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Executives

Dennis D'Andrea – IR

Fabrizio Freda – President and CEO

Richard Kunes – EVP and CFO

Analysts

Wendy Nicholson – Citi Investments Research

Alice Longley – Buckingham Research

Neely Tamminga – Piper Jaffray

Linda Bolton Weiser – Caris & Company

Andrew Sawyer – Goldman Sachs

Bill Schmitz – Deutsche Bank

Victoria Collin – Atlantic Equities

Lauren Lieberman – Barclays Capital

Chris Ferrara – Banc of America-Merrill Lynch

Ali Dibadj – Bernstein

The Estee Lauder Companies Inc. (EL) F1Q10 (Qtr End 09/30/09) Earnings Call Transcript October 30, 2009 9:30 AM ET

Operator

Good day everyone, and welcome to The Estée Lauder Companies fiscal 2010 first quarter conference call. Today’s call is being recorded and webcast. For opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Dennis D'Andrea. Please go ahead, sir.

Dennis D'Andrea

Good morning, everyone. We have on today’s call Fabrizio Freda, President and Chief Executive Officer; and Rick Kunes, Executive Vice President and Chief Financial Officer. Thia Breen, President of North America is also on the call and will be available for questions.

Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC where you’ll find factors that could cause actual results to differ materially from these forward-looking statements. You can also find a reconciliation between GAAP and non-GAAP figures in our press release and on the Investor Section of our Web site.

And I will turn the call over to Fabrizio now.

Fabrizio Freda

Thank you, Dennis. Good morning. I am pleased you have joined us for our fiscal 2010 first quarter earnings call. In our remarks this morning, I will discuss progress we’ve made against our strategy during the quarter, and Rick will provide the financial details.

Two weeks ago we said that sales for the quarter would be better than we had expected, and earnings per share would be significantly higher. This morning we announced that before restructuring, our sales were $1.85 billion, a 3% decline versus the previous year period. Diluted earnings per share were $0.85 compared to $0.26 in the year ago quarter. Sales were better than we forecasted due to improved business in Asia, better than expected airline passenger traffic in travel retail, and a major product launch.

Going into the quarter, we planned our spending to reflect the lower level of sales we anticipated. Although sales far exceeded our projections, we were extremely cautious in our spending, so earnings ended up substantially higher.

Our higher operating income came mainly from three areas. One, increased sales that we achieved without additional costs. Two, a lower cost of goods; thanks to the improved mix that was weighted towards skincare. And three, restrained spending because of uncertainty in the environment. Some of the spending that we curtailed will occur in the future quarters as we ramp up our innovation, advertising, and marketing activities behind improved consumer confidence and major opportunities. Looking at our top line, our quarter over quarter sales were unchanged on a constant currency basis reflecting continued strong growth in Asia, flat sales in Europe, and lower sales in Americas. We had higher sales than a year ago in several important international markets, in our priority skincare category worldwide and in our online business. We also benefitted from the selling of the new higher margin products and initial success of our strategy in travel retail, converting shoppers into buyers.

Foreign currency remained a drag on our results but not to the extent we envisioned. Despite the upbeat first quarter performance, we believe it is prudent to remain cautious in our outlook for the balance of the fiscal year. In the US, which is our largest market, high unemployment and weak consumer sentiment create continuing economic uncertainty, which affects consumer spending. These trends and other factors are also evident in several key western European countries, such as Italy and Spain as well as Japan.

Additionally, the holiday outlook in the US is uncertain. Some high-end retailers are under pressure, the H1N1 virus remains a risk that could affect our business, and we expect competitors to be more aggressive. Moreover, internally we have challenged to manage the vast amount of projects underway and at the same time adapt to the cultural change. Thus, while we are increasing full year guidance, we are tempering that outlook with a healthy degree of prudence.

Let me also remind you that during the quarter, we began executing the four-year strategy that William Lauder and I communicated last February, which seeks to grow our global share in prestige beauty and generate improved and sustainable profitable growth. This was the first of 16 quarters of our strategic journey. I am happy to say that we made quantifiable progress toward our goals right from the start. In the quarter, as a company, we gained share in the US prestige department store in skincare, makeup and the beauty department overall as measured by NPD.

Our brands also improved share in travel retail and prestige distribution in many markets, including the United Kingdom, China, and Russia. To advance our strategy, as we said we would, we took decisive actions on some brands to position us for greater future profitability. We made a difficult decision to close wholesale distribution of our Prescriptives brand. After considering various alternatives, we determined that the brand did not have strong enough global consumer appeal, nor did it meet our financial targets.

We will now be able to utilize Prescriptives’ key assets, including formulas and trademarks in other brands and deploy its resources against strategic priorities that have greater potential. This move underscores our commitment to moving forward aggressively and fine-tuning our portfolio so we have the most powerful collection of prestige beauty brands anywhere. We are locating our financial and human resources to those brands and businesses that provide the best returns.

In addition to Prescriptives, we discontinued some smaller brands and incubator investments. This is part of an effort to streamline our assets and not use management time and money on endeavors with little payoff. We closed Eyes by Design and evolved Grassroots into Grassroots Research Labs, which focuses on a handful of skincare products that combine nature and science.

As we discussed last quarter, Aramis and Designer Fragrances is working diligently to improve its profitability. It made good strides in the recent three months by cutting expenses, raising some wholesale prices where relevant and reducing the amount of promotional offerings. The division also is striking a better balance between supporting its classics and introducing new products. It recently began a new advertising campaign for Cashmere Mist, a 50-year-old classic that is still a best seller in the US prestige department stores; and it successfully launched Michael Kors Very Hollywood, which is distributed only in the US and UK, where the designer has a strong following. DKNY Be Delicious Fresh Blossom was successful addition to the Be Delicious franchise and helped the division performance globally.

The successful development of our strategic modernization initiative (SMI) is another integral part of our strategy. The next major undertaking is our North American manufacturing facilities which are scheduled to go live in April. At that point, about 50% of the implementation will be complete, up from 30% now. We are on track to substantially finish the development of the project by the end of 2012.

Our cost savings initiatives are also moving ahead according to plan. In the quarter, we realized savings of $48 million, roughly 25% of our target this year. Major areas of saving in fiscal 2010 will come from resizing and restructuring initiatives, merit salary freezes, improvements in cost of goods, and indirect procurement. Additionally, the expected head count reduction we previously announced, which we said could take up to two years will be two-third complete by the end of December. Reducing costs gives us better leverage on our sales and that leverage should grow as the savings accelerate over time.

The achievement of our strategic goals depend on cost cutting on one end but even more importantly on investing in the most promising opportunities worldwide to grow our business. Throughout the company, we are focused on leading in skincare and we grew sales and operating income in the category in our first quarter. This was accomplished in large part by selling of the Estee Lauder brand’s new version of its iconic Advanced Night Repair which launched in July in more than 140 countries. We expect it to be the biggest launch in the history of the flagship brand in its first year. The product has a high gross margin and helps drive the brand gains in global skin care sales and operating income.

Additionally, Clinique and Estee Lauder solidified their positions as the top two skincare brands in US prestige department store as they gained share of 60 basis points and 20 basis points respectively. In another example, our Bobbi Brown brand best-known for its makeup artistry, enjoyed a big jump in skincare sales in Asia, thanks to its new cleansing oil, which was developed specifically for that market. In line with the corporate strategy, Bobbi Brown is committed to increasing the percentage of skincare sale in its overall mix in the next several years.

In the makeup category, product expansions into lipstick and eyeshadows in the Estée Lauder brand (inaudible) franchise helped lift its sales. Clinique benefited from innovative lip and face products. MAC posted solid growth in international markets, driven by appealing makeup collection and door expansion. MAC entry level prices with prestige are helping to boost sales and attract consumers seeking great value. The company's future investment will continue to be directed to areas where we see the greatest momentum and potential. To accelerate its solid growth, MAC expects to open at least 65 freestanding stores this fiscal year, mostly in foreign markets.

A new MAC store in Grand Central Terminal in New York City has far exceeded expectation since its August opening, and the brand will open in another high traffic location in New York in Times Square slated for the spring. It will also rollout e-commerce Web site in German and Japan in January.

Other brands, such as Darphin and Origins are refocusing their core positioning to realize their potential. Darphin discontinued makeup and fragrance globally and closed department store distribution in North America and in the UK. In the quarter, it opened eight North America specialty stores and salons and expects to aggressively build on its pharmacy door distribution in Europe already this fiscal year. Origins has made good strides in refocusing its geographic presence. As we mentioned on our last call, the brand is latest [ph] to launch in China in March. Further, Origins recently closed its Australian affiliate but will continue to be distributed through a regional retailer, and it exited New Zealand, Philippines, Greece as it further enhances the skincare product line, cost should also improve.

Our brands continuously look for new ways of reaching consumers, consistent with their image. For example, a few weeks ago, Bumble and Bumble opened a styling bar and shop on the beautifully designed main floor of Bloomingdale's, 59th Street. This setup is the first for the store and the first for the brand. Bumble-trained stylists also working also (inaudible) services and advise consumers on the brand hair care products. In its first few weeks, the shop is bringing traffic to Bumble-salon network for cut and color service via salon locator onsite. During the quarter, Bumble also opened its first travel retail location at an airport in Singapore.

Clinique also unveiled its modern vibrant space in Bloomingdale's new beauty department, which will attract consumers looking for a variety of high-touch personalized services. The open floor plan lets consumer denote [ph] their concern by using a computer and conversing with a consultant, whichever makes them more comfortable. They can browse with a shopping basket. Play with the latest makeup shades or grab the pre-packet skincare kits and be out in a minute. Clinique’s new approach redefines its service model and elevates the company commitment to individualized service and education and offer consumer a choice in how they want to shop, that having created new energy and excitement at the counter. And servicing consumer in multiple ways, our brands would also help reinvigorate the department store and drive traffic to this important shopping destination.

Clinique opened a similar counter at Selfridges in London, and is exploring ways to provide high-touch service in European perfumeries where there are rent consultants dedicated to the brand. Our high-touch service in all itself [ph] is one of the important pieces that comprise our brand value proposition.

In North America, our brands have continued to emphasize their value. Retailers are posting prices, offering less expensive, smaller sized products, providing free makeovers and advise, and our brands are updating their superior service across new technologies and platforms. Estée Lauder brand has introduced smaller sizes and its best-selling fragrances for a suggested retail price of $29.50, slashing $10 of the previous entry-level price; and its holiday gift sets will have wider suggested price ranges, giving consumers more choice.

Turning to our regions; again, we are pleased with strong growth in Asia Pacific, with standout sales increases in China, Korea and Hong Kong. The continued recession in Japan depressed our sales in that market, particularly in skincare. But overall, sales in the region exceeded our projections. We are optimistic that Asia will show strong growth again in our second quarter. Upcoming investment in the region will be targeted to online expansion, new consumer insight and locally relevant innovation efforts.

The Europe, Middle East and Africa region performed better than planned; however, Spain and Italy had lower results as limited destocking continued in those markets. The Americas continues to be our most challenging region, and the forecast for the holiday season remains uncertain. That said, we have prepared for the current environment – we are prepared for the current environment by for example, producing fewer blockbuster gift sets. In this climate, consumers are looking for brands they know and trust, and we will support our popular classic products and franchises. We believe that our prestige products and gift sets, which combine innovation with good value, will attract consumers to our campus.

I want to emphasize that this quarter’s performance, while impressive, is just a first step in possibly the easiest step of our long journey to implement our strategy and become a sustainable and profitable company. There are still many quarters ahead of this difficult road and much work to do. Although we expect the external environment will improve in future years, we may face internal challenges for some time, and our corporate culture undergoes an important change.

That said, even though we aren't far along in our strategy it is encouraging to note that we had began to successfully align the fundamental building blocks that will fuel our growth. We are cutting costs substantially through resizing and restructuring; accelerated sales in skincare, which is our priority category, having higher gross margins; rededicated ourselves to innovation and created a more holistic efficient organization.

We expect to increase our investment during the remainder of the year to accelerate growth in our most promising opportunities, advance our priorities, and gain share. Our four key product categories are supported by a wide ranging portfolio of amazing brands, each of which is distinctive in its own way. Our unique high-touch service model enhances the performance of our products and forges strong emotional bonds with consumers. This winning combination, which is infused with innovation across product development and new approaches to customized service, should enable us to increase our global leadership position in prestige beauty. We are confident that we have started building the right fundamentals that should enable us to progress toward our goals by 2013.

Before I turn the call over to Rick, I want to take a moment to personally thank all our people for their hard work this quarter. Our talented employees are one of our most important strengths and they dedicate themselves everyday to making Estée Lauder Companies the best it can be, and I am extremely proud and grateful.

Now, I will turn the call over to Rick to provide the financial details of the quarter. Rick?

Richard Kunes

Thank you, Fabrizio, and good morning, everyone. A quick reminder, my discussions on the quarter and the outlook exclude restructuring and special charges, which I will comment on separately. As Fabrizio said, the quarter came in much better than we anticipated. In local currency, sales this quarter were comparable to the prior year. As you will recall, we had a very good first quarter last year before the financial crisis really took hold. Adverse currency translation continued to weigh on sales by about three percentage points, resulting in a reported sales decline of 3% to $1.85 billion.

Net earnings for the quarter more than tripled to $168 million compared with $51.2 million in the prior year quarter. And diluted EPS was $0.85 compared to $0.26 in the prior year, $0.55 above the high end of our expectations. There are number of factors contribute to the stronger-than-expected quarter. Before we review them, I would like to remind you that we have just started our four-year program. There may be interim volatility, since we have multiple initiatives going on at once in the midst of significant cultural changes, while we have our sights firmly on our goal of 12% to 13% operating margin by 2013.

We had anticipated organic sales growth of 2% to 5% and we came in flat. Therefore, we beat our sales projection by roughly $70 million. Those sales came primarily from our high margin businesses, travel retail and skincare, creating a favorable mix. Additionally, our operating expenses came in quite a bit lower than anticipated, given the weak consumer demand in some major markets, including the US, Japan, and much of southern Europe our affiliates were extremely cautious in their spending, although some of this will come back later in this fiscal year. Lastly, our lower-than-expected tax rate and more favorable foreign exchange rates contributed to the variance.

Compared to last year, we saw the fastest growth in the strategically important skincare category. Sales rose 5% in local currency, aided by the launch of Estée Lauder’s new Advanced Night Repair. Strong growth in Asia and Europe was fueled by high margin products and increased sales in our emerging markets also benefited the category.

In makeup, local currency sales decreased 1%, as growth at MAC was more than offset by declines in several other less profitable brands. Our fragrance business fell 8%, excluding currency, and declined across all geographic regions. This category has suffered disproportionately in the difficult economy. The success of the current quarter's launch of Michael Kors Very Hollywood and the recent introduction of DKNY Be Delicious Fresh Blossom was not enough to offset larger prior-year losses.

In hair care, sales rose 1% due primarily to Ojon’s good performance on direct response TV and innovative new styling products. Our business in salons remained soft as anticipated.

When we look at our geographic results, our strongest sales growth continues to come from the Asia-Pacific region, which saw a 12% rise in local currency on top of the 21% increase last year. Every country except Japan recorded increases. Among the top markets in the region, Japan declined 8%, as it continued to suffer from the tough economic environment. However, Korea, our second largest country in the region, grew 24%, and Australia rose 12%. Those three markets represent more than half of the region sales.

China, our major developing market, rose 37% fueled by like-door growth and expanded distribution. In Europe, the Middle East and Africa, sales were flat in local currency. This is not bad performance, given that the region grew 14% in the year ago quarter. Travel retail sales increased slightly for the quarter which was better than expected as declines in international passenger traffic were not as sharp as we had planned for. We are also improving the conversion of airport traffic into purchases in-store. The channel responded to the better traffic by select restocking of some inventories; however, given the volatility of this business, this may not indicate a trend.

Our UK sales arose about 2%, although business was more buoyant at retail. Travel retail and the UK affiliate represented just under half of our sales in the region. Developing markets in that region contributed positively to this quarter. Russia, Eastern Europe, and the Middle East rose double digits. Most of the western European countries declined. Trade destocking continued in a few markets and among niche brands, although it has abated in the heritage brands and in some key countries.

The 4% decrease in local currency sales in the Americas reflected the continued caution of the consumer. Sales in department stores, salons, and our own retail stores declined mid-single-digits. Those declines were partially offset by sales growth on Internet and direct response TV, and in Canada and Latin America. We continue to experience selective trade destocking among our high-priced brands in top-tier department store distribution.

Our gross margin improved by 260 basis points this quarter to 76.3%. Contributing to the increase were favorable mix of 90 basis points, favorable manufacturing branches and lower obsolescence charges of 50 basis points each, lower promotional costs of 40 basis points, and positive currency of 20 basis points. The lower obsolescence reflects the benefits of fewer SKUs and better inventory management. These figures include benefits from our cost savings initiative of $10 million or 50 basis points.

Operating expenses as a percentage of sales for the quarter improved 680 basis points to 62.1% compared to 68.9% last year. Cost-saving initiatives contributed $38 million or 210 basis points. Lower foreign currency translation losses compared to the prior quarter improved the operating expense margin by about 100 basis points. Our affiliates were cautious and did not spend all that they had planned in the quarter. This contributed 450 basis points. We expect much of this planned investment to be spent in the coming three quarters. These efforts were partially offset by higher IT and infrastructure costs of 80 basis points. As a result, operating income more than doubled to $262.7 million compared to $92.6 million last year and operating margin rose 940 basis points. Our cost savings initiatives are on track with total savings of $48 million or 260 basis points in the quarter.

Regarding our net interest expense, we reported $19.6 million this quarter versus $15.3 million in the last year’s first quarter. The increase is primarily due to the shift from short-term instruments to long term notes, which carry higher interest rates. The effective tax rate for the quarter was 32.1%, lower than expected due to the geographic mix of our earnings. We recorded $42.3 million in restructuring and other special charges. The charges primarily related to the Prescriptives reflect employee related costs, assets and inventory write-offs, contract terminations and other costs. These costs were equal to $0.14 per share for the first quarter. For the full year, we continue to expect to record charges of between $80 million and $120 million.

Our fiscal first quarter cash flow typically reflects the seasonal working capital levels as we gear up for the holiday season. This quarter, net cash flow from operating activities was $3 million, compared to cash outflows of $196 million last year. The biggest drivers of the gain were higher net earnings, inventory improvement, and the timing of tax payment.

Our day sales outstanding were 53 days this quarter, two days lower than last year. We continue to monitor the financial health of some key customers. Inventory days improved to 170 days compared with 188 days last year. While we have seen terrific improvements in inventory over the past year from better SKU management among other things, I want to remind you that we expect to build inventory in our second and third quarters in advance of the North American SAP rollout in April.

At the end of September, our SKU count was down 10% from the year earlier. We spent $45 million for capital expenditures, which includes spending for companywide systems initiative. For fiscal 2010, we expect to generate around $600 million of cash flow from operations and to use about $315 million to $330 million for capital expenditures.

Looking ahead, we are balancing the better than expected sales and earnings for the first quarter with healthy caution around the trajectory of a consumer recovery and other risk factors, such as the possible impact of the H1N1 virus, uncertainty around the upcoming holiday season, and the likelihood of more aggressive competition for the remainder of the year.

That's said, we believe it is reasonable to raise our expectations. For the year, international sales are expected to lead our growth. We continue to expect fiscal 2010 local currency sales growth of about 0% to 2%. Currency has been moving more favorably for us and it is now expected to add between two percentage points to three percentage points to our reported sales. Our new assumptions for the euro is $1.46; for the yen, 89 yen to the dollar; and for the pound, $1.61. If the dollar strengthens or weakens against these major currencies, it will further impact our financial results.

We expect to increase investing behind our strategic priorities in the remainder of the fiscal year to drive growth and increase share in our priority markets in Asia and Europe, and in our home market, North America. We plan to spend behind our fastest growing, most profitable brands and countries to further their momentum. We will accelerate all works to reinvigorate our North American department store business and develop our brands in emerging prestige channels. We are also continuing to invest in our IT infrastructure. At the same time, we are pursuing the cost savings initiatives we previously laid out for you. We continue to expect to save between $175 million and $200 million this year. Given our revised sales forecast and cost savings initiatives, we now expect a 220 basis point to 250 basis point improvement in operating margin this year.

At this time, we estimate our effective tax rate will be approximately 34.5%. We are raising our full year EPS forecast to between $1.95 and $2.10. Our outlook for holiday season reflects cautious consumer spending, balanced with better trade inventory levels than last year. Our sales growth for the second quarter is forecasted to come in between 0% and 3% in local currency. The positive impact of foreign exchange translation is expected to increase sales growth by about 3 percentage points to 4 percentage points. We expect EPS for the three months ending December 31, 2009 to be between $0.80 and $0.87.

Summing up, we delivered terrific results for the first quarter. We continue to focus on providing consumers with innovative products, delivered with unique service that sets us apart from the competition. We will accelerate our investments and strategic priorities while pursuing structural and sustainable cost savings and modernizing the information systems and processes of the company. Long term, we are working to realize our strategy, which we believe will deliver sustainable, profitable growth.

And that concludes our comments for today, and we will be happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question today comes from Wendy Nicholson with Citi Investments Research.

Wendy Nicholson – Citi Investments Research

Good morning. My first question has to do with the guidance for local currency revenue growth, because in past quarters when you had an unusual shipping or shift in the sales from one quarter to the next. You called that out specifically, but since you didn’t this quarter I am wondering if that means there wasn’t that much advance selling or shift in timing. And if that’s the case, then it seems like the lack of a positive revision to your local currency guidance might just be a little bit extra conservative at this point since travel retail in Asia is coming in better. It sounds like things are just doing better generally, so I am curious why you didn’t raise that guidance for the full year.

Richard Kunes

Well, Wendy, there was a shift, but – you are right, it wasn’t a terrific amount of money. I think it was about $10 million to $20 million of holiday shipments that went in the quarter that we didn’t expect. Travel retail was a little bit stronger in the quarter, but it is pretty volatile. And we did have, in the first quarter, a very successful launch of better than anticipated of the Advanced Night Repair. So that was, in essence, one of the explanations why the quarter was ahead of expectations. But again, that’s a sell-in activity, that’s not a sell-through, if you will, so we believe that there is still some good reasons for caution around the Christmas season upcoming. And Thia can talk a little bit about what she sees in North America, but I think it is prudent for us to be cautious in the outlook for the upcoming Christmas season.

Fabrizio Freda

Hello, Wendy?

Wendy Nicholson – Citi Investments Research

Yes, I was hoping to hear from Thia. Was she going to add some more commentary there?

Thia Breen

I certainly will. Our retailers are still being very conservative. We don’t see sales exceeding last year in terms of the purchases that they’ve made, but certainly improving from last year’s comps.

Wendy Nicholson – Citi Investments Research

Okay. And it just sounds like I mean in travel retail, you don't feel like, for example you've stuffed the trade, we have been watching the (inaudible) data and it’s gotten a lot better. So in terms of expecting things to get worse from here incrementally, it just seems awfully, awfully, whatever, conservative on your part, which I guess is fine, it’s a great place to be. But at the same time we want to have a realistic outlook for what you think you can do this year.

Richard Kunes

Sure. The airline miles projections that are out there are, continued to be lower year over year. So we see that continuing through at least our calendar-year 2009.The second half of our fiscal year shows a slight improvement in the airline miles being travelled. So our forecast are a little bit better than that internally, but that still doesn’t indicate a great growth in the second quarter.

Wendy Nicholson – Citi Investments Research

Okay.

Fabrizio Freda

Yes, Wendy, this is Fabrizio. Just one additional comment on travel retail. Passenger traffic is declining at 5.2% calendar-year ’09, to date. In 2010, the expectation is this will stabilize. And this is already an assumption, which is in our numbers, in our projection for the future. So there is an improvement which is in our number. Now, in this quarter the improvement has been well beyond our expectation. Now we believe that we have the assumption of an improvement in the future, which is realistic.

Now, there is also a risk in travel retail which is, if for any reason there will be a moment where the H1N1 pandemic should come out – the travel retail business will be amazingly affected as we know from our history and our risk in this area will become huge on the other side. So to be honest, in this very volatile environment we are taking a prudent approach try to be balanced between projecting some realistic upside, but also considering some existing risks to avoid – to then be caught in the middle and not to be able to deliver what we want to deliver. So we believe we are balanced. But you are right that this quarter we were surprised for a very positive travel retail business.

Wendy Nicholson – Citi Investments Research

Terrific, I will take it. Thank you very much. Bye-Bye.

Operator

Your next question is from Alice Longley with Buckingham Research.

Alice Longley – Buckingham Research

Hi, good morning. I have a sales question as well. It’s about the second quarter, just to sort of pinpoint this idea that maybe you are being quite conservative. And this is looking at US departmental stores, last year, I believe, your sales at retail were down 7%, but your shipments were down 19%. And if you do the math, your sales at retail could be down another 3% in department stores, but just to replenish the products that people buy, your shipments would be up 11%. I am not assuming inventory build up, I am just talking about replenishment. Is there some reason that would not happen?

Thia Breen

What we are seeing in terms of the retail is the retailers are very concerned that the customer is not coming back in the same velocity that she was a year ago. So we are not building inventory.

Alice Longley – Buckingham Research

I understand that, but just because your comp is so easy, down 19% last year, just simple replacement of what people buy even if what people buy is down would make your shipments up 10% or so.

Fabrizio Freda

Sorry, this is Fabrizio. I am not sure – maybe I am missing something. I don’t get the math [ph]. Last year, our comps were down because that’s the period where we started having some serious destocking and some lower sales. So this year, we – first of all, destocking is continuing although much more moderate and honestly only at the top of the high-end retailers. The destocking continues, there is no any restocking happening at any level and sales in North America, specifically continue to be relatively soft. So the only thing which has happened, and again, in the case of the quarter we have been surprised for the positive also on this one, is that as NPD established the September data has been slightly better than the July, August and than the previous periods, but is slightly better, still a negative number versus previous year. So negative will let you get negative. That’s a fact, now this is obviously difficult to predict with optimism at this phase with in front of us a very important period, which is Christmas, which we assess that it remains very high.

Alice Longley - Buckingham Research

Okay. I’ll go over the math with you later. Just one other question, alternative channels, can you tell us what that comp was in this quarter overall?

Rick Kunes

I don’t have, Alice, the numbers for all the alternative channels. But our retail stores and our salon business was as soft as our department store business here in North America. Our Internet business was pretty positive. I think that all of them together in the US were down still in that low-to-mid single digital number, so not terribly different than department stores.

Alice Longley - Buckingham Research

Thank you, very much.

Operator

And your next question comes from Neely Tamminga from Piper Jaffray.

Neely Tamminga – Piper Jaffray

Good morning, and great start to a good year. Just a question here for Thia, since we have her on the call. Could you talk a little bit about the My Macy's initiative, and how some of those changes have affected in your own business? And then maybe also talk about with an eye towards holiday, how the My Macy's initiatives might change things in terms of order flow or ability to respond to the product? If you could just walk us through that, since it is kind of new out there, that will be helpful. Thank you.

Thia Breen

I would be happy to do that, Neely. We actually started this North American affiliate structure, July 1, and although it might be new to us, it’s not new to us as a company. It’s the best practice of what we’ve been building on for years. And so the affiliate support is what we’ve always been, which is a brand-driven company. And My Macy's sits perfectly into this because we are able to leverage these brands individually in these 69 districts that have been established. We also have the advantage of the North American supply chain, and forecast and demand planning now which really helps our customers when you talk about Macy's more easily navigated through the various brands that we have.

We are working very closely with Macy's to reignite growth in that channel and the transformation is much stronger by leveraging our corporation and not just the individual brands, and it makes us much more nimble in dealing with Macy's. Another important capability is in the area of consumer insight, which certainly – they have announced Macy's in terms of how they are supporting stronger initiatives in this. So this is reigniting great partnership between our two companies in this area. We also see great progress in terms of online. In terms of holiday, we are very, very fluent with My Macy's in terms of the upcoming holiday season; and we’ve still believe there are some risks attached to what’s going to happen in terms of whether it’s job loss or whatever, she isn't coming back in the same way that we thought that she was two years ago.

Neely Tamminga – Piper Jaffray

Good luck.

Operator

Your next question comes from Linda Bolton Weiser with Caris & Company.

Linda Bolton Weiser – Caris & Company

Hi, thanks. Fabrizio, maybe you could describe a little bit more in detail how the – like cost budgeting process is working and how you are controlling that with regard to your affiliates and businesses? In other words, if they really belt tightened and really held back on spending but yet they have an annual budget, shouldn’t that all come back by the end of the fiscal year? Or do you reset budgets? How are you doing it with regard to changes in the macro environment? Can you just give a little more color on that?

Fabrizio Freda

Yes, sure. Basically what we are doing is brands are managing to a mix of opportunities and risks. So, speaking about brand budgets, the branding this moment each one of them have in front of them different situations, by region, by country. And this situation has suggested the majority of brands to avoid spending too much in the first quarter in order to be ready to balance an economy downturn or the flu explosion or the possible travel retail downturn, and some branch took this decision. But they took this decision to wait to spend because of the risk manager or in other cases to wait to spend to put the money on bigger opportunities, which are emerging in our strategy and analysis, and on some very appealing innovation opportunities we have in our pipeline.

So this has made some of the spending not be happening in the first quarter, but this part of the spending will happen in the successive three quarters during the fiscal year, and we are allowing this budgeting process, although it’s very transparent within the company and with a senior manager we are allowing these movements as far as they are appropriate, as I said, in terms of putting the money on the biggest opportunity and managing risk in the appropriate way. The second part or the process of cost management in the company is about all our cost restructuring and all our activities that we call the PMT activities, meaning we put together and to the senior management team which is managing, delivering all of the cost savings that we have committed for the next four years.

This part of the costs are managed by, as I said, by senior management team that we call the PMT. And they are each element of the cost, each element – each project of cost savings has a project team assigned to it and is connected with all the regions at the brands. Those are composed, as we have discussed many times, by a mix of restructuring projects, cost of goods saving opportunities in our procurement, etcetera. Those are progressing very, very well. We are very happy. There are two big positives.

First of all, we are delivering the saving in line with goals. In fact, this first quarter we ended up at the top of the range that we had in mind and wants to deliver. And on top of this we are doing this in a very integrated fashion in the company, which requires an important culture revolution to work more in teams and to connect more of the people and this is happening.

To help this, the new reward system that is in place as of July 1st where people not only rewarded for delivering their own goals but they're also rewarded for delivering the total corporate saving and corporate results by working in team is also helping this cultural revolution.

Linda Bolton Weiser – Caris & Company

Thanks.

Operator

And your next question comes from Andrew Sawyer with Goldman Sachs.

Andrew Sawyer – Goldman Sachs

Thanks, guys. I was wondering if you could help us a little bit more on the marketing spending side. Longer-term, could you just give us a sense on the 13% long-term margin, what you're kind of targeting or what you're thinking about in terms of advertising and promotion as a percent of sales?

And then just secondarily, as we think about it sounds like roughly $0.30 or so of your beat this quarter came from the marketing spending side. Any sense of sequencing and how you think the divisions or the business units will spend that back over the next three or four quarters? Thanks.

Rick Kunes

I think the spending patterns for the rest of the year is going to be up to, as Fabrizio was describing, those risk elements that are out there and how they develop and whether they develop at all. But it will be more or less spread over the remaining three quarters.

One thing on the savings initiatives that we have and the spending patterns year-over-year you have to remember that last year we had that belt tightening exercise which took place mostly in the second half of the year where we took out about $250 million out of our spending that we said a big majority of that was going to be temporary in nature and would have to come back. So, in a sense, we had some really good results relative from a spending perspective in the second half of last year, but this year now, we have a more, if you will, systemic and sustainable cost reduction program as Fabrizio mentioned that is implementing over the course of the year.

So we save $48 million in the first quarter. We anticipate about $50 million for our second quarter and we said between $170 million and $200 million for the year. So there's a little bit of an offset year-over-year on when those fundings would happen. Longer-term, I think that we don't want to get into the details on a line-by-line item of what our spending will look like in 2013, but we do intend to get to that 12% to 13% operating margin. There are some efficiencies in our advertising and promotional spending that we hope to obtain as part of those initiatives, but I think it'd be a little premature to say what that would be as a percentage of sales now.

Andrew Sawyer – Goldman Sachs

Just definitely, could you also talk a little bit about the topic of media deflation and how you guys are thinking about that whether you're going for more impressions at the same price or letting the deflation drop through? Thanks.

Rick Kunes

Sure, in most of our vehicles that we use, we are not seeing price reductions per se. Many of those prestige magazines have taken a decision to say we're holding our billing rates. And we noticed quite honestly the size of those magazines somewhat shrinking as people spend less money, but we haven't seen savings from a rate perspective in that. Ours as a company have spent less than we did year-over-year for the economic conditions that we're currently within. But we haven't seen any real savings from a rate perspective.

Fabrizio Freda

If I can give a perspective on the hedging, we are going to make efficiencies in our advertising spending and these efficiencies will mainly come from being able to target the consumer more accurately and to spend money only against the target consumer and to avoid dispersion.

Second, the mix of advertising around the globe is evolving and these changes country by country. For example, as all of you know digital marketing is taking a bigger role in all the communication spending in most of the markets.

We remain very committed to prestige magazine advertising, but we're also having some interesting results, for example, television advertising, in some emerging markets. So we are making a lot of learning on the mix of advertising too and we are making a lot of learning how to spend more efficiently, targeting better our consumers. This will drive higher return from our advertising spend and will improve over time the return on investment for every advertising dollar spent.

That said, I'm not sure that our goal is to reduce the total dollar of advertising. On the contrary, our goal is to continue to support our brand as aggressively as we can afford and as soon as the sales trend, the consumer demand attitude will change, we plan to invest more in advertising according to our needs.

Andrew Sawyer – Goldman Sachs

Thank you very much, guys.

Operator

And your next question is from Bill Schmitz with Deutsche Bank.

Bill Schmitz – Deutsche Bank

Can you just talk kind of the tenor of earnings now? So seasonality, because if I look at this quarter, you did $0.85. I think the second best sort of first quarter was in fiscal 2005. I think you did $0.41 and obviously the macro back then was much better. You could launch like a carrot top fragrance and sell 2 million units and you got the overhead absorption from that.

So is this the new normal in terms of that first quarter and that seasonality is gone and earnings will be more smooth across the year? Or it was just we really accelerated cost savings this quarter and we pulled some costs, moving go back to normal next year? Sorry for the long-winded question.

Rick Kunes

That's very good, but this year, quite honestly, everything went in our favor in the first quarter. We beat our sales expectations and we beat those by high profitability TRD business by the launch of a very profitable new product, Advanced Night Repair. If you look in cost of sales, our inventory improvements helped drive down our obsolescence numbers. We also had some exchange benefits in there.

Our operating expenses, as Fabrizio described them, were lower than we had planned because there's a level of conservatism in the spending patterns and caution by our affiliates, which will probably happen in the next year. The exchange rates went in our favor, the tax rate went in our favor. I mean everything, the stars were aligned somewhat in this quarter, and we're quite happy, terrific results, but that's why we temper that around the risk that we see in front of us and also the fact that this is the first quarter of a four-year program that we have in place and we have a ways to go to get to 12% to 13% operating margin.

So we're happy but we're also realistic in what the future holds for us. And this, I think Fabrizio used the term this was probably the easiest quarter in a sense. It's in a beginning of our program and we have a lot of work to go and a lot of change within the Company to achieve our long-term goals.

Bill Schmitz – Deutsche Bank

Okay. But nothing's really changed sort of structurally about the seasonality of the business, so the first quarter should still always be kind of the weakest quarter and the biggest working capital use quarter because of the holiday season? Is that fair?

Rick Kunes

I guess you don't.

Bill Schmitz – Deutsche Bank

Not this year, but going forward.

Rick Kunes

That's fair.

Fabrizio Freda

It's actually fair that nothing fundamental, but there is some improvements that we're making to the business, which are the one, which are part of the strategy, which are here to stay. Let me clarify. What's going right this month is that we have higher than expected sales and on this phase we didn't spend money. They came in September or last quarterly, before we spent the money. This obviously doesn't happen every quarter. When you plan the sales and you spend the money against it, the sales that come with [ph] brand normally are less profitable than the one that come unplanned. So that's part

The other thing that happened, however is that we are dramatically improving our mix and particularly, we are shipping more skincare as part of our mix and this is here to stay hopefully. At least this is part of our strategy. We'll do our best to make this stay.

The second key thing, we are improving all our so-called underperforming brands, which means that every single brand that last year was below company performance, this year is delivering much better results. This goes from the extreme of prescriptive that, as you know, we've announced a complete restructuring to other brands, which are simply dramatically improving their results this fiscal year versus previous year. This hopefully is here to stay and is a fundamental change. There is another (inaudible) which is all about spending.

As we said, we've been cautious in spending in the first quarter because of risk management in this very unusual volatile economic environment. This again on the contrary, may not be true next quarter or last year if the economical environment will be different and more predictable, our spending will probably be different and more predictable. So there are elements which are, I believe A) an evolution of our business model in line with our strategy, other elements, which are uniquely happening in this quarter will not happen probably in the future.

Bill Schmitz – Deutsche Bank

That's great. And then can I just ask you what percentage, if you know this, what percentage of your brands are gaining market share and improving profitability? I know they're two separate numbers. I don't know if you have the data because maybe it's not as current as you need, but do you know what that number is?

Rick Kunes

By brand, Bill, we do not, not at the moment.

Fabrizio Freda

We may calculate it, but consciously is we are improving market share as a company overall, globally, and in the majority of our strategic markets, in our key brands, our main brands are growing market share in the majority of the markets, so we have a possible trend here.

Bill Schmitz – Deutsche Bank

Okay, great. And then lastly, I promise, Rick, what do you think about share repurchase going forward? I mean cash clearly building.

Rick Kunes

Yes, cash is building. We suspended our program while there was so much volatility in the credit markets. The program, we still have 22 million shares, I think authorized by the Board, that we could repurchase and we'll evaluate that based on what we see in the credit markets and what we see for use of our cash.

Bill Schmitz – Deutsche Bank

Okay. Great. Thanks so much, guys.

Operator

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

Victoria Collin – Atlantic Equities

Hi, good morning, guys. I wonder if you could talk a little about the fragrance division and the swing to profitability there. I wonder if you could give a bit of color on whether that was coming from simply cutting excess costs within the business or whether that's been supported by the new launches and the resizing and the repackaging that you put out on existing brands.

And then secondly, if I could quickly ask if you could give me a recap on travel retail, percentage of sales, operating profit of that sub-segment. Thanks.

Fabrizio Freda

Let me answer the question on fragrances. I think the great swing that were improvements in profit that we are seeing in fragrances is the result of the very hard work, excellent work that the fragrance team has put into this in the last 12 months, 18 months, under exactly the strategic direction of improving the business model we are using in this category. This is a mix of stopping investing on areas, where we had limited opportunity, where we were not getting appropriate return.

And on the contrary, continue investing, actually in some cases accelerated investment in areas of a bigger return. This has been combined with a lot of activity of cost cutting. Some of the cost reductions are unique and specific to the category. Other are part of the big restructuring plan that we have announced for the Company. Both of these partially impacted the category.

And finally, the strategic refocusing on classics and on the ability of growing our business on classics with the right profitability versus maybe in some cases too many new small activities which a relatively low success rate. The rebalancing of those two elements is also helping the direction.

So, we are very encouraged by the direction and we believe that we will be soon as the economy allows us, we will be focusing also on growing this category again. We should also say that as you know, fragrance has been the category which is the most affected by the market trend, by the economical strain. The markets are really going down in most of the world in a very big way. So within fragrance as soon as the market come back, we will see the benefit of that.

Rick Kunes

And then, Victoria, your question on the travel retail business. In the quarter, it was about 9% of our sales, but historically that's represented about 7% of our overall sales mix and the profitability as we said is about 20% of the company's profits.

Victoria Collin – Atlantic Equities

Okay, that's great. Thanks very much, guys, and well done.

Operator

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

Lauren Lieberman – Barclays Capital

Good morning.

Rick Kunes

Good morning, Lauren.

Lauren Lieberman – Barclays Capital

A question on, you were just talking about the spending plans at all the affiliates and what I'm still really curious about is was the decentralized decision-making, because heading into the quarter, into the quarter, you've just reported, there was a thought that more money would be spent than it was. Now we are in the process of going into holiday and it's not clear to me what you know currently about your affiliate plans for spending around holiday, or let alone into the rest of the year. But I'm just a little stuck on just how much can swing intra-quarter, given that you actually communicate guidance and expectations once the quarter has already started, especially when we're in the middle of the holiday, we're sort of at the crux of the holiday season right now.

Fabrizio Freda

This is Fabrizio. Maybe I've given the wrong impression here. When we say affiliate, because the spending happens there, I was not speaking where the decisions are taken. Our process is a brand led decision, our global brand led decision making process on spend. So the brand lead the decision process and today in our new metrics there is a big dialogue with affiliates to decide when and how to spend the money, but then the money gets spent in the affiliates in the large majority.

So this decision is a very transparent decision making process since now about eight months, we're in the company, we have continuous teams, we meet once a month to discuss the spending of the next month, it's a very thorough process where we align forecast, the financial forecast and the man-management of products so we have very thorough processes now in place. So if I gave the wrong impression, the decision was taken (inaudible) by the affiliates, I'm sorry, this was the wrong concept.

The decision was taken in a very transparent way from the management team, brand affiliates and agree that with me and with Rick at the top. And so we know exactly what's happening out there. And I believe that the decision of prudently postponing or the adjustment of spending was this quarter the right decision for a series of reasons.

Lauren Lieberman – Barclays Capital

When if we look into the rest of the year, I'm very comfortable with the notion of where kind of the gross margin upside would come from, the benefits you experienced from mix, and a lot of that should really continue given the emphasis on skincare, the improvements on inventory, obsolescence (inaudible) will be a more positive point factor.

But still on this operating expense line, one that when we started the year we talked about belt tightening needing to come back. The proposition that the money that was saved was really very reactionary and the money would need to be spent in order to continue to stimulate growth.

And then the fact that there was this hold back this quarter. So is it all of it still comes back or gets reinvest, with the exception of gross margin because I understand how that sticks and continues. If the operating expense line where how much of this is truly sustainable change or is it all just going to get spent back and it's a matter of timing?

Fabrizio Freda

Let me (inaudible) try, Rick can give you specific numbers behind the concept. There is, as you know, there is some change which is really sustainable and this is clearly the change which goes with the cost savings in this quarter $48 million of sustainable cost savings. The change fundamentally the way we are working. There are other costs which are obviously the reflection of the mix, as you said, more skincare, other elements of the mix like less underperforming brand, et cetera. Those are obviously sustainable changes.

There is an element of improvements also in the investment, in the marketing, as we gain efficiency and we have better rate of return on investment in promotion, advertising, all these areas and this is progressing. But, however, there is also a management of risk in this moment, in this very volatile environment, which is not necessarily a sustainable thing for the next five years, is what we need to do now in this unique economical environment.

And as I said, we have in front of us the possibility that Christmas will go normally or will be a problem. We have in front of us the possibility that there is a flu epidemic, which means travel retail in Asia may be particularly affected and even the Christmas shopping may be particularly affected if this has to happen. We have the possibility of having at least we believe the competition will become more aggressive as soon as the economy improves.

And a lot of our competitors, many, who have been as prudent as we have been (inaudible) and creating for us some space that may not be available in the rest of the fiscal year, if the economy start going better. And on top, as I said, there is obviously an internal cultural change that we're going through to deliver and to exchange in our operational cost saving with sustainable change of business model and cost saving, which is a process which doesn't happen in one day. It contains some element of risk in some regions, in some areas, and in some groups.

So the combination of this risk management make us believe that we need to be prudent in trying to guess how much of this will be always going like this quarter, which is meaning everything played in the right direction at the same time. So that's it. So I think it's about at least an attempt to manage with a prudent and strong approach this transformational direction we are taking.

Rick Kunes

And, Lauren, you mentioned that are we spending at all, well, we're not actually. We took our estimate up $0.45, $0.50, depending on where you want to start from an EPS basis. So, we are anticipating that we're going to have better results. We did say that our operating margin was going to probably be 100 plus basis points higher than we had come into the year thinking. So, we are reflecting a lot of that in profitability and we are balancing that with all the risks that Fabrizio just mentioned.

Lauren Lieberman – Barclays Capital

Okay. Thanks a lot.

Operator

And your next question is from the line of Chris Ferrara with Banc of America-Merrill Lynch.

Chris Ferrara – Banc of America-Merrill Lynch

Hey, guys, just wanted to see if I could understand the relationship between where specifically the sales upside came in, I guess, and with the fact that you really didn't spend a lot, because on the surface it looks like sales were not particularly dependent upon your spending levels this quarter. I know that's probably being a little too not thoughtful about it, but just on the surface that's what it looks like. So I guess what's the nature of the under-spend relative to your budget and did that tell you anything for going forward as you think about ad spending for the year?

Rick Kunes

Okay, so Chris, you asked where did the sales come from and we mentioned that they came from travel retail, which is a highly profitable category of business for us. We just talked about it, representing roughly 20% of the company's profits on a normal basis and also from the biggest launch probably that Estee Lauder as a brand has ever had, which is the Advanced Night Repair, which is a sell-in kind of activity, so you have to remember that. But it is a very profitable piece of business for us as well. I mean those two upsides for the sales really drove a lot of profit for that.

As far as the advertising spending, I think we already sort of addressed that and that is that we intend to invest in the balance of the year and we were somewhat cautious in what we were spending in the first quarter. And it's not so much the actual print advertising because that's committed to, but it's all the other activities that go on around that, that we were cautious on in the first quarter and we anticipate those coming back in the balance of the year.

Chris Ferrara – Banc of America-Merrill Lynch

I'm sorry. I guess I'm not being clear. I mean what I'm trying to get at is you got significant top-line upside, partially from travel retail, partially from successful launch, despite the fact that you didn't spend as much as you had anticipated. So maybe it speaks more to where you didn't spend as much. I mean of the under-spending relative to budget, was any of that or was a lot of it advertising and promotion, and if so –?

Fabrizio Freda

This is Fabrizio, again. Let me clarify. The selling of Night Repair of Lauder as we have underlined is a sell-in. Sell-in is not influenced by advertising. It's a sell-in of an activity. The product has also started pretty well, but in the month of September, the majority of the extra is a sell-in. Travel retail is not influenced by advertising in the short-term basis. Obviously, travel retail is influenced by the equity of the brands on long-term basis, but on a month-by-month basis, it's not influenced by advertising in the regions, in the countries.

And finally, the other big extra that we got is Asian skincare, which is a very profitable item for us is skincare, in general, and this actually is influenced by advertising, and this is worse. So it's a mix feature again, and so, we got some upside this quarter which were kind of happening independently from the spending part in advertising. This may not be true in the future because there are other parts of our sales components, which are heavily influenced by our advertising spend.

Chris Ferrara – Banc of America-Merrill Lynch

Great. That's really helpful. Sorry for being dense on that. I guess and just one other quick one. Rick, I think you mentioned that FX on the SG&A line was actually a positive for the quarter. Did you mean positive relative to your forecast or positive in the absolute? And if it's positive in the absolute I guess why considering currency was still a drag just not as much of one for the top line.

Rick Kunes

Right, in our operating expenses, Chris, we have the impact of the gains or losses on the contracts that we have and so it was versus last year. We did not have anywhere near the losses in those contracts that we have last year so it was a net benefit year-over-year.

Operator

We have time for one more question. Your final question comes from with Ali Dibadj with Bernstein.

Ali Dibadj – Bernstein

I love that pressure. Couple long-term and short-term. One is, Rick, if you could just help with the sustainability of margins issue that we're all having I think. And just if you could please us repeat the margin improvement that you see, just clarify whether that's on a recurring or reported basis. I think you said 200 to 250, but I just want to make sure I heard that right, on operating margin.

Rick Kunes

Sure. Ali, what I had said was that this fiscal year with the guidance that we've given I think you'll do the math and it says that about 100 to 120 basis point improvement in operating margin from where we plan to come or year-over-year will be about 220 basis points to 240 basis points, I’m sorry, all right?

Ali Dibadj – Bernstein

Okay. Yes. That's helpful. And then, Fabrizio, I don't know my experience has been when you start doing some of these cost reduction plans, in some sense you kind of see the water go down and you see some other opportunities. I'm not pushing you for the 2013 number right now, but are you seeing more opportunities about 12 to 13, seems like there's more potential in it. How do you think about that, how do you kind of log ideas as you see more maybe opportunities in the company?

Fabrizio Freda

Ali, I already I think answered these questions when we first discussed in the February quarter conference call. The strategy that longer-term which we have visibility of this company to get to the 14%, 15% margins so we will see when and how after by 2013, we arrive to the 12%,13% range, we will discuss how to continue go forward. Now, honestly, it's a bit premature. I think we have so much work to be done to get to the 12% to 13% and this is the first quarter of 16% which are in the announced strategy. So really it's a very good one and that's why I'm honestly very happy that we have this good start, but it's a bit premature for start rediscussing the original goal.

The other important things the one to make a big distinguish is the 12% to 13% by 2013 year will need to be reached in a sustainable way, meaning, changing the fundamentals of our business model and cost structure and particularly, confirming our ability to grow the top-line in a very strong way over time, particularly, when the economy will go back to normal. The combination of those three things is what will determine the sustainability of the 13%. So in this first quarter, we have seen that when the key fundamentals of this new strategy play together, all positively, it seems to work in the right direction. But I think it's premature to say that we can sustainably imagine to go higher than the 12%, 13% before we have much more road behind us.

Ali Dibadj – Bernstein

And then just another longer-term, slightly different tactic, I do think it's a strategic controversy you're going to have to deal with which is just around how do you actually manage becoming more and more of a retailer over time? There was a little bit of a slowdown in your free-standing stores. Now feel like it's picking up again. So how do you manage that from an internal perspective?

And then secondly, at what point does the growth fill the white space potential that you have and it becomes cannibalistic either to the current brick and mortar retailer that are established there. And you may want to answer that question, obviously, U.S., Western Europe and then developing world.

Fabrizio Freda

Yes, first of all, we have no intention to become more and more of a retailer. That's absolutely not part of the strategy. And by the way, there is only one of our brands whose business model is designed by the way fantastically around having a certain amount of retailing stores. All the other brands, they are not designed in this way. So, really that's not our strategy, that's not our issue. And then in terms of cannibalization, we are very hard that (inaudible) does not what happen. So we can build our stores and alternative distributions at the same time and they don't cannibalize each other.

Actually, we have a strategy and we do this only when they do not cannibalize each other because again, our business is very much driven by productivity per store, sales per door, and where the productivity per store, the sales per door, are not the right one, our profitability is very difficult to be reached. So we look at this very carefully. And then anyway, the issue, if there will be an issue is only in the U.S., in Europe, in Asia, really those issues don't exist in a sense that the amount of our direct retailing is minimum, probably not significant at all in our business.

Operator

That concludes today's question-and-answer session. If you were unable to join for the entire call, a playback will be available at 12 noon Eastern Time today through November 13th. To hear a recording of the call, please dial 800-642-1687, pass code number 35926199. 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.

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