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Estée Lauder Companies Inc. (NYSE:EL)

F4Q09 Earnings Call

August 13, 2009 9:30 am ET

Executives

Dennis D′Andrea – Vice President of Investor Relations

William P. Lauder – Executive Chairman

Fabrizio Freda – President and Chief Executive Officer

Richard W. Kunes – Executive Vice President and Chief Financial Officer

Analysts

Alice Longley - Buckingham Research

Wendy Nicholson - Citi

Andrew Sawyer - Goldman Sachs

Chris Ferrara - BAS-ML

William Schmitz - Deutsche Bank Securities

Neely Tamminga - Piper Jaffray

Lauren Lieberman - Barclays Capital

Connie Maneaty - BMO Capital Markets

Alec Patterson - RCM Investment Management

John Faucher - J.P. Morgan

Victoria Collin - Atlantic Equities

Linda Bolton Weiser - Caris and Company

Ali Dibadj - Sanford C. Bernstein

Mark Astrachan - Stifel Nicolaus

Operator

Good day everyone, and welcome to the Estée Lauder Companies fiscal 2009 year end conference call. Today’s call is being recorded and webcast. For opening remarks and introductions I would like to turn the call over to the Vice President of Investor Relations, Mr. Dennis D′Andrea. Please go ahead sir.

Dennis D′Andrea

Good morning everyone. On today’s call are William Lauder, Executive Chairman, Fabrizio Freda, President and Chief Executive Officer and Rick Kunes, 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’ll find factors that could cause actual results to differ materially from these forward-looking statements.

And I’ll turn the call over to William now.

William P. Lauder

Thank you, Dennis. Good morning and thank you for joining our fiscal 2009 year end conference call. In our remarks I will review last year’s accomplishments, Fabrizio will discuss the company’s outlook for the coming year and Rick will provide the financials.

I’m pleased to say that our results for fiscal 2009 were in line with expectations and we consider our performance respectable given the economic conditions. More importantly, the global recession gave us a chance to build share and restructure the organization. We were profitable, enjoyed a healthy balance sheet and generated strong cash flow from operations.

We took many defensive steps that made us stronger, smarter and better able to tackle competitive challenges that may come our way. At the same time we also played offense by investing in our brands, introducing new products and improving our competitive position in many markets. Fiscal 2009 began strongly and our first quarter results exceeded our expectations, but as you are well aware the remainder of the year was extremely challenging and in fact was one of the toughest times our company has ever faced. The economic downturn impacted our business in all regions and all our brands to varying degrees, which is reflected in our lower sales and earnings.

To put the economic impact in perspective, our fiscal 2009 sales fell short of our original projections by nearly $1 billion. Going into the year we had anticipated sales growth of 6 to 8% and instead ended up with a 2% decrease in organic sales and an additional 5% from negative currency translation. As a result, fiscal 2009 emerged as a year of change and a year of opportunity. Faced with a sudden decline in consumer spending, our employees rallied together and were open to making radical adjustments. To protect our earnings, we moved quickly to cut costs, reducing our planned spending by $250 million. We learned how to succeed with less. While we coped with the unexpected downturn on the one hand, we were also busy developing a long term strategy that sets out new goals and directions. I am proud of how the company came together with our employees feeling a renewed sense of purpose.

We changed our collective mindset and began to work more cooperatively toward a new and necessary course for the future. During the year Fabrizio and I led the effort to implement many of the important structural pieces of the four year strategy. We are now in excellent shape to execute the strategy and navigate with a clear direction.

One of the first steps we took was to realign the organization to support this strategy. We restructured the responsibilities and positions of senior management so that every person is in a role that best fits his or her strengths. We established several executive leadership teams that direct the company’s goals, investments and cost saving initiatives. We organized our brands into four clusters that will enable them to lever their strength and knowledge. They are grouped based on their target consumers and distribution channels.

The strategy focuses more on our regions instead of individual countries. We expect this effort to lead to greater economies of scale and the creation of more locally relevant products and services. As part of this regional structure, we established an affiliate for North America, where some of our customers are also redesigning their operations. We’re working together to bring greater traffic and excitement to stores. As the largest beauty supplier in North American prestige department stores, we feel we are in an excellent position to work closely with them to create compelling shopping destinations and enhance consumer relationship efforts.

Another part of the strategy involved prioritizing our investments toward the most promising opportunities. Our top priorities include skin care, large core in emerging markets particularly the Asia region, department stores and high growth channels. As you can see we made excellent progress setting up the framework for the strategy. For a moment I want to discuss some of the operational successes we achieved this past year.

Overall our international business grew in local currency due to good momentum in Asia, which didn’t feel the effects of the recession nearly as much as the rest of the world. Asia’s strong local currency sales growth was fueled by significant advances in Korea, China and Hong Kong. As a company we are a leader in the region and we estimate we gained share in our distribution in every Asian market except Singapore, where we maintained our position.

In China, the world’s fastest growing market, our sales rose nearly 30%. The Estée Lauder, La Mer and Bobbi Brown brands made spectacular gains. Estée Lauder is the number two brand at prestige retail in China and is rapidly closing the gap with its top competitor.

Our global skin care sales grew 2% in local currency. This is our most strategically important category and was our best performing one for the year. In U.S. prestige stores tracked by NPD, we gained share in skin care for the 12 months ended June 30 and our three largest brands in that category, Clinique, Estée Lauder and La Mer grew faster than competitors. In the U.S., M-A-C gained share while prestige makeup overall declined. M-A-C is the largest makeup brand in the U.S. prestige arena.

We had other share gains by brands and in certain regions. Clinique gained share in U.S. prestige department stores for the first time in several years. Differentiating itself from competitors, Clinique developed a host of products that address specific areas of concern to consumers such as dullness, acne, redness and uneven skin tone. Clinique also increased share in 10 countries including Germany and Hong Kong.

In continental Europe retail sales of our products rose at least 6 percentage points faster than those of prestige beauty, indicating solid share gains. We believe the company gained share in Russia, Germany, France and Spain.

In the UK we grew faster in retail than prestige beauty overall, with particularly strong momentum from our makeup artist brands. Our online business continued to soar with nearly every brand recording double digit gains. We launched e-commerce in Korea for M-A-C and in China for Estée Lauder and Clinique. Virtually all of our brands are now sold online in the U.S., either through our own sites or retailer sites. Clinique, Estée Lauder and M-A-C re-launched their U.S. websites with new features and interactive capabilities.

In online marketing, our brands made great strides communicating with consumers through social networking sites and developed strong followings. M-A-C’s Facebook page is one of the most popular in the beauty industry.

Ultimately our success rests in the quality and ingenuity of our products, and innovation continued to play a key role across our brands. To cite a few examples, M-A-C’s Hello Kitty Spring Color Collection was the most successful collaboration in its history. In addition, sales of M-A-C’s mineral franchise nearly doubled, exceeding $100 million at retail worldwide.

Clinique made news with its Redness Solutions Instant Relief Mineral Powder and Even Better Makeup. Both were marketed as makeup but also have skin care benefits. Estée Lauder’s Time Zone line of anti-aging moisturizers based on proprietary technology did well.

As a company, we successfully adapted to the new economic reality and re-framed our marketing messages to emphasize value. In their own way, each brand stressed its inherent value including product quality and performance. This is complemented by the personal service provided by beauty advisors or makeup artists and the average cost of use over time.

Some retailers took the unusual but successful step of posting prices for our products on their counters, while certain brands emphasized their complementary services such as makeup lessons at Bobbi Brown and mini-facials at Origins.

Operationally we finished the year with major improvements in inventory days and the number of SKUs. Our SMI demand planning and financial backbone functions, along with our UK manufacturing successfully went live.

As part of our $250 million belt tightening efforts we imposed hiring and salary freezes. We also announced the unfortunate but necessary step of reducing the workforce by 6% or roughly 2,000 people over two years. As you can see, your company has many strong attributes that will enable it to flourish, regardless of global business conditions. As the past year has shown, we performed well in a difficult environment but we never lost sight of the fact that we were also building a platform for long term profitable growth.

On July 1, I became Executive Chairman. In my new role I continue to work closely with our President and Chief Executive Officer, Fabrizio Freda and focus on building our brand equity, maintaining our strong culture of family values, leveraging our strengths and refining our strategy.

This is the last earnings call I will lead and I have enjoyed the dialog with all of you over the years. I want to thank you for your support, constructive comments and insightful questions. Fabrizio and Rick will host future calls.

At this juncture, I want to thank our thousands of employees worldwide for their hard work and their continuing passion during a challenging year. I also want to congratulate Fabrizio on becoming Chief Executive Officer. I have complete faith that Fabrizio has a clear vision of where the company is headed and what it will take to strengthen our leadership in prestige beauty. I look forward to working with him and providing insights as we blaze new trails.

Now I will pass it on to Fabrizio to talk about our plans for fiscal 2010.

Fabrizio Freda

Thank you William for those kind words and good morning everyone. I’m pleased to be addressing you for the first time as the company’s Chief Executive Officer. I want to take a moment to thank William for his leadership during the past five years and acknowledge his many contributions. I’ll rely on his deep industry experience and company knowledge as we begin our exciting journey to make the company more competitive and generate increased, sustainable, profitable growth.

As William explained much of the company efforts last year were devoted to establishing the foundation for the strategic plan. With that successfully done, the focus now is on executing the strategy with excellence.

Fiscal year 2010 is the first year of our four year strategy. This year we expect to show significant achievements toward our goals and we will continue to build our capabilities in many areas.

To frame our discussion, let me reiterate the goals that William and I set out in February. They include gaining share by growing sales at least 1% ahead of global visibility each year. In fiscal 2010 we expect the global prestige beauty industry to be flat and our sales growth to be zero to up 2% in constant currency. We expect the strongest growth in Asia in emerging markets while Western Europe, [inaudible] and North America will likely remain challenges.

In terms of product categories we continue to focus on skin care to drive sales growth worldwide. We expect Estée Lauder reformulated Advanced Night Repair to be a major contributor to this category. The product, which recently launched, is anticipated to be the brand’s biggest introduction in its history.

Our second goal is deriving more than 60% of sales outside of the United States. We ended 2009 at 59%. In fiscal 2010 our brands will expand into new countries, open more foreign doors and explore different distribution channels. To cite a few examples, M-A-C will open more than 50 doors internationally including a store in the world’s busiest train station, Shinjuku, Japan. Origin is latest to launch in China in March, which will be our ninth brand in the country. Our online business will continue its international expansion as Germany, Japan, Austria start e-commerce. We will have more brands online in China and Korea and dramatically increase our capabilities in digital marketing across the globe.

Our third goal is striving for annual profit improvement and growing our operating margins to between 12 and 13% by fiscal year 2013. This year we expect to achieve the first 90 to 130 basis points. That improvement will mainly come from realizing about one-third of the savings we have committed over the four year strategy. This effort is being led by our program management team which has overseen more than two dozen initiatives. Rick will give you details of the planned savings in a few minutes.

Increasing return on investment capital is another goal, and this year we expect to achieve over 100 basis points improvement reflecting profit growth. Our last goal is reducing inventory days by 15 to 20% over the four year period. In fiscal 2010, we anticipate a continuing the excellent fundamental trend inventory reduction we have achieved the past year. However, that progress will be offset by building inventory media as a hedge for the spring S&P implementation in our North American plants.

Our strategy through 2013 seeks to take the company to the next level by building on our numerous strengths, while eliminating the barriers that are hindering our profitable growth. In fiscal 2010 we will see many elements of this strategy impact our financial results. The first strength in our company is our diverse portfolio of brands, including three with annual sales between $1 billion and $2 billion [audio impairment] globally [audio impairment].

In 2010 we intend to start [inaudible] to manage the portfolio by strengthening the big heritage brands, cultivating tomorrow’s leading brands and addressing under performing brands.

Another strength is our long history of superior creativity and innovation, which has led to scores of breakthrough products based on the latest scientific research and technology. Our creativity spans many parts of the business including branded element promotions, design in advertising and this year we will leverage this strength globally. Our innovations will be focused on fewer, bigger ideas in high priority areas and eliminate smaller introductions that take time and money but don’t have a major impact.

We also will source ideas globally and spend more on research and development outside North America. We have established an innovation center in Paris for the European region and are developing one in Asia as well. We are confident that by combining more robust consumer research with our own intuitive approach to innovation, we create the most coveted products for consumers around the world.

Our selective distribution model, aided by highly trained beauty advisors and makeup artists, creates a visibility and demand for our brands through education and services. We are actively working now to strengthen service in traditional department stores, while better customizing the high touch model in other retail environments.

In department stores some brands are looking at ways to provide service that takes less time and appeals to different kinds of shoppers. They will offer experiences ranging from full skin care consultation to express in-and-out service. We also have adapted our service to other channels and recently added high tech to high touch. In Japanese store retail, we are testing a program enabling consumers to access problem information on their cell phones. Additionally, we plan to launch e-commerce in Japan via mobile devices this year. Japan will be our first affiliate to develop this capability.

The company has tremendous global reach across more than 140 countries and territories, but there is still room for expansion. For example, in China we sell in 32 cities with population greater than 1 million and we will continue our aggressive door opening this year. There are more than 600 cities with this size population in China which give us much potential opportunity for the long term.

And as we explained before, not all of our brands are available in every country. In fiscal 2010 many of our brands will enter new markets such as Bobbi Brown, which plans to open in Poland. Further we are leveraging the company’s scale and improving integration. Throughout the company we have started to work more cooperatively and are leveraging our strength across brands, regions and functions. The North American affiliates which launched July 1 is a prime example on how we are bringing our brands together under one organization, to work more effectively with retailers and gain economic scale. Under pinning of this is our dedicated and talented work force that has steered this company’s astounding growth. Our employees possess a deep knowledge of the beauty industry and entrepreneurial spirit, creativity and passion and a strong dedication to our company.

In fiscal 2010 they will be aligned and focused on one common strategy. And of course we are financially healthy. This year we expect to continue to have strong cash flow which allows us to invest in the business and keep growing. However, the best leverage as leverage our strength and rise to the next level, we must continuously improve and re-think our business.

We believe one way to lift our core competencies is by having greater consumer insights. We have begun building this capability throughout our regions to analyze consumer research and market intelligence, in helping to direct R&D and marketing investments efficiently. We expect that starting this year this added consumer insight will stimulate our creative process and provide the tools to unleash unexpected ideas and concepts. We are digging deeper into what our consumers think about beauty products, to understand their aspirations and selectively tailoring products by region.

We have identified several areas which drain resources from our investment priorities including our under performing brands. For example, one of the teams farthest along [inaudible] Aramis and designer fragrance. It has already made improvements in yearly performance, mix and new product development and cut the number of SKUs by more than 50% since fiscal 2007. The division expects to improve its customers by 220 basis points in fiscal year 2007. ADF will re-emphasize classics, focus on fewer major launches and sell each fragrance only in the regions where it has the greatest opportunity. Over time, ADF expects to transform its portfolio and generate a sizable improvement in operating margin. To be a leader in prestige beauty, we believe it is essential to be in fragrance because consumers love the product and it is an important complement of sales, particularly in Europe and strong retail.

Another brand which is re-vamping its global strategy to significantly improve profitability is [Defense]. In fiscal 2010, the brand is refocusing its product offering on skin care and its distribution to European pharmacies as well as China. It’s pulling out of the makeup and fragrance categories.

The company will continue to explore new ways to express value to consumers, especially in the U.S. We firmly believe that prestige products can succeed in this environment because they provide greater inherent value than beauty products for sale in other channels. The value is attributable to high performance, continuous innovation, depth of choice, superior customization, education, service and great branding.

As of July 1 we have a new organization in design and we are implementing the compensation plan to support the strategy. The company’s evolving its performance based compensation plan to award employees for achieving certain financial goals related to their specific area as well as the company overall without. The plan encourages employees to work for the good of the entire company, not just their piece of it. Bonuses will have a greater focus on profitability, return on investment, regional alignment and collaboration.

As William said, our company has been through tremendous changes in recent months, from external forces like economy to internal activities including re-starting, restructuring and building new capabilities. Our employees have managed throughout this period with a passion and determination that speaks well for their future success.

In order to build up on that momentum, we have strengthened our education and communication. Over 1,500 employees have completed programs to hone their leadership skills, particularly those related to change management. Additionally we are working hard to maintain a dynamic dialog with employees, to make the changes transparent and insure that everyone has clear understanding of our goals and priorities.

I’m proud of the Estée Lauder company’s outstanding efforts in 2009. During a difficult year, our employees responded in an exceptionally positive way. I’m confident the organization will make good strides in this, the first year of our strategy. When we come out of the recession, we believe we will be fundamentally stronger. With my newly aligned team in place and our expanded capabilities, we expect to leverage our unique assets and deliver on our fiscal 2010 goals. We shall start the journey to significantly strengthen our leadership position in global prestige beauty.

Rick will take you through the financials now. Rick?

Richard W. Kunes

Thank you, Fabrizio. This morning I’ll briefly cover our fiscal 2009 full year and then give you some guidance on the coming year and quarter. These discussions reflect our results before restructuring and special charges, which I’ll comment on separately.

Fiscal 2009 was a challenging year from a financial perspective, yet we were able to react very quickly and accomplish a great deal. We immediately took action to protect liquidity, cash flow and profit, achieving $250 million in belt tightening savings.

For fiscal 2009 full year, sales fell 2% versus last year in local currency, in the middle of our range. The strong dollar shaved 5 percentage points of growth, resulting in a reported sales decline of 7% to $7.3 billion. Net earnings for the year were $280.1 million compared with $474.1 million last year. Diluted EPS was $1.42, well below the $2.40 reported last year.

Looking at the regions, Asia-Pacific once again led [audio impairment], rising 14% in local currency. Every country in the region except for Japan grew. Many markets saw double digit gains. Korea jumped over 30% as tourists took advantage of the weak currency. China rose nearly 30%, fueled by robust prestige beauty growth, expanded distribution and share gains. Hong Kong, which benefited from an influx of mainland tourists, gained 19%. Australia benefited from the purchase of a [Nevada] distributor, and Malaysia and Thailand also recorded double digit growth.

In Europe, the Middle East and Africa, local currency sales fell 4%. Trade de-stocking was broad based. We estimate that it reduced regional sales by approximately 10% or about 5 weeks of retail inventory. Our travel retail business declined 14% as international airline passenger traffic remained weak, retailers de-stocked and the Korean won devaluation drove down pricing at airports there.

Sales in the UK, our second largest market, remained a bright spot, rising mid single digits. The growth was due to the success of our makeup artist brands, the launch of Ojon and double digit growth in our developing e-commerce business. Travel retail in the UK affiliate continued to represent about 44% of the reported sales in the region.

Among developing markets, India jumped over 40% off a very small base, the Middle East and Russia each grew 13% and Turkey was up 12%. The Americas was the region most deeply affected by the tough economic environment. Department stores, our primary channel of distribution, were particularly hard hit as consumers avoided the temptation of shopping malls. De-stocking was also prevalent in the Americas, as department stores sought to preserve cash. Their overall sales fell nearly 12% on average for the fiscal year, but declined only 6% in their beauty departments. Retail sales of our products in U.S. prestige department stores also declined 6% according to NVD, while our shipments to this channel fell about 8%.

Sales in alternative channels were mixed. Company owned retail stores, salons and our fragrance business in broad distribution suffered from the same malaise as department stores. Our online sales continued to grow double digits and direct response television contributed positively. Sales in Latin America rose nearly 15%.

Gross margin contracted by 30 basis points to 74.5%. The decrease came primarily from the following items. Approximately 30 basis points resulted from excess overhead costs that were not recovered due to lower production levels, obsolescence charges of 40 basis points, negative currency impact of 20 basis points and increased promotional activities of 10 basis points. These were partially offset by positive mix of business and other manufacturing variances of 50 basis points and 10 basis points respectively.

Operating expenses as a percent of sales rose 300 basis points to 67.5%. The significant decline in sales was the primary factor driving up the operating expense margin. Cash and impairment charges, which related primarily to [inaudible], Ojon and Michael Kors brands, negatively impacted the operating expense margin by about 90 basis points. We consider these charges to be part of the normal course of business since they were not due to any change in our fundamental business plans or accounting, but were a direct result of the difficult business environment.

Reductions in selling, advertising, merchandising and sampling spending were not in line with the lower sales volume, causing operating expense margin to increase by 60 basis points. This was intentional, as we maintained our marketing support in critical areas to gain share.

Higher IT investment, which includes our SMI program, added about 50 basis points. Net losses from currency translation added 40 basis points, and charges related to the deterioration of some retail customers added 20 basis points. However, the implementation of cost savings initiatives helped us reduce the value of operating expenses compared to the prior year.

Operating income fell 37% to $510.1 million compared to last year. Net interest expense rose to $75.7 million this year versus $66.8 million in fiscal 2008. The main driver of the increase is higher average set balances, partially offset by lower average interest rates on pre-existing borrowings.

The effective tax rate for the year was 33.6%, lower than usual due to a favorable settlement with the Appeals Division of the IRS.

During fiscal 2009, we recorded $91.7 million in restructuring and other special charges, a start on the $350 to $450 million we expect over the next few years. The charges primarily reflect employee related costs, asset and inventory write-offs, contract terminations and other special charges including consulting fees. These costs were equal to $0.29 per share for the fourth quarter and $0.31 per share for the full year.

Moving on to operating cash flow, our days sales outstanding improved to 45 days compared to 47 days at this time last year. We continue to monitor the financial health of our customers. One U.S. retailer has liquidated and we are keeping an eye on certain customers in Russia. Despite lower sales and de-stocking in the quarter, our inventory days improved to 155 compared with 180 days last year. The 25 day improvement came from the following areas, SKU reductions and forecasting improvements of 16 days, currency of 4 days and 5 days from the excess overhead adjustment I made to cost of goods in inventory which I mentioned earlier.

Reflecting positive working capital trends, our net trade cycle improved significantly to 112 days from 160 days a year ago. For the year ended June 30, 2009 operating cash flow increased to $696 million compared with $690 million the previous year. The increase reflects tighter management of inventory and lower accounts receivable, partially offset by lower income.

We spent $280 million for capital expenditures in fiscal 2009, 22% below the prior year and 25% below our original plan. This reflects continued investment behind our strategic priorities such as SAP, while curtailing or postponing counter construction and other activities.

I would also like to add that our qualified defined benefit plan is fully funded, following a $10 million contribution we made in June. The investment environment during fiscal 2009 was difficult. However, the plans’ investment strategy of matching the duration of the plans’ assets to the underlying liabilities helped mitigate the negative impact on the plans funded status.

In the first quarter we repurchased approximately 1.2 million shares of Class A common stock for $55 million. However, we suspended the program to conserve cash when the credit markets collapsed. Since the programs inception, we have repurchased 65 million shares for $2.6 billion and have 23 million shares remaining in our current authorization.

We ended the year with $865 million in cash on the balance sheet. This is due to the issuance of $300 million of notes last November, the suspension of our share repurchase program, decreased capital spending, dramatic inventory improvements and belt tightening savings.

When we feel the financial markets have sufficiently stabilized, we will expect to continue to return cash to shareholders through share repurchases and/or dividends. In fiscal 2009, we maintained our $0.55 per share dividend in a difficult environment, paying out $180 million.

Now I’ll discuss a few assumptions for the coming fiscal year. Most economists are predicting that we will emerge from this recession in 2010. Many are also predicting a continuation of the relatively high unemployment and a slow recovery. Similarly, we are not expecting a radical turnaround in the economy any time soon. For the year, we expect to grow faster than global prestige beauty by at least 1 percentage point, as we focus on driving our business in skin care and makeup and expanding our brands in new markets. We are forecasting sales growth for the year to be zero to up 2% in constant currency.

Foreign currency translation could aid our reported sales by up to 1 percentage point. For the year, our assumption for the euro is $1.40, for the yen $0.95 to the dollar, and for the pound $1.60. If the dollar strengthens or weakens against these major currencies, it will further impact our financial results.

We expect gross margin to improve about 60 to 80 basis points for the year, driven by improved product mix, the benefits of SKU rationalization, supply chain savings and lower obsolescence. Operating expenses as a percentage of sales is forecasted to decrease between 30 and 60 basis points due to ongoing cost containment efforts and our savings initiatives.

Let me give you some details behind some of these. We expect to realize $100 million in savings from the organizational restructuring and resizing. Cost of goods activities, including mix, reduced inventory related costs and supplier consolidation, are forecasted at around $35 million. The salary freeze we implemented in fiscal 2009 is expected to contribute $40 million in fiscal 2010. We expect to save an additional $15 million in the indirect procurement area. Savings will come in part from counters and displays, printed materials, packaging and advertising. We expect the actions we are taking will result in approximately $175 to $200 million of savings in fiscal 2010, with about $40 to $50 million coming in the first quarter.

Our success with the SMI implementation to date has given us the confidence to accelerate our timeline by 7 months, and launch SAP simultaneously throughout our nine manufacturing locations in North America. This represents half our global production and should allow us to realize the benefits sooner.

While we took some first steps in fiscal 2009 to implement our strategy, fiscal 2010 will be the first full year of executing our plan. In fiscal 2010, we expect to take restructuring and other special charges of $80 to $120 million. We will update these estimates if necessary on future calls.

We are making every effort to drive growth more profitably by reducing costs and reallocating the savings back into the most promising and profitable areas of the business. We expect 90 to 130 basis points improvement in operating margin this year, which we consider a good start towards our long range targets.

We are changing our processes to pursue ongoing improvements in cost, rather than viewing savings as a one time effort. We are aiming for continuous productivity improvements by limiting the growth of overheads in any given year to the percentage of sales growth.

At this time, we estimate our effective tax rate will be approximately 36.5%. Diluted EPS for fiscal 2010 is forecasted to be between $1.55 and $1.70. We anticipate building inventory in our second and third quarters and advance the North American SAP launch in the spring, while continuing to pursue inventory improvements in other areas of the business. This should result in flat inventory days year-over-year. Without an overall improvement in inventory levels, coupled with approximately $60 to $80 million in cash outlays related to restructuring, we expect to generate approximately $550 million in cash flow from operations. We plan to use approximately $300 to $325 million of cash for capital projects.

We ended fiscal 2009 with a return on invested capital of 10.8% excluding restructuring charges. Limited by our current conservative cash position, we expect our ROIC to end fiscal 2010 at approximately 12%. We continue to target return on investment capital of 19 to 20% by the end of 2013.

Our first quarter will have a tough comparison to the prior year when we generated sales and EPS growth of 11% and 30% respectively. We expect sales for the quarter to decline 2% to 5% in local currency. Adverse foreign exchange could hurt growth by another 3 to 4 percentage points. EPS for the three months is expected to come in between $0.23 and $0.30.

Regarding restructuring plans, from fiscal 2009 to fiscal 2013 we expect to record $350 to $450 million in restructuring and other special charges, and derive $450 to $550 million in savings. As we said before, we expect the benefits to be relatively linear throughout the period, with incremental savings in each year. The guidance we have provided indicates expected restructuring costs of $170 to $210 million from fiscal 2009 through fiscal 2010. We estimate approximately $60 to $80 million in additional restructuring charges in each of the next three fiscal years.

We expect savings from our initiatives in fiscal 2010 of approximately $200 million. Each of the ensuing three years is expected to see incremental savings in the range of $75 to $100 million per year. In February we told you that the major categories of savings were cost of goods, SMI, SKU reduction, distribution optimization, indirect procurement, outsourcing and regionalization. As we have done for fiscal 2010, we plan to provide a similar level of detail in future earnings calls. Please note that these are estimates based on our plans and information as of today. They are subject to change as circumstances dictate.

I just want to remind you again that our guidance for fiscal 2010 for the first quarter and the full year does not include restructuring and other special charges.

And that concludes my comments for today and we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Alice Longley - Buckingham Research.

Alice Longley - Buckingham Research

My question is about shipments in North America through fiscal 2010, after the first quarter. And I’m asking because of the comparisons in fiscal ’09. In other words, in the December quarter I believe your sales at retail and department stores in North America were down about 7% but your shipments were down something like 19%. And that would lead me to think that starting this year, even if your sales at retail were down again, your shipments could be up just against that comparison, without inventory re-stocking at retail your shipments could be up. Is that the right way to think about? Should there be a disconnect in your favor starting in the December quarter in terms of shipments versus sell through at retail?

William P. Lauder

I think, Alice, I wouldn’t necessarily make that leap on the math and the flows, because don’t forget the flows of inventory in December are anticipated replacements for the sell through in the December period of time, for January, February demand. If the retailers which are historically the lowest demand months of the 12 months. So historically the retailers might not be too aggressive in replacement of full inventory if they’re not seeing aggressive sell through.

As Rick mentioned, we’re anticipating a flat calendar fourth quarter holiday period of time, which would indicate that at the base bottom level, and at that sell through rate and restocking rate I wouldn’t want to make a leap of faith to say oh, there’s going to be some brilliant shipment numbers. Nor would I say there may not be. It all depends on the general macro environment as well as the active sell through numbers through the fourth quarter and the retailers confidence for consumer demand in January and February.

Alice Longley - Buckingham Research

So I should just assume shipments will be roughly in line with sell through for most of the fiscal year?

William P. Lauder

Yes. Given the way we work with our North American retailers, I want you to always assume that. As an assumption, and obviously we have exceptions to those rules on either side.

Alice Longley - Buckingham Research

Now your press release cited something about expected further destocking through this coming year. How do I work that into what you just said?

William P. Lauder

We think that, Alice, in North America there’ll be a little bit of destocking and the destocking that we were referencing more concerns Europe, where we think that will go on probably through the first quarter and maybe a little bit beyond that in the European arena. Because it takes longer for them to work through their inventories in many of the small perfumeries. So that was what that comment was referencing.

Operator

Your next question comes from Wendy Nicholson – Citi.

Wendy Nicholson – Citi

My question had to do with the $1 billion of under performing brands that you talked about, and I know you gave us some color in terms of the SKU reductions going on there. But in terms of the top line guidance for next year, it’s being basically flat in local currency, it doesn’t look like you’re expecting much value or much of that $1 billion to fall away. So I had sort of assumed there’d be more of a revenue drag maybe from that, but it sounds like instead you’re going to keep the revenues but just focus on the profitability. Can you just clarify that for me?

Fabrizio Freda

Yes. This is Fabrizio. Actually we are expected to go down in sales on at least two-thirds of our under performing brands, specifically we continue to estimate to be down in our designer fragrances for example. And the same with other under performing brands. There are some of the under performing brands that will start showing some signs of life on the top line because of the actions we are taking. And so it is a mixed asset, but only know I think you should assume the top line revenue will trend down and the total profitability of these brands will trend up.

Wendy Nicholson – Citi

But it sounds like, I mean, you’re expecting enough growth on the rest of the portfolio so that the drag from that slug that’s going away is not going to negatively impact the overall portfolio all that much.

Fabrizio Freda

Correct. That’s the key idea. We are working the mix very carefully. That’s why this is a three year plan and not a six month thing. And we are working the progress in a way that we grow year after year, despite the fact that we will take down the overall revenue of the non-strategic under performing brands and then the mix asset will generate more profit and possibly aggressively grow in revenues when the economy will pick up.

And specifically, there is also a combination of everything capitally. In fact if you look to our guidance, we plan to grow in skin care, to continue growing in skin care, which is in fact the most profitable part of our portfolio and the one that contains the least number of under performing brands.

Wendy Nicholson – Citi

And just as a related follow up to that, you know, something like Origins I was surprised for your commentary. I mean I know Origins is a relatively small brand, but the fact that you’re launching Origins for example in China this year, if I heard that correctly, because I thought you had just been pulling Origins out of a bunch of the international market.

Fabrizio Freda

No, no, that’s correct by the way. But let me clarify. We are very committed to Origins as a brand. It is the leader of the growing natural beauty arena. Origins is probably [inaudible] on its new position of Powered by Nature and Proven by Science. So the brand has been really cleaning up its distribution for those doors and countries where it cannot get the critical mass, it cannot be successfully profitable. For example, the brand is recently exiting Australia and New Zealand, Greece and Philippines. But on the other side, we plan to enter China and we plan to continue building the brand in the other existing countries where the brand has very high chances of success. You know this brand is only good consumer trend, so the brand has to be fixed but it’s not a brand we want not to invest on. On the contrary, it’s an important brand for us.

Operator

Your next question comes from Andrew Sawyer - Goldman Sachs.

Andrew Sawyer - Goldman Sachs

I just had a quick question on the operating margin outlook as we think about fiscal ’10. You’re forecasting 90 to 130 basis points, and Rick you mentioned that about 90 basis points of an impairment that hurt the base year. Are we correct in thinking that most of that impairment should drop off and so basically ex the impairment we’re looking at a flattish operating margin? And if that’s the case, should we think about it like the $250 million in belt tightening is kind of washed out by the structural $200 million of savings? Is that kind of the right way to think about it?

Richard W. Kunes

Yes, you’re certainly on the right track, Andrew. We reported an operating margin of around 7% excluding restructuring. And built into that was as you correctly referenced some belt tightening savings, about $250 million. And we had said that most of those were temporary in nature. And going into this fiscal year, we had to replace those savings, so you know you can’t operate a company without holding sales meetings as an example. So we replaced that $250 million of temporary savings with permanent savings. You know had we not done that, our operating margin this year would have been 4 to 5%.

So you know we’re really starting from a base if you will of 4 to 5% and guiding up to as you say somewheres 8 or north of 8% operating margin next year. And that’s why that $200 million of savings that we’ve identified, that’s what its’ supporting, getting us up to that level. So you know we’ve had to make some changes in the way that we operate and systemic changes that will last. In a way our processes of running the company to be able to build that base if you will, up to the level that we’re anticipating for next year, and allow us to hopefully make progress towards our long term goal which is another 100 and 225 basis points per year going through 2013.

Andrew Sawyer - Goldman Sachs

Maybe just kind of a quick follow up to that, you know with the organic sales up zero to 2, how should we think about what level of sales growth you guys need for the operating leverage to really kick in, you know because that’s obviously where you guys get a lot of juice on the margin side. Does it need to be 3, 4% sales growth before we start to sort of see that margin bump?

Richard W. Kunes

We have plans that say longer term, we’re anticipating this year as we’ve said somewhat flattish. And that towards the end of our strategic planning period, that the prestige marketplace would return more to normal growth patterns which in our terms is around 3 to 5%. So you know we see a slow but steady improvement towards that level, as we go through our strategic planning period. And that’s what we built roughly into our long range plans. And so we’re going to achieve the value of those savings absolutely, $450 to $550 and hopefully when mixed with those kind of growth patterns we’ll achieve our operating margin.

Andrew Sawyer - Goldman Sachs

I was just thinking more just technically, if you think about the fixed versus variable cost components of your business. You know at what level of sales growth do you really start to see a significant, meaningful operating leverage?

Richard W. Kunes

You know if you look at fixed expenses and you assume that they go with roughly with inflation more or less you’re talking about you know 3, 3.5%. So once we start to go over that level we start to really leverage that sales growth.

Operator

Your next question comes from Chris Ferrara - BAS-ML.

Chris Ferrara - BAS-ML

I guess just kind of following on that line of questioning, I guess Fabrizio I guess now that you have a few months under your belt since you initiated, when you first communicated the long term plans I guess the 8% margin or so that you’re contemplating right now for fiscal ’10, is that lower than what you thought you’d be working off of when you originally laid out these plans? Or maybe it’s higher. I just want to get a sense for what you thought the starting place was going to be for the overall targets.

Fabrizio Freda

I think it is pretty close to what we originally thought. We’ve always been thinking of going up in a linear form over the four years. And this is the first 1 point, 1.2 margin improvement over the four years. And so its’ pretty relevant, pretty significant. Also as Rick explained very well, the farther we had to substitute [bells] tracking with real savings, in reality the improvement we’re making is bigger than that in this [career] and not smaller as the analysis of impairments may suggest. So it’s a very significant step ahead. Obviously the first time we start to think of this, the recession had not really fully impacted us, so there’s been a kind of change in the thinking based on the recessionary environment. But in terms of the year-to-year progress, it is very consistent what we had been discussing in February with all of you.

Chris Ferrara - BAS-ML

And that makes sense, I guess, that the year-over-year progress is in line with what you thought but I guess the macro factors, it seems like maybe the macro factors are causing some of the good benefits you guys are getting from company specific actions to be applied more towards I guess the leakage call it in the overall economic environment that’s causing de-leveraging. And that would put you I guess at a lower base relative to where your ultimate target is. Is that right? Do you understand what I’m saying?

Fabrizio Freda

No. I don’t think it is right. So what happened, just to go back to the historical progress of our discussions on the strategic long term subject, is that we started believing that we could achieve our goals one year earlier. Then when the recession hit, we communicated that our plan would go through 2013 so in our February discussions with all of you, we basically added one year to the achievement of the target. So if something has changed because of the recessionary environment is not the absolute amount and not the substance of the plan, is the ability to implement it in three years versus four years. Sorry, in four years instead of three years. Basically we have taken one year more because of the recession.

Chris Ferrara - BAS-ML

Is there anything, Rick, in Q1 that is helping you from a non-operational perspective? Because and maybe its my own forecasting error, but I would have expected the earnings trajectory as you go through the rest of the year to have accelerated more than what the implication is when you guide to, you know, $0.23 to $0.30 and then $1.55 to $1.70. In other words you’re growing in Q1 EPS despite a tough comp, yet the growth in Q2 through Q4 implied by your guidance isn’t much of an acceleration. I mean it certainly is some, but not as much considering what you faced last year. Could you just comment on that?

Richard W. Kunes

Yes. First and the comment that you hear from us all the time is you have to look at our fiscal year performance and quarters can certainly be volatile. And in this particular case in the first quarter we do have one very, very significant launch for the company which is the re-launch of Advanced Night Repair, which is really kicking in internationally as well as here in the U.S. I mean that’s for instance an example of one big factor which can swing that quarter’s results substantially. And that’s why we always try to take a look at the full year and how we’re doing on a year by year basis.

Operator

Your next question comes from William Schmitz - Deutsche Bank Securities.

William Schmitz - Deutsche Bank Securities

A couple of things, so in terms of the holiday season I know you kind of have to plan to guess the purchases for January and February. I mean are you going to have adequate supply going into the season? You know just because the macro environment has improved a little bit since then and I know you’ve obviously pretty early into the season in a pretty dismal environment.

William P. Lauder

We’re comfortable with our supply chain, Bill, and I will have inventory. I mean obviously inventory is one of the spots we’re working hard to bring down, so we do have quite a bit of inventory. But the key is to make sure that we have the right SKUs and we’re being very protective if you will of our top selling SKUs in this inventory reduction project that we’re underway in. So we’re pretty comfortable.

Also one other thing, Bill, you should really consider in the holiday selling period, really true success is very strong sell through in holiday related merchandise so that within the last 10 days before the holiday you’re selling regular priced merchandise to those consumers looking for gifts. That is designing and forecasting it right for consumer demand.

William Schmitz - Deutsche Bank Securities

Can you also give a little more granularity about the new bonus compensation structure? I know you kind of painted it with a pretty broad brush with more of a focus on ROIC and regional alignment. But what does it really mean in terms of numbers?

Richard W. Kunes

Well, Bill, you know traditionally our compensation plan has had two main components. It was based more on how an individual unit did and less on how the role that they played within the total company performance. So that’s one change which is happening. Now it’s focused on not just how you do or how your business unit does, but how that unit plays its role in the total performance of the company. So there’s a lot better integration if you will with this strategic plan in the overall compensation scheme.

The second part is that we’ve always been leaning towards or favoring sales growth if you will. And some might say maybe growth regardless of cost. And now there’s an equal weighting between cost, profitability, sales growth, working capital, management or the elements that make up return on investment capital, so managing your receivables, your payables, your inventory level, your capital investment. So there really is a balance if you will across the entire financial performance of the company, tied in certainly with growth, goes well with managing your profitability, with managing your capital spending, managing your investment and working capital elements. And so all four of those elements are sort of built into the new compensation plan.

William Schmitz - Deutsche Bank Securities

Just one last one. I know you don’t really look at the business this way, but can you just say how big a percentage of sales emerging markets are and then how much they grew this year?

Richard W. Kunes

As a percentage of sales, Bill, I can’t off the top of my head unless someone else knows it. But we did talk about the growth rates in India and China and Dennis will be able to fill you in on how big they are as a percentage of our business, but all of those grew strong double digits. They were between 12 and some markets 30%. So we’re growing pretty good in those emerging markets.

William Schmitz - Deutsche Bank Securities

I mean 9 to 10% was the number I had just off the top of my head. I just wonder if it’s substantially bigger.

William P. Lauder

That’s pretty close.

Fabrizio Freda

I had 9% in mine, so you’re pretty close.

Operator

Your next question comes from Neely Tamminga - Piper Jaffray.

Neely Tamminga - Piper Jaffray

Just want to go back to looking at the $1 billion that is under performing, two-thirds of which you still expect to under perform next year and one-third you hope to improve. Just wondering, can you talk a little bit more about what’s going on behind those improvements? What may be, what brands you’re doing specifically? Is it changing the channels you’re distributing into or just overall strategies? Any sort of color there would probably be helpful and could insight us into what could come. And then related as a follow up on to the holiday side in terms of the assortment, William, completely agree with you on you know get very sharp on the price point up front and let them pay full price those 10 days prior. Just wondering how this year’s assortment might compare with last year’s either in GWP, UWP or just price point, average price point in general. That would be helpful.

William P. Lauder

Neely, let me answer your comment about the holiday season and then I’ll have Fabrizio talk to you about the under performing brands. The price points, we looked very closely last year at what the strong sell throughs were and where the consumers seemed to be offering the least resistance on a price point and positioning and value standpoint. And the opposite of course which is where they seemed to be most resistant. So what I think this year our holiday gift programming in all its different varieties are appropriately priced from both a brand and value proposition. As you know the consumer is actively and very strongly responding to value proposition offerings as well as very clear, price pointing which helps them to clearly understand the value of what they’re getting from our brands and from the products.

So I’d hesitate to say across our many, very different brands is there one magical price point? No, but there are magical price point levels which we are continuing to focus on by making sure consumers have access to price points that are under $30, under $50, under $75, just as a rough statement. And each brand has a slightly different approach to how they’re doing that.

We’re pretty confident both in the mix amongst the different price points and the values as well as the products themselves, as well as working very closely with the retailers from a positioning standpoint that each brand has the proper mix. And we are anticipating we hope like we said, we’re anticipating flat overall in sell through for that period of time. And within that mix, we’re anticipating strong sell through of the holiday merchandise, so that would also be strong sell through of regular priced product.

Neely Tamminga - Piper Jaffray

And related to the under performing?

Fabrizio Freda

Yes. Related to the under performing brands is first of all, we have already explained that obviously one of our under performing categories is in fragrances, and I think I commented a few times on what we’re doing on those. But we don’t want to call out what are the other brands we consider under performing, as this will be very sensitive competitive information which is not appropriate to share in the audiences. Let me clarify what are the kind of activities which are going on.

First of all we are looking at cost cutting across this brand in a very aggressive way. We are aggressively cutting cost and changing the way we are operating in some cases. We are considering exiting categories in which some of these brands are operating, some of these brands operate in multiple categories. In some of these categories they are very unprofitable. In other parts of the business in some categories they actually profit, so we’re making some tough decisions to cut these categories.

Some other of these brands are operating okay in some countries and they’re losing a lot of money in some other minor countries where they tried to be successful and they failed, and we never took the tough decision just to get out. And we are now taking some tough decision to get out of countries where simply those brands have no future in our opinion.

In some of the cases we are re-launching the brands, meaning we are giving the brand a chance to be re-launched and to be re-invigorated with new innovation, with new positioning and in some case with new channels and channel is natural consideration. In theory, in other cases where we failed in those first three attempts, we may consider even to let some brands go. Depending on how this discussion and learning process evolves over the next few years, we will take all these counsel and decisions.

Operator

Your next question comes from Lauren Lieberman - Barclays Capital.

Lauren Lieberman - Barclays Capital

I just wanted to follow up on the belt tightening expenses, because the implication will be that nearly all of those cost savings are actually coming back in 2010. I know there was one comment that we can’t have another year without sales meetings but I had sort of thought that the pacing of those expenses coming back like hiring and salary increases and things would maybe come back more paced with a return to sales growth. So if you can talk a little bit about what are those areas of “belt tightening” that needs to come back so quickly.

Richard W. Kunes

Sure, Lauren, and what we had said was I think when we announced the $250 that we said about 70 to 80% of those savings were temporary in nature. Some of those savings are around the area of advertising, where we took some decisions to do some activities which we could maybe consider more nice to have spending and we cut that spending. Sales meetings, as you said we were very tough on travel. We did a lot of things which to run a global business for the long term probably were not in the best interest, but we felt an obligation to do as much as we could without really hurting our business in the short term to try to deliver the profitability that we did for this year.

So now going into next year, we have to replace those with permanent savings. And as we’ve said you know 50% of our costs in our P&L are around people cost. And in order to achieve more systemic changes you can’t just make a decision without kind of structuring your business in a way that is more efficient than it is today. And that’s one of the cornerstones if you will of our long term strategy is to leverage scale, to build capabilities in certain areas, to utilize those capabilities across brands and be as efficient in the way we run our business as we possibly can for the long term. So we’ve made a lot of structural changes and we’ve made a lot of progress quite honestly in moving in that direction.

And I think you’ll see that when we talked about the savings in 2010, $100 million of those were related to resizing and restructuring, another $40 million of those were related to the salary freeze that we put in place last year that is going to benefit us in 2010, so a large portion of those savings are all around people which is logical. But we didn’t do it in a haphazard way. We’re being very strategic in the way that we go about changing our organization.

Lauren Lieberman - Barclays Capital

My expectation has been also with some of this spending, things like you mentioned, the advertising would surely come back a little bit ahead of sales growth sort of ahead of the expectation of people are spending money again. So is the weighting of these costs coming back maybe more back end loaded in the year because the expectation is the macro will gradually improve as we get through the fiscal year?

Richard W. Kunes

Certainly our outlook for the business is exactly that, and we know we’re up against a tough comp in the first quarter and we’re not really seeing as William has said a flattish Christmas season. And yet for the year we’re saying between zero and 2% sales growth, so obviously we’re down in the first quarter and we’re roughly flat in the second quarter. We are seeing a if you will a little bit of a sequential nature in the improvement of business during our fiscal year so that’s certainly a true statement.

Operator

Your next question comes from Connie Maneaty - BMO Capital Markets.

Connie Maneaty - BMO Capital Markets

Just a housekeeping question first, why is the tax rate going up? And then secondly I think you mentioned that a retailer liquidated that you were watching a couple of them in Russia. Could you tell us who liquidated and in which market that occurred, how long you would expect a drag on sales from any excess inventory in the channel? And how big is Russia? If we need to be watching it for bankruptcies there.

William P. Lauder

First Connie, you know we’re not going to mention names of people but the one retailer that liquidated is in the U.S. and I think you probably are aware of that one. And we have a couple of big customers in Russia where we are somewhat concerned. I think you’ve seen our reserve for bad debt go up by about $20 million and it was really related to those three items, so that’s why I say that we’re being cautious with that.

The other part of your question, I’m sorry, Connie, was?

Connie Maneaty - BMO Capital Markets

The tax rate, why is it going up? And also how big is Russia?

William P. Lauder

Sure. And I think that regarding the tax rate its not really why next year its going up so much, its why this year was so low. And in our fourth quarter we received notification from the IRS that they upheld a position we were taking, and we were able to release our reserve. So if you look at the tax rate this year it actually went down rather dramatically in the fourth quarter. That helped us quite honestly, that plus a little bit of sales helped us offset what came along regarding impaired assets. So that’s how we were able to get close to our guidance number that we’re out there and actually towards the high end of that guidance.

And then Russia, you know Russia is growing quite nicely. It’s not a huge market but it’s north of $100 million right now, so it’s a pretty good market for us.

Operator

Your next question comes from Alec Patterson - RCM Investment Management.

Alec Patterson - RCM Investment Management

Fabrizio, a question for you because the strategic over-arching nature of the programs you’ve got lined up incorporates kind of a cultural transformation of the company. And I guess I’m just trying to size it up. You’ve made public the incentive comp at least for yourself and I presume it reflects what is up there for others. And there’s more salary or compensation at risk as I understand and the nature of it, but as I line up all the things you’ve got set up for this coming year it doesn’t seem like you’ve laid out a very aggressive set of objectives relative to the size of the potential return on comp. And so I guess I just wanted to maybe hear you speak to the degree to which compensation is truly at risk here. Is there a potential, is there a set of goals for compensation that maybe exceeds the baseline you’ve laid out here? Because you’ve got sales growth that’s really anemic, with ACB growth in front of you. You’ve got a de-stocking lap in front of you, you’ve got impairment charges you’re going to lap. So it doesn’t make it sound as aggressive as the comp scheme would suggest it might should be.

Fabrizio Freda

First of all, I mean I think that this plan that we have laid out for 2013 and the first step in 2010 is very aggressive for what the company ever achieved. So if you think of the level of activity which is going on strategically, internal restructuring, internal resizing organization, internal meeting all these costs, internal taking inventories down in a dramatic way, internal refocus on the portfolio in the long term, those activities are really activities which requires a lot of casual change internally. It requires an enormous amount of change.

And the goal that we set for ourselves are in my opinion reasonably aggressive also because at least on the front of the profitability on the cost category, they’ve never been achieved in the past. This company as you know has been a company very strong in growth and in growing, but in terms of being able to profitably reduce the cost structure we had to make some important changes. So we are in the beginning of these changes so we need to prove ourselves. So I think we are reasonably aggressive with the goals we set for ourselves.

Said this, our compensation program is very strict, meaning that in case the goals are not achieved the compensation goes down. There’s a lot of risk and it goes down not only the bonus but we can add variationals on the stock options that would [inaudible]. So beyond the salary, the bonus and the stock options are going to be a risk but also they will be potentially down or up. And this is the big difference with the new conditions of this scheme versus the past, meaning that we will, the board will set the compensation committee of the board will set the targets. But around the targets if we under perform as an organization, we’re going to receive significantly less than the targets. It is also true that if we over achieve there will be some opportunity up for the vast majority of the senior management.

So it’s a very competitive compensation scheme and the goals are aggressive. Anyway, the goals will be again set by the compensation committee of the company.

Alec Patterson - RCM Investment Management

Rick, just a follow up. The impairment charge, it’s been fairly sizable now. If we get into a better operating environment or economic environment, is that expected to be reduced or come down? How should we think about that element?

Richard W. Kunes

Alec, the way it works is you go through, there’s triggering events from an accounting perspective and also a requirement that at least annually we do a very thorough analysis of our goodwill asset that’s on our books, an intangible asset on our books. So what has happened because of the business climate unfortunately is that the discounted cash flow if you will, or the future streams of income from these businesses was not enough because of the recession to kind of justify the assets that are on our balance sheet. So to the extent that the business climate in the future gets better, we would then not incur those impairments hopefully going forward. But they don’t come back if you will. Once you write it down, its written down the asset.

Operator

Your next question comes from John Faucher - J.P. Morgan.

John Faucher - J.P. Morgan

In taking a look at the regional local currency guidance, we assume that Asia-Pacific will grow sort of roughly at the recent run rate. And then look at Europe being up for the year, which I believe is your guidance from a local currency standpoint. That implies that the Americas number is probably somewhere down in the 3 to 5% range. And I guess I’m just wondering, that looks like a much bigger sequential improvement in the Europe, Middle East and Africa local currency numbers. And you talked about the retailer destocking, so I guess is that correct that you are going to see a bigger sequential improvement in your Middle East, Africa? And can you talk about why that sequential improvement is so much greater than, or at least a little bit greater than what you’re seeing in the Americas?

Richard W. Kunes

And I think that certainly we’ll see a sequential improvement in Europe. I think that the regions themselves are not quite as broadly disbursed as we’ve seen this year, but we’re not anticipating quite as fast a growth in Asia as we had in this fiscal year. But still a pretty solid number. We are anticipating as we said a decline in the Americas region. And for Europe certainly there is a swing because that destocking sort of goes away, not totally as we mentioned earlier, but it begins to go away over the course of our year. And so that’s kind of the guidance that we’ve given, John, on a regional basis.

John Faucher - J.P. Morgan

And then one follow up on this, on the Asia piece should we assume since you say its going to be a little bit slower, you’ve got that really tough comp in the first quarter, are the 2010 trends going to be more in line with what you’ve seen over the last three quarters? Or do you get a further deceleration from there?

Richard W. Kunes

I think it’s more of a continuation of what we’ve seen in Asia towards the second half of the year. That’s probably more realistic for what we’re looking for next year to some extent.

Operator

Your next question comes from Victoria Collin - Atlantic Equities.

Victoria Collin - Atlantic Equities

I just have a couple of questions on the full year guidance. I wonder if you could give us a steer on what you’re expecting to see from the travel retail performance during full year ’10. And secondly if your thoughts on the Q2 holiday season has improved since the last call. I notice you’re still remaining fairly cautious by saying that its sort of flat, but I remember last time you said flat to maybe moderately up. I just wondered what your thinking was.

William P. Lauder

Victoria, you might have to repeat the second part. On the first part regarding travel retail?

Fabrizio Freda

Yes, we expect our travel business to track really the trend in traffic. And we had a 14% decline in fiscal 2009, while the travel industry is forecasting international passenger traffic to decline 7 to 8% for the rest of the calendar year, while in 2010 it is expected to become flat. And so we think that more or less this will be also our trend. That’s our assumption, although we are continuing to grow market share also there, particularly in the areas of skin care and makeup. And we’ll continue working on increasing the conversion of passengers into buyers, which is an area we are working on.

Obviously there is a risk there, which is the potential arrival of the pandemic flu. If this risk does materialize, obviously it will effect our sales in travel retail.

Victoria Collin - Atlantic Equities

And then the second part of the question was on the holiday Q2 course and if you expect to see a sequential improvement or if its very much more flat year-over-year.

William P. Lauder

Yes, and I think Victoria we mentioned that we’re anticipating kind of a flat Christmas versus last year. So the holiday season we see as relatively even with what the results we had this year on a sell through basis. And there won’t be the destocking certainly to the extent that we saw last year, so that’s our outlook for the second quarter.

Operator

Your next question comes from Linda Bolton Weiser - Caris and Company.

Linda Bolton Weiser - Caris and Company

I was just wondering if you could give some specifics about the 8-K filings that have occurred so far where you disclosed some severance charge amounts and how many in headcount reduction that pertains to, and just the timing of when all that is occurring. And does the $100 million of organizational restructuring savings for FY ’10 does that assume there will be more announcements of severance and headcount reductions or does that just reflect what has already been taken?

William P. Lauder

Linda, I think if we look at our program overall, by the end of this calendar year we’ll be roughly through two-thirds of the savings that we had anticipated. So the charges that you’ve seen us take towards the end of last year certainly the P&L benefit of those mostly comes into our fiscal 2010 as well as additional initiatives that we have underway. But as I said, by the end of this calendar year we’ll probably be roughly two-thirds through our program and we had said when we first started it that it would take us about two years in total to work through all of our initiatives in that area, but that’s where we should stand by the end of calendar 2009.

Operator

Your next question comes from Ali Dibadj - Sanford C. Bernstein.

Ali Dibadj - Sanford C. Bernstein

Was wondering if you could help out a little bit on the questions in terms of the trajectory to get your 12 to 13% goal, because it seems to me that in this next year it’s a higher dollar amount and it’s a lower dollar amount as you progress. But from a margin perspective you’re expecting a little bit more of I guess hockey stick instead of just linear. And I’m not quite getting there, with the top line growth that you’ve described and a little bit of kind of volume re-levering. So I’m trying to figure out whether the things in 2010 you’re investing in, that you’re not going to invest in going forward whether it be more goodwill impairment, whether it be you know expectations of retailers exerting more pressure on you to invest, whether it be more emerging market kind of investments or mix, the taxes. Just trying to get a sense of the progression because it doesn’t seem to be linear to me, at least on EPS growth or the margin perspective.

Richard W. Kunes

Well I think, Ali, if you look at the savings numbers there, they’re not perfectly linear for sure because in this first year as we mentioned we had to make up for those temporary savings that we took in 2009 that we have to replace with permanent savings, as well as additional savings to improve 2010. But I think if you say that we’re slightly 8 percentage or roughly around those numbers as the guidance that we’ve given for this fiscal year, how much further do we have to get to get to that 12 to 13 percentage, 100 to 125 basis points a year over the next three years or slightly more than that? And if you look at our savings anticipated numbers by year, we see it between $75 and $100 million per year and I think that the math pretty much holds together that that should be enough, along with a little bit of sales leverage so we know there’s some sales leverage coming towards the later end of our plan. And along with some sales leverage gets us to that operating margin of the 12 to 13%.

Ali Dibadj - Sanford C. Bernstein

Because there’s nothing you’re anticipating investing in 2010, whether it be through impairment or other things that you’re not necessarily anticipating in the later years?

Richard W. Kunes

Yes, just on impairment technically you know if you know about an impairment you book that impairment. So we’re certainly not anticipating any impairment. Regarding investments, yes you’ll remember that we did talk about building some capabilities to help us over the long term. And we had mentioned that we would invest about $50 million in new capabilities around consumer insights and R&D and Asia and some other initiatives that we had laid out in our strategic plan conference call. And we are doing almost half or a little bit more than half of that investment in 2010, so there is some investment to that extent. Absolutely in the early years, and there’ll be some more in ’11, but then that goes away.

Fabrizio Freda

I’ve been covering it in my prepared remarks. You remember we are building this consumer insight capability that will serve us for the four year planned. Obviously we are trying to build the majority of this in 2010. We are investing inherently in Paris and in Asia, and building those centers that obviously we are going to do in 2010. We are investing and again I say this in my remarks, in becoming much better not only in online e-commerce but also in digital marketing. And we are doing this in 2010. So a lot of the four key building blocks of capabilities to which we have allocated about $50 million of the savings, the vast majority of them will need to start in the beginning of the journey. And so obviously this is not going to be [linear].

Ali Dibadj - Sanford C. Bernstein

Just to add to that, can you give me a sense of how you guys are thinking about the North American retail growth? You know in terms of I guess splitting it up by comparables, some sense of restocking and then on the flip side, distribution gain. How should we think about those going forward? And I guess part of my question is just a concern for some of the retailers as you’ve mentioned even in North America and understanding how you’ve taken account of that in your guidance for store closures or potential store closures, etc.

William P. Lauder

Well Ali I think we’re looking at it a number of different ways. First and foremost, it would appear right now that our core North American retailers are seeing a certain level of stability in consumer demand. Our performance of our brands is an indicator relative to total store performance, relative to performance across retailers, would indicate to us that there’s a certain level of stability with occasional pops up, occasional pops down, perhaps its [counterization], perhaps its other factors. Does that lead us to have a level of confidence to say its safe to come out now? I’m not necessarily certain. Does that lead us to say we ought to be cautiously optimistic over the next 12 months? I think that’s probably a better characteristic.

Over the long term, I think we’re going to see a slower, less aggressive recovery than we might imagine. And I think about store closures its very hard to estimate store closures because as you know, our retailers appear to be managing their balance sheets effectively and are looking for positive cash flow. And so long as they can operate a store with a positive cash flow at whatever level, they would choose to operate it and take the write down associated with the closure.

That’s not to say they won’t close stores. We’re not in the retail business. They’re in the retail business. But certainly we’re not anticipating significant store closures as a factor in looking at our North American business. Nor are we anticipating aggressive recovery of consumer demand over the near term, 12 to 18 months.

Ali Dibadj - Sanford C. Bernstein

So more or less it sounds like status quoish, no big network shift you expect over the next little while.

William P. Lauder

No.

Operator

Your next question comes from Mark Astrachan - Stifel Nicolaus.

Mark Astrachan - Stifel Nicolaus

I guess just a follow up on that last line of questioning in terms of whether you can give a number about the amount of cost savings that are going to be reinvested back into the business. And then relatedly, if you could talk a bit about your views on consumer spending and what if anything you need to do in terms of brand support, promotional activity, etc., to really entice those folks to come back and be consumers again.

Richard W. Kunes

Mark, regarding the investment spending we talked about a $50 million investment for capabilities building and slightly more than half of that is happening in fiscal 2010. The remainder would probably be in 2011.

And regarding the other piece, I’ll leave that for Fabrizio or William.

William P. Lauder

Well you know generally, Mark, what we’re seeing as I just mentioned with consumer spending and consumer responsiveness, we’re seeing some caution from the consumer but certainly not the reticence she had from the late fall 2008 through the early spring of 2009. She is coming back, but she is responding to stronger value propositions, more obvious reframing of the value propositions if you will to a certain extent, which is something Fabrizio mentioned which is stating more clearly to her the obvious that was always there about the value that the consumer can get from our brands that she is interested in.

And I think we’re seeing response to this and we need to continue to be mindful of the fact that she is value conscious, will continue to be value conscious, appreciates the value she gets from our brands both from a service level, product performance and environment standpoint. And we need to be even more sensitive to those ideas that she responds to.

Fabrizio Freda

I just want to add that in order to recover the consumer, we need to first of all continue to push innovation in a big way. The consumer continues to respond very positively to outstanding innovation. And so we are getting up for that. And the other one is value, as William mentioned. And on value we are making a lot of new effort as I covered in my opening remarks. And driving those two things I believe we will be able to be very competitive in establishing the future comeback of the consumer. This will be very difficult in my region. In the U.S. the consumers are and will remain for a while very value conscious, very prudent. And they’re instant in how they’re going to buy and how much they will be sensitive to promotional efforts will remain where it is now I think for a while and will take some time before it goes back to more normal.

In Europe and in Asia we see very different behaviors. And the value conscious is there, but the promotional interest is much lower. And that’s an important thing. We don’t think in reality trading down outside of our prestige arena, despite many discussions that are happening in this area. Actually if you look at North American numbers, and take skin care which is our most important category, the number of units are going down both in mass and in prestige. And within our portfolio in prestige, we see some trading to our entry priced brands like Clinique or M-A-C, which are obviously growing share in a very nice way, but when we talk to our consumers they really like to stay within the channel they are casting.

And when we look internationally, actually we are seeing if anything people in Asia some trading up, which is in a very, very big way happening in China. So all in all we are pretty confident, but the toughest market always remains the U.S. but let’s not forget we have 60% of our market internationally.

Mark Astrachan - Stifel Nicolaus

Just one follow up. So I’m assuming that its fair to assume that your guidance is including some of that mix trade down in terms of potential value offerings.

William P. Lauder

Yes. Certainly. You know our numbers are built on Joe Saks. No question about it.

Fabrizio Freda

Sure. Let’s coincide that our entry price brands like Clinique and M-A-C which is the ones that are growing market share the best, and you know in our regions where we are growing the best, and I stick with skin care where we are growing more aggressively, our most profitable part of the business. So the direction we are taking over time will help our mix, not confuse it.

Operator

That concludes today’s question-and-answer session. If you were unable to join for the entire call, a play back will be available at 12:00 noon Eastern Time today through August 26. To hear a recording of the call please dial 800-642-1687, pass code 18586136. That concludes today’s Estée Lauder conference call. I would like to thank you all for your participation and wish you all a good day.

William P. Lauder

Thank you.

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