雅詩蘭黛 (EL) 2010 Q3 法說會逐字稿

Good day, everyone, and welcome to the Estee Lauder Companies fiscal 2010 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, 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 is Cedric Prouve, Group President International.

Cedric has responsibility for our business outside the United States and Canada representing more than half of the Company 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'll 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.

Thank you, Dennis.

Good morning.

I'm pleased you have joined us for our fiscal third 2010 third quarter earnings call.

In our discussion today I will review our performance and progress on our strategy.

Cedric will talk about the Company International business and Rick will follow up with financial details.

This morning, we again announced strong results, with solid sales gains and greater profitability.

Third quarter sales were $1.86 billion, up 10% compared to the same period of a year ago.

With improvements in all regions and categories.

Diluted earnings per share were $0.34, more than double last year's results before restructuring charges.

I'm also gratified that we continued advancing many of our strategic goals.

Let me give you some highlights.

First, we believe that retained sales of our products grew at a faster pace than prestige beauty trends in many critical countries and channels which means that we increased share.

Excluding Prescriptives, we saw gains in US department stores as well as Russia, and China, among others.

Our international business expanded more rapidly than our domestic business and we are approaching our target of generating more than 60% of sales outside our home market.

Our operating margin wasn't a gain, moving us closer to our long-range goal of 12 to 13%.

Our turnaround brands collectively showed continuing improvement in operating results this quarter.

And we made additional progress in our cost savings initiatives.

In each of our three quarters so far this calendar year we met or exceeded our sales and earnings estimates and successfully moved ahead of our strategic journey.

All of our employees should be extremely proud of these accomplishments, which are the results of their hard work and creativity, and I want to thank them for their efforts.

Now, let me turn to some of the specific areas that drove our growth this quarter.

Our international business provided the greatest momentum.

Asia Pacific remained robust, led by strong gains in greater China.

Sales in our European region climbed driven by (inaudible -- highly accented language) Russia and the Middle East.

Our strategy puts a new emphasis on our regions, which has enabled us to be more locally relevant and accelerate our growth.

The Estee Lauder brand enjoyed solid growth internationally in the quarter, particularly in Asia Pacific and trial retaining led by skin care sales.

Estee Lauder is the leading Prestige brand in Asia in our distribution.

One of the most exciting developments in our foreign markets this quarter was the launch for our origins brand in mainland China.

The brand's highly successful repositioning, powered by nature, proven by science, has been directed by Senior Vice President and origin General Manager, Jane Lauder.

She led the kick off at the Parkinson department store in Shanghai, joined by Executive Chairman William Lauder, one of the founders of the Origins 20 years ago, and other Company executives and local celebrities.

Cedric will give you more details about our international business in a few minutes, so now I want to discuss other areas that drove our sales.

Clinique skin care sales grew over 11% at retail, thanks to strong launch activity and gained share in the US department stores.

Clinique is the largest US cosmetic brand.

So when a brand of its size gains share, it is an impressive fit.

We were pertinent by the fact the US retail sales jumped strongly in March led by upscale department store which points to a possible initial recovery in consumer spending.

We are working closely with our large retail partners to create innovative shopping experiences in department stores.

For example, we are refining our high class service from education through post purchase.

We are also leveraging in store services differentiating by store size to better serve the needs of our consumer and improve profitability.

Our eCommerce business grew 25% with most of our brand sites reporting double-digit growth.

Retailer size in North America also posted solid sales gains.

In addition, we expanded our global web presence.

Clinique launched its online sales in Germany and M.A.C.

started eCommerce and mobile commerce in Japan, while we plan will follow with both types of online shopping in Japan next month.

As you know, one of our key missions is to build upon our global leadership position in skin care.

This universal focus across our brands is reflected in our results.

In the recent quarter, reported skin care sales rose 16%, and we launched two break-through products that we believe will be important contributors to their respective brand portfolios for many years to come.

Toward the end of the quarter, Clinique began shipments of even better clinical dark spot corrector which trades an even skin tone with results that are comparable to a leading prescription ingredient.

We have high expectations for even better Clinique and are supporting it with an unprecedented television campaign in the US, which launched last week.

The commercials we ran for five weeks including prime time spots during American Idol and Dancing with the Stars.

Our other major introduction was La Mer regenerating serum, which is the brand's first antiaging product.

We are excited by its initial sales but also encouraged that the serum has lifted sales of the brand's (inaudible).

La Mer is one of our high end Prestige brands and it had double-digit sales growth, with particular strength in North America, the UK, and throughout the retail.

We believe that consumers are beginning to reconsider luxury products, which certainly bodes well for our entire Prestige portfolio.

Another standout in skin care is Origins, which has been remarkable consumer acceptance in its revamped skincare line.

Origins had outstanding contour growth in its major US retailers during the quarter.

It also has been terrific improvement in the UK, where sales grew 12% this quarter.

With new merchandising, advertising, and communications, the brand global sales rose high single digits, led by new products, including ginseng screen and brighter by nature (inaudible).

In make-up reported sales increased 2%, due to the improvements by both of our make-up artist brands, M.A.C.

and Bobbi Brown.

M.A.C.

enjoyed strong sales growth in Europe and Asia.

Its brand equity and philosophy is closely tied to its annual VivaGlam lipstick sales, which benefited M.A.C.

AIDS fund.

VivaGlam for persons Lady Ga Ga and Cindy Lauper grew huge media attention.

Sales of VivaGlam product exceeded forecasts and had a hollow effect on the rest of the business.

Last week, M.A.C.

took a VivaGlam campaign to Asia.

Lady Ga Ga performed in Tokyo, which generated terrific media coverage.

This month M.A.C.

opened its most innovative and technology-driven stores in Times Square, this busy area attracts close to 0.5 billion people a day, making this location a superb retail opportunity.

Bobbi Brown recently visited China to do television and magazine interviews and makeup artist events to be the brand awareness.

She previewed upcoming launches which we expect will increase sales in the current quarter.

At (inaudible) recent shows during New York Fashion Week, the Estee lauder brand new creative makeup director gave a preview of the colorless Estee Lauder (inaudible) this fall.

This was the first time the brand had been involved back stage with a high profile runway show.

Aaron Lauder, Estee Lauder's Senior Vice President and Creative Director worked closely with Tom to create the first collection in the nostalgic imagery to support it.

We think his strong ties to beauty and fashion editors will attract a more fashion conscious consumer and bring increased (inaudible) and attention to our flagship brand when its product hits stores.

Along with the sales gains we generated, we also increased our profitability.

Our restructuring efforts are enabling us to work more efficiently.

In spite of our ongoing cost reductions, we trimmed $104 million largely achieved in cost of goods, in direct recruitment and resizing and restructuring initiatives.

Our year-to-year savings totaled $264 million and we now expect to save $300 million to $330 million for the fiscal year.

As you know, we have committed to reinvest a portion of our savings to build capabilities.

We are also refocused on continuously improving our productivity.

Starting this July, we have established a Company-wide mandate and plan the employee costs increase more slowly than sales growth.

Our turnaround brands showed solid financial improvements, which helped strengthen our bottom line.

The official closing of prescriptives wholesale business on January 31 was executed flawlessly and we received price from retailers noting how well it was handled.

We moved certain employees to other parts of the Company and are transferring popular prescriptive products and formulas to other brands, including (inaudible) Fragrance which is now part of Aramis and Designer fragrances.

Some prescriptive retail counters will be assumed by our other brands and its online sales will continue for a period of time.

The Aramis and Designer fragrance division has begun reaping the benefit of profit improvement strategy started in middle 2008.

It has dramatically improved its cost of goods, cut its SKUs by over 50% in the last three years and is launching fewer fragrances with bigger impacts.

The recent European introduction of pure DKNY was well received.

The fragrance is innovative because of its sustainability platform, which is unusual in the category.

ADS also began distributing the Coach fragrance in the US department stores -- beyond Coach retail stores.

Another key component of our strategy is to enhance our capabilities in certain areas to improve our competitiveness.

To that end, we announced the establishment of the corporate marketing center of excellence, which will be a resource for our research and development teams, brands and region, as we develop greater consumer insights and marketing tools.

Georgia Gabinos who worked for Johnson & Johnson has joined us to lead the new center.

Her responsibilities include capability development in most -- marketing, global consumer insight -- customer relationship management, digital marketing and (inaudible) services.

Georgia reports to me and is a member of the executive leadership team.

One of the Company's historical trends has been our innovation and creativity.

We believe that by utilizing more in-depth consumer insights and focusing our efforts on the biggest opportunities, we will produce even greater creative break throughs across the Company.

Our approach is to be creativity-driven and consumer-inspired.

We are developing a strong pipeline of new initiatives to drive growth over the next three years.

We are planning launches that will include new product ideas, as well as existing successful products that we will improve with updated technology, similar to what we did with Advanced Night Repair.

We will also accelerate innovation of the high tax services, which integrate our products to create a well differentiated Prestige experience.

We will give you further details at this initiative near their launch dates.

Earlier this month we rolled out our strategic modernization initiative to nine North American manufacturing facilities.

Over 80% of our in-house production is now on SAP.

Although it is too early to give details, the implementation has been smooth and we haven't encountered any major problems.

On our next earnings call, in August, we plan to provide early results of the North America effort, review the SMI project and discuss future steps.

With just two months left in fiscal 2010, William Lauder and I are extremely pleased with how far we've come in the first leg of our four year strategic journey.

Looking ahead we are prepared to move the Company from successfully navigating in a recession to growing during a recovery.

We plan to continue taking aggressive steps to fuel our momentum.

For example, our target advertising and promotional spending will be significantly higher in the fourth quarter versus the previous year, which should help drive sales going into fiscal 2011.

We will focus on our biggest opportunities, including major product launches, the best performing countries in our largest brands.

As our performance this year should confirm, we are a growth Company.

Furthermore, as global economy return to more solid footing and employment levels improve, the money spent on Prestige beauty products worldwide is expected to gradually return to historical norms.

We fully expect to capture a bigger share of the growing pie.

Now, I will turn the call over to Cedric Prouve who will talk about his area of the business.

Cedric?

Thank you, Fabrizio, and good morning, everyone.

Fabrizio mentioned the international business, once again, enjoyed strong sales and earnings growth in the recent quarter.

In fact, our sales have increased every year for the last decade in local currency, underscoring how important the international operations are to the Company as a whole.

International accounts for nearly 60% of sales, is the major growth driver, and is transforming the historic Company into a true global powerhouse.

Let me briefly explain why we've been so successful extending our brands into more than 140 markets.

First, we have a highly effective organization led by strong regional teams that are developing expanded capability.

They are supported by a powerful network of local affiliates, which stay in touch with our consumer states and thinking and provide excellent on the ground execution.

Our international organization continues to evolve and aligned with our global brands and function.

Of course we also have a diverse portfolio of our professional Prestige brands that allows us to leverage our strategies and optimize our growth based on where we see the most promising opportunities.

Market characteristics dictate our investments by categories, products, brands, and channels.

At the same time, we strive to balance our growth among emerging, developing, and mature countries.

Again, in alignment with each of our brand strategic priorities and plans.

This year, every international region is ahead of its sales and profit objectives after the third quarter.

Asia, however, is the standout, with continued momentum.

Within Asia, greater China has been a key performer.

The region's growth is being fueled by skin care, which accounts for a large majority of its sales.

Our strongest brand in Asia at the moment is Estee Lauder, which has seen such astounding skin care sales in China, that in the recent quarter it, became the brand's largest international business, surpassing the UK.

Earlier, Fabrizio mentioned Origins' recent launch in China.

We believe that Origins will be a perfect fit, since Chinese consumers are passionate about skin care and natural ingredients.

In its first week Origins was the top selling beauty brand in the Parson department store in Shanghai, and since its launch, Origins' retail sales have exceeded our projections.

We expect the brand to have six doors in Beijing and Shanghai by June 30.

Origins is the ninth brand to join the China portfolio, our most widely distributed brands are available in about 80 department stores across 35 of China's largest cities.

Our brands are also present in about 80 separate doors in the country.

There is still much room for expansion, which we are directing deliberately and strategically.

We're extremely pleased that China is no longer dilutive to the average probability of the Asia Pacific region.

And our results in the country have consistently outpaced our five year projections for sales and profits by at least a year.

China is the largest of our emerging markets, which as a total group grew 18% in the third quarter.

They account now for 12% of total Company sales and extend well beyond the break foursome to also include eastern Europe, the Middle East, and Turkey, just to name a few.

When we will accelerate our growth in emerging markets is by establishing our own affiliate early on.

This enables us to hire the best local talent, which gives us a competitive advantage, and we develop a long-term strategy and investment plan.

Our newest affiliate in Vietnam had strong double-digit growth in the third quarter and we will maintain the momentum by launching M.A.C.

there in this fiscal year.

As you heard troubled retail performance was strong and it rebounded sharply from the weak environment of the year-ago.

The improvement was so great that the division had its best sales month ever in March.

The channel was held by higher passenger traffic, initial success converting more travelers to buyers, great growth in Asia Pacific and some restocking following last year's difficult climate.

It continued to open doors for our younger brands, which accounted for about 15% of its sales growth this quarter.

Our results in the Europe, Middle East and Africa region were mixed with emerging markets outperforming the more mature ones.

However, we believe we gained market share in our distribution, despite market challenges in certain countries.

Our UK team has done an excellent job navigating our largest affiliate through a difficult economic environment, especially in Ireland, while growing and gaining share in our distribution.

Some of our less developed brands, including Jo Malone and Tom Ford showed solid gains in the European region.

M.A.C.

and Bobbi Brown were also strong and we plan to expand their point of sales, including more freestanding stores which allows us the best possible presentation to express their brand equity.

Business in Latin America has met our expectations.

Despite recent disruptions in Chile and Venezuela.

The region sales have more than doubled in last several years and our brands have sold well in Brazil and Mexico.

The Company has started fulfilling its mission to become completely integrated so that the best ideas and products generated in one area can easily translate and travel to the rest of the world.

As an example, when the Estee Lauder brands set out to create skin care commercials for Asian TV, it produced them on location in Hong Kong where the entrance of skincare products and local styles and aesthetics were best understood.

The ads were such a success that the brand will use some of them worldwide.

Our international business has delivered excellent cost savings, which has helped improve profitability and allowed us to increase investments.

Most of the incremental spending has gone to emerging markets to see future growth.

We expect to spend about 50% more on TV advertising this quarter throughout this country to raise awareness of our core brands and fuel our momentum.

For the first time, the Estee Lauder brand will run three integrated marketing campaigns in Asia, using television, print, and digital simultaneously for its skin care products.

This is a prime example of how we allocate our investments to ensure that our momentum continues.

Internationally, there are many growth opportunities in department stores, particularly in Asia where the channel remains strong.

However, we are also pursuing other Prestige channels, similar to our approach in the US and believe the opportunities are most promising where we can deliver an excellent high touch experience.

This includes our international push into more eCommerce platforms, generating not only significant sales growth, but also a more locally relevant dynamic high touch interface with new and existing consumers.

We are expanding eCommerce and mobile commerce and building our digital capabilities to run websites at regional and local levels in close collaborations with our brands.

Providing personalized service and demonstration is an important factor, as we grow our brands and introduce them to new consumers across various Prestige channels.

For example, we are looking at ways to refine this model to best suit European perfumeries, where we sell many of our brands.

We also intend to be a bigger player in European pharmacies, where the skin care category has been growing rapidly.

And in fiscal 2011, Aveda will be fully integrated into our international operations, as we focus on adding high end -- to our distribution network.

As we strive to gain a larger share of the consumers' total beauty purchases, we are learning from improved consumer insights to provide customization that is geared to local taste.

We are focusing on our innovation on creating locally relevant products, packaging, product delivery, services, and communications.

In closing, I want to emphasize how extremely proud I am of our international team and the result they have produced.

Our regions and travel retail channel intend to keep advancing the Company's strategy and align themselves to the commitment as Fabrizio just described of being creativity-driven and consumer-inspired.

We are confident that international will continue to propel the Company's growth and ensure that the Estee Lauder Company remains the worldwide leader in Prestige beauty.

Now I will turn the call over to Rick.

Thank you, Cedric, and good morning, everyone.

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

Once again, we had a solid quarter.

Sales rose 10% to $1.86 billion.

Excluding the impact of currency translation, sales were up 5% over the prior year period.

Net earnings for the quarter more than doubled to $68.9 million compared with $31.4 million in the prior year quarter.

And diluted EPS was $0.34 compared to $0.16 a year ago.

We continued to experience strong growth in the skin care category, reflecting our strategic focus in that area.

Sales rose 10% in local currency, contributing more than half of the global increase in net sales.

All three regions contributed to growth in this category, especially Asia and Europe.

In makeup, local currency sales fell 2%.

This category was adversely effected by the end of of wholesale distribution of prescriptives and was the most impacted by a charge for returns from European perfumeries, which I'll describe shortly.

Excluding the impact of these two factors, local currency sales grew 4% over the prior year.

The category grew double digits internationally on the strength from Clinique, M.A.C., and Bobbi Brown.

Our fragrance sales jumped 13% excluding currency.

And the category continued to improve its profitability.

The launch of pure DKNY in Europe, Signature in the US and increased sales of certain designer fragrances through self select outlets proved most of the increase.

In hair care, sales rose 3% in local currency due primarily to expanded distribution of Aveda in Japan, Korea and Australia.

Geographically, our international businesses continue to lead growth.

In Europe, the Middle East and Africa, sales gained 7% in local currency.

During the quarter, we recorded a charge for approximately $31 million to reflect anticipated returns from certain European perfumeries.

The returns primarily makeup, relate to a strategic effort to proactively align our product assortments by discontinuing slow turning SKUs in favor of carrying higher turning products.

Global travel retail sales continue to rebound from increased traffic and conversion of travelers to buyers.

Sales in the channel jumped over 45%, off an easy comparison in the prior year quarter, contributing substantially to the region's increase.

Our UK sales slowed in the third quarter to low single-digit growth, as adverse weather and an increase in BAT dampened purchases.

However, our makeup artist brands continued to produce double-digit growth in the UK.

Developing markets in their region, including Russia, the Middle East, India and Turkey all grew strong double digits.

Most of the Southern European countries performed below last year and the markets in Greece, Italy and Spain remained concerning.

Germany was largely unchanged and the Nordic countries grew high single digits.

Our Asia Pacific regions, sales climbed 10% in local currency with most affiliates contributing.

China continued to lead the region's growth, rising over 30% in the quarter.

Our business in Hong Kong rose 24% and Taiwan was up 25%.

Korea grew 10% and we continued to see strong results in Malaysia, Thailand and Vietnam.

The political unrest in Thailand could curtail future sales.

Japan declined mid single digits, as it continued to suffer from a tough economic environment.

Local currency sales in the Americas were up 2%, reflecting a modest pickup in consumer demand.

Excluding prescriptives, sales in department stores at our own retail stores rose low single digits.

Sales growth in Canada, Mexico, Brazil and our online division were more robust.

Sales in other channels were mixed.

Our gross margin improved by 250 basis points this quarter to 76.2%.

Our cost savings initiatives contributed 230 basis points, primarily from the tragic shift in our product mix and lower material costs.

We also benefited from favorable currency.

These factors were partially offset by higher obsolescence of 40 basis points, which included the cost of returns from the SKU rationalization in Europe.

Operating expenses as a percentage of sales for the quarter improved 70 basis points to 68.5% compared to 69.2% last year.

Improvements mostly came from cost savings initiatives, partially offset by higher advertising, merchandising, and sampling expense, and costs to build capabilities.

Operating income rose 87% to $142.8 million compared to $76.5 million last year, and operating margin increased 320 basis points to 7.7%.

Regarding our interest expense, we have reported $18.2 million this quarter versus $20.6 million in last year's third quarter.

The effective tax rate for the quarter was 44.4%, higher than normal due to the geographic mix of our earnings.

The impact of the new tax legislation related to health insurance reform was not material to our results.

We recorded net restructuring and other special charges of $16.5 million during the third quarter.

Net cash flows from operating activities for the nine months ended March 31, was $798 million compared to $307 million last year.

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

During the quarter, we repurchased approximately 1.3 million shares of our stock under our share repurchase program.

Our day sales outstanding were 47 days this quarter, 7 days lower than last year.

Business has been improving for many of our customers and so we are less concerned about their financial health at this time.

Inventory days were 157 compared with 154 days last year.

We built $35 million in inventory of our top-selling SKUs in advance of the rollout of SAP to our North American manufacturing facilities earlier this month.

We expect to work down the excess over the next two to three quarters.

Importantly, our global SKU count was down 8% from a year earlier at the end of March.

We spent $161 million for capital expenditures, which includes spending for our Company-wide systems initiative.

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, although some of the spending could spill into next fiscal year.

As you saw in this morning's announcement, we are planning to purchase $200 million of our outstanding debt during the fourth quarter, which is expected to result in a one-time charge of $26 million to $30 million, or $0.08 to $0.10 per share.

We expect interest savings of approximately $10 million to $11 million in fiscal 2011.

This reduces leverage back in line with a single-A target credit rating.

With two months left in the fiscal year, our forecast reflect continued growth in Asia and a measured consumer recovery here in the US and parts of Western Europe.

We remain cautious about the economic environment and several Southern Europe peen markets, as well as Japan, and we expect more aggressive competition.

Additionally, the recent disruption in European air travel caused by the volcanic activity in Iceland modestly impacted sales in our travel retail channel.

However, this is a reminder of the vulnerability of this channel to unforeseen events.

For the year, we now expect 2010 local currency sales growth of about 4 to 5%, led by our international business.

Currency is expected to add approximately 2 percentage points to our reported sales.

Advertising, merchandising, and sampling costs, should continue to accelerate behind our biggest launches and markets with good momentum, such as China and Russia.

We also continued to invest in building capabilities, as called for in our strategy, in areas such as digital programs, new high touch service models, regional research and development, and consumer insights.

We expect to deliver savings for the year of $300 million to $330 million and to record charges associated with restructuring activities of between $60 million and $90 million.

Given our progress to date, we now expect to improve operating margins by at least 400 basis points this year.

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

We are moving our forecasted full year EPS range up to $2.65 to $2.75 per share.

This range excludes the one-time charge of $0.08 to $0.10 related to the repurchase of debt, as well as restructuring charges.

We will review our long-term goals as part of our annual budgeting process over the summer and we plan to provide fiscal 2011 guidance on our year end call in August, as we do every year.

Refer, there is a degree of uncertainty and volatility inherent in our business.

Our full-year strategy is off to a good start and we are pleased with the progress to date.

We still have a lot of work ahead, building capabilities, while simultaneously driving measured, profitable, top line growth in a sustainable fashion and continuing to turn around underperforming brands.

That concludes my comments.

And we would be happy to take your questions now.

(Operator Instructions) Our first question today comes from William Smith of Deutsche Bank.

Hey, the charge in the quarter -- that $31 million for the inventory obsolescence, why wasn't that viewed as extraordinary?

Well, it wasn't extraordinary.

It was part of our thinking certainly and part of our strategy and that was to align the products that we have in the stores or in the perfumeries in Europe, with the highest selling SKUs.

So what we intended to do and what we are achieving is pulling back the slower moving SKUs, improving the turn, if you will, the profitability, you know, at point of sale within the perfuming markets, within Europe.

So it was part of our planning.

It was part of our forecasts, and Cedric, I don't know if you want to comment further.

This is a project that we felt was necessary and was definitely in our thinking and strategies.

We are working in partnerships with our customers because we are extremely focused on the productivity by door and to an extent by SKU and we know that the game is changing and we want to focus on the sell-through rather than sell in and make sure that we improve the turn of our SKUs and the return on investments for both our customers and ourselves.

Okay, great.

And then just a second one.

Just a commentary on the North American business about ongoing challenges faced by the Company's department store customers.

Is there something looming there?

Or this was put in there as sort of a cautionary comment?

It's more of a cautionary comment.

But I think that we're somewhat -- we see the environment improving in North America, but I think we're somewhat cautious to be too enthusiastic at the moment.

We see a measured improvement.

Things are getting slightly better, but, it is more of a cautionary statement than anything else.

Our next question is from Alice Longley with Buckingham Research.

Hi.

Could I just add a follow-up to that and then ask my own.

The $31 million in Europe, where is that recorded on the P&L?

Is it sales or profits or a combination, or where?

Yes, it's recorded in sales, so it is treated as a return.

It's primarily -- not primarily.

It's all in the European region and it is primarily in the makeup category.

Okay, and then my other question was, I think in two of your segments, you commented that sales were particularly strong in March.

You said US sales were strong in March led by upscale retailers and I think you said travel retail was particularly strong in March as well.

Does that -- is it reasonable to expect June results in both those segments to be even stronger, the June quarter even stronger than the March quarter results?

And as part of that offset that with the volcano effect, please.

Sure.

So I think that travel retail would be hard pressed to have another quarter like they just had.

But our business is stronger, but they were up against somewhat of a weak comp last year.

If you looked at the travel retail growth, I think versus 2008, it's more in the mid teen areas, which is more reasonable, quite honestly.

The volcanic activity, we estimate was about $5 million to $7 million of sales impact, and that's assuming that it's finished at the moment.

So that's that.

As far as North America, I think that our business, as I said, is somewhat improving, but I don't know if the month of March was anything outstanding versus, versus other periods.

I don't think I said that.

And if I, I -- so, business is improving slightly, but as we just said before, we're somewhat cautious on it.

We think it is improving at a measured pace, and that's what we're anticipating for rest of the year.

Our next question is from Andrew Sawyer with Goldman Sachs.

Just on the department store topic, I know, Fabrizio, you talked about getting this segment back to growth.

I was wondering if you could give an update on how some of the initiatives that you are having tests with, are working and what the path would be to getting that business back to more of a growth trajectory over the next couple of years?

Yes, sure.

I think that the activity that we -- are working.

We are improving in department stores, we are getting our key brands as growing share, I think particularly significant in the US department store in the last quarter was the share growth of our Clinique brand.

It was, as I said, significant.

And on a brand of such big size means that we are doing the right thing.

And the right thing is a combination of broader initiative, improvement of our high task service, which as you know passes through better service accounting and better activity in the store, and an increased level of service, plus a clarification of the value equation of the brands, which includes its position of prices, better value reframing on some of our SKUs, and activities in this area.

The combination of those things is working pretty well.

Now, in term of future development I think where we continue accelerating the initiatives and the thought was on big initiatives where we continue accelerating the expansion of our successful high tax models and these will start with expanding them in flagship stores and then adjusting our model, medium and smaller size doors over time, working with all our customers in the region.

Quick one for Rick, on capital structure, is this really just about the credit rating -- it's a favorable credit environment, why not I guess roll it or bring new debt to market and buy stock?

It is about the credit rating.

A single-A credit rating for us is really a sweet spot from our cost of capital perspective.

It gives us great flexibility going forward if we needed to access funds for any business reasons.

So we think it's an appropriate use of cash at this moment and it does solidify, if you will, single-A credit rating.

As far as making a -- levering up and buying a significant amount of shares, the share price is quite high at the moment and also we're not so sure that that's a long-term solid business strategy quite honestly at the moment.

Our next question is from Ali Dibadj with Sanford Bernstein and Company.

Hi, guys.

If we could talk a little bit about guidance, please, so the original guidance for the quarter, if I recall, $0.20 to $0.30 for this very quarter, which would have implied a higher Q4 than you're currently implying given your new guidance range -- trying to get an understanding of why is that.

What's changed?

Is it -- sounds like perhaps because of tax rate, is it because there's more spend, you expect, is it potentially because of a softer market?

Is it because fragrance doesn't seem like it's making money again this quarter and perhaps next quarter.

I want to understand that a little bit if you could, please.

Our spending plans are primarily around our investment in advertising merchandising and sampling expense, and that expense grew about 15% year-over-year in the third quarter, but in the fourth quarter, that will grow about 35%.

So some of it is the timing of that additional investment that we talked about in the second half of the year, and that's what affects the fourth quarter.

So other than that, I'm sorry about the fragrance business, you were wondering.

Well, is that part of the factor, you seem to do okay when the fragrance business does well.

It lost money this quarter.

Certainly it sounds like for investment purposes, but I guess I always wonder about that business and not to sound like a broken record, but obviously whether you should be in it or not and in particular, trying to understand what kind of operational tools you now have in place to try to monitor the ROI of that fragrance business?

Ali, just want to guide to one thing.

The Fragrance business for the year will make amazing improvements in profit.

And those improvements in profit as sustainable and they will continue to improve next fiscal year as per our plans.

The way fragrance deliver profit by quarter is influenced by the way we are also putting our specific initiatives on.

The moment we have a big launch, why -- and the entire launch of the advertising spending is going to take and repeat it, we obviously can get less profitable on a certain quarter.

But overall, the plan for the year is in the right direction.

And lastly, I'm not sure I can agree with the statement that our results are heavily dependent how we're doing on fragrances.

I think that's a of our results.

Our results has been much more dependent -- how we're doing in the most profitable regions of the world.

Our next question is from Lauren Lieberman with Barclays.

Thanks.

First thing is just about the belt tightening and then being loosened.

So this quarter -- so it actually felt that there maybe wasn't quite as much of a step-up or reversal in belt tightening as we might have expected.

So maybe if you can comment on that and next quarter or whether or not you've found some of those savings are savings you can hold onto versus the -- reverse out.

Well, what I did mention was the advertising, merchandising, and sampling spend, which is really where the investment in the second half of the year is taking place.

And I did mention that.

It only grew about 15% quarter over quarter in the third quarter, but we're anticipating that to be about 35% growth in the fourth quarter.

So it's the timing of that spending in the second half, quarter versus quarter.

But I think that was sort of built into our guidance.

Yes, Rick, I'm sorry.

I didn't mean the -- like the AMS reinvestment.

I meant, like, reactionary to the environment last year, quick tightening of the belt, as you guys kept talking about.

It wasn't just pulling back on marketing.

It was hiring freeze, salary freeze, no travel, that sort of stuff which you had talked about.

That spending coming back in the second half of this year, and that's what I was trying to talk about.

That's right.

We already said the big part of the belts tightening would have come back and -- the temporary cuts with more fundamental and sustainable cuts.

In fact, actually, this quarter we have delivered more savings than what we expected, our (inaudible) for the quarter $104 million and we are increasing the estimate of total savings for the year to $300 million to $330 million savings, which is actually above what we believe and was part of our original thinking.

So we are overdelivering savings and substituting temporary pullback occur of spending from last year with sustainable savings exactly in the way we said just slightly better than what we anticipated.

Okay.

So is the net, though, of those two, the initial conversation was I absolutely remember that you try to replace these savings, but there was also a very explicit statement that some of the cuts that were temporary, over time the idea was to replace them with restructuring savings, but this is seen as separate from restructuring savings.

So, yes, you're overdelivering on the structuring.

I'm just trying to get at whether or not that spending came back or if you were able to find some of it was more sustainable, didn't need to be replaced.

But I think it's a combination of both.

I mean to the concept of reducing sales meetings, of cutting back drastically on travel were temporary certainly in nature and those things are absolutely coming back.

There was some advertising spending that we did cut back last year.

That spending is coming back, as we were just describing, but it's coming back in a more efficient and effective way.

So we're being careful and targeted in the way we spend that money, whereas historically we were maybe not quite as good at measuring the ROI on that spending and we're spending things on inefficient initiatives.

So we're spending more money this year in those areas, but we're spending it more targeted.

So, in answer to your question, and just as Fabrizio described, we had temporary savings last year, which we said about 70% of that would probably come back.

That spending is coming back.

Some of it much more efficiently than the way we had done it before but we are more than compensating for that by the more permanent savings around our resizing, restructuring and cost savings initiatives.

Our next question is from Wendy Nicholson from Citigroup Investment Research.

Hi.

My first question has to do with the drag that you're seeing on the top line from the prescriptive exit and the SKU reductions that you're doing, I guess particularly in the makeup category.

By my math, that's probably pressuring your top line growth by about 100 basis points.

Is that a run rate that we should see, kind of for the next four quarters until we've anniversaried the prescriptives exit, or is the rate of SKU reductions going to accelerate and that pressure is going to be higher?

To be precise, this is two points.

So we have been growing -- in quarter three, we have gone 2 points faster without excluding the impacts of the things you mentioned.

Now, the second part of your question is what is sustainable, what is not?

I mean obviously we will continue to monitor SKU reduction, particularly making sure the low turns inventories are taken out of the matter whatever needed, but we do not forecast any other activity of that size (inaudible) for the foreseeable future.

I think these represent the larger part of what we have to do.

Terrific.

Okay.

And then I have a second question for Cedric.

With regard to Japan specifically, it sounds like some of the luxury goods companies are beginning to see a little bit stronger sales there.

How is your business doing, I guess, relative to your competitors in luxury beauty?

In other words, are your market shares still holding firm, or do you just think the overall category continues to be tough, and so you're down with the category?

Yes.

No, actually we are following Japan very closely and we are holding market share actually for, especially for this calendar year, since the beginning of the calendar year.

What I will say is that part of the beauty category is the best performing within the department store universe, but it's still in negative territory.

And we are, we are cautiously optimistic that we are seeing a stabilization of the business at the moment.

But I've only, I only have, let's say, a one-month perspective on that.

So it's a little bit early to say whether this is going to be sustained or not.

We're seeing, we're seeing a little bit better, and the consumer confidence index are improving in Japan and speaking to some of the retailers, they seem to fit a little bit better.

Our next question is from Linda Bolton-Weiser with Caris & Company.

Hi.

I was just wondering, in terms of your guidance for local currency sales growth in the quarter, I think it was 4% to 7%, and you did 5%.

What didn't happen in the quarter that you were envisioning could happen to get a potential of 7%, 6% or 7?

Was it just the Japan and the Southern Europe?

Are there any other areas of kind of disappointment relative to what you thought maybe could be achieved on the top line?

No.

First of all, I just want to -- the European plant and the quantification of the European plant is worth 2 points.

So only if we didn't have the decision of the European stock reduction, this would be 2 points of growth over the quarter.

And as we said, this has been always our idea, but we didn't have the quantification of this idea before and that's why we gave a range.

And that's why the range would have led us to be able to deliver what we promised, but still be able to quantify the input of this European strategy before making the final communication.

So that's what happened.

Okay, thank you very much.

Our next question comes from Mark Astrachan with Stifel Nicolaus.

One quick follow up on US trends, just curious given the acceleration in department store same-store sales, I'm curious how the trends looked in the US business month by month.

Was March the strongest month, was January the weakest month?

Is there anything granular there that you can give us?

Yes, I, I can tell you March was the stronger month.

And we have seen in the quarter overall Prestige beauty in the US department store Prestige channels being 2% ahead of year-ago.

And a big part -- the largest majority of the 2% increase was in the months thanks to the good month in March and also you need to realize there is in anticipation of Easter that holds an input in this index.

That's why we are cautious to say that this is just the -- that everything is normalized.

It is the beginning of positive signs, but we want to observe those signs for a longer period of time before making a final conclusion.

The other -- other positive thing we see is out of this 2% increase of the Prestige beauty business is faster than the increase we saw in the quarter, for example, in the mass business and that particularly faster in skin care where the increase of the Prestige has been 5 points faster than increase in mass so it is again a positive indication that consumers seem to be more comfortable with spending on the higher end of their product choices.

Meaning more in Prestige than they have done beauty in the recession.

There are a combined set of positive indications, but we need to see that for a longer time before being conclusive on the recovery.

Great, and then in terms of trying to get a sense of the impact on the increased marketing spend, just curious how you're seeing the correlation there.

Talking about the 35% increase in the June quarter versus the 15% increase in the March quarter, you're talking about I think a little bit of acceleration in currency-neutral growth, even exclusive of the prescriptives and destocking in Europe.

So is it a quick return?

Is it something that you're going to see longer term as well, that we should continue to see trends improve as we head into the next fiscal year, as a result?

Yes, that's a good question.

First of all, obviously the answer is both.

Those market investments has an immediate benefit in some cases, but those in some other cases are there to create long-term growth potential for the Company.

Let me clarify what I mean.

When the market investment is behind a new launch in developed markets, obviously you see some improved results of these launch initially in the quarter.

But when those investments like honestly the large majority of our extra investment at this point in time, and in emerging markets, where we are basically investing to create brand equity and long-term awareness of these brands, those investments are for using some immediate results but are particularly laying the ground for future long-term solid growth in these new markets.

Just to put the numbers straight, the increased advertising, merchandising promotion during the third quarter was 14%.

The increase in the fourth quarter that we expect is 35% versus year-ago, so even more.

And however, the advertising merchandise spend in percent for the year in our current communicated estimate is actually flat to the percentage.

The absolute level is well above because obviously we are calculating a flat percentage of higher sales.

So by the end of the year, we have spent over $100 million or more in support, heavily skewed on the second semester and we do see an acceleration, because if you made the number we have been growing excluding the return in Europe, 7% ex currency and we forecast a further slight acceleration of these for the fourth quarter.

So pretty solid growth in the context of the current economic environment.

Last point, we are also seeing obviously an increased spending from competition, so the other way to look at that is that we have been able in the first six months of this fiscal year to operate in a very efficient way with lower spend, but also in the context of competition also having on average lower spending.

This quarter and next quarter, we expect an increased spending also from our competitors that will make obviously our spending even more important.

Our next question is from Connie Maneaty with BMO Capital Markets.

Good morning.

I have a follow-up to that question.

The question is this.

Given that in the first half of this calendar year, the advertising and promotion and merchandise spending was lower than normal, should we expect this higher rate of spending to continue into the first half of fiscal '11 as your competitors pick up the pace and the economies worldwide improve?

As I said, we will communicate 2011 estimates in the next, at the end of next quarter.

But in terms, in general terms, if you look at total fiscally spending, the percentage has been flat for this fiscal year.

And just the way it went by quarter was reflecting the different initiative and competitive scenarios that we had.

The same would happen for next year.

We will decide the spending by quarter depending where we have the concentration of great initiative and opportunities and how we feel the competitive environment will be developing.

Okay, and my second question is could, Rick, could you give us the composition of the increase in the gross margin, please?

I think, Connie, the details will be part of our 10-Q, so you'll see -- we break it out in great detail there.

We should file that sometime early this afternoon or by the end of business today.

But the big, the biggest driver of savings in, and driver of our gross margin improvement is in the mix area, as well as inventory management.

I mean those are the two big drivers.

We have some favorability from, as well, from foreign exchange.

And then because of the return in Europe, our obsolescence in the quarter is an increase year-over-year because there is a provision that has to go along with those returns.

But as I say, the details are part of our 10-Q.

Our next question is from Victoria Collin with Atlantic Equities.

Hi.

Given the stellar performance in the travel retail business, I wonder if you are still expecting to see mid teens grades from travel retail for the full year.

I mean given that Q3 was up 45%, I wonder whether you've made some allowances in Q4 for maybe a recurring impact from volcano effect or anything like that, or whether your wage or estimates have gone up a little?

And then secondly, I just wondered if you could clarify whether the $31 million charge on the EMEA region for the European perfumeries, whether that's part of the overall restructuring or there's anything additional that you built in there once looking closer at the business and seeing that more savings could be realized from cutting more fees?

Thanks.

I'll take the first part on travel retail and I think we had a fairly weaker fourth quarter last year, so, yes, we are definitely, we are definitely seeing continued momentum on our -- barring any event, and for the full year, we'll be more in the 20s in terms of percentage growth.

And regarding the European return, that's really normal business, if you will.

It's very targeted, so it's very strategic in nature.

Returns are a part of our business, but in this case, those returns were specifically decided upon with our customers and then trying to improve the productivity of those stores and the turns of the inventory in those stores.

So therefore, our return on assets.

So it was a strategic, targeted, thoughtful process, which should limit future returns quite honestly, but it is, but it is not part of our restructuring activity.

Okay, that's great.

Thanks very much.

Our next question is from Chris Ferrara with Bank of America-Merrill Lynch.

Hi, guys.

I just wanted to ask about the tax rate.

I guess 44% in the quarter, I think you said that it was related to the mix of business and where your profit was.

But that's a pretty sizeable change and I think your guidance is back to 30, 32 for the year.

Was there a really big, big difference in where the profits came from this quarter as opposed to what it will be next quarter and going forward?

Chris, part of it is if you look at our rate in the third quarter of last year I think it was 43.2 or some numbers like that.

So the rate naturally is a little bit higher for a variety of reasons in our third quarter than the overall tax rate.

And, you know with FIN 48, there is more of a volatility of the quarter by quarter tax rates because you have to -- that's just the way the tax legislation works.

The good news is for us is that we've been invited into this cap program which is a program that not too many companies get into but it is an opportunity for us to have sort of a realtime audit going on with the IRS, which will take out a lot of the volatility of our tax rate on a quarter by quarter basis because there will be very little that's under discussion in future periods.

Got it, but there's nothing that's one-time in nature at all in that quarter you would expect it to, you would expect most Q3 to end up looking like this just generally speaking?

Yes, certainly for the last couple of years, it has looked that way, Chris, for sure, but all taxes in some respects are one-time in nature, right, because it depends on your results and where the earnings come from.

So, you know.

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