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The Estee Lauder Companies Inc (NYSE:EL)

F2Q10 Earnings Call

January 28, 2010 09:30 AM ET

Executives:

Dennis D'Andrea - Vice President of Investor Relations

Fabrizio Freda - President and Chief Executive Officer

Rick Kunes - Executive Vice President and Chief Financial Officer

John Demsey - Group President

Analysts:

Mark Astrachan - Stifel Nicolaus & Company, Inc.

Joe Altobello - Oppenheimer and Company

Lauren Lieberman - Barclays Capital.

Linda Bolton Weiser - Caris & Company

Bill Smith - Deutsche Bank.

Dana Telsey - Telsey Advisory

Chris Ferrara - Banc of America

Wendy Nicholson - Citi Investments

Alice Longley - Buckingham Research

Ali Dibadj - Bernstein

Leigh Ferst - Dudack Research

Caroline Levy - CLSA

Maria Vizuete - Piper Jaffray

Alex Patterson - RCM

Presentation:

Operator

Good day everyone, and welcome to The Estée Lauder Companies Fiscal 2010 second 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. Also on the call today is John Demsey, Group President with responsibility for seven brands including Estée Lauder and MzAzC, representing approximately half of our company’s sales.

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

I'll turn the call over to Fabrizio now.

Fabrizio Freda

Thank you, Dennis. Good morning. I am glad you have joined us for our fiscal 2010 second quarter earnings call. In our remarks today, I will discuss our performance in the quarter and further progress we made, advancing our long-term strategy.

John will talk about the Holiday season in the U.S. and the current stat of the high-end beauty business worldwide. Lastly, Rick will provide the financial details.

This morning we reported great results. The strong top line growth and continued improvement in profitability, which was achieved against a backdrop of a challenging environment.

Sales for the period were $2.26 billion, up 11% versus the previous year period. Diluted earnings per share increased 60% above the year ago quarter to $1.28. In addition, we continue to make progress, advancing our strategic goals.

We believe our sales grew faster than market trends in many countries. Our international sales expanded faster than out U.S. business, moving us closer to our target of generating more than 60% of sales outside the U.S.

Our results show a significant improvement in operating margin. Inventory days improved by 16 days from last year. Our turnaround brands collectively showed a substantial improvement in operating results for the first half before impairment charges compared to a year ago and our cost savings initiative saved $83 million this quarter, which was faster and larger than we had planned, including great progress in cost of goods.

I'm pleased with these quarterly results and our strong start executing our long-term strategy. Compared to the second quarter last year, our top line growth was driven by our robust International business. Thanks to numerous strategies, which are bearing fruit.

We had solid growth in Asia-Pacific led by Greater China and Korea. Sales in our European region expanded sharply driven primarily by travel retail in the United Kingdom, Russia and (Belarus).

Sales in emerging markets, which had increasingly important contribution climbed 14%. These countries which include China, Russia, Turkey and Brazil among others accounted for 12% of total sales.

During the quarter, we opened an affiliate in Vietnam to support our growing brand presence there. With a population of 86 million it is young, urban and has increasing disposable income. We see this emerging market adding to our growth in Asia.

Our line sales rose more than 25%. It is defined as the biggest sales day ever on Cyber Monday, nearly double the previous year. We now have e-commerce sites in nine countries and aggressive plans to expand further.

Our strong top line growth was achieved with lower levels of advertising, centering and merchandizing as we started capping ineffective spending in this difficult economy. We plan to accelerate more effective investment in this area in the second half of fiscal year 2010. I will go more in detail on this topic later.

During the first six months of our four-year strategy journey we made substantial progress on our long-term objectives. In the recent quarter we believe we gained share in many countries. In U.S. department stores, according to MPG our share expanded 10 basis points.

Our retail sales outlays over all prestige beauty in several important countries, including the U.K. China, Spain, Russia and Germany. As we have said, a key initiative is to build our leadership in skin care.

Our sales in this strategical important category climbed 12% in the quarter excluding currency. Internationally our skin care sales rose even faster led by Estee Lauder brand. The first quarter launch of its successful new Advanced Night Repair fueled demand throughout the brand.

It’s sales are so strong that Estee Lauder has become the leading brand in its distribution in China, Hong Kong and all of Asia combined in the first half of fiscal year 2010. Here in the United States, Clinique Skincare’s share grew 30 basis points in department store universe, which for a brand of its size, is a clear victory.

Clinique is a largest brand in U.S. prestige department stores and the largest in skin care. Even more impressive, 40 of the top 50 skincare SKUs in department stores are Estee Lauder Company’s products.

Our turnaround brands have made significant progress. Each one of these brands has a strategy to refocus on its most profitable and promising opportunity and the early signs of improvements are encouraging.

For the first six months of fiscal year 2010 their collecting efforts generated significant improvements in operating results excluding impairment charges compared to a year ago period. It was one of the top drivers of our year-over-year improvement.

Prescriptives will sharp its wholesale business on Monday while it was a difficult decision; the closing has been handled extremely well in Prescriptives loyal consumers, retailers and employees.

We have strategies in place to direct consumers to similar products of our sister brands and we're adopting Prescriptives assets, formulas, trademark and products to other brands leveraging the power of our company. In fact, the cost to wind down the brand has been less that we projected due to the careful planning and execution of the transition.

As you can see we've made real strives growing our business in many fronts. At the same time we've also made substantial progress in our ongoing efforts to reduce expenses in conjunction with our restructuring initiatives.

For the first half of the year, we aligned total saving of $160 million significantly higher than we expected. We're ahead of plan on cost of goods savings and some of the restructuring and resizing efforts. And we now expect full year savings to be between $275 million and $300 million.

The saving this year are currently predominantly from improved cost of goods, resizing a restructuring activities and indirect procurement. Part of our strategy is to boaster our capabilities in several areas, which is crucial to making us even more formidable competitors.

The company is accelerating investment in various digital applications.

Many of our brands have expanded their online and social media capabilities to market products, create stronger emotional bonds with consumers and provide information and resources.

Our Bobbi Brown brand is helping lead with this effort. It has attracted a growing number of followers on Facebook and Twitter and this month launched a campaign on its website, titled “Pretty Powerful” using videos of real women to convey the brands point of view.

We will keep building our digital presence. We see it as a critical way to educate and reach consumer and bring our brand and their philosophies to people across the globe. All of our brands are pushing comprehensive social networking and online campaigns.

As part of this effort, the fans started a blog and communicates regularly with fans on Facebook and Twitter. Our MzAzC brand is one of the largest Facebook communities of any beauty brand and launched e-commerce in Germany.

In Japan, we began e-commerce for Clinique including access from mobile devices. MzAzC and Bobbi Brown plan to follow in the third quarter. We are also piloting mobile e-commerce capabilities with Aveda in the U.S. and expect to expand this technology to other brands.

Product innovation has always been a cornerstone of our success. Our biggest new product achievement this fiscal year has been the Estee Lauder brand of Advanced Night Repair, which was formulated to appeal to many skin types.

Now we are advancing and fine tuning our effort at our regional innovation centers in Asia and Europe to create locally relevant products for multicultural consumers. The next generation of products to be developed from these international themes would be unveiled in the coming 12 months.

In the current third quarter Clinique, even better Clinique, a Dark Spot Corrector will be a major global launch supported by comprehensive integrated multimedia marketing effort including print, digital, and national television advertising in North America and Europe. This product combats an even skin tone, a large concern among many ethnicities around the world.

It marks the first time at a (stage) treatment rivals a prescription strength product for this concern. The key ingredient and the technology for even better Clinique was created in Asia and we expect to develop many more cutting edge products in this regime.

This quarter our La Mer brand we’ll introduce is break through anti aging regenerating serum, which we believe will bring new attention to this coveted luxury line. Another innovation effort is green chemistry, which minimizes the impact on people and environment in all phases of the product life cycle.

We are extremely excited about a possibility that these new ventures will bring to our company. We continue to invest in our strategic modernization initiative, which is expected to roll out to nine North American manufacturing facilities this spring. Subsequently we will, it will be deployed in the affiliate end regions.

We appointed Christopher Wood currently the General Manager of Korea to lead the SMI effort as it is integrated into the commercial side of our business. His both international and brand expertise will serve the company well in this role.

In the first six months of this fiscal year, we spent about $80 million less on advertising, merchandizing, and assembly than we did last year however, even though we spent less we invested it more efficiently.

Our advertising was better elaborated and focused on product with high return such as Advanced Night Repair rather than allocated across many smaller launches particularly in fragrances.

However we recognize the need to now increase our investment beyond effective advertising, merchandising and sampling. With consumer spending rising and the general sense that the economy has started to improve, we plan to accelerate our advertising for the next 6 months, spending between $150 million and $175 million more than last year.

In the second half of the fiscal year, we’re planning to invest efficiently and strategically behind these business-building opportunities we identified, which will include the highest investments in television and digital media ever made. Much of this will be allocated to developing markets.

Throughout the remainder of the year, we expect Estée Lauder brand to build on its fantastic momentum in Asia particularly in Greater China, and it will run three integrated print, digital, and TV campaigns for skin care products. MAC opened 47 international doors in the first half and plans to add at least 45 more in the next six months, building strong awareness in many markets.

We will continue to evolve our high-touch service model in department stores and other retail settings. We will also continue to strengthen our consumer insight capabilities recognizing that a consumer thinking changed during this recession. And the company is the first one to understand and tap into their new mindset will be best positioned to win as global economies improve.

We are confident in our direction and raising our full year guidance based on our performance to-date.

However, economic and political risk still exist that could impact future results. Threats to our business include continued high unemployment, a repeat economic downturn in the United States, and a more intensive wave of the H1N1 virus.

We made great strives this quarter, thanks to our employees worldwide and our exceptional leadership team. They worked with dedication and creativity to advance our strategic goals even while our company is undergoing an important cultural evolution in a disabled economy.

Based on our success in the first six months of our strategic journey, I'm even more confident in our team's ability to realize our goal. Our organization is showing great flexibility and I'm extremely grateful for the positive response.

Going forward we believe that our constant focus on creativity and innovation throughout our operation and the agility to adopt our high-touch service to different channels we reinforce and advance our leading position in global prestige beauty. We are moving ahead with optimistic confidence and strength to accelerate our momentum.

Now, I will turn the call over to John, who will talk about the holiday season in the luxury market. John?

John Demsey

Thank you Fabrizio. Let me start by providing you with some insights and how the company flared in the recent holiday season and then I will touch on the many ways we believe that we at the Estee Lauder Companies are well positioned going forward.

In United States, our holiday sales exceeded our expectations, in a difficult environment consumers were attracted to value offerings across all of our brands. We had improved sell through compared with a year ago. Our gift sets were highly successful and most of them sold out.

The Estee Lauder brands annual blockbuster set has suggested retail price this year of $55 along with the fragrance purchase. Price was higher than a year ago, but since its value was well communicated and readily apparent, we had a 100% sell through and it drove traffic into the stores.

In addition to holiday gift sets, we emphasize value in numerous ways and at very suggested prices. Brand selections range from small sizes at entry-level prices to large expensive products that offered great value.

Our case in point, Jo Malone offered little luxuries, a candle set for $30 and at the other end of the spectrum, a $390 luxury candle, both items were virtual sellouts. As you well know, holiday is the largest selling for fragrance.

As a company, we had five of the top ten women's fragrances in the United States Prestige Department Store Universe, as classic scents in general were the stars of the season.

Estée Lauder Beautiful on the market for over 25 years was ranked number one with its flankers and gained share in a declining category. From our perspective, the aspirational and luxury customer started returning with some force at the end of the year.

High-end specialty department stores showed strong improvement in December, which helped boost our sales. We also saw increased traffic in our free standing stores globally, a trend that is continued into January.

Consumers not only responded well to our special holiday gift sets and offerings, but they also made many purchases for themselves. Our basic business led by skincare and foundation was solid.

Match foundation sales climbed 15% in the quarter and comprised 20% of its total business and Estée Lauder Clinique's foundation's products did well.

We believe that our Prestige products succeeded even in a challenging environment by offering priceless value with personalized service and creating an emotional connection with consumers. Our high-tech service model sets us apart and is influential in driving sales day in and day our.

With a blurring of prices and products across mass and prestige, we are devoting more resources to emphasizing and reinforcing what we do best, providing individualized service that fits the right product to each consumer, high quality in-store environments and effective sampling and promotions.

As consumers have increasingly focused on value during this past year, MzAzC and Clinique, our entry-level prestige brands have benefited the most. Both brands gained share this quarter and MzAzC has had nine of the top 20 makeup launches in the United States department store universe this fiscal year.

During the last year, U.S. mass channels performed better than prestige distribution for beauty products. However, this high started to change in November when prestige channels out performed mass, a trend that has continued in December.

Consumers in emerging markets, notably Greater China, Russia and the Middle East, are a growing force in the luxury arena. With rising incomes, they are gravitating to our aspirational brands. Our high-end brands include La Mer, Bobbi Brown, Estee Lauder’s Re-Nutriv collection have seen exceptional growth in Asia.

In more mature markets, the U.K. was a bright spot benefiting from an influx of travelers from the continent who took advantage of the Pound against the strong Euro, as well as shoppers coming from Asia and the Middle East.

We have a diverse portfolio of prestige products, suggested price points and a strong affiliate network around the world. This enables us to be agile and positions us extremely well to accelerate a particular brand, or even certain products, wherever there is demand. We can optimize our assets to our advantage and direct our advertising and promotions to areas that are fueling our momentum.

We have the brand assets and creative talents to adjust our resources and positioning whenever we see fit. By strategically steering our investments in the most promising opportunities by brand, by country and by channel, we are confident that we can spark thrive.

Now, I would like to call over Rick, who'll discuss the quarter's financial results. Rick?

Richard Kunes

Thank you John and good morning everyone. A quick reminder, my discussions on the quarter and the outlook exclude the restructuring and special charges, which I will comment on separately.

The quarter again came in better than expected. In local currency, sales rose 6% over the prior year period when we were in the depths of the financial crisis. The impact of currency translation on sales growth turned positive this quarter, resulting in a reported sales increase of 11% to $2.26 billion.

Net earnings for the quarter rose 62% to $256.6 billion compared with $158.2 million in the prior year quarter and diluted EPS was $1.28 compared to $0.80 in the prior year.

We beat the midpoint of our sales projections by roughly $100 million. There were several factors driving the stronger than expected performance. Better holiday business in the U.S and the U.K accounted for about 75% of that over performance. Much of the favorability came in December, therefore the majority of gross margin from the incremental sales dropped to the bottom line. Furthermore, those sales came primarily from a high margin skin care business, creating a favorable mix that contributed to tremendous gross margin improvement.

Operating expenses came in towards the lower end of our forecast as we exceeded our expectations for cost savings and some spending was deferred into the second half.

Our improved inventory management reduced obsolescence and a fantastic progress on our cost saving initiatives delivered about $33 million more in savings than we expected. Lastly, a lower than expected tax rate contributed to the variance.

As it turned out, several potential risks that we mentioned in the last call did not impact our business. One of the largest threats was the H1N1 virus, which was prevalent, but not severe enough to gap in people’s travel plans or purchasing.

However, since we didn’t know how the risk would unfold we took a conservative stance on spending.

That said we had a terrific quarter compared to last year. Along with our strategy, we continued to experience the strongest growth in skin care. Sales rose over 12% in local currency with all three regions contributing to growth in this category, particularly Asia and Europe.

In make up, local currency sales rose 8% on strong international expansion of our make up artist brands. Inline with our strategy to improve fragrance profitability, we reduced the highly promotional portion of our U.S. business, as a result, our fragrance sales fell 6% excluding currency, but the category was far more profitable.

Recent launches in the Michael Kors and DKNY brands were not large enough to offset the prior year introductions. In hair care, sales fell 1% due primarily to soft salon sales.

Geographically, our international business continues to lead growth. In Europe, the Middle East and Africa, sales gained a 11% in local currency. Global travel retail sales experienced a short rebound of over 25% contributing substantially to the increase.

Travel retail is better than we expected, because international passenger traffic picked up sequentially each month. We expanded several brands into new doors and the H1N1 virus risk did not fully materialize.

Our U.K. sales rose about 13% driven by strong performance from our make up artist brands and solid business at Estee Lauder and Clinique. Developing markets in the region contributed positively this quarter. For example, Russia and Turkey rose strong double-digits.

The major Western European countries were mixed with Italy and France largely unchanged, while Germany delivered low single-digit growth. Pockets of trade destocking continued.

Our strategically important Asia Pacific region saw a 9% rise in local currency sales. Korea, our second largest country in the region grew nearly 18% and Hong Kong rose 24%. The momentum continues in China, which rose 26% fueled by the tremendous success of the Estée Lauder brand light to our growth and extended distribution.

Japan declined mid-single-digits as it continued to suffer from the tough economic environment. The flat local currency in the America's reflected the continued portion of the consumer. Sales in department stores, salons and our own retail stores declined low to mid-single-digits.

These declines were partially offset by sales growth from Latin America products sold online and direct response TV. Some of you have asked about our presence in Venezuela. Our business there represents less than 1% of our global sales and we do not have a significant asset at risk in the country.

Our gross margin improved by 150 basis points this quarter to 76.6%. The biggest contributors to the increase were lower obsolescence charges of 100 basis points and favorable changes in our mix of business of 60 basis points. Also these factors were better than anticipated and directly tie to our strategy and savings initiatives.

The lower obsolescence reflects fewer SKUs and better inventory management. We also benefited from favorable manufacturing variances of 30 basis points partially offset by an increase in the timing and level of promotion of 20 basis points and currency of 10 basis points.

Operating expenses as a percentage of sales for the quarter improved 290 basis points to 58.9% compared to 61.8% last year. Our cost-savings initiatives and conservative spending in the quarter contributed about 520 basis points.

Lower losses from currency transactions added 20 basis points. These efforts were partially offset by higher IT and infrastructure costs of 50 basis points and assets impairment charges related to our Darphin and Ojon brands of about 200 basis points.

Over the next six months, we expect to step up targeted investments behind effective advertising, merchandizing and sampling, our online business, consumer insight, regional R&D and new high touch service concepts.

Operating income rose 48% to $399.9 million compared to $270.6 million last year. And operating margin rose 440 basis points. Our cost savings initiatives are ahead of plan with total savings of $83 million or 370 basis points in the quarter bringing our first tax savings to 160 million.

We are working to improve our tracking and measurement capabilities to fully incorporate the benefit of this strategic shift in our mix. Regarding our net interest expense, we reported $19.9 million this quarter verus $19.6 million in last year’s second quarter.

The effect of tax rate for the quarter was 31%, lower than expected due to the geographic mix of our earnings. In the quarter, we recorded net restructuring and other special charges of 300,000.

Net cash flow from operating activities for the six months ended December 31, 2009 was $617 million compared to $217 million last year. The biggest drivers of the gain were higher net earnings, inventory improvement and the timing and level of tax payments.

During the quarter, we repurchased approximately 1.4 million shares of our stock under our share repurchase program. Our day sales outstanding were 44 days this quarter, two days lower than last year. We continue to monitor the financial health of some key customers. Inventory days improved to 150 days compared with 166 days last year.

At the end of December our SKU count was down 10% from a year earlier. We will be building inventory in our third quarter in advance of the rollout of SAP to North American manufacturing facilities this spring.

The pickup and demand has made it more challenging to build these safety stocks, so we are focusing on protecting our top selling SKU’s across all brands.

We spend $104 million for capital expenditures, which included spending for a companywide savings initiative. For fiscal 2010, we expect to generate between $800 million and $850 million of cash flow from operations and to use about $315 million to $330 million for capital expenditures.

Looking ahead, our full year forecast reflects the strong results to-date, a slowing improving global economy and the lessening of some risks such as H1N1. We remain cautious about the consumer recovery here in the U.S and the likelihood of more aggressive competition for the remainder of the year.

For the year, we now expect fiscal 2010 local currency sales growth of about 3 to 5% led by our international businesses. Currency is expected to add between two and three percentage points to our reported sales.

Our full year business model will look a bit different than the first six months. We expect to reap the benefits of our gross margin improvement and increased spending efficiency to fund activities that will build market share and enhance our long-term brand equity.

Our brands and affiliates have been authorized to invest in the second half against strategic priorities and to build on our sales momentum and share gains. We expect to increase investments in advertising and key markets such as China.

E-commerce and digital marketing programs, new high cut service models, consumer insight capabilities, regional R&D and other marketing innovation efforts.

We continue to pursue the cost savings initiatives we previously laid out for you and we are increasing our full savings estimate for the year to between $275 million and $300 million. For the full year, we now expect to record charges of between $60 million and $90 million.

Given our revised sales forecast, strategic investments, and cost savings initiatives, we now expect a 350 to 380 basis point improvement in operating margin this year. At this time, we estimate our effective tax rate will range between 30% and 32% for the year. We're raising our full year EPS forecast to between $2.55 and $2.73.

Sales for our fiscal third quarter are expected to grow between 4% and 7% in local currency. Currency translation is expected to add about 5 percentage points to sales growth. We expect EPS for the 3 months ending March 31st, 2010 to be between $0.20 and $0.30.

We’re very pleased with our business performance for the first half of the year. Our four-year strategy is off to a good start. Thanks to the great motivation and agility of our teams. We will continue to pursue cost savings to enable us to deliver sustainable profitable growth for the long term.

And that concludes my comments and we'd be happy to take your questions now.

Question-and-Answer Session

(Operator Instructions) Your first question comes from Mark Astrachan - Stifel Nicolaus & Company, Inc.

Mark Astrachan - Stifel Nicolaus & Company, Inc.

I wanted to just delve into the cost savings a bit more deeply. Just talking about moving forward some of those expectations and just simply greater expectations or greater savings in the December quarter and then for the year, what does that potentially mean as you look out on your longer term cost savings plan through 2013 in terms of whether you've uncovered additional savings or whether you had additional thoughts on how you are looking at that going forward?

John Demsey

Sure Mark. The biggest driver of our cost savings exceeding expectations has been in the cost of goods area and there are two elements of that, one is our inventory management and the SKU reduction programs which are contributing tremendously to the improvement year-over-year as well as managing our mix and that mix is three components, its geographic mix, category mix, and also within each brand, the SKU mix.

So the biggest driver is coming from the mix area but we also have savings coming from our resizing and restructuring program and our indirect procurements so all of those are doing quite well.

At this point, we set over the four year program rather that we say between $450 million and $550 million and we are not changing that number at this point in time, we are happy that we are going a little bit faster in the beginning but we are comfortable with that target over the full-year program.

Operator

Your next question comes from Joe Altobello - Oppenheimer and Company

Joe Altobello - Oppenheimer and Company

Thanks, good morning. Just wanted to follow up on that question for a second, so its sounds like you guys are just getting more benefits early on and cannot like you are pulling any savings from fiscal 11 and fiscal 10.

John Demsey

That’s a true statement.

Joe Altobello - Oppenheimer and Company

Then just on the spending, obviously you guys spent a little bit less than anticipated in the first half and talking about little bit more in the second half or actually a lot more in the second half. How did your spending compared to your competitors over the past six months and is that increase in spending in the second half more of a proactive response - a proactive act or a responsive act to how you anticipate your competitors to spend in the next six months?

Fabrizio Freda

We are spending competitively in the last six months, also we continue to spend competitively. The market obviously has been spending less. So, yes assume the competition will increase spending as well in the next six months to twelve months. So, at first they are trying to say that our extra spending is going to impact into a more competitive environment, however, it is not driven by that.

As our extra spending in the next six months is driven, first of all, by the great learning of the current six months. We focused this spirit in improving the targeting of our media spending, first of all, improving the quality of our communication, improving the mix of this communication, meaning focusing the communication and investment in advertising, merchandising and sampling on bigger initiatives with higher returns and in the most strategic countries and affiliates of the globe and we have learned that all these improvements are working very well for us, because in front of the reduced spending, we got a substantial acceleration of our top line in the last six months.

So, for the next six months, we want to level this new way to become more effective and efficient in spending, which as I explained some time ago is also now based on a more accurate rate of return on investment analysis on this spending and to go back on the attack on our biggest initiative in our most strategic countries and to build on current momentum to accelerate growth.

Operator

Your next question comes from Lauren Lieberman - Barclays Capital.

Lauren Lieberman - Barclays Capital

I just first have a quick follow-up actually on that particular line of questioning. I don’t doubt at all that you've got learning's in terms of ROI and what advertising works better than other advertising, but one of my questions would be, how do you know or do you have a sense for how much of the sales acceleration in the first six months of your fiscal year really just have to do with stabilization at the high-end consumer, lapping the really easy comps versus spending in the right places. Again, I don’t doubt that there would be things you’ve learned, but do you really know at this point, what the mix of how sales came through?

Fabrizio Freda

Yes, I think we know that we are spending in the right places. We know for example that we had been spending substantially more on the very successful launch of Estee Lauder Advanced Night Repair and we know that we've been spending for the first time on a more holistic mix of media including heavyweight or television advertising in developing markets specifically, which is proven in those market to be very, very effective for our big launches.

So, we know these are ready and we know which is evident, the results of this new strategy in our last six months. At the same time, it is also through, not beyond the factor of playing. As you said, it's clear that our top line growth comes from a continuous and successful overall share growth in markets where the consumer is coming back specifically Asia.

Asia, the last month has been a stronger economy than what we originally expected and in that economy we had a particularly strong program of growth, which obviously is delivering results.

The same we can say about Russia by about added developing markets and these also is playing a role. Finally, our sales growth has also been accelerated by a holiday season that went better than we expected. And finally, by some amazing results in travel retail, which delivered increased sales against better than expected traffic, but also importantly against early success in the ability to convert consumer from traffic to shoppers, because we are also in travel retail growing market share accordingly.

Lauren Lieberman - Barclays Capital

So how do you actually know that the affiliates are getting a better return on the less money being spent today, right so the affiliates are looking and saying, "we are delivering on the top line, we are more than delivering". How do you get comfortable that these affiliates are actually going to spend what is currently in the budget in the second half of fiscal year?

Fabrizio Freda

We are getting comfortable because we have discussed with the affiliates one-to-one how to support these plans. And because, we agreed the right methodologies on following up that we spent quarter-by-quarter what we have recently agreed to spend extra on the activities. So we get comfortable by a thorough follow up on this.

This said, we still have internal processes where in case we see opportunities or in case we see issues we may change our spending in the quarter in any affiliate, it could be a competitive reason, a big opportunity to see that the money is better spent later or earlier on a different opportunity. So, we have internal processes that offer agility of spending decisions and we believe this is a competitive advantage and not an issue.

Operator

Your next question comes from Linda Bolton Weiser - Caris & Company

Linda Bolton Weiser - Caris & Company

I just want to make sure I've got the big picture here on the guidance change. You raised the guidance for the fiscal year by more than the upside surprise in the second quarter. The spending is basically, the held back spending will comeback in the second half. So I guess the increase is because of the better sales growth and the leverage in here, in the model, am I getting that correct?

John Demsey

You are and you will recall that in the second half of last year, remember we had a $250 million belt tightening exercise last year and most of that was benefit that came from reducing the expenses in the second of the year. So when you go into this second half are coming for us.

What we're seeing is that we have to replace that with our permanent savings and we're doing that we're taking up our savings estimated as we just mentioned and so with that extra savings we're covering the belt tightening that had to comeback because it was temporary in nature and we're also investing a lot of that money and at the same time hopefully improving our profitability somewhat to come up with that full year forecast. You're correct

Linda Bolton Weiser - Caris & Company

I didn't catch, you gave a specific number for travel retail, can you give a little more specific, was it up 25% or so or?

John Demsey

It was up 25% in the quarter and it's up about 15%, 16% in the first half of the year.

Operator

Your next question comes from Bill Smith - Deutsche Bank.

Bill Smith - Deutsche Bank

Can we just talk a little bit more about the belt tightening, so I know it was $250 million, what does that anniversary, I know you said 70% is going to comeback in, is that number still 70% and kind of what's the timing of that reinvestment.

John Demsey

First of all Bill, of the 250 more than half of it certainly came in the second half of last fiscal year. So we will anniversary that in a sense by the time we end this fiscal year. What we're doing now is that savings as I've described the spending comes back into our P&L.

We're more than offsetting it with our savings programs and targeting savings around the cost of goods mix, around resizing and restructuring, around indirect procurement, around some of the other initiatives. So those overall savings programs, part of our strategic plan are more than offsetting that tiny returning, so that will be through our P&L by the end of this fiscal year.

Bill Smith - Deutsche Bank

Okay, is that why you are still going to reinvest about 70% of savings back in. is that a good --?

John Demsey

It is a reasonable number that goes between 60-70% of that we said would come back and that still holds true.

Operator

Our next question comes from Dana Telsey - Telsey Advisory.

Dana Telsey - Telsey Advisory

Can you talk a little bit about wholesale ordering patterns? How are you seeing them going forward and how is it different than six months ago or so? And also as you think about pricing trends, do you see that changing going forward and is there any adjustment to your forecast for travel retail going forward?

Fabrizio Freda

Is your question about stocks in the trade?

Dana Telsey - Telsey Advisory

Yes exactly.

Fabrizio Freda

Okay. So we see the retail inventories maybe have been difficult to forecast, it has been --- one of the elements has been difficult to forecast in the last six months. We see today if we can mix behavior around the world.

In the U.S. we have seen actually a moderate restocking in front of the holiday season. In Europe, on the contrary we see continued stocking particularly in the pharmacy channel across continental Europe in certain retailers. And in travel retail, we have seen actually a little bit of restocking in front of the new growth trend and in Asia not a big variation, so very, very different around the globe.

In total, we have seen basically stabilization of the stock impact and with some continuous de-stocking honestly in Western Europe where we don’t believe the trend is finished. So that’s the first answer, sorry what was the second part of your question?

Dana Telsey - Telsey Advisory

Pricing, do you pricing changing at all?

Fabrizio Freda

No we don’t expect in this moment that there is a lot more pricing possibilities that was estimated few months ago. I think the consumer continues to be very value-oriented and is not, there is basically the possibility on normal pricing trends that we assume in the next year, year and a half.

Dana Telsey - Telsey Advisory

Just lastly travel retail.

John Demsey

Yes and that for year, we see kind of a mid-teens for the full year for travel retail. So we are seeing obviously not quite the pace that we saw in the second quarter, but we are seeing a continued strong growth with that business for the rest of the year.

Fabrizio Freda

Yes and also that if I can, I would like to point out that travel retail is a very volatile segment and in this moment it’s doing very, very strong. But it’s a segment we have learned that is very, very influenced by specific events like advance of the flu in Asia can change dramatically the trend in travel retail or a terrorist attack could change dramatically the level of sales in travel retail.

So we estimate travel retail pretty carefully also because of it’s higher than the normal volatility risk.

Operator

Our next question comes from Chris Ferrara - Banc of America.

Chris Ferrara - Banc of America

Guys I just wanted to talked about I guess a pattern that we have seen emerging right and you guys report a quarter and spending is lower and you say we are going to spend more in next quarter and it gets differed, and I understand how the external environment can contribute to that.

But I guess as we see it happening this quarter, are you saying you’re going to spend a lot more next quarter and the next half? Can you talk about the budgeting process for this spending I mean is it top down? Is it bottoms up? And is it influenced at all at the segment level by the comp changes you guys made the fact that operating margin is bigger piece of things now?

Fabrizio Freda

Yeah, I would like first to take it straight to the numbers. It is true that it's been part of the spending. That is no big step. When we speak about $15 million, $20 million, often a very important amount of better results than forecasted.

So the majority of the better results are really coming out of top line sales and sustainable impressive better cost of goods because it makes every structure resizing indirect procurement. It means the large majority of our over-delivery, which just doesn't justify it obviously, which we need to get a better handle on this forecasting.

But the majority is about very healthy over-deliveries, sales growth restructuring savings, indirect procurement, mix of cost of goods, reduction of destruction, all what honestly, I predicted, that was our focus.

And specifically I want to clarify that the fact in many cases it happens, that a good plan of SKU reduction, a good sanction on inventories creates more benefits that were originally estimated because, in our case for example, it is having a very positive impact on reduction of destruction.

So and then we’re saying that there is some less spending in advertising, merchandising and sampling, which is attributable to the budgeting process, which your questions focused on. And the budgeting is a process where we have a clear agreement of what we spend against which client every quarter.

But as I was explaining there is some flexibility where they review every month in our business where we review every month brand by brand, affiliate by affiliate, where affiliate and brands can make proposals to change their plans based on the competitive environment of the market forces.

This is a point of trends over agility. Normally we don’t see big variations because what - you spend less or more is affected by either items in the total. In the last quarter we saw this variation that I mentioned which by the way is a small percentage of the total story of our delivery.

Said this, I want to go back on the side that we have - we understand your frustration with the trend that you had described and we share it and we are focusing to do better in the future but I also, to clarify that this last two quarters was very difficult to predict the environment, let me, said the way I see it, we've had many integrated software that were playing together the same time.

First externally, worst for us, it'd be difficult to predict how the economies will develop in this global world. In fact Asia went better than what we expected or it was difficult to predict the holiday season at a certain moment of time and the holiday season went better than what everyone expected first in the UK and partially better also in United States.

It was difficult to predict this impact on the flu as I explained the flu could have been devastating on our travel retail business, while on the contrary the travel retail business was a highlight of the last year, as you know it's a very profitable business, but when there is a variation there has a big impact on our business.

The flu could have an impact also on the holiday season, which didn’t on the contrary the holiday, season was solid as I have described. It was difficult to predict the trade, the stocking, the retailer de-stocking, we have big trends of de-stocking and then somehow they then continue for sure, they then continue in travel retail an din the U.S.

At the same time, we had many internal changes. With the first six months of the new strategy, what does that mean, there was a big cultural change and many people had to understand how to manage cost in a different way and was difficult to predict how good the organization would have been able to buy into that.

There was a new organization designed as of July 1st, with a creation of the region, a totally different dynamic or relation with the retailers and internal was difficult to predict that it would have been no issue at all in getting this going and while there is (inaudible). As I already explained, there was the impact of SKU reduction and inventory on the structure and mix, it was much more positive.

And finally, the effectiveness, so in the new way to invest AP and the bigger potential to (inaudible) investment, it was a premier for us. It was difficult to understand how fast this would have produced also positive top line results. So, I think we've learned, we've learned a lot in this first six months and I think we will apply this learning to our future ability to understand these trends and the possibility of our strategy.

Operator

Your next question comes from Wendy Nicholson - Citi Investments

Wendy Nicholson - Citi Investments

My first question, the ad spending in the first half, can you quantify exactly how much that was down year-over-year, so was the 150 to 170 in the second half going to make it flat for the year or commercially what we are talking about?

Richard Kunes

No, it was down in the first half about $75 million or $80 million versus the year before, and then in the second half, it should be about $150 million to $175 million up.

Wendy Nicholson - Citi Investments

And then second thing, do you have a specific number for travel retail in terms of the sell through, I know you should sell-in was up 25, but sell through for your business?

Richard Kunes

I do not have Wendy, the sell through numbers. But we are gaining share in our travel retail business, so it is certainly head of the market trend, but I don’t have the specific.

Operator

Your next question comes from Alice Longley - Buckingham Research

Alice Longley - Buckingham Research

Are you going to give us an update on your operating margin goals. I know it has been said 12% to 13% by 2013, but it looks like you might get there earlier?

Fabrizio Freda

No, in the sense that we don’t plan at this point in time to change our long-term targets. I think it’s just the first six months over a four-year strategy, we clearly have demonstrated that we are getting in the right direction faster than what we originally thought, but there is still a lot of work to be done in front of us. We are ahead on the saving plans, the top line has be to be obviously confirmed in its sustainability.

In term of capability buildings, we are inline with goals. I would define it as not ahead and particularly I need to become much more confident on the sustainability of this performance before adding any input on the top line growth and the long-term growth and the long-term margin goals that we have established.

Alice Longley - Buckingham Research

When you might you revisit those goals and talk about an update?

Fabrizio Freda

I think we will revisit those goals only at least after one full year of having been working with the new strategy and having understood the various elements and how the various cost savings become sustainable or not.

Operator

Your next question comes from Ali Dibadj - Bernstein

Ali Dibadj - Bernstein

I guess everyone is asking a similar type of question, but it feels like the response or at least I get a little bit of a dichotomy in the responses. On the one hand, we're surprised, we're pleased, it looks like there's a lot of fad here, it looks like we're getting better on gross margins than we thought we did, that's all great and we have good control over the affiliates.

But on the flip side we also, as I get this feeling of, we need to figure out what the affiliates are actually doing, we're having meetings so that they tell us exactly what they're going to do. We need to figure out more about the cost savings on comps.

And it's feels us, it's kind of like we're doing better so the surprise which is positive but then there's a, oh my gosh! What's going on the organization, we need to figure out a little bit more in detail and maybe it's just my interpretation a bit I kind of feel both size of that I just want to hear perspective on that interpretation.

Fabrizio Freda

Yeah, at first, I don't see this is a right interpretation and I think that there is nothing, which is our control actually it's a bit the opposite. This organization is becoming an efficient, effective and importantly integrated organization at the speed of light. If you want my honest point of view I had the, I was worried about how fast this organization would have been start to work in the way we're working.

As you know, as we started we have a set of a new corporate strategies, we have then strategies by brand, by functions, by affiliate and we spent a lot of time in the beginning integrating all these strategies and may clear that the organization become more interdependent in all these aspect.

This was a big cultural change for this organization and there was a certain level of risk there do would be low or will now work in certain areas and that to say that opposite is happening, this organization is integrating, is becoming very interdependent the clarity on the strategies is everywhere.

The processes I was quoting, that the U.S quarter like having affiliates meeting at all these is just the result of disintegration and the way in which we are learning how to descale.

Actually, I believe you should see the fact that we are over-achieving the results, a sign that the ability to descale and become an interdependent organization is much better than the original estimate and all these work with the affiliate that I was referring to is actually a positive and at least not something I'm worried of in the future.

John Demsey

And one more point on that Ali is that, I think one of the things that we need to improve on for sure is our visibility into how quickly those results are manifesting themselves and being able to predict the future better for sure and one of the things that is part of our SAP implementation is also a budgeting and financial modeling and forecasting system that goes along with that, which will enhance our abilities to have visibility into the pace and speed of which some of these changes are happening and the financial implications of them.

So, I think that is certainly a soft spot for us and one that we’re working on. It’s going to take us a little time to get there, but we are trying to improve that as well.

Operator

Your next question comes from Leigh Ferst - Dudack Research.

Leigh Ferst - Dudack Research

Your digital media strategy sense is quite robust and very effective. Can you talk about the strategy and how it relates to your more traditional business? Are there any conflicts there or is that all upside?

Fabrizio Freda

Personally, I don’t think there is any conflict here to clarify what is our digital strategy. First of all, we had E-commerce and a big part of our E-commerce is with our retailers with which we have brick and mortar activities. So there is no conflict, actually is the E-commerce of our retailers, which is growing very fast with us.

Part of our E-commerce is obviously on our brand, direct, which is also doing very well. But these e-commerce also is big equity builder for the brand and then creates advantages for all the channels and continues growth.

But another important theory of break through is not necessary in the e-commerce space but is in the digital where we are really working more and more in the digital world just as in area to build our brands to create social network, to exploit the new digital realities in every country and so basically is becoming a very sophisticated and important market investment area.

On this one we are making some important learning’s and breakthroughs and particularly we are going to invest heavily in this area in the next two, three years. This is one of the key strategic choices for breakthrough in the entire organization that we have taken and there is still a lot of potential obviously in the United States, but importantly in many international markets where the trend is extremely strong.

Leigh Ferst - Dudack Research

Can you say how much you are investing and how we would track up?

Fabrizio Freda

We said in, when we explained our long term plans we explained we would have savings between $415 million and $400 million and we said we would have invested back in the business in the area of capabilities $50 million. This still holds true and the areas where we are investing are, we are investing in this big new capability in the area of R&D international specifically building our ability to do products in Asia and Europe.

As I said we are investing in more consumer insights capability and importantly a big side of it was the investment in digital capabilities being developed around the globe.

Operator

Your next question comes from Caroline Levy - CLSA.

Caroline Levy - CLSA

Just a question on the competitive environment in your biggest markets, if you could talk a little bit about where you might be seeing an increased pressure? It seems like you're really gaining share. And then growth in natural and organic, and how robust is that?

John Demsey

I'll speak about the US market. Actually, yes the market is competitive; however the Estée Lauder companies in totality have gained share in this difficult time period. In fact the Estée Lauder brand is showing the first signs of stabilizing in the United States in many years and the brand on a global basis is the key pillar of our corporations enhanced profitability in this time period.

We had three out of the top ten fragrances in the United States. Our brand is the leading anti-age category. And with our largest skin care launch in Advanced Night Repair, and we’re now the number one leading prestige skin care brand in Asia.

So our core brands are performing better than the overall marketplace in terms of the cosmetic business, outperforming the channels that we sell in and at the same time gaining share.

The fragrance business for the holiday season was difficult in its totality, and our fragrance business though difficult outperformed what was taking place in the marketplace with strong ranks and strong performance as well.

Our skin care business in particular as we discussed before is strong and it's the strategic objective of the company highlighting our product innovation and our high-touch service in stores as well as our foundation business and the color business has stabilized a bit.

We also mentioned earlier in the presentation that up unto November the mass market was far exceeding the growth of the prestige channel that switched in the month of November and December and this is the first time that we've actually seen the prestige channel beginning to outpace mass.

So we view this as a return of the aspirational consumer and in more competitive set of aspirational brands competing effectively in the marketplace.

Fabrizio Freda

And I will add just to the perspective on the question on natural brands. We are having some very, very good encouraging results on our origin brands which is doing better and is growing nicely and importantly we are launching origins in China in few months so within the next quarter.

And this will be a great important event to bring strong brand and a strong national position in these growing markets. And importantly also our Aveda brands, which is in this area is doing well and continue to have very strong plans to grow and server the salon business in North America and internationally.

Operator

Your next question comes from Maria Vizuete - Piper Jaffray

Maria Vizuete - Piper Jaffray

I'm wondering if you could talk a little bit about distribution in Asia and more specifically in China, what brand are there currently and where is their opportunity in terms of the brands and point of distribution. And then also if you could remind me of the size of the business in China, that would be great.

Fabrizio Freda

The brands we have in China, we have a big part of our portfolio in China. Also in China we have our biggest brand, so the Lauder brand, Clinique brand, MAC brand, we have our high-end brand, Bobbi Brown, La Mer, we have Jo Malone and we have nine brands in total and we are launching one more brand I just explained in March.

In terms of the size of our business today, China, Mainland China is 3% of our business and we will grow and we believe the Greater China, which is the way also we look at it, may include Hong Kong and Taiwan has the potential to get really up to 8% or more of our business over the next five years. So it's really the important area of growth and development where we are focusing on.

In terms of pricing, we are today in the Tier 1 in two cities, but there are so many other cities that we can grow on. So there is a possibility of expanding in China our portfolio brands in the future still, there is a possibility of expanding the current brands in the existing distribution.

There is a huge possibility of further enlarging distribution in different cities into larger parts of the population. And finally, there is, at least we assume very strong growth of the e-commerce in China, also in China, in which we are going to participate from the beginning of this strong expansion. So a lot of possibilities.

We also want to verify that the success in China has a huge impact on Greater China and on travel retail Asia. So, the growth in China creates positive (hollow) assets on Hong Kong. We believe we create more (hollow) assets in the future also in Taiwan and it is definitely a big important input on our travel retail business.

Operator

Our final question comes from Alex Patterson - RCM

Alex Patterson - RCM

Hey Rick, I just wanted to make sure I heard you right about, as you were describing, the increased savings flowing through. It sounded like you mentioned mix as a factor on gross margin and I was just trying to understand that, A: did I hear that correctly and B: what do you mean by mix?

Richard Kunes

Sure you absolutely heard it correctly. It is one of the big drivers of our cost of goods improvement. Year-over-year it was about 60 basis points in the improvement and our margin in the second quarter.

What I mean by mix is more skin care less fragrance. More sales in travel retail in one of our highest profitability channels, not so much from gross margin perspective, but from an operating margin perspective.

Mix meaning using less of the set business during the Christmas season than we normally did. So driving more of our basic business in selective categories of our business like the fragrance category, which affected and improved our margin capability.

So, it’s all of those things that are driving our gross margin and that’s what I mean by mix in addition to the things that Richard was mentioned about our strong inventory management, SKU reductions and the benefits coming from that.

Alex Patterson - RCM

Okay, so that’s I wanted to be clear on. You are really referring to a sort of portfolio mix, product mix as opposed to raw cost reduction initiatives?

Richard Kunes

Yes, yes I mean we have those as well, but what we are talking about now is the mix, mix by geography, mix by channel of distribution, mix by products that we are selling, absolutely.

Alex Patterson - RCM

Okay, and well guys just quickly the impairment charge, 200 basis points roughly $40 million, is that pretty much it for the year or is that potentially more that’s coming?

Richard Kunes

Well, if there were more we would have recorded it, so the answer to that is at the moment we don’t believe there is any more coming. It’s based on, as we said some changes in -- those smaller brands actually suffered more in the current economic environment. You’ve seen that I think, throughout the industry.

Those brands are - were based on that struggle we looked at the distribution plans, their expansion plans, we change those plans, those plans resulting in slightly different forecast of future performance which therefore had discount in cash flow created the impairment.

But, yeah we believe in those brands and we will have a plan to make them a big part of our portfolio going forward but with that change we have to take the impairment charge. And in our, at the end of our or during our third quarter revenue, we're doing a very through analysis which is required on annual basis of overall of goodwill, that’s on our balance sheet and all of our acquisition, that process happens during our third quarter.

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 from February 11. To hear the recording of the call please dial 18006421687 pass code number 4910079.

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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