and components.

Through our strategic modernization initiative we are working to optimize all supply chain and business processes supported by robust end-to-end IT solutions.

This will have the added benefit of reducing our working capital requirements over time.

We are examining a full range of measures to capture indirect purchasing savings.

Everything we buy that doesn't directly touch the consumer in product or service, to ensure we appropriately leverage the scale of the Company.

This includes everything from travel, photography, and meeting and event planning.

Most of which has traditionally been purchased by the individual brands, rather than corporately.

You will hear more about these initiatives in a few minutes, and in the future, as we identify and realize savings opportunities.

Now, that we've discussed our strategic framework, let's talk about what we expect for fiscal 2006.

We are pleased with the performance we delivered in fiscal 2005, and our momentum is continuing into fiscal 2006.

For the top line, we expect net sales growth in the range of 5.5 to 6.5%, with little or no currency impact.

This represents sales growth in-line with our long-term goal despite challenging business environments in several of our major markets.

Looking at our product categories in fiscal 2006, we expect hair care to lead growth, followed by makeup, skin care, and fragrance.

In makeup, Clinique is starting off the year with several strong launches including Blushing Blush, Colour Surge, Buttered Shine Lipstick, and Repairwear Anti-aging Makeup, a great example of the power of technology crossover between skin care and makeup.

The Estee Lauder brand is also launching individual foundation with Ideal Matte technology to automatically adjust to the individual skin tone, allowing for a more excessive palette appropriate for a wide range of consumers worldwide.

In skin care, Clinique is expanding its popular Repairwear franchise, and is launching 3-Step liquid facial soaps in response to the desires of our international consumers for this format.

The Estee Lauder brand is planning some exciting new launches in this category as well and La Mer will continue to roll out its superior premium Essence.

In fragrance, we will continue to support our classic fragrances, such as, Pleasures and Clinique Happy, as well as recent winners like DKNY Be Delicious.

We will also plan to selectively introduce a few new fragrances from our Tommy Hilfiger franchise, as well as from our newest licenses with Sean John and Missoni.

Aveda has recently launched Pure Abundance Hair Spray, and Bumble's Creme de Coco line will lead of the category early in the year to be followed by several exciting new products in hair treatment during the year.

In fiscal 2006 we already have traction on our geographic expansion strategy.

As we speak, we are launching M.A.C and Bobbi Brown in China and we will continue to expand distribution for our core brands in that important market where Clinique has been the fastest growing prestige brand.

In terms of our geographic regions for fiscal '06, we expect Asia/Pacific will lead growth, followed by the Americas and Europe, and the Middle East and Africa.

In Asia/Pacific, we expect to see a continuation of exceptional growth in China and somewhat slower growth in Japan and Korea.

In Japan, Clinique is starting to see a pick up driven in part by a focus on locally relevant product introductions.

Also, some of our newer brands are growing impressively and Aveda is rapidly developing the salon business.

These efforts should help mitigate the tepid market growth in this strategically important country.

Korea is beginning to show signs of life, despite weak consumer confidence.

In the Americas region, the U.S. retail environment is sustaining its moderate growth level.

High-end retailers that are the source of growth for many of our best performing brands, are maintaining their front-runner position, while mid tier department stores are posting mixed monthly results.

The beauty business and prestige department stores has been growing at a mid single-digit pace and we expect it to continue.

In fiscal 2006, we will continue to develop the BeautyBank business with Kohl's in stores as Kohl's expands throughout the year launching the Grassroots brand and executing our first full-fledged holiday program.

With our four brands now on counter, both we and Kohl's are more engaged in investment spending to promote the brand.

The Federated/May merger will eventually impact our results in the Americas region.

However, let me reaffirm that we see this as a one-off event that should result in a stronger business in North America, based on higher productivity, through fewer points of distribution.

We anticipate that any impact from store closures will be partially offset by related operating expense savings, and the likelihood that a portion of the divested stores will be sold to other prestige retail customers.

In fiscal '06, the European region is expected to continue to benefit from strong and travel retail results, a growing Middle Eastern business, and more modest growth from the major European markets.

We will also see results from our foray into India, which has gotten off to a strong start.

To sum-up we see a lot of opportunities to enhance our top and bottom line growth and we are confident in our future prospects.

We are committed to taking the appropriate steps to realizing these opportunities.

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

Rick?

Thank you, William.

And good morning, everyone.

Let me start by saying that our EPS for the fourth quarter before the impact of the special tax charge of $0.12, came in at $0.42, a very solid 36% over the prior year quarter meaning our half year results were in-line with our previously stated guidance.

For the full fiscal year, reported net earnings from continuing operations increased 8% to 406.1 million, compared with 375.4 million last year, while diluted earnings per share from continuing operations rose 10% to $1.78 versus $1.62 for the 12 months of last year.

Full-year reported results include the impact of the special tax charge that William mentioned.

Looking at our full fiscal year operating profitability, the Company achieved operating income of 720.6 million, a 12% increase compared with the 644 million last year.

This translates to an 11.4% operating margin.

Our gross margin of 75 -- of 74.5% for the fiscal year remained unchanged compared with the prior year.

Favorable net changes in production and supply chain efforts of approximately 30 basis points primarily driven by favorable material sourcing were offset by the next -- net change in mix of our business within our geographic regions and product categories.

Operating expenses as a percentage of sales for the full year improved 30 basis points to 63.1% from 63.4% last year.

The decrease reflects the higher rate of sales growth and our ongoing cost containment efforts to control expenses in-line with our business needs.

This year we've again been successful reducing selling, administrative, and other costs by 80 basis points, including the benefit from the end of the international royalty payments.

These improvements were partially offset by planned increases in advertising, sampling, and merchandising of 50 basis points to support the long-term growth of our business.

For the fiscal year, total advertising and promotional spending, including the amounts reflected in both cost of sales and operating expenses, were 1.81 billion versus 1.61 billion last fiscal year.

Our sales growth remains strong and is due in part to the investment spending in this area.

Looking at operating profits by category, for the full fiscal year, skin care operating income increased 29.5 million to 365.8 million.

Makeup was up 37.2 million to 294.9 million, and fragrance rose 11 million to 35.8 million, all reflecting their higher sales growth.

In hair care, operating income decreased 800,000 to 22.8 million, as higher sales were offset by planned increased operating expenses to support the growth in the U.S., as well as distribution expansion in Korea and Japan.

By region, operating profit was up across the board.

The Americas posted the highest growth, increasing 38 million to 357.2 million, primarily due to higher sales resulting from an improved consumer spending environment, strong product launches, and growth from newer brands.

In Europe, the Middle East, and Africa operating results increased 31.7 million to 306.1 million.

Significant increases came in our travel retail business, Spain, the U.K., and Switzerland.

We experienced lower results in Russia where we converted our business from a distributor to a direct subsidiary, and in France, which was negatively impacted by the consolidation of retailers.

Asia/Pacific operating income increased 6.9 million to 57.3 million.

We generated the largest increases in Hong Kong, Taiwan, Thailand, and Japan.

That more than offset lower results in Korea and China.

We continue to invest in infrastructure in China to support future business opportunities.

Regarding our interest costs, we reported net interest expense of 13.9 million this year versus 27.1 million last year.

The decrease is primarily due to a lower amount of dividend on our redeemable preferred stock.

The effective income tax rate for the year was 41.2%, including the impact of the American Jobs Creation Act, versus 37.7% in the prior year.

This year, the AJCA added approximately 4 percentage points to our tax rate.

In fiscal 2006, we will repatriate 500 million of extraordinary inter-company dividends, which required us to record our liability based on the effective 5.25% rate provided by the Act.

As you know, this is a one-time nonrecurring tax charge.

For the full year, net earnings and diluted EPS from continuing operations and before the tax charge increased 16% and 17% respectively.

Our fiscal '05 EPS of $1.90 was in the middle of our guidance range given a year ago in August and at the high-end of our guidance provided last April.

Due to the nature of our business, we sometimes experience volatility within quarters.

However, as we have said many times, we continue to run our business on a full-year basis.

Switching to our financial position, the Company's cash balance was 553 million at June 30, 2005, a decrease of 58 million versus last year.

For the full year, we generated net cash from operating activities of 479 million versus 675 million in the prior year.

This change reflects decreases in deferred taxes, along with higher earnings from continuing operations, more than offset by certain working capital components.

Increased accounts receivable levels reflects overall sales growth for the year, led by international markets and customers, which carry longer payment terms.

The timing and payments of certain domestic customers also contributed to this increase.

In the first eight days of July, we received payments of $36 million from those customers versus 23 million last year.

Our higher inventory levels primarily reflects sales growth, the impact of foreign exchange, the building of safety stock in our new distribution center in Europe, and strategic sourcing decisions, such as, our Far East initiative.

This sourcing increases our inventory but provides substantial savings in our overall cost of goods.

The change in other accrued liabilities was primarily due to significant deferred compensation, and supplemental pension payments made to retired executives.

Let me highlight some of our uses of cash for the year.

We returned $529 million to shareholders in the form of stock repurchases and dividends. 439 million was spent to repurchase approximately 10.7 million shares of common stock under our share repurchase program.

And we made dividend payments on our common stock of $90 million reflecting a 33% increase in the annual dividend.

We also used $230 million of funds for capital expenditures.

In fiscal '06, we expect significant improvement in our net cash from operating activities as we grow our business, work down excess inventories, and where we will not anniversary deferred compensation payments.

We anticipate cash flow from operating activities to increase nearly 40% to approximately 660 million in fiscal '06.

We expect capital expenditures of approximately 275 million in fiscal '06, increasing versus fiscal '05 due to our systems initiatives that Malcolm will discuss.

We will continue to maintain the financial flexibility and access to liquidity required to take advantage of business opportunities as they arise.

Let me now briefly update you on our working capital.

At June 30, 2005, inventory was 768 million, an increase of 115 million versus last June.

Inventory days were 173 at the end of this fiscal year versus 162 days last year.

While this reflects a 7% increase in terms of days versus last year, it compares favorably to the 13% increase at the end of the third quarter and comes off our improvement over the last four years leading up to fiscal '05.

Malcolm will also discuss our inventory plans shortly.

Regarding receivables our DSOs were 45 days at June 30, 2005, compared with 43 days last year.

Our key return ratios continued the improvement we have experienced for the last two years, and in fact, our return on invested capital ratio has achieved our 2007 target early.

Let me now update you on a few assumptions for fiscal 2006 which include the impact of two special items that will affect our reported results.

The accounting rule change regarding expensing of stock options and the potential impact of the Federated/May merger.

First, effective July 1st, we adopted the new accounting rule regarding expensing of stock options.

This is expected to impact our full-year EPS by slightly more than $0.14.

Second, we expect the Federated/May merger impact in fiscal 2006 will reduce our reported EPS by $0.02 to $0.03.

For the full year, as William said, we anticipate reported sales growth of approximately 5.5 to 6.5% with essentially no foreign exchange impact.

We expect gross margin to improve about 30 to 50 basis points for the fiscal year, with supply chain savings providing most of the benefits.

Slightly offsetting these improvements will be the impact of product mix, including new products.

Combined, the expensing of options and the Federated/May merger will have a de minimus negative impact on our gross margin.

We anticipate operating expenses to increase between 40 and 60 basis points.

This will include the positive effect of sales growth and continued cost controls, offset by approximately 70 basis points negative impact of the two special items.

Operating expenses will also be negatively impacted by some spending related to our SMI project.

While we continue to invest in advertising, sampling, and merchandising for our core brand, our faster-growing newer brands do not spend at their levels.

Therefore, we will see this expense as a percentage of sales decrease in fiscal '06.

As a result of the gross margin and operating margin ranges our reported operating margin, including the 70 basis point impact I just mentioned is expected to range from a 10 basis point improvement to a 30 basis point decline.

When you run the numbers, you will see that without the special items we are moving closer to our original goal of 13 to 13.5% operating margin by the end of fiscal 2007.

We have made great strides towards this goal to date surpassing our targets on an absolute dollar value for sales, operating income, and EPS.

We are driving our efforts for margin expansion and we intend to pursue our goals vigorously.

Achieving those goals requires a sound strategic path that William has laid out.

Therefore, our reported diluted EPS is expected to be between $1.95 and $2.00, which again, includes $0.17 per share impact from expensing stock-based compensation and the potential impact of Federated/May.

Let me briefly touch on what the re-valuation of the Chinese yuan means to us.

While our business in China is growing rapidly it represents less than 1% of our total sales.

Additionally, most of our contracts with suppliers are in U.S. dollars.

Therefore, we expect minimal impact from this re-valuation in the near-term.

At this time, we expect our effective tax rate will be approximately 37% throughout fiscal 2006.

Our effective tax rate is subject to change during the course of the fiscal year as the rate is a function of mix of earnings, as well as potential new government legislation, and tax initiatives.

Regarding the fiscal '06 first half, we expect reported sales to grow between 7 and 8%, including approximately a 50 basis point positive impact of foreign exchange.

We expect a slight decrease in gross margin.

Operating expenses are expected to increase 60 to 80 basis points primarily as a result of expensing stock options.

Diluted earnings per share for the first half are expected to be essentially flat, included in these results is a $0.10 impact from expensing stock options.

Let me repeat, that we run our business on an annual basis and we experience volatility in our quarterly results.

In particular, this year will be impacted by the expensing of stock options and the timing of product launches and investment spending.

And now I would like to turn it over to Malcolm Bond, our Executive Vice President of Operations.

Thanks, Rick.

And good morning.

As William mentioned, achieving operational and cost excellence is a key element of our strategy to grow the business.

Our focus has to be to continue to provide a high level of service to the brands and markets around the world, while simultaneously embarking upon a strategic re-engineering of our business processes laying out plans and actions that will draw continuous improvement in the operational performance of the Estee Lauder companies.

We last reviewed the operation strategy at the Analyst Day in September of 2002.

And at that time we outlined our plans to achieve significant cost of goods improvements.

We are pleased that we have accomplished 130 basis point reduction since that time, in-line with our expectations.

In the area of inventory we saw continuous improvement until the deviation in fiscal '05 and we believe that the strategies we have in place are going to continue the long-term downward trend over the coming years.

In fiscal '05, inventory has been adversely affected by some of those changes that going forward will give us benefits.

Firstly, we have tripled the value of materials purchased in the Asia/Pacific region to over 15% of our total -- of our materials purchased.

While this adds six -- four to six weeks to the supply chain for these items it is more than outweighed by the gross margin improvements it creates.

Second, we have added to the year-on-year increase by opening new combinations of markets and brands more distant from our traditional sources of supply.

And thirdly, we made a conscious decision to move forward our peak full season production, which will result in improved efficiencies of fewer execution problems as we get into the high volume periods of late August and September.

The final supply chain contribution to the inventory increases versus last year, our distribution changes in Europe, which I will talk about shortly.

In the area of cost of goods, we continued to execute the strategies that have served us so well over recent years.

Any improvement must start with the supply base.

With incoming materials being approximately 76% of our cost of goods, and the biggest contributor to the success of a seamless supply, we continue to work with our strategic suppliers to improve not only the cost structure of the supply, but also the other essential ingredients of innovation, quality, and reliability.

We can no longer just pluck the low-hanging fruit of price negotiations particularly, in the light of the higher commodity and energy costs being felt by our suppliers.

We have been working with many of our largest suppliers to help them take a more holistic approach to the global resources they have available.

In the coming year, we will be expanding the Asia/Pacific arm of our Global Operations Group to take greater advantage of the rapidly-growing capability in the region for prestige cosmetics.

This is not only driven by a cost reduction imperative, but also as an acknowledgement of the region's growing importance to the corporation, both in terms of development, and innovation, as well as sales opportunity.

While we do not intend to build our own factories in the region, we have established key strategic manufacturing partnerships in both China and Japan, and our own operation structure will be enhanced in all the key disciplines to support the work of those partners.

Being a global company enables us to direct the resources that support our growth to the most advantageous regions without major restructuring in our existing businesses.

It is our intention over the coming five years to continue that trend and I see us increasing output in our Canadian factories, as well as the third-party manufacturers in the Asia/Pacific region.

Today, I would like to touch upon three initiatives high on our priority list over the coming years.

First, the strategic modernization initiative; second, restructuring our distribution network; and third, strengthening our product to market cycle.

First is our strategic modernization initiative, or SMI, which will lead to continued improvement on cost of goods, inventory, and other business processes.

Over the past year we have carried out a detailed review of systems and processes across the Company, and we recognize that we have a unique opportunity to improve the way we conduct our business.

We have teamed up with the software provider SAP, to provide a comprehensive suite of programs that will support the modernization of our processes from demand management, through procurement and planning, to financial management and improved customer relations on a global basis and for all divisions of the Company.

This major undertaking, which will be phased in over the next four to five years, will be the most comprehensive re-evaluation and redefinition of our processes the Company has undertaken.

Importantly, the investment behind the SAP implementation over the next four years is only marginally greater than the projected cost we would incur over the life of the project to maintain and enhance our legacy systems.

The Aveda brand has been selected to be the pilot sight and the first brand to implement the global design in the fall of '06.

We are planning to follow this by a series of phased implementations across all operating units of the Company concluding approximately by the end of fiscal '09.

Benefits should accrue later in the project primarily from process efficiency, but also from the corporate IT infrastructure.

We will enjoy more accurate forecasting, better supply integration, lower inventory, a streamlined IS infrastructure, easier integration of future acquisitions, and easier compliance with increasing regulatory requirements.

We have established a full-time group of executives from all disciplines of the Company to develop the blueprints that will be adopted.

While its detailed savings will not be finalized until this blueprint phase is complete over the next six months, we are expecting annual savings to be in excess of the $80 million a year by the fiscal year 2010, and continuous year-on-year improvements thereafter.

While the SMI undertaking will be the largest of our initiatives we are not going to rely on one pillar to support our ambition for improved performance.

The second major initiative is the restructuring of our distribution network on a global basis.

This will directly affect our ability to progressively reduce the inventory we need globally, while maintaining the service levels we demand.

With 75% gross margins we have a low risk tolerance in terms of the inventory required to support the business.

However, we believe that there is a real opportunity to better manage inventory by not only adopting the improved forecasting pools of SAP, but also re-evaluating and restructuring the fiscal distribution network around the world.

To facilitate this, we intend to establish regional inventory centers, which will both direct ship to our retail partners, and post lower levels of inventory into localized distribution points, depending on the regulatory and market demand.

This will reduce the number of substantive inventory holding points by more than 20 from the current 50-plus over the next five years.

The process has started.

The first such installation will be complete by the end of this calendar year in Northern Europe.

Located on the border between Holland and Belgium, the Northern European DC will enable us to eliminate inventory in four other holding points.

Through this period of change it has been necessary for us to increase inventory to mitigate the risk of service interruption.

But as this distribution strategy takes hold, it will yield improved working capital, as well as reduced distribution expense and continued improvement in cost of goods.

The third initiative is to strengthen the process of bringing new products to market.

Increasingly, we need to find better ways to get the great ideas out of our R&D laboratories and into the markets more efficiently.

With the technology of both products and packaging becoming increasingly complexed we need to continue to streamline and strengthen our decision-making project management and engineering skills.

This increased emphasis on our product to market cycle should benefit not only the certainty of the cycle time but improve the innovation and creativity we can offer our brands and customers.

We estimate that these initiatives will enable us to continue to drive down our cost of goods over the next five years by 30 to 40 basis points per year, and reduce our inventory days to achieve a 20% improvement over the same time period.

We are very excited about the opportunities which are opening up to us as we complete the globalization of our supply chain processes, with the adoption of the latest technology.

We have a worldclass operations organization, which why located in all the major areas of the world operate as a cohesive and integrated single entity separating competitive advantages to the Estee Lauder Companies.

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

[OPERATOR INSTRUCTIONS].

Our first question will come from Wendy Nicholson with Citigroup Investment Research.

Please go ahead.

Hi, good morning.

My question has to do, I guess following up Malcolm, on all of the things you listed.

It sounds like most of the margin improvement initiatives are going to hit the gross margin line, but where it seems like you're falling short of the targets you laid out in 2002 are on the SG&A side.

So can you talk about your longer-term operating margin goal?

The 13 to 13.5 by '07 seems maybe not realistic at this point.

Where are we and what you're doing specifically on the G&A side to get that level of cost spending down?

Wendy, it is Rick.

If you look at our progress to date, we've taken about 210 basis points out of expenses other than advertising, merchandising, and sampling and as you know we have reinvested a portion of that back in there.

But we've been doing a pretty good job I think of balancing profitability improvement and expense reduction.

If looking at our guidance for next year, and if you were to exclude those special items that we talked about, which were the expensing of options, and also the Federated/May impact, and taking the middle of our range, you would see that it requires an operating margin of about 12%.

Meaning, that to get to our target by the end of fiscal '07, we would have to improve 100 basis points in fiscal '07.

So we're not giving up on our target.

We think we're making great progress.

As you know we're growing our sales much faster than we had laid out in fiscal '02.

We're growing the value of our sales, the value of our operating income, and our EPS growth is growing much faster.

And we're not ready to throw in the towel and it's an ongoing process as well, but that doesn't stop in fiscal '07 but it goes beyond that.

And that is supported by the SMI project that Malcolm was talking about as well.

Okay.

And it sounds like one of the big initiatives that is going to help you get that overall operating margin up is going to be improvements in your fragrance margin.

And I think William in his prepared comments said that you're hoping to get your fragrance margins up to industry average.

Which depending on who you look at, is really a lot higher than yours right now.

What's the timing in terms of seeing fragrance margin improvements?

Is it 100 basis points a year?

Well, Wendy, I think it is very difficult for us to put our number -- a finger on it and say, okay, it's going to be -- we're going to make an enormous effort to make consistent strides year-on-year.

At the same time, we have to be mindful of the fact that a number of our very strong fragrance franchises have been strong fragrance franchises with a loyal following for many years, and we need to make sure we continue to enhance that loyalty, and reward that loyalty of the consumer with the same product that she has been used to using for many years.

Some of the very best fragrance franchises in our industry, most of which are ours, but unfortunately, not all of them are ours, are fragrances that have been around for 60, 70-plus years.

And that loyalty that is generated by or for those consumers is -- needs to be consistently looked at and we make sure we continue to reward that; as well as launching new products with the right appeal to consumers; as well as the right cost structure to be profitable.

So in terms of the rewarding loyalty, does that mean more gift sets?

I thought we were moving towards fewer gift sets?

No, I'm really talking about the formulations themselves.

Okay.

Because the big -- if -- from our perspective, when we look at it, probably the biggest -- there is mix of business issues which are gift sets and those are regionally driven, North America, being the most heavily gift-oriented fragrance business where the mix has an effect on the cost of goods.

But the absolute product cost of goods, the juice cost; for example, the bottling expenses and others, those also have an impact.

So there is two different -- they're all in cost of goods but there is a number of different ways we have packaged.

The package expense, the juice expense, and then there is a promotional mix, which goes into the cost of goods line, but it has an effect.

Okay.

And then just my last question is on the timing of some of the new fragrance launches.

It sounds like fragrance is going to have a weak first half but that surprises me because you have got the Gwyneth advertising and what not.

Is that just timing of new products and the level of spending?

I think that's probably an accurate statement.

Okay.

Thank you.

We will take our next question from John Faucher JPMorgan.

Please go ahead.

Yes, good morning.

I was wondering if you could articulate a little bit better in terms of -- it looks as though the consensus range for growth will have to come down for the first half.

And when I look at the topline growth it should be higher, when I look at the share repurchase at least from the fourth quarter that should add a little bit more to first half EPS growth and back half EPS growth.

So I'm trying to get my arms around why we're looking for such a big acceleration in underlying EPS growth, excluding the stock option impact for the second half, when you've got such a much higher topline target for the first half?

Well, I think when you exclude the stock option expense you see that the split in half really, as far as growth of EPS is not tremendously different, first half versus second half.

The second half is a little bit higher, there is no question, but it is not tremendously higher than the first half numbers.

And quite honestly, John, we do run our business on a full-year basis.

We put together our marketing programs.

We put together our launch calendars in such a way that makes the most sense from us from a business point of view and the profits fall where they may.

As long as we achieve our full-year numbers, we're happy.

So is it fair to look at it and basically just say that the spending -- the revenue and the spending both from a marketing standpoint will most likely be loaded into the first half of the year?

Is that the right way to look at it?

There, certainly, yes.

Okay.

Thank you.

Yes.

We will take our next question from Ann Gillin-Lefever with Lehman Brothers.

Please go ahead.

Good morning.

Just a quick question, Malcolm, from the outsider, I'm just trying to identify who will get the credit internally for -- as inventories come down or better yet kind of who is in charge of inventories internally?

Well, let me answer the question, Malcolm gets all of the blame and none of the credit when it comes to inventory management. [Laughter].

Okay, then who gets the credit then, William?

I think to answer the question, I think that it is clearly a total corporate responsibility.

And that is the whole point of going to an investment like SAP.

Because it is only by integrating the information that comes in from all around the world, and us being able to interpret that link correctly, and to use that information effectively, can we make sure that our inventories are put in the right place at the right quantities to be able to do best benefit to the corporation and provide the service if needed.

So is it a business-by-business, region-by-region?

Yes, it is by brand.

By brand.

Okay.

And all brands and all markets are -- do have bonus opportunities tied into working capital performance, which obviously this year we're a little bit disappointed in and we will be appropriately reflected in the results of those bonus opportunities.

Okay.

Is there a lag effect?

You noted that you have been able to triple the Asia/Pacific sourcing and that's going to be an opportunity in terms of lower costs.

But I'm wondering if there is a lag effect in terms of we're seeing a build in the inventory, but it is not yet flowing through gross margins perhaps because of FIFO accounting?

Well, there is a lag in the way in which the cost of goods hits the P&Ls, absolutely.

And you will see that we've made an improvement against '04 versus '03, in terms of the growth inventory year-on-year.

So yes, there is a lag to that extent.

I think when you talk about the resourcing of purchases into the Asia/Pacific region, I mean that's a continuous process that we have been building on for the last two to three years and we're not going to jump headlong into resourcing without making sure that our supply chains can cope and react to the needs of the business.

So we see that progressively working over the next four to five years as that area develops and we get the right infrastructure in place.

When do we catch up to that lag in terms of when do we start to see the better sourcing flowing through gross margins?

Well, certainly, every year we're getting improvements, it is a continuous improvement, but '06 will be the time when we see those benefits.

Okay.

Terrific.

And then just one last question, and I'm excited about the opportunity to get more visibility, I'm kind of hoping that we're not going to be sitting in August 16, 2007, getting earnings results.

But I'm wondering whether some of this will also enable you to collapse the perception of kind of brand silos in the Company?

In other words, you will be able to do some more functions across brands as you get more visibility from upgrading systems.

Well, we work very hard at making sure that we can do our best at keeping best practices and sharing best practices, across our brand, as well as corporately.

Right now, if you look at it, the best way to look at our organizational structure is that the brands are primarily focused on sales, marketing, and product development, which helps keep the uniqueness of each brand going.

And that everything that is behind the curtain and not visible to the consumer is predominantly supported corporately by fairly standard ways of doing business.

That being said, where we have the biggest opportunity is -- well, as Malcolm mentioned in the SMI efforts and in partnership with SAP, where a number of those intelligent processes, referring to forecasting, as well as other areas, will become more standardized in a manner that will allow us to better share best practices across brands, while maintaining brand uniqueness from a marketing consumer perspective.

Terrific.

Thanks very much.

We will take our next question from Linda Bolton Weiser with Oppenheimer.

Please go ahead.

Thanks.

Gap recently signed an agreement with Inter Parfums to do some expanded personal care and cosmetic items in their stores.

Is the specialty retail channel something you would like to do more with and is that type of agreement something you would consider doing?

Well, as you know we have over a 300 and some odd specialty stores brand dedicated stores predominantly under the M.A.C, Origins, and Aveda banners in depart -- outside of department stores, but in regional malls today.

We're fairly satisfied with that business today.

We also, of course, have as an alternative in the Kohl's -- our BeautyBank efforts with Kohl's in the United States.

Licensing opportunities like you referred to are certainly interesting.

They have their benefits, as well as their costs and we will always look at opportunities that might be attractive to us.

As we said before, most of our strategic opportunities that we will look at, whether they're licensing opportunities, as an example of what you mentioned, or acquisition opportunities, they need to be materially worth our while.

In other words, they need to be opportunities that are well greater than 50 million, and preferably well greater than a $100 million as an opportunity.

Okay.

And just along those lines, can you comment on how the profitability of the Kohl's business, whether it met your expectations in FY '05, and then what you expect to have for spending levels behind that in FY '06?

Linda, it met our profitability objectives.

We said it would more or less breakeven for this year, which is what happened.

It did impact our operating margins by about 10 basis points because we had sales and obviously with a breakeven profit that -- the mathematics of it.

We are anticipating progress -- a progression of improvement in profitability and we hope that by the time '07/'08 comes around that this Kohl's business will be very close to the overall profitability of the Company as well.

Okay, great.

Thanks very much.

We will take our next question from Chris Ferrara with Merrill Lynch.

Please go ahead.

Hey, good morning.

I just wanted to talk about your statement that you are going to be shifting some of the investment behind the Lauder brand towards skin care and makeup and away from fragrance.

What are the risks there considering how much you've talked about how important the fragrance business is, even though it is a challenged business from here?

Well, the risks that are associated with the fact, as I mentioned before, we've got some key franchises in the Estee Lauder brand in their fragrance category, most notably Beautiful and Pleasures, the two leading franchises, as well as Beyond Paradise, White Linen, there is a number of key fragrance franchises.

But the fact of the matter is, is that the Estee Lauder brand has strength -- significant leadership strength in fragrance, skin care and makeup, yet, we see very strong consumer loyalty not just in those key established fragrance franchises, but in key franchises within the makeup and skin care categories.

And as we've discussed many times before, the profitability and the sustainable profitability in those two key categories are very important to the continued success of the Company, as well as long-term loyalty for the consumer.

So the real benefit for us is to invest in the balancing and the re-balancing of the spending across multiple categories rather than dedicating a outside proportion of the spending and advertising, and voice in particular, into the least profitable category amongst the three.

So is it -- I mean is it fair to say we -- I think you might have indicated this already.

But is it fair that you probably see this more as a result of fewer launches, as opposed to lowering or lessening support of the current franchises?

Yes, I think that is a fair comment.

And then just one more in divestitures.

Has this -- is this a change in the way you guys have been thinking about it before?

I mean you mentioned that you would be re-evaluating the business model of certain businesses that aren't performing up to standards.

What has changed with your mind set on any specific business --? [multiple speakers].

Well, I don't think really much has changed, Chris, to tell you the truth.

I will remind you; for example, we had acquired a brand in 1997 called Jane and we sold it not too long ago after having an expensive lesson of doing business in the mass business.

We had a license in the Kate Spade franchise and we have recently given that license back to the Kate Spade brand -- Kate Spade Company.

And we're taking a very strict focus on all of our brands to make sure that they're performing up to the expectations, have the potential to perform up to expectations, and if we feel that they do not have the potential to perform up to the needs, we will look at alternative methods of disposal.

Got it.

And could you just comment on Western Europe?

Are you seeing -- had you been seeing destocking at retail in Western Europe to any significant measure?

And has that trend improved at all if were you seeing it at all?

We have been seeing some destocking in Western Europe and that trend is continuing some, but it is really a very lumpy inventory flow in Western Europe, primarily because of the margin structures and also as you heard, the recent transactions that have gone on in that region where there is a great deal of consolidation.

Thank you.

We will take our next question from Sandy Beebe with HSBC.

Please go ahead.

Hi, I had a question on working capital again.

I guess the operating cash flow for 2005 was below expectations.

And it sounds like you expect such a strong pick up next year.

But yet a lot of the working capital initiatives that you guys have been highlighting sound like they're more sort of longer-term initiatives, and not something that you would see sort of an immediate beneficial impact.

So why are you so confident that the operating cash flow and the working capital numbers will start to look better starting in fiscal 2006?

Well, Sandy, I think the first thing is that certainly we don't anticipate a deterioration, which is really what affected our cash flow for this year.

It wasn't so much -- it was the fact that our inventories increased and that our DSOs increased.

Next year we're not seeing the DSO increase based on the mix of business that we're foreseeing.

And we will take actions with inventory, which will begin to bring those inventories down.

Malcolm mentioned the European distribution center which is coming on stream and right now we're carrying duplicate inventories and their affiliates in that distribution center in Europe, but that will go away and we will begin to improve just our overall inventory performance.

So it is really -- if you look at our fourth quarter cash flow, you will see a significant improvement year-over-year, and we're anticipating a 40% improvement in fiscal '06, more getting back to business as usual.

Okay.

And then I guess on your prepared remarks, there were also some comments on receivables and talking about in terms of some of the customers if you increase the amount of business you're doing in Europe, how that increases, I guess, your receivables.

I mean is that -- why is that first of all?

And I guess is this something more secular that we should expect to continue?

Well, it happens because certain markets have longer terms and they're growing quite fast, versus our normal international business; for example, China.

Another example would be Russia, where we went from a distributor, which was almost a cash-on-delivery situation, to a normal affiliate with extending terms.

So those two items are one element of it.

The other is that as some of these smaller, if you will, mom-and-pop perfumeries are acquired by the larger chains, we have different trading terms with those smaller companies than we do with some of the bigger chains and that kind of changes the mix a little bit.

So we will see some pressure on receivables within international, but we think that we're able to take measures to hold it about where it is today.

So that's why I say that next year we're not anticipating any deterioration.

Okay.

Great.

And I guess just now that you've announced some of the latest Tom Ford initiatives for the Estee Lauder brand, can you give us some update as to maybe how the trade has seemed to respond to the new products and I guess what you're expecting on that front?

The trade receptivity to the Tom Ford initiative has been great.

And we are continually getting wonderful feedback from those retailers who have seen it, and they are wanting as much of it as we can give them.

But I want to caution you that the initial Tom Ford initiative in November is going to be primarily aimed at the upper-end of retail in specialty stores, such as, Neiman Marcus, Saks Fifth Avenue, and Bloomingdale's.

There will be some product available into the broader distribution of the Estee Lauder brand.

But by no means in this first season will you see this as some huge magnificent monster.

It will be what it is meant to be, which is aiming at the most loyal consumers who are the leading edge determinants of trends.

Okay.

And just one last question, just on the exclusivity of the initial Tom Ford product, is that something expected to continue?

Or I guess if you see how the project goes, would you be available -- willing to make it more available to broader distribution channels?

Well, our broader distribution channels --.

Not broader but more mid-priced department stores.

Probably a narrower range of SKUs than would be available in the more aspirational specialty stores would be available into the full range of Estee Lauder distribution going forward.

Thank you.

We will take our next question from Amy Chasen with Goldman Sachs.

Please go ahead.

Hi.

I wanted to start with sort of a broader question, just about, William, the strategy that you laid out, and in particular some of this cost savings focus.

What is the catalyst for this kind of -- I don't want to say new strategy, but the evolution of this strategy, and you presenting it, certainly in a more cohesive way than I've heard the corporation talk in the past.

I mean was there some sort of strategic review that you went through?

Did you use consultants?

Can you talk a little bit about that process?

Well, we're continually evaluating ourselves on a daily basis, as well as obviously being evaluated by our friends on the outside world.

And yes, Amy, you're right.

We have gone to a very extensive and expensive internal strategic review of where we are, what are the key core pillars of success for our Company in the future, and what are those key obstacles for achieving the levels of success that we expect from ourselves, and how are we going to knock those obstacles down to achieve that success.

This has been a very extensive review process.

It is a continuous process.

We haven't set something in stone and said, all right, let's go, nothing changes.

We have to continually evaluate how we are succeeding along the routes to these -- achieving this success, and what opportunities or obstacles that will come in our way that may force us to change course somewhat.

Essentially, I mean what we're saying to ourselves is the competitive landscape, the opportunity landscape for this Company will continually change, and we must be flexible in how we do this.

As an example, but by no means the only reason, our two largest customers in the world are merging, that creates a different environment in how we're going to conduct our business in the largest market, which we compete in the world in North America.

Another example not too far off from that is the fact that two of our larger customers in Continental Europe are very key strategic market for us, are also merging, and there is, if you will, a gravitational pull that is somewhat changing the dynamic in the second largest market, which we compete in, in the world.

As a third example, if you will, in China, and India in particular, two of the fastest growing emerging consumer economies, we need to focus our efforts and structure our companies in such a way that we have brands that are attractive and relevant to those emerging middle-class consumers with disposable income.

And we can't just say because we did it in the 1960s and '70s this way we will continue to do it in the 21st Century.

And William, when exactly did this review begin?

Oh, it probably began about two or three years ago.

And it has been an ongoing process.

And we have been working intensively on it over the last three to four months in a manner that has been very different, if you will, than the last couple of years.

Okay.

And along those same lines, I guess, just a lot of the things that you've talked about from a cost perspective are very similar to things we've heard over the past five years, but it just sounds to me like you're approaching it in a much more aggressive way.

Is that a fair statement?

Yes.

Okay.

Great.

Last question is just on Europe.

This is a little bit more micro, but for fiscal '06 it looks like you're looking for Europe to really slow down in the second half.

Why is that?

Well, I think one of the things we are generally concerned about with Europe is a slowing consumer confidence.

You heard about West -- the key markets in Western Europe, most particularly Germany and France, which have been somewhat slow over the last couple of years.

Italy and Spain, which have been a far more robust consumer economies over the last few years have appeared to slow down somewhat.

And the U.K., which has been the most robust consumer economy and retail economy over the last four to five years is also seeing a slow down.

So, if you will, those top five markets which make up the lion share of the European business -- and don't forget we also report travel retail through Europe, which is going strongly, we have confidence in.

But the consumer economy, the local consumer economies and those five key markets, we don't see them growing at the same rates perhaps as they used to be because there appears to be a slowing in consumer confidence.

And just out of curiosity, why are you able to buck that trend in the first half?

Why are we able to buck that trend in the first half?

Well, the specific issues are we have got some key launches going on, we have got some brand expansion going on, and we feel confident based on the way our local affiliates are operating their businesses they feel they have strong product in the pipeline for success in the first half.

They're a little less sanguine about the second half.

Okay.

And lastly, as we think about the next couple of years in Western Europe, is the mid single-digit local currency number better than the double-digit growth you've been reporting over the past five to 10 years?

That's fair.

Great.

Thank you.

We will take our next question from Bill Schmitz with Deutsche Bank.

Please go ahead.

Hi, good morning.

Good morning, Bill.

It looks like your restructuring charges are kind of in vogue for the entire group.

And I was just wondering will you fund a lot of these initiatives through the P&L or will there be one-off charges associated with that?

And then I have a follow-up.

These are not restructuring charges this is just business as usual, but somewhat, as William described it, more focused and we're working very hard on this.

Great.

And then I think you still run sales forces for each of the individual brands, is there an opportunity to kind of go down the road to consolidate some of the sales forces into maybe a cohesive Estee Lauder Company sales force to kind of mirror what some of your retail competitors are?

Or do you still think its a pretty huge competitive advantage to have these brands compete with each other.

Bill, we -- because we compete with ourselves in so many venues, so many stores, we've looked at it and we see no advantage of consolidating sales forces.

In some of our small brands, such as, we have Jo Malone and Creme de La Mer consolidated, but in the larger brands, M.A.C, Lauder, Clinique, Bobbi Brown it doesn't make any sense to us.

Okay.

And then just one last one.

In terms of the repatriation I think it's 500 million you said.

What are you going to do with the proceeds from that?

Those are just going to -- it is really, if you look at our balance sheet, Bill, it is moving it from one side of the ocean to the other, right?

But that cash is going to be invested to -- in the domestic company to fund business growth over the coming fiscal years.

Great.

Thanks very much.

We will take our next question from Constance Maneaty with Prudential.

Please go ahead.

Hi.

I'm impressed by an unusual amount of information on plans that you put forth today.

And I also note that you are going to be at CAGNY on September 14th.

Are you able to give updated targets -- 2008, 2009, from all of these initiatives, and do you plan to do so at this upcoming meeting?

No, Connie, I think the level of information, the focus, the way we look at our business and our general plans will continue to do the way we do it without giving you, if you will, specific numerical targets, as well as giving you ranges of how we expect to approach our business on a going-forward basis.

Okay.

You laid out a second task impact from the consolidation of May and Federated.

What is the full-year impact?

Do you know -- a 12-month impact once the store closings start?

Well, it is hard to determine as we said because while May and Federated have -- well, Federated, excuse me, has laid out its general plans as to the number of doors and they have not -- we do not know yet what the actual disposition of those doors may be like.

For example, if the store closes and goes dark and we no longer have business there, that's a very different scenario, as if a door is sold to, and is operated by another one of our retail partners where we will continue the operation of our brands just under a different banner in the mall.

If you will, those are the two extreme examples of which we can -- we would need to calculate what the impact would be.

So at this point, I would say it is highly speculative, not knowing any concrete plans, other than that they've announced that they will be changing the nameplates on a number of the May Company brand names other than Marshall Field's over the next year to 18 months.

But it should be safe to assume that there would be some impact still unquantified on fiscal '07?

Yes, that's fair.

Okay.

One final question for Rick.

How come the options expense affects the first half more than the second half?

It is really the implementation of the methodology and the way our options are written.

And it has to do with the fact that people who are retirement eligible-aged, and who have options the expense hits immediately.

So when we adopt a policy it really impacts us right out of the box going into fiscal '06.

You've got a lot of older people in management, huh?

Well --.

Please we'll take exception to that. [Laughter].

Yes.

Thanks a lot.

You're welcome.

We will take our next question from Alice Longley with Fulcrum.

Please go ahead.

Hi, good morning.

Could you break out the contribution of travel retail to sales and profits for the fragrance division for the year?

For the fragrance division, no, but we can tell you that this -- and maybe Dennis, if you want to call Dennis, he might be able to help you with some of that.

But it grew about 18% in the fourth quarter, and for the full year, around 15%.

What did?

In sales.

Sorry, in sales.

Well, we know that in previous quarters, travel retails contributed more than all of the profits of the fragrance division.

Is that true for the year?

Well, I think you're mixing apples and oranges, the truth is that travel retail channel, we sell a number of our brands across all categories, not just in the fragrance category.

When we reported our fragrance numbers, we are reporting the fragrance numbers by region.

So I don't know if you can make a fair comparison between the two.

Okay.

I will talk to Dennis about that later.

And then how much did Kohl's contribute to the sales growth in the fourth quarter?

I think the sales number was --.

Kohl's for the year was less than 1% for the total Company number.

The total Company sales growth.

Okay.

Thank you.

You're welcome.

We will take our next question from William Steele with Banc of America Securities.

Please go ahead.

Hello?

Hello.

Can you hear me?

Yes.

This is actually Gerry Gallagher, I have a couple of questions regarding your sourcing that you guys were talking about, it sounds like you have it outlandish on your plate.

Over the last year a lot of your competitors have recently been implementing some new more strategic initiatives for resale raw material costs by establishing a better line of communication with their supplier base.

I'm interested if you could provide a little more elaboration, a little more color and your opinion as well, the way you guys have in the hopper to establish a better line of communication with your suppliers?

Well, Gerry, it is Malcolm.

I think that there is a couple of things there.

In terms of the strategic communication with our vendors, obviously in the medium term, SAP and the whole infrastructure of our systems change, we will make a big inroad into that.

But one of the things I indicated in the notes earlier was that we are actually establishing a much bigger presence in operational terms, in the Asia/Pacific area, over the next year.

And having people on the ground with the right expertise is going to help us to maximize the benefits in that area.

I think that compared to some of our competitors our big spending is in our componentry area as opposed to chemicals, which is a much more valid -- value-added area of the business, and therefore, having packaging and engineering people in there is the area that we improved the communications and the execution of new products, which is the key part to that.

Right.

One thing I noticed over the last five years I have been following your Company is quality has always been a key driver, key metric that your Company engaged on.

What are you guys doing to make sure that your suppliers are living up to your quality standards?

Are you score carding them on a quarterly basis?

Are you meeting them within weekly or monthly through supplier forums?

What are you doing to make sure that they are making -- giving into your rigorous standards -- meeting your rigorous standards?

Well, you're absolutely right to point that out, and in fact, that may be sometimes we've been criticized for being slower in going into some of these new areas compared to our competitors because we are very keen to make sure that we are actually not affecting the quality of our product.

Most of the people that we're dealing with in the new areas that I indicated were our major global suppliers who we are working with to develop resources in those areas, who are very well aware of our requirements and what we need to make sure we maintain our quality.

So one of the things that we need to do is have people on the ground that maintain that, and the people that we work with for many years to be able to put their resources into Asia/Pacific so we can get the joint benefits.

Have you been pretty happy with your supplier base right now?

Or are you consolidating them and getting rid some of the suppliers who are not meeting those standards?

We are always happy with the people we are dealing with, but we're always reviewing it to make sure we keep up the standards that we need.

Okay, and final question.

What is in your supplier feedback?

It sounds like you guys have a lot of initiatives on your plate, not only over last year, but for the next several years to come.

Have they been feeling like they've been getting squeezed?

Are they more willing to participate with you?

What is been their overall feedback?

Well, we clearly make sure that we are not trying to drive our vendors into an unprofitable situation because that doesn't do us any good as a customer.

We try to work with them to identify opportunities to improve the benefit for both our companies.

And I think in most cases there is always exceptions, but in most cases we have that win-win situation on the table.

Okay.

All right.

Thank you very much.

We will take our next question from George [Niemond] with Merrill Lynch.

Please go ahead.

And he has disconnected.

George got tired.

[OPERATOR INSTRUCTIONS].

And we will take a follow-up question from Ann Gillin-Lefever with Lehman Brothers.

Please go ahead.

Thanks.

Just a quick question.

Any sense of charges from inventories that may be becoming obsolete?

And also from brands -- the underperforming ones as you may mark them to market for sale?

We go through a process of valuating the acquisitions that we made and the goodwill on our balance sheet and we've done that at the end of fiscal '05 and there is no impairment, so we're comfortable with that.

Regarding that sale, it depends obviously, if we were to sell something, it depends on the sale price that we're anticipating to receive.

As far as inventories go, we have an appropriate reserve based on our Company policies, which is reviewed by our auditors on our balance sheet to protect us against obsolescence.

And as you know, even though our inventories are a little bit high at the moment, they have long shelf lives.

We really don't throw that much out, it is just a matter of working it through the finished goods, and working it through as finished goods and then just cutting back production, and bringing it back in-line.

Thanks, Rick.

Yes.

We will take a follow-up question from Constance Maneaty with Prudential.

Please go ahead.

Hi, just back to the statement you made about possible divestitures.

How many of your brands might be reviewed for divestiture?

All of them.

Realistically, how many?

We look at all brands, we -- every brand has to justify its existence in our portfolio, both strategically, as well as financially.

And if they meet both the strategic and financial criteria, we think that they ought to remain as a member of the family.

If they continue to meet the strategic criteria but are challenged on the financial criteria we will work very hard with them to bring their financial performance up to our expectations.

And if they fail to meet both the strategic and financial objectives, we will probably look for other solutions.

How many of them -- just ballpark -- how many of them are below objectives?

Well, you know what?

If we constantly raise the bar,there is always somebody who is not up to where we want them to be and we are going to push them to get there.

Okay.

Also a follow-up, you made some comments about a pilot in Mexico for BeautyBank.

How might that work?

Well, I think the conversation is we are talking with one or two retailers who are different retailers than our current distribution, about bringing these brands to this market place to see the viability of the brands and, as well as the viability of the channel.

Okay.

Great.

Thanks.

We will take a follow-up question from Linda Bolton Weiser with Oppenheimer.

Please go ahead.

Thanks.

Just on the outlook for the sales growth in FY '06 I think you said that Asia/Pacific would be the highest growth for the full year but not for the first half.

What is going to make that pick up so much in the second half of the fiscal year?

Again, Linda, these are timing of programs and launches, and marketing activities that we have with the various market places.

So I mean you really have to go back and we would have to look market-by-market to see who was launching what in what time frame to explain it.

But this is the cadence of our business, and overall, on a full-year basis it is the fastest growing region and we anticipate that going forward.

And we are launching M.A.C and Bobbi Brown in China as an example, those are the things that are going to happen, which will happen and grow over the course of the year.

Do have you a projection for China growth in FY '06?

We certainly do, but our business, we've said as practically doubled year-on-year for the last couple of years, and we would anticipate something not maybe quite at that pace but very solid, solid double-digit growth.

Okay.

Thanks very much.

We will take our next question from Ari Rosenberg with Lowe's Corporation.

Please go ahead.

Yes, this is Eric [Iris] calling for Ari.

Just a couple of quick questions and one comment.

First the comment is you guys had a great quarter and I'm surprised that the sell side hasn't congratulated you on that.

Thank you.

The questions are, one, do you have any opportunities with other retailers to do something like what you're doing with Kohl's?

There are always opportunities.

It is really a matter of what are those opportunities, and is it a worthwhile effort from both of our standpoints, both ourselves and the retailers, to make this investment and effort.

And we are constantly in different conversations with different retailers of what those opportunities may be, as well as looking at our own management resources, as well as financial resources to make sure that this is a strategic area we wish to play in.

Terrific.

Could you also talk about your investment spending in Asia a little bit further?

I believe that you said that that was one of the reasons why your CapEx was going to be up.

I was hoping you could sort of quantify it and also talk about what it is you're actually doing?

I think the investment in CapEx spending is really related to our SMI, or the SAP project that Malcolm discussed.

That's the reason for the increase year-over-year.

When we talk about investment spending in -- and in particular, I think I referenced China, that's related to building and infrastructure.

So making sure we have the management talent, the distribution capabilities, the IS resources to run a business which is much larger than we currently have in China, because we want to be prepared to have a business, which we believe will be one of our largest affiliates in just a short few years.

Okay.

And just one follow-up, on that, after the set of investments, do you believe that you will have the infrastructure in place to keep you going for a couple of years?

Or will there be ongoing increases in CapEx for more infrastructure build?

No, again, if you are referencing China, we believe that China will become a profitable market in the not too distant future for us.

And so we're happy with that.

And as I said say we're building infrastructure for the longer term there.

Great.

Thank you very much.

And once again, a great quarter.

Thank you.

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

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That concludes today's Estee Lauder conference call.

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