Estee Lauder Companies, Inc. (The)

Q2 2022 Earnings Conference Call

2/3/2022

spk12: Good day, everyone, and welcome to the Estee Lauder Company's fiscal 2022 second quarter conference call. Today's call is being recorded on webcast. For opening remarks and introductions, I would like to turn the call over to Senior Vice President of Investor Relations, Ms. Rainey Mancini.
spk10: Hello. 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 our 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. Unless otherwise stated, all net sales growth numbers are in constant currency. and all organic net sales growth excludes the noncomparable impacts of acquisitions, divestitures, brand closures, and the impact of currency translation. You can find reconciliations between GAAP and non-GAAP measures in our press release and on the investor section of our website. As a reminder, references to online sales include sales we make directly to our consumers through our brand.com sites and through third-party platforms. It also includes estimated sales of our products through our retailers' websites. 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.
spk07: Fabrizio.
spk06: Thank you, Reni, and hello, everyone. It is good to be with you today as our hearts continues to be with those impacted by COVID-19 around the world. We achieved record sales and profitability in the second quarter of fiscal year 2022. Our multiple-enzyme growth strategy showcased the benefit of its diversification. Every category, region, and major channel expanded. We sized the favorable dynamics of skincare, fragrance, developed markets in the West, brick and mortar, and continue to prosper in the East with Chinese consumers, as well as in global travel retail and global online. The flexibility we built into our business model over the last decade enabled us to both allocate resources to attractive growth opportunities and effectively manage the impacts of an increasing inflationary environment. Our advanced planning for the key shopping moments of 11-11 and holidays allowed us to overcome supply chain obstacles. For our second quarter, reported net sales grew 14%. Organic net sales rose 11%, adjusted operating margin expanded, and adjusted dilute earnings per share increased 15%. Today's results are all the more impressive compared to the pre-pandemic second quarter of fiscal year 2020, when we delivered record organic sales growth in our seasonally largest quarters. Despite the answering challenges of COVID-19, which escalated during the quarter with Omicron, we far exceeded the exceptional results of two years ago. Reported sales are 20% higher, driven by organic sales growth and with every region now larger, and we are much more profitable. Our gains during the last two years reinforce our confidence in our ability to navigate the impacts of the prolonged pandemic. Moreover, our optimism in the opportunities of tomorrow remains incredibly strong, owing to the timeless desirability of our brands and our commitment during the pandemic to invest for the near and the long term. Our brand portfolio of large, scaling, and developing brands served as a powerful catalyst for growth as consumers reward the quality of our trusted brands and hero products. In the second quarter, 11 brands achieved double-digit organic sales growth versus the prior year period. This broad-based trend is similar to the contribution in the first quarter, despite a far tougher comparison. The momentum In our largest brands, Clinique, Estée Lauder, La Mer, and MAC continues as the hero franchises capitalize on innovation in product engagement and high-touch experiences and services to drive trial and repeat. La Mer and Clinique delivered standout results in skincare, while Estée Lauder and MAC drove makeup's emerging renaissance. Our scaling and developing brands achieved excellent results, Jo Malone London and Tom Ford Beauty led fragrance and were among our top performing brands, while Bobbi Brown grew strongly driven by skincare. Aveda Red Bumble and Bumble delivered accelerating sales growth in hair care as Too Faced and Smashbox rose double digits in makeup. Product innovation also served as a powerful catalyst for growth across our brand portfolio, contributing nearly 25% of sales. This level of contribution is notable in a quarter when holidays exclusives represent a larger mix of business, and especially so in a challenged supply chain environment. La Mer, fueled by its iconic heroes on trend holidays merchandising and highly sought new dehydrating infused emulsion, led the company's sales growth. The brand excelled in every region and across major channels, cherished by its loyal consumer and embraced by a new cohort of consumers, including more men. Clinique's skincare portfolio, with its desirable innovation and hero franchises, performed strongly. Its new smart clinical repeal wrinkle correcting serum drove sales gains in North America, amplifying the brand's global momentum in the serum subcategory. Clinique take the day-off makeup remover saw a dramatic uptick in sales, evidence of Makeup's emerging renaissance and the staying power of this cult-favorite skincare product, which is recruiting a new generation of consumers. For Makeup, the Estée Lauder brand is a driving force in the category emerging renaissance, with Makeup sales for the brand already larger than two years ago. Estée Lauder Double Wear Hero franchise delivers remarkable performance. while its Futurist Foundation, which is an east-to-west product born of skinification of makeup trend, was very strong. Our fragrance portfolio continued to go from strength to strength, owing to the enduring scent-based ritual created in the pandemic and enhanced by innovation. Better online storytelling and expanded reach as consumers in the east embraced this category. Each of Jo Malolando, Tom Ford Beauty, Le Labo, Kylian Paris, and Frederic Malle delivered strong double-digit growth in every region, demonstrating the allure of these brands around the world. Tom Ford Beauty exemplifies the benefits of a strategic focus on heroes and innovation. Its new ombre leather perfume had a hollow effect, on the eau de parfum, such that sales for the franchise doubled. In the third quarter, the brand is leveraging its global appeal with a flair of local relevance in the fragrance launch of Tom Ford Rose Trilogy. Our growth engines also continue to diversify by region, as we anticipate. Developed markets in the West perform especially well. North America executed with excellence to capture brick-and-mortar reopening trends and deliver a strong holiday across channels. Festive seasonal exclusives, including a still-loaded blockbuster set and a VEDA collaboration with Philippe Lim, proved highly sought. Indeed, our in-store and online activation and merchandising were incredibly successful, with Brand.com posting a record Black Friday. Every category grew double digits organically in North America, led by makeup, where our brand paired trusted products with enticing innovation as social and professional user education increased. Mac, Bobby Brown, and Too Faced produced engaging content and artist-led education to inspire consumers to size the joy and creativity of the category. Mainland China. delivered high single-digit organic sales growth, an impressive result given the regional restrictions in the quarter, the pressured brick-and-mortar and make-up. Online sales rose double digits organically, even after having posted significant growth in the year-ago period. For 11.11 on Tmall, the Estée Lauder brand ranked number one flagship store in beauty for the second consecutive year, as La Mer flagship store topped luxury beauty once more, and Jo Malone London again led in prestige fragrance. On JD, the Estée Lauder brand ranked number one flagship store in beauty in its first year. Skincare and fragrance grew double-digit organically in mainland China. Hero Produce and innovation excelled, driving new consumer acquisition and repeat purchases. Several brands expanded Prestige Beauty's share in the quarter, including Estée Lauder, La Mer, and Dr. Jart. Looking ahead, we are excited about the long-term growth opportunity in the vibrant Asia-Pacific region, and most notably in China. We are a few months from opening our new innovation center in Shanghai. Our aspirations for it are bold as we aim to meet and exceed the desires of Chinese consumers. The center is designed to enable end-to-end innovation from concept for product and packaging through development, scale-up and commercialization. I'm pleased to share that the build out of our state of art manufacturing facility near Tokyo is also progressing very well, which is a testament to the amazing work of our global supply chain team amid the pandemic. Its first phase is complete and we are on track to start limited production by the first quarter of fiscal year 2023. Our growth engines further diversified by channel as both online and brick-and-mortar prospered. Specialty multi and department stores contributed meaningfully, and freestanding stores in the West performed very well on reopening. Traffic improved and complemented our strategic actions, including those under the post-COVID business acceleration program to benefit productivity in brick-and-mortar. These channel trends are encouraging for the long term, even if temperate in this moment by Omicron. We continue to expand our omni-channel capabilities in the quarter to give consumers flexible and convenient shopping options for greater certainty for fulfillment. Buy online, pick up in-store offerings in the United States for Mac, Aveda, Jo Malone London, and Le Labo are driving favorable average order value trends, and we are expanding the capability to more doors internationally, which holds great promise for the future. Our global online channel delivered excellent performance, with organic sales rising high single digit after having surged over 50% in the year-ago period. Each of Brand.com's third-party platforms, PurePlayer, and retail.com contributed to growth. The drivers included higher levels of engagement for virtual try-on and tools for choosing shade and scent, sophisticated sampling to drive trial and repeat, and more and better live streaming. Indeed, in North America, La Mer generated the most sales from a live stream to date in the quarter. Our brands are innovating in social commerce on Instagram, Snapchat, TikTok, and WeChat, among others. We gained momentum in this promising online ecosystem during the quarter. Too Faced leveraged an Instagram live shopping event to launch its new fragrance. Estée Lauder's double wear followers on TikTok skyrocketed with its latest campaign also driving brand awareness and affinity much higher, and Tom for Beauty creatively debuted its new flagship site on WeChat's mini program in China. Embedded with these outstanding results across categories, regions, and channels is the progress we are making in social impact and sustainability. Since we spoke with you in November, we are pleased to have received several external recognitions of our ESG efforts. We were named to Forbes inaugural list, identifying the world's top female-friendly companies, leading the way to support women inside and outside their workforces. And for the fifth year in a row, we were named to Bloomberg Gender Equality Index. We were included in the CDP's Climate A-List for the second consecutive year, which is a tribute to our deep commitment to climate action and to the highest level of transparency around our environmental impact. Last, MSCI recognized our progress toward our 2025 ESG goal in a recent upgrade of the company to an A rating. The company, our brands, and our employees have a number of events and activations planned in honor of Black History Month. and we are continuing to focus on our racial equity commitments and the work of accomplishing our goals. As we embark on the second half of our fiscal year, our innovation pipeline is rich with newness, especially for sustainability. La Mer newly advanced the treatment lotion, which will be on counter in March, as a powerful upgrade inside and out, crafted using our unique Green Score methodology and housed in a new recyclable glass bottle made with 20% post-consumer recycled glass. This methodology, which was peer-reviewed in academic journal Green Chemistry during the quarter, evaluates ingredients and formulas throughout the lenses of human health, ecosystem health, and the environment. This approach can be adopted, built upon, and scaled by others across our industry to further advance sustainability. Esteloder is launching an all-new revitalizing supreme moisturizer created with innovations in formula and ingredients in a new recyclable glass jar. Smashbox is introducing photo-finished silkscreen primer collection fishery vegan formulas with a skin-defending compliance and instant make-up benefits. Lastly, Dasean Vegan Brands The Ordinary is welcoming back salicylic acid 2% solution, boosting a waitlist of over 400,000 for the new formula. In closing, we delivered outstanding performance amid the accelerated volatility and variability, as well as supply chain challenges of the pandemic. This demonstrates that we have the competency to navigate complexity well. Our commitment to invest for the long term is of great importance in this moment, as we benefit from the advancement we have made over the last few years in data analytics, technology, R&D, and supply chain. These enhanced capabilities combined with our strong portfolio of desirable brands, exceptional talent, and more flexible resource allocation are enabling us to realize the power of our multiple engines of growth strategy, even in a difficult external environment. The grace, wisdom, and ingenuity of our employee in this still challenging moment knows no bounds. They are the embodiment of our company's strong culture, and to them, I extend my deepest gratitude. I will now turn the call over to Tracy.
spk08: Thank you, Fabrizio, and hello, everyone. As you just heard, our momentum continued in our second quarter, with net sales growing 11% organically and 14% in total, led by a continued overall progression and recovery despite the volatility inherent across markets with the prolonged pandemic. We had a solid holiday performance across all of our regions. The inclusion of sales from the May 2021 Deciem investment added approximately three points to reported net sales growth, and the currency impact was neutral. From a geographic standpoint, organic net sales in the Americas rose 19%, as holiday shoppers returned to brick-and-mortar retail, where we had an exciting array of gifting products and holiday activations in-store. And even with more consumer shopping in stores, organic sales online also grew solidly in the Americas, with online representing more than a third of sales in the region. Every market in the region contributed to sales growth this quarter, and the inclusion of sales from Deciem added approximately five points to the total reported sales growth in the region. In our Europe, the Middle East, and Africa region, organic net sales rose 13%. Growth was diverse and broad-based, with global travel retail as well as every market contributing. All channels grew, led by double-digit growth across brick and mortar, as recovery continued in both developed and emerging markets in the region. Despite a strong performance during key shopping moments, organic sales online declined slightly, primarily driven by the UK due to a tough comparison with the prior year, which was more severely impacted by brick and mortar lockdowns. The inclusion of sales from Deciem added about three points to total reported sales growth in the region. Our global travel retail business grew low double digits. Travel restrictions have eased globally, and international passenger traffic continued to progressively improve, resulting in some stores reopening during the quarter, particularly in Europe and the Americas. Travel retail continues to be led by Asia Pacific, where demand from Chinese consumers remains strong. In our Asia Pacific region, organic net sales rose 5%. Most of the markets in the region grew, led by mainland China and Australia, although we continue to see variability in COVID restrictions and retail traffic across markets. Sales grew across most major channels in the region, especially online, which benefited from the recent launch of three brands on JD.com. The inclusion of sales from Deciem added approximately one point to total reported sales growth in the region. From a category standpoint, organic net sales of fragrances grew 30% with double-digit increases across all regions. Exceptional double-digit increases from Jo Malone London, Tom Ford Beauty, Lollabo, and Killian Paris reflected strong performances from Hero Products, new product launches, and the continued growth of the bath and body and home subcategories. Organic net sales in makeup rose 12% as consumers in the Americas and Europe responded to social media activations, holiday assortments, and trends. Estee Lauder foundations continued to resonate very strongly with consumers, especially those in the double wear and futurist franchises. MAC continued to drive the makeup renaissance with engaging, interactive campaigns throughout the quarter, like the special MAC Trend Halloween report and solid holiday collections. Too Faced, Tom Ford Beauty, Smashbox, and Bobbi Brown also contributed to growth in the category this quarter. Organic net sales in skin care grew 7%, reflecting double-digit increases from La Mer, Clinique, and Bobbi Brown. The inclusion of sales from Deciem added four percentage points to reported growth. Organic net sales in hair care rose 18%, as traffic in salons and stores improved, primarily in the Americas. Aveda's growth came mostly from holiday gifts and hero franchises and in online and freestanding stores, while Bumble and Bumble focused on recruiting new consumers in the specialty multi-channel. Our gross margin improved 20 basis points compared to last year. The benefits of strategic price increases and favorable currency more than offset the impact of higher makeup mix and lower gross margin on Deciem products. Inflationary pressures in our supply chain are expected to begin to more prominently impact cost of goods in our fiscal third quarter. Operating expenses decreased 140 basis points as a percent of sales. Our leverage of selling expense and general and administrative expense was partially offset by increases in advertising and shipping costs, the latter due to both inflation and our direct-to-consumer online growth. Operating income rose 22% to $1.44 billion, and our operating margin expanded 160 basis points to 25.9% in the quarter. Our tax rate at 21.4% continued at a more normal level this year versus the prior year, which was impacted by a one-time benefit associated with GILTI. Diluted EPS of $3.01 increased 15% compared to the prior year. For the six months, we generated $1.85 billion in net cash flows from operating activities compared to $1.98 billion last year, which reflects both a return to more normalized working capital needs as well as increased inventory to mitigate some of the risk of supply chain disruption given the ongoing global macro challenges. We significantly increased our capital investment to $459 million to support the construction of our new production facility near Tokyo, as well as investments in our online business and other technology enhancements. And we returned $1.84 billion in cash to stockholders through a combination of share repurchases and dividends, with an increase in our dividend rate occurring in the second quarter. So turning now to our outlook, we delivered an exceptional first half characterized by strong and diversified double-digit organic sales growth and disciplined cost management in the context of intermittent COVID disruptions, including the rise of the Omicron variant, high inflation, and volatility. Looking ahead, we are raising guidance to reflect our expectation for a strong year despite the potential further spread of Omicron, supply chain challenges, and increased inflationary pressures. Inflation in transportation and procurement is expected to impact our cost of goods in the second half. However, the benefit of pricing and cost mitigation efforts are helping to offset some of the inflation impacts for the fiscal year. At this time, we expect pricing to add approximately 3.5 points of growth, with the inclusion of the additional pricing actions we are taking during our second half. We are planning to support the continuation of the recovery with increased point of sale staffing as retail traffic continues to gradually improve. We are also planning to support key hero franchise launches in our third quarter from Estee Lauder, La Mer, and Origins with increased marketing and advertising support. This investment will increase costs toward the latter part of the third quarter with more of the benefit to be realized in the fourth quarter. For the full fiscal year, organic net sales are forecasted to grow 10% to 13%. Based on rates of 1.146 for the euro, 1.357 for the pound, and 6.399 for the Chinese yuan, we expect currency translation to be negligible for the full year. This range excludes approximately three points from acquisitions, divestitures, and brand closures, primarily the inclusion of Deciem. Diluted EPS is expected to range between $7.43 and $7.58 before restructuring and other charges. This includes approximately 7 cents of accretion from currency translation and 3 cents of accretion from Deciem. In constant currency, we expect EPS to rise by 14% to 17%. We expect organic sales for our third quarter to rise 8% to 10%. The net incremental sales from acquisitions, divestitures, and brand closures are expected to add about three points to reported growth, and currency is forecasted to be negative by about one point. We expect third quarter EPS of $1.55 to $1.65. Currency is expected to be one cent accretive to EPS, and the inclusion of Deciem is not expected to be material. In closing, our results thus far clearly demonstrate the power of our diversified portfolio. Temporary softness in our eastern markets driven by the pandemic was again offset by renewed growth in our western markets. A resulting slight slowing of growth in skincare was offset by remarkable growth in fragrances. We continue to be choiceful about where we invest, and the flexibility we have built into our cost structure is helping us to mitigate some of the COVID-related disruptions and inflation while allowing us to continue to invest appropriately in our future growth. This agility, along with the resilience of our remarkable teams worldwide, gives us confidence that we can continue to manage through the temporary complexities caused by the prolonged pandemic by focusing clearly on our long-term strategy and executing against it with excellence. And that concludes our prepared remarks. We'll be happy to take your questions at this time.
spk12: Thank you. 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 touch-tone telephone. To ensure everyone can ask their question, we will limit each person to one question. Time permitting, we will return you for additional questions. Just queue up by pressing the star key, then 1. And our first question today will come from the line of Dara Mosinian with Morgan Stanley.
spk03: Hey, good morning, guys. I was hoping to get an update on China. You mentioned the strong performance there from a brand perspective during the 11-11 holiday, but the category wasn't as robust as we've seen in past years in terms of growth. And we've also had the lockdown situation there. So any perspective on category growth in China in calendar Q4 and what you're seeing so far in calendar Q1 of this year would be helpful and risk from lockdowns, and maybe while you're on the subject, just longer term, touch on the growth curve of China in terms of per capita consumption development over time and your thoughts there. Thanks.
spk06: Yeah, no, sure. So we achieved high single-digit growth in mainland China this quarter. And where brick-and-mortar channels were impacted by COVID restrictions. But however, our online which was not impacted by closures grew double digits in quarter two and represented more than half of our business in china additionally our business in china travel retail grew rapidly as well as retail so we had four years of exceptional double-digit growth in china every quarter and we expect this strong trend to have the potential to continue frankly What you see in quarter two is just one specific segment, the brick and mortar, that affected by COVID restrictions went to single-digit growth, but the rest was all double-digit growth. So we remain absolutely excited by the potential of China. The long-term fundamentals that you were referring to in your question of the market remain really intact. There is the growing middle class continues. to develop the increasing per capita spending continuous, at least in all the data we see on our products. And what the agility for us to serve the Chinese consumers wherever they buy, meaning online, travel retail, brick and mortar, we are improving in all these elements. We are increasing the number of cities where we have brick and mortar. We are increasing the coverage online. You heard in the prepared remarks our reference to JD and the incredible success in JD, where Estelode is already number one shop in there, and the travel retail, where we continue to be very strong, super excited by Hainan and the huge quality expression of our brands that is happening there. So very strong Chinese consumers' trends and, in our opinion, a great, great future.
spk12: Thank you. Our next question will come from the line of Peter Grom with UBS.
spk04: Hey, good morning, everyone. Hope you're doing well. So I just wanted to ask about the operating expense leverage we have seen here today. It's just, you know, when I take a step back and look at the first half of this year and compare it to pre-COVID levels, it's just very impressive what you've been able to do there. And I know there's mixed benefits, sales leverage, you know, cost savings, and obviously costs that have yet to fully return to pre-pandemic levels. But Is there a way to help us frame how we should think about operating leverage longer term? Is there a way to kind of disaggregate the benefit you've seen here today that you believe has greater staying power versus what you might expect to really come back as we return to, I guess, quote, unquote, a normal environment? Thanks.
spk08: Yeah, thanks, Peter. You know, in terms of the operating leverage that we've seen thus far, it has been terrific, obviously, in the first half. You know, one of the things to keep in mind is, you know, our launch cadence in terms of when we actually have big product launches does affect quarter-to-quarter performance. But, you know, we certainly have, you know, continued to see some of the benefits of costs not returning. But brick and mortar is picking up, and clearly, you know, we're continuing to ramp up in the third and fourth quarter. are selling staff to support, you know, greater brick and mortar sales. So when you look at our full year, you know, the overall margin expansion that is included in our guidance, you know, is, you know, around 90 basis points. So well ahead of our, you know, guidance in terms of 50 basis points a year from a long-term perspective. And that includes not only some of the costs not fully returning, but also includes some of the incremental costs related to managing this pandemic, some of the safety procedures we've had in place, some of the additional testing that we have in place, et cetera, that we are incurring. But we certainly expect continued growth from our higher margin channels and categories in the future that will continue to benefit us going forward.
spk12: Thank you. Our next question will come from the line of Lauren Lieberman with Barclays.
spk01: Thanks. Good morning. I wanted to chat a little bit about the Americas and growth that you've seen in particular in North America outside of kind of COVID-related recovery. And here I'm thinking about some of the expanded distribution or consumer reach where you describe it, particularly the expansion of Ulta and Sephora doors into significantly new locations. So it's curious kind of what you're seeing in terms of how your brands are performing generally in those locations and and what you're seeing in terms of maybe new consumers coming into those franchises, again, as you think about that expanded consumer reach and your overall footprint broadening out. Thanks.
spk06: So let me start from there. First of all, we see our brands doing well in these new distributions. And, again, these new distributions, particularly the Target Ultra, the Cold Separat, that you are referring to, We are designed to get new consumers, particularly sourcing consumers from us. And we see this working and our initial projections continue to be strong. However, I want to clarify that in quarter two, a very small percentage of our growth was coming from those already. It's just the beginning. So the larger majority of our growth, of course, is true, was coming from just other organic activities that we are doing in the region. For example, we are strengthening and diversifying our product categories. Again, make-up renaissance is really getting also into new use education. So there are some fundamentals which are improving here. for the post-COVID. Then we are gaining share in many of the categories, subcategories. For example, Tom Ford, the German loaner, is doing outstanding. The skincare gains share. The ordinary is an important part of building our overall market share in the region. And then other things I could mention is our innovation and our marketing program has been super strong. And the distribution choices that we have done has increased our abilities to source new consumers. But apart from the new brick-and-mortar choices, the online progress in North America is bringing a lot of new consumers, particularly consumers that before were not shopping online, and now they're shopping omnichannel. And that's why our omnichannel progress in North America is also playing a strong role to sustain our growth now in the long term and continue sourcing new consumers. And finally, we are really executing with excellence. We are investing fast in rebuilding the stores in the correct way. We are investing fast in improving our execution online, as we discussed also in previous calls. And so this combination of investing, but at the same time, thanks to our restructuring program, we are increasing productivity of brick and mortar as brick and mortar continues. We are making also our ability to leverage the growth in North America much stronger than what it was before. And that's why North America is not only successful, not only successful, recovering strongly from the COVID, but also becoming a powerful engine of growth for the long term in this model of strategy, I should say, of multiple engines of growth.
spk12: Thank you. Our next question is going to come from the line of Andrea Teixeira with JP Morgan.
spk09: Thank you and good morning. My question is regarding EMEA-X travel, so I was hoping to see if Fabrizio can discuss a bit of that scenario. Unfortunately, Omicron was first into the UK, and as you exit the quarter, how continental Europe has been and the UK has been performing. And then as a follow-up, I think, Tracy, you mentioned, and I appreciate the bridge for the margin front in the third quarter. I think you explained that the timing of some of the hiring of bricks and mortar and also some market launches and waiting on the market spend. Can you give us some perspective if this is a result of just timing? And then we should see, again, the operating leverage, as you pointed out, 90 basis points for the year. as you go into the fourth quarter. Thank you both.
spk06: Yeah, I'll start from the travel. If I understand, your question was on travel and travel retail?
spk08: No, ex-travel retail. EMEA, ex-travel retail.
spk06: EMEA, ex-travel retail. Sorry, I didn't hear. No, EMEA, ex-travel retail was very strong, and we saw good progress in many markets. And also, in EMEA, the big acceleration is coming from online. across every single country. So very exciting progress with all our brands with progress. Also in EMEA, there are emerging markets which are doing very well, like India, the Middle East, Russia. And so all the overall EMEA is, again, a strong engine of growth that has been built over this year and now in the post-COVID acceleration is proving its role. building strong engines of growth. So all very strong. Tracy?
spk08: Yeah, and in terms of the margin, you know, we still in the second quarter did have, you know, quite a few open positions as it relates to our selling staff and certainly hope to be able to close that gap in the third and the fourth quarter. The big difference in the second half of the year is we will be spending more advertising as a percent of sales in the second half of the year to support the launches that we mentioned in the prepared remarks, and that will certainly impact, particularly in Q3, the margin, and we expect to see the benefit of that in Q4, but really beyond. I mean, these are our largest skincare brands, particularly Estee Lauder and La Mer, and the Hero franchise reformulations that we are doing on some of the products are really, you know, quite significant for us going forward. So, you know, that also should help the skincare category grow a bit. But again, skincare is largely affected by some of the shutdowns in, you know, high, you know, high concentration skincare markets like the Asia Pacific market. So, Certainly, as that market picks up, we expect that skin care will pick up as well. That, too, I would attribute to more of a temporary slowdown than anything else.
spk12: Thank you. Our next question will come from the line of Chris Carey with Wells Fargo.
spk05: Hi. Good morning. On the travel retail business, so low double-digit growth, again, keeps the division growing, which is great to see. And you noted that APAC continues to drive growth. I think you said with China travel retail growing rapidly. I guess I'm just trying to balance the strength that you're seeing in China travel retail with, I think there was a comment in the press release just around high non-traffic being impacted by restrictions. And so can you maybe just dimensionalize strong growth from the Chinese consumer and travel retail with high non-travel being negatively impacted with the strength that you're seeing there? And then I guess just bigger picture on this broader channel, just how this is developing in Asia, right? I think there's been a view that mainland China and Japan and Korea can continue to a little bit of really strong growth, just even as the Chinese travel retail business becomes so much bigger. And I'm just curious your latest thoughts on that. So thanks for all that on travel retail.
spk08: Well, let me start with your question on what we called out in terms of some of the disruptions that occurred in Hainan relative to the strong low double-digit growth that we had in travel retail. So the first quarter, actually, we had – greater double-digit growth in travel retail. And so when you look at the first quarter versus the second quarter, while it was double-digit, it was a bit less than in the first quarter. And that was a direct impact from the restrictions that occurred within China that impacted Hainan. We don't expect that level in the balance of the year. So we do expect to see travel retail pick up in the balance of the year. So Hynan, you know, continues to be a very strong driver of our travel retail business. And, you know, and it is incredibly luxurious. And I know Fabrizio likes to talk about Hynan. So I will let him, you know, expand on that as well. But But we continue to expand our presence in Hainan and continue to see fantastic, fantastic consumer receptivity to our brands in Hainan.
spk06: Yeah. So to speak to the travel retail trend, first of all, the travel retail globally was strong and was accelerating versus the previous quarter. And, yes, in Asia there were some elements of acceleration. Yes, Aynan was very strong, as Tracy was saying, but I want also to underline that there was a strong growth in EMEA in North America, as I think Tracy said during her prepared remarks as well. which was linked to more traffic during holidays in these regions, despite the Omicron variant growth. Now, this is a very important sign because the reactivity of travel retail sales to traffic increase is extraordinary. And we have seen this in EMEA, for example, during the last quarter, quarter two. So the first good news is that where traffic increased, travel retail respond very, very fast. And the other good news is what Tracy was speaking about, about the overall retail growth across despite some of the closures and some of the restrictions. On Hainan, Hainan is becoming an extraordinary place of luxury with amazing experiences. So it is probably one of the channels around the world which is more equity building for the brand. So that's an important thing. Also, in Ireland, there are many new retailers which are opening. And so, in Ireland, there is more distribution being built in several retailers which are investing in the island. That's also something that will generate, that will continue to generate expansions growth over time.
spk08: And regarding your question on travel outside of China, once travel restrictions are lifted, we certainly expect people to start traveling back to Japan and Korea and Thailand and other travel destinations for vacation as well as for business. So we certainly expect that those travel retail corridors will continue to recover, similarly to what we've seen the start of in EMEA and the Americas, although traffic is still well behind, obviously, pre-pandemic levels. So more growth to come as it relates to travel retail.
spk06: Yeah, and maybe one thing on that to add, Tracy, is the clarification of when the growth of international travel will restart. this will be only moderately cannibalizing anything like Hainan or domestic travel. Because remember that the external travel is only for people with a passport, and there is a relatively small percentage of the population has a passport to travel internationally, while Hainan is domestic travel and is open to the entire population. So when international travel will restart, this will be almost all net extra.
spk12: Thank you. And our next question will come from the line of Callum Elliott with Bernstein.
spk02: Hi, thank you. Fabrizio, we've seen a lot of leadership changes in the past few months, right, at the top of the business with, I think, both Chris Hope and Cédric Prouvé stepping down. And I think you've also made some structural changes with, I think, Joy now reporting straight into PETA at International rather than into Asia Pacific. So this is sort of elevating the importance of the mainland China business. So just hoping that you can talk a little bit about some of the structural and leadership changes, as well as maybe the culture of the business and how that's changed since 2009, in the context of how should we think about leadership transition risk and how that's evolving.
spk06: By the way, this is a great question, and I admire the knowledge you have of our amazing talent and team, so thank you for the question. So what you're seeing actually is the reflection of our culture. What you're seeing is some organization changes reflecting the shape of the business, particularly the elevation of China to be an independent region, given the importance of this region and the need of coordination with travel retailers, with the other key parts of the company, including online. And so that's an important next step that will make our ability to work with China and in our ability to our China team to get support for our growth capabilities increased. So the organization is basically increasing our power of execution in China. The changes, the organization changes. In terms of the changes of senior leadership, They are all well-planned retirement plans. The culture of the company is that our leaders share with us their plans in advance. We plan this with time and in a very professional way. And the very good news is that we have extraordinary succession plans already in place. We call it all the succession plans. of this position has been managed mutely with people that were ready for taking this position, that were trained for years to take this position. So I think you should take out of this the strength of our succession planning that is also the reflection of our culture and the culture is more and more collaborative cultures, which is united by our compass work, by our strategy work, and our collaborative execution is the result of very clear common goals and very uniting reward systems that make this organization a working team. And this has been since 2009 to today is progressing step by step gradually. I think today we are a well-oiled organization at the top.
spk12: Thank you. Our next question will come from the line of Olivia Tong with Raymond James.
spk07: Great. Thank you. Good morning. I wanted to ask you a little bit about brand support and promotion as we've obviously been hearing more and more about the cost to compete, particularly around key events like 11.11 in China, more promotions, deeper discounts, live streaming deals, cost of influences, things like that. So can you talk about how the market's evolving and your view on the investment spending necessities to succeed in Asia, even if you could give an idea, it's kind of funny to ask, but an idea of magnitude of volume versus price contribution perhaps in Asia, and then sort of part and parcel with that, if you could just sort of put The Q3 versus second half guidance in context, you know, the margin deceleration is fairly dramatic. That's implied in Q3. But a big bounce back in Q4, I get being prudent. I get that you mentioned the ad step up. But just it seems like you feel relatively optimistic about the future. So just if you could provide some context around that, that would be fantastic. Thanks so much. Appreciate it.
spk08: Okay. Well, in terms of, you know, 11.11, yes, you know, certainly 11.11 continues to be, you know, to get, you know, more and more competitive. And we've, you know, spoken in the past about how we do promotion as it relates to 11.11. A lot of it's done with samples. And certainly, you know, increasingly there is more and more media support for 11.11 as well. It is a big opportunity for us, as we view it, to recruit new consumers. And it is one of the biggest events that we have during the course of the year to, in a concentrated period of time, have the ability to recruit new consumers, which then we retain, work to retain over the balance of the future years. Media costs have gone up, for sure. You know, live streaming activity has gone up, for sure. And we have, you know, shifted and adjusted our activity to, you know, to make sure that our brands perform well within that environment. So it's a big planning event for the organization. We're really pleased with how our brands performed in general during 11-11. And I've already started planning for next year's 11-11, which that's how long in advance we have to plan for it. So as it relates to the cadence of Q3 and Q4, you know, we have spoken, you know, Olivia, I know you know, for many years about the fact that, you know, we focus on the year. And we guide quarter to quarter, but we focus on managing the year. And in any given year, we might have, you know, very large product launches in the first quarter or, in the case of this year, in the third quarter. And so we do feel very positive about the future, obviously, and it is a rebalancing, to your point, between the third quarter and the fourth quarter. The other thing that is embedded in our guidance for the third quarter quite honestly, is the fact that Omicron is still impacting brick and mortar. We also have the beauty of weather here in New York, but Omicron is impacting the environment and in brick and mortar. So we are seeing a slower recovery in the third quarter for brick and mortar than certainly we we saw just a few months ago. And so we are cautious as it relates to that. And then I did mention that we do have a step up in, you know, continued step up in some of our shipping costs and some of our supply chain costs as well. We have taken pricing. So the second half of the year, our pricing increase is 4%. It was 3% in the first half of the year, you know, hence the average of 3.5%, which I spoke about in my prepared remarks. And we know we have agility going forward if this environment continues to take additional pricing as it warrants. But the combination of pricing and cost savings are really what allows us to invest for long-term sustainable growth in things like a new innovation center in Shanghai, the new plant that we are investing in in Japan, as well as the investments we're making in the other capabilities that Fabrizio spoke about and deliver a very, very strong year in terms of double-digit top-line growth and 90 basis points of margin expansion.
spk06: Yeah, and if I can just underline one thing that Tracy has explained, is that this really between quarter three and quarter four is a rebalance. We are taking up the year, and we believe in the strength of the year. And if you look at our fiscal year estimate, is our guidance, is it's going to be a very strong year. And it's going to be a very strong quarter four in this year. The quarter three, we have three big, big launches where we have the investment in quarter three and the benefits in quarter four. And that's the important thing. And then the price increases that we are accelerating as of January, February in certain regions, as Tracy explained. have the biggest impact, the full impact in quarter four. And so that's the rebalancing we're doing. But in total, we are going to deliver, we are guiding a very strong year and a strong quarter four. And we are confident on it.
spk08: And because I know our brands are listening, so we do have three big skincare launches in the third quarter, but we do have makeup, fragrance, and hair care launches as well. that we are supporting.
spk12: And we do have time for one final question. And our last question that we'll take today will come from the line of Wendy Nicholson with Citi.
spk11: Hi. Thanks very much. I'm hoping I can sneak two in because I think what's kind of making folks nervous is the slowdown in travel retail. So can you just speak to your confidence? I mean, obviously, you know, consumers are still managing to get their skincare product and their fragrance and whatnot. They're just shopping more online. So is there any concern that you have that sort of longer term, you know, travel retail is going to be less of a buoyant channel for you? Maybe there's just been a shift in consumer behavior? Or how confident are you that when people start traveling again, that travel retail channel is going to really accelerate? And then I don't think you commented specifically, and it goes back to Dara's question, I think, on the China promotional environment. Again, that's something that we've heard from other players out there that maybe Este in particular has been exceptionally promotional in China. Can you just comment on that and sort of give us your take on that? Thanks.
spk06: Yeah, first of all, we are not promotional in China. In China mainland, actually the majority of our activities are sampling rather than pricing promotion. So if for promotional, we mean that we have increased our sampling, our product that we give as a gift when that's our promotional model. Yes, we have been obviously in 11-11 during the quarter. we have done the promotionality needed to succeed in that event, I think.
spk08: And, Wendy, just realize that retailers with the slowdown in brick and mortar are also promotional. And so they are using promotion to drive traffic. So when we have seen and we saw a bit of this, as well in the U.S. market when brick and mortar slowed down that, you know, some of the retail activity was quite promotional. So that is clearly a retailer-driven decision.
spk06: Yeah, I think you, Teresa, clarified that retailers pricing a promotion, they decide, we don't decide. But our promotions, as I was saying, is a lot about sampling and creating trial opportunities. So it's expansive rather than pricing. And then obviously the retailers do what they believe is right for them in a given environment. Your question on travel retail, I think I have extreme high expectation for the long-term quality of travel retail growth. I think this is an extremely promising channel. We have just seen the beginning of what will be a long-term powerful channel expansion for travel retail. And I spoke to this several other times. There are two drivers of travel retail which are very important. One is obviously the amount of travelers and what happens to travel, so the traffic. But the other is the conversion, so the amount of travelers that become shoppers. And the conversion of travelers into shoppers has been pre-COVID, was still in the 10%, 15% dependent by region. So enormous expansion possibility or conversion are still in front of us. And the arrival of online in travel retail, which we call pre-tail, that today is very strong in Asia, but just at the very, very beginning in any other region of the world, this is, we know, is a huge conversion driver. Because where this happened, we saw conversions of travelers into shoppers go from the 10-50% into the 30s. So you can imagine over time, with the expansion of the online possibility to buy pre-tail, that conversion will dramatically grow around the world of travel retail. When you add to this perspective the fact that the domestic duty-free Hainan thing is going to be not cannibalized a lot when international travel will restart, as I explained in a previous answer. And so that when international traffic will come back, a lot of it will be net extra. And when you have in front of us the proof that I was quoting before, then where, for example, in EMEA, we have seen some traffic coming back during the recent holidays, we saw great sales recovery. And so the responsiveness of travel retail to traffic coming back is very, very high. And so when you combine all this consideration and you put on top of it that we have a great travel retail team, not only with extraordinary commercial capabilities, but with great marketing capability. And that the traveling stores, the stores for travelers are becoming more and more an important trial driver for everything we do, a super important equity building opportunity for the brands. And so they're becoming an integral part of the creation of the overall consumer experience and the trial repeat dynamic that we built. So I hope you realized why we do believe in travel retail as a long-term strategy channel.
spk08: And again, I think we feel very good when you look at this quarter, you know, the results that we achieved. You know, travel retail had a great quarter, you know, as we said, low double-digit growth, but the overall company grew at 14%. So, you know, the diversified engines of growth that we have really gives us the flexibility to continue to deliver overall against our expectations and grow our consumers and grow our profits.
spk12: Thank you. If you were unable to join for the entire call, a playback will be available at 1 p.m. Eastern time today through February 17th. To hear a recording of the call, please dial 855- 859-2056, passcode 957-5055. That concludes today's Estee Lauder conference call. I would like to thank everyone for their participation and wish you all a good day. Thank you.
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Q2EL 2022

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