雅詩蘭黛 (EL) 2006 Q1 法說會逐字稿

Good day, everyone, and welcome to The Estée Lauder Companies fiscal 2006 first-quarter conference call.

Just as a reminder, today's call is being recorded and webcast.

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

Please go ahead, sir.

Good morning, everyone.

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

Also with us today is Dan Brestle, our Chief Operating Officer, and he will be available for the Q&A session.

Since many of our remarks today contain forward-looking statements, let me refer 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.

Today, I will highlight our first-quarter results, and more importantly focus on the factors that will drive our business for the next nine months and beyond.

As you have seen from our press release this morning, this quarter's results were below prior year, and I am disappointed with that performance.

While we are faced both internal and external challenges, we are quickly taking aggressive action on the strategic imperatives that we discussed on our last conference call.

As a result, we expect to show some meaningful improvements in our performance this fiscal year and beyond.

I'll talk about those actions shortly, but first, let me briefly recap this quarter's results.

For the first quarter, we reported net sales of $1.5 billion, flat with last year's first quarter, when we grew 12%.

Excluding foreign currency, net sales for the quarter decreased slightly.

Our sales in the Americas were affected by the planned timing of product launches, weaker store traffic with several key retailers, a lower-than-expected response to our gift-with-purchase promotions, and the impact of store closures in the areas hit by the unusually strong hurricane season.

On the International side, our businesses experienced softness in certain key International markets, coupled with start-up issues at our new European inventory center, and a tough comparison with double-digit growth last year.

Our results this quarter reflect the flat sales growth, increased investment spending, spending for our strategic modernization initiatives, and incremental expenses related to stock-based compensation.

Net earnings from continuing operations for the quarter were $61.8 million, compared with 95.7 million in the prior year's quarter, and diluted earnings per share of $0.28 compared to $0.41 in the prior year's period.

Let me now discuss the quarter's product category results.

In Skin Care, reported sales were flat with the prior year, coming in at $523.4 million, and declined 1% in constant dollars.

Last year, Skin Care sales grew 13% in the quarter, strong sales were generated from recently launch products such as Perfectionist CP+ by Estée Lauder, and Super Defense Triple Action Moisturizers from Clinique, offset by lower sales in existing products.

Makeup sales of $604.9 million increased 3% in dollars, and also in local currency.

This category grew 23% in the prior year period.

Our M.A.C., brand generated strong growth while new and existing products from other brands also benefited the category.

The Fragrance category continues to be challenging.

Sales decreased 6% to $293.2 million on both a reported basis, and excluding currency.

While the current quarter benefited from the excellent growth of DKNY Be Delicious, and the recent launch of American Beauty Wonderful, they were up against stronger fragrance launches in the prior year.

Hair Care sales rose 12% this quarter to $70.4 million on a reported basis, and grew 11% in local currency.

Sales benefited from the new salon distribution and growth in existing salons, as well as new and existing products.

Geographically, sales in the Americas were relatively unchanged from the prior year's quarter at $881 million.

There were several factors behind these results.

On the positive side, new and recently launched products were well-accepted in most major product categories, especially makeup and hair care, and most developing brands along with our Internet business, reported sales increases.

Offsetting these positives, was timing of planned product launches which this year are skewed more heavily to upcoming quarters.

Additionally, our fragrance category posted lower sales in this region.

While sales growth at high-end specialty stores was solid, overall our sales reflect the weakness in certain key retailers, where a greater portion of our business is done.

Additionally, our Fall gift programs from the Estée Lauder and Clinique brands, did not perform to expectations.

We have responded rapidly and proactively, and both Estée Lauder and Clinique are redesigning and re-promoting their gifts to recoup some of the lost sales.

Toward the end of the first quarter, it became clear that retail weakness and the soft gift programs, would negatively impact our planned sales by approximately $35 million and was the major reason we previously lowered our first half expectations.

To a lesser extent, we also felt the effects of store closures in the hurricane-affected southern region of the U.S.

Approximately 25 stores were affected, and 11 stores remain closed.

The loss of sales from these stores in the quarter including returns, was approximately $5 million.

We also believe sales are reflecting lower foot traffic, due to consumer reaction to higher energy prices.

In Europe, the Middle East, and Africa, sales decreased 1% over the prior year's quarter to $417.5 million, and declined 1% on a local currency basis.

In local currency, sales were weaker in Spain, the U.K., Italy and Austria.

This region of sales grew 29% in the prior year's quarter.

Our northern European inventory center came online during the first quarter; however, the start-up was slower and more problematic than anticipated which caused a backlog in shipments.

We are now shipping to our normal business profile, and we expect them to be operating as originally planned by the end of our fiscal second quarter.

Partially offsetting these results were higher sales in Germany, and the Company's travel retail and distributor businesses.

In Asia-Pacific, sales this quarter grew 5% over the prior year quarter to $198.6 million.

In local currency, sales this quarter were up 2%.

Our business in China continued its momentum, once again generating high double-digit growth.

The local currency increase also reflects double-digit growth in Hong Kong, and good growth in Taiwan.

Now, let's talk about our expectations for the remainder of fiscal 2006.

We have a lot of activity to fuel growth, including a full slate of terrific product launches throughout our brands.

We are excited about the opportunities that emerging markets and expanded geographic penetration presents, along with leveraging our business in alternative distribution channels.

Let me give you some details.

In the Americas region for the full year, we have taken up our forecast for the Tom Ford Estée Lauder collection, due to strong buyer demand.

We expect the buzz generated by the launch will fuel excitement for the Estée Lauder brand.

We will continue to develop our new brands in Kohl's, adding stores as Kohl's expands throughout the year, and executing our first full-fledged holiday program.

Additionally, our other channels, freestanding stores, salons, and the Internet are performing quite well.

We are likely to see a continuation of faster growth at the high-end specialty retailers, which make up about 20% of our U.S. department store business, while prestige department stores may be more challenged for the reasons cited earlier.

However, since our press release of September 19, the consumer spending environment in the U.S. has deteriorated, and we also now believe that Federated will move more quickly on their planned post-merger store closures.

We had previously expected closures to begin in March, and take place over time with only a handful of closings this fiscal year.

Our assumption now is that Federated will simultaneously close in early calendar 2006 more than half of the 82 announced stores.

This will affect our full-year sales, as we will take inventory returns for all of the stores, and lose a considerable portion of their sales for the the remainder of our fiscal year.

The good news is, that we should get approximately half of the pain out of the way, and see less of a pinch in fiscal 2007.

While we have had on-going discussions with our largest customer to attempt to mitigate the disruptions at some stores, Federated has stated that they expect disruptions and weakness to continue for some period of time.

The estimated impact of these closures and potential disruption in fiscal 2006 full-year sales is a reduction of $50 million, which equates to approximately 80 basis points of growth.

As we have said before, store closures should be a long-term positive, as less disruption equates to more productivity per mall, and therefore higher profitability.

In addition to Federated store closures, our revised outlook considers stores in the Gulf Coast region that remain closed.

We also expect to take returns of damaged goods.

The combination of store closures and returns are expected to adversely impact full-year sales by about 20 to 25 million.

Additionally, higher energy costs are starting to be felt beyond the gas pump, and many consumer products and services companies are passing on their higher costs to their consumers, which is reflected in the steep drop in the consumer confidence index.

The internal and external factors that I have discussed in the aggregate, are negatively impacting our full-year sales by over $100 million.

In Asia-Pacific, we expect to see a continuation of exceptional growth in China, fueled by growth in prestige beauty, and expansion of our brands.

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

And Aveda is developing its salon business.

Korea is beginning to show signs of life, despite weak consumer confidence, while the rest of the Asian countries, are expected to produce sales growth in the mid to high single digits.

The European region is expected to rise on travel retail growth, on middle Eastern business, and the expansion of our emerging business in India, which has gotten off to an impressive start, and is trending well above our plan.

From a product category perspective, in Makeup, Clinique started off the year with several strong launches, and we have high expectations that those products, along with new Colour Surge eye shadow extensions, will generate continuous repeat business.

The Estée Lauder brand is launching new lip products under its Double Wear and Pure Color lines.

M.A.C. has a robust holiday program, along with the Catherine Deneuve collection, and Bobbi Brown has a very strong Spring program.

In skin care, Clinique is undertaking a major Spring relaunch of its 3-Step program which by comparison is larger than many cosmetic brands.

For the first time the brand is supporting the launch with television ads.

Resilient Lift by Estée Lauder is the #1 lifting moisturizer in U.S. prestige distribution, and the brand is launching Resilience Lift Extreme this December.

Origins is in the process of launching its first products under Dr. Andrew Weil umbrella.

You may have seen Dr. Weil on the cover of Time magaziner's October 17 edition, where he expounded on his secrets for Aging Well.

In fragrance, we are supporting the the 10-year anniversary of Pleasures, with new advertising featuring Gwyneth Paltrow, in both print and TV.

We are excited that Tom Ford has reinterpreted the Youth Dew fragrance, as part of the new Amber Nude collection for holiday.

We are looking forward to the December launch of Unforgivable from Sean John, as well as the Spring launch of Missoni products.

In hair care, continued comp store growth as well as select new points of distribution for Aveda and Bumble & bumble, are expected to boost sales.

While our efforts to drive sales growth are critical to the health of our business, we are aggressively moving to improve our bottom line.

The first action behind our strategic imperative of portfolio management is the disposition of the Stila brand.

Our portfolio currently contained two top makeup artist brands, M.A.C. and Bobbi Brown, which are both fast-growing and highly profitable.

It makes more sense for us to focus corporate resources behind brands, categories and regions which provide a superior return, while finding a buyer for Stila that can continue the brand's growth path.

We are also accelerating some actions behind the strategic imperative of operational and cost excellence.

Specifically we are driving two significant incremental cost reduction programs this fiscal year.

First, we are implementing value analysis reviews of our processes and organizations, and second, we are accelerating indirect purchasing and noncritical spending savings.

We are tackling overhead costs by streamlining the organization and processes to match our portfolio objectives in both the support functions and within the brands.

We have initiated an intensive pilot around several corporate support functions and underperforming brands.

In the support functions, we look for activities that are not contributing significantly to growth, or to the effective management of our operations.

In the brands, we will seek to optimize performance by better understanding the economics of its various components, including sales and marketing functions and product lines to allocate investment to those activities with the highest returns.

Additionally, we are going to accelerate our efforts to reduce our indirect purchasing costs, beyond the initiative we announced in August.

We are starting with a review of our spending with our top 20 vendors by brand and by corporate department, to ensure we are properly leveraging the breadth of our business in negotiations.

We will also be examining the organizational model for indirect purchasing, including looking for opportunities to create a more centralized structure and greater coordination between the brands.

Coupled with this, we have undertaken some serious belt tightening by aggressively identifying projects and costs that do not critically need to take place this fiscal year.

We will re-evaluate the need for these projects in our fiscal 2007 budgets.

We have a fundamental commitment to cost reduction for both the near term and the long term.

These initiatives are expected to deliver between 40 million and $45 million in incremental savings this fiscal year, and improve our profitability going forward.

To summarize my discussion and put it into focus, for the full year, we now expect sales growth to be between 3 and 4% in constant currency.

Foreign currency translation is estimated to negatively impact full-year sales by approximately 1.5%.

Our EPS from continuing operations is now expected to be $1.87 to $1.94.

We are confident that our business fundamentals, strategic direction, and the actions we discussed with you in August and today, should create a lot of opportunities to enhance our top and bottom-line growth.

We are committed to taking the appropriate steps to foster healthy sales growth while keeping a keen eye on the bottom line.

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.

My discussions today will also focus on our results from continuing operations.

The Company achieved first-quarter operating income of $105.1 million compared with $156.3 million last year.

This reflects a decrease in operating margin of 350 basis points to 7%, primarily due to flat sales during the quarter.

Our gross margin of 72% for the quarter decreased 60 basis points over last year's 72.6%, reflecting an increase in obsolescence charges of approximately 60 basis points, proportionate to the change in inventory, as well as unfavorable changes in exchange rates and promotional activities of approximately 50 basis points.

Partially offsetting these increases was the net change in the mix of our business within geographic regions and product categories of approximately 50 basis points.

Operating expenses as a percentage of sales for the quarter increased 290 basis points to 65% from 62.1% last year.

The increase reflects the absence of sales growth leverage during the quarter.

Operating expenses also increased approximately 90 basis points, due to the recognition of stock-based compensation of about 20 basis points, and about 20 basis points for costs related to our strategic modernization initiatives.

Looking at operating profits by category, skin care decreased $26 million to $38.8 million, due to soft sales, particularly in Europe, while our spending to support this business continued.

Makeup was down $5.3 million to $60.5 million, as slightly higher sales were more than offset by increased investment spending.

We also anniversaried the prior year shipments of our Beauty Bank brand, where makeup represents a large portion of the product mix.

Fragrance fell $23.3 million to a loss of $1 million, due to the lower sales, which reflect the continued difficult fragrance business in the U.S., coupled with higher product support spending.

In hair care, operating income increased $2.5 million to $5.3 million, primarily reflecting improved results domestically, as well as result of comp store growth and expanded points of distribution.

By region, operating profits in the Americas declined $28.1 million to $80.4 million, due to the sales weakness William described, and cost related to stock-based compensation, and our strategic modernization initiative.

In Europe, Middle East and Africa, operating results decreased $19.6 million to $22.4 million.

Global results were experienced in certain key markets like Spain, the U.K., our travel retail and distributor businesses, and Italy.

The shortfall on product shipments in certain continental and European countries, that occurred as a result of this start-up of our new regional inventory center, also negatively impacted our operating results.

Improved results were posted in France and Germany.

Asia-Pacific operating income decreased 3.5 million to 2.3 million, reflecting lower results in Hong Kong, Taiwan, Malaysia, and Thailand.

China's results were also down, as we continued to investment in infrastructure in China to support future business opportunities.

Solid improvement in Australia, and a modest increase in Japan, partially offset these results.

Regarding our interest cost.

Net interest expense of $5.6 million this quarter versus $4.1 million last year.

The increase is primarily due to outstanding Commercial paper during the current quarter.

The effective income tax rate for the quarter was 36% versus 37% in the prior year.

This decrease is primarily because of the tax effect of the Company's foreign operations, a decrease in state and local income tax expense, and an increase in tax credits.

At this time, we expect our effective tax rate will be approximately 36% throughout fiscal 2006.

For the fiscal first quarter, net earnings from continuing operations was $61.8 million, compared with $95.7 million last year, while diluted earnings per share were $0.28 versus $0.41 for the three months of last year.

Switching to our financial position, the Company's cash balance was $390 million at September 30, 2005, which was comparable to last year.

For the quarter, net cash flow is used for operating activities, were $62 million versus 98 million in the prior year period.

These outflows reflect seasonal working capital levels, and should improve in the coming quarters.

For the full fiscal year, we expect net cash flow from operating activities of approximately 600 to 625 million, reflecting lower sales, but expected improvements from our savings initiatives, and working capital over the next nine months.

Our higher inventory level, primarily reflects lower-than-expected sales growth, the safety stock in our new regional inventory center in Europe, and increased sourcing from the Far East.

During the quarter, we aggressively repurchased 1.9 million shares of stock for a total of $71 million.

This brought the total shares repurchased under our program to approximately 29 million shares, and to-date we have returned over $1 billion in cash back to stockholders.

We continue to buy an additional 3.7 million shares during the first week of October.

We anticipate capital expenditures of approximately $300 million in fiscal '06, increasing versus fiscal '05 due to our company-wide systems initiative.

Let me briefly update you on our working capital.

September 30, 2005, inventory was 815 million, an increase of 102 million versus last September.

Inventory days were 186 at the end of the quarter versus 171 days last year.

This increase includes 7, 4, and 4 days respectively, attributable to the sales shortfall, the new European distribution center backlogs, and business building activities.

Regarding receivables, our DSOs of 55 days at September 30, 2005 were relatively unchanged compared to a year ago.

Let me now update you on a few assumptions for fiscal 2006, which includes the accounting rule change regarding expensing of stock-based compensation, the revised potential impact of the Federated/May merger, and the impact of our incremental cost savings initiatives.

For the full year, as William said, we anticipate sales growth of approximately 3 to 4% in constant currency.

And we expect foreign currency translations to negatively impact reported results by approximately 1.5%.

We expect gross margin to decrease slightly for the fiscal year, with supply chain savings offset by the impact of the unfavorable gift program, pressure on our costs resulting from higher energy prices, negative foreign exchange, and potentially higher obsolescence cost.

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

Regarding expensing of stock-based compensation, as a result of the changes in our stock price and our equity-based compensation plan, the expected impact to our full-year operating income is now approximately $35 million.

This translates into a EPS impact of $0.12 compared to the slightly more than $0.14 we have previously forecasted.

The impact on our first quarter was $0.04, and we expect $0.07 for the half.

Additionally, we now expect the Federated/May merger impact in fiscal 2006 will reduce our reported EPS by $0.09 to $0.10.

Earlier William described some incremental cost savings opportunities we have identified this fiscal year.

We are pursuing these savings with vigor, but expect to realize the majority of the savings in the second half of our fiscal year.

Associated with these projected savings may be certain yet to be determined one-time costs, that we will record as incurred, which we expect will benefit the current and future fiscal years.

We now anticipate operating expenses to increase 20 to 40 basis points, excluding any one-time charges.

This will include the positive effect of our stepped-up cost savings, offset by lower sales growth, and approximately 50 basis point negative impact of stock-based compensation expense.

Operating expenses also include approximately $23 million of spending related to our SMI project.

As a result, our operating margin is expected to range between a 20 to 60 basis point decline.

Therefore, our reported diluted EPS from continuing operations is now expected to be between $1.87 and $1.94, which again, includes approximately $0.22 per share impact from expensing stock-based compensation, and potential impact of Federated/May.

Our expectations also include the effect of the additional cost savings of approximately $0.12, but does not include any one-time costs associated with these savings initiatives.

Separately, subject to the final negotiated sales price, we may report a gain or loss on disposal of Stila, which would be included as a component of discontinued operations.

Regarding the fiscal '06 first half, we expect sales to grow between 3 and 4% in constant currency, and anticipate approximately 1% negative impact of foreign exchange.

We expect a gross margin decrease of 90 to 110 basis points.

Operating expenses are expected to increase 130 to 150 basis points, primarily as a result of slower sales growth, and stock-based compensation expenses.

Diluted earnings per share from continuing operations for the first half are expected to be between $0.83 and $0.88.

We expect the effect of the Federated/May merger to impact our first-half results by $0.04.

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

In particular, this year we will be impacted by the expensing of stock-based compensation, the timing of product launches and investment spending, implementation of our cost-savings initiatives, and the pace and implementation of retailer consolidation activities.

This concludes my comments for today, and we are happy to take your questions now.

Thank you.

Thank you. [OPERATOR INSTRUCTIONS] Our first question today comes from Chris Ferrara of Merrill Lynch.

Hi, while the weakness is pretty-broadbased I wanted to talk about Europe, and the sluggishness there on the top line.

Can you talk about how much of that related to distribution center issues, and also on travel retail?

What's going on with travel retail?

What was the number there, and why was it so weak?

Well, Dan is going to address the distribution issues and I will come back to talk to you about some of the top-line consumer issues.

Chris, this is Dan.

We estimate that between the distribution center in Oevel, in our major distribution point, we lost somewhere between 10 million to $15 million of shipments in the first quarter.

Some of that will be recouped with the replenishment of existing basic stock, but a lot of it was promotions that were running during that September period, and they won't come back to us.

As far as top-line issues, there are a number different issues.

Let me give you the highlights -- one of the highlights is our travel retail business, which currently, year-to-date, is tracking on a comp currency basis at 5%.

They are projecting their year at 7.

But just to give you an example, the month of October is tracking at plus 18% for travel retail.

But to give you an idea, overall consumer confidence on continental Europe is not particularly strong.

There are a number of reasons for that in the major markets.

As well, a significant factor is that after five consecutive years of significant, strong consumer demand and growth in the UK, we are seeing a slowdown in UK demand.

UK is still relatively good compared to Continental Europe, but not nearly as strong as it used to be.

So I think you are seeing some of the same factors we experienced here in the United States with consumer confidence -- lack of consumer confidence.

We were also experiencing those same issues in Continental Europe also in the major markets.

Okay.

And then I just wanted to follow-up on the gift-with-purchase issues.

I know you didn't really have success on the fall promotions, and I think you mentioned about repositioning the gifts and repackaging them and getting them back out there.

What is the longer-term fix there?

Obviously not as effective a piece of a business as it was at one point.

What is going on in the long term, and how do you get past that?

Well, a couple of issues.

The specific short-term issue in the Fall this year related to the gift-with-purchase programs, which was more acute is we made a fairly significant bet on a look which is around tweed for the Fall gift programs, and as you know, in August and September, throughout most of the United States, we experienced unusually warm weather, where the consumers were hot and sweaty just looking at tweed, let alone touching it.

So those programs were not as attractive to the consumer as we would have liked or hoped.

Interestingly now in the month of October which has been significantly cooler throughout North America, these same gift programs that are now running with retailers are much stronger than the same programs were a month ago.

As far as the reworking is concerned, both the Estée Lauder and Clinique brands are taking different approaches to how they rework the existing gift inventories to try to recoup their business with different offers that are incentivizing the consumer to focus primarily on the more attractive of Skin Care and Makeup.

The longer-term secular issue of gift-with-purchase is not insignificant.

We are looking at over three-plus years of general weakness in, or declining return on investment in the gift-with-purchase programs, which is a concern for us.

That being said, these programs are still much more efficient than most of the alternatives for the significant investment we might have that stimulates the top line.

So while the return on investment is nowhere near where we would like it to be, and what it ought to be, and what it has historically has been, it still seems to be more efficient than alternative uses of these funds.

We are looking at strategic alternatives in reallocating amongst the different communications and motivating vehicles for the consumer, but we need to do this in a manner that does not significantly affect our top line, which ultimately helps fund the productivity in a full-year basis.

Chris, I would like to follow up with that.

That is why we have been so bullish with the Macy's National advertising program because that gives us a vehicle to reinvent gift-with-purchase.

We will go to National dates for most of our major stores.

You are confident that is the right move to stay with gift-with-purchase and sort of reinvent it, rather than find another way of executing things?

Well, part of the reinvention is a different way to execute different promotional vehicles to support it, but as William said it is a large part of the three major brands in the United States business, and we can't walk away from it.

We have to reallocate funds to other areas, but we still have to make it successful.

Thanks.

We will go next to Amy Chasen of Merrill Lynch.

Actually Goldman Sachs.

In terms of the Belgium logistic problems.

You quantified it, and that was great, but can you walk us through what the issues were there.

Your confidence in getting this fixed by the end of the second quarter, and I am wondering whether that's the reason -- sort of the fact that your longer-term cost reduction programs are taking longer to implement, is the reason that you are stepping up your short-term cost reduction program.

I am sorry to make this a long question, but could you also, William, maybe flesh out a little bit more your short-term cost reduction plan?

I understood the indirect expense focus.

I wasn't sure about the rest of it, and you talked about potentially having to take a charge.

I am not sure why there would be a charge associated with that.

Sorry that is such a long question.

Well, there are multiple parts of that.

I will let Dan answer the first part of your question about the Belgian distribution center.

Amy, let me give you -- it is a two-part issue.

Part one our distribution center in Oevel.

We went into a new building with a new system, and we did not anticipate the complexity of the start-up problems we had.

Our direct shipments to customers in four major markets were impacted tremendously during the August-September period.

Compounding the issue we have a major contract with DHL, who supplies all of our facilities and major distribution centers throughout Europe, and got dramatically behind in the August timeframe, and did not recover in time for the quarter.

That is being addressed, and we think that will be fixed, and is fixed as we speak.

Our Oevel distribution center is fixed, in terms of meeting our everyday shipping needs, it is not running as efficiently as we want, but we are confident by the end of the quarter it will give us the efficiencies that we would expect.

As far as the short-term initiatives are concerned Amy, there are a number of different initiatives that we are taking, that we are very aggressively going after a number of the opportunities, and as you may have caught in the text of my message, there is really two main focuses.

One is an activity-based approach toward our processes, which looks to rationalize on an economic basis our activities, and make sure that all the activities we are pursuing, are in truth accretive to the needs of the total company, and to eliminate those activities which seem to be perhaps marginal at best, given the new realities of the current business environment around the world.

Are you talking marketing spend, or can you just give an example?

Well, it is not -- you know marketing spend comes as a tail which is created by the dog, which is all about program creation and initiatives, and what other forecasted returns on these marketing programs.

The general theme that we are emphasizing very emphatically with the brands is spend more on fewer programs, but make each of those programs more impactful.

So rather than promoting a dozen programs throughout the season, we are going to ask them to focus on 6 to 8 programs, and make more noise and more impact with those 6 to 8, rather than the 12 different programs.

And that manifests itself in an emphasis in the creation of fewer programs, an emphasis on the reduction of the expenses associated with the creation, and instead a reallocation of these funds, towards advertising and promotional vehicles which will drive those fewer programs to greater success.

The second part of that is, a more efficient, more focused look at indirect spending and coordinated indirect spending, between and amongst the brands so there isn't any duplicative efforts and perhaps less efficient use of total corporate funds and, again, the focus on improved productivity, and doing more with less for more impact.

So William -- what's the one-time cost associated with these two programs?

Because these seem like they are pretty straightforward, and you just sort of drive them internally through really sitting down and fleshing this out with the different managers.

Well, there is a number of different one-time costs that would be associated with that.

It may be termination of contracts with suppliers who are not as cost effective as other competitive suppliers, as other divisions as example.

It may entail one-time cost with reductions in force in areas that are not as effective or efficient, or return on investments.

Those are examples.

In addition the most important things about one-time costs is, you are saying, hey, look, we are going to be lowering the absolute levels of spending not this year so it comes back next year.

We will be lowering the absolute level of spending this year, and in the following years for good.

We will move next to Wendy Nicholson of Citigroup.

My first question has to do with the Skin Care business.

Would it be fair to say that the promotional issues, would have affected Makeup more than Skin Care.

I am wondering why the Skin Care business was so weak, whether it is a market share issue, and how confident you feel about a pickup in that category specifically?

Wendy, if you look at it, you are mostly right in what you say, but not entirely right.

The Skin Care weakness that we saw in the first quarter was largely related to the weakness in the promotional programming, and also, as you may have heard us say, also related to the sequencing of our shipments, and our focus in programs in Skin Care this year versus last year.

So if the weaker gift-with-purchase programs in the first quarter, you saw weaker Skin Care, because total sell-through was weaker because of the gift-with-purchase programming.

In addition to that the launch programming associated with that was less skewed to Skin Care this year versus last year.

That effects most of the weakness and we expect to recover most of that going forward.

Why would the tweed program sounds more like a shade statement or color statement to me.

What in there would be Skin Care related?

Well, there is nothing specifically Skin Care-related about the gift in and of itself, but one of the major attractive programs of the gift itself is a bag.

And unbuyable bag where the consumer gets not only in the gift with purchase a number of products, but the bag it comes in, and the emphasis of that bag was in the tweed program.

So it wasn't about a color story per se, it was literally about was the bag itself attractive to the consumer?

Next from Deutsche Bank, we will hear from Bill Schmitz.

Good morning.

If I could I want to keep this kind of broad here.

What do you think about the long-term top and bottom-line growth targets you have set out, 5 to 6% top line growth, the 13 to 13.5% operating margin, and 12 to 15% EPS growth?

Well, certainly if you look at it, we need to continue to hit our numbers each year, to be able to achieve our long-term growth.

We have confidence in the fundamentals, given what our current visibility is today over the long-term, what we see as opportunities around the world in our key categories.

We have confidence not only in our own ability to achieve that, but also in the strength of our brands, very unique and attractive positions within their markets to our consumers and to the retailers, as well as in the abilities of these brands to achieve individually their goals, which means we roll it up to a total company, we believe in our total abilities to invest those objectives.

The obvious issues that could be obstacles going forward will be any longer-term secular disruptions, like we have seen in the recent couple of months, that extend on a broader basis for a more sustained period of time.

And I wish I had some control over that, but unfortunately those factors, especially the weather, are out of our control.

Okay.

That's fair.

And then just a follow-up.

Can you talk a little bit about your SAP implementation, and whether or not you think that the tools you have are forecasting now are, you know, below par, and should we see a marked improvement in that, as you move forward on this system integration?

Sure, certainly, Bill.

The tools that we have today are nowheres near as good as the tools we will have under SAP.

So we are anticipating a much better forecasting capability with the implementation of SAP, which as you know is a couple of years away, but that is one of the driving reasons that we are implementing it, the ability to forecast better, and also the benefits it will bring to the supply chain, and some of the processes and the way we run our business.

We will move next to Linda Bolton Weiser of Oppenheimer.

Thanks.

Just had a question again on the gift-with-purchase programs.

I guess one of the other negatives would be that that kind of thing could encourage consumer pantry loading.

Do you have any method of monitoring that?

And what do you think the current consumer inventory levels are of your products?

You know, it is very hard to judge about what the consumer inventory levels are.

When I visit friends' homes do I not look in their drawers to see how many extra lipsticks and eye shadows they have.

My hope is they have lots of them, and they are all our brands, certainly.

If I use a proxy for that, as an example last night I was looking on E-Bay of how many items were for sale for our different brands, and you look at 8,000 to 10,000 items offered for sale of the Estée Lauder brand, or the Clinique brand, or some 5,000 to 7,000 for the M.A.C. brand, being offered by consumers on E-Bay, and I use that as a proxy, if you will, a consumer interest, if you will, a different level.

Saying there is a lot of product out there, but there is still plenty more for consumer to want to spend money on.

Over time, one of the things that we've seen happen is -- let's use the Los Angeles Southern California market as an example. 10 years ago, there were five major different retailers who offered our brands in the region.

So each season the consumer had, for both the Clinique and Lauder brands five different gift-with-purchase offers in any given season.

So ten weeks out of the season, she was being offered from one the retailers a gift-with-purchase from the Estée Lauder or the Clinique brand.

Today those five retailers are now two.

So she now has a choice, not of five different gift-with-purchase which she could shop for at her favorite brand amongst her different local stores.

She now has the choice of two.

Does that create a greater incentive for her to pick each one if she was, in fact, a gift shopper, versus a loyal Macy's shopper, or loyal Nordstrom shopper?

Perhaps.

But I don't believe you are going to see stockpiling in our category of merchandise, much like you would see in other categories, primarily because we don't believe the consumer is extremely price sensitive, one.

And two, there is an instant gratification associated with the purchase of our category of merchandise, that may not be associated with others, and I don't believe the consumer buys 3s, 4s and 5s, with one exception, when their favorite color is discontinued for one reason or another, usually their sales associate in the store will tell them, and call them up and say your favorite color is being discontinued.

Then the consumer stockpiles it, because she doesn't want to not have her favorite color.

Okay.

Thanks, William, that's helpful.

[OPERATOR INSTRUCTIONS] Again, please limit yourself to one question and a related follow-up.

We will go next to John Faucher of J.P. Morgan.

I would say that is a new pronunciation.

I want to just follow up on the guidance issue, which related to the significant sequential improvement you are expecting, can you talk about sort of how we should view discontinued ops in that, versus what we had previously modeled before, and then, you know, as we look at the problems with the distribution center in Belgium, you know, short-term execution probably will remain a bit of a concern, and how comfortable can we feel in the short-term cost saves, given some of the execution issues we have seen over the past couple of quarters.

Thanks.

Sure.

John, regarding discontinued operations, I mean obviously the reason that we are discontinuing operations is we think it benefits us.

Not so much on the performance that we in a sense move aside from Stila, but the fact that we now have resources that we can invest into other brands that will give us a better return.

Regarding the cost savings initiatives, most of those kick in the second half, obviously it is almost November now, and most of those benefits of those programs that William outlined, are going to benefit our second half.

So that's really contributing, if you will, to the sequential improvement that we see for the second half of the year.

Regarding the distribution centers, Dan pointed out most of the issues that we have with the distribution centers have been resolved at the moment.

It is not running as efficiently as we would like it to be, but it is certainly operating as we would have expected it to operate from the beginning.

And by the end of the second quarter, we think we will have all the issues sorted out with that.

Rick, are you guys giving a number on the discontinued Ops side, so that we can track that through and plan accordingly?

I think it will certainly be part of our Q, so you will see the numbers that -- and you will see it reported that way.

For the year of the benefit, -- John, I want to state benefit is probably $0.03 or so, $0.02 to $0.03.

Okay.

Most of benefit already coming through in this quarter then, probably.

A lot of it coming through in this quarter, yes.

Okay.

Thank you very much.

We will move next to Connie Maneaty of Prudential.

If we can go back to travel retail for a second.

You explained how sales were growing, but why did operating profit decline in the first quarter?

There's any number of reasons why operating profits declined in the first quarter, and the relation is not necessarily to travel retail in particular.

I will remind you of what we've said before about the travel retail business specifically.

Travel retail has a lower gross margin than our standard business model, but a higher operating profit, because of lower operating expenses than our standard business model, but I will remind that you travel retail is reported through our European region, even though this business is dollar denominated on a global basis.

Connie, part of it is the timing.

You know we do do activities related to travel retail.

But in general, our operating expenses are lower.

We do do occasionally some activities as we open new airports, and we do in-airport, if you will, certain activities to help drive longer-term growth, and some of that is affecting our first quarter as well.

You are saying there was investment in travel retail that caused its particular operating profit to decline, because the sales are growing faster than the overall average?

The answer to that is yes.

Could also ask a question on inventory.

As inventories have been growing faster than sales for quite a while now, and I was happy to get the breakdown of the different days and their sources, but what is the long-term target here, and how do you get there?

Well, longer term, we had talked earlier about the benefits of the improved forecasting systems from SAP are going to bring us, and one of those benefits will be better forecasting so better supply chain production of goods, and better inventory management tools, so that's the end gain is that when we have SAP fully implemented, we will have tools that will allow us to do a much better job of managing our inventory than we have today.

Because of the length of our supply chain, when we have a sales result like we had in the first quarter, unfortunately, that leads to driving our inventory numbers up, and that was the -- as you said there were 7 days increase versus last year in our inventory numbers, related to unfortunately the flat sales in the first quarter.

So longer term, we turn our inventory now twice, a little more than twice a year, and our objective is to get that to closer to 3 times by the time we have SAP implemented.

Shorter term, we wanted to get back by the end of this fiscal year to an inventory in terms of days, similar to where we were at the end of fiscal '04.

But you know, we announced a program recently about reducing a number of points of distribution going from 50 points of distribution, to down to slightly below 30.

That is obviously going to help benefit us as well.

So, I mean, we are working on it.

It is just -- you know, because of the length of supply chain it takes a little longer.

Given the current sales environment, do you think you can get to the fiscal '04 day number?

It's going -- it is certainly going to be tougher, no question about it, Connie.

That is still our objective.

Will we get all the way there by the end of the year, we will see, it is possible we may not, but we are working hard to try to get there by the end of this fiscal year.

Sandhya Beebee with HSBC has our next question.

I have a question in terms of the top-line growth guidance for the first half.

It does sound like you look for a sequential pickup between Q1 and Q2 that is fairly significant to get to 3 to 4% constant currency sales growth.

I was wondering what was going to really be different in this quarter outside of the promotional problems not reoccurring hopefully again, that would get you there, and also I guess as sort of an auxiliary question to that, on the market share of Clinique and the Estée Lauder brands, is there anything that you are seeing outside of what happened on the promotional problems in the first quarter, that would make you feel like the rate of decline in the shares of those brands have accelerated somehow versus what we have seen in previous years?

Well, you know, the gift-with-purchase business represents 35% approximately for both the Clinique and Lauder brands of their total sales.

So 35% of your business is weak, obviously you have to strengthen your business the other times.

And one of the things we are seeing which gives us some confidence and more than some confidence is that basic business, nonpromotional business is quite strong for these brands.

Literally from one day to the next, from a day you are going against the promotion, to a day you are going against the basic business, we are seeing a significant pickup in that business.

So we have some confidence from a share point, much of the issues in share erosion are primarily related to the gift-with-purchase programming.

And let's not forget that the absolute value related to their total market share, because of the promotional spending is quite significant to the total business that these brands experience, as well as the average productivity per door that they are able to enjoy because of all the promotional spending.

Secondly, we do have some confidence in Christmas.

We have got stronger Christmas programs.

Christmas programs so far that are early in the stores seem to have nicer sell through.

We have confidence both in the Tom Ford for the Estée Lauder program.

As we mentioned before, we have Sean John launching in the November time period.

And we are expecting that Europe will be approximately up 10% or so for the holiday season, because of a number of different programs, as well as some other recoveries.

Okay.

Then I just had one other question that related to some of the comments you made earlier, and that was really talking about how the newer products were performing pretty well.

It is the base business that is suffering.

Something that you guys need to do to maybe step up your innovation rate, or pick up the R&D spending.

So it is what the customer wants, you can maybe cater to that more?

Well, it seems over the long-term, Sandy, what we have seen pretty consistently, is that approximately 30% of our business comes from product launch within the last three years.

And 70% of our business continues to come from product launched more than three years ago.

And this has been pretty consistent now over the last 10 to 12 years.

The difference is that the 70% that is coming in basic, is coming in a less concentrated manner than it has before, which relates to the inventory question, where it is taking more SKUs to make up that 70% of the basic business at three years old, as it did before.

If you will, some of the basics of the traditional 80/20 roll, where 80% of your sales were made up of 20% of your SKUs are changing somewhat.

The consumer response to the innovation rate and the success of our new product launches, continues to be a pretty consistent basis.

The real question is about the new product launches is their sustainability in years 2, 3, and beyond, and the consistent contribution that these new products bring to the table.

We have time for one more question today.

And that comes from Alice Longley of Fulcrum.

Hi, good morning.

Just so I can understand your guidance better.

Can you tell us where on the P&L, the 40 million to $45 million in savings, will show up and how much of that is in cost goods sold, and how much of that is in operating expenses?

Probably about 80% of that number will show up in operating expenses.

There will be some benefit in cost of sales, but the vast majority will be operating expense related.

Okay.

And then can you give us an update on what the ratio of advertising to sales is going to look like year-over-year for the year?

You know, it's -- it's somewhat sensitive as you know.

Somewhat sensitive to the level of sales growth that we have overall as the Company.

We were forecasting that number to start to come down as a percentage of sales.

I still believe that that will in true for the year, but, again, it depends where our sales come within the range of the 3 to 4% guidance that we have given you.

All righty, thank you.

Don't forget when you are looking at the advertising ratio, our two largest brands, the Estée Lauder and Clinique brands are the biggest advertisers yet, our fastest-growing brands have significantly lower advertising rates as a total of their sales.

So as our mix of business changes, and our faster-growing brands that are not as dependent on advertising for their growth begin to contribute a larger portion of the total, while our actual voices and page rates, and other GRP measurement points of advertising voice for the existing brands, Lauder and Clinique in particular don't change, the mix changes on its own, because of the growth in brands that are not as advertising-dependent.

Can I ask a question about that for the brands not as advertising intensive, whatever advertising you do, is that intensity going up?

In other words, is the ad-to-sales ratio for the smaller brands likely to intensify as they become bigger brands, and more established brands?

Well, in actual fact what we are finding is, that these brands are able to stimulate their top line quite effectively, with a very consistent marketing message that is a very different mix, than more traditionally advertising-driven brands.

And they are not looking towards increasing their voice to accelerate their growth, because they are finding that the different means and methods to which they accelerate their growth, are not necessarily dependent on advertising.

All right, thank you.

Thank you.

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