Welcome to The Estée Lauder Companies Fiscal 2010 Third 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.
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 is Cedric Prouve, Group President - International. Cedric has responsibility for our business outside the United States and Canada representing more than half of the 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.
Thank you Dennis. Good morning. I am pleased you had joined us for our fiscal 2010 third quarter earnings call. In our discussion today, I will review our performance and progress on our strategy. Cedric will talk about the company international business and Rick will follow-up with financial details.
This morning we again announced strong results with solid sales gains and greater profitability. Third quarter sales were $1.86 billion, up 10% compared to the same period a year ago, with improvements in all regions and categories.
Diluted earnings per share were $0.34, more than double last year's results before restructuring charges.
I am also gratified that we continued advancing in many of our strategic goals. Let me give you some highlights; first, we believe that retail sales of our products grew at a faster pace than Prestige beauty trends in many critical countries and channels, which means that we increased share.
Excluding Prescriptives, we saw gains in US department store, as well as Russia and China among others. Our international business expanded more rapidly than our domestic business and we are approaching our target of generating more than 60% of sales outside our home market.
Our operating margin widened the gain, moving as closer to our long-range goal of 12% to 15%. Our Turnaround brands collectively showed continue improvement in operating results this quarter and we made additional progress in our cost savings initiatives.
In each of our three quarters, so far this fiscal year, we met or exceeded our sales and earnings estimates and successfully moved ahead of our strategic journey.
All of our employees should be extremely proud of these accomplishments, which are the results of their hard work and creativity and I want to thank them for their efforts.
Now let me turn to some of the specific areas that drove our growth this quarter. Our international business provided the greatest momentum. Asia Pacific remain robust led by strong gains in Greater China.
Sales in our European region climbed driven by travel retail Russia and the Middle East. Our strategy is to continue emphasis on our regions, which has enabled us to be more locally-relevant and accelerate our growth.
Estée Lauder brand enjoyed solid growth internationally in the quarter particularly in Asia-Pacific and travel retailing led by skin care sales.
Estée Lauder is the leading Prestige brand in Asia in our distribution. One of the most exciting developments in our foreign markets this quarter was the launch for our Origins brand in mainland China. The brand highly successful repositioning powered by nature proven by science has been directed by Senior Vice President and Origin General Manager, Jane Lauder.
She led the kick-off at the Parkson Department Store in Shanghai, joined by Executive Chairman William Lauder one of the founders of Origins 20 years ago and other company executives and local celebrities. Cedric will give you more details about our international business in a few minutes, so, now I want to discuss other areas that drove our sales.
Clinique skin care sales grew over 11% at retail, thanks to strong launch activity and gained share in the US department stores. Clinique is the largest US cosmetic brand, so when a brand of its size gained share it is an impressive feat.
We were confident by the fact that US retail sales jumped strongly in March led by upscale department stores, which points to a possible initial recovery in consumer spending.
We are working closely with our large retail partners to create innovative shopping experiences in department stores. For example, we are refining our High-Touch services from education through post purchase. We are also leveraging in-store services differentiating by store size to better serve the needs of our consumer and improved profitability.
Our e-commerce business grew 25% with most of our brand sites reporting double-digit growth. Retailer side in North America also posted solid sales gain. In addition, we expanded our global web presence, Clinique launched online sales in Germany and M.A.C started e-commerce and mobile commerce in Japan.
Bobbi Brown will follow with both types of online shopping in Japan next month. As you know, one of our key mission is to build up on our global leadership position in skin care. This universal focus across our brands is reflected in our results.
In the recent quarter, reported skin care sales rose 16%, and we launched two breakthrough products that we believe will be important contributors to their respective brand portfolios for many years to come.
Toward the end of the quarter Clinique began shipments of Even Better Clinical Dark Spot Corrector, which treats uneven skin tone with results that are comparable to a leading prescription ingredient.
We have high expectations for Even Better Clinical and are supporting it with an unprecedented television campaign in the US, which launched last week. The commercials will run for five weeks including prime spots during American Idol and Dancing With The Stars.
Our other major introduction was La Mer Regenerating Serum, which is the brand's first anti aging product. We are excited by its initial phase, but also encouraged that the serum has reached the sales of the brands Signature moisturizer.
La Mer is one of our high end Prestige brands and it had double-digit sales growth with particular strength in North America, the UK and travel retail. We believe that consumer are beginning to reconsider luxury products. It certainly bodes well for our entire Prestige portfolio.
Another standout in skin care is Origins, which has been remarkable consumer acceptance in its revamped skin care line. Origins had outstanding comp door growth in its major US retailers during the quarter. It also has been terrific improvement in the UK where sales grew 12% this quarter. With new merchandizing, advertising and communications the brand global sales rose high-single digits led by new products including GinZing eye cream and Brighter by Nature skin peels.
In makeup reported sales increased 2%m due to the improvements by both of our makeup Artists Brands, M A C and Bobbi Brown. M A C, enjoyed strong sales growth in Europe and Asia. Its brand equity and philosophy is closely tied to its annual Viva Glam lipsticks sales, which benefit the M.A.C AIDS Fund.
This year Viva Glam, spokespersons Lady Gaga and Cindy Lauper drew huge media attention. Sales of Viva Glam product exceeded forecast and had a (halo) effect on the rise of the business. Last week M A C took the Viva Glam range to Asia. Lady Gaga performed in Tokyo, which generated terrific media coverage. This month M A C open it's most innovative and technology driven store in Times Square. This busy area attracts close to thousand billion people a day making this location a superb retail opportunity.
Bobbi Brown recently, visited China to do television and magazine interviews and make-up artists events to build brand awareness. She previewed upcoming launches, which we expect will increase sales in the current quarter.
At Derek Lam's recent show during New York Fashion Week, the Estée Lauder brand's new Creative Makeup Director, Tom Pecheux gave a preview of the colors Estée Lauder will debut this fall. This was the first time the brand had been involved in backstage with the high profile runaway show.
Evelyn Lauder, Estée Lauder's Senior Vice President and Creative Director work closely with Tom to create the first collection and we had the static imagery to support it. We think his strong ties to beauty and fashion editors will attract a more fashion-conscious consumer and bring increased [buzz] and attention to our flagship brands when these products hit stores.
Along with the sales gains we generated, we also increased our profitability. Our restructuring efforts are enabling us to work more efficiently. As part of our ongoing cost reduction, we trimmed $104 million largely achieved in cost of goods, indirect procurement and resizing and restructuring initiatives.
Our year-to-year savings totaled $264 million and we now expect to save $300 to $330 million for the fiscal year. As you know, we have committed to reinvest a portion of our savings to build capabilities. We are also re-focused on continuously improving our productivity. Starting this July, we'll establish a company-wide mandate and plan that employ cost increase more slowly than sales growth.
Our Turnaround brands showed solid financial improvements, which have strengthened our bottom-line. The official closing of Prescriptives wholesale business on January 31 was executed flawlessly and we received praise from retailers noting how well it was handled. We moved the certain employees to other parts of the company and of transferring popular Prescriptives products and formulas to other brands including Calyx fragrance, which is now past over Aramis and Designer Fragrances. Some Prescriptives retail counters will be assumed by our other brands and its online sales will continue for a period of time.
The Aramis and Designer Fragrances division has begun reaping the benefit of a profit improvements strategy started in May 2008. It has dramatically improved its cost of goods, cut its SKUs by over 50 % in the last three years and is launching fewer fragrances with bigger impact. The recent European introduction of PureDKNY was well received. The fragrance is innovative because of its sustainability platform, which is unusual in the category. ADF also began distributing the Coach Fragrance in the US department stores, broadening its availability beyond Coach retail stores.
Another key component of our strategy is to enhance our capabilities in certain areas to improve our competiveness. To that end we announced the establishment of a Corporate Marketing Center of Excellence; which will be a resource for our research and development teams, brands and region as we develop greater consumer insights and marketing tools
Georgia Garinois, who worked for Johnson & Johnson, has joined us to lead the new center. His responsibilities include capability development in multicultural marketing, global consumer insight, customer relationship management, digital marketing and advertising services. Georgia reports to me and he is a member of the executive leadership team.
One of the company’s historical trends has been our innovation and creativity. We believe by utilizing more in-depth consumer insights and focusing our efforts on the biggest opportunities, we will produce even greater creative breakthroughs across the company.
Our approach is to be creativity-driven and consumer-inspired. We are developing a strong pipeline of new initiatives to drive growth over the next three years. We are planning launches that will include new product ideas as well as existing successful products that we will improve with updated technology, similar to what we did with Advanced Night Repair.
We will also accelerate innovation of the High-Touch, which integrate our products to create a well differentiated Prestige experience. We will give you further details as this initiative near their launch dates.
Earlier this month, we rolled out our strategic modernization initiative to nine North American manufacturing facilities. Over 80% of our in-house product is now on SAP. Although it is too early to give details, the implementation is being smooth and we haven't encountered any major problems.
On our next earning call in August, we plan to provide early results of the North American effort, review the SMI project and discuss future steps.
With just two months left in fiscal 2010, William Lauder and I are extremely pleased with how far we have come in the first lag of our four-year strategy journey. Looking ahead, we are prepared to move the company from successfully navigating in a recession to growing during a recovery.
We plan to continue taking aggressive steps to fuel our momentum. For example, our target advertising and promotional spending will be significantly higher in the fourth quarter versus the previous year, which should help to drive sales going into fiscal 2011.
We will focus on our biggest opportunities including major product launches in the best performing countries and our largest brands. As our performance this year should confirm we are growth company. Furthermore, as global economy returns to more solid footing and employment levels improve the money spend on Prestige beauty product worldwide is expected to gradually return to historical norms. We fully expect to capture a bigger share of the growth in sight.
Now, I will turn the call over the Cedric Prouvé who will talk about his area of the business. Cedric?
Thank you, Fabrizio and good morning everyone. As Fabrizio mentioned, the international business once again enjoyed strong sales and earnings growth in the recent quarter. In fact our sales have increased every year for the last decade in local currency, underscoring how important the international operations are to the company as a whole.
International accounts for nearly 60% of sales, is the major growth driver and it's transforming to the Estée Lauder company in to a true global power house.
Let me briefly explain why we have been so successful expanding our brands in to more than 140 products. First, we have a highly effective organization led by strong regional teams that are developing expanded capability. They are supported by a powerful network of global affiliates, which stay in touch with our consumer's taste and thinking and provide excellence on-the-ground execution.
Our international organization continues to evolve and align with our global brands and functions. Of course, we also have a diverse portfolio of professional Prestige brands that allow us to leverage our strategies and optimize our growth, based on where we see the most promising opportunities.
Market characteristics dictate our investments by categories, product, brands and channels. At the same time we strive to balance our growth among emerging, developing and mature countries, again in alignment with each of our brand strategic priorities and plans.
This year every international region is ahead of its sales and profit objectives after the third quarter. Asia however is the standout with continued superb momentum. Within Asia, Greater China has been a key performer. The region's growth has been fueled by skin care, which accounts for a large majority of its sales.
Our strongest brand in Asia at the moment is Estée Lauder, which has seen such astounding skin care sales in China that in the recent quarter it became the brand's largest international business surpassing the UK.
Earlier Fabrizio mentioned Origins recent launch in China. We believe that Origins will be a perfect fit since Chinese consumers are passionate about skin care and natural ingredients. In its first week Origins was the top selling beauty brand in the Parkson Department Store in Shanghai. Since its launch Origins retail sales have exceeded our projections. We expect the brand to have six doors in Beijing and Shanghai by June 30th.
Origins is a ninth brand who joined the China portfolio. Our most widely distributed brands are available in about 80 department stores across 35 of China's largest cities. Our brands are also present in about 80 separate doors in the country. There is still much room for the expansion, which we are directing deliberately and strategically. We are extremely pleased that China is no longer dilutive to the average profitability of the Asia Pacific region and our results in the country have consistently outpaced our five-year projections for sales and profits by at least a year.
China is the largest of our emerging markets, which as a total grew 18% in the third quarter. They account now for 12% of total company sales and extend well beyond the BRIC foursome to also include Eastern Europe, the Middle East and Turkey just to name a few.
One way we accelerate our growth in the emerging market is by establishing our own affiliates early on. This enable us to hire the best local latent, which gives us a competitive advantage and develop a long-term strategy and investment plan. Our newest affiliate in Vietnam had strong double-digit growth in the third quarter and we will maintain the momentum by launching M-A-C there in this fiscal year.
As you heard travel retails performance was strong and it rebounded sharply from the weak environment of a year ago. The improvement was so great that the division had its best sales month ever in March. The channel was helped by higher passenger traffic, initial success converting more travelers to buyers, great growth in Asia/Pacific and some restocking following last year’s difficult climate. We continue to open doors for our younger brands, which accounted for about 15% of its sales growth this quarter.
Our results in the Europe, Middle East and Africa region were mixed with emerging markets outperforming the more mature ones. However, we believe we gained market share in our distribution despite market challenges in certain countries.
Our UK team has done an excellent job navigating our largest affiliate through a difficult economic environment especially in Ireland, while growing and gaining share in our distribution. Some of our less developed brands including Jo Malone and Tom Ford showed solid gains in the European regions.
M-A-C and Bobbi Brown were also strong and we plan to expand their point-of-sales including more freestanding stores, which allow us the best possible presentation to express their brand equity.
Business in Latin America has met our expectation, despite recent disruption in Chile and in Venezuela. The region's sales have more than doubled than last several years and our brands have sold well in Brazil and Mexico.
The company has started fulfilling its mission to become completely integrated, so that the best ideas and products generated in one area can easily translate and travel to the rest of the world.
As an example, when the Estée Lauder brand set out to create skin care commercials for Asian TV, it produced them on a location in Hong Kong, where the new launches of skin products and local spice anesthetics were best understood. The ads were such a success that the brand will use some of them worldwide.
Our international business has delivered excellent cost savings, which has helped improve profitability and allowed us o increase investments. Most of the incremental spending has gone to emerging markets to see future growth.
We expect to spend about 50% more on TV advertising this quarter throughout this country to raise awareness of our core brands and fuel our momentum. For the first time, the Estée Lauder brand will run three integrated marketing campaigns in Asia, using television, print and digital simultaneously for its skin care products. This is a prime example of how we allocate our investments to ensure that our momentum continues.
Internationally, there are many growth opportunities in department stores, particularly in Asia where the channel remain strong. However we are also pursuing other Prestige channels similar to our approach in the US, and believe the opportunities are most promising where we can deliver an excellent High-Touch experience.
This includes our international push in to more e-commerce platform generating not only significant sales growth but also a more locally relevant, dynamic, High-Touch interface with new and existing consumers.
We are expanding e-commerce and mobile commerce and building our digital capabilities to run website at regional and local levels in close collaboration with our brands.
Providing personalized service and demonstration is an important factor as we grow our brands and introduce them to new consumers across various Prestige channels. For example, we are looking at ways to refine this model to best suit European perfumery, where we sell many of our brands.
We also intend to be a bigger player in European pharmacies where the skin care category has been growing rapidly. Then in fiscal 2011, Aveda will be fully integrated in to our international operations as we focus on adding high-end salons and spas to our distribution network.
As we strive to gain a larger share of the consumers total beauty purchases, we are learning from improved consumer insights to provide customization that is geared to local taste. We are focusing on our innovation on creating locally relevant products, packaging, product delivery, services and communications.
In closing, I want to emphasize how extremely proud I am of our international teams and the results they have produced. Our regions in travel retail channel intend to keep advancing the company’s strategy and allowing themselves to the commitment as Fabrizio just describe of being creativity driven and consumer inspired.
We are confident that international we’ll continue to propel the company’s growth and ensure that Estée Lauder companies remains the worldwide leader in prestige beauty.
Now I will turn the call over to Rick.
Thank you, Cedric, and good morning, everyone. A quick reminder, like discussions on the quarter and the outlook exclude restructuring and special charges, which I’ll comment on separately. Once again, we had a solid quarter. Sales grew 10% to $1.86 billion excluding the impact of currency translation sales grew up 5% over the prior year period.
Net earnings for the quarter more than double to $68.9 million compared with $31.4 million in the prior year quarter and diluted EPS was $0.34 compared to $0.16 a year ago.
We continue to experience strong growth in the skin care category reflecting our strategic focus in that area. Sales growth was 10% in local currency contributing more than half of the global increase in net sales. All three regions contributed to growth in this category especially Asia and Europe.
In makeup local currency sales fell 2%. This category was adversely affected by the end of wholesale distribution of Prescriptives and was the most impacted by a charge for returns from European perfumeries, which I'll describe shortly.
Excluding the impact of these two factors, local currency sales grew 4% over the prior year. The category grew double-digit internationally on the strength from Clinique, M A C and Bobbi Brown.
Our Fragrance sales jumped 13% excluding currency and the category continued to improve its profitability. The launch of PureDKNY in Europe, Coach Signature in the US and increased sales of certain designer fragrances through self-select outlets drove most of the increase.
In the hair care, sales was 3% in local currency, due primarily to expanded distribution of Aveda in Japan, Korea and Australia.
Geographically, our international businesses continued to lead growth. In Europe, the Middle East and Africa sales gained 7% in local currency.
During the quarter, we recorded a charge of approximately 31 million to reflect anticipated returns from certain European perfumers. The returns, primarily make up relate to a strategic effort to proactively align our product assortments by discontinuing slow turning SKUs in favor of carrying high returning products.
Global travel retail sales continued to rebound from increased traffic and conversion of travelers to buyers. Sales in the channel jumped over 45% of an easy comparison in the prior year quarter, contributing substantially to the region's increase.
Our UK sales slowed in the third quarter to low single-digit growth as adverse weather and an increase in VAT dampened purchases, However, our make-up artist brands continue to produce double-digit growth in the UK.
Developing markets in the region including Russia, the Middle East, India and Turkey all grew strong double-digits. Most of the southern European countries performed below last year and the markets in Greece, Italy and Spain remain concerning. Germany was largely unchanged and the Nordic countries grew high single-digits.
Our Asia/Pacific regions sales climbed 10% in local currency with most affiliates contributing. China continued to lead the regions growth rising over 30% in the quarter. Our business at Hong Kong rose 24% and Taiwan was up 25%.
Korea grew 10% and we have continued to see strong results in Malaysia, Thailand and Vietnam. The political unrest in Thailand could curtail future sales. Japan declined mid single-digits as it continued to suffer from the tough economic environment.
Local currency sales in the Americas were up 2% reflecting a modest pickup in consumer demand. Excluding Prescriptives, sales in department stores and in our own retail stores grew at low single-digit.
Sales growth in Canada, Mexico, Brazil and our online division were more robust. Sales in other channels were mixed.
Our gross margin improved by 250 basis points this quarter to 76.2%. Our cost savings initiatives contributed 230 basis points primarily from the strategic shift in our product mix and lower material cost.
We also benefited from favorable currency. Each factors were partially offset by higher obsolescence of 40 basis points, which included the cost of returns from the SKU rationalization in Europe.
Operating expenses as a percentage of sales for the quarter improved 70 basis points to 68.5% compared to 69.2% last year. Improvements mostly came from cost savings initiatives partially offset by higher advertising, merchandising and sampling expenses and cost to build capabilities.
Operating income rose 87% to $142.8 million compared to $76.5 million last year and operating margin increased 320 basis points to 7.7%. Regarding our interest expense, we reported $18.2 million this quarter versus $20.6 million in last year’s third quarter.
The effective tax rate for the quarter was 44.4%, higher than normal, due to the geographic mix of our earnings. The impact of the new tax legislation related to Health Insurance Reform was not material to our results. We reported net restructuring and other special charges of $16.5 million during the third quarter.
Net cash flows from operating activities for the nine months ended March 31st were $798 million, compared to $307 million last year. The biggest drivers of the gain were higher net earnings and the timing and level of tax payments.
During the quarter, we repurchased approximately 1.3 million shares of our stock under our share repurchase program.
Our day sales outstanding were 47 days this quarter, seven days lower than last year. Business has been improving for many of our customers, and so we are less concerned about their financial health at this time.
Inventory days were 157 compared with 154 days last year. We booked $35 million in inventory of our top selling SKUs in advance of the rollout of SAP to our North American manufacturing facilities earlier this month. We expect to work down the excess over the next two to three quarters.
Importantly, our global SKU count was down 8% from a year earlier at the end of March. We spent $161 million for capital expenditures, which includes spending for our company-wide systems 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, although some of the spending could go spill into next fiscal year.
As you saw in this morning's announcement, we are planning to purchase $200 million of our outstanding debt during the fourth quarter, which is expected to result in a one-time charge of $26 million to $30 million or $0.08 to $0.10 per share. We expect interest savings of approximately $10 million to $11 million in fiscal 2011. This reduces leverage back in line with single A target credit rate.
With two month left in the fiscal year our forecast reflects continued growth in Asia and a measured consumer recovery here in the US and parts of Western Europe. We remain cautious about the economic environment and several Southern European markets as well as Japan and we expect more aggressive competition.
Additionally, the recent disruption in European air travel caused by the volcanic activity in Island modestly impacted sales in our travel retail channel. However, this is a reminder of the vulnerability of this channel to unforeseen events.
For the year, we now expect 2010 local currency sales growth of about 4% to 5% led by our international business. Currency is expected to add approximately two percentages points to our reported sales.
Advertising, merchandizing and sampling costs should continue to accelerate behind our biggest launches in markets with good momentum such as China and Russia. We also continue to invest in building capabilities as called for in our strategy in areas such as digital programs, new High-Touch service models, regional research and development, and consumer insights.
We expect to deliver savings for the year of $330 million and to record charges associated with restructuring activities of between $60 million and $90 million. Given our progress to-date, we now expect to improve operating margins by at least 400 basis points this year. At this time we estimate our effective tax rate will range between 30% and 32% for the year.
We are moving our forecasted full year EPS range from $2.64 to $2.75 per share. This range excludes the one- time charge of $0.08 to $0.10 related to the repurchase of debt as well as restructuring charges.
We will review our long-term goals as part of our annual budgeting process over this summer and we plan to provide fiscal 2011 guidance on our year-end call in August as we do every year. Remember, there is a degree of uncertainty and volatility, inherent in our business.
Our full-year strategy is off to a good start and we are pleased with the progress to-date. We still have a lot of work ahead, building capabilities for simultaneously driving measured, profitable, top-line growth in a sustainable fashion and continuing to turnaround underperforming brands.
That concludes my comments. We'll be happy to take your questions now.
(Operator Instructions). Our first question today comes from William Schmitz with Deutsche Bank.
William Schmitz - Deutsche Bank
The charge in the quarter that $31 million for the inventory obsolescence, why wasn't that viewed as extraordinary?
Well, it wasn't extraordinary, it was part of our thinking certainly and part of our strategy and that was to align the products that we have in the stores or in the perfumeries in Europe with the highest selling SKUs. So what we intended to do and what we are achieving is pulling back the slower moving SKUs, improving the turn if you will, the profitability at point of sales within the perfumery markets within Europe. So it was part of our planning, it was part of our forecast and Cedric if don’t know, if you want to comment.
Definitely this is the project that we thought was necessary and was definitely in our thinking and strategies. We are working in partnerships with our customers because we are extremely focus on the productivity by door and to a certain extent by SKUs and we have know that the game is changing and we want to focus on the sell-through rather than sell-in and make sure that we improve the turn of our SKUs and the return on investment for both our customers and ourselves.
William Schmitz - Deutsche Bank
Okay. Just a second one, a basic commentary in the North American business about ongoing challenges faced by the company department store customers, is there something looming there or just put in there as sort of a cautionary comment.
It’s more of a cautionary comment, but I think that we see the environment improving in North America, but I think we are somewhat cautious to be too enthusiastic at the moment. We see a measured improvement. Things are getting slightly better, but it is more of a cautionary statement than anything else.
Our next question is from Alice Longley with Buckingham Research.
Alice Longley - Buckingham Research
Hi, can I just add a file up to that and then ask my own. The $31 million in Europe where that recorded on the P&L is it sales or profits or combination or where?
Yes, it’s recorded in sales. So it is treated as a return, it's primarily, not primarily it is all in the European region and it is primarily in the makeup category.
Alice Longley - Buckingham Research
Okay. Then my other question was I think in two of your segments, you commented the sales are particularly strong in March. You said the US sales were strong in March led by upscale retailers and I think you said travel retail was particularly strong in March as well. Is it reasonable to expect June results in both those segments to be even stronger, the June quarter even stronger than the March quarter results and as part of that offset that with the volcano effect please?
Sure. So I think that travel retail will be hard pressed to have another quarter like they just had, but our business is stronger and they were up against somewhat weak comp last year. If you look at the travel retails growth I think versus 2008 it's more in the mid-teen areas, which is more reasonable quite honestly. The volcanic activity, we estimate was about $5 million to $7 million of sales impact and that's assuming that it's finished at the moment, so that's that.
As far as North America, I think that our business as I said is somewhat improving, but I don't know if the month of March was anything outstanding versus other periods. I don't think I said that, so that business is improving slightly, but as we just said before, we're somewhat cautious on it, we think it's improving at a measured pace and that's what we are anticipating for the rest of the year.
Our next question is from Andrew Sawyer with Goldman Sachs.
Andrew Sawyer - Goldman Sachs
Just on the department store topic. I know Fabrizio talked about getting this segment back to growth. I was wondering if you can give an update on how some of the initiatives that you are having tested with are working and what the path would be to getting that business back to more of a growth trajectory over the next couple of years?
For sure. I think that initiatives we are testing our working, we are improving in-department stores, we are getting our key brands as it grow in share, I think particularly significant in the US department store in the last quarter was the share growth of our Clinique brand that was as I said, significant and on a brand of such a big size means that we are doing the right thing and I think its a combination of product initiative, improvement of our High-Touch service, we said passes through better service at counter and better activity in-store and an increased level of service plus a clarification of the value equation of the brands, which includes disposition of prices, better value reframing on some of our SKUs and activities in this area. The combination of those things is working pretty well.
Now, in terms of future development, I think we will continue accelerating the initiatives and the talk was on big initiatives. We will continue accelerating the expansion of our successful High Touch models and these will start with expanding them in flagship stores and then adjusting our model also in medium and smaller size doors overtime working with all our customers in the region.
Andrew Sawyer - Goldman Sachs
A quick one for Rick on capital structure, is this really just about the credit rating, I guess with favorable credit environment why not, I guess roll it or bring new debt to market and stock?
It is about the credit rating, a single A credit rating for us is really a sweet spot from our cost of capital perspective. It gives us great flexibility going forward if we need it to access funds or for any business reasons. So we think it's in appropriate use of cash at this moment and it will solidify if you will our single A credit rating.
As far as making a leveraging up and buying a significant amount of shares, the share price is quite high at the moment and also we are not so sure that that’s a long-term solid business strategy quite honestly at the moment.
Our next question is from Ali Dibadj with Sanford Bernstein & Company.
Ali Dibadj - Sanford Bernstein & Company
If you could talk a little bit just about guidance, please. So the original guidance for our quarter if I recall its $0.20 to $0.30 for this very quarter, which would have implied a higher Q4 that you’re currently implying, given your new guidance range that's a little bit raised in the guidance range. Trying to understanding of why is that? What's changed? Is it, sounds like perhaps because of the tax rate, is it because there's more spend you expect, is that potentially because of the softer market, is it because Fragrance doesn’t seem like its making money again this quarter and perhaps next quarter. Just I want to understand that a little bit if you could please?
Ali, our spending plans are primarily around in investment and advertising, merchandizing and … sampling expense and that expense grew about 15% year-over-year in the third quarter, but in the fourth quarter that will go about 35%. So some of it is the timing of that additional investment that we talked about in the second half of the year and that's what affects the fourth quarter. So Ali now I am sorry, about the fragrance business you are wondering?
Ali Dibadj - Sanford Bernstein & Company
Well, is that part of that factor, you seem to do okay when a fragrance business does well. It lost money this quarter, certainly it sounds like for investment purposes. I guess I was wondering about that business end. I don’t want to sound like a broken record, but obviously whether you should be in it or not and particularly try to understand what operational tools you now have in place to try to monitor the ROI of that fragrance business.
Ali just want to clear that one, the fragrance business for the year will make amazing improvements in profit and those improvement profits are sustainable and that will continue to improve next fiscal year as per our plans. The way fragrance delivered profit by quarter is influenced by the way we are also putting our specific initiatives on. The moment we have big launch by Donna Karan tour in Europe and the entire launch of the Daisy Fuentes we feel than we obviously can get less profitable on a certain quarter, but overall the plan for the year is in the right direction.
I am not sure I can agree with the statement that our results are heavily dependent on how we are doing on fragrances. I think that is very small percent of our results. Our results has been much more depending on how we are doing particularly in skin care and make up and how we are doing in a most profitable regions of the world.
Our next question is from Lauren Lieberman from Barclays.
Lauren Lieberman - Barclays
First thing was just about the belt tightening and being loosened. So this quarter it still actually felt tight that maybe wasn’t quite as much of step-up or reversal in belt tightening as you might have expected. So, can you would be just comment on that in next quarter or whether or not you now found that some of the savings are savings you can hold on to versus they may sort of reverse out?
What I did mention was the advertising, merchandising and sampling spend, which is really where the investment in the second half of the year is taking place and I did mention that it only grew about 15% quarter-over-quarter in the third quarter, but we are anticipating that to be about 35% growth in the fourth quarter. So, it’s the timing of that spending in the second half quarter versus quarter, but I think that was sort of built in to guidance.
Lauren Lieberman - Barclays
Rick I’m sorry I didn’t mean like AMS reinvestment I know it like reactionary to the environment last year, quick tightening of the belt that you guys were talking about that wasn’t just pulling back on marketing. It was hiring freeze, salary freeze, no travel that sort of stuff which you had talked about. Is that spending coming back in the second half of this year and that’s I was trying to talk about?
Definitely right, we already said a big part of the belt tightening would have come back and we would have substituted these temporary cuts with more fundamental and sustainable cuts. In fact, actually this quarter we have delivered more savings than what we expected all right. That leaves for the quarter $104 million saving and we are increasing the estimate of total saving for the year to $300 million to $330 million saving, which is actually above what we should believe that and which was past our original thinking. So, we are over the lever in saving and substituting temporary pullback of spending from last year with sustainable saving exactly where we said just slightly better than what we anticipated.
Lauren Lieberman - Barclays
So, is the net of those two the initial conversation was, I absolutely remember that you tried to replace these savings, but there was also a very explicit statement that some of the cuts that were temporary, over time the idea was replacing with restructuring savings, but this was seen as separate from restructuring saving. So yes, you're were delivering on restructuring, I'm just trying to get at whether or not some of that spending came back or if you're able to find some of that was more sustainable, didn't need to be replaced?
I think it's a combination of both, I mean the concept of reducing sales means of cutting back drastically on travel were temporary certainly in nature and those things are absolutely coming back.
There was some advertising spending that we did cut back last year. That spending is coming back as we are just describing, but it's coming back in a more efficient and effective way. So we're being careful and targeted in where we spend that money.
Whereas historically, we were maybe not quite as good at measuring the ROI on that spending and we're spending things on inefficient initiatives. So we're spending more money this year in those areas, but we're spending them more targeted.
In answer to your question and just as Fabrizio described, we had temporary savings last year, which we said about 70% of that would probably come back. That spending is coming back, some of it much more efficiently than the way we had done it before, but we are more than compensating for that by the more permanent savings around our resizing, restructuring and cost savings initiatives.
Our next question is from Wendy Nicholson with Citi Investment Research.
Wendy Nicholson - Citi Investment Research
My first question has to do with the drag that you're seeing on the top line from the Prescriptives' exit and the SKU reductions that you are doing, particularly in the make-up category.
By my math that's probably pressuring your top line growth by about 100 basis points, is that a run rate that we should see kind of for the next four quarters until we anniversary the Prescriptives exit or is the rate of SKU reduction going accelerate and that pressure is going to be higher.
Actually to be precise, this is two points, and so we were being growing in quarter three would have gone 2 points faster without excluding the impacts obviously you mentioned. Now, the second part of your question is what is sustainable what is not? I mean obviously we will continue to monitor SKU reduction in particularly making sure the low turns inventories are taken out of the market whenever needed, but we do not forecast any other activity of that size, while we are doing Europe now for the forcible future. I think this represent that larger part of what we have to do.
Wendy Nicholson - Citi Investment Research
I have second question for Cedric, with regard to Japan specifically it sounds like some of the luxury good companies are beginning to see a little bit stronger sales there. How is your business doing I guess relative to your competitors in luxury duty? In other words your market share still holding firm or do you just think the overall category continues to be toughen so you are down with the category?
Yes, actually we are following Japan very closely and we are holding market share actually especially since the beginning of the calendar year. What I’d say is that probably the beauty category is the best performing within the department store universe, but it still in negative territory. We are cautiously optimistic that we are seeing family addition of the business at the moment, but I only have let’s say, one month perspective on that. So, its little bit early to say whether this is going to be sustained or not, but we are saying a little bit better and the consumer confidence index are improving in Japan and speaking to some of the retailers they seem to feel a little bit better.
Our next question is from Linda Bolton-Weiser with Caris & Company.
Linda Bolton-Weiser - Caris & Company
Hi, I was just wondering in terms of your guidance for local currency sales growth in the quarter. I think it was 4% to 7% and you did 5. What didn’t happen in the quarter that you were envisioning could happen to get a potential of 7%, 6% or 7%. So, it was just the Japan and the Southern Europe, are there any other areas of disappointment relative to what you thought maybe could be achieved on the top line?
No. First of all, I just want to clarify that the European plan and the quantification of the European plan is worth two points. So, only if we didn’t have the decision of the European stock reduction, this will be two point extra growth over the quarter and as we said, this has been always our idea, but we didn’t have the quantification of this idea before and that's why we gave the range and that's why the range would have led us to be able to deliver what we promised, but still be able to quantify the input of these European strategy before making the final communication. So, that's what happened.
Our next question is from Mark Astrachan with Stifel Nicolaus.
Mark Astrachan - Stifel Nicolaus
One quick follow-up on US trends, just curious given the acceleration in department store, same-store sales, I’m curious how the trends looked in the US business month-by-month, it was March the strongest month, was January the weakest month, is there anything granular there that you can give us.
Yes, I can tell you March was the stronger month and we have seen in the quarter overall prestige beauty in US department store prestige channels of being 2% ahead of year ago and the larger majority of the 2% increase was in the month, thanks for the good month of March and also you need to realize that is an anticipation of Easter that also an impact in this index. That’s why we are cautious to say that it is just the recovery started everything is normalized. It is the beginning of positive signs, but we want to observe those signs for a longer period of time before making a sign of conclusion.
The other positive thing that we see is that out of these this 2% increase of the prestige beauty business is faster that the increase we saw in the quarter for example in the [mask] business and that particularly faster in the area of skin care, where the increase of the prestige has been five points faster than the increase in M-A-C. So, it is a gain a positive indication that consumer feel a bit more comfortable with spending also on the higher end of the product choices meaning more in prestige than that done during the recession. So there are a combined set of positive indications, but we need to see that for a longer time before being conclusive on the recovery.
Mark Astrachan - Stifel Nicolaus
Great and then in terms of trying to get a sense of the impact on the increased marketing spend, just curious how you are seeing the correlation there. You’re talking about the 35% increase in the June quarter versus the 15% increase in the March quarter, you are talking about I think a bit of acceleration in currency neutral growth even exclusive of the Prescriptives and destocking in Europe. So, is it a quick return? Is it something that you’re going to see longer term as well that we should continue to see trends improve as we head in to the fiscal year as a result?
That’s a good question. First of all obviously the answer is both. Those marketing investment have an immediate benefit in some cases, but those in some other cases there to create long term growth potential for the company. Let me clarify what I mean, when the market investment is behind the new launch in a developed markets, obviously you see some improved results on this launch initially in the quarter, but when those investments like honestly the large majority of our extra investment at this point of time, and in adding emerging markets ,where we are basically investing to create brand equity, a long-term awareness of these brands, those investments after using some immediate results, but particularly are lay in the ground for future long-term solid growth in this new markets.
Just to put a number straight, the increased advertising, merchandising and promotion during the third quarter was 14%. The increase in the fourth quarter that we expect is 35% versus year ago, so even more and however the advertising merchandising spending in percentage for the year in our current communicated estimate is actually flat to the percentage, but the absolute level is well above because obviously we're calculating this flat percentage on higher sales.
So, by the end of the year, we would have spent over $100 million more in support heavily skewed on the second semester, and we do see an acceleration, because if you made the number we have been growing excluding the return in Europe is 7%, ex-currency and we forecast a further slight acceleration of this for the fourth quarter. So, pretty solid growth in the context with the current economic environment.
Last point I want to add, we are also seeing obviously an increased spending from competition. So, the other way to look at that that we have been able in the first six months of this fiscal year to in a very efficient way with lower spending, but also in the context of competition also having on average lower spending. This quarter and next quarter we expect an increase spending also from our competitors they will make obviously our spending even more important.
Our next question is from Connie Maneaty with BMO Capital Markets.
Connie Maneaty - BMO Capital Markets
I have a follow-up to that questions and the question is that given that in the first half of this calendar year the advertising and promotion and merchandise spending was lower than normal. Should we expect this higher rate of spending to continue in to the first half of fiscal '11 as you competitors pick up the pace and the economies worldwide improve?
As I said, we will communicate 2011 estimates in the end of next quarter, but in term of general term if you look at the total fiscal year spending, the percentage has been flat for this fiscal year and just they way it went by quarter it was reflecting a different initiative and competitive scenarios that we had the same would happen for next year. We will decide the spending by quarter depending, where we have the concentration of great initiative and opportunities and how we feel a competitive environment will be developing.
Connie Maneaty - BMO Capital Markets
My second question, Rick could you give us the composition of the increase in the gross margin? Please.
I think the details that will part of our 10-Q, we break it out in great detail there. We should file that sometime early this afternoon or by the end of business today, but the biggest drive of savings and driver of our gross margin improvement is in the mix area as well as inventory management I mean those of the big drivers. We have some favorability from as well, from foreign exchange and then because of return in Europe, our obsolescence in the quarter is an increase year-over-year because there is a provision has to go along with those returns that as I said the details are part of our 10-Q.
Our next question is from Victoria Collin with Atlantic Equities.
Victoria Collin - Atlantic Equities
Given the stellar performance in the travel retail business, I wonder if you're still expecting to see mid-teens growth from travel retail for the full year. I mean given that Q3 was up 45%, I wonder whether you've made some allowance in Q4, so maybe a recurring impact from volcano effect or anything like that or whether your overall estimates gone up a little.
Then secondly, I just wondered if you could clarify, whether the $31 million charge on the EMEA regions of the European perfumeries, whether that part of the overall restructuring or is anything additional that you built in there once looking closer at the business I’m seeing the more savings could be realized from cutting more fees? Thanks.
This is Cedric. I’ll take the first part on travel retail. I think Rick alluded to it earlier; we had a fairly weaker fourth quarter last year, so yes we are definitely seeing continued momentum on our travel retail. I mean barring any event of course and for the full year we will be more in the 20s in to the percentage growth.
Regarding the European returns that's really normal business if you will. It’s very targeted. So, it’s very strategic in nature. Returns are part of our business, but in this case those returns were specifically decided upon with our customers and then trying to improve the productivity of those stores and the returns of the inventory in those stores, so therefore return on asset. So, it was a strategic targeted thoughtful process, which should limit future returns quite honestly, but it is not part of our restructuring activity.
Our next question is from Chris Ferrara with Bank of America-Merrill Lynch.
Chris Ferrara - Bank of America-Merrill Lynch
Hey guys I just wanted to ask about the tax rate. So, I guess 44% in the quarter I think you said that it was related to the mix of business and where your profit was, but that’s a pretty sizable change and I think guidance expect 30% to 32% for the year. I mean was there a really big, big difference in where the profits came from this quarter as suppose to what it will be next quarter and going forward?
Chris, part of it is if you look at our rate in the third quarter of last year I think it was 43.2% or some numbers like that. So, the rate just naturally is a little bit higher for variety reasons in our third quarter than the overall tax rate and you know that with FIN 48 there is more of a volatility of the quarter by quarter tax rates of course the way that the tax legislation works. The good news is for us is that we have been invited in to the CAP program, which is a program not too many companies get in to, but it is an opportunity for us to have sort of real time audit going on with the IRS, which will take out lot of the volatility of our tax rate on a quarter by quarter basis because of the very little less that’s under discussion in future periods.
Chris Ferrara - Bank of America-Merrill Lynch
Got it, but there is nothing that one-time in nature at all in that quarter you’d expect most Q3 end up like this just generally speaking?
Certainly for the last couple of years it is look that way Chris for sure, but the old taxes in some respects are one-time in nature right because it depends on your results and where the earnings the come from, so.
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 May 11. To hear a recording of the call, please dial 800-642-1687, pass code number 67734609.
That concludes today’s Estée Lauder conference call. I would like to thank you all for your participation and wish you all a good day.
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