Good day, everyone and welcome to the Estée 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 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 will 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 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. It also includes estimated sales of our products through our retailers’ websites. [Operator Instructions] And now I will turn the call over to Fabrizio.

Thank you, Rainey 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 travel 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 Tracey 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 Hainan 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, evidenced in the underlying 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 fiscal year 2023, we plan to continue investing in our…

Thank you, Fabrizio and hello everyone. Our first quarter organic net sales declined 5% 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 reopen, 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 6 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…

Thank you. [Operator Instructions] And our first question today will come from Dara Mohsenian 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 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, etcetera? It’d 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 asked that in relation to what you’ve talked about recently, which is greater flexibility in ad spend more agility to respond to market conditions. 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.

Yes. It’s a complex question, so there is a lot to say. I will start, and then Tracey will join me in – 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 this 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 could – I can explain later all the many things, which are going well in this direction. But for example, it’s a quarter where our M·A·C brand really demonstrated it is back to growth, with a 22% growth. And for our North America business, to see M·A·C retail coming back so strongly is great news because as you know, Clinique and M·A·C are a big part of the growth potential of our North America particularly business. So, great news to have M·A·C 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 digits, 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 will be gradually recovering, this – now the brick-and-mortar remained with less traffic, but we gradually improve the trend. And the decline has been still a decline, but less –…

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 are 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 of, is – that there could be 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.

Good morning.

So I’m sure China 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 Estée 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 China TikTok. It feels like the organization is certainly becoming more comfortable working with different kinds of channels. And I wonder, just in the context of a broader recovery, and certainly, there is going to be a big debate on what is the true earnings power of this organization, I wonder if you can just comment on 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.

Yes. No, I think we’ve been very much focused on having the right level of distribution and focus where the consumer preferences is – are evolving over the last years. We operate in 12 channels now versus basically one-channels 15 years ago. And so this comfort is there, and you can see this, first of all, in our online expansion that continues to be – we have obviously our brand.com that continue 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 to 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 continued to be expanded. And then in terms of our comfort with specialty-multi, I believe this is not new. We are very comfortable, and there is – with specialty-multi, we are doing well. We are growing. We have increased our market shares in the channel as 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…

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 for Fabrizio and Tracey. But is there a rate of overall consumption or retail sales growth that you anticipate across your portfolio in the year, just that we can compare to the flat to 2% positive organic growth that you have assumed in your outlook? That’s the question – kind of follow-up. And then I guess I would also, if possible, like a little bit more context around the retailer destocking that you have called out broadly, but particularly in the U.S. as it’s not something I think – I don’t think we have heard that from your peers, but certainly a dynamic we have 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 have seen, how much you think maybe specific to your portfolio and what the outlook is 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 obviously, given some of the disruptions 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 have had more disruption or we have the anticipation of a slowdown, that’s where we are 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. 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 are making in any of the categories of pricing that you are 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? And how you are thinking about inventory going forward? Thank you.

So, I will start with the pricing. We are looking at – so there is 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, channels that have had lower traffic are the ones that we are most focused on in terms of, obviously, slowing our shipments to those channels, so they don’t end up over stock, 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, we are a bit more cautious. Freestanding stores 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. Where both ourselves as well as our retailers 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 Bryan Spillane with Bank of America. Please go ahead.

Hi. Good morning. Thank you, operator. Tracey, maybe just a 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 is, 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?

Yes. I think we certainly have seen 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 have seen wage inflation as well. And again, that has been incorporated in some of the pricing that we have anticipated this year. We have seen advertising rates stabilize a bit. And so we are not seeing as much media inflation as we were seeing previously. So, those are, I would say, the biggest areas of inflation that we are watching. But the supply chain area is one that is a particular focus for us going forward. And again, 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 what we – the same point of view we expressed in the last quarter, 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 is emerge 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 and possible price increases in January-February to see if in selective markets where there is also a big pressure of currency, not only of inflation, we can also make some selective adjustments in these areas. But our goal to remain to offset most of the price – most of the inflation we are 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 mainly of our cost activity are contributing to covering the overall impact of inflations. 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 are 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?

Yes. 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 needs to evolve, because retail growth overall is positive, and it’s 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 is – that trend is what we believe will continue to happen in the future. And it’s 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 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 roughly over time would continue to go well. But then on the contrary, now is – in October, was still minus 70 again. So, basically, it’s the expectation of future traffic that make the inventories 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 traffic 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, will be – 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. Thank you. I am going to rapid fire a couple of questions. First, to put a fine point on the answer to that last question, the exit rate for the year, are you assuming that Hainan is like back to bright running at normal traffic, down 30, down 50, if you can clarify that, I guess sequential improvement, but to what level is still uncertain? Second question, is Europe the next shoe to drop like in terms of destocking? And then lastly, you have multiyear plans. I am not asking for multiyear guidance. But as you think about like what you thought your earnings power may be in fiscal ‘24 and fiscal ‘25, how has that changed in light of all the dynamics that you are discussing today? Thank you.

So, let me start, Jason. In terms of Hainan, no, we don’t anticipate that Hainan will be fully back to normal in Q4. Much improved, but not fully back to normal. And so 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, 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 are 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 have 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. Obviously, everyone has been talking about a European recession. But I think as many have talked about, and we would say the same, we are not seeing it yet. So, that’s Europe. As it relates to fiscal ‘24, when you think about this year, really the biggest – one of the biggest impacts we have had outside of the disruptions in terms of travel retail…

Thank you very much, ladies and gentlemen. This concludes our question-and-answer session. If you were unable to join the entire call, a playback will be available at 1 p.m. Eastern Time today through November 16th. To hear a recording of the call, please dial 877-344-7529, pass code number, 9985405. That concludes today’s Estée Lauder conference call. I would like to thank you all for your participation and wish you all a good day. Take care.