The Estée Lauder Companies Inc. (EL) Q3 2011 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Estée Lauder Companies Fiscal 2011 Third Quarter Conference Call. Today's call is being recorded and webcast. For opening remarks and introduction, I would like to turn the call over to the Vice President of Investor Relations, Mr. Dennis D'Andrea. Please go ahead, sir.

Thank you. Good morning, everyone. On today's call are Fabrizio Freda, President and Chief Executive Officer; and Rick Kunes, Executive Vice President and Chief Financial Officer. Also with us is Olivier Bottrie, President of Travel Retailing Worldwide. Olivier will give an overview of Travel Retail and discuss our strategies for growth in the channel. 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'll find factors that could cause actual results to differ materially from these forward-looking statements. We will also discuss certain of our results in non-GAAP financial terms, and you can find a reconciliation between GAAP and non-GAAP figures in our press release and in the Investors section of our website. I'll turn the call over to Fabrizio.

Good morning. Thank you for joining us. Our company had another strong quarter in which we continue to show fantastic momentum. Our growth was broad-based, encompassing all regions and categories, and every category grew in every region. More than half of our brands grew double digits. The luxury consumer is clearly... [Audio Gap] The strength is driven by affluent shoppers in the U.S. and wealth creation markets especially in China. Demand for premium goods and services in the U.S. is expected to rise 8% this year according to a recent survey of affluent and wealth in America. In the U.S., premium brands are generating the strongest gains among consumer goods and luxury travel is outperforming economy travel. However, luxury consumers are very demanding. They're willing to spend, but they expect excellent product and services and an experience that provides added value. This trend rewards our focus on high-quality products and reinforces our commitment to invest at point-of-sales in beauty advisor online and all other aspects of our High-Touch experience. In fact, our luxury brands -- Bobbi Brown, La Mer, Jo Malone, Tom Ford -- grew strong double-digits for the quarter. The soundness of our strategy of launching fewer, bigger innovations and supporting them with stronger advertising and excellent High-Touch service is confirmed again this quarter. We continue to lead in the strategically important Skin Care category, which saw strong increases in all regions. Recent technologically advanced innovations include Clinique Repairwear Laser Focus, Estée Lauder Advanced Night Repair Eye Recovery Complex, La Mer Regenerating Serum and Origins Plantscription. We are pleased with the success of these new products, and we have a strong pipeline of innovations ahead of us to sustain our leadership. Importantly, we continue to nurture our other categories. Makeup, our second-largest category, also grew strongly in every region.…

Thank you, Fabrizio. Good morning. Let me first introduce myself. I've been with the Estée Lauder Companies for 15 years, running Travel Retail division for the past 7 years. I also worked with the different brand in North America and won the international division of Aramis and Designer Fragrances. To begin, I would like to give you some background on the Travel Retail channel. We estimate retail sales in excess of $30 billion in 2010. The Travel Retail channel provides shopping opportunities to travelers around the world, tourists and business people alike. The Travel Retail channel grew an average of 7% annually over the past 10 years. Travel Retail was born as a beauty advisory channel. It has evolved into one of the most vibrant, rapidly growing brand equity building, global market business. The channel provides a great platform to build brand new [indiscernible], introduce new consumers to brands and improve their travel experience. While historically, sales growth in the channel for passenger [indiscernible] quite closely. The recent and rapid development of new airports and improved facilities in existing airports and had both retailers and brands to focus in attracting an ever-growing number of travelers into shopping and buying. Our retailers have done a great job securing the right mix of brands and improving store layouts and merchandising. This is reducing the coalition between traffic growth and sales growth. The emergence of the Chinese travelers eager to consume nursery [ph] products in our channel is also changing. The Beauty category enjoys the growing leadership in addition to the channel, over 30% of all sales. In the past 10 years, sale are growing at the rate of 10% annually. Within every category, Fragrances have a dominant position with a global share of 58%. However, their share have been declining as Makeup…

Thank you, Olivier, and good morning, everyone. As you know, my discussions on the quarter and the outlook exclude restructuring and special charges. We had another strong quarter, driven by broad-based growth across our regions and categories. Sales rose 16% to $2.17 billion. Excluding the impact of currency translation, sales were up 15% and earnings for the quarter more than doubled to $142.6 million compared with $68.9 million in the prior year quarter, and diluted EPS was $0.71 compared to $0.34 last year. Sales growth was about 6 points higher than the top end of our guidance. Approximately 2 points was due to a weaker U.S. dollar than we had forecast. Some of our retail customers ordered extra inventory ahead of the April 1 launch of SAP in 7 of our International sales affiliates, increasing our third quarter sales by about another 2 points. These sales would have likely been made in our fourth fiscal quarter. The remainder came from stronger-than-expected sales, mainly in Travel Retail, North America and China. The incremental sales, combined with well-managed operating expenses, were only partially offset by an impairment charge for Ojon, allowing the majority of the benefit to drop to the bottom line. Compared to last year, all product categories grew. Skin Care, Makeup and Hair Care saw double-digit gains with the fastest growth in the Makeup category. Sales rose 22% in local currency, with improvements in every region. The Makeup category benefited from an easy comparison to the prior year when we recorded approximately $27 million in returns for product reassortment at certain European perfumeries. This compares an added about 4.5 points of growth to the Makeup category. The strong underlying category growth was driven primarily by our M-A-C and Bobbi Brown brands and the addition of Smashbox. In Skin Care, local…

[Operator Instructions] Our first question today comes from Chris Ferrara with Bank of America Merrill Lynch. [Technical Difficulty]

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

Could you quantify the EPS impact of the $42 million in incremental sales you got in the third quarter, because we have no way of calculating the costs associated with those sales.

Sure. That sales shift was about $0.10 EPS.

Okay. And then that takes $0.10 off the next quarter obviously. And then, could you elaborate on the 180 basis points improvement in margins you got in selling and shipments? I think that line includes compensation for people who help out customers in stores, and tell us where you're getting the bulk of that savings.

Sure. As you know, our business model is built on generating high volumes through as few doors as possible, if you will. So that productivity at point of sale, and what we're seeing is tremendous results from a sales perspective, which is helping us to drive our productivity at point of sale. And just generally across the company, we're doing I think a pretty effective job of leveraging growth. So our growth has been ahead of what we actually thought we would achieve this fiscal year, and what we are doing is very effectively controlling our costs associated with that, and at the same time, taking some of that additional profitability and investing it in advertising, in particular, magazine and television advertising, which is helping drive our business especially in markets like China. So the business model that we built is working pretty well for us so far.

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

It is a question actually on Travel Retail. So if you were talking about sort of improvements in the selling environment and so on, I know historically, it's in your P&L today, most of the -- the emergence of Travel Retail are so accretive because a lot of the advertising and marketing costs is actually allocated to the regions themselves, not to travel. So as we go forward, there's more investment sort of in-advertising within the channel and merchandising within the channel itself. Does that sort of cost allocation and implied probability change at all?

This is Fabrizio. Actually, first of all, Travel Retail will continue to exploit the power of our brands in the key markets because consumers we try in this market when to travel the Lauder brands. And the advertising in those markets will continue to influence positively Travel Retail. But what is the new trend and new possibility this channel offers is actually also using the channel for equity building. And I like Olivier to explain exactly how we is doing that with his team in that channel.

Well, again, what we want to do is to exploit the possibility given to us with very low penetration and conversion rates that we observed in airports in particular. So what we do is put a series of activities to give advantage to advertising of course as we mentioned, towards also improving our contest in airports includes theaters and events all this again to drive consumers into strong and improve conversion therefore, more sales. So the question on how this could affect profitability, in effect, we investigate more sales, and as a result, actually the profitability goes up.

Your next question comes from the line of Chris Ferrara with Bank of America Merrill Lynch. [Technical Difficulty]

Your next question comes from the line of Connie Maneaty with BMO Capital Markets.

Could you talk about the next wave of roll out of SAP, which countries it's going into, and would you expect the same sort of sales shift that you saw this quarter? And specifically, which quarter does the next wave start in?

So our next wave starts about 12 months from now, I believe. And, I mean, we're working on it now as we speak. I don't know, Connie, off the top of my head the countries involved. It depends of the retailers. So what we saw this time was because of their past experience with other suppliers, they were somewhat concerned, I guess, about whether we would have any problems going live with SAP. And what happened was actually that our implementation and go live went very well for us. So I don't know whether in the future now, other customers will look at that experience and assume the same or whether they'll be cautious as well and also order in advance of us going live in their markets.

Okay. My follow-up question is this, what is the nature of the investment spending in the fourth quarter? And should we assume that level of spending going into the first half of fiscal '12?

Yes, the nature of the spending is basically advertising and sampling a key merchandising activity on the biggest new initiatives and launches on the biggest brands in the main markets like China or the U.S. And we are increasing overall advertising by one full point. So 100 basis point in the year on average. And in the quarter, we are increasing about 140 points. So we are really taking a big stance in building our business aggressively, building on our best brands, countries and initiatives. And we have built a business model where this is supposed to continue. So yes, it will continue for the future. Because in our business model, our pool activities have a bigger role.

Does that suggest then that in fiscal '12, this investment spending would be up about 100 basis points over fiscal '11?

No, I didn't say that every year we'll go up a point. I just said that we have increased the point, and this level is supposed to continue, and we will find -- we will look for opportunities to continue to gradually take this amount up depending on business needs and opportunities.

Great. That's helpful.

Your next question comes from the line of Linda Bolton Weiser with Caris. Linda Weiser - Caris & Company: Just a follow-up question on the Travel Retail impact. That impact that you gave, the 0.5% for the fiscal year, does that include just your sales in stores and other channels in Japan or does it include the anticipated effect on the Travel Retail? And can you also comment on whether -- we found some data points that about 15% of the Travel Retail sales globally are to Japanese travelers traveling abroad, and can you comment if it's accurate? And maybe you can just give us some commentary about what -- I mean, are you seeing any impacts in terms of specifically the Travel Retail piece of the Japanese situation? That would be the first question. And then my second question has to do with the Americas strength. I'm wondering if you could give us some more detail on that, maybe department store sales compared with alternative channels, because the number that you're showing there seems extremely strong, and I just want to better understand the growth that's happening there on the Americas.

Okay, let me put the number first ahead. Japan is about 5% of our business. We are seeing about a 10% reduction because of the dramatic event, and Travel Retail related to Japanese people, so Travel Retail in Japan and influenced by Japanese travelers is about 6% of the Travel Retail business. And on that front, we are seeing, for the time being, about a 20% to 30% impact. So the combination of those 2 elements, meaning the Japanese traveling, Travel Retail and Japan mainland is the $0.05 impact that we have quoted. The next question is on the U.S., is that we see the specialty stores in the U.S. continue to be the fastest-growing channel in Prestige. But department stores are also growing pretty fast in this field. As I said, the combination of department stores and specialty store Prestige channel is growing at this point faster than drug and mass.

Your next question comes from the line of Wendy Nicholson from Citi Investment.

My first question has to do on the Travel Retail business and one of the comments I think that Olivier made was that the market share for Estée is only about 14.5% and that surprises me that, that is so much lower than what we see in terms of your department store market share, and I was wondering if you could split that out maybe geographically or some other way because it just seems like an awfully low number.

Well, it's slow but it's growing. So that's the good news. And we actually said the fastest-growing company in the channel, I think, has been great for 2 years now. The reason why we have a global market share of 14.5% only is due to the fact that the Travel Retail market historically is a European plane and it's a Fragrance plane. As a company, we are specialized in cosmetics and beauty, more than in fragrances today, and our trend is really in Asia. Now as I mentioned as well I think in my prepared remarks the trends towards Makeup and Skin Care, and we have very good expectations, very good hope that we could, going forward, continue to gain market share in the channel and increase that share on the back of Makeup and Skin Care as a company of course deploys also more investments acquiring brands to show our presence in Fragrances worldwide.

Okay. And then given that, and given, I mean, it just seems like you've got a tremendous amount of headroom there, and that's great, and given the margin profile, Frabrizio, even if the fourth quarter margin is flat with year ago, which I think is kind of what you're implying with the guidance which seems really hard to believe with foreign exchange and everything else, you're still going to end this year kind of halfway towards your 2013 margin goal, north of 13% already. Is there any reason for us to think that margins aren't going to be up in 2012 and then again in 2013, because it just seems crazy that you're not raising that 2013 margin target at this point?

No, we are not raising at this point, because we are still analyzing details all the elements. And we have all the elements, we will continue to update our guidelines in this sense. But if your question is should you expect to continue to see our margin progress, yes, you should. As we said, we had a very strong margin progress at the beginning of our program. We are today at the middle. We are after 2 years of our full-year program, because the majority of cost savings and the majority of mix improvement and the majority of improvement on underperforming brands they were a big part of our historical issue, all these things happened in the first 2 years. Now we will continue to progress may be at a different base. We said already in a previous call that we will see that only as 60 points. So 0.5% margin per year minimum as our ongoing ability to continue grow. So we will work on these and then when -- in August, we will present. The next fiscal year, we will also update our thinking on the long term.

Your next question comes from the line of Caroline Levy with CUSA. Caroline Levy - Credit Agricole Securities (USA) Inc.: I just want to clarify quickly a couple of points. In Europe, Middle East, et cetera, a year ago, I think you had a charge of $21 million -- $31 million. And so if I would add that back to last year and take out the pulled forward sales this year, it looks like the growth in Travel Retail would have been about 7% for EBIT. So that would be adjusting up the charge from last year and taking out the pull forward sales. And I just want to know if I'm getting that wrong or is that the right calculation.

You're doing the right calculation for the region, but not for Travel Retail. None of that was associated with Travel Retail. So the $31 million charge last year was associated with the SKU assortment in perfumeries in Europe. So that was a charge, you're absolutely correct on that. And the shift in sales was all at the sales affiliate level, U.K. and Germany this year where sales from the fourth quarter were moved into the third quarter. So those would be the 2 adjustments that you would make. Caroline Levy - Credit Agricole Securities (USA) Inc.: The Travel Retail is obviously very strong but it sounds like in the other businesses, the EBIT was down, and I'm just wondering how much was discretionary because you felt like you had the money to spend with margins under pressure ex-Travel Retail.

No, you're right. It was based on spending patterns, but has nothing to do with our profitability improvement within the region. I think if you look on a year-to-date basis in Europe, you'll see that our numbers are up substantially, and I think you'll still see for the full year a substantial improvement in the profitability of the European region and quite honestly throughout all our regions.

Your next question comes from the line of Bill Schmitz with Deutsche Bank.

Can you talk more about what's going on with Fragrances? So I just kind of read some the guidance here, are you going to exit more brands? Is that why it feels heavy flow. It's kind of written cryptically. I don't have a follow-up.

No, we are not going to exit more brands. Actually, we are building more our Fragrance portfolio. As we announced, we have Zegna, also included in our portfolio for the future. We are investing in improving our Fragrance business around the globe. As we said, we made excellent progress in fragrances in the last year, so now they are contributing to our profit improvement year-to-year in a substantial way. And our high-end Fragrance is like Jo Malone and Tom Ford, among the fastest-growing brands in our portfolio. So actually [indiscernible] shape that.

Okay, great. And then just my follow up question is you kindly provided us with sales and operating impact of the pull forward of those SAP related prebuy. It looks like the margin on Asia was 83% and incremental sales and something like 72% in Europe. Why are those margins so high?

Well because there's -- for us, Bill, you see our gross margin, and there's really very little expenses associated with it. So when they ordered additional - at the end of March, ordered additional stock, there was no expenses associated with it. So it's pure gross margins to us. And same happens next quarter when those sales don't happen. So we don't change our spending plans as a result of that. Those stay sort of constant. So that's what generates that huge margin.

Your next question comes from the line of Joe Altobello with Oppenheimer. Joseph Altobello - Oppenheimer & Co. Inc.: Just a couple of questions. First, over the past few years, it seems like you benefited nicely from the trade down within the Prestige channels to opening price point wins like Clinique, like Estée Lauder. Are you still seeing this in a big way or are you -- it just seems like those brands did well this quarter but also the superpremium brands did well like La Mer, for example. So are you just gaining share across different price points or are you seeing trade up?

Actually, what we are seeing is really the strength of our broad portfolio of businesses or brands. Because what we are seeing is that our Clinique and M-A-C brands, for example, which are at the entry price points of Prestige, they continue to benefit from the trade up, actually, from mass into Prestige. They are at the entry of Prestige, and they are the brands which are growing, thanks to our -- the ability of our model to attract people and consumers also from mass drive and other channels around the world. On the contrary, our high-end brands, meaning the most luxury brands in our portfolio, are currently benefiting from the fact that the luxury consumer is back, and they are looking now for quality and for high-quality brands. And in our portfolio, we have brands to offer in that area. And those brands are now growing faster again where those brands, as you know during the recession, had been weaker than they are today. Joseph Altobello - Oppenheimer & Co. Inc.: Okay. Just one second one. In terms of the de-emphasis on promotional activity or for the pull strategy is you call it. Our promotional levels now sustainable or are there additional production next year that should be redeployed into its advertising?

I think that we are on a journey. We will continue to rationalize our market spending, including our promotional spending and to reinvest part of this rationalization into activities with higher return, and again, advertising, particularly digital, and on a certain extent, also print and TV depending by country we'll continue to gradually increase.

Your next question comes from the line of Jason Gere with RBC Capital Markets.

I guess, the first question, just the language in the release just on the Americas, Europe, the outlook remains cautious and that may be just your normal language. But I was just wondering in the context if you could talk about inventory levels maybe at retail, first. Second, the competitive environment, may be in the department store right now. And then third, I think, Rick, you mentioned something about fuel prices. I'm just wondering any type of studies you've done. I mean, typically we think the fuel prices are affecting the low-end consumer not the high-end. Though, I was just wondering what type of studies you've done, to kind of analyze that.

We are cautious in Europe because some markets are under pressure. So we definitely continue to see soft markets in Greece, in Portugal, in Spain, specifically, we continue to see soft markets also in Australia and obviously in Japan and in some of the Middle East countries which are closely affected by the political turmoil. On North America, actually, we're not cautious. We see that the North America business, the market trend is pretty positive in this moment, as I said, driven by the fact that the luxury consumer is back.

Yes, regarding fuel prices. At a certain point in time, we realized that our customers for the most part are not -- probably have the disposable income to buy our products regardless of the fuel prices. But at a certain point in time, fuel prices start to work on the consumer confidence and start to affect people spending pattern in the way they look for their economic well-being, if you will, and starts to affect the overall economy. So there is a point in time, gas is at, whatever, $4.40 or $4.35, I think I saw in the way in to the office this morning. So gas is starting to push up and what we're saying is that if that continues, if that price dramatically changes, there could be an effect on the consumer sentiment, which will obviously affect our business.

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

Couple of questions. First off, just around your guidance. I guess, I still struggle with it. First off, for next quarter, even if you pull out the kind of [indiscernible] you probably increase in advertising spend, et cetera. I just have trouble believing, I guess, in a down quarter. And I guess in that context more broadly, I guess, I'm certainly questioning guidance, I guess, in a broad sense in terms of what you've done over the past several quarters. How should we think about guidance? How much credence should we give guidance? Any guidance on that would be helpful, I guess. And as a piece of that, if you could address the impact of foreign exchange on the bottom line this quarter, it sounds likes it's a little too low for at least our numbers for next quarter. I mean, what kind the impact do you have on the bottom line versus the top line? Then I have a follow up for Olivier, please, on Travel Retail.

So let me first try to give you some specific numbers, and then you can judge our guidance in this case. But first of all, the high-end of our phase guidance would be in terms of sales growth for the last quarter. It will be about 12% if you have to adjust for the shift in orders that we had to have the rest, it might go live in April and for the input on Japan in the quarter, which is about 2 percentage points in the quarter. So if you adjust for this, the top line will be about 12%. Now 12% is in line with the first 9 months, more or less. And so in line were the 10%, 11% we see in the first. So we don't see the full quarter to be too different in terms of apple-to-apple comparison to our bottom line. In term of bottom line, you will need to, again, keep under account the fact that we are investing, 140 points more behind advertising opportunity for a specific choice that I've been frankly repeating that we are taking the flexibility to invest in our biggest opportunities for the long term. And we are taking the opportunity to build and consolidate our strong market share gains in places like China and Travel Retail now that we can, now that the market is strong. Because that's the right moment to do it for the long term. And we are taking advantage of the right windows when they open. And so, yes, you are going to see a certain important increase in advertising investment. They should benefit in turn also our top line in 2012. And you need to keep under account that last year, we had $31 million tax credit that we do not have in the last quarter of this year. That should include increase the quality list of the earning will be different. Now, I don't know, Rick, if want to add anything.

Yes. Ali, the exchange benefit that we had versus our estimate, we mentioned 2% of sales. That was worth -- it's worth about $0.04 from earnings in the quarter.

Okay. And just a longer-term guidance on Travel Retail, then we have Olivier on the phone, might as well take advantage of it. Olivier Could you talk to us a little bit about what you saw the category in Travel Retail growing? You talked about traveler growth, but the category had been growing over the past x number of years and how you see that going forward, you did again mention the traveler growth going up a little bit, but could you give us some sense of that? And then if you would just aggregate that. So you talked about traveler growth, obviously, you talked about penetration which I guess, is distribution, you talked about conversion, how should we think of those buckets over the past couple of years for you, and how should we think about those as the pieces of your growth going forward?

First of all, let me qualify penetration. Penetration is a ratio of travelers in stores, number of percentage of travelers visiting stores. When we talk about our long-term outlook, a key factor of our growth in the future is of course traffic. It was explained we're able now to update traffic quite handsomely through techniques and activities that actually drive penetration and conversion. The category, which is a tough question, had been steadily growing in the industry over -- they're growing category to start, the beauty category is #1 in the channel and has been growing, as I said in the past 10 years, at 10% annually, while the overall channel, including all categories have been doing 7%. And again, that trend will be perceived continuing in the future if only due to the rise of Asian travelers and more specifically, Chinese travelers who happened to be avid consumers of Skin Care brands and spent much more on average than the typical American Consumer.

We have time for one more question which comes from the line of Marc Astrachan with Stifel, Nicolaus. Mark Astrachan - Stifel, Nicolaus & Co., Inc.: Wondering if you could talk a bit about what's driving the sales growth sustainably and meaningfully ahead of just global Prestige Beauty. And then somewhat relatedly, I'm curious if you see any gaps in the portfolio where you think there's an opportunity to expand into new categories, price points, et cetera?

First of all, we believe we can continue to drive our sales growth ahead of the market by about 1 point minimum every year. That's what we said for the long term. Now we are doing better than that in this moment, thanks to the many great success in activity we are running. But then the minimum stand that we have given ourselves for the long term. Now why we believe we can achieve that and why we are doing better than that today is because in reality, we are putting focus on the biggest opportunity. We have chosen to play in areas which are the fastest growing areas. We put our boat in the wind very well, and the wind is coming from China. The wind is coming from the other emerging markets. The wind is coming from multicultural, multiethnic consumers. The wind is coming from high-quality brands. And importantly, we gave a great contribution to create new wind in our core channel, which is U.S. department store, which is now growing again, and is growing also because of the many important efforts in new business model we are deploying in this channel. So we can grow faster because we are particularly well-positioned in the fastest-growing segments of the entire global market. And by the way, Travel Retail is part of this. The second question is what are the gap in opportunity portfolio? Definitely, we had put a huge priority on Skin Care, and I believe this just the beginning of a journey, particularly, there is more and more opportunity to continue to leverage the Skin Care category in Asia and, as Olivier just explained, in the fast-growing Travel Retail channel. And that will be an area where we'll continue to focus, continue to reinforce our position among others.

That concludes today's question-and-answer session. If you were unable to join for the entire call, a playback will be available at 12 noon, Eastern time today through May 12. To hear a recording of the call, please dial 1 (800) 642-1687, passcode 61746037. That concludes today's Estée Lauder conference call. I would like to thank you all for your participation, and wish you all a good day.