雅詩蘭黛 (EL) 2011 Q1 法說會逐字稿

Good day, everyone.

And welcome to the Estee Lauder Company's fiscal 2011 first quarter conference call.

Today's call is being recorded and webcast.

For opening remarks and introductions I would like to turn the call over to VP of Investor Relations, Mr.

Dennis D'Andrea.

Good morning everyone.

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

Also on the call is Harvey Gedeon, Executive Vice President in charge of global R&D and innovation.

Harvey will be available for the questions.

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 on the investors section of our website.

I'll turn the call over to Fabrizio.

Good morning and thank you for joining our fiscal 2011 first quarter conference call.

Today I will discuss the quarter's highlights and progress we made against our strategy.

And Rick will provide details of our financial performance.

We announced this morning that before restructuring charges, sales for the quarter grew 13% to $2.1 billion.

This was a milestone since it's the first time we had exceeded $2 billion in sales in our first quarter.

Our strong performance was due to robust business around the world, and was helped by the dollar, which was weaker than we had forecast.

Diluted earnings per share were $0.97 on a non-GAAP basis, up 14% versus a year ago.

Our success was broad based.

Sales climbed by double digits in every region, including North America and in our three largest categories, driven by strong product launches and increased advertising spending in the previous quarter.

In fact, our higher sales spanned the range of the portfolio from our entry level Prestige brands to high end luxury ones.

Most significantly, our largest brands lead the way, Estee Lauder, Clinique, M.A.C., and Aramis designer fragrances had such great momentum that each rang up double digit sales gains globally and delivered substantial improvements in North America.

All in all it was a terrific performance in many regards.

Several of our financial measures broke records for a first quarter, including sales, operating margins, earnings and EPS.

Our strategy is clearly working, and we are executing it well, which is reflected in these outstanding financial achievements.

We also made progress against many of our specific strategic goals.

We again gained share in skin care, and in important channels in countries, including US Prestige department stores and our Prestige distribution in China.

Also our turnaround brands showed farther improvement.

Our creativity resulted in blockbuster launches.

We exceeded our cost saving projection by about $50 million and we continued building our strategy capabilities.

William Lauder and I are proud that our executive leadership team is directing our strategy so well around the world that the entire organization is executing it so successfully.

This strong staff is a fantastic way to launch the new fiscal year.

Our positive performance this quarter gave us greater confidence in the remainder of the year, so we are increasing our full year EPS guidance to $2.90 to $3.10.

Let me now provide you with some color behind the numbers.

In recent quarters the fastest growing areas have been skin care, China, travel retail, and on-line.

While these businesses continued to record solid growth we also saw a strong performance in US department stores and fragrance, which had been declining.

We attribute our success to external factors, including pent up demand and stronger consumer spending, as well internal achievements creating exciting new products and unique high touch services that appeal to consumers over the world.

Our more effective marketing, which includes compelling advertising, has contributed to our success by making consumers more aware of our newest products and services.

A key part of our strategy is focusing our talents and efforts on fewer but bigger product launches, outfitting cutting edge innovation.

Recent introductions from our research and development teams have been outstanding and the success of these products underlined our super sales growth.

Our brands have a rich pipeline of truly novelty launches over the next several years that we believe will continue to set the pace and set us apart in the industry.

Harvey can answer questions about our innovation strategy during the Q&A.

Our year--old America affiliates has been working with department stores to make the beauty floor more exciting and the initiatives are paying off for us and the retailers.

Our sales in North America department stores grew double digits this quarter.

Sales of Estee Lauder M.A.C.

brands into China grew double digits and Clinique recorded solid gains.

Some of our largest US department stores customers, particularly Macy's and Nordstrom, posted solid sales gains for the recent three months and higher traffic contributed to our sales growth.

We believe our more focused and frequent advertising, which entices consumer to buy our must-have products, helped generate the traffic, the higher traffic.

And while we've made inroads against Prestige competitors, we've also gained against Mass.

The luxury consumer is shopping again.

And we are seeing our strategy contribute toward the old Prestige beauty growing faster than Mass, in many parts of world.

For the three months ended September 30, 2010, total US beauty sales in Prestige department store and Sephora, grossed 4% according to NPD, while sales in Mass China grew 1%.

The spread was even greater in skin care, where Prestige sales growth was five points higher than Mass.

Our sales in Europe rose sharply, helped by incremental orders from perfumes, as part of the re-assortment effort we began last March.

Asia sales growth was a little softer this quarter, but still rose 10%.

Skin care in Asia is a main area of strategy focus, and now accounts for 61% of the region's total sales, up from 56% only a year ago.

In the recent quarter, our Asian skin care sales rose 19%.

Rick will talk more about the regions in a few minutes.

A key strategic focus has been to advertise our newest and most popular products effectively to pull consumers into stores.

We have put the most money behind Clinique Repairwear Laser Focus, and Even Better Clinical, Estee Lauder Advanced Night Repair franchise and the pure DKNY fragrance.

Once consumers come to our counters and websites, we leverage our high class service to build a personal connection, foster brand loyalty and sell multiple products.

Although we are investing more in advertising, our total advertising and promotional spending hasn't increased as a percentage of sales.

Instead we have reallocated our spending in the category.

We are putting less into gifts and sampling and more into advertising, including TV, on-line, and print, to build greater awareness and demand for our brands globally.

The company's focus on skin care is driving sales growth in many of our brands.

Estee Lauder, Clinique, Origins, and La Mer had substantial advances in their skin care business.

Both Estee Lauder and Clinique's global skin care sales surged more than 19% with gains in four regions.

The Estee Lauder brand continues to make impressive gains in Asia Pacific and travel retail, fueled by the popularity of several recent product introductions.

Currently, the flagship brand is updating Re-Nutriv Ultimate, its luxury line, which we believe will continue to propel its winning skin care story.

Clinique's strategy to target skin care products for specific concern paid huge dividends.

In addition the brand's recent launch of Repairwear Laser Focus, fueled solid growth in Asia, in particularly in China.

Clinique is the largest beauty brand in the United States, yet it managed to expand its skin care share in Prestige department stores by more than one point.

Throughout the quarter our brands continued tailoring their products and communications in different regions as they become more locally relevant.

Aramis and designer fragrances successfully launched Coach Poppy and pure DKNY in North America and Tommy Hilfiger Loud in the UK.

EDF sales climbed more than 25% and coupled with lower cost of goods and cost cutting initiatives, its operating profit improved sharply.

Our fragrance category, led by EDF, courageously changed its strategy to first improve its bottom line before accelerating top line growth.

That approach has paid off dramatically, as higher sales coupled with smarter spending resulted in much improved profitability this quarter.

Other brands in our portfolio that are turning around have also made substantial strides toward greater profitability, which has helped the company overall performance.

Two of our high end fragrance brands, Jo Malone and Tom Ford, generated healthy sales increases particularly in Europe and in the Middle East because they created heavier and more intense scents that appeal to consumers in those markets.

This quarter was the first that included our newest brand, Smashbox, and it's off to a good start.

Smashbox is a strong brand in the United States, with a loyal consumer following.

It helps strengthen our makeup category, and our presence in alternative channels.

We are working to integrate the brand organizationally and functionally.

While our brands have been busy accelerating their individual strategies, on a corporate basis, we have taken steps to strengthen our capabilities both regionally and globally.

With the digital universe increasingly important in everything we do, we have committed to building on our expertise and expanding our global presence on-line.

We are constantly evolving our communications and use of social media on-line in searching for better ways to sell and promote our products.

To that end, we feel that employees must be engaged and dedicated to these endeavors.

To show our commitment, the company organized a digital media conference in New York in August for hundreds of our executives to immerse them in the fast-paced on-line world and provide them with a deeper understanding of the potential it holds.

The event included speakers from Facebook, Google, Four Square as well as digital executives from other consumer companies at the forefront of social networking.

The day was a tremendous learning experience, and reinforced to our management that this is an area that we believe holds amazing promise and potential.

Looking ahead, we are anticipating a solid holiday season.

The US department store business is healthier than last year, and our brands have created a wide selection of products offering compelling value.

We believe consumers will find our products and unique services to be attractive in these environments.

As we continue on our path of achieving sustainable profitable growth, we will bring our brands to more people.

For example, M.A.C.

plans to open about 50 doors in the international market in the second quarter and La Mer and Aramis in designer fragrances expect to launch in commerce in Japan.

We will open more than 90 locations in China this fiscal year for our nine brands there.

As a dynamic enterprise, we must constantly look ahead to be in the forefront to stay on top of our game.

So we are re-investing some of our profits in our future, introducing our most promising opportunities by brand, by market, in China.

They're backed by an unwavering commitment to innovation and to talent.

Our focus this year centers on five areas embedded in our corporate strategy.

Strengthening our creativity in innovation, expanding our high touch services, deepening our local relevance and widening our lead in the digital arena.

We also will continue to tighten our costs and run our business in a smarter, more efficient and integrated manner.

I want to thank my leadership team and our worldwide employees for their hard work and continuous innovation.

We couldn't have accomplished any of this without you.

As we continue to push to our goals, William Lauder and I are working to preserve the company's solid foundation, its culture and the integrity instilled by the Lauder family for more than 60 years.

We are in the unique position to leverage and draw inspiration from our historic strengths as we move forward to make our strategy a reality.

The Estee Lauder Companies will always pride itself on creative thinking and entrepreneurial spirit and the will to win.

It's wonderful for the entire organization to be able to leverage the success of the past while participating in and embracing the company's bright future.

Now, I will turn the call over to Rick.

Thank you, Fabrizio.

And good morning, everyone.

A quick reminder, my discussion on the quarter and the outlook exclude restructuring and special charges.

As Fabrizio said, we had a terrific quarter driven by better than anticipated sales.

In local currency, sales road 14%.

Adverse currency translation was less than 1 percentage point, resulting in a reported sales growth of 13% to $2.09 billion.

Net earnings for the quarter rose 16% to $194.4 million, compared with $168 million in the prior year quarter, and diluted EPS was $0.97 compared to $0.85.

Sales growth was about four points more than our guidance.

About two points of the upside was due to a weaker US dollar than we had forecasted, and another two points from stronger overall business.

We're very pleased to see the sales momentum increase during the quarter, including the effect of targeted advertising behind key products in Estee Lauder and Clinique.

We saw this especially in our Americas and European regions.

The quarter also benefited from sell-in of faster moving SKUs, as part of the reassortment program in European perfumeries, after having taken a charge for returns of slow moving products in the fiscal 2010 March quarter.

This program is now essentially complete, and we do not expect to see incremental sales at the same level for the remainder of the fiscal year.

Additionally, our cost of goods were lower than anticipated due in part to a shift of some GWP and set shipments to the second quarter and better than expected improvements in obsolescence.

Importantly, operating expenses came in where we expected, reflecting a more normalized cadence to our marketing spending.

Two of our major categories grew double digits, compared to last year, we saw the fastest growth in the strategically important skin care category.

Sales rose 18% in local currency aided by product launches.

Skin care sales grew by double digits in every region.

In makeup, local currency sales rose 11%, driven by growth in our M.A.C., Bobbie Brown and Estee Lauder brands, as well as the addition of Smashbox.

This was partially offset by the discontinuation of Prescriptives in department stores.

The category grew double digits in the Americans and European regions.

Our fragrance business grew 17%, excluding currency.

Fragrance launches in the US and UK helped growth in the Americas and Europe.

In hair care, sales declined 3% primarily due to soft results at Ojon.

We're reformulating Ojon products and plan to relaunch the brand with a new marketing campaign later this fiscal year.

On a geographic basis, all regions grew double digits.

We are pleased with a 12% growth in the Americas, our best performance in a number of years.

The strongest contributions came from our largest brands, Estee Lauder, Clinique, M.A.C., and the Aramis and designer fragrance group.

Additionally, Latin America grew more than 25%.

In Europe, the Middle East and Africa, sales rose 18% in local currency.

Travel retail grew 24% as the channel continued to benefit from improved traffic led by Asia and Latin America.

Our UK sales rose 12% driven by good retail traction across the brand portfolio, and positive response to our television advertising.

Emerging markets in the region were up strong double digits.

All of the western European countries grew, although many benefit from the perfumery re-assortment program.

We believe our underlying retail growth in the major western European markets is mid single digits.

We continue to see overall sales growth in the Asia Pacific region, which had a 10% rise in local currency.

China rose 32%, fueled by 16% like store retail growth and expanded distribution.

The appetite of Chinese consumers for our products is also driving strong double digit gains in Hong Kong and Taiwan.

Korea grew 6% but Japan and Australia declined, reflecting their tough economic environments.

Our gross margin improved by 40 basis points this quarter to 76.7%.

Contributing to the increase were lower obsolescence charges of 30 basis points and positive currency of 20 basis points.

These figures include the benefit of our cost savings initiatives of $21 million.

Operating expenses as a percentage of sales rose ten basis points to 62.2%.

Factors affecting operating expenses as a percentage of sales including lower selling and shipping costs of 130 basis points, partially offset by higher advertising merchandising and sampling, and general and administrative costs of about 110 basis points.

These figures reflect savings of $28 million from our cost reduction programs.

As a result, operating income rose 15% to $302.6 million and operating margin rose 30 basis points to 14.5% of sales.

Our cost savings initiatives are moving ahead well and we achieved total savings of $49 million in the quarter.

We now expect to save between $135 million and $145 million for the full year.

Regarding net interest expense, we reported $16.1 million this quarter, versus $19.6 million in last year's first quarter.

The decrease is due to lower debt levels.

The effective tax rate was 32.7%, within our projected range.

We recorded $4.6 million in restructuring and other special charges equal to $0.02 per share for the first quarter.

For the full year, we expect to record charges of between $60 million and $70 million.

Our fiscal first quarter cash flow typically reflects seasonal working capital levels as we gear up for the holiday season.

This quarter, net cash used for operating activities was $39 million compared to $3 million of cash generated last year.

The biggest driver of the variance is the increase in accounts receivable.

Our Days Sales Outstanding were 50 days this quarter, three days lower than last year.

Inventory days were 177 days, compared with 170 days last year, reflecting the expected second quarter sales growth.

At the end of the September, our SKU count was down 7% from a year earlier.

However, we have experienced service issues as some vendors are having difficulty meeting the increased industry wide demand for ingredients and components.

As we continue to improve our forecasting and react to the increase in demand, we may build some additional inventories to address these service issues.

We spent $58 million for capital expenditures, which includes our company wide systems initiative.

We also used $258 million primarily for the purchase of Smashbox.

For fiscal 2011, we expect to generate around $850 million to $900 million of cash flow from operations, and use about $350 million for capital expenditures.

During the quarter, we repurchased approximately 2.4 million shares of our stock under our share re-purchase program.

Looking ahead, we are balancing the better than expected sales and earnings of the first quarter with the risk of a possible consumer downturn after the holidays, more aggressive competition and volatile currency markets.

However, we remain confident in our business and believe it is reasonable to raise our expectations.

For the year, we expect local currency sales growth of 7% to 9%.

Our fiscal year guidance builds in assumptions of approximately $1.30 for the Euro, JPY85 for the Yen and $1.55 for the Pound.

This scenario would reduce reported sales growth by about 1 percentage point.

We expect to continue investing behind our strategic priorities in the remainder of the fiscal year to drive growth and increased share.

At the same time we continue to pursue the cost savings we previously laid out.

We expect a 50 to 90-basis point improvement in operating margin this year.

At this time, we continue to estimate an effective tax rate of between 32% and 34%.

We are raising our full year non-GAAP EPS forecast to between $2.90 and $3.10.

Our outlook for the holiday season reflects an improvement in consumer spending compared to last year.

Our sales growth for the second quarter is forecast to come in between 8% and 10% in local currency.

The negative impact of foreign exchange translation is expected to decrease sales growth by about three percentage points.

We expect EPS for the three months ended December 31st, 2010, to be between $1.32 and $1.45.

We are encouraged by our results for the first quarter and we are optimistic about the response to our innovation and unique service that sets us apart.

Longer term, we are working hard to make our four-year strategy a reality.

That concludes my comments for today and we'd be happy to take your questions now.

The floor is now open for questions.

(Operator Instructions) Our first question comes from Wendy Nicholson with Citi investments.

Hi, good morning.

My first question has to do with the fragrance business and the margin that you saw there, which I think is the highest I've ever seen.

I'm wondering how much that is now a realistic run rate.

Is fragrance now permanently a double digit margin business, or is there a chance that as new products move to the forefront of your priority list, margins dip down into the single digits again?

Thank you.

Wendy, what I think you're seeing in the first quarter is the benefit of some of the launch activity that we mentioned.

So there's a lot of, if you will, sell in of those new launches, so we are making pretty good progress in improving our profitability, but no, that, that double digit number in the first quarter is not indicative of where we think the year will be.

Although the year will certainly show substantial improvement over last year and will continue to show if you will, going forward, measured improvement in the fragrance category.

And your next question comes from the line of Alice Longley of Buckingham Research.

One of the shifts that you're making is less promotional activity through gifts with purchase and purchase with purchase, I guess, and more advertising on-line, in print and TV.

Can you go over what you see as any possible risk of doing that in the holiday season in that I believe your holiday sales historically have been driven in the US to a good degree by these kinds of promotions, and gift sets, excuse me, and gift sets as well.

And could, maybe, you quantify what percentage of sales in the holiday season in the US historically have been driven by gifts and what percentage you expect to be driven by these, this year?

This is Fabrizio.

No, I personally don't think our strategy is risky.

We are doing these changes very gradually and globally.

And we're not taking the risk in the short-term.

Particularly during the holiday season.

We are going to have a lot of very appealing promotions, as I was saying in my prepared speech, and we have also had some very interesting value activities for our consumer during the holiday season, but if you look to the first quarter and if you look to the year as a total, you will definitely see a reduction of our gift and promotional activity in total, and increase at the same time of advertising spend in print magazines, in television and on-line advertising.

The other important difference, these activities of extra advertising have been focused and concentrated on our most successful and biggest launches globally, which means there is another advantage versus the past model, where is the level of support is our potential, most potentially winning activity we're having is dramatically increasing.

And, in fact, a lot of our accelerated growth came from the extraordinary success of some of our launches like Clinique, Even Better Clinical or Lauder Advanced Night Repair, or DKNY Pure, which is also the response to a concentrated effort of advertising on those initiatives.

Obviously the reduction of promotional activity and more push activity has an influence.

Meaning it will reduce a little bit our volume.

But this is being more than offset by the benefit we see in more focus and increased advertising.

Thank you, and can I ask a related question about North America?

Your shipments in the Americas were up 12% in the quarter, how much were your sales at retail up just so, so we can see if there's any difference between shipments and sell through?

So obviously there's always a bit of a disconnect in our first quarter because what happens is our retailers are buying into their anticipated Christmas season and then we, and then you know that sell through activity is comparable to that.

But we're, there's probably a few, a few percentage points differences, quite honestly, between sell-in and sell through activities that we see, but that's kind of normal in our first quarter because there's always, as I say, a buy in leading up to the Christmas season, and based on their anticipated, what they think their Christmas holiday season is going to be like.

How fast do you think you grew at retail, in the quarter, in the Americas?

In the high single digits.

Thank you.

And your next question is from the line of Neely Tamminga with Piper Jaffray.

Congratulations on a great start to the year.

Hey, just wanted to talk a little bit since we do have your innovation officer on the phone today, maybe qualitatively I'm just kind of curious how your team would work with the, the consumer insights group and just wondering how the interaction works from a process change today from maybe where Estee Lauder was just two years ago.

That would be really helpful, thanks.

Yes, actually we are gathering very valuable consumer insights around the globe, and we are using those consumer insights to inspire our creativity in product development and guide our R&D investment priorities.

In other words, we are keeping the focus on creativity and imagining what the consumer does not expect.

We are keeping the focus on our great R&D efforts and product development effort.

We are inspiring those efforts more with consumer based insight, particularly global understanding of consumer.

This is working pretty, pretty well, and I would like Harvey to comment on how these R&D efforts are benefiting our business.

Well, this is Harvey Gedeon.

One of the areas that we've done so far, one the main focus is in areas of, of bigger opportunities and categories of huge demand.

And that requires strong partnership with consumer research, and consumer insight along with the alignment with corporate and win strategy.

Our focus has been to create fewer and bigger initiatives, what we call hero products whose performance is proven and can be easily recognized such as even better clinical, supported by strong and effective advertising to inspire the consumer to come to the counter where she can delighted with our high touch.

So, again using consumer insight we are focusing on the big priorities, we don't use them to meet consumer demand; we try to anticipate the consumer demand and consumer needs but they are a strong partner with our strategy.

Thank you, and good luck.

Thank you.

And your next question is from the line of Caroline Levy, with CLSA.

Hello, everybody and congratulations.

Couple of questions.

In China I understand there's been a delay in getting new products to market for the entire industry.

You were still up 32% but could you comment on what you think the prospects are for that changing or how that might impact sales?

And then I think you touched on the fact there have been some shortages in North America and at a beauty event we heard the same thing, that the retailers were a little worried about certain products getting to market.

Could you just bring up us to date on that?

Yes, in China, there is, in this moment, the authorities there are revising their policies, so as you say the entire industry is not getting through new product approval for the time being.

We, we assume this is a temporary measure, and we are ready to start to gain the approvals as soon as the authority will allow this to happen.

In the meantime, we are working hard to create the right transition plan, if you want.

First of all, we still have a good valid pipeline of products, which have been previously approved and we are launching in this moment, so we do not have a problem in the very short-term.

Then in case this has to continue longer in the future year or more, then we have plans, obviously, to re-promote and relaunch some of our most important activities.

You need to understand that in China, even our most successful products for the moment have trial levels, which are still well below 30% or 40%, so the farther we may need to push those products more and continue to make more consumers awareness of trying this product is not necessarily a bad idea.

And anyway, we'll definitely continue to build our, our volume for a certain period of time.

In the longer term, obviously we are, we are counting on this going back to normality, although we are well aware this will go back to normality but with a new policy that we will need to understand and adapt ourselves to.

And regarding your question on supply, we have sort of three things working at once.

One is, there is a pick up that we see in the Prestige marketplace and our sales results kind of reflect that.

Second is, we have some terrific products which are doing very, very well from our perspective, somewhat better than we even anticipated.

And the third element that's mixed in there is the fact that some of our suppliers are having difficulty responding to the increased demand across the industrywide, you know, cosmetic industry, so what we're dealing with are those three factors, which is creating a little bit of tension within our supply chain and our reaction to that may very well be as I mentioned in my prepared remarks, that we may build some extra inventory to ensure that we improve our service level.

Thank you very much.

I was just wondering, travel retail, is it strong across the board, or is there any particular areas of weakness or strengths?

It's across the board, but I think we mentioned in our remarks that Asia and Latin America were in particular doing well.

Is that in the local country or those traveling to other parts of the world?

Well it's in travel retail locations, so it's people coming in and out of countries, right?

Yes.

It's airports.

I'm just trying to understand if it's Latin and Asian travelers going through Europe or the pickup is within those countries?

The pickup is mainly international traveling, but you are right that the origin of the international traveling which has the highest increase is from Asia.

Okay.

Thank you.

And your next question is from the line of Ali Dibadj with Bernstein.

Hi.

A couple questions, one is just would love your insights a little bit on what you see for the next few quarters, given that you're not carrying through the, the strong beat on this quarter.

What exactly are you saving up for?

I mean, you mentioned a few things; you mentioned competition.

Are you seeing competition increasing yet, and if so where?

You mentioned kind of sell in, mismatch, potentially now versus the holidays, how do you think the retailers perhaps in that context are thinking about the consumer holidays?

You mentioned some of the shortages.

Just kind of what are you saving up for?

What are you trying to be conservative about, I guess?

And I ask that, of course, in the context of your implied margins being, I don't know, I'm kind of doing it live here but call it flat to semi basis points roughly versus last year for the full fiscal year, so, I'm just trying to get a little bit your insights about go forward here.

Okay.

Ali, let me explain.

First of all, we are very, very positive on our strategy, and we are getting every quarter more positive about our ability to execute in general.

And also we start seeing positive results in the important US department store channels for us.

So those are all positives, and we are pretty bullish on those key aspects.

However, we need to balance the results of this quarter with the expectation for the next three quarters within the fiscal year, for the following reasons.

First of all, because also in part for the supply chain issues being discussed, we have some of the gift-with-purchase promotions which are in holiday sales, for holidays, we saw regionally had to be shipped in September, will be actually be shipped in October, and this interestingly is actually creating a better gross margin in the first quarter and will create some worse gross margin in the second quarter, so this is an element of balancing that we have taken under account.

The second important element is that the incremental orders that we got in Europe because of the re-assortment program that have positively impacted our first quarter will not continue after early October, so we do not expect this positive trend to continue in the remaining part of the fiscal year.

Next point is the low base, I mean, our first quarter last year was the worst in terms of growth, and so this, the comps, are going to be matched faster for the remaining three quarters of the fiscal year.

Importantly, then is currency.

Now the currency rates has been more favorable than anticipated in this first quarter.

We honestly do not expect this trend to continue.

As Rick has explained in the prepared remarks, we are assuming for the average of the remaining of the fiscal year in Euro at $1.30.

As you know, this has been pretty volatile and difficult to predict.

And finally, not least, less important, we are only one quarter into the year, and we have some concerns for the external macro factors, specifically, in the US, the expectation for the holiday season is pretty positive but the January-March or the January-June period is a big question mark.

There are many factors that may generate softening of the market after January, particularly if the unemployment rate had to remain at the current level.

And then we continue to be pretty worried by the pocket of softness around the world, namely Japan and Australia in Asia and southern Europe in general, that remain very worried.

To this worry you can add the recent news of the UK program.

Now UK is our second biggest market, and so we are prudent, on what would be the effect on consumption of the new measures in UK and end of year increase in general in the UK for the second 6 months of our fiscal year.

So the combination of these factors is the reason why you see us taking the yearly guidance up but not of the total amount that we've been doing better in the first quarter.

That's very helpful, for that granularity, I appreciate that.

If I could perhaps take advantage of your generosity for two very quick questions.

One is, Rick, Smashbox is about 1% on the quarter.

Is that the right way to think about it?

And then two, it sounds like we are implying a little bit of acceleration in hair care in the rest of this year.

Just would love a little bit of an idea around that.

Thanks.

Sure, you're exactly right; with Smashbox, Ali, it is about 1% on the year, that's added to overall growth.

And then we are expecting some better results for the remainder of the year for hair care, certainly.

Okay.

Thanks.

Yes.

And your next question is from the line of Linda Bolton-Weiser from Caris.

Hi, how are you?

Can you give a little more on the growth in Latin America, and can you remind us roughly what percentage of the Americas is Latin America?

Can you talk a little bit about Brazil, because you have talked very enthusiastically about the growth opportunities there, and I think L'Oreal is saying also positive things about that part of the world.

And can you address the idea that it's been a dominant, direct selling market and what you are doing to bring Beauty, you know, into the regular channels of distribution?

Just talk about that market a little bit?

Sure.

Just on the percentage of overall business, it's 2% to 3% of our sales, so it is, it is fairly small, but honestly we do see an opportunity in Latin America that's emerging for us, and we're being pretty aggressive in going after it, but, Fabrizio, if you want to --

Yes.

Again, Latin America for us is a very big opportunity forward.

It's not been very meaningful in terms of percentage to the business so far, but we have very serious plans to accelerate our penetration in the future in Latin America.

We are very relevant already in markets like Mexico, Venezuela and Chile.

Our key focus now will be really to accelerate our penetration in Brazil and we are doing this with various programs in, in the retailing environment.

You know, working with a few outstanding stores would be one strategy which is already the strategy of our M.A.C.

brand which we plan to accelerate over time, and we are evaluating other projects, also in this area.

Importantly, our travel retail division also has important role is bringing our brand in an efficient way in Latin America and we have serious plans to accelerate this one as well.

Thank you.

And your next question is from the line of Andrew Sawyer with Goldman Sachs.

Thank you, guys.

I was wondering if you could talk a little about the issues in Japan and you've done a nice job giving the US department store business, which had been struggling, going again.

Is there any similar path to get Japan back to a growth trajectory?

Yes, that's a very good question.

Actually, yes.

I believe there is some similarities between the opportunity of getting the department store growing again in Japan, and what is working today to get the department store traffic in cosmetic up again in the US.

So we are definitely working on this.

We are transferring some of our US learnings into our Japan program and working with retailers there to generate the right level of learning and particularly the level of learning in how to improve the high touch, how to improve the differentiation, versus the Mass channel.

How to improve the role of new initiatives and mega launches to attract new consumers to the floor of beauty in big department stores and finally how to improve the cost structure to liberate the funds that need to be invested in attracting new consumers and serving them with higher quality.

All elements that will definitely be used also in Japan to relaunch the segment.

However, the Japan economy is really under pressure, so this may take some time because it requires some improvement of the business model, but at the same time will require that the economy in Japan will at least stabilize or hopefully one day be turned around.

And just a quick one on the US, we've heard about some of these Macy's beauty impulse boutiques, and, you know, I know you guys have Smashbox in these efforts but how should we think about those store within a store and the impact it would have on the conventional cosmetics counters?

I think you know, the entire specialty channel in the US, you know, Sephora, first, is developing, and is developing pretty well, so this forum in our opinion will continue to grow very successfully in the US market, and we are, with our portfolio brands, we are trying to participate to all the channels.

Our portfolio brand is strong because it's also wide enough and designed to be able to win in area of this Prestige luxury channel, which are developing limiting the amount of conflicting overlap or cannibalization.

All right.

Thanks very much guys.

Your next question is from the line of Bill Schmitz with Deutsche Bank.

Can you just talk about some of your competitors, I think L'Oreal, said that the category was flat, and then if you just look at some of the scanner data in US and Europe, it seems like Mass is also down 1% or 2%.

Are you seeing something differently in the categories or are you taking just loads and loads of market share?

We are taking strong market share, and from the number we see, the categories globally is growing about 2% is our estimate, which is again, is not very, is not a super strong growth, but we see the overall category is starting again growth.

We do see that the growth in Prestige or whatever we define as Prestige channel in the different parts of the globe, we see that Prestige is growing faster than Mass in some key markets around the globe, and this is an indication that the Prestige consumer are coming back actually faster than the less affluent consumers on the one side, but it's also an indication that the Prestige business model, the way we are evolving it, has some appeal for the consumers, and some more appeal for the consumers, and make, I believe, the entire segment more competitive in the long-term.

Okay.

Great, and then, can you just tell me like what do you think the incremental margin was on the sales beat?

You know, so I think you were calling for sort of 11% at the midpoint of your previous range, and it came in three points higher.

Did almost all that gross margin just flow down to the operating line?

So what happened, Bill, was two things.

One, absolutely, because we had pretty good control of our operating expenses and we continue to focus on that and we actually had some savings, as I mentioned in our prepared remarks, and also we talked, and Fabrizio elaborated upon the idea that we had some gifts that did not ship, that are shipping in the second quarter so the combination of both those two, sort of, in semi quotes fixed operating expense base, lower cost of goods, all of that money flowing to the bottom line, that was one the reasons for the beat for sure.

Okay.

Great.

Thank.

"Buon lavoro!") I think you say, Fabrizio.

And your next question is from the line of Connie Maneaty from BMO Capital Markets.

Thank you, could you just give a little color on the effort in the perfumery channel, the whole re-assortment, how big is that channel and what exactly does re-assortment mean?

Yes.

What this means is that, again, as part of our improvement of the business model, historically in Europe where perfumeries are relatively small doors, versus the big department store doors, we've been selling in our full assortment of big assortments of products.

The result of this is that for a few years, you know, every complete assortment is composed of high moving items that move very frequently in the course of year and slow movers.

Now after some time, the accumulation of too many slow movers into this relatively small door like European perfumeries create the inability of those retailers, then, to buy in sufficient quantities, the high movers.

So we took the important strategic decision to help the retailers to eliminate slow movers from their assortments so they could create space to get in the high movers.

That's what re-assortment is.

This is having an amazing benefit because on one side is making our assortment better in each single perfumery, on the other side is giving to each single perfumery a composition of high mover which make their overall rotation increase and, importantly, make better profit for the retailer and better profits for us.

So it's been probably one of the smartest investments we could have done, now the key challenge in front of us is to maintain the assortment in those stores with the right balance between complete, completeness of the assortment and focus on high mover SKUs, which is the plan.

So it sounds as though in this quarter there was something like a pipeline sale of a more select, faster moving assortment of products; is that correct?

That's correct.

As Rick said in his prepared remark, while we see above double digit growth in continental Europe, in reality our retail growth in continental Europe is in the high single digit, so there is a difference between the sell in and the sell out, and this difference is the re-assortment program which I've just explained, which, however, in my answer to the other question before, I was clarifying, we do not expect to continue, so we cannot expect this extra stocking will continue in the next three quarters.

And just one final question.

How big is the perfumery channel?

Perfumery business is roughly 18% to 20% of our total business.

Okay.

Great.

Thanks.

And your next question is from the line of Joe Altobello, from Oppenheimer.

Thanks, good morning guys.

Just first question is broader, I guess, in scope.

If you just put aside your market share gains you mentioned earlier, Fabrizio, that the upscale consumer is coming back, given the faster growth of the Prestige segment of the category.

And you also eluded to sort of pent-up demand.

If part of this is pent-up demand, how long does that phenomenon last, how many more quarters do you think you have before you know the Prestige, the Prestige segment starts to revert back to a more normalized growth rate?

Sorry; could you repeat the last part of the question?

Yes, how many quarters do we have until that pent-up demand starts to abate and the Prestige segment sort of reverts back to a more normalized growth rate?

I think this will happen pretty soon in the sense that Prestige, the Prestige segment will go back, I believe, as of this quarter, I mean, as of October/November -- I would say, again the holiday season will still be different, influenced by different factors, but let's say as of January, I think this will go to very normalized patterns.

But again, I believe that the way we are building the Prestige segment again is really via our new model of pull and push, meaning amazing innovation with great advertising to pull the consumer into the store, and then high touch services brought to the next level, to sell the consumer the full Prestige experience.

That's the model that has the potential to have Prestige growing nicely for many years to come and maybe to be more competitive with the Mass growth, even when the markets will normalize.

I would ask maybe Harvey to say a few more words on a way this innovation program can impact the Prestige market development and our market share enhance.

I mentioned before -- this is Harvey Gedeon.

And I like to think that the load, that pent-up demand, is due to innovation.

I mentioned before that we focus on, very focused on big initiative to bring the consumer to the counter and delight them with high touch.

But if you combine that with what we're doing, which is more locally relevant products, where we're really focused on, on the consumer on the local consumer need, and back it up with strong innovative capabilities in that region, that also is having an impact in places where, like China and places like the Middle East, where the products are much more tiered to the local need.

We have one more thing that we do, which is we create products closest to the most demanding consumer and make them global hits.

So, what we're doing is creating products that can require (inaudible) and collaboration between several different regions but creating products satisfy that consumer which is extremely demanding, one of which, for example, is Asia, and then taking that idea globally so that we have a very big hit.

If you do those things, back it up with, with strong advertising, I think, you know we can delight the consumer with more and more products.

So I think the whole pipeline of product innovation is extremely strategic and important to making, and keeping the consumer coming to our counter.

Got it.

Thank you.

And your next question is from the line of Lauren Lieberman from Barclays Capital.

Thanks.

I thought if you guys can comment a little bit on trends in hair care.

I know the channel salons itself are still relatively weak.

But do you think you could talk a little bit about competitive positioning and sort of longer term outlook into what degree this set of businesses is still on or is on the turnaround list?

Thanks.

Actually, just to clarify, this business is not on the turnaround list.

This business has been decently profitable for some time.

What we need to turn around is the top line and we need to accelerate the top line on this business.

Now, in fact, this is very much linked to the trends.

The salon business, the high end salon business, in which we operate in North America particularly is still relatively soft.

The market is not recuperating fast and we are suffering part of this softness.

At the same time we are making some important improvements to the plan of our high end salon business.

We are improving our distribution in high end salons in North America.

We are working on the continuous but gradual international expansion of our key brands Aveda and Bumble and Bumble.

For example we have started the expansion of Bumble in the UK very recently, and we are working to link, particularly on Bumble, the business also with a retailing format that, format execution, that could develop our retailing sites and at the same time help and support our salon network to farther build that business.

And on that front, we are in running a very exciting third market with Sephora here in the US that, if successful, will, can really transform the high end hair care industry, in my opinion, in North America and possibly in the future internationally.

And your next question is from the line of David Wu from Telsey Advisory Group.

Hi, good morning, everyone.

Congrats on a great quarter.

Just have three questions.

First, your cash position remains pretty solid at the end of the quarter and I was wondering if you could perhaps share with us, you know, your plans for future cash deployment?

And just secondly, you know, can you maybe perhaps talk about what you're seeing in terms of raw material cost trends and your expectations for the remainder of the fiscal year?

And just lastly, are you still targeting a long-term operating margin to 12.5% and 13.5% by FY '13?

Thank you.

So we did make use of some cash this quarter.

We purchased Smashbox, as you know, for about $250 million and we also bought about 2.4 million in shares so we are using some of that cash balance.

We've always said our priorities for cash are, are, you know, invest in our business.

Make strategic acquisitions, and then return excess cash to shareholders through share repurchase and dividends, so I mentioned share repurchase.

Dividends really is part of a capital allocation discussion that we have with the board of directors, and we do that rather frequently but the declaration of dividends is in their hands, quite honestly.

We're lucky that would he do have a strong balance sheet that gives us a great deal of flexibility.

Regarding material costs, we have seen some pressure in material costs, but and we've mentioned this on earlier calls.

Quite honestly, the value of the materials that we buy is not so much in the raw materials, but in the, in the creative process, if you will, the construction of what we buy so the creation of the caps or bottles or boxes that are specific for us.

That's really the cost add component, if you will, of our cost of goods, so material costs make it more difficult for us to continue to improve our gross margin, but it is not quite as onerous for us as it is for some other companies.

And you're exactly right, our long-term target is 12.5% to 13.5%.

And we're working very hard.

I don't know if Fabrizio will add to that.

Yes, I just want to add that we'll continuously look at this target and at the appropriate times we'll decide how do we invest in these targets and communicate to you how we feel versus the target.

As you know, for the longer term, we always said that we believe we can aim at a 15% in a very long-term.

So we will first decide how fast we can get to the target of 12.5% to 13.5% and then elaborate our next margin growth target in the future.

But for the moment, I believe it's premature to change the target up to only one quarter in reality in which we have just declared a new target, which, by the way, was already increased [up one] point versus the previous one.

Right.

Excellent.

Thank you very much.

You're welcome.

And your next question is from the line of Victoria Collin from Atlantic Equities.

I just wanted to ask a question on the makeup segment if I could.

It seems to be reinstated in the full year guidance as a leading contributor to growth for the rest of the year and I wondered what kind of growth you've been seeing in the first quarter, whether it was an element of restocking from some consumers or whether there was a particular region or launch or product that you brought out which is selling faster than you'd expected originally?

Thank you.

I think the, the restocking did not affect, if you will, restocking did not affect makeup categories.

In fact, in the perfumery specifically, that was more geared toward skin care than it was, well it's a little bit of makeup and skin care, but other than that particular element there's nothing unusual with our growth rates of makeup we think it's going to be pretty solid for the year and it's built into our forecast, so it's, you know, M.A.C.

is doing very well.

The two key reason on the makeup is, as I said, the European re-assortment includes makeup obviously and then we have some brands, particularly M.A.C., which is having an amazing momentum and is growing very, very nicely, so you know, we say that our key priority as being skin care development, but makeup, is, you know, almost an equally important priority for us, and we are growing very nicely, very actively in this category

And your final question is from the line of John Faucher from JPMorgan.

Thank you.

You know, going back several years ago it seems like this type of gross margin performance actually often would be sort of spent back.

I guess, as we look at this, can you talk about the evolution of your understanding of the efficiency of your marketing spend and how that changes your decisions in terms of, you know, whether or not you're going to spend back gross profit upside?

Is it the fact now that you seem to have a much better idea of the efficacy of this spending, that you don't need to sort of throw extra money at the problem and you can still deliver top line growth above your expectations?

Yes.

We believe, again, we are learning, it's only a few quarters that we are into this model, and we seem to be learning that the, like in this quarter without changing our total spending of advertising and promotion, but just reshuffling for major efficiency and effectiveness our spending, we are getting the growth that we want.

So we are optimistic on the ability to grow only gradually the spending and achieve a lot of improvements by reshuffling and efficiency.

At the same time, however, we will continue to feel as free to make important investments when we see opportunities, which are very relevant for the long-term, like investing and anticipating a market share gains in a big new developing markets before we got a lot of question about Brazil, for example, or in any other area where we may decide that it is the right time to make investment and build our penetration in market share for the long-term.

So in general, I think we are going to continue to win also in an efficiency and efficacy in our marketing plan, but we also will make some important strategic investment in capabilities in new markets over the next years.

And on top of that, John, we're also, as you know, being pretty aggressive in finding efficiencies in our organization from costs in lots of other programs that we have underway, so we are driving, if you will, efficiency through everything else and investing, as Fabrizio, said to also drive the top line.

So that's hopefully our business model.

Okay.

Thank you very much.

That concludes today's question and answer session.

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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.