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Executives

Richard Kunes - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Harvey Gedeon - Executive Vice President of Research & Development and Product Innovation

Fabrizio Freda - Chief Executive Officer, President and Director

Dennis D'Andrea - Vice President of Investor Relations

Analysts

Ali Dibadj - Sanford

Victoria Collin - Atlantic Equities LLP

Lauren Lieberman - Barclays Capital

Constance Maneaty - BMO Capital Markets U.S.

John Faucher - JP Morgan Chase & Co

Joseph Altobello - Oppenheimer & Co. Inc.

David Wu - Global Crown

William Schmitz - Deutsche Bank AG

Wendy Nicholson - Citigroup Inc

Andrew Sawyer - Goldman Sachs Group Inc.

Linda Weiser - Caris & Company

Caroline Levy - Credit Agricole Securities (USA) Inc.

Neely Tamminga - Piper Jaffray Companies

Alice Longley - Buckingham Research

Estee Lauder Companies (EL) Q1 2011 Earnings Call October 29, 2010 9:30 AM ET

Operator

Good day, everyone, and welcome to The Estée Lauder Companies Fiscal 2010 Year End (sic) [First Quarter 2011] Conference Call. [Operator Instructions] For opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Dennis D'Andrea. Please go ahead, sir.

Dennis D'Andrea

Good morning, everyone. On today's call are Fabrizio Freda, President and Chief Executive Officer; and Rick Kunes, Executive Vice President and Chief Financial Officer. Also on the call is Harvey Gedeon, Executive Vice President, in charge of Global R&D and Innovation. Harvey will be available for the questions.

Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC, where you'll find factors that could cause actual results to differ materially from these forward-looking statements. You can also find a reconciliation between GAAP and non-GAAP figures in our press release and on the Investors section of our website. So I'll turn the call over to Fabrizio.

Fabrizio Freda

Good morning, and thank you for joining our Fiscal 2011 First Quarter Conference Call. Today, I will discuss the quarter's highlights and progress we made against our strategy, and Rick will provide details of our financial performance. We announced this morning that before restructuring charges, sales for the quarter grew 13% to $2.1 billion. This was a milestone since it's the first time we have exceeded the $2 billion in sales in our first quarter. Our strong performance was due to robust business around the world and was helped by the dollar, which was weaker than we had forecast. Diluted earnings per share were $0.97 on a non-GAAP basis, up 14% versus year ago.

Our success was broad-based. Sales climbed by double digits in every region, including North America and in our three largest categories, driven by strong product launches and increased advertising spending in the previous quarter. In fact, our highest sales spanned the range of the portfolio, from our entry-level Prestige brands to high end luxury ones. Most significantly, our largest brands led the way, Estée Lauder, Clinique, M-A-C and Aramis designer fragrances had such great momentum that each rang up double-digit sales gains globally and delivered substantial improvement in North America.

All in all, it was a terrific performance in many regards. Several of our financial measures broke records for the first quarter, including sales, operating margin, earnings and EPS. Our strategy is clearly working, and we are executing it well, which is reflected in these outstanding financial achievements. We've also made progress against many of our specific strategic goals. We again gained share in skin care and in important channels and countries, including U.S. Prestige department stores and our Prestige distribution in China. Also, our turnaround brands showed further improvement. Our creativity resulted in robust launches. We exceeded our cost-saving projection by about $50 million and we continued building our strategic capabilities.

William Lauder and I are proud that our executive leadership team is directing our strategy so well around the world that the entire organization is executing it so successfully. This strong start is a fantastic way to launch a new fiscal year. Our positive performance this quarter give us greater confidence in the remainder of the year. So we are increasing our full year EPS guidance to $2.90 to $3.10.

Let me now provide you with some color behind the numbers. In recent quarters, the fastest growing areas have been Skin Care, China, Travel Retail and Online. While these businesses continue to record solid growth, we also saw a strong performance in U.S. department stores and fragrance, which had been declining. We attribute our success to external factors, including pent-up demand and stronger consumer spending, as well as internal achievements, creating exciting new products and unique High-Touch services that appeal to consumers over the world. Our more effective marketing, which includes compelling advertising has contributed to our success by making consumers more aware of our newest products and services. A key part of our strategy is focusing our talents and efforts on fewer but bigger product launches offsetting cutting-edge innovation. Recent introductions from our research and development teams have been outstanding, and the success of these products underline our superb sales growth. Our brands had a rich pipeline of truly novelty launches over the next several years that we believe will continue to set the pace and set us apart in the industry. Harvey can answer questions about our innovation strategy during the Q&A.

Our year old America affiliates have been working with department stores to make the beauty floor more exciting and the initiatives are paying off for us and the retailers. Our sales in North America department store grew double digits this quarter. Sales of Estee Lauder and M-A-C brands into China grew double digits and Clinique recorded solid gains. Some of our largest U.S. department stores customers, particularly Macy's and Nordstrom, posted solid sales gains for the recent three months and higher traffic contributed to our sales growth. We believe our more focused and frequent advertising, which entices consumers to buy our must-have products helped generate the higher traffic. And while we have made inroads against Prestige competitors, we have also gained against mass. The luxury consumer is shopping again, and we are seeing our strategy contribute toward the old Prestige beauty growing faster than mass in many parts of the world. For the three months ended September 30, 2010, total U.S. beauty sales in Prestige department stores and Sephora rose 4% according to NPD, while sales in mass channel grew 1%. The strength was even greater in skin care, where Prestige sales growth was five points higher than mass. Our sales in Europe rose sharply, helped by incremental orders from perfumes as part of the reassortment effort we began last March. Asia sales growth was a little softer this quarter, but still rose 10%. Skin Care in Asia is a main area of strategic focus, and now accounts for 61% of the region's total sales, up from 56% only a year ago. In the recent quarter, our Asian Skin Care sales rose 19%. Rick will talk more about the regions in a few minutes. A key strategic focus has been to advertise our newest and most popular products effectively to pull consumers into stores. We have put the most money behind Clinique Repairwear, Laser Focus and even better Clinique Estée Lauder franchise and the pure DKNY Fragrance. Once consumers come to our counters and websites, we leverage our High-Touch service to build a personal connection, foster brand loyalty and sell multiple products. Although we are investing more in advertising, our total advertising and promotional spending hasn't increased as a percentage of sales. Instead, we have reallocated our spending in the category. We are putting less into gifts and sampling and more into advertising, including TV, online and print to build greater awareness and demand for our brands globally. The company's focus on skin care is driving sales growth at many of our brands: Estée Lauder, Clinique, Origins and La Mer have substantial advances in their Skin Care business. Both Estée Lauder and Clinique's global skin care sales surged more than 19%, with gains in all regions. The Estée Lauder brand continues to make impressive gains in Asia/Pacific and Travel retail, fueled by the popularity of several recent product introductions. Currently, the flagship brand is updating Re-Nutriv Ultimate, its luxury line, which we believe will continue to propel its winning skin care story.

Clinique's strategy to target skin care products for specific concern paid huge dividends. In addition, the brand's recent launch of Repairwear Laser Focus fueled solid growth in Asia and particularly, in China. Clinique is the largest beauty brand in the United States, yet it managed to expand its skin care share in Prestige department store by more than one point. Throughout the quarter, our brands continued tailoring their products and communications to different regions as they become more locally relevant. Aramis and Designer Fragrances successfully launched Coach Poppy and Pure DKNY in North America and Tommy Hilfiger Loud in the U.K. ADS [ph] sales climbed more than 25% and coupled with a lower cost of goods and cost-cutting initiatives, its operating profit improved sharply.

Our fragrance category, led by ADS [ph] courageously changed strategy to first improve its bottom line before accelerating topline growth. That approach has paid off dramatically as higher sales, coupled with massive spending resulted in much improved profitability this quarter. Other brands in our portfolio that are turning around have also made substantial strides toward greater profitability, which has helped the company's overall performance. Two of our high-end Fragrance brands, Jo Malone and Tom Ford, generated healthy sales increases, particularly in Europe and in the Middle East because they created heavier, more intense scents that appeal to consumers in those markets. This quarter was the first that included our newest brand, Smashbox, and it's off to a good start. Smashbox is a strong brand in the United States, with a loyal consumer following. It helps strengthen our makeup category and our presence in alternative channels. We are working to integrate the brand organizationally and functionally. While our brands have been busy accelerating their individual strategies, on a corporate basis, we have taken steps to strengthen our capabilities, both regionally and globally. With the digital universe increasingly important in everything we do, are committed to building on our expertise and expanding our global presence online. We are constantly evolving our communications and use of social media online and searching for better ways to sell and promote our products.

To that end, we feel that employees must be engaged and dedicated to these endeavors. To show our commitment, the company organized a digital media conference in New York in August for hundreds of our executives to immerse them in the fast-paced online world and provide them with a deeper understanding of the potential it holds. The event included speakers from Facebook, Google, Foursquare, as well as digital executives from other consumer companies at the forefront of social networking. The day was a tremendous learning experience and enforced to our management that this is an area that we believe holds amazing promise and potential.

Looking ahead, we are anticipating a solid holiday season. The U.S. department store business is healthier than last year and our brands have created a wide selection of products offering compelling value. We believe consumers will find our products and unique services to be attractive in this environment. As we continue on our path of achieving sustainable profitable growth, we will bring our brands to more people. For example, M-A-C plans to open about 50 doors in international markets in the second quarter and La Mer and Aramis and Designer Fragrances expect to launch e-commerce in Japan. We will open more than 90 locations in China this fiscal year for our nine brands there.

As a dynamic enterprise, we must constantly look ahead to be in the forefront to stay on top of our game, so we are reinvesting some of our profits in our future and pursuing our most promising opportunities by brand, by market, in China, backed by an unwavering commitment to innovation and to talent. Our focus this year centers on five areas embedded in our corporate strategy: Strengthening our creativity and innovation, expanding our High-Touch services, deepening our local relevance and widening our lead in the digital arena. We'll continue to tighten our costs and run our business in a smarter, more efficient and integrated manner.

I want to thank my leadership team and our worldwide employees for their hard work and continuous innovation. We couldn't have accomplished any of these without you. As we continue to pursue our goals, William Lauder and I are working to preserve the company's solid foundation, its culture and the integrity instilled by the Lauder family for more than 60 years. We are in the unique position to leverage and draw inspiration from our historic strengths as we move forward to make our strategy a reality. The Estée Lauder Companies will always pride itself on creative thinking and entrepreneurial spirit and the will to win. It's wonderful for the entire organization to be able to leverage the success of the past, while participating in and embracing the company's bright future.

Now, I will turn the call over to Rick.

Richard Kunes

Thank you, Fabrizio, and good morning, everyone. A quick reminder, my discussions on the quarter and the outlook exclude restructuring and special charges. As Fabrizio said, we had a terrific quarter, driven by better-than-anticipated sales. In local currency, sales rose 14%. Adverse currency translation was less than one percentage point, resulting in reported sales growth of 13% to $2.09 billion. Net earnings for the quarter rose 16% to $194.4 million compared with $168 million in the prior year quarter and diluted EPS was $0.97 compared to $0.85. Sales growth was about four points more than our guidance. About two points of the upside was due to a weaker U.S. dollar than we had forecasted and another two points from stronger overall business. We are very pleased to see the sales momentum increase during the quarter, including the effect of targeted advertising behind key products in Estée Lauder and Clinique. We saw this especially in our Americas and European regions. The quarter also benefited from the sell-in of faster moving SKUs as part of the reassortment program in European perfumeries, after having taken a charge for returns of slow-moving products in the fiscal 2010 March quarter. This program is now essentially complete, and we do not expect to see incremental sales at the same level for the remainder of the fiscal year.

Additionally, our cost of goods were lower than anticipated due in part to a shift of some GWP and SAP shipments to the second quarter and better-than-expected improvements in obsolescence. Importantly, operating expenses came in where we expected, reflecting a more normalized cadence to our marketing spending. Three of our major categories grew double digits. Compared to last year, we saw the fastest growth in the strategically important Skin Care category. Sales rose 18% in local currency aided by product launches. Skin care sales grew by double digits in every region. In Makeup, local currency sales rose 11%, driven by growth in our M-A-C, Bobbi Brown and Estée Lauder brands, as well as the addition of Smashbox. This was partially offset by the discontinuation of Prescriptives in department stores. The category grew double digits in the Americas and European regions. Our Fragrance business grew 17%, excluding currency. Fragrance launches in the U.S. and U.K. helped growth in the Americas and Europe. In Hair Care, sales declined 3%, primarily due to soft results at Ojon. We are reformulating Ojon products and plan to relaunch the brand with a new marketing campaign later this fiscal year.

On a geographic basis, all regions grew double digits. We are pleased with a 12% growth in the Americas, our best performance in a number of years. The strongest contributions came from our largest brands, Estée Lauder, Clinique, M-A-C and the Aramis and Designer Fragrance group. Additionally, Latin America grew more than 25%. In Europe the Middle East and Africa, sales rose 18% in local currency. Travel Retail grew 24% as the channel continued to benefit from improved traffic, led by Asia and Latin America. Our U.K. sales rose 12%, driven by good retail traction across the brand portfolio and positive response to our television advertising. Emerging markets in the region were up strong double digits. All of the Western European countries grew, although, many benefited from the perfumery reassortment program. We believe our underlying retail growth in the major Western European markets is mid-single digits.

We continue to see overall sales growth in the Asia/Pacific region, which had a 10% rise in local currency. China rose 32%, fueled by 16% like retail growth and expanded distribution. The appetite of Chinese consumers for our products is also driving strong, double-digit gains in Hong Kong and Taiwan. Korea grew 6% but Japan and Australia declined, reflecting their tough economic environments. Our gross margin improved by 40 basis points this quarter to 76.7%. Contributing to the increase were lower obsolescence charges of 30 basis points and positive currency of 20 basis points. These figures include the benefit of our cost savings initiatives of $21 million. Operating expenses as a percentage of sales, rose 10 basis points to 62.2%. Factors affecting operating expenses as a percentage of sales include lower selling and shipping costs of 130 basis points, partially offset by higher advertising merchandising and sampling and general administrative costs of about 110 basis points. These figures reflect savings of $28 million from our cost-reduction programs. As a result, operating income rose 15% to $302.6 million and operating margin rose 30 basis points to 14.5% of sales. Our cost-savings initiatives are moving ahead well and we achieved total savings of $49 million in the quarter. We now expect to save between $135 million and $145 million for the full year. Regarding net interest expense, we reported $16.1 million this quarter versus $19.6 million in last year's first quarter. The decrease is due to lower debt levels. The effective tax rate was 32.7%, within our projected range. We recorded $4.6 million in restructuring and other special charges, equal to $0.02 per share for the first quarter. For the full year, we expect to record charges of between $60 million and $70 million.

Our fiscal first quarter cash flow typically reflect seasonal working capital levels as we gear up for the holiday season. This quarter, net cash used for operating activities was $39 million compared to $3 million of cash generated last year. The biggest driver of the variance is the increase in accounts receivable. Our days sales outstanding were 50 days this quarter, three days lower than last year. Inventory days were 177 days compared with 170 days last year, reflecting the expected second quarter sales growth. At the end of September, our SKU count was down 7% from a year earlier. However, we have experienced service issues as some vendors are having difficulty meeting the increased industry-wide demand for ingredients and components. As we continue to improve our forecasting and react to the increase in demand, we may build some additional inventories to address these service issues. We spent $58 million for capital expenditures, which includes our company-wide systems initiative. We also used $258 million primarily for the purchase of Smashbox. For fiscal 2011, we expect to generate around $850 million to $900 million of cash flow from operations and use about $350 million for capital expenditures. During the quarter, we repurchased approximately 2.4 million shares of our stock under our share repurchase program.

Looking ahead, we are balancing the better-than-expected sales and earnings in the first quarter with the risk of a possible consumer downturn after the holidays, more aggressive competition and volatile currency markets. However, we remain confident in our business and believe it is reasonable to raise our expectations. For the year, we expect local currency sales growth of 7% to 9%. Our fiscal year guidance builds in assumptions of approximately $1.30 for the euro, 85 for the yen and $1.55 for the pound. This scenario would reduce reported sales growth by about one percentage point. We expect to continue investing behind our strategic priorities in the remainder of the fiscal year to drive growth and increase share. At the same time, we continue to pursue the cost savings we previously laid out. We expect a 50 to 90 basis point improvement in operating margin this year. At this time, we continue to estimate an effective tax rate of between 32% and 34%. We are raising our full year, non-GAAP EPS forecast to between $2.90 and $3.10.

Our outlook for the holiday season reflects an improvement in consumer spending compared to last year. Our sales growth for the second quarter is forecast to come in between 8% and 10% in local currency. The negative impact of foreign exchange translation is expected to decrease sales growth by about three percentage points. We expect EPS for the three months ended December 31, 2010, to be between $1.32 and $1.45. We are encouraged by our results for the first quarter, and we are optimistic about the response to our innovation and unique service that sets us apart. Longer-term, we are working hard to make our four-year strategy a reality. That concludes my comments for today, and we'll be happy to take your questions now.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Wendy Nicholson with Citi Investment.

Wendy Nicholson - Citigroup Inc

My first question has to do with the Fragrance business and the margin that you saw there, which I think is the highest I've ever seen. And I'm wondering how much that is now a realistic run rate? Is Fragrance now permanently a double-digit margin business? Or is there a chance that as new products move to the forefront of your priority list, margins dip down into the single digits again?

Richard Kunes

Wendy, what I think you're seeing in the first quarter is the benefit of some of the launch activity that we mentioned. So there's a lot of, if you will, sell-in of those new launches, so we are making pretty good progress in improving our profitability. But no, that double-digit number in the first quarter is not indicative of where we think the year will be. Although, the year will certainly show a substantial improvement over last year and will continue to show, if you will, going forward, measured improvement in the Fragrance category.

Operator

And your next question comes from the line of Alice Longley of Buckingham Research.

Alice Longley - Buckingham Research

One of the shifts that you're making is less promotional activity through gifts with purchase and purchase with purchase I guess in more advertising online in print and TV. Can you go over what you see as any possible risk of doing that in the holiday season, in that I believe your holiday sales historically have been driven in the U.S. to a good degree by these kinds of promotions? And can your -- and gift sets as well? And maybe you quantify what percentage of sales in the holiday season in the U.S. historically has been driven by gifts and what percentage you expect to be driven by these this year.

Fabrizio Freda

This is Farbrizio. No, I personally don't think our strategy is risky. We are doing these changes very gradually and globally. And we are not taking the risk in the short-term, particularly during the holiday season. We are going to have a lot of very appealing promotion as I was saying in my prepared speech. And we have also had some very interesting value activities for our consumer during the holiday season. But if you look to the first quarter, and if you look to the year as a total, you will definitely see a reduction of our gift and promotional activity in total and increase at the same time of advertising spend in print, magazines, in television and online advertising. The other important difference, these activities of extra advertising had been focused and concentrated on our most successful and biggest launches globally, which means there is another advantage versus the past model where the level of support that will most potentially win our activity having is dramatically increasing. And in fact, a lot of our accelerated growth came from the extraordinary success of some of our launches like Clinique Even Better Clinical or Lauder Advanced Night Repair or DKNY Pure, which is also the response to a concentrated effort of advertising on those initiatives. Obviously, the reduction of promotional activity and more push activity has influenced, meaning will reduce a little bit our volume. But this is being more than offset by the benefit that we see in more focused and increased advertising [ph].

Alice Longley - Buckingham Research

And can I ask a related question about North America? Your shipments in the Americas were up 12% in the quarter. How much were your sales at retail up so we can see if there's any difference between shipments and sell-through?

Richard Kunes

Obviously, there's always a bit of a disconnect in our first quarter, because what happens is our retailers are buying into their anticipated Christmas season and then that sell-through activity is comparable to that. But there's probably a few percentage points differences, quite honestly, between sell in and sell-through activities that we see. But that's kind of normal in our first quarter because as always, as I say, a buy in leading up to the Christmas season and based on their anticipated what they think their Christmas holiday season is going to be like.

Alice Longley - Buckingham Research

How fast do you think you grew at retail in the quarter, in the Americas?

Richard Kunes

In the high single digits.

Operator

And your next question is from the line of Neely Tamminga with Piper Jaffray.

Neely Tamminga - Piper Jaffray Companies

Just wanted to talk a little bit, since we do have your Innovation Officer on the phone today, maybe qualitatively, I'm just kind of curious how your team would work with the consumer insights group and just wondering how that interaction works from a process change today from maybe where Estée Lauder was just two years ago? That will be really helpful.

Fabrizio Freda

Actually, we are gathering very valuable consumer insights around the globe, and we are using those consumer insights to inspire our creativity and product development and guide our R&D investment priorities. In other words, we are keeping the focus on creativity, on imagining what the consumer did not expect but keeping the focus on our great R&D efforts and product development effort, that we are inspiring those for more with consumer based insight particularly global understanding of consumer. This is working pretty, pretty well. And I would like Harvey to comment on how these R&D efforts are benefiting our business.

Harvey Gedeon

One of the areas that we've done so far, one of the main focus is in areas of bigger opportunities and categories of huge demand. And that requires a strong partnership with consumer research and consumer insight, in alignment with corporate and win strategy. Our focus has been to create fewer and bigger initiatives, what we call heal products [ph] whose performance is proving can be easily recognized such as Even Better Clinical, supported by strong and effective advertising to excite the consumer to come to the counter, where she can be delighted with our High-Touch. So again, using consumer insight, we are focusing on the big priorities. We don't use them to meet consumer demand. We try to anticipate the consumer demand and consumer needs. But we have a strong partner with our strategy.

Operator

And your next question is from the line of Caroline Levy with CLSA.

Caroline Levy - Credit Agricole Securities (USA) Inc.

In China, I understand there's been a delay in getting new products to market for the entire industry. You were still up 32%. But could you comment on what you think the prospects are for that changing or how that might impact sales? And then I think you touched on the fact that there have been shortages in North America and at the beauty event, we heard the same thing that the retailers were a little worried about certain products getting to market. Could you just bring us up-to-date in that?

Fabrizio Freda

Yes. On China, there is, in this moment, the authorities there are revising their policies. So as you see, the entire industry is not getting through new product approval for the time being. We assume this is a temporary measure and we are ready to start to gain the approvals as soon as the authority will allow this to happen. In the meantime, we are working hard to create the right transition plan, if you want. First of all, we still have a good, valid pipeline of products, which have been previously approved and we are launching in this moment. So we do not have a problem in the very short term. Then in case this had to continue longer in the future year or more, then we have plans, obviously, to re-promote and relaunch some of our most important activities. You need to understand that in China, even our most successful products for the moment have trial levels, which have stayed well below level of 30% or 40%. So the fact that we may need to push those products more and continue to make more consumer awareness to try this product is not necessarily a bad idea. And anyway, we'll definitely continue to build our volume for a certain period of time. In the longer term, obviously, we are counting on these going back to normality, although, we are well aware this will go back to normality but with a new policy that we will need to understand and adapt ourselves to.

Richard Kunes

And regarding your question on supply. We have sort of three things working at once. One is there is a pickup that we see in the Prestige marketplace and our sales results kind of reflect that. Second is we have some terrific products, which are doing very, very well from our perspective, somewhat better than we even anticipated. And the third element that's mixed in there is the fact that some of our suppliers are having difficulty responding to the increased demand across the industry-wide, cosmetic industry. So what we're dealing with is those three factors, which is creating a little bit of tension within our supply chain and our reaction to that may very well be, as I mentioned in my prepared remarks, that we may build some extra inventory to ensure that we improve our service level.

Caroline Levy - Credit Agricole Securities (USA) Inc.

And I was just wondering, Travel Retail, is it strong across the board? Or is there particular, any areas of weakness or strength?

Richard Kunes

It's across the board, but I think we mentioned in our remarks in Asia/Pacific and Latin America were in particular, doing very well.

Caroline Levy - Credit Agricole Securities (USA) Inc.

And is that in the local country or those traveling into other parts of the world?

Richard Kunes

Well, it's in Travel Retail locations so it's people coming in and out of countries, right?

Fabrizio Freda

It's airports.

Caroline Levy - Credit Agricole Securities (USA) Inc.

I'm just trying to understand if it's Latin and Asian travelers going through Europe or the pick up is within those countries?

Fabrizio Freda

The pickup is mainly international traveling. But you're right that the origin of international traveling, which has the highest increase is from Asia.

Operator

And your next question is from the line of Ali Dibadj from Bernstein.

Ali Dibadj - Sanford

I would love your insights a little bit on what you see for the next few quarters, given that you're not carrying through maybe strong this quarter. What exactly are you saving up for? I mean, you mentioned a few things. You mentioned competition. I guess, are you seeing competition increasing yet? And if so, where? You mentioned kind of sell-in not potentially now versus the holidays? How do you think the retailers perhaps in that context are thinking about the consumer holidays? You mentioned some of the shortages. Just kind of what are you saving up for? What are you trying to be conservative about, I guess. And I asked that, of course, in the context of your implied margins being, I don't know -- I'm kind of doing it live here, but call it flat to 70 basis points roughly versus last year for the full fiscal year. So I'm just trying to get a little bit of your insight going forward here.

Fabrizio Freda

Ali, let me explain. First of all, we are very, very positive on our strategy, and we are getting every quarter more positive about our ability to execute in general. And also, we start seeing positive results in the important U.S. department store channel for us. So those are all positive and we are pretty bullish on those key aspects. However, we need to balance the results of this quarter with the expectation for the next say, quarter or within the fiscal year for the following reason. First of all, because also, in; fact for the supply chain which has been discussed, we have some of the gift with process promotions which are in holiday sales. Which originally had to be shipped in September, will be actually shipped in October. And this interestingly, is actually creating a better gross margin in the first quarter, and we create some worse gross margin in the second quarter. So this is an element of balancing that we are taking under account. The second important element is that the incremental orders that we got in Europe because of the reassortment program that have positively impacted our first quarter will not continue after early October. So we do not expect this positive trend to continue in the remaining part of the fiscal year. Next point is the low base. I mean, our first quarter last year was the worst in terms of growth. And so the comps are going to be much tougher for the remaining three quarters of the fiscal year. Importantly, then is currency. The currency rates has been more favorable than anticipated in this first quarter. We honestly, do not expect this trend to continue. As Rick has explained in the prepared remarks, we are assuming for the average of the remainder of the fiscal year, a euro at 41.30. And as you know, this has been pretty volatile and difficult to predict. And finally, but not less important, we are only one quarter into the year and we have some concerns for the external macro factors, specifically in the U.S., the expectation for the holiday season is pretty positive, but the January March or January June period is a big question mark. There are many factors that may generate a softening of the market after January, particularly, if the unemployment rate had remained at the current level. And then we continue to be pretty worried by the pocket of softness around the world, namely Japan and Australia, in Asia and Southern Europe in general, they remain very worried. To this worry, you can now use of the U.K. program. Now U.K. is our second biggest market. And so we are prudent on what will be the effect on consumption on the new measures in U.K. and the increase in January in the U.K. for the second six months of our fiscal year. So the combination of these factors is the reason why you see us taking the yearly guidance up, but not of the total amount that we've been doing better in the first quarter.

Ali Dibadj - Sanford

If I could, perhaps take advantage of your generosity for two very quick questions. One is, Rick, Smashbox about 1% on the quarter, is that the way we think about it? And then two, it sounds like we're implying a little bit of acceleration in Hair Care in the rest of this year. Just would love a little bit of idea around that.

Richard Kunes

You're exactly right with Smashbox, Ali. It is about 1% on the year that's added to overall growth. And then we are expecting some better results for the remainder of the year for Hair Care, certainly.

Operator

And your next question is from the line of Linda Bolton-Weiser from Caris.

Linda Weiser - Caris & Company

Can you give a little more on the growth in Latin America? Can you remind us roughly what percentage of the Americas is Latin America? And can you talk a little bit about Brazil, because you have talked very enthusiastically about the growth opportunities there, and I think L'Oreal is saying also positive things about that part of the world. And can you address the idea that it's been a dominant direct selling market and what you are doing to bring beauty into the regular channels of distribution? Just talk about that market a little bit.

Richard Kunes

Just on the percentage of overall business, it's 2% to 3% of our sales, so it is fairly small. But honestly, we do see an opportunity in Latin America that's emerging for us and we're being pretty aggressive in going after it. But Fabrizio, you want to...

Fabrizio Freda

Again, Latin America for us is a very big opportunity forward. It's not being very meaningful in terms of the percent of the total business so far, but we have very serious plans to accelerate our penetration in the future in Latin America. We are very relevant already in markets like Mexico, Venezuela, or Chile. And our key focus now will be really to accelerate our penetration in Brazil. And we are doing this with various programs in the retailing environment, working with future outstanding [ph] stores will be one strategy, which is already the strategy of our M-A-C brand, although, we plan to accelerate over time. And we are evaluating other projects also in this area. Importantly, our Travel Retail division also has an important role is bringing our brand in efficient way in Latin America. And we have serious plans to accelerate this one as well.

Operator

And your next question is from the line of Andrew Sawyer with Goldman Sachs.

Andrew Sawyer - Goldman Sachs Group Inc.

I was wondering if you could talk a little bit about the issues in Japan, and you've done a nice job of giving the U.S. Department Store business which have been struggling, going again. Is there any similar path to get Japan back to a growth trajectory?

Fabrizio Freda

Yes, that's a very good question. Actually, yes. I believe there is some similarities between the opportunity of getting the department store growing again in Japan and what is working today to get the department store traffic in cosmetic up again in the U.S. So we are definitely working on these. We are transferring some of our U.S. learnings into our Japan program and working with retailers there to generate a high level of learning. And particularly, the level of learning in how to improve the High Touch, how to the differentiation versus the mass channel, how to improve the role of new initiative and make the launches to attract new consumers to the floor of beauty in big department stores. And finally, how to improve the cost structure to liberate the funds that needs to be invested in attracting new consumer and serving them with higher, higher quality. All elements that will definitely be used also in Japan to launch the second. However, the Japan economy is really under pressure. So this may take some time, because it requires some improvement of the business model. But at the same time, we'll require that the economy in Japan will be less stabilized or hopefully one day be turned around.

Andrew Sawyer - Goldman Sachs Group Inc.

Just a quick one on the U.S., we've heard about some of these Macy's beauty impulse boutiques. And I know you guys have Smashbox in this effort but how should we think about those store within a store and the impact it has on the conventional cosmetic counters?

Fabrizio Freda

I think the entire specialty channel in the U.S. first is developing and is developing pretty well. So this in our opinion, we continue to grow very successfully in the U.S. market, and with our portfolio brands, we are trying to participate through all the channels. So our portfolio brand is strong because it's also wide enough and designed to be able to win in every of these Prestige and luxury channel, which are developing limiting the amount of conflicting overlap or cannibalization.

Operator

Your next question is from the line of Bill Schmitz with Deutsche Bank.

William Schmitz - Deutsche Bank AG

Some of your competitors, I think L'Oreal said that the category was flat. And then if you just look at that some of the standard data in the U.S. and Europe, it seems like M-A-C is also down 1% to 2%. So are you seeing something differently in the categories or are you just taking loads and loads of market share?

Fabrizio Freda

We have taken strong market share, and from the number we see, the categories globally is growing about 2% is our estimate, which is again, is not super strong growth but we see the overall category is starting to gain growth. We do see that growth in Prestige or whatever we define as Prestige channel in the different parts of the globe, we see that Prestige is growing faster than mass in some key markets around the globe and this is an indication that the Prestige consumer are coming back actually faster than the less affluent customers on one side but it's also an indication that the Prestige business model, the way we are evolving it, has some appeal for the consumers and some more appeal for the consumers and make, I believe, the entire segment more competitive in the long term.

William Schmitz - Deutsche Bank AG

And then can you just tell me what do you think the incremental margin was on sales beat. I think you're calling for sort of 11% the midpoint of your previous range, and you came in three points higher I mean, did almost all of that gross margin just flow down to the operating line?

Richard Kunes

No, what happened, Bill, was two things. One, absolutely, because we had pretty good control of our operating expenses and we continue to focus on that. We actually had some savings, as I mentioned on our prepared remarks. And also, we talked, and Fabrizio elaborated upon the idea that we have some gifts that did not ship that are shipping in the second quarter so the combination of both those two sort of in semi-quotes fixed operating expense base, lower cost of goods, all of that money flowing to the bottom line, that was one of those reasons for the beat for sure.

Operator

And your next question is from the line of Conie Maneaty from BMO Capital Markets.

Constance Maneaty - BMO Capital Markets U.S.

Could you just give a little color on the effort in the perfumery channel, the whole reassortment? How big that is channel and what exactly does reassortment mean?

Fabrizio Freda

What this means is that again, as part of our improvement of the business model, historically, in Europe, where perfumeries are relatively small doors versus the big department store doors, we've been selling in our full assortments or big assortment of products. The result of this is that for a few years, every complete assortment is composed of high moving items, items that move very frequently in the course of the year and slow movers. After some time, the accumulation of too many slow movers in a relatively small door like European perfumeries creates the inability of those retailers then to buy in sufficient quantities than high movers. So we took the important strategic decision to help the retailers to eliminate the slow movers from their assortment so they could create space to get in the high movers. That's what reassortment is. This is having an amazing benefit because on one side, it's making our assortment better in each single perfumery. On the other side, it's giving to its single perfumery a competition of high mover, which makes their overall rotation increase and importantly, make better profit for the retailer and better profit for us. So it's been probably one of those investments that we could have done, now the key challenge in front of us is to maintain the assortment in those stores with a right balance between completeness of the assortment and focus on high mover SKUs, which is the plan.

Constance Maneaty - BMO Capital Markets U.S.

So it sounds as though in this quarter, there was something like a pipeline sale of a more select, faster moving assortment of products. Is that correct?

Fabrizio Freda

That's correct. As Rick said in his prepared remarks, while we see about a double-digit growth in Continental Europe, in reality, our retail growth in Continental Europe is in the high single digit. So there is a difference between the sell-in and the sell-out and this difference is the reassortment program, which I've just explained, which, however, in my answer to Ali's question before, we do not expect to continue. So we cannot expect that this extra stocking will continue in the next three quarters.

Constance Maneaty - BMO Capital Markets U.S.

How big is the perfumery channel?

Richard Kunes

Perfumery business is roughly 18%, 20% of our total business.

Operator

And your next question is from the line of Joe Altobello from Oppenheimer.

Joseph Altobello - Oppenheimer & Co. Inc.

First question is more broader, I guess, in scope. Just put aside your market share gains, you mentioned earlier, Fabrizio that the upscale consumer is coming back, given the faster growth of the Prestige segment of the category. And you also alluded to sort of pent up demand. If part of this is pent-up demand, how long does that phenomenon last? How many quarters do you think you have before the Prestige segment has revert back in more normalized growth rates?

Fabrizio Freda

So could you repeat the last part of the question?

Joseph Altobello - Oppenheimer & Co. Inc.

Yes. How many more quarters do we have until that pent-up demand starts to abate and the Prestige segment sort of reverts back to a more normalized growth rate?

Fabrizio Freda

I think this will happen pretty soon in the sense that the Prestige segments will go back, I believe, as of this quarter as of October, November. Or I would say again, the holiday season basically, will be differently influenced by different factors. But I say generally I think as we saw go to very normalized patterns. But again, I believe, that the way we are building the Prestige segment again is really by our new model of pull and push, meaning amazing innovation, with great advertising, to pull the consumer into the store and then High-Touch services, brought to the next level to sell the consumer the full Prestige experience. That's the model that has the potential to have Prestige growing nicely for many years to come and maybe to be more competitive with the mass growth even when the markets will normalize. I will ask just maybe Harvey to say a few more words on the way this innovation program can impact the Prestige market development. And our market share needs.

Harvey Gedeon

Yes, I mentioned before, I like to think that pent-up demand is due to innovation. I mentioned before that we focus the focus on initiatives to bring your consumer to the counter and delight them with High Touch. But if you combine that with what we're doing, which is more locally relevant products, we're really focused on the consumer, on the local consumer need and back it up with strong and rigid capabilities in that region that also is having an impact in places like China and places like the Middle East, where the products are much more catered to the local need. And we have one more thing that we do, which is we create products closest to the most demanding consumer and make them global hits. So what we're doing is creating products that could action and collaboration between two more different region buy creating products that satisfy that consumer which is extremely demanding, one of which for example is Asia, and then taking that idea globally, so that we have a very big hit. If you do those things, back it up with strong advertising, I think we can delight the consumer with more and more products. So I think the whole pipeline of product innovation is really strategic and important to making on keeping the consumer coming to our counter.

Operator

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

Lauren Lieberman - Barclays Capital

I just wondered if you guys can comment a little bit on trends in Hair Care. I know the channel, salons itself are still relatively weak. But just maybe talk a little bit competitive positioning and sort of longer-term outlook and to what degree this set of business is on the turnaround list?

Fabrizio Freda

Actually, just to [indiscernible], this business is not on the turnaround list. This business has been decently profitable for some time and what we need to turn around is the top line and we need to accelerate the top line on this business. Now in fact, this is very much linked to the trends. The High-End Salon business in which we operate in North America particularly, is still relatively soft. The market is not recuperating fast, and we are suffering part of this softness. At the same time, we are making some important improvements to the plant of our High-End Salon business. We are improving our distribution in high end salons in North America. We are working on the continuous but gradual international expansions of our key brands, Aveda and Bumble and bumble. For example, we started the expansion of Bumble in the U.K. very recently. And we are working to link particularly on Bumble, the business also, with a retailing format that form a execution that could develop our retailing sales and at the same time help and support our salon network to further build that business. And on that front, we are running a very exciting test market with Sephora here in the U.S. that, if successful, can really transform the high-end hair care industry in my opinion in North America and possibly in the future, international.

Operator

And your next question is from the line of David Wu from Telsey Advisory Group.

David Wu - Global Crown

First, your cash position remains pretty solid at the end of the quarter. I was wondering if you could perhaps share with us your plans for future cash deployment. And just secondly, can you maybe perhaps talk about what you're seeing in terms of raw material cost trends and your expectations for the remainder of the fiscal year? And just lastly, are you still targeting a long-term operating margin of 12.5% to 13.5% by FY '13?

Richard Kunes

So we did make use of some cash this quarter. We purchased Smashbox, as you know, for about $250 million and we also bought back about 2.4 million shares, so we are using some of that cash balance. And we've always said our priorities for cash are investing in our business, make strategic acquisitions and then return excess cash to shareholders through share repurchases and dividends. So I mentioned share repurchase. Dividends really is part of a capital allocation discussion that we have with the board of directors, and we do that rather frequently. But the declaration of dividends is in their hands quite honestly. We're lucky that we do have a strong balance sheet that gives us a great deal of flexibility. Regarding material costs, we have seen some pressure in material costs, and we've mentioned this on earlier calls, quite honestly, the value of the materials that we buy is not so much in the raw materials but in the creative process, if you will, the construction of what we buy. So the creation of the caps or bottles or boxes that are specific for us, that's really the cost to add component, if you will, of our cost of goods. So material costs make it more difficult for us to continue to improve our gross margin. But it is not quite as only risk for us as it is for some other companies. And then you're exactly right, our long-term target is 12.5% to 13.5%. And we're working very hard. And I don't know, Fabrizio will add to that.

Fabrizio Freda

I just want to add that we will continuously look at this target, in the appropriate times, we will decide how we're doing versus these targets and communicate to you how we feel versus the target. As you know, for the longer-term, we always said that we believe we can meet a 15% in the very long term, so we will first decide how fast we can get to the target of 12.5% to 13.5%, and then elaborate our next margin growth target in the future. But for the moment, I believe it's premature to change the target after only one quarter in reality in which we have just declared the new target which, by the way, was already increased asset volume versus the previous one.

Operator

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

Victoria Collin - Atlantic Equities LLP

I just wanted to ask a question on the Makeup segment, if I could. It seems you reinstated in the full year guidance as a leading contributor to growth for the rest of the year. And I wonder what kind of growth you'd been seeing in the first quarter, whether it's an element of restocking from some consumers or whether there was a particular region or launch or product that you both have, which is selling faster than you'd expected originally?

Richard Kunes

I think the restocking did not affect, if you will, restocking did not affect the makeup category. As a matter of fact, in the perfumery, specifically that was geared towards skin care, than it was -- well, it's a little bit of Makeup and Skin Care. But other than that particular element, there's nothing unusual with the growth rate of Makeup. We think it's going to be pretty solid for the year, and it's built into our forecast. So M-A-C is doing very well.

Fabrizio Freda

So the two key reasons on Makeup is the European reassortment includes Makeup and obviously, and then we have some brands, particularly M-A-C, which is having an amazing momentum and is growing very, very nicely. So we say that our key priority has been Skin Care development, but Makeup is almost an equally important priority for us and we are growing very nicely, very actively in this category.

Operator

And your final question is from the line of John Faucher with JPMorgan.

John Faucher - JP Morgan Chase & Co

Going back several years ago, it seems like this type of gross margin performance often would be sort of spent back. And I guess, as we look at this, can you talk about the evolution of your understanding of the efficiency of your marketing spend and how that changes your decisions in terms of whether or not you're going to spend that gross profit upside? Is it the fact now that you seem to have a much better idea of the efficacy of the spending that you don't need to sort of throw extra money at the problem and you can still deliver top line growth above your expectations?

Fabrizio Freda

No. Again, we are learning only few quarters that we are into this model and we seem to be learning that like in this quarter, without changing our total spending of advertising and promotion, but just reshuffling for major efficacy and effectiveness our spending, we are getting the growth that we want. So we are optimistic on the ability to grow only gradually the spending and achieve a lot of improvement by reshuffling and efficacy. At the same time, however, we will continue to feel free to make important investments when we see opportunities, which are very relevant for the long term like investing and anticipating market share gains in a big, new developing markets before we get a lot of question about Brazil for example, or in any other area where we may decide that it's the right time to make investment and build our penetration and market share for the long term. So in general, I think we are going to continue to win also in efficiency and probably efficacy of our marketing plan. But we also will make some important strategic investment in capability and new markets over the next years.

Richard Kunes

And on top of that, John, we're also as you know, being pretty aggressive in finding efficiencies in our organization from costs and lots of other programs that we have underway. So we are driving, if you will, efficiency through everything else and investing, as Fabrizio says, to also help drive the top line. So that's hopefully our business model.

Operator

That concludes today's question-and-answer session. If you were unable to join the entire call, a playback will be available at 1:00 p.m. Eastern time today through November 12. To hear a recording of the call, please dial 800-642-1687, pass code number 16642055. 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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