Q3 2006 The EstA[c]e Lauder Companies Inc. Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: 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.

DENNIS D'ANDREA, VP, INVESTOR RELATIONS, THE ESTEE LAUDER COMPANIES INC.: 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.

WILLIAM LAUDER, PRES AND CEO, THE ESTEE LAUDER COMPANIES INC.: 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, Azuree, 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 Creme 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 …