The Estée Lauder Companies Inc.
Q4 2006 Earnings Call Transcript

Published: 16 Aug 2006

[Operator:]

Good day everyone and welcome to the Estee Lauder Company's fiscal 2006 year end conference call. Today's call is being webcast and recorded. 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.

[Dennis D’Andrea:]

Good morning, everyone. We have on today's call William Lauder, President and Chief Executive Officer; and Rick Kunes, Executive Vice President and Chief Financial Officer. Dan Brestle, our Chief Operating Officer; and Cedric Prouve, Group President responsible for all markets outside of North America, are also here and they 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 and our reports filed with the SEC, where you will find factors that could cause actual results to differ materially from these forward-looking statements. A reconciliation of non-GAAP measures discussed in this call appears in our press release and on our website. I'll turn the call over to William now.

[William Lauder:]

Thank you, Dennis. Good morning. Thank you for joining us to discuss our fiscal 2006 year end results and outlook for 2007. I'm pleased to report that sales for fiscal 2006 grew for the 60th consecutive year since the Company's founding, a remarkable achievement. Sales were $6.46 billion, up 3%. Excluding special charges, earnings per share were $1.92 which was within the range of guidance we provided to investors. Rick will discuss the specific numbers later on. The global prestige beauty industry remains highly competitive. It's driven by creativity, scientific advancements in skin care and makeup, and exciting branding and marketing. Moreover, the products need to resonate across a diverse consumer base. Although we accomplished all that and more, 2006 brought a unique set of challenges; and our results, while respectable given those challenges, were nonetheless impacted by several factors that were outside of our control. Let me elaborate. While we have had to deal with department store consolidations over the past several years the Federated May consolidation had the largest impact. This merger of our two biggest customers resulted in the closing of 75 stores and business disruptions. As you can imagine it had a significant impact on our sales. In addition, we lost business for several months early in the fiscal year in areas of the Southern United States, most particularly along the Gulf Coast, that were impacted by adverse weather conditions. We repurchased large amount of inventory from shuttered stores and took returns of damaged goods. Yet, despite these setbacks, we boosted sales for the year. In addition, by enacting tighter cost controls and strengthening and supporting our core brands we were able to achieve a solid bottom line. Even as we dealt with short-term adversities, we have made substantial improvements in the way we run our business. As a result, we believe we're poised for solid improvement and are well positioned to increase stockholder value. At this time last year, we outlined our vision to drive the Company's growth in a rapidly changing environment. That directive was incorporated into five strategic imperatives. They are a roadmap to help us stay on track, deliver value to stockholders, meet financial targets and maintain our leadership. We made progress in each, and I'm confident we will show greater gains this year and in the years ahead. I will highlight some of the progress we made in fiscal '06 in the context of the five strategic imperatives which are

[Rick Kunes:]

Thank you, William, and good morning everyone. My discussion today will focus on our results from continuing operations. We reported EPS for the fourth quarter of $0.23 which reflected $0.28 per share of special charges related to our cost savings initiative and the resolution of certain tax issues. Not including the special charges, EPS was $0.51, a very solid 21% increase over the prior year quarter. As William noted, for the full fiscal year the Company achieved sales of $6.46 billion, a 3% increase over last fiscal year. In local currencies, sales rose 4%. Reported net earnings from continuing operations for the year were $324.5 million, compared with $409.9 million last year. The year's results included previously announced special charges of approximately $92 million related to our cost savings initiative and a $35 million special tax charge, primarily for the settlement of audit issues with the Internal Revenue Service. Fiscal 2006 diluted EPS from continuing operations was $1.49 versus $1.80 for the 12 months of last year. Full fiscal year 2006 reported results included $0.43 of special charges with $0.27 and $0.16 per share related to our cost savings initiative and income tax issues respectively. Our full fiscal year EPS projection that we made in October 2005 was $1.87 to $1.94. Excluding the special charges, you'll see that we came in towards the higher end of that range. Our press release details net sales on operating income by product category and geographic region. I'll expand on just a few key items regarding those results. Skin care sales were led by our Asia and Europe businesses, where we benefited from several product introductions from Estee Lauder and Clinique. Skin care sales in the U.S. increased moderately, impacted in part by store closures resulting from the Federated May merger. In makeup, our makeup artist brands continued to have outstanding double-digit sales growth, while increasing sales in virtually every country they sell in, which offset declines in categories from certain of our core brands. As expected, our fragrance business decreased compared with the prior year with the Americas and Asia declining and Europe increasing slightly in local currency. Still there were some bright spots. During the year the international success of DKNY Be Delicious and a strong double-digit performance of Estee Lauder Pleasures contributed positively to the category sales. We also generated terrific net sales from the launch of our new fragrance, Unforgivable. In haircare, salon expansion door growth, new product introduction and the acquisition of a distributor led to solid double-digit sales gain. When we look at our geographic results for the year the low single-digit sales growth in the Americas reflected the strength of most specialty stores and more modest growth in department stores. All product categories, except fragrance, were up and almost all developing brands posted increases. Strong sales gains in our makeup artist lines, haircare products and Internet businesses lifted our results in the region. Overall double-digit growth in Canada and Mexico were positive factors. We continue to experience decreases in our core brands primarily reflecting retailer consolidation as well as competitive pressures. Our BeautyBank division reported lower sales, due to a difficult comparison with last year when the brand initially launched in approximately 650 new Kohl's stores, although same-store sales increased nicely at retail. In Europe the Middle East and Africa, our travel retail business generated high single-digit gains this year. The UK recorded strong dollar value growth while sales in Russia, one of our emerging markets, grew almost 40%. In Spain a difficult retail environment and changes to our distribution policy resulted in lower sales for the year. Asia Pacific had the highest percentage growth with almost every country reporting local currency sales gains. Our business in China and Hong Kong posted strong double-digit local currency sales increases, and in Korea we generated solid year-over-year gain. In local currency, Japan had low single digit sales gains this year marking a return to growth after four years of relatively flat performance. Our gross margin of 73.9% for the year decreased 60 basis points over last year. Factors contributing to the decline were the change in the mix of our business within our geographic regions and product categories of approximately 20 basis points, increased obsolescence charges of approximately 40 basis points, and 20 basis points related to commodity material prices. Partially offsetting these decreases were favorable changes in promotional activities of approximately 30 basis points. Operating expenses as a percentage of sales for the full year increased to 64.3% from 62.9% last year. The increase reflects 60 basis points related to stock-based compensation, as well as 140 basis points attributable to the special cost savings charge. The principal components of the cost savings initiative were a voluntary separation program, efficiencies in the Company's distribution network and product offerings, as well as the elimination of non-critical costs. Operating expenses were also negatively impacted by about 40 basis points due to the estimated affect of retailer consolidation and the adverse weather conditions that affected the Southern United States. Partially offsetting these increases were the Company's aggressive and disciplined savings efforts, including the incremental savings this year associated with our cost reduction program. Also, operating expense improvement of approximately 90 basis points resulted from the sales growth in brands and channels with lower advertising merchandising and sampling cost structures. For the fiscal year, total advertising and promotional spending, including the amounts reflected in both cost of sales and operating expenses, was $1.79 billion, which is consistent with last fiscal year. As a result, our operating income was $619.6 million compared with $726.8 million last year. This translates to a 9.6% operating margin, again impacted by 140 basis points for the special cost savings charge. Over the past four years we've achieved significant cost savings in selling, distribution and general and administrative expenses, reducing these costs by approximately 210 basis points. We have strategically reinvested some of those savings in advertising, merchandising and sampling to continue driving our growth for the long-term health of our business. Looking at operating profits by category, each of our product categories was negatively impacted by the incremental operating expenses associated with stock-based compensation and all, except haircare, by the implications of the Federated May merger. Skin care profits declined due to lower than anticipated sales in the U.S. from some of our core brands. Operating results in fragrance also declined due to lower sales from certain established fragrances, along with a higher launch and development costs. Makeup's results were up strongly reflecting improvement in our makeup artist brands which were partially offset by declines in certain core brands and at BeautyBank due to the difficult comparison I mentioned earlier. In haircare, operating income increased due to higher sales. By region, operating profits in the Americas declined, primarily because of costs related to stock-based compensation as well as challenges in certain of our core brands due to competitive pressures and retailer consolidation. These decreases were partially offset by healthy operating income gains in our makeup artist brands and online business, as well as certain other developing brands. In Europe, the Middle East and Africa, operating income decreased compared with last year as improved results in France, the Company's travel retail business and Central Europe were more than offset by lower results in Spain, Benelux and Italy. Our business in Asia Pacific generated strong operating income growth with Korea and Japan each reporting solid double-digit gains. China's year-over-year operating loss was lower, as we are beginning to see positive results from our investments in that market. On the negative side lower results were reported in Taiwan. Regarding our interest costs, we reported net interest expense of $23.8 million this year versus $13.9 million last year. The increase is primarily due to higher average interest rates and higher average debt balances as a result of outstanding commercial paper during the year. The effective tax rate for the year was 43.6% including the previously announced impact of the IRS tax settlement and the American Jobs Creation Act which added approximately 5.9% percentage points to our tax rate. In fiscal 2006, as planned, we repatriated $500 million of extraordinary inter-company dividends under the AJCA. Let me now switch to our financial position. Our net cash flows from operating activities for the fiscal year ended June 30, 2006 improved 52% to $727 million, reflecting a strong improvement in certain working capital components. The year-over-year improvement in accounts receivable primarily reflects higher domestic collections during the fiscal year. Inventory levels remain relatively constant in value at June 30, 2006 compared with the prior year, due to the successful efforts managing our inventory. Increases in other accrued liabilities were primarily due to higher selling, marketing and advertising accruals and the absence of the significant deferred compensation and supplemental pension payments made to retired executives in the prior year. During the fiscal year, we returned $486 million to stockholders in the form of stock repurchases and dividends. We spent $401 million to repurchase approximately 11 million shares of our stock under our share repurchase program. This program, which has no fixed timeframe or required dollar amount, gives us the flexibility to take advantage of market conditions as they arise. We will continue to aggressively buy back our stock under the right conditions and return excess cash to our stockholders. We made dividend payments on our common stock of $85 million. We will continue to review our dividend policy to ensure we have the desired balance for the uses of our cash. We spent $261 million of funds for capital expenditures which includes incremental spending for our company-wide systems initiative. In fiscal '07, we anticipate approximately $685 million of cash flow from operations. We expect capital expenditures of approximately $290 million in fiscal '07. Regarding our working capital, inventory at June 30th, 2006 was $766 million, slightly lower than last June. Throughout the year, our goal was to reduce inventory days back to the 162-day level we reached in fiscal 2004. We ended fiscal '06 at 166 days, slightly short of our target but a very favorable improvement compared to the 175 days last year. We anticipate continued improvement next fiscal year. Our days sales outstanding was 43 days this year, a three-day improvement over last year. Let me now update you on a few assumptions for fiscal 2007. Please remember, as you've heard us say many times, we run our business on an annual basis. For the year we anticipate strong domestic and international sales growth driven by the strategies William discussed. Our forecasted sales growth for fiscal '07 is approximately 5% to 7% with minimal foreign exchange impact. Our plan reflects current business conditions and those we can reasonably anticipate at this time. While we feel confident about the top-line in fiscal '07, there are a few factors that carryover from fiscal '06 as well as new initiatives this year that will affect our reported results. First, we expect Federated will close approximately 15 additional doors during our fiscal '07 year. At the same time, during the first seven months we will be impacted by lost sales from the 75 stores that closed in fiscal '06. Reflected in our fiscal '07 full-year forecast is a loss of approximately $55 million in sales, and $0.08 per share of lost earnings resulting from these closures. Also, as you know, Federated announced the sale of its Lord & Taylor division which it expects will occur this fall. The buyers of Lord & Taylor have said they will continue to operate the chain as a going concern. Based on this information, we have at this time included in our fiscal '07 estimate approximately $50 million of net sales equal to $0.06 per share relating to our business in the Lord & Taylor chain. However, if store closures are announced, we may have to reduce our projections. Second, the cost reductions we made in the second half of fiscal '06 are expected to result in an incremental $37 million of savings this fiscal year. These savings have been included in our overall expectations for the fiscal year. We expect gross margin to improve about 50 to 100 basis points for the fiscal year with supply chain savings, product mix and lower promotional spending providing most of the benefit. We anticipate operating expenses to increase between 50 and 100 basis points. As I mentioned, we expect lower promotional spending, which is captured in our cost of sales, but plan to shift that spending into advertising, merchandising and sampling. This year more of our spending is planned for our faster growing and developing brands, although they still do not spend at the same levels as Estee Lauder and Clinique relative to sales. We've planned higher selling costs as we undertake an enhanced focus on training and education of our beauty advisors which, as you know, are key to the value proposition our consumers receive. The increase in operating expenses will also reflect higher levels of investment spending behind new product launches and new channel initiatives, as well as incremental in-store activities to support our business during the national nameplate change to Macy's in September. We also expect operating expenses will be negatively impacted by incremental spending related to our strategic modernization initiative and for compensation changes which better align employees interest with that of our stockholders and the Company's goals. William has already outlined some of our more significant cost savings initiatives for fiscal '07. As I've said before, we plan to be very aggressive in pursuing financially justifiable cost savings throughout the Company and will act as opportunities present themselves. As a result of the gross and operating expense ranges, our reported operate margin is expected to be relatively consistent with fiscal 2006. Since fiscal 2002, when we laid out our five-year financial objectives much has transpired both within the Company and the marketplace that has affected our business. We acquired or licensed seven brands and developed five others. We've entered new channels and have seen our core channels consolidate. We have, on average, grown our sales faster than planned, generated more operating income than planned, and increased our return on invested capital ahead of our target. While this is a solid performance over the last four years and we've overcome many challenges, we will not reach our original restated goal of 12.5% to 13% operate margin by the end of fiscal 2007. Nevertheless, we do believe that our underlying business fundamentals are solid. We have formulated a number of promising initiatives to drive future growth and we have ample opportunity for margin expansion. We are planning to hold an investor conference in the spring of 2007 here in New York to update you on our strategic initiatives and lay out our financial goals for the next three to five years. As we get closer, we will provide a specific date and agenda. At this time we expect our effective tax rate will be approximately 37% throughout fiscal 2007. Our reported diluted EPS for fiscal 2007 is expected to be between $2.00 and $2.10, which again reflects $0.08 per share impact from Federated and includes $0.06 of earnings from Lord & Taylor doors. Looking at our first quarter, we expect EPS for the three months ended September 30, 2006 to be between $0.15 and $0.20. Our forecasted sales growth for the fiscal first quarter is approximately 5% to 7% in local currency. We expect the impact of foreign exchange will be minimal. Our first quarter will be impacted by the Federated stores that closed last year, particularly for Estee Lauder and Clinique. During our first quarter, we plan to invest significantly more in some of our fast-growing brands, as well as in Clinique in North America to build momentum throughout the year. We are also investing heavily in Tom Ford Beauty, as we continue to develop that brand; in our sales force initiative, and in supporting the Macy’s national nameplate change. That concludes my comments, and we would be happy to take your questions now.

[Operator:]

(Operator Instructions) Our first question comes from Chris Ferrara - Merrill Lynch.

[Chris Ferrara:]

I just wanted to ask about the incremental spending that is going on for 2007. Is it fair to say that the bulk of the incremental spending is hitting in the first quarter of 2007, since that is really where you see the biggest meaningfully lower EPS on a year-over-year basis?

[Rick Kunes:]

That is a fair statement, Chris. If you look at our sales growth for the year, you know, 5% to 7% including some carryover effect of the Federated May merger, that’s pretty solid sales growth and we are investing heavily -- and in particular in the first quarter -- to achieve that sales growth. So, yes, that is a true statement.

[Chris Ferrara:]

Okay and then just as a follow up, what we had been seeing through 2006 was lower advertising as a percentage of sales. The argument was that you were growing faster in brands that are less heavily skewed toward advertising and now you guys have made this decision to invest real heavily into this year with no margin expansion despite savings. Did something change on your outlook for overall sales growth? Does something look like it is needs more urgent fixing than you had originally thought, or is there really not much difference there? And also was any of the shift in spending related to the nationalization of gift with purchase and just uncertainty on needing to spend more heading into that?

[Rick Kunes:]

No, the spending relates to a few initiatives that I think we outlined in the call. One was for the sales force initiatives and the training and education of our beauty advisors and that is a pretty big program that we have going this year. Second is that we are investing quite heavily in those brands, some of our newer brands and developing brands and fastest-growing brands. So even though you will see in fiscal '07 that our advertising, merchandising and sampling as a percentage of sales is coming down, it would have come down further were it not for this incremental investment into that area. We also have things like the SMI program going on and some pretty big investments in the Clinique brand to help make that brand grow. So those are really the big drivers.

[Operator:]

Our next question comes from Sandy Beebee - HSBC.

[Sandy Beebee:]

Good morning. I was wondering when we look out beyond fiscal 2007 if the bulk of this additional investment is something that is going to be part of the cost structure going forward?

[Rick Kunes:]

Sandy, it's really related to, if you will, jump starting our business. While we're happy with the 3% sales growth or at least we are happy that we have achieve that, we are not satisfied with it. We want to jump start the year and start out with a solid footing. Again that 5% to 7% sales growth is pretty good, understanding that there is still about $55 million of lost sales, if you will, around the Federated May merger. So it is really around that more so than a permanent, higher level of investment spending.

[Sandy Beebee:]

Just as a follow-up to Chris's question just on the developing brands and the investment that you are stepping up there, can you just provide some color as to why now you feel like there is a need to step up the investment behind those brands, since they are doing pretty well without very high A&P today?

[Rick Kunes:]

They are doing pretty well, Sandy, but its part of our overall strategy to really support those brands as part of our portfolio management strategy. So we are continuing to focus our resources on the brands that provide the greatest opportunity. Those brands do provide a terrific opportunity around the world. So we are investing quite heavily in those brands next year. Why now? Well, you know, last year we obviously were constrained a little bit from a spending perspective based on some of the events that occurred and we were doing our best to protect the bottom line. But going into next year, we are building some of this spending into our plan.

[Operator:]

Our next question comes from Filippe Goossens - Credit Suisse.

[Filippe Goossens:]

Good morning and many thanks for taking my question. My question is actually addressed to both William and Cedric. Last year you paid down debt, your cash flow improved significantly; all of that basically contributed to a further strengthening of your financial flexibility. With that as a background, in the press release you state that you're looking this year to further build your foothold internationally. William and Cedric, are you largely going to focus on organic opportunities with both core brands as well as the faster growing new brands? Or might we also see an increased desire to look at M&A opportunities to accelerate the expansion of that footprint internationally? Thank you.

[William Lauder:]

I think primarily our primary investment focus that we are committed to, that is reflected in our plans for the year, is in our organic growth and expansion of existing brands and existing markets as well as expansion of existing brands into newer and emerging markets. We will continue to look for opportunistic M&A activity in emerging markets as well as markets outside of North America as they strategically fit within the criteria which we have been pretty consistent in laying out for you over the last couple of years.

[Operator:]

Our next question comes from Wendy Nicholson - Citigroup.

[Wendy Nicholson:]

Two things. I know you talked about Estee and Clinique being down year-over-year for the full year in the U.S. Can you tell us what Estee and Clinique did globally for the year? Second thing is I just want to go back to the first quarter guidance for a second. I'm a little confused in terms of just how much money is being spent in the first quarter, because it looks like you are getting great sales growth but I thought you had an easy comp to last year's first quarter when you spent a lot. So to forecast an operating margin of something like 4% in the first quarter seems incredibly, incredibly low. Can you give us a sense of specifically advertising spending, what the delta is going to be year-over-year in Q1? Thanks.

[William Lauder:]

Well, Wendy, the first part of your question about the Estee Lauder and Clinique brands, as you know we do not actually report detailed results on a brand-by-brand basis, either a global or regional basis. Both brands on a global basis did expand marginally. It was primarily driven through their accelerated growth in markets outside of North America. We are pleased with the progress that both of these brands are making, especially in these markets, and we will continue to expect more improved results from these brands in the future. As far as the second part of your question, I think I'm going to let Rick handle some of those pieces to it, but suffice it to say we are continuing to advertise as well as support these brands on a promotional basis, and there are some shifts going on on a brand-by-brand basis, both in North America and international, which are affecting us.

[Rick Kunes:]

Wendy, we like to run our business on an annual basis. Our business plans are such that we are investing money in the first quarter for what we think are good business reasons and good business opportunities to deliver the full fiscal year. We'd rather, quite honestly not dwell, if you will, on first-quarter plans. We did lay out what we said, which was we're investing in the Clinique brand pretty heavily; we're investing in some of our newer and growing brands. So we are making some strategic decisions and investments in the first quarter that we think is going to kick-start the year and deliver the full year results.

[Wendy Nicholson:]

Thank you very much.

[Operator:]

Our next question comes from Bill Schmitz - Deutsche Bank.

[Bill Schmitz:]

Good morning. Can you talk about the absolute dollars of advertising and promotional expenses this year versus last year? Because I think you broke it out in previous years' calls.

[William Lauder:]

We did, and I did in the conference call, Bill.

[Bill Schmitz:]

I'm sorry, I didn't pick it up.

[William Lauder:]

That’s okay. I think our number was up slightly year-over-year. Our advertising as a percentage of sales, advertising, merchandising and sampling went up. Our gift spending went down, but the net of the two numbers was a slight increase this year versus last year.

[Bill Schmitz:]

Great, thanks. Then just in terms of travel retail, why don't you think there is going to be an impact? You already see that people are afraid to fly. This liquid ban, that is uncertain how long it's going to take, and I know you said there's a lot of business outside of the UK and the US. It's going to have some sort of impact, isn't it?

[William Lauder:]

I'm going to ask Cedric Prouve if he can answer that question.

[Cedric Prouve:]

Yes, we've been keeping in touch with our teams, as you can imagine, and based on what we know now, we don't see a material impact. We have been affected, of course, in the first few days in the areas in the UK and the US. But we see the recovery as coming on fairly fast and steady. I have to say our first concern is safety. We're happy that the silver lining of the whole series of events is that a major catastrophe was prevented. We think the fundamentals of the travel retail channel were excellent. Actually, just prior to the event, BAA actually had reported record numbers for July. So the fundamentals are good. The recovery seems to be coming on, and based on what we've measured as the impact to date, we can make it up. We just started our fiscal year. We have time to react to this, and we think we're sticking to our objectives.

[Operator:]

Our next question comes from Elizabeth Montgomery - Cowen & Co.

[Elizabeth Montgomery:]

All my questions have been answered, thanks.

[Operator:]

Our next question comes from Javier Escalante - Morgan Stanley.

[Javier Escalante:]

Good morning, everyone. I have a couple of questions. One if you could help us understand the Americas growth, if you could break it down between U.S. department stores, company-owned stores, online sales, just to get a feel where the growth sources have been?

[William Lauder:]

I think the most important thing, let's look at it this way, Javier, our fastest-growing channel of distribution in the world is online. We have meaningful growth in that category, well into the high 20s. Its beginning to become a significant number as we said in our script. Our retail store growth is very nice, it is somewhat better than our department store growth. We are looking at 10% growth excluding department stores in fiscal '06. I would expect similar, if not greater trends, in '07 as we look at the brand's success overall.

[Javier Escalante:]

Mexico and the international markets, where they a contributor in the fourth quarter?

[William Lauder:]

Yes.

[Javier Escalante:]

Does the Aveda distributor, the acquisition or consolidation of that distributor in any way help the Americas or is it not material?

[William Lauder:]

It helped the Americas, but it is really not material in the context of the overall sales value of the Americas region.

[Operator:]

Our next question comes from Amy Chasen - Goldman Sachs.

[Amy Chasen:]

Hi, two things. First of all, just on this new brand spending for the smaller brands. Can you just tell us what type of spending you are planning? I mean are you going to start to advertise for those brands?

[William Lauder:]

The initial phase, Amy, is primarily in development expenses, in developing the brand and developing the product, developing the portfolio and then the advertising spend kicks in as we're developing the network and distribution.

[Amy Chasen:]

Is this outside the U.S.?

[Rick Kunes:]

Some of it is, certainly, Amy, like for instance Aveda has big expansion plans within Europe and we are also spending in China as you know, in Japan we are spending money. As these brands roll out around the world and we're accelerating the pace of some of that.

[Amy Chasen:]

But I guess my question is for M-A-C and Bobbi Brown in the U.S., are you planning anything different as it relates to their traditional marketing strategies?

[William Lauder:]

No, we are not, Amy, the strategies will stay in place. They are not highly advertised brands, as you know.

[Operator:]

Our next question comes from Linda Bolton Weiser - Oppenheimer.

[Linda Bolton Weiser:]

Thanks. Just to better understand the travel retail issue again. Is there any way you can break down the 900 doors that you said you serve in travel retail? Secondly, you said you had mentioned a lower price lip gloss in one of your lines. I think you mentioned $16 versus a $20 price. It that one of the ways that you fight competition or is a more pervasive method to just invest more heavily in the A&P or is the pricing part becoming one part of the competitive landscape?

[William Lauder:]

I'm going to ask Cedric to answer the first part of your question.

[Cedric Prouve:]

Breaking down the 900 doors, I'm not going to break them down in details but the bulk of the doors, if you look at door distribution, is more in Europe. Then would come Asia and then the Americas. In terms of our marketing strategy, I mean this is a very complex question. We are looking at all the components and pricing of course is a key element of our strategies. Also we are looking at channel-specific products and value sets for that to become more attractive to the passengers.

[William Lauder:]

As far as your second part of your question referring to an Estee Lauder strategy, I'm going to ask Dan Brestle if he can answer that part of the question.

[Dan Brestle:]

Yes. I think price is always part of the equation as we talked in the call we talked about high price skin care and $2,100 SKUs; on the color side, $16 SKUs or products are important. So I think there are always those products that bring new customers in and a $16 price point entices a whole different customer to the Lauder brand.

[Operator:]

Our next question comes from Alice Longley - Buckingham Research.

[Alice Longley:]

Hi, sorry if I missed this, but can you give us the absolute number for the year for advertising, merchandising and sampling as that part of SG&A?

[Rick Kunes:]

Advertising, merchandising and promotion was about a little under $1.5 billion for the year. That is just that piece of it. Then there was spending in gifts as well which is another couple hundred million dollars. So the total number was relatively flat with the year before up just very slightly.

[Alice Longley:]

The advertising, merchandising, the $1.5 billion is the number that appears in SG&A, right? The $200 million is off sales?

[Rick Kunes:]

Yes, the advertising, merchandising and sampling is in operating expenses, the gift spending and promotional purchase with purchase activity is in cost of sales.

[Alice Longley:]

Then you said that your SG&A ratio overall would be going up 50 to 100 basis points in '07. I assume that administration and some of the other ratios are not going to be going up. So how much is that advertising, merchandising sampling ratio going up in '07? Would that be up more than 100 basis points?

[Rick Kunes:]

No, that one is not up more than 100 basis points. What is happening though is I also mentioned that we're shifting some of our promotional spending, so doing less of that in '07 but moving that into SG&A or advertising, merchandising and sampling expense. I think the overall percentage actually goes down very slightly in fiscal '07 versus '06, but we're also investing pretty heavily in selling expenses as we mentioned as well. There's approximately $20 million increase in selling expenses related to training and education of our beauty advisors.

[Alice Longley:]

So again to repeat this the advertising, merchandising, sampling ratio to sales is not going up in fiscal '07?

[Rick Kunes:]

If the spending is going up, the relationship to sales is approximately flat with the prior year in '07. But again, based on the sales growth and the brands that are growing under normal circumstances that relationship would go down as a percentage of sales. But because of the investment spending that we're talking about, it is actually holding relatively flat.

[Alice Longley:]

So the only reason that the SG&A ratio is supposed to be up 50 to 100 basis points next year is the increase in selling, the salespeople on the floor in department stores?

[Rick Kunes:]

No, we mentioned a lot of other things. Again you are right the selling was one but we also have new initiatives in new distribution, in new channels of distribution. We have spending on our SMI project which is about an incremental $20 million that is related primarily again to the installation of SAP but also some other changes and infrastructure and equipment. There's a couple of other items that are in there, but we laid out some of those initiatives regarding new channels and new opportunities for distribution for the brands.

[Operator:]

Our next question comes from Connie Maneaty - Prudential.

[Connie Maneaty:]

Good morning. Could you talk a little bit about the SMI initiative? I thought you were to implement Aveda in the summer. Has it been pushed off a few months?

[Rick Kunes:]

Connie, it wasn't in the summer. It was actually late in this calendar year that we anticipated to go live with Aveda and because Aveda has just completed an acquisition of one of its distributors, which we take ownership of on November 1, we felt that the risk -- because November is a pretty big shipping month for Aveda -- and the risk combined with the acquisition as well as the normal business activity that we should hold that off for a month or two. So I think it's going to go sometime after the first of the year.

[Connie Maneaty:]

Also back to travel retail, when you say there has been a recovery does the recovery mean that more people are traveling or more people are in duty-free stores buying products that are other than the ones that you can't take on a plane anymore?

[Cedric Prouve:]

Well, some of the numbers that I'm getting from my team are in terms of the business volume, and if I measure the impact on last Thursday versus what we are in the last couple of days, we see a major recovery. So the purchases are resuming. The restrictions are really targeted to U.S. bound travelers and certain categories of travelers. But we see a major recovery in the sales.

[Connie Maneaty:]

And if there are restrictions on European travel, would that have a material impact?

[Cedric Prouve:]

Of course.

[William Lauder:]

I just want to be careful about one thing, please. This situation currently has existed for six days. The rules and the rumors about the rules have changed about a dozen times in these six days. If you were to simultaneously watch MSNBC, CNN and the BBC, you would get three different stories, three different times on three different channels simultaneously. I think this as yet an undecided and still very fluid situation. I wouldn't take any one snapshot of opinion to measure anything in the future.

[Cedric Prouve:]

Actually, that is a very good point. The communication issue and the passenger confusion is really at the root of some of our problem and that is really what all the parties are trying to work out very hard right now.

[Operator:]

Our next question comes from Chris Ferrara - Merrill Lynch.

[Chris Ferrara:]

I wanted to ask you about the European pharmacy channel. I know you've said it is an area of opportunity. Can you just tell us what percentage of European prestige that channel might represent? What your share there is and how it is to your overall share, how much is it of your European share in general?

[Cedric Prouve:]

I think I can give you some examples. I think our estimate is that in France it is about as big as the perfumery channel, particularly skewed toward skin care. So it is a very sizable market and our share obviously in pharmacy is not that big at the moment. So we see that as a big opportunity.

[Chris Ferrara:]

No more specific than that though?

[William Lauder:]

I think the thing to consider, Chris, is that this is a channel of distribution where we really do not have much of a presence at all. Currently we only have the Darphin brand in there as a key player in the very top end of the French pharmacies and a few other markets. And as we mentioned, we have experimented with Origins in some 20-odd doors in France and see this as an opportunity for expansion in the future. The pharmacy channel is predominately a skin care channel and obviously from a demographic sector as well as what we've seen in macro trends in growth in this sector, there seems to be more growth in skin care in the pharmacy sector than in our traditional distribution and the perfumery sector. So we see this as a long-term future opportunity which we will look at both for existing brands and/or any opportunities we may have for expanding our presence in this channel.

[Operator:]

Our next question comes from April Scee - Banc of America Securities.

[April Scee:]

Thank you. Just two quick questions. On the first, if you could just clarify for me what the cost savings were that came through in the quarter and I apologize if I missed that. What should give us comfort in what I believe is now the $76 million in guided forward cost savings in fiscal '07, which seems to be up. I recall it was $75 million the last time you gave us guidance on it. Then on the Kohl's initiative, if we could get an update there specifically if there have been any changes in staffing based on your conversation with Kohl's or any changes in promotional levels? And whether or not this could be a portion of your international expansion plans that you did talk about?

[Dan Brestle:]

Let me cover the last part, the Kohl's part. We talked about the soft comps against the launch of Grassroots in 600 doors last June and July. Our retail sales have been good, I think on a productivity basis Kohl's and we are very pleased with what we are producing in the space allowed. The Daisy Fuentes fragrance took off and started to sell very well initially so we know there is a fragrance business there. The ongoing discussion about having demonstrations at point-of-sale continues with Kohl's. They are a terrific partner and a very willing partner. Some of the new store formats are laying out where historically cosmetics has been behind jewelry. Their new store formats in Jersey City has cosmetics going in front of jewelry. So this whole process in department is evolving. I think both ourselves and Kohl's see the opportunity in cosmetics and we're continuing to move forward. Who had the first part?

[William Lauder:]

On the cost savings you asked how much came through in the quarter. It was approximately $20 million. Why should you have confidence in the overall savings? The bulk of that was related to our voluntary severance program and those people have actually, for the most part, left the Company so those savings are, in a sense, in the bank. Another piece of it was in overhead efficiencies through closing points of distribution and the warehouse. All those things have all happened.

[Operator:]

Our next question comes from Filippe Goossens - Credit Suisse.

[Filippe Goossens:]

Good morning. One additional question with two parts to it in terms of new channels. The first one, William, when can we hear something with regard to the J.C. Penney-Sephora alliance? What the involvement, if any, will be of Estee Lauder? The second part of the new channel question is, in terms of international you're looking now at the apothecaries in France and Europe as an additional channel. Now if we look at what L'Oreal recently did with the purchase of the Body Shop, do you see opportunities or do you see the need of also looking at perhaps acquiring a stake or outright purchase of a specialty store channel to give you that enhanced footprint internationally? Thank you.

[William Lauder:]

Filippe, let me answer the second part of your question first. We established a brand in 1990 called Origins which was based on many of the natural principles. And from the get go we launched that brand in dual channels of distribution, both our traditional distribution in department stores predominately in North America, Asia as well as a handful of pharmacy and alternative distribution in Europe; and retail stores predominately in North America to complement the department store business. That brand today has over 100 and some odd stores in North America as well as quite a number of its own stores in other markets in the world, as well as many hundreds of department stores and perfumery businesses throughout the world. In 1997 we acquired Aveda, which also has about 7,000 points of distribution in North America, 120 some odd of which are its own retail stores and the remainder being independent salons operated in a number of different categories. If you add to that the M-A-C brand which also has over 100 retail stores as well as a group of stores we have in North America as well as in Europe called the Cosmetics Company Stores, we already operate a group of about 500 retail stores which are owned by the Company and operated by the Company. I believe one of the reasons our competitor was interested in acquiring The Body Shop was that they did not have a presence either in the naturals or in a retail presence of any meaningful way and this was perhaps a way for them to jump up in scale. I can't speculate on what their strategic initiatives were, perhaps you might want to ask them. But I would imagine that would be one of their motivations. We believe that the naturals offer us a great opportunity and both Origins and Aveda will be continuing to exploit those opportunities on a regional and global basis, and we're continuing to look at other strategic opportunities that might allow us to continue to penetrate alternative distribution markets. As far as whether we want to become a retailer or not, I want to be quite careful, we are global brand marketers, first and foremost. We look at strategic opportunities for retail distribution that complement our primary strategy as global brand marketers, who are able to establish flagship brand images in key markets as well as offer alternative distribution when consumers are shopping for our brand where our traditional distribution does not necessarily appeal to the consumer. I'm quite hesitant though, on a broad basis to become a significant retailer because that is not necessarily our specific expertise. Our specific expertise is in branding and marketing on a global basis.

[Dan Brestle:]

This is Dan. As to the first part of your question, we have two brands that are presently selling so far is the Aramis line of fragrance brand and Clinique. As best as I understand, the negotiations are still going on as to whether either of these brands are going into the JC Penney venture with Sephora. I would think, Filippe that it is probably early September before we know and have clarity on that.

[Operator:]

Our next question comes from Javier Escalante - Morgan Stanley.

[Javier Escalante:]

Good morning. My question is with regards to understanding better the May and Federated impact the store closures. Basically if you can go back to the 2006 and if you can split it between how much of it was product returns versus forgone sales of the stores? Secondly going forward, you are estimating $0.08 impact in '07. So how much of that is forgone sales and what does your research show about consumption of prestige cosmetics by the shoppers of these closed stores? Where are they buying? Is it that they are not buying prestige cosmetics, or they are buying elsewhere? So if you can help us understand the impact, that would be great.

[Rick Kunes:]

Regarding the financial numbers, Javier – these are very, very rough numbers so please understand that -- about three-quarters of the impact is lost sales and about one-quarter of the impact is related to returns. Those are rough numbers. It might be a little bit more for returns and a little bit less for lost sales, that is in fiscal '06. When you go into fiscal '07, it is a little bit more heavily weighted toward lost sales because MSNs were anniversarying all of those doors that closed in '06. We're only anticipating another 15 doors to close in '07. So the returns number is certainly going to be much lower and it's going to be much more heavily weighted toward lost sales.

[Dan Brestle:]

Just to address two parts of that, Javier, this is Dan. We were also very clear in the conversations all year long that it is just not the focus of lost sales. The May Company cosmetic business was off significantly for a lot of other factors getting through this consolidation and this merger. So it wasn't just the lost sales. In those 75 malls where we have closed doors we see anywhere from 80% to 100% pick up in the everyday business. The critical business going forward will be those promotional activities and we are not seeing the same type of pickup in promotions. The promotions are not picking up all that business, that is the initial tick. Now for Clinique and Lauder, we're talking about September, October, are the major two months now that we have national dates. So we will know more about the pick up of the closed doors coming out of the September for Estee Lauder and October for Clinique timeframe.

[Operator:]

Our next question comes from Amy Chasen - Goldman Sachs.

[Amy Chasen:]

Just a question about Clinique and Sephora, Dan, it sounded like you did not rule out the possibility of Clinique going into those J.C. Penney/Sephora doors and I'm actually pretty shocked by that given the philosophy of the whole Estee Lauder Company's distribution.

[Dan Brestle:]

Amy, I didn't think we could do anything to shock you. But we have not ruled it out. Clinique is a very valuable brand to us. We are listening to both sides of all the discussions and what opportunity J.C. Penney will bring. The importance of understanding this deal is will the product offering that Sephora brings into J.C. Penney seduce that 26-year old Sephora customer into J.C. Penney, or will they have to bring a product offering that services the 49-year old J.C. Penney customer? So there are a lot of questions still sitting out as to how this is going to go down. But, yes, I did not rule it out.

[Amy Chasen:]

Can you also just talk about the fact that you are doing gift with purchase in Kohl's? I was a little bit surprised by that given the changes that you are making to your gift with purchase program on your more traditional brands. I'm surprised you would want to go down that path in this new distribution.

[Dan Brestle:]

We have been talking for months now about trying to get our promotions in line with the attitudes of the store. Obviously in Kohl's the most successful promotional tool for us is the off-price where we go into their flyers and look at off-price. I don't think gift with purchase is a major component in the whole program. We've been doing free lipsticks, gift with purchase. But off-price, which we had that flexibility given the fact that we have no other customers in the world and the product is exclusive with Kohl's, it seems to be the most favorable promotional vehicle.

[Operator:]

Our next question comes from Linda Bolton Weiser - Oppenheimer.

[Linda Bolton Weiser:]

Thank you. Can you just elaborate on the overall net impact of the Macy's national rollout in the fiscal first quarter '07? I think you mentioned there was a major promotion, is that a gift with promotion or is that not until October? Secondly, is it just that the spending is far outweighing any volume increases you would get from the national promotion? Can you just explain it a little bit more?

[Dan Brestle:]

This is Dan again. I'm going to explain what is happening and Rick may want to comment on some of the financials. The critical date for the May Federated merger is September 9. September 9 all the May Company stores change, as you know, to Macy's stores. Macy's Federated, the corporation, is putting together a major promotion around the change of the nameplates. That promotion includes national advertising, local advertising. Fortunately the Estee Lauder brand starts their national gift with purchase a week later. So there will be tremendous activity to the Estee Lauder gift with purchase because of the change in their nameplate and the investment that Federated is making during that very important timeframe for them.

[Rick Kunes:]

We also have planned certainly some in-store activities to support that transition and to make sure that the customers when they come to now a Macy's store which used to have a different name on the door that their in-store experience is a very positive one, that initial experience. So some of that has shifted. There's a little bit of advertising shift so there is some spending that is in the first quarter related to the national nameplate change as well.

[Dan Brestle:]

You have to understand that there are many markets that have never experienced a Macy's store in their market. If you look at all the conversion of the Foleys stores to Macy's, most of those markets have not had Macy's. Where it is different in the Northeast or where we live where you've been in Macy's or Filene's. So that customer has already made that decision and that transition is going to need some other methods of bringing her back into the Macy's store.

[Linda Bolton Weiser:]

So of the $0.08 impact of just the store closures, how much of that is expected in the first quarter?

[Dan Brestle:]

Well, the store closures we are anniversarying seven months so the whole first quarter all 70 stores were anniversarying all those lost sales. If in fact they were on promotion during that time, I don't know specifically whether Filene's was on promotion or which stores, so it's a quarter worth of 70 doors worth of sales and we take that through the second quarter right through January of next year. So we have seven months of full sales for 70 doors plus we're going to live through 15 doors with 12 months of their sales through the same period.

[Operator:]

Our next question comes from Connie Maneaty - Prudential.

[Connie Maneaty:]

Hi. You mentioned in your remarks, William, that Estee Lauder’s brand operating margin rose. Can you tell us is this the first time in a while and give us an order of magnitude that suggests how that brand might be stabilizing?

[William Lauder:]

Well there are two different factors to that, Connie. First and foremost is the stabilization and improvement of their performance in North America as well as their improvement outside of North America. The Estee Lauder brand like the overall total part of the Company, has better earnings outside of North America than inside North America. The Estee Lauder brand was growing at a fairly healthy clip in Asia, travel retail and Europe in that order throughout the fiscal year and with a higher mix of their total profitability, the order of magnitude was 60 basis points. So they did a significant job in improving their total profitability but that was driven primarily, if you will by regional mix, as well as some other activities and expense control at home.

[Connie Maneaty:]

That is great. If I could just have one final question on travel retail. Have you been asked to take any liquids or restricted products off store shelves?

[William Lauder:]

No.

[Connie Maneaty:]

Okay, thanks.

[Operator:]

Our next question comes from April Scee - Banc of America Securities.

[April Scee:]

Yes, just a follow-up on my prior question. Relative to the fiscal '06 savings guidance of $45 million, where did you come in for the full year? And if you fell short of this, why wouldn't that be transferring to fiscal '07?

[Rick Kunes:]

It was really a timing -- we were a couple of million dollars short of the $45 million I think that we anticipated this year and it was really just a timing of the execution of some of those things. So that is why when they are fully executed they will deliver annual savings of the $75 million, $76 million. So it was just a timing thing, that's all. And a very small difference, quite honestly.

[April Scee:]

Okay, great. Thank you.

[Operator:]

Our next question comes from Sandy Beebee - HSBC.

[Sandy Beebee:]

Hi, I had one question on Tom Ford. While he transitions and moving onto his own brand, what do you expect to happen to the Estee Lauder collection? What do you expect for the new brand as it rolls forward in '07?

[William Lauder:]

Well, Sandy, first of all as we mentioned in the script, Tom Ford will continue to be doing some limited collections for the Estee Lauder brand and extensions again of the Amber Noon and Azuree collections -- perhaps one or two more -- as he continues to build his own Tom Ford brand. Obviously his program for the Tom Ford brand are not just in our activity in the fragrance category with Black Orchid, but a number of other activities and other categories for which others have partnered with him on. As he continues to plan the expansion and develop the expansion of the brand in a number of categories as well as markets around the world, we will continue to work with him to expand the distribution of that brand.

[Sandy Beebee:]

Great. And then I had just one follow-up question on some of the investment activities. What gives you confidence that the incremental spending that you are going to be putting behind the beauty advisors will give you an adequate sales return?

[William Lauder:]

Well, I think first and foremost, Sandy, we believe primarily in the department store markets around the world, those are Anglo department store markets as well as Asian department store markets, we find that one of the most powerful vehicles for driving sales is the quality of our beauty advisors, Clinique consultants, makeup artists and their impact and touch to the consumer. We find that when we do invest in this category and improve retention as well as the quality of their selling experience to the consumer that we do get meaningful returns relatively quickly. In fact, if you want to look at it, the main differentiating value proposition that our prestige brands offer to the consumer is this high level of service to the consumer at the point-of-sale versus more mass-oriented brands where it is offered at blister pack and pegboards without any assistance in finding the right product, the right shade and the right formulation for the consumer.

[Operator:]

Our next question comes from Linda Bolton Weiser - Oppenheimer.

[Linda Bolton Weiser:]

Yes, can you just tell us what percentage of total sales the Internet sales have now become?

[Rick Kunes:]

Linda, I don't know off the top of my head. It's still fairly small but it's becoming much more meaningful from a profit perspective.

[William Lauder:]

The growth as we talked about earlier.

[Linda Bolton Weiser:]

Is it still less than 10% of sales?

[William Lauder:]

Oh yes.

[Linda Bolton Weiser:]

Is it more than 10% of profit?

[William Lauder:]

No.

[Linda Bolton Weiser:]

Okay, thank you.

[Operator:]

That concludes today's question-and-answer session. If you were unable to join us for the entire call, a playback will be available at 12