雅詩蘭黛 (EL) 2006 Q2 法說會逐字稿

Good day everyone and welcome to the Estee Lauder company's fiscal 2006 second quarter 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.

On today's call is William Lauder, president and chief executive officer, and Rick Kunes, executive vice-president and chief financial officer.

Also with us today is Cedric Prouve, group president responsible for sales and profits in all markets outside of North America.

Dan Brestle, our chief operating officer, is also here, and he'll be available for the Q & A session.

Since many remarks contain forward-looking statements, let me refer you to our press release where you'll find factors that could cause actual results to differ materially from these forward-looking statements.

I'll turn the call over to William.

Thank you, Dennis.

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

I'm happy to report that overall the quarter sales came in within our expected range, while the bottom line was better than anticipated.

We told you we would quickly act on our strategic imperatives, and some of the cost containment efforts we started are paying off.

I'll talk in more detail about these actions shortly, but first let me recap the holiday season.

On the international front, where we now derive almost half of our sales and more than half of our profits, the holiday period was strong.

Travel retail sales during the quarter grew double digits.

The UK had a terrific Christmas.

Japan and Korea are starting to rebound, and the emerging markets of China and Russia had stellar growth.

Some Western European countries remain challenging due to a relatively weak retail environment and destocking by several retailers. but overall, the international business was solid.

Those of you who follow the U.S. retail sector know much of the department store foot traffic materialized just before the holidays.

Our sales followed a similar pattern showing strong double-digit gains at retail during the week prior to Christmas.

Once again, the largest retail sales growth was in specialty department stores like Neiman Marcus and Nordstrom, with more tepid increases elsewhere.

Estee Lauder's annual blockbuster promotion grew 11% at retail, despite a small price increase.

The brands' other holiday sets also proved popular.

Nearly one-third of annual fragrance sales in U.S. department stores take place in the month of December.

Estee Lauder Pleasures grew 29% at retail during the quarter, DKNY Be Delicious held flat against its strong prior year launch, and Donna Karan Cashmere Mist grew 4% at retail.

These positives were offset by declines in Estee Lauder Beyond Paradise and, to a lesser extent, Clinique Happy.

During the quarter, we continue to forge ahead on our strategic imperatives.

We're in negotiations with potential buyers for Stila and expect to complete the sale by the end of this fiscal year.

We are encouraged with the strides we are making with the Estee Lauder brand.

The Tom Ford and Amber Nude collection created huge excitement for Estee Lauder, both at the counter and in the press.

The publicity value was immeasurable, with virtually every major franchise, fashion and beauty magazine covering the launch.

The results were felt immediately.

In November and December, U.S. sales of the Estee Lauder brand grew an additional five percentage points where Amber Nude was sold, compared with locations that didn't carry the line.

Internationally the results were even more startling.

For instance, in the UK only five stores launched the Tom Ford collection, but they saw Estee Lauder sales increase significantly faster than other doors in the country.

We are also excited about the consumer response to actress Gywneth Paltrow as the new face of one of our best-selling fragrances, Estee Lauder Pleasures.

We saw a measurable impact on U.S. sales when we began running the ads in November.

A similar surge was seen in the UK and Asia.

At Clinique, Lynne Greene, a veteran with our company, was appointed president of the brand responsible for its worldwide business.

Lynne has 25 years' experience in the industry and previously led four of our other brands.

Clinique sales continue to grow in the important Japanese market this quarter, even faster than they did in the first quarter.

In fact, over the past six months we have seen sustained monthly growth, giving us confidence that Clinique has turned the corner in Japan.

We expect to continue the momentum with the March launch of DermaWhite, a line of twelve facial products.

As we mentioned in earlier calls, the brand's core product line, the 3-Step skin care system, represents a significant portion of global sales.

The relaunch of 3-Step in Asia and Europe in the second quarter has been very encouraging, and we look to the U.S. restaging in the fiscal third quarter.

During the last three months we also strengthened our product categories.

We opened a state-of-the-art innovation institute in Shanghai to help develop advances in skin care.

Scientists there will study how genetics affect the skin's response to the environment.

The company has also established a panel of Chinese dematologists to advise on research and innovations, continuing long tradition of partnering with leading educational, medical, and research organizations.

We expect that studies conducted at the institute will provide us with a better understanding of Asian skin so we can combine ingredients to best meet the need of consumers in that region.

The skin care category was boosted by a number of new products.

Estee Lauder brand is exploiting growth at the high end of the skin care category with its luxury Re-Nutriv line.

The brand added Ultimate Lifting Serum with a suggested retail price of $200, and Re-Creation Day/Night Cream with a suggested retail price of $900 per set.

Demand for both was strong.

At Origins, the new Dr. Weil line helped drive skin care growth.

The brand was also honored with an industry award for the best-executed launch strategy.

In makeup, sales of M-A-C and Bobby Brown each achieved double-digit growth globally this quarter.

M-A-C won five readers' choice awards from Allure Magazine, reflecting its success with consumers.

Expansion of our developing brands in new and established countries provides a consistent avenue for growth.

I had previously shared with you the excitement about our prospects in China as well as other international opportunities.

Cedric Prouve is here today, and he will discuss our foreign business in more detail in a moment.

There has been a lot of activity in our distribution channels.

We operate in a dynamic market which is evidenced from the number of consolidations and ownership changes among retailers worldwide.

The most significant of these, for us, is the Federated/May merger and the related store closings.

I want to impress upon you the longer term positive impact we see for our business in this combination, as Federated focuses on building two strong national brands, Macy's and Bloomingdale's.

Among other things, we will be able to run national television, radio and print advertising which will expand our choice of media outlets and enable us to reach new consumers.

As we've said previously a sharp focus on fewer stores should also translate to higher productivity per store.

We are also committed to driving growth in our other channels of distribution.

Our strategic company-owned retail stores saw accelerating sales during the quarter up 11% overall led by strong performance from M-A-C and improvements at Origins and Aveda.

This increases primarily like door growth.

We haven't added many new stores this year.

Our online business jumped more than 40% in the second quarter driven by both brand-specific and retail-partner sites.

This significantly outpaced the 25% growth reported for total e-commerce sales in the U.S. during the quarter.

Now that most of our brands are sold online in the U.S., we're beginning to expand into other top markets.

Our salon business remains healthy.

Sales were up sharply in the quarter, and Aveda continues to migrate its business to highly productive concept salons and has been focusing on stylist training, improved service. and consumer retention.

It also is accelerating its business overseas.

Aveda added 60 salons in Europe and Asia this quarter.

In October we marked the first anniversary of Beauty Bank in Kohl's.

Our four brands had a successful holiday season.

Growth in our American Beauty brand was driven by introduction of the new fragrance, Wonderful, represented by spokeswoman, Ashley Judd.

All brands had appealing selection of gift sets.

Those from American Beauty and grassroots sold particularly well.

Same-store sales in the quarter were healthy, and we believe the business continues to develop in a steady manner.

The travel retail business remains on a growth path with sales rising in the mid-teens for the quarter.

I'll let Cedric discuss this area in more detail.

On the operational front, we plan to open more efficient distribution centers.

During the next 9 to 12 months we will open locations in Pennsylvania, Japan, China and Spain.

Last quarter, more new supplier hubs came online, allowing them to ship on a just-in-time basis and enabling us to keep lower inventories.

We have been increasing production of promotional items in China in line with our five-year plan.

We also established an operations team in Shanghai to facilitate incountry purchasing, quality assurance, and packaging developments.

Our strategic modernization initiative is moving along.

The blueprint phase is complete, and we plan to implement SMI at Aveda, our pilot location, later this year.

We pledged $40 million to $45 million in cost savings this year and we expect to achieve the high end of that goal.

During the quarter, our brands and corporate departments heeded the call for austerity and reduced non-critical spending.

As part of this, we offered a voluntary separation program to employees in November, which enabled us to reduce costs.

We expect to realize financial benefits from this program and other budget cuts this year and beyond.

We continue to look for savings and indirect procurement in other areas of SG&A.

Rick will take you through some of these specifics in a moment.

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

The second half of our fiscal year will continue to be challenged by the transformation of Federated and disruptions at other retailers.

However, I believe we have sufficient momentum in other areas of the business to meet our current top line objectives.

The cost savings we're pursuing should help us achieve our goals for the bottom line.

Let me give you some details on activities we have planned.

The Estee Lauder brand is rolling out the Youth Dew Amber Nude fragrance developed by Tom Ford to broader distribution this month.

This will be followed by the Tom Ford Estee Lauder Spring Collection which will feature a more excessive color cosmetic line and will have broader distribution in the initial offerings in the second quarter.

Clinique is relaunching its 3-Step system in the U.S. and, for the first time, is using television advertising.

Based on the positive response we've seen with 3-Step in foreign markets, we expect it to at least lift Clinique in the United States.

This month Clinique is bringing out extensions to its popular Turnaround line with two products designed to improve the skin's clarity and smoothness.

Two fragrance brands from fashion designers will be introduced in the third quarter.

Sean John's Unforgivable for Men, and Missoni for Women.

Sean John created by music and entertainment icon Sean Combs aims to attract the youthful consumer.

The Missoni scent from the Italian fashion house will be launched in Italy, the UK, and U.S.

Importantly it will give us a stronger strategic presence in Europe.

We continue to expect our international business to lead growth.

The momentum in China is anticipated to continue fueled by growth in prestige beauty and expansion of our brands.

We are cautiously optimistic about Japan given that Clinique has been able to maintain several months of growth and Aveda is trending above plans.

Korea is showing signs of a turnaround in consumer sentiment and retail excitement.

Many other Asian countries are expected to produce sales growth in the mid- to high-single digits.

We believe sales in the European region will rise on travel retail growth and strong retail environments in the Middle East, Russia, and Turkey.

Western Europe is expected to Improve somewhat as destocking abates, and we hope the buoyant holiday period in the UK carries over into spring.

The Americas region will likely be driven by growth in our non-traditional channels and high end specialty retailers which we believe will continue their superior performance.

We are confident that our strategic direction is sound. and the actions we are taking should drive strong top and bottom line growth.

Earlier this month we were added to the S & P 500 index which affirms our roll as an industry leader.

Now, I'd 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 focus on our results from continuing operations.

The company achieved second quarter sales of $1.78 billion, a 3% increase over the $1.74 billion in last year's second quarter, and local currency sales rose 5%.

In today's earnings release we added a table of our net sales and operating income by product category and geographic region.

As a result, I will not specifically mention those numbers but rather refer you to the press release for details.

I'll just touch on a few key items.

Let me begin by looking at sales by category.

In the quarter, skin care sales were led by Europe, Middle East, and Africa business and continue to benefit from the ongoing success of our La Mer brand. makeup sales benefited from a continued strong performance from M-A-C and Bobby Brown, as William mentioned, and new and existing products also lifted in the other category.

The fragrance business is still challenging with sales declining versus the prior year's quarter.

Fragrance sales were lower in each region, although less so in Europe where our travel retail business is reported.

On a positive note, DKNY Be Delicious continues its terrific global success.

Christmas sets sold well in the U.S., and several new products were launched this quarter.

Geographically our overseas business led this quarter's growth.

As you know, international continues to be our largest opportunity.

Cedric will cover these results, but we are particularly pleased with our performance in China.

Sales in the Americas came in slightly lower than expected, reflecting the mixed retail environment over the holiday season.

Once again, specialty stores generated solid increases compared with more modest growth and certain key retailers where a portion of our business is done.

We experienced softness in our core brands, primarily reflecting continued challenges in the fragrance category.

In the quarter we made incremental provisions for anticipated sales returns reflecting our estimated impact of announced store closings by certain retailer groups.

To a lesser extent we also continued to be affected by store closures in the southern U.S. resulting from the hurricanes.

Switching to operating income, for the current quarter we reported an 8% increase to $250.7 million compared with $232.7 million last year.

This reflects an increase in our operating margin of 70 basis points to 14.1%.

Our gross margin of 74.3% for the quarter decreased 10 basis points over last year.

This reflects an increase in obsolescence charges of approximately 40 basis points, proportionate to the change in inventory and unfavorable changes in exchange rates as well as higher travel retail sales which carry a higher cost of sales of approximately 20 basis points.

Partially offsetting these increases was a net change in the mix of our business within our geographic regions and product categories and the effect of a shift in the timing of shipments of promotional goods of approximately 40 basis points.

Operating expenses as a percentage of sales for the quarter decreased 80 basis points to 60.2% from 61% last year.

The decrease reflects the company's efforts to reduce costs in line with softer sales, aggressive and disciplined spending controls relative to marketing, and general and administrative activities, as well as shift of certain spending into the second half of this fiscal year.

The improvement was also due to sales growth in businesses with lower operating expenses.

Combined these improvements represented 220 basis points.

Partially offsetting these improvements was a recognition of stock-based compensation, the incremental provision for retailer returns, and a charge related to cost savings initiatives.

These items combined amounted to approximately 140 basis points.

Looking at operating profits by category, skin care and makeup increased due to higher sales, while fragrance declined reflecting lower sales and, to a lesser extent, product support spending for the development of new products and brands.

In hair care, expenses related to a distributor acquisition, customer retention programs, and start-up costs for additional points of distribution resulted in lower operating income.

By region, operating profits in the Americas declined, primarily due to costs related to stock-based compensation and the incremental sales return provision I mentioned earlier.

In Europe, the Middle East, and Africa, our travel retail business posted the highest income growth with a strong double-digit increase, and certain key markets, like France and Germany also posted improvement.

Asia-Pacific operating income increased primarily due to improved results in some of our larger markets, including Korea, China, and Japan.

Let me remind you that our results for both the fiscal second quarter and first half include the negative effect of external factors and business uncertainties which affected our first-half sales and operating income by approximately $29 million and $49 million respectively.

These factors will continue to affect us throughout the rest of the fiscal year, and I'll talk about that a little later on in my outlook.

Regarding our interest costs, we reported net interest expense of $6.9 million this quarter versus $3.3 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 37% versus 37.6% in the prior year.

This decrease is 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 to be 36.7% throughout fiscal 2006.

Switching to our financial position, the company's cash balance was $370 million at the end of December 2005, versus $578 million last year.

For the six months, net cash flows from operating activities improved 28% to $389 million versus $305 million in the prior year period.

For the full fiscal year we expect net cash from operating activities of approximately $550 million.

During the first six months we spent $306 million to repurchase approximately 8.8 million shares of our stock under our share repurchase program.

We plan to continue to buy back shares opportunistically, returning excess cash to shareholders.

Also during the quarter we redeemed the remaining 68.4 million of the 2,015 preferred stock that was outstanding at last fiscal year end.

We anticipate capital expenditures of approximately $275 million in fiscal '06, higher than last year due to our company-wide systems initiative.

Regarding our working capital at December 31st 2005, inventory was $727 million, an increase of $28 million versus last December.

Inventory days were 165 at the end of the quarter versus 164 last year, a significant improvement compared to the relationship at the end of the first quarter.

A day sales outstanding was 42 days at December 31, 2005, compared with 43 days a year ago.

Let me now update you on a few assumptions for fiscal 2006.

We've talked about the external factors affecting our business this fiscal year, and here is what we have built into the full year forecast, and what we have not.

Included in our estimate is the following.

First, as announced by Federated on January 16, 62 of the 82 doors they plan to close will take place in February.

Based on this information, the full year impact on our sales is expected to be approximately $62 million, comprised of both lost sales in the closed doors and a general weakness in the overall business due to uncertainty.

There is a--this is $12 million higher than our previous estimate.

Second, about $11 million of lost sales due to the hurricanes in the first half of the fiscal year and, third, there will be approximately a $35 million impact to our full-year operating income because of expensing stock-based compensation.

What's not built into our forecast at this time is one, the remaining 20 Federated store closures and, two, the divestiture of Federated's 55 Lord & Taylor stores where we do approximately $49 million in sales.

At this time, we believe these will occur in fiscal 2007.

When further announcements regarding these events are known, we may have to adjust our expectations.

As we said before, we believe the retail consolidation in our sector in the long term results in better productivity and improved profitability.

Our forecast also includes a positive factor that is in our control.

Our cost savings initiative.

We have finalized plans to realize about $45 million incremental cost savings this fiscal year which translates to approximately $75 million annually in future years.

They will come from these major areas: Organizational restructuring which is supported by voluntary separation program, affecting approximately 500 positions will result in current year savings of $24 million and a future annual benefit of approximately $47 million.

Pending reductions in the area of overhead will total approximately $12 million.

This initiative is expected to generate about $20 million in annual savings, and advertising and promotional efficiencies of about $9 million.

In connection with these savings initiatives we expect to record a one-time charge of approximately $88.5 million in the second half of this fiscal year.

A majority of this charge will likely occur in the third quarter.

We will continue to to be very aggressive in pursuing cost savings, and if further reductions are identified that provide a reasonable payback, we will not hesitate to act.

For the full fiscal year, we now anticipate sales growth of approximately 3% in constant currency. and we expect foreign currency translation to negatively impact reported sales by approximately 1.5%.

We expect gross margin to decrease slightly with supply chain savings offset by the impact of the unfavorable gift program in the first quarter, pressures on our costs resulting from higher energy prices, and negative foreign exchange.

We now anticipate a significant increase in operating expenses.

The one-time charge will affect our operating expenses by approximately 140 basis points.

Operating expense margins will also include the effect of lower sales growth and approximately 50 basis point negative impact from stock-based compensation expense.These will be partially offset by the positive effect of our stepped-up cost savings.

As a result, our full-year reported operating margins is expected to decline substantially.

Our results this year would be stronger if it were not for the one-time charge which should provide benefits in the future period, any unusual external factors.

A reported diluted EPS from continuing operations is now expected to be between $1.61 and $1.68.

This range includes approximately $0.12 per share impact from expensing stock-based compensation. $0.13 attributable to the impact of Federated May. $0.03 related to the hurricanes and $0.26 related to the one-time costs associated with our savings initiatives.

These are partially offset by a positive $0.13 from our additional cost savings.

Regarding the fiscal '06 second half, we expect sales to grow approximately 4% in constant currency and anticipate 2.5% negative impact of foreign exchange.

We expect gross margin to decrease slightly and operating expenses to increase significantly, which will also include the one-time charge, the previously mentioned external factors, and our cost savings.

As a result, our second half operating margin is expected to decline.

Diluted earnings per share from continuing operations for the second half are expected to be between $0.64 and $0.71.

This will include approximately $0.40 for the combined impact of Federated/May merger, hurricane, stock-based compensation, and one-time charge.

While we do not give explicit quarterly guidance, our fiscal third quarter profit, in particular, is expected to be impacted by the one-time charges, the shift of some of our advertising and promotional spending from the second quarter into the third, store closings and/or business disruptions related to retail consolidation, as well as our originally planned marketing spend.

As a result, our fiscal third quarter net earnings from continuing operations are expected to be significantly below last year's third quarter.Therefore, we believe our fourth quarter will increase significantly.

Let me emphasize that all of our second half profitability growth is expected to occur in our fiscal fourth quarter.

Please remember that we run our business on an annual basis and we experience volatility in our quarterly results.

That concludes my comments for today, and I'll turn the call over to Cedric Prouve.

Thank you, Rick and good morning, everyone.

Let me start by saying that our growth for international divisions are in synch with the global strategy imperatives established by William for the company.

Our focus has been and remains centered on the following five goals.

Our first goal is to gain market share for our four brands in the most important countries.

We look at key markets in terms of their size and strategic importance.

Critical markets for our industry outside the U.S. are the UK, France, Japan, and now China.

They are key innovation centers, translating areas, and, of course, hotbeds for global competition.

We have been successful in our market share acquisition strategies in all of these countries.

Japan is more challenging for a number of years but recent results have shown renewed sales and share gains for our portfolio brands in prestige distribution.

Our second goal is to accelerate the rollout of newer brands.

Estee Lauder, Clinique, and Aramis, operate in roughly 130 markets around the world, followed by M-A-C which is in 64 markets, and La Mer in 41, and Bobby Brown in 34.

While this appears to be straightforward process, we usually decide whether to enter a country on specific criteria, including the assurance that we have a clear business model, the ability of the local organization to take on a new brand, and the long-term viability of the distribution channels.

Generally, most of our newer brands open two to three new markets a year.

Our third goal is to act aggressively in key European markets.

The [inaudible] countries are at the center of this objective where we have focused the most attention and effort during the past three years.

Central Europe, Turkey, and Vietnam are the next areas of interest in our emerging market strategy.

In addition, we are much more focused on Latin America, which has produced significant returns in the past several years.

Our fourth goal is to accelerate our business initiatives in areas that exhibit great growth potential, and have shown strong financial performance.

Those are mainly the travel retailing channel and the [inaudible].

For these two entities, acceleration means increased investments that can be recouped rapidly.

It also translates into putting our newer brands into more locations around the world faster.

Our fifth goal is to explore and develop new channels such as e-commerce, home shopping, European pharmacies, and free-standing stores.

This also includes increased investment in our customer relationship management initiative, allowing us to understand our consumer better, and to communicate with them more directly.

We're particularly successful with our new e-commerce-enabled sites in the U.K., Korea, and Japan.

Let me elaborate on our international results.

We operate in a complex environment and we cover a wide array of regions, markets, and channels of distribution.

Our growth rates range from quite low right now in major continental European markets to spectacularly high in China with many stages in between.

From the brand perspective, our core brands Estee Lauder and Clinique are growing in the single digits.

Our Aramis and designer fragrances division is extremely well right now, led by the enormous success of DKNY Be Delicious in virtually every market.

This performance is especially pleasing given the difficulties the overall fragrance category is experiencing.

Our makeup artist brands are also doing so well across the board and exceed our goals for the year to date.

M-A-C continues to reach new customers.

It launched in Cyprus during the second quarter, and Cyprus is the fourth new country it entered this fiscal year.

M-A-C added nineteen new points of distribution internationally in the second quarter, bringing the total number of doors outside North America to more than 350.

We're embarking on international rollout of Jo Malone, and it is running above expectations.

Most recently we introduced our British born brands in Australia, France, Germany, Greece and Thailand.

Let me give you a few more details on performance by region, highlighting the main challenges and opportunities.

Much of the performance of our key categories mirrors global trends.

We have seen a better performance in retail sales than in wholesale in many major markets including the UK, France, and Japan.

This is due to general destocking and an effort by some of our key retailers to place more emphasis on inventory control.

Still, we are focusing our efforts on retail sales growth since this is a better barometer of business success and market share improvements.

In Europe, we are growing at a slower pace than originally expected, yet two starkly different pictures emerged.

The five major markets, UK, Spain, Germany, France, and Italy have been challenging with a particularly difficult business this year in France, although Germany is showing encouraging signs.

Part of the shortfall in France resulted from the logistical issues addressed last quarter.

On the positive side, the rest of Europe, and Africa are way ahead of our budget and growing at double-digit rates, with best showings coming from Eastern Europe and the Middle Eastern countries.

Our Asia-Pacific region is showing healthy growth.

China having an increasingly significant impact.

Hong Kong continues to benefit from the strong influx of mainland tourism and aggressive developments in Macao.

China remains a key market for growth and sales continues to increase dramatically.

Our business is evolving as we enter new cities and expand to additional retailers.

The Estee Lauder and Clinique brands currently are in 56 stores compared to 41 a year ago.

Overall this fiscal year, these brands have seen high double digits [inaudible] growth.

Estee Lauder and Clinique remain the two fastest growing prestige brands among the top five in the Chinese market today.

Estee Lauder has nearly 100% sell-through on its Christmas offerings while Clinique continues to build on its core 3-Step franchise in the region.

We currently sell eight brands in China with new entries, La Mer, M-A-C, Bobby Brown, Aramis, Tommy Hilfiger, and Donna Karan gaining tremendous press and word of mouth.

As you know, we have been in investment mode in China to build our business.

We expect those to start making a modest profit there next fiscal year well ahead of our earlier forecast.

Korea is finally showing signs of a turn-around, as exhibited by positive consumer sentiments and important moves by our retail partners.

I am referring more specifically to the recently announced public offering of Lotte department stores which could mean increased capital investment in the Korean prestige retail sector.

It also appears that the consumer credit issues experienced over the past two to three years are behind us.

Consumer spending appears to be on an upward climb in Southeast Asia as well.

Australia has been a more challenging market.

Our business there is erratic at the moment because of the very difficult fragrance category overall and the announced sale of our largest customer, Myers.

Nonetheless we still enjoy terrific market shares in that region.

The news from Japan is relatively bullish, and we are cautiously optimistic.

We expect low single-digit growth for the full year led by a solid performance from Clinique, the stabilization of our Estee Lauder business, and solid gain from most of our other brands.

Department store sales projections are also improving and beauty remains one of their best performing categories.

Although Latin America is a fairly small percentage of our international business, we continue to experience great results in top- and bottom-line growth and particularly in prestige market share.

The region is of increasing importance because of the growing clout and larger numbers of Latin customers in North America.

Sales overseas are also taking place online.

We have established e-commerce sites in the UK for Estee Lauder, Clinique, and Jo Malone.

Our products are old on Boots' and Debenhams' websites as well.

And elsewhere we are selling on Lotte's sites in Korea and Perfumeries, [inaudible] in Europe.

M-A-C and Origins will launch e-commerce sites in the UK in March.

Finally, our travel retailing division, which operates in a traditionally volatile environment continues to perform extremely well, and is projected to exceed our expectations again this year.

Travel retailing tends to follow the trends we see geographically and by category.

As a result, key European markets and the fragrance category except again for the overwhelming success of DKNY Be Delicious are more challenging areas, but the outlook for growth remains positive for the channel, thanks to increasing passenger traffic and ever-expanding airport capacity worldwide.

To conclude, we believe that international business will contribute a larger share of the Estee Lauder Company's sales this year and, as mentioned by William, will get us closer to the 50% mark which we aim to surpass very soon.

Thank you for your time, and that concludes our comments.

We will be happy to take your questions.

Thank.

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

If you have a question, simply press the star key followed by the digit one on your touchtone telephone.

To ensure that everyone has the opportunity to ask questions, we will limit each person to one question and a related followup.

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

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

And we'll take our first question from Bill Pecoriello with Morgan Stanley.

Bill Pecoriello.

Good morning, everybody.

Question on the--if you could help us out in the quarter, the advertising promotion, how much was it down, how much had you shifted into the back half, and how much will it be down on the full year?

That was the first part of it.

And then, also, how much of the overhead cuts, how much of the $45 million on the full year has already been realized in this quarter, if any?

Year to date basis, Bill, our A & P spending as a percentage of sales is below last year.

That gives you an indication for the full year though obviously it will be in line.

It gives you an indication of the amount of spending that's shifted into the third quarter.

Regarding our $45 million, there's very little of it in the second quarter, just a few million dollars that has been achieved and looking at the second half of the year the bulk of the savings are actually going to come into the fourth quarter which is another reason why our fourth quarter profitability is so high.

If you were to split the remaining savings for the rest of the year, it is about one-third in the third quarter and two-thirds of that savings in the fourth quarter.

And then just on the advertising promotion, I know there is efficiencies you're looking at but as you're trying to turn around the core brands and improve your marketing campaigns, what gives you the confidence you can do that and improve the top line while you're cutting or holding back on the advertising promotion?

And then another part is just on the Federated/May I wanted to follow up and move that up to the $0.13 impact with fewer stores closing in this fiscal year, only 62 of the 82, so how much were the provisions in the second quarter and why did you bump that up to $0.13?

Well, we bumped it up because they announced I think it was the second week of January that rather than close the 43 doors that had previously been announced in February, that they were going to change that number to be 62.

So, you know, we can only provide based on the information that we have.

And when they changed their guidance we obviously had to change a provision that we made.

So that was the reason for the change.

Regarding A & P spending, you have to remember that some of our fastest growing brands use a different marketing vehicle to drive their business.

So, we are spending behind the core brands, and we are increasing spending behind those core brands but just the percentage relationship changes as some of those newer, faster-growing brands are a bigger percentage of our business.

And if you could just clarify for me how much of the $0.13 wound up in the provision in the second quarter on the Federated/May store closing?

Year to date through the first half, if you just give me a second I will let you know.

About $0.06 of the total year's impact we anticipate has happened through the first half of the year.

Thank you.

Yup.

We'll go next to Wendy Nicholson with Citigroup Investment Research .

Hi.

My first question has to do with your discussion of a couple new distribution centers to be opened over the next year.

I guess that kind of makes me itch I remember in the first quarter one of the big things that went wrong was some execution issues in opening up the DC in Belgium.

So are there things you are going to do differently this time to make sure there isn't sort of the same level of business disruption?

Wendy, This is Dan Brestle.

I'm sorry you're itching.

We're not.

The mistakes and problems we had in the global distribution center in Belgium was just one particular group of issues.

We've successfully opened up PADC with most of our brands in Pennsylvania; we just opened up a new distribution center in the UK; we have one -- we just opened up one in the same time frame, one in Canada for M-A-C.

So, we know how to open distribution centers.

We had a one-off issue that we think we're in the process of straightening out.

So nothing funny that we need to anticipate on the balance sheet in terms of higher inventory levels or anything like that.

We do not think so, no.

Okay, and then just a quick followup.

Can you give us a sense of how big China is expected to be this year in dollar terms?

Well, right now we think it's going to be close to $75 million.

Terrific.

Thanks, very much.

And we'll go next to Amy Chasen with Goldman Sachs.

Can you just following up on this A & P, Rick, can you just give us the exact number of A & P that was shifted from the second quarter into the third quarter?

Amy, our plans always call for spending more A & P in the third quarter.

We have three things going on in the third quarter that we've known about for the whole year.

We have the launch of MIssoni, we have the launch of Sean John, and we have the television advertising which is the first time that Clinique has ever done that supporting 3-Step.

So those activities were always planned.

But we do have control, in a sense, of short-term marketing activities and we clamp down very hard on those in the second quarter until we established our savings program, because we wanted to make sure we achieved the $45 million that we committed to.

Now that we have that, we're releasing some of those controls, if you will, and so some of that spending is moved into the third quarter.

You know, we're not really going to get into this quarterly what happened, what didn't happen, we run our business, as you know, on an annual basis and we really try to avoid just this type of discussion, which is explaining one quarter to another quarter.

Okay.

And just on the Europe and the UK, I'm a little bit confused about the UK because I thought that William said it was strong but then Cedric indicated that it was weaker.

Can you just give us an overall comment about the UK in the second quarter, and then I believe you said in the press release that Europe would be the slowest-growing of all your regions at the second half but again that didn't sound to be consistent with Cedric's comments?

Yes, I'm sorry, this is Cedric again, I didn't want to confuse you, actually.

I was talking about the five largest markets, and UK clearly is the best performing of all of them.

I meant to say UK slowed down compared to the historical growth we experienced.

We're still growing in mid-single digits right now at net and wholesale and the retail is actually outperforming that number.

Amy, William was referring to the Christmas holiday season when he referred to the UK specifically.

Okay.

So do you still expect that Europe is going to be the slowest-growing region, and why, given the strong second quarter performance?

When you say Europe we have to define, because we are--the slowest growth is going to be in the larger continental markets.

Let's not -- let's make sure we understand.

Embedded in our European numbers that you see regionally is also travel retail, is also the more faster growing emerging parts of Europe -- Central and Eastern Europe and Russia, as well as the Middle East.

The big issue, which is what Cedric talked about is, that it is the five largest most established markets in Western Europe do not have the same retail strength that these other markets we cited do.

Okay.

And, last but not least, just can you tell me whether third-quarter earnings excluding the charges will be down?

Yes.

Thank you.

We'll go next to Bill Schmitz with Deutsche Bank.

Hi.

Good morning.

Good morning, Bill.

Sorry to keep drilling down on this Europe thing, but can you just break down sales in Europe by travel retail, traditional Western European, developed countries, and then emerging Europe and Middle East?

You know, we're not going to, Bill, break it down by the three elements but we did mention that TRD was up mid-double-digits in the second quarter for the year.

We're anticipating TRD to be up high single digits so the second half growth rate of CRD business is a little bit slower than it was so far year to date, and Cedric did mention that the bigger markets within Western Europe are slower-growing than Eastern Europe and the Middle East.

So I mean hopefully that gives you a picture of what it is going to look like.

I mean, just because, I think, maybe my model is wrong, but I think those countries you cited are about 65% of European sales.

I don't understand how in the quarter Europe could have been up 11% when you had effectively flat sales in the five largest countries.

So if something in the travel retail group double-digits there must have been amazing growth in Central and Eastern Europe and the Middle East, is that a good assumption?

Well, we don't have flat sales in all five big markets.

We have positive sales growth in Spain and UK and, yes, we have a very strong growth in Russia and central Europe.

Bill, last year in the second quarter Europe growth was relatively flat.

So we're up an easy comp in the second quarter in Europe.

Okay.

Great.

That's fair.

Just on the Stila discontinued operations charge, that $69 million, what went into that map?

I know there is an impairment there.

I was under the impression that Stila sales were less than $100 million.

Well, I mean, what went into the math, and you read it in the queue quite honestly, Bill, unanticipated loss on sale.

We had a purchase price that we went in there, we also had ongoing investments in the Stila business while we owned it, and then we're comparing its investment in its totality against what we anticipated to glean from the sale of the business.

Okay, great.

Sorry.

One last one if I could.

As a percentage of sales going forward I know the old model was you could increase it and fund it with lower other G & A costs.

Is that still a safe assumption?

And fund what, specifically, Bill, I'm sorry?

Higher A & P spending.

You know, we said that our A & P spendings as a percentage of sales would start to flatten out because of the growth of the brands that grow much faster and don't spend as much in A & P spending.

We actually said that our A & P percentage would begin to flatten out, but that we would continue to invest in A & P behind our core brands more or less equal with the sales growth that we anticipate.

In other words, the absolute value in investment in A & P and the key brands that use the A & P particularly as a vehicle will continue to grow.

Because the mix of our business and the growth of brands which use a lower portion of A & P to their total you'll see a percentage change.

Okay.

Got you.

That makes good sense.

Thank you very much.

And we'll go next to Linda Bolton Weiser with Oppenheimer.

Thank you.

Could you give little bit more color on Japan, because I think you said Clinique was up but all of Japan was down in the quarter.

So what was down?

The Estee Lauder brand was still down, but we saw minus one to zero growth in December, so we are very encouraged by the stabilization of the Lauder brand.

As William said, Clinique has been growing for six consecutive months now.

That is a very good performance for us.

And our other brands, the makeup artist brands, like M-A-C and Bobby Brown are growing in very high double digits Origins is a bit down right now.

Okay, and then you had said that M-A-C and Bobby Brown were up double digit globally.

Can you give some indication how they were in the Americas?

Both brands were extremely strong in the Americas.

Up double digit or just single digit?

High double digits.

Okay.

On a very healthy base.

Okay.

So then I mean I would assume that the core Estee Lauder and Clinique brands were down in the Americas in the quarter.

Was one kind of down more than the other?

I think you can refer to the NPD data for something that can maybe be specific.

Suffice it to say, both of those brands did not perform up to our expectations and, in fact, we are very concerned about whether or not they can continue to gain share at the rate we're expecting them to perform.

But we see both brands having tremendous potential to right their direction, and we have seen some recent trends which give us hope.

Okay.

And then so can you just explain a little bit more then, why the Americas will go to being the highest growth region in the second half versus the lowest in the second quarter?

I don't think we said the highest and I think it is actually probably going to be the second fastest growth out of the three and really not by a great deal more than we're anticipating the growth in Europe.

Okay.

And were the Kohl's sales up in the quarter versus prior year when you had sales in the prior year?

Comp door sales were up very nicely at retail in Kohl's where we're anniversarying.

Okay.

And then finally in terms of your store openings, do you have a target for that globally for FY '06 versus FY '05?

If you're talking about our own retail store openings, no, we do not.

We are opportunistic and strategic and we are looking for locations.

But we do not take into our plans any expected number of stores.

We have about 400 stores right now in total.

That's globally?

That's globally, yes.

Okay.

I thought I heard you say you opened something like a couple hundred of something, did I misunderstand?

We're confusing--when we talk about our own retail stores, these are our own retail branded stores.

We make reference to doors which may be either our own doors and/or with partnered locations with department stores or parfumeries.

Okay.

Thank you.

I got confused on that.

Thanks very much.

We'll go next to John Faucher with J.P. Morgan.

Yes, good morning everyone.

Couple of accounting questions, actually, First off, just for my own edification, travel retail from a segment standpoint, is my understanding was that was flowing through the fragrance segment, or is that simply fragrance from travel flows through there. can you clarify that?

It flows through whatever segment, whatever category the sales are in.

And I think where the confusion you might have, John, is that we always say that 60%, , 65% of the overall travel retail business is fragrance-related.

It is less of a percentage from our business.

But the overall travel retail is a high [inaudible]

Okay.

So, to follow up on that, is -- are your fragrance trends, I'm assuming your fragrance trends in travel retail are dramatically better than your overall fragrance trends.

Is that a fair assumption to make?

Yes.

Okay.

And then one other accounting question which is obviously with the shift in spending we're seeing pretty decent amount of volatility surrounding your advertising and promotional spending, and it's leading to a lot of earnings volatility.

I'm wondering have you considered using more of a sales-curve type of accounting system where your marketing spending gets allocated across the year based on revenues as opposed to on a cash basis.

A lot of consumer companies do this, and it tends to limit some of the quarter-to-quarter volatility.

Is this something you thought about?

I think, John, I think I understand mat you're asking and let me sort of give you a response to what I believe you're asking.

The problem you have is. is to match it up against our sales you realize that our sales, our net sales in shipments at any given period lead the actual sale-through to the consumer while the advertising and promotional spend comes far closer to the time period associated with the consumer sales.

So to match those up would be very difficult in actually driving the business through to the consumer.

Just as an example, we start building inventories in the late spring and early summer for the holiday shipments that come in the latter part of the first quarter and the early part of the second quarter, for advertising that comes in the latter half of the second quarter.

That's just an example of the flows and uses of the cash in distribution and retail sell-through.

While we may report to you the health of our retail business sell-through from the retailers in the fourth quarter, that is actually reflective of the sell-through of inventories shipped into them and net sales booked in the latter half of the first quarter and the second quarter.

Yet the spend associated with that comes later in the quarter.

Okay.

Does that answer your question?

Not sure.

I think I'll try to follow up with that off line.

But The question is, you guys are expensing your advertising and promotions on a cash basis, correct?

When it goes out the door as opposed to trying to match up spending with revenue.

If you do 24% of your revenue in the second quarter, you book 24% of your A & P. That's not how you do it, right?

We do--John, we do match it up but we don't match it up as a percentage of our shipments.

We do match up our spending.

But I think the real basic issue is the fact that, you know, the market and the business environment that we're in now is changes daily, weekly, monthly and we have to change our business plans based on what we see competition doing, what we see as opportunities, where we see we have to cut back spending.

When you say is there more volatility, I think the answer is yes but I think the world in a sense is more volatile because the world reacts more quickly to changes that are going on.

Okay.

Thank you very much.

We'll go next to Alice Longley with Buckingham Research.

Hi, my question is tied to travel retail as well.

Are your margins on travel retail -- I know they're much higher than the corporate level -- are they even higher than the average for the year in the December quarter for seasonal reasons?

No, they run -- they're fairly consistent on a period-over-period basis, but you are correct they're much higher which is one of the reasons our profitability was pretty strong in the second quarter.

Okay.

And this is adding to questions that were asked earlier, which categories for driving growth and travel retail most in which brands?

In other words, was makeup growth into travel retail faster than fragrance growth?

It was makeup, followed by skin care, and fragrance was difficult.

Better than the company, but tough.

So when it would -- when makeup was driving growth the most, was that --- which brands?

It was the makeup artist brands that I mentioned, M-A-C, Bobby Brown and also Clinique performed very well.

Okay, excellent.

Thank you.

We'll go next to Sandhya Beebee with HSBC.

Hi.

I have one question just on the shift of A & P spend, I guess where your margins came through more strongly was in the international markets, and yet I would have thought that most of the shift in A & P spend would have been in the US, between quarters, so can you confirm that or was it in international?

No, you know, your assumption is wrong about the U.S. versus international.

I mean, when we made a decision to control expenses, we just didn't control them here in the U.S. but we tightened up on a world wide basis.

There is a certain amount of flexibility we have with that spending and there was a certain amount of that spending that we held off on a worldwide basis in the second quarter which shifted into the third.

Okay.

And then I had one other question, just in terms of some of the corporate downsizing that you're undertaking.

I guess as you've gone through the process of finalizing the details, have you found that maybe the opportunity extends beyond just 2000 and -- fiscal 2006 and that maybe there are further opportunities to streamline the organizational structure not just from a supply chain perspective but from a fixed cost perspective as well?

Sandhya, we believe this is a virtuous cycle and that this is never stopped.

Okay.

So it's not just a question of one year being really tough and so you look for the opportunity reduce fixed costs.

This is something that maybe that could happen beyond fiscal 2006.

We expect this to be an ongoing constant effort well into the future.

Okay.

Thank you.

And we'll go next to Chris Ferrara with Merrill Lynch.

Hi, how fast does the Estee Lauder and Clinique brands together have to grow in the Americas in the longer term for you guys to be at a total company top line rate that you're comfortable with?

Well, no growth is too high, is the best way to put it and obviously with these two big core brands representing a significant portion of our total business these brands need to grow at the mid to low single digits on a reasonable basis in order to provide a solid base for the faster-growing brands to pull the total along at a healthy clip.

So you need three to five essentially.

That's about right

On a world wide basis.

On a global basis, yes.

On a global -- so, I mean, would it be fair to expect, obviously, the U.S. to lag that?

I mean, so you might only need one to three --

Given the environment, given the retail environment in North America as well as the penetrations of these brands to the total, our expectations are that we will continue to see faster growth toward these brands internationally than we will see in North America.

Yeah, yeah.

Also then one other kind of silly question, when you guys say mid-double digits, does that mean midway between double digits and triple digits?

No, no, we're not an internet company.

I'm sorry.

We don't report those kind of numbers.

We're a consumer company.

Mid-teens.

Got it.

Thank you.

Yup.

We'll go next to Amy Chasen with Goldman-Sachs.

I just wanted to follow up, William, on the comment you made about Estee Lauder and Clinique and being, quote, very concerned whether they can gain share at the rate that you currently expect.

Number one, was that a global comment or worldwide comment or just a US comment?

Number two, what do you expect to do about it?

I mean, are you guys thinking about this in your strategic plan?

How are you moving forward on this?

Amy, I'll refer you to the last answer to my question which is the high penetration of both the Clinique and Estee Lauder brands and share in the North American market.

You realize that in many of the largest department store markets for us in the world the Clinique is the number one brand and Estee Lauder is the number two brand.

M-A-C is rapidly approaching in each of its points of distribution being the number one, two or three brand.

So we have very significant share of the market in all of these locations.

The real key question is, can these brands continue to grow, which we must make sure these brands continue to grow at or above the department average trend, so they at least maintain, if not continue to expand, their share.

We are not particularly comfortable, nor happy, at allowing brands other than our own brands to grow at a faster clip than the department.

So our goal is to make sure that these brands continue to grow at a reasonable enough clip, number one, to support our plans and expectations and refer to the other comment of the 3% to 5% growth that we're looking for, and, number two, to defend and expand their share.

Those are the key core concerns, and obviously at any one given moment when the brands perform extremely well, we are pleased, and when the brands don't perform as well, we say okay, guys, what are you going to do to make sure you can continue to expand your share?

We're seeing very healthy share expansion for Clinique brand, in particular, as well as the Estee Lauder brand in many of our international markets, and we're very pleased with their share in the key core categories such as makeup and treatment in Europe, as well as the UK, as well as the continued growth for Clinique, we mentioned the restored growth for Clinique in Japan, and the continued growth of the Estee Lauder and Clinique brands in Asia.

All of these factors go into the success of the total brands and, as we talked about before, our long-term goal is that our share of the total business, especially for Clinique and Lauder, the more mature and developed brands in North America will grow at a faster clip internationally, and we hope as the U.S. grows at a nice clip, international grows at a far healthier clip, and that we expect in the long term that 60%-plus of our sales for these brands will come from outside of North America.

Right.

So the question is, William, you're concerned because kind of on an overall basis these brands have stalled.

What do you plan to do to get them going?

There's a number of different efforts.

I think we talked about a number of them in the call.

Not only the initial efforts of repositioning offer the Estee Lauder using Tom Ford as an example, as well as Re-Creation and Re-Nutriv, going after the higher end businesses which, as you see, are growing at a far faster clip, and we're taking these efforts around the world in a more aggressive manner.

We talked about the 3-Step efforts with Clinique where first in Europe and Asia we're looking at restaging the 3-Step as well as the use of TV and other vehicles to drive this key core segment of the total Clinique business, and now bringing it to North America.

There are a number of other different efforts that both brands are making in key categories, and one of the key efforts is to continue to make sure that locally, regionally as well as globally these brands, both on a category basis and overall, continue to be relevant and in demand by the consumer and a strong basis.

Okay.

We'll go next to Javier Escalante. with Morgan Stanley.

Good morning, everyone.

I have a quick question with regards to something that we noted recently.

We had seen some of your products in CostCo basically, [inaudible] products, Origin products, I would imagine that is not that you guys are piloting channel diversification this way, is this diverted product so why is it that these cannot be controlled given the issues with the branding.

Javier, yes.

Your assumption is correct.

These are diverted goods.

We are making every effort to find the source of these goods and we'll close them down.

Thank you.

And our final question of the day will come from Kathleen Reed with Stanford Financial.

Good morning.

Just a quick question on your overall global fragrance business.

With sales down and profits down 35%, can you just remind us if you had a major fragrance launch in your prior year quarter, and if not, was it mainly just declining department store traffic, and I guess coupled with weaker, you know, overall international sales just in fragrance?

Or is there another problem?

It is actually all of the above, plus some other factors.

There are a number of factors that go into the overall global fragrance performance trend right now.

Specifically we're looking at a shifting of the spend from one brand to another in the Estee Lauder brand in particular, where the Estee Lauder brand had a significant spend last year against its Beyond Paradise fragrance and they shifted their spend from predominant spend to Beyond Paradise into the Pleasures brand which we shared with you has experienced some great results and as a result, though, the Beyond Paradise segment has been falling also.

In addition, we cannot ignore the fact that one of our other key fragrance brands, the Tommy Hilfiger brand, continues to show extraordinary weakness in North America and is dropping at a rapid rate.

Unfortunately, we're doing all we can to support the brand, but the overall health of the brand is a concern to us.

In addition , of course, let me reiterate the strategic importance especially with our channels of distribution of the overall fragrance sector and the efforts we're making to shore up the performance in the total sector.

We believe the fragrance sector is very important in our key strategic markets, and will continue to be, but I'll remind you that the best analogy I can draw about the fragrance business-- it is the movie business.

There's lots of launches going on all the time.

A hit is a hit and it is a very successful hit and if it is not a hit, it'ss on to the next very quickly.

The consumer's attention is that way; the retailer's attention is that way; and we'll continue to find ways to make sure we can make this sector make a contribution to the total efforts of the company.

I want to just leave you with a few final thoughts about our company.

We have a uniquely powerful global franchise that provides us with abundant avenues for growth.

These avenues include the launch of innovative products and new brands, expansion in new and existing markets and particularly emerging markets.

And the development of other channels of distribution.

These issues are underway in each of these areas and positioning us to continue our 59-year record of uninterrupted annual sales growth.

By maintaining our rigorous expense discipline, I assure you that this is going to help us grow and give our benefits to the bottom line.

I'm very excited about our company and what the future holds and want to thank you for joining us this morning and for your very sound, challenging questions.

Thank you very much. .

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

If you are unable to join the entire call a playback will be available between 12:30 Eastern time today until February 2nd.

To hear a recording of the call, please dial toll-free 888-203-1112 and the passcode for that replay is 3278543.

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.