Estée Lauder Companies Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 2, 2023

There are 9 speakers on the call.

Operator

Good day, everyone, and welcome to the S. A. Lager Company's Fiscal 2023 Second Quarter Conference Call. Today's call is being recorded and webcast. For opening remarks and introductions, I would like to turn the call over to the Senior Vice President of Investor Relations, Ms.

Operator

Rainey Mancini.

Speaker 1

Hello. On today's call are Fabrizio Freda, President and Chief Executive Officer and Traci Travis, Executive Vice President and Chief Financial 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. To facilitate the discussion of our underlying business, The commentary on our financial results and expectations is before restructuring and other charges and adjustments disclosed in our press release. Unless otherwise stated, all organic net sales growth also excludes the noncomparable impacts of acquisitions, divestitures, Brand closures and the impact of foreign currency translation. You can find reconciliations between GAAP and non GAAP measures in our press release and on the Investors section of our website.

Speaker 1

As a reminder, references to online sales include sales we make directly to our consumers through our brand.com and through third party platforms. It also includes estimated sales of our products through our retailers' websites. During the Q and A session, we ask that you And I'll turn the call over to Fabrizio.

Speaker 2

Thank you, Rain, And hello to everyone. It is good to be with you today. Turning to results. For the Q2 of fiscal year 2023, Organic sales fell 11%, which was within our outlook despite the incremental pressure of COVID-nineteen resurgence in China. Many developed and emerging markets globally outperformed our expectations to offset The COVID related impacts of significantly reduced retail traffic as well as limited staffing in Beauty Advisor, in Domestic China and Travel Retail in November December.

Speaker 2

Adjusted EPS fell 49%. While a steep decline, this was meaningfully better than our outlook, driven by both disciplined expense management and moderation of the stronger U. S. Dollars. Importantly, we continue to prudently invest for growth, launching sought after and increasing A and P as a percentage of sales.

Speaker 2

For fiscal year 2023, we are lowering our Outlook for organic sales growth and adjusted diluted EPS, primarily for two reasons. 1st, Inventory levels in Hainan remained somewhat more elevated than we expected due to the disruptions in travel and in store staffing levels in November December. 2nd, the recently announced potential rollback of COVID related supportive measures in Korea duty free are creating a near term transitory pressure to our business with our courier duty free retailers. In the Q3, this is more than offsetting the initial positive impact from the resumption of international travel by Chinese consumers As well as favorable trends in our Q2, including outstanding performance across many developed Markets in Western Europe and Asia Pacific, as well as many emerging markets globally and a better than expected currency environment. All told, our return to growth has shifted from the Q3 to the Q4, which Tracy will discuss in greater detail.

Speaker 2

We remain focused on investing in our brands, including for innovation, advertising, Strategic entry into new countries and expanded consumer reach to fuel our multiple engines of growth strategy. Our growth engines in the 2nd quarter were many among categories, regions and channels, and we anticipate The gradual return of more growth engines across the second half of fiscal year twenty twenty three. Beginning with categories, Fragrance its long running double digit organic sales growth streak in the 2nd quarter, rising 12%. We are inspired by the growth prospects still ahead for the luxury and artisanal segment of the category as consumer pulls a unique, distinct And long lasting sense of the highest quality. Many of today consumers seek to build an occasion based collection To express ourselves differently across seasons, time of the day or events, our portfolios As demand increases globally, we are excited about our plans to bring these brands to new markets and channels in the coming quarters.

Speaker 2

Innovation will also continue to be a key growth pillar. For example, Tom Ford Beauty outstanding launch of Nuure, Stren Parfums in the first half will be followed by the cherry collection in the second half, Building on the success of regional hero lost cherry. Makeup grew organically in the Americas as well as In the as domestic markets in EMEA and across Southeast Asia in the Q2. Our brands are indeed realizing the promise of the category Renaissance. As professional and personal user education resume and accelerate With on point innovation, alluring marketing campaigns on new platforms and best in class artistry.

Speaker 2

MAC was a standout success. The brand growth engines were many. Freestanding doors excelled, welcoming consumers with expert services delivering double digit organic sales growth globally. Across channels, blockbuster innovation, hero products and holiday merchandise proved highly sold. Clinique further fueled makeup across subcategories led by lipstick as the brand has created a hero franchise with cult favorite Almost Lipstick in Black Honey.

Speaker 2

Estee Lauder Double Wear Foundation had exceptional success With its My Shade, My Story campaign in Western Europe. Virality on TikTok drove strong new consumer acquisition and the franchise strengthened its number one ranking foundation with prestige beauty share gains. Looking ahead, we are excited For the launch of Estee Lauder Pure Color Lipstick in the second half, the brand reinvented its iconic franchise to capitalize on lipstick revival and integrate skincare benefits for lips. Designed to flatter all skin tones across matte cream And lastly finishes, the line packaging pays homage to the brand original lipstick from the 1960s. In hair care, our brands extended the category organic sales growth straight to 8 consecutive quarters.

Speaker 2

For the second half, Aveda launched last July in Mainland China will be complemented by the brand recent entry into Travel Retail in Hainan, as we continue investing for the vibrant growth opportunity of prestige hair care with the Chinese consumers. Moreover, Aveda became a certified B Corporation, joining Lelabo in our portfolio In achieving this important third party validation as the brand deepened its decades long commitment to social and environmental responsibility. Skincare organic sales fell sharply in the 2nd quarter. There were a few heads win, with the biggest challenge being COVID-nineteen in travel retail in Asia and with the Chinese consumer, given the categories exposure. Amidst the tough landscape for skincare, the ordinary was a striking success.

Speaker 2

Its organic sales growth accelerated from high single digit in the first quarter to strong double digits in the Q2. The brand's hero product excelled as did the blockbuster innovation of multi peptide lash And Browse Cereal. While The Ordinary also realized outstanding performance in the specialty multichannel, it gained momentum from its exciting launch in India in the Q4 of last year. We are focused on returning skincare to growth globally With sequentially improving trends from the Q3 to the Q4 as a transitory pressure from travel retail abate. To that end, we have an incredibly rich innovation pipeline primed to launch.

Speaker 2

Here are a few among them. Already out from MAC is its new HyperReal franchise. As the brand leverages its expertise To create an artistry approved skincare line of products, which are purposely designed to perform also with makeup. La Mer revamped moisturizing soft cream arrived this month with powerful new clinical results to reverse and receives visible signs of aging. Thereafter, Clinique will bring MonsterSuge SPS to market, Extendi is popular hero product to meet consumer desire for hydration and sun protection With a lightweight texture that has made Monster Surge 100H an icon.

Speaker 2

With these launches, we aim to reach New consumers' demographics tapped into high growth subsegment. Let me now turn to geographies. While the U. S. And domestic China were challenged in the second quarter with sales folding single digit organically in each market, We believe both will be growth engines in the second half.

Speaker 2

For the U. S, we are optimistic for a return to growth given Sequentially improving monthly trend in niche of organic sales and retail sales performance throughout the Q2. Building on this momentum, the market is equipped with numerous growth drivers, including An exceptional innovation pipeline across brands, rollout of new Clinique counters to select doors after a successful pilot of Clinique Lab in Macy's Herald Square and launch of exclusive products by many brands in specialty moods. We are also progressively modernizing numerous freestanding stores as they are primed to be an important contributor to growth following rationalization of the footprints. Moreover, our enhanced omnichannel capabilities Are also primed to contribute to growth in the U.

Speaker 2

S. As consumers who engage with our brands online and in store drive consistently higher value from upsell and cross sell. This was especially true during holidays in the second quarter. For domestic China, we are confident in a vibrant recovery for our business following the relaxing of COVID restriction, as the economy is well positioned to rebound and Chinese consumers are passionate for prestige beauty. We entered this phase with momentum, having expanded our market share of prestige beauty in China during the Q2, Driven by gains on all of skincare, makeup, fragrance and haircare, demonstrating the desirability of our brand portfolio and the excellent go to market strategies of our local team.

Speaker 2

While the 3rd quarter Is set to be more variable because of the high level of COVID cases, we now anticipate even stronger Organic sales growth as of the 4th quarter as recovery evolves. We expect online to continue its strength and anticipate a gradual return to more fulsome brick and mortar traffic by the end of the fiscal year. Online organic sales rose single digit in the 2nd quarter, fueled by many brands and led by La Mer double digit growth. We achieved excellent results for 1111 as the Estee Lauder brand realized top ranks across platforms. Moreover, our retail sales growth in online channel meaningfully outpaced the industry in the quarter for strong Beyond the U.

Speaker 2

S. And China, we realized outstanding organic sales growth in many large developed and emerging markets around the world. Our local team have been executing with excellence to deliver broad based sales gains. Western Europe, led by the U. K, prospered, while Japan and Australia contributed India, Brazil, Turkey and Malaysia are among the stars of our emerging markets, with each Posting strong double digit organic sales growth led by India rising nearly 50%.

Speaker 2

We are very encouraged with the excellent performance we are delivering in emerging markets. As these emerging markets evolve in recovery from the pandemic, We foresee compelling long term growth opportunity arising from the expanding middle class trading up into prestige beauty. We entered this important phase of recovery from a position of strength as we hold leading prestige beauty share in many of these markets. For example, in India, Mexico, South Africa, we are the number one rent company in both prestige makeup and skincare, While we lead in prestige makeup in Malaysia, Thailand and Turkey. Let me now turn to the strategic deal We announced in November to acquire Tom Ford.

Speaker 2

This transformational luxury acquisition will make Tom Ford an owned brand of Estee Lauder Companies, enabling us to manage the brand's intellectual property and equity. Staying true to our focus as a pure player in prestige beauty, We have also reached agreements with luxury companies, Zegna Group and Marcolin, to license the brand's fashion and eyewear businesses, respectively. We first partnered with Tom Ford over 15 years ago, and his singular vision of modern luxury is beyond compare. Together, we have elevated Tom Ford Beauty into the top echelon of high growth luxury beauty. Impressively, Telfort Beauty is expected to achieve $1,000,000,000 in net sales annually over the next couple of years, And we are promising profitable growth opportunities ahead.

Speaker 2

Before I close, I want to recognize the start of Black History Month in the U. S. And thank our employees to have created an engaging calendar of events In closing, while we are lowering our fiscal year 2023 outlook to reflect the additional transitory pressures Affecting our travel retail business, we are encouraged by both the strong underlying trends in many other areas of our business and improving macro trends. Inflation has stabilized in many markets globally. The strength of the U.

Speaker 2

S. Dollar has moderated and the return to mobility of the Chinese consumer, both domestically and international travel Is happening earlier than expected. Moreover, in the first half of fiscal year twenty twenty three, We made exciting progress on several strategic initiatives to drive growth and resiliency In our business, we significantly strengthened our capabilities in innovation, manufacturing and distribution, having opened The China Innovation Labs, our first plant in Asia Pacific, our new DC in China, while we also announced Our brand portfolio with Tom Ford and Balmain Beauty. All told, we have great confidence That we will emerge from this volatile transitional year even better positioned to realize the long term growth opportunity of Global Prestige Beauty. To our employees, our future is bright because of your creativity, Passion and wisdom, I extend my deepest gratitude for your significant contribution to our long term success.

Speaker 2

And now, I turn the call over to Tracy.

Speaker 3

Thank you, Fabrizio, and hello, everyone. As Fabrizio mentioned, our business in the Q2 continued to be pressured by the external headwinds of COVID related impacts, including the rising number of COVID cases in China, lower shipments of replenishment orders in the U. S. And the stronger U. S.

Speaker 3

Dollar. Our 2nd quarter organic net sales declined 11% and earnings per share decreased 49% to 1.54 Tighter expense management and a slightly improved currency impact contributed to our better than expected EPS results. From a geographic standpoint, organic net sales in the Americas declined 3%. We saw healthy demand for our holiday offerings as consumers gravitated to our in store and online promotions. However, we also experienced lower shipments of replenishment orders due to both retailer inventory tightening as we anticipated and a later improvement in retail trends post Christmas.

Speaker 3

In Latin America, organic net sales rose double digits, reflecting continued growth in nearly all markets, the evolution of recovery in makeup as consumers return to stores and the strength of our fragrance portfolio. Organic net sales in our Europe, the Middle East Africa region declined 17%, including the negative impact from foreign currency transactions in key international travel retail locations of 3%. The decline was driven by Travel Retail as expected, while growth from nearly every market in the rest of the region was strong. Our global travel retail sales were significantly pressured by the ongoing COVID related impacts. Despite Stores being opened throughout the quarter, travel to Hainan remained largely curtailed and as a result shipments of replenishment inventory remained low.

Speaker 3

Elsewhere, we experienced strong sales growth in Travel Retail, reflecting increased international tourism as travel restrictions in many countries lifted from the prior year. The ongoing pressures in Asia Travel Retail more than offset the growth we experienced in the rest of the EMEA region, including both developed and emerging markets such as the United Kingdom, France, India and Turkey. We continue to see various stages of recovery across the region that coupled with the strong resumption of tourism fueled brick and mortar growth during the quarter. Organic net sales in our Asia Pacific region fell 7%, primarily due to the ongoing COVID related impacts in Greater China. This affected brick and mortar sales in Greater China and Doctor.

Speaker 3

Jart Travel Retail in Korea. Online sales continued to grow in Mainland China due in part to the expansion of our online presence with the recent launches on JD and Doian as well as solid performance during the 11/11 Shopping Festival. Most of the other markets in the region continued to progress in recovery as the return of brick and mortar traffic led to high single digit Or double digit growth in Japan, Australia, Malaysia and the Philippines. From a category standpoint, Fragrance continued to lead growth with organic net sales rising 12%. Strong holiday demand for our beautiful line of fragrances from Estee Lauder And double digit growth from both Lalabeau and Tom Ford Beauty propelled the category's growth in every region during the quarter.

Speaker 3

Organic net sales in hair care rose 4% and declined 3% in makeup, the latter driven primarily by the COVID restrictions in China, A solid performance from both MAC and Clinique drove growth in both the Americas and in domestic markets in EMEA. Organic net sales and skincare declined 20%. This category continues to be the most affected by the COVID restrictions in China, particularly in Asia Travel Retail and Mainland China, where skin care accounts for a large majority of our business. Our gross margin declined 4.30 basis points compared to last year. The positive impacts from strategic pricing in this Quarter were more than offset by inflationary pressures in our supply chain, region and category mix and higher costs due to promotional items.

Speaker 3

Operating expenses increased 500 basis points as a percent of sales, driven primarily by the reduction in sales. This also reflects our investments in areas such as advertising, promotional activities and innovation, which increased 150 basis points compared to last year. Operating income declined 46 percent to $768,000,000 and our operating margin contracted 9 30 basis points to 16.6% in the quarter. During the quarter, we recorded $207,000,000 of impairment charges related to the 3 brands, primarily Diluted EPS of $1.54 decreased 49% compared to last year. The impact from foreign currency And foreign currency transactions in key travel retail locations negatively impacted diluted EPS by 5% and 4%, respectively.

Speaker 3

During the quarter, we generated $751,000,000 in net cash flows from operating activities compared to $1,800,000,000 last year. The decline from last year reflects lower net income and the negative impact from changes in working capital, primarily due to the timing of payments. We invested $419,000,000 in capital expenditures and we returned $708,000,000 in cash to stockholders through both dividends and share As we expected, our first half performance was pressured by ongoing external headwinds. Let me now turn to our outlook for the remainder of fiscal 2023. For the second half of fiscal twenty twenty three, we are encouraged by the easing

Speaker 4

of COVID restrictions in China and the

Speaker 3

expected return of in China and the expected return of travelers throughout Asia and around the world once more stabilization occurs With outbound flights and visas as well as COVID entry and testing requirements. In Hainan, We are starting to see increased positive signs already as traffic level declines have moderated in recent months. However, Retailer inventory levels are still somewhat elevated, reflecting the impact of the lengthy store closures as well as the rapid reduction in traffic and in store And in Korea Travel Retail, an incremental headwind has emerged since the last outlook we provided in November. The recently announced potential rollback of COVID related supportive measures in Korea duty free is creating a near term transitory pressure to our business with our Korean duty free retailers, which is pressuring our Q3 outlook. We now also expect more moderate net sales growth near term in our China business as the rise of COVID cases in November December Slowed expected brick and mortar retail traffic and social usage occasions, which continued in January during the pre Lunar New Year shopping timeframe.

Speaker 3

Collectively, we expect these impacts to create greater headwinds in the Q3 than we originally anticipated. As a result, we are updating our outlook to reflect a shift in the start of the travel retail recovery in Asia from the third to the Q4 of fiscal 2023 due to the normalization of inventory levels in Hainan, the uncertain pace of recovery of travel retail traffic in Korea and a more moderate acceleration of growth in China. The momentum from our other developed and emerging markets in EMEA and Asia Pacific in the first half is expected to continue as those markets progressively Evolve and Recovery. We are also cautiously optimistic and expect our North America net sales performance to improve as our retail growth trend in the region has already increased, particularly in January. And we have a supportive innovation pipeline planned for the second half, as Fabrizio Theo mentioned.

Speaker 3

As it relates to our operating income, while these external headwinds have introduced a high level of volatility That has had a meaningful impact on our financial results this fiscal year, we remain confident in the ongoing strength of Prestige Beauty, Our business strategy and our ability to reaccelerate long term profitable growth. We therefore These investments also support the continued strengthening of our multiple engines of growth as we invest in emerging markets And faster growth channels that are already progressing well in their recovery. As a result, we expect to see pressure on our operating income in the 3rd quarter, with The negative impacts from foreign currency that we anticipated in our previous guidance have improved due to the recent weakening of the U. S. Dollar.

Speaker 3

However, currency is still expected to be a meaningful drag to our reported sales and diluted EPS growth for the Q3 and full year. Our outlook is now based on December 30 spot rates of 1.067 for the euro, 1.207 for the pound, 6.964 for the Chinese won and 12.63 for the Korean won. So with that backdrop, our guidance is as follows. We expect organic sales for our Q3 to decline 10% to 8%, primarily reflecting the pressures to our Travel Retail business that I mentioned previously. Currency translation is expected to be dilutive to reported net sales by And the impact of certain foreign currency transactions in key international travel locations is not expected to be material.

Speaker 3

The impact of sales from certain Designer Fragrance license exits are expected to dilute reported growth by approximately 1 point. We expect Q3 adjusted EPS of $0.37 to $0.47 for a decline between 81% to 75%. Currency translation is expected to be dilutive to EPS by $0.04 such that constant currency adjusted EPS is expected to decline between 79% to 73%. This includes the negative impact from certain foreign currency transactions in key international travel retail locations of approximately 1 percentage point. Of approximately 1 percentage point.

Speaker 3

For the full year, assuming a reacceleration of Travel Retail in the 4th quarter, We expect organic sales to range between down 2% to flat. Currency translation is expected to dilute Reported sales growth for the full fiscal year by 4 percentage points and we expect an additional one point of dilution from the impact of certain foreign currency transactions in key international travel retail locations. The impact of sales from certain designer license exits are expected to dilute reported growth by approximately one point. We expect full year operating margin to be approximately 15.1%, A 460 basis point contraction from the prior year period, primarily due to the geographical and category mix to be approximately 25.5 percent, reflecting in part the change in our estimated geographical mix of earnings. Diluted EPS is expected to range between $4.87 $502 before restructuring and other charges.

Speaker 3

This includes approximately $0.29 of dilution from currency translation. In constant currency, We expect EPS to fall between 29% 27%, which includes a negative impact from foreign currency transaction Regarding the Tom Ford brand acquisition, we expect to complete this transaction in the Q4 and to fund it through a combination of cash, debt and deferred payments. In anticipation of closing this transaction, in January, we increased our commercial paper program by $2,000,000,000 We also estimate a slight EPS dilution to the full year outlook that I just provided due to the final purchase accounting inclusive of transaction costs. While this year has undoubtedly been a perfect storm of unforeseen macro pressures on our business And the transition to accelerated recovery has indeed been longer than we anticipated. We have navigated through the challenging environment and strengthened the company in the process.

Speaker 3

Thanks to our amazing employees, our company values and our multiple engines of growth strategy. We are encouraged by the many signs of improvement in the overall environment and the progress our incredible teams have made in preparing us for a strong recovery. Our fundamentals are solid and intact, reinforced by the actions we have taken over the past few years. From the acquisition of the majority interest in DECIEM in fiscal 2021 to the recent announcement of our agreement to acquire the Tom Ford brand and the Balmain license agreement, We are expanding our brand portfolio at both the entry and luxury levels of prestige beauty. We've taken strategic to enhance our go to market capabilities, supply chain agility and local relevance through our new innovation, production and distribution facilities in Asia.

Speaker 3

We've enhanced our digital marketing capabilities and continued to progress on our ESG initiatives. These actions and many more demonstrate that we remain confident in the long term sustainable profitable growth of our business. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Operator

The floor is now open for questions. On telephone. To ensure everyone can ask their questions, we will limit each person to one question. Time permitting, we will return to you for Our first question today comes from Lauren Lieberman with Barclays. Please go ahead.

Speaker 5

Great. Thanks. Good morning. I was hoping and This is Ty, more for you, Tracy. If you could walk through with us how your I guess the length of the supply chain works For supplying both Hainan and Mainland China currently, knowing it's shifting.

Speaker 5

Because as we think through The change forecast in demand and think knowing what I believe is a pretty lengthy supply chain, how you're managing production versus Shipments and if that's sort of informing why there's so much visibility seemingly on 4Q? And I guess we should see inventory spike up on your balance sheet in 3Q, That's right.

Speaker 3

Yes, you're correct, Lauren, that we do expect that we will Two things. 1, inventory levels are still coming down in Hainan. They are almost at the level that we would expect Sales to accelerate. So yes, you should start to see an inventory build related to the shipments that we expect To see in Q4. In Korea, again, the pace is a little bit more uncertain given The transitory nature of what's going on right now.

Speaker 3

So we do anticipate, as I mentioned in the prepared remarks, That we will start to see resumption of travel in Korea. And depending on the pace of that resumption, that will Depend on the amount of shipments that we have in the quarter, but we have taken obviously an assumption there. We are sitting on a decent amount of inventory even in our own warehouses to supply the sales that we expect

Operator

The next question is from Dara Mohsenian of Morgan Stanley. Please go ahead.

Speaker 6

Hey, guys. Good morning.

Speaker 2

Good morning, Nick.

Speaker 6

Just sort of extend that question a little bit, right? We have a lot of quarterly volatility in terms of Q3 versus Q4. Q2, there's A difference in shipments versus underlying retail sales, obviously COVID impacts in China. So it's hard to get a great underlying Sense of retail sales here and how the business is doing. So for retail, maybe you can just give us a little bit of an update On retail sales by region, I'm particularly interested in category growth and any macro impacts in the U.

Speaker 6

S. And Europe. And then how you're thinking about Asia Pac and China versus the rest of the region, less so On near term results here, but more how results came into the quarter versus what you originally expected and that might inform The revenue trajectory as you look out over the next couple of years and how you think about it. I think you touched on a lot of aspects of that, but it'd be helpful to get a general overview.

Speaker 2

Yes. No, absolutely with pleasure. Let me start with China, First of all, and so China, the results in the quarter We're pretty good. We built significant market share. So the overall market in China It was negative double digit.

Speaker 2

Our net sales were and our retail was negative Single digits, and we build market share in every single category. So in moisturizers, we build market shares In makeup, in fragrance, in hair care, in every aspect. Now this for us is a very important sign That the our brands are really working. The aspirational value of our brands remains very, very strong, Which in the moment of reopening is a very strong position to be. So excellent performance relatively to market.

Speaker 2

Some of our brands were shining. La Mer in skincare was the brand that was gaining The best market share, Tom Ford Beauty in makeup and Jo Malone London in fragrance was really leading the share gain. The other important reading of China is that during 2011, our net sales were up 10.9%. Now our retail sales were up 11.9% and holding the number one ranking across various categories. And there was a lot of great success on the brand creative activity, on live Streaming on innovation.

Speaker 2

And so the way when the consumers are back In this very difficult volatile period, like a situation like 11.11, where there is obviously high traffic, our brands respond enormously. And Obviously, when the consumers are not back or don't travel or are sick at home is when, obviously, we have seen some issues. So in total, China is developing the way we planned and from a market share standpoint, recovering also and is definitely going in the right direction. In term of the future, the potential of China, We continue to see now the opening to create again traffic in Mainland. In brick and mortar, we see the continuation of the online success and we see the obviously, the reopening of Hainan, So the Chinese consumer on all fronts.

Speaker 2

Also, we see the fact that the Chinese consumer is starting to travel internationally, And this will gradually increase as the governments will agree visas and models of growth in this moment that are Parts of the world, we are already opened. Others, we will open soon. Japan, we has been in agreement, but is not yet open, will be in soon. Korea is the one where the agreement is not yet finalized, but we are optimistic That in the future, this also will be resolved. So that's another very important trend.

Speaker 2

This will have a positive impact, obviously, in our retail channel, But also in the countries of destination, like it's always been historically happened. In term of Categories in China, obviously, the most important thing that will happen as the China accelerate on all fronts Will be that skincare will accelerate for us. And so the acceleration of Travel Retail Asia, the acceleration of China, The acceleration of international travel of Chinese, which we have in front of us, in part in quarter 4, but in part in fiscal year 2020 This will generate a substantial improvement of our skincare trends that in turn We'll have a positive impact on our margin mix. So that's obviously an important element of the program. Then other regions Of the world, as I commented in my prepared remarks, has been very strong in Europe, Where we build market share in most of the European markets, very strong in the rest of Asia, particularly Strong gains in Japan and Australia, as I commented already.

Speaker 2

And in Korea, excluding the travel retail inputs That are particularly heavy on our Doctor. Jard brand, which has a big percentage in travel retail. Excluding that also Korea started Progressing very well. So good progress in all the other regions. Then North America.

Speaker 2

Now North America, Obviously, we also continue to lose share in the quarter. And overall, we would like to Accelerate our plan of share recovery, but the good news is there's been very strong progress in quarter 2. Every single month, October, November and then December, there was progress in top line sales acceleration. First of all, In retail, the quarter in the U. S.

Speaker 2

Ended at plus 2%, so on the positive. But December was plus 6.5%, 7 So in line with our goals of acceleration. So we see the U. S. Progressing.

Speaker 2

Now the next 6 months, There is an even stronger plan. In the U. S, we have strong acceleration of innovation. I mentioned already some In the prepared remarks, like Estee Lauder Pure Chloralistic, Morso Surgeon Clinique, Hyper Real or MAC, Soft Cream on La Mer, Cherry collection of Tom Ford. So and then we have some important distribution improvement.

Speaker 2

We are deploying more The ordinary is entering some doors on Nordstrom's. We are deploying in Ulta and in Sephora new doors, incremental new doors and incremental expansion of our key brands in these doors. And we are renovating 100 freestanding stores, opening 8 new freestanding stores And continuing to improve our omni channel capabilities on all fronts. So We see an acceleration of our progress also in the U. S.

Speaker 2

So in summary, When I should add what Tracy also underlined that at the same time, we have improved our capability behind this program. Our digital marketing is Our supply chain is shortened and faster. Obviously, we have done progress in our factory in Japan. Our R and D has opened our R and D center in China that will increase the amount of local relevant innovations in Asia In an important way in the next fiscal year starting this fiscal year in a significant way. And we have opened a new distribution, 1 that serves Travel Retail in Switzerland and one that serves obviously China, within China as we discussed also in the last call.

Speaker 2

So there are all these investments and progresses in capability that make us ready for the reacceleration in the future. And so this fiscal year, in summary, has been a year where really we suffered About the COVID lockdowns, particularly in Asia, and then the high level of infections during the reopening And the impact of the strength of the U. S. Dollar that was particularly big In our high profit, high important channels like Travel Retail, like China Travel Retail Asia, Because on Korea and China, the dollar was particularly impactful. So it was really a perfect storm kind of situation.

Speaker 2

But all the rest, apart from these three areas, Really progressed and in some cases very successful in market share gaining. So that's my overview. I hope the answer to your Dara having an overview of the situation, but I would say is very, very encouraging for the recovery period.

Operator

The next question is from Peter Grom of UBS. Please go ahead.

Speaker 4

Thanks, operator, and good morning, I hope you're doing well. So Tracy, I wanted to ask about the implied outlook for organic revenue growth in the 4th quarter, which is quite strong And better than expected. And I know we're still a few months away from fiscal 'twenty four here, but is the implied exit rate in the 4Q guidance a Fair way to kind of think about the potential top line recovery looking out to next year? Or are there kind of these timing related impacts given what you're forecasting in 3Q That could be driving them a stronger growth. Thanks.

Speaker 3

Thanks, Peter. So look, we are expecting a Stronger Q4 than probably you anticipated and us as well, given a few months back. And part of that, as we said in our prepared remarks, is because of the shift of recovery expectation, certainly in terms of some of Travel Retail. I would just remind you that I and I know you're well aware of this that we are also anniversarying last year's some pretty significant shut So this volatility that we're speaking about actually started at the end of our fiscal 2022 in Q4 And we're coming up on the anniversary of that. So the numbers look particularly large from a growth standpoint, Because we are anniversarying some lockdowns in China and in travel retail in Hainan in particular, Which was the start of some of the problems that we have anticipated on this call today.

Speaker 3

I think we are anticipating for fiscal 2024 and we're not giving fiscal 2024 guidance right now. But given that In the Q4, all markets are anticipated to be open and remain open, And traveling will gradually resume. And again, uncertain about the pace of that resumption, but we've Certainly seeing encouraging signs in many of our markets that fiscal 2024 will be a strong year for us. So I wouldn't take The Q4 implied growth and apply it to fiscal 'twenty four, Peter, if that's what you're getting at. But certainly, we There will still be volatility in fiscal 2024, but Tilly related to the pandemic and some of the things that we've experienced this year should be much More moderate than certainly what we've experienced this year.

Speaker 3

And if you have any predictions on currency, certainly do let me know.

Operator

The next question is from Michael Binetti of Credit Suisse. Please go ahead.

Speaker 7

Hey, thanks for taking our question here. Tracy, maybe I could just dovetail on that a little bit. You told us a few quarters back that 20% margin was a North Star. As you think out to next year and many of the moving parts of your business finally start to come back online, is that Is there any I don't know there may be some pull forward revenue that leaks into the first half of the year. I don't know.

Speaker 7

Obviously, you gave us the Q4 here. But you look out to next year's, is 20% an appropriate North Star for next year given the revenue drivers back online? And then I guess, Fabrizio, can you help us size the travel business a little better since it's such a big swing factor in the model here going forward? I think it was about 15% of sales pre COVID, Half of it China, you spoke a little bit about the shape of it at a conference in December that the pre COVID the Chinese business the Chinese traveler was largely Tier 1 international traveler, I think you said Hainan has only has completely replaced that, but it's a different customer, maybe lower tier customer. Just because this moves the model around so much, can you help us just think about how big that business is today in the non China markets, Hainan, Nan, Heinen, China to help us think about the model?

Speaker 2

So,

Speaker 3

let me just and Fabrizio will pick up On your questions on travel retail, but travel retail actually was larger. You're remembering, Michael, our online business was 15% pre pandemic. Travel Retail was more like 26% pre pandemic. But in terms of the operating margin for fiscal 2024, as you can imagine with some of the More recent events, we are still going through what our expectations are for fiscal 'twenty four and we'll certainly provide guidance As we normally do in the August timeframe, I think 20% is a little ambitious right now for fiscal 2024 based on what we're seeing, but some of that has To do with how currency moves, which was my previous comment in terms of if you have projections on currency, let me know. But certainly in terms of the business fundamentals, the growth, we would expect obviously more margin That is in our normal algorithm for fiscal 2024 because of the recovery of volume.

Speaker 3

And obviously, when you're down in volume as we are this year, as much as we protect The strategic investments, but also make choice for discretionary investments as well. Volume solves a lot of sins. And So we would expect more leverage on our expense base next year certainly than we're able to get this year practically because of the volume trends and as well as the shocks in terms of when those hits have occurred And how fast we can react to them. So again, we are expecting a certainly Progressive fiscal 2024 and with all of the things that we spoke about in the prepared remarks as it relates So the investments that we made that will come online, we'll have a new factory operational in Asia that will make our time to market shorter. We'll have the new innovation center, which will start to contribute to the development of product for us in the future, etcetera.

Speaker 3

So all of those things that we said in the prepared remarks should also support the acceleration of growth in fiscal 2024. Now for your travel for more on your travel retail question, I'll turn it to Fabrizio.

Speaker 2

Yes. Thank you, Tracy. And also, I want to add on the margin thing is what The first step of normalization of our margin that Tracey is describing, on top of volume is also will depend on which volume, Because obviously, if you assume that the normalization of business would be in travel retail in China, then you are assuming that the normalization would be in Skincare, they tend to be higher margins. So there will be a moment of recovery and normalization. And then from there, We will restart our normal algorithm.

Speaker 2

And obviously, we will see how the normalization trends evolve And how long they will take, but that will be the way we will maneuver back. In terms of the Travel retail question has Tracy clarified 26% before and then even more during COVID. But the You are asking about the what are the key dynamics in Travel Retail. So the dynamics in Travel Retail will be, 1st of all, Hainan is now established. Yes, I said that when the international travel of the Chinese consumers will restart, Hainan will not be cannibalized in a big way.

Speaker 2

Hainan is now a well established vacation place for Chinese for internal travel. Yes, there are different target groups. The high end travel is obviously more affordable, easy, doesn't require a visa, doesn't require a passport, by the way. Keep in mind that at least before COVID, I do not have the last information now that everything is changing on the Visa model. Before COVID, it is less than 20% of Chinese had a passport.

Speaker 2

And so there is anyway 80% of Chinese that will go to Hainan and will not travel internationally in this So Hainan will continue and will continue to develop. The addition will be the international travel, which is coming back In an important way. And then obviously, the Korea and rest of Asia, so Korea has always been a very big business. But as you know, Hong Kong, Macau, Japan, we are all very important Travel Retail businesses The now will improve. And so there will be different levers of growth, obviously, in all of this.

Speaker 2

Now in term of Categories. The because of the prevalence of Chinese consumer and Asia travelers in general As a percentage of the total global travel retail, skincare is a very important category. So the travel retail Acceleration in the future will carry, as I was saying before, skincare. And so this will be a double positive impact on marginality and Profitability is that combination is powerful. And then by category, we see in Travel Retail a strong acceleration of the Fragrance category, particularly the high end fragrance category, which is again profitable and very interest In category for the consumers in this moment, we observe many travel retail partners around the world making more space For the high end fragrance development in the future of Travel Retail.

Speaker 2

So that's another Important, important positive. And then the last point I want to make is keep in mind that the travel retail is driven by increased traffic And by increased conversion, the numbers that were available before COVID in a normalized way in 2019 were depending which part of the world, The travelers to buyers commercial was between 10% 15%. We know also that when there is retail like in China and Korea, so where people can buy online before they go to the airport, this conversion number increased substantially. And there is a lot of retail business that has developed very well in Asia, particularly linked to Hainan. And so the amount of conversion of these travelers is increasing.

Speaker 2

And last thing I want to say is that The comeback of Chinese consumers in international travel is very good news, because the Chinese consumer, when they travel, used to have much More purchase per person than the average travelers from different regions. So the increasing mix of Chinese travelers It's very good news for Global Travel Retail as well. So in the post COVID world, When will be really post COVID? I think we are going to see some years of exciting opportunity globally in the travel retail development.

Operator

We have time for one more question. It is from Mark Astrachan of Stifel. Please go ahead.

Speaker 8

Yes, thanks and good morning everyone. I wanted to ask about the sustainability of Growth in some of these categories, which benefited from reopening, like fragrances, makeup and expectations for Skin Care Improvement, it sounds like you're obviously talking to improving skin care trends globally, obviously, China as well. And then I wanted to ask the same Question around China. So should we expect a similar reopening trajectory? Or are you expecting a similar reopening trajectory In China that we've seen around the rest of the world in terms of growth and in terms of the categories which benefit?

Speaker 8

Thank you.

Speaker 2

So the reopening of China is in China today, the level of sales online It's the biggest percentage of the world. So to be clear, the reopening on China will mainly impact The reopening of brick and mortar. So we'll impact 50% Of the business in China about will be very positively impacted by the reopening. Obviously, during the period like The one we just leave doesn't mean it since mid November to mid January, where the level of infections in China, so COVID were super high, 80% of families had somebody with the virus, etcetera. So the implications were normal.

Speaker 2

In this Period. You see also a reduced consumption, everything, reduced consumption online, reduced interest, for sure, in makeup In other categories. So but that's temporary, obviously. So your question is more what happened when all this is regular. The only thing I want to clarify, there has to be regular, not Only the ability to purchase in stores, but also frankly to be free of COVID, really free of COVID when consumption come back.

Speaker 2

So when People will be free of COVID as a disease. When they will go back to the brick and mortar, we will see at least Half of the business in China increasing dramatically its own traffic. And we will see a continuous acceleration, a gradual continuous of the online, which is already very strong. There are many new platforms online that have been opened in China as we speak, which are Promising, which are doing success. In our case, our success on JD or Douyin has been very, very strong.

Speaker 2

It's One of the reasons behind the market share growth and the success of the amazing Tmall events, particularly 11.11 of June 16 June 2018, it's been extraordinary. So there are a lot of good potential levels of growth that will be activated by the Cameco Then you are asking about the categories that will be at TKS. First of all, skincare will be the biggest beneficial for the simple reason that Skincare is the biggest percentage of beauty business in China. To be clear, that's not the case in Europe or in U. S, Where there are other categories which are bigger percentage of the total business.

Speaker 2

So it is a unique profile of the Chinese consumer where Skincare will be the biggest benefit benefiting the biggest from the normalization of the consumption patterns End of departures, partners of the consumer. 2nd, fragrance is on a roll in China. Fragrance was already growing before COVID. It's been growing during the period where Chinese had lower COVID levels than the rest of the world and will continue to grow with the reopening because there is a Clear passionate development of this category. In China, the fragrance category is developing bigger percentage at the high end where we are focused.

Speaker 2

So the high end fragrance is actually a much bigger percentage of the total market than in the rest of the world, which is great news for the development of this category. Make up with also make up is the category which is most Affected by COVID situation. So now is the most affected. By the way, it's been the most affected everywhere in the world by the COVID situation, not only in China. And so the resurgence of makeup that we are seeing in this moment in U.

Speaker 2

S, in Europe and some of our brands, particularly M. A. C. Benefiting from this very well, will happen also in China when COVID will normalize. And last, We have launched Aveda in China for a reason that we have seen the clear signs of development of Sure.

Speaker 2

Hair Care. Obviously, hair care is a category super well developed among the Chinese consumers, but it's mainly developed in mass. It's the beginning of the journey of the development of a luxury hair care, sustainable hair care And so that's really also exciting and is in front of us for the future development.

Speaker 3

And in terms of fragrance, we continue to expand our fragrance portfolio. We're certainly seeing a pickup and A pickup in travel retail as it relates to fragrance, and fragrance is still a growing category in Asia. So certainly, During the recovery, we expect that fragrance trends will continue to grow, particularly in the markets that are reopening now.

Operator

That concludes today's question and answer session. If you were unable to join for the entire call, A playback will be available at 1 pm Eastern Time today through February 16. To hear a recording of the call, please That concludes today's Estee Lauder conference call. I would like to now thank you for your participation and wish you all a good day.

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Earnings Conference Call
Estée Lauder Companies Q2 2023
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