Estee Lauder Companies, Inc. (The)

Good day, everyone, and welcome to the Estee Lauder Company's Fiscal 2020 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 Senior Vice President of Investor Relations, Ms. Rainey Mancini.

Good morning. On today's call are Fabrizio Freda, President and Chief Executive Officer, and Tracy Travis, Executive Vice President and Chief Financial Officer. Since many of our remarks today contain forward-looking statements, let me refer you to our press release and other reports filed with the SEC where you'll find factors that could cause actual results to differ materially from those 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. All net sales growth numbers are in constant currency. You can find reconciliations between GAAP and non-GAAP figures in our press release and on the investor section of our website. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Thank you, Rainey. Good morning to everyone. We deliver exceptional results in the second quarter, which I will elaborate on shortly. But first, I want to acknowledge how concerned we are for all the people, including our employees and consumers, who are affected by the recent outbreak of the coronavirus in China and around the world. Our hearts go out to them, and I will discuss what steps our company is taking to support them in a few minutes. In the second quarter, our Prestige Beauty portfolio resonated with consumers globally. Our successful strategy, based on multiple engines of growth, once again helped fuel our performance, as we grew in all regions and all major categories. Skincare rose in every region, as did fragrance and hair care, while makeup grew internationally. The company generated 16% constant currency sales growth, the highest organic growth rate in 20 years. in the seasonally largest quarter of our fiscal year, allowing us to gain significant share in global prestige beauty. While our second quarter continues to be boosted by holiday, it now also includes another important event driver, single day. Our advanced planning for these events delivered strong growth across our business, led by Asia-Pacific region the global online and travel retail channels, and the skincare and fragrance categories, powered by the extraordinary performance of Estée Lauder, La Mer, and our luxury and artisanal fragrance brands. With disciplined expense management, we leverage our sales growth into a 21% increase in adjusted and used earnings per share. Our strong performance reflected smart and deliberate investments in the best opportunities worldwide, including focused product innovations, increased advertising, enhanced digital marketing, better use of data analytics, and greater local relevance. We attracted a broader group of consumers and continued to build strong repeat rates for our products, driving greater loyalty. During the quarter, we completed the acquisition of the Korean-based Heaven Bee Company after having taken a minority stake four years ago. Its Dr. Jart skincare brand has grown rapidly with cutting-edge innovation and excellent speed-to-market capabilities. We are optimistic about our first acquisition in Asia. and we see many opportunities to further cultivate the brand globally as consumer interest in skincare continues to expand. Our momentum continued in the first three weeks of January. But as you all know, the global environment has changed meaningfully following the outbreak of the coronavirus. Our thoughts are with individuals who have been diagnosed and those who mourn family and friends. The Chinese government has responded in a very serious manner, along with many other countries and organizations, and they are working tirelessly to address and contain the outbreak and help those afflicted. As a company, we are focused on the well-being of our employees in China and globally and are taking appropriate measures to protect them based on guidance from local authorities and the World Health Organization. Our consumer and business partners in China and elsewhere are also top of mind, and we are actively engaged in ways to support them. We are pledging 5 million RMBs to support coronavirus relief efforts for needs across China, and we are matching donations of U.S.-based employees to assist with the outbreak. We are working on various support initiatives to support people and their recovery. Over the past 10 years, in my role as CEO, I've made numerous trips to many regions of China. I met with our local employees, talked to consumers of all ages, and conferred with our business partners. I've traveled all over to learn more about this beautiful country and its wonderful people. My heart goes out to the citizens of China during this difficult time, and I look forward to my next trip there, hopefully in the near future. Although it is difficult to anticipate the full impact of the coronavirus on our business, we expect the next couple of months will be very challenging. Chinese consumers in many big cities are staying home and retailers are closing stores or limiting hours in an effort to help contain the spread of the virus. Additionally, global travel is being restricted. and the asset is being sold beyond China into major travel retail corridors and large tourist cities. Given what we know now and our experience with past epidemics, we believe our business will gradually recover toward the end of the fiscal year. We stand ready to invest to facilitate the recovery as soon as the market supports it. leveraging the flexibility of our resource allocation and our multiple growth drivers. We remain committed to China and to the Chinese consumers for the long term and plan to increase our R&D investment in the market in order to drive bold, breakthrough, prestige-built innovation for China, the Asia-Pacific region, and the rest of the world. Reflecting China leadership in science, we will expand upon our existing in-market capability and build a new state-of-the-art innovation center complete with the latest technologies and tools. This facility will also highlight our passion and commitment to quality, sustainability, and employee wellness. Our enhanced capability and capacity will ensure we meet the needs of Chinese and Asian consumers with local relevancy and local trends. as well as with creativity, agility, and speed. This investment aims to sustain the long-term development of our company in China and around the world. We will continue working to advance this new development and look forward to sharing more details in the future. Turning back to the second quarter results, the Estelode brand was again a star in our portfolio. The brand grew strong double digits globally in both skincare and makeup and rose in every region, powered by its many hero franchises, including Advanced Night Repair, as well as Renutri, Revitalizing Supreme, Micro Essence, and Double Wear. This is a beautiful example of our multiple engines not only winning across many brands, but also within a big brand. Renault Trip, Estée Lauder luxury skincare line, delivered superb results supported by targeted marketing with a luxury consumer, enhanced merchandising, and desirable innovation. Looking now at our geographic results, sales advanced in every region with strengths across categories. In Asia Pacific, virtually every market grew, led by China, which accelerated, generating strong double-digit growth as all our brands, categories, and channels advanced. We had terrific growth from smaller cities in China, which are becoming a greater part of our business and a promising long-term growth driver. We expanded into two new cities, bringing our total to 123. Our online business in China more than doubled, elevated by well-integrated online and offline campaigns for a single day. The Estée Lauder brand was among Tmall's best performers for the event, while MAC, La Mer, and Jo Malone London each excelled in their respective categories. Our brand expansion strategy on Tmall was a distinct advantage. As an example, Following Tom Ford Beauty launch on Tmall in 2019, the brand executed its first single day to tremendous success in both fragrance and makeup. Its performance was twice that of its Tmall launch day, which was our biggest launch ever on the platform. Chinese consumer interest in prestige fragrance category is rising, and we are nicely positioned with our wide portfolio of luxury fragrances Domalon London and Top4Beauty excelled in the quarter, helping to further diversify our business in China. We plan to launch additional luxury flyers there later this year. We deliver strong growth in our other emerging markets outside of China, led by terrific results in Russia, India, Thailand and Brazil. In the quarter, we continue to invest for growth and attract new consumers. For example, Brazil is the fourth largest market globally for hair care, and we launched Aveda, our 10th brand there. We are showcasing the brand's historical commitment to sustainability, the environment, and botanically-based products with a salon in Sao Paulo that includes sustainable elements. Across Europe, the Middle East, and Africa, Estée Lauder, MAC, Clinique, and La Mer, our four biggest brands, prospered. demonstrating the appeal of established brands that have broad exposure to multiple subcategories and compelling innovation. Every category advanced in the region. Our skincare brand led the growth, which sought after newness from La Mer, D'Arfain, and Origins. In the UK, grew modelously for the second consecutive quarter in a difficult environment, and several of our brands gained share. Our growth strategy is showing promise amid macro and industry-specific headwinds. In North America, we made good progress towards stabilization of the business. We leaned into our multiple engines of growth, leveraging our successful skincare and fragrance franchises during the holiday season in light of industry challenges in makeup. There were several bright spots. brand representing about half of our sales grew, and we had gains in the specialty multi and online channels. In fact, La Mer delivered record Black Friday sales on its own sites, driven by a unique product assortment and an influencer-led holiday campaign. As we work to rejuvenate the makeup business in North America, We are creating products that leverage consumer insight from our enhanced data analytics. For example, we learned consumers want products that combine skincare benefits with makeup. In response, the Estelode brand just launched Futurist Hydra Rescue, a new moisturizing foundation combining the positioning of our winning Futurist franchise in China with consumer needs in North America. The launch is off to a very strong start with high ratings and reviews. Looking now at the channels, our global online business delivered stellar results. Our brand sites, third-party sites, and retailer sites all grew double-digit with broad-based strengths across regions. Our online business was vibrant globally around Cyber Monday, as our brands offered well-received products and sat in the important holiday gifting giving seats. We continue to invest in our excellent growth prospects online. We launched our brands on more third-party sites, which are rising in popularity, deployed new digital payment technologies across several of our brand sites in the U.S., and expanded our loyalty programs. With rich and engaging content, we have increased the time consumers spent on our brand sites, and classic has grown, increasing the inherent media value these sites provide. Travel retail also continued its momentum. Our top eight brands grew double digits at retail, with strengths in skincare, and our luxury and artisanal fragrance brands grew strongly. aided by expanded distribution in the channel. Innovative pre-retail campaign, unique retailers' activation, and effective advertising all contributed to fantastic results. The pre-tail segment of travel retail excelled in the quarter and is becoming an increasingly important part of our business. Pre-tail enabled us to engage with consumers before they travel, build brand equity and desirability and drive conversion when tourism and travel resume following containment of the coronavirus we anticipate that pre-tail will continue to expand another important highlight this quarter was the publication of our 2019 citizenship and sustainability report last march we announced new goals and the report details our vision and progress. One of our goals is to promote ingredient transparency across our brands, and Aveda led the way with an ingredient glossary on its website. Other brands will soon follow. Innovation is the core of our company. It once again helped drive our performance, accounting for over 25% of sales. We have exciting innovation from our four biggest brands coming in the second half of our fiscal year, many in their hero franchises. We believe these launches will be well received by consumers globally, and these important franchises have high loyalty. We are pleased by our strong start in the first half. We are now focused on managing effectively throughout the coronavirus outbreak. we are determined to serve our consumers in the best ways possible. We believe that the efforts of the China's government along with leadership from around the world to contain the outbreak will prove effective. I want to thank our employees worldwide to their extraordinary efforts working through this challenging time while supporting each other, our consumers, the communities where we work, and our business. Their grace and agility are a testament to our company culture. Now, I will turn the call over to Tracy.

Thank you, Fabrizio, and good morning, everyone. Certainly, our thoughts and best wishes are with everyone managing through a very difficult situation in China and globally. We are committed to supporting our employees and other stakeholders while we also manage the business impact as best we can during this time. As a reminder, my commentary today is adjusted for the items that Rainey mentioned at the beginning of the call, and net sales growth numbers are in constant currency. We acquired Have&Be, the owner of the Dr. Jart brands, towards the end of December. The results for the new brand will be recorded in future periods on a one-month lag, so you can expect operating results from Dr. Jart to be reflected in our fiscal third quarter for the first time. including the impact of purchase accounting and the interest expense on the debt we issued largely to fund this acquisition. So, starting with the quarter results. Net sales for the second quarter rose 16%, driven by strong growth in our international regions and improvement in North America. Sales growth in Asia, travel retail, and online continued to exceed our expectations. From a geographic standpoint, our Asia-Pacific region net sales rose 30% with broad-based growth across the region. Sales in Greater China accelerated, rising very strong double digits. Our sales in mainland China continued to deliver broad-based growth across cities, brands, categories, and channels, and our brands saw record results on Singles Day. As expected, Sales in Hong Kong declined more than 20%. Among developed markets in APAC, we again delivered double-digit sales growth in Korea this quarter. Our sales in Japan rose mid-single digits despite the October 1st VAT increase last year that contributed to double-digit growth last quarter. And emerging markets in Southeast Asia grew high single digits, led by Thailand. Net sales in our Europe, the Middle East, and Africa region rose 18%, with most markets contributing to growth. Our global travel retail business rose strong double digits, driven largely by light door growth, the continued rapid development of online pre-ordering, and the successful introduction of newer brands like Lollipop and Killian. Emerging markets in the region grew double digits, led by India and Russia. Western European markets grew low to mid-single digits, led by Italy, Iberia, and Germany. Net sales in the Americas rose 1%, a significant improvement from last quarter. Skincare and fragrance showed good growth, driven by Estee Lauder, Origins, and La Mer, as well as strong holiday performances from Joe Malone and Tom Ford. Initial shipments of Estee Lauder's new Futurist Hydro Rescue moisturizing makeup launch helped to partially offset the overall continued weakness in the makeup category. In North America, sales rose high single digits across all our online channels. Our sales in the specialty multi-channel grew double digits, while the brick-and-mortar department store business remained challenged. From a category standpoint, skincare once again led growth this quarter. Net sales accelerated to 28% growth, with strong contributions from Estee Lauder, La Mer, Origins, and Clinique. Innovations such as Estee Lauder Advanced Night Repair Intense Reset Concentrate, La Mer the Regenerating Serum, and Clinique ID BB Gel contributed incremental sales and supported their hero franchises. Net sales in makeup grew 7%, led by Estee Lauder, Tom Ford, and Bobby Brown. Solid innovation and support in foundation and lip products as well as special holiday sets and products drove growth in the category. Sales of fragrances grew 9%, driven by strong holiday activations at Jo Malone London and the launch of Metalique from Tom Ford. Fragrance sales grew across all regions but were strongest in the Americas and in Asia. Our hair care sales rose 5%, driven by the launch of the NutriPillinish line of products from Aveda and improvement at Bumble and Bumble. Our gross margin increased 20 basis points compared to the second quarter last year. Favorable pricing and mix was partially offset by the impact of the incremental tariffs and higher obsolescence costs. Operating expenses as a percentage of sales improved 130 basis points. We continue to leverage higher sales and greater efficiency than our selling model and store operating costs to fund advertising and strategic investments in technology and other capabilities. Operating income rose 23% and operating margin increased by 150 basis points. Adjusted diluted EPS of $2.11 increased 21% compared to the prior year, and the currency translation impact was negligible. EPS was higher than expected due to the stronger sales growth as well as disciplined expense management and was partially offset by a slightly higher tax rate. During the quarter, we acquired the remaining stake in HavanV, the Korean-based skincare company. The transaction resulted in a one-time gain of $576 million, primarily related to the re-measurement of our previously held minority equity investment to fair value. We also recorded $777 million of impairment charges related to three of our four makeup brands, a reflection of the continued challenges in the makeup category that have been most prevalent in North America. While the market momentum for makeup has slowed in the near term, as we have previously discussed, the growth opportunities and the strategic value of these brands remains compelling, as evidenced by our increased share and capability in specialty multi-retail. the enhanced social media expertise of the brands, and an increased consumer base of Gen Z and millennials. Turning now to cash flow. For the six months, we generated $1.26 billion in net cash flows from operating activities, which was roughly flat with the prior year. Higher earnings were offset primarily by the timing and level of accounts payable. We invested $291 million in capital expenditures with cash, and $1.04 billion to acquire the remaining equity interest in Havenby, which was funded with debt. We also continued to return cash to stockholders by utilizing $813 million to repurchase 4.3 million shares of our stock and $330 million to pay dividends. So we ended the first six months of the fiscal year with strong net sales growth of 14% in constant currency, and adjusted EPS growth of 21%, a tremendous reflection of the hard work of our teams, as well as strong consumer momentum that we have in our markets. So now, let's turn to our outlook for the balance of this year. The strong performance in the first half of our fiscal year, our multiple engines of growth strategy, and the greater financial flexibility and agility we have built into our operating models. is expected to help us to effectively manage through the short-term disruption caused by the coronavirus outbreak. Due to the rapid escalation and the fluidity of the situation, it is both complex and difficult to predict the timing and the corresponding impact on our business. Therefore, we are not giving explicit guidance for the third quarter. We also remain mindful that a variety of macro risks such as ongoing trade tensions and continued challenges in Hong Kong's retail environment, could impact our second half results. For the year, for the fiscal year, we now strive to achieve net sales growth of at least 6% to 8% in constant currency. This range is before the impact of one point of growth from the inclusion of sales from haven B. Currency translation is expected to negatively affect reported sales growth by one percentage point, reflecting weighted average rates of 110 for the euro, 127 for the pound, and 703 for the yuan for the fiscal year. With this sales guidance, EPS is expected to range between $5.60 and $5.70 before restructuring and other charges. This includes approximately $0.05 of dilution from currency translation and $0.18 dilution from the have and be acquisition. In constant currency, we expect EPS growth of 6% to 8%. Excluding the dilution from have and be, EPS growth is expected to be at least 9% to 11%, which remains in line with our long-term objectives. For the second half, net sales are expected to increase approximately 1% to 2% in constant currency. Currency translation is expected to negatively impact growth by one percentage point, and the inclusion of have and be is expected to add two percentage points. In terms of cadence throughout the second half, we have anticipated the greatest negative sales impact from the coronavirus to be in the third quarter, followed by a gradual recovery in the fourth quarter. We are severely curtailing discretionary costs while continuing to support critical areas of growth. Leading Beauty Forward has reduced our percentage of fixed costs in our operations, which gives us greater agility to manage more effectively with flowing sales. We expect the belt tightening to have the maximum benefit in the fourth quarter. EPS is forecast between $1.86 and $1.91 before restructuring charges. This includes approximately 3 cents dilution from currency and 17 cents dilution from have and be, which includes some impact from the coronavirus outbreak, purchase accounting, and interest expense on the debt issuance, as I mentioned previously. While our outlook for the balance of this year is uncertain, we do remain quite optimistic about the long-term growth opportunities for the company. We believe we can manage through this difficult health crisis while maintaining the agility to invest as needed and regain our momentum once the recovery is established. On behalf of the entire Estee Lauder companies, we extend our deepest well wishes to those who have been affected and thank everyone for their extraordinary efforts to manage during this period, particularly our incredibly hardworking and wonderful team in China. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

The floor is now open for questions. If you have a question, you simply press the star key, followed by the digit 1 on your touchtone telephone. Questions will be taken in the order in which they are received. To ensure everyone has the opportunity to ask their questions, we will limit each person to one question. Time permitting, we will return to you for additional questions. Just queue up again by pressing the star key and the digit 1. Our first question today comes from Sarah Mosinian with Morgan Stanley. Please go ahead.

Hi. Good morning, guys. So just was hoping for a bit more clarity on the coronavirus and how you guys are thinking about the potential impact longer term. I guess what we've seen with past epidemics is usually beauty demands come back pretty quickly after a couple of quarters. I know there's not a lot of visibility here, and the duration of the illness is obviously still a big wild card, but just to read through any initial thoughts or context on if you think this could be an issue that impairs longer-term growth as we look out over the next few years. You talked about a gradual recovery through fiscal year-end. Should we expect things to sort of ramp up pretty quickly after that, or how are you thinking about it in terms of longevity of impact? Thanks.

So obviously we don't know about the specific medical health recovery timing, which is the unknown at this point. But we are in agreement with your assumption, which is basically this will have an impact in the short term, and definition of short term is what is unknown today. But then after this period, there will be a recovery, and people will come gradually back to normal habits. And so we do expect to recover our momentum at the end of the health crisis. And in terms of our assumption today, are in line with what you said. We assume the two quarters to be affected by the impact, and we expect a normalization in fiscal year 21. That's our assumption today. The other important thing is that we are ready to stay close to the current mitigation of the issue and resolution of the health crisis as we are doing, supporting our China team and all the activities that the government is putting in place in China today. And we also will stand ready to support the recovery when the recovery will be happening and to invest. behind the recovery as required by the market opportunity, but most importantly by the needs of rebuilding the right consumption of Chinese consumers in the name of the economical development of China.

Great. That's helpful. Thank you.

The next question will come from Lauren Lieberman with Barclays. Please go ahead.

Great. Thanks. Good morning. I was hoping we'd talk actually a little bit about the Americas because the strength this quarter, the inflection was very notable. So I was wondering if you could talk a bit more about how much you think this is tied to just being really proactive in promoting and getting behind, I should say, using these fragrance and skin and holiday being the key to this, or are you starting to see other lists that you think can carry through past holiday? And then in part with that, of course, we've had the news about incremental Macy's door closures this week. So if you can just comment on the outlook for the rest of the year in the Americas. Thanks.

So first of all, as we said, this quarter has contributed to the stabilization of our North America business. And this has been in line with the strategy we communicated in Investor Day. And we remain committed to continue the work of stabilization in the next months. But what happened this quarter is, first of all, we have used, as anticipated, much more granular insight in the market to activate our plants and much more local relevance in the activation. The other thing that happened, we have recognized the softness of the overall make-up market And that's why we have accelerated our activity in skin care and particularly fragrances during the holiday season. They were well-fitting the situation, and we got great results. So we have, if you want, adjusted our engines of growth in a way that they contributed to the good results. Our innovation pipeline, as anticipated, has been strong, and the impact of innovation has improved significantly. And so all this has been a positive impact. We will continue to operate in that direction, but we do have still to confront some of the headwinds. To be clear, the makeup softness, particularly the color makeup softness, is continuing. As you mentioned, the closures of certain retailing stores where we do have high market share will continue, although we completely share the Macy's strategy of focusing on the high-performance doors and of gradually stopping the smaller and lower-performance doors. As I said, we support this strategy, but obviously we will need to operate with the strategy with making sure that we retain the consumer, the brands, and this will be difficult, but we will do our best to do that. So we need to take under account our extraordinary efforts to improve our model that are working, but also take under account that we will continue to be headwinds. So our strategy remains, at this point, stabilization.

Great. And just as a follow-up, how are you thinking about the impact of Chinese travelers not really visiting the U.S. over the next several months just in terms of the outlook?

That's actually a good point. We assume that there will be obviously an important reduction of Chinese travelers not visiting the U.S. in the next at least two, three months. And this will have a negative impact, obviously, on the sales to Chinese tourists. Frankly, in this moment, we are assuming in our guidance also a slowdown on any tribal population. To be clear, in this moment, because of the coronavirus global concern, tourists in general is being reduced temporarily. So we are taking this temporary assumption, sorry, the assumption of this temporary reduction under account in our guidance.

Okay, great. Thanks so much.

And I just want to add, as it relates to our guidance, I mentioned the range of 182 to 191, which is within our press release. I think I mentioned a different number in our guidance for the second half.

The next question is from Michael Benetti with Credit Suisse. Please go ahead.

Hey, guys. Thanks for taking our question. And congrats on a really good quarter. So I want to ask you on the Dr. Jart dilution, could you walk us through how much, you know, the 18 cents? We're trying to think forward, I guess, over the four quarters of integrating that business. How much of that is one time in nature? And when you see that starting to wear off or even possibly turn to, to an accretive position. And then I want to ask you, as you think through the U.S. number a little bit, do you think the retailers that you worked with on the holiday strategy to get more skincare and fragrance out there, they really seem to want to keep pushing on makeup even as the warning signs were showing up over the last year or two. Do you think they've gone through the psychological change yet that skincare is going to be the driver for the medium term? And are they accepting that they have to pull back more on makeup in a structural way? I guess are the gains you saw in skincare and fragrance We characterize those as sticky and shelf space gains that are gonna remain dedicated to those categories as we look into calendar 2020.

Yeah, so starting with the have and be dilution, we obviously have the step up in inventory, which is one time, depends on how you're treating the interest expense, which is also in that number. What I would say, Michael, is that we expect that have and be will be, if you think forward, relatively flat, including purchase accounting, so eliminating those one-time items next year, and accretive the following year.

Okay.

The make-up question is the second question?

Yeah. Sorry, could you repeat who was the subject of the make-up question? When you said they, I didn't understand.

Yeah. Well, it sounds like it was a pretty meaningful acceleration. Obviously, in North America, or in America, we can see your numbers, but it sounds like the... The number that you got from Specialty Multi, which was a great growth channel for you guys over the last few years, but slowed recently. It sounds like it improved a lot this quarter, and it sounds like you worked with them on skin care. I'm just wondering if you feel like that channel, they feel like they've gone through the mental change of saying, look, skin care is going to be the bigger driver. And we're going to give that category more shelf space that sticks around under 20.

Frankly, yes. I think everyone realizes the power of skin care in this moment. And we are all working together to leverage the power of skin care. Skin care for instant results and skin care product combined with makeup is on a growth. So, yeah, you speak about shelf space, which obviously is a bit more gradual in the way it changes. But definitely innovation programs are reflecting a lot of this. So there is more activity, more social media, more advertising. in skincare than before, and this is a reflection on the results. But anyway, makeup is a big category. The makeup for face, meaning foundation, for example, still do it very, very well. The place which is softer is color. And importantly, what we are doing to contribute not only to leveraging skincare fragrances better, but to reinstate growth in makeup in the future is we are accelerating the innovation in the makeup category contributing to the future results of our retail partners also in this category so to be clear we are not giving up at all on makeup we are just accepting that in the short term we are focusing more on our category and innovating better in makeup to reactivate the consumer interest thank you very much congrats on getting North America back to a positive

Thank you.

The next question will come from Erin Murphy with Piper Sandler. Please go ahead.

Great. Thanks. Good morning, and let me add my congratulations. I guess my question is around Amazon. There's been some press out recently talking about them potentially evolving their model to launch some luxury brands, maybe using a concession model. If something like this was to play out, would you ever reconsider Amazon as a channel for luxury beauty And then just to follow up on China, can you share, Tracy, maybe what percent of physical doors have been shuttered, and are you seeing any major change in trend in the online business in China since the outbreak has escalated? Thank you.

Okay. On the first question, the answer is no. At this point, we are not considering Amazon a channel for our luxury beauty products, and we are focusing on of our current channels and our current partners to build and continue the stabilization in North America of our business. As far as the China question is, the number of physical doors, I'll let Tracy go with that.

Yeah, so as you can imagine, it's quite fluid. And one of the things that we've seen is the Chinese New Year extended for many of our employees. You know, our stores have closed as malls have closed. So, you know, very recently, two-thirds of our department store doors were closed, and the remaining doors were on reduced hours. Now, that could change next week. So this is a very fluid situation.

And on the second part of the China question, which is the online question, Absolutely, the online channel is very strong in China in this period, as we said, in the second quarter. But in this moment, also online is suffering because in this moment, in the middle of the outbreak, the delivery system in homes and in the big distribution centers, also people are not working. Like in this moment, till February 10, many people, the non-essentials, activity in factories and other situations like this is stopped. The same is for distribution centers, the same for other activities. So online, at least in the short term, is having the same issues of brick and mortar. In terms of the role of online in the recovery in the future, we are optimistic that online will play a very strong role in the recovery, when the recovery will happen.

Thank you for that context. All the best.

Thank you.

The next question will come from Steve Sterculia with UBS. Please go ahead.

Hi, good morning. So first part of my question, just wanted to follow up on Erin's question. Can you give us a little bit more texture as to how to disaggregate how many mainland China sales are performing versus the travel retail component of the business? Primarily it's how we think about modeling the back half of the year. One of those businesses is housed within the EMEA segment, and the other business is clearly housed in APAC. So I just want to get a little bit more texture as to which one's being more impacted real-time. And then, Fabricio, if you use history as a guidepost here, how do we think about once the issue is, call it, quote-unquote, contained, what is, like, the recovery path from that moment forward? Is it typically from what you've seen beforehand? three, four months for travel retail to come back online from flights being booked. Any help would be appreciated. Thanks.

Yeah. So the short answer to the first question, in this moment, travel retail is the most impacted channel because if you think just to give you the context of what's happening, you probably know that more than 60 airlines have just closed. their flights. So in this moment, the travel in and out of China is suspended in the large majority of cases. So there is lack of traffic for just in and out of China. Second, in general, tourism in this moment is more prudent because it's a global issue, the outbreak. It's a global concern. And so many people which are concerned to travel in this moment are reducing their choice or postponing some of their travel. And I'm speaking touristic travel. Then there is a third factor, is many companies have banned travel to Europe. to China, but also to any other place where there is the virus. And so business travel is being reduced, not to count the many companies are reducing business travel for cost containment reasons. So in this moment, the amount of travel in airports is reduced and traffic is significantly reduced. So that's the biggest impact. The second biggest impact is obviously China mainline itself and Hong Kong, which are reduced significantly. So I would say the greater China area. Because all the reasons that we already discussed in the prepared remarks that I'm not going to repeat, but the most important thing is that Keep in mind that until February 10, most of the cities are not even, people are not back to work. Until February, children are not back to school. And people are requested, rightly so, not to get out of home for reasons which are not essential and not to go in public transportations where there is a risk of contamination. So the behaviors of the entire population is fundamentally changed. And because of this, this is the second area where, in the short term, we expect an impact. The second part of your question is the recovery. Now, the recovery, you know, we know what you know. We have studied all the previous cases and all the previous situations, and what we see is that the recovery tends to be a hockey stick, meaning when the thing is back, it's back, particularly in the traveling. When traffic is back, traffic is back, and the people buy. The thing that we can do more in terms of the business learning that we apply, you know, during... during the period before the recovery in travel retail will be very important to push conversion. You know, travel retail is built by traffic and by conversion. Conversion is an area where we're making many improvements. So in this period of transition where traffic will go, we are reworking our plans to use conversion as a key mitigating element of the DEEP. And then, obviously, we are preparing for future recovery plans when the time will arrive. The last point I want to make is that we will try to tune the recovery plans. to the recovery of the Chinese economy and the Chinese population. We don't want just to look at this as a business. We want to look at this as a contribution to the recovery of the country and really supporting our employees at the country in this. And the same will happen in travel retail where, for example, some of our customers and retail partners are Chinese and we are going to stay close to them to contribute to the recovery of the travel retail business to make sure that our long-term retail partners will benefit from the recovery as much as possible and to start this all again to restart the right process and to regain momentum not only for us but for the entire industry.

The next question is from Andrea Texera with J.P. Morgan. Please go ahead. Thank you. Good morning, and I just want to echo the congrats on your results.

Thank you. So as a follow-up on the North America and the comments that you made for Mix, Fabricio, and obviously it's natural that in the holidays it's more giftable skincare and fragrances, and you're also putting more, I think prudently putting more marketing behind those lines. Do you think that innovation and momentum continue to build into the next few quarters, or, you know, we maybe potentially had some seasonal positive impacts of that into the second quarter? Thank you.

So I'll start, and then Fabricio can also add his comments. You know, we are progressing towards stabilization in North America, and clearly it was a strong holiday, you know, and strong second quarter for us in North America and in other parts of the globe. So, you know, our teams have worked awfully hard to make this holiday season a very good one, and consumers responded, and we're very happy about that. As we look at the back half of the year, Fabrizio touched on the fact that we do have tourists that we expect that that business to be a bit softer, given the situation that we're managing through globally. And I would also say that North America is making progressive progress, however. You know I would not expect that the second quarter would necessarily be reflective of a continued acceleration from there But the North America team is executing against all of the strategies that that were laid out last year And and we're seeing some good good outcomes from that so what we told you last quarter was North America you know we expect certainly to have better performance this year and than we did last year in North America. So that is progression towards stabilization. Lauren asked earlier about the Macy's announcements. And clearly, as we've been saying for some time, we believe that brick and mortar needs to be taken out of North America. North America's been over-retailed for some time. So we are very much aligned with what Macy's has announced in their investor day yesterday. the doors that actually would be closing in our fiscal year were already included in our guidance.

That's helpful. The next question will come from Mark Asherken with CIFL. Please go ahead.

Thanks, and good morning, everybody. I was wondering if you could quantify the online percentage of sales from China. And related to that, Also, if you could just quantify the impact benefit from e-commerce accelerating consumption via enhanced availability in China. In other words, previously consumers would have to visit cities selling the product, and now you're up to 123. E-commerce obviously makes the product available everywhere. So maybe if you could just talk a bit about how you think about that dynamic as having helped past tense sales and how you think about that on a go-forward basis. And maybe if you think about some of those tier three to five cities, which didn't readily available, have product readily available, but now people can order online. How do you think about that in terms of accelerating demand, maintaining that demand, and kind of how it will impact future growth?

Yeah, that's a very good question. As I commented other times on the subject, this is a very important phenomenon because today we have physical distribution in China in 123 cities with our most distributed brands, which are Loder and Clinique, and much lower city coverage in the other brands, which are still on the growth trajectory. So there is a lot of physical distribution potential in the long term still untapped. But at the same time, we know there is demand in China now in over 600 cities. So there are over 450 cities where there is strong demand, and there is not yet physical distribution of prestige luxury, and for sure prestige luxury of Estée Lauder brands. So this demand gets filled by online and gets filled by when these consumers travel, also travel within China, like in amazing TR markets like Hainan Island, then where they can access the products, or when they travel for internal business, for vacation, like going to Beijing or to Shanghai. So that's the situation. But online... cover a lot these cities and that's why also it's growing and it's very strategic because it gives us access to these consumers in a very productive way. The other important positive consequence of this dynamic is that the brick and mortar can remain very productive. It can remain very focused where there is the right productivity and online can cover productively the rest. So this is a good phenomenon, continue to grow. It is definitely one of the reasons behind my comment that we are having better and better results also in the Tier 3 and Tier 4 cities, also where physical distribution has not yet arrived. In terms of percentage of sales, you know, China is the highest percentage of sales online. versus other markets. He's on the high side, and he's continued to grow.

We have time for one more question, and that question will come from Nick Modi with RBC Capital Markets.

Yeah, thanks for the question. Good morning, everyone. I just wanted to follow up on Mark's question. How much flexibility do you have to turn up the dial on you know, really focusing on some of those lower tier cities that you just referenced. You know, I'm just thinking about as kind of the year progresses and, you know, if you really wanted to turn up the dial to generate sales growth in some of these other tier cities, you know, do you have that kind of control in the near term or is it a much longer term burn?

I mean, we have control of the online. I mean, with our partners like Tmall and obviously our own online activities, But remember, our way to build distribution and also to build coverage is we are in luxury. And for us, selective distribution, which means demand ahead of supply, is very important. So we gradually build the demand. And the reason why today demand is growing so fast also in this city is social media. Because while in the past advertising was local, Many advertising was focused in the cities where there was physical distribution. Social media, by definition, is national. So you are in a dynamic where demand is normally ahead of supply, and that's the typical demand of a good luxury market. And we are filling this demand gradually and making sure that we keep the concept of desirability and high quality and high quality also the experience that we give to our consumer in mind. So we are not selling products. We are selling quality and full experiences, and we only do that when we can provide the best possible service to the consumer. So the short answer is gradually, but yes, we have the capability to dial up as the market opportunity reveals itself.

And just a quick follow-up, of the 450 cities you cited in China as opportunity, how many do you believe Estee Lauder as a company has very good handle on demand and just the general consumer insights in those cities?

I will not give you specific numbers, but I can tell you that we have the consumer data, so we know the number of consumers that are buying from different cities. Even we use this data analytics data. to decide where to open physical distribution. So we use the demand and the elements of the strength of the demand from the cities also to judge our physical distribution strategy to make sure that we continue to provide better high-touch services to the consumer when the demand is sufficient to be productive and to offer the quality and the service that we need to offer. So it's a gradual development of quality service.

Very helpful. Thank you.

Welcome.

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 p.m. Eastern Time today through February 20th. To hear a recording of the call, please dial 855-859-2056, passcode 4437719. That concludes today's Estee Lauder conference call. I would like to thank you all for your participation and wish you all a good day.