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Operator
Good day, and welcome to the Estee Lauder Companies fiscal 2007 first quarter conference call.
Today's call is being recorded and webcast.
For opening remarks and introductions I would like to turn the call over to Vice President of Investor Relations, Mr. Dennis D'Andrea.
Please go ahead, sir.
Dennis D'Andrea - VP IR
Good morning, everyone.
We have on today's call William Lauder, President and Chief Executive Officer and Rick Kunes, Executive Vice President and Chief Financial Officer.
Dan Brestle, our Chief Operating Officer is also here and he'll be available for the Q&A session.
Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC, where you'll find factors that could cause actual results to differ materially from these forward-looking statements.
And I'll turn the call over to William.
William Lauder - President and CEO
Good morning.
Thank you for participating in our first quarter conference call for fiscal 2007.
I'm pleased to report that sales for the quarter grew 6%.
Diluted earnings per share were $0.27, which was better than what we had forecast in part because of more favorable gross margin and spending pattern slightly different than planned.
Rick will provide more details a little later.
The year is off to a solid start.
Sales trends are in line with our overall expectations.
We feel positive about the upcoming holiday season.
Department stores September sales were robust and the retail climate is more upbeat than we saw just a few months ago.
Unlike this time last year, there haven't been any severe weather disruptions to impact our business or the economy.
While we are pleased that fiscal '07 have started on a firm footing, we continue to be mindful that the periods which are typically our most profitable are still ahead of us.
International sales grew by double digits led by strong showings in Korea, China, the United Kingdom and Germany.
Developing brands continued to push into new markets as part of an orchestrated steady roll-out across the globe to reach new consumers and a long-awaited opportunity La Mer opened in Bon Marche, Paris and has been well received.
Our travel retail business performed nicely in the quarter with sales up in the high single digits, in line with our expectations, despite a temporary ban on passengers carrying liquids on some flights.
At this point, most travel retailing logistical issues have been resolved and duty free sales have returned to normal levels.
The ban and subsequent slow down at some duty free shops and travel retail locations had little impact on our overall business.
At this time, we don't expect any lasting repercussions.
During the quarter, every major U.S. department store chain switched to one gift date, which simplified our gift programs.
We executed the events seamlessly.
The Estee Lauder brand held the first national gift with purchase event with the new consolidated Macy's stores.
The brand's gift related sales at Macy's measured on a same store basis, rose slightly in line with our expectations.
Having one day throughout our chain enables all of our retailer stores to focus on the events simultaneously and where appropriate, lets us advertise nationally or at least throughout several regions of the country.
For example, Estee Lauder advertises Macy's gift in People magazine for the first time.
However, it will take time to get accustomed to holding the programs on different and more concentrated dates.
We're working to stabilize these important promotional vehicles and looking forward to new gift concepts to be unveiled in the spring.
At our year-end conference call in August, we said we planned to spend significantly more than last year during the quarter.
A portion of the added investment went to some of our rapidly growing brands including MAC, Aveda and Bobbi Brown.
We spent more on a variety of initiatives, including special events, public relations, advertising, sampling, training programs and makeup artist education in an effort to garner incremental sales now and down the road.
Some of those costs coincided with the Macy's name plate change.
Additional outlays were directed to large sampling programs at Clinique.
The brand has begun offering millions of trial size foundations and three-step-samples to build traffic and entice consumers to try its products for free.
We encouraged start-up costs in connection with launching our newest brand, Tom Ford Beauty, and invested behind the continued roll-out Sean John and Missoni.
We took numerous steps to plant the seeds for widening our distribution network.
Our beauty bank division announced an exclusive partnership with Coach, a popular, classic American brand for a fresh and sophisticated fragrance that will debut in Coach stores in the spring.
This is the first product developed by our entrepreneurial Beauty Bank division to be sold outside of Kohl's department stores, and we have other such ventures in the pipeline.
Moreover, we also intend to start selling Beauty Bank's American Beauty and Daisy Fuentes fragrances in dozens of travel retail locations in the Caribbean in the coming months.
Clinique announced it will expand to a small number of upscale beauty boutiques within Canada's largest drug chain, Shopper's Drug Mart, where prestige cosmetics and fragrances line the shelves.
Over the next few years, we expect to roll out the full range of Clinique products in all stand-alone Sephora stores in the United States.
At this time, we've decided not to sell Clinique to Sephora inside J.C. Penney.
However, Aramis and designer fragrances will participate in the Penney's Sephora initiative with several scents.
We also plan machine to produce special sizes of Sean John's Unforgivable fragrance for broader distribution starting in the spring.
Additionally, Darphin, which is mainly sold through European pharmacies, is making further inroads into spas both here and abroad with products, services and training.
We are committed to reaching high end consumers wherever they shop.
One way of achieving this is to broaden our channels of distribution where it is appropriate for our brands.
We are encouraged of course by the vitality of department stores, which remain our largest and most important channel.
We're also examining each brand to ensure they properly concentrate resources and launch products that will advance several of our strategic imperatives.
At Bobbi Brown, sales climbed sharply during the first quarter, thanks to new colors and products as well as everyday staples.
In the U.K., the brand's largest European market, sales surged nearly 50%.
Bobbi Brown, which is currently available in 36 countries, has identified travel retail as a strategic focus over the next several years, and we will commit additional funding to this channel.
On the product side, Estee Lauder launched Advanced Night Repair concentrate.
Using on-line marketing, the brand created a companion website for the best-selling night repair line, which explains the science behind the anti-aging treatments and gives consumers a voice through testimonials.
Both the 21 day, nighttime concentrate and the on-line promotion, the first of its kind in prestige beauty, have generated attention and positive reaction.
Another promising new entry is Donna Karan Gold, a high end fragrance just hitting the stores now.
Retailers have been enthusiastic.
We're excited that next week he with whim introduce the exclusive Black Orchid fragrance, the first creation from Tom Ford Beauty.
Although we expect Estee Lauder and Clinique will attract new and existing consumers with offerings incorporating our latest shades and science, the brand's main strategy this year will be strengthening core products in critical markets.
They will focus on the items that embody the core values of each brand.
Those stalwarts Include products such as Estee Lauder's double wear, More Than Mascara and Pure Color Eye Shadow as well as Clinique's Three Step and Clinique Happy.
We expect these products to benefit from revamped advertising, line extensions, improved packaging, and intensive sampling.
After building solid foundations, Estee Lauder and Clinique can then layer on the latest trends.
Behind the scene in operations we recently began moving the Clinique distribution center from Long Island to our state-of-the-art facility in Pennsylvania, which has doubled its capacity.
This is part of our ongoing effort to modernize and streamline the distribution network.
In the last year or so, we have closed nine older facilities and moved warehousing and distribution operations to five more efficient automated plants.
Distribution hubs opened in Canada, California, Belgium, China and Japan in the last year.
We expect a new one in Spain to be up and running later in fiscal '07.
Now that we are almost a month into the second quarter, which includes important holiday sales, we remain confident in our plans to show improvement over last year.
The U.S. economy appears to be in good shape and much of the international retail environment is buoyant.
Assuming current global conditions continue, we are optimistic about our performance in the second quarter.
We believe that consumers will find our holiday sets, product launches and fall gift programs attractive.
We continue to run the business with our five strategic imperatives as a constant back drop to help boost the top and bottom line which we believe will deliver increasing value to stockholders.
On that note I am pleased to announce that the Board of Directors has raised the annual dividend 25% to $0.50 per share.
Now, I'd like to hand it over to Rick Kunes, our Chief Financial Officer, to take you through the financial details.
Rick?
Rick Kunes - CFO
Thank you, William and good morning, everyone.
My discussions today will focus on our results from continuing operations.
Our sales this quarter totaled $1.6 billion, a healthy 6% increase over last year's quarter.
In local currency, sales rose 5%.
Net earnings from continuing operations for the quarter were $58 million, compared with $61.8 million last year.
Diluted EPS was $0.27, versus $0.28.
These results exceeded our projected levels due to lower than planned cost of sales and operating expenses.
Let me refer you to today's press release for the detailed numbers on our net sales and operating income by product category and geographic region.
In this year's first quarter, each of our product categories except hair care was adversely impacted by fewer department store doors resulting from the consolidation of Federated and May last year.
Skin care sales were led by our European and Asian businesses where we benefited from several product introductions from Estée Lauder and Clinique.
Skin care sales in the U.S. also increased but at a more moderate rate.
In makeup, our makeup artist brands continued to lead the category with double-digit sales growth worldwide, once again increasing sales in virtually every country they sell in.
Certain of our core brands continue to post declines in the category.
Fragrance sales were modestly lower compared with the prior year quarter, with a majority of the decline coming in the Americas while sales in Europe increased nicely.
Overall, our lower sales of certain existing products more than offset some of our recent launch successes.
In hair care, slight door growth, salon expansion, new product introductions and the acquisition of a distributor all contributed to solid double-digit sales gains.
As far as our geographic results go, Europe and Asia each generated double-digit sales increases.
In Europe, the Middle East, and Africa, our travel retail business grew high single digits this quarter, despite the temporary disruption in this business that William mentioned.
Virtually every market in the region had strong local-currency sales gains, with most recording double-digit growth.
The strong sales growth reflects an easy comparison with a prior year quarter when sales in certain markets were adversely impacted due to the transition to a new regional inventory center in Belgium.
Asia Pacific also had solid sales growth with most countries recording local currency sales gains.
The strongest growth came from China, Korea, Hong Kong and Australia, of which several.
Low single digit sales growth in the Americas reflected the strength of most specialty stores but more modest growth in department stores.
All product categories except fragrance were up, and almost all developing brands posted increases.
Strong sales gains came from our makeup artist lines, hair care products, and [armor on] businesses.
We continue to experience weakness in certain of our core brands as a result of competitive pressures and retailer consolidation.
You may recall that store closures resulting from the Federated-May merger affect our core brands more than our developing brands.
In comparison, the prior year period was adversely impacted by severe weather conditions and consumer reaction to rising gas prices.
Gross margin increased 110 basis points in the quarter to 73.1%, reflecting a favorable change in the mix of our business, and decreased in the level and change in the timing of promotional activities, decreased obsolescence charges and favorable exchange rates.
As we described on our last conference call, we plan for a high level of investment spending in our Fiscal '07 first quarter to drive momentum.
Operating expenses as a percentage of sales for the quarter increased to 66.9% from 65% last year.
The increase reflects higher advertising, merchandising and sampling, as well as investment spending behind the national nameplate change at Macy's, new product launches and growing and developing brands.
Donations of proceeds from the increased sales of MAC Diva brand products also added to the operating expenses.
Increased selling expenses reflect higher demonstration and education costs of beauty advisors and makeup artists.
Investments in new channel initiatives as well as incremental in-store activities.
Partially offsetting these increases were the company's aggressive and disciplined savings efforts, including incremental savings this year associated with our cost reduction program.
As a result, our operating income was $99.9 million compared with $105.1 million last year.
Looking at operating profits by category, each of our product categories, except hair care, was negatively impacted by the carryover implications of a Federated-May merger.
Still, skin care profits increased, reflecting a higher sales in the category.
Operating results in fragrance increased as we balanced our efforts between sales and support spending.
Makeup results were lower, reflecting declines in certain core brands partially offset by improvements in our makeup artist brands.
Operating results in hair care also decreased due to a higher level of spending for product launches, new distribution points and expenses related to our strategic modernization initiatives.
By region, operating profit in the Americas and Europe declined, while Asia posted an increase.
The competitive pressures and retailer consolidations that have negatively impacted certain of our core brands in the Americas continued in the first quarter.
This region's operating income was also impacted by strategic investments in certain brands to further build their businesses.
These decreases were partially offset by operating income gains by in our makeup artist brands and online businesses.
In Europe, the Middle East, and Africa, operating income decreased compared with last year's quarter, despite the sharply higher sales.
The Company continued to support key markets with increased advertising, merchandising and sampling, as well as higher selling expenses.
Lower results in France, the U.K., Switzerland were partially offset by higher results in Germany and Italy.
Our business in Asia Pacific generated strong operating income growth.
China reported an operating profit this quarter, where we are beginning to see positive results from our investment in that market, compared with an operating loss in last year's quarter.
Both Korea and Australia each reported healthy operating income gains due to sharply higher sales.
The effective tax rate for the quarter was 35.9%.
Regarding cash flows, our fiscal first quarter always reflects seasonal working capital levels as we gear up for the holiday season.
As such, cash outflows for the quarter ended September 30th, 2006, were $70 million compared with $62 million last year.
Accounts receivable at September 30, 2006, increased by $65 million, compared with last September, due to higher sales.
Our day sales outstanding were 55 days this quarter, equal to the number of days last year.
Inventory at September 30th was $834 million, a $19 million increase over the prior year period, while inventory days had a four day improvement to 180 compared with 184 last year.
During the quarter, we repurchased approximately 3 million shares of our stock at a cost of $111 million.
As William mentioned earlier, we increased our dividend 25%, thus continuing to return excess cash to our stockholders through both share repurchases and dividends.
We spent $67 million for capital expenditures during the quarter which includes incremental spending for our company wide systems initiative.
For fiscal '07, we anticipate approximately $685 million of cash flow from operations and expect capital expenditures of approximately $290 million.
Now I'll update you on our assumptions for the balance of the fiscal year.
We are reaffirming our previous sales growth estimate of approximately 5 to 7% in constant currency with foreign currency translation expected to positively affect reported sales by approximately 1%.
We anticipate continued solid domestic and international sales growth.
Our estimate of reported diluted EPS from continuing operations remains at $2 to $2.10.
As a reminder, this EPS forecast includes the carryover impact of the Federated May merger and an additional 15 expected store closures this year, equal to approximately $0.08.
For the full year we expect improvements in gross margin to offset increased operating expenses resulting in a relatively consistent operating margin versus last year.
Our gross margins should benefit from supply chain savings, product mix and lower promotion spending.
As I discussed on our last call, operating expenses are impacted by a number of factors, including higher levels of investment spending behind new product launches and new channel initiatives, more spending in selling and training, as well as for our faster growing and developing brands, incremental spending related to our strategic modernization initiative.
The cost reductions we made in the second half of fiscal '06 are expected to result in an incremental $30 million of savings this year.
These savings have been included in our overall expectations.
Also, the new owners of Lord & Taylor have said they will continue to operate the chain as a growing concern.
Based on this information, we have approximately $50 million of net sales, equal to $0.06 per share, related to our business in the Lord & Taylor chain, included in our fiscal '07 estimate.
We continue to be very aggressive in pursuing financially justifiable cost savings throughout the company and will act as opportunities present themselves.
At this time we expect our effective tax rate will be approximately 37% for fiscal 2007.
Looking at our second quarter, our forecasted sales growth is approximately 6 to 8% in local currency.
We estimate we anticipate a positive impact of foreign exchange of about 2%.
We expect EPS for the three months ended December 31st, 2006 to be between $0.73 and $0.78.
On our last call, I mentioned that we are planning to hold an investor conference in the spring of 2007 here in New York to update you on our strategic initiatives and lay out our financial goals for the next several years.
We have set the date for our meeting, for Tuesday, March 6th, 2007.
As we get closer we will provide a specific agenda.
That concludes my comments for today and we would be happy to take your questions now.
Dennis D'Andrea - VP IR
If we could have the operator queue up the first question that would be terrific.
Operator
[OPERATOR INSTRUCTIONS] Our first question today comes from Wendy Nicholson, Citigroup Investments.
Wendy Nicholson - Analyst
Fragrance business, it was the only segment that showed a decline year-over-year in sales growths and I'm just wondering how much of that is a sort of strategic shift away from the business.
I know you've had successful new advertising in that business and some new product launches that have been well but the business still isn't growing year-over-year.
If you could address that and talk specifically about the Russia business.
I know in your press release, you said Russia was actually a strong business, but I would have expected that the alcohol based import problems might have affected that market.
William Lauder - President and CEO
Wendy, I'm very sorry your question got cut into the middle of your speak, your question.
Can you start again?
Wendy Nicholson - Analyst
Sure, sure, sure.
I'll make it shorter.
It was just about the fragrance business and why even though you've got great advertising and lots of new products that are doing well, why the business is still down year-over-year from a sales growth perspective and if you could address Russia specifically as it wee late to the fragrance business, how Russia is doing and whether you're back on track in terms of managing through the alcohol based import issue.
William Lauder - President and CEO
Let me take the back end of your question first.
Without specifically addressing the fragrance business in Russia, our total Russia business is actually doing quite well.
We're very pleased with the growth we have year on year, store by store and we're pleased with the growth we have because the predominant presence of our business to date has been in Moscow, and St. Petersburg.
We're beginning to expand our footprint and presence to other major cities in Russia, as well as other CIS countries.
And we're finding our growth to be very effective.
I think our primary growth engines in Russia are makeup and skin care.
Our fragrance businesses are doing quite nicely but the primary engines really throughout Europe for our brands are makeup and skin care with fragrance coming along.
Our Russian business grew 45% which is very nice and it's getting to be a very meaningful business.
We expect it will continue.
As far as the general fragrance business is concerned, I think this is an ongoing theme we've talked about now for a number of years.
There is a sector challenge in fragrance overall, which is a little more acute for us because of the mix of brands we have, which are predominantly American brands.
And the American fragrance business is a more challenged sector than any others.
Our fragrance presence in Europe is not nearly to the same size as it is in North America because of our brand mix.
The fragrance business in Europe in particular for us, while not meaningfully large or large enough, certainly actually operates on a profitable basis.
The issue for us is that our fragrance presence in North America is continuing to be challenged because we believe very strongly that two thirds of our fragrance business are based on brands with larger brand equity beyond the fragrance category as a whole.
I refer specifically to the Estée Lauder and Clinique brands.
While our other fragrance-only brands such as Tommy Hilfiger, Aramis, Donna Karan and whatnot, those are not as big in a much more sectorly challenged market where we choose not to go deep into the popular sector, which is where the vast majority of profit is earned in North America.
Wendy Nicholson - Analyst
I would have been -- frankly, though, you've seen so many market share gains for the Gwyneth Paltrow advertising.
I thought the Sean John line was doing well.
I'm surprised year-over-year you're just not seeing sales growth in the fragrance business.
Are you seeing real declines in some of the more established brands?
William Lauder - President and CEO
Yes, we are, more specifically in the Tommy Hilfiger brand, which is quite a concern for us.
Is that something would you consider discontinuing or putting less money behind in terms of reinvestment dollars?
We're seeing good growth in the Tommy Hilfiger brand in Europe actually.
The new management in Tommy Hilfiger today comes from the European region, where they have operated the total business at a far more effective basis.
They've now taken over the North American Tommy business so we are hoping in a reasonable period of time that as they turn their brand around, we will see some turn around also in the Tommy Hilfiger franchise in the fragrance area.
Operator
Our next question comes from John Faucher with J.P. Morgan.
John Faucher - Analyst
Yes, that's Gaylord Faucher. [ LAUGHTER ]
William Lauder - President and CEO
Very good.
John Faucher - Analyst
Thank you.
I've used it. -- I apologize if I've used that one before.
Can you talk a little bit about the distribution changes.
Don't want to read too much into this Canada thing, but it definitely seems like you guys are sort of more proactive in finding some distribution changes.
Can you talk about maybe how that will impact the business going forward?
Rick Kunes - CFO
Well, quite honestly Shoppers Drug Mart in Canada is a baby toe in the water this way.
We certainly expect we'll be finding other adventures, if I can use this word, like this that will both cast our ability to take these great brands to new and different distribution where we believe the prestige consumer is shopping to see both the financial impact as well as the branding impact as a whole, without jeopardizing the extraordinarily strong franchises we've established with our established retailers right now, which is a tremendously successful position for us.
John Faucher - Analyst
Got it.
Okay.
Thank you.
Operator
And our next question comes from Elizabeth Montgomery with Cowen.
Elizabeth Montgomery - Analyst
Hi, guys.
Congratulations on a really good quarter.
Rick Kunes - CFO
Thank you.
Elizabeth Montgomery - Analyst
I had one question, I apologize if this was in the opening comments because I was on another call for a bit.
But it seems as if you reduced your expected cost savings for this year by about 7 million I wondered if you could discuss why that was.
Rick Kunes - CFO
And you are correct, some of it -- the main reason is because some of it has taken a little longer to execute so we don't think -- we're expecting about another $37 million and we're going to generate about $30 million, and it's just an execution issue with moving some of our distribution facilities down to Pennsylvania and the timing of when those will kick in.
Elizabeth Montgomery - Analyst
Okay.
And then also on the revenue line it seems as if despite the fact that revenue was higher than I think a lot of people were expecting in had this quarter, that you didn't change your outlook for the year despite that effects will now be more of a help.
Is that just conservatism or is that reflecting something that you see?
Rick Kunes - CFO
I think if you including exchange we did take our year up because we said 5 to 7% without the benefit of much exchange last call and now we're seeing a 1% benefit from exchange so our reported numbers, we're now saying, are going to be between 6 and 8%.
We did take our numbers up based on the exchange.
As far as normal business, we gave a range for the first quarter of 5 to 7 and that's sort of where we fell.
Elizabeth Montgomery - Analyst
Okay.
Great.
Thank you.
Operator
We now have a question from Lauren Lieberman with Lehman Brothers.
Lauren Lieberman - Analyst
Thanks, good morning.
William Lauder - President and CEO
Good morning.
Lauren Lieberman - Analyst
I still -- I don't feel like I got a good understanding from what you guys have shared so far as to where all this very significant upside came from this quarter.
In the way that I had modeled it out, the big difference is really currency.
Most of -- about three quarters of the upside on revenues was currency.
How much of that flowed through and actually impacted EPS?
Rick Kunes - CFO
Our revenue estimate for the quarter was a growth of 5 to 7%.
And we actually came in at 5%, with a 1% benefit from exchange.
So 6% reported basis.
So I think our revenue estimate was spot-on, quite honestly.
As far as our profitability, you cannot underestimate the implications of going to a national gift program, because we said last year that this would have big implications on our numbers for this year and that's why we said listen, you need to focus on the year because quarter by quarter comparisons are going to be difficult to make.
From our perspective, it was a big initiative to ship all of these gifts on a nationwide basis in the first quarter and effectively what had happened was some of those gifts shipped in September, some will be shipped in October.
Some of our Christmas sets that were planned to go out in the first quarter, actually went out in October, which affects our basic business mix.
So we were favorable in cost of goods.
We spent a little bit less in operating expenses as we referred to in our call.
We had a slightly favorable tax rate.
I mean, all of those things are things which generated a slightly higher result in the first quarter, but a lot of those things are going to be offset in our second quarter and they're built into our second quarter guidance that we gave you.
We still focus on the year.
That's what's important to us.
And we're holding our year and we're comfortable with those numbers.
Operator
Our next question is from Phil Schmitt with Deutsche Bank.
Phil Schmitt - Analyst
Can we just talk more about the shift in the promotional calendar.
How much of that 110 basis points of gross margin expansion was just from that shift in the promotional spend, the gift with purchase spending.
Rick Kunes - CFO
Bill, I think if you read the queue which we should be filing today, we give the break down of the benefits and the change in gross margin.
But a lot of it is related to shift.
And again, it's -- that's why we don't want to focus on the quarters.
We're happy to talk about what happens in the full year, we're comfortable with our guidance for sales and EPS for the full year.
Phil Schmitt - Analyst
A follow-up on that, so the incremental training costs, will some of that also get pushed into the quarter.
Will that continue throughout the year?
Was that kind of a one off event here in the first quarter.
Rick Kunes - CFO
Some of it will continue but there was some run off spending associated with the name change, no doubt about it.
We did a lot of in store activity in the first quarter.
Phil Schmitt - Analyst
Great thanks very much.
Operator
We now have a question from Linda Bolton Weiser with Oppenheimer.
Linda Bolton Weiser - Analyst
Thanks.
I was just hoping you could elaborate a little bit more about the Americas sales growths.
It was just a little bit lower than we had thought and the comparisons get tougher as the year progresses.
So I'm kind of wondering about your optimism for the remainder of the year and would the sell in of the Clinique to the remaining Sephora stores have to do with that?
And can you also give us some idea whether the Kohl's shipments were up or down in the quarter?
Rick Kunes - CFO
The first quarter numbers were, don't forget they are still impacted pretty substantially by the Federated-May door closures.
So there's a big effect with that.
Also, have you to remember that there's lot of sales that happen around the gift programs and the Clinique gift program has kind of shifted from first quarter to second quarter, year-over-year.
So we're okay with the numbers in the first quarter were what we expected in North America for the year.
We're anticipating mid digit, mid single digit growth in the Americas region.
So we're okay.
William Lauder - President and CEO
As far as Kohl's, Linda, our Kohl's business is down somewhat.
Some of it has to do with some anniversary dates.
But we encourage Kohl's to put in an additional gondola fragrances, which we think round out the cosmetic area for Kohl's.
The good news was that went in in the middle of the quarter.
The bad news was it has affected our sell through in that some of the gift business has now shifted to that dominant fragrance location.
In the long term, it's going to be good but I think we had a little bit of a slowdown through these last two months in Kohl's but we expect it to come back up for Christmas.
Operator
Our next question is from Alice Longley with Buckingham Research.
Alice Longley - Analyst
Good morning.
My questions are about gross margin as well.
Can you be more specific in the gross margin guidance for the year?
Rick Kunes - CFO
We said that our improvements in gross margin would be offset by our growth in operating expenses, so flat operating margin.
I think for the year, our gross margin is anticipated to improve about 75 to 100 basis points.
Alice Longley - Analyst
Okay.
That's good.
Thank you.
And then if the first quarter came in well above your guidance because mainly because of the shift in promotional -- well, of the gift program into the second quarter, why -- it sounds as though that is not taking away from the second quarter because your guidance is fairly close to what you said before.
Rick Kunes - CFO
Yes, we never said anything on the second quarter, Alice, so --
Alice Longley - Analyst
well you had the first half guidance.
Rick Kunes - CFO
No, we only gave -- we only gave full year guidance and we gave an indication of sales and EPS for the first quarter.
We never talked about second quarter.
Alice Longley - Analyst
But your gross margins are maybe going to be coming in in the December quarter a little lower than you had originally thought?
Rick Kunes - CFO
Yes.
Alice Longley - Analyst
As an offset?
Rick Kunes - CFO
Yes.
Alice Longley - Analyst
Okay and then again on gross margins you said one of the benefits was mix.
Can you tell us which brands are most driving the favorable mix?
Rick Kunes - CFO
It wasn't related to a brand issue it was related to the fact that because of producing all of these gifts and the timing of manufacturing and shipping of those gifts, we shipped less of our Christmas set business, which is normal business but carries a higher cost of goods, less of our Christmas set business in the first quarter than we had anticipated and that was placed by basic business.
So it's just the timing of shipments of some of that Christmas set business which has shifted into the second quarter.
Alice Longley - Analyst
Okay.
Got it.
Thank you very much.
Operator
Our next question comes from Chris Ferrara with Merrill Lynch.
Chris Ferrara - Analyst
Just on the timing of the gift with purchase, what does it mean for the top line?
Did you have fewer gift with purchase days, per se, in Q1, out there at retail than you did in the year ago quarter because of the nationalization?
Rick Kunes - CFO
Yes, year-over-year, that is correct.
William Lauder - President and CEO
Yes, realize, Chris, in the markets where there were Federated and May doors, we have one less gift with purchase date.
They're consolidated into one date now where they used to be two.
Chris Ferrara - Analyst
So when you say that the same store gift with purchase sales numbers were slightly up year-over-year, I guess what would be the total all in gift with purchase sales result for the quarter?
I mean, it was much lower than that, I guess, right?
William Lauder - President and CEO
Well, you're talking about the closed doors?
Closed door numbers are out of there for both gift with purchase and regular business.
Chris Ferrara - Analyst
Okay.
So that same store sales ---but the same store sales number, that does include an instance where you might have had a promotion last year at Strawbridges, but now under Macy's you didn't this quarter.
Is that right?
William Lauder - President and CEO
Yes.
Dan Brestle - COO
Correct.
Correct.
Rick Kunes - CFO
That is correct.
But again, the key thing, Chris, is one of the reasons we say it's very difficult to draw comparisons year-over-year is just the point that you're raising which is how many gift days were there in the first quarter of last year versus gift days in the first quarter of this year, what is shifting back and fort and that's why we're really focusing on the full year results and we're quite comfortable with our sales guidance and the EPS guidance for the full year at this point in time.
That's why we really want to avoid the quarterly discussions.
Chris Ferrara - Analyst
That's fine.
I understand that.
I'm just trying to get a sense because we have to model on a quarterly basis.
Does that mean that you'll get a benefit on having more gift with purchase days year-over-year in the December quarter?
Rick Kunes - CFO
I think, Chris, I think it's -- to go back to what Dan said before, because of the reduction in number of name plates with whom we do business and if you assume for a moment that with every name plate, we did a distinct gift with purchase, in all those markets where Federated and May merged and they eliminated one if not two name plates, if you were to actually go market by market, gift with purchase activity, market by March at the time, roll it up on a national basis and add them all up, there are fewer doors with distinct gift dates this year versus last year because of the merger.
And that same effect -- and the shift quarter to quarter is really, truly very confusing because -- I'll give you the example is Lauder and Clinique are now national dates.
The predominant as Rick said before, the national dates have moved.
So basically what you'll see is sales in the second quarter will go up.
Gross margin will go down.
Primarily driven by the fact that there are more gift costs associated with what's going on.
But I want to caution you to try to make that comparison year on year is extraordinarily difficult because of all the shifts and on top of all the shifts with the date shifts themselves, some of the traditional dates with certain retailers in certain markets have moved.
So where Estée Lauder may have been on promotion with Macy's West during their spring flower show over Easter, they may not be now and instead it may be Clinique.
So the Estée Lauder brand may have shipped to a different promotional date on the calendar but Clinique was on gift in Macy's East in the flower show.
Now that Macy's is national and Clinique and Lauder will be national dates, there's all sorts of shifting going on and I just want to repeat it again, for this year, and this is what Rick has said, trying to compare retail,year on year, day-to-day, month to month, quarter to quarter, will be very difficult because of all the shifts going on.
Chris Ferrara - Analyst
Thank you.
Operator
Our next question comes from the Sandy Beebee with H.S.B.C.
Sandy Beebee - Analyst
Hi, Sandy Beebee.
I had one or two follow-up questions.
I guess with all the shifts that are going on, how should we think about whether you're getting a good return on your investment spending and a good return on the changes that you've made with gift with purchase when we look at the annual numbers?
So what kind of expectations do you have for Estée Lauder and Clinique in the U.S. for fiscal 2007?
And then I had had another question about why you chose not to go into the J.C.
Penney Sephora stores.
William Lauder - President and CEO
Let me answer the first part of -- the second part of your question first, then I'll ask Dan to respond to the first part of the question.
We chose not to go into the J.C.
Penney Sephora venture primarily because we could not agree between us on the business terms and conditions which would be favorable to the brand.
Dan?
Dan Brestle - COO
Okay.
And the first part of your question was Lauder and Clinique for the year.
We expect both businesses to be up.
We think that we're doing a great job in capturing the day in, day out business of the closed doors.
Where we're still struggling is in the promotional business where a market would have two promotions in the season, now consolidated into one.
We have a certain percent of our business, our customers although low, are gift shoppers and we're missing one date.
But we really expect both Clinique and Lauder to have positive results at the end of this year in North America.
Internationally, the businesses are fine and both brands will grow for the year.
Sandy Beebee - Analyst
Okay and then in terms of not being able to agree on the business terms and conditions, is its more to do with how you wanted the brands to be presented?
William Lauder - President and CEO
It's all of the above.
Dan Brestle - COO
I can't emphasize enough, in our minds Clinique is arguably one of the top three brands in the world and to enter a new distribution channel without some favorable terms was just unacceptable to us and we didn't want to get into the dialogue of what it meant to our existing distribution until we resolved that issue.
Sandy Beebee - Analyst
And then just one last question, just on the U.K. market.
It sounded like it had gone pretty well this quarter.
Is there just a -- is there just a recovery going on?
I guess the market was a little bit weak a year ago.
Or can you just give a little bit more color on that?
Rick Kunes - CFO
The U.K. was up high single digits so we're quite happy with the results in there and I think that William referenced specifically the performance of Bobbi Brown in that marketplace.
So that was a solid result as well.
So you know, is there a recovery going on?
Our business is doing better, certainly.
Sandy Beebee - Analyst
Thank you.
Operator
We now have a question from Amy Chasen with Goldman Sachs.
Amy Chasen - Analyst
Hi, good morning.
Firstly, just on Sephora did you guys say that you're expanding Clinique broadly into Sephora that you're going to have broad distribution.
William Lauder - President and CEO
Let me be specific.
We are expanding the distribution of Clinique in North America into the Sephora full line stores.
Those are the bigger doors that are four or 5,000 square feet that exist in the middle of the mall.
We are not taking the Clinique brand into the venture between Sephora and J.C.
Penney's which are the somewhat smaller Sephora branded environments inside of the four walls of the larger J.C.
Penney stores.
Amy Chasen - Analyst
Okay.
Great, so what I don't understand, because I heard your comments about you couldn't agree on the terms and conditions and so on, I've seen the Sephora layout in J.C.
Penney at least in one door and have spoke tone their management and they basically said they took their top SKUs its the exact same layout, it's the exact same terms with all of their vendors so I don't understand what the disconnect is there.
William Lauder - President and CEO
I wouldn't really want to on what any of our retailers say and what their key strategies and terms and conditions are, I can only comment on what we know about our businesses and our brands.
And I think it's safe to say that we, Clinique and the Estée Lauder Companies, could not come to terms with the management who is responsible for the joint venture between Sephora and Penney's on acceptable terms and conditions on how we we would do business together with the Clinique brand in that venture.
Amy Chasen - Analyst
Can you also just go back to Estée Lauder and Clinique.
I think you said something about focusing on the base business and then trying to do more to create newness or something like that.
Can you extrapolate on what you mean by that and how that might be different on what you've been talking about over the past six months or so?
William Lauder - President and CEO
There's a couple of things.
First and foremost, if you look at our trends in our business over the last 10 years, one of the consistent themes has been that 30% of our sales come from products launched within the last three years.
Which means that 70% of our sales is coming from products we launched more than three years ago.
Yet the vast majority of our marketing effort and our marketing dollars are spent on that 30% which is new.
Obviously the consumer responds to newness and she is motivated to come to the store and pay attention to the brands because of the newness we present to her.
But the fact of the matter is that when she does show up, seven out of ten times she says I like the product I know.
So what we're trying to do is allocate a more meaningful portion of the total marketing efforts and dollars in the advertising and promotion to those core established products which she really likes.
For example, as I referenced in this script, Clinique's Three Step, Clinique Foundation, Estée Lauder Advanced Night Repair franchises.
These are solid, strong franchises, which when looked at on their own would be meaningfully sized brands on their own and yet they live within an even larger brand.
We're trying to devote enough effort to it so we can promote to the consumer the solid fabulous product they've come to know and use over many years and have relied upon so that we can grow our business on some of those core followings.
Amy Chasen - Analyst
Great.
That's very helpful.
Thank you.
Operator
We'll take our next question from Amy Cee with Banc of America Securities.
Amy Cee - Analyst
The question on Clinique, is there any way you could discuss the productivity and margins of Clinique and Sephora versus the department stores and just wondering if the negotiations with Sephora and JC Penney are ongoing or whether this is something that has been ruled out, also just two quick questions.
The charge in the Americas for an unemployment matter, what is this and how big is it and on guidance, is your guidance policy changed or why have we gotten guidance guidance for next two quarters in a row now.
Dan Brestle - COO
I'll answer the first part of that Rick will do the second.
We won't talk margins but on average a classic U.S. department store Clinique does anywhere between 750 and $800,000.
In Sephora that same Clinique presentation is doing about 150 to $200,000.
That's the relative size of the two businesses.
Rick Kunes - CFO
Regarding the legal action, it was matter that was settled through mediation.
It was really around an interpretation of law as opposed to any specific discussions with any employees.
And it was -- it's immaterial to our full year results but it did add about 20 to 25 basis points to our operating expenses in the quarter.
Regarding guidance, we still believe strongly in running our business on an annual basis.
And we continue to provide hopefully most of our comments and color around our business related to our full year performance.
Having said that, we understand that at times, and certainly that the importance to the investment community of understanding what's happening in the next quarter, so we felt that as appropriate, we will give you just the sales and EPS outlook for the next quarter, without going into a great deal of business details but at least if it's important to you, you'll have a feel for what's happening in the next quarter.
But again, most of our comments and discussions will be around full year results.
Amy Cee - Analyst
Thank you.
Operator
And our next question comes from Filippe Goossens with Credit Suisse.
Filippe Goossens - Analyst
Yes, good morning, gentlemen, and congratulations on a very good start to the year.
William, kind of would like to ask you more strategic question with regard to the department store business.
If we look at the overall kind of veteran department stores it's clear that there are not that many more regional malls being built with the channel to build growth going forward.
Secondly, within the cosmetics category, amongst others, also seeing increased competition from new formats like J.C.
Penney and, the discounters are trying to grab a little bit of that business as well.
Now, as they search to grow earnings for their own shareholders, what risk do you see, if any, that they may knock on the door of some or their vendors, including yourselves, and say hey, what can you do to help us to grow our earnings per share, therefore there is some risk that the business model that we've known for the last four to five decades, let's say, could come somewhat under pressure?
And if that were to be the case, how would you respond, if that request were to come from the retailers?
Thanks so much, William.
William Lauder - President and CEO
That's a wonderful question.
That's one of the key, if you will, questions we ask ourselves on a daily basis.
And I think it comes down to, if you will, a balance of power for want of a better word, between ourselves and our key retailers and making sure that we have something that they want and they have something that we want.
What we have is great brands with a great connection to our consumers.
They've got a great retail brand name, great real estate presence in the right place where there are consumers who are shopping.
So the mutual benefit we both have is putting our great brands in their retail space in a great location.
With the balance of power could get out of whack is if we no longer have something that they want, that they don't have and therefore they feel that they can apply a form of leverage to us without our ability to respond.
So the long-term challenge for us is to always have brands and positions and retail locations for which they would like us to consider expansion of distribution, which they do not have.
Therefore, if you will, and this is something we've been doing for 40 plus years, the promise of expanded distribution with new brands comes on making sure you take care of the brands that exist.
And it's a fine balance between us and basically we have to make sure that we have that balance of power.
Let's not forget that our focus right now, where we are very saturated and very highly penetrated with our key large brands is Clinique and Lauder, that we're looking for most of our growth for those brands in particular to come from outside of North America.
While we aggressively expand our newer and emerging brands in North America as well as outside of North America.
So the balance comes -- we have said one of our long-term goals is that our balance of sales that will come from around the world on a geographic basis we expect to shift over time.
Right now we're roughly a 50/50 between the North America and the rest of the world.
I would like to say in the next five to seven years that that shift would go 60/40 outside of North America, if not more.
In addition to that, we must continue to innovate and create new brands that can be successful in the department store channel which we can grow behind the brands that are existing and growing so that we help the retailer with their growth in this key category of cosmetics by continuously bringing new brands that will attract new consumers while our existing brands continue to grow.
Filippe Goossens - Analyst
Thank you so much for that insight.
Maybe just a follow-up on that same theme.
Over the last year, you've shared with us the impact on your business from the integration of May department stores into Federated.
Can you provide us with any color as it relates to the integration of the businesses that were acquired by Bon Ton stores?
Dan Brestle - COO
I think it's too early to tell.
Right now we're -- everything is being sorted out.
It was sort of hidden behind all the discussions about May company.
Bon Ton now a major player for us.
Some of their franchises, Carson Pirie Scott, et cetera, are wonderful, wonderful businesses for us.
I think that between what the Belk bought of the southern doors in the Sax group and what bought in the northern, we don't see a major impact.
I think that at least in the Belk case there will even be a positive impact.
So I think it's too soon to tell in the northern group.
But the in the southern group we're looking for a more positive business with the way Belk runs cosmetics.
Filippe Goossens - Analyst
Thank you.
Maybe if I can just conclude with one final question.
On SAP, if I understand correctly, it is currently being rolled out at the Aveda brand.
Any initial read and what are the other brands that you will put on the platform during the remainder of your fiscal year '07?
Thank you.
Dan Brestle - COO
I'm sorry.
In fiscal '07 it would just be Aveda.
But we will start other locations and it will be company-wide.
The reason that it just happened to be be related to a specific brand is because that is the location that we chose to do first.
It's a stand-alone, if you will, a stand-alone business and it's something that we felt was appropriate to test and make sure that we have everything right before we roll out.
So it will go live this fiscal year and we'll begin expansion into Europe and some financial backbone work here in North America as well.
Operator
Thank you.
Our next question question comes from Josh Zanc with Prudential.
Connie Maneaty - Analyst
It's Connie Maneaty.
Not to beat this national gift date to death, but for housekeeping purposes, could we have a list of what the national gift dates were or the major gift dates were last year from your national accounts and how many they're going to and what those major dates might be in fiscal '07.
Dan Brestle - COO
Connie, if we can do the Rubik's cube first, we can do that second.
There were major shifts everywhere.
An example, Clinique did Dillard historically in October.
Dillards Clinique this year went in August.
The consolidations are all across the board and I'm not sure what you could do with it.
The shifts are such that it's going to take us a full fiscal year, both spring and fall to get through.
William talked about shifting the other activities within the store and how they affected dates.
How you come now between and what you're selling on the dates, you're selling Christmas sets.
It is a very complex thing and the pure dates don't mean that much.
The calendars have been historic for years between those two big brands.
We have in Loreal with Lancome.
I don't think -- there's nothing could you do with it.
Connie Maneaty - Analyst
Okay.
Fair enough.
And then one more question about what you had planned for Clinique and the gift program in the first quarter, shifting to the second quarter.
If you could help us understand the dynamics of when there.
From one point of view it seems like there's so much planning and long lead planning that goes into all of this and then all of a sudden things shift from one quarter to the next quarter.
What shifted?
Was it the gift date?
Was it the timing of shipments?
Was it the Christmas sets?
Dan Brestle - COO
Well, it was the last two, primarily.
We had some Christmas shifts because we had some late deliveries of some set-up boxes from September into October.
We had some -- realize, just as plant it in your mind, the Clinique Macy's gift with purchase was 88 trailers full of gifts and some of those didn't make it out in the last end of the month and they went in the first couple days of October.
It's a massive, massive logistic effort.
So it's not a shift of -- it's a matter of days or weeks.
Connie Maneaty - Analyst
Okay.
And then you mentioned that Sean John was going to go to special sizes to reach more consumers.
What exactly does that mean?
Dan Brestle - COO
We think in the popular business in the pricing structure, especially when we get to the popular business with Sean John and even in the department store business, it's going to give a broader price point.
It came out at a premium price point.
And it's going to give it an entry level that is more acceptable.
Connie Maneaty - Analyst
Where would these special sizes be sold?
Dan Brestle - COO
Everywhere.
Connie Maneaty - Analyst
I mean, like Walgreens or everywhere in department stores.
Dan Brestle - COO
No, right now the Sean John brand is in the department store world.
Connie Maneaty - Analyst
Okay.
Great.
Thank you.
Operator
And we now have a question from Linda Bolton Weiser with Oppenheimer.
Linda Bolton Weiser - Analyst
Yes, you had mentioned in your commentary that you were experimenting with some new gift with purchase ideas for the spring.
Could you give a little more information.
Is that just different types of items to be offered as the gift or a different financial structure with the company that you might partner with?
Dan Brestle - COO
No, what we're trying to do is take advantage of national dates.
Now that we have them, what kind of national programs can reinforce this vehicle?
And the one that we're talking about, I guess we're just talking about, I'm assuming that Clinique is now shared with their retail partners, is that they are doing a joint venture with a lot of the magazines, where we had let the editors of the magazines select and put together the gift.
So that the gift may be from the editors of Allure magazine or from Vogue or from Glamour.
And it's I think it gives credence to the gift itself and tells the consumer that someone thought about the quality of the gift and components so it's not just a bunch of samples put together.
And because we have a national date now, we can deal with national magazines.
Before you had national dates, the regionalization of the gift didn't give you permission to use national vehicles.
That's one example.
There are others we're doing but that's one we're talking about.
Linda Bolton Weiser - Analyst
Thank you very much.
Dennis D'Andrea - VP IR
That concludes today question and answer session.
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