雅詩蘭黛 (EL) 2010 Q2 法說會逐字稿

Good day, everyone, and welcome to the Estee Lauder Companies fiscal 2010 second quarter conference call.

This 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.

Good morning, everyone.

We have on today's call Fabrizio Freda, President and Chief Executive Officer, and Rick Kunes, Executive Vice President and Chief Financial Officer.

Also on the call today is John Demsey, Group President, with responsibility for seven brands, including Estee Lauder and MAC, representing approximately half of our company's sales.

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.

You can also find a reconciliation between GAAP and non-GAAP figures in our press release, and in the Investor section of our website.

I'll turn the call over to Fabrizio now.

Thank you, Dennis.

Good morning.

I'm glad you have joined us for our fiscal 2010 second quarter earnings call.

In our remarks today, I will discuss our performance in the quarter and further progress we made advancing our long-term strategy.

John will talk about the Holiday season in the US., and the current state of the high-end beauty business worldwide.

Lastly, Rick will provide the financial details.

This morning we reported great results, with strong topline growth and continuing improvement in profitability, which was achieved against the backdrop of a challenging environment.

Sales for the period were $2.26 billion, up 11% versus the previous year period.

Diluted earnings per share increased 60% above the year-ago quarter to $1.28.

In addition, we continue to make progress advancing our strategic goals.

We believe our sales grew faster than market trends in many countries.

Our international sales expanded faster than our US.

business, moving us closer to our target of generating more than 60 percent of sales outside the US.

Our results show a significant improvement in operating margin.

Inventory days improved by 16 days from last year.

Our turnaround brands collectively showed a substantial improvement in operating results for the first half, before impairment charges, compared to a year ago; and our cost savings initiatives saved $83 million this quarter, which was faster and larger than we had planned, including great progress in cost of goods.

I'm pleased with these quarterly results, and our strong start executing our long-term strategy.

Compared to the second quarter last year, our topline growth was driven by our robust international business, thanks to numerous strategies which are bearing fruit.

We had solid growth in Asia Pacific, led by Greater China and Korea.

Sales in our European region expanded sharply, driven primarily by travel retail in the United Kingdom, Russia and Benelux.

Sales in emerging markets, which are an increasingly important contribution, climbed 14%.

These countries, which include China, Russia, Turkey and Brazil among others, accounted for 12% of total sales.

During the quarter we opened an affiliate in Vietnam to support our growing brand presence there; with a population of 86 million that is (Yang urban) and has increasing disposable income, we see this emerging market adding to our growth in Asia.

Our online sales rose more than 25%.

This division had its biggest sales day ever on Cyber Monday, nearly double the previous year.

We now have e-commerce sites in nine countries, and aggressive plans to expand further.

Our strong topline growth was achieved with lower levels of advertising, sampling and merchandising, as we started cutting ineffective spending in this difficult economy.

We plan to accelerate a more effective investment in this area in the second half of FY 2010.

I will go into more detail on this topic later.

During first six months of our four-year strategy journey, we made substantial progress on our long-term objectives.

In the recent quarter, we believe we gained share in many countries.

In US.

department stores, according to [MPD], our share expanded ten basis points.

Our retail sales outpaced overall prestige beauty in several important countries, including the UK, China, Spain, Russia and Germany.

As we have said, a key initiative is to build our leadership in skin care.

Our sales in this strategically important category climbed 12% in the quarter, excluding currency.

Internationally, our skin care sales rose even faster, led by Estee Lauder brand.

The first quarter launch of its successful new advance in eye repair has fueled demand throughout the brand.

Its sales are so strong that Estee Lauder has become the leading brand in its distribution in China, Hong Kong, and all of Asia combined, in the first half of FY 2010.

Here in the United States, Clinique's skin care share grew 30 basis points in the department store universe, which for a brand of its size is a clear victory.

Clinique is the largest brand in US.

prestige department stores, and the largest in skin care.

Even more impressive, 40 of the top 50 skin care SKUs in department stores are Estee Lauder Companies' products.

Our turnaround brands have made significant progress.

Each one of these brands has a strategy to refocus on its most profitable and promising opportunity, and the early signs of improvement are encouraging.

For the first six months of FY 2010, they are collective efforts generated significant improvements in operating results, excluding impairment charges, compared to the year-ago period.

It was one of the top drivers for our year-over-year improvement.

Prescriptives will shut its wholesale business on Monday.

While it was a difficult decision, the closing has been handled extremely well by Prescriptives loyal consumers, retailers and employees.

We have strategies in place to direct consumers to similar products of our sister brands, and we are adapting Prescriptives assets, formulas, trademarks and products to other brands, leveraging the power of our Company.

In fact, the cost to wind down the brand has been less than we projected due to the careful planning and execution of the transition.

As you can see, we made real strides growing our business in many fronts.

At the same time, we've also made substantial progress in our ongoing effort to reduce expenses in conjunction with our restructuring initiatives.

For the first half of the year, we realized a total saving of $160 million, significantly higher than we expected.

We are ahead of plan on cost of goods savings, and some of the restructuring advertising efforts, and we now expect full year savings to be between $275 million and $300 million.

The savings this year are coming predominantly from improved cost of goods, resizing and restructuring activities, and (inaudible) performance.

Part of our strategy is to bolster our capabilities in several areas, which is crucial to making us even more formidable competitors.

The Company is accelerating investment in various digital applications.

Many of our brands have expanded their own line and social media capabilities to market products, create stronger emotional bonds with consumers, and provide information and resources.

Our Bobbi Brown brand is helping lead these efforts.

It is has attracted a growing number of followers on Facebook and Twitter, and this month launched a campaign on its website titled Pretty Powerful, using videos of real women to convey the brand's point of view.

We will keep building our digital presence.

We see this as a critical way to educate and reach consumers, and bring our brands and their philosophies to people across the globe.

All of our brands are pushing comprehensive social networking and online campaigns.

As part of this effort, a fan started a blog and communicates regularly with fans on Facebook and Twitter.

Our MAC brand is one of the largest Facebook communities of any beauty brand, and launched e-commerce in Germany.

In Japan, we began e-commerce for Clinique, including access from mobile devices.

MAC and Bobbi Brown plan to follow in the third quarter.

We are also piloting mobile e-commerce capabilities with Aveda in the US., and expect to expand this technology to other brands.

Product innovation has also been a cornerstone of our success.

Our biggest new product achievement this fiscal year has been the Estee Lauder brand Advanced Night Repair, which was formulated to appeal to many skin types.

Now we are advancing and fine-tuning our effort at our regional innovation centers in Asia and Europe, to create locally [developed] products for multicultural consumers.

The next-generation of products to be developed from these international teams will be unveiled in the coming 12 months.

In the current third quarter, Clinique's Even Better Clinical Dark Spot Corrector will be a major global launch, supported by a comprehensive integrated multimedia marketing effort, including print, digital and national television advertising, in North America and Europe.

This product combats uneven skin tone, a large concern among many ethnicities around the world.

It marks the first time a (inaudible) treatment rivals a prescription strength product for this concern.

The key ingredients and the technology for Even Better Clinique was created in Asia, and we expect to develop many more cutting edge products in this region.

This quarter our La Mer brand will introduce its breakthrough anti-aging regenerating serum, which we believe will bring new attention to this coveted luxury line.

Another innovation effort is green chemistry, which minimizes the impact on people and the environment in all phases of the product lifecycle.

We are extremely excited about the possibilities that these new ventures will bring to our Company.

We continue to invest in our Strategic Modernization Initiative, which is expected to roll out to nine North American manufacturing facilities this Spring.

Subsequently, we will -- it will be deployed in the affiliates and regions.

We appointed Christopher Wood, currently the General Manager of Korea, to lead the SMI effort as it is integrated into the commercial side of our business.

His broad international and brand expertise will serve the Company well in this role.

In the first six months of this fiscal year, we spent about $80 million less on advertising, merchandising and sampling than we did last year.

However, even though we spent less, we invested it more efficiently.

Our advertising was better levered and focused on products with high return, such as Advanced Night Repair, rather than allocated across many smaller launches, particularly in fragrances.

However, we recognize the need to now increase our investment behind effective advertising, merchandising and sampling.

With consumer spending rising, and a general sense that the economy is starting to improve, we plan to accelerate our advertising for the next six months, spending between $150 million and $175 million more than last year.

In the second half of the fiscal year, we are planning to invest efficiency and strategically behind big business-building opportunities we have identified, which will include the highest investment in television and digital media we have ever made.

Much of this will be allocated to developing markets.

Throughout the remainder of the year, we expect Estee Lauder brand to build on its fantastic momentum in Asia, particularly in Greater China, and it will run three integrated print, digital and TV campaigns for skin care products.

MAC opened 47 international doors in the first half, and plans to add at least 45 more the next six months, building strong awareness in many markets.

We will continue to evolve our high touch service model in department stores and other retail settings.

We will also continue to strengthen our consumer insight capabilities, recognizing that the consumer's thinking changed during this recession, and the companies that are the first ones to stand and tap into her new mindset will be best positioned to win as global economies improve.

We are confident in our direction, and raising our full year guidance based on our performance to date.

However, economic and political risks still exist that could impact future results.

Threats to our business include continued high unemployment, a repeat economic downturn in the United States, and a more intensive wave of the H1N1 virus.

We made great strides this quarter, thanks to our employees worldwide and our exceptional leadership team.

They worked with dedication and creativity to advance our strategic goals, even while our Company is undergoing an important cultural evolution in a difficult economy.

Based on our success in the first six months of our strategic journey, I'm even more confident in our teams' ability to realize our goals.

Our organization has shown great flexibility, and I'm extremely grateful for the positive response.

Going forward, we believe that our constant focus on creativity and innovation throughout our operation, and the agility to adapt our high touch service to different channels, will reinforce and advance our leading position in global prestige beauty.

We are moving ahead with optimism, confidence and strength to accelerate our momentum.

Now I will turn the call over to John, who will talk about the Holiday season in the luxury market.

John?

Thank you, Fabrizio.

Let me start by providing you some insights into how the Company fared in the recent Holiday season, and then I will touch on the many ways we believe that we at the Estee Lauder Companies are well-positioned going forward.

In the United States, our Holiday sales exceeded our expectations.

In a difficult environment, consumers were attracted to value offerings across all of our brands.

We had improved sell-through compared with a year ago.

Our gift sets were highly successful, and most of them sold out.

The Estee Lauder brand's annual Blockbuster Set had a suggested retail price this year of $55, along with a fragrance purchase.

The price was higher than a year ago, but since its value was well communicated and readily apparent, we had 100% sell-through, and it drove traffic into the stores.

In addition to holiday gift sets, we emphasized value in numerous ways and at various suggested prices.

Brand selections ranged from small sizes at entry level prices, to large expensive products that offered great value.

A case in point.

Jo Malone offered Little Luxuries, a candle set for $30, and at the other end of the spectrum, a $390 luxury candle.

Both items were virtual sell outs.

As you well know, Holiday is the largest selling season for fragrance.

As a company, we had five of the top ten women's fragrances in the United States prestige department store universe, as classic scents in general were the stars of the season.

Estee Lauder Beautiful, on the market for over 25 years, was ranked number one with its [flankers], and gained share in a declining category.

From our perspective, the aspirational luxury customer started returning with some force at the end of the year.

High-end specialty department stores showed strong improvement in December, which helped boost our sales.

We also saw increased traffic in our own free-standing stores globally, a trend that has continued into January.

Consumers not only responded well to our special Holiday gift sets and offerings, but they also made many purchases for themselves.

Our basic business, led by skin care and foundation, was solid.

MAC's foundation sales climbed 15% in the quarter, and comprised 20% of its total business, and Estee Lauder and Clinique's foundation products did well.

We believe that our prestige products succeeded even in a challenging environment by offering priceless value, through personalized service and creating an emotional connection with consumers.

Our high touch service model sets us apart and is influential in driving sales day-in and day-out.

With the blurring of prices and products across mass and prestige, we are devoting more resources to emphasizing and reinforcing on what we do best, providing individualized service that fits the right product to each consumer, high-quality in-store environments, and effective sampling and promotions.

As consumers have increasingly focused on value during this part year, MAC and Clinique, our entry-level prestige brands, have benefited the most.

Both brands gained share this quarter, and MAC has had nine of the top 20 makeup launches in the United States department store universe this fiscal year.

During the last year, US.

mass channels performed better than prestige distribution for beauty products.

However, the tide started to change in November, when prestige channels outperformed mass, a trend that has continued in December.

Consumers in emerging markets, notably Greater China, Russia and the Middle East, are a growing force in the luxury arena.

With rising incomes, they are gravitating to our aspirational brands.

Our higher brands include La Mer, Bobby Brown, Estee Lauder's Re-Nutriv Collection, have seen exceptional growth in Asia.

In more mature markets, the UK was a bright spot, benefiting from an influx of travelers from the Continent who took advantage of the Pound against the strong Euro, as well as shoppers coming from Asia and the Middle East.

We have a diverse portfolio of prestige products, suggested price points, and a strong affiliate network around the world.

This enables us to be agile, and positions us extremely well to accelerate a particular brand, or even certain products, wherever there is demand.

We can optimize our assets to our advantage, and direct our advertising and promotions to areas that are fueling our momentum.

We have the brand assets and creative talents to adjust our resources and positioning whenever we see fit.

By strategically steering our investments to the most promising opportunities by brand, by country and by channel, we are confident that we can thrive.

Now I would like to call over Rick, who will discuss the quarter's financial results.

Thank you John, and good morning everyone.

A quick reminder; my discussions on the quarter and the outlook exclude restructuring and special charges, which I will comment on separately.

The quarter again came in better than expected.

In local currencies, sales rose 6% over the prior year period when we were in the depths of the financial crisis.

The impact of currency translation on sales growth turned positive this quarter, resulting in a reported sales increase of 11% to $2.26 billion.

Net earnings for the quarter rose 62% to $256.6 million, compared with $158.2 million in the prior year quarter, and diluted EPS was $1.28, compared to $0.80 in the prior year.

We beat the midpoint of our sales projections by roughly $100 million.

There were several factors driving the stronger than expected performance.

Better holiday business in the US.

and the UK accounted for about 75% of that over-performance.

Much of the favorability came in December.

Therefore, the majority of gross margin from the incremental sales dropped to the bottom line.

Furthermore, those sales came primarily from our high margin skin care business, creating a favorable mix that contributed to tremendous gross margin improvement.

Operating expenses came in toward the lower end of our forecast, as we exceeded our expectations for cost savings and some spending was deferred into the second half.

Our improved inventory management, reduced obsolescence, and the fantastic progress on our cost savings initiatives delivered about $33 million more in savings than we expected.

Lastly, a lower than expected tax rate contributed to the variance.

As it turned out, several potential risks that we mentioned in the last call did not impact our business.

One of the largest threats was the H1N1 virus, which was prevalent but not severe enough to dampen people's travel plans or purchasing.

However, since we didn't know how the risk would unfold, we took a conservative stance on spending.

That said, we had a terrific quarter compared to last year.

In line with our strategy, we continued to experience the strongest growth in skin care.

Sales rose over 12% in local currency, with all three regions contributing to growth in this category, particularly Asia and Europe.

In makeup, local currency sales rose 8% on strong international expansion of our Makeup Artist brands.

In line with our strategy to improve fragrance profitability, we reduced the highly promotional portion of our US.

business.

As a result, our fragrance sales fell 6% excluding currency, but the category was far more profitable.

Recent launchings in the Michael Kors and DKNY brands were not large enough to offset the prior year introductions.

In hair care sales fell 1%, due primarily to soft salon sales.

Geographically, our international business continued to lead growth.

In Europe, the Middle East and Africa, sales gained 11% in local currency.

Global travel retail sales experienced a sharp rebound of over 25%, contributing substantially to the increase.

Travel retail is better than we expected, because international passenger traffic picked up sequentially each month.

With expanded -- we expanded several brands into new doors, and the H1N1 virus risk did not fully materialize.

Our UK sales rose about 13%, driven by strong performance from our Makeup Artist brands, and solid business at Estee Lauder and Clinique.

Developing markets in the region contributed positively this quarter.

For example, Russia and Turkey grew strong double digits.

The major Western European countries were mixed, with Italy and France largely unchanged, while Germany delivered low single-digit growth.

Pockets of trade destocking continued.

Our strategically important Asia Pacific region saw a 9% rise in local currency sales.

Korea, our second largest country in the region, grew nearly 18%, and Hong Kong rose 24%.

The momentum continues in China, which rose 26%, fueled by the tremendous success of the Estee Lauder brand, light door growth and expanded distribution.

Japan declined mid-single digits, as is it continues to suffer from the tough economic environment.

The flat local currency sales in the Americas reflect the continued caution of the consumer.

Sales in department stores, salons and our own retail stores declined low to mid-single digits.

These declines were partially offset by sales growth from Latin America, products sold online, and direct response TV.

Some of you have asked about our presence in Venezuela.

Our business there represents less than 1% of our global sales, and we do not have significant assets at risk in the country.

Our gross margin improved by 150 basis points this quarter to 76.6%.

The biggest contributors to the increase were lower obsolescence charges of 100 basis points, and favorable changes in our mix of business of 60 basis points.

Both of these factors were better than anticipated, and directly tied to our strategy and savings initiatives.

The lower obsolescence reflects fewer SKUs and better inventory management.

We also benefited from favorable manufacturing variances of 30 basis points, partially offset by an increase in the timing and level of promotion of 20 basis points, and currency of ten basis points.

Operating expenses as a percentage of sales for the quarter improved 290 basis points to 58.9%, compared to 61.8% last year.

Our cost savings initiatives and conservative spending in the quarter contributed about 520 basis points.

Lower losses from currency transactions added 20 basis points.

These efforts were partially offset by higher IT and infrastructure costs of 50 basis points, and asset impairment charges related to our Darphin and Ojon brands of about 200 basis points.

Over the next six months, we expect to step up targeted investments behind effective advertising, merchandising and sampling, our online business, consumer insights, regional R&D, and new high touch service concepts.

Operating income rose 48% to $399.9 million compared to $270.6 million last year, and operating margin rose 440 basis points.

Our cost savings initiatives are ahead of plan, with total savings of $83 million or 370 basis points in the quarter, bringing our first half savings to $160 million.

We are working to improve our tracking and measurement capabilities, to fully incorporate the benefit of the strategic shift in our mix.

Regarding our net interest expense, we reported $19.9 million this quarter versus $19.6 million in last year's second quarter.

The effective tax rate for the quarter was 31%, lower than expected due to the geographic mix of our earnings.

In the quarter we reported net restructuring and other special charges of $300,000.

Net cash flow from operating activities for the six months ended December 31, 2009, was $617 million, compared to $217 million last year.

The biggest drivers for the gain were higher net earnings, inventory improvements, and the timing and level of tax payments.

During the quarter we repurchased approximately 1.4 million shares of our stock under our share repurchase program.

Our day sales outstanding were 44 days this quarter, two days lower than last year.

We continue to monitor the financial health of some key customers.

Inventory days improved to 150 days, compared with 166 days last year.

At the end of December, our SKU count was down 10% from a year earlier.

We will be building inventory in our third quarter in advance of the rollout of SAP to North American manufacturing facilities this Spring.

The pick-up in demand has made it more challenging to build these safety stocks, so we are focusing on protecting our top- selling SKUs across all brands.

We spent $104 million for capital expenditures, which included spending for our company-wide savings initiatives.

For fiscal 2010, we expect to generate between $800 million and $850 million of cash flow from operations, and to use about $315 million to $330 million for capital expenditures.

Looking ahead, our full year forecast reflects the strong results to date, a slowly improving global economy, and the lessening of some risks such as H1N1.

We remain cautious about the consumer recovery here in the US., and the likelihood of more aggressive competition for the remainder of the year.

For the year, we now expect fiscal 2010 local currency sales growth of about 3% to 5%, led by our international businesses.

Currency is expected to add between 2 and 3 percentage points to our reported sales.

Our full year business model will look a bit different than the first six months.

We expect to reap the benefits of our gross margin improvement and increased spending efficiency, to fund activities that will build market share and enhance our long-term brand equity.

Our brands and affiliates have been authorized to invest in the second half against strategic priorities, and to build on our sales momentum and share gains.

We expect to increase investments in advertising in key markets such as China; e-commerce and digital marketing programs; new high touch service models; consumer insight capabilities; regional R&D; and other marketing innovation efforts.

We continue to pursue the cost savings initiatives we previously laid out for you, and we are increasing our full savings estimate for the year to between $275 million and $300 million.

For the full year, we now expect to record charges of between $60 million and $90 million.

Given our revised sales forecast, strategic investments and cost savings initiatives, we now expect a 350 to 380 basis point improvement in operating margin this year.

At this time, we estimate our effective tax rate will range between 30% and 32% for the year.

We are raising our full year EPS forecast to between $2.55 and $2.73.

Sales for our fiscal third quarter are expected to grow between 4% and 7% in local currency.

Currency translation is expected to add about five percentage points to sales growth.

We expect EPS for the three months ending March 31st, 2010, to be between $0.20 and $0.30.

We are very pleased with our business performance for the first half of the year.

Our four-year strategy is off to a good start, thanks to the great motivation and agility of our teams.

We will continue to pursue cost savings to enable to us deliver sustainable and profitable growth for the long-term.

That concludes my comments, and we would be happy to take your questions now.

The floor is now open for questions.

(Operator Instructions)

Our first question today comes from Mark Astrachan with Stifel Nicolaus.

Good morning, everybody.

I wanted to do just delve into the cost savings a bit more deeply, just talking about moving forward some of those expectations, and just simply greater expectations or greater savings in the December quarter and then for the year, what does that potentially mean as you look out on your longer-term cost savings plan through 2013, in terms of whether you've covered additional savings or whether you have additional thoughts on how you are looking at that going forward?

Sure, Mark.

The biggest driver of our cost savings exceeding expectations has been in the cost of goods area, and there are two elements of that.

One is our inventory management and the SKU reduction programs, which are contributing tremendously to the improvement year-over-year, as well as managing our mix.

And that mix is three components.

It's geographic mix, category mix and also within each brand the SKU mix.

So the biggest driver is coming from the mix area, but we also have savings coming from our resizing and restructuring program, and our [indirect] procurement.

So all of those are doing quite well.

At this point, you know, we said over the three -- or four-year program, rather, that we'd save between $450 million and $500 million, and we're not changing that number at this point in time.

We are happy that we are going a little bit faster in the beginning, but we are comfortable with that target over the four-year program.

Thank you.

Our next question comes from the line of Joe Altobello with Oppenheimer & Co.

Thanks, good morning.

Just wanted to follow-up on that question for a second.

So it sounds like you guys are just getting more benefits early on; it's not like you're pulling any savings from fiscal 2011 into fiscal 2010?

That's a true statement.

Okay, perfect.

And then just on the spending, obviously you guys spent a little bit less than anticipated in the first half, and are talking about a little bit more in the second half, or actually a lot more in the second half.

How did your spending compare to your competitors over the past six months, and is that increase in spending in the second half more of a proactive response -- a proactive act, or a responsive act to how you anticipate your competitors to spend in the next six months?

We are spending competitively.

In the last six months also we continue to spend compared -- the market obviously has been spending less.

So, yes, we assume the competition will increase spending as well in the next six months, 12 months, so it is a fair statement to say that our excess spending is going to input into a more competitive environment.

However, it is not driven by that.

Our extra spending the next six months is driven, first of all, by the great learning of the current six months.

We focused this period in improving the targeting of our media spending, first of all; improving the quality of our communication; improving the mix of this communication, meaning focusing the communication and investment in advertising, merchandising and sampling, on bigger initiatives with higher returns and in the most strategic countries and affiliates of the globe; and we have learned that this improvement, all these improvements are working very well for us, because in front of the reduced spending we got a substantial acceleration of our topline in the last six months.

So for the next six months we want to lever this new learning, this new way to become more effective and efficient in spending, which as I explained some time ago is also now based on a more accurate rate of return on investment and analysis on the spending, and to go back on the attack in -- on our biggest initiative in our most strategic countries, and to build on current momentum to accelerate growth.

Our next question comes from Lauren Lieberman with Barclays Capital.

Thanks, good morning.

I just wanted to quickly follow-up actually on that particular line of questioning.

I don't doubt at all that you've got learnings, you know, in terms of ROI and what advertising works better than other advertising.

But one of my questions would be, how do you know or do you have a sense for how much of the sales acceleration in the first six months of your fiscal year really just had to do with stabilization at the high-end consumer, lapping the really easy comps, versus spending in the right places?

Again, I don't doubt that there would be things you've learned, but do we really know at this point what the mix of how sales came through is?

Yes, I think we know that we are spending in the right places.

We know, for example, that we have been spending substantially more on the very successful launch of Estee Lauder Advanced Night Repair, and we know that we have been spending for the first time on a more holistic mix of media, including heavy weight on television advertising in developing markets specifically, which has proven in those markets to be very, very effective for our big launches.

So we know this already.

And we know -- there is evidence of the results of this new strategy in our last six months.

At the same time, it is also true that that is not the only factor playing.

As you said, it's clear that our topline growth comes from a continuous and successful overall share growth in markets where the consumer is coming back, specifically Asia.

Asia the last months has been a stronger economy than what we originally expected, and in that economy we had a particularly strong program of growth, which obviously has delivered results.

The same we can say about Russia by -- about other developing markets, and this also is playing a role.

Finally, our sales growth has also been accelerated by a Holiday season that went better than we expected, and finally by some amazing results in travel retail, which delivered increased sales against better than expected traffic, but also importantly against [any] success in ability to convert the consumer from traffic to shoppers, because we are also in travel retail growing market share accordingly.

So how do you actually know that the affiliates -- the affiliates are getting a better return on the less money being spent today, right?

So the affiliates are looking and saying, look, we are delivering, we are delivering on the topline, we are more than delivering.

How do you get comfortable that the affiliates are actually going to spend what is currently in the budget in the second half of the fiscal year?

We are getting comfortable because we have discussed with the affiliates one-to-one how to support these plans, and because we are agreed on the right methodologies, on following up that we spend quarter by quarter what we have recently agreed to spend extra on the activities.

So we get comfortable by a thorough follow-up on this.

Saying this, we still have internal processes where in case we see opportunities, or in case we see issues, we may change our spending in the quarter in any affiliate.

It could be a competitive reason, it could be the opportunity to see that the money is better spent later or earlier on a different opportunity.

So we have internal processing that offer agility of spending decision, and we believe this is a competitive advantage and not an issue.

Our next question is Linda Bolton-Weiser with Caris.

Hi, just I want to make sure I have the big picture here on the guidance page.

You raised the guidance for the fiscal year by more than the upside surprise in the second quarter.

The spending is basically -- the held-back spending will come back in the second half; so I guess the increase is because of the better sales growth and the leverage inherent in the model?

Am I getting that correct?

You are.

And you will recall that in the second half of last year, remember, we had a $250 million belt-tightening exercise last year ,and most of that was benefit that came from reducing expenses in the second half of the year.

So when you go into this second half upcoming for us, what we are seeing is that we have to replace that with more permanent savings, and we are doing that; we are taking up our savings estimate, as we just mentioned.

And so with that extra savings, we are covering the belt tightening that had to come back because it was temporary in nature, and we are also investing a lot of that money, and at the same time hopefully improving our profitability somewhat to come up with that full year forecast.

So you are correct.

Okay, great.

Then I didn't catch that you gave a specific number for travel retail.

Can you give a little more specific, was it up 25% or so?

It was up 25% in the quarter, and it's up about 15%, 16% in the first half of the year.

Our next question comes from Bill Schmitz with Deutsche Bank.

Hey, good morning.

Can we just talk a little bit more about the belt tightening?

I know it was $250 million.

When does that anniversary?

I know you said 70% is going to come back in.

Is that number still 70%, and kind of what's the timing of that reinvestment?

And I have a little follow-up after that.

First of all, Bill, of the $250 million, more than half of it certainly came in the second half of last fiscal year.

So we will anniversary that, in a sense, by the time we end in this fiscal year.

What we are doing, though, is as that savings -- rather spending comes back into our P&L, we are more than offsetting it with our savings programs, and targeted savings around cost of goods mix, around resizing and restructuring, around indirect procurement, and around some of the other initiatives.

So those overall savings programs, part of our strategic plan, are more than offsetting that belt-tightening returning, and so that will all be through our P&L, if you will, by the end of this fiscal year.

Okay, and is that right, that you are still going to reinvest about 70% of the savings back in?

Is that still a good number?

It is a reasonable number, Bill, between 60% and 70% of that we said would come back, and that still holds true.

Our next question comes from Dana Telsey with Telsey Advisory.

Good morning, everyone.

Can you talk a little bit about wholesale ordering patterns, how are you seeing them go forward and how is it different than six months ago or so?

And also, as you think about pricing trends, do you see that changing going forward?

And is there any adjustment to your forecast for travel retail going forward?

Thank you.

So, is your question about stocks in the trade?

Yes, exactly.

Okay.

So we see, the retail inventories, by the way, have been difficult to forecast; it, it's been one of the elements that have been difficult to forecast the last six months.

We see today a pretty mixed behavior around the world.

In the US, we have seen actually a moderate restocking in front of the Holiday season.

In Europe, on the contrary, we see continuous destocking, particularly in the pharmacy channel, across Continental Europe in certain retailers.

And in travel retail, we have seen actually a little bit of restocking in front of the new growth trend, and in Asia not a big variation.

So very, very different around the globe.

In total, we have seen basically a stabilization of the destocking pattern, with some continuous destocking, honestly, in Western Europe, where we don't believe the trend is finished.

So that is the first answer.

Sorry, what was the second part of your question?

Pricing, do you see pricing changing at all?

No, we don't expect in this moment that there is a lot more pricing possibilities than was estimated a few months ago.

I think the consumer continues to be very value-oriented, and is not -- there is basically the possibility of normal pricing trends that we assume in the next year, year and-a-half.

Just lastly, travel retail?

And that for the year, we see kind of a mid-teens for the full year for travel retail.

So we are seeing obviously not quite the pace that we saw in the second quarter, but we are seeing continued strong growth with that business for the rest of the year.

Yes, however, if I can I would like to point out that travel retail is a very volatile segment, and at this moment it is doing very, very strong.

But it is a segment we have learned that is very, very influenced by specific events like a [batch] of the flu in Asia can change dramatically the trend in travel retail, or a terrorist attack could change dramatically the level of sales in travel retail.

So we estimate travel retail pretty carefully, also because of its higher than normal volatility risk.

Our next question comes from Chris Ferrara with Banc of America.

Hey, guys, I just wanted to do talk about i guess a pattern that we've seen emerging, right, I mean you guys report a quarter and spending is lower, and you say you are going to spend more next quarter and it gets deferred.

I understand how the external environment can contribute to that, but I guess as we see it happening this quarter and you are saying you are going to spend a lot more next quarter and the next half, I guess can you a talk about the budgeting process for the spending?

Is it top down, is it bottoms up, and is it influenced at all at the segment level by the comp changes you guys made, the fact that operating margin is a bigger piece of things now?

Yes, but I would like first to take you straight to the numbers.

It is true that it has been part of the spending that has not been spent.

When we speak about $15 million, $20 million [it's over] a very important amount of better results than forecasted.

So the majority of the better results are really coming out of topline sales, and a sustainable impressive better cost of goods because of mix and restructuring, resizing and (inaudible) performance.

It means the large majority of our [over-delivery], which doesn't justify obvious which will -- we need to get a better handle on this forecasting, but the majority is about very healthy over-delivery; sales growth, restructuring savings, indirect procurement, mix of cost of goods, reduction of the [structure], all that honestly I predicted was our focus.

And specifically, I want to clarify that the fact that in many case this happens, that a good plan of SKU reduction, a good reduction on inventories, creates more benefits than were originally estimated because, in our case for example, it's having a very positive impact on reduction of this structure.

And then we are seeing there is some less spending in advertising, merchandising and sampling, which is attributable to the budgeting process which your question focused on.

And the budgeting process is a process where we have a clear agreement on what we spend against, which we plan every quarter, but as I was explaining, there is some flexibility, where we review every month in our business, where we review every month brand by brand, affiliate by affiliate, where affiliates and brands can make proposals to change their plans based on the competitive environment and the market forces.

This is point of (inaudible) of agility.

Normally, we don't see big variations, because what -- if you spend less or [more], it is offset by other items in the total.

In the last quarter we saw this variation that I mentioned which, by the way, is a small percentage of the total story of over-delivery.

Saying this, I want to go back on the fact that we understand your frustration with the trend you described, and we share it, and we are focusing to do better in the future.

But I also want to clarify that this last two quarters was very difficult to predict the environment.

Let me say that I see -- we had many integrated factors that were playing together at the same time.

First, externally, it was for us a bit difficult to predict how the economies would develop in this global world; in fact, Asia went better than what we expected.

It was difficult to predict the Holiday season at a certain moment of time, and the Holiday season went better than what everyone expected, for sure in the UK, and partially better also in the United States.

It was difficult to predict this impact on the flu.

As I explained, the flu could have been devastating on our travel retail business, while on the contrary the travel retail business was a highlight of the last period.

As you know it's a very profitable business, and when there's a variation there it's a big impact on our business.

The flu could have had impact also on the Holiday season, which it didn't; on the contrary, the Holiday season was solid, as I described.

It was difficult to predict the trade destocking, the retail destocking.

There were big trends of destocking that then somehow didn't continue, for sure didn't continue in travel retail and in the US

At the same time we had many internal changes with the first six months of the new strategy.

What does that mean?

There was a big cultural change, and many people had to understand how to manage costs in a different way, and it was difficult to predict how good the organization would have been able to buy into that.

There was a new organization design as of July 1st, with the creation of the region, a totally different dynamic organization with the retailers and internal.

It was difficult to predict that there would have been no issue at all in getting this going in one [various] moment.

As I already explained, there was the impact of SKU reduction and inventory on the [structure] and mix that was much more positive.

And finally, the effectiveness on the new way to invest AP and a bigger potential to raise our return on investment was a premiere for us; it was difficult to understand how fast this would have produced, also, positive topline results.

So I think we have learned.

We have learned a lot in this first six months, and I think we will apply this learning to our future ability to understand the strengths and the possibility of our strategy.

Our next question comes from Wendy Nicholson with Citi Investments.

Hi.

My first question, the ad spending in the first half, can you quantify exactly how much that was down year-over-year?

So was the $150 million to $170 million in the second half going to make it flat for the year, or dimensionally what are we talking about?

No, it was down in the first half about $75 million or $80 million versus the year before, and in the second half it should be about $150 million to $175 million up, was the --

Okay.

Perfect.

The second thing, do you have a specific number for travel retail in terms of the sell-through?

I know you said sell-in was up 25, but sell-through for your business?

I do not have, Wendy, the sell-through numbers, but we are gaining share in our travel retail business, so it is certainly ahead of the market trend, but I don't have the specifics.

Our next question is from Alice Longley from Buckingham Research.

Are you going to give us an update on your operating margin goals?

I know it has been said 12% to 13% by 2013, but it looks like you might get there earlier?

No, in the sense that we don't plan at this point in time to change our long-term targets.

I think it's just the first six months over a four-year strategy, we clearly have demonstrated that we are getting in the right direction faster than what we originally thought, but there is still a lot of work to be done in front of us.

We are ahead on the saving plans, the top line has be to be obviously confirmed in its sustainability.

In terms of capability buildings, we are in line with goals, I would define it as not ahead, and particularly I need to become much more confident on the sustainability of this performance before adding any input on the top line growth, and the -- sorry, the long-term growth and the long-term margin goals that we have established.

But when might you revisit those goals, and talk about an update with us?

I think we would revisit those goals only at least after one full year of having been working with the new strategy, and having understood the various elements and how the various cost savings become sustainable or not.

Your next question comes from Ali Dibadj with Bernstein.

Hey guys, how are you?

I guess everyone is asking a similar type of question, but it feels like the response -- or at least I get a little bit of a dichotomy in the responses.

On the one hand, we're surprised, we're pleased, it looks like there's a lot of fat here, it looks like we're getting better on gross margins than we thought we did, that's all great and we have good control over the affiliates.

But on the flip side we also, I get this feeling of, we need to figure out what the affiliates are actually doing, we're having meetings so that they tell us exactly what they're going to do.

We need to figure out more about the cost savings on comps.

And it feels -- it's kind of like we're doing better so the surprise, which is positive, but then there's a "Oh my gosh, what's going on in the organization?

We need to figure out a little bit more in detail." And maybe it's just my interpretation, but I kind of feel both sides of that, and I just want to hear your perspective on that interpretation?

Personally, I don't think this is a right interpretation, and I think that there is nothing which is in our control; actually it's a bit the opposite.

This organization is becoming an efficient, effective and, importantly, integrated organization at the speed of light.

If you want my honest point of view, I had the -- I was worried about how fast this organization could have been start to work in the way we're working.

As you know, as we started we had a set of a new corporate strategies, we have the strategies by brand, by function, by affiliate, and we spent a lot of time in the beginning integrating all these strategies, and make clear that the organization become more interdependent in all these aspects.

This was a big cultural change for this organization, and there was a certain level of risk that it would be low or would not work in certain areas.

I'd like to say the opposite is happening; this organization is integrating, is becoming very interdependent.

The clarity on the strategies is everywhere.

The processes I was quoting, the [first] quarter like having affiliates meeting and all this, is just the result of this integration, and the way in which we are learning how to build scale.

Actually, I believe you should see, in the fact that we are over-achieving the results, a sign that the ability to build scale and become an interdependent organization is much better than the original estimate.

And all this work with the affiliates that I was referring to is actually a positive, and not something -- at least not something I'm worried of in the future.

One more point on that, Ali, is I think one of the things that we need to improve on for sure is our visibility into how quickly those results are manifesting themselves, and being able to predict the future better for sure.

And one of the things that is part of our SAP implementation is also a budgeting and financial modeling and forecasting system that goes along with that, which will enhance our ability to have visibility into the pace and speed at which some of these changes are happening, and the financial implications of them.

So I think that is certainly a soft spot for us, and one that we are working on.

It's going to take a little time to get there, but we are trying to improve that as well.

Our next question comes from Leigh Ferst with Dudack Research.

Your digital media strategy sounds quite robust and very effective.

Can you talk about it, the strategy, and how it relates to your more traditional business?

Are there any conflicts there or is it all upside?

No, personally, I don't believe there are any conflicts.

Let me clarify what is our digital strategy.

First of all, we have e-commerce, and a big part of our e-commerce is with our retailers with which we have brick and mortar activities.

So there's no conflict actually, it is the e-commerce of our retailers which is growing very fast with us.

Part of our e-commerce is obviously on our brand.

The rest is also doing very well.

But this e-commerce also is a big equity builder for the brand, that then creates advantages for all the channels in continuous growth.

But another important area of breakthrough is not necessarily in the e-commerce business but is in the digital world.

We are really working more and more in the digital world just as an area to build our brands, to create social network, to exploit the new digital realities in every country.

So basically it's becoming a very sophisticated and important marketing investment area.

And on this one we are making some important learnings and breakthroughs, and particularly we are going to invest heavily in this area in the next two, three years.

This is one of the key strategic choices for breakthrough in the entire organization that we have taken, and there is still a lot of potential obviously in the United States, but importantly in many international markets, where the trend is extremely strong.

Can you stay how much you're investing and how we would track that?

We said -- when we explained how long-term plans, we explained that we would have savings between $450 million and $500 million, and we said that we would invest it back into the business in [digital] capabilities, $50 million.

This still holds true.

And the areas where we are investing are -- we have invested in this big new capability in the area of R&D international, specifically building our ability to do products also in Asia and Europe.

As I said, we are investing in more consumer insight capability, and importantly a big side of it will be investment in digital capabilities with that around the globe.

Our next question comes from Caroline Levy with CLSA.

Good morning.

Just a question on the competitive environment in your biggest markets, if you could talk a little bit about where you might be seeing increased pressure?

It seems like you are really gaining share.

And then the growth in natural and organic, and how robust is that?

This is John Demsey, and I will speak about the US market.

Actually, yes, the market is competitive.

However, the Estee Lauder Companies in totality have gained share in this difficult time period.

In fact, the Estee Lauder brand is showing the first signs of stabilizing in the United States in many years, and the brand on a global basis is the key pillar of our corporation's enhanced profitability in this time period.

We had three out of the top ten fragrances in the United States.

The brand is the leading anti-age category brand, and -- with our largest skin care launch in Advanced Night Repair, and we are now the number one leading prestige skin care brand in Asia.

So our core brands are performing better than the overall marketplace in terms of the cosmetic business, outperforming the channels that we sell in, and at the same time gaining share.

The fragrance business for the Holiday season was difficult in its totality; and our fragrance business, though difficult, outperformed what was taking place in the marketplace, with strong ranks and strong performance as well.

Our skin care business in particular, as we discussed before, is strong, and is a strategic objective of the Company, highlighting our product innovation and our high touch service in stores, as well as our foundation business, and the color business has stabilized a bit.

We also mentioned earlier in the presentation that up until November, the mass market was far exceeding the growth of the prestige channel.

That switched in the month of November/December, and this is the first time that we've actually seen the prestige channel beginning to outpace mass.

So we view this as a return of the aspirational consumer, and a more competitive set of aspirational brands competing effectively in the marketplace.

And I will add just a little perspective on the question of natural brands.

We are having some very, very good encouraging results on our Origins brand, which is doing better and is growing nicely.

And importantly, we are launching Origins in China in a few months, so within the next quarter, and this will be a great important event to bring a strong brand and strong national positioning in this growing market.

And importantly also our Aveda brand, which is in this area, is doing very well, and we continue to have very strong plans to grow and build the salon business in North America and internationally.

Thank you.

Our next question comes from Maria Vizuete with Piper Jaffray.

Thanks, good morning, it's Maria on behalf of Neely Tamminga.

I'm wondering if you could talk a little bit about distribution in Asia, and more specifically in China, what brands are there currently, and where is there opportunity in term of the brands and point of distribution?

And then also if you could remind me of the size of the business in China, that would be great.

Thanks so much.

The brands we have in China -- we have a big part of our portfolio in China.

In China we have our biggest brands.

So the Lauder brand, Clinique brand, MAC brand; we have our high-end brand, Bobbi Brown, La Mer, we have Jo Malone, and we have nine brands in total, and we are launching one more brand, I just explained, in March.

In terms of the size of our business, today China, mainland China, is 3% of our business, and will grow, and we believe that Greater China which is the way also we look at it, meaning including Hong Kong and Taiwan, has the potential to get really to 8% or more of our business over the next five years.

So it's really a big, important area of growth and development where we are focusing on.

In terms of presence, we are today in the Tier 1 and 2 cities, but there are so many other cities that we can grow on.

So there's a possibility of expanding in China our portfolio brands in the future still, there is the possibility of expanding the [current] brands in the existing distribution, there is a huge possibility of further enlarging distribution in different cities and to a larger part of the population.

And finally, there is -- at least we assume -- very strong growth of the e-commerce China also in China, in which we are going to participate from the beginning of this strong expansion.

So a lot of possibilities.

We also want to clarify that the success in China has a huge impact on Greater China and on travel retail in Asia, so the growth in China creates positive travel effects on Hong Kong.

We believe it will create more positive effects in the future also on Taiwan, and it is definitely a big important impact on our travel retail business.

Thank you.

Our final question comes from Alec Patterson with RCM.

Yes, hey, Rick, I just wanted to make sure I heard you right about -- as you were describing the increased savings flowing through, it sounded like you mentioned mix as a factor on gross margin.

I was just trying to understand that, A, did I hear that correctly and, B, what did you mean by mix?

Sure.

You absolutely heard it correctly.

It is one of the big drivers of our cost of goods improvement.

Year-over-year, it was about 60 basis points of the improvement in our margin in the second quarter.

What I mean by mix is more skin care, less fragrance.

More sales in travel retail in one of our highest profitability channels, not so much from a gross margin perspective but from an operating margin perspective.

Mix meaning using less of the set business during the Christmas season than we normally did, so driving more of our basic business in selected categories of our business like the fragrance category, which affected and improved our margin capability.

So it's all of those things, you know, that are driving our gross margin, and that's what I mean by mix, in addition to the things Fabrizio was mentioning about our strong inventory management, SKU reductions, and the benefits coming from that.

Okay.

So that's what I wanted to be clear on.

You are really referring to sort of portfolio mix, product mix, as opposed to raw cost reduction initiatives?

Oh, yes, yes, yes.

I mean we have those as well, but what we are talking about now is the mix, mix by geography, mix by channel distribution, mix by products that we're selling, absolutely.

Okay.

And while I've got you here just quickly, the impairment charge, 200 basis points, roughly $40 million, is that pretty much it for the year or is there potentially more of this coming?

Well, if there were more, we would have recorded it, so the answer to that is at the moment we don't believe there is any more coming.

It's based on, as we said, some changes in -- you know, those smaller brands actually suffered more in the current economic environment.

You've seen that, I think, throughout the industry.

Those brands are -- based on the struggles we looked at their distribution plans, at their expansion plans, we changed those plans; those plans resulted in a slightly different forecast of future performance, which therefore the discounted cash flow created the impairment.

But we believe in those brands and we are -- have a plan to make them a big part of our portfolio going forward, but with that change we had to take the impairment charge.

And at the end -- or during our third quarter, rather, we did a very thorough analysis, which is required on an annual basis, of all of our goodwill that is on our balance sheet and all of our acquisitions, so that process happens during our third quarter.

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

If you were unable join for the entire call, a play back will be available at 12 noon Eastern Time today through February 11th.

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That concludes today's Estee Lauder conference call.

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