雅詩蘭黛 (EL) 2004 Q2 法說會逐字稿

Good day, everyone and welcome to the Estee Lauder Companies fiscal 2004 second quarter conference call.

Today's call is being recorded and webcast.

For opening remarks and introductions, I'd like to turn the call over to the VP of IR, Mr. Dennis D'Andra.

Please go ahead, sir.

Good morning and thanks for joining us today.

On the call are Fred Langhammer, President and CEO;

William Lauder, COO; and Rick Kunes, SVP and CFO.

Some of our remarks today contain forward-looking statements, which involve risks and uncertainties.

In addition to specific risks described in the call, you will find additional factors that may cause actual results to differ materially from these forward-looking statements in our press release today and in the 10(Q) we expect to file later today.

I'll turn it over to Fred now.

Thank you, Dennis and good morning, ladies and gentlemen.

It's a great start in the new year with the news of a very strong quarter for our company.

Our solid second quarter and outlook for the fiscal year reflects the momentum we have had for the past few quarters.

Based on our first half performance, together with our programs in the second half of the year, we're increasing our expectations for full fiscal year earnings per share from continuing operations by 5 cents to a range of 1.50 to $1.55.

For the second quarter, we turned in outstanding net sales growth of 15% to 1.26 -- to 1.62 billion from 1.41 billion in last year's quarter.

Excluding the benefit of foreign currency translation, net sales grew 9%.

Net earnings attributable to common stock from continuing operations for the quarter were up 21% to $126.3 million, compared to $104.4 million in the prior year quarter.

Diluted earnings per share from continuing operations came in at 54 cents, compared to 44 cents in the same period last year, a very solid 23% growth that was ahead of our expectations.

As you saw in our press release this morning, we've classified our jane brand as discontinued operations.

Rick will touch on this at a later date during the conference call.

In the U.S. retail, retail environment bounced back -- back and forth during the holiday season.

Ending with a late spending surge just before Christmas.

Results by retailer were mixed, however many of our top accounts had a terrific season, and post-holiday retail sales were also quite strong.

Our new product pipeline, a substantial recovery in travel retail, and solid growth in our retail stores all drove sales this quarter.

We saw increases in all product categories and regions, reflecting a meaningful return on the investments we've made over the last couple of years.

Our international business accelerated with Europe and Asia growing 34 and 19% respectively.

Including the positive effects of changes in foreign exchange rates.

Most current categories had double-digit reported growth this quarter.

In fact, skin care makeup, and fragrance all grew in every region.

In skin care, reported sales increased 19% to $572.1 million.

And grew 12% in constant dollars.

Several factors drove skin care, including new and existing products such as Clinique's hair wear line and recent launch of pore minimizer.

Estee Lauder's idealist Micro-D, a new moisture cream hydro complete.

The Estee Lauder brand also continued to record strong sales in renewed intensive lifting products.

The category benefited from the addition of sales from Darphin, which is predominantly skin care, and our exclusive La Mer brand saw double-digit growth in every region.

Makeup was also strong with sales increasing 12% to $527.1 million in dollars rising 7% in local currency.

M.A.C. and Bobbi Brown again generated strong double-digit growth around the world, driven by new color stories, appealing holiday sets, and increased distribution.

While recent launches such as Clinique High Impact and Estee Lauder MagnaScopic did very well.

Estee Lauder popular Blockbuster makeup set sold through virtually 100% by December 20, reaffirming the appeal of this holiday program.

As expected, fragrance results improved again.

Fragrance sales for the quarter increased 16% to $446.4 million on a reported basis and rose 9% over the last year excluding currency.

Estee Lauder Beyond Paradise, was a real hit, exceeding our expectations and ranking number 3 in womens for the quarter in the U.S. department stores.

This exciting fragrance was also very well received in the U.K. and travel retail.

Aramis Life rolled out this quarter, achieving our goal of a top 10 mass ranking in the United States department stores.

We're committed to building this franchise on an ongoing basis.

Supported by a full promotional program for the spring with more visuals of Andre Agassi.

Clinique Happy Heart made its holiday debut and performed well.

While the introduction of Clinique Simply was in line with the expectations .

Fragrance sales were also boosted by strong sales in our travel retail division.

Incremental sales from our new licenses -- license arrangement with Microcourse helped the category, as well.

Hair care rose 5% this quarter to $63 million due to Bumble and bumble, which saw double-digit increases this quarter from a launch of a line of products of curly hair, strong comp store growth, and expanded distribution.

Aveda had a tough comp in hair care due to the prior year major launch of the light elements line.

Following the opening in September of the holistic center in Tokyo, Aveda opened an institute in Berlin to support the network of 175 still in the region.

We believe we can more than double our network over time.

These institutes support further expansion of Aveda's international presence to help establish it as a major brand around the globe.

Let me now review our geographic regions.

In the Americas, sales rose 3% from the prior year to $804.7 million.

This fall is a 9% growth in the first quarter, giving us a healthy 6% increase for the six months.

In fact, retail inventory at the end of our first half was well balanced, reflecting a matching of sell through and selling during the half.

Sales increases this quarter occurred in every product category, particularly in fragrance, with the introduction of three major launches.

Estee Lauder and Clinique posted higher sales along with growth from virtually all our developing brands, with most posting double-digit sales increases.

Our free-standing retail stores are accelerating return on investment as M.A.C. and the data elevate double-digit growth.

In Europe, the Middle East and Africa, net sales jumped 34% over the prior year to $586.7 million and grew an impressive 20% on a local currency basis.

Our travel retail business continued its recovery this quarter, rising a healthy 35% on top of the 50% growth reported in last year's second quarter.

As we discussed in last quarter's call, adverse weather conditions and retailer negotiations during our first quarter resulted in lost or delayed shipments in this region.

In the second quarter, we recovered most of those sales in the effective markets.

We also benefited from growth in most markets, particularly in the U.K., Spain, and Greece, while France, Italy, and Germany remain somewhat weak.

The addition of Darphin, which generates most of its sales in Europe also aided the region.

In Asia Pacific, net sales grew 19% over the prior year to $227.7 million.

In local currency, sales were up 8%.

Local currency sales increased in every market.

Taiwan, China, Malaysia, and Hong Kong, all had double-digit sales increases, and Korea was strong, while in Japan, sales were up slightly.

Let's now look ahead to the remainder of the -- of the year.

Economic news around the globe is mixed.

The U.S. appears to have pockets of recovery although it needs to be sustained.

In Europe, we continue to see the same markets like the U.K. and Spain accelling each quarter, and other markets like Germany and France experiencing difficulties.

In Asia, we continue to see growth opportunities.

Japan has begun to improve, and we hope to build momentum there.

We feel very good that our new product lineup, coupled with our spring promotional programs will drive strong sales growth in the second half.

The Estee Lauder brand is already generating buzz with its Oscar spot program linked to the academy awards.

This will have great PR benefits.

On the new product front, the brand is excited about the moisturizer category this spring, following the recent launch of Hydro Complete, and anticipating the April launch of a technologically advanced body-care line.

Clinique is making strong moves in Asia with the spring launch of Active White Lab Solution skin care.

What makes the launch a departure from the past is a new and exciting campaign targeted at Asian consumers, which emphasizes the product benefits.

We have very good expectations in regard to this launch.

I'm sure you'll agree that M.A.C. has been striking the right cord with consumers with the products and price points.

We are tremendously excited about the Viva Grand 5, the lipstick and promotional vehicle that benefits the M.A.C.

AIDS fund and generates a lot of activity.

The campaign will feature a host of unique personalities for this launch that will be announced in mid February.

Stay tuned.

As you saw, our press release on Tuesday issued jointly with Tommy Hilfiger, we announced an exciting new agreement with Beyonce Knowles, who will become the spokesperson for a new Tommy Hilfiger fragrance, slated for a global launch this fall.

Beyonce is the best-selling award artist with international acclaim and universal appeal.

She will bring new dynamics into our fragrance business and attract and expand the brand's consumer base while also connecting with our existing customers.

We're excited about this new agreement and look forward to working with Beyonce.

Based on the current tone of our business, we expect sales growth of between 10 to 12% on the reported basis and 7 to 8% in local currency for the fiscal year.

And we're now comfortable with a new fiscal 2004 diluted earnings per share from continued operations estimate in the range of $1.50 to 1.55.

Therefore, our second half top line growth expectations are between 9 and 11% on the reported basis, which translates into 7 to 8 a constant currency.

As for the bottom line, in the second half we're comfortable with the continuing operations EPS guidance in the range of 62 cents to 67 cents.

Now on a more personal note, as you know, we announced early early this month that I will be retiring at the end of June from my position as President and CEO.

I have always believed that the ultimate career success is to reach a point where one can be in charge of one's own time.

After nearly 30 rewarding years and exciting years with the company, for me that time has come.

Going forward, I'm delighted to be able to advise the company in the area of global strategy, including the development of the China opportunity.

Over the past several years, we have put in place a very strong organizational structure and a great team of leaders, most notably, the formation of group presidents to oversee distinctive groups of business as well as president of operations.

I've said to you before that financial performance in any given period is only a scorecard and doesn't tell you where you're going.

What tells you where we are going is the appropriateness of the strategies in place.

From this point of view, I'm very optimistic about the future.

I would like to take this opportunity to congratulate William Lauder for having been selected to follow me as Chief Executive Officer.

William's qualifications cover a broad spectrum of company and industry knowledge.

He's worked very closely with me beyond his formal areas of responsibility in the formation of strategy, including overall direction and execution.

I'm very confident that with his leadership and the skilled passion of our people, the best years for The Estee Lauder Companies are ahead of us.

William and Rick will be addressing you on future calls.

As this will be my last conference call, I'd like to thank each of you for your support and confidence since our ideal eight years ago and wish you all the best in your future endeavors.

Now I'd like to hand it over to Rick, our CFO.

Rick, it's yours.

Thank you, Fred.

And -- and we're certainly all going to miss you and the conference calls will never be the same without you, that's for sure.

Let me begin with a few results for last -- for the past quarter.

Reported net earnings attributable to common stock for the quarter were $95.7 million, compared with 103.8 million in last year's quarter.

Reported diluted earnings per share were 41 cents versus 44 cents for the three months of last year.

We've been giving you indications for some time that jane is not a good strategic fit for us and is not performing to our standards.

Last month, we committed to a plan to sell the assets and operations of jane and to actively market the brand.

We will keep you informed of our progress.

As a result, effective with our December quarter, we are treating jane as a discontinued operation.

In compliance with GAAP, we recorded the operating results, associated shut down costs, and related goodwill impairment attributable to jane as a separate line item in the P&L.

The remainder of my discussions today will focus on our continuing operations as this is the way we evaluate and view our business performance.

Now some of our second quarter highlights: The company achieved second quarter operating income of $219 million, a 28% increase over the $171.2 million in the prior year.

This reflects an increase in operating margin of 130 basis points to 13.5% due to strong improvements both gross margin and operating expenses.

Our gross margin of 74.5% for the quarter increased 70 basis points over last year's 73.8%.

This reflects favorable supply chain initiatives and lower costs from promotional activities of approximately 40 basis points each.

Contributing to the promotional expense reduction was a strategic shift from promotional spending to advertising spending, as well as a shift in the timing of certain promotions from our second quarter into our third quarter.

These benefits were partially offset by approximately 10 basis points, due to a change in our mix of business.

Notably the recovery in travel retail and higher fragrance sales.

Operating expenses as a percentage of sales for the quarter improved 60 basis points to 61% from 61.6% in last year's quarter.

The decrease as a percentage of sales reflects the higher sales growth rate, particularly travel retail, a shift in some support spending in through the second half of the year, and also tight management of operating expenses.

As you've seen for some time, we have -- while we have invested in advertising, sampling, and merchandising expense and spent monies for beauty bank and regulatory compliant costs like Sarbanes Oxley, we have reduced all other operating expense costs as a percentage of sales.

Looking at operating profits by category, all major categories increased primarily due to higher sales with each category growing strong double digits.

Skin care increased $33.8 million to $118.2 million.

Makeup was up $5.9 million to $64.5 million.

Fragrance operating income grew $5.8 million to $27.1 million.

And hair care rose $4 million to $8.8 million.

Turning to operating profits by region.

We've seen some swings between our first and second quarters for both the Americas and Europe regions that have somewhat offset each other through the first half.

Resulting in operating income growth in the Americas and Europe of 29% and 16% respectively for the six months.

In the quarter, the Americas decreased by $12.7 million to $59.4 million.

The decrease reflects the relatively small increase in sales in the quarter with the timing of certain promotional events and other cost reduction efforts particularly as they relate to manufacturing being more than offset by increase support spending behind product launches.

In Europe, the Middle East, and Africa, operating income jumped $55.4 million to $128.8 million versus last year due to the significant increase in the travel retail business and strong improvements in the U.K., Greece, Italy, and Spain.

Also, as Fred said earlier, this region was positively impacted by the recapture of lost sales from the first quarter that resulted from certain runoff circumstances.

Asia Pacific operating income rose $5.1 million to $30.8 million due to improved results in Taiwan, Australia, and Japan partially offset by the continuing investment in new brand expansion and business opportunities in markets like China.

Regarding our interest costs, we reported net interest expense of $7.2 million this quarter versus $2.2 million last year.

The increase is due to the inclusion of the preferred stock dividend and higher average net borrowings partially offset by a lower effective interest rate during the quarter.

At the end of December, we restructured the preferred stock, resulting in substantially lower dividend payments and higher earnings for common shareholders.

For the December quarter, the savings amounted to $1.6 million, and we expect savings for the full year of approximately $4.7 million.

If the preferred stock continues to remain outstanding through June 30, 2005, the total savings for the company will be $11 million.

Thereafter, the restructuring provides us access to low cost liquidity until redemption with essentially no impact on the company's earnings.

The effective income tax rate for the quarter was 38.1%, versus 33.5% in the prior year.

The increase was primarily due to the inclusion of the preferred stock dividend in interest, which is nondeductible, as well as the current forecasted full year mix of global earnings.

At this time, we expect our effective tax rate throughout fiscal 2004 to be approximately 37.4%, up from 36% reported at the end of the first quarter.

This change reflects the first-half results revised estimates of our full year mix of earnings and the timing of certain tax savings initiatives.

Net earnings attributable for the quarter increased 21% to $126.3 million, compared with $104.4 million in the prior year.

As I mentioned earlier, we reclassified the preferred stock dividends as interest expense in accordance with a new accounting rule.

This rule does not allow restatement of prior years, so our period-over-period net earnings are not comparable.

However, our net earnings attributable to common stock from continuing operation and EPS both include the effect of the preferred dividends and are comparable in each period.

Diluted earnings per share from continuing operations for the quarter rose 23% to 54 cents from 44 cents in the prior year quarter.

Regarding our financial position, the company's cash balance was $870 million at December 31, 2003, an increase of $215 million versus last year.

During the six months ended December 31, we generated net cash from operating activities of $382 million, a 3% increase over the $372 million in the prior year period.

The current period's cash from operating activities includes approximately $10 million of preferred stock dividends.

On an apples-to-apples basis, as if we had reclassified last year's stock dividends, cash flow from operating activities would have increased 6%.

During the six months, we spent $20 million to repurchase approximately 600,000 shares of stock under our share repurchase program, bringing the total shares repurchased under the program to $14.4 million.

We now expect cash from operations to exceed 600 million for the full year, with capital expenditures between $190 and $200 million.

Let me now update you on our working capital.

At December 31, 2003, inventory was $574 million, an increase of $40 million versus last December.

Inventory days were 152 at the end of the quarter versus 149 days at last December.

Our inventory days were impacted by the addition of (INAUDIBLE) and Michael Kors and to a lesser extent, the strengthening of foreign currencies against the U.S. dollar.

Regarding receivables, our DSOs of 43 days at December 31, 2003, improved by one day versus last year.

Once again, our return ratios continued on the improving trends we experienced last year.

Let me now update you on a few assumptions for the year.

For the full fiscal year, we anticipate reported sales growth of approximately 10 to 12%, which includes approximately 3 to 4% of positive impact of foreign exchange.

Sales and local currencies are forecasted to grow 7 to 8%.

While the weakening dollar benefits our reported sales, no not all of that benefit drops to the bottom line.

In addition to the natural offset of sales and expense translation, changes in foreign currency exchange rates affect the company's cash flow hedges, resulting in losses on foreign currency contracts which are recorded on the P&L effectively offsetting some of the benefits that came through translation.

We expect gross margin to improve about 60 to 80 basis points for the fiscal year from ongoing supply chain initiatives and strategically lower activities.

We expect operating expenses to be flat to up approximately 20 basis points.

This is due to the investment in beauty -- in the beauty bank initiatives of approximately $15 million for the full fiscal year, strategically higher advertising sampling and merchandising spending and the shift of a portion of our marketing investments from promotional to advertising spending, which benefits our cost of sales but increases operating expenses.

These increases are expected to be partially offset by sales growth, tight cost controls in nonbusiness building areas, and the benefits of prior restructuring.

Operating margin is estimated to increase 50 to 70 basis points.

And as Fred said earlier, for the full year, we now anticipate diluted earnings per share of between $1.50 and $1.55.

For the second half, we expect an increase in promotional activities due to a shift in the timing of some of our programs and continued increase in advertising sampling and merchandising spending to support launch activity and to stimulate sales momentum.

We expect reported sales in this year's second half to grow between 9 and 11%, including approximately 2 to 3% positive impact of foreign exchange.

In local currencies, we anticipate sales growth of between 7 and 8%.

We expect gross margin improvement of between 0 and 20 basis points for the second half, due primarily to the promotional spending shift I mentioned earlier.

Operating expenses are forecast to be relatively flat or show a slight improvement as we continue to support our launch activities and build momentum.

As a result, operating margin for the second half is estimated to improve between 0 and 30 basis points.

Diluted earnings per share for the second half are expected in the range of 62 to 67 cents.

This improvement will come in the fourth quarter, as our third quarter is up against a difficult comparison to last year's third quarter when EPS grew 79%.

And that concludes our comments for today, and we will be happy to take your questions now.

Thank you, sir.

The question-and-answer session will be conducted electronically.

If you have a question, please press the star key followed by the digit one on your touch-tone telephone.

And please be sure that your mute function has been turned off so your signal can reach our equipment.

To ensure that everyone has the opportunity to ask a question, we will limit each person to one question and a related follow-up.

Time permitting, we will return to you for additional questions.

Just queue up, again, by pressing the star key and the digit one.

Our first question will come from Wendy Nicholson of Smith Barney.

Hi.

My first question has to do with the travel retail business.

I'm just trying to go back over history and remember, I know the last two years have obviously been really tough in the fourth quarter with travel retail affected by, oh, 9/11 and all those sorts of things, but are we now back to a normalized level?

I'm trying to think of what kind of growth we should expect from travel retail going forward.

Is there more catch-up to do?

I'm not sure about catch-up, but by and large the travel retail business environment has improved, particularly in Asia and to some extent also in -- in -- in -- in travel around Europe.

So, I think we've caught up pretty well.

From now on, it's more take away.

Okay, so in terms of the normalized growth of that business, if you looked it, you know, year-over-year, let's say for calendar '05, does that business continue to grow double digits?

Well, I think it depends also on the activity, of course.

You know, we had some good ammunition in the fragrance business.

We're launching Beyond Paradise in Europe in the -- in the spring season.

That will have an impact on travel retail.

The Agassi franchise is being very well received.

So when you have ammunition into that marketplace then you can stimulate growth and we see continued growth opportunity for our company in that channel.

Okay.

And sorry, Wendy, the one thing to remember is that in last year's fourth quarter we had the impact of SARS, as well as the -- the Middle East -- the war.

So, so therefore, you know, the fourth quarter is going to be a pretty strong one for TRD.

The fourth -- the fiscal fourth quarter of '04?

Yes.

Yeah.

Okay.

And just one quick question on jane.

The fact that you've officially decided to exit that business, is that a comment on sort of your long-term strategy about the mass channel?

Or is that just this brand wasn't right, but you're still open to thinking about the mass channel over the longer term?

I think you can assume from that decision that we're focusing on the upper end areas of the market and the diversity of distribution of the diversity in the market is reality.

We're operating in seven different distribution channels but more to the upper end.

We feel more at home in that area.

Fair enough.

Thank you very much.

Our next question will come from Amy Chasen of Goldman Sachs.

Two things.

First of all on Europe, can you -- you talked about what the travel retail change was.

Can you tell us what the Darphin contribution to the sales growth in the quarter was?

I don't think we're -- we're giving you specific numbers in regards to any brands, Amy.

Unless my memory is lapsing, since I've not, you know, decided to -- to resign as CEO at the end of June, maybe that's the reason for it, but, you know, we don't give brand-specific information, as you know.

I'm just trying to understand whether the level of growth that we saw in Europe this quarter is sustainable.

Well, as I said, Europe is a mixed bag and has been all along for the last couple of years.

Some markets are doing very well and some of them are strikingly a little bit more.

In addition to that, there has about some talking in the more difficult markets like France and Germany, but that should be coming to an end somewhere along the line.

So, if you coupled that with what we said about our new product pipeline, we feel pretty good about the prospects going forward.

And Amy, we mentioned that, you know, a lot of the growth in the second for Europe, there are certainly some pockets of good business, but also there was that timing impact that we had mentioned in the first quarter, where we had no sales growth.

And now in the second quarter, obviously coming back with very strong sales growth and some of that is due to recovering some of the -- the timing issues from the first quarter.

Okay.

So in other words, you expect it to be strong, but probably not at the same rate we saw this quarter.

Not at all.

Because -- you know, we've mentioned that before.

I think you're better off looking at the business as it evolves over at least a six-month period Wednesday don't give quarterly guidance anymore.

That gives you a better indication as to the overall trends.

Okay, great.

Just a question on the second half.

First of all, can you tell us what the loss or -- or -- or profit for jane was in the year-ago period?

In other words, I'm trying to get a sense for how much of the sort of downward guidance for the second half is due to the discontinuation of jane?

Well -- Rick, you want to respond to that?

Sure.

The guidance we've given is from continuing operations, so it does not include the impact of jane for this fiscal year.

For last year, Amy, it was -- it was relatively small, and I'm going to say for the year, although please, we're still in the process of restating last year because we just made this decision, as you know, in December.

So, we had some restatements to do, we want to review those with KBMG.

But having said that, I think the loss last year was worth a couple of cents for jane, and probably the number we're backing out of this year was between 3 and 4 cents.

That's a full-year number?

Yes, a full-year number.

Sorry.

And I'm not fully clear, maybe you can explain this promotional thing a little better, I am not fully clear on why the second half earnings guidance, and specifically the third quarter, is coming down?

Is that all because of this shift in promotion?

If so, can you explain what's going on there?

Well, first of all, you have to remember that last year, the third quarter -- ours earnings were up 80% over the previous year.

Okay?

So, when we look at our programs and our launching schedule this year, also with the launch of Beyond Paradise in Europe, the way our programs skew is more toward the earnings growth will occur in the fourth quarter.

That's how it skews right now, based on the programs the way we see them structured.

It has nothing to do with the performance at the half.

Well, the total half numbers are -- are at least less than what I was expecting.

Maybe my estimates were off.

I'm trying to understand, you know, why that is.

And whether -- let me ask it a different way.

Have your second half expectations changed when you lump it all in?

Or was that sort of always the number you were thinking about?

Let me not focus on the second half, let me reiterate that our expectations have changed to the point we said our guidance is now $1.50 to $1.55.

We're very happy with that.

Thank you.

Okay.

And can you tell us what the promotional shift is?

There is promotional activity going on in the Clinique brand and in some of the -- and in the Lauder brands.

Also there's some support activity going on in w some of the launches that are happening international, which happened in the U.S. and not rolled out yet.

So, that's what that is about.

Okay, thank you.

Okay.

And our next question will come from Andrew McQuilling of UBS.

Thanks very much.

Fred, it looks like in the U.S., by having that Blockbuster sold out by December 20, there is less promotional spending in the U.S.

Do you have a sense for what type of impact that was on the top line?

Well, first of all, you know, the Blockbuster is not necessarily linked to promotional spending.

The Blockbuster is a combination of a purchase/repurchase idea.

It's not just for purchase.

Obviously it drags down margins, so, you know, were these more profitable sales in the U.S.?

Obviously the U.S. margin was down, more advertising support for the rollouts.

You know, is the underlying, you know, promotional spending in the U.S. business coming down such that profitability minus the fragrance marketing is improving?

Well, look, I don't -- what we have found as you saw in the first half, we supported fragrance launches in the U.S. into the quickness business.

In the springtime, we have more activity going on more skewed to skin care.

And international, the rollout is in fragrances.

So, as far as the U.S. is concerned, you know, I -- we look at it more on a yearly basis and half-year basis.

We don't really look at a quarterly basis as much as perhaps you do.

Fair enough.

And maybe just a question for travel retail.

Obviously the number was wonderful against a very tough comp last year.

Yeah.

Is that kind of run rate -- is that unusually high?

I won't say the run rate, the way you're seeing it now, is relatively high.

I don't think the run rate we have at this juncture is sustainable.

I think eventually you will see sell through and selling in, you know, match each other.

Then it's driven by what new ideas you introduce into the marketplace.

That propels you take market share.

And in December, travel retail, is it fair to say the consumer side of travel retail, not the wholesale shipments, are they running up 10, or so or is it better than that?

Just the consumer take away within the travel retail channel to the extent you can tell?

It depends on the marketing area.

We don't have all the data in on that yet.

And maybe one last one.

U.S. freestanding retail, sales up double-digit at Aveda and M.A.C..

That's very good.

Can you talk about profitable in the business?

Are you above corporate averages now?

I'm going to pass that over to William.

Andrew, I think we're looking at the total retail profitability of being right on corporate averages, if not slightly above corporate averages.

What we're seeing now as -- we've spoken to you before, is that the bulk of new store openings are coming on to two and three.

We are seeing the numbers improving.

So we're confident that these stores will continue to deliver nice numbers.

And do you think that same-store double-digit can continue?

It is on consumer confidence.

Aveda and M.A.C..

Terrific, nice quarter.

Thank you.

Thank you.

Our next question is coming from Carol Wilke of Merrill Lynch.

Thank you.

Are you expecting second half America sales to be up 6%, similar to what they were in the first half?

Well, I think that, you know, we don't have a crystal ball, but pretty well, what we've said in the past is in order to achieve our global top line numbers.

On constant currency basis, that means that our large brands -- the Clinique and the Lauders have to grow in the four to five region and the rest of them are pretty well on the double-digit path.

If we deliver that, you will get the kind of guidance we gave for the second half and the year.

That's pretty well what we see around the globe.

As for the United States, you know, it's -- as I indicated in my comments, it's a bit of a mixed bag, some of our accounts are doing extremely well.

Others are struggling a little bit.

So, the -- time will tell, but we feel that basically the momentum we've had should continue on the U.S. side of the business.

Thanks.

And moving on, we will take our next question from Connie Madey of Prudential.

Good morning.

Can you give us any kind of update on Kohl's, how many different products, lines, or brands you've decided to develop?

How far along they are?

And where you might have an unveiling of all of them?

I will ask William to comment on that.

Actually, Dan Brestle is in the room with us, and he is directly responsible for the beauty bank activities, and we will have him answer.

We have not announced -- we have resolved and we plan to announcing the activities sometime in the middle of May.

Okay.

The rest of my questions have been answered.

Thanks.

Thank you.

You're welcome.

And next we will hear from Linda Bolton Weiser of Oppenheimer.

Thank you.

I was just curious about the Hilfiger fragrance franchise and how that was doing?

Is that whole franchise growing now in entirety?

Which one is?

The fragrance?

The Hilfiger fragrance business.

The Hilfiger fragrance business, in fact, is doing quite well.

And we think that, you know, if you look at the marketplace around the globe, any branch that did not launch anything new, they had double-digit declines in terms of the existing brands.

With a few exceptions in our portfolio.

And Hilfiger performed pretty well under the circumstances.

So, we feel that giving it a little attitude with Beyonce will be a little boost for it.

So, we feel pretty good about that part of the business.

And from what I see, the overall retail performance out of the marketplace is improving.

Okay.

And just on Japan, you've mentioned that that was improving.

Can you give a little more color on the major brands' performance in Japan?

Well, we had some strong performance in the Lauder brand in Japan for some time, and from what I see in the -- in the -- the trend in the general area continues to be very strong.

I also see a little turn around in the Clinique on the positive side in the -- in generic.

But, you know, we still have work to do on the Clinique front.

In terms of new product introductions, product innovation and also communication.

So, some of the other brands, like Bobbi Brown, are all doing very well, including La Mer, et cetera.

Okay.

And can you tell us if the Clinique and Estee Lauder brands grew in the Americas in the quarter?

The Clinique and Estee Lauder brands grew, yes.

Oh.

Okay.

Great.

Thanks very much.

Okay.

And as a reminder, it is star one to be placed in the queue for a question.

We will next hear from Nancy Johnson of Deutsche Banc.

This is Bill Smith here, actually.

What happened to the share repurchase activity in the first half of the year?

It went from 166 last year to about 20 this year.

In value, we purchased about 600,000 shares this year and -- and, you know, last year, obviously, that -- the price was different than it is now.

We are much more active in it.

We've almost finished -- or not quite, but purchased 14.4 million to date out of an $18 million total between the two programs.

So, you know, we'll be -- we continue to be active and -- and, you know, I mean it's just -- just a matter of timing.

Okay.

And then just to go back to Amy's question about the guidance, you must have much lower expectations for the third quarter because you effectively reduced your guidance by a penny for the full year.

You didn't reflect the 6 cent beat this quarter.

Well, you know, when you talk about the full year, you have to also make sure you factor in the impact of the tax rate, because that's rather substantial.

I think if you do the calculations, you will see the impact on the tax rate in the first half and especially even in the second half, are rather significant.

So, I mean looking at our business before taxes, you know, our guidance is actually pretty good, and there are a few things --

I'm sorry --

I'm sorry, go ahead.

I didn't mean to interrupt, but didn't you know about the tax rate when you gave us the guidance last quarter?

No, in fact the mix of our earnings continues to shift.

And also, we had some major initiatives under way and all of those initiatives, we -- before we actually implement some of them, we like get rulings from government.

While we planned on some of the rulings coming through before the end of the fiscal year, we're not so positive at the moment.

We're being prudent in the tax rate and taking it to what we believe will be the results, but unfortunately does negatively impact our EPS numbers.

Okay, great.

And one final question, if I may.

Is there any currency in the America's number?

Because the Canadian dollar has been very strong.

You know, Canada -- there's a very small amount of currency in the Americas.

Is that half a percent --

I'm sorry, Canada relative to the U.S. is really just a small piece.

Okay.

So there is no material impact?

No, very little.

Okay, thanks very much.

Good quarter.

Next we'll hear from Janet Clarksenburg of JJK Research.

Good morning, everyone.

Congratulations.

Thank you, Janet.

Thank you.

You're welcome.

I have a couple of questions.

First on Japan.

I -- I was glad to see the increase but I'd like to learn more about Clinique, about product roll outs there, Fred, and when you think the business can accelerate.

I was also wondering about any outlook for acceleration of new stores in the U.S. since they're performing so well.

And then I have a couple of follow-on questions.

Okay.

Well, as far as Japan is concerned, I will take that one.

The U.S. one I will pass on to William.

As far as Japan is concerned and the Clinique scenario, as you know, we've been having some declines there for a couple of years in Clinique, in the sell-through areas or the sell-in.

And the -- the competitiveness of the Japanese market, of course, has dramatically increased and Clinique was the leading brand with a tremendous market share.

And as more brands entered into the arena, Clinique was obviously to some extent impacted.

Right.

We have stepped up our initiatives in terms of Asia-specific products, and we set up our center in Japan to develop these.

And I think what you will see is some of the products are coming on stream to supported with some new ideas in terms of communication that is more relevant to the Asian customer, that, by the way, has also resolved.

We're working towards that and we are seeing for the first positive signs of that new strategy.

I'm not expecting any miracles here, but I think that the -- the -- you will see a -- an ongoing sort of improvement in the Clinique brand in the Japanese marketplace.

Do you think some of it has to do with the Japanese economy?

Or is it fundamental to Estee Lauder that it's been a little weaker than expected, although now improving?

Let's not confuse.

This is nothing to do with Estee Lauder.

This is purely Clinique.

I meant with Estee Lauder, Inc..

No, no.

This is more related to Clinique than Estee Lauder, Inc. because a lot of the Estee Lauder, Inc. brands are very vibrant in the Japanese market.

In fact, they are taking market share.

Okay.

Thank you.

It's the Clinique that adds that major position there and has had an onslaught by all kinds of entrants into the marketplace over the years, and we just stepped up to the plate on the product in the innovation side more specific to Asia, and you will see us more aggressive in the area going forward.

All right.

Janet, a part of your question about retail store activity, we're looking at by the end of the year we will have added between 15 and 20 new retail store doors in the United States between all three of our brands, bringing our total to approximately 385 doors in the United States.

And that's the -- the level that we should look forward to going forward?

That kind of store opening?

What we've done with all the brands is we've not asked them to be too aggressive on either not opening or opening.

They're being opportunistic and looking for the right opportunities where they feel the markets -- the markets where strategically they want a presence, and we're also strongly encouraging them to be reasonable and rational in their economic forecast of what can be done.

Okay.

Thank you.

And, Rick, on the America's operating profit outlook, I know it was down a bit here in this quarter.

I'm confused about the outlook for the third and fourth quarter.

Well, I -- I did reference that for the first half, I think, our operating income in the Americas is up about 29%.

Right.

When you combined the first and second quarters.

It was just a mix issue between the first and second?

Absolutely.

And so going forward, we should expect it to be up in the third and the fourth?

Well, we said -- as we've said, most of our profit improvement for the second half, you're going to see that in the fourth quarter.

So, I wouldn't -- I wouldn't make that assumption for the third quarter, but we're comfortable with the full-year numbers we've given, as Fred eluded to.

That's the way we look at our business.

Okay.

And just lastly on the advertising line.

I know there's higher advertising going on as your promotional initiatives decline.

But is there an overall higher level of advertising plan in the second half of the year versus last year exclusive of the change with the promotional strategy?

I understand.

There -- let me just giving you a feel based on the six months.

Our A&P numbers we've increased by 40 basis points year-over-year.

Right.

An all other spending, excluding the spending we're doing for beauty bank and regulatory things like Sarbanes Oxley has actually decreased 50 basis points.

We're continuing with the strategy which is to put our money into things that build our brands and build our business and at the same time focusing very tightly on controlling operating expenses.

That's the kind of trend i think you will see over the course of the year.

Janet, as you can see, our -- if you reviewed our, you know, business over the last couple of years, you could see that the -- the momentum obviously, in terms of sales is working in favor of the strategy we're employing.

Right.

Right.

I see that.

We're looking at this business, you know, how do we have a great platform for 205 and 206?

You know, instead of worrying about what the next quarter is going to do.

I'm not worried.

So, what we're focusing on as a corporation is to ensure we create shareholder value over time.

We're not into speculation.

We want to be sure the company drives forward in growth.

As you know, a couple of years ago, everybody was on my case about my strategy to invest in our brands and rolling out across the world, and they wanted to see cutting employees and cutting sales because of 9/11, and I refused to do that, as you recall.

Now, the -- the hindsight is always 50/50.

Two years later, we're looking at the business and we have pretty nice momentum.

Thank you very much.

And the investment we've made is paying back pretty handsomely.

So, you know, we're -- we're the people who are responsible of driving the strategy and the performance of this company, and we feel good about the -- the future, but we got to stick to a clear plan and strategy and plan and execute.

And I think that's the way we will continue to operate, and I know William has -- has definitely the commitment to continue with that.

I think that's a great strategy.

Congratulations, again.

Thank you so much.

Next we'll hear from John Jarishoff of Founders Fund.

Actually, my questions have been answered, but I have two comments.

Number one is congratulations on a nice quarter.

Number two, Fred, thanks for your hard work over the years.

I just wanted to wish you good luck as you move into your new role.

I very much appreciate it.

That's very kind of you.

Thank you so much.

Next we will hear from Neil Goldner of State Street advisors.

Just two questions, and Fred, I, too, want to wish you congratulations on going out on top and good luck with whatever you're going to do going forward.

Thank you so much.

Two questions.

One, I guess to Rick, is the gross margin -- gross margin improvement, excuse me.

Last quarter you were able to kind of break it down where if came from, I wondered if you can do it again for us?

Sure.

I did during the call and it's about 40 basis points come from supply chain initiatives and, you know, the stores group continues to do a great job at that and they've been delivering actually probably ahead of plan, and -- and our expectations now, they will probably exceed at some point, the objectives that we laid out in the five year plan; that's going very well. 40 basis points was due to the promotional shift, which is a combination of timing, you know, moving some of that promotional activity a little later into the year as well as shifting it into advertising spending in the second half.

And then that was offset by about 10 basis points negative impact on our gross margin by the mix of TRD business with the rather substantial growth in the quarter of that business.

Okay.

Great.

And the 15 cents, I think it's 15 cents for the beauty thing costs this year.

I'm --

It's $15 million.

I'm sorry.

I'm sorry.

Thank you. $15 million, yeah. 15 cents, that wouldn't be a lot of money.

The $15 million this year, I'm actually curious if that's going to come back next year; i.e. it's not going to recur.

The implication is that's a one-time charge for this year to get the business up and running.

Yeah, what happens -- what happens, Neil, is the fact that next year we will actually have sales and shipments, so the spending we will do next year will be offset by the gross profit that we will earn on the shipments and initial sales.

Okay, thank you.

Yep.

And we have time for one more question.

That will come from Kathleen Reed of Sanford Financial.

Good morning.

Could you give us more details on your opportunity in China and just what the channel looks like over there?

Well, China is obviously a substantial opportunity that needs to be built over time, properly.

There is no quick wind falls in China, but there's a lot of rewards if you do it right.

I'm very happy to say that we've established Clinique and Estee Lauder in a very strong position.

The retail sales are growing fabulously.

And we're in the best outlets in -- in China, and we've been very prudent about not overreaching.

Obviously we will be focusing on China with also is some of our other brands in the future, but you can rest assured that we will have a very concentrated effort on China, which is, of course, also supported by the fact that we have moved our regional headquarters from Singapore to Shanghai, recently.

So, we're -- we're excited about the -- the future prospects of China.

Okay.

Great.

And finally, could you give us a little more color on your margins by channel?

If travel retail was a negative to your gross margin, how did it rank, you know, compared to your typical department store channel and some of your stand-alone stores?

I -- I don't want to really get into the specific on this end.

On exactly what it is by -- by channel, but directionally I think, Rick, if you want to make a comment on that?

Sure, I mean if we're talking operating margins, we've said many times that the TRD business is basically double, really, the -- you know, close to double our -- our normal business profitability.

So, you know, it's a highly profitable business, it carries with it a higher cost of sales, but lower operating expenses.

But, you know, it's -- I must say it adds something onto this, you know.

It's very profitable; it's because the way we're -- because the way we're allocating our expenses to some extent, too because national advertising is allocated to the -- to the markets and not -- and not to travel retail.

Of course, that enhances the profitability in that channel, as well.

Yes, absolutely.

Okay?

Okay.

Thank you.

And that concludes today's question and answer session.

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That concludes today's Estee Lauder conference call.

I'd like to thank you all for your participation and wish you all a good day.

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