雅詩蘭黛 (EL) 2006 Q3 法說會逐字稿

Good day, everyone, and welcome to the Estee Lauder Company's Fiscal 2006 Third Quarter Conference Call.

Today's conference 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.

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

Also with us today is Philip Shearer, Group President responsible for Clinique, Origins, Aveda, Bumble and Bumble and our online business.

Dan Brestle, our Chief Operating Officer, is also here and he will be available for the Q&A session.

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

I'll turn the call over to William now.

Thank you, Dennis.

Good morning, everyone.

And thank you for joining us.

We reported today that sales for the fiscal third quarter were 1.58 billion, up 3%.

Earnings per share were $0.29.

The press release provides more detail, and Rick will go through specific numbers later on.

The Prestige Cosmetics business continues to grow at a steady pace, around 3% to 4% annually in the U.S. and much higher in emerging markets.

There are a number of exciting growth opportunities in the Beauty business.

New products, creativity and great branding create excitement and fuel demand.

Half of the baby boomers have already turned 50.

They are remaining active and healthy longer, and they want to look their best.

Additionally, the ethnic population in the U.S. is growing rapidly.

At the Estee Lauder Companies, we are well positioned to benefit from these growing industry trends.

We believe the economic and industry trends underlying our business are positive.

Recently, we've been impacted by several unusual factors that have hindered our growth.

Yet we still feel that we have still generated a solid underlying performance.

We are confident that once we get over these hurdles, namely the Federated-May merger, we should be poised to resume stronger sales gains.

The later Easter holiday in April impacted results across the board for March.

But more importantly, growth in main stream U.S. department stores, still our core business, has been sluggish at best.

For us in particular, the pace and execution of the Federated-May merger continues to depress our results.

We now expect Federated to close a total of 75 doors during our 2006 fiscal year.

For us, that means an expected $70 million less in revenues stemming from lost sales, returns, and disruptions.

With their integration not complete, business in the remaining stores hasn't yet stabilized.

During the ongoing consolidation, stores will close, move, refurbish and reopen.

As Macy's and Bloomingdale's become national chains, promotional calendars will be altered.

As a result, we anticipate that it will be difficult to establish meaningful sales comparisons for Federated for at least another year.

It is likely that during our next fiscal year, there could be a resolution in the pending sales of Lord and Taylor and Parisians.

We are positioning the Company to address this new reality.

We are restructuring the sales force to better service our retail customers.

We are excited about having the ability to promote our brands nationally.

This should allow us to run broad advertising programs and reach new consumers in a manner we have not been able to do before.

While the contraction in department stores is difficult now, we are optimistic that the changed landscape eventually will prove beneficial.

For us, dealing with a condensed department store universe isn't a new development.

To give you some perspective, in 1970 the Estee Lauder and Clinique brands were sold at 202 different department store names in the United States.

That number was 75 by 1990.

Today there are just 17 department store name plates that sell our products, and it's possible that one or more of those could disappear in the not too distant future.

However, while the name plates decreased, over the same time period the number of Prestige stores has increased.

North American department stores currently comprise 37% of our total sales, down from 46% four years ago.

We've built our business on that distribution channel, and still believe in its viability and vitality.

That said, we've also followed our consumers as they have found other places to shop for cosmetics.

Just as we've expanded our portfolio to 25 brands, our distribution options are more diversified and we are not as reliant on any one channel.

Distribution diversification has been a cornerstone of our strategy for at least a decade, and we reaffirmed it in the strategic imperatives we outlined at the start of this fiscal year.

The travel retail channel, high-end specialty stores, our own retail stores, salons and online have been solid contributors to growth.

As measured by sales, our high margin travel retail division has become one of our largest international affiliates.

International passenger traffic is expected to grow at least 5% annually, which should lead to continued strong sales gains at travel retail locations.

MAC is the biggest cosmetics brand at Nordstrom, and we're seeing strong results throughout the upper end specialty store channel.

Overall, our retail stores rang up sales increases in the high single digits, led by MAC's 136 worldwide locations.

Our online business has also become sufficiently large to be meaningful to the bottom line.

In terms of what we sell, we've taken strengths to -- steps to strengthen our two largest franchises, Estee Lauder and Clinique, and are pleased with some early results.

Although Estee Lauder's overall share has slipped at retail, it still boasts the two top fragrances in the United States Prestige department stores, Pleasures and Beautiful, and the number one anti-aging product, Perfectionist CP+.

The Estee Lauder brand Share a Fragrance, has stabilized in the last few months.

Consumers have responded to an ad campaign featuring actress Gwyneth Paltrow as the face of Pleasures, with sales of that scent increasing 32% at retail during the quarter.

As a result, Pleasure overtook Beautiful to become the top-ranked fragrance.

Gwyneth Paltrow also is promoting our new Pure White Linen fragrance,which is on counter, as we speak, in time for Mother's Day.

We are optimistic our classic appeal will bear a similar result.

As we mentioned last quarter, Tom Ford brought renewed attention and buzz to our namesake brand reviving sales, particularly in Europe.

His anxiously awaited spring line, Azurée, will be introduced shortly and is more extensive than the first collection.

The Estee Lauder brand recently gained market share in China, thanks to strong January promotions and a very positive -- and a very positive season for whitening products.

The brand developed two new skin care lines geared to younger consumers in Asia, where the average age of the department store shopper is the youngest in the world.

We expect the Estee Lauder brand to perform well in international markets where it has greater opportunity.

About 60% of its sales come from outside of North America.

At Clinique, the brand is re-emphasizing its roots, stressing its core Three Step regimen and allergy tested underpinnings.

Clinique has created a dramatically different gift with purchase concept that will be unveiled in the spring of 2007, and we expect to reinvigorate the program.

Philip Shearer is on the call, and will discuss more about Clinique shortly.

At a company like ours that owns a multitude of brands targeting diverse consumers, some brands perform better than others at different times.

The more exclusive brands in our stable, MAC, Bobbi Brown, Jo Malone and Crème de la Mer were fast growing in our third quarter.

MAC, which has shown robust double-digit sales growth year over year shows no signs of slowing.

In the third quarter its sales at retail grew 23%, led by international.

Almost one of every three dollars spent on Prestige makeup in the U.S. last year went to Artist and alternative brands from next to nothing a decade ago.

We sold Stila last month, allowing us to focus on our two leading Makeup Artist brands, which continue to gain share.

That move was part of our commitment to optimize our brand portfolio, another strategic objective.

The Fragrance business has been challenging, but we have good news to report.

Thanks to inventive marketing, Sean John's Unforgivable became the number one selling men's fragrance in U.S. department stores after its February introduction, making it the most successful men's launch in the industry in the last four years.

Its sales more than doubled our expectations, and the fragrance is attracting a younger urban audience.

For the first time, we used an internet-based marketing approach in order to reach fans of Sean Combs' music.

We designed a web portal for the brand, bought banner ads, hyped interest through 200 lifestyle sites and created an e-card containing a controversial ad that people could e-mail to friends.

We will roll the fragrance out to the U.K. and travel retail locations shortly, and introduce ancillary products.

We are optimistic that Unforgivable could become a multi-year success, thanks to Sean Combs' huge following.

If that transpires, it should bolster the Fragrance category, one of our strategic imperatives, and help improve Fragrance profitability.

We continue to stretch our reach geographically, another imperative we outlined, to penetrate new markets, search for promising opportunities brand by brand, and expand the ones that have put down stakes.

In China, Estee Lauder and Clinique are the fastest growing Prestige brands as measured by same-store sales, driven by skin care and makeup.

La Mer, MAC and Bobbi Brown entered China about a year ago, and consumer reception has been enthusiastic.

Some of our largest brands are sold in 130 countries and territories.

The other lines have much expansion potential left.

In the third quarter, MAC entered Jordan, and Estee Lauder was introduced in Vietnam.

Bobbi Brown is exploring points of sale in Turkey, Benelux and the Nordic region.

It is expected that when Bobbi Brown is available in the Seoul airport this quarter, the counter will become its largest door in the world.

On the cost side, work is progressing on our SMI initiatives and the pilot project at Aveda remains on track to be implemented at the end of this calendar year.

In several years, when it is fully operational company-wide, the effort is expected to result in annual savings of about $80 million.

We are committed to cut costs by approximately $45 million this fiscal year under our cost savings initiative.

Going forward, we expect to realize savings from this program of approximately $75 million annually.

We continually search for ways to boost the bottom line through stricter cost controls and better business practices.

As we have often said, we run the Company with a long-term perspective.

While we hope to achieve positive results each quarter, because of calendar shifts, product introductions and promotional timing, such a short-term standard is difficult, if not impossible, to be measured against.

We have often said our performance should be measured over a wider timeframe.

We've managed our business for 50 of the last 60 years on a long-term, multi-year basis.

With that in mind, the Company will be moving from the current practice of providing half- and full-year guidance to giving guidance on a full-year basis beginning with the next fiscal year.

I understand this is a big change, but we believe this will appropriately focus all of us on the long-term performance of our company.

We plan to offer greater insight on the growth drivers of the business and significant trends to continue to provide investors with a better understanding of the factors that affect our performance.

To sum up, we are confident the Company is well-positioned to resume our long tradition of solid annual growth.

We have a commanding presence here at home and tremendous growth potential abroad.

Combined with a focus on sharpening our execution and enhancing our growth drivers, we are confident we can maintain our position as a pre-eminent global Prestige beauty company.

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.

As William noted, the Company achieved third quarter sales of 1.58 billion, a 3% increase over last year's third quarter.

In local currencies, sales rose 6%.

We reported diluted EPS of $0.29, which included a $0.15 per share special charge related to our cost savings initiative.

Our press release today detailed net sales and operating income by product category and geographic region.

I'll expand on just a few key items regarding those results.

In the quarter, Skin Care sales were led by our Asia and -- led by our Asia and Europe, Middle East and Africa businesses where we benefited from several product introductions from Estee Lauder and Clinique.

In this category, our La Mer brand continued to grow during the quarter.

And at Origins, the ongoing strength of modern friction products and sales of its new Dr. Weil line were positive contributors.

Philip will speak to some of our results related to Clinique.

In Makeup, MAC and Bobbi Brown continued to be the sales growth front runners with each generating solid gains worldwide.

Our Beauty Bank division reported lower sales, as they were up against a difficult comparison with last year when the brand rolled out to approximately 300 new Kohl's stores.

Our Fragrance business increased nicely over the prior year's quarter, and was up in each region led by the Americas.

Contributing strongly to the category was the terrific launch results of our new Sean John fragrance, Unforgivable, which William noted has far exceeded our expectations.

The ongoing domestic success of Youth Dew have renewed, along with its international rollout, helped lift the category sales as well.

Estee Lauder Pleasures is continuing its strong performance, once again up double digits reflecting a positive affect of the Gwyneth Paltrow marketing campaign.

When we look at our geographic results for the quarter, the mid-single digit sales growth in the Americas reflected the strength of most specialty stores and more modest growth in our other department stores.

All product categories, except Skin Care, were up.

The introduction of Unforgivable by Sean John bolstered our fragrance results while Makeup Artist lines, Hair Care brand and internet businesses lifted our other categories in the region.

Overall growth in Canada and a strong performance in Mexico were positive factors.

We continued to experience softness in our core brands, primarily reflecting retailer consolidation as well as competitive pressures.

In Europe, the Middle East and Africa.

Our business in Russia and Middle East distributors each rose more than 50% this quarter in local currency, while France turned in a solid double-digit sales increase.

Travel retail grew in tandem with the increase in airline passengers.

Asia-Pacific saw the highest percentage growth, with our business in China and Hong Kong continuing to post very strong double-digit local currency sales increases.

We are also pleased with the strong return of momentum in Korea and the solid growth in local currency in Japan this quarter.

Our gross margin of 73.9% for the quarter decreased 90 basis points over last year.

Factors contributing to the decline were an unfavorable change in the mix of our business within our geographic regions and product categories of approximately 90 basis points, an increase in obsolescence charges of approximately 40 basis points, and a charge related to unutilized tooling of approximately 30 basis points.

Partially offsetting these decreases were favorable changes in promotional activities of approximately 70 basis points.

Operating expenses, as a percentage of sales for the quarter, increased 340 basis points to 66.5%.

The cost savings initiative charge of 52 million, primarily related to an employee voluntary separation program, made up almost all of the increase, approximately 330 basis points.

Operating expenses were also negatively impacted by about 80 basis points due to the estimated effect on net sales of retailer consolidation.

The incremental stock-based compensation expense added about 40 basis points.

Partially offsetting these increases were the Company's aggressive and disciplined spending efforts, including savings associated with our cost reduction program.

Operating expense improvements of approximately 80 basis points resulted from sales growth in brands with lower advertising, merchandising and sampling cost structures and tighter spending controls, as well as approximately 30 basis points related to sales growth from our travel retail business.

As a result, our operating income for the quarter was 116.3 million, compared to 178.8 million last year.

I'd like to note that by the end of this fiscal year, we will have achieved significant cost savings in selling distribution and general and administrative expenses, reducing these costs by approximately 210 basis points over the past four years.

We have reinvested some of those savings in advertising, merchandising and sampling, true to our belief that consistent investment spending will further drive our growth and ensure the long-term viability of our business model.

Looking at operating profits by category.

Skin care was lower due to difficult comparisons to prior launches in some of our core brands.

Operating results in Fragrance also declined due to lower sales from certain established fragrances, along with higher launch costs.

Makeup results were flat, reflecting improvements in our Makeup Artist brand, which were offset by declines in certain core brands and at Beauty Bank due to the difficult comparison I mentioned earlier.

In Hair Care, operating income increased due to higher sales.

By region, operating profit in the Americas declined, primarily reflecting changes in certain of our core brands due to competitive pressures and retailer consolidations.

Adding to their decrease were costs related to stock-based compensation.

These decreases were partially offset by healthy operating income gains in our Makeup Artist brands and online business.

In Europe, the Middle East and Africa, operating income grew primarily due to improved results in Russia, France, Germany and our Middle East distributor business.

Our business in Asia Pacific generated strong operating income growth with Japan, Australia and Hong Kong reporting the largest increases.

We are beginning to see improved and consistent results in Japan, which has been a difficult market for a long time.

Regarding our interest costs, we reported net interest expense of 6.6 million this quarter versus 3.3 million last year.

This increase is primarily due to outstanding commercial paper during the quarter.

Our balance sheet and cash flow remain strong, providing us with the financial flexibility to take advantage of the right opportunities.

Our net cash flow from operating activities for the nine months ended March 31, 2006 improved 61% to 476 million.

For the full fiscal year, we expect net cash from operating activities of approximately 575 million.

During the first nine months, we spent 353 million to repurchase approximately 10 million shares of our stock under our share repurchase program.

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, inventory at March 31, 2006 was 718 million, slightly lower than last March.

Inventory days were 158 at the end of the quarter versus 168 last year continuing the improving trend you've seen over this fiscal year.

Our days sales outstanding were 51 days at March 31, compared with 54 days a year ago.

Let me briefly talk about the balance of this fiscal year.

We are reaffirming our previous sales growth estimate of approximately 3% in constant currency, with foreign currency translation expected to negatively impact reported sales by approximately 1.5%.

Our estimate of reported diluted EPS from continuing operations is $1.61 to $1.72.

As a reminder, this EPS forecast includes the estimated impact of the Federated-May merger, stock-based compensation, and the special charge associated with our savings initiative, which collectively amount to between $0.46 and $0.50.

Our projection of EPS from continuing operations is consistent with the $1.87 to $1.94 we made in October of 2005, at which time we could not estimate the special charge.

Let me say that Federated store closures and the business disruption associated with their merger remains a moving target.

We now have built into our forecast for this fiscal year 75 fewer stores compared with 62 last year -- last quarter, rather.

Sorry.

The remaining 14 doors that have been announced for future closure and the resolution of Lord and Taylor will be part of our fiscal '07 plan.

Our EPS estimate also includes the 45 million of incremental cost savings we described on last quarter's call.

In connection with these savings initiatives, this fiscal year we expect to record special charges of up to $90 million.

As I've said before, we will continue to be very aggressive in pursuing financially justifiable cost savings throughout the Company.

For the full year, 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 also anticipate a significant increase in operating expenses due primarily to the special charge.

Operating expense margins will also reflect the effect of slower sales growth and about a 50 basis point negative impact from stock-based compensation.

These will be partially offset by the positive effect of our cost savings.

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

At this time, our effective tax rate is projected to be 37.4% throughout fiscal 2006.

We are currently in discussions with the IRS regarding its field audit of fiscal years 1998 through 2001.

It is probable that additional tax liabilities will result from these discussions, but an estimate of the final outcome cannot be made at this time.

We may conclude negotiations during our fourth quarter and if a resolution is reached, we expect it to be reflected in our year-end reported results.

Please remember that we run our business on an annual basis and, as such, we will be changing to annual guidance beginning next fiscal year.

This concludes my comments for today and I'll turn the call over to Philip Shearer.

Thank you, Rick.

Good morning, everyone.

As Dennis said earlier, I'm responsible for Clinique, Origin, the hair care brands which are Aveda and Bumble and Bumble, as well as the ELC online which covers our online activities across all brands.

This portfolio represents roughly 40% of global sales for the EL Company.

Today I'm going to speak specifically about Clinique, an integral part of the Company's portfolio optimization strategy, and will be pleased to answer questions on my other responsibilities.

As you know, Lynne Green took over leadership of the brand in January and her extensive expertise will help drive Clinique strategies worldwide.

Now Clinique's [inaudible] positioning the first brand developed with a dermatologist has helped it become one of the largest global beauty brands.

Clinique is the leading brand in department stores in the U.S., the U.K. and Canada.

Now the opportunities and challenges vary by region.

Let's start with North America.

North America Clinique is the number one player in Prestige beauty and a greater than 50% share of Prestige in Canada 2005.

In Skin Care and Makeup, its share of Prestige exceeds 20%.

Because it's sold by [inaudible], Clinique sells almost three times as many units in skin care as the second largest player, and in makeup Clinique sells more than a quarter of all units.

Also among women's fragrances sold in U.S. department stores, Clinique Happy ranked among the top players in dollar volume in Canada '05.

So Clinique's position in North America is very strong.

But lately our growth in this market has slowed which, in my opinion, is due to three main factors that we are addressing.

First of all, competition from emerging players in Prestige, such as [inaudible] brands, as well as competition from some mass market brands trying to corrupt Clinique positioning.

Our response to this challenge to re-emphasize our core equity.

We have just relaunched Three Step, our largest franchise in North America.

We grew this franchise by 8% in the last quarter at retail, well above the market average.

Based on this success, we intend to aggressively promote Three Step in the form of an extensive use of national TV, thereby leveraging the consolidation of our retailers.

Also, this strength will make successful additions to the turnaround franchise building on our strength in exfoliation, which is absolutely essential to the brand.

To support our core positioning on a wider basis, we're also leveraging our partnership with Weil [con-elm], a leading medical institution, to enhance our knowledge of the skin which we'll then use in developing products.

Second challenge has been our gift with purchase programs, which support about 30% of our sales.

Starting next spring, we will revamp the program by partnering with beauty authorities such as magazine editors, who will choose the products offered in the gifts, thereby endorsing the promotion.

Also, with the consultation of our distribution, we removed national dates, which is an opportunity to improve the execution of the program.

Of course, the main [inaudible] in our basic business where we can leverage the expertise of our highly trained and knowledgeable beauty consultants a major point of difference.

Third, we are challenged by the department store consolidation, which probably affects Clinique more than other players because of the disproportionate share of unit volume.

Clinique was the first brand in the Company to rely on its sales force to better service our retailers, which improves our efficiency within the new retail structure.

Additionally, we continue to evaluate the latest retailer developments to decide what is best for the brand.

Also from marketing point of view, we are also expanding our outreach programs to capture a new consumer who may not show up in traditional channels.

So although the North America market is currently difficult, we are addressing the challenges of [inaudible] think about the future.

There are two significant opportunities worth mentioning.

One, the North American market is growing.

To take advantage of this opportunity, we are adapting some of our products and advertising because the next generation of young consumers has different ethnic background from the baby boomers.

Two, we are the leader in Prestige men's skin care, which is growing double digits.

We know that because of its universal appeal, Clinique is well accepted by all groups.

I have just review North America, about 45% of the Clinique business.

Now let's talk about the other 55%, the international side, which has been growing solidly in the mid-single digits.

Starting with Europe.

Clinique's position is strong.

We estimate that the brand ranks four or five overall in Prestige, and it has gained share over the past five years.

We believe we are third in Skin Care with consistent gains and second in Makeup, also with a share gain.

We are quite confident that the brand has strong appeal at it's suggested price points, and we expect it to improve its market position in the years to come.

Actions such as the relaunch of Three Step last fall, our strength in foundation, should drive growth in the future.

Clinique should continue to perform well in the U.K. and in Spain, our largest European market.

And we've also been very successful in central Europe and Poland, although this market remains small but growing.

Let's turn to the Asia Pacific region.

Japan currently represents about 40% of Clinique sales and has been a challenge over the past several years.

I am quite happy to report that we have made significant progress and are on a positive trend.

During this fiscal year, we produced consistent monthly growth and stabilized our share of Prestige.

Actually, over the first three months of Canada we [inaudible] estimated we gain share.

We accomplished this by building on our core equity products.

Again, Three Step, exploration and by significantly reinforcing our education programs.

A recent survey ranked Clinique first in [inaudible] counters, which is critical to serving the Asian consumer.

We also have a data level point of sale imagery and successfully launched a new advertising campaign.

As a result, internal data shows a significant increase in new consumers.

In the rest of Asia.

We are seeing strong gains in China where we now own 51 doors and expect to open several more by the end of the fiscal.

Elsewhere.

Business is improving in Korea and Taiwan, where we have started applying the approach we employed in Japan.

Southeast Asia is small in volume and, in general, we have good market positioning.

From product standpoint, we have specific product for the region and our new whitening line, Dermawhite, is off to a very strong start across all markets.

For the south.

Clinique is number two in Australia.

There are other opportunities for the brand in small but fast growing markets, such as the Middle East and some Latin America countries.

Travel retail remains a very significant contributor.

As conclusion, Clinique is a significant player worldwide with solid growth potential, and we are actively pursuing the opportunities ahead.

At this time, we will be happy to take your questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question today comes from Bill Pecoriello with Morgan Stanley.

My question is on the Americas.

If you could just decompose the components of the growth for us in terms of how much was the U.S., because you mentioned the Canada-Mexico contribution.

Also, how much should the Kohl's decline, and what was the contribution from the alternative channels to the Company-owned stores and internet?

The non-U.S., Mexico and Canada -- I think the total contribution for them was about $8 million, and I think the remaining was in the Americas which was around 23 million in its totality.

Kohl's was down -- and I don't have the exact figure, but it was down somewhat because of the anniversary of that -- you know, 300 stores which launched simultaneously last year.

I'm sorry, the rest of your question?

The -- well, I -- you know, getting the alternate channels, the Company-owned stores and the internet contributions.

Our Company-owned stores are up solid single digits.

They did pretty nicely in the quarter.

And, you know, our Makeup Artist brands did very well in the quarter.

And our core brands remain somewhat challenged, again, because of the -- They are really the most affected by the disruptions with the consolidation of Federated-May.

But also I just wanted to follow up what's going on in the U.S.

Can you comment on the JC Penney-Sephora deal.

Are you going to allow your brands in that channel?

Does that change any developments with the Kohl's strategy.

And then with that decline on the Beauty Bank, what's your outlook for growth there in the coming quarters?

And what are the plans to reactivate the growth there?

Well, in the four questions embedded into one -- I'll try to knock them off one at a time.

For the Sephora-JC Penney announced joint venture, it certainly is an interesting development for both of those retailers.

We are in discussions with Sephora about what their plans will be, and have not yet concluded anything as to whether or not any of our brands will be participating with them on that.

As we develop our conversations with them, of course, if there's any significant result we will share that with you.

We will announce it with the broad community.

The next part of your question was the possible impact of this joint venture with Kohl's and Beauty Bank.

We don't believe there will be any impact at all.

It's our understanding that the vast majority of the 800 or 900 or so doors that are JC Penney doors throughout the United States are predominantly in regional malls where we also have a distribution.

And the key core -- the cornerstone of the strategy with Beauty Bank and Kohl's is that Kohl's is not in regional malls where we have other brands in distribution.

Kohl's is really counter programming themselves too in more traditional department stores and regional malls.

And we do not expect that there will be much of an impact.

The next two parts of your question.

Can you please refresh my memory?

Just in terms of what you're going to -- the growth outlook at the Beauty Bank and what you're going to do there to reactivate the growth there.

Well, one of the things we're seeing now that we're about 18 months is the active retail management with Kohl's is that the -- We're getting into, if you will, the basic blocking and tackling of growing a business at retail which is something we have a little bit of experience in.

And what we're finding is that some of the key core principles of -- this is door by door, build the business, build a following with the consumer, get management support and buy in.

We find that there are general trends, whether it's the store manager who really believes in the business and encourages his team to support, whether they're seeing great results in traction with experienced salespeople in the store.

There are a number of different factors.

And we are going to be building this business over a long term.

We have a multi-year agreement with Kohl's in building these brands.

We don't build brands overnight.

These are new brands and consumers are not -- were never aware of before they were launched 18 months ago.

And this is a new category of merchandise that are being offered in these stores for these consumers.

We will -- We are seeing good improvement of penetration of the cosmetics brands, our brands, to the store total, which is the best measure we can use of success.

And we are continuing to get strong support from the merchandising in store operations organizations to encouraging their local store management to improve performance on a penetration basis door by door.

Thank you.

Our next question.

Chris Ferrara with Merrill Lynch.

Hi.

I was wondering if you could just say whether or not the EPS in this quarter was ahead of your internal expectations?

Chris, our EPS was pretty much in line with our expectations.

And as you know, we didn't give guidance for the quarter but we're comfortable with our guidance that we gave for the second half.

And that is the same guidance, as I mentioned in my prepared remarks, that we gave when we came out of our first quarter at the end of October.

Great.

And then also, can you talk about U.S. skin care?

I mean if I heard right -- I thought you guys said Three Step, Three Stage drove 8% growth for that product in the U.S., but Skin Care was down in the U.S.

So if I'm right on that, if that's the case, what happened to the rest of Clinique Skin Care in the U.S.?

Well we're talking about a number that's retail.

The 8% I mentioned was retail numbers.

And it's -- What's happening on the U.S. side -- net shipment level -- okay, with the consolidation of the stores -- From the returns that are happening in the stores, the net shipments have been down.

So there's a gap between what's happening at retail and what's happening at net.

Three Steps, specifically, was extremely powerful and other products as well.

You have to remember, Chris, that the biggest impact of the Federated-May door closures is felt by Clinique and by Estee Lauder.

So when there's big returns coming from those doors that are closing, it affects those brands extensively.

And there's a big piece of that that's related to Skin Care.

So what's your sense of what take away was for the rest of Skin Care?

I guess the retail take away for the rest of Skin Care and and Clinique's X Three Step.

Overall, Clinique Skin Care was up over the first quarter.

All somewhat affected though by the lack of performance of the [inaudible].

Thank you very much.

Our next question.

Amy Chasen with Goldman Sachs.

Good morning.

Can you -- You mentioned a change in the sales force, William.

Can you just flesh that out for us?

I couldn't quite understand what you're doing.

Yes.

What we -- I'm taking that question because that's what we did at Clinique.

You know, before the sales force was mainly organized geographically by all the regions and the different states and the -- that's the way it was organized.

Now with the consolation of retailers that William went through, explaining that now we have a lot less name plates to deal with, we have found that it was more effective probably for the long run to have specific dedicated people to each and every account. so that we can have specific programs that are run on a more efficient basis.

And that's what we have done lately.

That should drive some efficiencies both at the level of the relationship with the remaining retailers, and also eventually in the number of people who call on the accounts.

And is that how your competitors are organized?

Or are they still doing this regionally?

As far as I know, I couldn't really tell, but I think they are organized for the most part regionally.

But I couldn't tell specifically.

Okay.

And then you mentioned -- and I'm sorry, but I just couldn't catch it all, Philip.

On the G with P change, can you just walk us through a little bit more slowly what you're doing there for Clinique, how it's changing?

Besides, I heard the part about the beauty editor, but I didn't understand the other part about the national timing of it.

Okay.

The way we see it, especially as we go on -- What's happening now with the less retailers, right, is that we go to what we call national dates.

If you will, up until now most of the promotions we are running, were run by different dates depending on the parts of the country where they were run.

Right?

So by moving to what we call national dates, we will have more specific dates for each of the key retailers which, by the way, will make the reading of the retail sales in the first quarter -- first part of next year quite challenging.

But the point is, that this will drive efficiency because one, you will have less promotion in the marketplace at a given date because there are less promotion overall because there are less retailers.

That should be more efficient.

Second, there is the opportunity to leverage our relationship with the existing retailers by reallocating some of the resources, especially the promotional -- what we call everything we do with them when it comes to advertising expenses for promotions.

And this -- I think we have an opportunity to reallocate them, first because even though the number of markets remained the same, the number of promotions advertised will decrease.

So we see it as a positive in the long run even though we know the transition will be quite erratic.

We will take our next question from Wendy Nicholson with Citigroup.

Hi.

My first question has to do with advertising spending.

And I know you talked in December about a real shift in advertising from December into March and I'm wondering, given that margins came in at least higher than I had expected, whether we saw all that advertising hit in the March quarter?

And I guess maybe the best way to answer that is maybe giving me some sense for the full year, since I know that's how you break out advertising spending as a percentage of sales.

Are we on track for spending in the 29% of sales range or something different than that?

Wendy, I think -- The first part of your question.

We spent more in reported dollars and constant dollars in the quarter and on a year-to-date basis in advertising merchandise and in sampling than we did last year.

What you are seeing though that is affecting the percentage of sales, is the fact that some of our best performing brands right now, our fastest growing brands, are used less advertising, merchandising and sampling as a vehicle to drive their sales.

So we have talked about this for some time, that you would see over time that relationship to sales on a percentage basis begins to come down.

And that has -- Some of that effect is happening right now and you see it in the third quarter, and you will see that for our fiscal year as well.

Okay.

And I know that's been a strategy anyway for Clinique and Estee Lauder to decline as a percentage of the overall mix, but I was thinking that because you were spending even more, given the new product activity there, that somehow that number would go up for the full year.

Wendy, let me put a finer point on it.

This is really a mix issue.

If you will, the lower A&P -- the lower use as a percent of sales A&P brands such as MAC and Bobbi Brown and Crème de la Mer are growing at a faster rate than Clinique and Lauder, which are at a higher number.

So if you were to look just at the Estee Lauder and Clinique brands as a percent of sales, their A&P in fact is going up, because their spanned on a constant basis it's staying about the same.

Yet their sales are even.

So the real result is that there's a mix on the total.

What you're seeing is the percent changing.

Okay.

And don't forget, one of the key components to our total presentation to the consumer is selling cost, which is the cost of the makeup artist, Clinique consultants, Estee Lauder beauty advisers in the store.

And that investment is going up because we believe that is one of the key differentiators of our brands.

Fair enough.

That sounds good.

The follow up question though I had as it relates to advertising, and I guess maybe this is a question for Phillip.

I may be way off base, but it strikes me that one of the things that's really helped the Estee Lauder brand has been some changes in the advertising strategy, not only with different people like Gwyneth Paltrow and whatever, but just more modern fresh updated advertising.

But my sense is with the Clinique brand, because you don't use people to do the advertising, it's all just pictures of the product -- maybe your hands will a little bit tied behind your back in terms of what you can do to reposition the brand visually.

Am I crazy or is that something you're thinking about changing?

Would that help pick up sales growth for the brand?

Well I won't answer on the first part of your question.

But on the second, I would say that Clinique communication is very clearly what it is.

In other words, we are -- made our point very clear.

The territory of Clinique is one where we don't say this is an ingredient with a beautiful face.

Choose the ingredient and you're going to look like that face.

That's not at all what Clinique is.

So we've focused our efforts on customizing offering to each and every customer by doing the skin diagnostic and all of the things we do pretty well at counter.

When it comes to the advertising, it has to be consistent with that positioning.

Hence the emphasis on the product as we speak to people, not to show them what they may or may not look like, but what really is core to our communication strategy.

Now, this being said, we are evolving in the way we do this.

So I don't think we will change the format.

We will not change the idea, but we will probably evolve as we have already in Asia in format.

Where we have in Asia used a face but that's not a face.

We call it face as a canvas.

So the idea is to exaggerate the product benefits that stays within the philosophy of Clinique not to be literal in its communication when it comes to people, but it's an evocation of what the product can do.

Based on the same idea, the same format, we have also and we are going to see in the fall in North America -- We are re-emphasizing the voice of Clinique.

Something that made Clinique very, very special in the early days of Clinique was the voice and the communication.

And you will see coming in the fall in the -- almost everywhere in the world, some more aggressive way of saying why we are.

And as we probably or you have not seen, or have seen -- What we've done on Three Step is we took a line, which was the original line of the first article that was written at the time for Vogue, which was "Can great skin be created?"

And the answer is yes.

And so we've put more voice.

So to summarize.

We are evolving advertising.

The core communication concept will remain basically the same.

The execution will evolve through new photography, through more voice and, in some of the parts of the world, this idea of face as canvas that we've used quite successfully in Japan.

Our next question.

Linda Bolton Weiser with Oppenheimer.

Thank you.

I just had two questions.

One on Clinique.

We had noticed that Clinique is carried by ASDA in the U.K. and I'm wondering if that kind of shift to kind of a different channel a little bit there is contributing to the international growth?

And if you would consider some channel alternatives in North America for Clinique?

And then the second question has to do with Fragrance profitability.

The profitability of Fragrance has deteriorated year over year in each of the three fiscal quarters so far.

And even with Sean John doing well this quarter, it still has not really improved year over year.

Can you restate again, William, your strategy for improving Fragrance profitability?

I'm going to take your last one first because by the time you were done with the last part I forgot the first two parts.

But let me make a real quick comment.

We do not sell ASDA.

Any product of our brands that's offered by ASDA is diverted grey market goods, and that is not part of our strategy going forward.

The last part of the question improving our Fragrance performance.

One of our key core components is making sure we can be competitive on a global basis and performance in fragrance.

There are a number of factors that are challenging that -- challenging us at the moment.

Most of it is driven by our positioning -- our brand positioning and the mix of business as a result.

The predominance of our American-oriented brands in the offering affects our mix as a total -- our cost and margin mix as a total because the American fragrance business, as you know, overall is more than somewhat challenged and is very heavily promotional which drives up the cost of goods.

The single largest fragrance market in the world, which is Europe, is predominantly oriented towards more European-based brands which we are sadly somewhat weak on in our total offering.

Which gives us a competitive challenge in the broad global reach.

But how do I look at this, is the glass is half full.

Which is our skin care and makeup businesses are a heavier portion of our total than many of our competitors, which have a much higher margins as a total.

But in the single largest Prestige market in the world, continental Europe, where 60% of the business is done in fragrance, we need to be and must be more competitive.

And we are actively looking for opportunities and options that will address that.

At the same time, we are enforcing a far stricter financial discipline to how we execute our business.

And the fact of the matter -- the fact of the matter is we do have a brand in Europe, like Missoni and we have Jo Malone, which are both European fragrance brands.

But the Fragrance business overall is tending towards a more commoditized mass-oriented business than the rest of the Prestige sector as a total.

Okay.

Our next question.

Alice Longley with Buckingham Research.

Hi.

Good morning.

My question's about travel retail.

How fast is that channel growing and what's happening with your share within travel retail, specifically in fragrance?

The travel retail business on a year-to-date basis, and for this fiscal year, is up very strong single digits.

You know, 8%, 9%, so we're happy with its performance.

And your second part of your question was how's our market share related to the fragrance piece of that business?

Right.

We are less penetrated in fragrance than our competitors in travel retail and, as William mentioned, that's related to our strength or lack thereof in Europe in the Fragrance category.

But it's something that we're working on.

But we -- Our share in men's Skin Care and Makeup is much more heavily weighted in share.

And I do believe our share is growing in the travel retail business overall, but Asia as a sector of travel retail is the fastest growing sector and that is a predominantly Skin Care oriented sector.

Oh.

Okay.

Do you have your share within travel retail overall then, for getting Fragrance in all categories?

As far as I understand, the travel retailers are not very forthcoming in that information.

So a lot of it is somewhat self-reported.

But it's our understanding, from what knowledge we do have on a door by door basis, that our share has been increasing over the last few few years mainly because of the mix of our brand.

And did that -- Did travel retail grow 8% to 9% in the March quarter as well as year to date?

Year to date, yes.

And the March quarter was a little bit less.

Okay.

Thanks a lot.

Our next question.

Sandy Beebee with HSBC.

Good morning.

I wanted to start off just asking about Europe where the performance has been pretty strong.

Is it just off of -- in a sort of weak number as last year?

Or are you seeing the European Prestige market showing signs of recovery?

And my second question was on Clinique.

We talked a little bit about what Clinique would do on the marketing side and with Gift with Purchase.

But what about with the product side?

Is there something you can bring from an innovation standpoint that can become more relevant and revitalize that brand again?

And my last question was just on 2007.

It seems like the impact of Federated and May's, from a store standpoint, will be the same as it was in '06.

But do you think there's going to be less of an impact from a revenue perspective as maybe some of the opportunities to take advantage on the efficiency side makes up for the lost dollar sales of having fewer doors?

Let's try to take each of these piece one at a time.

I'm going to ask Dan to take the Federated question first.

Yes, Sandy, let me just address the Federated.

We continue to see the May Company doors that are now owned by Federated performing much weaker than the Federated doors cosmetically.

We think we're over the hurdle for most of the major closings of the doors.

As you all know, and as Federated has published, the next critical date will be that September 9 date when they change the names on the 400 May company doors to Federated.

We expect some disruption there.

We don't know exactly how much.

We're preparing for it.

We're overstaffing for it. we're getting people in the stores to make sure the transition is smooth.

Places like Chicago with Marshall Fields, where the name plates were historic, we think may give us some problems.

The lone remaining major disruption will be what happens to Lord and Taylor.

And we are waiting anxiously, like everyone else, as to how that plays out.

But yes.

There will be efficiencies, whether it's the way Philip described his organization structure, better servicing, more efficiently servicing the accounts and the fewer promotional activities, the multiple ads because of the multiple promotions.

So there will be efficiencies from that side.

Now, the next part was Clinique.

Clinique.

Okay.

Clinique product line.

I think that was your question.

Yes.

Right.

The -- Each brand has its own personality.

Our personality is one of simplicity, and that's what has been really driving the very core equity of this very powerful brand.

So this being said, if I take Three Step as an example, which has not evolved for quite a number of years, we have recently introduced a gel form of DDML which is the cream moisturizer.

We have just now introduced s liquid soap as opposed to we had only a bar soaps.

So within that franchise, by keeping the same fundamental methods, we have evolved in formula.

We evolve also in terms of product delivery and convenience to the customer, which is very crucial.

It's part of the [inaudible] of Clinique that we are very functional in the way we deliver products.

This being said, in other categories of treatment likes exfoliation, we have reactivated our exfoliation franchise with the launch of Turnaround Concentrate and the mask that we've just done.

We also have launched -- last year entered a new territory which goes beyond protection [inaudible] which is one of the core territories of the brand, with the introduction of Super Defense and the introduction of a new concept which is to go beyond the single protection external of the skin and try to do more.

That was Super Defense, which has been a very successful product all around the world.

So -- and I will spare you the details.

We've got other franchises such as Moisture Surge.

When it comes to Makeup, we are probably the leader in foundation.

Undoubtedly in North America as well as in continental Europe -- in Europe overall.

And so we have -- we constantly launch new formulae that are updating our expertise, if you will.

Recently we launched Perfectly Real makeup, two years ago.

Now we've come up with a compact form of that foundation, a very successful one.

We have just launched a very specific mascara which for the -- in Asia.

We also have repackaged a lot of our product line, especially the eye shadows.

We've come up with a new lipstick case.

So -- and also we are what we call trend, and we've been very successful with coming up with what I call other products which should [inaudible] to do at the counter and the work of the consultant -- make the workers of the consultants more interesting.

At the same time in Asia we are -- we have very specific categories there with a whitening range.

We had a product called Active White.

We just launched DermaWhite, which again deals with our knowledge and expertise in whitening coupled with our dermatologist background.

All this to say that we are very active when it comes to the product line, but we try and we remain simple functional, because that's the great positioning of the brand.

And we have entry points [inaudible] as well as Prestige, and that's why we are so powerful in units almost everywhere where we are.

So if you are -- that's the personality of the brand.

Rick will take the last piece of the question.

Do you remember what it was?

Europe.

The European mix, if I'm not mistaken.

Travel retail was part of -- as of Europe?

Travel retail's certainly part of Europe.

It contributed to the results of Europe.

But our overall European business was also up reasonably solidly.

So you know our -- the market's performed very well.

But I'm sorry, I've forgotten the specifics of what you asked.

The specifics was what else did -- relative to the market.

Right.

You have to remember -- I'll reinforce, we report our global travel retail business in the European region because all of our shipments for travel retail around the world come out of a European-based distribution center.

To break it down more if you will, take travel retail out.

We also have the Middle East and Africa in there, which is also growing on a very healthy basis.

The more traditional western markets, the larger western European markets are not growing as quickly as the emerging markets in central Europe and Russia, for example.

The U.K., while not growing at the same pace as it has historically, is still growing at a nice pace and we are very pleased with the way the U.K. business is evolving overall.

Our next question comes from Connie Maneaty of Prudential Equity Group.

Good morning.

This is Layla on for Connie.

Just a quick question on the Beauty Bank weakness in skin care.

Was this expected?

I mean, was this kind of baked into the budget?

Well, I wouldn't want to characterize Beauty Bank as weakness, because really if you're looking -- It's very difficult for new brand launches which you -- I f you were to ship 300 in one brand -- 300 stores simultaneously, you're going up against the pipeline of filling a pipe versus regular year-on-year business.

And so I wouldn't characterize it as weakness.

We're seeing very solid store for store growth in like doors at retail at Beauty Bank.

We consider that to be successful.

What you're looking at, from our standpoint, is the shipments.

Shipments of pipe versus shipments of replacement business, which are really not comparable.

Okay.

And is this only in Makeup?

Or is it Skin Care as well?

I think we're characterizing it as predominantly Makeup.

Skin Care is a smaller portion of the total business there.

Okay.

Can you talk to the profitability of the Beauty Bank brands?

Well now -- We really don't break out to the profitability on a brand performance basis, but we can say that they've improved dramatically over the previous years and they are on our plans and expectations for the long-term growth.

Okay.

And lastly can you talk about the expectations for the balance of the calendar year for Beauty Bank?

The balance of the calendar year?

Yes.

We really only talk to you about our fiscal years.

As we've said, on an overall basis we're confident with the guidance we have given you for the balance of our fiscal year.

And as we get through our programming, we will be sharing with you what our expectations are for the following fiscal year.

We'll go next to April Scee with Banc of America Securities.

Hi.

Thank you.

Just a couple of quick questions.

First on May-Federated.

After seeing the early history of this, are you seeing that what's happening is in line with your expectations?

Or are you maybe losing less of the business than you had originally anticipated?

And then on Kohl's, a couple of questions.

Can you comment on the Daisy Fuentes initiative that has been reported you might be doing there?

Can you talk about the promotional testing that you've mentioned and what impact that may be having on the business?

And then just two quick clarifications.

Cost savings during the quarter, did you mention what those were?

Should we assume that it was 8 million?

Thanks.

Sure.

Let's do cost savings first and then we'll go to the meatier stuff.

Cost savings was about a third of our stated 45 million, so roughly 15 million in the quarter.

Yes.

Okay.

Let me take the second one.

Daisy.

Daisy Fuentes has a very nice ready to wear business going on in Kohl's We've got together.

We're going to be launching the fragrance, as we announced a couple weeks ago.

We expect great things.

The wonderful fragrance that we launched using Ashley Judd for the American Beauty line as been a tremendous success.

So we see fragrance as a real opportunity in that category.

So we have great expectations for that.

It will stay exclusive in Kohl's, like our other venture with Kohl's.

Federated.

I think Federated is pretty much as we expected.

We are getting a high transfer of the basic business customer as long as the stores -- and it did vary a little bit division by division.

It took the appropriate staffing levels and ordered the appropriate inventories, when you merge stores.

Everyone's focusing on Federated.

I just don't want to leave it hanging out there.

Realize that another probably 12, 13% of our business is also up for sale or was sold.

You know, Belk bought McRae's.

Bon-Tons are now buying the Saks Northern Group, and we're going through that exercise with them.

So there's a lot of disruption in the marketplace.

And a lot of our people are focused on other things than driving business because of that disruption.

But Federated for us, pretty much as expected.

The capture of the Gift with Purchase customer is much less.

It goes about 60%.

So I think averaging 70 -- 60, 75% is where we thought it would be, based on different parts of the country.

But we're looking at $70 million one way or the other.

Our next question.

John Faucher with JP Morgan.

Yes.

Good morning.

Thank you very much.

Wanted to follow up on some of the advertising questions, which -- You guys have sort of talked about in the past your ability to adjust spending sort of on the fly depending on how the quarter's going.

So a more macro question, which is would you say the overall ad spend was in line with what you were thinking heading into the quarter given your commentary on the last conference call?

And then you talked about the mix impact from the Estee and Clinique brands in terms of bringing down the growth in ad spending, or at least bringing down the ad to sales.

Can you talk a little bit about what you're doing in terms of spend on those brands year over year?

Are you spending more money as you're looking to relaunch and refocus?

Or, again, did you adjust some of the spending in the quarter on those brands given where the trends came in?

Thanks.

John, the spending on our big brands is more or less in line with our sales, and you'll see that for the year and it certainly was the case in the quarter.

As I mentioned, our investment in advertising, merchandising and sampling has increased in the quarter and on a year-to-date basis versus the prior year.

And as William described it's -- What we have as a percentage of sales is really a mix issue which is the brands that use less of that vehicle, less advertising, merchandising and sampling are growing -- are our fastest growers.

And it's really just the mathematics of the relationship to the sales.

And as far as expectations are concerned, John, I guess it depends on whom you ask.

If you were to ask those with whom we advertise the most, our advertising isn't nearly up to what they'd like or expect.

And if you would ask some of our brands they'd like to be able to spend more than perhaps what they have.

But we're trying to manage this in a manner that makes it the most efficient spend to generate the sales dollars that are appropriate.

And like I -- I want to re-emphasize one of the key, key ad spending if you will, and I put that word in quotes, is the selling cost and the makeup artists for MAC and Bobbi Brown, the Estee Lauder beauty advisers, the clinique consultants, the Origins guys, the Prescriptives analysts, whatever we call those people who represent our brands in stores are a very key component to what we put forward for the consumer for promoting and building the equity of the brand.

Ladies and gentlemen, that will conclude today's questions and answer session.

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That does conclude today's Estee Lauder conference call.

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

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