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The Estée Lauder Companies Inc. (NYSE:EL)

F3Q09 Earnings Call

May 4, 2009 9:30 am ET

Executives

Dennis D'Andrea - Vice President, Investor Relations

William P. Lauder - Chief Executive Officer, Director

Fabrizio Freda - President, Chief Operating Officer

Richard W. Kunes - Chief Financial Officer, Executive Vice President

Daniel J. Brestle - Chief Operating Officer

Analysts

William G. Schmitz - Deutsche Bank

Alice Longley - Buckingham Research

Wendy Nicholson - Citigroup

Neely Tamminga - Piper Jaffray

Ali Dibadj - Sanford Bernstein

Christopher Ferrarra - Banc of America Merrill Lynch

Linda Bolton-Weiser - Caris & Company

John Faucher - J.P. Morgan

Lauren R. Lieberman - Barclays

Constance Maneaty - BMO Capital Markets

Andrew Sawyer - Goldman Sachs

Jason Gere - RBC Capital Markets

Operator

Good day, everyone and welcome to the Estée Lauder company’s fiscal 2009 third quarter conference call. Today’s call is being recorded and webcast. For opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Dennis D'Andrea. Please go ahead, sir.

Dennis D'Andrea

Good morning, everyone. We have on today’s call William Lauder, Chief Executive Officer; Fabrizio Freda, President and Chief Operating Officer; and Rick Kunes, Executive Vice President and Chief Financial Officer. Dan Brestle, our Vice Chairman and President of ELC North America, is also on the call and Dan will be available for questions.

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.

And I’ll turn the call over to William now.

William P. Lauder

Good morning and thank you for joining our fiscal 2009 third quarter conference call. I want to begin by congratulating Fabrizio on his election to Chief Executive Officer effective July 1 as part of the succession plan and senior management transition we announced in November 2007. Fabrizio has been with the Estée Lauder company for just over a year and in that time, he has accomplished a great deal, working in partnership with me and other executives. Soon after he arrived, Fabrizio immersed himself in all the facets of the company and visited affiliates and retailers. He is a quick study. With a fresh eye, he sized up the company’s strength and identified areas for improvement. He then took the lead in developing a long-term strategy that will better integrate the company’s brands, regions, and functions, with the goal of making us more unified, productive, and profitable.

We are leveraging the company’s numerous strengths and sharing knowledge and resources. By focusing on innovation, consumer insights, and a holistic approach to running a multi-national business, we expect to enhance the company’s leadership in global prestige beauty.

When I assume my new role as executive chairman, we will continue to work closely as we refine the company’s blueprint for growth and cost reduction as times and needs dictate.

Turning to another major transition, I want to acknowledge the tremendous impact Dan Brestle has had during his more than three decades with the Estée Lauder companies. Dan will retire at the end of June and his outstanding business judgment, teamwork, and brand building skills will be greatly missed. During his career, he has worked in virtually all of our brands and been an important contributor to the company’s direction and growth.

In fact, when Dan joined, we had just three brands and one main channel of distribution. In his current position as Vice Chairman and President of ELC North America, he has helped create the North America affiliate, which is a vital component in the reorganization and refocusing of our regional structure. He will continue to be engaged in broader issues through our industry trade association.

It’s been an honor for so many of us to have worked with Dan and we are deeply appreciative of all he has done for the company.

I am sure many of you saw the announcement last week that [inaudible], currently global president of the flagship Estée Lauder brand, will become the President of the North American region, a newly created role. [Cia’s] next assignment is one of several changes in the senior leadership team. Fabrizio will talk more about those changes in a few minutes.

Turning now to global business conditions, we are finding it is still difficult to know when we will start to see real improvement. With conflicting economic reports and ongoing uncertainty, our visibility remains limited. That said, we are running our business under the assumption that the challenging climate will last for at least the next 12 months.

In the recent quarter, our U.S. sales declined but at a slower rate than in our second quarter. In the U.S., there are early signs of economic improvement but retail sales remain soft, particularly at high end department specialty stores, which continued to show significant decline.

However, prestige cosmetics have outperformed department stores overall business. For the three months ended March 31, the U.S. prestige beauty sales fell about half the rate of the average decline for department stores total business. Moreover, within beauty, we have good news to report. We gained ground on competitors, achieving identifiable success.

In the U.S. prestige department and specialty store universe tracked by NPD, the Estée Lauder companies added 100 basis points of share during our fiscal third quarter, compared with the prior year quarter. The biggest increase was in skincare, which is our most strategically important category and has the largest growth potential. Makeup also gained and fragrance grew marginally.

By brand, Clinique had the largest share growth due to strong gift programs and product launches, followed by M-A-C. The Estée Lauder brand was flat. In both the skincare and makeup categories, our brands sold the top two positions in U.S. department stores, as measured by NPD.

In this difficult economy, consumers contemplate their purchases more carefully and are attracted to innovative product and those that offer a good value. Innovation has always been a priority for our company and we are devoting even more resources and attention to creating outstanding products that fulfill and exceed consumers desires. Skincare is a critical area for driving growth and profitability, so we are committed to being in the forefront of innovative skincare products.

Clinique introduced a new anti-aging product, Youth Surge, which uses cutting edge technology. It’s unique characteristic is that it prevents and repairs visible signs of aging simultaneously. Shipments were strong and consumer response has been enthusiastic.

Clinique’s new retina solutions mineral powder acts like a makeup to cover retinas, but is a skincare treatment at heart. This unique product helped drive the brand’s domestic skincare sales this quarter.

The Estée Lauder brand reformulated its best-selling 27-year old advanced night repair. The latest version, which hits counters in July, contains our exclusive technology to support the natural synchronization of the skin’s repair and protection processes.

Estée Lauder launched time zone moisturizers a few months ago and they have been strong sellers. Time zone enabled skin to look and behave younger. Line extensions will be introduced in coming months to build on the momentum.

The company’s acquisition last year of applied genetics incorporated dramatics, a manufacturer of cosmetics ingredients, will be instrumental in creating breakthrough skinare technologies. AGI’s founder and president, Dr. Daniel [Yeroche], an expert in DNA repair, has joined our company. As you all know, consumers are being more selective about what they buy during this global economic slowdown. They are still making purchases but are buying products that are functional without being conspicuous. As a result of this trend, skincare sales are holding up better than makeup products.

We are also placing a greater emphasis on the value our products provide and reframing our message to consumers. Value isn’t just a reflection of price but encompasses quality, performance, personalized service, and the average cost over time.

Across the company, brands and businesses are reviewing their marketing and communications and channeling their messages to position themselves for the consumers’ new mindset. We believe value, which can be expressed in various ways, will be a powerful message for the foreseeable future, especially for prestige brands.

So what are our brands doing? Let me give you a few examples -- the 9,000 Clinique consultants in the U.S. have begun explaining to consumers that the brand’s three-step treatment system can last for three months, making it a great value.

The Estée Lauder brand is actively promoting its free signature services and further educating its beauty advisors so they can discuss a product value as well as its performance. The brand got a taste of the new consumer attitude at Valentine’s Day when fragrance sold rapidly, thanks to having more inherent value than the previous year, and stronger merchandising.

In travel retail, there are several initiatives underway. Clinique and Estée Lauder are working on new ideas to highlight values and special offerings. Bobbi Brown and Clinique are communicating the complementary services available in airports. Some consumers do equate value with price, so several brands are launching products at lower suggested retail price points. For example, the Estée Lauder brand is creating smaller sized fragrances. These examples show how our brands are reacting smartly and creatively to the challenging environment. Thanks to many corporate and brand specific actions, we believe we are well-positioned to emerge even stronger when the economy improves. We’ve taken steps to resize the company for the current downturn and restructure for long-term success.

We view fiscal 2009 as a transition year. When the next fiscal year begins in less than two months, we believe the Estée Lauder companies will be well on its way to becoming a leaner, more strategic, and better focused global business.

Now I will turn the call over to Fabrizio, who will talk about progress we’ve made toward our strategic goals. Fabrizio.

Fabrizio Freda

Thank you, William and good morning, everyone. Since we spoke to you three months ago, we have been busy putting in place the structure to implement our full year strategic plan. Today I will provide an update on our accomplishments.

As William mentioned, last week we announced the newly [inaudible] organization that will take effect on July 1st. I have to say that since I joined the company, I have been extremely expressed with the talent and dedication of the people here. The top executives have deep industry backgrounds and in many cases years, even the case wih our company. The team consists of new executives who fill needed capabilities, as well as our own experienced leaders. Many of them are moving to different roles or taking on other responsibilities. This still provides much continuity yet also injects new thinking and ideas.

I am confident that these will prove to be a superb group of leaders who will reach across brands, regions, and functions to achieve our financial goals and successfully implement the corporate strategy. Our 29 brands are now being reorganized into four clusters based on channel and consumer segmentation, enabling great platform for growth. This will allow the brands to take advantage of synergies, leverage ideas and scale, and better understand consumer needs.

In addition, we are strengthening the way we do business in the Americas, our largest region. It involves the creation of a North America affiliate, which we launched July 1st. The affiliate will execute distribution opportunities across brands and allow us to align ourselves with department stores as some of them full service structure.

By leveraging scale, all three of our regions also will have more resources available to develop locally relevant marketing plans and product offerings. The regional structure will enable the affiliates to coordinate their approach to customers and share consumer and competitive insights. This organization also provides a stronger platform for growth opportunities while reducing cost and complexity.

The company functions will be more fully integrated with all of the brands and regions and with focused -- and with focused [inaudible] services, productivity, and financial discipline. The newly formed executive leadership team that I discussed on the last call includes all the brands, region, and function heads under my direction. The group is responsible for achieving the company’s annual goals, implementing strategic priorities and resolving critical business issues.

One of the main priorities of our strategies is to improve cost and productivity. These efforts are being driven by our program management team. On that front, we have already taken action. We will close a Long Island assembly facility by end of this calendar year, and move the functions to our Pennsylvania plant, where we have excess capacity.

We entered into an agreement to outsource a range of information technology services and support for the company at a lower cost. Our brands continue to make progress, reducing inventories and SKUs. Even in the phase of our global trade stocking and lower sales, our inventory days improved 13% as of March 31st compared to the previous year.

We anticipate by the end of this fiscal year the number of SKUs company wide will stand at approximately 15,400, down 25% from two years ago. We are progressing in [inaudible] procurement, where we expect to save money by leveraging scale. To facilitate our buying power, we are converting our existing fragmented organization to full-time professional buying groups. This approach will give us better control over processes, policies, and spending.

Our [inaudible] rollout continues to move forward and we are pleased with the performance and quick adaptation of the functions and units that [go online]. The next step, scheduled for this month, will involve demand planning for several brands and retailer interruptions.

In addition, we plan to accelerate the [inaudible] implementation at our North American manufacturing facilities. Based on the success of installing SLP in our U.K. brand and at Aveda, we are planning to launch SLP all at once at our North America plant next April, shaving seven months off the previous schedule.

Our origin brand is concentrating on countries where it can achieve better returns and as part of this, each strategy calls for its [exit several] small markets by the end of the fiscal year. Our [fragrance task] force has taken several positive steps to improve the profitability of the [fragrance] division. We selectively raised suggested retail prices early in the year based on competitive analysis, achieved lower cost of goods without sacrificing quality, and a standard distribution in U.S. specialty stores. IN addition, Aramis and designer fragrances intends to cut the number of individual SKUs by 15% this year on top of 20% it eliminated in fiscal year 2008.

As you saw in this morning’s press release, we took an initial $6.2 million charge for restructuring, primarily for employee related cost. This is part of the $73 million restructuring and other special charges that we disclosed mid-April.

Improving performance, however, involves more than just cutting costs. The other side of the equation, generating growth, is equally important. Our strategy focuses on investing behind our most promising opportunities. As William discussed, product innovation is critical to our success and we are continuing to develop breakthrough technologies.

We are also focusing our resources on the most important markets and our strategy is really paying off. In this quarter, we gained share in our distribution in many countries and regions, which we see as a direct outgrowth of this strategy.

The Asia-Pacific region has been a bright spot for us. In each of the first three quarters of this fiscal year, we have outgrown our sales in Asia between 15% and 21% in constant currency. We expect to finish the fiscal year strong in this region.

For the quarter, we grew sales at retail in nearly every market in the region and as a company, we estimate our share grew. In Japan, our largest market in the region, we fixed up share despite a difficult environment. Certain brands also gained share in specific markets. For instance, the Estée Lauder brand became the top-selling prestige brand in Hong Kong and increased share in our distribution in China.

In Europe, we believe retail sales of prestige beauty products declined in the quarter. However, our sell-through at retail grew low- to mid-single-digits, so we grew share overall. In the U.K., our largest market outside the U.S., we estimate our retail growth was nearly double than of the prestige beauty as a whole.

So despite the global recession, we believe we continue to gain on competitors in our regions, which is a goal of our strategy.

Outstanding geographic and distribution diversification is another way to further our strategic objectives. The following examples show how brands are exploring fast-growing channels and venturing into new markets.

[inaudible] opened in several locations in J.C. Penny and will run a U.S. infomercial later this month. We continue rolling out [Good Skin Labs’] best-selling [inaudible] anti-aging products. It entered Hong Kong and Brazil and its successor product, [inaudible], made in-roads in Europe. Good Skin Labs expects to launch in more markets in the fourth quarter, adding to the 50 that are open now.

Origin will host a show on Japan QVC Channel. Even as traffic has fallen in stores, we have seen more shoppers online in every region, which we attribute to consumers wanting to avoid being conspicuous and to target their purchases.

Market Clinique relaunched their website with enhanced features and brands continue to expand international e-commerce capabilities.

Bobbi Brown opened freestanding stores in Tokyo, Dubai, and Paris. Its 12 global freestanding stores locations attract a new range of consumers. As we transition into our full-year strategy, I am extremely pleased with the first steps we have taken and with the initial progress we have already made. We established the strategy goals and parameters, selected the right people for every job, taken decisive actions and operations and refocused the portfolio toward opportunities with the highest margin and best growth potential.

By leveraging scale and ideas, investing in consumer knowledge and global R&D, and strengthening financial discipline, we expect the Estée Lauder companies to enhance its position as the global leader in prestige beauty.

Now Rick will speak to you about the financial results of the quarter. Rick.

Richard W. Kunes

Thank you, Fabrizio, and good morning, everyone. Overall, sales came within the range we forecasted. In local currency, sales this quarter decreased 2% from last year at the high end of our expectations. The strengthening dollar negatively impacted sales by eight percentage points, resulting in a reported sales decline of 10% to $1.7 billion. Reported net earnings for the quarter were $27.2 million, or $0.14 per diluted share. These results included restructuring and special charges of $6.2 million, or $4.2 million after tax, equal to $0.02 per diluted share.

Net earnings excluding the charges in both periods were $31.4 million, compared with $89.7 million in the prior year quarter, and pro forma diluted EPS was $0.16 compared to $0.46 in the prior year quarter.

Earnings came in $0.08 above the high-end of our range, due to the timing of some expenses, which are expected to occur in our fiscal fourth quarter. The Americas regions continues to be our most challenging. Sales for the quarter fell 7% in local currency, largely because of difficult U.S. business and softness in Canada and Mexico.

U.S. prestige department stores were challenged in the quarter. Their overall sales fell more than 10% on average but only 5% in their beauty departments. Retail sales of our products in U.S. prestige department stores declined 3%, according to NPD, with our shipments to this channel -- while our shipments to this channel fell about 8%. Clearly the de-stocking we experienced last quarter continued.

Results in other U.S. channels were mixed. Sales declines in our freestanding stores were comparable to our retail performance in department stores. The lines continued to suffer the effects of the downturn, but our e-commerce business rose in the high teens with all brands recording double-digit growth.

Our local currency sales in Europe, the Middle East, and Africa fell 3%, while sales declined in some key Western European markets, including Spain, France and Italy, we saw growth in the United Kingdom and Germany. Developing areas, including the Middle East, Turkey and Russia, continued to see growth. However, as expected, our travel retail division was pressured by reduced airline passenger traffic and continued trade destocking.

Local currency sales rose 13% in Asia-Pacific with all countries except Japan contributing to the growth. We are particularly pleased with our performance in Asia-Pacific this year. For the nine months, the region grew ahead of plan and more than 15% over last year in local currency.

Korea saw the fastest growth this quarter, due to the devaluation of the WON, which caused Koreans to curtail travel and buy locally. China continued to expand at a pace exceeding 20%. Same-store retail sales in China grew mid-teens, reflecting the health of the business in this critical market. The countries in this region are not immune to the economic issues felt elsewhere but so far, they have held up very well. Japan has faired the worst in the region, recording a mid-single-digit decline after a government report on declining GDP appeared to effect consumer spending.

Moving on to gross margin, we had a 120-basis point drop this quarter to 73.7%. Our ability to absorb overhead costs has been hampered by reduced production levels. The impact of this was approximately 100 basis points this quarter.

Higher promotional activities trimmed margin by about 40 basis points and adverse currency and mix were 20 basis points each. On a positive note, these decreases were partially offset by reduced obsolescence charges and other favorable manufacturing variances of 30 basis points each.

Pro forma operating expenses as a percentage of sales for the quarter were 69.2%, compared to 66.3% last year. Total pro forma operating expenses declined approximately 6% this quarter as we continued our belt-tightening efforts. However, sales declined at a faster pace. Continued investment in global IT systems and infrastructure, charges related to difficult business conditions at certain of our retail customers, and net losses from currency transactions hurt the operating expense margin by about 60 basis points each.

Intangible asset impairment charges, which related primarily to our [inaudible] brand, negatively impacted the operating expense margin by about 90 basis points.

Pro forma operating income fell to $76.5 million this quarter, compared to $160.5 million last year. Reported operating expenses were 69.6% of sales as restructuring and other special charges added about 40 basis points. As a result, reported operating income dropped to $70.3 million, including the charges.

Regarding our net interest expense, we reported $20.6 million, compared with $16.1 million in last year’s third quarter. It rose primarily due to higher debt levels, including the $300 million five-year notes we issued during our last quarter, partially offset by lower average rates on borrowings. The effective tax rate for the quarter was 43.1%, primarily because the majority of the write-off of intangible assets was non-deductible.

Moving on to working capital and cash flow, our cash balance at the end of March was $641 million. Our day sales outstanding were 55 days this quarter, the same as last year. We continue to keep an eye on the financial health of the parties with which we do business. For example, one U.S. retailer is liquidating and we are closely monitoring one customer in Russia.

Despite lower sales and de-stocking in the quarter, our inventory days improved to 154 compared with 176 days last year. Reflecting positive working capital trends, our net trade cycle improved to 128 days from 161 days a year ago. For the nine months, net cash flows from operating activities were $307 million, compared with $519 million in the prior year period.

We spent $216 million for capital expenditures in the nine months of fiscal 2009, 14% below the prior year and reflecting significantly tighter controls on uses of cash versus our plan.

For fiscal ’09, we expect to generate around $470 million of cash flows from operations and to use about $270 million for capital expenditures.

We continue to pursue our growth strategies while protecting our bottom line. We expect about $250 million in spending reductions this year from our belt-tightening initiatives.

As William and Fabrizio said, we began to execute the long-term strategic plan that we laid out last quarter. This resulted in restructuring and other special charges of $6 million, representing the first actions against our targeted $350 million to $450 million in charges over the next few years. We expect to have a clearer picture of the timing and amount of cost and savings by our fiscal year end.

Keep in mind that as restructuring decisions are made, we plan to update you through 8K amendments as we did in mid-April. The figures cited in these amendments represent charges that will eventually be recorded in our P&L as the relevant criteria are met. We will keep you apprised as we continue to make progress on the strategy in the months ahead.

Let me now discuss our thoughts on the year. We remain cautious about the consumer and continue to believe the current globe economic conditions will contribute to soft retail sales. Our ability to forecast remains difficult but we can convey our assumptions to give you some guidance.

For the year, on a constant currency basis, we expect our international business to continue to be our leading performer. We are forecasting sales growth in Asia in the low teens, although the environment could worsen. Europe and the Americas are each forecasted to decline at mid-single-digit rates. We expect fiscal 2009 local currency sales to decrease between 1% and 3% compared to last year.

Foreign currency translation is likely to lower our reported sales by approximately five to seven percentage points. For the remainder of the fiscal year, our assumption for the Euro is $1.33; for the Yen, $0.98 to $1.00; and for the Pound, $1.43. If the dollar strengthens or weakens against these major currencies, it will further impact our financial results.

We are tightening our pro forma full year EPS forecast to between $1.32 and $1.44. This includes approximately $0.21 to $0.23 related to the negative impact of foreign currency translation. This range does not reflect any one-time expenses or charges that may result from the implementation of our strategic plan.

The expected $350 million to $450 million in restructuring will be reflected in our P&L as per accounting rules. Again, we expect to give a clearer picture of the timing and amount of these costs and savings related to our program by our fiscal year-end.

This implies that sales for our fiscal fourth quarter are forecasted to decline 8% to 10% in local currency. The negative impact of foreign exchange translation is expected to lower sales growth for the quarter by about eight percentage points. As I mentioned earlier, some of the operating expenses we thought would occur in our third quarter are now expected to be incurred in the fourth quarter. Additionally, we are also expecting continued foreign exchange translation losses.

We forecast pro forma EPS for the three months ending June 30, 2009, to be between $0.11 and $0.23.

Our assumptions for the economy and our business have not changed materially. Our performance is dependent on trends in the consumption and trade stock levels. Our outlook assumes that the downturn will last for at least another 12 months. We remain focused on executing our strategy, reducing costs, and conserving cash, while steadfastly maintaining vital investments.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Bill Schmitz with Deutsche Bank.

William G. Schmitz - Deutsche Bank

Good morning, guys. Hey, just talking about the local currency guidance for the fourth quarter, the down 8% to 10%, I mean, did you see something in April that made you kind of switch that from a negative 2% you saw this quarter?

Richard W. Kunes

No -- you know, we had a very strong fourth quarter last year, Bill, and as well, there was -- there’s some of our gifts are in the third quarter, which drove a little bit of the retail performance in North America and so there’s a little bit of a change from last year but overall, we remain pretty confident in the range that we gave for the full year.

William G. Schmitz - Deutsche Bank

Okay, great and then just sort of a kind of related follow-up, I mean, in the guidance, do you have -- are there restructuring related charges or more good will write-offs in there? I mean, is there anything besides just the sort of GAAP defined restructuring that we should be mindful of in the numbers?

Richard W. Kunes

Bill, the total that we talked about was $350 million to $450 million and that would be incurred over the next several years, so will there be further restructuring and one-time charges in our fourth quarter? I think the answer is yes to that. The question is how big will the magnitude be. But we will inform you as soon as any of those decisions are reached via an 8K, but that is not included -- you know, those numbers are not included in our guidance.

William G. Schmitz - Deutsche Bank

Okay, Rick -- more the question was like if the amortization charge you guys reported this morning wasn’t included, so is there anything that isn’t defined as restructuring under GAAP that might also impact numbers, like along the lines of that write-off, the dual amortization?

Richard W. Kunes

Bill, the reason that we included that in our normal operating results is in our minds, that was business as usual and it was business decisions that we reached. It wasn’t something unusual in the fact that we are changing major distribution patterns or whatever around brands. It was really just driven by our business and that’s consistent with the way we treated some of that previously, so we included that in our numbers.

William G. Schmitz - Deutsche Bank

Okay, great. Thank you very much.

Operator

Your next question is from the line of Alice Longley with Buckingham Research.

Alice Longley - Buckingham Research

Good morning. Can you tell me with that 8% to 10% decline for the fourth quarter, how much of that do you think is continued destocking at retail or by retailers? And are you seeing destocking continuing in both North America and in Europe?

Richard W. Kunes

Yeah, we are seeing destocking continue in both places. I think the pace of destocking is beginning to slow a little bit but part of it again, as I had just mentioned, is because of the timing of some gift activity here in the U.S., which was in the third quarter, which drove some of the performance here a little bit better than maybe you are seeing it versus last year. And we did have a strong fourth quarter last year. I think we reported 9% comparable currency and 13% or 14% reported numbers in the fourth quarter of last year, so we had a strong fourth quarter last year which we are up against as well.

Operator

Your next question is from the line of Wendy Nicholson with Citigroup.

Wendy Nicholson - Citigroup

My first question has to do with travel retail -- could you spell out specifically how that did in the third quarter and what your guidance is for the fourth quarter?

Richard W. Kunes

In our third quarter, Wendy, our travel retail business was down around 20%. For the year, we see airline traffic down about 10% and we think our overall business will be roughly around those kinds of numbers -- mid-teens.

Wendy Nicholson - Citigroup

And are you seeing destocking there too or is there a good translation between what your business is doing on a sell-through basis and what you are shipping in?

Richard W. Kunes

No, there is absolutely a destocking in that business as well -- it’s the same pattern that we’ve seen quite honestly in many of our businesses where everyone is reacting to the economic conditions and pulling down their working capital investments, if you will.

Wendy Nicholson - Citigroup

And do you think you are gaining share in that channel the same way you are in the traditional channels?

Richard W. Kunes

Yes, we believe in travel retail, we are gaining share.

Wendy Nicholson - Citigroup

Okay. Thank you very much.

Operator

Your next question is from the line of Neely Tamminga with Piper Jaffray.

Neely Tamminga - Piper Jaffray

Good morning, gentlemen. I just wanted to ask a little more a big picture on the strategic plan. Could you -- for retail or for Rick, could you give us a sense in terms of the buckets, the biggest buckets towards that plan? You’ve outlined you have several different initiatives, but wondering where you think you are going to see some of the earliest and possibly the biggest movements in basis points towards the op margin goal. That would be very helpful. Thank you.

Richard W. Kunes

Sure. I guess from a cost perspective, certainly I will answer and if you need more than that, but you know, we did talk about reducing our workforce by approximately 2,000 people. That’s a big driver of the savings and that’s done through improving our productivity and also the new regionals alignment structure that Fabrizio said, we’re looking to drive efficiencies and pull out some of the back office duplicative costs that the company has traditionally held, so that’s the biggest opportunity for us.

In addition to that, we see a great deal of savings coming from the indirect procurement organization that Fabrizio outlined in his prepared remarks. We see SMI and the implementation of SAP software, particularly in our supply chain, to be a big driver of our savings. I mean, those are the three really big buckets, which is people costs around improving our efficiencies and organizational structure, indirect procurement with the global buying groups, and then the implementation of SMI and the SAP software, which will help us drive efficiencies in our supply chain.

Neely Tamminga - Piper Jaffray

But Rick, that would seem to me that some of those cost savings are going to come sooner rather than later, kind of lumpier maybe up front, if you’ve already implemented some of these workforce reductions.

Richard W. Kunes

Well actually, our workforce reductions are in two parts -- one is sort of achieving the productivity that we have traditionally had and the second is around the organizational structure. And we see those savings coming over the next 12 to 24 months, quite honestly, before they are fully achieved. Indirect procurement is one that we are working diligently against but it does take a little bit of time and the SAP implementation, as we have mentioned I think historically, we see that shifting over from a cost to a savings during our fiscal 2011.

Neely Tamminga - Piper Jaffray

Thank you.

Operator

Your next question is from the line of Ali Dibadj with Bernstein.

Ali Dibadj - Sanford Bernstein

Hey, guys. A couple of questions about this transformation, and the first couple is around the announcement on Wednesday for a management change. It didn’t seem like there were many new faces, many new people, and then tying it to the comment today in the prepared remarks that we’ve selected the right people for every job, I guess I was surprised by that, that there weren’t more new people, more people coming, maybe, given how hard, at least my experience has been in terms of changing of culture of an organization, which sounds like what you guys have to do.

Fabrizio Freda

Actually, I think we have some real great people with excellent expertise in the industry that already are showing that they can drive the new strategy in the right way, and so we obviously put the accent on expertise and continuity wherever this was possible. There are a few cases where we have taken expertise from outside the company and in the future in different positions in the mid-management level, there will be more cases like that to inject the kind of skills and new expertise that we need. Largely as you summarized, we believe we have a strong team that will bring the [strategic] success. And the reason for this is that the strategy and the key actions and the new way of working together are going to make the same people that we had produce honestly better results because of the way we are focusing on the goals, more than because of the change of the people. The people will be, as you said, largely the same, and they are excellent.

Ali Dibadj - Sanford Bernstein

Okay. Can you comment a little bit in the structure about the oddity of, you know, Rick as CFO and Amy as HR, reporting at least partially to the Chairman? How does that work? I have never really seen that before.

William P. Lauder

Well quite honestly, Ali, we are a unique company and to try to put us into your round tag is really going to be quite a difficult challenge. The fact of the matter is that the skill sets and the partnership that Fabrizio and I have is we believe very efficient, very unique, and will allow us to work very closely. There’s a number of initiatives that are being led by both Rick and -- in the finance area and Amy in the HR area which were initiated before Fabrizio came, which we think are important for continuity purposes, to continue to work closely, both with Fabrizio and me. The fact of the matter is, is that what’s most important for all of us is the closeness with which Fabrizio and I work together and the closeness with which our entire senior team works together. And it’s less about reporting and more about partnership that makes us all successful.

Ali Dibadj - Sanford Bernstein

Okay. Last question just about the transformation is in terms of the SG&A, it was certainly lower in dollar terms than we expected this quarter. How much of that is the shifting that you mentioned, how much of that is a permanent change, and how much of that is a not-so-permanent change? Not so much shifting but costs in terms of belt tightening we may see come back in 2010?

Richard W. Kunes

Ali, the difference quite honestly between the guidance that we had given and what we actually turned out, that’s really a shifting and it’s a shifting in some respects of investment spending, where as we entered into the third quarter, we were watching everything, including what we would, in many respects consider strategic spending, very carefully to make sure we delivered our year. As we now feel much more confident in delivering the year, we are letting some of that strategic spending happen in the fourth quarter, so that’s I think what you will see.

Regarding the belt tightening, we did mention I think on the last call that a lot of that belt tightening cost reduction is temporary in nature. What we had to do was react to the economic climate that we all encountered in October as quickly as we can, but we are incorporating that into our savings targets and our strategic plan overall and we intend to, if you will, more permanent tithe those savings in some form or fashion over the long-term.

Ali Dibadj - Sanford Bernstein

Thanks. Very helpful answers.

Operator

Your next question is from the line of Christopher Ferrarra with Banc of America Merrill Lynch.

Christopher Ferrarra - Banc of America Merrill Lynch

Hey, thanks, guys and sorry to make you go through this again but I’m wondering if you could just go through all of the different timing issues that hit, and I guess Rick, you touched on some of it, talking about some of the strategic spending I guess that you are allowing to happen in Q4. But can you go through -- I thought you said something about gift timing or more gifts last quarter? I don’t know if that is just because there was better performance or because there was some timing shift for something, but can you just go through any sort of timing that might have changed from Q3 versus Q4 on the cost or the revenue side?

Richard W. Kunes

Sure. I think that the gift comment that I made was more around the sales and the question was why are our sales -- why do we think our sales are so much weaker in the fourth quarter versus the third, and part of that sales performance was driven by a planned gift shift from the fourth quarter into the third quarter, so that was the reason for that.

The rest of it, Chris, the other spending quite honestly was us being very, very cautious in the way we spent our money, even from a strategic point of view, towards the beginning of the third quarter, just to ensure that we could achieve our full-year results and we are comfortable with being able to deliver earnings within the guidance that we have just given and so we are allowing that spending to happen.

Christopher Ferrarra - Banc of America Merrill Lynch

Great, and just for the -- I guess for the related follow-up, I mean, you are talking -- it seems like we see some of your shipping, you’re trailing consumption, you are still seeing inventory destocking, you just saw your sales growth come in not as bad as the previous quarter, and I get some of the gift shift in timing but can you talk more broadly -- I mean, do you guys feel like you have seen the edge? You’ve seen it as bad as it is going to be and now things are sort of leveling off a little bit? Like do you actually see that in your business? And I understand it’s hard to predict -- I’m just looking for a general sense of how you are viewing the world from here.

William P. Lauder

Well, it’s really going to be very difficult, Chris, for us to give you any sort of insight. Quite honestly, my instinct is until we get to the mid to late fall of this year, when we start going against what were meaningfully weaker retail sales, we are not going to be able to give you some indication of oh gee, you know, things are better, things are the same. Are we bumping along the bottom, are we bumping along a plateau with another drop? I think not until we turn the corner against weak sales can we even begin to give you an instinct of where we think we are going.

But probably we’ve got another 12 months to go. Certainly right now I think what you are seeing is both the consumer as well as the retailers with whom we trade are adjusting to a level. Now the question is where is this level relative to where we were a year ago and where is this level relative to where we expect we might be in a year? I think it’s very soon, too soon to tell on that one.

What we are really focusing in on is adjusting our own ability to operate in this current environment under the assumption that this is the worst it gets, but preparing ourselves in case it is worse than how we can adjust to that reality.

Christopher Ferrarra - Banc of America Merrill Lynch

Thanks, that’s helpful.

Richard W. Kunes

Sure, and Chris, one point also to remember is that we had a fairly strong first quarter this fiscal year, so we are not really [focused] on next year but just -- you should bear in mind that when we do enter into next year, we had a very strong first quarter this fiscal year to go up against.

Christopher Ferrarra - Banc of America Merrill Lynch

Got it. Thanks again.

Operator

Your next question is from Linda Bolton-Weiser with Caris.

Linda Bolton-Weiser - Caris & Company

I was just curious if on the restructuring program, if when you give guidance for FY10 in July or August, will you be ready at that point to indicate to us the total amount of cost saves from the restructuring and new strategy that you are expecting for FY10? Or is it going to be a gradual disclosure throughout FY10 as you take actions?

Richard W. Kunes

No, Linda, I think we’ll be in pretty good shape by the time we speak to you again to have the timing of costs and savings associated with our program laid out by fiscal year and hopefully by quarter, roughly for fiscal 2010. As you can appreciate, a multi-year program like we have, there will be some changes, plus or minus, but we should be in pretty good shape by the next time we speak to you.

Linda Bolton-Weiser - Caris & Company

Okay. That’s good. And then can I just ask about -- you had mentioned like in fragrance you were making some smaller sized units that were lowering the average price per unit -- is that -- are you doing that type of thing in some of the other brands or businesses? Can you talk about that and what are the effects? Is that helping you achieve volume growth, but is that hurting price per unit? And how is that affecting profitability? Can you just talk about that?

Fabrizio Freda

Yes, we are doing this in very different brands, depending on the opportunities and in different regions. Basically we are looking for [inaudible] higher value wherever we can. Where we do that, this does not affect others profitability, otherwise we tend not to do it, obviously. But we are able to deliver this in a pretty meaningful way for the consumer and for us internally. We see the consumer obviously has been interested in reducing the risk of new trials, reducing the risk of failing in experimenting new innovation. In this way, some entry price point and some lower trial opportunities, lower priced trial opportunities are delivering some good results across the globe.

Linda Bolton-Weiser - Caris & Company

Okay. That’s very interesting. And then finally, can you disclose what was the fragrance asset impairment, the small amount that was taken in the quarter for which fragrance license?

Richard W. Kunes

Yeah, it was a small one around our Tom Ford license.

Linda Bolton-Weiser - Caris & Company

Okay. That’s all. Thank you very much.

Operator

Your next question is from the line of John Faucher with J.P. Morgan.

John Faucher - J.P. Morgan

Good morning. A quick follow-up -- I apologize for asking again about these spending numbers but any chance you are going to give us an amount in terms of the spending that is moving, or should we just sort of back into that, given the guidance?

And then secondly, over the past couple of years, your receivable terms have really been extended, as you’ve given more credit to retailers internationally. Do you have a sort of [inaudible] now and should we expect to see maybe a little bit slower growth internationally if you reign in on receivables over the next couple of years? Thanks.

Richard W. Kunes

Sure -- John, I’m sorry, the first part of your question was --

John Faucher - J.P. Morgan

Yes, the first part of the question --

Richard W. Kunes

Yes, I’m sorry, John, that was approximately a little over $20 million I believe in spending from one quarter to the next, so that was that answer.

Regarding receivables, even in this difficult climate, we are doing a pretty good job of maintaining our receivable balance and being very tight on that and actually our receivables are in quite good shape.

There will be, as our growth internationally is faster, there will be that natural pressure, if you will, on terms because they are longer trading terms internationally but we hope to mitigate that from a working capital perspective by also being smart with our payables and very, very tough on inventory. So our overall working capital, we are looking for improvements as time goes one. But in terms of the mix of our international business, you may see a slight upward pressure on our DSOs.

John Faucher - J.P. Morgan

Okay. Thank you.

Operator

Your next question is from the line of Lauren Lieberman with Barclays.

Lauren R. Lieberman - Barclays

Thanks. Good morning. My first question was just throughout the prepared remarks, you talked quite a bit about gaining share, and I know that that is sort of the new -- in the strategic plan that you are benchmarking your success in terms of growth, not just by profitable growth but by gaining market share, so is it just a change in the dialog or did something actually change this quarter in terms of your market share performance and if so, what happened that it worked so quickly?

William P. Lauder

Well, Lauren, I would be careful about saying worked so quickly. One of the fundamentals that we are seeing, and I think we talked about this actually for a while, is that it seems quite obvious in this environment that the consumer is shifting not only to value and the positions around value, but she’s also shifting to the brand she knows and knows well, where previously adventure and trying something new may have been a priority over what she knows, in this environment I think with a great deal of uncertainty, the consumer seems to be tending towards those things that she knows, those things that she’s more confident in. We can see that clearly in our sector but anecdotally, we’ve heard that it’s other sectors of inventory -- merchandise and consumer purchasing that were not part of our universe.

And when you think about it, especially in North America, the two largest most well-known brands in North America in prestige cosmetics are the Estée Lauder brand and the Clinique brand, and we continue to -- we see these brands regaining some of the share that has eroded over the last few years. I think that’s one of the primary objectives, not only because of their gift proposition and the value around their gift proposition, but also if you look at the retailers with whom these brands trade, those retailers who are let at the top of the pyramid, perhaps one step down, they have a strong -- these brands have a strong presence and the consumer seems to be more comfortable shopping in this environment the way she is spending right now.

In particular, when you talk about on a quarterly basis the orientation of the brands, the gift propositions, the value proposition in consumer spending was weighted more heavily in this quarter versus -- in the third quarter versus the fourth quarter. I will remind you again, Easter fell at a different time this year than versus last year and that changed the spending -- our shipping patterns to retailers year-on-year.

Lauren R. Lieberman - Barclays

Okay, great.

Fabrizio Freda

And I just would like to add a couple of points on this one, which is in the last year or six months, particularly [within 55 days], the focus on innovation has been very clear. There are some excellent innovation which is coming out which is playing [inaudible] for us. Second, we had really a transformation in the way we speak value to the consumer as of October, November, and this is really paying dividends and also we are using our consultants in-store, our advisor in-store to deliver this message, which is a unique way to leverage our scale and our value versus other competitors in other channels, which needs to use [inaudible] to [do the same exercise]. Then, as William said, we have some very strong brands that in these tough periods come out. And we are refocusing investment on these brands and particularly focus investment, as we said many times on skincare and makeup, which are paying our big dividends for us.

And finally in this period of recession, our entry price of prestige brands, namely Clinique and M-A-C, are as I say being receiving a lot of consumers that are trading down somehow but yet want to stay within prestige. So some of our imported brands are on the receiving ends of [inaudible] trade down, which is helping us as a company overall and obviously helping these brands.

Lauren R. Lieberman - Barclays

Okay. That’s great. Thank you.

Operator

Your next question is from the line of Constance Maneaty with BMO Capital.

Constance Maneaty - BMO Capital Markets

Good morning. I would expect at this point in the year, you and your retail partners have started to talk about Christmas and I am wondering what the tone of your conversations is. I suspect there will be a real value message but how are the two of you thinking about Christmas this year?

William P. Lauder

Well Connie, thankfully there’s more than just two of us. We have a number of retail partners around the world. There are fewer than there were but there still are plenty with whom we can have the dialog.

Obviously we are all looking to at least match last year, if not slightly exceed last year. We have a reasonable plan in place based on the sell-throughs last year of our Christmas specific programs as well as our full-priced programs. We’ve got a reasonable plan in place on a brand-by-brand basis to continue to offer good values at the right price points that we believe the consumer will respond to. I think that’s probably one of the most important principals we are talking about, which is the proper price points that appeal to the consumer, and where she in her mind is comfortable spending both for her friends and family for whom she’s buying gifts, as well as for herself.

Believe it or not, we’ve started ordering and buying and we are building for Christmas as we speak right now, so for us and our manufacturing facilities over the next few months, Christmas is now and we’ll start shipping in the -- we’ll start shipping into the retailers and building their inventories starting in September or October.

Constance Maneaty - BMO Capital Markets

Okay, and my follow-up is on retail inventories -- can you give us a comparison either you, William, or Rick, of where retail inventories stand now compared to the last period when there was big destocking, which I think was around the Federated/May merger?

William P. Lauder

Connie, let’s break it up between North America, where we have more visibility, and it’s about two weeks, we would say. And quite honestly, the frictional notion of going through destocking, you don’t like it when you are in the midst of it, but once you are through it you like it better because at least from our perspective and I would hope from the retailers perspective, faster turns are more profitable for everybody -- better selling product and a faster turn out of the retailer side is a better cash conversion rate, I would imagine better use of working capital.

Constance Maneaty - BMO Capital Markets

What exactly did you mean of two weeks? What was two weeks?

Richard W. Kunes

It’s two weeks less, Connie, than --

William P. Lauder

The retailers are holding two weeks less of inventory on hand at the given sales rate.

Constance Maneaty - BMO Capital Markets

Okay, great. All right. Thanks very much.

Operator

Your next question is from the line of Andrew Sawyer with Goldman Sachs.

Andrew Sawyer - Goldman Sachs

I was wondering if you could help us frame up how you are thinking about investment spending into your fiscal ’10. I know on the plus side you have media deflation, you guys are working internally on improving efficiency and that’s been a big initiative, I know. But I guess on the flip side, you guys mentioned in the very near term you guys have been mindful of the weak consumer atmosphere and maybe not investing as heavily into that, because -- could you frame up how you guys are thinking about what type of A&P budget you are going to look at as we look into next year?

William P. Lauder

Andrew, you have to look at our A&P budget and break it down into two pieces -- the A, advertising piece, and the P, the promotional piece. Quite honestly, what we are seeing right now is that as we define it, advertising, the advertising piece is primarily around forms of national advertising, which is predominantly but not exclusively print. And we are looking at it being down approximately 6% year-on-year. And the promotional piece, which is primarily around gift with purchase and other value-oriented programs at retail, we are seeing those about flat to last year on a spending basis, but we are seeing greater response to these programs than we have in previous years.

Now let me put this in context -- gift with purchase, promotional programming were primarily but not exclusively oriented around the Estée Lauder and Clinique brands. Over a three- to five-year period of time, as we have spoken about before, we saw an erosion of the consumer response into these categories so that the portion of the total sales that these brands were getting from this spending was going down as the portion of total. We’ve now seen that flatten and actually increase, so the proportion of their total sales in this one segment of our spending is starting to go up. Not a surprise because that is a strong value proposition which the consumer responds to.

What we are looking towards in the future is we want to make sure the consumer is responding and she is shopping. It’s obvious she is shopping and responding to value in all spectrums and we need to be responsive to what she wants.

I don’t know if you have anything you want to add.

Andrew Sawyer - Goldman Sachs

So that means you would be shifting more of the mix to promotional spending, you think, as we think out to next -- you know, if the consumer environment is soft for another 12 months, are we thinking more promotion for that period then?

William P. Lauder

You know, Andrew, our goal is to maintain more -- to get more efficiency out of our promotional spending than we have in the past. We seem to be getting it because the consumer is responding more, so if you will, on an absolute value basis, I wouldn’t say we are expending more -- we are just trying to get more out of what we’ve got than we previously have.

Andrew Sawyer - Goldman Sachs

If I can, can I just ask one other question on a separate line -- you guys alluded to the North American reorganization allowing you to kind of go to market with I guess better optimize your distribution. Can you talk about how you are thinking about perhaps expanding into some of these specialty retailers where you have only had narrow product assortments to date?

Fabrizio Freda

Well, what the organization will allow us to do, on top of [expanding or not expanding], which will be strategic decisions that we will take [gradually as appropriate], is wherever we stand to be able to tailor our business model to the channel or to the region or to the country in the category in which we are standing in. So the organization structure is designed to allow us to tailor, to maximize, to customize and wherever we decide to play, we will be relevant to the channel and to the region in which we are playing. That’s what the organization will do. And then in which channel we will expand, I think we said this very clearly -- we are going to continue winning in department stores across the globe, which are our core channel. We will continue win there even more and continue growing share as we have shown this last quarter, and we are going to expand in many different channels, including special channels, [inaudible], and among all, I want to mention online, that we have not discussed in this call so far but is really growing very nicely across the globe. It is our best-performing channel where we are investing seriously for further expansion?

Andrew Sawyer - Goldman Sachs

Thanks a lot, guys.

Operator

The final question is from the line of Jason Gere with RBC Capital Markets.

Jason Gere - RBC Capital Markets

Good morning. I was just wondering if you could give an update on the kind of portfolio assessment that you are going to take over the next one to two years, and then put into context the destocking that you’ve been seeing in North America and EMEA -- is it logical to say that we are seeing more destocking in those brands that are underperforming where you might be having to make some of those longer term decisions? Thank you.

William P. Lauder

I think it’s a two-part question when you talk to a portfolio assessment, that’s a dynamic, a continuously dynamic process where it never stops. We are continually looking at the brands we have in our portfolio, their strength and relevance in the channels of distribution in which they exist, as well as where the future opportunities lie and where we are investing our money. We will continue to do that. There is no deadlines on anything, make a decision now or not, and as far as the destocking -- quite honestly, let’s look at it -- yes, some of those smaller brands are impacted but quite honestly, on a macro basis, our three largest brands have the largest impact on any movement of the inventories, as well as our sales associated with them. And we will continue to focus on these brands’ strength and success by channel, by region, by market, to continue to drive them where they can. And I just want to remind you, I made this comment earlier, while the frictional notion and the moment of destocking may be a concern, the long-term benefit is we are selling more of our best-selling products and less of the less productive products, which means we are making fewer of the unproductive, making more of the more productive, and ultimately we, our retailers and ourselves, are more productive as a result.

Operator

And there are no further questions at this time. I would like to turn the call back to management for any closing remarks.

Dennis D'Andrea

Thank you very much. If you were unable to join for the entire call, a playback will be available at 1:00 p.m. Eastern Time today through May 18th. To hear a recording of the call, please dial 800-642-1687, pass-code number 94912923. That concludes today’s Estée Lauder conference call. Thank you all for participating and we wish you a good day.

Operator

This concludes today’s conference. You may now disconnect.

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Source: Estée Lauder F3Q09 (Qtr End 3/31/09) Earnings Call Transcript
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