雅詩蘭黛 (EL) 2017 Q2 法說會逐字稿

Good day, everyone, and welcome to The Estee Lauder Companies fiscal 2017 second quarter conference call.

Today's call is being recorded and webcast.

For opening remarks and introduction, 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.

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

Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC, where you will find factors that could cause actual results to differ materially from these forward-looking statements.

To facilitate the discussion of our underlying business, the commentary and our financial results and expectations is before restructuring and other charges.

You can find reconciliations between GAAP and non-GAAP figures in our press release and on the investor section of our website.

During the Q&A session we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for the call.

And I'll turn it over to Fabrizio.

Thank you, Dennis.

Good morning, everyone.

I am pleased that in the second quarter we delivered our financial targets.

Our sales grew solidly, up 5% in constant currency.

It was a meaningful acceleration from the first three months.

In constant currency, our adjusted diluted earnings per share rose 5%, reflecting strong growth in high profit channels and disciplined expense management, coupled with sales growth leverage.

During the quarter, we enhanced many important strategic growth levers, which created positive momentum across our diversified business in our brands, channels, geographies and categories.

These gains were fueled by strong strides in our innovation, social media and digital engagement.

We continue to make priority investments through our Leading Beauty Forward initiative, which is proceeding according to plan.

I will elaborate on each of these areas in a moment.

Our two biggest challenges currently are the brick-and-mortar business in US midtier department stores, which continues to be impacted by soft traffic, and a slowdown in consumer purchasing in the Middle East.

Additionally, Hong Kong continued to be soft and we remain cautious about the impact of political issues and terrorism affecting our business in certain markets.

We also continue to be penalized by the strength of the US dollar.

Despite these headwinds, we continue to successfully activate many of the elements of our strategy, which give us confidence in the strength and sustainability of our business growth.

The first successful element of our strategy is the positive momentum of our diverse brand portfolio and we continuously build on this strategic advantage.

In the quarter, our best performers were our midsize luxury brands, which continue to gain the vote of consumers, and strengthen the desirable product offering and services.

They are headed on a path to become big brands.

Tom Ford, La Mer, Jo Malone, Darphin, and the brands we acquired in the past few years generated impressive constant currency double-digit growth globally.

Tom Ford products were particularly well received and the brand grew in every category in every region.

Two of our big brands generated improved sales and grew globally in constant currency.

The Estee Lauder brand sales increased mid single digits, with positive growth both in skin care and makeup.

Estee Lauder Revitalizing Supreme+ was the largest US skin care launch in calendar 2016, according to NPD.

The brand's makeup sales increased in every region and globally were up double digits, led by foundations and lip products.

Estee Lauder brand grew in every region, which included an acceleration in China and in travel retail.

Makeup fueled growth in the UK, where the brand has a high makeup penetration.

MAC global business also grew in constant currency, as we had anticipated.

The brand international business further accelerated, with double-digit gains in most markets as well as in travel retail.

In the US, MAC sales showed improvement versus the first quarter, but still declined, due primarily to weak traffic in brick-and-mortar midtier department store and its tourist focused freestanding stores.

We expect MAC international sales to increase further in the second half of the fiscal year.

We continue rapid online growth, creative innovation, expanded consumer coverage in overseas markets, including launching in new cities, improved merchandising in store and accelerating its successful efforts in social media.

Our aim is to strengthen the brand competitiveness in the US while investing behind its international momentum.

We also strengthened our portfolio with the acquisitions of BECCA and Too Faced, two of the fastest-growing prestige makeup brands.

With a strong millennial following, they extended our presence in specialty multi-retail, which is one of the fastest-growing channels for beauty.

Too Faced joined our company in mid-December just as it was introducing its Sweet Peach Collection, which became its most successful launch ever.

The collection attracted nearly 100,000 consumers online who waited up to four hours to make a purchase.

We were excited about the prospect of maximizing the potential of BECCA and Too Faced going forward, and we are doing with our -- as we are doing with our new brands.

The other acquisitions we made over the last two years are growing rapidly.

We continue to integrate them into the Company while we expand their consumer coverage and offerings.

As an example, we launched Le Labo in Nordstrom and create a new fragrance set which were popular [gates] best-sellers online.

Our important strategy of diversifying our distribution to expand our consumer coverage is progressing well.

We are evolving the Company distribution footprint to meet consumer changing shopping patterns.

We are accelerating the execution of the strategy as some US department stores closed unproductive doors while our most profitable channels deliver outstanding performances, including specialty multi-retail, travel retail and online, all of which rose double digits in the quarter.

We have deep experience successfully managing our business across a wide variety of distribution channels, for example in the UK and in many European countries.

In the fast-growing specialty multi-retail channel, we are increasing our presence by launching more brands globally to reach new consumers.

In the quarter we launched Estee Lauder initially in 30 ULTA stores in the US and on ULTA.com, and had very strong results.

Clinique's expansion in the channel included more than 50 new doors with Sephora in JCPenney, where it was the number one skincare brand in those doors.

Outside the US, Clinique launched in the largest specialty multi-retailer in Korea.

In travel retail, our strategy to make our limited distribution brands more widely available and offer a broader portfolio of brands in the channel has yielded outstanding results.

We have broadened our makeup offerings in travel retail to capture growing demand while Jo Malone growth has helped drive a reinvigorated fragrance business, and we are introducing some of our newer artisanal fragrance brands to airport locations.

Our retail sales growth was more than double the 8% passenger traffic growth in the channel, as more than half of our top 30 travel retail markets posted double-digit gains.

However, it bears mentioning that travel retail remains volatile as political issues as well as currency fluctuation can cause significant changes in travel patterns.

We continue to execute on our eCommerce strategy, which delivered accelerating double-digit growth in the quarter as we supported our own sites and retailers' sites with new programs and innovation.

Our sales were strong across brand sites, led by MAC, as well as retailers and third-party sites.

Traffic and orders rose strong double digits compared to last year.

We opened our -- or launched in approximately 100 new sites globally for our brands and products and began selling online for the first time in Hong Kong, the Middle East and the Balkans.

In North America, several brands had record-breaking online sales during holidays, including Estee Lauder, Clinique, Origins and Aveda.

We continue to focus on mobile engagement and saw significant growth in traffic, which drove m-commerce sales increase of 75% over the Thanksgiving Cyber Monday weekend.

Our brands on retailers' sites also posted double-digit growth in the quarter.

Our online business was exceptionally strong in China, where sales nearly doubled thanks to a highly successful Singles Day on Tmall.

During that event on November 11, sales of our six brand stores on Tmall were twice that of previous year.

At Estee Lauder most of the consumer who purchased products that day were new to the brand on Tmall, illustrating the success of our strategy to reach new consumer through different channels.

From a geographic standpoint, two of the largest markets we had expected to improve this quarter, did so.

Our business in France showed solid growth and our US sales improved, led by our high-end fragrance brands which were big business at holidays.

Estee Lauder's blockbuster set helped drive traffic and sold out weeks before Christmas.

Our sales in China were strong, with many of our brands rising double digits.

La Mer was a standout, driven by the successful launch of its renewal oil and skin color collection, a key entry in the fast-growing area that bridges skincare and makeup.

The skin color line is all the incremental sales and adding a positive (inaudible) set on the brand's skincare business.

Makeup continued to be a fast-growing category in China, and we are responding to the demand.

MAC's growth in China was outstanding, as lipstick sales rose strongly.

The brand's [accounting] launch on Tmall is expected to further drive sales particularly in cities without brick-and-mortar.

We expect Estee Lauder brands' momentum in China to continue.

In our third quarter we plan to launch its best-selling Double Wear Foundation in a [casual] compact, a package innovation that is coveted by Chinese consumers.

Looking at our categories now, our three major ones are growing solidly on a constant currency basis.

Skincare returned to growth and we have created a new profile growth engine with the fragrance category with our now extensive portfolio of high-end fragrances, which includes Jo Malone, Tom Ford, AERIN and [Zegna Essenza], as well as newer brands such as Kilian, Frederic Malle and Le Labo.

They had growth of nearly 30% during the quarter.

These luxury fragrance brands were primarily powered by strong new fragrance launches and social media.

In addition, innovation is driving our success across multiple engines of growth spanning our brands, regions, channels and target consumer groups.

We are leveraging opportunities across the largest and fastest-growing subcategories and areas of consumer benefits while creating and leading new breakthroughs.

We are increasing our speed to market and creating more superior products.

Additionally, our research and development team continues to develop new proprietary technology platforms and our innovative concepts extend beyond product to also include packaging, delivery systems, merchandising, services and even new approaches to digital engagement.

One of our newest products in packaging innovations is Clinique's Fresh Pressed Daily Booster.

Launching this month, the booster represents a new subcategory for our Company.

The product, concentrated vitamin C, is intended to be freshly pressed into our moisturizer to immediately brighten and even skin tone.

Fresh Pressed should also increased sales of Clinique core moisturizer business since they are used together.

Our brands are also focusing innovation around [hero] products and [hero] franchises.

Creating new offerings around the core collection is very efficient and draws renewed attention to the brand priorities.

For example, Estee Lauder recently introduced new products to reinforce its two biggest franchises, Advanced Night Repair and Double Wear.

And it paid off, as both grew double-digits.

In the US, sales of the core Advanced Night Repair Serum rose 17%, boosted by its innovative Intensive Recovery Ampoules.

And a new eye mask that just launched last month as part of the franchise should further lift the serum and entire collection.

I am proud that several of these products are being recognized for their innovation.

Last month, Estee Lauder received Marie Claire's prestigious Prix D'excellence award in research and development for three products: Advanced Night Repair PowerFoil mask, Advanced Night Repair Ampoules and Revitalizing Supreme+.

This award honors the most innovative products of the year.

Our innovation is helped by our brands' and retailers' websites, which play a key role as a marketing vehicle to raise awareness of our new products.

Millions of people can research the latest launches and read ratings and reviews before purchasing.

We will continue to invest in capabilities to further expand our presence online and our brands are making important strides to stay on the cutting edge of social media, which continues to strongly influence beauty choices.

As an example, in the last years, MAC has significantly increased its digital engagement.

The number of global Instagram followers on MAC has increased by 75% to 40 million, and its number of global Facebook fans has climbed sharply.

MAC has launched local Instagrams account in several markets, including Brazil, Germany and Russia, and the content is [shoppable].

MAC's global makeup artists are engaging consumers with locally relevant content and the brand is using more influencers in user-generated posts to augment its messaging.

We just announced a collaboration with 10 global beauty influencers and bloggers who will create their own MAC lipsticks.

Our brands' actions to drive [earned] media value through influencers is working well and we made gains in all product categories.

As a Company, we are tied to the number one position in earned media value share in total beauty, as measured by Tribe Dynamics, which quantifies the value of digital content created by third parties about a brand.

We have the largest corporate share in skincare and fragrances, and we are tied for first in makeup.

Where Tom Ford, Smashbox and now Too Faced are strongly growing share of engagement with influencers, which is reflected in the higher shares in prestige beauty.

In the second quarter, MAC strongly increased its social and influencer engagement, which led to a 30% rise in earned media value.

And in another impressive achievement in China, the Estee Lauder brand was ranked number one and the only Genius Brand in the recent L2 China beauty index, which cited the brand's leadership in digital marketing, mobile and social media.

Now, let me turn to outlook.

We expect to achieve constant currency sales growth of 6% to 7% in fiscal year 2017.

This includes approximately 1% of incremental sales from our recent acquisitions of Too Faced.

We continue to expect our sales and profits to accelerate in the second half.

The stronger gains are expected to come from four main factors, including organic growth, regular price increases that took effect in January, increased consumer coverage tailored by brand, and contribution from the recently acquired brands.

There are certain brands, channels and countries that we believe will be superior growth engines.

They include our luxury brands and the online, travel retail and specialty multi-channels.

By market, we expect China to remain strong and Hong Kong should start stabilizing.

As we capitalize on the best growth prospects, we are also managing costs and reallocating resources from slower growth areas to priority ones, aided by Leading Beauty Forward.

We continue to hire talent where we need skill sets and investing capabilities that will position us to win in the fast-moving, competitive world of global prestige beauty for the long-term.

With a diversified business that's directed by a proven strategy and powered by multiple engines of growth, which we have strengthened even further with our seasonal fragrances and our recent acquisition of fast-growing makeup brands, we are confident in our long-term outlook.

Our results will continue to be fueled by the best brand portfolio and the best people in the industry, which will drive our winning strategy and continue our leadership in global prestige beauty.

Now, I will turn the call over to Tracey.

Thank you, Fabrizio, and good morning, everyone.

First, I will review our fiscal 2017 second-quarter results and then cover our expectations for the third quarter and for the full year.

As a reminder, my commentary excludes the impact of restructuring and other charges.

As you have seen from our press release this morning, net sales for the second quarter were $3.21 billion, up more than 5% in constant currency compared to the prior year period.

Incremental sales from our recent acquisitions of By Kilian, BECCA and Too Faced contributed approximately 90 basis points of this growth, slightly less than half of that from Too Faced.

From a geographic perspective, Europe, Middle East and Africa saw the fastest growth again quarter.

Net sales rose 9% in constant currency with double-digit growth from the travel retail channel, developed markets like Italy, France and Germany, and emerging markets like Russia, Central Europe, the Balkans and India.

Sales in the UK were also a major contributor to the region's growth in constant currency, up high single digits.

Last quarter we called out France and the Middle East as two markets that pressured our first-quarter sales in EMEA.

As we anticipated, sales in France returned to growth in the second quarter as prior year comparisons eased, although the country continues to experience lower levels of tourism than before.

Net sales in the Middle East again fell sharply as distributors in the area continued to align inventory to weaker retail traffic.

This trend is expected to ease slightly in our third quarter and more significantly in the fourth quarter as we anniversary the downturn.

Excluding the Middle East, the EMEA region grew 12%.

Sales in the Asia-Pacific region grew 5% in constant currency.

Growth was led by a double-digit increase in China and the Philippines, followed by strong growth in Korea and Malaysia.

Both Japan and Australia rose low single digits.

Hong Kong sales continue to decline, although at half the rate of last quarter.

Excluding Hong Kong, the region grew 7%.

Net sales in the Americas grew 1% in constant currency.

Latin America grew 7%, led by strong growth in Chile, Peru and Mexico, while Brazil and Venezuela remain challenged.

Canada was flat and the US declined 1%, representing an improvement from last quarter.

Our sales in both the online and specialty multi-channels again rose double digits.

However, we saw continued declines in the brick-and-mortar business of midtier department stores as well as tourist-driven freestanding stores.

Net sales by product category were led by the 11% constant currency growth in fragrances for the quarter, reflecting the success of our strategy to focus on the higher margin luxury and artisanal segment of the category.

Jo Malone fragrances again led the category growth this quarter, as sales rose strong double digits, reflecting a very successful holiday program and expanded consumer reach.

Fragrance sales from Le Labo, Tom Ford and Frederic Malle rose strong double digits.

Makeup sales rose 7% in constant currency.

The biggest contributor was Tom Ford, which doubled its makeup business this quarter.

Estee Lauder and Smashbox rose high single digits and La Mer nearly tripled its small makeup business due to the successful launch of a new foundation.

MAC's makeup sales grew globally, with strong results in travel retail and in Asia-Pacific.

The brand's North America business improved from last quarter, but still declined low single digits due to slow foot traffic in its core channels of distribution.

Clinique sales were also soft as they were adversely affected by a promotional shift and the timing of new product launches.

Skincare sales grew 3% in constant currency, a nice improvement from last quarter.

Nearly all brands saw growth in skincare this quarter, led by double-digit increases from La Mer, GLAMGLOW and Bobbi Brown, and solid contribution from Estee Lauder.

Hair care sales fell 7% in constant currency, primarily due to the cadence of innovation on hair care products at Aveda.

Our gross margin declined 90 basis points from the prior year due primarily to obsolescence, new product mix and currency.

Operating expenses as a percent of sales decreased 60 basis points, primarily reflecting prudent expense management and general and administrative expenses in addition to our cost savings programs, and partially offset by higher store operating costs associated with our retail store growth.

Operating income rose 1% and operating margin decreased 30 basis points.

Net earnings decreased 1% to $454 million, reflecting higher net interest expense and a higher effective tax rate.

Diluted EPS of $1.22 was flat to the prior year, as reported, and grew 5% in constant currency.

Earnings per share for the quarter included $0.06 of unfavorable currency translation and $0.02 of dilution from our acquisitions, half of that from Too Faced.

EPS was higher than anticipated due primarily to favorable channel mix and more prudent expense management.

With respect to cash flow and capital allocation for the six months, we generated $824 million in net cash flows from operating activities and we invested $208 million in capital projects and $1.7 billion to complete the acquisitions of both BECCA and Too Faced.

The acquisitions were financed with both cash on hand and commercial paper.

We continue to return cash to stockholders, using $363 million to repurchase 4.2 million shares of our stock and $236 million to pay dividends.

So we are pleased with our Q2 results.

Now let's turn to our outlook for next quarter and for the full year.

With the inclusion of our acquisitions, we expect sales to grow between 6% and 7% in constant currency for the fiscal 2017 year, reflecting approximately 2 points from pricing, approximately 2 to 3 points from distribution as we expand the consumer reach of some of our brands, and 2 points from innovation and the acquisitions of By Kilian, BECCA and Too Faced.

We expect Too Faced to contribute more than half of this impact.

Currency translation is expected to depress sales by 2%, reflecting weighted average rates of $1.08 for the euro, $1.25 for the pound and JPY111 for the yen for the fiscal year.

Diluted EPS is expected to range between $3.29 and $3.33 before restructuring charges, including approximately $0.16 of dilution from currency translation and $0.07 dilution from the recent acquisitions, of which $0.04 is from Too Faced.

In constant currency, we expect our EPS to rise by 8% to 9%.

For the fiscal 2017 third quarter, our sales are expected to rise by approximately 7% to 8% in constant currency, including the incremental impact of acquisitions of approximately 350 to 400 basis points.

Negative currency translation is expected and estimated at approximately 2 percentage points.

The Middle East is expected to see sequential improvement over the next six months, as I indicated previously.

Net sales began to slow sharply in the second quarter last year and declined about 15% in the fourth quarter.

We expect to see more normal ordering patterns emerge as inventory becomes more in line with current sales trends in the Middle East.

Hong Kong is another market where we expect sequential improvement as the tourist business there has started to show a stabilizing trend.

Our business in US midtier department stores is expected to continue to remain challenged.

EPS is forecast to be between $0.65 and $0.70 before restructuring charges.

This includes dilution of about $0.03 from currency and $0.03 from acquisitions.

We delivered the first half within our sales range, and importantly, about our EPS forecast in constant currency.

We remain focused on delivering our full-year guidance against an accelerating backdrop of political, economic and currency volatility.

The political landscape around the world shifted considerably in 2016.

We recognize the potential challenges this changing landscape presence and there may be implications for our business in the US and around the world.

While we remain committed and confident in our strategy, we are somewhat cautious in the near term as a result of the global macro uncertainty.

We are very proud that despite the headwinds we have experienced, we continue to proactively manage our business around the globe to deliver excellent sales and profit growth with our amazing teams.

And that concludes our prepared remarks.

We will be happy to take your questions now.

(Operator Instructions).

Lauren Lieberman, Barclays capital.

I was hoping you could talk a little bit about Leading Beauty Forward actually, particularly given you referenced it a little bit.

And my understanding or my interpretation of the program has been that in part it's about investing for the future in new channels, new distribution and so on, and new business systems more for digital eCommerce, freestanding stores, etc.

But that part of the reason we don't see a margin benefit from the restructuring element of this is you need to keep your infrastructure around -- for example, US mature department stores -- fully intact until this new system is up and running.

Can you just -- is that a reasonable way of thinking about it?

And given how sharply the US piece of this is declining, is there an acceleration in being able to take some cost out of this, if you'll call it legacy distribution model?

Thanks.

Thank you for the question, Lauren.

Leading Beauty Forward actually is comprised of multiple programs, as you suggest.

Some were shorter-term, and some are longer-term, because they require structural changes.

One of the things that we are looking at, to your point, is in light of some of the acceleration that we are seeing and channel shifts in some parts of our business, certainly in the US.

How we might look to accelerate different components of Leading Beauty Forward, we are aggressively pursuing -- expanding our digital capabilities in the Company.

We are aggressively pursuing looking for other cost savings opportunities under the Leading Beauty Forward program, as well as other -- our other cost-saving programs as well.

But Leading Beauty Forward, the reason why we indicated initially when we announced the program that there was no cost savings this year and we would see some next year, but it was included within our guidance for next year, was just the timing of some of the longer-term items that were planned under Leading Beauty Forward that required some structural change.

But certainly we are looking, as we always do, aggressively to accelerate opportunities as we see them.

Just to add, one aspect that -- beyond reducing costs and doing what Tracey has explained, I believe one of the key benefits in the next two, three years of Leading Beauty Forward to reallocate resources to the fast-growing opportunity and the fast-growing businesses that we have around the world.

So this should further reinforce our strengths on top of creating more cost-saving and more margin over the long-term.

Ali Dibadj, Bernstein research.

I have a couple of things.

One is from a top-line perspective, at least to our math, based on your disclosures last quarter of sales and growth rates on your acquisitions, all of your acquisitions together this year, including the growth of those acquisitions, should be adding close to 3 points to your top-line growth.

So, not just the sales but the sales and the growth.

So does that mean your underlying organic local currency growth is about 3% to 4% for the year?

And if yes, how should we think about the attainability of your longer-term 6% to 8% local currency sales growth target, which I get is only about 5% to 7% excluding typical 1% M&A.

So that's on a top line.

And then the second question I had was on your inventory levels, I'm still just shocked that it's not improving.

Your own inventory levels, I think they're up about 20% year-on-year.

And I guess I'm disappointed and surprised given SAP is now in place and you should see [some] improvement and hopefully generate some more cash flow there.

so thanks on those two questions.

I'll start and perhaps Fabrizio will join in.

And the two questions are actually related, in terms of why we are not seeing some of the improvement that we had expected to see this year in terms of inventory.

So, our underlying business, if you exclude Kilian and Too Faced and BECCA, is more in the 4% to 5% range.

So you're correct with your math.

And that is for the reasons that we shared in our press release and in our prepared remarks.

We are seeing some pretty strong challenges here in the US in midtier department stores.

The Middle East, which is an very -- has historically been a very strong growth and profit market for us, is challenged.

And we've talked about Hong Kong now for the last couple of years.

So those are the primary drivers.

We expected a bit of a different mix in terms of the business, so that has left us with some higher inventory levels in some of our brands.

In other brands we've actually had to chase inventory because they are growing faster than we had expected, like Tom Ford and Jo Malone and some of those brands.

And we are managing all of that obviously to deliver the results that we shared with you this morning.

We are still committed certainly to leveraging SAP.

It has helped us tremendously as the portfolio has become broader and more complex to manage in more volatile times, so thank goodness we have SAP.

And we along with our supply chain and business partners can manage the different flows of inventory as situations change around the globe.

But we are still committed to the levels of inventory management that we have shared with you at the end of our year last year as we gave our three year guidance.

And we will certainly update that in August.

And I would just like to add one thing on the top line, which is 4% to 5% organic plus acquisition is what we see today.

And definitely all what we are doing in terms of action is to improve the ability of all these elements to grow faster in the future.

Meaning the organic is -- the good news is there are so many very strong drivers of growth within the current organic: travel retail, China gains, stabilization of Hong Kong, continue of online.

And they are all accretive in terms of margins.

So, the organic with the activity that we are doing and with actually we did decrease of the department store in the US, we chase this point to the most disappointing performance as part of our portfolio.

This part is decreasing as percentage of business and what is increasing as percentage of business are all the fast-growing channels and fast-growing activity.

So the 4% to 5% can become stronger over time and not weaker.

Plus the acquisition.

Now, the acquisition are doing fantastic.

We acquired great brands, both these concept of artisanal high-end fragrances, which as I said in my prepared remarks, all together are growing more than 30%, and the new acquisition like Too Faced, BECCA, which has high-growth brands into high-growth channels.

So the mix of improving our organics with the new change of mix and adapting to the new reality, and the strong acquisitions actually aims to reinforce our growth potential rather than dilute it.

And then the only other thing I will add, Ali, to Fabrizio's remarks is back to inventory.

Just remember that in Q2 we also have included the inventory from our new acquisition, mainly Too Faced.

Bonnie Herzog, Wells Fargo.

I have a question on MAC.

It seems that much of the brand softness in the US has been due to issues that have been outside your control, like weak tourist volumes and weak traffic at midtier department stores.

So, first, would you agree with that point?

And then second, in terms of what's in your control, you did mention some success you've had with your social media presence, which is great.

But curious how effective some of your promotions have been with MAC, and whether you've had success in attracting new consumers to the brand.

No, I frankly disagree that all what's happening on MAC is out of our control.

There are two things which happen on MAC.

One which is soft traffic in the distribution where MAC is present, and we need to correct that over time.

And so it's kind of in our control.

We can correct that.

And second, MAC had to make improvements in the social media activity penetration, and we are making these improvements.

And this is in our control and it's an area that we could do better.

And we are doing better, as I explained, and we'll continue to do even better.

And the third part is marketing programs.

MAC quality collection, quality of innovation will need to improve and continue to improve in the US, and we're working on it.

And some of the things have been already visible in quarter two, and more to come in the next quarter.

So it's not only a distribution adjustment, it's also a consumer engagement opportunity and also innovation programs opportunities, and we are addressing all of these three.

Then I want to add that on MAC we are also working on new freestanding store formats that will address the ability to have freestanding store also in lower productivity situations where low tourist traffic, because there will be smaller, more connected online, more engaging for the consumers and more profitable.

Rupesh Parikh, Oppenheimer.

I had a question on the gross margin line.

The gross margins came in a little bit light compared to expectations.

Can you help us understand the key drivers for the decline and what your expectations are for the back half of the year?

Sure.

So as I indicated in my prepared remarks, gross margin was impacted by some obsolescence.

Product mix, and in particular some of the programs that we've introduced this year, have been a bit higher cost than prior programs, so that has impacted our gross margin this year.

And then there's some geographic mix in there as well and channel mix, so we have a lot of mix components.

And then the last component is currency.

So currency for -- in terms of the transaction impact of currency has negatively impacted cost of goods this year.

And certainly that's what we had anticipated.

In terms of the back half of the year, we still expect to have some gross margin pressure on -- as it relates to some of the higher cost programs.

However, as Fabrizio indicated and as I indicated in my prepared remarks, we do have incremental pricing that we've taken in the second half of the year, so that will help mitigate some of that.

Steph Wissink, Piper Jaffray.

Tracey, just a follow-up on your previous comment regarding price increases.

If you could just give us some sense of historically how effective those have been and if we can think about it as an effective mix or if it's like-for-like pricing.

And then as a counterbalance, how you're thinking about using discounts and promotion to drive conversion, even on higher pricing if that's a thing we should think about.

As it gives you a little bit more flexibility to use some promotional tactics.

Great question.

Our pricing historically has been a combination of mix and like-for-like pricing.

I would say probably a little bit more like-for-like than mix, although I indicated obviously that we have introduced some higher cost programs, which obviously have higher prices in both last year as well as this year.

In terms of promotional activity, that's something that we have certain of our brands that have embedded within their operating model promotions, like Estee Lauder and Clinique, and the gift with product promotions that they do.

And in certain situations where the environment during certain times of the year becomes more promotional, we have the flexibility within our model to react and respond.

And certainly the US is one of the places where around holiday it has become more promotional and some of our brands have reacted and responded to that.

And then the last place that we will use promotion is in a situation where we do have higher inventory levels with certain brands, and you might see some very short-term promotional activity to liquidate that inventory.

So those are primarily the areas that we use promotion.

[STPs] have always been a part of our business, particularly in travel retail, and that's a form of value to the consumer.

But by and large, we are not heavy promotion company.

And so, we certainly use advertising and digital and social media now to drive traffic with the innovation of our products and the innovation of our marketing campaigns.

And the only thing I would like to add is that in a moment of evolution where consumers are really sensitive to innovation and to trying new products, one of the areas of promotion where we are investing more is sampling.

And we really are learning more and more how to make samplings very effective, also models that we call paid samplings, which are a very effective way to sampling.

So we are increasing sampling and thanks to this we are increasing the trial level of our new innovations.

Steve Powers, UBS.

So, clearly the 5% to 6% underlying growth that you're guiding to is still impressive versus what we've heard from other companies, but it is below the level you [were] confident in a few months ago, even while Q2 came in more or less aligned with expectations.

So could you just help us better frame where that more muted outlook over the second half of the year is coming from?

Because it doesn't look like your market expectations have changed all that much.

You seemed muted on department stores and the Middle East coming into the quarter, etc.

And then secondly, on expense control, which you've talked a little bit about, it looks as though your EPS guidance now reflects the higher FX headwinds that you've called out plus the Too Faced solution, and really nothing else, despite that underlying top-line growth reduction of 200 basis points or so in the back half.

So if that's correct, that implies a good deal of expense control to absorb the lower top line.

And I know, Fabrizio, you alluded to this in your prepared remarks, but could you or Tracy just provide some more color on where that -- where spending levels have been reduced relative to the October outlook?

Thanks.

Sure.

Let me start with the growth.

So we see the market 4% to 5%; our goal, our -- high-end goal has always been to grow at least 1 point more than market, meaning to continue growing market share.

And we are delivering that and we believe we will continue to deliver that in the long-term.

Now, to explain the detail of what happened, in reality we are taking the estimate down 1%.

That's what's happening.

And we are obviously still delivering 6% to 7% thanks to Too Faced.

But there is 1% less expected growth than there were before Too Faced.

Now, where this comes from and why we believe we will accelerate in second half, this comes from midtier department stores in the US that did less than what we expected originally.

And comes from the Middle East, emerging market mainly.

Middle East, that was really tough, and Turkey.

Turkey was a super-high-growth market for us.

And the very unfortunate event of the quarter two make Turkey grow much less than we were expecting.

And so this is what was 1% less.

And on the other side, there were many things that continue to do well, actually did it in better than what we expected.

So for example, the improvements in Asia and particularly in China are even better than expected.

The trend of stabilization of Hong Kong is very good news.

The continued success of Korea is really amazing, and this has huge implications for travel retail, frankly the super-high growth of travel retail, which show how our strategy is working, is even better than what we could have anticipated.

And the online continue to be very strong.

So at the end, the net of this is that many of them of our engines of growth that are getting better and better.

Two of the things that took us down in the past, Middle East and Hong Kong, are stabilizing.

And the issue remains midtier department store US, where we do not anticipate a lot of improvements in this quarter.

And that's what is the result of our estimate.

You need to add to this that our acquisition are very strong and they could do very well and even better.

And so that's the other element of strength that we are adding to the second semester in our ability to deliver our growth.

Now Tracey, on EPS.

Yes.

So on the expenses, as I spoke previously, one of the things that we have done certainly is tried to ramp up our cost-saving programs in light of some of the softness we are seeing in some parts of the business.

So some of the planned expenses that we had had in some parts of the business we have certainly pulled back on.

We have cut back on travel, we have cut back on some of the consulting projects that we had planned to do this year that have been canceled, and some of the hiring in certain areas that we had expected to do.

So those are the primary areas that we have addressed in terms of expense management.

Caroline Levy, CLSA.

Wondering what your advertising and marketing spend looked like year-over-year and as a percentage of sales.

And if you can just help us think through the third and fourth quarter as to how that might flow.

And do you see year-over-year maybe a decline in the fourth quarter?

And the other question is around this gross margin, just the risk that that has peaked, given that a lot of your growth is coming from more expensive input and that you're driving sampling and so on.

I'm just wondering if -- we seem to have been missing margin goals for a number of reasons, I don't know how much of that is currency and how much of that is just the change in the portfolio.

So at this time I could start and say our absolute advertising spending is going to be more or less stable across the year.

And is assumed to be a bit stronger, actually, in the second six months.

So in the six months we have in front of us, particularly in the third quarter, because of innovation launches and activities.

In terms of percentage of sales, so will goes largely down in the year, and this percentage is driven also by mix, meaning our advertised or more advertised brands -- I should say our traditionally advertised brands, are becoming a lower percentage of our total business.

And our brands which are supported by different tools from social media to sampling and to others, like in-store activities, are becoming a bigger percentage of the business.

Because of that, you should assume an overall stability for the next months of our absolute investment and a slight reduction of percentage of sales.

In gross margin, Tracey, you want to comment on that?

So in terms of gross margin, Caroline, as you know -- and clearly we talked about some of the factors that are driving it this year -- but you're right; the last couple of years it's been relatively flat.

That happens to correspond with mix shift in terms of the significant growth of makeup and fragrance and the slowdown in skincare.

So we do have different gross profit margins depending on the category.

We do also have certain of our cost activities that are targeted against cost of goods, and we do expect that that will continue over the next couple of years.

And again, clearly if the skincare mix picks up, that will also help gross profit margins.

So I do think we can see, and we do expect to see, some increase in gross profit margin.

But as long as makeup and fragrance are driving the best growth from a category standpoint, it will be somewhat suppressed.

Jason English, Goldman Sachs.

I'm going to try to jam two in here.

First, sort of a follow-up to the margin questions, or maybe it's a follow-up to Steve Powers' flow through question.

Fabrizio, in your answer to Steve's question, it sounded to me like you were saying there's also a mix shift by channel happening.

So while you're getting slower growth your slower growth is in lower margin channels, your faster growth is in higher margin channels, and this is helping to mitigate the bottom-line impact of this lower top-line growth.

So question one is, is that a reasonable interpretation?

And then second question, back to about to sustainability of top line, 4% to 5%, we hear you on that sort of underlying.

You've done 3.5% in the first half, on average.

You're guiding to 3.5% to 4% the third quarter and your full-year guide implies something in the 6% to 8% range by the time we get to the fourth quarter.

So how do we get comfort in that pace of acceleration?

And should we view even the slightly lower guide as still carrying a degree of risk?

Thank you.

So on the first question, the answer is yes.

The evolution of our channel mix is accretive.

But not only to margin, it's also accretive to growth potential, because we are swinging a bigger percentage of our business into higher growth channels from what we've seen.

So there is a positive on margin, a positive on growth.

And to your point, to your second question, I think I believe I already explained the key thing, is that the key area of acceleration are pricing; we had pricing in January, which added about 2 points of acceleration.

We have a lot of new -- particularly for new brands, new distribution opportunities which are planned to start being impacting the business in the second semester.

And there are 2 or 3 points that will come out on new distribution.

And this new distribution, I do mean -- new distribution for example, Tom Ford, Jo Malone in new countries, new cities, so it's not cannibalizing distribution.

It's really coverage of consumer.

That's why we call this consumer coverage opportunities.

Plus this includes some of the mix acceleration; meaning the moment Estee Lauder brand successfully build doors in ULTA, and they work very well.

This automatically creates more distribution which grows better.

So there is more of this in the second semester.

Then there is strong organic growth, the innovation that is working, as we have explained in our prepared remarks, will now continue to impact and grow in multiple areas.

I believe the good news that skincare is growing again and is adding [this engine].

And the other good news is that the engine we just created of fragrances, high-end fragrances, continue to grow very well and we continue to accelerate growth on a higher base.

Plus as I explained, Middle East and Hong Kong that have been two negatives in the first six months, should be better in the second six months.

And finally, the base is lower, frankly, particularly in quarter four.

The base is lower.

And so we believe that the combination of these things will bring our organic growth to the level that we are estimating.

On top of that, the new acquisitions, Too Faced and BECCA, are doing very well and we believe they will add a very significant sense of comfort to the ability to deliver the right growth.

And by the way, this will continue into next fiscal year.

Wendy Nicholson, Citi Research.

Just following up on that, I think this is two quarters in a row where you've come in at the low-end of your guidance, and yet some of your peers are saying the market has improved.

So I'm wondering, number one, what your commentary is on that.

Do you think you have the right forecasting ability, etc., etc., just to boost our confidence, if you will, in terms of the guide for the back half?

The other question I had, Tracey, you've talked in the past about the point of as you expand into specialty multi, there is a risk that the productivity of your doors or your counters in apartment stores will drop.

And I'm wondering if in the US you are seeing that?

As you expand distribution, as you open up more of your own freestanding stores, are you facing a problem at some of the major department stores?

And is that putting pressure on your growth?

So let me start with the second question, Wendy.

One of the things that our team is very careful about is the doors that we do open in specialty multi and the distance they are from certain department stores.

So we do look at the impact of cannibalization of doors, and we haven't seen it.

When we look at -- whether it's Clinique's performance, or whether we look at Estee Lauder, which is now starting to perform or expand in ULTA, as Fabrizio said, we are not seeing that cannibalization.

The net of the double points of distribution, if you will, are accretive and are growth for the brands.

One of the things that -- and we have talked about in the past, Wendy -- is that there is a shift in the retail landscape, obviously in the US where we are -- there is space being taken out of department stores that are closing doors.

And obviously we are working with them and managing to try to shift that business to online or to other department store doors.

But then our specialty customers, like Sephora and ULTA, are adding doors every year.

And so we are adding doors -- adding our brands in those doors as well as they expand.

And that's a shift that I think we will see for the next couple of years in the US.

It's driven by consumer and consumer traffic patterns.

It's certainly not driven by any of the actions that we are taking with respect to our business.

If anything, we are trying to be where our consumers are shopping, and they are shopping in multiple points of distribution.

So I think what we are seeing and how we are managing it is the right way to go for both parts of our business, but painful at least here in the near term this year.

And going back to the first part of the question is yes, we came at the low-end of the guidance, but the guidance has a high end and a whole low end.

So I would not conclude that we have issue of forecasting.

The issue is the one I explained.

The issue is that versus our competition, we are absolutely overexposed to midtier department store in the US particularly.

And this very high exposure, we have been obviously hit harder than others on the soft traffic that this channel has experienced in the last year.

And that's what we are trying to react to.

We are trying to continue to diversify our business globally in order to be able not to be over-dependent by any channel, any country, any brand.

And to have such a well-diversified portfolio that we can deliver our 1 point ahead of market or more growth independently from any other area of the business, or any specific area of the business.

So frankly, I'm very proud how we are pivoting the Company in terms of online, TR, specialty multi-distribution; how we are pivoting the Company in terms of social media versus historical more traditional way to engage the consumers; how we are pivoting the Company to penetrate makeup boom in a very aggressive way; how we have pivoted the Company to speed up and change our innovation models.

We are pivoting, and we are pivoting while continue to be one of the fastest growth companies in the consumer industry.

I personally am very proud of my team and the way we are managing this, although we do recognize that we were at the low end of our estimates, and we are overexposed to the softer than usual midtier department store in the US.

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.