Estee Lauder Companies, Inc. (The)

Good day, everyone, and welcome to the Estee Lauder Company's fiscal 2023 first quarter conference call. Today's call is being recorded and webcast. For opening remarks and introductions, I would like to turn the call over to the Senior Vice President of Investor Relations, Ms. Rainey Mancini. Please go ahead.

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 these forward-looking statements. To facilitate the discussion of our underlying business, the commentary on our financial results and expectations is before restructuring and other charges and adjustments disclosed in our press release. Unless otherwise stated, all organic net sales growth 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 that 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, Reni, and hello to everyone. It is good to be with you today. Since we spoke in mid-August, the headwinds of COVID-19 restrictions in China, high inflation globally, and a strong U.S. dollar intensified significantly. Amid the increased complexity, we delivered organic sales down 5% in line with our outlook and adjusted diluted EPS higher than expected. Even in these conditions, our multiple engines of growth strategy empower us to seize prevailing growth opportunities. Indeed, we realized outstanding performance in many developed and emerging markets around the world, to partially offset the impact of COVID-19 restrictions in Asia trial retail and domestic China, as well as tighter inventory management by some retailers in the U.S. To reflect this prolonged and heightened external pressure, we are reducing our outlook for fiscal year 2023, most notably for the second quarter. While Tracy will discuss our revised outlook in detail, there are three primary drivers. The first is the impact of ongoing COVID-19 restriction in Asia travel retail, particularly Hainan. The restrictions are leading to a slower return of tourism versus what retailers had anticipated, resulting in tightening of inventories. While it is significant, this near-term temporary pause does not diminish our deep conviction in Heinen for the long term, as it is among the best brand-building destination for new consumers' acquisition. The second driver is the tightening of inventory by some retailers in the U.S., and the third is the far stronger U.S. dollar. Encouragingly, beyond these headwinds, consumer demand is robust in markets which are emerging from the pandemic. Evidence in the underlining fundamentals of our first quarter results and retail sales growth. Our optimism in the long-term growth opportunities for our brands and for Prestige Beauty is intact. During Syscadia 2023, we plan to continue investing in our brands, including for innovation, advertising, strategic entry into new countries, and expanded consumer reach to grow profitable prestige beauty share. We expect a gradual sequential improvement to low double-digit organic sales growth and high teens adjusted EPS growth on a reported basis in the second half of fiscal year 2023. As these pressures begin to abate, the momentum in other areas of our business builds and our ongoing investments drive growth. Let me now share some insights from our first quarter, as while we had had wins, we also had many bright spots that give us confidence in the second half and beyond. We realized double-digit organic sales growth in many large developed and emerging markets around the world. Japan and the UK grew strongly, alongside Brazil, India, the Middle East, and Thailand, to name just a few. Brick and mortar prospered in these markets as we welcomed consumers with high-touch services, engaging activations, and newness. Domestic China delivered sequentially improving organic sales trends of down single digits, driven by excellent growth online, and better performance in brick and mortar. Our luxury brands, La Mer and Tom Ford Beauty, contributed to online growth, as did Aveda and Bobby Brown, among others. We are very encouraged by the terrific results of our expanded consumer reach on JD and Dowin. From a retail sales perspective in the online channel, we grew nearly twice as fast as Prestige Beauty in China to gain share. In the U.S., our freestanding store excelled, benefiting from both enhanced omnichannel capabilities and greater demand for our high-touch services, be it artistry at Mac or personalization at Jo Malone London and Le Labo. Specialty Multi also performed especially well, powered by traditional store and enhanced by the partnership of Ulta Beauty at Target and Sephora at Kohl's. Clinique, MAC, and Bobbi Brown led growth. Given excellent results in Ulta Beauty over the last year, MAC and Bobbi Brown are further expanding their presence. We continue to see promise in the U.S. evidence in its overall retail sales growth in Prestige Beauty, despite the recession risk, and the strong performance our brands delivered in freestanding doors and specialty multi. We remain committed to investing in innovation, advertising, and granular consumer acquisition strategies as we aim to best capture the market growth opportunities. Looking at brands globally. 13 brands rose organically, collectively increasing high single-digit to represent over half of our organic sales. Among the 13, MAC excelled in makeup, La Mer in luxury skincare, Jo Malone London in fragrance, and Aveda in hair care. While The Ordinary, our newest brand, appealed to consumers with its authenticity and innovative approach to ingredient transparency. Fragrant sales rose an outstanding 18% organically and expanded in every region. Tom Ford Beauty, Jo Malone London, Le Labo, Killian Paris, and Édition de Parfum Frédéric Malle all contributed, driven by sought-after innovation and heroes as our luxury and artisanal portfolio evolves from strength to strength. For example, Jo Malone Lando's momentum continues with gains balanced across the regions. Innovation serves as a catalyst for growth. In China, the new night collection resonated beautifully, as did the limited edition brick collection. Globally, the brand brilliantly leveraged its hero strategy, creatively reimagining the power of English PIA and Frisia in a campaign to recruit new consumers. Demand for fragrance was even stronger as ongoing supply issues of glass and componentry constrained this still excellent sales growth. Profitability for fragrance improved despite the significant currency headwinds, further evidence of the benefits derived from our strategic pivot to the higher end of the category. Haircare double-digit organic sales growth was fueled by increasingly diverse growth engines. We were thrilled to launch Aveda in mainland China, marking our entry in prestige haircare in the market. In the U.S., Bumble and Bumble realized gains from strong results in Ulta Beauty at Target, and expansions into Macy's. In skincare, while the Estée Lauder, Dr. Jart, and Origins brands were most pressured by reduced retail traffic and travel in China, several brands still prospered. La Mer, Bobbi Brown, and The Ordinary grew organically, driven by coveted heroes and newness to showcase the gains to be had from entry prestige through luxury. Innovation also resonated strongly in skincare, which bodes well for the future when these transitory pressures abate. In China, Estee Lauder luxury-oriented Renutri was highly sought after, and the launch of Renutri Ultima Diamond Transformative Brilliant Serum boosted overall demand for the franchise. Clinique Smart Clinical Repair gained momentum in China and also in the U.S. as its new moisturizer complemented the regimen's popular serum and eye cream, which launched last year. The Clinique Smart franchise benefited from its 360-degree marketing campaign of these three products, featuring powerful scientific credentials and claims. Makeup Renaissance was evident as markets both reopened and evolved in recovery. The category growth in emerging markets was especially striking abroad-based, from Latin America to the Middle East, India, and Southeast Asia, while makeup also grew in most developed markets in Western Europe, along with Japan and Korea. MAC had a remarkable quarter, fueling passion for makeup around the world growing high single digits organically. Consumer embraced its unparalleled artistry, and the brand's innovation proved captivating, especially Powder Kiss Velvet Blur Lipstick for the lipstick finish and elevated packaging, as well as MAC Stack Mascara. MAC's creative marketing activations further contributed to growth. In Southeast Asia and Latin America, the brand's TikTok challenges realized standout results, driving significant new consumer acquisition on Lazada's Superbrand Day, a strong double-digit volume growth across Latin America, as over 400 content creators contributed to the campaign. Before I close, I'm also pleased to share that today we will release our fiscal year 2022 social impact and sustainability report. It features exciting progress made possible by the extraordinary efforts of our employees around the world across our ESG areas of focus and previously stated goals. The report also details new goals for electric vehicles, water reduction, and responsible sourcing. Finally, on the last few earning calls, I discussed actions we were taking to make more progress in our commitment to racial equity as well as women advancement and gender equality, which are also reflected in the report. In conclusion, the current external pressures are many. However, As we look ahead, we remain confident in our focus on advancing our long-term growth strategy, further balancing and diversifying our multiple engines, and fully leveraging the long-term promise of Prestige Beauty. We aim for fiscal year 2023 to be another year of progress on our strategy, despite the headwinds. In the first quarter alone, We set the stage to expand our luxury portfolio, having announced a deal to create Balmain Beauty with the Couture Fashion House. We extended our consumer reach in productive distribution in high-growth channels to match success across regions and continue to strategically expand brands into new countries with a data launch in domestic China. We also welcome colleagues into our new China Innovation Labs in Shanghai, amplifying our ability to best create for the Chinese consumer. And we began limited production for skincare in our new manufacturing facility near Tokyo. I would like to close with my deepest thanks to our employees for their exceptional commitment amid the complexity of the environment. Your creativity, wisdom, and passion are beyond compare. Thank you. And I will now turn the call over to Tracy.

Thank you, Fabrizio, and hello, everyone. Our first quarter organic net sales declined 5 percent and earnings per share was $1.37. Net sales were in line with our expectations and earnings per share exceeded them, even with incremental headwinds in the quarter. While sales overall met expectations, our mix of sales was different than we expected. In August, our outlook anticipated that first quarter sales would be negatively impacted by continued COVID restrictions in China and Hainan, with gradual improvement throughout the first half of the fiscal year as the restrictions lifted. However, the impact on our first quarter sales was greater than we anticipated in Hainan, as stores were closed for most of the quarter, and as they reopened, traffic remained quite modest which resulted in lower shipments due to the anticipation of a slower pace of recovery. Our outlook also reflected the comparison to the prior year in the U.S., when certain of our retailers secured shipments earlier for holiday due to supply chains and concerns, in stark contrast to the tightening of inventory by retailers this year due to concerns about slower traffic. Our actual results for the quarter reflect even tighter than expected inventory management with certain retailers in the U.S. These additional headwinds were somewhat offset by a faster pace of recovery in other parts of Asia Pacific and in EMEA, as well as the benefit of strategic pricing actions we took in July and August. From a geographic standpoint, organic net sales in the Americas declined 3%, reflecting the timing of shipments in the prior year, as well as the tightening of inventory this year. The timing of shipments in the U.S. contributed six percentage points to the overall region's prior year growth. In Latin America, nearly all markets grew double digits, fueled primarily by the strong recovery of makeup. In our Europe, the Middle East, and Africa region, organic net sales declined 5%, primarily due to continued challenges in travel retail and APAC, including the negative impact from foreign currency transactions in key international travel retail locations of 2%. Our global travel retail business declined as the ongoing COVID restrictions in China curtailed travel to Hainan. Stores there were closed for most of the quarter and traffic has been slow to return, resulting in lower shipments as we support stricter inventory management with certain retailers. Conversely, Travel retail sales in European markets and in the Americas rose triple and double digits, respectively boosted by increasing resumption of professional and personal travel. Net sales in the United Kingdom increased with double-digit growth from the ordinary. Elsewhere in EMEA, the lifting of COVID restrictions and the return of tourism in the region drove growth in many markets led by India, the Middle East, and Turkey, and resulted in double-digit growth in brick and mortar. Organic net sales in our Asia Pacific region fell 7% due to the ongoing COVID restrictions impacting brick and mortar sales in Greater China and travel retail in Korea. In Korea, double-digit growth from nearly all brands was more than offset by the decline from Dr. Jart's travel retail business. The rest of the region delivered strong net sales growth, led by Thailand, Malaysia, and Japan. Many markets in the region continued to recover as restrictions lifted and traffic returned to stores. From a category perspective, fragrance-led growth with organic net sales rising 18%. Strong consumer demand for our brands and innovation drove growth. Our luxury and artisanal brands continued to thrive, led by Tom Ford Beauty, Jo Malone London, and Lollabo. Net sales from Clinique rose strong double digits. winning across all regions with the Clinique Happy product franchise. Our hair care net sales rose 11% organically. Aveda led category growth, driven by double-digit growth in Europe, the Middle East, and Africa, from Hero products and strong innovation, including the launch of the Color Control product line. Organic net sales in makeup declined 6%, driven by the COVID restrictions in China, as well as a difficult comparison to the prior year period, due to the timing of shipments for holiday in the U.S. Net sales rose strong double digits in Southeast Asia and in the emerging markets of EMEA, due to strong performance from MAC, Bobby Brown, and Estee Lauder. MAC continues to be an overall top performer, driven by the success of both Hero products and strong innovation across the foundation, lips, and eye subcategories. Organic net sales in skincare declined 11%, This category has been the most impacted by the COVID restrictions in Hainan, where skin care accounts for a majority of our business. Our gross margin declined 190 basis points compared to the first quarter last year. The positive impacts from strategic pricing were more than offset by higher costs due to promotional items and inflationary pressures in our supply chain. Operating expenses increased 250 basis points as a percent of sales driven by the reduction in sales. Operating income declined 29% to $668 million, and our operating margin contracted 440 basis points to 17% in the quarter. Diluted EPS of $1.37 decreased 28% compared to the prior year, slightly better than expected as a result of effective cost management. The impacts from foreign currency transactions in key travel retail locations and the exit of certain designer licenses negatively impacted diluted EPS by 4% and 3%, respectively. During the quarter, we utilized $650 million in net cash flows from operating activities, reflecting increased working capital, primarily due to the timing of payments and higher inventory levels, as well as lower net income. We invested $152 million in capital expenditures for supply chain improvements, online capabilities, and distribution expansion. We returned $325 million in cash to stockholders through both dividends and share repurchases. And additionally, this morning, we announced a 10% increase in our quarterly dividend. So again, we delivered our overall quarter one results as we anticipated. Now let's turn to our outlook for the remainder of fiscal 2023. While we believe the headwinds that impacted our first quarter results are largely temporary, it is also apparent that both the timing and speed of the stabilization of inflation and recovery from both the pandemic and currency challenges are uncertain. As retailers in Hainan were prepared for a faster recovery of traffic to the island with their inventory levels of our products, we have further modified our shipments to be more in line with a slower retail environment. And although we expect the adjustment to inventory by certain of our retailers corresponding with potentially lower traffic, To continue into the second quarter, particularly in Hainan, we believe this adjustment will subside in the second half as COVID restrictions ease and consumers begin to travel with less safety restrictions in China. Until that happens, ongoing restrictions are expected to result in lower net sales in these areas. We also anticipate the tighter inventory management in the U.S. to abate in the second half, given the still strong demand for our products at retail. We expect the remainder of our first half performance to be pressured as we navigate through these uncertainties. Despite the headwinds to net sales, we remain confident in the strength of our business strategy and expect to sustain our investments to drive long-term profitable growth. We plan to continue to invest in the areas of advertising, innovation, production capacity, consumer engagement, as well as new consumer reach, and continued strategic entry into new countries for some of our brands. For the second half, we anticipate trends to improve sequentially as restrictions are lifted, travel throughout greater China, including Hainan, progressively resumes, and the tightening of inventory subsides in Asia travel retail and in the U.S. We expect continued recovery in various markets in EMEA and Asia Pacific for the balance of the year. Currency is also projected to be a significant drag on our reported results in the second quarter and for the full year as the U.S. dollar has continued to rapidly strengthen against key currencies. As we entered fiscal 2023, we took strategic pricing to mitigate higher than normal inflation. Both the magnitude and speed of currency movements experienced thus far, combined with inflation, have further suppressed our expectations for the balance of the year. Specifically, based on mid-October spot rates of 0.978 for the euro, 1.122 for the pound, 7.29 for the Chinese yuan, and 1436 for the Korean yuan, currency translation is anticipated to continue to negatively impact reported sales and diluted EPS growth for the second quarter and for the full year. We expect organic sales for our second quarter to fall 11% to 9%, primarily reflecting the continued risk of disruption in Hainan, leading to further tightening of inventory and continued tightening of inventory by certain retailers in the U.S. Currency translation is expected to be dilutive to reported net sales by seven points, with an additional two points due to the impact of certain foreign currency transactions in key international travel locations. The impact of sales from certain designer license exits are expected to dilute reported growth by approximately one point. We expect second quarter adjusted EPS of $1.19 to $1.29 for a decline between 60% to 57%. Currency translation is expected to be diluted to EPS by 20 cents, such that constant currency adjusted EPS is expected to decline between 54% and 50%. This includes the negative impact from certain foreign currency transactions in key international travel retail locations of approximately 7 percentage points. For the full year, we expect organic sales growth to range from flat to up 2%. Currency translation is expected to dilute reported sales growth for the full fiscal year by 6 percentage points, and we expect an additional 2 points of dilution from the impact of certain foreign currency transactions in key international travel retail locations. The impacts of returns associated with restructuring and other activities and sales from certain designer license exits are each expected to dilute reported growth by approximately one point. We expect full-year operating margin to be approximately 16.1%, a 360 basis point contraction from the prior year period, primarily due to the geographical mix of sales, foreign currency impacts, and the strategic investments I previously mentioned. We now expect our full-year effective tax rate to be approximately 25 percent, reflecting the change in our estimated geographical mix of earnings, and less benefit from excess tax benefits related to share-based compensation. Diluted EPS is expected to range between $5.25 and $5.40 before restructuring and other charges. This includes approximately $0.44 of dilution from currency translation. In constant currency, we expect EPS to fall between 21% to 19%, which includes a negative impact from foreign currency transactions in key international travel retail locations of approximately 10 percentage points. In closing, We remain confident about the long-term prospects for global prestige beauty and in our multiple engines of growth strategy. Despite the temporary external challenges, we plan to continue to invest selectively in strategic priority areas to support the ongoing growth of our amazing brands now and into the future and to gain profitable share globally. That concludes our prepared remarks. We'll be happy to take your questions at this time.

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 telephone keypad. To ensure everyone can 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. And our first question today will come from Dara Sinean with Morgan Stanley. Please go ahead.

Hey, good morning. Good morning, Dara. How are you? So obviously a large cut to top line expectations in terms of organic sales growth for the fiscal year today, but you still sounded pretty enthusiastic about underlying demand for retail in your comments. So can you just give us more detail on how much of the fiscal 23 top line revision is is more related to the temporary issues in terms of COVID or inventory issues you highlighted as primary reasons versus a second bucket in terms of underlying demand related to the greater macro pressure, et cetera. It would be helpful to know how much from each of those buckets is driving the top-line revision. And then can I just also ask a similar question in regard to 24-earnings? How much of sort of the 23 earnings degradation versus your prior guidance might extend longer term? Is your view that it's more temporary? And I just ask that in relation to what you've talked about recently, which is greater flexibility in ad spend, more agility to respond to market conditions, to just trying to sort of understand how that plays into the longer-term earnings outlook beyond this year and what we're seeing this year. Thanks.

Yeah. It's a complex question, so there's a lot to say. I will start, and then Tracy will join me, particularly in the second part of your question. So we are very confident in our retail trend globally and the growth of our business, even in these very difficult external complex times. So just to give you an example of this, in North America, our retail was growing in the quarter, mid-single digits. And I can explain later all the many things which are going well in this direction. But for example, in the quarter where our MAC brand really demonstrated it is back to growth with a 22% growth. And for our North America business to see MAC retail coming back so strongly is great news because, as you know, Clinique and MAC are a big part of the growth potential of our North America, particularly business. So great news to have MAC back into growing and market share growing brands in our top brands portfolio. Then when you look at China and you look at Chinese consumers combined, what was the retail in travel retail and the retail in mainland in domestic business, we grew mid-single digit, the retail, despite the inventories tightening issues that we have explained in the prepared remarks and in the press release. So there is an underlying strength. Then when you look, for example, to the China domestic recovery from the difficult moment of the Shanghai closure where we couldn't ship for some time. And we have spoken in the last quarter to the fact that we'll be gradually recovering this. And now the brick and mortar remained with less traffic, but we gradually improved the trend. And the decline has been still a decline, but less, much less. than in the previous quarter. And online, where there was no issue of restrictions, we have been growing above the market, double than the market, growing again market share in online in China. Then we spoke about the fact that we are very encouraged in general by the extraordinary progress in the fragrance business. Now, we have taken the strategic decision to focus on the luxury artisanal fragrances. And they are growing, they are profitable, and they are growing more than double-digit, as you heard from the numbers, even in presence of a complex supply chain, particularly for glass globally, which reduces the ability to get to the maximum potential in this moment to fully fulfill demand. So more to come, also because these supply constraints will abate over time gradually. So we have now our hair care business is also in the double-digit growth, which is the other engines that we are activating in our efforts to balance the growth across the different engines. And the launch in China of Aveda has been a big step of this, but also there is growth in the West very strongly in our hair business. The other interesting indication is the makeup. Makeup globally, except the lockdowns, situations in China and the travel retail issues that we have described. But wherever there is market reopening, makeup is doing very well and is continuing the recovery. As I said, with MAC performance at the center, which make us very, very happy because that's a very important step forward. And then we have extraordinary skincare innovation pipeline. Admittedly, the majority of it will come in quarter three. and in quarter four. But we will continue on our strong innovation in skin care. And then when you look at distribution globally, there are many good news of expanded productive distribution. So the start in China is very, very promising. And this reflects also in a promising start of 11-11. The distribution in the North America specialty multi is becoming more and more productive, and we are expanding the productive part of it in the next year. We'll continue this expansion. And there is also the important concept of expanding our brands in new countries, which technically is new distribution of our brands to new consumers. And obviously, Aveda in China is the big, but it's not the only one. And in quarter three, quarter four, we will continue with these expansions. So just a few examples to give you the sense that we are strong, by category, strong in healthcare, strong in fragrances, strong in makeup, wherever there is reopening, and so strong in the future, in the market that will reopen in the future. And in skincare, the large majority of the issue that we are encountering is linked to the lockdown and very strong innovation plan to restart growth there. So we remain very confident on the long-term growth. Proof of that, last point, is that in the second semester, if you look to our outlook, we are assuming to go back in total in the semester to double-digit growth, but obviously, as we explain gradually, in quarter three and then more stronger in quarter four. Tracy?

Yes. And so, Dara, obviously what's impacting us at the beginning of this year are significant unanticipated impacts to the business starting in the third and fourth quarter of last year and continuing into the first quarter. with disruptions as it relates to some of the lockdowns and key parts of our business. As we think forward and for the outlook that we've provided today, we are expecting some easing, as Fabrizio said, in the second half of the year. And in the fourth quarter, we're expecting further easing As we think about the construct of the business heading forward and assuming more stabilization of some of these matters, our business is intact in terms of the leverage that we can get, the margin expansion that we can get, and the growth that we can get as well. As Fabrizio said, consumer demand is strong. It has been disrupted. We are mindful, as everyone else is, that there could be you know, recessionary pressures in some of our key markets, and we are taking that into account. But the flexibility that we've created in our cost structure over the last few years remains intact and certainly positions us well in the future once there is more stabilization in the macro environment for continued strong top-line growth and also continued strong margin expansion and EPS growth.

Thank you. And the next question will come from Chris Carey with Wells Fargo. Please go ahead.

Hi. Good morning. Morning. I'm sure China and recovery will get plenty of focus on the call today. So perhaps I'll just actually – take a bit more of a medium, longer-term angle here. Fabrizio, can you just comment on the willingness of the Estee Lauder organization to take some of your brands beyond historical channels or types of interactions with retailers? I think you called out the specialty multi-expansion in the U.S. Clearly, in China, you've expanded with JD and Chinese TikTok. It feels like the organization is certainly becoming more comfortable working with different kinds of channels. And I wonder, you know, just in the context of a broader recovery, and certainly there's going to be a big debate on what is the true earnings power of this organization, I wonder if you could just comment on, you know, whether this is true, this concept of sort of expanded comfort with new opportunities and whether you see additional opportunities ahead and where those might be.

I think we've been very much focused on having the right level of distribution and focus where the consumer preferences are evolving over the last years. We operate in 12 channels now. versus basically one channel 15 years ago. And so discomfort is there. And you can see this, first of all, in our online expansion that continues to be strong. We have obviously our brand.com that continues to be expanded to more brands, to better sites, to more services in the sites. You have our 3PP, meaning the Tmall model, which is expanding around the world. Also, Alibaba is present in different countries, and we are collaborating with them in expanding the model in different countries, Lazada being probably the most evident example at this point of this expansion. We are playing with pure play more and more, and we have many examples, particularly in Europe, of this, and obviously our retail.com model. continue to be expanded. And then in terms of our comfort with specialty multi, I believe this is not new. We are very comfortable, and with specialty multi, we are doing well. We are growing. We have increased our market shares in the channels, well, in North America, but not only in North America, in many other parts of the world. And this is progressing very, very well. The other important news in this sense is direct to consumers. So our freestanding stores had a tremendous quarter. And we see the model of freestanding store coming back really strongly. wherever there is a reopening and wherever the consumers are really enthusiastic to go back to the brick and mortar. And today our freestanding stores are more efficient and more effective for the many efforts of cost management and the expertise in retail we brought in the company in the last years. So the return of traffic to freestanding stores is very promising. Just to give an example, our free-standing stores in the U.S. for fragrance brands were plus 33% in the course. So very, very strong sign of remaking. And so we will, the expansion, you said, you spoke about JD, but I spoke also about Douyin, exactly the Chinese TikTok, and this is a more recent expansion. And the interesting thing is not only we are more comfortable with playing in these channels, but we are winning when we play in these channels. Look at what happened in JD, when we entered, we entered really, really well with a great partnership and great results. So we are definitely continuing to manage our distribution. in line with consumer preferences, with evolution of where the consumers we serve go. However, we will keep in mind that our distribution has to be with high-touch services, has to be a distribution which serves the consumer not only with, you know, availability of product and pricing, but serves the consumer with our education, customization, care services, and they're focused on building brand equity or building experiences and they are focusing on building the unique elements of luxury. We are a pure play in luxury. So it's not only about distributing wherever there is mass of consumers. It's about distributing with quality, branding, and services. And so that focus has not changed, but we have become better in creating these environments in places where there is more and more consumer traffic. Tracy, do you want to add anything?

Thank you.

The next question will be from Steve Powers with Deutsche Bank. Please go ahead.

Great. Thank you, and good morning. Maybe following up on Dara's question, your comments were helpful, both Fabrizio and Tracy, but is there a rate of overall consumption or retail sales growth that you anticipate across your portfolio on the year? just that we can compare to the flat to 2% positive organic growth that you've assumed in your outlook. That's the question to kind of follow up. And then I guess I'd also, if possible, like a little bit more context around the retailer stocking that you've called out broadly, but particularly in the U.S., as it's not something I think, I don't think we've heard that from your peers. It's certainly a dynamic we've seen across other categories, but so far beauty hasn't been a focal point for that. So just again, a bit more detail on what you've seen, how much you think may be specific to your portfolio, you know, and what the outlook is, you know, through the holidays into the second half. Thank you.

So, let me start on retail. It's hard to do an average retail across all of our markets, as you might well imagine. I would tell you that in all of our markets, as we look at the projection for the year, retail is positive. It varies by market, but, you know, obviously given some of the disruptions and, you know, and slowness in certain markets, but it's positive in every market. In some markets, it's actually double-digit positive. And so, again, the gap between retail and net in many of our markets, certainly in our recovery markets, is not very big at all. In markets where we've had more disruption or we have, you know, the anticipation of a slowdown, that's where we're seeing some more of the disconnect between retail and net.

Thank you. And the next question will be from Dana Telsey from Telsey Advisory Group. Please go ahead.

Good afternoon or good morning. It feels like afternoon already. Good morning, everyone. As you think about what was embedded in your prior guidance in terms of pricing, is there any change that you're making in any of the categories of pricing that you're looking at? And then in the U.S., are you seeing any difference, whether it's your freestanding, whether it's specialty, multi, or department stores? Is there a difference in performance in how you're thinking about inventory go forward? Thank you.

So I'll start with the pricing. We are looking at, so there's no change in terms of the pricing that we took at the beginning of the year. We talked about pricing at about 5.5% on average across our markets, and that was taken in the July-August timeframe. We also anticipated in the prior guidance a secondary price increase, and we are looking at that in light of some of the inflation pressures and looking at taking slightly more pricing in certain markets, not across all markets. And that would be in the January, February timeframe. As it relates to our channels, you know, channels that have had slower traffic are the ones that we're most focused on in terms of obviously slowing our shipments to those channels so they don't end up overstocked so we can bring down some of the stock levels. in those channels. So we talked about, if you just think about the first quarter, we called out the channels that performed strongly for us in the first quarter. So our specialty multi-channel performed strongly in our first quarter. Online in China performed strongly in our first quarter. So those are the channels that continue to perform strongly for us. Other channels, you know, we are a bit more cautious. Freestanding stores, you know, performed strongly for us in the first quarter. And we expect in recovery markets that freestanding stores will continue to perform well. So we will continue, obviously, to supply our freestanding store network. We're both ourselves, as well as our retailers, you know, are a little bit more cautious on some of the traffic trends that are being anticipated. we are being a bit more cautious in terms of how we supply those retailers.

Thank you. And the next question will be from Brian Spillane with Bank of America. Please go ahead.

Hi. Good morning. And thank you, operator. Excuse me. Thank you, operator. Tracy, maybe just to follow up on the pricing and inflation question, can you just give us a little bit more detail on some of the sources of inflation and what's been incremental, I guess, since the start of the fiscal year and maybe a little bit of an expectation as you see it today. Do you continue to see that rising? Is that going to be a factor as we go into fiscal 24? Just trying to get a sense of how we should be thinking about continued inflation as we go through the balance of the year.

Yeah. I think we, you know, we certainly have seen, you know, quite a bit of inflation in our supply chain, particularly as it relates to transport. We do see that continuing in parts of our supply chain. In other parts, we actually see it moderating. We've seen wage inflation as well. And, you know, again, that, you know, has been incorporated in some of the pricing that we've anticipated this year. you know, we have seen, you know, advertising rates stabilize a bit. And so we're not seeing as much media inflation as we were seeing previously. So those are, I would say, the biggest areas of inflation that we're, you know, that we're watching. But the supply chain area is one that, you know, is a particular focus for us going forward. And again, you know, we one of the great things about our category. We do have pricing power, and so we have certainly exercised that where we see the inflationary impacts.

And I just want to add that we continue to remain on the same point of view we expressed in the last course, which is we are in a position to offset most of the inflations with pricing, and we are doing that. The other thing, however, which has emerged stronger in this last quarter is the currency. So the dollar has become even stronger. And so now we are also looking with the next consideration of possible price increases in January, February, to see if in selective markets where there is also a big pressure of currency and not only of inflation, we can also make some selective adjustments in these areas. But our goals remain to offset most of the inflation we're pricing. And then the rest, we are doing things like, for example, Our innovation has been higher price on average and focused well on protecting gross margin, our cost savings, and many of our cost activity are contributing to covering the overall impact of inflation. So we believe we are and we will be in good shape in that sense.

Thank you. And the next question will be from Rupesh Parikh from Oppenheimer. Please go ahead.

Good morning. Thanks for taking my question. So in China, I was curious if you can just give some additional color in terms of what you're seeing on the ground today in both the mainland and the Hainan corridor. And as you think about the China recovery, do you essentially assume a return to more normal conditions by Q4? Is that the way to think about it?

Yeah. In China, our assumption, as I said before, is that there will be a gradual recovery from the restrictions. And with the gradual recovery with the restriction, we will see increased traffic in Hainan and in the brick and mortar in domestic China. So those are the two key things that need to evolve because retail growth, overall is positive. And it is interesting that retail growth overall is stronger than the economy, the way the economy is being communicated. So the phenomenon that is historically proven that beauty, prestige, industry grows on average more than the economy and then we grow on average more than the beauty industry, that trend is what we believe will continue to happen in the future and is happening as we speak. However, the traffic movements are very different. And again, to clarify what I think the prepared remarks should have clarified in detail, but But take the Hainan situation. Hainan traffic, the last time Hainan traffic was, if you want, regular, was January, February. Last January, February, where it was full normal traffic. Then after the first lockdown, went down 80%. And then in July, recovered and went to minus 30%. And there was the assumption that this traffic over time would continue to go well. But then on the contrary, now in October, it was still minus 70% again. So basically, is the expectation of future traffic that make the inventory's presence too high for that level of traffic and need to be readjusted? And the second factor is that traffic at minus 70 is obviously much less than what originally was expected, and also in terms of consumption. But on the other side, there is more consumption online, there is more growth online, there is people that are going through channels. So in total, we have seen, as I said before, a mid-single-digit growth, even in this tough situation with reduced traffic levels. So when the traffic will recover, in brick and mortar, both in travel and in domestic. When this will happen, the retail should further improve, further increase, and be pretty positive. And we do assume that this phenomenon will be more visible in our quarter four, so in the April, June period is when we assume there will be a rebuild of traffic. And that between now and then, as we explained, we don't see a lot of improvements in quarter two, but we then see a start of gradual improvement also in quarter three. That's the dynamic we are seeing.

Thank you. The next question will be from Jason English from Goldman Sachs. Please go ahead.

Hey, good morning, folks. Thanks for slotting me in. I'm going to rapid-fire a couple of questions. First, to put a fine point on the answer to that last question, if the exit rate for the year, are you assuming that Hainan is like back to bright, running normal traffic, down 30, down 50, if you can clarify that? I get sequential improvement, but to what level is still uncertain. Second question, is Europe the next shoe to drop, like for instance, destocking? And then lastly, I'm sure you have multi-year plans. I'm not asking for multi-year guidance, but as you think about, like, what you thought your earnings power may be in fiscal 24 or fiscal 25, how has that changed in light of all the dynamics that you're discussing today? Thank you.

So let me start, Jason. In terms of HINAN, no, we don't anticipate that HINAN will be fully back to normal in Q4. Much improved, but not fully back to normal. And so, you know, we are now looking at fiscal 24 for traffic to recover. And again, it's a guesstimate at this point in time. So the recovery obviously has been slower than I think all of us have anticipated. But we do know that there is a commitment by the retailers in Hainan and certainly the area in general to get back to fantastic growth. They just opened a new mall. So it is still an exciting travel destination, and we look forward to the recovery. But it is not fully recovered in our Q4 thoughts right now, more fiscal 24. In terms of Europe, Europe, you know, as we said in our prepared remarks, is recovering. And so we have seen strong growth in Europe, particularly in emerging markets in Europe. We are seeing makeup recover. We're seeing strong fragrance growth. And the one category that has been a bit slower really in all of our markets has been skin care. But we've got strong innovation in the second half of the year and certainly into fiscal 24 that we believe will accelerate our skin care growth. But right now, we do not believe that there are any reasons to be concerned about Europe. Everyone has been talking about a European recession, but I think as many have talked about, and we would say the same, we're not seeing it yet. So that's Europe. As it relates to fiscal 24, when you think about this year, really one of the biggest impacts we've had outside of the disruptions in terms of travel retail has been currency. And so our fiscal 24 is dependent on, you know, in terms of what we thought before will be impacted by, you know, what happens with currency. And, you know, one of the things that we talked about as well in the prepared remarks, some of our currency impact is adjusted out in our constant currency results and guidance. And some of it is not as it relates to travel retail in particular. And that's a big amount. So as you're Looking at our margins, you know, and the significant impact on our margins, currency is an impact on our margins. So depending on what happens with currency rates, that, you know, influences our outlook for fiscal 24. But most importantly, Jason, as it relates to the fundamental health of our business, once these disruptions are behind us, we still feel very strongly about obviously the strategies that we executed throughout the last couple of years, this temporary impact, and how we have prepared the business for future growth. We're opening, you know, a new production and R&D facility in Asia that will reduce some of the transport issues. Oh, by the way, it will reduce some of the currency issues as well. And so there are many things that we've done over the last few years that have really strengthened our business once we emerged from the disruption that, you know, has been extended, you know, unfortunately this year. And our teams are managing through with fantastic resiliency. And we are, as Fabrizio indicated, incredibly proud of all of them and what they've been doing to support the business.

Thank you very much, ladies and gentlemen. This concludes our question and answer session. If you are unable to join the entire call, a playback will be available at 1 p.m. Eastern time today through November 16th. To hear or recording the call, please dial 877-344-7529. Passcode number 9985405. 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. Take care.