Q2 2007 The Estée Lauder Companies Inc. Earnings Conference...

F I N A L T R A N S C R I P T

EL - Q2 2007 The Este Lauder Companies Inc. Earnings ConferenceCall

Event Date/Time: Jan. 31. 2007 / 9:30AM ET

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C O R P O R A T E P A R T I C I P A N T S

Dennis D'AndreaEstee Lauder - VP of IR

Rick KunesEstee Lauder - CFO

Dan BrestleEstee Lauder - COO

William LauderEstee Lauder - CEO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Sandhya BeebeeHSBC - Analyst

Amy ChasenGoldman Sachs - Analyst

Chris FerraraMerrill Lynch - Analyst

Filippe GoossensCredit Suisse - Analyst

Bill SchmitzDeutsche Bank - Analyst

Linda Bolton WeiserOppenheimer - Analyst

Wendy NicholsonCitigroup - Analyst

Neely TammingaPiper Jaffray - Analyst

Christian AndreachManning and Napier - Analyst

Justin HottBear, Stearns - Analyst

Connie ManeatyPrudential - Analyst

P R E S E N T A T I O N

Operator

Good day, everyone, and welcome to the Estee Lauder Company's fiscal 2007 Second Quarter Conference Call. Today's call isbeing recorded and webcast.

For opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. DennisD'Andrea. Please go ahead, sir.

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Jan. 31. 2007 / 9:30AM, EL - Q2 2007 The Este Lauder Companies Inc. Earnings Conference Call


Dennis D'Andrea - Estee Lauder - VP of IR

Good morning, everyone. On today's call we have William Lauder, President and Chief Executive Officer, and Rick Kunes, ExecutiveVice President and Chief Financial Officer. Dan Brestle, our Chief Operating Officer is also here, 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 and ourreports filed with the SEC where you'll find factors that could cause actual results to differ materially from these forward-lookingstatements. And I'll turn the call over to William.

William Lauder - Estee Lauder - CEO

Thank you, Dennis. Good morning, and thank you for joining us to discuss our second quarter results. We continue to executeeffectively and advance our strategic imperatives which are reflected in our performance. I'm pleased to report that sales rosea strong 12% reflecting net sales growth in all major product categories within each region. Diluted earnings per share fromcontinuing operations was $0.99 cents, up 42%. The results exceeded our forecast thanks to stronger sales, lower operatingexpenses, the mix of our business, and foreign currency translation. Rick will provide more details later.

During the critical holiday season in North America, we achieved solid gains across many brands, categories and channels. TheEstee Lauder brand's Blockbuster gift proved extremely popular as did gift sets from various other brands. Much of the holidayrelated inventory was sold prior to Christmas which was good news. Our retail sales in North American department stores wereflat for the quarter but there were approximately 100 fewer doors this year versus last; however we saw gains in other channelsof distribution including online, freestanding stores and salons. Consumer demand seems healthy and we feel confident aboutperforming well during the remainder of the fiscal year.

We've indicated previously that we expect much of our growth to come from international markets and this is reflected in thisquarter. Sales in Europe and Asia rose double digits. We were also helped by the weak U.S. dollar which boosted reported salesby 3 percentage points. Sales, of course, varied by brand and country but in general we posted solid growth in major marketsincluding Japan, the UK, and Germany. We also had robust improvements in many emerging markets. Sales of our two largestbrands, Estee Lauder and Clinique, rose in all international regions. Worldwide, sales of each brand climbed by low single digits.MAC is now available in more than 60 countries and continues to be a major success. It is widely accepted by people of disparatecultures and varying complections. Higher same door sales and 19 new doors helped lift MAC's international sales by doubledigit rates. Despite concerns earlier in the year the travel retail business also grew double digits. Estee Lauder, MAC, BobbiBrown and DKNY were particularly strong in the channel.

We advanced our imperative to further expand our brands and products across the globe. To pursue the latest science, weestablished the Kobe Skin Research Institute in Japan. Scientists at this facility are conducting research for our Company intoAsian skin characteristics and focusing on developing products to address pigmentation and skin aging. Aveda opened a lifestylesalon in Osaka marking its second flagship in Japan and its first location in the Western half of the country. Aveda products arealready sold in more than 100 salons in Japan's Eastern region and we plan to pursue opportunities in the rest of Japan. Elsewhere,we plan to start selling Aveda products in Spain in April. We established an affiliate in Brazil which began operations in December.We recently imported MAC, Clinique, and Aramis and designer products into Brazil under the new affiliate. MAC recently launchedin Peru, where it rapidly became the number two brand in it's two doors. Italian consumers can now buy Jo Malone in Milan,and La Mer is available in Poland and Argentina. We continue to revitalize our two largest brands and now have a seasons worthof experience with national gift dates implemented by major U.S. department stores.

We had anticipated that total gift sales would decline due to fewer department store doors than last year. For the Estee Lauderbrand, gift sales were flat for the six-month period in like doors. For Clinique, where gift related sales in like doors for the sixmonths declined, the business is more challenging. We believe that both brands were impacted by having fewer promotionsto offer consumers as several regional department store name plates were relegated to history. For example, in Boston, lastyear, consumers would have received free Clinique gifts with purchases at Filene's and Macy's. Filene's is now closed so consumersonly have one store, Macy's, where they can shop the gift program. Both brands are taking steps to make gifts more appealing.






Based on good response, Estee Lauder plans to expand its choice gift program this spring into more Dillard's stores. Clinique'sEditor's Choice program debuted at Lord & Taylor in December and is set to continue throughout the spring season. Cliniqueplans to increase the value of its gifts to make them more attractive to consumers. Last week, Clinique opened the Clinique SkinWellness Center at Wilde Cornell medical college in New York, the center of the first of its kind for research and patient servicesreaffirms Clinique's dermatological heritage and further establishes its authority in skin care.

Looking at our business by category, the holiday quarter is crucial for fragrance. More than 1/3 of its sales occur in this period.Sales of fragrance, our most challenging area grew double digits during the quarter but bear in mind that we had easy comparison.During the same period last year fragrance sales fell 11%. We have seen consumers tastes have begun shifting from celebritydriven scents to more classic and designer names, which helps our portfolio. We have invested in our scents that have universalappeal or the cachet of a fashion designer believing they have more longevity than the latest celebrity craze. During the holidayquarter, four of the top five women's fragrances in U.S. department stores were ours, led by Estee Lauder Beautiful. One of ournewest fragrances, Sean John Unforgivable was ranked fourth for mens scents in prestige. Consumer demand for our newfragrance, Tom Ford, was higher than planned and is currently available in limited distribution in nine markets. Jo Malone salesrose by strong double digits in the quarter thanks to U.S. and international distribution including two new doors in California.The Aramis Fragrance business improved outside North America helped by the recent launch of DKNY Red Delicious.

We devote tremendous resources and talent to keep all our categories fresh with new products. In March, through our BeautyBank division, we will launch the Coach fragrance, which will be sold exclusively at 220 Coach freestanding stores in the U.S, anew distribution channel for us. We are also optimistic about other upcoming introductions including MAC's Raquel WelchBeauty Icon collection and Clinique's Continuous Rescue, just to name a few.

We remain on the look out for new opportunities in the area of distribution. Bobbi Brown tried TV for the first time. It debutedon QVC in the United Kingdom. The product sold quickly during an hour long show and more segments are planned.. We expandour visibility at one of our most important retail locations,Bloomingdale's 59th Street store in New York City. The Estee Lauderbrand unveiled a remodeled selling space which includes a dedicated counter to show its high end skin care line. Luxury skincare is a growing profitable area and we want to draw attention to the successful product line. Looking to reach new consumers,we brought La Mer into the busy cosmetics area of Bloomingdale's 59th Street store. Accelerating our retail store strategy, weopened 16 new freestanding stores during the quarter, mostly for MAC.

Let me now give you some details about our thriving online initiatives. To attract consumers to all points of sale and to reacha broader audience we directing more marketing dollars to new media, while online spending is still a fraction of our advertisingbudget. We are making progress experimenting with online tools. We launched microsites for Estee Lauder Advanced NightRepair and Clinique Happy, and devoted about half of the media budget for Sean John Unforgivable to the online space. Morerecently, Estee Lauder teamed up with The Knot.com, a wedding site, to advertise Beautiful Love, a new addition to the Beautifulfragrance collection. Estee Lauder is using the internet to spread the word about Resilience Extreme Ultra Firming makeup, animportant foundation that has skin care benefits. Next month, MAC will launch it's first micro site for the Barbie Makeup Collection.During the quarter we partnered with NBC universal for a new kind of interactive television show called I-village live. We linkedour brand e-commerce site to the program website and consumers can buy products in real time while watching television.Glossy magazines are still the mainstay of our advertising and marketing agenda and we are working with them as they tooincrease devoting resources to our online operations.

We had committed to reaching a wide cross section of consumers whatever their reading, surfing, and shopping habits.Increasingly they are shopping online. E-commerce sales from our brand and retailer sites rose by double digits in the quarter.We are considering promotions other than free shipping to keep the channel fresh and drive new and repeat business. OurFrench and Australian affiliates have begun selling MAC online and plan to add more brands to their e-commerce operationsduring this fiscal year. The four brands we have available online in the UK sold well in the first holiday season and we expectfour more to be added next fiscal year. With the half of the 2007 fiscal year behind us, we are happy with our results andaccomplishments and with with the efforts of our management team and all the people throughout our organization.






Now I'd like to hand it over to Rick Kunes, our Chief Financial Officer to take you through the financial details. Rick?

Rick Kunes - Estee Lauder - CFO

Thank you, William and good morning, everyone. My discussions today will focus on our results from continuing operations.Our sales this quarter totaled $1.99 billion, a very strong 12% increase over last years quarter. In local currency sales rose 9%.Net earnings from continuing operations for the quarter were $208.5 million compared with $150.4 million last year. DilutedEPS rose 42% to $0.99 cents versus $0.70 cents last year. These results exceeded our projections due to a number of factors,including higher than planned sales, lower operating expenses, and a weaker than expected U.S. dollar. I'll discuss these andother factors throughout my comments. But first, let me refer you to today's Press Release for the details of our net sales andoperating income by-product category and geographic region.

As was the case in the first quarter, the Americas region , and each of our product categories except hair care, were adverselyimpacted by fewer department store doors resulting from the consolidation of Federated and May last year. In our third quarterwe will anniversary the majority of those store closures. a reported basis our sales this quarter came in higher than we forecasteddue to the weakened U.S. dollar, unexpectedly benefiting our business by approximately 2%. Also, in local currency, our actualsales growth exceeded our projections. Skin care sales had the largest increases from our European and Asian businesses, whilemore moderate growth was reported in the Americas. Internationally, we benefited from several product introductions as wellas strengthened some existing products particularly from Estee Lauder and Clinique. In makeup, the Asia region generatedstrong double digit growth while our business in Europe and the Americas turned in high, single digit gains in local currency.Throughout our makeup artist brands continued to lead the category with double digit sales growth worldwide.

Fragrance sales were up nicely benefiting from a solid performance in Europe and a successful holiday season in the Americas.While this category was up against an easy comparison to last year when sales declined 11%, this year our holiday sets provedto be more popular with many selling out early in the season. We enjoyed solid results from some new and recently introducedfragrances, while at the same time experienced lower sales of certain existing products. In hair care, organic growth in salonsand independent distributors, salon expansion, and new product introductions were the main reasons behind the double digitsales gains.

Geographically, our international business led our growth this quarter. In Europe the Middle East and Africa, despite comingoff double digit local currency growth last year, we grew net sales 9% for the quarter. A few key businesses drove this performance,including travel retail, which posted a double digit increase. Even with the temporary disruption that occurred last quarter, ourtravel retail business is nearly at year-to-date plan levels. In the United Kingdom, which is our largest market in the region, salesgrowth was very high single digits, owing to a strong performance in our biggest account, Boots, as well as solid results indepartment stores overall. Russia, one of our emerging markets, has shown terrific progress and reported an outstandingquarter, and in Turkey, where we recently established an affiliate, sales were up nicely, exceeding our expectations. Sales in AsiaPacific also fared well this quarter, with all countries reporting local currency sales increases. China and Hong Kong were againdouble digit growth contributors, while sales in more established countries like Japan and Korea rose high single digits reflectingimproved economies and consumer sentiment.

In the Americas, net sales increased 7%. This performance was slightly better than expected due to a strong surge of ordersfrom retailers during the middle of the quarter. As expected, most specialty stores had stronger increases; however there wasmore modest sell-through growth in department stores. Strong sales gains came from our makeup artist lines, new productsfrom Sean John, and our hair care and online businesses. We continue to experience weakness in our core brands as a result ofcompetitive pressures and retailer consolidation. You may recall that store closures resulting from the Federated-May mergeraffects our core brands more than our developing brands. We will anniversary the majority of these closures in our third quarter.That said, think remains a disparity in the growth of our business in Federated legacy doors versus the May doors where thename plate change to Macy's has occurred.






Moving on to gross margin, we had a 60 basis point improvement this quarter to 74.9%. This gain reflected a decrease in thelevel and change in timing of promotional activities, decreased obsolescence charges, a favorable change in the mix of ourbusiness and favorable exchange rates. Our operating expenses for the quarter as a percentage of sales decreased to 58.2%from 60.2% last year. This 200 basis point improvement exceeded our forecast due to the higher sales growth especially frombrands carrying lower operating costs and the fact that certain core brands reduced spending in response to softening retailsales towards the end of the quarter. We expect a higher level of investment spending during our fiscal second half for programsand initiatives that we believe will drive both our basic business and gift sales. Part of our improvement in operating expensemargin reflects the prior year periods' incremental provision for sales returns from the announced store closing related to retailerconsolidations. Additionally, we continue to benefit from incremental savings this year associated with our cost reductionprogram.

Partially offsetting these improvements were increased selling expenses reflecting higher demonstration and education costsof beauty Advisors and Makeup Artists as well as investments in new channel initiatives. The combined benefits from highersales, lower operating expenses and foreign exchange resulted in incremental EPS of approximately $0.14 cents versus ourprevious forecast. As a result, our operating income rose 33% to $332.4 million with a 260 basis point improvement in margin.Looking at operating profits by category all categories improved basically reflecting strong sales results this quarter.

By region, operating profit increased across-the-board. In the Americas, higher sales, our efforts to balance advertising,,merchandising and sampling spending with our net sales levels in our core brands as well as other planned companywide costcontainment efforts resulted in the improvement in operating income. Stronger sales from our hair care and online businessesalso contributed to the improved results. As a reminder, in the prior year period, operating income in the Americas was negativelyimpacted by a $10 million incremental returns provision due to retailer consolidations. In Europe, the Middle East and Africa,operating income increased compared with last year's quarter. Due to improvements in some key markets and businesses suchas the UK, travel retail and Russia. Slightly offsetting these increases were lower results in the Benelux countries, France, andItaly. Our business in Asia Pacific generated strong operating income growth with virtually all countries posting increases.Healthy operating income gains were reported in Hong Kong, China, Australia, and Taiwan, due to sharply higher sales. Theeffective tax rate for the quarter was 34.9%. This rate also is lower than we have previously anticipated for the quarter, due toenacted tax legislation regarding certain tax credits as well as the change in the tax effect of foreign operations, generatingapproximately $0.04 incremental EPS for the quarter.

Now let me turn to our cash flow and balance sheet. Cash flows from operating activities were $313 million for the quarterended December 31, 2006, compared with $389 million last year. The change primarily reflects an increase in accounts receivableat December 31 of $137 million compared with last December, due to the higher sales especially from our international operations.As you know, our international businesses generally carry longer payment terms. In this quarter we're coupled with the extensionof credit to some international customers to strategically expand our business in certain Markets. Our day sales outstandingwere 45 days this quarter compared with 42 days last year. Inventory at December 31, 2006, was $783 million, a $56 millionincrease over the prior year period. While inventory days were slightly higher that 165 days compared with 163 days last year.During the quarter we repurchased approximately 3.5 million shares of our stock bringing the total for the six months to 6.5million shares returning $254 million to stockholders. During the quarter, we were more aggressive in our share repurchasesthan we planned, which added another unplanned $0.02 to EPS.

All of our return ratios continued to improve including our key return on invested capital ratio which increased nicely duringthe quarter. We spent 1$41 million for capital expenditures during the quarter which includes incremental spending for ourcompanywide systems initiative. For fiscal '07, we anticipate approximately approximately $700 million of cash flow fromoperations and expect capital expenditures of approximately $290 million.

Now, I'll update you on our assumptions for the balance of the fiscal year. For the full fiscal year, we estimate our sales growthat approximately 7% in constant currency. We now estimate that foreign currency translation will benefit our reported top lineapproximately 1-1.5%. We anticipate continued solid domestic and international sales growth. Our strong first half results give






us the opportunities to step up our investment spending in the second half to drive long term growth. At the same time, weare are comfortable increasing our full year estimate of diluted EPS from continuing operations to between $2.10 and $2.20.

For the full year, we expect improvements in gross margin to offset increased operating expenses resulting in a relativelyconsistent operating margin versus last year. Our gross margin should benefit from supply chain savings, product mix, andlower promotional spending. In operating expenses, we continue to expect several factors to impact us this year, includingplanned higher levels of investment spending behind new product launches and new channel initiatives, more spending onselling and training as well as for our faster growing and developing brands, incremental spending related to our strategicmodernization initiative as well as IT security related enhancements. And in addition, we now see an opportunity to selectivelyand strategically invest additional funds to drive growth in the second half of our fiscal year and beyond. We remain on trackto realize an incremental $30 million of savings this year resulting from the cost savings initiative that we implemented lastyear. These savings have been included in our overall expectations. At this time, we expect our effective tax rate will beapproximately 35.5% for fiscal 2007. This change in rate comes from our previous forecast of 37%, reflects similar reasoning tothat discussed earlier regarding our second quarter effective rate.

Looking at our third quarter, our forecasted sales growth is approximately 4 to 6% in local currency. We anticipate a positiveimpact of foreign exchange of about 1.5 to 2%. We expect EPS for the three months ended March 31, 2007, to be approximatelyflat with last year.

Separately, we are moving along with our preparations for our Analyst and Investor Day on March 6th here in New York. Welook forward to seeing you at that time. For those of you that will not be able to attend in person, the entire event will be webcaston our corporate website. That concludes my comments for today and we'll be happy to take your questions.

Q U E S T I O N S A N D A N S W E R S

Operator

The floor is now open for questions. [OPERATOR INSTRUCTIONS] Our first question comes from Sandhya Beebee with HSBC.

Sandhya Beebee - HSBC - Analyst

Hi, good morning. I have a question about the level of investment that you guys are talking about now, because you quantifiedthe amount of increase investment spending at the start of this fiscal year. Is that now going to be higher than you thoughtbefore? And can you talk a little bit about where, if there is addition all spending, where we should see that, what businessesare going to be benefiting from that?


Sandy, it's going to come in a number of different places. It's not going to come in any one specific bucket. We are primarilyfocusing our brand management on a number of different activities which is predominantly, as we mentioned, in new media.Basically, we want to use the momentum we have in good results now to motivate our brand management to pay attention towhat we think is a primary engine for acquiring new consumers and communicating with them in a different manner, and wewant to try to motivate them with what seems to be the biggest bait out there which is money.







Okay, because you beat the quarter significantly versus, the quarter came in significantly ahead of plan and yet the second halfguidance is not appreciably, the full year guidance is not going up to the same extent. So is that difference some additionalspending?


Sandy, yes, the difference is addition all spending but we do manage our business on a full year basis and based on our firsthalf results, we were able to take our full year guidance up, depending on how you want to look at it from $2 to $2.20, at thetwo extremes of the ranges we have given. And at the same time as William just described to be able to invest strategically inbusiness growth opportunities that we think will benefit the Company long term. We were admittedly probably somewhatconservative in our plans for the first half of the year. We wanted to make sure that we're able to meet our financial committmentbut at this time, we're comfortable with the guidance that we've given for the year and we're also comfortable with the conceptof having money to really grow our business long term.


Okay, thank you.

Operator

Your next question comes from Amy Chasen with Goldman Sachs.

Amy Chasen - Goldman Sachs - Analyst

Hi, good morning. North America, William, you said that sales were flat in department stores but that includes the door closings,so that implies that if you exclude the door closing that your sort of same-store department store sales are stronger. Can youtell us how much that was up?


Amy, the same-stores were flat because most of the doors were closed, so our department store business in North America wasa little bit stronger than we believe, than we had anticipated and than it should have been by probably a couple of percentagepoints. The reason for that is that we saw the department stores buy into what they thought was a much stronger Christmasseason than I think overall it turned out to be, and we're seeing some of that impact affect us in the third quarter which is whywe have that slightly slower sales growth number in the third quarter because they aren't replenishing inventory that hasn'tsold through.


Okay, so just to be clear, the North American same-store department store sales were flat?

Dan Brestle - Estee Lauder - COO

Amy, Dan Brestle. We were up low single digits. Total company department store sales, same-stores, low single digits.







Right. Total Company or North America?


North America.


Okay.


All brands.


Okay and so there was a little bit of kind of the department stores were buying ahead of what they thought -- there's basicallygoing to be inventory destocking in the third quarter?


Let me explain it real quickly. We had tremendous sell-through in our Christmas gift sets. It was the Year of Value and thosevalue sets sold through, and all Christmas shipments we have Christmas gift sets that sell in and a lot of basic goods that sell inwhich the beauty Advisors put together at full value. The softness we saw was on the full value sets. Those last ten days thatconsumer who is usually desperate whether they were buying ready to wear it at markdown prices or whether it was the giftcard phenomenon, that was the softness of the business but the sell-through the full gift set business was record numbers. Wesold out of gift sets, blockbuster, you name it faster than we have the last ten years. Now, your overall North American businesswas actually pretty good, up 7%, which I think is a great number, despite everything you're describing. Can you give us somecolor on the biggest drivers of that in terms of retail stores versus salons versus any distribution gains you may have had?


It's primarily driven by three factors, Amy and you named it. One, retail stores have a tendency to trend above department storesales and that happened. Secondly, our hair care business was significantly up, partially fueled by an acquisition of a distributerin the Aveda network and Bumble's growth too, those are the biggest engines. And of course our emerging brands which wetalked about, MAC, Bobbi Brown and what not, have seen faster growth than the more established deeply purchase drivenband.


And Amy, we also had strong growth in our internet business as well.







Yes, our internet business is continuing to be our fastest growing channel of distribution and it's meaningful.


Okay. Last but not least, can you just give us an update on any potential acquisitions you maybe looking at?


No.


Are you looking at any?


Of course.


Okay. Thank you.

Operator

Your next question comes from Chris Ferrara with Merrill Lynch.

Chris Ferrara - Merrill Lynch - Analyst

Hi, guys. Talk about the leverage back there for the quarter. I mean, it looks like if you assume most of your advertising is fixedrelative to your guidance, you go into the quarter with a certain level of advertising, you expense it as incurred. Most of yourselling is probably fixed. Can 3 points of sales upside generate a couple hundred basis points of operating expense leveragefor you?


You know, I think you hit upon it, Chris, the fact that most of those expenses are fixed and we were surprised to some extentwith the foreign exchange, the weakness of the dollar which added about $20 million of sales to the quarter and our basic saleswas about 1% higher than we had anticipated it to be and that's $40 million. And there's very little expense associated withthat, quite honestly, so it does drive quite a bit of profitability in the quarter.







Got it. And then just I guess on MAC, did that business decelerate given you had a bunch of door openings and I know you saidit was up double digits but it wasn't up to 20% we've been accustomed to. I guess where is that business if you look at it on asame-store basis?


The MAC business on a same-store basis is trending very nicely. It perhaps does not have the same velocity it's had year on yearespecially in the data you might be seeing versus NPD, but it continues to have very nice trend. MAC did have, they did stubtheir toes a little bit in the second quarter, primarily due to some restrictions they had in the State of California, both fromemployment practices and communications with consumers, which tied their hands. And the State of California is a verysignificant portion of the total MAC business, but the brand is growing at approximately 20% on a global basis. North Americamay be the biggest chunk chunk of it but on a growth basis it's still growing at a very aggressive number. It's a meaningfulbusiness.


Great and then just one quick thing on the extension of credit to international customers to strategically grow the business,who are you extending credit to?


You know, Chris, primarily it's in Russia where historically we had cash on delivery business there and now that business isgrowing nicely and we have normal sort of trading terms, and we are also increasing the credit limits of that business as it grows,so in other words if we had we would allow a credit limit of up to a million dollars, we now have increased that number to $5million or $7 million, that's sort of the concept, so it's not that we're extending payment terms if you will. We're just expandingthe normal credit terms as the business grows.


Great. Thanks a lot.

Operator

Your next question comes from Filippe Goossens with Credit Suisse.

Filippe Goossens - Credit Suisse - Analyst

Yes, good morning, gentlemen, and congratulations on the wonderful quarter here.


Thank you.







My first question if I may, William, as part of your normal business practices, you are always reviewing your portfolio to seewhether some weakness is and where you can strengthen it. Given the continued kind of challenges within the fragrance sideof the business, is any reason why we should believe that perhaps you could be looking at divesting some of the weaker brandson the fragrance side? And alternatively just as a follow-up on Amy's question from an acquisition perspective, now that you'veopened this affiliate in Brazil , is it fair to assume from an acquisition perspective you probably won't be doing anything in LatinAmerica for the foreseeable future?


Filippe, there's a number of different things there. I think in regards to your second question first, I wouldn't want to make anycommittments one way or the other as to where we might be looking at acquisition opportunities or not. Regionally, globally,categorically. So we'll be talking in more detail when we see you on March 6th at our investor conference. And a number ofstrategic alternatives we might be looking at seriously, and perhaps might not be the right time to address it. But I don't wantto committ to you and say we're not going to go somewhere, we're going to go somewhere definitely. But we're looking at anumber of meaningful alternatives some of which may in retrospect look obvious and some which may in retrospect not beobvious but be right for us. And in regards to your first question about fragrance, you know this has been one of those ongoingexistential questions that we go through but essentially you have to look at our fragrance business as made up in two parts.There's the pure fragrance business which is represented by our Aramis and designer fragrance business with the Aramis brand,Tommy Hilfiger, Donna Karan, Missoni, Sean John, those businesses that are somewhat challenged on a global basis for a numberof reasons many of which we've talked about before. And then we have got the fragrance business associated with the EsteeLauder and Clinique brands primarily. Those businesses, the Estee Lauder fragrance businesses and the Clinique fragrancebusinesses represent more than 50% of our total global fragrance businesses. So while we may lump it on a categorical basisinto the two, they are two very distinct businesses. The Estee Lauder and Clinique businesses are associated with a larger, greaterbrand structure and as well as selling expense as well as total offerings, for which these fragrance businesses are still meaningfulcontributors, certainly on the top line and perhaps ought to be better contributors on the bottom line.

The more traditional pure fragrance business is the area where we think there's trouble. Categorically on a macro basis in thetwo key markets, Europe and North America in particular, a little less so in travel retail, and there the biggest challenge for usis, for us to be a major player in the cosmetics trade on a global basis, we must be a meaningful player in the fragrance business.So really, our challenge is we must continue to operate that pure fragrance business on a better basis than we're currentlyoperating it, and we must have brands that are relevant on a global basis. As we've talked to you about before and I think we'lltalk about it again in more detail in March, one of the bigger challenges we have is that the vast majority of our fragranceportfolio are North American oriented brands. We do not have a very meaningful European or designer fragrance orientationthat is non-North American driven. Yet , the largest most powerful fragrance regions, Europe, and travel retail, are predominantlyoriented towards European and European-designer oriented fragrances, so there's somewhat of a mismatch there for a numberof reasons and we'll go into greater detail with you in March.


And then if I may get my follow-up question. It looks like the initial comments that we're hearing from the Sephora and JCPennyjoint venture, are rather encouraging. Based on that data point, any change in your thinking, what you might change thatrelationship going forward? Thanks very much.


Chris, this is Dan. We're hearing the same positive feedback. We don't know for fact but I'm sure it has been successful, and no,at this point it hasn't changed our attitude to which brands, if any, will go into that.







Okay, thank you very much.

Operator

Your next question comes from Bill Schmitz with Deutsche Bank.

Bill Schmitz - Deutsche Bank - Analyst

Hi, good morning.


Good morning, Bill.


Can we just start talking about how sort of the sales forces change because it seems like the business is migrating more andmore to alternative channels outside department stores, so can you sort of break down North America or global sales bytraditional department stores versus kind of all other outlets and what's changing your philosophy to go to market with someof these smaller stores?


Let me try to structure itfor you. 30 years ago we had 195 separate regional department stores for our customers. We have 16today. So obviously, the world has changed. The basic change in our field force, our Account Executives and Trainers is that wehave regionalized. So that because we've found that an Account Executive can handle more doors of the same customer versusmultiple customers. The alternative distribution that you speak, much of it is handled by a separate division of ours calledspecialty store and they service people like the [Casbar], the military, smaller accounts that don't get the same level of servicenor the quality of education or training. It's done usually by the account themselves. But short of that, we really haven't seenmuch change in the way we do business. We still sell the same 2,200 customers for the big brands we've sold for the last fiveor six years.


Okay, great. Thanks. And then just in terms of the receivables. Is there going to be a down tick in the days receivable numberin the first quarter and also can you just comment on global trade inventories and kind of where they stand?


Bill, I don't know, our receivables have always hoverered around the low 40s and I don't think there will be a measurable downtick. It might go down a day or two as the year progresses but nothing significant. As you know, we have very little bad debt asa company so it's really not something that we are overly concerned about and it's really driven by the fact that our internationalbusiness is growing so much faster and it's just normal trade terms are longer internationally. And I'm sorry the second part ofyour question?







No, I was asking the question if that's unchanged because it looks like receivables increased about 22% or something year overyear in a 12% increase in sales.


Right. And I think as we explained it previously related to new markets, primarily Russia but there's also we opened businessesin Turkey, that became an affiliate, and also in Brazil. So, those are the three new markets that really have sort of longer paymentterms where our business is growing nicely and it sort of affects the weighting overall.


Okay, great. And if I could do one follow up on SAP and what the timeline is for that, where you stand in the process and whichdivisions are going to go first?


We're still pretty much on schedule I think with what we talked last pretty much on schedule I think with what we talked lasttime to you, Bill. The Aveda division will go first and that's the best place to go first because it's a self-contained business. We'llhit every aspect of the implementation from distribution, manufacturing, right on through. We're probably looking at late springto turn the switch. Still working through some data integrity that we've uncovered and we're working through the warehousingsystem that we don't think is quite yet ready to go. So the pressure is on getting it right for us, not when it's going to go, soprobably late spring is where we're looking now. We'll do Aveda first and then we'll talk about it probably again in March, andthen we'll give you a rollout schedule after Aveda and the success of Aveda, where do we go from there.


Okay, in March will you put numbers around the savings possibility or potential?


Yes. [Dan Brestle and William speaking at once] And we'll give you a number and tell you what the world looks like once this isinstalled.


Okay, great. Thanks very much.

Operator

Your next question comes from Linda Bolton Weiser with Oppenheimer.






Linda Bolton Weiser - Oppenheimer - Analyst

Thanks. I was just curious if you could comment on how Kohl's is doing and also, could you give us, I don't think you gave usgrowth in the U.S. Overall, all channels, if you exclude the growth in Latin America, Mexico, and Canada.


Well, overall, the Kohl's business is doing nicely. We think that there is an opportunity to improve it further. We saw somestrength in December which we were very pleased with, and we're continuing to refine the model with them about the elementswhich drive the business. One of the things they're learning, something we've known for a long time that they're learning isthat probably the single biggest contributor to the growth in the business is the dedication to staff in store to giving theconsumer service. And as they learn that the investment in staff dedicated to cosmetics drivers their business in an outsizemanner, they are beginning to invest more. In addition we have, we are looking at the right product mix and promotional mixfor their store and how we communicate with the consumer. We're pleased with the progress of where Kohl's is going. We thinkit can do better, should do better, but we both, ourselves and the Kohl's management, are committed to making this a successfulenterprise in the long term as we train the consumer. And the overall U.S. business, I think?


Growth is around 4 to 5% excluding, you know, just America -- just the United States, excluding Canada and Latin America.

Linda Bolton Weiser - Oppenheimer - Analyst

Okay, great. Thanks very much.

Operator

Your next question comes from Wendy Nicholson with Citigroup Investments.

Wendy Nicholson - Citigroup - Analyst

Hi. I just wanted to follow-up on Bill's question. I don't think we got an answer. For what percentage of your business in the U.S.is the department stores, I know it used to be around 80% but has that come down materially?


Yes. It was, Wendy, I think the number was 80% of department store business, that was on a worldwide basis and that was quitea few years ago. But North American Department Store businesses around 38, 39% of our business.


Our total business.


Global business.







No, no, okay I just want to know in the U.S. Just in the U.S, What percentage of the U.S. Business is department stores.


It's roughly around 75-80% of the North American, of the U.S. business is department stores and the other 20% is non-stores.


And can you break down that 20%? I'm just trying to get a sense for how big has the internet become versus the salons? Becauseit's just if the department store business is 80% of your business and it was flat, I'm trying to get a feel for exactly how much theinternet versus the company owned stores versus the salons were up.


Well, they were all up meaningfully more than the department store business. The highest growth in meaningful double digitswas internet. Next would be a salon, and then third would be retail.


All non-department store business in North America was up about 19%.


Okay, good. That's what I was looking for. Thank you.


Wendy, excuse me.


Yes.


It was not flat. It was up low single digits. So the department store business was not flat. All brands up low single digits.


Okay, thank you very much. But my second question has to do with sort of I think what could be perceived as sort of an increasinglevel of complexity in the business and I don't know whether that's a fair characterization or not. It strikes me that between theQVC thing, Kohl's, Sephora, Coach, the emerging market businesses, it seems like there's a massive amount of activity going onwithin the company and that's awesome and exciting and clearly it's having a huge positive impact on your top line so that's






awesome. But I'm just wondering, is that a fair characterization that it seems like you guys have moved into over drive in termsof pursuing different growth initiatives or is it just my external perspective that sees it that way?


It's a fair characterization that we have increased the complexity of a number of different aspects of our business, that's verytrue. We are both pursuing new alternative distribution opportunities for existing brands as well as creating or findingopportunities in alternative non-traditional channels of distribution for ourselves. Non-traditional is what we discussed in NorthAmerica and anything outside of traditional department stores and non- traditional in Europe is everything outside of traditionaleither chain or independent parfumeries. And we'll continue to look for those opportunities where there are consumers whoare shopping for better, aspirational cosmetic products around the world. We know they have alternatives about how andwhere they will shop at our price points and quality, and we need to make sure we have our brands our creating or acquiringbrands which capture their imagination into those channels of distribution. And we are the world's leading prestige marketerof cosmetics and must continue to do so wherever and whenever they shop for products such as ours.


And do you think you have the right management team? I mean, do you have the right organizational structure, not just theright bodies but given you've got your sort of toes in all of these different waters if you will, do you think you have the rightorganizational structure to accommodate and manage that growth? Because I guess today's upside surprise is shocking andawesome and wonderful but there have also been lots of quarters in Estee's history where there's a big negative surprise, andI'm just wondering from an adequate control on the business, do you feel like you've got your arms around everything that'sgoing on?


Well since I have most of my senior management in my room I'll ask them to cover their ears while I answer the question foryou.


Okay.


I do believe we have the right management structure. We need to be flexible. There's no static management structure that canwork ad infinitum in the same structure and we're continually looking at optimizing and matching the right talent for the rightopportunities and looking for the right talents. As far as you say the volatility of our business, I would really encourage you tocontinue to look at our business on a year on year basis, not on a quarter by quarter basis. I think we've been talking about thistheme for quite some time now and that there is a tremendous amount of volatility in our business quarter to quarter, and Iwould actively encourage you to really look at our business year on year where you will see, I hope, a steadier, more rationalprogression of the business. And we continue to manage our business on a long term basis.

Long term for us is multiple years. That we look on it year on year is very important but we really want to encourage you longterm is not three consecutive quarters. Long term is three, four, five consecutive years, and that's really the right way to look atour business. There are a number of different factors, a number of which Rick has spoken about before and we've spoken aboutbefore. There are fundamentals in the business themselves, the execution of the business themselves and then there are theexternal financial factors which come into play in any given period of time. And we roughly estimated that all of the upside






surprise, to use your words in the quarter, about half of that would be due to factors that are somewhat beyond our control,be it interest rate driven, FX driven, tax rate that comes from the mix of business, and some of them are business rates drivenwhere our management did a far better job than they expected to do in a number of different aspects. I'd rather be surprisedon the upside than on the downside and manage the opportunities we then present ourselves by managing our business better.We still believe on an operational basis that there's enormous room for us to improve on a number of different executionalareas. This goes back partially to the implementation of SAP and other companywide initiatives as well as addressing some ofthe fundamentals about having the right brands for the right products and the right markets and the right retail channels atthe right time.


That sounds great. Thanks, William.

Operator

Your next question comes from Neely Tamminga with Piper Jaffrey.

Neely Tamminga - Piper Jaffray - Analyst

Great, good morning, and let me add my congratulations on a phenomenal quarter. William, just a bigger picture question foryou and then a follow-up just in general on innovation. Clearly you guys are making great strides and from a talent innovationpoint of view, call it Beauty Bank or the specialty stores and then most recently with Bobbi Brown and QVC, but I'm wonderingon the makeup side with respect to product innovation. It seemed to me that outside of the makeup artist brands there couldbe room for improvement on the makeup product innovation, clearly there's a very strong mineral based makeup messagegoing out there in the industry. I'm just wondering what role they have to play in prestige.


Well, obviously, the mineral based story has had a tremendous impact in the psychology of the consumer. A number of ourbrands do have a number of products which we're addressing that direct competition. If you were to look at the Clinique brand,for example, in the foundation category, Clinique is by far and away the leading marketer of foundations on a global basis andcertainly in North America on a value basis. The numbers are significant. And if you were to add the Estee Lauder and the MACbrands to it as a total company, the three brands combined, we are the leading marketer of foundations by far and away, andamongst the different formula across all brands, there are dozens and dozens and dozens with tremendous innovations, andwe're seeing a number of different trends which are coming together. And I want to be careful. Product innovation in and ofitself is important but the real driver is that the brands capture the imagination of the consumer and the service level that'soffered for that consumer. And if you look at the spectrum of what we're offering the consumer there still is a tremendouslystrong, loyal following for all three, all four of our, primarily -- excuse me, five -- I keep thinking of our family of 26 brands everyonehas a great offering but the Clinique brand is the leader as I mentioned in North America and the foundation business. The MACbrand is a close second in the foundation business. The Estee Lauder brand is tremendously strong. Bobbi Brown brand istremendously strong, and really, the emotional and intellectual parent of the makeup artist trend is actually the Prescriptivesbrand, which it continues to be the leader in the custom blend, exact color format, and the product innovation that comes fromour brands are really the cutting edge within the industry. We can and should get better at attaching ourselves to each of theindividual trends, but we need to make sure each of our brands are offering the highest quality product for the right consumerin the right shades and we do believe that our brands are doing quite a good job at that.







Thank you and just one quick follow-up on the salon business. In terms of the strength maybe Rick can speak to this. Was thestrength coming out of the salons primarily services driven or was it product sales driven? Thank you.


Well, it's product sales. It's mostly product sales driven. There's a small component of salons but we really only have the Bumble& Bumble salon. That's meaningful for our business but that's the only one.


Thank you very much.

Operator

Your next question comes from Christian Andreach with Manning and Napier.

Christian Andreach - Manning and Napier - Analyst

Hi, good morning. Was wondering if you could just give a little bit more clarity to this second half step up in strategic investmentspending. You mentioned some new media, but is there, are there other areas, maybe some cost savings investments oradditional brand building investments, diversification investments? Can you just add some color there?


I think, Christian, the short answer is yes. We're going to be doing all of the above, everything you mentioned. And I'd like tosort of save something to really have meaningful conversation with you in March about what we're going to be doing, but thefact of the matter is is that we think we have some room to invest in this remaining half of this year and rather than repeat whatwe've been doing for the last 50 years, I'm actively encouraging each of the brands to make an investment in new, alternativegroundbreaking opportunities to drive their business rather than just repeating what they've done before. That's the generaltheme. How that plays out for each brand may be different. I'm encouraging them in new media but that doesn't mean it willonly be in new media. Each brand will have the opportunity to propose an idea to us which we will agree to invest in.


Okay, so you're looking for this incremental investment to be more bottoms up rather than top down driven?


Yes. And also the general theme we've told each brand is this is a one-time only deal. They are not resetting any base for nextyear. If it's a successful investment that gives them a meaningful return above the norm, we're expecting them to incorporatewhatever it is that they've planned, whatever success is, into next year's base. This is not a step up in base. They must actuallyreallocate their spending for the following year to incorporate this new pioneering activity.







Okay, thank you. And I imagine so in March you'll give us more color on what opportunities there might be in cost savings andwhat not?


Yes.


Okay, thank you.

Operator

Your next question comes from Justin Hott with Bear Stearns.

Justin Hott - Bear, Stearns - Analyst

Thanks. First you talked a little bit about how you managed the business from year to year. My question is why give quarterlyguidance especially when it's going to vary so much quarter to quarter.


Boy you ask a wonderful question. I don't know if you're asking anybody who is expert. You're more expert than us. We, if youmay recall, we were giving quarterly guidance from 1995 when we went public. A number of years ago, based on expert advicefrom the financial community, we went to giving half yearly guidance which meant effectively we were giving actually noguidance only on the first and third quarters and guiding the second and the fourth quarters, and that didn't seem to makesense, so we started going to annual guidance. Well, in the process of going to annual guidance one of the things we foundwas the volatility in the trading of our stock as well as more importantly the volatility and the accuracy of the financial communitywho was covering us and their ability to properly forecast in the First Call number started becoming a little difficult for everyoneto manage. Now, obviously, you know better the politics in what goes on about how First Call or other institutions roll up yourestimates and then sort of put out a press release. Essentially because it's somewhat difficult for the outside community tomodel our business on the units -- quarters -- in which you measure, it became increasingly difficult for your community to doso, which increased the spread of your projections, which decreased the accuracy, which increased the liability in any giventime that we may or may not actually perform to your expectations versus our expectations. This is a long way of saying, it'sdifficult for you to read our business enough, to be able to accurately project, and since the world measures us not on what wethink we're going to do when we say we did it, instead versus on what you think we're going to do versus what we do, we feltthat to reduce our volatility, it might be better for us to give you the guidance that we think we're doing. I don't know if thatmade sense, but it made sense to us.


I appreciate you giving me an answer, and --







Thank you.


One more question. On the 200 basis points of operating margin improvement, can you give us some idea how much wasadvertising expense in the quarter, what the growth was or anything like that?


Our advertising expense grew in value but it dropped as a percentage and part of that, Justin, is related to the fact that a lot ofthe upside surprise if you will in sales came from brands which really spend a lot less in advertising, merchandising, and samplingthan some of our more traditional brands, Estee Lauder and Clinique. So it was a combination of the higher sales growth andthat growth coming from the brands that spend less which made the percentage go down in the particular quarter.


Would you say that the spending is going to based on previous quarter versus this quarter, will the spending have to come upa little in the second half of the year?


Yes, and certainly the programs that we talked about which is investment opportunities to drive our business long term aretargeted spending and in particular, right in that particular category of spending, so yes, they will come up in the second halfof the year definitely.


Okay, thank you.

Operator

We have time for one more question. Your last question comes from Connie Maneaty with Prudential.

Connie Maneaty - Prudential - Analyst

Hi. Good morning. Just to get back to the increased spending in the second half. Rick, did you say that with that spending youexpected the operating margin for the year to be flat versus 2006 or did I misunderstand?


No, you're correct, Connie. We said they would be relatively flat.







So last year's margin, operating margin was 9.6% and you think you'll be somewhere close to 10% or 9.5% still in '07?


No. Our operating margin was around 11% last year for the full year and that's what we're talking about.


Okay, so there was the difference since restructuring charges?


Oh, yeah, sorry, yes.


Okay. Also, in your North American sales growth of 7%, what was the impact of the distributers that was acquired?


It was very small, quite honestly, Connie. It was more related to the hair care category and I think that was what William referencedbut the acquisition took place I think October or early November so it was just a very small impact in the quarter.


Okay, and finally if I could ask one last thing. The core weakness that you cited versus competition, has there been a change inthe competitive activity?


I don't know if there's been a change. The competition is quite strong and what we were saying was specifically around theEstee Lauder and Clinique brands where they faced the brunt, if you will, of the effects of the consolidation of Federated-May,and certainly because of their leading market share when anybody grows, including MAC and Bobbi Brown, it in all likelihood,a piece of that is coming from the market share leaders which is Estee Lauder and Clinique.


So it's actually more internal competition?


Well, it's internal but it is external as well.







But by the way that's a purposeful broad strategy of our Company.


Right. Okay, thanks.


Thank you.

Operator

That concludes today's question and answer session. If you were unable to join for the entire call a playback will be availableat 12 noon Eastern Time today through February 7th. To hear a recording of the call, please dial 800-642-1687. Passcode Number595-6790. That concludes today's Estee Lauder Conference Call. I would like to thank you all for your participation and wish youall a good day.

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Cover PageCorporate ParticipantsDennis D'Andrea (1 Turn)Rick Kunes (12 Turns)Dan Brestle (11 Turns)William Lauder (33 Turns)

Conference Call ParticipantsSandhya Beebee (3 Turns)Amy Chasen (8 Turns)Chris Ferrara (4 Turns)Filippe Goossens (4 Turns)Bill Schmitz (7 Turns)Linda Bolton Weiser (2 Turns)Wendy Nicholson (9 Turns)Neely Tamminga (3 Turns)Christian Andreach (4 Turns)Justin Hott (5 Turns)Connie Maneaty (7 Turns)

PRESENTATION1. Operator2. Dennis D'Andrea3. William Lauder4. Rick Kunes

QUESTIONS AND ANSWERS1. Operator2. Sandhya Beebee3. William Lauder4. Sandhya Beebee5. Rick Kunes6. Sandhya Beebee7. Operator8. Amy Chasen9. William Lauder10. Amy Chasen11. Dan Brestle12. Amy Chasen13. Dan Brestle14. Amy Chasen15. Dan Brestle16. Amy Chasen17. Dan Brestle18. William Lauder19. Dan Brestle20. William Lauder21. Amy Chasen22. William Lauder23. Amy Chasen24. William Lauder25. Amy Chasen26. Operator27. Chris Ferrara28. William Lauder29. Chris Ferrara30. William Lauder31. Chris Ferrara32. Rick Kunes33. Chris Ferrara34. Operator35. Filippe Goossens36. William Lauder37. Filippe Goossens38. William Lauder39. Filippe Goossens40. Dan Brestle41. Filippe Goossens42. Operator43. Bill Schmitz44. William Lauder45. Bill Schmitz46. William Lauder47. Bill Schmitz48. William Lauder49. Bill Schmitz50. William Lauder51. Bill Schmitz52. Dan Brestle53. Bill Schmitz54. William Lauder55. Bill Schmitz56. Operator57. Linda Bolton Weiser58. William Lauder59. Rick Kunes60. Linda Bolton Weiser61. Operator62. Wendy Nicholson63. William Lauder64. Dan Brestle65. William Lauder66. Wendy Nicholson67. William Lauder68. Wendy Nicholson69. William Lauder70. Rick Kunes71. Wendy Nicholson72. William Lauder73. Wendy Nicholson74. Dan Brestle75. Wendy Nicholson76. William Lauder77. Wendy Nicholson78. William Lauder79. Wendy Nicholson80. William Lauder81. Wendy Nicholson82. Operator83. Neely Tamminga84. William Lauder85. Neely Tamminga86. Rick Kunes87. Neely Tamminga88. Operator89. Christian Andreach90. William Lauder91. Christian Andreach92. William Lauder93. Christian Andreach94. William Lauder95. Christian Andreach96. Operator97. Justin Hott98. William Lauder99. Justin Hott100. William Lauder101. Justin Hott102. Dan Brestle103. Justin Hott104. Dan Brestle105. Justin Hott106. Operator107. Connie Maneaty108. Rick Kunes109. Connie Maneaty110. Rick Kunes111. Connie Maneaty112. Rick Kunes113. Connie Maneaty114. Rick Kunes115. Connie Maneaty116. Rick Kunes117. Connie Maneaty118. Rick Kunes119. William Lauder120. Connie Maneaty121. William Lauder122. Operator

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Q2 2007 The Estée Lauder Companies Inc. Earnings Conference...

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