Good day, everyone, and welcome to the Estée Lauder Companies Fiscal 2022 Second Quarter Conference Call. Today's call is being recorded and webcast. For opening remarks and introductions, I would like to turn the call over to Senior Vice President of Investor Relations, Ms. Rainey Mancini.

Hello. On today's call are Fabrizio Freda, President and Chief Executive Officer; and Tracey 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 non-comparable 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 Investors 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 and 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 will turn the call over to Fabrizio.

Thank you, Rainey, 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 engines of growth strategy showcased the benefit of its diversification. Every category, region and major channel expanded. We size the favorable dynamics of skin care, fragrance developed markets in the West, brick-and-mortar, and continue to prosper in the East with Chinese consumer as well as in global travel retail and global online. The flexibility we built into our business model over the last decade enable us to both allocate resources to attractive growth opportunities and effectively manage the impacts by 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 diluted 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 quarter. Despite the ensuing 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 reinforced our confidence in our ability to navigate the impacts of the prolonged pandemic. Moreover, our optimist 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…

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 a 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' return to brick-and-mortar retail where we had an exciting array of gifting products and holiday activations in store. And even with more consumers' shopping in stores, organic sales online also grew solidly in the Americas, with online representing more than 1/3 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 U.K. 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…

Thank you. The floor is now open for your questions. [Operator Instructions] To ensure that everyone can ask their question, we will limit each person to one question, time permitting, we will return you for additional questions. [Operator Instructions] And our first question today will come from the line of Dara Mohsenian with Morgan Stanley.

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. So -- and with also 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?

Yes. No. Sure. So we achieved a 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. And 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 remained really intact. There is the growing middle class continues to develop. The increasing per capita spending continues, 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 Estée Lauder 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 looking great, great future.

Thank you. Our next question will come from the line of Peter Grom with UBS.

So I just wanted to ask about the operating expense leverage we have seen year-to-date. It's just -- 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 been very impressive what you've been able to do there. And I know there's a mix benefit, sales leverage, cost savings, and obviously, costs that have yet to fully returned 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 year-to-date that you believe has greater staying power versus what you might expect to really come back as we return to, I guess, "a normal environment?"

Yes. Thanks Peter. In terms of the operating leverage that we've seen thus far, it has been terrific, obviously, in the first half. One of the things to keep in mind is our launch cadence in terms of when we actually have big product launches does affect quarter-to-quarter performance. But we certainly have continued to see some of the benefits of cost not returning. But brick-and-mortar is picking up. And clearly, we're continuing to ramp up in the third and fourth quarter, our selling staff to support greater brick-and-mortar sales. So when you look at our full year, the overall margin expansion that is included in our guidance is around 90 basis points. So well ahead of our 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.

Thank you. Our next question will come from the line of Lauren Lieberman with Barclays.

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 you describe it, particularly the expansion of Ulta and Sephora doors into significantly new locations. So curious kind of what you're seeing in terms of how your brands are performing generally in those locations 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?

So let me start from that. First of all, we see our brands doing well in these new distributions. And again, these new distributions, particularly the target Ulta, the cool Sephora you are referring to, were 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 in quarter two 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, makeup renaissance is really getting also into new user education. So there are some fundamentals, which are improving for the post-COVID. Then we are gaining share in many on the categories, subcategories, for example, Tom Ford, Jo Malone was doing outstanding. The skin care gained share. The Ordinary is an important part of building our overall market share in the region. And the other thing I could mention is our innovation and our marketing progress 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 growth to sustain our growth now in the long term and continue sourcing new consumers. And finally, we are really executing with excellence. We are reinvesting fast in rebuilding the stores in their [core] way. We are investing, in fact, 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 to 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 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 engine of growth.

Thank you. Our next question is going to come from the line of Andrea Teixeira with JPMorgan.

My question is regarding EMEA ex-travel. So I was hoping to see -- if, Fabrizio, you can discuss a bit of that scenario. Unfortunately, Omicron was first seen in the U.K. And as you exit the quarter, how Continental Europe has been and the U.K. has been performing. And then as a follow-up, I think, Tracey, 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 in waiting on the market spend. Can you give us some perspective if this is a result of this timing and then we should see again operating -- the operating leverage, as you pointed out, 90 basis points for the year as you go into the fourth quarter?

Yes. I'll start from the -- if I understand your question was on travel and travel retail.

No. Ex-travel retail. EMEA ex-travel retail.

EMEA, ex-travel retail. Sorry, I didn't hear. 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 brands -- good progress also in EMEA, there are emerging markets, which are doing very well, like India, the Middle East, Russia. And so, overall EMEA is again strong engines of growth that is being built over this year and now in the post-COVID acceleration is proving its role of building strong engines of growth, so all very strong. Tracey?

Yes. And in terms of the margin, we still, in the second quarter, did have 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 skin care brands, particularly Estée Lauder and La Mer and the hero franchise reformulations that we are doing on some of the products are really quite significant for us going forward. So that also should help the skin care category grow a bit. But again, skin care is largely affected by some of the shutdowns in high concentration skin care 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.

Thank you. Our next question will come from the line of Chris Carey with Wells Fargo.

On the travel retail business, the low double-digit growth, again, keep the division growing, which is great to see. And you noted that APAC continues to drive growth, I think you said with the 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 Hainan traffic being impacted by restrictions. And so can you maybe just dimensionalize strong growth from the Chinese consumer and travel retail with Hainan travel being negatively impacted with the strength that you're seeing there? And then, I guess, just bigger picture on this broader channels, 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 deliver 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.

Well, let me start with the -- 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. For 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 Hainan continues to be a very strong driver of our travel retail business. And it is incredibly luxurious, and I know Fabrizio likes to talk about Hainan. So I will let him expand on that as well. But we continue to expand our presence in Hainan and continue to see fantastic, fantastic consumer receptivity to our brands in Hainan.

Yes. So to speak to the travel retail trends. First of all, the travel retail globally was strong and was accelerating versus the previous quarter. And yes, the -- in Asia, there were some elements of acceleration. Yes, Hainan was very strong, as Tracey was saying, but I want also to underline that there was a strong growth in EMEA and North America, as I think Tracey 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 the where traffic increase, travel retail respond very, very fast. And the other good news is what Tracey was speaking about the overall retail growth across despite some of the closures and some of the restrictions. The -- on Hainan, Hainan is becoming an extraordinary place, luxury, with amazing experiences. So it's probably one of the channels around the world, which is more equity building for the brand. So that's an important thing to underline. Also, in Hainan, there are many new retailers, which are opening. And so in Hainan, there is more distribution being built in several retailers, which are investing in the island. That's also something that will generate and will continue to generate expansion growth over time.

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.

Yes. And maybe one thing on that, to add, Tracey, is the clarification, 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 passports. And there is a relatively small percentage that people in Asia has a passport to travel internationally. Well, Hainan is domestic travel. It is open to the entire population. So the -- when international travel will restart, this will be almost all net extra.

Thank you. And our next question will come from the line of Callum Elliott with Bernstein.

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 Cedric Prouve stepping down. And I think you've also made some structural changes with, I think, join our reporting straight to Peter at International rather than into Asia/Pacific 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.

Yes. By the way, this is a great question, and I admire the knowledge you have of our amazing talented team. So thank you for the question. And 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 retail with the other key part of the Company, including online. And so that's an important next step that will make our ability to work with China and our ability of our China team to get support for grow the capabilities increased. So, the organization is basically increasing our power of execution in China, the change -- 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 because all the succession of this position has been managed mostly 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 execution. Collaborative execution is the result of very clear common goals and very uniting reward systems to make this organization 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.

Thank you. Our next question will come from the line of Olivia Tong with Raymond James.

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 is evolving and your view on the investment spending necessary to team 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. 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 little bit 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. I appreciate it.

Okay. Well, in terms of 11.11, yes, certainly, 11.11 continues to be -- to get more and more competitive. And we've spoken in the past about how we do promotion as it relates to 11.11. A lot of it is done with samples. And certainly, 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. So media costs have gone, for sure. Live streaming activity has gone up, for sure. And we have shifted and adjusted our activity 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 have 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, we have spoken -- Olivia, I know you know for many years about the fact that 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 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…

Yes. And if I can just underline one thing that Tracey has explained is that is really between quarter three and quarter four is 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 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 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 Tracey explained, have the biggest impact, the full impact in quarter four. And so that's the rebalance we are 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.

And because I know our brands are listening, so we do have three big skin care launches in the third quarter, but we do have makeup, fragrance and hair care launches as well that we are supporting.

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.

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, consumers are still managing to get their skin care 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, 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 Estée in particular has been exceptionally promotional in China. Can you just comment on that and sort of give us your take on that?

Yes. First of all, we are not promotional in China Mainland. Actually, the majority of our activities are sampling rather than pricing promotions. So if for promotional we mean that we have increased our sampling, our products 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 promotional needed to succeed in that event. And I think...

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 some of the retail activity was quite promotional. So that is clearly a retailer-driven decision.

Yes. Thank you, Tracey, to clarify that retailers rising a promotion, they decide. We don't decide. But our promotion, as I was saying, is a lot about sampling and creating trial opportunities. So it's expensive rather than pricing. And then obviously, the retailers do what they believe is right for them in a given environment. The -- 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 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 these several other times. There are two drivers of travel retail, which are very important. One is the, 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%, depending by region. So, enormous expansion possibility of conversion are still in front of us. And the arrival of online in travel retail, which we call pretail today is very strong in Asia, but just 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%, 15% into the 30s. So you can imagine over time with expansion of the online possibility to buy pretail that conversion will dramatically grow around the world of travel retail. When you have 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 the previous answer. And so, that the international traffic will come back. A lot of it will be net extra. And when you have in front of us, the prove that I was quoting before then where, for example, in EMEA, we have seen some new -- 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 these considerations 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, that the traveling stores -- the stores for travelers are becoming more and more an important 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've built. So, I hope you realize why we do believe in travel retail as a long-term strategic channel.

And again, I think we feel very good. When you look at this quarter, the results that we achieved, travel retail had a great quarter, as we said, low double-digit growth, but the overall company grew at 14%. So, 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.

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 17. To hear a recording of the call, please dial 855-859-2056, passcode 9575055. That concludes today's Estée Lauder conference call. I would like to thank everyone for their participation and wish you all a good day. Thank you.