Estee Lauder Cos. Inc (EL) — Q2 2015 Earnings Call Transcript

Good morning. On today's call are Fabrizio Freda, President and Chief Executive Officer; and Tracey Travis, Executive Vice President and Chief Financial Officer; and Chris Good, President of the U.K. and Ireland. Chris is going to discuss both the strategy and our current business in the area. 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. Our discussion of our expectations for the full fiscal year is before the impact of accelerated retail orders that took place in the fourth quarter of fiscal 2014 July implementation of our Strategic Modernization Initiative, which would have occurred in our fiscal 2015 first quarter. You can find reconciliations between GAAP and non-GAAP figures in our press release and on the Investor Relations section of our website. And I'll turn the call over to Fabrizio.

Thank you, Dennis, and good morning, everyone. Our global business delivered strong financial results in the second quarter of fiscal 2015. Net sales rose more than 5% in local currency, better than we anticipated, and earnings per share also exceeded our forecast. Many of our brands, channels and countries contributed, and importantly, we expect this momentum to accelerate in the second half of our fiscal year due to the strength of our upcoming launch calendar. Prestige beauty continues to grow, sustained in part by heavy spending by key companies and occurred against the backdrop of increasing volatile macro events, including sharp currency fluctuations, political unrest and slower growth in some countries. We continue to invest in the future by acquiring 4 prestige brands that position us well for our sustained growth and profitability. I will start to discuss these acquisitions later on. Our results this quarter clearly demonstrated our strategy is working, since we were able to deliver solid performance when faced with market challenges and currency volatility. This is also a testament to our talent and the flexibility we have built into our business model to create resilience and agility. We are able to quickly adapt and change our focus when we see consumers and market dynamics shifting. Our consistent success is rooted in our multiple engines of growth, which has enabled us to find opportunities across geographies, channels, consumer demographic, brands, innovation and acquisitions. We have strategically broadened our reach, so when the unexpected occurs, we are less exposed and have more positive levers to pull. Our strength in the second quarter was led by many of our prominent growth engines. Our luxury and makeup brands were standouts, which continued a recent pattern. We enjoyed excellent double-digit growth in the U.K. and most emerging markets, and by channel, in our own lines, specialty-multi and freestanding stores. Sales rose in most product categories. Skin care, our largest, was supported by recent launches, including Clinique Smart Custom-Repair Serum, which climbed to the #2 position in prestige serums in the United States. Clinique Sonic System Purifying Cleansing Brush also performed well and is gaining momentum globally. It's a strong seller in travel retail, and in key Asian markets, it has overtaken its main competitor to become the bestseller device. Throughout December, we estimate that nearly half of all North America consumers who purchased the brush also brought at least one of the Clinique 3-Steps products. The brush is part of Clinique's strategically important 3-Step cleansing system and reinforces its authority in this area. In other skin care news, Estée Lauder luxury Re-Nutriv Ultimate Diamond Dual Infusion has been well received and soon will be paired with the new lifting cream. We have had good consumer acceptance of the Re-Nutriv franchise, strengthening the brand in the high-end segment of skin care. Our makeup momentum continued and we generated strong sales growth, most evident in our 3 makeup-oriented brands. M·A·C sustained its fantastic brand, with growth in all regions and notably in many emerging markets, including China, Brazil and Turkey. Its Holiday kits sold out in North America, and business in its freestanding store worldwide was brisk. Smashbox growth was also stellar, thanks to strong retail in specialty-multi and online, expanded global distribution and popular new palettes. Within makeup, our brands are significant players in the key subcategory of foundations. One of the highest loyalty products, Bobbi Brown Skin Foundation Stick and Estée Lauder Perfectionist and Double Wear products were bestsellers. Beyond Perfecting, Clinique's newest liquid foundation, incorporates concealer and is beginning to launch in the stores now. The Estée Lauder brand makeup business climbed high single digits globally, driven also by its usually popular Pure Color Envy lip franchise. Also in the lip category, we expect the spring launch of Clinique Pop Lip Colour and Primer to generate excitement. In fragrance, sales declined against heavy launch activity in the previous year's period. However, our luxury scents from Jo Malone and Tom Ford continue to rise sharp double digits, and we had a nice lift from our successful Michael Kors Collection. In hair care, Bumble and bumble generated strong U.S. sales and has 2 exciting hair care products launching this fiscal year that we expect to boost its salon business. As you see, there is a great deal of product excitement across the portfolio that we believe will contribute to accelerate sales in the second half. We also continued to drive sales from several high-growth channels. Our e- and m-commerce business rose more than 30% in the holiday quarter with double-digit increases on brand and retailer sites, and even larger gains on third-party sites. Also impressive is that nearly 1/3 of the sales came through mobile devices. Importantly, all metrics, traffic, conversion and orders increased over last year. The lion's share of our company's e-commerce business comes from the U.S. and the U.K., and our second quarter sales in each country surpassed the market's overall online growth. The largest market for e-commerce in the world is China, and we are making good progress there as well. We have now 6 brands online in China and their combined online sales increased nearly 200%. We have tremendous opportunities to expand our online footprint by brand and country around the world. Our midsized brands are growing in importance to the company overall, and this is also true in travel retail. Aveda, Jo Malone, La Mer, Tom Ford accounted for much of the 4% increase in retail sales in the travel channel. Our net sales in travel retail declined approximately 4% because retailers rebalanced inventories. Additionally, the Chinese New Year holiday is later this year, moving the shipment to the third quarter. Sharp currency moves and political unrest in part of the world have curtailed travel and have affected groups that had large purchases of beauty products, including Russians, Brazilians and Chinese. A bright spot was Japan, where travelers took advantage of a weak yen and we had strong retail growth. Another positive factor is our continued expansion in the channel. We opened more airport doors for certain brands, which are generating good growth. From a geographic standpoint, we tailor our products and resources to where we see the best growth prospects. We continue to believe China is one of the most exciting opportunities and will remain a key growth driver over the next decade. China's prestige beauty growth remains at high single digits, and we see wide spaces of opportunity to enter additional cities, doors and channels and launch more brands. Our net sales in China rose 4% in the quarter. We were competitive promotionally, and our retail sales climbed 15% with virtually all brands rising double digits. Estée Lauder, the leading prestige beauty brand in the market, had a terrific performance, especially in December, when retail sales rose sharply and it widely outperformed the industry. We expect its positive retail trends to continue for the rest of the fiscal year. Chinese consumers are passionate about beauty products and branching out beyond skin care. M·A·C, Bobbi Brown, Tom Ford and Jo Malone had fantastic results, pointing to higher makeup and fragrance consumption in that market. M·A·C emphasized Korean beauty trends that are popular throughout Asia, sending its sales up sharply. Emerging markets beyond China have been helping to drive our consistent growth as our compass predicted. The group, which includes Brazil and India, maintained its healthy momentum at 25%. Our business in Europe, the Middle East and Africa was strong. Net sales growth in constant currency in Western Europe rose mid-single digit. And we estimate we gained share in Germany, Spain, Switzerland, Benelux and Nordic region. Emerging markets there grew more than 20%, driven by Russia, the Middle East and Turkey. The U.K. has done a phenomenal job embracing the company's strategy with outstanding execution, strategic innovation and local relevance. There are many lessons we have learned in the U.K. that are applicable to other markets. We should foster future gains around the world. Chris will elaborate shortly. Our net sales in Hong Kong declined slightly as protests and tensions impacted retail traffic. But our results were better than we had anticipated. Although spending by tourists is expected to remain low, we anticipate a return to growth in the second half as political unrest abates. Our sales grew modestly in Korea, although local brands continued to gain share. We are encouraged that a number of our brands, including Aveda, Origins, La Femme and Jo Malone are accelerating in some heritage brands, assuring signs of recovery. In addition, we successfully launched Tom Ford Beauty in Korea with very strong demand. Retail sales of prestige beauty improved in the U.S.A. A trend led by many of our brands, the holiday period was promotional for all prestige beauty, culminating in a strong retail showing for the month of December. The consumer sought value and responded well to our holiday programs that were popular across brands and channels. We expect sales to accelerate in the U.S. in the second half, reflecting a strong launch calendar and marketing activities. We are working to extend our scope by reaching new consumer demographics. One of our most exciting initiatives comes from the Estée Lauder brand, which signed 19-year-old Kendall Jenner as a spokesmodel. Kendall is a star in social media and has a huge built-in audience with over 18 million followers on Instagram. The Estée Lauder brand remains focused on its core consumers as evidenced by innovation into luxury and anti-age business. However, at the same time, it is taking steps to broaden its appeal and be disruptive in a way that will draw the attention of a new generation. Our namesake brand has other exciting announcements and launches planned as it tries to attract more influencers and millennials. Now I'd like to update you on the new brands in our portfolio. Each one we recently acquired has a unique position in the fast-growing area of prestige beauty. RODIN olio lusso in oils, Le Labo in high-end fragrances and sensory body products as we discussed last quarter. More recently, we added GLAMGLOW, a Hollywood skin care brand focused on fast-acting facial masks with a robust presence in specialty-multi channels. And Editions de Parfums Frédéric Malle, which offers a collection of luxury fragrances crafted by some of the world's most talented perfumers. Over the years, we have acquired many small brands that today are formidable global competitors in the prestige beauty space. Our creative and operational strengths position us well to develop this next collection of brands into more sizable brands for the future. We warmly welcome the brands and their entrepreneurial founders into the Estée Lauder Companies family. We look forward to accelerating the momentum of each of the brands by leveraging their strengths, and together, we will develop their potential. These brands are being overseen by 2 talented executives, who bring complementary skills and intimate knowledge to our company. Caroline Geerlings, who most recently headed Tom Ford Beauty, is focused on commercializing the brands and their operations. Daria Myers, who has extensive brand and R&D experience oversees innovation, product development and creative initiatives. Both executives report to Group President, John Demsey. Our long-term strategy emphasizes our many pillars of strengths, including a strong bench of talented leaders, diverse brand portfolio, balanced geographic presence, and most importantly, multiple engines of growth highlighted in our compass. We are committed to strengthening our robust growth levers, finding new ones and continuing our journey to keep delivering sustainable profitable growth. With a solid first half behind us and exciting programs ahead, we are confident we can execute against the global challenges and risks we may face, and deliver another year of above-industry constant currency growth. I want to thank all our talented employees who contributed to our excellent performance throughout their collaborative spirit and dedication and ability to steer through many volatile environments. Now I will turn the call over to Chris, to talk about our fantastic U.K. business, which on a local level mirrors the terrific global collaboration and execution I just discussed.

Thank you, Fabrizio, and good morning, everyone. I am delighted to be here. I have been with Estée Lauder Companies for 15 years in a variety of leadership roles in Asia and Europe, and for the past 3 years as President of the U.K. and Ireland. The U.K. was the first market to be opened by the company outside North America in 1960, and indeed, it remains our second largest market after the U.S., representing more than 8% of total company sales and an even greater share of profits. Fabrizio spoke of the company's multiple areas of growth and the U.K. is one of our largest engines. Our company is #1 in prestige beauty in the U.K. and #2 in total beauty, which includes mass. The U.K. business is large, complex and has a very different distributional profile from Continental Europe. Many would view the U.K. business as mature. Average growth for total beauty has hovered between 3% and 5% for the last few years, with prestige beauty growing at approximately 5% on average. However, we view our U.K. business as an emerging market. What we mean by this is that we pursue high-growth opportunities across geographies, channels, categories and consumer segments. This approach has resulted in 3 years of growth trending well above the market. Our net sales in constant currency grew 11% last year and we are currently up 13% for the first half of fiscal '15. Strong results in an economy with GDP growth of only 2.6%. The U.K. is one of the world's most diverse nations and a top tourist destination. We go to great lengths to offer the most ethnically appropriate mix of business at every counter. We ensure our staff in merchandising is well-suited to the consumers of each location. Our approach is also successful by product category. Prestige skin care is growing modestly across the U.K., but if you look at specific subcategories within skin care, there is good growth to be had if you have the right products and the right targeting. For example, masks are a high-growth subcategory where we are a leader. Origins has the #1 rank in prestige masks in the U.K. Crème de la Mer has jumped up to #3, following the launch of its Intensive Revitalizing Mask and Lifting and Firming Mask, with its masks sales quadrupling in value. Our brands combined show a growth of plus 28% for the first half in masks, more than double the prestige growth. In fragrance, our best performance this year has been the luxury brands Jo Malone and Tom Ford, which both grew at over 20% against prestige fragrance as a whole at 3%. This bodes well for the new acquisitions of Frédéric Malle and Le Labo, where we are poised to take advantage of the U.K. consumers' strong appetite for luxury fragrance. A further area that illustrates our granular approach is our distribution. We have continued to expand our freestanding stores into new areas, including major transportation hubs. M·A·C and Jo Malone stores opened at St Pancras International train station, and both are now trading ahead of plan. Further opportunities exist for distribution in areas that might not be the most obvious choice, but quickly prove their worth. The new Jo Malone freestanding store in the popular tourist golfing destination of St Andrews in Scotland is an example. We have also had success with new formats, such as pop-up stores, to test and learn in new locations. An example is a Jo Malone in Brown Thomas in Dublin and Clinique in London's Covent Garden. Our well-balanced portfolio brand is helping drive growth. We've had solid single-digit growth from our heritage brands, Estée Lauder and Clinique. Clinique is the #1 brand in the U.K. and continues to resonate with consumers. The brands' new launches, Smart Serum and the Sonic System, propelled facial skin care growth of 10% retail during the first 6 months. The heritage brands are fortified by strong double-digit sales growth of M·A·C as well as the next tier of brands such as Jo Malone and Bobbi Brown. And this, the next tier, including Tom Ford, Smashbox and Bumble and bumble are all demonstrating well above industry growth rates. This balanced portfolio of brands at different phases of their evolution allows us to continue to grow at above-average rates overall. For this reason, we are very excited about our latest acquisitions, which have tremendous potential. The U.K. has a successful history of growing new acquisitions. When we bought Jo Malone 15 years ago, it had just 2 locations in the U.K. Today, it has 53 stores and counters and is the fastest-growing fragrance brand in the top 5. Throughout our business, we deliver High-Touch at everything we do. We have 7,500 dedicated sales representatives at retail and our freestanding stores, bringing High-Touch services to the consumer. I believe that in this era where a consumer can get whatever she wants, whenever she wants it, the brands that can provide unparalleled service are best positioned to grow. The U.K. has a higher percentage of mobile shoppers than any other European country and we have made great strides. All our brands in the U.K. have mobile sites. According to a recent survey by an industry think tank, L2, we have the top 5 mobile sites for beauty. Our reach-out growth for the second quarter was led by strong results from Jo Malone, M·A·C, Smashbox and Tom Ford, each of which saw sales rise 20% or more. The U.K. recorded its strongest-ever Cyber Monday, with online sales up 46%. At Jo Malone, great demand for personalization such as the new online engraving service for cologne, candles and bath oils, boosted sales. While e-gift cards, click and collect and same-day delivery service in London strengthened the brands' omnichannel experience. We had strong results across our channels, with several growing digits. During the holiday season, online was a marked success with our own sites growing at 32% and retailer sites, 36%. The developing click-and-collect capabilities of many retailers are a key factor in their growth rates. In our own channels, we have also started to offer click-and-collect services for Jo Malone and Bobbi Brown, which helped drive our success and demonstrated our High-Touch approach to the consumer. Specialty-multi channels had healthy growth in the quarter, up more than 10%, led by Boots. As part of our strategy to expand brands in specialty-multi retailers as appropriate, Smashbox and Bumble and bumble brands expanded their presence in Boots. And our freestanding store channel was a huge success, growing at more than 30%. Department stores remained a key channel for us in both brick-and-mortar and online. We had solid growth overall and double-digit sales gains in a number of our largest department store partners. Going forward, we remain optimistic about the macroeconomic situation in the U.K. and confident in the continued growth in prestige beauty. Thanks to our tremendous team in the U.K. and our proven ability to execute with excellence, we remain committed to pursuing the best opportunities to grow our business ahead of the industry and continue to be an important growth engine for the company overall. I will now turn the call over to Tracey.

Thank you, Chris, and good morning, everyone. First, let me briefly review our fiscal 2015 second quarter results, and then I will share with you our expectations for the third quarter and the full year. Reported net sales for the second quarter grew 1% compared to the prior year and rose 5% in constant currency, exceeding the top end of our expectations. December sales accelerated beyond what we expected, driven by the strength of our holiday programs, as well as the results in Hong Kong being better than what we had anticipated, despite the disruption from the political protests. Our gross profit margin of 81.2% was 50 basis points above the prior year, primarily reflecting favorable manufacturing variances and foreign exchange. Operating expenses rose 140 basis points to 60.4% of sales. The largest driver of the increase was higher general and administrative costs of 150 basis points, primarily reflecting strategic investment and capabilities, such as R&D and information technology as well as our acquisition activities. Retail store expenses rose 40 basis points, reflecting the addition of almost 150 freestanding retail stores over the past year. Partially offsetting these increases was 60 basis points of favorability in advertising, merchandising and sampling expenses, due primarily to the mix impact from the strong growth of our lower advertisement brands as well as the cadence of major launch activities for our heritage brands. As a result, operating margin decreased 90 basis points to 20.8%. Earnings per share came in at $1.13, approximately $0.08 above the top end of our guidance range, up 3% from the prior year, due primarily to the impact of the better-than-expected holiday results and improved tax rates and the decision we took to shift some of our marketing investments to the second half of the fiscal year to support planned strong launch activity. EPS would have been $0.07 higher on a constant currency basis for the quarter, resulting in strong EPS growth of 10%. All elements of working capital continued to improve during the quarter, compared to the prior year. Inventory days to sell decreased by 15 days to 171, which was driven by a combination of both currency translation as well as improvements in service level. During the first 6 months of the fiscal year, we generated approximately $1 billion of cash from operating activities, a healthy increase of 27%, or $211 million, versus the prior year period, which is primarily due to the improvements we achieved in working capital. We reinvested $187 million in capital projects to support the business as we continued to primarily invest in customer-facing areas, such as counters and new retail stores to support our brand growth plans. And regarding return of capital to stockholders, we also took the opportunity to accelerate our stock repurchase activity, deploying $479 million of cash to repurchase approximately 6.4 million shares of stock. This level was more than twice the amount we repurchased during the first half of last year. As a result of the accelerated share repurchase activity that we began last year and are continuing this year, we have reduced our diluted shares outstanding by approximately 9 million shares from the prior year period, which has also contributed to our earnings per share growth. In addition to our share repurchase activity, we have also distributed $169 million in dividends to stockholders in the first half of this fiscal year, which was a 14% increase to the prior year's first half. Over the past 5 years, we have steadily increased the total amount of annual cash distributed to stockholders with steady increases in both our dividend rate and stock repurchase level in addition to delivering solid earnings growth. During the second quarter, we also completed the acquisitions of RODIN olio lusso and Le Labo, which we funded outside of our free cash flow with a combination of cash on hand and commercial paper. We are proud that our financial performance generates ample free cash flow to reinvest back into our business to fund growth while at the same time allowing us to continually increase our distribution of cash to our stockholders. We ended the quarter with $1.2 billion in cash and cash equivalents and $500 million in short and long-term investments. As you are aware from our earlier remarks, we have again utilized our strong liquidity in the third quarter to acquire 2 additional brands, Editions de Parfums Frédéric Malle and GLAMGLOW, and to continue to opportunistically repurchase shares and support our dividend program. We are well positioned to fund our new acquisitions with a combination of cash on hand and leverage as appropriate. Let me now turn to our outlook for the third quarter and for the full fiscal year. To provide additional clarity on our underlying business performance, my commentary for the full year continues to exclude the impact of the acceleration of retailer orders that shifted sales from the first quarter of fiscal 2015 into the fourth quarter of fiscal 2014 related to our July rollout of SMI. As a reminder, the impact of that shift was $178 million in sales and $127 million in operating income, equal to approximately $0.21 per share. Reported and adjusted results are also reflected in the press release you received this morning. As we complete the first half of this fiscal year, we do continue to expect global prestige beauty growth of 3% to 4% this year. However, we remain cautious with respect to the macro environment, given the high degree of political and economic uncertainty. So now let me walk you through our guidance for the year and try to clarify for you the expectations for our underlying business performance, the impact of currency headwinds we're experiencing and the initial impact of our acquisitions. In our outlook for the remainder of the fiscal year, we are reconfirming the range of our constant currency sales and EPS guidance. That means that our sales growth guidance for the fiscal 2015 full year remains at 5% to 6% in constant currency. The 4 acquisitions we've completed to date are relatively small today and are expected to contribute a combined incremental 40 basis points to sales growth this year, still within our full year guidance sales range. As you are all aware, the U.S. dollar has continued to strengthen since we provided guidance last quarter, and currency translation is now expected to negatively impact our full year sales growth by approximately 4 percentage points, which equates to approximately $480 million in sales. Our estimate assumes current stock exchange rates for the remainder of the year of 1.13 for the euro, 1.51 for the pound and 1.18 for the yen. On a reported basis, our sales growth guidance, including the negative currency impact, is 1% to 2%. Regarding earnings per share, we are also reconfirming our previous guidance for the full fiscal year in constant currency, and that growth expectation remains at 7% to 10%. This excludes the impact of negative currency translation on our earnings, which was a 4% negative sales impact equating to approximately $0.23. Therefore, our revised expectation for reported EPS, including the negative currency impact, is a range of $2.93 to $3.01, which is an increase of $0.10 from what we had expected last quarter. This compares to our fiscal 2014 EPS of $2.95 before charges and the accelerated orders. The impact of our acquisition is expected to dilute operating margin by approximately 40 basis points and EPS by approximately $0.06. We expect to manage the EPS impact of these acquisitions within our previous guidance range. Our sales in the third quarter are expected to grow 6% to 7% in constant currency or flat to last year on a reported basis due to the impact of the strong dollar. Contributing to sales acceleration on a constant currency basis in the third quarter are: multiple new skin care and makeup launches from Estée Lauder and Clinique, as Fabrizio mentioned, coupled with strong marketing support; 70 basis points of incremental growth from acquisitions; a recovery in Hong Kong; our return to more normalized growth in travel retail; and easier retail comparison in North America against the prior year's severe weather and late Easter; and an easier comparison in Venezuela now that we will anniversary the transition to SICAD II. As I mentioned earlier, the cadence of our launch activity is greater in the second half of the year, and we plan to increase marketing support for these launches at a level greater than sales growth in the quarter. Additionally, we expect approximately $0.02 dilution from acquisitions. Therefore, we anticipate the third quarter EPS will come in between $0.45 and $0.50. The approximately 6% to 7% negative currency impact on sales growth in the quarter equates to approximately $0.07 per share. The momentum we have experienced in our business in the first half of the year in markets like the U.K., which Chris shared with you, our emerging markets in EMEA and a powerful and resilient brand portfolio, which we have recently expanded, coupled with the strength and dedication of our global teams gives us the confidence that our strategy is working and that we will continue to manage well through these volatile times and achieve our long-term goals. That concludes our prepared remarks, and we'll be happy to take your questions at this time.

First, just a shorter-term question. I think it's impressive that you're expecting improved growth in Q3 relative to Q2 on a like-for-like basis. And you walked through a couple of the key drivers just now, but which ones are trending better relative to your going-in expectations?

Our business is picking up speed. Firstly, our Clinique and Lauder brands are gaining momentum. In the third and fourth quarters, we anticipate some significant product launches backed by substantial advertising efforts in key regions worldwide. This is one of the main drivers of our acceleration. Secondly, our midsize brands continue to grow and expand their distribution globally. Moreover, M·A·C is performing exceptionally well. As Tracey mentioned, we expect a recovery in Hong Kong, and travel retail has returned to normalized growth, although we experienced a net decline in Q2 due to retailer stock adjustments that we believe will soon be resolved. Together, these factors, along with an easier comparison period due to prior severe weather conditions in the United States, lead us to believe that we are on track to accelerate our growth trend.

I have so many questions. I guess, 2 things, one was just on the acquisition math. I understand the 40 basis points drag, but was just curious if you're including transaction costs in that. And then the second thing was I know it's very early and it's just been announced, but Fabrizio, your perspective on how Macy's acquiring Bluemercury could impact your business? Are there brands that you currently distribute in Bluemercury that have less distribution in the U.S.? That sort of thing would be great.

So Lauren, on the 40 basis points, yes, it includes transaction costs. It includes the performance of the acquisitions for the time that we've owned them, and it also includes our current preliminary estimate for purchase accounting, so it includes all of those things.

And on Bluemercury, yes, I think your observation is correct. We have some brands, which are in Bluemercury, which have a lower distribution in the U.S. and they're doing very well within Bluemercury. So the plan that Macy's announced yesterday of expanding Bluemercury and to continue building their business the way they announced yesterday will be very favorable to our brands and to the distribution strategy of some of our high-end brands in the United States.

I would appreciate some clarification. On one hand, I'm hearing about optimism and growth, which is encouraging. On the other hand, I want to understand how this impacts EPS, as you've indicated a decrease of about $0.10 for the latter half of the year, following a beat of $0.08 to $0.09 this quarter. This represents a larger drop in EPS than I would have anticipated due to currency fluctuations. I would like to grasp the rationale behind this more clearly. Additionally, could you provide insights on your expectations for a rebound in Hong Kong and China more generally? During our recent visit, we noticed elements of social unrest and discussions about the Chinese consumer potentially trading down, which may indicate a more lasting trend. I would appreciate your perspective on this as well.

So on the first question in terms of our EPS guidance. We spoke about the fact that we did make a decision within the last quarter to shift some of our marketing funds into the third quarter, primarily, and some into the fourth quarter to support our second half launches, particularly for our heritage brands, given the some of the strength in those programs, so that's the piece of it. And then the other piece is from an EPS standpoint, within the range covering the dilution effect of the acquisitions. So those are the 2 pieces that are impacting that.

I want to emphasize that we are intentionally supporting our new innovation for Lauder and Clinique significantly, as one of our goals is to boost the growth of these brands. If we succeed in this, it will enhance the strength of our overall company. Regarding Hong Kong, we anticipate a return to growth, though we acknowledge it won't match the levels seen a couple of years ago due to reduced foot traffic from Chinese tourists who are now less high-end than before. Consequently, while we expect growth in Hong Kong, it will not reach prior levels. However, I don't believe the overall attitude of Chinese consumers is to downgrade; rather, high-end Chinese consumers are simply shifting their travel destinations. While Hong Kong may have seen a reduction in this tourist profile, other locations like Japan are witnessing an increase, with high-end Chinese travel in Europe rising. Chinese consumers continue to be avid travelers, significant spenders, and are passionate about beauty products, particularly high-end prestige items. The changing destinations illustrate the need for our agility in managing travel corridors effectively. You will observe the impact of this in the coming months.

So a couple of things. On the acquisitions, is the dilution limited to purchase accounting and will it last a quarter or 2? Or will it also stretch into next year? Then I have a question on China.

The purchase accounting dilution is related to three main factors. First, the one-time deal acquisition costs, which will not carry over moving forward. Second, the operating performance of the combined acquisitions, which is currently minimal. Lastly, the purchase accounting estimates for some of the acquisitions that we haven't finalized yet. You will see the complete details in our 10-Q later today, and the impact of purchase accounting will continue. However, we have strong expectations for the four brands, and Chris has expressed his excitement about their potential in the U.K. market. We anticipate that the dilution will decrease over the next few years.

Okay. And then on China, I think you said sales rose 4%, but what did same-store sales do?

You mean the same-store sales? Sorry, what is the question?

Yes, same-store sales growth in China. What did that do?

Plus 4%. So the numbers in China this second quarter were plus 15% retail growth, plus 4% same-store retail growth and plus 4% net sales.

A trend change from the first quarter.

Yes, big acceleration from the previous quarter. And as I said in my prepared remarks, there is an acceleration across all brands with a great performance of the biggest brand in prestige beauty in China, Estée Lauder, and in acceleration all our midsize brands as well at the same time.

On Asia, can you tell us what local currency sales in Asia would have been, excluding ...

We lost your first part of the sentence. Could you repeat?

Sure. I apologize for that. Regarding Asia, can you share what the local currency sales growth in Asia would have been if we excluded the impacts from Hong Kong? To provide some context related to your long-term revenue growth target of 6% to 8%, Asia has been showing a trend that, although it varies quarter-to-quarter, is actually slower than your other regions. I'm curious about your long-term confidence considering the challenges in Korea, and the weak performance in Taiwan and Singapore. Do you believe Asia can return to growth at a rate similar to the higher-performing regions, or are we facing a more sustained slowdown in Asia? Additionally, I would like to revisit your optimistic view on Clinique and Estée Lauder. While it's encouraging that these brands are gaining momentum, does this not create some margin pressure due to increased advertising costs? It would be helpful if you could discuss your confidence in meeting your margin goals with these brands accelerating.

So let me start with Asia, Wendy. And thank you for those questions. In terms of APAC, excluding Hong Kong, APAC for the second quarter would have grown low single digits.

On Asia, currently, it's clear that the region is not experiencing top growth. As you mentioned, Hong Kong is slow, China has generally slowed down even though we had a strong quarter, Korea is stable, and Japan is in a recession. Interestingly, Australia and New Zealand are among our best performers in Asia. Right now, Asia is experiencing some softness. However, I believe that our strategic focus on the future will rely on the fact that this situation will change. Asia will experience volatility—this is a downturn moment. Still, Asia represents a long-term opportunity and is a robust region for projected long-term growth due to the significant rise of the middle class and the expansion of the prestige channel in these markets. We have only tapped a small fraction of our portfolio in Asia, and there are ample distribution opportunities. Assuming stabilization in political or economic conditions, Asia remains a strong long-term opportunity. As I mentioned earlier, particularly in China, there continues to be considerable long-term potential for the company, especially as Chinese consumers travel. Also, Asians are avid travelers and spenders, and we will strive to enhance travel retail in China and Asia, which we believe will be a long-term success. Regarding Lauder and Clinique, we are talking about acceleration; however, it's important to note that both brands are currently growing slower than the average of the company. Our enthusiasm stems from the early stages of this acceleration, and we aim to invest in it to activate this crucial growth engine. Although Lauder and Clinique are not operating at full capacity now, I am pleased to see that we are achieving exciting growth ahead of others in the industry. Our goal is to elevate these two brands to full speed without negatively impacting our profit. In fact, when combined, Lauder and Clinique are profitable brands. While we aim to invest more in advertising, it's important to note that they also incur costs in other areas of their P&L. Therefore, the overall profitability of Lauder and Clinique will positively contribute to the company's profitability when these brands are growing at the appropriate levels. Thus, I feel confident in our long-term margin acceleration objectives.

I wanted to continue the discussion about margins, particularly considering the upcoming launches. How should we approach your targets after what is expected to be a year with very low margins due to SMI? Do you anticipate fiscal year '16 being an exceptionally strong year for margins? How much of that will you allow to impact earnings versus reinvesting in these initiatives?

I'll let Tracey add her thoughts, but I want to emphasize that we aim to manage this company for long-term, sustainable, and profitable growth. We are facing significant volatility and a constantly changing competitive environment. I believe our agility and flexibility in responding to these internal and external challenges are key strengths. To effectively manage these strengths, we have outlined our long-term objectives, and we will optimize based on internal and external circumstances. Our strategy involves a combination of brand mix, growth, leverage, productivity improvements, and cost savings from various initiatives, including SMI. We are also focused on growth acceleration in key regions, particularly China, and high-profit channels like travel retail and online. We believe this approach will help us achieve our long-term goals. The flexibility we are maintaining allows us to leverage our strengths to succeed in a volatile world.

I think you said it well. The only thing I would add is we spoke a quarter or two ago about the program that we have established for the next few years on cost savings, and we have quite a structure around that. The team is delivering results in multiple areas, in direct procurement, returns, and there's a focus on obsolescence. And as I mentioned in my prepared remarks, some of the benefits that you're seeing from inventory and working capital are a result of the efforts of the teams working together on really improving the supply-demand match and starting to bring, with increased service level, starting to bring inventory levels down. So more of that will be coming over the next few years and we certainly see a bigger year from an impact standpoint in fiscal '16. That is supporting, as Fabrizio mentioned, some of the investments that we're making in these other areas for long-term growth. So we are very pleased with the model we have, the combination of cost savings and investments for long-term growth.

Fabrizio, wanted to follow up on your comments regarding the performance in travel retail channel, if I may. It's been such a strong growth driver over the years. I think this quarter, you mentioned it was growing at about mid-single digits, a bit of a slowdown, but you expect it to return to more normal growth patterns going forward. I wonder what that confidence is based on. Is this based on innovation? Or are you expecting to gain share going forward?

We are gaining market share in travel retail and have continued to grow ahead of the market during the first nine months of 2014. We aim to keep increasing our market share in this sector. Key drivers for this growth include expanding our brand portfolio, ongoing development of airport opportunities, and growth in existing high-traffic airports, primarily driven by increased conversion rates. Currently, only 10% to 15% of travelers make purchases, so even a small increase in conversion presents a significant growth opportunity. The overall traffic in airports is also increasing, and the recent slowdown isn't indicative of a long-term trend but rather a specific situation related to the traveler mix. Both our growth and the industry's growth are slightly below traffic levels. The changing mix includes more American and European travelers and fewer Brazilian, Russian, and Chinese travelers. This shift affects conversion levels temporarily, impacting travel retail sales growth relative to traffic. Once the traveler mix stabilizes, I expect conversion rates to boost sales growth ahead of traffic again. We have a competitive edge since we lead the market in skincare and makeup, while we lag in fragrances. Given the growing interest in makeup and skincare among travelers, our position puts us at an advantage, supporting our long-term favorable outlook in the travel retail sector.

I have a couple of housekeeping questions and then a broader sort of question. The first is on FX impact. Is that transaction and translation? Or just translation? And then maybe, like sort of how you view your pricing versus if there's any pre-buy ahead of maybe some pricing and some mix to offset some of the currency hit? And then on the acquisition side, so the math is $40 million of sales, but it seems like based on your guidance for the EPS dilutions, it's a $33 million loss. So I'm just trying to figure out how that happened? And then the longer-term strategic question is: First, Greater China, if you included Hong Kong, Macau, travel retail and the mainland, what that would be as a percentage of sales? And then the implications. It sounds like wholesale prices in China might be going down because I guess there's some stuff going on with e-commerce where they waived the duty on products there. So do you think that shifts consumption back to mainland and maybe away from some of the other faster-growing channels like travel retail? That would be really appreciated. I'm sorry for the long-winded question.

No, that's fine, Bill. Let me start. In terms of the foreign exchange impact we discussed for both the quarter and the year, we were referring to the translation impact. However, included in our reported results is the effect of transaction foreign exchange. I mentioned that we actually experienced a benefit related to transaction foreign exchange in our cost of goods, which is linked to some favorable hedges we have in place that will help mitigate impacts over time. The reported numbers I provided were primarily translation figures. Regarding the acquisitions, there are three components to the dilution effect for this year. One part is a one-time cost associated with four acquisitions. Another part is preliminary purchase accounting, and we will adjust that in the next quarter or so. The smaller portion is related to the operating performance of the acquisitions, which should become accretive, at least the operating aspect of them, over the next year. The purchase accounting, due to the structure of the deal, is dilutive and will continue to be, but not to the same extent as this year.

Okay. When it comes to Hong Kong and China, I would exclude travel, but Hong Kong and China make up about 10% of our business. We don’t view travelers this way because we analyze travel retail through corridors. Wherever there are Chinese shoppers, there are also Korean and Japanese shoppers, making it challenging to clearly define Greater China. However, Hong Kong and China account for about 10%, and it represents an interesting opportunity in travel retail linked to Chinese consumers. We believe this area holds substantial growth potential for the long term, and we have a very strong portfolio. We are the market leader in this segment with an excellent range of brands, yet we haven't fully leveraged our strengths to reach this demographic. For instance, we have not fully engaged with new acquisitions. The changes or regulations in China are frequent and evolving, but I do not foresee them impacting travel retail or successful channels like online sales. I am confident that online channels in China will continue to expand due to shifting consumer habits and preferences, and we are prepared to capture market share in this area. Travel retail stems from the passion of Chinese consumers for traveling and purchasing during their trips. Even if price differences decrease, I still see significant growth prospects among traveling Chinese consumers.

And then I would just add, Fabrizio called out the results that we saw in the last quarter as China is accelerating in terms of performance. So I think in terms of what is going on now with e-commerce and the ports, we are not seeing an impact yet from any of that activity.

I have a couple of questions, one regarding margins and another about the top line. I was quite encouraged by your gross margin this quarter, as it seems to be the highest we’ve seen historically, at least over the past decade. However, Tracey, you tempered my enthusiasm when you mentioned the hedge gains included in that figure. Can you explain what's behind that gross margin, what's driving it, and how much of that benefit might be temporary? Additionally, concerning the top line, I appreciate the enthusiasm for your heritage brands like Estée and Clinique, but it's challenging to fully embrace that enthusiasm given the market share trends we've been observing in the U.S. and the sluggish performance that you also highlighted in the press release this morning. Could you provide more details on the U.S. market and the initiatives you have in place to rejuvenate these two key brands?

We're pleased to have you with us. Regarding the gross profit margin, approximately 20 basis points of the 50 basis points I mentioned were due to foreign exchange transaction gains. The remainder was influenced by manufacturing variances and some product mix effects. As you're aware, both category and geographic mix significantly affect our gross profit margins, along with pricing impacts. We anticipate ongoing benefits, but these will fluctuate from quarter to quarter based on our regional and channel mix. This was the specific impact for the quarter related to the transaction gain.

Okay. Regarding the acceleration of the Lauder and Clinique brands, we are just at the start of this improvement process. Our enthusiasm stems from our belief in the programs set for the next 12 to 18 months for these two brands. We are excited about witnessing early signs of progress and the upcoming initiatives, and we recognize that you may not yet be fully convinced, so we need to demonstrate this to you. Additionally, we are eager to apply the insights we've gained from positioning these two brands for success, highlighting the strengths of our heritage brands. Clinique and Lauder have been among the industry's top brands for a long time. In fact, during our U.K. presentation, we showcased the potential of these brands when supported by the right distribution initiatives. I will also ask Chris to elaborate shortly on the lessons learned in the U.K. that we plan to implement in other regions, including the U.S., which aligns with our confidence in future acceleration.

Thank you, Fabrizio. Yes. Well, first and foremost, it's really about growing the consumer base. And in that sense, we've been working very hard on sourcing for mass, and we've seen great results in that area. And also specifically targeting many of the new consumer groups, like the multi-ethnic consumer and the growing emerging consumer in that area. Also broadening the breadth of product usage of our existing customers, so getting them to buy across the brands and across the portfolio. Playing the portfolio very strongly indeed because we have in the U.K. the 4 portfolio of brands, almost the 4 portfolio. Reaching consumers in the way that they want to shop, so really building upon and developing the omnichannel experience. And finally, and very importantly, executing with excellence the terrific innovation that the brands deliver for us.

And with these conditions in place under the current innovation plan, Lauder and Clinique are experiencing mid-single digit growth in the U.K. as we speak, even prior to the acceleration programs.