Good day, everyone, and welcome to the Estee Lauder Company's Fiscal 2023 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 the 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 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 also excludes an noncomparable impacts of acquisitions, divestitures, brand closures and the impact of foreign 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'll turn the call over to Fabrizio.

Thank you, Rainey, and hello to everyone. It is good to be with you today. Turning to results. For the second quarter of fiscal year 2023, organic sales fell 11% and which was within our outlook despite the incremental pressure of COVID-19 resurgence in China. Many developed and emerging markets globally outperformed our expectations to offset the COVID-related impacts of significantly reduced retail traffic as well as limited staffing in beauty adviser, in domestic China and Travel Retail in Hainan in November and December. Adjusted EPS fell 45%. While its deep decline, this was meaningfully better than our outlook, driven by both disciplined expense management and moderation of the stronger U.S. dollars. Importantly, we continue to prudently invest for growth, launching thought after innovation and increasing A&P as a percentage of sales. For fiscal year 2023, we are lowering our outlook for organic sales growth and adjusted diluted EPS primarily for 2 reasons. First, inventory levels in Hainan remains somewhat more elevated than we expected due to the disruptions in travel and in-store staffing levels in November and December. Second, the recently announced potential rollback of COVID related supportive measures in Korea Duty Free are creating a near-term transitory pressure to our business with our courier duty-free retailers. In the third quarter, it is more than offsetting the initial positive impact from the resumption of international travel by Chinese consumers as well as favorable trends in our second quarter, including outstanding performance across many developed markets in Western Europe and Asia Pacific as well as many emerging markets globally and a better-than-expected currency environment. All told, our return to growth has shifted from the third quarter to the fourth quarter, which Tracey will discuss in greater detail. We remain focused on investing in our brands including for innovation, advertising, strategic…

Thank you, Fabrizio, and hello, everyone. As Fabrizio mentioned, our business in the second quarter continued to be pressured by the external headwinds of COVID-related impacts, including the rising number of COVID cases in China, lower shipments of replenishment orders in the U.S. and the stronger U.S. dollar. Our second quarter organic net sales declined 11% and earnings per share decreased 49% to $1.54. We tighter expense management and a slightly improved currency impact contributed to our better-than-expected EPS results. From a geographic standpoint, organic net sales in the Americas declined 3%. The -- we saw healthy demand for our holiday offerings as consumers gravitated to our in-store and online promotions. However, we also experienced lower shipments of replenishment orders due to both retailer inventory tightening as we anticipated, and a later improvement in retail trends post-Christmas. In Latin America, organic net sales rose double digits, reflecting continued growth in nearly all markets, the evolution of recovery and makeup as consumers return to stores, and the strength of our fragrance portfolio. Organic net sales in our Europe, the Middle East and Africa region declined 17%, including the negative impact from foreign currency transactions and key international travel retail locations of 3%. The decline was driven by travel retail as expected, while growth from nearly every market in the rest of the region was strong. Our global travel retail sales were significantly pressured by the ongoing COVID-related impacts. Despite stores being opened throughout the quarter, travel to Hainan remain largely curtailed, and as a result, shipments of replenishment inventory remained low. Elsewhere, we experienced strong sales growth in Travel Retail, reflecting increased international tourism as travel restrictions in many countries lifted from the prior year. The ongoing pressures in Asia travel retail more than offset the growth we experienced in the…

[Operator Instructions] Our first question today comes from Lauren Lieberman with Barclays.

I was hoping -- and this is probably more for you, Tracey. If you could walk through with us how you're I guess, the length of the supply chain works for supplying both Hainan and Mainland China currently, knowing it's shifting. Because as we think through the change forecast in demand and knowing what I believe is a pretty lengthy supply chain, how you're managing production versus shipments and if that's sort of informing why there's so much visibility seemingly on 4Q. And I guess we should see inventory spike up on your balance sheet in 3Q. Is that right?

Yes. You're correct, Lauren, that we do expect that we will -- two things. One, inventory levels are still coming down in Hainan. They are almost at the level that we would expect sales to accelerate. So yes, you should start to see an inventory build related to the shipments that we expect to see in Q4. In Korea, again, the pace is a little bit more uncertain given the transitory nature of what's going on right now. So we do anticipate, as I mentioned in the prepared remarks that we will start to see resumption of travel in Korea. And depending on the pace of that resumption that will depend on the amount of shipments that we have in the quarter. But we have taken obviously an assumption there. We are sitting on a decent amount of inventory even in our own warehouses to supply the sales that we expect to see in the fourth quarter.

The next question is from Dara Mohsenian of Morgan Stanley.

So just sort of extend that question a little bit, right? We have a lot of quarterly volatility in terms of Q3 versus Q4. Q2, there's a difference in shipments versus underlying retail sales. Obviously, COVID impacts in China. So it's hard to get a great underlying sense of retail sales here and how the business is doing. So a ratio, maybe you can just give us a little bit of an update on retail sales by region I'm particularly interested in category growth and any macro impacts in the U.S. and Europe? And then how you're thinking about Asia Pac and China versus the rest of the region. Let's so -- on near-term results here, but more how results came into the quarter versus what you originally expected and that might inform the revenue trajectory as you look out over the next couple of years and how you think about it? I think you touched on a lot of aspects of that, but it would be helpful to get a general overview.

Yes. No. Absolutely, with pleasure. Let me start with China, first of all. And so China, the results in the quarter where pretty good. We built significant market share. So the overall market in China was negative double digit. Our net sales were and our retail was negative single digits, and we built market share in every single category. So in most arises, we build market share in makeup in fragrance, in health care in every aspect. Now this, for us, is a very important sign that the -- our brands are really working the aspirational value of our brands remains very, very strong, which in the moment of reopening is a very strong position to be. So excellent performance relatively to market. Though some of our brands were shining, La Mer in skin care was the brand that was gaining the best market share on for beauty in makeup and Jo Malone London in fragrance was really leading the share gain. The other important reading of China is that during 11/11, our net sales were up 10.9%, and our retail sales were up 11.9% and holding the #1 ranking across various categories. and there was a lot of great success on the brand creative activity in live streaming on innovation. And so the way when the consumers are back in this very difficult volatile period like a situation like 11.11, where there is obviously high traffic our brands respond enormously. And obviously, when the consumers are not back or don't travel or our site is when, obviously, we have seen some issues. So in total, China is developing the way we planned. And from a market share standpoint, recovering also and is definitely going in the right direction. In terms of the future, the potential of China, we continue…

The next question is from Peter Grom of UBS.

So Tracey, I wanted to ask about the implied outlook for organic revenue growth in the fourth quarter, which is quite strong and better than expected. And I know we're still a few months away from fiscal '24 here. But is the implied exit rate in the 4Q guidance a fair way to kind of think about the potential top line recovery looking out to next year? Or are there kind of the timing-related impact given what you're forecasting in 3Q that could be driving them a stronger growth So look, we are expecting a stronger fourth quarter than probably you anticipated and us as well, given a few months back. And part of that, as we said in our prepared remarks, is because of the shift of recovery expectation, certainly in terms of some of Travel Retail, I would just remind you that -- and I know you're well aware of this, we're also anniversarying last year's some pretty significant shutdowns. So this volatility that we're speaking about actually started at the end of our fiscal 2022 in the fourth quarter. And we're coming up on the anniversary of that. So the numbers look particularly large from a from a growth standpoint because we are anniversarying some lockdowns in China and in travel retail in Hainan in particular, which was the start of some of the problems that we have anticipated on this call today. I think we are anticipating for fiscal '24, we're not giving fiscal '24 guidance right now. But given that in the fourth quarter, all markets are anticipated to be open and remain open and traveling will gradually resume and again, uncertain about the pace of that resumption, but we've certainly seen encouraging signs in many of our markets. that fiscal '24 will be a strong year for us. So I wouldn't take the the Q4 implied growth and apply it to fiscal '24. Peter, if that's what you're getting at. But certainly, we expect that we -- many of -- there will still be volatility in fiscal '24, but the volatility related to the pandemic and some of the things that we've experienced this year should be much moderate than certainly what we've experienced this year. And if you have any predictions on currency, certainly do let me know.

The next question is from Michael Binetti of Credit Suisse.

Tracey, maybe I could just dovetail on that a little bit. you told us a few quarters back that 20% margin was a North Star. As you think out to next year and many of the moving parts of your business finally start to come back online? Is that -- is there any -- I don't know there may be some pull-forward revenue that leaks into the first half of the year. I don't know, obviously, you gave us the fourth quarter here. But as you look out to next year, is 20% in appropriate North Star for next year given the revenue drivers back online? And then I guess, Fabrizio, can you help us size the travel business a little better since it's such a big swing factor in the model here going forward. I think it was about 15% of sales pre-COVID, half of it China. You spoke a little bit about the shape of it at a conference in December that the pre-COVID that Chinese business -- the Chinese traveler was largely a Tier 1 international traveler. I think you said Hainan only has completely replaced that, but it's a different customer, maybe a lower-tier customer. just because this moves the model around so much, can you help us just think about how big that business is today in the non-China markets, Hainan -- non-Hainan China to help us think about the model.

So let me just -- and Fabrizio will pick up on your questions on Travel Retail. But Travel Retail actually was larger. You're remembering, Michael, our online business was pandemic. Travel Retail was more like 26% pre-pandemic. But in terms of the operating margin for fiscal '24, as you can imagine, with some of the more recent events, we are still going through what our expectations are for fiscal '24, and we'll certainly provide guidance as we normally do in the August time frame. I think 20% is a little ambitious right now for fiscal '24 based on what we're seeing. But some of that has to do with how currency moves, which was my previous comment in terms of if you have projections on currency, let me know. But certainly, in terms of the business fundamentals, the growth, we would expect obviously more margin expansion that is in our normal algorithm for fiscal '24 because of the recovery of volume. And obviously, when you're down in volume as we are this year, as much as we protect the strategic investments, but also make choiceful discretionary investments as well. Volume solves a lot of sins. And so we would expect more leverage on our expense base next year, certainly than we're able to get this year. practically because of the volume trends and as well as the shocks in terms of those hits have occurred and how fast we can react to them. So again, we are expecting a certainly progressive fiscal '24. And with all of the things that we spoke about in the prepared remarks as it relates to the investments that we made that will come online, we'll have a new factory operational in Asia that will make our time to market shorter, will have the new innovation center, which will start to contribute to the development of product for us in the future, et cetera. So all of those things that we said in the prepared marks should also support the acceleration of growth in fiscal '24. Now for your travel -- or more on your travel retail question, I'll turn it to Fabrizio.

Yes. Thank you, Tracey. Also, I want to add on the margin thing is the first step of normalization of our margin that Tracey is describing on top of volume is also -- will depend on which volume. Because, obviously, if you assume that the normalization of business would be in travel retail in China, then you are assuming that the normalization will be in skin care that tend to be higher margin. So there will be a moment of recovery and normalization. And then from there, we will restart our normal algorithm. And obviously, we will see how the normalization trends evolve and how long they will take. But that will be the way we will move back -- in terms of the travel retail question, stress clarified before and then even more during coded. But the -- you are asking about the -- what are the key dynamics in that retail. So the dynamics in fiber details will be, first of all, Hainan is now established. And yes, I said that when the international travel of the Chinese consumers will restart, Heinen will not be cannibalized in a big way is Hainan is now well-established vacation place for Chinese, for internal travel is, yes, there are different target groups. The high-end travel is obviously more affordable, easy does require visa doesn't require a passport, by the way. Keep in mind that at least before COVID, I do not have the last information now that everything is changing on the Visa model. But before Covis less than 20% of Chinese had a passport. And so there is anyway 80% of Chinese debt will go to Hainan and they will not travel internationally in this model. So Hainan will continue and will continue to develop. The addition will be the…

We have time for one more question. It is from Mark Astrachan of Stifel.

Yes, I wanted to ask about the sustainability of growth in some of these categories, which benefited from reopening like fragrances makeup and expectations for skin care improvement, it sounds like you’re obviously talking to improving skin care trends globally, obviously, China as well. And then I wanted to ask the same question around China. So should we expect a similar reopening trajectory? Or are you expecting a similar reopening trajectory in China that we’ve seen around the rest of the world in terms of growth and in terms of the categories which benefit.

SP-2 So the reopening of China is in China today, the level of sales online is the biggest percentage of the world. So to be clear, the reopening on China will mainly impact the reopening of brick-and-mortar. So will impact 50% of the business in China about will be very positively impacted by the reopening. Obviously, during the period, like the 1 we just lived many since mid-November to mid-January, where the level of infections in China, so COVID were super high. 80% of families had somebody with the virus, et cetera. So the implications were normal. In this period, you see also a reduced consumption. Everything, reduce consumption online, reduce interest for sure it make up in other categories. So, but that’s temporary, obviously. So your question is more what happened when all this is regular. The only thing I want to clarify that has to be regular, not only the ability to purchase in stores, but also, frankly, to be free of COVID, really free of COVID [indiscernible] consumption come back. So when people will be free of COVID as a disease. When they will go back to the brick-and-mortar, we will see at least half of the business in China increasing dramatically on traffic, and we will see a continuous acceleration, a gradual continuous accusation of the online, which is already very strong. There are many new platforms online that have been opened in China as we speak, which are promising, which are doing success. In our case, our success on JD to win has been very, very strong. It’s one of the reasons behind the market share growth and the success of the amazing Tmall events, particularly 11.11 or June 18 have been extraordinary. So there are a lot of good potential levers of growth. That…

That concludes today's question-and-answer session. If you were unable to join for the entire call, a playback will be available at 1:00 p.m. Eastern Time today through February 16. To hear a recording of the call, please dial (877) 344-7529 and use passcode 6947935. That concludes today's Estee Lauder conference call. I would like to like to thank you for your participation and wish you all a good day.