雅詩蘭黛 (EL) 2005 Q2 法說會逐字稿

Good day everyone and welcome to the Estee Lauder Company's fiscal 2005 second quarter conference call. [Operator Instructions].

Today's call is being recorded and webcast.

For opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations Mr. Dennis D'Andrea.

Please go ahead sir.

Good morning and thanks for joining us.

We have on today's call William Lauder President and CEO, and Rick Kunes, Senior Vice President and Chief Financial Officer.

Also with us today is Dan Brestle our newly appointed Chief Operating Officer with responsibility for a number of our key brands, our BeautyBank division, local operations and R&D.

Let me remind you that some of our remarks today contain forward-looking statements which involve risk and uncertainties.

In addition to specific risks described in this call you will find additional factors that could cause actual results to differ materially from these forward-looking statements in our press release today.

Additionally, our discussion today will focus on our results from continuing operations.

I will turn the call over to William now.

Thank you, Dennis.

Good morning and thank you for joining us today.

Let me start by saying that I'm pleased with our overall first half results.

Our actual top line performance was within the guidance we gave while our bottom line was better than expected.

The quarter benefited from disciplined expense tightening, a delay of promotional spending into January and favorable foreign exchange, which mitigated slightly softer comparable currency sales.

The retail environment this 2004-holiday season was mixed and repeated a pattern we have seen for a number of years with retail starting out slowly but ending with a flurry of last minute shoppers in the final two weeks.

For the second quarter, we reported a net sales increase of 8% to $1.75 billion from $1.62 billion in last year's quarter which included a better than expected impact from foreign currency translation.

Excluding foreign currency net sales rose 5%, which was at the lower end of our expected range.

Net earnings from continuing operations for the quarter were up 10% to $138.3 million compared with $126.3 million in the prior year's quarter.

We delivered diluted earnings per share from continuing operations of $0.60 compared to $0.54 in the prior year, an increase of 10%.

In constant currency, sales growth this quarter was led by the Americas followed by Asia while Europe was flat as growth in the prior year quarter was unusually high.

Our skin care category reported an 8% sales increase to $617.4 million and grew 4% in constant dollars.

Future Perfect from the Estee Lauder brand and Clinique's Superdefense, two of our newest skin care products to perform very well this quarter.

La Mer again had strong sales growth this quarter, particularly in international, owing to extraordinary products such as the Lifting Face Serum, the Lifting Intensifier and the concentrate.

Our new American Beauty and Good Skin brands added incremental skin care sales although they are relatively immaterial to the category.

Make-up sales growth was strong rising 12% to $592.4 million and 10% in local currency.

We had terrific sales growth this quarter from our make-up artist brands with MAC, Bobbi Brown and Stila each posting double digit increases.

MAC continues to report stellar growth, driven by light tour (ph) increases, new distribution and great product introductions.

New or recent products from our core brands benefiting this quarter were Superbalance compact make-up and the Color Surge line from Clinique, as well as Lash Excel maximum length mascara and Electric Intense lip crème by Estee Lauder.

The inclusion of our BeautyBank brands, Flirt and American beauty, also benefited this category's sales.

Fragrance was up against some major launches last year.

Our second quarter fragrance sales increased 3% to $458.6 million on a reported basis and decreased 1% excluding currency.

While Christmas is a large fragrance season, the category continued to be challenged.

The trend toward celebrity fragrances took spotlight over the holiday, drawing the consumer to the appeal of star-studded products.

We benefited from the recent launches of Lauder Beyond Paradise Men, True Star by Tommy Hilfiger as well as DKNY Be Delicious which has been doing exceptionally well and exceeded our expectations.

We also launched Donald Trump the fragrance in limited distribution for the holiday.

However, these fragrances were up against the strong launches of Beyond Paradise and Aramis Life last year and growth in the quarter was tempered by lower sales of the prior period launches as well as from existing brands.

Hair care sales rose 14% this quarter to 71.6 million on a reported basis and grew 12% in local currency.

Aveda again had double digit sales increases due to successful product introductions such as P re Abundance and professional color products and increased concepts along distribution.

Aveda has launched its e-commerce site in November and early results are positive.

Bumble and Bumble sales growth was strong resulting from the launch of its new scalp treatment line, the success of existing products and new salon openings.

On a geographic basis, sales in the Americas region increased 9% from the prior year's quarter to $877.7 million.

Consumer traffic picked up toward the end of the quarter with the most impressive growth again seen at high end specialty stores.

We are pleased with our performance in this region with virtually all our brands recording sales growth.

New and recently launched products contributed to growth in all major product categories.

We continued our momentum in Canada posting double-digit growth there and the current period inclusion of our three new BeautyBank brands contributed to the regions higher sales this quarter.

Europe, the Middle East and Africa had a very tough comparison with the prior year quarter when net sales grew 34%.

This quarter, net sales in the region rose 7% over the prior year to $628.9 million and were comparable on a local currency basis.

In local currency, we saw strong increase in the U.K. where our department store business is doing very well.

Additionally, our U.K. based brand Jo Malone turned in solid results due to strong retail sales in its freestanding stores and new product offerings.

This was offset by lower sales in several countries including Italy, Spain and Austria.

In Asia Pacific, net sales grew 7% over the prior year to $243.7 million.

In local currency, sales were up 4%.

Local currency sales were up in most markets with the largest double-digit increases in Taiwan, China and Hong Kong.

Sales in Japan and Korea were lower this quarter.

The tsunami that struck the country's bordering the Indian Ocean was a terrible event.

Many of you have been interested in the potential effect it had or may have on the companies you follow.

Of the countries impacted our biggest businesses are in Thailand and Malaysia and our products are sold primarily in the larger cities that were not directly impacted.

Those businesses combined represent approximately 1% of our total sales.

Another point to make is that we do not manufacture in the affected areas.

We believe the overall impact is not likely to be material.

That said, we are carefully monitoring our travel retail business in Asia, which may be impacted by a pullback in tourism.

Additionally, we are uncertain at this time of the psychological effect on global consumer buying habits that may develop.

Based on the magnitude of the needs surrounding this disaster, we have made cash and product donations to four relief organizations totaling $1 million.

That wraps up the quarter so let's move to the balance of the year.

I'm very excited about the leadership changes we announced over the last quarter.

We further strengthened our board of directors with the election of Mellody Hobson.

She is president of Ariel Capital Management and her extensive financial background will be a true asset to our board and audit committee.

Additionally, her marketing experience and leadership capabilities will serve the company and our stockholders well.

Dan Bresol was named COO where he will tap into his expertise in branding sales and operations he has developed over 25 years with our company.

In addition to overseeing global operations and research and development, Dan will be responsible for the Estee Lauder and MAC brands, the specialty brands of Prescriptives, Jo Malone, Kate Spade and La Mer and the BeautyBank group.

Patrick Bousquet-Chavanne will focus on our strategic efforts to develop new opportunities across Europe and Asia within existing and alternative distribution channel and product categories.

Patrick will continue to lead the Aramis and designer fragrance group while adding responsibilities for Bobby Brown, Stila, Darphin and Rodan & Fields.

Philip Shearer will continue to lead Clinique, Origins and the online division.

Additionally, Philip has been charged with substantially and strategically building our prestige haircare businesses Aveda and Bumble and Bumble.

These changes reflect my desire to maximize the talents of our leadership by blending responsibilities for both brands and corporate-wide priorities.

Additionally, John Dempsey has taken over global responsibility for the Estee Lauder brand.

John's tremendous energy and success leading the MAC brand make him the perfect choice to continue the evolution of our flagship Estee Lauder brand.

Looking near term, in a broad view of the retail environment, we see the U.S. sustaining at moderate growth level lead by high-end retailers.

In Europe, the U.K., Spain, Greece and the emerging business in Eastern Europe we are expected to perform well.

We will continue to benefit from the conversion of our Portuguese distribution business to an affiliate operation.

Developing markets for us in Asia remain buoyant while our two largest markets, Japan and Korea, continue to be weak.

Resolution of Japan's economic woes doesn't appear to be on the horizon and Korea's mounting consumer credit card debt continues to dampen consumer spending.

Heading into the second half, we have a number of exciting product offerings.

We are launching two new products in March from our top brands that we expect will mitigate some of the competitive pressure from German (ph) brands.

First, is Perfectionist CP Plus from Estee Lauder which helps reduce the appearance of lines, wrinkles and age spots and second, Repair Wear Deep Wrinkle Concentrate by Clinique, a new technology that addresses the appearance of wrinkles at their base.

MAC recently launched the Diana Ross color collection and will introduce its Madam Butterfly collection next month as well as other products covering foundations, concealers and lipsticks.

Flirt has announced its next Guest Creator collection developed by Mila Kunis from the 70's show with two palates set for launch in February.

The men's grooming category is gaining more consumer attention as evidenced by the 13% growth in the segment in calendar 2004.

Clinique is looking to build on its leadership in men's skin care with several new products and enhancements to existing products scheduled for launch in April.

Clinique will also be launching Happy To Be, its third fragrance under the Happy collection and building on the terrific reception of DKNY Be Delicious we are introducing a men's version next month.

These fragrance launches plus additional activity should give us some growth in this category in the second half of the fiscal year.

Some additional items of note.

We are on track to launch our BeautyBank brands in approximately 300 more Kohl's stores in March, which Dan will touch upon later.

Our online business has been growing extremely well and we expect to further drive sales through the recent launches of Aveda's and Lab series e-commerce sites.

Similarly, Bumble and Bumble will join this initiative, launching its own site towards the end of the fiscal year.

As you are aware, much of our continental European business is done through the perfumery channel with Marionnaud being one of our largest customers.

Recently Marionnaud agreed to be acquired by AS Watson, a Hong Kong based conglomerate.

It's too early to determine any potential implications to our business resulting from this transition.

But we will keep you apprised of further developments.

You have also recently read in the press about a potential combination of the Federated and May Department stores, our two largest customers.

At this time we are reading the same newspaper articles as you are and we are following it closely.

As such it would be premature to speculate on the potential implications if any on our business.

Based on the current tone of business, our second half top line growth expectation is approximately 9% on a reported basis, which translates to approximately 7% in constant currency.

On the bottom line, we are comfortable with an EPS range of $0.87 to $0.92 for the second half.

For the full fiscal year, we expect sales growth of between 9% and 10% on a reported basis including about 2 to 3 percentage points of positive foreign currency effect and we remain comfortable with our full fiscal year 2005 diluted earnings per share estimate in the range of $1.88 to $1.93.

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

Rick.

Thank you, William and good morning, everyone.

The company achieved second quarter operating income of $230.5 million, a 5% increase compared with $219 million last year.

This translates to a 13.2% operating margin for this quarter.

While our -- for the first fiscal first half rather our operating income increased 11%, bringing our operating margin to 11.9%, a 10 basis point increase over the prior period.

Our gross margin of 74.4% for the quarter decreased 10 basis points over last year 74.5%.

This decrease reflects an unfavorable net change in our mix up business with geographic regions, channels of distribution and products.

Partially offsetting these results were net favorable changes in production and supply change efforts.

Operating expenses as a percentage of sales for the quarter increased 20 basis points to 61.2% from 61% last year.

The increase as a percentage of sales reflect higher planned advertising cost, which we discussed on last quarter's call, to support new launches and the new brands for the holiday season.

This increase was partially offset by the rate of sales growth coupled with efficiencies in general and administrative expenses.

Operating expenses also benefited from the elimination of related party royalties.

Looking at operating profits by category, make-up rose 7.9 million to 72.4 million and skin care was up 2.7 million to 120.9 million reflecting the higher sales.

Hair care operating results were higher by 500,000 to 9.3 million, primarily due to improved international results partially upset by increased operating expenses incurred to support our growth in the U.S.

Fragrance operating income was relatively flat at 27.2 million.

This category was up against a difficult comparison to the prior year quarter, which grew 27% and reflected a successful holiday for launches such as Beyond Paradise.

The quarter's results were due to the continued soft fragrance business coupled with ongoing development costs for future fragrances and brands and well as sustained support spending relating to existing products.

Our operating profit in the Americas increased 23.8 million to 83.2 million.

This region was aided by the comparison to last year when operating income decreased 13 million.

This quarter's results reflect a more normalized level of profitability compared with the average operating income over the past few years.

During the quarter, we continued to spend on advertising sampling and merchandising for both prior period products and certain current period launches.

In Europe, the Middle East and Africa, operating income decreased 11.4 million to 117.4 million versus last year.

As William described, this region was up against a very difficult comparison to last year when operating income increased by $55 million.

The decline reflects lower results in our travel, retail and distributor businesses as well as in Italy.

Asia Pacific operating income decreased $900,000 to 29.9 million.

Strong increases in Taiwan and Hong Kong were more than offset by lower results in China and Korea.

As you know China is a developing market for us where we continue to invest in brand expansion and business opportunities.

Regarding our interest costs, we reported net interest expense of 3.3 million this quarter versus 7.2 million last year.

The decrease is primarily due to a lower amount of dividends on our redeemable preferred stock.

The effective income tax rate for the quarter was 37.6% versus 38.1% in the prior year, adjusting our year-to-date tax provision to our new expected full year effective tax rate of 37.4% versus 37.7% last year.

The change was due to the forecasted full year mix of global earnings, partially offset by the reduction in the amount of nondeductible preferred stock dividends.

As you may know, the American Jobs Creation Act of 2004 was enacted in October.

This legislation contains significant changes to the U.S.

Internal Revenue Code.

The company is investigating the repatriation provision to determine whether it might repatriate extraordinary dividends of up to 500 million during fiscal 2005 or fiscal 2006.

At this time, we are currently evaluating the new legislation's impact on our business and our effective tax rate.

We will keep you apprised on future conference calls.

For the fiscal second quarter, net earnings from continuing operations increased 10% to 138.3 million compared with 126.3 million last year, while diluted earnings per share from continuing operations also rose 10% to $0.60 versus $0.54 for the three months of last year.

Regarding our financial position, the company's cash balance was 578 million at December 31, 2004, a decrease of 292 million versus last year.

This decrease reflects in part the fact that we used about $290 million to redeem 80% of our then outstanding preferred stock in June 2004.

During the six months ended December 31, 2004, we generated net cash from operating activities of 298 million versus 382 million in the prior year period.

This change reflects higher earnings from continuing operations more than offset by certain working capital components including deferred compensation and supplemental pension payments.

For the full fiscal year, we now expect net cash from operations of approximately 650 million or 20 million lower than the prior year.

This decrease is due to sales growth towards the lower end of our expectations, certain deferred compensation and supplemental retirement payments and higher forecasted inventory levels.

During the first six months, we spent $188 million to repurchase approximately 4.2 million shares of common stock under our share repurchase program, bringing the total shares repurchased under the program to 20.9 million.

In fiscal 2005, we expect capital expenditures of about 250 million as we continue to catch up on some deferred spending, invest in leasehold improvements for our recently extended corporate office lease and begin a company-wide systems upgrade program.

Let me briefly update you on our working capital.

At December 31, 2004, inventory was 699 million, an increase of 125 million versus last December.

Inventory days were 164 at the end of the period versus 152 days last year.

These increases reflect a somewhat slower growth in our business, the introduction of new brands, expansion into new markets, the impact of regulatory compliance in Europe and the timing of promotional shipments.

As we have said before, our business model, which generates exceptional growth margins, will always require us to carry more inventory than other consumer products companies.

Regarding receivables, our DSOs are 43 days at December 31, 2004 -- were equal to last year.

Our return ratios continued the improvement we have experienced for the last two years.

Let me now update you on a few assumptions for fiscal 2005.

For the full year, as William said, we anticipate reported sales growth of approximately 9% to 10% which includes a benefit of about 2 to 3 percentage points from foreign exchange.

We expect gross margin to improve about 10 basis points for the fiscal year with supply chain savings providing most of the benefits.

Slightly offsetting these improvements will be the impact of BeautyBank and product mix including new products.

We anticipate operating expenses to improve between 20 and 40 basis points for the full year.

This is due primarily to the sales growth and tight cost controls in non-business building areas.

These improvements are expected to be partially offset by continued investment in the BeautyBank initiative, strategically higher advertising sampling and merchandising spending and to a lesser extent a shift of a portion of our marketing investment from promotional to advertising spending.

Operating expenses will also reflect the end of the international royalty payments.

Operating margin is estimated to increase 30 to 50 basis points.

For the full year we continue to anticipate diluted earnings per share of between 1.88 and 1.93.

Last month, the Financial Accounting Standards Board issued a new rule that requires stock base compensation to be recognized as an expense.

This rule becomes effective for us in our fiscal 2006 first quarter.

In our SEC reports, we provide pro forma disclosures relative to this topic.

Regarding the fiscal 2005-second half, we expect sales in local currency to grow approximately 7% and anticipate about 2 percentage points of positive foreign exchange impact.

Reported sales in this year's second half are expected to grow approximately 9%.

Gross margin is expected to increase approximately 40 basis points for the second half due primarily to supply chain initiatives, partially offset by the impact of BeautyBank and a shift of timing of a gift program to the second half.

Operating expenses for the second half are expected to improve between 10 and 40 basis points, compared to the same period in fiscal '04.

In the second half, while we continue to have start-up cost for the BeautyBank business, sales are expected to outpace expenses.

Advertising, merchandising and sampling expense to support new launch activity is forecast to grow slightly faster than sales, with the majority of that spending growth coming in the third quarter.

We will continue to tightly control non-business building expenses.

As a result, operating margin for the second half is estimated to increase 50 to 80 basis points versus the prior year.

Diluted earnings per share for the second half are expected in the range of $0.87 to $0.92.

This profit improvement will be substantially weighted towards the fourth quarter due in part to the planned spending levels in each of our third and fourth quarters.

Additionally, our third quarter will be up against a difficult comparison to the same prior year period when operating income increased 31% or 140 basis points and EPS rose a very healthy 28%.

That concludes my comments for today and I'm pleased to turn the call over to Dan Brestle.

Thank you, Rick and good morning.

Throughout my career at Estee Lauder I have witnessed a remarkable evolution from a company with a few home grown brands and a small presence outside the United States to a $6 billion public company with 23 brands and sales in some 130 countries and territories.

I couldn't be more pleased to join William in taking the company to the next level.

As William mentioned, my duties include responsibility for a number of brands as well as operations and R&D that support all of our brands.- Additionally, I will act as the corporate-wide liaison with our major U.S. retailers to provide both strategic direction and conflict resolution across all brands.

One of my first challenges is to get back up to speed on the manufacturing side where I started my career and continue to pursue the supply chain initiatives that are underway.

Our primary mandate in operations has always been to deliver the highest quality and that will never change.

While we have made great strides in reducing our cost of goods over the last several years we still have room for further improvement.

We have continued to push the envelope on speed to market.

The time span from innovation to store shelves has been shrinking largely due to improved coordination between the brands and operation.

This is one area I hope to add value in my new role.

Finally, we remain committed to building the most efficient supply chain in the industry.

By developing the systems and processes to manage the complexity inherent to our business.

Once I'm fully up to speed on the challenges and the opportunities of our supply chain I will come back to you along with Malcolm Bond, our Executive Vice President of Global Operations, to outline the initiatives supporting the strategies in more detail.

Next I would like to briefly update you on the projects of our BeautyBank division.

We are now just 15 weeks past the launch of the largest logistical program ever attempted by the Estee Lauder companies.

Three brands, about 600 SKU's, nearly 300 stores and the training of 1,500 beauty associates.

We are pleased with the results so far and we look forward to phase two of the launch, which yesterday began rolling out to the remaining 300 plus Kohl's stores and began the training of the additional 1,500 beauty associates.

The official launch of the phase two stores will be March 6.

As massive an undertaking as the launch was, the most challenging part of the endeavor is just beginning.

That is our ability to build customer demand and acceptance for the new brands.

Building brand awareness is difficult in any venue but it is both more challenging and potentially more rewarding to bring an entirely new category of business to a retailer.

It requires us to build awareness, not only of the brands but also the availability of cosmetics in Kohl's.

And as I said, we are off to a good start and the launch of phase two will only increase advertising support both in the press and in the Kohl's circulars.

Some items of note, we are learning how to better promote the brands more effectively within the Kohl's promotional framework.

In the future, we will develop more attractive and competitive holiday programs which we do not have this year as we weren't fully launched.

Additionally, the Good Skin brand represented by Dr. Doris Day will debut on QVC this Saturday allowing the brand to more fully educate consumers about the range of skin care offerings in the line.

The fourth brand to be launched will be announced to the press in May.

Last but not least, I want to convey my excitement at the return of John Dempsey to the Estee Lauder Brand.

I look forward to working with John on the evolution of the brands renewal program begun by Patrick.

John's work on the MAC brand and the MAC age fund is legendary and I'm sure he will bring the same vitality and dedication to Estee Lauder.

Thank you and that concludes our comments for today and we will be happy to answer your questions.

[Operator Instructions].

Our first question today is from Linda Bolton Weiser of Oppenheimer.

Thank you, your America sales growth was pretty robust.

Can you give us some sense of what part of that growth was represented by Kohl's?

And am I correct in understanding that the sales to Kohl's in the quarter would be replenishment and not sales to new stores?

I guess that's my first question.

Second quarter sales to Kohl's were replenishment, correct.

The first part your question is what is the contribution of Kohl's?

It was not material, really.

Not material.

Okay.

And can you just on the fragrance profitability, this is actually the first time that the operating margin in fragrance has improved year over year in a few quarters and I know you are focusing on profitability there.

Is this the real start of a trend here that we should expect to see improved profitability?

Can we expect that in the next few quarters as well?

We certainly like to believe that it is a start of a trend and will continue.

We will see as we continue to grow.

You know of course that traditionally the rhythm and cadence of the fragrance business on a global basis is that you will see healthier margins in the piping quarters, if you can accept that phrase, versus the replenishment and normal sell through quarters and since the fragrance business is primarily weighted to the first half of our fiscal year the balance will be somewhat, there will be somewhat of an imbalance from a margin perspective between the first half to the second half.

Our next question is from Amy , Goldman Sachs.

Can you just talk about the fact that the second half expectations look like they are coming down, obviously you know you did better in the first half than you had expected going in, but I guess what I am confused about is that the EPS numbers are going to come down and yet your sales guidance is higher than what it was originally.

Can you just discuss that discrepancy?

Amy I don't think our sales guidance is higher, actually it's a little bit towards the lower end of our range, still within the numbers, but we had hoped to do 7% to 8% on comparable currency basis for the year and we have now just said that it will probably come closer to 7%.

So that is really the impact.- I mean our second quarter sales while they were terrific and our first half sales we were quite pleased with they were a little bit less than we had hoped they would be, and we see that, you know, impact in our full year a little bit so we are toward the lower end of our sales range, not towards the higher end for the year.

But Rick, maybe I'm a little bit confused but I thought you said 9% sales growth.

I am assuming a difference here is currency.

Yes, there is 2% currency, approximately 2% in the second half so on a comparable currency basis 7%.

Right but so including currency, too and some of that is going to flow through to the EPS.

Some Amy but as you know we take hedging contracts on cash flows and the effect of those contracts and actually in a case when we gain on sales or losses on those contracts and that mitigates the profitability impact.

So, there's really not that great an impact on the profitability when we generate sales in a given particular fiscal year.

I'm still a little confused but I guess I will follow-up with them.

Can you also just talk about the slowing that we saw in Europe?

I know you had tough comps but are you expecting that we will resume sort of that you know high single low double-digit growth in Europe over the next couple of quarters or is there something else that has kind of changed here that we should change our expectations?

The second quarter was really the impact of the tremendous growth last year and you know for the first half I think if you look at Europe you will see that sales growth was pretty reasonable at around 7% on a comparable currency basis and if you see numbers approximately in that area for the second half of the year as well, so really the second quarter was purely the impact of exchange.

I'm sorry the second quarter was purely the impact of last year.

I think general retail, the general retail mood in Europe, Amy, excluding the U.K., is not that buoyant where we have seen general strength if you will over the last two, three plus quarters in Europe with the exception of the U.K. we are not really seeing that in the major continental European markets and obviously there will be some effect, we are not certain what, with the consolidation of Marionnaud and Watson.

We will take our next question from Andrew McQuilling with UBS.

Thanks very much, I guess first congratulations to Dan Brestle on his new responsibilities.

Thank you, sir.

And I have a question, I guess for William, if you can talk about, and Dan, I guess it's for both of both of you, if you could talk about your spending priorities for fiscal 2005, where is the most incremental money going by brand and region?

Where are you investing for growth in fiscal 2005?

Well I think Andrew that's...

Other than BeautyBank.

The best way to answer it is that we have got a number of different spending priorities or allocation priorities.

First and foremost, is we are trying to take as many of our expenses out of those areas which are not visible to consumers, focus them primarily on those areas that are most visible to consumers which give us the best results.

That is both refinement of A and P and selling cost spending by brand, by retailer and by region as well as a very important part of this is a rationalization of our spending.

We have, as Dan mentioned ,we have over 23 brands, we have 23 brands operating around the world in one way, shape or form.

We have got some key strategic markets, which we are investing in such as China.

We are looking at other emerging markets like India very seriously for investment in getting going within the next year to 18 months.

And we are trying to make sure that we are positioning ourselves both to continue to maintain momentum in our substantially existing markets like North America and Europe, continuing to invest in Asia, especially in the faster growing parts of Asia as well as to shore up the more mature markets in Asia.

And additionally we have to make sure that our significant presence in North America continues to be enhanced and expanded in a manner that is in keeping with our expectation so we continue to blend our For us a long period of time is a number of years.

If you had incremental money to spend obviously the SG and A number it's a pretty big number.

If you have incremental money to spend where are your first priority?

Let's say things are better than expected for whatever reason on margin where does the money go?

The money goes into maintaining momentum in the fast growth larger markets as well as those brands which are giving us an above average return on investment.

Terrific.

And just one maybe one on the travel retail, was the business, was it up in a local currency was it up 5%, 10% or was there a slowdown in travel retail?

In the first half the business I think was up high single digits.

Any impact to the Asian travel?

Or not really?

In fourth quarter.

First of all we are not going to see the impact of this, we will see, Andrew, in this quarter to tell you the honest truth because as you know the tragedy happened very late in December.

So the impact I think that the region is feeling on a tourism basis is really happening as we speak.

And so, the echo to that if you will comes from sale through demand from the retailers operating in the region.

Terrific, thank you very much.

We will go to our next question from Neal Goldner with State Street Global Advisers.

Hi everybody, William, quick question for you.

I was actually just playing around on the Internet, yesterday trying to buy somebody flowers and wound up on Amazon and all of a sudden I wind up on this personal care site of Amazon.

And just about every brand that I could buy from Estee Lauder in a department store, it's on Amazon.

Explain to me why that's a channel that's good for you to be in.

Well I believe if you were to look at the Amazon site as I understand it, the Amazon site is really just a front-end pass-through for other existing retailers.

Amazon themselves are not direct customers of ours, and in fact if you were to look at it, they just will take a percentage of a sale that's done through a third party retailer.

All the third party retailers who Amazon represents, I believe, are not authorized retailers of ours but are in fact grey marketers.

It is possible, though I am not certain, that one or two of our authorized retail partners who sell online might be passing through on the Amazon site but I'm not aware of that.

But we do not sell directly to Amazon for any of our products and brands.

The authorized retail environment on line are multi-brand environments on line are gloss.com, our own site in partnership with Chanel and Clarins, As well as existing bricks and mortar retailers such as nordstrom.com, macys.com and other existing retailers.

And then of course we have our own dedicated brand sites which sell on line, too.

But Amazon is not, and Sephora also for a couple of our brands but Amazon is not an authorized retailer of ours.

But you are comfortable with one of your existing retailers allowing Amazon to, I guess, I'm not sure what the right term is but Amazon basically is just a front for gloss.com in a sense where I as a consumer don't necessarily know I'm on.

I wouldn't necessarily say comfortable.

I'm not aware whether any of our existing retailers have partnered with Amazon in the beauty space.

So, I would be hesitant to make a comment about my comfort or lack of comfort without full knowledge of which of our existing retailers have an arrangement with Amazon in the beauty space.

For the gray marketers, the unauthorized retailers who are selling products of our brands, of our companies through Amazon I'm not comfortable with that because as you know we are -- we take our brand equity seriously and believe strongly that the brand equity is not wrapped up with the quality of the retail environment and shopping experience associated with that.

Okay, and one more question if you don't mind maybe for Dan, I was actually surprised during the January, during January and maybe late December, after Christmas season was over, picked up my weekly Kohl's advertisement that gets mailed to my wife and I looked at it and there was like a half page save 15% on all beauty products in American Beauty, Flirt and Good Skin.

And I was actually surprised to see these brands on sale which is not normal you would see at your normal department store setting type of thing.

Realize, we really don't care about the selling price.

It is not what our responsibilities are However, if you would have read the fine print you would have seen that that 15% off is for Kohl's credit card customers, which is an ongoing event that Kohl's does.

It has nothing to do with -- not necessarily just our product but any product a customer buys during certain periods if you are a credit card customer you get 15% off.

Okay, so they are just using your brand in their other stores to basically build their own brand loyalty to the store?

It is a continuing program they have, that by using the Kohl's credit card you get 15% during certain periods.

They highlighted that with the cosmetic department and our brands.

We will take the next question from John Faucher with JP Morgan.

Thank you very much.

You talked a lot about a lot the difficult competitive environment in fragrance, can you give us any sort of your historical perspective, have you seen it be like this before? - Can you give us an idea in terms of how long you think it may last and how sustainable is this whole sort of cult of personality surrounding celebrities and is there something that you know we should expect for the next couple of years to keep advertising costs high or is there a trend that just sort will roll over relatively quickly?

Well John, if you had a day we could go into a great deal of detail but I will try to do answer it as quickly as possible.

I think what we are seeing now is a very visible obvious result of what has been a long-term really tectonic shift in the prestige fragrance business and if you will the ship really started some 10-plus years ago when many of our competitors began for any number of reasons to support the, what is euphemistically called popular distribution in a number of different markets in the world predominantly in fragrance.

Essentially, popular distribution is a nice euphemism for something other than prestige retailers for fragrances in particular.

The result of that is that it is, a far higher sustained maintained margin business for the manufacturers who sell in this environment.

However, it depends on the imagery that's established in prestige in the advertising that it supports.

Couple that with the fact that the popular retailers who now offer these prestige brands were able to move their average price point up by selling prestige brands at a competitive price to prestige retailers at a greater maintained retail price than selling mass brands to the mass customer, there's been a tremendous shift.

Couple that with the fact that launch mania has become an enormous part of what we do as an industry, in the period of 1992 to 1994 there were approximately 45 major fragrance launches over a two-year period of time in the industry.

In the period of 2002 to 2004 there were approximately 245 major fragrance launches in the two-year period of time, 10 years apart.

You can just imagine the competition to gain noise and gain attention in the noise with the dramatically increased amount of launch activity.

The average lifespan of a new fragrance launch is now barely 18 months to two years unless it gains significant traction with consumers, for any number of reasons.

So what you are seeing now is a very obvious changes in the foundations and fundamentals of the prestige fragrance business predominantly in Europe and North America, the two largest on an absolute value basis.

The two largest fragrance markets in the world.

As to celebrity, in one way shape or form somebody has been saying sooner or later the celebrity following will diminish.

I don't expect to see it happen any time soon.

It has only been growing and growing in leaps and bounds.

Share an interesting anecdote with you.

In a conversation with an editor of a major fashion publication who was describing to me that five years ago, seven out of their 12 covers would be with a model and a beautiful photograph and the other five would be celebrity, now they never use models on a cover unless the models themselves are a celebrity in their own right and they only use celebrity as defined on the covers.

That is just an example of the consumer obsession with celebrity.

You also are very aware as we are going to the awards seasons whether it is the Golden Globes, the Oscars, Grammies, whatever, there's an enormous competition in the fashion industry to outfit the most attractive celebrities and to make a big deal of it.

That is just a small indication of the competition to get recognized by the use of aspirational personalities, which the consumer follows.

It sounds like this is going to keep going there and it is just a cost of doing business.

It is a not only the cost of doing business, but it is a simple fact that the consumer is voting very clearly and saying this is what I will respond to.

Okay.

Thank you very much.

The next question comes from Connie Maneaty from Prudential Equity Group.

Good morning.

Could you give -- I don't know if I missed it in your presentation but could you give us some of the business reasons why earnings in the second half will be tilted more towards the fourth quarter than the third?

I think we all know about the tough comps what are the projects that push it in that direction?

There's a few things, Connie.

One is we mentioned in our script there was a shift of a gift program that was posed to launch in late -- ship in late December.

Its now actually shipped in the first week of January.

That was worth actually about a penny in earnings.

We had some benefit from exchange in the first half but now the exchange rates are more stable versus last year in the second half that won't be quite as big.

And also there's lesser extent as a shift in Easter.

Easter moves from April 11 to March 27 this year.

So that shifted things from some spending and there's a little bit heavier promotional activity a little bit heavier advertising spending.

We also have quite a few major launches going in the third quarter and while we do benefit from the launch activity there's also a great deal of spending to support those launches appropriately and that is happening in the third quarter.

And also, and you mentioned it, don't forget the very difficult comp against the third quarter last year when the profits increased tremendously.

So that is the way it.

That's why we like to give guidance only on the half and that why, that's what we are doing but we just wanted to make you aware that of the way it was sorting itself out between the third and first quarter

So, I mean as we look at the business, does it kind of shape out that there may be a 10% increase in the third quarter and 40% in the fourth?

Is it that magnitude of a shift?

And again we don't like to use guidance by quarter so I am going to leave at the wording we used in the script and I think that's sufficient.

Okay one question on inventory.

Of the several things you mentioned that had an impact on inventory days, can you rank them in order of which was the biggest contributor?

Certainly an easy one and short one was the fact that our sales were a little lower than we thought and that affected our inventory at the end of the quarter.

The second highest one would be inventory related to new markets and that's in two forms.

One is markets that are really growing quite rapidly and we want to make sure we have stock and those are China and Russia but we built up intentionally kind of higher inventory levels there.

The other one is a market that we have just acquired, a distributor in Portugal where we acquired that which is carrying more inventory than we would normally do.

That will work itself down over time but that's the other one.

One that is favorable decision by our part is to move some suppliers as you know we talked about it, suppliers to the Far East.

But that if you will elongates the supply chain related to materials so while we are saving and it is benefit on the cost of goods lines we have added a little bit of inventory because of the time it takes for that material to come to the Far East, come to the U.S. from the Far East.

Those are kind of the rankings.

And we have by the way at the end of the second quarter both some inventories for obviously the second wave of shipments related to BeautyBank.

We will take our next question from Bill Schmidt with Deutsch Bank.

Hi, this is actually Martha Brantly.(ph) I just wanted to actually go back to your strength in the U.S. and just get an idea from you about what you see driving it.

Was it just kind of a better comps especially in some of the high-end department stores, are you seeing kind of some momentum build in the core brands that you have been under attack for a while?

If you look at the growth in the U.S. business, definitely the higher-end specialty stores, the Neimans and the Saks enjoyed a much more robust second quarter business and our business particularly was great in brands like Creme de la Mer, Bobby Brown, big increases in all the brands that support the specialty stores.

Generally speaking, the big brands are still under attack but they are doing better.

We are not totally happy with all of the performances but we are certainly satisfied with how the season ended.

But certainly more upscale retailers in our category did better than the broad based department stores.

You said that I think almost all of your brands grew in the U.S.

Which one didn't?

As you know, we do not talk about the specific brand performance on a numerical basis for a number of reasons.

And the discussions will be broadly based, based on region and channels of distribution but not specifically on brands.

Can we expect to see, I guess, I'm getting at kind of the two, you know Clinique and Estee Lauder, that we're obviously focused on.

In terms of, I guess ,keeping things going throughout the year besides the new product launches that you talked about in the third quarter, what other initiatives do you have in place to keep momentum going and keep those stabilized?

Certainly, one of the most powerful parts of the Clinique and Estee Lauder brands, in particular, but also a number of our brands, especially in North America, is the fact that we have dedicated brand, dedicated sales force in the store for the primary engines for sustained basic business growth and they feed off of the traffic in the stores.

The talented pool of Estee Lauder beauty advisors and Clinique consultants and Prescriptives analysts and Origins guides, whatever names we call them, they are the primary engines to growing the business on a daily basis and a lot of our efforts will continue to be focused on giving them the right product and the right ways to speak to their customer to motivate that customer to want to buy our products.

That's truly the hidden value proposition for the consumer in these marketplaces.

And the consistent trend over a very long period of time when we look at the differentials in business on a door-by-door basis or even buy a store group-by-store grope basis is predominantly revolves around the quality of the people in the store and the quality change and they always drive great business and we will continue to focus our efforts really on that door-to-door level.

So you see turnover come down.

You know I think the from the historical high or low unemployment rates of a couple of years ago we have implemented a number of different activities to reduce turnover at this level as well as, very importantly, to improve their selling skills and abilities and we have seen a number of improvements as the average tenure of these people has gone up some.

Or, put another way, the turnover rate has come down.

The next question from Olivia Tong with Merrill Lynch.

Hi, can you just talk a little bit about Japan and may be the competitive dynamics of the market and what you are doing to turn around business there?

The Japanese market as you know for a number of years has been a very challenging market.

The overall consumer takeaway not only non category was merchandized by a number of categories of merchandise in Japan has been challenging for the last three to five years certainly.

And in that competitive dynamic we have seen a number of different things go on.

First of all there's been some restructuring of the trade itself.

There have been some bankruptcies and restructurings and consolidations which has had an impact on the business and one-way share perform.

In addition, the competitive environment has changed some over that same period of time where the consumer concern for imported brands, the consumer affinity for imported brands, brands not based on Asian principles and manufactured and marketed by Asian companies has changed some and that consumer has become a little bit more receptive to Asian based brands or Asian oriented brand in one way shape of form.

Those are probably the two biggest trends.

Though by western standards still the store traffic and consumer interest in our category of product and in shopping in general is still quite high, the reality is getting the growth out of this area is not the same as it was five to 10 years ago.

So how do you jump start growth in that area? - Would did you do in that division or maybe another strategy?

Well, there's a couple of things.

It is not necessarily acquisition based so much as into marketing base both for existing brands as well as finding those right programs and opportunities in a number of different markets.

Obviously, as you know, a general trend in the consumer products business as a whole is in more mature markets with less overall absolute growth the competition for market share becomes very acute and the cost of market share acquisition or preservation becomes far greater than in an expanding market.

By focusing some of our efforts and opportunities in the more rapidly expanding market such as China, Taiwan and Hong Kong with rapidly expanding market the cost of market share acquisition in those markets is perhaps not as high as the cost of market share acquisition in contracting or static markets like Korea and Japan.

Thank you.

We will go now to Kathleen Reed from Stanford Financial.

Good morning.

I just have a quick clarification question on your comments you made on capital retail.

I think you said it was up 7% in the first half.

Do you have what it was just up in the second quarter?

I said it was high single digits I think actually in the half it is 10% comp rate.

In the second quarter the sales growth was relatively low single digits.

Okay and what would be the reason for this, second quarter up low single?

Yes and for the half up 10% plus a little bit high that that.

Okay, so what would be the sequential slow down from September to December assuming like the tsunami I think you said would be impacting this quarter that we are in.

I think, if I recall correctly, last year, a year ago, the travel retail comps in the first half of our year were huge because of the echo impact of SARS.

Okay.

And so, this year we are still reflecting that and I think also what you are seeing is it really took the retail channel almost nine months to catch up to fill their pipe with enough inventory to meet the expected level of demand and we caught up with that.

Okay.

And this segment is included in your European division?

Correct, yes it is.

Could you break out what percent that is roughly of your European division?

Of the total company, it's about 6% of our business so you can sort of do the math.

Okay, 6% of your total sales.

Okay, thanks very much.

We have time for one more question.

We will take that from Janet Cloppenberg (ph), JLK Research.

Hi everybody, just a couple of more questions.

You had talked a little bit about; you mentioned twice some promotional activity that maybe was moving into January that might have been planned for December.

Can you talk a little bit about that?

And I was wondering given your caution on the travel retail business if we should look for that business to be tough as we go through the comparison?

And I don't remember the comparison from the third quarter last year.

And also comment on the specialty store performance in the quarter would be helpful.

Thank you.

Sure.

As far as the -- it was nearly just a timing of shipment Janet and as I said it was worth about a penny so I think the program is $4 million or $5 million in value and it was supposed to shift in at the end of December and it actually it shifted in the first week of January so it was just a tiny thing that had to do with the late arrival of a component we can get it.

Did it have any effect on the sales?

No, no, because it is supporting a gift period that's happening in January.

Okay. - But it is just the timing of a shipment that's primarily that is effected.

That's all but you know those are the types of things that can swing numbers and we like make you aware of them.

Right, Okay.

As far as the T.R.D. for the second half of the year nor does there's nothing that is concerning for us.

The second half of the year should be similar to the first half of year as far as the growth rate goes.

Okay, what was the comparison last year in the third quarter?

I don't know the growth rate in the third quarter for last year, I'm sorry.

That's Okay, thanks.

And your third question was?

Your specialty store performance in the quarter.

You are talking about our own branded base stores?

Yes.

The numbers have been pretty good, not great.

I think that is a reflection as much as anything else in relatively flat consumer foot traffic in the malls of the United States.

Overall the numbers are mid to high, I think high single digits overall but we think that they are really reflective of general softness in consumer foot traffic.

And when you say mid to high single digits is that a total number or would that be a comparable store number?

Comparable -- it's comparable.

We have marginal new stores in the total population.

So it would be a high single digit comp?

Yeah you know Janet.

Four or five.

I want to be clear.

I wouldn't have characterized that as soft.

Maybe that was soft to plan but I wouldn't have characterized it that way.

I guess if you recall for a number of years we have been talking about the fact that for the brands like MAK and Origins which sell predominantly in department stores and their own stores, we have generally seen anywhere between the 25% to 30% different in sell through in the same mall in our own stores versus department stores.

That's been a general trend we have enjoyed over a substantial period of time.

I would say that different is off slightly primarily because the department stores in which those brand have their activity have far more aggressive promotional programs relative to what the malls can do in generating traffic.

So those differentials come down slightly.

And as a whole we have largely not expanded the total number of stores, the total universe of retail stores that we operate ourselves over the last three to four years in the same manner we have expanded the department store activity for some of these brands.

Okay.

Great, thanks so much.

Thank you.

That concludes today's question and answer session.

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