William Lauder

Estee Lauder's first quarter was a tough one, but the firm is working on bolstering profits, including the sale of Stila and a cost-savings plan.

NEW YORK — Estée Lauder Cos. Inc.’s first quarter was a tough one but the company is taking steps to increase profitability, including the sale of its color brand Stila.

The firm is also working on a cost-saving initiative that could reap up to $45 million in fiscal 2006.

It faced several hurdles during the quarter, such as the impact of department store consolidation, higher energy costs and storm-related store closures in the South, as well as lower sales relating to its fall promotions. As a result, net earnings from continuing operations for the first quarter ended Sept. 30 fell 35.4 percent to $61.8 million, or 28 cents a diluted earnings per common share, from $95.7 million, or 41 cents a share, in the same period last year.

Sales in the first quarter rose 0.5 percent to $1.5 billion from $1.49 billion, while the company’s gross margin rate fell slightly to 71.98 percent in the quarter from 72.64 percent in the prior year. Both sales and earnings came in below Wall Street’s expectations.

“While we’re faced with both internal and external challenges, we are quickly taking aggressive action,” said William Lauder, president and chief executive officer of the Estée Lauder Cos., referring to the company’s strategy to increase profitability.

Making good on that commitment, the company decided to sell Stila, a makeup artist brand it acquired in 1999. While the company would not comment on the size of the cosmetics brand, latest industry sources’ estimates put Stila at $35 million to $45 million in U.S. retail sales.

“Stila has been part of the family for the last seven years,” Lauder told WWD. “We feel that we’ve given it enough time to make a go of it,” he said, adding that ultimately Stila didn’t prove as strategically important as its fellow makeup artist brands MAC Cosmetics and Bobbi Brown.

During a call with analysts in August, Lauder hinted at the possible sale of low performers, referring to the cost-saving measure as “brand optimization.” When asked Wednesday if there are other brands that might be suited for divestiture, he responded, “It’s a continual process.”

The firm is in talks with potential buyers of Stila and expects to complete the sale by the end of its fiscal year. Industry analyst Allan Mottus speculated that Limited Brands could be an interested party, as its Bath & Body Works division continues to pursue a multi-branded strategy.

This story first appeared in the October 27, 2005 issue of WWD. Subscribe Today.

The company said it’s recording Stila as a discontinued operation. As a result, discontinued operations (net of tax) showed a loss of $3.3 million in the first quarter, which compares with $700,000 in the same period last year. Including that loss, net earnings came in 36.5 percent lower at $58.5 million in the most recent quarter, which compares with $95 million last year.

The company’s forecast for 2006 has earnings from continuing operations pegged at $1.87 to $1.94 per share. This includes a 22-cent-per-share charge relating to expensing stock options. It also takes into account the negative impact of the merger between Federated Department Stores and May Department Stores. Sales for the first half are seen growing around 4 percent, at a constant currency rate.

The company anticipates Federated will accelerate the pace of its planned store closures, shuttering more than half of the 82 doors slated to close by early next year.

Lauder said the closures will affect full-year sales as the company copes with inventory returns and lost sales. “The good news is that we should get approximately half of the pain out of the way and feel less of a pinch in fiscal 2007,” the ceo added.

Partially offsetting the Federated impact is the burgeoning popularity of high-end retailers, the Estée Lauder Cos. expansion with Kohl’s and the growth of its Internet businesses.

This fall, the company also experienced weakness with its gift-with-purchase program, a staple of the Estée Lauder and Clinique brands, given it accounts for 35 percent of their total sales. Lauder acknowledged the program has declined in terms of its return on investment but said it is still more cost effective than the alternatives, such as sampling and in-store events.

Lauder said that both Clinique and Estée Lauder are redesigning and repromoting their gifts to recoup some of the lost sales.

Lauder said the company’s full slate of product launches would drive growth in fiscal 2006, citing strong retail buyer demand for Tom Ford’s Estée Lauder collection and BeautyBank’s first full-fledged holiday program at Kohl’s.

Other hotly anticipated initiatives from the Estée Lauder Cos. include the fragrance Unforgivable by Sean John, due out at Saks Fifth Avenue in December; the 10th anniversary ad campaign for Pleasures featuring Gwyneth Paltrow, and the spring launch of the Missoni fragrance.

During the quarter, on a reported basis, skin care sales were flat at $523.4 million, while makeup sales increased 3 percent to $604.9 million and sales of hair care products climbed 12 percent to $70.4 million. Despite successes such as DKNY Be Delicious and True Star Men from Tommy Hilfiger, fragrance sales decreased 6 percent to $293.2 million.

By region, sales in Europe, the Middle East and Africa decreased 1 percent, while Asia-Pacific jumped 5 percent. Sales in the Americas were flat at $881 million.

William Schmitz, research analyst for Deutsche Bank, described the company’s new earnings guidance as aggressive, given the effects of the Federated-May merger. Lowering the price targets, though, is only one step. Schmitz wrote that “options, retail consolidation and potential restructuring charges complicate the numbers, but what is clear is that uncertain macroenvironment and brand turnaround begun too late are not just short-term hiccups … We don’t see a quick or easy solution to current problems, which are both macro and company-specific in nature.”

Merrill Lynch analysts Christopher Ferrara and Olivia Tong downgraded shares of Estée Lauder Cos. to “neutral” from “buy.”

“The change is based on sales growth concerns across both the U.S. and Europe and the immediate catalyst to the downgrade is the detail surrounding [Estée Lauder’s] miss of our already lower sales and EPS estimates for [the first quarter],” the analysts said in their report. “We had previously been willing to ride out near-term choppiness with a view of improvement in [the second half of 2006]. At this point, we are no longer convinced that things will improve meaningfully. This, combined with longer-term distribution channel issues, drives our move.”

Shares of Estée Lauder Cos. dropped 7.7 percent Wednesday to $30.71 on the New York Stock Exchange.

Lauder remains optimistic about the company’s position: “We have confidence in the fundamentals given what our visibility is today over the long-term, and what we see as opportunities around the world in our key categories,” he said.

“We have undertaken some serious belt-tightening by aggressively identifying projects and costs that do not critically need to take place this fiscal year,” Lauder explained, adding that by supporting fewer programs, the impact will be greater. The company expects its efforts to deliver between $40 million to $45 million in incremental savings.

— With contributions from Amy S. Choi and Arthur Zaczkiewicz

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