雅詩蘭黛 (EL) 2008 Q3 法說會逐字稿

Good day everyone, and welcome to the Este Lauder Company's fiscal 2008 third 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 the Vice President of Investor Relations, Mr.

Dennis D'Andrea, please go ahead, sir.

Good morning.

On today's call are William Lauder, Chief Executive Officer, and Rick Kunes, Executive Vice President and Chief Financial Officer.

Fabrizio Freda, President and Chief Operating Officer is also here.

Fabrizio just started with us on March 3rd, and he will make some brief remarks, but he will not be available for questions today.

Also on the call is Dan Brestle, our Vice Chairman and President of North America.

Dan will 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 will find factors that could cause actual results to differ materially from these forward-looking statements.

And now I will turn the call over to William.

Thank you, Dennis.

Good morning, everyone and thank you for joining us.

I want to start by welcoming Fabrizio to his very first Este Lauder Company's earnings calls.

Fabrizio joined our Company two months ago, and he and I have began forging a terrific partnership.

His valuable consumer products experience and financial acumen are a great addition to our management team.

I look forward to working closely with him, as we take the Company to new heights, and reinforce our position as the global leader in prestige beauty.

In our discussion this morning I will highlight our results and global business trends.

Fabrizio will discuss where he plans to initially focus his attention, and Rick will walk you through the financial results.

A hallmark of our Company strategy is the geographic and category balance, that enables us to consistently generate strong sales growth.

To build on our momentum and capsulize on where we see the greatest opportunities, we have made strategic investments in our international businesses, including emerging markets.

We are seeing that spending pay off, as it evident by our strong international results, which have helped offset the sluggish economy in the United States.

We achieved the solid performance for the fiscal third quarter, with reported sales rising 11%, and local currency sales up 7%, diluted earnings per share equalled $0.46.

We again saw rapid growth in emerging markets, up nearly 30% in the quarter as a whole, and good, steady expansion in most mature countries.

On a global basis, sales of our three largest brands, Este Lauder, Clinique, and M.A.C., expanded.

Este Lauder and M.A.C.

had higher sales in every region.

Clinique sales were lower in the Americas, but rose everywhere else.

Viewing our business by region, Asian Pacific was a standout thanks to solid like door growth, as well as continued expansion of our brands into additional markets, doors, and channels.

The region sales climbed significantly.

Sales were up in nearly every country led by China, Hong Kong, and Korea.

Most countries in the region had robust double-digit gains.

Every product category expanded by double-digits, driven by skincare with constant currency growth in the high-teens, and higher sales were recorded by virtually every brand sold in the region.

We tailor our products and marketing to specific areas in cultures, and the brands are resonating with consumers.

That is especially true in China, where most of our brands rang up double-digit increases at retail.

The Este Lauder brands, like door sales, and department stores, increased by one-third, and the brand also expanded it's distribution in department stores and Sephora.

We believe that the Este Lauder Companies is the largest prestige cosmetics group sold in our department store distribution in China, and we again have gained share in this channel this fiscal year.

In Japan, sales grew in the high-single digits.

Department stores are our main channel of distribution in Japan, and we outperformed the cosmetics category, as well as the total department store business during the quarter.

As a Company, retail sales of our products have climbed for 15 of the last 16 months.

Clinique, our largest brand in the market, has posted higher sales in the last three years.

Our skincare sales continue to show positive momentum.

This year we expect the category sales will more than double last year's growth rate.

The makeup category is also growing led by M.A.C., which opened new doors and had several successful product launches in the quarter.

Aveda now sells in approximately 175 salons in Japan, 20% of them are concept salons, which sell Aveda products exclusively.

While still a relatively small business, Aveda sales in Japan were up sharply in the quarter.

Our outlook for the Asia Pacific region remains extremely upbeat.

Turning now to Europe, the Middle East, and Africa, our business in the quarter was healthy.

The U.K.

was up despite facing a challenging environment.

M.A.C.

and Bobbi Brown led the growth.

Sales of our eight brands sold online more than doubled, due to strong organic growth, plus the addition of three new brand sites for Aveda, Bobbi Brown, and La Mer.

Much of Europe's expansion in the quarter was driven by Russia and emerging markets in eastern Europe.

The Russian economy remains robust, prestige beauty has been growing 15 to 20%, and our brands outperform the industry.

In total, we posted like door retail growth of 27% for the quarter.

Building on the momentum, Clinique ran TV ads in St.

Petersburg for the first time last month.

Additionally, many brands are stepping up their investment in beauty advisors since Russian consumers value advice at point of sale.

It is worth noting that some markets in Europe have begun to see pockets of softness.

We believe our business will continue to grow nicely in the region, but the pace should slow.

The travel retail division continued it's strong performance.

As a result of the size of the business and it's excellent growth rate, travel retail continues to be a major contributor to the Company.

General industry trends are favorable.

Sales of beauty products have outperformed the entire travel retail channel.

Our strength in makeup and skincare which are fastest growing beauty categories ahead of fragrance.

Our makeup sales climbed 25% and skincare was up 22% in the third quarter.

Our slate of products made exclusively for the travel retail channel did exceptionally well, and have become a critical component of the business.

In addition, the number of international travelers has been growing mid to high-single digits, with an even greater percentage coming from emerging markets.

Although airport stores represent the bulk of industry sales, downtown locations and Asian cities, border stores in Latin America, and shops on cruise ships have shown accelerating growth.

Switching to the Americas as you have seen and heard, in many companies the business environment hag challenge in the United States, nonetheless we increased sales for the region, led by Canada, Latin America, and strength in alternative channels, including the Internet, self-select distribution, and direct TV.

Our free standing stores posted smaller gains than in past quarters, reflecting lower consumer spending.

Our comparable retail sales in U.S.

department stores declined 4% for the quarter, as the weak economy and high gas prices affected foot traffic.

However, we are working hard to bring people into department stores, and we had some success.

The Este Lauder brands Spring Gift at Macy's was considerably better than the prior year, which represents a major improvement.

We added value to the gift, and gave consumers a choice of products, which was well received.

As a result, the average transaction size increased by about $4.

The slowdown in U.S.

department stores underscores the value of channel diversification.

One example is the recent expansion of our presence on direct response television.

Clinique debuted on QVC in the United States in February, and the show was the largest two-hour beauty launch in the network's history.

Viewers ordered 41,000 units worth $1.5 million in sales.

As we strategically planned, the QVC segment also increased sales of the products that were highlighted on the show in department stores.

Other brands with regular shows on QVC are Bobbi Brown, Ojon, Origins, and Prescriptives, also Beauty Bank announced it will create a prestige brand to be sold exclusively on HSN starting in July.

TV retailing is one of the fastest growing channels for beauty products, and it represents a global opportunity.

Some of our brands have hit the airwaves in other markets.

Ojon debuted on QVC in Germany during the quarter, and sold out sooner than expected.

Prescriptives and Bobbi Brown aired on QVC in the U.K.

In Korea, Origins have sold through several television networks, and Good Skins TRI-AKTILINE product launched on the top home shopping channel with outstanding results.

One of our fastest growing channels is e-commerce.

We now sell 18 brands across our own e-commerce sites in five countries.

In North America about three-quarters of our online sales come from our own brand sites, the balance from retailer sites.

Together these enhance our consumer shopping experience.

All of our brands recorded strong double-digit gains online.

We also expanded our online operations internationally.

Good Skin and Flirt!

began e-commerce in Korea, which was chosen because it has the highest percentage of Internet users relative to it's population.

This marked the first time we put our brands online without having first established them in traditional retail venues.

Additionally, in April we launched a website for Clinique in France.

For the balance of this fiscal year, international markets will continue to drive our growth.

As I said earlier, we expect Asia Pacific to lead growth.

Europe, the Middle East, and Africa should perform well noting the caution I cited.

But at the same time there is no evidence that the United States pointing to an imminent turnaround in consumer confidence and spending.

We will, however, be aggressive in all regions to broaden our brands, generate buzz about products, and diversify distribution, to ensure that we consistently build upon our growth.

Fabrizio joins us at an exciting time.

Let's now hear from him.

Fabrizio?

Thank you, William.

Good morning to everyone.

I am pleased to have the opportunity to introduce myself to you this morning, and to briefly discuss a few of my observations and my thoughts for the future.

Before I do that, I would like to say what a pleasure it is to be here at the Este Lauder Companies.

I admire this Company for it's fantastic brand, highly talented people, superior creativity, innovation, and global reach.

I have great respect and admiration for the Lauder family.

They are as focused on nuturing a successful business enterprise as any I have seen.

These are all factors that were foremost in my decision to join this organization.

I am thrilled to be here and I am excited to be working with William and the rest of the team, to help the Company build on it's legacy and long, heavy touch of success.

Let me now tell you a little about myself.

I spent the last 20 years of my career with the Procter & Gamble company.

My responsibilities included more than a decade in the health and beauty care division, and most recently, as President of Global Snacks.

Prior to that, I spent some time at Gucci, directing marketing and strategic planning.

At Este Lauder I am delighted to have several key global brands reporting to me, along with our international business, worldwide operations, packaging, and R&D.

In the first few months I am observing, listening and learning as much as possible, as fast as possible.

I am working to understand how our strength can be leveraged, and how to address our key opportunity.

With that in mind, I have done a lot of traveling in this first two months to many of our affiliates and operations, to get to know our business and employees.

I have also met with customers around the world.

These meetings have proven to be essential, to help me determine where I can best use my experience, to unlock the full potential of this Company.

While I have only been here a short time, there are some key areas where I initially plan to focus my attention, to determine how shareholder value can best be created in the future.

Most importantly, putting the consumer first in our business model, starting from the culture created by the famous touch that Mrs.

Este Lauder always insisted upon, the expression of warmth and genuine interest in understanding our consumers, and always surpassing their expectations.

Second, leveraging at best the great creativity and innovation, which is the lifeblood of our Company.

We must emphasize our innovation capabilities that provide the [efficacy] and results our consumer expects, as well as the service and the motions, the prestige experience delivers.

Third, insuring that we strengthen our financial discipline, so that these are the forefront of all of world processes.

Together we will work towards understanding how we can achieve a more competitive cost structure, for example, by leveraging scale, synergies, marketing ROI, and importantly, addressing underperforming businesses.

As part of this, we will benchmark internally and externally with the Best-in-Class.

Fourth, by continuing to drive the strategic modernization initiative that is underway, to ensure the most implementation and maximum benefits, he will focus on how to execute with excellence to improve costs, speed to market, and inventory management.

Lastly, how to further accelerate growth in old prestige channels.

Our traditional ones, as well as new fast growing ones.

These areas of focus will build on the strength we have in the Company, and will further energize the passion, teamwork, leadership, and capabilities I see at every level.

Working with William, we will bring our Company to the next level, insuring our place as a prominent leader in prestige beauty for years to come.

I understand that the challenges we face in the United States are substantial.

That said, with the strength of our Company, I am confident we can overcome them.

Our portfolio of brands is like no other, with strong consumer recognition and reputation for quality.

While the variety of cosmetics brand and shopping venues is abundant, I believe we can continue to differentiate our brands, and further build the excitement essential to attract and retain consumers.

In a moment of soft markets, we will continue investing in our business to further strengthen our fundamental positioning as well, for when the markets improve.

As William discussed, our company has strong international strategy.

I am thrilled by the large potential in emerging markets, as well as the opportunities in more developed countries.

The expansion of luxury markets across the world provide a new opportunity for our brands, and we will continue to vigorously pursue this growth.

My commitment to all of you is that I will continue moving quickly to emerge myself in this business.

I am gathering the proper insights that will allow me to be thoughtful in bringing my leadership to our strategy and operations.

I look forward to meeting all of you in person, and to begin establishing productive relationships, listening and understanding the how-to is a fundamental aspect of my introduction to this Company.

I eagerly await the opportunity to listen more to you, as well as to gain your perspective.

Now I will turn the floor over to Rick, who will discuss the financial results.

Rick.

Thank you, Fabrizio.

Sales this quarter were up 7% over last year in local currency.

The U.S.

dollar weakened a bit more than we anticipated, adding 4 percentage points of growth, resulting in reported sales growth of 11% to 1.9 billion.

Net earnings for the quarter were $90.1 million, compared with $93.9 million last year, and diluted EPS was $0.46, compared to $0.45 in the prior year quarter.

The local currency sales growth came in slightly below our expectations, EPS was at the midpoint of our guidance range.

With 10 months of the year behind us, we are now comfortable narrowing our forecasted full year EPS toward the higher end of our range, between $2.34 and $2.40.

During the quarter we saw outstanding sales growth internationally and in most categories.

We turned in a remarkable 18% sales growth in Asia Pacific in local currency.

Among our largest markets in the region, we are pleased with the high-single digit growth in Japan, where nearly all brands saw increases this quarter.

Korea, the second largest country in Asia Pacific, grew over 20%.

These two markets represent nearly half of the region's sales for the quarter.

China jumped 50%, fueled by robust prestige beauty growth, expanded distribution, and share gains.

We are now in 84 department stores and 35 Sephora stores, an increase of eight doors during the quarter.

Strong double-digit growth was also seen in Hong Kong, Malaysia, Taiwan, and Thailand.

Conversely, while sales were up, Australia experienced slower growth reflecting some retail softness.

In Europe, the Middle East, and Africa, we posted 9% local currency sales gains.

Once again our travel retail business grew rapidly.

It's 22% sales gains this quarter was fueled by increases in international travelers, new airports, improved retail stores, and expansion of new brands and products into the channel.

In the rest of the region, nearly all countries saw growth.

The U.K.

rose mid-single digits, fueled by the continued success of our makeup artist brands, sharpening our sales from our e-commerce business, and strong results from the Jo Malone brand.

Travel retail and the U.K.

affiliate represent over 40% of our sales in the region this quarter.

Among our developing markets in the region, Russian once again grew double-digits, while Turkey and our eastern European businesses each grew about 20%.

The sales growth in the Americas reflected solid results in Canada, aided by the inclusion of sales from the Ojon brand acquired last July, and most countries in Latin America.

Additionally, the regions underlying growth was generated by sales gains in alternative channels, especially our online business, fragrance sales and self-select distributions, and direct TV.

Taken together, these areas grew nearly 10% in the quarter.

These factors mitigated our 4% retail decline in U.S.

department store channel reflecting the soft consumer sentiment in the U.S.

Our gross margin was 74.9% for the quarter, a 10 basis point increase over the prior year quarter.

Favorable exchange rates and a decrease in the level and timing of promotions were partially offset by an increase in obsolescence charges, and an unfavorable mix of business.

Operating expenses as a percentage of sales for the quarter rose 80 basis points to 66.3% over last year.

As planned, the increase reflected about 120 basis points of higher investments in advertising, merchandising and sampling, to support new product launches globally, as well as brand awareness in emerging markets.

We continue to spend incrementally on global information technology worth about 50 basis points.

These increases were partially offset by about 60 basis points for organizational costs, related to the pharmacy channel in the prior year, and 40 basis points in favorable exchange rate transactions.

Operating income rose 3% to 161.2 million, compared to last year.

Looking at operating profits by category, skincare and makeup results each rose, due to the strong international performance.

Fragrance posted a wider operating loss, primarily due to spending in support of new designer launches.

Hair care results declined reflecting soft sales, investment to support growth and distribution, and higher amortization of intangible assets from recent acquisitions.

By region, operating profit decreased in the Americas, but grew substantially elsewhere.

In Asia Pacific, operating income jumped primarily on the strength of sales growth in China, Japan, Korea, and Hong Kong.

In Europe, the Middle East, and Africa, operating results reflected improvements in travel retail, Italy and Spain.

These gains were partially offset by spending in support of our continuing expansion in Russia.

The decline in the Americas was primarily because of the increased cost for information technologies and infrastructure, higher spending on advertising, sampling and merchandising, and activities in support of our hair care business.

Regarding our net interest expense, we reported 16.1 million this quarter, versus 8.8 million in last year's third quarter.

The increase is due to higher average debt balances, from financing our accelerated share repurchase last fiscal year.

The effective tax rate for the quarter was 37%.

Moving to operating cash flow, for the nine months ended March 31, 2008, we increased operating cash flow by 14%, to $518.5 million, compared with 456.3 million last year.

The increase primarily reflects higher income, after adding back certain noncash items, such as depreciation, amortization, and stock-based compensation, as well as the timing of payments and costs for marketing activities and employee compensation.

Our days sales outstanding rose 3 days to 54 this quarter, reflecting the rapid growth of our international business, which carries a longer training time.

Domestic days were flat for the quarter, inventory days increased to 176 days compared with 168 days last year, due to additional inventory, from the inclusion of Ojon, and to support new business in emerging markets.

Foreign currency translation of our balance sheet at quarter end, and from the expected sales growth of our business in the fourth quarter.

During the nine months we repurchased approximately 2.2 million shares of our stock, at a cost of $94 million.

Year-to-date we spent 250.3 million for capital expenditures, which includes incremental spending for counters and our company-wide systems initiative.

For fiscal '08, we expect to generate approximately $700 million of cash flow from operations, and to use approximately 325 million for capital expenditures.

Now I will update you on our assumptions for the balance of the fiscal year.

I would like to remind you that we spent heavily in the fourth quarter last year, creating a relatively easy comparison.

The investments we made in advertising and distribution expansion, have fueled the terrific sales growth we enjoyed this year, primarily in international.

We still expect fiscal 2008 local currency sales growth to fall within our full year guidance of about 7 to 9%.

Foreign currency translation is likely to add approximately 4 percentage points of growth.

Asian Pacific should continue to lead growth, followed by the Europe, Middle East, and Africa business.

We continue to expect the Americas region to grow, but be tempered by the tough retail environment in the U.S.

At this time, we estimate our effective tax rate will be approximately 36%.

As I said in my opening remarks, we are now comfortable with a full year EPS forecast of between $2.34 and $2.40.

That concludes my comments.

We would be happy to take your questions now.

The floor is now open for questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Bill Schmitz with Deutsche Bank.

Good morning.

Good morning.

Good morning, Bill.

Can we talk about inventory for a little bit?

Because I know you have this plan to take out one-third of the inventory, I am not sure what the timeframe is for that.

Could you just remind us of what the timeframe is, to take out the third of inventory, and also it continues to creep up.

Is that more international growth, or kind of what is driving that?

Bill, our inventory certainly was higher coming into the year and remains higher year-over-year, but we are making some progress in bringing it back towards the level that we ended last year.

But we had said if you recall, a couple of calls ago, that the bulk of our inventory improvement will result from the implementation of the SAP software, so that is over the next couple of years is when most of our locations start to come online with that.

We are working very diligently at bringing that number down.

We have an SKU reduction program that is under way at the moment.

Actually seeing some pretty good results from the report I just looked at this morning, so we are making some progress, Bill, but the real big numbers will start to happen when we get a little better handle on it from a systems perspective.

And I lot of it, don't forget, is based on the growth of our international markets in particular some of our fastest growing markets, where we intentionally carry more inventory, because the growth is so rapid that we want to make sure we don't miss a step, and an opportunity in some of those markets.

Great.

Thanks.

Can I ask one follow-up?

Sure.

Okay.

Great.

And then as it relates to some of the President level departures, are you going to fill those slots with people from the inside, or are you looking to outside the organization as well to fill some of those seats?

Bill, we are looking to find the very best talent for our Company inside or outside of our company.

We believe we have got a great deal of talent inside of our Company, where we will be able to fill these slots, but Fabrizio and I are taking the opportunity with the departures of a few of our more senior level executives, to look at our organizational structure, and to find a way to reorganize our structure for a more effective working structure, both for Fabrizio and myself and for the total Company.

Great.

Thank you very much.

Your next question comes from the line of Lauren Lieberman with Lehman Brothers.

Thanks.

Good morning.

Good morning.

I guess, first question would be on the rate of investment in the business.

I think you definitely had said coming into this quarter you expect to spend a lot to support the brands, but I feel like in the past we have talked about the Company's mind-set of saying, if the consumer is kind of not in the store, you are not going to push on a spring and spend a lot of money behind the brands at that time, and given the environment we are in in the U.S., new challenges in the U.K.

and you have mentioned some increasing softness in Europe, what your plans are for reinvestment, if the thought process around how much to invest in tough times has changed, and maybe you could just share on that perspective?

Lauren, you have touched on a number of key subjects.

I think the best way one of the things I want to talk about is growth and share growth, and one of the things that we find is extraordinarily important is that we continue to fight wherever we can, for meaningful investment for share growth, and/or share preservation.

The latter being more the case in markets where we have a deeper share penetration, such as North America or the U.K., but at the same time it is very clear in markets like Europe, travel retail, and Asia Pacific as a whole, where our share penetration is lower than our relative penetration in the market place we find these markets are growing, and that investment is giving us an meaningful return on investment, both in market share as well as total growth.

In addition, an interesting thing that we found, and we have seen this before in previous consumer slowdowns, is that money properly aimed at those consumers who are shopping, gain you a great deal of loyalty when they become more confident, as well as becomes a pretty good investment in share preservation, and/or growth.

One of the things we are currently seeing is that both the Lauder and Clinique brands stepped up some of their spending here in North America this Spring and their Gift with Purchase programs, and we actually saw some pretty meaningfully good results for the first time in five seasons.

And the consumer is telling us very clearly there is not as many of her shopping, but those who are shopping, they do have money to spend, and if we are properly focusing our efforts, we will get a return on investment from her.

Okay.

Great.

I guess then just a follow-up would be, in a market like the U.S., how does the relative mix change of where you spend?

Is it less print and more in store?

I think it is predominantly less print, more in store because we are going to take advantage of those who are there.

That is a key, key factor.

The consumer who is already in the store, already has a propensity to want to spend money, or be willing to spend money, as opposed to spending the money to hopefully drive the consumer in.

But I think, Lauren, you can't miss the fact that overall on a global basis, we have reallocated most of our spending towards our international markets, where we are seeing faster growth, and a better return on our investment.

So while we may be reallocating some of the monies we have in more established markets like North America, please don't lose sight of the fact that we have consciously, across most of our brands with a global platform, pushed our monies towards those markets where you will see greater growth in the markets, as well as market share gains, as well as profit growth.

Great.

Thank you.

Your next question comes from the line of John Faucher with JPMorgan.

Thank you very much.

I wanted to follow up on the North American profit numbers, where you talked a little bit about the IT spending, marketing, and then hair care.

If we look at it over the past couple of years, the operating profits have been more than cut in half, and I guess as we try to model out the fourth quarter, do any of these go away as we look at the run rate here, and should we be concerned about the fall-off in operating profit in the third quarter over the past couple of years, or is it just your normal quarter-to-quarter volatility?

I think it is more a factor of the quarter-by-quarter volatility, and going into our fourth quarter as I mentioned in my prepared remarks, we spent very heavily last quarter, and even though this year we are spending at a more normalized pace, it is much less than it was last year, so you will see a change in that certainly in the fourth quarter, but the U.S.

business, to William's point suffers somewhat when the sales slow down, and in some cases our strategic decision to target some spending to gain market share and better position our brands for when hopefully the economy recovers.

Okay.

Thank you.

Yes.

Your next question comes from the line of Filippe Goossens with Credit Suisse.

Yes.

Good morning if I can just maybe start with a housekeeping question for Rick, and then I have a real question for William.

Rick, when you exclude the positive impact of foreign currency, was operating profit still up year-over-year?

Operating profit was less.

I don't know the operating profit off the top of my head Filippe, but in the third quarter would I have to say relatively flat certainly at best in the third quarter, but year-over-year obviously, on a year-to-date basis and for the full year our profit is up.

And then for William.

William, obviously some disappointing results last week from Elizabeth Arden on the fragrance side, also surprisingly somewhat cautious comments on the category from Procter & Gamble.

Now, if we specifically look at the Este Lauder portfolio, obviously, it has not been your best category, but yet longer term, I think it provides one of the better opportunities.

Any updates you can give us based on your initial conversations with Fabrizio, what he believes that the Este Lauder Company can do, to really deliver on the potential that is out there within the fragrance category both in the U.S.

and particularly also in Europe?

Thank you.

Well, Filippe, I am glad you are asking that question.

We are taking a number of very aggressive initiatives, to find a way to make sure we bring our fragrance category performance at least up to par with our total corporate performance, if not up to par with the performance of our competitors.

One of the many steps we have taken, is we have engaged McKenzie in a benchmarking study against the industry as a whole, to look at both our own performance metrics, as well as the performance metrics of our competitors, and as well as we have engaged a number of our industrial trade partners, those with whom we do business who also do business with our competitors, to understand where we can operate more effectively and more efficiently, so we can bring a better, more competitive cost structure to our brand portfolio.

That being said, and this is something we have talked about before, compared to our key global competitors in the fragrance arena, we believe that one of the obstacles we have, is our portfolio of brands compared to their portfolio of brands.

We realize this category in particular is dominated by European-oriented brands and positioning, and the vast majority of our brands are North American or American-oriented brands.

We do have to look at that as a long-term strategic opportunity for us, and I appreciate you seeing that as an opportunity for improved performance.

In addition, I don't want to lose sight of the fact that our position as the world's leading marketer of prestige cosmetics, fragrance is a meaningful portion of it, by all means not necessarily the single largest on a global basis, and we believe in order to maintain our leadership in channel capacity, we must maintain a presence in this category, but we must maintain the presence in the category on a competitive basis, and return financial performance that is expected for something of the size of this category.

Great.

Thank you very much, William.

Can I finish one thing, Filippe?

So that there is no misunderstanding, the most passionate executive on our team now for improving this performance is Fabrizio, and it will put a great deal of pressure on him in the next few years to accomplish this, but I have no doubt in his abilities to move our organization in that direction.

We look forward to it, Fabrizio.

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

Hi, guys.

A couple of questions.

One is just trying to understand, I guess in the context of the fact that you have so many new things going on, going into new channels, going obviously into more geographies, as you look at your sales growth, either this quarter or certainly kind of going forward in particular, what do you think the growth rate has been, between kind of the sell-in or the initial take, so a new airport opens up, you have a new DFS placed in there, how do you think of the mix between the sell-in versus the steady state sales growth?

What are you talking about, the travel retail category?

Are you asking this in a global question?

Broadly.

I just used travel retail as one small example.

Well Ali, you are asking a wonderful existential question.

The reality of it is, we are evaluated first and foremost on our abilities to sell into the retail channel.

That is how we report our net sales.

The fact is over a long-term period of time however, sell-in is really just a function of consumer demand or retail sell-out.

So as we can improve our consumer demand, our consumer knowledge, and improve how we can position and market our brands, to create greater demand and therefore sell through, we will generate better sell-in results on a global basis.

If you look at it market by market, there are some quirks, mainly due to history and trade structures and others, that may distort these numbers somewhat.

For example, in North America 95-plus percent of our trade in North America is on an EDI system, whether it is the retailer system or our system, that gives us total visibility in sell-through.

And reality is is the sell-in business in North America, mirrors exactly the sell-through business.

If you have the healthy sell-through, you will have a healthy sell-in, and it is a fairly clean operation relative to it.

When you go to Europe on the other hand, and you get away from the U.K.

where we have predominantly a department store based business, and you realize that the vast majority of our distribution is a far more diffused, dispersed, and less organized, when I say organized, chain-related distribution, sell-in and sell-through are not as closely linked functionally, and the result is you will occasionally see some distortions that will come back to bite you, if you will, one way or the other, which are either overstocks or understocks, based on the accuracy or inaccuracy of information.

When you go to Asia, on the other hand, where the vast majority of our distribution is department store, they don't hold much inventory, and deliveries are done on a once, twice or three times a week basis, you again see a very close link between sell-in and sell-through.

That is very helpful.

Let me clarify maybe my question a tad.

How much of the current growth is opening a new store, or opening a new place, --?

Oh, you are talking organic growth versus, the vast majority of our growth is organic.

The expansion and distribution is really not meaningful for the largest brands that contribute the vast majority of our profit.

So steady state growth roughly is what we are looking at here?

That is the vast majority of it, yes.

And in certain categories, for example, travel retail, our travel retail partners are opening new doors in those markets that are growing, but those businesses are largely a reflection of the success of those brands in their home markets.

Okay.

Okay.

Can I ask a question on operating margins, then?

Over the past several quarters certainly, and almost next to the past couple years, skincare, Asia Pacific have really been driving our operating margin health in a certain sense.

How do you see that sustainably going forward?

The Asian market is certainly a skincare dominated market and it is a terrific opportunity for us, both from the health of the economy, the growth of the business, the growth of the prestige marketplace, so we see that as a really a long-term opportunity and a key focus, if you will, for the company going forward.

So nothing diminishing so far that you guys see?

No, not by any means.

We see lots of growth opportunities there for sure.

Okay.

And if I may, just one last real quick question around, like your balance sheet, I see close some inventory and AR issues, and we have briefly talked about, but one thing I do see also is cash building up here.

Can you tell us about your acquisition strategy going forward, if that is getting a little more heated, and in particular I am interested in understanding where on kind of your priority list of things you think about or look at, is dilution to the shareholder?

Well, certainly you asked a couple of questions there, so one on the use of cash obviously, as we have said many times, that investment in our business, make strategic acquisitions when I make business and financial sense for us, and return excess cash to shareholders.

That is our priority if you will.

We continue to buy shares, we bought shares in the quarter as we highlighted, and to the extent that there isn't an acquisition out there, or use of that cash that we will either through dividends or share repurchase return excess cash to shareholders.

The second question you asked was I'm sorry what was our strategic initiatives around acquisitions, and how big a part would they play going forward?

Well, in particular just, I mean, when you go through your kind of priority list of things you look at when you look at an acquisition, where does dilution to the shareholder fall?

Yes.

We look at the longer-term return of an acquisition, but in our case if our acquisitions, depending on the size, smaller ones are very rarely dilutive even in year one, larger ones we would accept a slight dilution initially, if we saw a longer term opportunity that made sense to us.

So it is sort of a balance if you will, between size and opportunity.

Thanks a lot, guys.

Your next question comes from the line of Chris Ferrara with Merrill Lynch.

I was wondering if I could ask Fabrizio, I guess you gave five initial key areas of focus, and I just want to ask a little more about the middle one, which was strengthened financial discipline, and I think you used the word synergy.

I just wanted to see if there is a little more color to be had there on the integration of the brands that have run relatively independently over the last number of years?

Chris, this is William.

As Fabrizio said in his statements, he is going to be more prepared to talk about a number of the different initiatives which he is looking at in our Company, in our fourth quarter call in the middle of August.

So until then, he is going to be still on his listening/learning tour and understanding tour.

If you will, one of the issues we always look at, is the synergies between and amongst our brands and how they operate, and it is always a delicate balancing act on a market by market basis, and how much of a synergy, how much synergies we can project into the brand, in both the front of the house and the back of the house.

The tendency in our Company is to create strong sibling rivalry in the front of the house in the sales and marketing areas, and to generate as many synergies as possible in the back of the house, so that there isn't any duplication of effort on behalf of the brands.

And we continue to focus that way.

And one of the other things we are doing is, we are looking at regional integration and stronger basis and you now know that Dan Brestle is the President of our United States business, this is the first time we have brought under the leadership of one executive our very diverse portfolio of brands, which hopefully can bring even more leverage at the point of retail, as well as greater coordination between and amongst the brands activities here in North America, and then additionally, we have the same structure in place, we are just moving into the same structure in Europe and Asia, and we expect over time we will have both a stronger voice with our trade partners, as well as greater, more cohesive coordination between and amongst countries and brands inside of each country, so that we have less leakage and duplicated effort.

Got it.

That is fair enough.

I guess an unrelated question, Rick, can you just give a quick update on where you are with respect to projected SMI costs, as well as some of the other initiatives like additional training for consultants, stuff like that?

Yes, certainly.

Chris, we are pretty much in-line with what we anticipated when we laid out our 3-year plan, I guess it was a year ago March, we had talked about the next few years' performance, and what we were expecting.

We are fairly close to that.

We continue to incrementally increase our spending on the SMI initiative, and that will go on for another year and a half or so, and then we will start to see the benefits outweigh some of the costs that are associated with that.

So that is on track.

It is pretty much business as we had planned, but we are formulating around some of the areas I think that were part of Fabrizio's comments, we are formulating some strategies on some possibly opportunities for more aggressive cost savings in certain areas.

Got it.

Thanks a lot, guys.

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

Hi.

My first quick question is just a follow-up to the discussion of McKenzie.

What is the timing on that?

Are they taking six months, nine months in order to give you feedback on the benchmarking stuff?

We have already had a number of presentations and very in-depth discussions with them.

They have given us some very enlightening material, and they have given us a great deal of general roadmap, and the benchmarks of where we can improve and ought to improve.

Now comes the much harder work, which is the internal identification, and if you will, digestion of this information, to see where and how we can begin to improve our performance benchmark's versus our competition.

A lot of it has to do with very historical practices of our Company, and a lot of it has to do with basically saying, okay, just because we have done it this way for 40 years, doesn't mean we have to continue to do it.

It is time to stop, press the restart button, and start again, with a new way of doing business that is more competitive.

Terrific.

That sounds exciting, but my bigger picture question is actually on the European operating margins, and we have seen sort of a steady trickling down, kind of going back four or five years on the margin in Europe, and I know or I think some of that has got to be all the investment spending in eastern Europe and in India, but I also wondered at some point, do we get to kind of a floor in European margins, and markets like Russia start to turn profitable, so how low do those margins go?

Is that an ongoing phenomenon, and is there some issue with mix there that I am not thinking of or is it really just the investment spending?

Thanks.

Wendy, you hit upon it I think in your comments which it is really a mix by affiliates more than anything else, and in particular the spending that we're doing in Russia and in eastern Europe to grow those markets, so there is, will it continue to trickle down, it is part of our plans.

There is a little bit of a flatlining, if you will, in the operating margins in Europe, but as those markets begin to mature, you will see that profitability start to improve.

Has there been any degradation or deterioration in the operating margin of the travel retail segment, because that is such a high margin business, and that is growing so rapidly, I would have thought that that would have offset some of the negative mix from the other stuff?

There has been a very small deterioration in the level of profitability but that was intentional, because of some of the spending we are doing to grow that business, and we have been driving some of that great growth by some of the, a little bit of spending in certain areas, like some of the stores in certain airport venues, and things like that.

So we have intentionally let that split just a little bit but it's really nothing that is systemic, if you will.

Got it.

Thank you.

Your next question comes from the line of Andrew Sawyer with Goldman Sachs.

Hello.

I was going to ask quickly on just a broad resource allocation question, and I look at year-to-date and your margin in the Americas, I suppose, including some of the IT spending is down call it 250 basis points, and you have gotten, call it 3% local sales growth, and if you look at Asia, spending levels aren't quite as high relative to the revenue growth, and I was kind of wondering how we should think about the type of spending you are putting against the Americas market without quite as high of sales return, versus what we see in Asia, and if you can kind of compare and contrast the two?

Thanks.

It is a very good question and I appreciate you segregating out the corporate infrastructure spend if you will, which resides predominantly here in North America, versus our market spend with a little more comparable market to market.

You have to realize, of course, that the United States is a very fully developed, very sophisticated market, and a very, very competitive market, that is not to diminish the level of competition we experience in Asia.

The fact of the matter is is that if you remember your high school physics, or maybe even college physics, the principal of an object in motion remains in motion, and an object at rest remains at rest.

The fact of the matter is that our market share growth that we are seeing, and the total market growth that we are seeing in Asia, dictates a certain level of investment, and a return on investment that is resulting of that, as well as the mix of business as we have talked about, which is predominantly in the skincare sector which has traditionally a higher gross margin structure, and hopefully a higher operating structure.

North America is a far more competitive business, it is a far more unfortunately stagnant total market business, with far greater share penetration, which results in the fact that you have a more stagnant business, which requires a somewhat greater investment on very large volume and infrastructure costs, to make sure we can move these businesses along.

We cannot continue to allow our business in North America to remain stagnant, and we must find ways to continue to maintain that momentum and growth, because it is our fortress market, it is our largest share, it is the market which you would call our home, and it is extraordinarily important for our global success, for our brands to continue to be successful in our home markets.

I am just kind of maybe just building a little on the Americas comments.

How would you characterize the margin pressure as being defensive within your department stores, or offensive versus driving your alternative brands and channels?

That is a very interesting question.

A lot of it is scale related, if I can put it that way.

Our investment in alternative channels, we find very attractive, but the fact of the matter is is that most of our alternative channel investments, while giving us a very good return on our investment, we find that there are cross synergies, cross channel synergies.

The fact of the matter is that the majority of our alternative channel investment strategies, while profitable on a discrete basis, are not necessarily as large in scale as our traditional channel distribution, so that the absolute values are different.

They will move the needle on the margin, but until they start getting real critical mass and scale, they are just that, they are good alternative businesses, but of a significantly smaller scale than our traditional channel.

Thank you.

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

My question is on travel retail.

Could you just repeat how much it was up, and then could you tell us how much it was up in local currencies, and then how much of travel retail is in western Europe versus the rest of the world, and the final piece of that, is how much is travel retail up in western Europe in local currencies?

Thank you.

Well, I don't know if we have all of those pieces, quite honestly, Alice, but in the third quarter on a comparable currency basis, travel retail is up 23%, for the nine months it's up 21%, so our business is quite strong year-over-year.

and on a reported basis third quarter was around 25%, and nine months about 22%.

And how much is western Europe versus the rest of the world?

Well, the two biggest opportunities our biggest travel retail market is certainly Europe, followed by Asia, smaller in the Americas, but I don't have that split by region, by travel retail.

Is Europe maybe 60% of it?

I don't think so, no.

It is probably lower than that, but --

Dennis can certainly give you that level of detail if you want after the call.

Thank you.

We have a follow-up question from the line of Lauren Lieberman with Lehman Brothers.

Great.

Thanks.

I have actually got two.

First thing was on hair care, just it has been growing at a 15 to 20% rate for like two years now, and the growth sort of disappeared.

I know that specifically in the press release, you guys mentioned the Bumble and bumble and hotel program but I can't imagine that is it.

Was one of the changes that you did not acquire any distributors in the quarter, and if so, is that, an important part of the growth algorithm growth forward?

If you look at the hair care growth on a year-to-date basis, it is about 12%.

The quarter was affected by a couple of things.

There was a launch last year by Aveda, which generated some strong growth in last year's quarter, that wasn't anniversaried this quarter.

We did have that hotel amenities program that you referenced, and that did have a big impact, and also the hairdressers are feeling the same economic pressures, if you will, that we see in the U.S.

department stores, so that is affecting their business somewhat.

So those are the things that affected the quarter specifically, but on a year-to-date basis, it is our fastest growing category, we expect it to remain that way for the year, and as I said through the nine months it is up on a comp basis about 12%, on a reported basis about 14%.

But my question specific to the distributor acquisitions.

I mean is that part of it, and do you expect it to reaccelerate next quarter or --?

When we acquire a distributor it adds to sales certainly, but I don't think it is a material impact on this particular quarter.

Okay.

Great.

And then the other thing was, I was surprised to hear that Clinique was down in the Americas, Lynn Green had the spotlight last quarter, it sounds like everything has really been quite good with the QVC, so I was surprised.

Can you maybe talk a little bit about that?

Yes, I think Dan can.

Yes, we talked about on the last call Lauren, and we made note that there was a shift in the Clinique Gift with Purchase business.

The Clinique business is healthy, it is down somewhat.

But on a general statement, all of our brands are trending much better than our retail partners.

We are absolutely somewhat amazed at the Gift with Purchase programs, and how the response was this quarter.

Clinique had a terrific April with the Macy's gift.

Este Lauder had a terrific March with the Este Lauder gift.

So Clinique is very healthy.

It is down a couple points, but it is very healthy going forward, and I think we are going to have a good Mother's Day.

Okay.

And then just was the Clinique gift in the first quarter last year, so is that part of what you were getting at?

It was the first quarter of last year, it moved to the second quarter.

That is what I meant.

Yes.

Perfect.

And this year we have moved out of the third quarter into the fourth quarter.

So there is no --

Oh, I am sorry.

I messed up fiscal and calendar.

We are on the same page.

It is okay.

Yes.

Our third is the fourth.

That is what I meant.

You will see the Clinique number come back in April.

And our final question comes from Connie Maneaty with BMO.

Good morning.

Good morning.

Still on the Americas, you mentioned the department store sales were down 4%, and that you were starting to see some weakness in some of your own stores.

How much was the U.S., how big was the U.S.

decline for all the parts of the U.S.

business?

Well, our total outside of department stores, all those other channels of distribution in the Americas region were up 10% for the quarter, and I think that the number was 70% of our sales comes from U.S.

department stores in the Americas region, so I think there is a mathematical equation in there somewhere that you could come to your answer.

I don't have it off the top of my head.

Okay.

And as a follow-up, what is your latest read on the Clinique pilot program?

How is that going in Dillard's and Macy's?

The early reads are terrific.

We continue to see the turnover of our beauty advisors, or in Clinique's case the consultant decrease.

We are getting tremendous enthusiasm, the average unit sale, and the transactions are going up.

I think it's camouflaged somewhat with the general state of the economy, but we are very happy with it, and we continue to roll it out in more in more markets.

How many doors is it in right now?

I don't have that, Connie.

I can't tell you.

Okay.

Thanks very much.

Okay.

That concludes today's question-and-answer session.

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I would like to thank you all for your participation, and wish you all a good day.