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 results 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 the non-comparable 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, reference to online sales, include sales that 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.

Tracey Travis:

Thank you, Fabrizio and hello everyone. Our third quarter organic net sales increased 6% at the higher end of our expectations. As Fabrizio mentioned, we are pleased with the progress we've made thus far in Asia travel retail, with reducing retailer inventory and the corresponding return to net sales growth. These achievements in the quarter were a bit earlier than expected and led to a partial shift in the expected timing of the resumption of replenishment orders from the fourth quarter to the third. Partially offsetting this growth was lower-than-expected net sales in Mainland China, reflecting the impact of ongoing softness in overall prestige beauty, in part due to subdued consumer confidence and softness during holiday and key shopping moments. Our earnings per share of $0.97 exceeded our outlook for the quarter, due to the acceleration of skin care, the return to net sales growth in our Asia travel retail business, tighter expense management and a lower tax rate. The reduction in our tax rate was largely driven by the shift in our geographical mix of business. Regarding our regions, organic net sales in our Europe, the Middle East and Africa region increased 12%, driven largely by the growth in our Travel Retail business. Our Travel Retail net sales increased strong double digits, returning to growth after seven consecutive quarters of decline given the sequential acceleration of retail sales and shipments, as well as the anniversary of lower shipments last year, which were pressured by transitory headwinds in Hainan in Korea, as well as limited international flights, visas and group tours from China to other markets last year. Elsewhere in EMEA, organic net sales in our priority emerging markets increased strong double digits where we drove growth from most brands and in most channels of distribution given our strategic initiative to expand consumer reach in particular for our fragrance and skincare brands. Our results in mature markets were mixed resulting in overall flat growth. Organic net sales in our Asia Pacific region increased 3% led by Hong Kong SAR, Mainland China and Japan reflecting mid-single-digit net sales growth in skin care and high single-digit growth in fragrance. Organic net sales in the Americas increased 1% largely due to Latin America where continued growth in Mexico and Brazil led by makeup drove double-digit increases in department stores and freestanding stores. Organic net sales in North America were flat in the quarter as growth in fragrance and skin care was offset by declines in makeup and hair care. The double-digit growth in specialty-multi driven by Estée Lauder and M·A·C was offset by softer performance in department stores and direct-to-consumer channels. From a category standpoint, organic net sales in skin care rose 9% largely driven by our Asia travel retail business as well as from Hong Kong SAR and Mainland China. Organic net sales from La Mer and Estée Lauder propelled the category's growth led by strong campaigns behind our hero product franchises with new product innovation and increased in-store activations. Organic net sales in makeup increased 4%, largely driven by our Asia travel retail business and by Latin America. Net sales from Estée Lauder and Clinique led the category's growth fueled by ongoing activations behind our hero product franchises. This was partially offset by a prior year benefit from changes made to M·A·C's take-back loyalty program. Excluding the impact from the prior year benefit, M·A·C net sales increased mid-single digits with growth across all regions mainly driven by new product innovation. Organic net sales in fragrance increased 1% and in hair care declined 4%. In fragrance net sales growth was driven by our luxury and artisanal brands led by Jo Malone London and Le Labo. Jo Malone London grew double digits in travel retail and specialty-multi. Le Labo saw double-digit growth in our direct-to-consumer channels particularly in freestanding stores, driven by both same-door growth and targeted expanded consumer reach. Partially offsetting these increases was a decline from Estée Lauder due to retail softness during holiday and key shopping moments. Our gross margin increased 280 basis points compared to last year. This reflects positive impacts from changes in category mix driven by the acceleration of skin care, lower obsolescence charges given the reduction in excess inventory compared to last year and stronger strategic price realization through lower levels of promotion. These improvements were partially offset as expected by the impact of the previous pull down of production that triggered a requirement to recognize the related manufacturing costs in the current period instead of when products are sold. This resulted in a 215 basis point headwind to gross margin. Foreign currency also pressured gross margin in the quarter. Operating expenses decreased 290 basis points as a percent of sales during the quarter, driven by the sales growth leverage and expense management including advertising and promotional expense, which decreased approximately 240 basis points compared to last year. This reduction reflects the anticipated shift in certain spending from the third quarter to the fourth to support innovation launches in key holiday moments in the fourth quarter. Operating income increased 75% to $554 million, and our operating margin expanded 570 basis points to 14.1%, compared to 8.4% last year. Our effective tax rate for the quarter was 30.5%, compared to the elevated rate of 43.1% last year. The decrease in the effective tax rate was primarily driven by a lower effective tax rate on our foreign operations due to the difference in timing of the estimated change in our full year geographical mix of earnings in the current and prior year periods. This was partially offset by the unfavorable impact associated with previously issued stock-based compensation. Diluted EPS was $0.97 compared to $0.47 last year largely due to the increase in sales improvement in gross profit margin and a lower tax rate. The impact from the business disruptions in Israel and other parts of the Middle East was $0.01 dilutive to EPS in the quarter. The acquisition of the Tom Ford brand was neutral to EPS as interest expense related to our debt financing was offset by the combined benefits derived as the licensor of the brand from royalty revenue this year and savings from no longer having to pay royalties on the beauty business. For the nine months, we generated $1.5 billion in net cash flows from operating activities compared to $1 billion last year. The increase from last year reflects lower working capital, which was largely due to the actions we have taken to reduce in-house inventory levels primarily finished goods and semi-finished goods that resulted in a significant improvement in our days to sell. We invested $702 million in capital expenditures and we returned $710 million in cash to stockholders through dividends. As Fabrizio mentioned, our plans under the profit recovery plan are progressing and are on track. This quarter we began taking charges under the restructuring program and expect approval to accelerate in the fourth quarter of this year and throughout fiscal 2025 with meaningful benefits beginning to flow into our fiscal year 2025 results. Turning now to our outlook for the remainder of fiscal 2024. We are pleased with our progress thus far in reducing inventory levels, resuming replenishment shipments in Asia travel retail, accelerating innovation and selectively expanding our consumer reach. These efforts have led to sequential improvements in both net sales and operating margin from the first half of the year, culminating in our return to profitable net sales growth this quarter. With these results and our outlook for the fourth quarter, we continue to expect a stronger second half compared to last year, underscoring that we believe we are at a sales and profitability inflection point. While we delivered on the high end of our third quarter expectations, we are lowering our fiscal 2024 organic net sales outlook range to reflect continued risks from evolving macroeconomic volatility, including continued softness in Mainland China and geopolitical tensions in certain areas around the world. In Asia Travel Retail, we are also mindful of potential short-term volatility in retail sales related to actions certain retailers are taking to increase their profitability. With the recalibration between our third and fourth quarters, we discussed earlier we are maintaining our full year operating margin expectation and are increasing our EPS outlook slightly to reflect disciplined expense management year-to-date somewhat offset by our plans to strategically invest in key areas of our business in the fourth quarter to continue to drive profitable growth and reflecting incremental headwinds from foreign currency translation. The combination of our third quarter performance and outlook for the fourth quarter results in a strong second half compared to the first half with improvements in net sales and operating margin. Excluding the in-period charge we recognized in the third quarter, gross margin is also expected to improve in the second half. We believe our assumptions for the second half mark a meaningful turning point for the company, demonstrating the signs of our recovery and better position us along with our profit recovery plan initiatives to drive sales growth and profitability further in fiscal 2025 and beyond. Using March 29 spot rates of 1.079 for the euro, 1.262 for the pound, 7.227 for the Chinese Yuan; and 13.50 for the Korean won, currency translation is anticipated to negatively impact reported sales and diluted EPS for both the fourth quarter and the full year. We now expect organic net sales for our fourth quarter to increase 6% to 10% with increased consumer facing investments including shifts from the third quarter and aligned to support innovation in key shopping moments in the fourth quarter. This growth also reflects the anniversary of some business disruptions we experienced last year, primarily in Hainan. In Mainland China, we expect the ongoing softness of overall prestige beauty to continue to pressure net sales. Currency translation is expected to be dilutive to reported net sales by one point. We expect fourth quarter adjusted EPS of $0.18 to $0.28, an increase of over 100%. Currency translation is expected to dilute EPS by $0.01 and potential risks of business disruptions in the Middle East are expected to be dilutive by $0.03. Adjusted EPS in constant currency is expected to range between $0.19 to $0.29. For the full year, we expect organic net sales to range between a 1% to 2% decline. Currency translation is expected to be dilutive to reported net sales by one point. Our full year operating margin outlook remains unchanged and is expected to be between 9% and 9.5%, a contraction from 11.4% last year. We continue to expect our full year effective tax rate to be approximately 35% compared to 26.5% last year. Diluted EPS is expected to range between $2.14 and $2.24 before restructuring and other charges. Currency translation and potential risks of business disruptions in Israel and other parts of the Middle East are expected to dilute earnings per share by $0.09 and $0.06, respectively. In constant currency, we expect EPS to decrease between 33% to 36%. Our fiscal 2024 outlook also assumes the purchase of the remaining outstanding equity interest in DECIEM anticipated to be completed in May of 2024. In closing, our expected second half results starting with our strong third quarter performance demonstrate our progressive return to sales growth and profitability. We have navigated through numerous challenges over this past year with resilience and determination to take meaningful actions to begin to improve the trajectory of our business. Our results show we have made great strides and we have immense gratitude for the resolve and hard work of our teams globally. And while we are pleased with our progress and results this quarter, we remain keenly aware of the additional work that lies ahead to continue down the path of restoring stronger profit margins. We are intensely focused on doing the necessary work to return to long-term sustainable growth and profitability supported by the profit recovery plan initiatives and executed by our dedicated employees. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Bryan Spillane:

Thanks, operator. Good morning, everyone. So Tracey, I just wanted to ask I guess a question about the 4Q guide and what's implied. So I guess, the implied margin in 4Q steps down from 3Q, yet the revenue will be roughly the same. It just implies maybe there's not as much leverage. But so if you can just give us some perspective on the margin step down quarter-to-quarter. And then as we think about the run rate into 2025 is there anything that we should read into the fourth quarter guide that would sort of inform exit rate for 2024 into 2025 both in terms of organic sales and margins. Thank you.

Operator:

Our next question comes from Olivia Tong from Raymond James. Please go ahead with your question.

Fabrizio Freda:

So, global trade retail return to growth also driven by frankly growth and retail growth across all the regions. So, the first important point is retail sales growth. And this was very, very strong in EMEA Americas in many parts of APAC and was single-digit in the China TR part. But this is a very important progress versus the past. And this is for Estée companies brands is great news also for the future. The second thing that we are seeing is a very robust traffic recovery across the travel retail channel which is driving the sales to travelers there is work to be done still on conversion which is the areas of improvement that we are still working on, but we had a lot of work and progress in this by activations and retail division activating particularly in Hainan with a lot of activity and this activation are working. And so we see progress also in this area. And then as it was part of your question, because of all these elements strong improvement in the inventories in our retailers and so reaching the targets in several retailers and in several SKUs ahead of our original communicated target. So, at the end, this created a very good growth which is based on retail growth and sell into replenishment because of the decreased inventory levels versus the past. This combination is very solid. We expect this to continue and to progress in line with our goals.

Lauren Lieberman:

Great. Thanks. I just had a question about spending levels. It was great. Tracey thanks for being so specific on the advertising and the reinvestment this quarter and then shipped into 4Q. But if I remember in 3Q, there was also some timing shift on spend. So, I wanted to talk a little bit about maybe the decision tree of like when to put that spending in? Is it -- because if it's shifting is it about pace of getting innovation ready and launched? Is it about the consumer environment, maybe avoid putting money in play that would be like pushing on a string if the consumer isn't there. But it does feel like some of those spending plans are shifting gently quarter-to-quarter. And so I was curious if you could just comment on that. Thanks.

Operator:

Our next question comes from Dara Mohsenian from Morgan Stanley. Please go ahead with your question.

Tracey Travis :

Great. No, thank you for the question. So, yes, let me take the opportunity to talk as you asked about the profit recovery plan. We're always focused on profitable growth, let me start there. The actions that we're taking both within the profit recovery plan as well as outside of the profit recovery plan are focused on profitable growth. The profit recovery plan is an accelerator of our growth and in particular an accelerator of our margins. And let me just try to simplify it a bit. I know we've said that we will share which we will more with you in August once our plans are complete and we provide guidance for the next year, but the profit recovery plan is first and foremost focused on restoration of our gross margin. Now we're mindful of shifts in category mix and channel mix relative to history. Obviously, we had growth in fragrance in our artisanal and luxury fragrance portfolio and that's very important. We're also focused on restoration of our makeup growth. But certainly as you saw in this past quarter, we are also experiencing the acceleration of our very important skin care category, and we expect that that will continue. The biggest drain on our margin has been our gross margin. And it's in the aftermath of the pandemic. It has been the biggest focus of our recovery, and we are focused on price realization. Part of that will be driven by the actions that we are taking in terms of inventory management to control discounts in excess and obsolescence. You saw a bit of the results of that in Q3. And you will see certainly more of that in fiscal 2025. So that is a very big focus of our profit recovery plan, the focus on restoration of our gross margins. We're also focused on supply chain efficiencies that will help our gross margins and accretive innovation. And we talked about some of the processes in Fabrizio's prepared remarks that we are deploying and strengthening in order to be able to do that. The second area of focus is greater leverage of our expense base. We have efforts in indirect procurement in terms of accelerating some of the savings there. And we have -- are taking some difficult decisions as it relates to rightsizing and streamlining parts of our organization and that's the restructuring program that we spoke to you about before. That is really the combination of that should drive the $1.1 billion to $1.4 billion of incremental operating profit over two years. And again, we said that slightly more of that will happen in fiscal '25 then in '26. And again, in terms of the mix of where that recovery is expected more in gross profit margin, but also in our operating expenses. But I want to take the opportunity to talk about a couple of other benefits as it relates to the profit recovery plan. So in addition to the margin recovery, the program is expected to fund additional investment to your point for growth namely in consumer activation, more consumer activation for our brand. So the expectation is, we are going to save more than the $1.1 billion to $1.4 billion that we are committing to in terms of operating profit improvement in order to also increase some of our advertising spend retarget and selectively against the momentum that we see in our business. And last, but not least, we expect to streamline and reduce some of the complexity in the organization that is built up over time in our processes and that's expected to increase our speed, agility and effectiveness in our markets. And I know our organization in particular very much looks forward to this benefit. So, it's a powerful program. I'm glad you asked about it. When we deliver on all elements of it and we will share more in terms of helping with the modeling of it in August.

Filippo Falorni:

Hey good morning everyone. I had a question on the Mainland China business. You clearly mentioned strong start in January, but then a deceleration. You mentioned that the exit rate has been soft in the country. So maybe you can comment particularly like, what you've seen more recently from a category growth standpoint, promotional activity levels and maybe market share? And then maybe longer term, if you take a step back, based on your analysis on the market, what do you think has been the main driver of the weakness? Is it mainly macro related? Is it more trade down in the category? Or are competitors doing better? Any sense of what the drivers of this slowdown will be helpful. Thank you.

Operator:

Our next question comes from Steve Powers from Deutsche. Please go ahead with your question.

Tracey Travis:

Yeah, no.

Tracey Travis:

No, no, go ahead with your second question, Steve.

Tracey Travis:

Okay, Steve. So I'll take the first part of that question on the inventory in Asia Travel Retail and Fabrizio will take the Amazon Clinique follow-up question. Regarding the inventory in trade in Asia Travel Retail, we did reach the objectives that we had in the third quarter actually before April. And so the reason that we ended up shifting a bit more from -- or doing a bit more from a replenishment standpoint in the third quarter is because we actually reached those levels a bit earlier than what we had anticipated. We anticipate reaching them by April, which is the beginning of the fourth quarter obviously, and we reached them within the third quarter. So that is the reason why some of the shipments were a bit higher in the third quarter and we will expect the retail sell-through in the fourth quarter. And so – and as Fabrizio mentioned, we are expecting as well an acceleration of retail in the fourth quarter. Just remember for the cadence of what we're anniversarying we actually had some disruption even in the fourth quarter as it related to Hainan last year. So we are going to see a bit of a disconnect between retail and net for a couple of quarters because of the significance of the interruptions that we had both at the beginning of the third quarter last year and the end of the fourth quarter last year, as well. And so we would expect that net will as we replenish relative to the comparison year-over-year to last year then that would be ahead of retail but we will be maintaining the inventory levels in the range that we and our retailers have agreed to.

Operator:

And our next question comes from Andrea Teixeira from JPMorgan. Please go ahead with your question.

Tracey Travis:

So, I'll take your last part of the question first. We'll give more guidance on the calendarization of the profit recovery plan in August. We're still -- we're well into the finalization of some of those plans and making taking some decisions within the next couple of months. So, we'll be able to provide you with much better guidance on calendarization in the August time frame.

Operator:

And ladies and gentlemen, this will conclude 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 May 15th. To hear a recording of the call please dial 877-344-7529 using passcode 5758677. 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. You may now disconnect your lines.

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 organic net sales growth also excludes the non-comparable 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. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. Now I’ll turn the call over to Fabrizio.

Tracey Travis:

Thank you Fabrizio, and hello everyone. I’ll start by reviewing our second quarter financial results, followed by a third quarter and full year outlook. I’ll also provide details on our expanded profit recovery plan. As Fabrizio mentioned, our second quarter organic net sales decline of 8% met our expectations. Additionally, through tighter expense management and despite experiencing a higher tax rate due to the shift in our geographical mix of business, our earnings per share of $0.88 exceeded our initial outlook for the quarter. From a geographic standpoint, organic net sales in our Europe, Middle East and Africa region declined 14%, mainly attributable to the persistent challenges in our Asia travel retail business. The impact from business disruptions in Israel and other parts of the Middle East accounted for a 2% reduction in the region’s overall net sales growth. The markets in the region had mixed results, leading to overall flat growth across all markets. Organic net sales in our Asia-Pacific region fell 7%, reflecting continued challenges in mainland China. While our results on Douyin nearly doubled, our total online sales declined due to softer than expected performance on TMall during the 11.11 event. The overall online performance more than offset the increase in brick and mortar sales, which was led by double-digit growth in our freestanding stores. In the rest of the region, we saw strong organic net sales growth led by double-digit growth in Hong Kong SAR and Korea, as well as high single-digit growth in Japan. Our luxury fragrance brands Le Labo, Jo Malone London, and Tom Ford drove double-digit fragrance growth in the region, which was fueled by both effective commercial activations as well as compelling holiday product offerings. Organic net sales in the Americas declined 1%, driven by a prior year benefit from changes made to MAC’s take-back loyalty program in North America last year. Excluding this benefit, net sales were relatively flat in North America, reflecting growth in specialty multi and our freestanding stores and offset by softer performance experienced in department stores and online. In Latin America, organic net sales rose double digits, reflecting continued growth in nearly every market and strong performance during holiday and key shopping moments. From a category standpoint, organic net sales fell 10% in skincare and 8% in makeup. In skincare, the ongoing challenges in Asia travel retail and mainland China drove the majority of the decrease. Organic net sales from The Ordinary and La Mer grew across every geographic region. The Ordinary saw double-digit growth in specialty multi, including ongoing expansion, and continued its focus on education-first content to drive successful social media activations. Net sales from La Mer increased both online and in brick and mortar, benefiting from captivating social media and holiday product activations. In makeup, the persistent challenges in Asia travel retail were compounded by the prior year benefit from MAC that I previously mentioned. Organic net sales fell 6% in hair care and were flat in fragrance. Net sales from La Labo grew double digits, fueled by both targeted expanded consumer reach and same store sales. The brand’s ethos and high touch services persistently attract both new and loyal consumers, as evidenced by the double-digit net sales growth in our freestanding stores as well as strong performance during holiday and key shopping moments. For Jo Malone London, results from the brand’s holiday collection were strong and net sales increased in nearly all channels of distribution. This growth was offset by a decline from Estée Lauder due to the timing of holiday shipments compared to last year. Our gross margin decreased 60 basis points compared to last year. The positive impacts from brand mix and net strategic pricing actions were more than offset by higher costs due to promotional items and foreign currency. Operating expenses increased 260 basis points as a percent of sales, driven largely by the reduction in sales. Selling, advertising and promotional activities and innovation collectively accounted for 160 basis points of the increase compared to last year as we supported retail growth while also continuing to destock certain accounts in Asia travel retail. Operating income declined 25% to $577 million, and our operating margin contracted to 13.5% from 16.6% in the prior year. Our effective tax rate for the quarter was 37.7% compared to 24.9% last year. The increase in rate was primarily due to a true-up in the quarter to reflect the now higher estimated tax rate on our foreign operations for fiscal 2024 as a result of the change in our geographical mix of earnings. This also reflects an unfavorable impact related to previously issued share-based compensation. Diluted EPS of $0.88 decreased 43% compared to last year, including a dilutive impact of $0.19 from the change in the effective tax rate. The impact from business disruptions in Israel and other parts of the Middle East was $0.02 dilutive to EPS in the quarter. The acquisition of the Tom Ford brand was neutral to EPS as interest expense related to our debt financing was offset by the combined benefits derived as the licensor of the brand from royalty revenue this year and savings from no longer having to pay licensee royalties. During the quarter, we generated $937 million in net cash flow from operating activities compared to $751 million last year. The increase from last year reflects lower working capital partially offset by the decline in net earnings. The favorability from working capital was largely due to the actions we have taken to reduce inventory, primarily finished goods and semi-finished goods, that resulted in a significant improvement in our days to sell. We invested $527 million in capital expenditures and we returned $474 million in cash to stockholders through dividends. Turning now to our outlook for the remainder of fiscal 2024, which excludes the impact from the remaining payment for the outstanding Decium equity anticipated to occur in May 2024 and includes Clinique’s heightened focus in active derma, while we delivered on our Q2 expectations, we are lowering the high end of our fiscal ’24 organic net sales outlook range to reflect continued risks from evolving macroeconomic volatility and geopolitical tensions in certain areas around the world. Despite this change to our sales outlook, we are maintaining our full year operating profitability expectation. Furthermore, we are updating our EPS outlook primarily to reflect the increase in our estimated full year effective tax rate, largely due to the anticipated geographical mix of our earnings. This is expected to more than offset the EPS benefit from foreign currency translation. Using December 29 spot rates of 1.107 for the euro, 1.273 for the pound, 7.109 for the Chinese yuan and 12.90 for the Korean yuan, currency translation is anticipated to negatively impact reported sales for the third quarter and diluted EPS for both the third quarter and the full year. We expect organic net sales for our third quarter to increase 3% to 5% as both our businesses in Asia travel retail and in mainland China are expected to return to growth. In Asia travel retail, this growth assumes the continued reduction in retailer inventory as well as the anniversary of some business disruptions we experienced last year. Currency translation and the potential risks of further business disruptions in the Middle East are each expected to be dilutive to reported net sales by one point. We expect third quarter adjusted EPS of $0.36 to $0.46, for a decrease between 3% to 24%. Currency translation and the potential risk of further business disruptions in the Middle East are each expected to dilute EPS by $0.03. Adjusted EPS in constant currency is expected to range between an increase of 3% to a decline of 18%. For the full year, we expect reported and organic net sales to range between a decline of 1% and an increase of 1%. Our plants have been running at reduced capacity, reflecting the pull-down of production in line with our lower shipments and to support the reduction of inventory levels both in-house and in the trade. This has resulted in inefficiencies in some of our manufacturing locations and may trigger a requirement to recognize the related manufacturing costs as in-period costs instead of when products are sold. We have reflected this potential expense and the corresponding pressure to gross margin in our outlook for the balance of the fiscal year, primarily in the third quarter. Our full year operating margin outlook remains unchanged and is expected to be between 9% and 9.5%, a contraction from 11.4% last year, and planned to partially offset the incremental pressure to gross margin through disciplined expense management. We now expect our full year effective tax rate to be approximately 35% compared to 26.5% last year. The increase reflects a larger mix of our expected fiscal 2024 earnings in higher tax jurisdictions as well as the unfavorable impact of previously issued share-based compensation. Diluted EPS is expected to range between $2.08 and $2.23 before restructuring and other charges. The potential risks of further business disruptions in Israel and other parts of the Middle East and currency translation are expected to dilute earnings per share by $0.08 and $0.07 respectively. In constant currency, we expect EPS to fall between 34% to 38%. Given the progress we have made in strategic initiatives the first half of the year, we expect to return to organic net sales growth and stronger operating profitability in the second half. In November, we announced a profit recovery plan to support the progressive rebuilding of our profit margins in fiscal years 2025 and 2026. Today with the announcement of a two-year restructuring program, we have further expanded this plan. As Fabrizio mentioned, we are focused on strategically leveraging our strengths to accelerate our return to more sustainable profitable growth while elevating our consumer activations and increasing our operating agility. The restructuring program is designed to right-size and streamline select areas within our organization, which unfortunately necessitates us making the difficult decision of an expected net reduction in positions globally of 3% to 5%. The restructuring program is expected to begin in the third quarter and continue for the duration of the profit recovery plan. We expect to take charges of between $500 million and $700 million and generate annual gross savings of $350 million to $500 million before taxes. A portion of these savings is expected to be reinvested in consumer-facing activities to drive long term sustainable profitable growth. We now expect to drive incremental operating profit through all initiatives under the profit recovery plan of $1.1 billion to $1.4 billion, inclusive of net benefits from the restructuring program announced today. The plan is expected to yield almost all of the anticipated benefits by the end of fiscal year 2026, with slightly more than half of these benefits realized and contributing to operating profitability in fiscal 2025. In closing, we express our sincere gratitude to our teams around the world as they work tirelessly to execute against our priorities and drive our business forward. We believe that with the work that is being done to position us to return to growth in the second half of the fiscal year and beyond, and with the successful execution of our expanded profit recovery plan, we will be better positioned to return our company to long term sustainable growth and profitability. That concludes our prepared remarks. We’ll be happy to take your questions at this time.

Dara Mohsenian:

Hey, good morning guys. First, just a couple clarification questions under the restructuring and profit recovery program. Could you just give a little more detail on the structural changes in the program beyond the job cuts, and in the past, you’ve done a pretty good job of delivering upside to savings goals, so how do you think about other savings areas that could potentially emerge over time and are you pushing beyond what’s potentially announced? Then if you’ll be generous enough to entertain a question on China, I think clearly there are some structural changes that have emerged in China beauty - the consumer perception of the category itself, willingness to be ostentatious, etc., changes in daigou selling, promotional impacts, mass brand performance. There have been impacts to Estée brand share, so maybe Fabrizio, just take a step back and broad thoughts on the opportunity in China from here, but also specifically how do you adjust to these changes, what are your focus points from here in this new China reality? That’d be helpful, thanks.

Fabrizio Freda:

Yes, so on the China question, first of all, we had some soft consumer sentiment in the recent period that drove this lower prestige sales growth. However, first of all, we remain very optimistic about the long term opportunity in China and continue to invest for growth. The second point is you asked about the brand health and what’s changing. Our brands are really, really strong. The retail sales growth has been much better than the net growth, and have been extraordinary, double-digit growth on many of our brands, particularly in luxury, like La Mer, Tom Ford, Jo Malone, Bobbi Brown, Kilian, Frederic Malle and Aveda, also Le Labo continues to track. In terms of market share, importantly we gained market share over the fiscal year in quarter two, despite there was a small reduction from market share in quarter two, but we gained market share in skin care category 80 points, we gained in fragrances, we gained in healthcare, and there are several important of our--many of our brands, we had really top ranks in 11.11. Another element to support the strength of our equity is the freestanding store double-digit growth both in total and in live doors in mainland China, and I should also mention the strength in Hong Kong, where we grew substantial market share, in part reflecting success with the Chinese consumers. Where we go from here? As I said, we are going to continue to invest in China and we believe we have a great team there and determination to continue building market share, winning in the long term. The first step is building our distribution in winning online channels, that this will continue, particularly accelerating the win in the short term, and continue to build market share in new cities in brick and mortar, where I would like to underline is in quarter two, we grew substantial brick and mortar market share in China. We’ll also continue to leverage our current trend where retail sales [indiscernible] and we will support very strong holiday plans, which as you know, there is a high concentration of sales in China during the various holiday plans in the course of a year. We also believe that there is a particularly strong opportunity in the luxury area, around our luxury brands, which as I said are doing very well, and I’m referring to Estée Lauder Re-Nutriv launch that we mentioned in the prepared remarks. La Mer, Tom Ford, Le Labo, Bobbi Brown have extraordinary aggressive plans. Strong innovation plans in H2, by the way, will continue and will accelerate, leveraging the new laboratory in Shanghai, which is an important opportunity for us. It is important--you asked what is changing in the various other aspects, so in the relationship with travel retail and in the managing of the overall pricing and promotions across the China consumer framework, we have dramatically improved the model or the process between the China team and the PR team in making decisions about promotionality, pricing, channel prioritization, and this is working better and better for the future. Also about the development of local brands, for the moment they are mainly in mass. We completely acknowledge there will be a continuous development of local brands, and the strength of our innovation and the differentiation of our brands is going to be key, and so we’ll continue to invest in this [indiscernible] and in the strengths. The investment in our local lab, that will develop a lot of local innovation, is part of the answer to how to compete in this evolving environment as well. Last, we are shortening the supply chain with a factory in Asia Pacific and the ability to plan more accordingly to demand, and to be more agile in responding to demand is the added big capability that will increase the flexibility, the agility of our China team in following demand. Net, we have a strong business in China, we have strong market share, and we are determined to continue to invest for the long term in China.

Bryan Spillane:

Thank you Operator. Good morning Fabrizio and Tracey. My question is just related to maybe how you’re going to measure yourself as an organization over the next two years, so the ’25 to ’26 time frame, and I guess I ask that in the context of stock clearly today reflecting an inflection, right - a positive inflection, but at the same time, there’s a lot of mix things, right? China, slower than it was, but again optimistic for the long term. You’ve got a lot of work to do underneath the hood, right, to execute on the restructuring program and improve margins. I guess I’m just curious how you’re thinking about how linear this improvement would be, and again, are you going to change the way you’re going to maybe measure yourself in the near term, just given how much work you’ve got to do and maybe how different it was versus business as normal over the last couple of years. Thanks.

Operator:

The next question comes from Olivia Tong with Raymond James. Please go ahead.

Fabrizio Freda:

As you know, we are working on this for some time, and the way we address it is that we are going to continue to increase the focus on high growth channels. We have done some extraordinary improvement in the specialty channel in the last year, and that will continue to be our focus. We are also obviously focusing our support to our department store partners where we have high market share, and we are managing this business carefully, and we are continuing to accelerate online with various opportunities that we have in this world, and the consumer is shopping more and more omnichannel, and so we are going to continue to put focus on the opportunity of omnichannel growth that we have in the United States. That’s what we are doing, and you will see this strategy to be implemented step by step in the next 12 months, accordingly, to these opportunities.

Oliver Chen:

Hi Fabrizio and Tracey. You mentioned agility many times. What are your thoughts on the priorities in terms of what you’ll do there, as well as direct-to-consumer and digital? Community engagement, as you know, is very important in terms of user-generated content and making sure to embrace a lot of new formats. A follow-up - as we model inventory in the back half, your inventories are in much better shape, but what gives you the conviction that the inventory levels related to Asia travel retail will be healthy in terms of the back half? Just some key aspects and being more confident there. Thanks a lot.

Fabrizio Freda:

Then your question in agility, there are two measures of agility that we look at as very important. One is agility in responding to volatility faster in reallocating resources, so the action in this area has been the shortening of our supply chain in Asia, for example, and the various aspects--even the way we are repositioned. We are leveraging the historical heritage position of Clinique and doubling down on it in active derma, the way we are leveraging The Ordinary strength in active derma, so in other words how we are responding to the consumer trend of active derma now very decisively, so those are elements of agility. We want to improve our ability to do these things faster and more promptly in the future. The other aspect of the agility is the way we go to market, so reaction to, for example, the new platforms. We are learning how to operate with Tiktok globally; much more, we are focusing on earned media value much more our organization, including resource allocation but also the training and the development and the understanding of the various models. We are doing this is all markets for the world at the same time. We are modernizing our promotional models and making them more relevant to the current consumer trends, and importantly as an umbrella concept, we are becoming more and more able to react to trends. There are two kinds of trends we are working our organizational development on. The first is the long term trends, the fundamental changes in consumer preferences, where frankly we have been always pretty strong, and we are further refining these abilities. Then there are the short term trends, the trends that can change in a week, in a month of what’s going to be popular online in a certain country, in a certain moment, where we have developed better and better models to react to short term trends with our brands, with our execution, with our resource allocation. And by the way, the work on organization of the profit recovery plan is also pillared to improve our ability in both these areas, meaning the agility in resource allocation and the agility in reacting to trends and to the new models of marketing around the world.

Dana Telsey:

Hi, good morning Fabrizio and Tracey. As you think about pricing and the new launches that you have coming, how do you think about pricing both for existing hero and new products and how it’s changing? Then as you continue to enhance the specialty multi distribution, how do you see engaging with the department stores and what that relevance--how that relevance changes? Thank you.

Fabrizio Freda:

Yes, and on the different retailers, the retail channels, we obviously support every one of the retail channels, so specialty multi, department store. Every retail channel is going to be supported more and more in a tailored way, meaning tailoring to their model, to their strategy, to their specific consumer profiles, and this will be very different country by country. There are countries where certain channels grow faster than others and maybe the opposite happens in other countries, so it’s not about their preferences are changing, the strategy is about tailoring the strategy to each channel, supporting every one of our customers. At the end, the result of this is that the mix of our business in every country of the world will be focused on growth. It will be focused and leveraging the channels that the consumer is in that specific moment we choose, or the different target of consumer we choose in every channel, so it’s about tailoring to all the opportunities wherever they are.

Steve Powers:

Hey, thank you and good morning. Back to the profit recovery plan, I think your outlook today at the midpoint implies roughly $1.5 billion or so of operating profit in fiscal ’23, and you frame the recovery program as incremental profit from here, which assuming the benefits are all off a fiscal ’24 base, that implies $2.5 billion to $3 billion or so of operating profit in fiscal ’26, and I think that’s before considering presumed underlying growth in the business over those next couple of years.

Steve Powers:

Okay, great. I guess the question is how do you protect--against that objective you’re saying today, how do you protect against those incremental profits being essentially countered by incremental investments that emerge over that time, because you’re seeing the expectation for investors today that the profit comes, it’s a pretty firm objective, but how do you guard against other costs creeping into the model over the next couple of years?

Fabrizio Freda:

I’d just like to add one point, is that as you said, the $1.1 billion to $1.4 billion being defined as extra profitability, which means that the reinvestment part in building our brands and accelerating growth comes from more savings than what we define as extra profit, so to be fair, there will be more savings. Some of them will be reinvested in consumer-facing growth acceleration, and the $1.1 billion to $1.4 billion is our target for extra profitability, and that’s why we have been very clear on that. The investment in growth that will be done, or the extra investment in growth for the future that we want to develop capabilities for, are for consumer-facing. We are not planning to invest in many new capabilities; rather, we want to leverage the capabilities we have built in the last period in a very efficient way, so that’s the way to think, I believe, about the profit recovery plan.

Lauren Lieberman:

Great, thanks. Good morning. Two things I wanted to touch on. The first was just, I think during the prepared remarks, you commented that retail sales ex-China and travel retail are up mid-singles, but organic also excluding those things was down 3, so. I know you’ve spoken very explicitly about the inventory dynamics in Asia travel retail, but I was just curious about inventory dynamics outside of those markets and why that disconnect was that large. That was question one. Then question two is just on the go-forward plan around unstructured markets across Asia. Of course we all know there’s been regulatory change in China and Hainan, but you’ve spoken many times in the past, Fabrizio, about how that market tends to shift and move with the travelers and currency and all sorts of things that can impact where it’s taking place, so was curious on your thoughts about that unstructured market going forward, what you are or aren’t going to do in terms of regulating the degree of participation, because I think it has a lot to do with how we should be thinking about and modeling the absolute size of the travel retail business in dollar terms as we look out over the next several years. Thanks.

Fabrizio Freda:

On the unstructured market, our focus is on travelers and travelers converting, and that is getting better and better around the world, just to be clear, apart from the China situation that we have discussed many times. In the rest of the world, there is extraordinary progress in this area, double digits, in some cases triple digits in every market of the world, so this will happen more and more, also in China, also in Korea, and also in the part which has been the slowest to recover in that direction. So first part of the answer is the focus to continue growing in travelers and continuously improving the travelers’ conversion. As we are seeing from the data of the market, the travelers has been improving very, very nicely, but the conversion of the travelers for the moment is below expectations. The unstructured market as such is reducing, and I want to say it’s reducing also for regulations for the intentions of the government, so the retailers, so there is a trend to reduce the amount, and obviously this is also what we are doing, and so the way you should expect is that the unstructured market will be reduced, in my opinion will reduce also as a market, but will be reducing for us. It will be reducing in a gradual way as the travelers improve and increase over time.

Laraine 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 the 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 that 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.

Tracey Travis:

Thank you, Fabrizio, and hello, everyone. Let me begin with a brief review of our first quarter results in order to devote the majority of my discussion to our revised fiscal 2024 outlook and our profit recovery plan. Our first quarter organic net sales declined 11%, and earnings per share was $0.11. From a geographic standpoint, organic net sales in the Americas increased 6%, led by mid-single-digit growth in North America and continued strength in specialty multi. In Latin America, net sales rose high single digits and was driven by continued strength in makeup as well as strong growth in both brick-and-mortar and online channels. Organic net sales in our Asia Pacific region fell 3%, primarily due to incremental headwinds from the slower-than-expected recovery of overall prestige beauty in Mainland China. There were several bright spots in the rest of the region, led by triple-digit growth in Hong Kong SAR as well as double-digit growth in Japan and Australia. Our strategic investments in brand activation and new product innovation continue to resonate well with consumers in these markets. Hong Kong SAR also benefited from increased traffic in brick-and-mortar due to fewer COVID-related restrictions compared to last year and the resumption of tourism. Organic net sales fell 27% in Europe, the Middle East and Africa due to the ongoing headwinds in our Asia travel retail business. The overall challenges in our travel retail business more than offset the performance in the rest of the region, where we saw strong growth in skin care and makeup as well as growth in most Western and emerging markets. Organic net sales growth was driven by our developed markets, led by the U.K., Germany and France. From a category perspective, fragrance continued to lead growth with organic net sales rising 5%. Strength from hero products as well as compelling innovation from Le Labo propelled double-digit increases in the Americas and in Asia Pacific. Tom Ford also contributed to growth, rising double digits in the Americas. Organic net sales rose 1% in makeup. We continue to enhance consumer engagement through strategic investments and brand campaigns, including social media activation and new product innovation. Once again, M·A·C was the overall top performer, and Too Faced, Tom Ford and Clinique all contributed to growth as well. Organic net sales declined 7% in hair care and 21% in skin care. The pressures in Asia travel retail and in Mainland China drove the decrease in skin care. The declines from Estée Lauder and La Mer were somewhat offset by strong growth from The Ordinary. Consumer demand for the brand's hero products and new product innovation boosted its standout performance in the quarter. Our gross margin declined 440 basis points compared to last year. The benefits from the strategic pricing actions we took at the beginning of the fiscal year were more than offset by the under-absorption of overhead in our plants due primarily to the lower production of skin care products that accelerated in the second half of fiscal '23, higher obsolescence charges and an increase in promotional items, such as sets and samples, to support consumer activation. Operating expenses increased 950 basis points as a percent of sales driven largely by the reduction in sales. We maintain key investment plans in areas such as advertising and promotional activities, innovation and selling to accelerate growth where we had momentum, which collectively accounted for 480 basis points of the increase compared to last year. Operating income declined 84% to $108 million, and our operating margin contracted to 3.1% from 17% last year. Diluted EPS of $0.11 decreased 92% compared to the prior year. The impact from the cybersecurity incident we disclosed this past July was $0.08 dilutive to EPS. The acquisition of the Tom Ford brand was neutral to EPS, including interest expense related to our debt financing and reflecting savings from royalties we no longer pay as we now own the brand. During the quarter, we utilized $408 million in net cash flows from operating activities compared to $650 million last year. The decrease from last year reflects lower levels of working capital, including lower inventory levels, partially offset by lower net income. We invested $295 million in capital expenditures, and we returned $236 million in cash to stockholders through dividends. Turning now to our outlook for the second quarter and the full year. As Fabrizio mentioned, while we delivered on our Q1 expectations, we are lowering our fiscal '24 outlook for the balance of the year to reflect the slower-than-expected pace of recovery due to incremental external headwinds that continue to evolve during the second quarter. This includes the slower-than-expected growth in overall prestige beauty as well as the containment of the unstructured market activity in Asia travel retail and in Mainland China. This reduction also reflects the risks of potential business disruptions in Israel and other parts of the Middle East as well as currency headwinds. Using September 30 spot rates of for the Korean won, currency translation is anticipated to negatively impact reported sales and diluted EPS for the second quarter and for the full year. We expect organic sales for our second quarter to decline 8% to 10%. The incremental pressures from impacting sales in our Asia travel retail business and Mainland China are expected to continue to more than offset anticipated growth in other markets globally. Currency translation and the potential risk of further business disruptions in the Middle East are each anticipated to dilute reported sales growth for the second quarter by 1 percentage point. We expect second quarter adjusted EPS of $0.48 to $0.58 for a decline between 62% to 69%. This includes dilution of approximately $0.08 from assumed risks of potential business disruption in Israel and other parts of the Middle East and approximately $0.04 from currency translation. The increases in our full year effective tax rate and net interest expense are collectively expected to dilute EPS by $0.04. In constant currency, adjusted EPS is expected to decline between 60% and 66%. For the full year, we expect organic sales to range between a decline of 1% and an increase of 2%. Currency translation and the potential risk of further business disruptions in the Middle East are each anticipated to dilute reported sales growth for the fiscal year by 1 percentage point. We expect full year operating margin to be between 9% and 9.5%, a contraction from 11.4% last year due to the lower sales growth level. We now expect our full year effective tax rate to be approximately 28%, reflecting the full year estimate of our geographical mix of earnings. Diluted EPS is expected to range between $2.17 and $2.42 before restructuring and other charges and adjustments. This includes approximately $0.22 from the potential risk of further business disruptions in the Middle East as well as approximately $0.16 from currency translation. The increases in our full year effective tax rate and interest expense are collectively expected to dilute EPS by $0.16. In constant currency, we expect EPS to fall between 25% to 33%. Given this more challenging backdrop for fiscal '24, we have advanced the development of our multiyear profit recovery plan to support our priority to progressively rebuild margin in fiscal years '25 and '26. This plan is designed to accelerate the pace at which we expect to rebuild our margins while also facilitating operational efficiencies to support go-to-market agility in our local markets. The plan initiatives will target specific areas to deliver expanded gross margin and operating profitability improvements and is initially expected to drive $800 million to $1 billion of incremental operating profit over the next 2 fiscal years. We aim to accelerate many initiatives and substantially operationalize the plan in the second half of fiscal '24 to enable the realization of a meaningful amount of the benefits beginning in fiscal '25. Our first priority is to accelerate the rebuild of our gross margin. We plan to optimize our category, product and channel mix to support profitable growth as well as focus on accretive innovation. We aim to better capitalize on our strategic pricing initiatives by reducing discounts related to excess production and continuing to exercise our pricing power ahead of inflation in our markets. Furthermore, we plan to reduce excess and obsolete inventory by enhancing our operational efficiencies and begin to leverage the investments we've made to regionalize our supply network in Asia. Our profit recovery plan will also target OpEx reductions while further investing in consumer-facing activities that are imperative to accelerating recovery and driving long-term profitable growth. Our main areas of focus include containing head count as well as reduction in costs related to indirect procurement, T&E and transportation. These are just a few examples of actions we expect to take under our profit recovery plan. We plan to share more during our second quarter earnings call in February. In closing, while we are encouraged by the strength we are seeing across our brand portfolio and recovery markets, intensifying macroeconomic and geopolitical volatility as well as weakening consumer confidence in certain markets have unfortunately slowed the pace of our anticipated recovery in isolated markets. Given these incremental challenges, we are taking actions through the advancement of our profit recovery plan to support our intention to progressively rebuild our profit margins over the next few years. We remain confident about the long-term prospects for global prestige beauty and in our corporate strategy to drive long-term sustainable profitable growth. The desirability of our brands as well as the positive momentum we are seeing across categories and in certain markets give us optimism for the future recovery in all of our markets and demonstrate the resilience of our multiple engines of growth and our ability to drive share gains globally. Our return to sales growth, combined with the profit recovery plan, which we plan to finalize and begin implementing in the second half of this year, as I said before, support the achievement of margin rebuilding and profit recovery in the next few years. I would like to extend our heartfelt appreciation to our employees around the globe for their continuing commitment and efforts to deliver our results during these challenging times. That concludes our prepared remarks. We'll be happy to take your questions at this time.

Dara Mohsenian:

So apologies for a multipart question, but just had a few things on the profit recovery program. Conceptually, it sounds like it's more of a recovery from a depressed fiscal '24 base pushing even harder on some of the building blocks you outlined previously. Is that the case? Or are there more significant organizational changes that are now new in this plan to generate incremental savings? And also that $800 million to $1 billion profit recovery, should we think of that as just savings and recovery from a depressed base, and then base business top line growth on top of that could lead to greater recovery? How do we think about that? And then just, b, taking a step back, why not get even more aggressive here in terms of posture with a larger restructuring? Obviously, the external environment has changed. There's been some internal issues with supply chain and forecasting. So just thoughts on taking a more aggressive tack with the broader restructuring at some point?

Laraine Mancini:

Thank you, everyone, for your patience. We apologize for the difficulty. Fabrizio and Tracey are ready for our Q&A session now. So Jamie, if you can take us to our first question, please?

Dara Mohsenian:

So just wanted to start with a clarity question on the profit recovery program. It sounds like it's stemming more from a recovery versus a depressed fiscal '24 base and pushing even harder on some of the building blocks you had previously outlined. Is that the case? Or is it more of the larger organizational changes here that are new in this plan versus 3 months ago? And also, is that $800 million to $1 billion profit recovery, is that just the savings and recovery from a depressed base? Or -- and should we expect base business growth on top of that in terms of a top line rebound and the flow-through to profit? And then b, and apologize for the multipart but I want to get clarity there, just taking a step back, why not get more aggressive here with the larger restructuring? Obviously, the external environment has changed. There's been internal issues the last few quarters with supply chain and forecasting. In theory, SG&A levels have looked high ex marketing relative to peers. So just any thoughts on taking a more aggressive tack with a broader restructuring and how you guys think about that?

Operator:

Our next question comes from Stephen Powers from Deutsche Bank.

Tracey Travis:

Yes. So no, you're exactly right. The assumption is that we ship more towards -- we're able to ship more towards the retail trends. I mean, as we said in the prepared remarks, our retail trends are ahead of our net trends in Asia travel retail, both still down because we are destocking the trade. And so the expectation is that, that will be completed by the end of the third quarter, so in the second half of the year. So part of this -- a large part of the step-up that you see in the second half of the year is our shipping more towards the retail trends that we are expecting in the second half of the year. That's a big part of it. And when you think about what happened to us and what we're anniversarying from the second half of last year, where we had the policy changes first in Korea that impacted our third and fourth quarter and then the policy change -- or policy reinforcement in Hainan, which impacted our fourth quarter. We had, in some parts of our Travel Retail business, very low shipments given those policy changes. And so we are anniversarying as well some of the initial shocks of that. Lastly, I would say that we are seeing travel come back slowly, so again, more slowly than what we anticipated. We are seeing lighter levels of conversion relative to what we saw certainly prepandemic or even pre- the significant changes in policy across the Asia region. And -- but we are seeing traffic pick up, and we are certainly expecting that, that conversion will gradually pick up as well in the second half. So those are some of the things that are underlying our second half expectations and the reason you see that big step-up in terms of volume. It's a combination of multiple factors, mostly in our Asia travel retail. A bit of it is a pickup as well in China also. Fabrizio, I don't know if there's anything you want to add.

Tracey Travis:

For calendar year.

Operator:

Our next question comes from Jason English from Goldman Sachs.

Tracey Travis:

Yes. No, great question, Jason. So if you look back to the composition of the P&L in fiscal '19, you'll see that our gross margins were higher. And certainly, our cost as a percent of sales was a bit lower. And obviously, given the pull-down that we've had in this latest guidance review, our cost as a percent of sales are higher as well. But we did have -- we've had 2 cost-saving programs. We had the Leading Beauty Forward program, and then we had the post-COVID Business Acceleration program. In both of those instances, certainly Leading Beauty Forward gave us runway. We were actually expanding operating margins by over 100 basis points a year, anywhere between 60, 80 to 100 basis points a year through that program. And that program allowed us to reinvest in capabilities that we needed, in particular to accelerate some of our digital marketing activities, to create some shared service structures in some of our functional areas and to be able to leverage cost better in those areas. So those programs -- that program was successful in both delivering margin expansion and expense leverage at the time. Advanced allowed us to close some of our underproductive brick-and-mortar doors and take a little bit of or adjustments as well. But we have, over the last few years, invested in a number of capabilities that have been needed in terms of in our regulatory area. That includes cyber, but also in the regulatory area given the increasing regulations in all of the countries that we do business with and the claims and -- that we need to support our brand marketing initiatives going forward. We've made investments in areas like our sustainability program. So we have made a number of investments that, other than the shocks that we've had over the last couple of years, have been investments that were needed in the company. Certainly, as we look forward, we are looking at, as I said before, the profit recovery program is both focused on gross margin because we're not back at the gross margin levels that we were at in fiscal '19 or even before. And we also are looking at expense areas, everything from our procurement program where we expect that we can get some savings there, to other org efficiencies. So more to come in January, February, actually when we give you our second quarter results on what the final plan will look like. But it's -- believe me, we are as focused on the P&L structure recovery as you are, Jason.

Operator:

Our next question comes from Olivia Tong from Raymond James.

Fabrizio Freda:

Yes. Yes, it was -- it's our retail sales I was referring to. So calendar year-to-date in 2023, our trend of retail is mid-high single digit up to date. And our estimate for the future is to continue improving that trend. So my point is that retail is solid. And the negative net sales that we see in this first 6 months, for sure, our -- first, this month of the fiscal year are related to the readjustment of inventories that Tracey was mentioned. Second, on the visibility on these inventories in travel retail and -- by the way, when we say this retail, we say ex the travel retail numbers, just one clarification. So it's once the travel retail number. The point we are trying to make is that when the travel retail number, the retail and the net will be aligned, and we said they will be aligned as of the end of the third quarter. As of this moment, the retail -- the solidity of the retail progress is already in the making. That's the point we are trying to make. Anyway, on travel retail, we had a significant stock reduction in this first quarter. And we aim to be in line with the inventory expectation of retailers by the end of March. And we have visibility into these numbers. We have visibility. We have exactly the understanding for -- with each one of our retailers on where we are today, what are the programs that we are doing in order to accelerate sales retail of the existing stocks and what are the programs to obviously replenish and sell in innovation and all what we need to do in these areas. And finally, how by end March, we aim to have the retail and the net aligned. That's the program.

Filippo Falorni:

So I wanted to ask a question on Mainland China. It's the first quarter where you guys talked about a bit of a slowdown relative to prior quarters. So maybe, Fabrizio, can you give some context on the level of slowdown that you're seeing in the category? And then from a competitive standpoint, we've seen some local brands doing a little bit better, more on the mass side. But have you seen any trade-down within the category, both on skin care and cosmetics?

Operator:

Our next question comes from Bryan Spillane from Bank of America.

Tracey Travis:

Yes. No, it's a great question. Given where travel retail is right now, and certainly, we, I'm sure many others are thinking about the future of travel retail, which we are very encouraged by in terms of a return to growth but a return to the prior levels? Don't know. You have much now of the volume that has shifted to the local market. And I would expect to continue to see growth in the local market as well. So there may be a rebalance as it relates to the consumption for the Chinese consumer in particular as well as perhaps other consumer groups. So we're not counting on travel retail to get back to prior levels. If it does, that's great. But our profit recovery program, combined with some of the growth plans that we have for our markets and brands going forward, are not relying on that to return to profit margin -- the profit margins that we had previously.

Bryan Spillane:

Okay. So to be clear, we can get back to kind of the previous profit algorithm even if travel retail and basically Hainan is not as big as it was previously?

Operator:

And ladies and gentlemen, with that, we've reached the end of today's question-and-answer session. I'd like to turn the floor back over to Fabrizio for any closing remarks.

Operator:

Ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.

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 the non-comparable 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 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 yourselves to one question, so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Tracey Travis:

Thank you, Fabrizio, and hello, everyone. While we certainly had many successes this past fiscal year, as you just heard, we are not satisfied with our fiscal 2023 financial results and are executing on our strategy to progressively rebuild the margin accretive areas of our business over the next few years, and leverage the investments we have made in manufacturing, distribution and technology capabilities. I will further address our plans when I discuss our fiscal 2024 outlook, but first, I will cover the fiscal 2023 fourth quarter and full year results. Our fourth quarter organic net sales increased 4% and earnings per share was $0.07. From a geographic standpoint, organic net sales grew in nearly all markets in both Asia Pacific and EMEA. This strong performance was partially offset by the ongoing challenges in our Asia travel retail business as we expected. Organic net sales in Asia Pacific rose 36%, reflecting double-digit growth in most markets, led by Mainland China and Hong Kong SAR, as they continue to progress in recovery with fewer COVID-related restrictions compared to the prior year. They also benefited from our successful brand innovations, new product launches, activation consumer -- of consumers and targeted consumer reach. In Mainland China, online realized over 30% organic growth and achieved approximately 60% penetration of sales in the quarter. In EMEA, organic net sales decreased 15%. The growth in nearly all markets and channels of distribution was more than offset by the performance of our Asia travel retail business. In Hainan, retail sales declined more than we expected in the quarter for the reasons Fabrizio mentioned. Excluding our travel retail business, net sales in both Makeup and Fragrance rose double digits in the region, benefiting from our strategic investments in advertising and promotional activities and the reestablishment of services in our stores. Organic net sales in the Americas were flat compared to last year. The strong double-digit increase in Latin America driven by the re-acceleration of Makeup growth in Brazil and Mexico, was offset by the decline in the United States due to the slower-than-expected pace of improvement in retail sales of several of our brands. Standout performance from The Ordinary continues to be a bright spot in the region for the many reasons that Fabrizio mentioned earlier. From a product category perspective, Makeup organic net sales increased 13%, reflecting growth in each region led by Asia Pacific as recovery continued and usage occasions increased. M.A.C, Estée Lauder and TOM FORD drove growth, benefiting from investments in brand activations and increases in in-store staffing, the continued success of hero products, as well as new product launches. Fragrance organic net sales rose 12%, led by Le Labo and TOM FORD. Strong double-digit growth from Le Labo reflected increases in every region, momentum from our city exclusive special collection as well as growth from both existing and new points of distribution, including its expansion into mainland China. The increase from TOM FORD was fueled by strategic investments in advertising and promotional activities to support key shopping moments and brand activations. Organic net sales increased 6% in Hair Care and declined 3% in Skin Care. The pressures in our Asia travel retail business drove the Skin Care decline and were largely offset by the exceptional growth in the Asia/Pacific region. La Mer and Estée Lauder declined, while The Ordinary, Bobbi Brown and M.A.C grew. M.A.C's growth was driven by the launch of the Hyper Real line of skin care products. Our gross margin declined 330 basis points compared to last year. This decline primarily reflects the under absorption of overhead in our plants due to the pull down of production throughout the year given our elevated inventory levels, as well as increased obsolescence charges. Operating expenses increased 70 basis points as a percent of sales, driven largely by the increase in advertising and promotional activities to support commercial activations in the quarter. Operating income declined 66% to $71 million, and our operating margin contracted 380 basis points to 2% in the quarter. Our effective tax rate for the quarter was a negative 17.9% compared to 14.2% last year due to a true-up in the quarter to reflect the final effective tax rate for the fiscal 2023 full year. Diluted EPS of $0.07 decreased 82% compared to last year. The impact from foreign currency translation and foreign currency transactions in key travel retail locations negatively impacted EPS by 7% and 9%, respectively. As we discussed in May, we completed the acquisition of the TOM FORD brand and the related intellectual property on April 28, paying approximately $2.3 billion. As a result of this acquisition, we entered into arrangements to license the TOM FORD trademark for eyewear to Marcolin and fashion to Zegna, which were the brand's prior licensees, creating a new revenue stream for the company. This acquisition had a dilutive impact to EPS of $0.01 including interest expense on our debt financing and reflecting savings from royalties we no longer have to pay. Shifting now to our full year results. This has certainly been a more volatile year than we anticipated. The challenges to our business in Asia travel retail and the United States as well as in the first half in Mainland China were partially offset by the progression of recovery everywhere else. In Mainland China, we continue to gain share in all major product categories, demonstrating the strong demand for our products, although we remain conscious of the evolving economic conditions. And overall, our investments in brand activations, increased in-store staffing, distribution expansion and online capabilities aided in the acceleration of recovery of sales which largely occurred in brick-and-mortar channels, excluding travel retail. Net sales growth was strong in brick-and-mortar, particularly in our freestanding stores and with our specialty multi-retailers. Global travel retail represented 20% of our reported sales in fiscal 2023. And online net sales, which were flat, represented 29% of our reported sales. Organic net sales fell 6%, primarily reflecting the challenges in our Asia travel retail business, which drove the declines in our EMEA region of 16% and in Skin Care of 14%. Nearly all other domestic markets in EMEA grew double digits. In Asia Pacific, net sales rose 4% as markets continue to progress in recovery throughout the year and benefited from investments in advertising and promotional activities, innovation and distribution expansion. Net sales in the Americas was flat compared to last year. Regarding categories, Fragrance net sales increased 14%, rising double digits in every geographic region and benefiting from the continued strength of hero products, successful innovation and distribution expansion, while Skin Care was more challenged in Asia travel retail and North America. Net sales grew 6% in Hair Care and was flat in Makeup. Our gross margin declined 440 basis points compared to last year, largely due to the slower-than-expected recovery in Asia travel retail. This includes higher obsolescence charges under absorption of overhead in our plants due to the pull-down of production throughout the year, given our higher inventory levels and less favorable category mix from our Skin Care mix. Operating expenses increased 390 basis points to 59.9% of sales, driven primarily by the decline in sales. Despite the pressures to sales, we sustained our investments to support markets where recovery was evident, including in areas such as advertising, promotion, innovation and selling, which collectively increased by 280 basis points as a percent of sales. Operating income declined 48% to $1.8 billion from $3.5 billion last year, and our operating margin contracted 830 basis points to 11.4% for the full year. In spite of the challenges that materially impacted our top line growth, we continued certain of our strategic investments important to support recovery and drive long-term sales growth and profitability. Our effective tax rate for the year was 26.5% compared to 21.3% last year, primarily reflecting the change in our geographical mix of earnings. Net sales declined 53% to $1.2 billion, and diluted EPS of $3.46 decreased 52% compared to last year, including the dilutive impacts from foreign currency translation and foreign currency transactions in key retail -- travel retail locations of 4% each. The acquisition of the TOM FORD brand was dilutive to EPS by $0.01. Now turning to our cash flows for the fiscal year. We generated $1.7 billion in net cash flows from operating activities compared to $3 billion last year. The decrease reflects lower net income, partially offset by lower working capital. We invested $1 billion in capital expenditures for supply chain enhancements, including our new manufacturing facility in Japan, consumer-facing capital, such as distribution expansion, investments in existing counters and online capabilities. We returned $1.2 billion in cash to stockholders through both dividends and share repurchases. Beginning in December of 2022, we suspended the repurchase of shares given the increase in debt due to the TOM FORD acquisition. Before I turn to our outlook for the full year, I want to take a moment to first address the recent cybersecurity incident we disclosed in July, involving an unauthorized third-party that gained access to some of our systems. After becoming aware of the incident, we proactively took down some of our systems. We began bringing our systems back online within days, which limited the incidents impact on the company's operations. Based on the information available to date, we believe the incident is contained. So now, let's turn to our outlook. This past year has undoubtedly been difficult, largely given the challenges we faced from increased market volatility in certain markets and the corresponding impact on our business. As we work to return to net sales growth in fiscal 2024, and over the next few years, progressively rebuild our operating margin, we remain focused on the transition of key areas of our business that have been disproportionately impacted by a slower pace of recovery, while also continuing to support growth in those areas where the recovery is more advanced. Over the next few years, mainland China and our travel retail business are expected to remain key drivers of our long-term profitable growth, and we anticipate continued growth with other areas of our business, including emerging markets globally, our more mature markets in the West and our direct-to-consumer channels globally. Assuming an eventual return to global prestige growth of 4% to 5%, we expect to return to more consistent compounded annual sales growth within our 6% to 8% long-term growth algorithm. Restoration of our operating margin is a top priority, though margin recovery will not happen in one year. We do, however, expect to progressively drive margin expansion as we return to profitable growth in Skin Care, improved Makeup margins and continue to drive our momentum in Fragrance, particularly our high-end artisanal fragrance brands. In addition, we plan to expand our gross margins through continuing to leverage our prestige pricing power, inclusive of driving additional accretive and compelling innovation, and improvements in operational efficiencies including enhanced supply demand planning and inventory optimization to reduce excess inventory and discount. We will begin to leverage the further regionalization of our manufacturing and distribution network in Asia to create greater inventory agility as demand fluctuates. Overall, beginning in fiscal 2024, we expect to recapture lost operating margin -- overall -- I'm sorry, beyond fiscal 2024, we expect to recapture lost operating margin at an accelerated pace by delivering annual margin expansion that is faster than our pre-pandemic historical average. This acceleration is expected to become more evident after the first quarter of fiscal 2024. So turning to fiscal 2024. We expect to continue to deliver net sales gains in the areas that performed well in 2023, including Asia Pacific, our Western and emerging European markets and Latin America, as they continue to progress in recovery from the pandemic, and benefit from the strategic actions we are taking to accelerate growth, including targeted consumer activation, compelling innovation and distribution enhancements that we drove throughout the pandemic period. We are, however, mindful of the macroeconomic headwinds that have emerged in Chinese economy. This has also resulted in our Asia travel retail business taking a bit longer than we originally anticipated to return to growth as travel and conversion remain pressured, which has been exacerbated by the sudden reduction of sales to non-travelers relative to the return of individual travelers in Korea and in Hainan. Correspondingly, inventory levels in the trade in Asia travel retail have improved at a slower pace. This will create greater pressure on our first half as we expect to continue to both adjust our shipments and increase our retail activation but also should yield sequential quarterly improvements throughout the year in both sales and margin. With that backdrop in mind, and using June 30 spot rates of $1.087 for the euro, $1.261 for the pound, $7.253 for the Chinese yuan and $13.21 for the Korean won, the full fiscal year organic net sales are forecasted to grow 6% to 8%. Royalty revenue from the acquisition of the TOM FORD brand is not expected to be material to net sales growth and will be excluded from organic net sales until the fourth quarter. The cybersecurity incident is also not expected to have a material impact to net sales. Currency translation is expected to dilute reported sales growth for the full fiscal year by 1 percentage point. We take the majority of our pricing actions at the beginning of our fiscal year. Our strategic price increases, including new products are expected to add approximately 5 points of growth. We expect the net benefits from strategic pricing, discount reductions and lower obsolescence to drive gross margin expansion for the full year, partially offset by manufacturing under absorption. We are aligning our production volumes to address a more variable demand environment with the intent to carry less inventory in our system and in the trade, while we continue to regionalize our supply base in Asia. However, we expect the lower mix of net sales from the highly margin-accretive areas of our business, including Asia travel retail and Skin Care, and the under-absorption of overhead to result in margin contraction in the first half of the year. This is expected to be more than offset by gross margin expansion in the second half of the year, given the greater mix of our travel retail business and Skin Care and less obsolescence charges compared to last year. Our full year operating margin is forecasted to be approximately 12% to 12.5%, a 60 to 110 basis point expansion from fiscal 2023. In fiscal 2024, we anticipate sequential margin expansion throughout the year driven by improvements in gross margin, while also maintaining go-to-market initiatives where appropriate. We expect our full year effective tax rate to be approximately 27%. Diluted EPS is expected to range between $3.50 and $3.75 before restructuring and other charges. The cybersecurity incident is expected to be approximately $0.07 dilutive to EPS. Our EPS range also includes approximately $0.11 of dilution from currency translation. In constant currency, we expect EPS to grow by approximately 4% to 12%. Net cash flows from operating activities are forecasted between $1.7 billion and $1.8 billion. Capital expenditures are planned at approximately 6% of forecasted net sales as we expect to fund new distribution and online capabilities, further enhance our manufacturing and distribution network, including the completion of our first manufacturing facility in Asia located in Japan to support the development of our Asia Pacific region. We also plan to continue investing in information technology to support our business. Our fiscal 2024 outlook also assumes flat quarterly dividend and the continued suspension of our share repurchases as we focus on deleveraging after the TOM FORD acquisition and prepare for the payment to purchase the remaining outstanding equity interest in DECIEM anticipated in May of 2024. For our first quarter, we currently expect organic net sales to fall 12% to 10%. The cybersecurity incident is not expected to have a material impact to net sales. At this time, we expect first quarter diluted EPS of negative $0.31 to negative $0.21 before restructuring and other charges. The cybersecurity incident is expected to be approximately $0.07 dilutive to EPS. This also includes approximately $0.02 of dilution from currency translation. In constant currency, we expect EPS of negative $0.29 to negative $0.19. I would like to close by thanking our employees for their dedication and focus during what turned out to be a challenging year. While we are not satisfied with our performance overall, we are certainly pleased by the results we were able to deliver in many recovering markets and brands. For fiscal 2024, we believe we have the right plans to navigate the environment as we gradually return to our historical cadence of long-term progressive and sustainable sales and profit growth, fueled by our highly desirable brand portfolio and our incredibly talented employees. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Stephen Powers:

Yes. Hi. Good morning and thank you. I'd love it if you could address two topics, maybe one for you, Tracey, one for you, Fabrizio. First for Tracey, just -- appreciate your commentary at the end there, but just maybe a little bit more detail, if you could expand on the assumptions embedded in the 1Q step back and declines juxtaposed against what looks like a pretty rapid return to fairly -- to basically double-digit organic growth over the remainder of the year? Just little more color there, and I'm assuming a lot of the variability focused on Hainan, so maybe some expansion there? And then Fabrizio, I know the company had a leadership offsite in June. I'd love your perspective on how recent changes in the operating environment impacted points of emphasis of that meeting? And how the related discussion may have informed your 2024 outlook? Thank you very much.

Fabrizio Freda:

Yes, on our leadership [Technical Difficulty] In June, we look at the strategy and the strategy of the future. And so what Tracey and I have presented in our prepared remarks are the results of also this work of reconfirming the strategy for 2024 for the next three years. And so, what are the key takeaways was your question. It's that, first of all, the market of global prestige beauty continue to be very attractive and will continue to be more and more attractive in the future. And our strategy is, as I explained in the prepared remarks, is now focused on continue building on our strengths and continue building the areas where we are really delivering great results and supporting this growth. At the same time, continue reinforcing the health of our brands and the innovation of our brands and refocusing resources and activities in all these areas. And then fix the TR issue, including a much better coordination between TR organization in China and China region organization in mainland, and the plans for the North America acceleration and to continue winning emerging markets. By the way, in the last quarter we're astonishing with a 38% growth. And so, deploying the resources, the capabilities, the skills to continue doing this in the key emerging markets, I have to say, the excitement in India is particularly high. And so, in summary, the leadership of the company has agreed and allocated resources and skills on the key components of the strategy for the next three years, which is, leverage the growth of the market and obviously, continue to build our strengths, fix our issues, and most importantly, support the profit recovery plan that again, we explained in the prepared remarks, in every single aspect at the accelerated pace of profit recovery, as Tracey just explained.

Dara Mohsenian:

Hi, guys. So two part question on my end that I think builds on that answer, Fabrizio. Some fairly unique circumstances in the past year, both externally and internally that caused weaker results than you originally expected. That's uncharacteristic versus a longer-term track record. So just wanted to get your perspective on, A, if you think you have good visibility on this fiscal 2024 earnings guidance? How much investment are you assuming incrementally to drive a recovery post 2024? And then B, perhaps, Tracey, you gave us some detail on margin expectations. But how should we think about sort of the ability to get back to peak historical margins at some point over the next few years? And how quickly we might see margin recovery relative to this 2024 base just as we think about those four building blocks you mentioned from here? Thanks.

Tracey Travis:

Yes, Dara. So I mean, certainly, we are encouraged by some of the signs we see -- recent signs that we see in terms of recovery. The return of travelers. We are, as Fabrizio mentioned, in terms of our fiscal 2024, taking actions to pretty dramatically pull back on some of our production so that we can get our inventory levels in line. And that will improve our margin. And I talked about in my prepared remarks that we're expecting gross margin recovery from some of those actions. As the situation normalizes and more travelers come back to travel retail, we are very confident in the strategy that we've had previously. Pre-pandemic, we were well on our way to those 20% operating margins. We don't see any reason why, once things normalize, that we can't get back to those 20% margins. Timing, I can't give you. I have said in our prepared remarks that we certainly, over the next few years, have plans to accelerate the margin progression well above our historical guidance of 50 basis points of margin improvement, and that does recommend -- that does represent a catch-up in margin progression and again, the strategies that we have to do that. But we are incredibly focused as an organization on returning to the margins that are more representative of our growth and our growth potential. I will also underscore the fact that we will not do that at the expense -- at the short-term expense of hurting our brands or hurting our markets that are in recovery, so it is a balancing act for us in terms of making sure we're making the right surgical investments that support not only the recovery and the markets that are further along in recovery, and as well as the long-term investments that we need to continue our growth algorithm of 6% to 8% top line growth and margin expansion. So again, I can't -- I know that's not the answer you're looking for in terms of you want a specific year and a specific number. And hopefully, we will be able to give that to you when we get a bit more clarity on more stabilization in the environment. But right now, you have the commitment of our entire organization that we recognize and have plans to accelerate our margin progression well beyond our historical levels in order to try to catch up.

Chris Carey:

Hi. Good morning, everyone.

Chris Carey:

So just one quick follow-up, and then a kind of a geographic question. Just on the China travel retail inventory dynamic. Fabrizio, you had mentioned that there's going to be greater collaboration between your teams in mainland and China travel retail. What's your confidence that some of the things that you may need to do to invest behind clearing your inventory won't impact brand equities and brand health? And I'm basically just trying to get a sense of the types of actions that you might be taking to clear inventory of -- consumption trends are as volatile as you say? And then just the geographic question would be, you had mentioned quite impressive growth rates in India, but also some underperformance in North America. Just over the next 12 months or longer, how do you think about this non-Asia market progressing, with perhaps to touch on what you see in some of these newer faster-growth markets? Thanks so much.

Operator:

Our next question comes from Bryan Spillane from Bank of America. Please go ahead.

Tracey Travis:

So I'll start in terms of that question. We don't control it, right? We sell to our travel retail operators, and so the whole mix of who is buying in Hainan is really with our retail partners. Part of the adjustment that we are seeing right now is the timing of when regular travelers return to Hainan when individual travelers, to your point, return to Hainan, and some of the changes in enforcement and regulations that have happened in China. And so there is a disconnect in timing that certainly is impacting our sales, combined with the fact that we are reducing the inventory levels that we have in Hainan. So that is all having a disproportionate effect. I think when we look at the development that has been done in Hainan, and we've talked about this for several years. Our expectation is that travelers, regular individual travelers, will return to Hainan and they will enjoy the fantastic shopping experience that has been created in Hainan, and we have no concerns whatsoever about travel retail growing with traveling consumers. It's a timing issue for us right now, and so I just wanted to really underscore that. It's a pretty -- it's having a timing issue that's having a big short-term, temporary impact for us. But we are not concerned at all about what we have shared with you in the past in terms of our strategy to continue to grow travel retail globally, and certainly in all of our markets in Asia.

Operator:

Our next question comes from Lauren Lieberman from Barclays. Please go ahead.

Tracey Travis:

Okay. Thanks, Lauren. So part of the capital that we'll be spending this year is to complete the factory. So we've done some preproduction runs in fiscal 2023. The factory will be producing a bit of the volume for the region in fiscal 2024. We have very specific plans on -- which, largely Skin Care, as we've talked in the past, some foundation products will be manufactured in the plant. Given where we're at right now, as you -- as we just spoke about in terms of Skin Care, that will be more gradual. So we have to first complete the plant. We also have opened a new, temporary distribution center in China. We'll be expanding on some of our distribution footprint in China as well. So I would say in terms of -- it will take a couple of years of ramp-up before we have the Asia supply chain fully operational and full from a capacity standpoint. That doesn't mean that as we gradually ramp up over this year and next year, we won't be creating more agility by being able to start to shift some of the production in those areas. But right now, we're working on contracting some of our production just given some of the shocks to the system. So you are absolutely right that long term, this will create agility for us. There are other things that we're doing to create agility. We've talked in the past in terms of some of the investments we've made in technology to help our -- especially in a very dynamic demand environment in order to try to forecast more accurately. I don't know that any forecasting tool would have forecasted what we experienced this past year. But certainly, as we think about all of our new innovation, all of our SKUs, new brands, et cetera, the more that we can technology enable and coordinate our inventory planning and our supply planning, the better we will have from -- experience we will have from an agility standpoint as well. So there's a tremendous amount of work that is going on to very much improve the situation going forward. Right now, we're managing just some tremendous shocks to the system that we're in the process of correcting.

Operator:

That concludes today's question-and-answer session. If you are unable to join for the entire call, a playback will be available at 1:00 p.m. Eastern Time today through September 1. To hear a recording of the call, please dial (877) 344-7529, pass code #4620398. 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.

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 the non-comparable 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 Web site. 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' Web sites. During the Q&A session, we ask that you please limit yourselves to one question, so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Tracey Travis:

Thank you, Fabrizio, and hello, everyone. Our third quarter organic net sales declined 8% and earnings per share decreased 75% to $0.47. As Fabrizio mentioned despite continued challenges in our Asia travel retail business, we experienced accelerated growth across our markets globally with nearly every market expanding as they progressed through various stages of recovery from the pandemic. From a geographic standpoint, organic net sales in our Asia-Pacific region rose 7% with nearly all markets contributing led by Hong Kong which doubled in size partially due to the return of Chinese traveler while Australia grew nearly 50% and Japan rose double-digits, Mainland China also returned to growth this quarter, showing positive signs of recovery in February and March, after the pressure from the increase in COVID cases, and slower retail traffic in January. Throughout the regions, markets continue to progress and recovery with fewer COVID restrictions compared to last year, leading to growth in all product categories, with the return of brick-and-mortar traffic. Strong double-digit growth from the regions in emerging markets contributed one point to Asia-Pacific's growth. Organic net sales in the Americas grew 6%, lead by the United States. In North America, organic net sales grew mid single-digits, reflecting growth in skincare, makeup, and fragrance. The Ordinary, M·A·C, and Le Labo excelled, each rising double-digits in the quarter. Specialty multi-growth including distribution expansion drove the increase in brick-and-mortar along with contributions from freestanding stores and department stores. In Latin America, organic net sales grew double-digits, benefiting from growth in every country and in all product categories with particular strength in makeup and fragrance. Organic net sales in our Europe, the Middle East, and Africa regions fell 24%, driven entirely by the travel retail business. Our global travel retail sales continue to be pressured by our Asia travel retail business, which Fabrizio described. Outside of Asia, we experienced double-digit sales growth in travel retail, as international travel increased throughout Europe, and the Americas. The overall performance in travel retail more than offset the organic net sales growth from the rest of the EMEA region, where we drove strong performance in all product categories and from nearly all channels of distribution. Organic net sales rose across both developed and emerging markets, lead by the United Kingdom, Germany, France, Italy, and Turkey, as the progression to recovery continued, and tourism resumed. From a category standpoint, fragrance continued its momentum as organic net sales rose 14%. Strong demand for our products and high-touch services as well as innovation fueled growth across every geographic region. TOM FORD Beauty, Le Labo, and Estée Lauder each grew double-digits in the quarter. Organic net sales in hair care grew 3%, and sales were virtually flat in makeup. Makeup growth in the Americas, Asia-Pacific, and the markets in EMEA, excluding travel retail was offset by the pressures in Asia travel retail. M·A·C and Clinique continue to drive makeup recovery, and double-digit growth from TOM FORD Beauty and Too Faced also contributed. Nearly every market in Asia-Pacific realized strong growth in the category, partially offset by softness in Mainland China. Organic net sales in skincare fell 17%, due to the pressures affecting Asia travel retail. The declines from La Mer and Estée Lauder were partially offset by standout performance from The Ordinary and M·A·C. The Ordinary benefited from strong growth in specialty multi-channel, particularly in the U.S., as well as from geographic expansion into India and the Middle East this year, as well as the success of new product innovation. The launch of M·A·C hyper-real product franchise expanded its offering in the category, and contributed to growth. Our gross margin declined 750 basis points compared to last year, largely due to the slower-than-expected recovery in Asia travel retail. This includes obsolescence charges, higher promotional costs, and gets that to drive increased consumption, excess overhead absorption in our plants due to the pull down of production throughout the year, given higher inventory levels, and less favorable brand and category mix. Operating expenses increased 570 basis points as a percent of sales, driven largely by the reduction in sales. We continued our investments to support recovery markets in areas such as advertising, promotional activities, and innovation, which collectively increased 230 basis points, compared to last year. Operating income declined 66% to $360 million, and our operating margin contracted 1,320 basis points to 8.4% in the quarter. Despite the volatility that has significantly impacted net sales we have sustained certain of our strategic investments to support recovery in select markets, and the strengthening of our multiple engines of growth. We continue to invest in areas inherited to long-term profitable growth, including innovation, advertising, the growth of our emerging markets, the geographic expansion of some of our brands, production capacity, and consumer engagement. Our effective tax rate for the quarter was 43.1%, compared to 21.3% last year. The increase in rate was primarily due to the expected further reduction in earnings, related to our travel retail business for fiscal 2023. Diluted EPS of $0.47 decreased 75% compared to last year. This was at the high-end of our outlook, despite the significantly higher-than-normal tax rate. The impact from foreign currency translation and foreign currency transactions in key travel retail locations negatively impacted diluted EPS by 1%, and 3% respectively. For the nine months, we generated $1 billion in net cash flows from operating activity, compared to $2 billion last year. The decline from last year reflects lower net income, partially offset by lower working capital. We invested $652 million in capital expenditures, and we returned $945 million in cash to stockholders through both dividends and share repurchases. On April 28, we were pleased to complete the acquisition of the TOM FORD brand. The amounts paid at closing of approximately $2.25 billion were funded through a combination of cash, including the proceeds from the issuance of commercial paper, and $250 million received from one of the licensees of the brand, Marcolin. An additional aggregate amount of $300 million in deferred payments and 5% interest per annum to the sellers become due from the company, beginning in July, 2025. We estimate an EPS dilution to the full-year of approximately $0.03 to $0.04. And now turning to our outlook for fiscal 2023, clearly this fiscal year has proven to be a perfect storm of higher-than-anticipated volatility, from both global, external headwinds and uncertainties surrounding the timing and pace of recovery from the COVID-19 pandemic, primarily in China and Asia travel retail. In August, we expected a gradual improvement throughout the first-half of the fiscal year, as markets in international travel began to recover from the impacts of COVID restrictions. However, the actual impacts to our business in Asia travel retail and China to a lesser extent have been far greater than we anticipated, given the prolonged challenges from the pandemic, including a slower-than-expected recovery of traffic and sales conversion in prestige beauty in these markets. Further compounding this pressure is the tightening of inventory by retailers in Hainan. We now expect that a far more gradual return to normal sales growth in Asia travel retail is likely to persist into the first-half of fiscal 2024. In addition, higher inflation and currency volatility as well as promotions in certain markets to alleviate high stock levels more than offset our price increases, and further pressured our business margins. In sight of the volatility in Asia travel retail that delayed the recovery relative to what we had expected, as well as the macro pressures from inflation and currency, we have been encouraged by the faster-than-anticipated improvements across many of our markets globally, as they progress through various stages of recovery from the pandemic. While we are lowering our full-year outlook to reflect continued decline in net sales in Asia travel retail, including the tightening of inventory by certain retailers, we plan to invest in markets where traffic and consumption are returning, and expect to return to overall net sales growth in the fourth quarter. This reflects double-digit sales growth in the Asia-Pacific region, including Mainland China, as well as in EMEA, excluding Asia travel retail. The Americas has planned to grow single-digits. Currency also continues to pressure margins relative to prior year. As Fabrizio mentioned, we are certainly not satisfied with our results this fiscal year, and will address plans to progressively rebuild the margin accretive areas of our business beyond this fiscal year from the current year's level. When full recovery does occur from the pandemic, we do expect the return to healthy growth of our Asia travel retail business, and in our related skincare category supported by a more normalized level of investment in selling, advertising and promotional activities, reflective of the increased brick-and-mortar traffic. With these assumptions as our backdrop and using March 31st spot rate of 1.09 for the euro, 1.239 for the pound, 6.872 for the yuan, and 12.97 for the Korean won, we now forecast organic net sales for the full-year to decline 75%. Currency translation is expected to dilute reported sales growth for the full fiscal year by 4 percentage points. And we anticipate an additional 1 point of dilution from the impact of certain foreign currency transactions and key international travel retail locations. The impact of sales from certain designer license access is expected to dilute reported growth by approximately 1 point. Full-year operating margin is forecasted to be approximately 11.1%. An 860 basis point contraction from the prior year period, primarily due to the disruptions from COVID restrictions that not only impacted sales in Asia travel retail and Mainland China but also resulted in increased obsolescence charges, discounts and promotional expenses. Foreign currency impact and the strategic investments, I mentioned previously. are also expected to pressure margin. We now expect our full-year effective tax rate to be approximately 27%, reflecting the change in our estimated geographical mix of earnings for the balance of the year. Diluted EPS is expected to range between $3.29 and $3.39 before restructuring and other charges. And, includes the expected impact of the Tom Ford acquisition I mentioned previously. This includes approximately $0.26 of dilution from currency translation. In constant currency, we expect EPS to decline approximately 51% which includes a negative impact from foreign currency transactions in key international travel retail location of approximately four percentage points. While this has been a challenging and disappointing year, navigating through many uncertainties the strength we are seeing in many of our recovery market gives us tremendous optimism for the future. Our long-term fundamentals and strategy remain intact as does our confidence in the long-term growth opportunity for global prestige beauty in our brands with the investments we have made to sustain long-term profitable growth. On behalf of Fabrizio and the Estée Lauder company's leadership team, we want to extend our immense gratitude to all of our employees around the world. We recognize that this has been an incredibly challenging year for you. And we want to thank you for your extraordinary efforts through dedication and commitment to the company and your resilience as we continue together on our path to recovery. And that concludes our prepared remarks. We will be happy to take your questions at this time.

Dara Mohsenian:

Hey, good morning, guys. So, I just wanted to touch on the three areas of weakness versus your guidance in terms how Korea and China taking a step back, the magnitude of changes to your guidance stemming from the areas is obviously severe, and it also looks more onerous than peers. So, just as you take a step back and look at the weakness versus what was expected, how much of that is do you think more just a timing of recovery in beauty at the consumer level coming out of COVID, or retail inventory issues, which [inferior] (ph) more shorter term versus the potential for the longer term recovery in beauty category is low in these areas, so, really just perspective on lower long-term sales potential versus more short-term issues? And I know it's hard to speak relative to peer results and guidance, but it does look like the issues are more severe for Estée versus peers. So, just any perspective on Estée's market share company performance in these areas would also be helpful. Thanks.

Fabrizio Freda:

And Dara, I just want to add -- so, as Tracey explained, in theory it's really an issue of inventory versus stage of recovery. Another proof of that is our retail in travel retails is so much stronger than our net. So, we had a minus 45% in quarter three versus a single-digit decline in retail. So, there is a lot of inventory absorption which is going on with the recovery. And, a lot of the speed of this absorption will depend on the speed of the recovery that we have in front in us. We are estimating that given the trend in this period in the quarter four, retail will go positive. And then, the absorption will continue to improve over time. And eventually continue in quarter 1 of next fiscal year. Other encouraging point, I want to touch briefly the China that you asked also about. So, in China we returned to organic growth which is excellent news. And we expect the double-digit growth in quarter four in China Mainland. We accelerate the market share gains for the second quarter in a row, and I want to underline that when the problem with the volatility in China started in the period where Shanghai was closed, and we were particularly affected by the closure of Shanghai. At the moment, during these three months of closure, we lost significant market share. Now, the good news, we now essentially made that for the lost market share from the lockdown. We are back in line with the total market share that we expect in quarter four, because also of the low base to get into a positive market share growth versus also the pre-lockdown period, which is a store gain, we said, that would have tried to recover these in one year, and we will do that and better than that. The other important thing to underline that linked to this TR issue that is the skincare issue, because there is a high percentage of skincare, which is a very profitable category for us. And I want to also underline that skincare is growing, the asking rate is growing globally by 6% percent. So, we are growing skincare. We are growing skincare in China Mainland. Our retail is growing ahead of the market that we are building market share in quarter three, and we expect to do even more in quarter four. And Estée Lauder and La Mer is driving this growth, with La Mer growing double-digit retail in the quarter in China, and Lauder single-digit. So, the last part of your question is our different situation versus peers, I would say that if you look at business overall, the answer of the difference is in the level of stocks, in the TR and the volatility, and the fact that we are bigger in the historical to the strong accretive channel that in a moment of crisis obviously resulted into a big negative.

Chris Carey:

Hi, good morning everyone.

Chris Carey:

So, you know, I guess just I think these revolved in taking Dara's question, in consideration, I guess it's like APAC and Americas actually exceeded expectations, which in a way probably helped come back this dynamics, if it's a category or brand or stockholder issue. I think it's also probably not fully understood that L'Oréal and others have much smaller travel retail businesses, maybe understood, but I guess the question is, clearly you have created a unique business where you're more bigger in travel retail than many of your peers, and this has been something that's been growing over the last several years, and obviously that created a lot of great tailwinds during the up move, but it's just created an enormous amount of volatility, and I think also a lot of visibility as we come into this kind of downtrend, right? And I hear you on rebuilding demand-evolving activities and remaining at markets, but I just wonder this market needs to reset lower before you can really talk about validation or are we really just -- we got one more quarter of two of issues, and any more really rebuilding from there, right? And I appreciate Korea and China all have different dynamics, but I think the overall context here is certainly the travel retail business is creating a ton of volatility for your business? And then, just related to that, and I apologize, but the fiscal Q4 guidance range is quite wide, and I think that maybe sees the visibility kicking in. Can you maybe just talk about how you might be approaching the concept of this guidance, given the lack of visibility, so that perhaps we can maybe avoid some of these resets? So, thank you so much for that perspective, I very much appreciate it.

Tracey Travis:

So, as Fabrizio said, we have made some structural changes to the business that going forward should allow us to manage volatility. Hopefully we will see the level of volatility that we have seen certainly over the past year, but we will have more agility in our operations. To your question on the fourth quarter and what's in our implied guidance, as it relates to travel retail, coming off of the trends that we are seeing in March, the progress of trends that we're seeing through the third quarter, we are expecting that our retail sales and travel retail will be up double-digits, and our net sales are down double-digits, more than our retails are up. So, again, this is another quarter of trying to -- we have little down the inventory that's in the trade, hence the impact that you see in the fourth quarter, and as Fabrizio said, much of that being our very strong skincare business. So, we do expect, as I said in my prepared remarks that some of this will bleed into the first quarter, and perhaps a little bit into the second quarter, but get progressively better. And so, we get to the inventory levels that both we and our customers want in the trade. We are working with and partnering with our customers on their programs, also now that traffic increase back in airports, we are investing in advertising in airports, we are employing some of the sales staffs that was not there when the airports were empty, and we are working with our brands on great programs and promotions for customers as they return to airports. So, our travel retail team has been quite busy working with our retailers to recapture the growth that we are now seeing, in particular, in Hainan and hopefully soon in Korea as well.

Rupesh Parikh:

Good morning, and thanks for taking my question. So, obviously you had a step back in your earnings power. I am trying to get a sense in terms of how you guys think about the profitability of getting back to 20% operating margins in earnings north of seven. So, I'm just trying to better understand how you guys are thinking about the proper recovery.

Operator:

And our next question comes from Oliver Chen from TD Cowen. Please go ahead with your question.

Tracey Travis:

Yes. I mean in the prepared remarks, Oliver, we talked about areas that we are gaining share, and so, I think we are seeing strong momentum in some of the recovery markets that are gaining share, inclusive of China, and China is a real indicator for what we can expect when some of the areas that have been suppressed this year, like travel retail Hainan and in Korea when Chinese traveling consumers returned to Korea. So, I think those things are quite positive. We have strong innovation programs as well to support our growth for certainly next year as well. And the fact again, the biggest volatility that we've seen this year has been in some of the COVID restrictions in certain markets that had been lifted. And so, now it's a matter of the timing in case of that recovery. We see a little bit better, but I'm a bit cautious obviously given what we have experienced this year, but recognizing that trigger is one that really has created as much volatility for the reasons that we have already spoken about. We are feeling a bit better. There will be still volatility certainly in the fourth quarter, and there will be volatility next year, but we have always been a company that's been relatively good at managing volatility, this year, given the severity of it, and the severity in the channel of operation that it happened has caused us to have these results, but rest assured, myself, Fabrizio and the entire management team are diligently working on recovering our profitability, and certainly recovering growth, and our brands continue to be very strong with consumers.

Operator:

And we have time for one additional question. This question comes from Lauren Lieberman from Barclays. Please go ahead with your question.

Tracey Travis:

So, Lauren, let me take that last one. Yes, we do expect that our sales will be down again in the first quarter, and pick up in the second quarter. And so, that's the cadence that we are seeing right now. Again, it much depends on retail sales, and again, as we said, we are encouraged by how retails sales have picked up in Hainan, not as much in Korea at the moment, but we remain encouraged that will happen as well. So, the pace of retail, which has been slower, again than we expected this year, will determine how quickly we resume shipments. We do have some very exacting new products that we do hope that we can actually ship them in the first and second quarter, but again, with the activities that we have going on with our travel retail partners I believe that we will see a continued acceleration of retail like we started to see in this quarter.

Operator:

And ladies and gentlemen, that will conclude today's question-and-answer session, as well as today's presentation. If you were unable to join for the entire call, a playback will be available at 1:00 p.m. Eastern Time today through May 17. To hear a recording of the call, please dial (877) 344-7529, and use passcode 8161271. That concludes today's Estée Lauder conference call. I would like to like to thank you for your participation, and wish you all a good day.

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.

Tracey Travis:

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 rest of the EMEA region, including both developed and emerging markets such as the United Kingdom, France, India and Turkey. We continue to see various stages of recovery across the region that coupled with the strong resumption of tourism fueled brick-and-mortar growth during the quarter. Organic net sales in our Asia Pacific region fell 7%, primarily due to the ongoing COVID-related impacts in Greater China. This affected brick-and-mortar sales in Greater China and Dr. Jart Travel Retail in Korea. Online sales continued to grow in Mainland China due in part to the expansion of our online presence with the recent launches on JD and Joyn as well as solid performance during the 11.11 Shopping Festival. Most of the other markets in the region continued to progress in recovery as the return of brick-and-mortar traffic led to high single-digit or double-digit growth in Japan, Australia, Malaysia and the Philippines. From a category standpoint, fragrance continued to lead growth with organic net sales rising 12%. Strong holiday demand for our beautiful line of fragrances from Estee Lauder and double-digit growth from both La La bond Tom Ford Beauty propelled the category's growth in every region during the quarter. Organic net sales in hair care rose 4% and declined 3% in makeup, the latter driven primarily by the COVID restrictions in China as solid performance from both MAC and Clinique drove growth in both the Americas and in domestic markets in EMEA. Organic net sales in skin care declined 20%. This category continues to be the most affected by the COVID restrictions in China, particularly in Asia travel retail and Mainland China, where skin care accounts for a large majority of our business. Our gross margin declined 430 basis points compared to last year. The positive impacts from strategic pricing in this quarter were more than offset by inflationary pressures in our supply chain, region and category mix, and higher costs due to promotional items. Operating expenses increased 500 basis points as a percent of sales, driven primarily by the reduction in sales. This also reflects our investments in areas such as advertising, promotional activities and innovation, which increased 150 basis points compared to last year. Operating income declined 46% to $768 million, and our operating margin contracted 930 basis points to 16.6% in the quarter. During the quarter, we recorded $207 million of impairment charges related to the 3 brands, primarily reflecting lower-than-expected growth in key geographic regions and channels given the pressure on consumer demand from the impacts of COVID. Diluted EPS of $1.54 decreased 49% compared to last year. The impact from foreign currency translation and foreign currency transactions in key travel retail locations negatively impacted diluted EPS and by 5% and 4%, respectively. During the quarter, we generated $751 million in net cash flows from operating activities compared to $1.8 billion last year. The decline from last year reflects lower net income and the negative impact from changes in working capital, primarily due to the timing of payments. We invested $419 million in capital expenditures, and we returned $708 million in cash to stockholders through both dividends and share repurchases. As we expected, our first half performance was pressured by ongoing external headwinds. Let me now turn to our outlook for the remainder of fiscal 2023. For the second half of fiscal 2023, we are encouraged by the easing of COVID restrictions in China and the expected return of travelers throughout Asia and around the world once more stabilization occurs with outbound flights and visas as well as cover entry and testing requirements. In Hainan, we are starting to see increased positive signs already. as traffic level declines have moderated in recent months. However, retailer inventory levels are still somewhat elevated, reflecting the impact of the lengthy store closures as well as the rapid reduction in traffic and in-store staffing levels in November and December. And in Korea travel retail, an incremental headwind has emerged since the last outlook we provided in November. The recently announced potential rollback of COVID-related supportive measures in Korea Duty Free is creating a near-term transitory pressure to our business with our Korean duty-free retailers, which is pressuring our third quarter outlook. We now also expect more moderate net sales growth near term in our China business as the rise of Cove cases in November and December slowed expected brick-and-mortar retail traffic and social usage occasions. -- which continued in January during the pre-Lunar New Year shopping time frame. Collectively, we expect these impacts to create greater headwinds in the third quarter than we originally anticipated. As a result, we are updating our outlook to reflect a shift in the start of the travel retail recovery in Asia from the third to the fourth quarter of fiscal 2023 due to the normalization of inventory levels in Hainan, the uncertain pace of recovery of travel retail traffic in Korea and a more moderate acceleration of growth in China. The momentum from our other developed and emerging markets in EMEA and Asia Pacific in the first half is expected to continue as those markets progressively evolve in recovery. We are also cautiously optimistic and expect our North America net sales performance to improve as our retail growth trend in the region has already increased, particularly in January. -- and we have a supportive innovation pipeline planned for the second half, as Fabrizio mentioned. As it relates to our operating income, while these external headwinds have introduced a high level of volatility and that has had a meaningful impact on our financial results this fiscal year. We remain confident in the ongoing strength of prestige beauty, our business strategy and our ability to reaccelerate long-term profitable growth. We, therefore, plan to sustain the strategic investments imperative to that growth, including innovation, advertising and continued geographic expansion for many of our brands. These investments also support the continued strengthening of our multiple engines of growth as we invest in emerging markets and faster growth channels that are already progressing well in their recovery. As a result, we expect to see pressure on our operating income in the third quarter with an accelerated improvement in the fourth quarter as the sales recovery in travel retail, Mainland China, and skin care start to materialize more meaningfully. The negative impacts from foreign currency that we anticipated in our previous guidance have improved due to the recent weakening of the U.S. dollar. However, currency is still expected to be a meaningful drag our reported sales and diluted EPS growth for the third quarter and full year. Our outlook is now based on December 30 spot rates of 1.067 for the euro, 1.207 for the pound, 6.964 for the Chinese yuan and 12.63 for the Korean yuan. So with that backdrop, our guidance is as follows

Lauren Lieberman:

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?

Operator:

The next question is from Dara Mohsenian of Morgan Stanley.

Fabrizio Freda:

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 to see now the opening to create a gain traffic in Mainland, in brick-and-mortar, we see the continuation of the line success. And we see the -- obviously, the reopening of Hainan. And so the Chinese consumer on all fronts. Also, we see the fact that the Chinese consumer is starting to travel internationally. [indiscernible] and this will gradually increase as the governments will agree theses and models of growth. In this moment, there are parts of the world we already opened, others we will open soon Japan, we understand it's been an agreement, but it's not yet open, we'll be in soon. Korea is the 1 where the agreement is not yet finalized, but we are optimistic that in the future, this also would be resolved. So that's another very important trend. This will have a positive impact, obviously, in our retail channel, but also in the countries of destination, like it's always been historically happened. In terms of categories in China, obviously, the most important thing that will happen as the China accelerate on all fronts will be the skin care will accelerate for us. And so the acceleration of Travel Retail Asia, the Aleris China, the acceleration of international travel of Chinese, which we had in front of us in part in quarter 4, but in part in -- fiscal year 2024. This will will generate a substantial improvement of our skin care trends that, in turn, will have a positive impact on our margin mix. So that's obviously an important element of the program. Then other regions of the world. As I commented in my prepared remarks, has been very strong in Europe where we built market share. in most of the European markets. Very strong in the rest of Asia, particularly strong gains in Japan and Australia, as I commented already. And in Korea, excluding the travel retail impacts, that are particularly heavy on our Dejar brand, which has a big percentage in Travel Retail, excluding that also Korea started progressing very well. So good progress in all the other regions. Then North America. Now in North America, obviously, we also continue to lose share in the quarter. And overall, we would like to accelerate our plan of share recovery. But the good news is there's been very strong progress in quarter 2. Every single month, October, November and then December, there was progress in top line sales acceleration. First of all, in retail, the quarter in the U.S. ended plus 2%, so on the positive. But December was plus 6.5%, 7%. So in line with our goals of acceleration. So we see the U.S. progressing. Now the next 6 months, there is an even stronger plan. In the U.S., we have a strong acceleration of innovation. I mentioned already some in the in the prepared remarks like Estee Lauder Pachorolistic, Moreso Sudo Clinique, Hyperion Marc, soft cream on La Mer, cherry collection to Ford. So -- and then we have some important distribution improvement. We are deploying more distribution in department store of our high-end fragrances in Macy's in dealers the ordinary is entering some doors and strands. We are deploying in Ulta and in Sephora new, incremental [indiscernible] and incremental expansion of our key brands in these doors. And we are renovating 100 free stand store opening 8 new freshen stores and continue to improve our omnichannel capabilities on all fronts. So we see an acceleration of our progress also in the U.S. So in summary, when I should add what Tracey also underline that at the same time, we have improved our capability behind this program. Our digital marketing is strong. Our supply chain is shortened and faster. Obviously, we have done progress in our factory in Japan, our R&D has opened our R&D center in China that will increase the amount of local relevant innovations in Asia in an important way in the next fiscal year -- starting this fiscal year in a significant way. And we have opened a new distribution on the serves travel retail in Switzerland and on the service, obviously, China, within China, as we discussed also in the last call. So there are all these investments and progresses in capabilities that make us ready the reacceleration in the future. And so this fiscal year, in summary, has been a year where, really, we suffered about the COVID lockdowns, particularly in Asia. And then the high level of infections during the reopening and the impact of the strength of the U.S. dollar that was particularly big in our high profit, high important channels like travel retail, like China, travel retails because on core and China, the dollar was particularly impactful. So it was really a perfect storm kind of situation. But all the rest, apart from these 3 areas really progressed and in some cases, very successful in market share gaining. So that's my overview. I hope to answer your question that having an overview of the situation. but I would say is very, very encouraging for the recovery period.

Peter Grom:

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.

Michael Binetti:

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.

Fabrizio Freda :

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 international charter, which is coming back. in an important way. And then obviously, the Korea and rest of Asia, so Korea has always been a very big business. But as you know, Hong Kong, Macau, Japan were all very important travel retail businesses that now will improve. And so there will be different levels of growth, obviously, in all of this. Now in term of categories, the -- because of the prevalence of Chinese consumer Asia travelers in general, as percentage of the total global travel retail, skin care is a very important category. So the travel retail acceleration in the future will carry, as I was saying before, skin care. And so this will be a double positive impact on marginality and profitability is that combination is powerful. And then by category, we see in Travel Retail a strong acceleration of the fragrance category, particularly the high-end fragrance category, which is, again, profitable and very interesting category for the consumers in this moment. We observed many travel retail partners around the world, making more space for the high-end fragrance development in the future of travel retail. So that's another important positive. And then the last point I want to make is keep in mind that the travel retail is driven by increased traffic and by increased conversion. The numbers that were available before covered in a normalized way in 2019 were depending which part of the world, the travelers to buy as conversion was between 10% and 15%. And -- we know also that when there is retail like in China and Korea, so where people can buy online before they go to the airport, this conversion number increased substantially -- and there is a lot of retail business that has developed very well in Asia, particularly linked to Hainan. And so the amount of conversion of these travelers is increasing -- and last thing I want to say is that the comeback of Chinese consumers in international travel is very good news because the Chinese consumer, when they travel used to have much more purchase per person than the average travelers from different regions. So the increase in mix of Chinese travelers is very good news for global travel retail as well. So in the post corded world, when will be really postal I think we are going to see some years of exciting opportunity globally in the travel retail development.

Mark Astrachan:

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.

A –Tracey Travis :

And in terms of fragrance [indiscernible] continue to expand our fragrance portfolio. We’re certainly seeing a pickup and expecting a pickup in travel retail as it relates to fragrance, and fragrance is still a growing category in Asia. So certainly, during the recovery, we expect that fragrance trends will continue to grow, particularly in the markets that are reopening now.

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 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.

Tracey Travis:

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 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 continue to thrive led by Tom Ford Beauty, Jo Malone London and Le Labo. 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 M·A·C, Bobbi Brown and Estée Lauder. M·A·C 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 skin care 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 the 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 14.36 for the Korean won, 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 7 points with an additional 2 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 1 point. We expect second quarter adjusted EPS of $1.19 to $1.29 forward, a decline between 60% to 57%. Currency translation is expected to be dilutive to EPS by $0.20 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 1 point. We expect full year operating margin to be approximately 16.1%, up 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%, 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 and 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 will be happy to take your questions at this time.

Dara Mohsenian:

Hey, good morning.

Dara Mohsenian:

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.

Tracey Travis:

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.

Chris Carey:

Hi, good morning.

Chris Carey:

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.

Operator:

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

Tracey Travis:

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.

Dana Telsey:

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.

Operator:

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

Tracey Travis:

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.

Operator:

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

Fabrizio Freda:

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.

Jason English:

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.

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 will find factors that could cause actual results to 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 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 third-party platforms. It also includes estimated sales of our products through our retailers’ websites. During the Q&A session, we ask that you please limit yourself to one question, so we can respond to all of you within the time scheduled for this call. And now, I will turn the call over to Fabrizio.

Tracey Travis:

Thank you, Fabrizio and hello everyone. I will briefly cover the fiscal 2022 fourth quarter and full year results, followed by our thoughts on the outlook for fiscal 2023. Our fourth quarter organic net sales fell 8%, a bit better than we expected, reflecting the disruptions in China related to COVID restrictions, including travel retail in Hainan as well as the suspension of our commercial business in Russia and Ukraine. These matters more than offset continued growth from the recovery in the Americas and the rest of the EMEA region. Reported sales growth included approximately 1 percentage point from the addition of sales from DECIEM, while currency translation negatively impacted growth by approximately 3 percentage points. From a regional perspective, net sales in the Americas rose 9% organically led by double-digit increases in makeup and fragrance. Consumers continued their return to brick-and-mortar, leading to strong growth in freestanding retail and specialty multi-stores. We grew sales in nearly every market in the region, with particular strength in Canada and across Latin America. Net sales in our Europe, the Middle East and Africa region decreased 9% organically driven almost entirely by the disruptions in travel retail in China and the suspension of business in Russia and Ukraine. Of the remaining markets in the region, 10 rose double-digit as tourists returned to the region and consumer traffic and brick-and-mortar retail thrived. The makeup, fragrance and hair care categories rose strong double-digits in EMEA, while the decline in skin care reflected the soft travel retail sales in Asia. Global travel retail, which is primarily reported in this region, declined in Asia due to the COVID restrictions in China. Hainan, in particular, was impacted as stores were closed a portion of the quarter, travel was curtailed to the island and courier services for online deliveries were disrupted. However, travel retail in European markets and in the Americas rose triple-digits as airport traffic returned and doors in the channel reopened. Net sales in the Asia-Pacific region fell 19% organically. Greater China and Korea net sales were the most impacted by the COVID restrictions. Hardest hit was Shanghai, where the city-wide lockdown lasted 2 months, impacting our distribution capacity serving all of China through the end of May. Overall, our brands performed well for the important 6/18 holiday festival and maintained top rankings across the beauty space on both Tmall and JD. Elsewhere in Asia, there were some other bright spots. Malaysia, Japan, the Philippines and Vietnam continued to recover and have begun to reopen to tourism. Looking now at net sales by product category, fragrance led organic growth, with net sales rising 22% versus prior year. The fragrance category grew double-digits across all regions. Luxury fragrances continue to resonate with consumers looking for indulgence and our brands, including Tom Ford Beauty, Jo Malone London and La Labo were once again star performers. Net sales in makeup rose 8% organically driven by the continued recovery and increased usage occasions in Western markets, where makeup is generally the largest category. M·A·C and Clinique were top brand performers driven by hero products like MAC Studio Fix and the newly launched Macstack Mascara as well as Clinique’s Almost Lipstick in Black Honey. Continued success and expansion in specialty multi-doors is also aiding category growth. Hair care net sales grew 5% organically. Excellent performance from Bumble and bumble in specialty multi contributed to growth. The launch of Aveda’s vegan hair color in EMEA and a successful activation around the brand’s hero and body franchise in Korea also aided category growth. Net sales in skin care were the most impacted by the COVID-related restrictions in China, affecting Greater China, Asian travel retail and Korea. Skin care continues to represent approximately two-thirds of our business in the Asia Pacific region. Net sales fell 21% in the quarter due to the disruption of the Shanghai distribution center, with the greatest impact felt by Estée Lauder and La Mer brands. Skin care growth benefited from the addition of DECIEM sales in the quarter by approximately 3 percentage points. Our gross margin declined 370 basis points compared to the fourth quarter last year driven primarily by factors affecting our supply chain. Global transportation delays, port congestion, labor and container shortages and higher costs for both ocean and air transport have increasingly pressured our cost of goods. Unfavorable category mix from softer skin care sales also contributed to the decline. Operating expenses decreased 9% driven by the curtailment of spending this quarter as COVID restrictions sharply reduced store traffic in China, including Hainan. We delivered operating income of $207 million for the quarter compared to $385 million in the prior year quarter. Diluted earnings per share of $0.42 included $0.03 dilution from the acquisition of DECIEM. Shifting now to our full year results. Giving the volatility experienced throughout the year, the results reflect the benefit derived from the diversification of our top line growth as well as the incredible agility of our teams and their ability to effectively manage costs while also simultaneously investing selectively for future growth. Net sales rose 8% organically, with double-digit gains in three out of four product categories and two out of three regions. Sales of our products online continued to thrive even as brick-and-mortar recovered, rising 11% for the year and representing 28% of sales. Among brick-and-mortar retail, most channels grew double digit, while department stores ended the year down slightly as pressure from COVID restrictions in Asia offset growth in other regions. And our business in travel retail also grew, ending fiscal 2022 at 27% of sales. Our gross margin fell 60 basis points to 75.8%. Favorable pricing and currency were more than offset by higher supply chain costs, which were more pronounced in the back half of the year, the impact of the acquisition of DECIEM and higher costs for new products and sets. Operating expenses declined 150 basis points to 56% of sales. Disciplined expense management and general and administrative costs was the largest contributor to the decline. The changes in our channel mix continue to reduce selling costs. And additionally, we continue to drive more effective resource allocation in our advertising and promotional mix. These favorable trends were partially offset by increased shipping costs. During the year, we continue to create more flexibility in our cost structure to absorb inflation in wages, media and logistics. We achieved significant savings from our cost initiatives, including the post-COVID business acceleration program. This has enabled us to realize great expense leverage while also reinvesting in areas that support profitable growth, resulting in an overall improvement in our operating margin. Our full year operating margin was 19.7%, representing an 80 basis point improvement over last year. This improvement includes the absorption of 60 basis points of dilution from DECIEM. Our effective tax rate for the year was 21.3%, a 260 basis point increase over the prior year, primarily driven by a lower current year tax benefit associated with share-based compensation and the prior year favorable impact of the U.S. government issuance of final GILTI tax regulations that provided for a retroactive high-tax exception. Net earnings rose 11% to $2.6 billion, and diluted EPS increased 12% to $7.24. Earnings per share includes $0.04 accretion from currency translation and $0.05 dilution from the acquisition of DECIEM. The Post-COVID Business Acceleration Program is wrapping up, with final estimated restructuring charges of $500 million to $515 million at the top end of our original projections. We are pleased with the progress we achieved from this program. We realigned our brand portfolio by exiting four designer fragrance brands as well as the BECCA and [indiscernible] brands, and we are streamlining our market distribution for Smashbox and GLAMGLOW to improve their long-term viability. We optimized our brick-and-mortar distribution network. We have been and will continue to close underproductive freestanding retail stores as we rebalance our distribution network. By the end of fiscal 2023, we expect to have closed nearly 250 freestanding retail stores under the program. We’ve also rationalized department store counters and other retail locations, improving our ability to focus our efforts on driving more profitable omni-channel opportunities in our remaining distribution. We also approved initiatives to optimize our organization across regions and throughout global functions to reduce complexity, leverage our scale and enhance our go-to-market capabilities. When we are finished executing the program, we expect a net reduction of between 2,500 and 3,000 positions globally. We expect to execute the remaining projects to achieve estimated annualized gross savings of between $390 million and $410 million before taxes beginning in fiscal 2024. A portion of these savings have been and will continue to be reinvested in capabilities that sustain our long-term growth, including data analytics, online and advertising. Turning now to our cash flow. We generated $3 billion in cash from operations, a 16% decrease from the $3.6 billion in the prior year period. The primary driver was higher working capital due to the end of year disruptions related to the pandemic the past few years as well as inventory to support future growth and to help mitigate the supply chain challenges we have faced in certain raw material and componentry areas. We utilized $1 billion for capital improvements, an increase of approximately $400 million over last year. We continue to invest in capacity and other supply chain improvements. We increased consumer-facing investments to support in-store experiences and recovery markets. We renovated office space, and we continue to invest in information technology. We also returned cash to stockholders at an accelerated pace this year as the need for more stringent cash conservation subsided with the progression of the recovery. During the year, we repurchased 7.4 million shares for $2.3 billion, and we paid $840 million in dividends, reflecting the 13% increase in our dividend rate that became effective in our fiscal second quarter. All in all, we delivered a strong year despite significant disruptions, including continued outbreaks of COVID, higher inflation, supply chain constraints and the invasion in Ukraine. And we also continue to invest in foundational capabilities for the future, including new production capacity and innovation to support growth. Now looking ahead to fiscal 2023, we believe that the prestige beauty category has ample opportunities for continued strong growth. Global prestige beauty is expected to grow mid to high single-digits driven by the continued recovery and the gradual reopening of the remaining market impacted by COVID restrictions. Additionally, we look forward to the continued resumption of international travel, especially in Hainan and the rest of Asia. We are concerned, however, that the recovery this fiscal year will once again not be a smooth one. Record inflation and the threat of recession or slowdown in many markets could temporarily dampen consumer enthusiasm and is causing some retailers to be more cautious regarding inventories. The strengthening dollar is putting pressure on our international earnings. Additionally, heightened geopolitical tensions could prove to be disruptive. With that backdrop in mind, for the full fiscal year, organic net sales are forecasted to grow 7% to 9%. We discontinued four designer fragrance licenses at the end of fiscal 2022. These brands generated $250 million in sales in fiscal 2022. In fiscal ‘23, we will sell some remaining inventory to the new licensees, primarily in the first half. Sales from both years will be excluded from our organic growth figures. At current levels, currency is projected to be a significant drag on our reported results in fiscal ‘23 as the U.S. dollar strengthens against key currencies. Based on July 31 spot rates at 1.018 for the euro, 1.215 for the pound, 6.746 for the Chinese yuan and 13 03 for the Korean won, we expect currency translation to dilute reported sales growth for the full fiscal year by 3 percentage points as well as an additional 1 point due to the impacts of foreign currency transactions in key international travel retail markets. There are a few other items impacting our sales growth in fiscal 2023. Our list price increases are expected to add approximately 5.5 points of growth, helping to offset inflationary cost pressures. We take most of our pricing actions at the beginning of our fiscal year. New distribution, including new doors in existing markets, new markets for certain brands and expansion on new online platforms, could add another 2 points. Conversely, the loss of sales in Russia and Ukraine are expected to trim about 1 percentage point from sales growth. We plan to continue to drive margin expansion through operational efficiencies and cost savings while fueling additional advertising investment where appropriate. Our full year effective tax rate is expected to be approximately 23%. Diluted EPS is expected to range between $7.39 and $7.54 before restructuring and other charges. This includes approximately $0.20 of dilution from currency translation. In constant currency, we expect EPS to rise by 5% to 7%. The impact from foreign currency transactions in key international travel retail markets is also expected to negatively impact adjusted diluted earnings per common share by – growth by 6 percentage points. At this time, we expect organic sales for our first quarter to fall 4% to 6%. The impact of sales from certain designer license exits are expected to dilute reported growth by approximately 1 point and currency is expected to be dilutive by approximately 3 points. Our first quarter sales are expected to be negatively impacted by continued COVID restrictions in China and Hainan. As you may recall, last year, we mentioned that some of our retailers in North America secured holiday shipments earlier due to supply chain concern, contributing 1.5 points to our growth in the first quarter of fiscal 2022. This year, retailers in the U.S. have been tightening their inventories, causing our net sales to trail retail sale. We expect China and travel retail in APAC to gradually improve throughout the first half of the fiscal year as COVID restrictions lift. And comparisons should ease in the back half of the year as we lap the invasion of Ukraine and the significant impact of COVID restrictions in China. We expect first quarter EPS of $1.22 to $1.32. Currency translation is expected to be dilutive to EPS by $0.04. The impact from foreign currency transactions in key international travel retail markets is expected to negatively impact adjusted diluted earnings per common share growth by 5 percentage points. In closing, we remain confident about the long-term prospects for global prestige beauty and in our strategy to outpace industry growth. Our multiple engines of growth delivered in fiscal 2022, and we anticipate this more diversified growth can continue in the coming year. And importantly, we continue to reinforce the fundamental drivers of our business that both enable and contribute to continued strong future sales and EPS growth. I would like to close by extending our heartfelt gratitude to our employees around the globe for continuing to deliver our results during this challenging macro environment. That concludes our prepared remarks. We will be happy to take your questions at this time.

Dara Mohsenian:

Hi, good morning.

Fabrizio Freda:

Good morning, Dara.

Tracey Travis:

So I’ll start, Dara, regarding China and what we’ve baked into our assumptions. Clearly, the first quarter, we are seeing some intermittent disruptions. Our distribution center is open. We’re actually – and opened in June, as we mentioned. So we were well prepared for the 6/18 holiday festival, as I mentioned in our prepared remarks. We are still seeing some intermittent shutdowns, not whole city shutdowns in China at the moment. So that is still disrupting brick-and-mortar retail. So we have factored that in, certainly to our Q1 expectations for the China market. As it relates to Hainan, as we mentioned also in our prepared remarks, and I’m sure you all have seen, Hainan is experiencing a lockdown right now. So, all of the doors are closed. Courier services as well have been suspended for online orders. And we’re obviously monitoring that day by day, but that is something that began in the month – at the beginning of the month of August. And right now, we’re expecting that to continue through the end of the month of August with some resumption in September, but not full resumption in September, recognizing that as this situation continues to impact the market, there will be some level of reticence for consumers to travel. But we certainly expect that, that will improve in the upcoming months. So I think first quarter and first half, we are expecting some level of muted performance in the region related to these issues. We do expect second quarter to be better than first quarter. And then in the second half, obviously, we’re anniversarying quite a bit of disruption in the fourth quarter, some of which, again, in the third quarter for both Hainan as well as China. And we do expect that we will see strong growth in the second half. For the full year, we do expect China to grow double digit. And so again, we are – it is a market that we know there is very strong demand for prestige beauty and for our products and the same with Hainan as well. So we are just navigating through these first few months of the year until we get on the other side in the second half.

Operator:

The next question is from Lauren Lieberman of Barclays. Please go ahead.

Tracey Travis:

Yes, Lauren. So I’ll start. Good morning. We did call out, obviously, in our prepared remarks and in the press release a couple of adjustments in our revenue numbers this year. So we did exit our prestige designer licensed businesses. Basically, we ended those licenses. Our focus is on luxury fragrance and artisanal fragrance. And so we did let those licenses expire. That is about 1 point of growth. The other point is related to the suspension of our operations in Russia and Ukraine. And so that is also contributing another point, if you will, to adjusted growth and to the suppression of growth that you’re referring to. And then lastly, the currency impact on revenue also impacts us in terms of our growth algorithm. So if you adjust for all of those items, it’s about 6 points of difference between what we’ve guided for the full year and where we expect – where we would expect to end if none of those events had happened. So that is the reason why the growth looks a bit muted even with the 5.5% pricing. The other thing I would say again is we are starting the year with a fair amount of disruption as we just spoke about in some of our very important markets. And we are assuming a more gradual recovery, and that, too, impacts our unit growth.

Nik Modi:

Yes, thank you. Good morning, everyone. I just wanted to revisit China and just given some of the economic data that we’ve been seeing recently and curious if you’ve witnessed any evidence of any economic pressure impacting consumption. And I know it’s hard with all the noise of COVID and the shutdowns, but perhaps maybe some of the markets where you haven’t seen a big COVID impact, maybe you can share what trends would look like. Any perspective would be helpful?

Operator:

The next question is from Rupesh Parikh of Oppenheimer. Please go ahead.

Tracey Travis:

Yes. Obviously, we experienced some gross margin pressure in Q4. It was related to some of the activity that we had to manage through in terms of getting product to market and some of the disruption that’s in general in the supply chain. So – and as we think about the first quarter and the guidance that we have provided, we do expect gross margins to be down as well in the first quarter, not to the same extent as they were in the fourth quarter, and that will gradually improve throughout the year as we are anniversarying some of those disruptions. So, for the full year, we are expecting gross margins to be around flat at the moment. But the first – it’s a tale of two halves in terms of the first half and some of the things we are anniversarying and some of the pressures that we are seeing on the business. But we do expect for the full year gross margin to be flat. In terms of SG&A, again, we expect that we will continue to get good SG&A leverage. I think we are incredibly proud of what our team was able to deliver this past fiscal year and fiscal 2022 in terms of the expense leverage that we were able to deliver. And it’s something that we are keenly focused on while also focused on investing in the important areas that drive our long-term growth algorithm. So, those are things that we continue to manage throughout the year, and we will get continued expense leverage this year.

Mark Astrachan:

Yes. Thanks and good morning everybody. Wanted to follow-up sort of directionally on the last question on gross margin, if you take a look at it even pre-COVID, pre-supply chain and inflationary pressures adjust for some of the accounting changes kind of going back 3 years, 4 years ago, it’s still kind of down over the last 5 years, and your expectations were flat this year. I guess kind of the puts and takes, which you are taking out of price. You have got a post-COVID business acceleration plan, so there is productivity, there is a mix shift in the business towards direct-to-consumer. I guess maybe if you could talk directionally about kind of what has led the progression down, but more importantly, kind of where do you think it can go over time. Is that high-70s level achievable again? Why or why not, that would be helpful. Thank you.

Operator:

The next question is from Steve Powers of Deutsche Bank. Please go ahead.

Tracey Travis:

Okay. So, let me – I will start. In terms of makeup, we continue to be quite bullish on the makeup category. We did see a recovery, particularly in our Western markets. So, part of the strength that we saw this year – this past fiscal year in terms of the growth in makeup and the improvement in margin that we saw in makeup was related to the recovery, in particular, in brick-and-mortar in our Western markets, so in the Americas as well as in Europe. We are still challenged a bit in makeup in our Eastern markets because of some of the disruption that’s going on, in particular, in brick-and-mortar. And – but we expect makeup to gradually improve as the disruption in those markets improve, and similar to Western markets, as consumers resume their normal social and professional occasions. So, that is our expectation in terms of when we will get back to fiscal ‘19 levels for makeup, depending on the disruptions this year. It may take another year or so. But our makeup brands have fantastic innovation for this year, in particular, the MAC brand, but others as well. And so we are very encouraged in terms of makeup. As it relates to the margin, the makeup category has been particularly hit by the pandemic that is now going on for 3 years because of the brick-and-mortar distribution of makeup, and in particular, with a few of our makeup brands where services in-store are very well loved by our consumers and the in-store experience, that took – that was a bit of a challenge with doors closed and with traffic down. And traffic is still down in brick-and-mortar, even in the markets that are in recovery, traffic has not recovered to prior levels, but it’s well on its way to do so. So, I think one of the reasons why we took some of the actions we did with the post-COVID business acceleration program is take a point of view to your point of what that will look like when things are stabilized and what the mix between brick-and-mortar and online should be and took proactive measures to close some underproductive doors, and largely, that will help the makeup category. Most – many of those stores were makeup doors. Some of them were Origins stores. Some of them were Bobbi doors, actually. So, that should continue to help the makeup category as volume returns to – in particular, brick-and-mortar.

Operator:

The next question is from Bryan Spillane of Bank of America. Please go ahead.

Fabrizio Freda:

Yes. I will start on the product innovation. The product innovation was a 25% already last year. This is a very good number, and we believe it’s an efficient number. Now, it can be 25% or 30%, depending by quarter. But that’s, anyway, very powerful innovation. The thing that we have improved also the rhythm of innovation. We have innovation really gradually per category, per quarter, per brand in a very sophistic way, market-by-market to make sure that we can leverage it. And the innovation is strongly supported by sufficient media. And our advertising in total is increasing in fiscal year 2022 in absolute level. And that’s a list in the current assumptions guidance. And these advertising – some part of it is guiding the innovation and the innovation results. But also, a lot of our innovation is attracting earned media value in a fantastic way. A good example of this has been MACStack’s in the last fiscal year. So, it’s not only paid media, but it’s also earned media that is attached to high-quality innovation. And so, some of the high-quality innovation is also efficient from the spending standpoint, from a media standpoint for that reason and then finally, innovation is driving pricing because innovation many times is about improving product, improving product performance or entering benefit areas that are more important for the consumer that’s willing to pay more. And so we can invest in our standing products that deliver these results and price for these results as well. So, it’s a combination of factor why innovation is and will continue to be a very strong driver. And if you assume more or less the same percentage of innovation on a growing business, so innovation in absolute – will also increase year-after-year in absolute level. On distribution, we have opportunities still to increase distribution. And we are doing it particularly online where there are a lot of new online ways to access consumer in efficient and productive way. It’s also important to understand that the distribution opportunity at the end is about consumer coverage. It’s about covering consumers that have desire today that are not covered. The best example of this is, for example, in emerging markets, starting from China, as an example, where we are covering 148 cities, but demand come from 600 cities or more, and we serve the cities where there is no physical distribution value online. This is happening the same in India. It’s happening in Brazil. It’s happening in Mexico. It’s happening in many of the emerging markets. So, the new distribution online is covering new consumer in the large majority of cases, and it’s very efficient. There is a lot of opportunity. There is some, which are already in this fiscal year, the fiscal year 2023 assumption. And there are many in the medium to long-term that we are studying and prepared to do.

Olivia Tong:

Great. Thanks. I wanted to ask you a little bit more about the price increases that you are planning, realizing, of course, it’s not clearly the same as CPG. But by tier, sort of super luxury, beauty prestige, how your prices will compare to your peers, especially given that more and more sales are happening in multichannel or online where you will be closer to other brands or consumers can see multiple brands on one screen? And then if I could just sneak in another question sort of piggybacking on Bryan’s about the distribution, the targeted expansion of distribution to retailers that provide broader consumer reach. Fairly certain, I know what isn’t included, but if you could talk a little bit about what that might entail globally and how that – the channel mix progresses as a result? Thank you.

Olivia Tong:

That’s right. Just understanding when you say you are expanding your distribution to provide a broader consumer reach, what – I think we all know what that does not entail, but what that does entail globally and what that – what the implications might be both for sales and profit?

Tracey Travis:

Yes. And Olivia, so we mentioned in the prepared remarks, we are introducing Aveda into China. That’s expanding distribution for the brand. So, one way we expand distribution is introducing products into a new market, as Fabrizio was indicating, other emerging markets. We introduced The Ordinary into India via NYKAA. So, that’s one way that we expand distribution, particularly in a market where consumers had not had that opportunity to purchase that product before unless they traveled. We also expand with our existing retailers. So, here in North America, as Ulta and Sephora opened new doors or any other retailer opens new doors, it is our consideration without being over retailed from a brick-and-mortar standpoint of expanding in those stores as well. And that’s an expanded – expansion in terms of distribution. So, if our retailer opens 20 new doors this year, we will open those doors with them. And so we include that in our distribution. I think I said in my prepared remarks that we expect around 2 points of growth this year from distribution. And largely, it’s those types of distribution. Fabrizio talked as well about pure plays. Pure plays have been a fantastic way for us to actually – selective pure plays. We are very selective to actually reach new consumers, in particular, younger consumers and – who are shopping more online and maybe shopping on an apparel site online that we have an opportunity to introduce beauty products to and get a new consumer as well as a new shopping occasion as they are shopping for their apparel products. So, it’s a very thoughtful way that we think about distribution and expanding distribution right now really to focus on reaching new consumers.

Andrea Teixeira:

Thank you for squeezing me in and good morning everyone. So, my question is on the cadence of the quarter of the year guidance within the quarter. The sell side consumers are more cautious to travel, you mentioned retail inventory, if I am mistaken. I wonder if you are embedding some adjustment to retained employees in Q1? And if so, the magnitude of that impact that would give us more confidence on the recovery for the remaining nine months. And just a clarification on how much you expect sales to decline in China, including Hainan, in Q1, embedded in your guidance? Thank you.

Fabrizio Freda:

I think the other part of the question was Hainan. And in Hainan in this moment, they are not ordering. So, there is no inventory sold, but they are – still, what they are selling, they are selling from existing inventory. So, there is – there will be the possibility in the future to rebuild and normalize inventories when COVID abates.

Operator:

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 p.m. Eastern Time today through September 1. To hear a recording of the call, please dial 877-344-7529, passcode 3602158. 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. You may now disconnect.

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 net sales growth numbers are in constant currency, and all organic net sales growth excludes the noncomparable impacts of acquisitions, divestitures, brand closures and the impact of currency translation. You can find reconciliations between GAAP and non-GAAP measures in our press release and on the 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.

Tracey Travis:

Thank you, Fabrizio, and hello, everyone. Our third quarter net sales grew 9% organically despite the increased complexity and volatility caused by the pandemic and the invasion of Ukraine. Growth was broad-based across categories and markets as most regions across the world continue to recover and grow, albeit at different rates. Sales in specialty-multi and freestanding retail stores led growth and online sales rose mid-single-digits. The inclusion of sales from the late May 2021 DECIEM investment added approximately 2 points to reported net sales growth, and currency was a headwind of approximately 1 point. From a geographic standpoint, organic net sales in our Europe, the Middle East and Africa region rose 18%. Growth was realized across most markets, channels and brands. Market growth was led by both the recovery in the largest Western markets as well as in key emerging markets like Turkey and India. All brick-and-mortar channels grew, led by double-digit growth in department stores, freestanding stores and specialty-multi stores. Organic sales online declined when compared to the prior year quarter where online sales benefited both from the pandemic-driven store closures and reduced store traffic. All product categories and most brands grew in the region, led by La Mer, Jo Malone London and M-A-C. Our global travel retail business again grew double digits despite the challenges that arose during the quarter. Asia is the largest region for our travel retail business, and sales in the key markets of China and Korea were very robust at retail for most of the quarter. However, there was a precipitous decline in Chinese travel in March as restrictions to contain COVID were increased in China. We continue to see a sharp increase in travel retail sales outside of Asia as traffic increased throughout Europe and the Americas. Net sales in the Americas rose 11% organically, with all markets contributing to growth. All product categories grew with particular strength in makeup and hair care. The two largest prestige makeup brands in the U.S., M-A-C and Clinique, outpaced overall category growth to gain share. Bobbi Brown and Tom Ford Beauty also gained share helping to further drive the makeup renaissance as more consumers continued their return to the workplace and resumed more social occasions. Our sales in specialty-multi and in freestanding retail stores strongly outperformed this quarter as consumers return to stores for shopping and services. The inclusion of sales from DECIEM added approximately 3 points to growth, and favorable currency movement contributed 1 point to sales growth in the region. In our Asia-Pacific region, organic net sales fell 4%, driven entirely by Greater China. For the quarter, net sales in Mainland China declined mid-single-digits. Following a strong Lunar New Year in February, sales declined in March as additional COVID restrictions impacted many cities, most notably Shanghai, where our distribution centers serving the entire country are located. The restriction sharply curtailed productivity at these facilities, affecting our ability to both receive product being shipped into the country and to fulfill demand across all channels of distribution. However, shipments should begin to normalize as restrictions ease. Net sales in Hong Kong also declined throughout the quarter as the city took increasing measures to contain the virus. Partially offsetting these decreases with strong net sales growth in most other markets, including Japan, Malaysia, Thailand and Singapore. Online sales in Asia-Pacific grew strong double digits as we continue to expand our brand reach across new platforms. Our gross margin improved 70 basis points compared to last year. Strategic price increases of approximately 4% combined with favorable currency and reduced obsolescence contributed to the increase in gross margin as well as the favorable impact of anniversary last year's under absorption of manufacturing overhead. This more than offset the impact of increased inflationary pressures in our supply chain, mainly in logistics and materials and increasing start-up costs for our new plant in Japan. Operating expenses decreased 40 basis points as a percent of sales. Our leverage of general and administrative expense was partially offset by increased shipping costs related to higher freight rates and more air shipments on increased sales volume. Additionally, as cities throughout China began tightening restrictions and traffic to Hainan slowed, we reduced certain expenses to correspond with slower retail traffic. Operating income rose 15% to $917 million, and our operating margin expanded 110 basis points to 21.6% in the quarter. Diluted EPS of $1.90 increased 17% compared to the prior year. During the quarter, we recorded $216 million of impairment to goodwill and other intangibles primarily related to Dr. Jart+, reflecting forecast for slower-than-expected growth in China and travel retail. We continue to believe in the growth potential of the brand, which has been impacted by the temporary COVID disruptions in Asia given its strong growth prior to the start of the pandemic as well as the growth seen in recovering markets. For the 9 months, we generated $1.97 billion in net cash flows from operating activities compared to $2.78 billion last year, which reflects investments in working capital to both support growth and mitigate some of the risk of supply chain disruptions as well as higher cash paid for taxes. This was partially offset by higher net income. We significantly increased our capital investment to $658 million to support the ongoing construction of our new manufacturing facility near Tokyo. Investments in our innovation center in Shanghai as well as investments in online and technology enhancements. And we returned $2.62 billion in cash to stockholders through a combination of share repurchases and dividends. Turning now to our outlook. As you have heard and are aware, there have been two significant headwinds that have emerged since we last gave guidance in early February, increased COVID-related restrictions in China also impacting Hainan and the invasion of Ukraine. Our current guidance for the balance of this year reflects continued momentum in the Americas and EMEA excluding travel retail as well as the continuation of lockdowns and corresponding distribution constraints in China through at least the first half of our fourth quarter. While we expect continued growth at retail in both Mainland China and Hainan, the severity of the distribution constraints we are experiencing are expected to result in a meaningful decline in net sales for these areas for the quarter. We are cautiously optimistic that we will be able to fulfill the majority of our orders in time for our planned 6.18 activities. The elimination of sales in Russia and Ukraine has reduced expected fourth quarter sales growth by approximately 120 basis points. At the same time, we delivered outstanding results for the first 9 months of the fiscal year, with greater diversification of our growth drivers. Our geographic diversity is a tremendous asset, and we expect our multiple engines of growth to continue, including the ongoing recovery of the Americas, Western Europe and most markets in Asia. We expect to also deliver strong margin improvement for the year. The benefit of our strategic pricing actions this year, along with agility and our cost management are helping to offset the initial effects of increasing inflation throughout this fiscal year. We plan to continue to invest in the recovery, support innovation and assuming current disruptions abate, fuel upcoming key shopping moments in the quarter, like 6.18 in China and Mother's Day. With these assumptions as our backdrop for the full fiscal year, organic net sales are now forecasted to grow 5% to 7%. This range excludes approximately 2 points from acquisitions, divestitures and brand closures, primarily the inclusion of DECIEM, and currency is forecasted to be neutral. Diluted EPS is expected to range between $7.05 and $7.15 before restructuring in other charges. This includes approximately $0.05 of accretion from currency translation and $0.02 dilution from DECIEM. In constant currency, we expect EPS to rise by 8% to 10%. These expectations imply margin expansion of approximately 70 basis points, including dilution of 40 basis points from DECIEM this year. In closing, we managed extremely well through an increasingly complex environment in our third quarter, and these complexities are expected to meaningfully impact our fourth quarter. Despite this, we continue to expect to deliver a very strong year with above-average organic top line growth, excellent margin expansion and solid EPS growth. We are confident that we can continue to manage through the present temporary headwinds and be well prepared for accelerated momentum when the pandemic effects ease. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Lauren Lieberman:

Tracey, for retail, just hoping to get a little bit more visibility, if you will, to like the on-the-ground inventory dynamic in China currently and how you're thinking about that, I guess, for the first half of the quarter. So if I were to go on any of the e-commerce sites or to a store, what do I see now? Am I able to place an order online? Or does it say out of stock? If I go to a store, is there inventory? Because I'm trying to piece together the comment, Tracey, that you saw by 6.18 you'd be caught up, but knowing that Shanghai is the way kind of in and out, and you're assuming that's constrained for the first half of the quarter? I'm just trying to put those pieces together for that fourth quarter outlook.

Operator:

Your next question comes from the line of Steve Powers from Deutsche Bank. Your line is now open.

Fabrizio Freda:

Yes, sure. No, actually, we believe our North America business is actually accelerating and is in very good trend. Obviously, the sales by quarter may vary for a serious thing, including presence of holidays or presence of specific brands, innovations, et cetera. But in general, we had a plus 24% in the last 12 months and plus 10% in quarter three. If you see in that quarter three, Clinique is ranking number one overall brand, M-A-C number one in makeup, Bobbi Brown, Tom Ford, M-A-C, The Ordinary, they're all growing share. We are doing -- we are executing well the strategy of better covering all U.S. multi-ethnic consumer groups. We have improved our distribution mix, which now is more focused on high-growth, high-profit areas in general, particularly we have improved our online penetration during COVID, and we are maintaining it now. We have reestablished strong brick-and-mortar productivity, which was heavily hit by COVID, also closing 40 freestanding store and exiting a number of closing department stores doors. We are rolling out successfully the Ulta Target, the Sephora called new doors, which are proving by the way to reach new consumers. We have a stronger M-A-C and Clinique performance business, which in North America are, frankly, the two key brands that are driving the overall size of the growth. We have some strong innovation successes in quarter three. For example, Macstack, which we had mentioned in the prepared remarks, which is so far an extraordinary success. And I would underline, we are in a market where prestige has been recovery much faster pace than mass, which is exactly proving also that we are back into sourcing from mass new consumers, particularly with our entry prestige pricing brands like M-A-C, like Clinique, like The Ordinary. We also added with DECIEM acquisitions The Ordinary Brand, which is the fourth -- number fourth in prestige U.S. brands already in skin care, which is an extraordinary position and ranking first in units in many of the retail partners where they're sold. And on top on speaking about distribution, one-third of our North America business now is in direct-to-consumer model with freestanding store brand.com and certain online activity, really, including social media direct activities, which give us a lot of more data, consumer data and understanding of the consumer that we ever had in the past. So it's been years of reshaping our North America business in a condition that we believe today is strong and is much more stronger platform for continued growth and continued market share development of most of our brands in the future as well. So we are very positive of our North America trend and also very proud of today having a strong and motivated team, which is in action and which is driving the business forward.

Nik Modi:

For retail, I wanted to get maybe an assessment on M-A-C in the U.S. because, I guess, prior to the pandemic, the brand was under a lot of pressure. It seems like things are looking better now, but I didn't know if that's a function of just improved mobility and a makeup category lift overall or if there's an improvement in the underlying fundamentals of that brand. If you could just help kind of frame the situation for us, that would be helpful.

Operator:

Your next question comes from the line of Dara Mohsenian from Morgan Stanley. Your line is now open.

Tracey Travis:

Yes, Dara, so I'll start. There are two things going on in the fourth quarter that are impacting us. Given the pandemic management in China right now, there is also a slowdown in traffic to Hainan. And so travel retail is being impacted as well in the fourth quarter, specifically Hainan along with China. As you saw in the third quarter when traffic slowed in our distribution and online, we pulled back on expenses, and we would be prepared to do the same in the fourth quarter if our assumptions change. The other thing that we are looking to do is have a temporary distribution center outside of the area that is most affected and hopefully, we'll mitigate some of the pressure on our Shanghai campus. So those are a couple of the things that we're planning to do as our plan B, if you will, if the market does not open up in the middle of May. But we are encouraged by some recent signs that we've seen in terms of -- or heard in terms of some of the cases coming down. But it's quite volatile, Dara, so this is the best estimate that we have at this time of the situation and what we could deliver in Q4.

Operator:

Your next question comes from the line of Andrea Teixeira from J.P. Morgan. Your line is now open.

Tracey Travis:

So let me start, Andrea, with the pricing. My 400 basis points really was for the second half of the year. We started the year taking 3.5% of pricing increase. And typically, we take most of our pricing increases at the beginning of our fiscal year. We did take a second price increase in January. So the impact year-over-year for our second half is 4% pricing relative to prior year. And we expect to, in our upcoming -- the beginning of our upcoming fiscal year in July, take additional pricing. So -- and that pricing is strategic between levels within the tiers of our categories. So yes, skincare or higher-priced skincare might take higher price pricing, our lower-priced skin care would take lower price increases. It's very much dependent on the market, the currency, the inflation there's a very sophisticated model that we use to determine what pricing for our various brands. So yes, we will have lower skincare sales in the fourth quarter. But on average, the pricing increases that we've taken will still be around 4%, and we do expect that they would cover the inflation that we are experiencing at the moment.

Operator:

Your next question comes from the line of Bryan Spillane from Bank of America. Your line is now open.

Fabrizio Freda:

No. So far, we are not seeing any impact in this area, also because -- not only because, as I said, the demand remained robust, and you can look at the demand -- you need to look at the demand in China in this moment since when global COVID started mainly, since when Chinese started traveling internationally less. You need to look at it like the brick-and-mortar in China, the online in China and Hainan. The combination of these three has been very, very strong, even if you look at our quarter three and you put together the results in together with the results in Mainland China online, as I said before, we were growing market share and growing double digit and the brick-and-mortar very soft moment. But when you put it all together, you see demand growth. When you look only Mainland China or only Hainan in certain moments without -- you may see different patterns by channel, but the total Chinese consumption has been very, very solid for us, for the industry, for competition in general. The other important thing to clarify that this is not changing also in the composition. For example, the most important segment in this moment in the China demand is high-end luxury brands. So both in our portfolio, brands like La Mer or Tom Ford or in our competitive portfolio or within our portfolio within a brand like Lauder, the performance of Renotriv, which is the high-end part of the brand. So everywhere, the high luxury part is doing better in growth than any other part. This doesn't suggest that the consumers are worried by the economy. This suggests the consumers are actually looking for high performance and strong experiences more and more in this moment. Said this, there is obviously a lower economic than expectation in this moment, but also, there is a lot of trust in the possibility of economic stimulus and in the possibilities of restarting stronger economic development. So I believe that the consumer sentiment is still overall solid.

Korinne Wolfmeyer:

Kind of expanding on that last question on consumer sentiment more broadly. How have the recent developments macro-wise affect or kind of changed your viewpoint or impacted your viewpoint on the resiliency of prestige beauty as a category more broadly geographically both here in the U.S. and in EMEA and in APAC? We've seen these consumer-centric numbers start to get a little bit depressed over the past few weeks. So just wondering how you're viewing the resiliency of prestige beauty in these market dynamics.

Tracey Travis:

And the only thing I would add to that is even as we've commented, the fragrance category during this time has picked up, so to Fabrizio's point in terms of self tampering and prestige hair care. So we're actually seeing an acceleration in some categories of prestige during this time, particularly in the markets that are in recovery. So this really is a temporary situation that we're experiencing now and into the fourth quarter. Our team on the ground in China has been working diligently to try to get product to consumers, respecting obviously, the restrictions that are in place and staying healthy. And we are incredibly thankful to them for all of the things that they're doing to make sure that they can as best they can under these circumstances meet the demand of our consumers in China who really are looking for our products, and we'll get them as soon as we can get them to them so.

Dana Telsey:

As you think about the categories of makeup and skincare, what are you looking at for skincare going forward as makeup is recovering so strongly in terms of new product releases? And then any expansion of what you're seeing at the new Ulta and Target relationships and your product expansion there?

Operator:

That concludes today's conference and today's question-and-answer session. If you were unable to join for the entire call, a playback will be available at 1 p.m. Eastern Time today through May 17. To hear a recording of the call, please dial (855) 859-2056 passcode 9349743. 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.

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.

Tracey Travis:

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 some stores reopening during the quarter, particularly in Europe and the Americas. Travel retail continues to be led by Asia/Pacific where demand from Chinese consumers remained strong. In our Asia/Pacific region, organic net sales rose 5%. Most of the markets in the region grew, led by Mainland China and Australia, although we continue to see variability in COVID restrictions and retail traffic across markets. Sales grew across most major channels in the region, especially online, which benefited from the recent launch of three brands on JD.com. The inclusion of sales from DECIEM added approximately one point to total reported sales growth in the region. From a category standpoint, organic net sales of fragrances grew 30% with double-digit increases across all regions. Exceptional double-digit increases from Jo Malone London, Tom Ford Beauty, Le Labo and Kilian Paris reflected strong performances from hero products, new product launches, and the continued growth of the Bath & Body and Home subcategories. Organic net sales in makeup rose 12% as consumers in the Americas and Europe responded to social media activation, holiday assortments and trends. Estée Lauder foundations continue to resonate very strongly with consumers, especially those in the Double Wear and Futurist franchises. M·A·C continued to drive the makeup renaissance with engaging, interactive campaigns throughout the quarter, like the special M·A·C trend Halloween report and solid holiday collections. Too Faced, Tom Ford Beauty, Smashbox and Bobbi Brown also contributed to growth in the category this quarter. Organic net sales in skin care grew 7%, reflecting double-digit increases from La Mer, Clinique and Bobbi Brown. The inclusion of sales from DECIEM added four percentage points to reported growth. Our organic net sales in hair care rose 18% as traffic in salons and stores improved, primarily in the Americas. Aveda's growth came mostly from holiday gifts and hero franchises and in online and freestanding stores, while Bumble and bumble focused on recruiting new consumers in the specialty-multi channel. Our gross margin improved 20 basis points compared to last year. The benefits of strategic price increases and favorable currency more than offset the impact of higher makeup mix and lower gross margin on DECIEM products. Inflationary pressures in our supply chain are expected to begin to more prominently impact cost of goods in our fiscal third quarter. Operating expenses decreased 140 basis points as a percent of sales. Our leverage of selling expense and general and administrative expense was partially offset by increases in advertising and shipping costs, the latter due to both inflation and our direct-to-consumer online growth. Operating income rose 22% to $1.44 billion, and our operating margin expanded 160 basis points to 25.9% in the quarter. Our tax rate at 21.4% continued at a more normal level this year versus the prior year, which was impacted by a onetime benefit associated with GILTI. Diluted EPS of $3.01 increased 15% compared to the prior year. For the six months, we generated $1.85 billion in net cash flows from operating activities compared to $1.98 billion last year, which reflects both a return to more normalized working capital needs as well as increased inventory to mitigate some of the risk of supply chain disruption given the ongoing global macro challenges. We significantly increased our capital investment to $459 million to support the construction of our new production facility near Tokyo as well as investments in our online business and other technology enhancements. And we returned $1.84 billion in cash to stockholders through a combination of share repurchases and dividends, with an increase in our dividend rate occurring in the second quarter. So turning now to our outlook, we delivered an exceptional first half characterized by strong and diversified double-digit organic sales growth and disciplined cost management in the context of intermittent COVID disruptions, including the rise of the Omicron variant, high inflation and volatility. Looking ahead, we are raising guidance to reflect our expectation for a strong year despite the potential further spread of Omicron, supply chain challenges and increased inflationary pressures. Inflation and transportation and procurement is expected to impact our cost of goods in the second half. However, the benefit of pricing and cost mitigation efforts are helping to offset some of the inflation impacts for the fiscal year. At this time, we expect pricing to add approximately 3.5 points of growth with the inclusion of the additional pricing actions we are taking during our second half. We are planning to support the continuation of the recovery with increased point-of-sale staffing as retail traffic continues to gradually improve. We are also planning to support key hero franchise launches in our third quarter from Estée Lauder, La Mer and Origins with increased marketing and advertising support. This investment will increase cost towards the latter part of the third quarter with more of the benefit to be realized in the fourth quarter. For the full fiscal year, organic net sales are forecasted to grow 10% to 13%. Based on rates of 1.146 for the euro, 1.357 for the pound and 6.399 for the Chinese yuan, we expect currency translation to be negligible for the full year. This range excludes approximately three points from acquisitions, divestitures and brand closures, primarily the inclusion of DECIEM. Diluted EPS is expected to range between $7.43 and $7.58 before restructuring and other charges. This includes approximately $0.07 of accretion from currency translation and $0.03 of accretion from DECIEM. In constant currency, we expect EPS to rise by 14% to 17%. We expect organic sales for our third quarter to rise 8% to 10%. The net incremental sales from acquisitions, divestitures and brand closures are expected to add about three points to reported growth, and currency is forecasted to be negative by about one point. We expect third quarter EPS of $1.55 to $1.65. Currency is expected to be $0.01 accretive to EPS, and the inclusion of DECIEM is not expected to be material. In closing, our results thus far clearly demonstrate the power of our diversified portfolio. Temporary softness in our Eastern markets driven by the pandemic was again offset by renewed growth in our Western markets. A resulting slight slowing of growth in skin care was offset by remarkable growth in fragrances. We continue to be choiceful about where we invest, and the flexibility we have built into our cost structure is helping us to mitigate some of the COVID-related disruptions and inflation while allowing us to continue to invest appropriately in our future growth. This agility, along with the resilience of our remarkable teams worldwide, gives us confidence that we can continue to manage through the temporary complexities caused by the prolonged pandemic by focusing clearly on our long-term strategy and executing against it with excellence. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Dara Mohsenian:

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?

Operator:

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

Tracey Travis:

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.

Lauren Lieberman:

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?

Operator:

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

Fabrizio Freda:

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

Fabrizio Freda:

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?

Operator:

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

Tracey Travis:

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.

Tracey Travis:

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.

Operator:

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

Fabrizio Freda:

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.

Olivia Tong:

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.

Fabrizio Freda:

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.

Operator:

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.

Fabrizio Freda:

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...

Fabrizio Freda:

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.

Operator:

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.

Rainey Mancini:

Hello. On today's call, our 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 other 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 net sales growth numbers are in constant currency, and all organic results exclude 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. During the Q&A session, we ask that you please limit yourself to 1 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.

Tracey Travis:

Thank you, Fabrizio and hello everyone. We're off to an outstanding start with first quarter net sales growing 18% organically driven by the Nascent recovery in the Americas and EMEA during the quarter compared to a more difficult environment in the prior year. Global logistic constraints caused some retailers, primarily in North America, to order earlier to ensure popular sets and products would be on counter for Holidays. We estimate that this contributed approximately 1.5 points to our first-quarter sales growth that otherwise would have occurred in the second quarter. The inclusion of sales from the May 2021 DECIEM investments added approximately 3 points to reported net sales, growth and currency added just over 2 points. From a geographic standpoint, organic net sales in the Americas climbed 27% as COVID restrictions eased throughout the region. Brick-and-mortar retail grew sharply across all formats compared to the prior year period when many stores were temporarily shutdown. Distribution and Kohl's with Sephora and in target with Ulta Beauty, began its phased roll-out to initial stores and online in mid August with minimal impact on net sales growth for the quarter. With the strong resurgence of Brick-and-mortar traffic online, organic sales growth in the Americas declined single-digit against the sharp increase last year, while organic online penetration remains solid at 31% of sales. The inclusion of sales from DECIEM added about 9 points to the overall reported growth in the region. In our Europe, the Middle East, and Africa region, organic net sales rose 19% with virtually every market contributing to growth led by the emerging markets in the Middle East, Turkey, and Russia, as well as the U.K. Most markets throughout the regions saw COVID restrictions lifted and some tourism resume during the peak summer months. By channel, the region saw more balance between brick-and-mortar and online growth. All major categories grew this quarter and the region saw the strongest growth in fragrance and makeup as social occasions increased. Our global travel retail business grew double-digit as China and Korea continued to be strong. Internal travel restrictions during the quarter in China slowed Hainan sales temporarily, but restrictions lifted in early September and traffic rebounded. Retailers also responded to the August dip by driving post-travel consumption online. Summer holiday travel in Europe and the Americas ticked up but international travels still reached only 40% of pre-COVID levels. In our Asia-Pacific region, organic net sales rose 10% and driven by Greater China and Korea. The region overall experienced higher levels of COVID lockdowns this quarter, compared to last year's quarter due to the rise of the Delta variant, although online remains strong. Sales growth in Mainland, China was somewhat slower due to COVID restrictions during July and August and the pace of online sales growth slowed following the successful 6-18 programs last quarter, and in anticipation of the 11.11 Shopping Festival. As we've mentioned before, these key shopping moments have created some additional seasonality in our business in this region. More than half of our brands, and virtually all channels rose double-digit in Mainland China. Hong Kong and Macau were bright spots this quarter. They benefited from strong new product launches from La Mer and Jo Malone and successful marketing campaigns from several other brands. From a category perspective, net sales growth in fragrance jumped nearly 50%. Virtually every brand that participates in the category contributed to growth with exceptional double-digit increases from Tom Ford Beauty, Jo Malone London, and La LeBeau. Perfumes and colognes led the category growth and bath, body and home fragrances continued to perform well. Net sales in makeup rose 18% as markets in the Americas and Europe began to recover from COVID shutdowns. We are encouraged by the sequential improvement in makeup versus pre - COVID level. However, makeup sales in the quarter was still 19% below 2 years ago. Nonetheless, Estee Lauder foundations continued to resonate strongly with consumers, and MAC leaned into the makeup recovery with a number of fun and compelling campaign. Skin care sales remained strong during the quarter. Organic net sales grew 12% and the inclusion of sales from DECIEM added 6 percentage points to reported growth. Nearly all of our skincare brands contributed to growth, although Estee Lauder had a tough comparison with the prior year launch of its improved Advanced Night Repair serum. Our hair care net sales rose 8% as traffic in salons and stores in the U.S. and Europe began to return. Both Aveda and Bumble and bumble saw growth in hair products as well as continued strength from innovation. Our gross margin declined 100 basis points compared to the first quarter last year. The positive impacts from strategic pricing and currency were more than offset by higher obsolescence costs for both basic and holiday product sets and the inclusion of Visium. Operating expenses decreased 240 basis points as a percent of sales. Our strong sales growth was partly due to earlier orders from some North America retailers concerned about logistics constraints and costs related to these sales are expected to be incurred in our second quarter. We do continue to manage costs with agility, realizing savings from our cost initiatives while also investing to support a continued brick-and-mortar recovery, as well as our strategic initiatives. Our operating income rose 32% to $941 million, and our operating margin rose 140 basis points to 21.4% in the quarter. Diluted EPS of a $1.89 increased 31% compared to the prior year. During the quarter, we used 81 million in net cash flows from operating activities, which was below the prior year. This reflects a more normalized first quarter where we typically have seasonally higher working capital needs. We invested $205 million in capital expenditures as we ramped up our investment to build the new manufacturing facility in Japan, and we returned $749 million in cash to stockholders through both share repurchases and dividends. We also announced this morning, an increase in our quarterly dividend. Now let's turn to our outlook. We are encouraged by the green shoots we are seeing around the world even in the context of an environment of increased volatility. Our strong performance reflects our ability to navigate through the volatility while leveraging our multiple engines of growth. At the same time, we are mindful that recovery is tenuous and likely to be uneven. Nevertheless, we are cautiously optimistic in our assumption for fiscal 2022 remain consistent. We continue to expect an emerging Renaissance in the makeup category as restrictions are safely lifted and social occasions increase. We welcome the resumption of some travel in the Americas and EMEA in the first quarter. And as intercontinental restrictions are lifted, we expect international passenger traffic to build toward the end of the fiscal year. We began taking strategic pricing actions in July and overall, pricing is expected to add at least 3 points of growth, helping to offset inflationary pressures. On the cost side, we plan to continue to increase advertising to support our brands and drive traffic in all channels. Selling costs are expected to rise to support the reopening of brick-and-mortar retail. We also continue to invest behind key strategic capabilities like data analytics, innovation, technology, and sustainability initiatives. As you are all aware, global supply chains are being strained by COVID and it's related effects in some markets, resulting in port congestion, higher fuel costs, and labor shortages at a time when demand for goods is rising. This is causing us to experience inflation in freight and procurement, which we expect to impact our cost of goods and operating expenses beginning next quarter. Based on what we see through October, the expected benefit of pricing combined with good cost discipline elsewhere, are enabling us to maintain our expectations for the year. For the full fiscal year, organic net sales are forecasted to grow 9% to 12%. Based on rates of 1.163 for the euro, 1.351 for the pound, and 6.471 for the Chinese yuan, we expect currency translation to be negligible for the full fiscal year. This range excludes approximately 3 points from acquisitions, divestitures, and brand closures, primarily the inclusion of DECIEM. Diluted EPS is expected to range between 723 and 738 before restructuring another charges. This includes approximately $0.04 of accretion from currency translation and $0.03 accretion from DECIEM. In constant currency, we expect EPS to rise 11% to 14%. At this time we expect organic sales for our second quarter to rise 8% to 10%. The net incremental sales from acquisitions, divestitures, and brand closures are expected to add about 3 points to reported growth, and currency is forecasted to be neutral. Operating expenses are expected to rise in the second quarter as we support holiday activations and the continued recovery of brick-and-mortar retail around the world. Additionally, the prior-year quarter included some benefit of government subsidies which are not anticipated in the current year quarter. We expect second quarter EPS of $2.51 to $2.61. Both currency and the inclusion of DECIEM are expected to be immaterial to EPS. Notably, our EPS forecast also reflects a 23% tax rate compared to 15.9% in the prior year when we benefited from certain one-time line up In closing, we are pleased with the terrific start to the year and are proud of the continued efforts of our global team. We remain confident in our corporate strategy with its multiple growth engines to drive sustainable, profitable growth. That concludes our prepared remarks. We'll be happy to take your questions at this time.

Erinn Murphy:

Great. Thank you. Good morning. I guess my question is around the supply chain, Tracey for you, if you could talk a little bit more about your ability to get product to the end markets in a timely manner into holiday. And are you seeing any major shifts in product launches? And then maybe if you can share, if you think about the higher OpEx, how you're balancing air freight versus ocean freight currently? Thank you so much.

Operator:

And our next question is going to come from the line of Lauren Lieberman with Barclays.

Tracey Travis:

Yeah. Hi, Lauren. So you stated out, and at the very beginning, what -- your question is about what specifically?

Tracey Travis:

Oh, MAC, yeah.

Tracey Travis:

Yeah, no. As we announced last year in our post COVID acceleration program, we did take the opportunity last year to close some stores and some additional stores will close this year. And not only freestanding stores, but there are some counters as well that MAC has pulled that up. We were encouraged at the end of last year and encouraged through the first quarter with MAC performance in both the Americas. So both North America, as well as Latin America, and also EMEA. So we really -- with return to brick-and-mortar, as we had indicated before, we saw a higher productivity of the remaining brick-and-mortar doors that we had open, and we saw a bit of softness more in North America than in EMEA, but a bit of softness in online as traffic return to brick-and-mortar. We think that will normalize out a bit in Q2 and we will see a bit more balanced, but as I think all of us can imagine, I think consumers were very excited about going back to brick-and-mortar stores in markets where restrictions were lifted, and people felt more comfortable going out and socializing.

Operator:

Thank you. Our next question comes from the line of Nik Modi with RBC Capital Markets.

Fabrizio Freda:

So, I think there are 2 question. So what we see online? Obviously, online is doing pretty well on a two-year stack, we've doubled it. And so it's a very strong acceleration versus two years. And we see the progress to continue and the growth to continues. Obviously, in the moment where there was the opening of brick-and-mortar, the amount of growth online slow down, but the continuous growth is what is really encouraging. So the most important part of your question, what happened to the consumer's behavior. So what we saw during COVID, that the consumers that were already online before, like younger consumer, continue to be online even more intensively. But many new consumers, they just appeared online during the COVID. They were more the ageless consumer, the more adults consumers. Now, this consumer really enjoyed so they are staying online and so that's what showed that the online continues to grow even when brick-and-mortar open side. But obviously, the 2 channels growth get re-balanced in this situation. So very optimistic for online. The other thing that the online continues to grow is that there are very different channels with different level of growth and we are growing in every single channel. We are growing in 3PP. We are growing in brand.com. We are growing in retail account. We're growing in the pure place and these are very different by region because in every region, one of this channel is stronger than the others. The combination of the global online growth is continuing to be pretty exciting. And we count to this to continue, even when brick-and-mortar will be fully, fully recovered. And as a result, we have reached already 28% of our business in online and this will gradually continue to grow over time. So very strong. In terms of -- sorry, your second question, because it was a separate question on consumer behaviors in Asia. Could you repeat it?

Fabrizio Freda:

I think the exploration of newness in the world of beauty will continuous, will never stop. And personally, I don't have any data points that suggest was dependent on COVID. The disploration is not only by our new brands, but this disploration is about the newness of the existing brands. In fact, our percentage on newness continues to be very, very high and our innovation program continues to be super exciting. We are continued to be in the 30% of new products per year, which is extraordinary and has been a huge progress in the last years. So we continue to see consumers to be interested in innovation, and we continue to make our innovation program one of the best drivers of growth globally.

Dara Mohsenian:

Hey, guys, good morning.

Fabrizio Freda:

Good morning.

Tracey Travis:

Yeah. Yeah. Thanks, Dara. In terms of -- we are encouraged obviously, as we should be by our Q1 performance. We're still only at quarter end, as you mentioned, as you mentioned it. We did have some early shipments in the quarter that obviously came out of the second quarter. So some of the growth, as we mentioned, about 1.5 was related to that. But as we look at the balance of the year, we are -- also while we're seeing encouragement, there's still a lot of volatility in the market. We did have some markets unexpectedly that were shut down in the first quarter. We are still managing through this pandemic. And so we are -- we believe that certainly as you look at Q2 on a 2-year stock basis, it is -- and really versus pre-pandemic, it's really quite strong. And again, you're seeing some of the seasonality related to 11-11, continue to impact Q1, and that's reflected in the -- Q2, and that's reflected in the guidance that we've provided. But we feel that the guidance that we've given for the year is incredibly strong. The only difference between the guidance that we gave last time and this time, is currency. Our outlook on currency is a bit less. So that's the 1 point change in the guidance that you see. And then from a reported EPS standpoint, our guidance actually on a constant currency basis has improved quite a bit. We -- I would say we are seeing green shoots, we are expressing confidence in the guidance that we are providing quite a bit when you actually look at it from an EPS standpoint, even with all of the things that we're navigating through as it relates to transport, etc. And that goes to the choices that we're making as an organization in terms of where to invest and where not to invest, along with the pricing actions that we're taking as well.

Steve Powers:

Hey, thanks. First is just a cleanup. Apologies if I missed it, but were the early holiday sales in North America that you've mentioned in the first quarter to any particular brand or product category? That'd be helpful. And what I really want to ask you about was picking up on something there I mentioned, but I'm not sure you addressed Tracey, was just the relative softness in China and Asia that you experienced in the quarter against the curtailed mobility backdrop versus the improvement that you saw in September. and what I hear is enthusiasm entering December at around the 11.11 Holiday. Maybe you could just expand on a little bit on how trends evolve through the September quarter and then what you're expecting in the Asia-Pacific region, as we go through fiscal 2Q? Thank you.

Operator:

Thank you. Our next question will come from the line of Stephanie Wisinc(ph ) with Jefferies.

Fabrizio Freda:

Yeah. No, we see obviously a very strong fragrance mascot and we see great growth in every single regions. So it's good. We see particularly strong fragrance traction in the high-end fragrances, in what we call the luxury artisan of our portfolio. This is really a stand, so brands like Jo Malone, Tom Ford, Le Labo, Kilian, Frederic Malle. And -- and we believe this will continue. This is a trend we have identified some years ago and we have focused the growth of our portfolio and our innovation on this kind of highly sophisticated fragrance experiences. And while we have seen that the -- during COVID that this trend is accelerated, the consumers are even more interested. The other interesting thing is during COVID, the element of our fragrance brands that were, for example, home, like candles or personal cleansing, or pampering parts of the lineup beyond the fragrance also was accelerating, and this acceleration continues. So the positives that consumer have learned, also the possibility of the pampering in-house element of products that these brands provide, they continue to buy them also after the COVID period or this COVID thing. So the entire fragrance brands are strong. The fragrance category is strong. And we expect to have a good holiday season. In this area, we expect continuous growth over time.

Andrea Teixeira:

Thank you. Good morning and congrats on your results. Can you comment on the cadence of the quarter in Asia-Pacific and how you exited? It seems that you had a hiccup in China consumption towards the end of the quarter. And Tracey, you mentioned that in your prepared remarks, and I think question, but is the deceleration in the fiscal second quarter a function of normalizing the pull forward or more how conservative you're seeing things happening? And then obviously, you have this seasonality they have been calling for 11.11. So if you can just elaborate more on that, I would appreciate. Thank you.

Tracey Travis:

And Andrea as it relates to the rest of APAC, we are expecting a pickup in the second quarter, so we are not anticipating as many of the restrictions to be in place in the rest of APAC that we saw in Q1.

Olivia Tong:

Great. Thank you. Actually, I want to talk a little bit about some of the new brands, like the ordinary. And if you could just give a little bit of commentary around things that you've learned since the majority stake that you've taken and how that could potentially be influencing other brands in your portfolio with respect to where you could potentially invest going forward with retailers might your other brands work in that you may have not have thought about earlier. Thank you.

Operator:

Thank you. Our next question will come from the line of Mark Astrachan with Stifel.

Fabrizio Freda:

Keep in mind that in China, our most distributed brand, which is Estee Lauder in 140 cities where today with a strong social media and with the strong aspiration of values of our brand. As we speak, we can -- we are demand in more than 700 cities. So there are many, many consumers in China they can only buy either online or traveling and traveling domestically today. And historically Kelly also traveling internationally. And so the -- it is just the market, commercially, the market is designed to have a very limited between the Mainland, China, and the Hainan service. An enormous amount of consumer that comes also from Tier 3, Tier 4 cities, areas where there is not a lot of brick-and-mortar distribution. And so Hainan cannot track this consumer in this moment, also is a place where people go for holidays, as part of these holiday's this -- there is a lot of the pleasure of shopping, the pleasure of discovery. The business in China is proving to be a great trial builder, more than an cannibalizing business and is building trial of people that otherwise would not be able to try our problem, then we'll repurchase them. We'll repurchase them maybe again in the future travel, but most of the times in their everyday lives in Mainland China. So obviously, there is commercial competition. The market is becoming very competitive. There is a lot of players. And commercially, there is that will continue to be intense competition. But there is -- every channel serves, frankly, a very different role. And so our strategy is to be able to leverage each one of these channel in the best possible way. We are maximizing the coverage and the service to the total consumers in China that are interested in Beauty, and over time to be able to better differentiate the scope of the channels and how the consumer will be served by the different channels. Last thing I want to say, Hainan had at least the last number I've seen over the 80 million visitors in the last year. So if you think that Hainan serves the entire middle class because it's domestic travel. You don't need to have a passport. So today, in our knowledge, about 12% of Chinese consumer at the task force, even when international travel will restart. There will be even limited cannibalization versus international travel, because China would serve many consumers that do not plan to travel internationally. So we are very positive on the long term and very positive on the ability to serve the consumers using different channels, which is our strategy.

Wendy Nicholson:

Hi. Two things, if I can. When you were running through the brands and what's growing for you and what's doing. Especially, well, I think you called out La Mer first. And I just wanted to clarify, how much of La Mer's growth is coming from China and Travel Retail or is the brand also growing strongly on -- in the U.S. and Western Europe non - Travel Retail? So that's my first question. And then second thing, I know you said, Tracey, that there was only minimal sales in the first quarter from the pipeline sale into Target and Kohl's, but now that we're already into November, can you comment a little bit about what you're seeing there? And especially, I'm curious what percentage of the sales that you're getting from Target and Kohl's are in makeup as opposed to skin? I'm just wondering that if those 2 channels really take off for you, what kind of mix effect that might have on your North American business? Thanks.

Fabrizio Freda:

I just wanted to add that our North America growth discourse, which has been extraordinary, is the result of manufacturers. It's definitely not yet the impact of Ulta, Target, or Sephora, or Kohl's. That was just at the beginning and only in the last months of the quarter. So it's the result of many other very positive signs. Also, we have been getting shares with categories during the quarter in Clinique, in MAC, in La Mer, in Bobbi, in Tom Ford, in Jo Malone, so it's a very broad growth across. We are really ready with our innovation with the strong marketing programs. We had anticipated they come back for makeup. We have strengthened our program in what we call the Makeup Renaissance in anticipation on the return to back-to-school or back to work. And we had amazing programs so that we have had the obviously the ordinary, which is the number four brand in a skincare in prestige U.S. to our portfolio. So is a combination of factors of improvement of the strategy and improvement of the execution in our North America organization. So it's a refilled quarter, and we do expect the Ulta Target and Sephora to contribute more in the next quarters, or was not the key contributing factor in quarter one.

Operator:

Thank you. And with that, that will conclude today's question-and-answer session. If you were unable to join through the entire call, a playback will be available at 1 PM Eastern today through November 16th. To hear a recording of the call, please dial 855-859-2056. Enter pass code 6086-324. Again, the pass code 6086-324. That concludes Estee Lauder conference call. I'd like to thank you all for your participation and wish you all a good day.

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 as before restructuring and other charges and adjustments disclosed in our press release. Unless otherwise stated, our net sales growth numbers are in constant currency and all our organic results excluding the impact 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 includes Sales we make directly to our consumer to our brand.com sites and through third-party platforms. It also includes estimated sales of our products through retailers website. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Tracey Travis:

Thank you for [Indiscernible] and hello, everyone. I concur with Fabrizio in thanking our incredible team who have demonstrated great resilience during the pandemic. Navigating through the highly uneven recovery this past year has certainly required greater agility and flexibility and our teams across the globe rose to the occasion, delivering superb results for the Fiscal year, while also establishing a stronger foundation for future growth and profitability. We delivered exceptional net sales growth of 56% in our fourth quarter as we anniversary pandemic-related store closures in the prior year. The inclusion of six weeks of sales from DECIEM added approximately three points to growth in the quarter. Our performance also exceeded the pre-pandemic levels of the Fiscal 2019 Fourth Quarter by 9% driven by significant sales increases in Mainland China, the skincare and fragrance categories, global online, and travel retail in Asia. All three regions grew and all product categories within each region grew during the Quarter. Net sales in the Americas region rose 86% against the prior-year period with almost no brick-and-mortar retail open. Throughout the quarter, consumer confidence in the U.S. grew as COVID restrictions abated and people resume shopping in stores again. Our brands responded with strong program supporting recovery, new product launches, and animating key brand shopping events like Mother's Day. Sales in the region remained below Fiscal '19 level for the quarter, reflecting in part the loss of over 900 retail locations that represented nearly 170 million in annual sales. Additionally, makeup has historically been the largest category in the region, and the category has yet to fully recouped sales loss during the pandemic. Nevertheless, we are encouraged by the sequential acceleration in North American sales, which has been better than we expected. Net Sales in our Europe, the Middle East, and Africa region increased 65% with all markets contributing to growth as COVID restrictions eased throughout the Quarter. Global Travel Retail, which is primarily reported in this region, continued to suffer from a significant drop in international travel traffic, but grew strong double-digits in the Quarter as comparisons eased and local tourism in China, especially to Hainan remained robust. Across developed markets in the region, store traffic has begun to pick up and retailers have become more comfortable with restocking. Emerging markets in the region saw strong retail in the Quarter, driven by locally relevant holiday activation, retailer events, and online performance. Sales in the region were slightly above Fiscal '19 levels for the Quarter, primarily due to the resilience of travel retail. Net sales in the Asia-Pacific region rose 30%. Virtually every country contributed to growth, although the pace of improvement varied widely among the markets and a resurgence of COVID has slowed a full recovery. Sales of our products online continued to rise strong double-digit in the region driven by the successful 618 Shopping Festival campaign in China and including the continued strength of social e-commerce. Mainland China continued to experience robust double-digit growth with broad-based improvement across product categories, brands and channels. Other markets in the region, including Korea, Hong Kong and Japan grew exceptionally against prior year Brick-and-mortar lockdown. Sales in the region were 50% above 2019 levels, largely reflecting China's rapid emergence from the pandemic last year. Net sales in all product categories grew sharply this quarter. And skin care, fragrance and hair care drove higher sales than Fiscal 2019. Fragrance-led growth with net sales rising 150% versus prior-year. Luxury fragrances resonated with consumers looking for self-care and indulgence and among Chinese consumers, increasingly attracted to the category. Home, bath, and body products have also gained traction during the pandemic and helped to attract new consumers. Jo Malone London saw recovery to pre-pandemic levels in Brick-and-mortar. And the brands Blossom and Brit collections were popular in Asia. Standouts from Tom Ford Beauty include the recent launch of Tubereuse Nue and the continued strength of Bitter Peach and Rose Prick. Net sales in makeup jumped 70% against the prior year that reflected the greatest beauty category impact of COVID-19, particularly in western markets, where makeup is the largest category. The makeup category in prestige beauty has proven to be especially sensitive to brick-and-mortar recovery due to the use of testers and in-store services by consumers. Estee Lauder saw strong growth of Futurist and Double Wear foundations in Asia, and MAC liquid lip colour and eye products, especially mascara, outperformed. Haircare net sales grew 52% as salons and stores reopened. The launch of Aveda's Blonde Revival Shampoo and Conditioner also contributed to category growth. Adding to other strong innovation programs over the past several months from Aveda. Net sales in skincare continued to thrive. They rose 42% in the quarter driven by strong increases from the La Mer Estee Lauder, Clinique and [Indiscernible] with its brands, particularly in Asia. Skincare sales growth also benefited from the addition of DECIEM in the quarter by approximately 4% points. Our Gross margin improved 650 Basis points compared to the fourth quarter last year. This favorability reflected significant improvements in obsolescence and manufacturing efficiencies compared to the prior year impact of COVID-19 on our Sales and on our manufacturing locations. Operating expenses rose 36% driven by the planned increase in advertising and selling costs to support the reopening of retail and the recovery. Additionally, we sharply curtailed spending last year in response to the onset of the pandemic and some of these costs were reinstated, primarily compensation. We delivered operating income of 385 million for the Quarter compared to a $228 million operating loss in the prior-year quarter. Diluted earnings per share of $0.78 included $0.02 of favorable currency translation and $0.02 dilution from the acquisition of DECIEM. Our full-year results reflect the benefits of our strategic focus as we leaned into current growth drivers and invested behind future areas of growth, while effectively managing both costs and cash. The sequential acceleration of our business throughout the year culminated in net sales growth of 11%. The strength of Chinese consumer demand, both at home and in travel retail, the resilience of the skincare and fragrance categories, and the momentum we drove in our online channels, all supported our growth. Our distribution mix continued to revolve even as Brick-and-mortar reopened. Sales of our products through all online channels continued to thrive as they rose 34% for the year and represented 28% of Sales. Despite the continued curtailment of international travel, our business in the Travel retail channel grew ending Fiscal 2021 at 29% of Sales. Among Brick-and-mortar retail, specialty multi and perfumeries grew while department stores and freestanding stores experienced the greatest impact from the ongoing pandemic and declined for the year. Our Gross margin rose 120 Basis points to 76.4% driven by favorable pricing, lower obsolescence, increased manufacturing efficiencies and lower costs for testers and stores and partially offset by currency due to the weakening of the U.S. dollar. Operating expenses declined 300 Basis points to 57.5% of sales. Selling and store operating costs decreased as high service stores were either closed for part of the year or they reopened with reduced traffic and staffing levels. Additionally, in-store merchandising costs decreased while advertising investments, primarily Digital media, rose faster than Sales to support our brands in the recovery. We achieved significant savings from our cost initiatives, including Leading Beauty Forward and the preliminary benefits from the Post-COVID Business Acceleration Program. And this gave us the flexibility to reinvest in necessary capabilities, absorbed some of the inflation and media and logistics costs, as well as support the reinstatement of certain compensation elements that were reduced or frozen due to the onset of the pandemic. Our full-year Operating margin was 18.9%. representing a 420 basis-point improvement over last year and 140 basis points above Fiscal 2019. This year also includes 50 basis points of dilution from the inclusion of Dr. Jart and DECIEM. Our effective tax rate for the year was 18.7%, a decrease of 450 basis points over the prior year, primarily driven by the geographic mix of earnings, which included a favorable one-time adjustment for Fiscal Years 2019 and 2020 related to recently issued GILTI Tax Regulation s. Net earnings rose 57% to $2.4 billion and diluted EPS increased 57% to $6.45. Earnings per share includes $0.11 accretion from currency translation and $0.08 dilution from the acquisitions of Dr. Jart and DECIEM. In Fiscal 2021, we recorded 148 million after-tax or $0.40 per share of impairment charges related to our Smashbox and GLAMGLOW brands, as well as certain freestanding retail stores. Restructuring and other charges related primarily to the Post-COVID Business Acceleration Program, were 176 million after-tax or $0.48 per share. These charges were more than offset by the one-time gain on our minority interest in DECIEM of 847 million after-tax or $2.30 per share. The Post-COVID Business Acceleration Program is progressing quickly with projects underway across all regions. We have closed nearly 500 doors or counters, including about 50 freestanding stores under the program in Fiscal 2021. We also closed approximately 100 additional freestanding stores outside of the program and upon lease expiration, primarily in North America and in Europe. We've realigned our go-to-market organizations to better reflect our evolving channel mix. We're also winding down certain brands such as BECCA and Rodan. These actions are expected to continue into Fiscal 2022. For the total program, we continue to expect to take charges of between 400 million and 500 million through Fiscal 2022 and generate savings of 300 to 400 million before tax by Fiscal 2023, a portion of which will be reinvested. We continue to focus on maintaining strong liquidity while also investing for future growth during the year. Cash generated from operations rose 59% to $3.6 billion were primarily reflecting the higher net earnings. We utilized 637 million for Capital improvements, supporting increased capacity and other supply chain improvements, further e-commerce development and information technology. We repaid 750 million of Debt outstanding from our revolving credit facility, issued 600 million of new long-term Debt and retired 450 million of Debt. We used 1.1 billion net of cash acquired to increase our ownership interest in DECIEM. And we returned 1.5 billion in cash to Stakeholders during the year via increased Dividends and the reinstatement of share repurchase activities in the second half of the Fiscal year. So looking ahead to Fiscal 2022, we are encouraged by the increasing vaccination rates and reopening of markets around the world. We look forward to the resumption of international travel, increasing foot traffic and Brick-and-mortar retail and the development of our recent acquisitions. We are still mindful, however, that the recovery has evolved unevenly and some markets are seeing their third or fourth waves of COVID, including increasing effects of new more contagious strains of the virus, hindering a return to normal life. This has been particularly evident in the U.S. over the past several weeks. Additionally, increasing climate and geopolitical events make it difficult to predict the corresponding impact on our business. Nevertheless, given the strength of our programs, we are cautiously optimistic and therefore providing a range of sales and EPS expectations for the Fiscal year caveated with the following underlying assumptions. Progressive recovery in the makeup category as full vaccination rates increase and mass wearing abates in western markets during the first half of the Fiscal year. Beginning of the resumption of international travel in the second half of the Fiscal year. The addition of new retail accounts for some of our brands should provide broader access to new consumers, notably through Sephora at Kohl's and Ulta at Target in North America and the addition of JD.com in China online. The inclusion of incremental sales from DECIEM, benefiting sales growth for the fiscal year, primarily in the Americas and AMEA region and in the skincare category. Pricing is expected to add approximately 3 points of growth, helping to offset inflation risk and freight, media, labor, and commodities. Increased advertising support as markets reopen and further investment behind select capabilities, including data analytics, innovation, technology, and sustainability initiatives while maintaining good cost discipline elsewhere. We forecast increasing benefits from our post - COVID business acceleration program as it ramps up this year. Approximately, 200 million of the cost we cut during the pandemic are expected to be reinstated. These primarily include hiring, travel and meeting expenses, furloughs and other leaves of absence, and compensation. In addition to these assumptions, there are a few non-operating items you should be aware of as you adjust your models. Our full-year effective tax rate is expected to return to a more normalized level of approximately 23% from 18.7% in Fiscal 2021. Net interest and investment expense is expected to be around $150 million. The increase is primarily due to the comparison to last year when we recorded the benefits of our minority interest in DECIEM through May 18th 2021. At that time, we acquired a majority ownership in DECIEM and we began to fully consolidate the entire business and deduct a portion of the income we don't own as a charge to net earnings attributable to non-controlling interest. This charge is expected to be less than $5 million in Fiscal 2022. Net cash flows from operating activities are forecast between $3.2 billion. Capital expenditures are planned at approximately 5% of projected Sales. As we develop additional manufacturing and distribution capacity, notably for the building of our new facility in Japan. We also expect to fund more robust research and development capabilities in China and North America. Increased investment in technology and support new distribution and e-commerce for our brands. Our Capex plan for the year also includes some spending differed from last year. Also, beginning in Fiscal 2022, we plan to entry -- introduce the concept of organic sales growth in our earnings materials and investor presentations, organic growth, adjust reported sales growth for both currency and changes in structure, such as acquisitions, divestitures, and brand closures. This should help provide a more meaningful understanding of the performance of our comparable business. Additionally, reflecting the level of volatility still in the environment, we are at this point widening our guidance ranges for the year. For the full fiscal year, organic net sales are forecasted to grow 9% to 12% based on August 13 spot rates of 1.17 for the Euro, 1.381 for the Pound, 1164 for the Korean Won and 6.479 for the Chinese Yuan. We expect currency translation to add one point to reported Sales growth for the full Fiscal year. As I mentioned earlier, this range excludes approximately three points from acquisitions, divestitures and brand closures, primarily, the inclusion of DECIEM theme. Diluted EPS is expected to range between $7.23 and $7.38 before restructuring and other charges. This includes approximately $0.19 of accretion from currency translation. In constant currency, we expect EPS to rise by 9% to 12%. This also includes approximately $0.03 accretion from DECIEM. At this time, we expect organic sales for our first quarter to rise 11% to 13%. The incremental sales from acquisitions, divestitures, and brand closures are expected to add about 3 points to reported growth and currency is expected to be accretive by approximately three points. Operating expenses are expected to rise in the First Quarter as we invest in the reopening and recovery of brick-and-mortar retail around the world and some of the temporary cost measures start to ease. We expect First Quarter EPS of a $1.55 to a $1.65. Currency is expected to be accretive to EPS by $0.05 and DECIEM is forecast to have no impact. In closing, while we're cautious about the uneven recovery to date, we remain confident about the strategic actions we continue to take to support sustainable, profitable growth post-pandemic, and the agility we have demonstrated this past year. On behalf of the entire Estee Lauder Company's leadership team, we give thanks to our incredible teams around the world for their extraordinary efforts to manage during this unprecedented period. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Dara Mohsenian:

Hey, good morning, guys.

Fabrizio Freda:

Good morning.

Fabrizio Freda:

So, let me start is -- first of all, I would say the large majority of our online progress during COVID is very sticky. And keep in mind that we attracted also many new consumer. The new consumer were also among the older consumers, and they really liked it. And so, we see they're coming back and they're staying, even when store reopens, obviously, with a different balance, but this is definitely happening. But then in total, our online is continuing to grow and we expect this to continue to grow from many years to come and the trend will not stop after COVID. Also, our online mix, which is 3PP in China for example which as you heard from the prepared remarks, flying the our last 18/6 event was really strong and then retail.com that for many retailers around the world is booming to a play, which is very much growing and then brand.com and obviously brand.com in the moment -- the part of brand.com in the moment that is the bigger reopening and people go back to store will temporarily stabilize or slightly decrease. But then will start growing again. That's our expectations. So overall, all-in-all our online business will continue to progress as percentage of total business over the next years.

Dara Mohsenian:

Great, thanks.

Olivia Tong:

Great. Thank you. Good morning. I was wondering if you'd talk a little bit more about Asia-Pacific and the improvements there? And if you could talk about the drivers there? You mentioned the strength of 618. So, should we expect more quarterly variability in Asia, whether because of 618 or 11.11, and how that could influence how the year develops? And then if you could just talk a little bit about the current trends, given another uptake in volatility [Indiscernible] with the pandemic? Thank you.

Operator:

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

Tracey Travis:

Well, as you mentioned, Lauren, we take pricing every year, usually in the 2% to 2.5% range. We are taking approximately 3% of pricing this year and yes, it is certainly considering the inflationary environment that we're operating in. We do take differential pricing, so that it is an average across all of our markets, all of our brands. And -- and -- and but -- but so there's no specific category that we're taking any more pricing and -- then others. But -- but it is tiered certainly by the tearing of our -- of our brand Portfolio.

Operator:

And our next question is going to come from the line of Rob Ottenstein with Evercore.

Fabrizio Freda:

And sorry, could you repeat the one on the U.S.?

Robert Ottenstein:

Just -- just an update on the.com business in the U.S., the percent of Sales, I think it's -- was running 40% and then how that's breaking out between the direct business and the retail.com.

Robert Ottenstein:

No, we don't see any issue on China potential in our industry on our last improvement, what you're saying.

Tracey Travis:

Yeah. In terms of the online percentage we ended last year a little over 40% online. Again, as you know, we started the year with some of our Brick-and-mortar doors actually closed. So very, very strong online penetration. And as Brick-and-mortar reopened, the online penetration lessened a bit, but we did end the year at about 40%. In terms of the retailer.com versus brand.com, we are seeing -- and it varies. So we saw quite a bit of strength in retailer.com towards the second half of the year and strengthen -- and brand.com earlier in the year. And this year, obviously, we have some very strong plans for both brand.com and retailer.com in the U.S. to continue to grow.

Operator:

Our next question will come from the line of Steve Powers, Deutsche Bank.

Fabrizio Freda:

So we -- we -- we are preparing for the makeup brand source and we are working on all our makeup brands and in all our regions to leverage these as user education comes back. The prove that what was exactly happening in the U.S. in this last Quarter is very encouraging. In the last Quarter, our makeup was extraordinarily strong. For example, in countries where the world's have a recovery growth, like the U.S. and we saw great results from MAC onto phase and to many other brands. And we saw, particularly, the recovery start s from foundation and lipsticks, which is very good news, a very good sign. So what we're doing is first of all, we are preparing programs, marketing programs, and innovation programs and new launches for every market, making sure that we timed those to the expected recovery trend. That would be gradual but we will be -- as you know, we'll be dependent on vaccination levels and on the ability to control the COVID spikes where this happens. And so we have all analytics that tell us when this timing could be in different parts of the world. We time our marketing the auction, our advertising relaunch auctions, our innovation auctions to the different expected recovery moments. So it's a pretty complex elaboration or plan, but it's very effective. And so far has given us the kind of results we wanted, but most importantly, the kind of return on the investment that we wanted when you time it correctly. The second thing that we're doing obviously is making sure that we use data analytics and we use the understanding of the consumers to really tailor it to where the trend will start, and this is set by makeup subcategories. There are very different priorities that the consumer choose in coming back to makeup when the [Indiscernible]. And so we have some outstanding new capability in analytics that drive us also in maximum effectiveness in these areas. So, in -- all-in-all, we are very, very encouraged by the early recovery in the countries where this happened, which are mainly U.S., China, and we are well organized to follow up on the recovering gradually in the course of 2022.

Grace Ong:

Hi, good morning. This is Grace Ong for Steph. I wanted to dig in a little on the Travel retail recovery that you're expecting and how you think about the growth in market locations like Hainan. Would you expect that Hainan continues to grow on international travel resumes or is there a re-balancing where the demand is realized? Thank you.

Operator:

And our next question is going to come from the line of Mark Astrachan with Stifel.

Fabrizio Freda:

So we -- we -- we expect the -- the market in China to continue to grow double-digit. And we're very, very optimistic on the strengths of this market, as well as on -- on our position with the consumers in this market. We -- we expect to see a continuous acceleration of online, which is already 50% of Mainland China business today and farther growing. We see the possibility of continued growth in the existing platforms, like Tmall, which is for us, for beauty, for our brands, very successful and a great partners that we will continue to develop and manage with also specific products of specific brands -- of specific new brands in the future. And then we see an acceleration of brand.com. And in the marketing models around the brand.com in which we are investing and also improving our technologies to keep it aligned with the extraordinary development of technology in China, and the ability to make this technology very appealing to the consumers. And so we keep learning and keep evolving in this area. And then there are certain brands that are appealing to certain demographics that also decided to expand [Indiscernible], and just now in July. And so very optimistic with also the results of these increased coverage of consumers that we're getting. And there would be more opportunity in the future is a very, very dynamic market and competitive market, which keeps evolving and our principal is always to stay ahead of devolution, which admittedly is not easy in such a demanding market. But we're trying to stay always ahead of the evolution and anticipate change. And we'd get helped in this by our extraordinary Chinese leadership team, that keep us braced around what's happening and help us anticipating all the trends. And we get helped by our compass that we discussed in our time, which gives us a good, good point of view on what will be the evolution in the consumer preferences in every market, but particularly in China.

Erinn Murphy:

Great. Thanks. Good morning. My question is for Tracey. If you could talk a little bit more about what you expect for the Sales and the profitability of rebound in the North American segment in Fiscal 2022. Particularly when you're kind of layering on some of the new distribution partnerships, both Kohl's and Sephora and Ulta Target. And then I do have a follow-up Fabrizio on DECIEM. I know that ordinary has been driving the large success to date, but they do have a number of other brands in their Portfolio? So curious on your plans to scale some of them. Thank you.

Fabrizio Freda:

And on these, you are absolutely right. DECIEM is a Company with an extraordinary Portfolio brands. The Ordinary is today, the biggest, and is continued to be very successful in growing as an extraordinary brand. But our other brand light [Indiscernible], which is more science-based, that we intend with the DECIEM team to continue to develop. And also DECIEM is adding twice that of the Company, the capability of an extraordinary incubation, [Indiscernible], and ability. So we definitely intend to continue incubate new brands, develop new ideas, and continue with the days and philosophy of the challenge of the status quo and seeing new different point of views to be offered to the consumers and develop the extraordinary new brands in the long-term. But in this moment, the opportunity for the ordinary to continue to grow -- to continue to expand is frankly amazing and is obviously the priority we are focusing on in fiscal year 2022.

Operator:

And our next question is going to be from the line of Chris Carey with Wells Fargo.

Tracey Travis:

So -- so I can confirm Travel retail in terms of the percent of mix at -- at 29% on it -- we did have strong growth and travel retail in the fourth quarter. And in terms of the AMEA region, we did see growth as well in the AMEA region excluding -- excluding Travel retail, the UK was a little challenge. But -- but as we mentioned in the prepared remarks, all our regions grew in the fourth quarter

Operator:

Thank you. That's all the time we have for questions and answers with Ben. I would like to conclude the Q and A portion of today's call. If you were unable to join for the entire call, a playback will be available at 1:00 PM Eastern Time today through September 2nd. To hear a recording of the call, please dial 855-859-2056. Pass-code is 6687-487. Again, dial 855-859-2056 and passcode is 6687-487. That concludes the Estee Lauder Conference Call. I would like to thank everyone for their participation and I wish you all a good day.

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 net sales growth numbers are in constant currency and all organic results exclude the impacts of acquisitions. 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 site and through third-party platforms. It also includes estimated sales of our products through our retailer’s websites. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Tracey Travis:

Thank you, Fabrizio. I certainly echo that statement and look forward to the continued progression of our recovery. For our fiscal third quarter, net sales rose 13% as we left the onset of the COVID pandemic, and delivered exceptional growth in the Asia Pacific region and in the skin care and fragrance categories. While our brick-and-mortar distribution continue to experience soft foot traffic, our online channel delivered strong growth across all formats and all regions. Conversely, the environments in Western Europe, Latin America and parts of North America were challenged throughout the quarter. Our gross margin increased 90 basis points compared to the prior year quarter favorability and category and channel mix driven by skin care and online growth, as well as lower tester costs were partially offset by obsolescence, negative currency and COVID related under recovery of fixed cost primarily in our facilities that manufacture makeup products. Operating expenses improved by 530 basis points compared to the prior year quarter, largely reflecting the improved sales leverage this year. You will recall that when the pandemic struck in the prior year quarter, the sudden and dramatic drop in sales created expense deleverage that was difficult to fully offset despite the cost actions we took at that time. This quarter, we benefited from both temporary and longer term cost savings, which is reflected in the substantially lower selling and store operating costs as a percent of sales continued to shift from brick-and-mortar to online as sales continued to shift from brick-and-mortar to online. This was due in part to temporary store closures in response to a resurgence of the virus in certain EMEA and Latin American markets. We realize some subsidies and the extension of furlough benefits in some of the affected markets. We've also prudently managed staffing levels in our stores, and new hires on our management teams, until we see the recovery gaining more consistent momentum. Advertising spending grew double digits, and was predominantly focused on digital spending. We invested to support our online acceleration as well as our new product launches, a strong recovery in certain markets and key shopping moments such as Lunar New Year, Women's Day and Valentine's Day. As a result, our operating margin rose 620 basis points to 20.5%, which was 40 basis points above fiscal '19 level. Our effective tax rate for the quarter came in at 20.7%. The lower tax rate for the quarter was primarily due to a lower rate on the company's foreign operations. Diluted EPS of $1.62 increased 92% compared to the prior year. EPS exceeded our expectations primarily due to the higher sales, continued cost management and a lower effective tax rate. Our plans under the post-COVID business acceleration program are progressing. Year-to-date, we have taken actions in three main areas to adjust our distribution footprint in Latin America and EMEA including travel retail, to exit global distribution of BECCA products, and to realign resources and capabilities, including employee related costs between our brick-and-mortar and online channels. We are already beginning to realize the modest benefits from these actions. As the program continues, we expect to further rationalize our brick-and-mortar retail footprint, primarily in Western markets. For the 9 months, we generated $2.78 billion in net cash flows from operating activities, which was substantially above the prior year, primarily due to higher net earnings as well as working capital improvements. We invested $386 million in capital expenditures to support key investment areas like production and distribution capacity and technology, including our online business. Conversely, we spent far less on counters and stores. We ended the period with approximately $6.4 billion in cash and cash equivalents, including cash from $600 million and senior notes issued in March to support the increased equity investment in DECIEM, once the deal was finalized. We also reinstated our share buyback program in March and utilized $316 million of cash to repurchase our stock and we paid $561 million in dividends. After the end of the quarter, we used $450 million in cash to pay down debt maturing in the fourth quarter. Given our strong cash generation this year, we still remain in a very strong position to pursue further growth opportunities after these actions. So now, let's turn to our outlook. We continue to be encouraged by the sequential improvement we have seen in our business throughout the fiscal year. And we are optimistic that restrictions and hesitancy on travel and social activities will begin to ease in certain markets as vaccine coverage steadily increases. In China, Australia, and Israel, which are at the leading edge of recovery, we are seeing higher makeup sales with usage occasions increasing as social and professional engagements gradually normalize. For example, sales in our freestanding stores in Israel have returned to pre-pandemic level and even lipstick sales are almost back to normal. The upcoming addition of the DECIEM brands to our portfolio and the expansion of our business with Sephora and Ulta beauty in the U.S. represent additional growth drivers for us as we progress in recovery from the pandemic shock, giving us further cause for optimism. We have led with our strengths, our values and our amazing team and have proactively addressed areas where which we could control while at the same time ensuring we are protecting our strategic growth areas. As a result, in the context of a very challenging environment in fiscal 2021, we expect to end the year with sales growth of between 9% and 10% in constant currency. Currency translation is expected to add approximately 2 percentage points to reported growth, reflecting rates of 1.18 for the Euro, 1.33 for the pound and 6.64 for the Yuan. 6 months of incremental sales from the December 2019 acquisition of Dr. Jart, and approximately 1 month expected from DECIEM are contributing approximately 2 percentage points to our expectations of growth for the year. Mindful of the more gradual resumption of traffic to our brick-and-mortar distribution, we kept tight control over costs this year to protect investments needed for long-term growth. Some of the costs we cut temporarily will gradually return as more doors open, subsidies will correspondingly diminish and we plan to meaningfully ramp up advertising spending in our fourth quarter as consumers return to social and professional engagements. That said, we expect to end this fiscal year with an operating margin of approximately 18.5%, an improvement of roughly 100 basis points above fiscal 2019. Full year EPS is expected to be between $6.05 and $6.15, before restructuring and other charges. This reflects approximately $0.10 accretion from currency translation and $0.04 dilution from acquisitions. Our fourth quarter sales are expected to rise between 44% and 50% in constant currency. This reflects both the recovery in many parts of the world as well as an easier comparison against the prior year period most impacted by the pandemic. Currency is expected to be accretive by approximately 4 percentage points and the addition of approximately 1 month of sales from DECIEM would contribute less than 2 percentage points to sales growth. Fourth quarter EPS is expected to be between $0.38 and $0.48, reflecting the sales outlook and increased investments to support the ramp up of our innovate -- innovation and manufacturing capabilities in Asia. Continued investment to drive our online business and the advertising and promotion to support recovery, with a resulting operating margin more typical of our pre-pandemic levels of mid to high single-digit in the quarter. Currency is expected to add $0.02 to EPS, and the addition of DECIEM is immaterial for the quarter, given the short timeframe in purchase accounting. In closing, we are pleased with our performance in the third quarter in the context of a challenging macro backdrop. Our skin care and fragrance brands have proven to be resilient during this time, as consumers shifted online and we enhanced the digital experience with increased services on our sites. As we navigate through the final months of our fiscal year, we are investing in both the near-term recovery and the drivers of long-term sustainable growth that create value for our multiple stakeholders. While it is difficult to predict the growth of global prestige beauty in the near-term, we are confident as we have demonstrated that we can nimbly allocate resources to continue to operate with agility and gain share as the recovery gives way to the new normal. That concludes our prepared remarks and we'll be happy to take your questions at this time.

Lauren Lieberman:

Great, thanks. Good morning.

Lauren Lieberman:

Good morning. I was hoping you could talk a little bit about Asia Pacific because as strong as trends are, on a 2-year basis, things were a little bit slower this quarter. I know the fiscal second quarter you have 11.11 that's probably a much bigger shopping holiday than Chinese New Year. But from the aggregate level that we see in Asia, things were probably a little bit slower than people expected. So could you just give us a little bit more color there, describing maybe trends in China -- Mainland China, I should say versus whether it was Hong Kong, Japan, other areas where things might have slowed down. And also any other thoughts on Hainan and the degree to which shopping there may be overlapping with things that purchases that used to happen in other Asian markets as Chinese were travelling more overseas are now maybe repatriating those purchases to Hainan? Thanks.

Tracey Travis:

And you covered it, Fabrizio.

Operator:

Your next question is from Erinn Murphy with Piper Sandler.

Fabrizio Freda:

Well, first of all, what we see is that the recovery on makeup is particularly -- benefits particularly of the recovery of brick-and-mortar omni-channel shopping because people does like to interact with the products and like the experience of shopping together. And so this is really one driver. And so in China, we see this getting stronger and as the recovery unleash. What we see in terms of product, that people -- and again, I speak about China where these active at all. Australia and Israel is another place where we see signs of what happens during the recovery. And the signs are consistent by the way. And first of all, people go back to their core makeup also because they have not used it for some time and may not be fresh anymore in some cases. So, there is a lot of back to foundation, to lipstick, to mascaras that needs to be purchased back. And now depending which region of the world, a different proportion of these subcategories as you know. But this is back to core. But there is also a huge interest in newness, is obviously that from an emotional standpoint people don't want to go back to the past. They want a new normal. They want to forget actually this very difficult year when they’re in a recovery mode and go back to a new future. So they look for newness, for novelty. And that's why in our renaissance plan, we are both planning in every region of the world where and when this recovery will happen. We are ready to bring back our core and allow the consumer to reload what is their core habits, the core products. And at the same time, an outstanding mix of new product innovation, breakthrough idea, fresh way to use makeup, new looks, and most importantly, looks which are consistent with the renaissance of the user educations because to be clear, makeup is not only about shopping -- emotional shopping. It's about having the occasions in your social life, your professional life to use makeup. And so we are studying how those occasions come back and which kind of makeup core and newness is of interest for each occasions. And the occasion are different by region. And so with this level of analytics, we are preparing what we call the renaissance, which is a comeback, that is very specific. And our ability today to manage these with precisions and avoid excessive pool show, avoiding the wrong subcategories focus. In other words, ensuring a good return of our investments during the recovery. Our ability to do that has dramatically increased, thanks to analytics, which are not only giving us more data to understand what's happening but is giving us more data to anticipate what is going to happen, and that's what we are working on.

Operator:

Your next question is from Nik Modi with RBC Capital Markets.

Fabrizio Freda:

Good morning.

Fabrizio Freda:

Yes, sure. First of all, Gibu is now in -- since some months and is an exceptional new lead -- new hire and a leader, well integrated by now in our organization. He will bring our online business to next level. As you said, we have done well for many years, but he is here to bring it to a completely new level. And so the priority is, first of all, to continue our growth and leverage this huge acceleration in every single channel, in brand.com, in third parties, in pure plays, in retail.com and in making sure that we have the circulation of the best practices around the world, that we learn from what's happening in every angle in -- of the world, both in our business and in what competition or retailers are doing, the third-party are doing. But I would say the center of all this is to add more technology in order to make the consumer experience in each one of these touch points really, really high quality and even more competitive. So the focus is on taking the consumer experience to the next level. You heard me speaking in the past about chats, virtual try-on, live streaming, and many other experiences that are possible but need to become better and better over time and surprise the consumer for positive. And if we do that correctly, we will continue to drive traffic to our online because we will attract traffic, not only because of our great brands, of our great innovation, but also because of our outstanding services online and because of the experience online that will be frictionless. And also, we will need to make sure that this happens in a very efficient way and in a way which is driven by technology and become consistent across the world so that we can scale it very fast every single time this is going to be needed. And finally, we -- also, one of the priorities is to make digital advertising, and particularly, all the advertise linked to eCommerce more efficient and more effective. And with these to continue to push conversion that will be one of the key challenges and the key opportunities of the next year's in the world of online.

Dara Mohsenian:

Hey, guys.

Dara Mohsenian:

Just given the unique nature of the COVID crisis, can you just give us a bit of an update on your expectations for the travel retail category going forward? How quickly do you think demand comes back? How do you manage the business for the pace of recovery, but also potential volatility? I just love a bit of an update there. Thanks.

Tracey Travis:

And the only thing I would add, Dara, to what Fabrizio said, we are obviously watching traffic patterns and travel patterns pretty closely. Our travel retail team is -- so international travel is really projected at this point in time not to recover until perhaps even the second half of fiscal '20 -- our fiscal '22. So again, we're watching it closely obviously. If it will recover sooner, the travel retail business internationally in terms of consumption would pick up correspondingly. But in the meantime, the travel retail team has done a fantastic job of making sure that we are managing the Western travel retail markets prudently in terms of investments until we see the recovery of traffic and consumption in the Western markets. And the only thing I -- the other thing I would say is that travel retail and online combined now are a little more than half of our total business. And so when you think about our growth momentum going forward and the recovery -- the strength that we see in online and the recovery of travel retail it bodes very well for our future growth.

Operator:

Your next question is from Jason English with Goldman Sachs.

Fabrizio Freda:

Good morning.

Jason English:

I guess I want to -- good morning. I want to come back to, I guess, the first question where growth was a bit slower than many of us expected. And one thing that surprised me was just the sequential drop. I know that 2Q is always bigger than 3Q, but the drop down from 2Q to 3Q in terms of revenue was larger than is typical, pretty much across every region but especially Asia Pacific. So in fact one or two questions. One, was last quarter maybe a bit inflated with some retailers once again stepping back into the market reloading inventory? Or are we seeing more of a setback? I mean, I know you talked about some markets tightening down, but generally from where we sit and look globally, it looks like the world is slowly reopening and obviously not all consistent -- consistently. So help me contextualize around my head around why we would see the sequential debt?

Fabrizio Freda:

Yes. And so frankly, I just want to underline what Tracey said. I will read in this more of a strong Q2, particularly driven by an extraordinary 11.11 where some of our brands were topped in the 11.11 project and by the fact that holidays were a moment also in the West. They were pretty positive. People were possible, they were allowed, went back to shopping, some brick-and-mortar were open. And then, maybe because these holidays where in some places were open to early, then there was a lot of closures immediately after that, Japan, U.K. Italy, part of North America, Canada. So we've got an enormous amount of closures in the January, March period, in the West particularly, and Japan, obviously. And so that's the combination. The combination is the pandemic impact on brick-and-mortar. Now, keep in mind that as you have seen in the results, we have extraordinary skin care and fragrance, and [indiscernible] brand is doing really strong. The question is the makeup recovery, and the makeup is very linked to the comeback of the brick-and-mortar experience. So all the closures that happened actually after the holidays in many Western markets and in Japan did have an impact on makeup. And we have seen that. So I would not say there is any long-term sign in this Q3. Actually, it is an extraordinarily strong Q3. By the way, it was ahead of our guidance because we had seen that in our guidance. We had seen these kinds of things that would have happened because of the closures. And so it was a very strong quarter and Q2 was just an extraordinary quarter. But as Tracey said, Q2 will be pretty strong because in the future there will be always a combination of holidays and a strong peak of commercial activities like 11.11 and more that we create a high in terms of an absolute level of sales.

Operator:

Your next question is from Rupesh Parikh with Oppenheimer.

Fabrizio Freda:

No, no, I would definitely not. I think we are counting on it, again, as the COVID abates and the opening. As I've said before, I want to repeat that, makeup is about user education. So -- and the user education on makeup at exactly the social and professional occasions that when there are closures or when the pandemic is very active and not there and so consumption goes down. So we are really -- we don't see any reason why we would not go back to first stabilization and then growth in makeup when these social occasions come back and these professional occasion comebacks. Just want to take the opportunity to make the pictures. Today, we have our current drivers, which are the Chinese consumer, the global online, and the skin care category and now the high-end fragrance category that will continue to drive. There is no discussion. These areas have been accelerated by COVID. But in reality, their trends were strong already before, so COVID does accelerated, and we are really ready and as you see we are having great success on these drivers even in the middle of COVID. Now, there are new drivers that should be added to these drivers as COVID will abate. Makeup usage, as I said, brick-and-mortar productivity in most markets, certain markets and consumer groups like U.S., U.K., Japan, continental Europe, emerging markets today are unfortunately really badly hit by COVID. We come back, and we gradually come back as the COVID improves. Younger consumer consumption, which is especially linked to makeup will come back. And the TR [ph] outside of Hainan as we said before and pretail acceleration will come back. So there are all these new drivers that we need to accelerate in the next 18 months assuming that will be the pace of return from COVID gradually. Then there are new strengths that we have built during COVID and we have invested in them. There is better innovation in Asia with the center in Shanghai and the quality of our innovation that is creating higher repeat process rates. There is more skin care and more makeup skinification and we have more production capacity of high quality production capacity in our upcoming factory in Tokyo; better consumer understanding and better ability to anticipate trends driven by our investment in analytics; more resources for advertising, especially digital advertising, which is increasing; better high touch services online, as I explained before when there was a question on online; brand portfolio, which is becoming stronger with the acquisition of DECIEM and Dr. Jart; a huge investment and acceleration in every ESG activity during COVID. And all of these combined is what I call the new strengths that we are bringing to the [indiscernible]. So the way we see it is that the current drivers will drive, the new drivers including makeup will come back and the new strengths that we have built in Estée Lauder Companies during this year will hit. And that's why we really believe that this quarter is just the confirmation that we are creating a very solid long-term sustainable growth pattern for the company.

Tracey Travis:

And the only thing I would add to that is, just to underscore some of the investment in technology we've made for virtual try-on. So when you think about those social and professional occasions coming back, whether someone wants to come in the store and try makeup or if they want to try it online, the engagement that we see online from some of the capabilities and features that we've added to online certainly bodes very well for when those occasions come back and the makeup category acceleration.

Operator:

We have time for one more question. Your final question will come from Chris Carey with Wells Fargo.

Tracey Travis:

Yes. So, Chris, as you know we typically give forward guidance for the upcoming fiscal year in August, which we will certainly do. I mean this has been an unusual year because of all of the things that you've mentioned. We had part of the year where we had temporary salary reductions, we've had furloughs and we've also done a fantastic job, our teams have, in terms of managing costs. Some of those costs will come back next year and some of them won't. Some of the door closures that we've permanently done, those costs and the remaining fleet of doors should be more productive as traffic continues to accelerate to brick-and-mortar, which is where we see the bulk of the recovery. So given the cost actions that we've taken, given where we expect growth to come from next year disproportionately, we would expect continued margin progression. But we will be able to say more specifically what that will be in the August timeframe. But as we've said for many years, our growth areas are all margin accretive when you think about travel retail, when you think about online when you think about the strength that we've had over multiple years in terms of skin care. And as Fabrizio said, we expect skin care and fragrance to continue to grow and makeup will also grow more strongly certainly next year as those occasions come back. So we've got multiple engines, multiple ways to progress margin even as investments do come back for brick-and-mortar and in other areas. We will, in the fourth quarter as you indicate, and as I said in my prepared remarks, so -- strongly invest as we normally do for a start of a strong fiscal year and we will invest more in advertising to support what we believe will be an acceleration. It's selectively in the markets that we think that it will happen in.

Operator:

That concludes today's question-and-answer session. I would like to turn it over to management for closing remarks.

Operator:

Thank you. If you were unable to join the entire call, a playback will be available at 1 p.m. Eastern Time today through May 17. To hear recording of this call, please dial 1-855-859- 2056. The passcode number 5569398. That concludes today’s Estée Lauder conference call. I would like to thank you all for your participation and wish you a good day.

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. All net sales growth numbers are in constant currency and all organic results exclude the impacts of acquisitions. You can find reconciliations between GAAP and non-GAAP figures 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 Brand.com site and through third-party platforms. It also includes estimated sales of our products through our retailer’s websites. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Tracey Travis:

Thank you, Fabrizio and I certainly echo your comments regarding our wonderful employees. As a reminder, my commentary today is adjusted for the items that Renee mentioned at the beginning of the call and net sales growth numbers are in constant currency. Our net sales rose 3% in the second quarter. The COVID-19 pandemic continue to pressure traffic in our brick-and-mortar distribution, but sales declines in stores were entirely offset by strong growth across our online channels and in travel retail in Asia. The December 2019 acquisition of Dr. Jar added approximately three point to net sales growth. Sales performed above our expectations in large part reflecting the outstanding execution during the annual team 1111 Shopping festival as well as the many activations our brands deployed during key shopping events like Brett Black Friday and Fiber Week. In addition to the acceleration and growth we saw in skincare, fragrance sales were strong in the quarter and home fragrance continued to resonate during the pandemic. Our gross margin increased 10 basis points compared to last year's second quarter. Favorable channel mix was driven by the growth in our online sales and also reflects lower costs for testers in our brick-and-mortar distribution. From a category perspective, the acceleration of sales in skincare also benefited gross margin. The positive mix was partially offset by higher obsolescence and a negative currency impact. Operating expenses improved by 160 basis points as a percent of sales, reflecting both the strength of our sales leverage during key shopping moments and our cost containment measures. Many of our COVID related cost containment measures remained in place during the quarter and contributed to our improved profitability along with the benefits of our leading beauty forward initiative. Lower selling cost and other in-store promotion cost also reflected the mix shift of our business from brick-and-mortar to online as well as some remaining government subsidies in certain countries. Given the challenged environment, we continue to experience periodic tour closures. Partially offsetting the cost favorability was higher investment behind our strategic priorities, including China, online and digital technology as well as the inclusion of Dr. Jart expenses this year. As a result, our operating margin rose 170 basis points to 24.3%, a significant accomplishment during this important holiday quarter considering the record results achieved in the year ago period. Our effective tax rate for the quarter came in at 15.9%. The lower tax rate for the quarter was primarily due to the recognition of a onetime retroactive benefit related to recently finalized guilty US tax rate regulation. We now expect our effective tax rate for the year to be approximately 20% reflecting this development. Diluted EPS of $2.61 increased 24% compared to the prior year. EPS was higher than expected due primarily to the combination of strong performance during the key shopping moments in the quarter and the lower tax rate while maintaining strict cost management. This performance is truly a testament to our team's ability to navigate the business through the difficult macroenvironment. Our plans under the post-COVID business acceleration program are progressing. Through the past six months, we've taken charges of $46 million primarily to close underperforming freestanding retail stores in our EMEA region and an employee-related cost as we align resources to support our online business and our digital capabilities. As the program continues in the second half we expect to continue to rationalize our retail footprint primarily in Western market. Additionally, we took an $81 million impairment charge for our glam glove brand reflecting the COVID-related disruption of the brand growth plans and lower than expected growth from its planned geographic expansion. During the first half of our fiscal year, we generated $1.98 billion in net cash flows from operating activities, which was substantially above the prior year, due primarily to improvements in working capital management. Accounts payable increased reflecting timing-related items that also support our second-half growth plans and accounts receivable reflected the rapid growth in our direct to consumer business and a five-day improvement in DSO. We invested $250 million in capital expenditures to support key investment areas like additional production capacity and technology. Conversely we spent far less on counters and stores due to lower traffic and brick-and-mortar doors. We ended December with $5.5 billion in cash and cash equivalents just above our total debt. With the strength of our cash position, our free cash flow generation and our confidence in our business drivers as we recover, we expect to reinstate share repurchases and maintain our dividend during the second half of our fiscal year. So now let's turn to our outlook, we are obviously encouraged by the sequential improvement we saw in every region as we continue to manage through the effects of the pandemic. While cases of COVID-19 and the variance of surging again in some markets, resulting in renewed door closures, restrictions and lockdowns, we are optimistic that once the vaccines reach enough of the global population, the restrictions on travel and social activities will ease. Nonetheless we've not assume a second wave. Therefore, the more accelerated global recovery we originally anticipated in our second half has clearly been delayed. So while we are pleased with our performance in the first half, the prolonged uncertainty with respect to the pace and timing of the recovery makes it still difficult to provide sales and EPS guidance for the full year. We do continue to expect sequential, quarterly sales growth improvement as comparisons to the prior year ease and the global recovery unfolds. The inclusion of six months of incremental sales from the acquisition of Dr. Jart, which benefited our growth in the first half adds two percentage points to sales growth for the full fiscal year. As you know, several of our retail customers are liquidating or reducing their store footprints. Notably Lord & Taylor, Staged Stores and [indiscernible] are liquidating and Macy's, Nordstrom [ph] have announced store reductions. Additionally, we expect to close certain freestanding stores in North America and EMEA now that the holidays are behind us. In aggregate, the law sales represent between 1% and 2% of our total full-year sales and we do expect to recapture a portion of those sales in other locations in online. While we will continue to execute our cost savings programs, it is important to recognize that some of the temporary cost measures we took last year will be returning in the coming months. The principal areas of returning cost includes some additional advertising, promotion and point-of-sale employee cost, which were all meaningfully reduced during the time that retail doors were closed last year, as well as the restoration of certain temporary pay reductions we took. Travel and retail consulting costs are expected to ramp up more slowly. Costs will also increase as offices reopen and our facility to continue to implement enhanced safety protocols. We will incur incremental spending for our new Asian manufacturing plant and innovation center and as we continue to see signs of consumer's willingness to resume their normal activities including return to stores, we plan to invest incrementally as we normally did pre-pandemic in our fourth quarter to strongly support our launch programs and begin to reaccelerate our makeup business in the upcoming fiscal year. Looking at the near term, for the third quarter we expect sales to rise between 10% and 11% in constant currency. We have a terrific lineup of product offerings and activations for the Lunar New Year and we expect continued strong online sales. You may recall that we had an exceptional January last year. We have lacked the purchase of Dr. Jart at the beginning of our third quarter and the brand is now part of our organic growth. Currently, is expected to be accretive by approximately three percentage points. Third quarter EPS is expected to be between $1.10 and $1.20 reflecting the sales outlook and a careful balance between cost containment measures and investment in key growth areas such as online and technology and currency is expected to add $0.03 to EPS. We remain optimistic that the pandemic will be controlled and out of home activities will resume under a new normal. With a solid first half behind us, we've proven we can deliver in the context of a difficult macroenvironment while continuing to support our employees, our social and environmental commitment and invest in the capabilities needed to sustain our growth over the long term. The resiliency of our business during this time and the passion and dedication of our teams, reinforce our confidence in our strategy and the continuation of our ability to deliver long-term sustainable growth. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Dara Mohsenian:

So I wanted to focus on topline, clearly very strong performance in skincare and e-commerce during COVID. Can you talk about the sustainability of that strength in each of those areas as we move to a post-COVID environment as well as what some of your key strategies might be to maintain momentum post-COVID and then on the makeup side, that's obviously been a laggard area for obvious reasons. How quickly do you think category growth recovers in makeup post-COVID and what's your outlook there, thanks?

Operator:

And our next question is going to come from the line of Lauren Lieberman with Barclays.

Fabrizio Freda:

So first of all the online business has done very well this quarter plus 60% globally and is interesting we are growing double or triple digit in every brand, every region, every channel, a meaningful channel brand.com, retail.com, third party platform pure plays and so Western Europe is the same. Western Europe is growing depending by market double-digit or triple digit in online and obviously the holiday season has been because of the lockdown as you know in Western Europe particularly COVID was pretty high in November, December. Because of this, the brick-and-mortar were closed in countries like the UK as an example, December was a super difficult month and so it was no regular Christmas holidays in brick-and-mortar and obviously UK was not the only place and so because of this we were able to pivot to online in an historical way. I think our teams have done an amazing work in taking care of our consumer online when they were because of proven behavior for COVID now going into the brick-and-mortar and what we've seen that this works in many, many cases meaning again the consumer's certain categories we're working because of repeat meaning the consumer didn’t do without their preferred Le Mer cream or their preferred advanced whatever and so we got a lot of the selling via the online channel. But also we are able to stick to their gifting habits and we created gifting opportunities and delivering all those for gifting etcetera. So it was a lot of activity and invention in this area. Now this online in general, I believe the online will continue to be very strong also in the long-term and this acceleration will continue also post COVID and one of the reason for that which is particularly true in Western Europe is that the new online focus created growth online, more than created new consumers including more mature consumers. Online particularly in Europe was really dedicated to millennial or younger consumers while during COVID, more mature consumers came online and they're lacking it and they're becoming loyal and so they will also post COVID have a bigger percentage of their shopping online than before. On top of this, if you think that we are adding high touch services online, so what were the services that in before were available in brick-and-mortar now gradually but they're also available online and we've been able to scale the speed online. Just to give you a number to understand our ability to scale new ideas is today digital try [ph] is already available in 90% of our brand.com sales internal coverage. Now imagine that that it was not even close to that six months ago and so the consumer responded to that and this is driving also in Western Europe a lot of online and probably sustainable and more loyalty online across different group of consumers. So online had a big role in Western Europe in quarter two and will continue to have a bigger and growing role over time in the next years.

Erinn Murphy:

Question is around the landscape where in North America we've seen some pretty unique partnerships recently with [indiscernible]. Are you expecting to participate in these partnerships? I know historically math hasn’t been that appealing but maybe with ultra target structure what's coming your brand expense? And then I guess secondly if you think about the post behavior of consumer retailer post pandemic, how comfortable are you with the entirety of this brand portfolio today if that ever makes sense? Thank you.

Erinn Murphy:

Are there any brands thinking of the makeup portfolio in particular that you would ever consider investing on the other side of the pandemic. I am just curious on your comfort with the entirety of the portfolio today?

Operator:

And our next question is going to come from the line of Rupesh Parikh with Oppenheimer.

Fabrizio Freda:

Yeah the makeup category in China is stronger than makeup in the other regions because as I say responded to broader social locations and the user locations, but it's still decline, so is not different than the rest of the world China meaning skincare is very, very strong, fragrance is accelerating and makeup is large even in China however, on a completely different proportion because when you see -- when you think of this nature just gave before that makeup is completely correlate to the location of user in China because of the good control of COVID and because of the occasions like business offices are open, people are shopping more regularly, brick-and-mortar shopping is more present in most of the cities. Because of these more occasions makeup is in better shape but still is the lag between the categories and mostly in China I'd say from our consumer understanding is because of mask waving meaning China is better controlling COVID but also better controlling COVID because there is very disciplined mask wearing and mask wearing also is the reason for less use of makeup. So stronger than the rest of the world but still not as strong as it will be after COVID and post COVID where we assume there will be or expect that will be a strong recovery on makeup also in China.

Nik Modi:

Fabrizio, I wanted to go back on the online discussions, you guys have done a great job with analytics and understanding consumer behavior and given how much migration has occurred on one, I'm just curious what your data and research and analytics are saying about the stickiness. For instance, you talk about the very mature consumers and developed markets migrating online, how strictly do you think that behavior will be I think that will be an important discussion going forward given the margin differential between online and some of the other channels, thank you.

Operator:

Our next question will come from the line of Olivia Tong with Bank of America.

Tracey Travis:

So regarding our production capacity as you’ve seen from our results over the last couple of quarters, clearly where we have been in need and have been investing in terms of production capacity is in skincare and we have invested in North America, we've invested in Europe and as you heard us announce this morning in our prepared remarks, we are also investing in a new facility in Asia to support primarily skincare and there will be some makeup primarily foundation as we're thinking right now in Asia. So very much having capacity closer to where our strong demand growth is will be a real benefit to us and we're looking, were certainly looking forward to that. As it relates to the margin, I would as I said in my prepared remarks Olivia, we had done an excellent job of controlling cost last year once the pandemic hit. Many of those cost controls were temporary controls. When you think about the management salary reductions, some of the rent abatements that we got, given the fact that our stores were closed, some of the furloughing benefit and some of the other back on we controlled headcount, TV, etcetera. So selling terms of the learning going forward, clearly there are some areas of I'd say more discretionary cost as we emerge out of the pandemic that we will continue to control, but the long-term sustainable cost controls really come from our cost saving programs. That's where the permanence, more sustainable cost take up comes from. So that's the reason why you're seeing if you think about what we said last year in terms of our cost programs and the significant amount of management that we did in the third and the fourth quarter to control costs given the fact that all of our brick-and-mortar doors over the course ended up closing that some of those costs certainly will be back in the second half in the third and the fourth quarter. But we will continue to manage costs in a disciplined way as we have up to this point.

Chris Carey:

So I just wanted to follow up on the operating margin question, I think it's important EMEA strongest margin we've seen, fragrances I think strongest margin we've seen and from just hearing the answer to that question, it sound like there was -- there has been a lot of efforts around cost savings, but certainly the channel dynamic as well with EMEA online doubling and certainly you’ve seen strengthen in skincare in Asia and so I'm just wondering how much the margin improvement actually might be more sustainable over time from channel mix standpoint?

Operator:

Our next question will come from the line of Michael Binetti with Credit Suisse.

Tracey Travis:

It's again over the very long term, so look I'd say that certainly that is something that we are targeting, given all of our -- again given the tailwind in terms of channel growth and category growth might change obviously makeup might we believe makeup will recover and we're certainly going to support it to recover and the margins will improve on makeup as well. Makeup actually is the category that has the biggest penetration of freestanding stores and brick-and-mortar. So it is a category that is particularly challenged from a margin standpoint in this particular environment. But certainly Michael, everything that we're doing from a business management standpoint and from a cost management standpoint would get us in that North Star of 20%.

Fabrizio Freda:

Yes now as I said before, our travel retail business in the short term is really driven by Asia in general and China domestic in particular within China domestic, China is the star and is driven by the new traffic and by the increased conversion and by the quantities past just because of the regulations that you just explained and by the developmental of retail. So those are all very important long-term strengths of the channel which is developing. Now when the normal travel will and will never be normal except, but the new normal travel stated after COVID and you are this progress of the domestic travel in China, the international travel in America and Europe within the rest of Asia and the Chinese consumer will go back travelling the world and that's obviously their desire one of the biggest aspiration shoot to the consumer when I look to the consumer opinions and research for the long-term. So when there will be a combination of the stated international travel with stronger domestic travel model that has been developed during this period, this will make still one of the most important long term channels of opportunity -- full of opportunities and again the biggest opportunity remain technically driving conversion. So the conversion of travelers into bias and the retail, so the possibility of buying also without queuing in a store for a long time where you need to take a plane I think, those two elements are big drivers of the future travel retail independently from the short-term management of the cash. And in term of the China overall business, we do monitor Chinese consumers. We spoke to it last time. This time our Chinese business between quarter one and quarter two is basically double the level of growth our China mainland business. Our TR business has also accelerate but not as strong as the China Mainland business which was driven by amazing online events like 1111 during the November period. And so the combination of the development of online within China the sudden brick-and-mortar in China is still double-digit in quarter two was growing double-digit showing the potential of brick-and-mortar when COVID is more managed or will be more manageable and then travel retail continues to do very well and so when look is also to our total Chinese consumer consumption bringing altogether what is domestic travel retail and Mainland China we still see an acceleration in total from quarter one to quarter two and so we believe this is a very, very strong potentially. We're working to manage it in a way which is still building equity of our brands, still protecting every single one of our partners been able to do good business with us for the long-term and that's our goal and we are working on it.

Mark Astrachan:

Maybe just follow-up and one other question, so just on online where does did that settle as a percentage of the category sales post pandemic and how do you think about retention of those incremental consumers on reseller.com versus your own brand.com. I've seen for you all and then just quickly, holistically I am thinking about your guidance on a go forward basis, are big events like 618 and 1111 becoming more important in driving your business meaning that the June quarter might be a little bit bigger than its historical level. Same thing for the December quarter and to that part can you explain kind of why we saw somewhat weaker September quarter guidance and I think maybe people had expected the time is same for the March quarter today. Thank you.

Fabrizio Freda:

Brand.com, online is different channels, they are brand.com, retail.com, pure play and third-party platform, which we did find that the chemo model and so these channels have different level of developments by counties and this is the results of consumer preferences and historical development of the channel. So it's not that we're driving. We're driving all of them and particularly we work with our retail partners very close to drive their retail.com, which is most of the times doing very well, particularly in this period but also for the long-term. So for example in China, retail.com is very limited and white brand.com and most importantly, third-party platform is the most developed while in the US, retail.com is very, very strong and we see a lot of great developments recently in the retail.com of our key partners and this also serves in this moment as a mitigating factor to the brick-and-mortar issues of productivity that we've discussed before. So we will continue develop each one of these channels and is the consumer deciding where to go and obviously we talked with each one of our retail partners to do the best possible job in every channel.

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 disclosed in our press release. All net sales growth numbers are in constant currency. You can find reconciliations between GAAP and non-GAAP figures 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 Brand.com and through third-party platforms. It also includes estimated sales of our products through our retailer’s websites. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Tracey Travis:

Thank you, Fabrizio and hello everyone. As a reminder, my commentary today is adjusted for the items that Rainey mentioned at the beginning of the call and net sales growth numbers are in constant currency. So, starting with the first quarter results, net sales decline 9% driven by the ongoing effects of the COVID-19 pandemic on our brick-and-mortar distribution throughout the world. We achieved strong growth in our global online channel, Mainland China, and the skincare category and delivered better than expected results in the travel retail channel and in North America. Other areas progressively improved compared to last quarter as retail doors reopened. The December 2019 acquisition of Dr. Jart contributed approximately three points of net sales growth. From a geographic standpoint, our Asia-Pacific region rose 7%, driven primarily by strong double-digit growth in skincare and the addition of Dr. Jart sales in Mainland China rose double-digits as sales in brick-and-mortar retail continued to improve. The pace of online sales growth in China was slower this quarter, following the highly successful 6.18 Mid-Year Shopping Festival programs last quarter. Most brands and channels rose double-digits and China. Korea rose high single-digits, excluding Dr. Jart and several smaller markets returned to growth as well. Sales in Japan declined due to a tough comparison to the prior year, in which sales grew nearly 20% as consumers bought ahead of an October 2019 VAT increase. The market has also suffered from softer in store traffic due to a second wave of COVID-19. Sales in Hong Kong continued to be depressed as well due to the pandemic. Net sales in our Europe, the Middle East, and Africa region declined 9% with virtually every market continuing to feel the effects of the pandemic. While online growth continued to be quite strong, brick-and-mortar traffic remained soft, heavily impacted by COVID-19, which also resulted in significantly lower tourism in key markets. Skincare sales in the region grew double-digits driven by travel retail, but were more than offset by declines in makeup and fragrance. The major Western markets of France, Spain, and the U.K. contributed the most to the decline in sales, as did the Middle East. Our global travel retail business was essentially flat as outstanding results in Greater China, particularly Hainan Island and Hong Kong, and sequential improvement in Korea offset the effects of the significant reduction in international travel. Additionally, the growth of pre-tail and the increase in duty free purchase limits in Hainan drove higher conversion rates. Net sales in the Americas declined 24% as virtually all markets in the region continue to be impacted by COVID-19. Online sales growth continued to be a bright spot rising over 40%, however, brick-and-mortar retail remain difficult, especially in department stores and in freestanding stores. From a category standpoint, skincare was the most resilient. Net sales grew 10%, driven by continued strong performance from the Estée Lauder and La Mer brands in Asia, including travel retail, as well as incremental sales from the acquisition of Dr. Jart. Net sales and makeup fells 32%, a significant sequential improvement from last quarter. Make up the seen the biggest impact from COVID-19, as many consumers continue to partially or fully work from home and forego social gatherings. Fragrance net sales declined 13%, a substantial improvement from last quarter. The category grew strongly in Asia, reflecting double-digit increases from both Tom Ford and Jo Malone London, as well as the recent launches of Kilian Paris and Frédéric Malle in Mainland China. Bath, body, and home fragrances continue to perform very well. Our haircare net sales were essentially flat, declining only 1%, while stores and salons were not operating at full capacity during the quarter, the category benefited from exceptional innovation from Aveda, including the recent launch of Botanical Repair, as well as strong online sales. Our gross margin increased 20 basis points compared to the first quarter last year. Favorable category mix and lower costs for in-store testers were partially offset by negative currency impact. Operating expenses decreased 7% and the deleveraging effect of the sales decline caused operating expenses as a percent of sales to increase 80 basis points. Agile cost management and lower selling costs resulting from both channel mix and the impact of the COVID-19-related temporary furloughs and salary reductions on employee costs resulted in a 20% operating margin, which was just 60 basis points lower than the year ago quarter despite the lower sales. Diluted EPS of $1.44 decreased 14% compared to the prior year. EPS was higher than expected due to both improved sales performance as well as more proven cost management as doors reopened throughout the quarter. During the quarter, we generated $358 million in net cash flows from operating activities, which was above the prior year, due primarily to timing of working capital items. We invested $116 million in capital expenditures, repaid the remaining $750 million outstanding on our bank revolver, and paid $174 million in dividends. We also announced this morning a 10% increase in our quarterly dividend to $0.53 per share. Our plans under the post-COVID business acceleration plan are on track with approvals expected to accelerate in the second quarter and benefits beginning to flow later in our fiscal year. So, now let's turn to our outlook. We are pleased with the sequential improvement we saw in nearly every market as the world continues to manage the effects of the pandemic. The path to recovery is not expected to be smooth as cases of COVID-19 have begun to surge again in many markets, creating renewed restrictions on travel and social activities. We are mindful of the risk of a global recession or a slow economic recovery as government support measures in certain markets taper off. We also recognize macro risks, such as ongoing trade tensions, and political uncertainty. Nonetheless, prestige beauty remains a highly desirable product category as evidenced by the sequential improvement in sales trends we experienced this quarter. And we believe our multiple engines of growth strategy positions as well to return to strong global results when the impacts from the pandemic subside. With only one quarter of the year completed and the degree of uncertainty I just described, we are not providing explicit sales and EPS guidance for the full year. However, we will provide some underlying assumptions for the year. We continue to expect sequential quarterly sales improvement as the global recovery unfolds, assuming no significant second wave resulting in broad scale retail door closures again or other major disruptive events. And we do expect to return to sales growth as of the end -- as of the third quarter. Comparisons to our record performance in the past prior year first half will be difficult. Conversely, we expect sales and profit to grow significantly in the second half of the year against a period of considerable COVID-19 impacts, with particularly strong growth in the fourth quarter. The inclusion of six months of incremental sales from the acquisition of Dr. Jart should add about one to two percentage points to sales growth for the fiscal year, but remain slightly dilutive to profit for the year. We expect to close a number of our less productive freestanding retail stores and exit certain wholesale doors primarily in Western markets. While several of our retail customers are also reducing their store footprint, many of the unproductive doors are expected to close later in the fiscal year. Our gross margin is recovered from last quarters inefficiencies related to the sudden COVID-19 impact. Additionally, we continue to invest in increased capacity to support our strong skincare growth. We will continue to leverage a portion of the savings generated from our cost programs to support advertising and expanding services and capabilities to enable strong growth in our online channel. As I mentioned before, we increased our quarterly dividend rate by 10% to $0.53 per share. We also expect to reinstate share repurchases as we gain comfort that the recovery is more sustained. So, while the environment remains quite uncertain, we are providing guidance for the second quarter. For the quarter, we expect sales to decline between 4% and 6% in constant currency. As a reminder, we are comparing against the record prior year quarter where we delivered 16% sales growth and 21% EPS growth last year. We have a robust lineup of holiday offerings at a variety of attractive price points that are carefully targeted to relevant consumer trends we are seeing during this pandemic and we expect continued strong online sales on our retailers and on our own brand sites. The incremental sales from Dr. Jart are expected to add about two points to growth and currency is expected to be accredited by approximately one point. We expect second quarter ups of $1.45 to $1.60, reflecting the sales outlook, continued cost containment measure, and investment in key growth areas like online innovation and China. Currency is expected to add $0.02 to EPS and Dr. Jart is forecast to dilute EPS by $0.03. We will continue to leverage our multiple engines of growth to invest behind a strong recovery in the context of the macro environment. We are taking strategic actions to support long-term sustainable growth by investing appropriately for the long-term, while supporting the recovery in the near-term. With a more solid start to the fiscal year and mindful of continued macro volatility over the next several months, we look forward to leveraging the tremendous strength of our brands and driving a strong recovery as the market accommodates. And that concludes our prepared remarks. We'll be happy to take your questions now.

Lauren Lieberman:

Great, thank you. Good morning, everyone. My question was about channel make shift both longer term and in the quarter itself and for fiscal 2021. So, first piece of it is just over the longer term with the things you've already talked about the acceleration of ecommerce growth. Curious if you think it's fair to say that half of your margin expansion over the next several years could come from that that channel mix dynamic. The second was that as we look into fiscal 2021, how we should be thinking about the benefits of channel mix on one hand, but then the drags that you will experience as less productive doors get closed to the degree that there's stranded costs that come with that or what the impact of door closures -- your own doors and also wholesale doors or customers choosing due to closed doors, what impact that has on the P&L in the short-term? Thanks

Tracey Travis:

Yes. And Lauren, as you indicated, I mean timing is will really impact that. So in terms of, when we expect door closures to occur. We've already had a number of wholesale door closers and freestanding door closures over the last few years, when you think about the number of retailers that have gone out of business, unfortunately, in the last couple of years. And certain retailers have also indicated their intent to close doors over the next couple of quarters. With our post-COVID acceleration program, we too will be closing doors over the next couple of quarters more towards the end of the year, as well as some freestanding stores. So there will be a timing issue where we do see pressure from under productive brick and mortar doors, while we see the uplift that Fabrizio spoke about from our online acceleration. And that's all embedded within the guidance that we've given certainly for the second quarter and, and we'll see how the second half of the year plays out. But that's certainly a dynamic that we will be managing in fiscal 2021 as the foreclosures are staged throughout the balance of the year and into fiscal 2022.

Dara Mohsenian:

Hey, good morning, guys.

Dara Mohsenian:

So for Fabrizio, I was hoping maybe you could give us some perspective on how much of the increased ecommerce demand you've seen since the beginning of the pandemic is sustainable in your mind as you look at longer term? And perhaps within that, can you detail with the e-commerce sales increase you've seen during the pandemic? How much of that you think is driven by new customers? What level of repeat rates you're seeing among those new customers?

Operator:

Thank you. Our next question will come from the line of Dana Telsey with Telsey Advisory Group.

Fabrizio Freda:

So our point of view and make up, we go back to be a very attractive, a very fast growing category, once called we retreat and is you know, the makeup is very much linked to use educations for makeup and the use of education for makeup include business, obviously meetings or, going to the office, includes social gathering of any kind, and include also positive mood of recovery and in the interest of expressing ourselves. And so the oldies will come back, will come back strongly, and make-up will come back with it. As we said in the prepared remarks, there are certain categories of make up which are already coming back. Already growing is visible the makeup is much stronger were called the bait like in Asia, and is -- so is obviously going to come back, and we will be ready for that. We are preparing starting from the categories that in our opinion, we come back first and -- and we are investing not only in ready to sustain the recovery, but also investing in innovation in the category that will be the first one to come back. If you take, today reality for example eye makeup is much stronger than other categories, just because in a period of masking, eye makeup is more relevant, then out of the lips, for example. And so -- there is a very positive trend in our opinion, just a matter of time. And that time will depend on the COVID. In terms of your second part of the question, specialty multi around the world will remain a very strong channel, very strong channel for us, a strong channel of growth and in specialty multi the strength, in our opinion, would also be the fact that the retail.com, this channel should continue to increase fashion to get out, to be very, very strong is the specialty multi the key opportunity is to continue to be strong in -- in-store, obviously, but particularly to become equally strong in the retail to come and to bring the services and the experiences that have been so strong in brick and mortar to the retail.com in the long term everywhere in the world.

Operator:

And our next question will come from the line of Steve Powers with Deutsche Bank.

Fabrizio Freda:

Yes, I'll start, and please Tracey add, any perspective. If I understand correctly, your question, so the strength by category is in consumption is clearly in skin care and this remains very strong and in certain regions rather accelerating. And within skin care, there are certain sub-categories like moisturizers, serum, masks, which are really flying or eye products or products for the contour of the eye, et cetera. So, there are -- so skin care and certain skin care category is clearly the fastest growing consumption. Makeup, I just answer one question is makeups dependent by category eye makeup is strong consumption, for example lip makeup is under pressure in this moment. But even with this within category these allow us to focus more on the growth consumption in this category. Fragrance, surprisingly, back faster than what we originally thought and this is great news for the holidays. In fact, we are ready to try to push fragrances clearly in the best possible way during the holidays that we believe is a big opportunity, particularly our high-end fragrances in our artisanal fragrances like Jo Malone, Tom Ford, Frédéric Malle, KILIAN and Le Labo. Le Labo is extraordinarily well everywhere in the world. And so then hair care. Now, as I think Tracey explained in her prepared remarks that Aveda is doing exceptionally well. For us, Aveda is heading great innovation, a great program, great work online in support of also the salons that work with Aveda. And in this brand is also hitting all the areas, because is obviously is about natural, is about taking care of the world and so is also very much into the consumer space of sustainability. And this is starting to paying dividends. So hair care also is strong on consumption. And so net by category is skin care, strong hair care, strong fragrance recovery, and makeup is the more gradual recovery that we assume for the long-term. In terms of the dynamic of the regions, obviously, you have a consumption recovered in Asia, which is much faster than anyone else. And on the contrary, in the U.S. and in Europe, the impact of recovery has been much bigger. But we see progress everywhere. That's the important thing. The important thing is that the level of progress is recovery is consistent. Every part of the world, despite the Asia is ahead in the trend of recovery. And then in terms of consumer groups, consumption, I found particularly interesting that the consumption is being extraordinary in a more mature consumers. And that's what we see, that is a long-term benefit. I mean, the younger consumer is being the driver of [Indiscernible] and in this moment that's less the case. But the mature consumer being a bit more following the young consumer in the last probably five years, I think this is changing, the mature consumer are getting a much more active even in experimenting and trying new innovation. And again, this is for us is a very positive sign for the long-term. So consumption overall is gradually recovering, and is gradual recovery across every segment, but with very different return and speed by segments.

Steve Powers:

Yes. Thanks so much.

Erinn Murphy:

My question is around travel retail, it improve very nicely in the quarter. Could you just share a little bit about how much was driven from the higher duty free allowances in Hainan Island? And then how are you thinking about travel retail for the balance of the year? Thank you.

Operator:

Thank you. Our next question will come from Jason English, Goldman Sachs.

Fabrizio Freda:

Good morning, Jason.

Tracey Travis :

Yes, I mean, I think in -- on the last call, Jason, we indicated that we expected to get potentially to our fiscal 2019 margins by fiscal 2022. Now part of the post-COVID acceleration program, certainly is helping to accelerate the achievement of that. But I think that math is a little aggressive right now for fiscal 2023. As we think about the recovery of the business, and obviously, it all depends on how quickly we get back to your point normal as it relates to normal consumption from a brick-and-mortar standpoint, and where the balance of the channel mix plays out. So that's a little bit aggressive, but recognize that certainly given the cost actions we take as it relates to post-COVID acceleration to accelerate our brick-and-mortar productivity and therefore help our margin. And some of the favorable mix items that Lauren indicated earlier from the growth of online as well as when travel retail resumes, which is another factor for us. We had good travel retail performance quarter. Travel retail is another accretive channel for us in international travel whenever that resumes and what that looks like will also be a factor. So we're very comfortable that we will have margin progression. And we will get to the 19.5 that you're referencing. It's just a matter of timing.

Rob Ottenstein:

Great. Thank you very much. I'd love to circle back to mainland China. And perhaps can you tell us a little bit about the overall sales growth online and offline, kind of what sort of impact travel retail had on the business. And given your comments about increases in domestic travel, retail in China and Hainan, should we kind of think that Mainland China X travel retail may not see the kind of growth that it's had before? And then, finally related to China, any kind of impact for timing on 11.11 did that have any impact? Thank you.

Operator:

Thank you. And our next question will come from the line of Fulvio Cazzol with Berenberg.

Fabrizio Freda:

Yes, first of all, our innovation has been very strong as 30% of sales in the previous quarter has been 20%, 25%. So frankly, we don't aim to a specific percentage as innovation is very strong and we have a great pipeline. So your question is how do we decide how to focus on which innovation? This obviously was the moment where skin care was the most demanded from consumers. And we tend to focus our innovation where there is the strongest trend and the stronger consumer demand. And so definitely skin care was a big focus. Now, obviously, on skin care, you cannot plan innovation in a few months is a very important investment for the long-term. So we had this extraordinary innovation advance the retailer and concentrate on La Mer that we have planned for that period. It's just that we went even deeper, even stronger because we saw the opportunity. So the innovation timing is set that we have flexibility obviously, to move them when needed. But the most important thing which is flexible, is the amount of investment, the amount of focus that we can have on different innovation, depending on the consumer demand in that specific moment and in a very different location. So I our agility is about we tailor innovation locally and so the local teams have the opportunity to launch it light, launch a big, go deeper, postpone demand, anticipate demand, there is a lot of flexibility to tailor the innovation to the local consumers. But the fundamental innovation is done with a very accurate pipeline for the long-term. And that's why we say that our pipeline is never been stronger, frankly, and this was already in place before COVID.

Fulvio Cazzol:

Fantastic. Thank you.

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 other 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. All net sales growth numbers are in constant currency. You can find reconciliations between GAAP and non-GAAP figures in our press release and on the Investors section of our Web site. For clarity, I would like to remind you that references to online sales include sales of our products from our online channel, including Brand.com and third party platforms, as well as estimated sales of our products through our retailer’s 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.

Tracey Travis:

Thank you, Fabrizio, and hello everyone. As Fabrizio said, fiscal 2020 was an extreme tale of two halves. At the end of December, we delivered our best half year performance on record. And by the time we closed the year on June 30th, COVID-19 had created the backdrop for our worst second half [performance]. Navigating through this year has certainly been one of the most significant challenges we have faced. Same time we are proud to recognize the incredible compassion and resilience of our employees who continue to support their communities and each other as they also work to both mitigate the business impact of COVID-19 and also drive the recovery of our growth. As a reminder, my commentary today is adjusted for the items that Rainey mentioned at the beginning of the call, and that sales growth numbers are in constant currency. And now for the quarter results. Net sales for the fourth quarter fell 31%, as the majority of our brick and mortar distribution throughout the world was closed for much of the quarter. We rapidly accelerated programs to capture additional growth globally online, resulting in nearly double our online sales year-over-year. As a result, online sales including Retailer.com represented more than 40% of our total sales in the quarter. The December acquisition of Dr. Jart added approximately 3 points to net sales growth. Regarding our regional performance, net sales in Asia-Pacific rose 16%, driven primarily by very strong double digit growth in skincare. Mainland China returned to previous levels of robust double digit growth as brick and mortar retail reopened and online more than doubled on strong 618 midyear shopping festival programs. Nearly every brand and channel rose strong double digits in China. Korea rose mid-single digits while other markets in the region have been slower to recover. Net sales in our Europe, the Middle East and Africa regions fell 39% with all markets declining. Global travel retail, which is primarily reported in EMEA, was hard hit by the 97% drop in international passenger traffic but still managed to decline less than 30% for the quarter supported by strong local tourism within China. Net sales in the Americas declined 54%, reflecting a very difficult environment throughout the region. From a category standpoint, skincare was the most resilient. Net sales grew 3%, driven by continued strong increases from the Estée Lauder and La Mer brands in Asia. Skincare sales also benefited from the acquisition of the Dr. Jart brand. Net sales in makeup fell 61%, reflecting the greatest impact of COVID-19 work from home and social distancing guidelines on consumer preferences, particularly in Western markets where makeup is the largest category. Fragrance net sales declined 56%, reflecting the impact of store closures and a shift in consumer preferences from personal colognes to hand wash and home fragrances. Our hair care net sales fell 35%. Most stores and salons were shuttered during the quarter. Our gross margin decreased 840 basis points compared to the fourth quarter last year as we expected. A number of factors contributed to the decline and most were triggered by the impact of COVID-19 on our sales and on our manufacturing locations. Increased obsolescence contributed more than half of the decline as demand for all products, particularly makeup was sharply curtailed by COVID-19. Inefficiencies caused by the temporary shutdown in some of our manufacturing locations and the implementation of social distancing measures reduced capacity and triggered a requirement to recognize these manufacturing costs in the current period rather than when the product is sold. This contributed approximately 210 basis points to the decline. The inventory step up related to the Dr. Jart acquisition increased tariffs and other supply chain impacts made up the remainder of the decline. Operating expenses declined 22%, reflecting the $550 million in cost actions we implemented during the quarter. However, the sudden and dramatic sales decline and the gross margin impacts I just mentioned, resulted in a $228 million operating loss for the quarter. The diluted loss per share of $0.53, including $0.03 of unfavorable currency translation and $0.06 dilution from the acquisition of Dr. Jart. Let me now discuss a few elements of our full year results. Net sales declined 3% in constant currency, reflecting the record performance in the first half, followed by the impact of COVID-19 on the second half. Our distribution mix shift continue to evolve, accelerated by COVID-19. Online sales growth accelerated during the year and continue to outpace other channels. Online, including retailer.com, represented 22% of our total sales during fiscal 2020, a 7 point increase compared to last year. Travel retail delivered strong performance despite the sharp downturn in the second half, and grew high single digits for the year, ending fiscal 2020 at 25% of sales. Department stores globally, including their retailer.com business, represented 31% of fiscal 2020 sales. And North America department stores were 9% of our global sales mix. Our gross margin fell 220 basis points to 75.2%, driven largely by the factors I just described in the fourth quarter. For the full year, the increase in obsolescence comprised about half of the decline. The COVID related manufacturing efficiencies were approximately 50 basis points, and the Dr. Jart acquisition increased tariffs and other supply chain impacts caused the remainder of the decrease. Operating expenses declined $240 million or 3% for the year, reflecting savings from Leading Beauty Forward and our ongoing costs initiatives, as well as the cost containment actions we took in response to COVID-19 in the second half of the fiscal year. Our full year operating margin fell 280 basis points to 14.7%, primarily reflecting the gross margin decline, 40 basis points dilution from the inclusion of Dr. Jart and the deleveraging effect of lower sales. The capabilities we built during this time and the actions we took and are taking should help position us to emerge strongly when the recovery is in full swing. Our effective tax rate for the year was 23.2%, an increase of 200 basis points over the prior year, primarily driven by the geographic mix of earnings. Net earnings declined 24% to $1.5 billion and diluted EPS fell 23% to $4.12. Earnings per share was negatively impacted by $0.04 from currency translation and $0.11 dilution from the acquisition of Dr. Jart. We recorded $1.2 billion after tax or $3.31 per share of impairment charges, primarily related to our makeup brands that were initially challenged by a general slowdown in the overall makeup category and along with certain freestanding retail stores have been further challenged by the impact of COVID-19 on consumer demand. In fiscal 2020, we recorded approximately $68 million after-tax, or $0.19 per share in restructuring and other charges for our Leading Beauty Forward initiative. We remain on track to substantially complete initiatives under the program by the end of fiscal 2021, and we continue to expect annual net benefits of approximately $475 million before taxes. These charges were partially offset by the gain on our minority interest in Dr. Jart and favorable changes in the fair value of contingent consideration. As you have heard, COVID-19 has created a number of disruptions to our business, including accelerating changes in our distribution mix that had been expected to occur over a longer period of time. The post-COVID business acceleration program that we announced today reflects the need to accelerate additional organizational changes during fiscal 2021 to operate more effectively in the post-COVID reality. We expect to close select department store counters and between 10% to 15% of freestanding retail stores, primarily in Europe and North America, while also further supporting the accelerating consumer shift to online shopping. This necessitates commensurate changes in our commercial organizations that will reduce the number of employees by a net range of 1,500 to 2,000, primarily point of sale and support personnel related to those retail locations. While some positions will necessarily be eliminated, we also plan to increase investment in online talent and capabilities, including online consultation by sales associates. We also intend to reinvest a portion of the savings from the program to further build out our online technical capabilities, including accelerating omnichannel capabilities linked to our retail stores and to increase digital media to reach both new and existing consumers. The program is beginning now and we expect to realize results fairly quickly, mostly in the coming two years. We expect to take charges of between $400 million and $500 million through fiscal 2022 and generate savings of $300 million to $400 million before tax by fiscal 2023, a portion of which will be reinvested to drive growth. Moving on to cash flows. Cash generated from operations was slightly below last year at $2.3 billion, reflecting lower net sales, partially offset by call to actions and favorable working capital. We utilized $623 million for capital improvements, primarily supporting our ecommerce capabilities, supply chain improvements and information technology. We eliminated or deferred approximately one third of our planned CapEx, mostly related to retail stores and office space upgrades. We also used $1.04 billion net of cash required to purchase the remaining ownership interest in Dr. Jart. During the year, we borrowed $2.7 billion net of repayments to both fund the acquisition of Dr. Jart and to provide liquidity and flexibility as the COVID-19 impact spread during the second half of the year. We ended the year with $5 billion in cash and cash equivalents and $6.1 billion in short and long term debt. Even with these liquidity actions and with lower earnings, we returned $1.4 billion in cash to stockholders during the year via dividends and share repurchase activity. In August, we repaid the remaining outstanding $750 million drawn on our revolver. In the near-term, while we are encouraged by the gradual reopening of markets around the world, it remains difficult to predict the duration of the pandemic, the timing and trajectory of the recovery and the corresponding impact on our business, even while online remains a significant bright spot. Where stores are open, we are seeing traffic return slowly. We are also mindful of the risk of the global recession and a likely slow recovery in employment, as some businesses in Western markets remain closed and many government support measures taper off. Therefore, we are not providing explicit sales and EPS guidance for the full year. However, we can provide you with some underlying assumptions to help at least frame some of your expectations for the year. We do expect to see progressive quarterly sales and profit improvement as retail doors reopen and traffic and travel gradually resumes, assuming no significant second wave occurs. Given this expectation, for the first half of the fiscal year, comparisons to our record performance in the prior first half will be difficult with sales and profit below prior year levels. While online is expected to perform strongly, the momentum for recovery in brick-and-mortar and travel retail will not be realized until later in the second half. Conversely, we expect sales and profit to grow significantly in the second half of the year against a period of considerable COVID impact, particularly in the fourth quarter. The inclusion of six months of incremental sales from the acquisition of Dr. Jart should add about 1 to 2 percentage points to sales growth for the fiscal year. Pricing is expected to add another 2 points of growth. Our manufacturing capacity is back to near normal levels and we expect our gross margin to recover accordingly. We expect to realize the full benefit from Leading Beauty Forward in fiscal 2021, and we will continue to maintain some of the COVID-19 cost controls as we progress through the first half of the year. These savings are expected to give us the flexibility to invest more in digital marketing and advertising to support innovation, recruit new consumers and drive brand awareness, while also supporting our operating margin recovery. Our full year effective tax rate is expected to be approximately 23% and net interest expense is expected to be approximately $170 million. Capital expenditures are planned at approximately $900 million as we continue to invest in additional manufacturing and distribution capacity, technology and data analytics, research capabilities and ecommerce to support future growth. And as you saw in press release today, we declared a quarterly dividend of $0.48 per share. We also expect to reinstate share repurchases sometime during the year as we gain comfort that the recovery is more sustained. As we are all already halfway through our first quarter, we are more comfortable providing guidance for this quarter. At this time, we expect sales to decline 11% to 12% in constant currency. Sales declines peaked in April and have been gradually improving each month as retail markets around the world reopened for business. The incremental sales from Dr. Jart are expected to add about 2.5 points to growth and currency is expected to be dilutive by approximately 1 point. We expect first quarter EPS of $0.80 to $0.85, reflecting the sales outlook, continued cost containment measures and investment in key growth areas like online, innovation and China. Currency is expect to dilute EPS by $0.01 and Dr. Jart is forecast to dilute EPS by $0.06. We look forward to leveraging the tremendous strengths of our business and driving a strong recovery in the new fiscal year as the market accommodates. Protecting our agility to invest appropriately for both the near term recovery and the long-term opportunities inherent in global prestige beauty is paramount to the strategic actions we are taking to continue to support long-term sustainable growth. On behalf of Fabrizio and The Estée Lauder Company's leadership team, we give thanks to all of our employees around the world for their extraordinary efforts to manage during this unprecedented period. That concludes our prepared remarks. We'll be happy to take your questions at this time.

Erinn Murphy:

I guess my question is for Fabrizio. You've had a lot of success in digital that was really expounded upon this quarter. Have you changed your views on how you view Amazon as a potential beauty partner? And then secondly, as stores are starting to reopen. Can you just talk about how consumers are interacting with stores? Thank you.

Operator:

The next question will come from the line of Lauren Lieberman with Barclays.

Fabrizio Freda:

Yes. So, first of all, your first part of the equation in North America our online business has been exceptionally strong, and our brand.com business has been really exceptionally strong. And the penetration of the online business has increased dramatically up to the 40% and so that’s changed. Now a lot of this will be sustainable for the reason I was explaining before. Meaning that retail.com is increasing and there are reason why it would be sustainable, the engagement of the consumers there is increasing. Our brand.com increase in the 90% is sustainable, because we see it from the consumer engagement for the amount of time people spend on our brand.com just to give you a sense, a few data points that the virtual try on that we have added, or the chat with consultants that we have added, or the entertainment activities that we have added in the story explanation of innovation, all of these brought in some brands, and Estée Lauder as an example. We have consumer that spent 26 minutes of our site interacting with us. So we see real time of interaction, the time of engagement going-up. So this is -- will make this very sustainable growth over the long-term. And joined with our new technologies will make it probably one of the best consumer experiences overtime in luxury consumer experience, full of experience and our omnichannel capabilities. So that's what's happened now. To be clear, this was in our plans. This was part of our compass. But the COVID-19 has anticipated these trends and the speed of marching of these trends of at least two three years that’s what we have seen. Now, the impact of COVID-19 outbreak, however, is also expected to disrupt the brick and mortar in the near term, is in fact include the store closure in the parent stores, which are happening obviously in the quarter -- last quarter they were closed. In many, many cases, the closure directed by us will also be added in the future as we explained in the post COVID-19 acceleration program. And then we are conscious of the highest level of unemployment and that is affecting consumer sentiment, in total, in general. And we see also these affecting particularly for the time being the make up category. We are managing through this, pivoting towards the online business as I explained, supporting also -- supported by our new understand -- granual understanding of consumer and the biggest availability to data that we can drive and in our post-COVID business acceleration program will, however, accelerate the increased productivity in our freestanding store, in our department stores and should work really to rapidly bring productivity back in the future. Fewer brick and mortar location, which is what's happening there. Now in the short term but also will continue in the medium term will reduce our fixed cost and should have also making the region becoming more profitable with the different mix between online and brick and mortar.

Operator:

Our next question will come from the line of Nik Modi with RBC Capital Markets.

Fabrizio Freda:

I don't know. I can say our online margins are stronger than average. So the development of our online business is accretive to the business that is a fact. And how we are thinking of this? I mean, we are thinking of the continuous growth of the penetration of online in our business. I'm not going to give you a specific number, because there's a lot, has to be written in the future. But as a point of reference, we have today at the level of 40% in the most developed online markets in the world, US, UK, China, and other markets are growing tremendously from a much lower base than these three markets. But in every market, there is a tremendous growth. So the potential is very high. And we will learn more about what this specific landing point could be, but it’s going to be significantly higher than today.

Operator:

Our next question will come from the line of Mark Astrachan with Stifel.

Fabrizio Freda:

I'm not sure I understood completely the way you frame the question. But basically, we are growing global market share and we are in prestige, our -- the global market leader. And the total market share is growing and is growing ahead of our competition in general a global level, because we are focusing on the area of fastest growth and most importantly, we are focusing on the areas of profitable, sustainable long-term growth. And because of this, the total is growth. Now there are areas of the business where because of our historical business model, we are losing market share. In some cases also, we're losing more market share than some of our competitors and those are -- this is specific to the U.S., for example, is an example of this. But there are areas like China, travel retail, Asia, in general, where we are growing and we are growing very fast. So our strategy is not to add our multiple engines of growth to grow all at the same time at any cost. We are trying to put the resources. We have located resources, where there is the highest sustainability and better returns. And in that sense, we really look at the key measure of the global market share. And so that’s answer part of your question. The other part of the equation, how we see this market share develop by quarter. As we explained in our prepared remarks, we see really a gradual improvement of our business quarter-by-quarter during fiscal year '21. We explained, which is our view of the first quarter, the second quarter will be better and the last semester will be really strong. And that's our view of the recovery and this is a reflection of the way the stores will reopen, COVID will hopefully be managed around the world and the market, particularly the consumer sentiment in different part of the world will be reestablished. Where the consumer sentiment is reestablished? Where COVID has allowed the reopening in most of the channels like China, we are seeing tremendous business and tremendous share gain. So is also in the area of consumption in market share was the core of your question. We see a gradual acceleration and recovery over the years in the fourth quarter of fiscal year 2021. Tracey, maybe you want to add some perspective.

Operator:

Our next question will come from the line of Wendy Nicholson with Citi.

Fabrizio Freda:

Let me start and then Tracey may add some. First of all, we are doing what the consumers are telling us they want. So we are following the consumer preferences evolution. And second, we are responding to the decisions of our retail partners, because to be clear there are retailers which are using the number of stores, there are retailers which are closing. And so first of all, we need to reflect what is the reality of the market. Second, we need to reflect what the consumer preferences are. And these will result in closing the stores, which are the least productive. And so the stores that will remain, which is obviously the large majority, these stores would be more productive and will allow us to make these store experiential and in the appropriate cases also multichannel. And these will make these stores not only sustainable for the long-term but will make these stores brand building. While the non-productive stores, which are not working and there is no traffic, frankly, are losing their power of being branded business. But the large majority of the remaining brick and mortar will remain -- will be more productive and will be a fantastic brand building tool that will continue to create the relationships that we have experienced. But the unproductive stores of the world are frankly not very productive relationship to date. And on the contrary, the online, new way to work and particularly the new way of the consumer to engage online, is becoming much more relationship building, much more brand building than ever before. And I think if I had to summarize what is in my opinion the biggest change of COVID-19 that made all the online channel, brand.com, platforms, pure plays, retailer.com, much more brand engaging and so much more fully luxury experiences, thanks to technology than ever before. And so to last part of your question, the savings from these productivity improvement in brick and mortar will be in fact obviously, going to the bottom line but in fact will be invested and will be invested in making the remaining brick-and-mortar store and our online much more brand building, growing faster and continue to create outstanding relationship with our consumers. Now to underestimate the fact that a lot of the strong online growth is in brand.com and platforms. So where we have the data access will also give us much more information, data insights, to manage the consumers and the business better in the future.

Operator:

Our next question comes from the line of Steve Powers with Deutsche Bank.

Tracey Travis:

So and obviously margin, we don't expect will recover this year. And certainly with the actions that we're taking, we would hope that we could recover back to fiscal ‘19 margins by next fiscal year. But that is just the pattern as we believe in fiscal ‘22 again, all things going smoothly, which has not been the case for last several years. But that in fiscal ‘22 assuming a normal year, we will be back to the margins that we had pre-COVID and would progress from there, as Fabrizio indicated in his prepared remarks, to back to our 6% to 8% top line growth and 50 basis points of margin expansion.

Rupesh Parikh:

So on the makeup category, I was curious just to get your perspective in terms of how you guys think the makeup recovery could take place from here? And then also, I guess related to that question. I know obsolescence related to makeup was a big headwind on the gross margin line in Q4. So I was just curious whether that headwind would continue into this fiscal year? Thank you.

Fabrizio Freda:

And to the question of when makeup recover. Absolutely, makeup is a category, is coming back. This is -- what we are seeing is the impact of what COVID has created on the consumer sentiment or consumer behaviors, is the result of wearing masks in many parts of the world, which has an impact of lipstick, the result of being in homes and having less interaction and less social interaction between people. And there is also frankly the stress that causes and the situation today in many parts of the world is creating that is conducive, it’d be less to the use of makeup that again is part of the joyful moments and individual moments, more than anything else. And so we expect this to come back, and to come back now, this is now into point of views. From my point of view, the makeup cycle will come back very strongly as soon as consumer sentiment will be back and obviously will be back in the future. We'll see this category booming again and we'll be ready for that. That's exactly the essence of the multiple engines of growth that in this moment is skincare, and there is reason why is skincare. Somebody was asking me if the lipstick index is finished. You all remember the lipstick index concept was that beauty is a resilient category, both in situation of crisis like this one and in particular situation of recession risk, because they are affordable purchases for indulging and taking care of yourself. And consumer really love their routines. Now this has remain exactly true also in this crisis. What has changed is the category, because of COVID is, lipstick was not the right category to indicate that but the resiliency of the overall beauty is still evident and is still vary from market. But the way I answer is the lipstick index has been substituted by the most rising index but the concept of index is still there. This is a very resilient category and makeup will come back when consumer sentiment will come back.

Steph Wissink:

Our question relates to trial and discovery. I think, Tracey, you mentioned you have some new launches planned and also, Fabrizio, you talked about some of the emerging technologies, live streaming, virtual try-on that you're using in your online business. Can you talk a little bit about how you think about trial and discovery going forward, whether it's makeup or skincare, and then also just intertwining your comments on data, customer data and data access? Thank you.

Operator:

The next question will come from Michael Binetti with Credit Suisse.

Tracey Travis:

So let me start with -- again, reiterating the fact we are not giving guidance. So as we try to help you frame the your model for the year, given the fact we're not giving guidance. One of the things to think about as we believe that the second half of the year, we will still be recovering our sales growth but will be more normalized assuming no additional impacts from COVID-19. The way you could think about our second half EPS is similar to our adjusted fiscal '19 EPS in the second half. Again, with the ramp up and acceleration in sales that we expect to see. So that is a way to kind of think about the second half. But again, that depends obviously on a continuation of progress as it relates to the recovery. As it relates to the first quarter, what we said in our prepared remarks is we do expect gross margin to recover. And so when you think about the margin for Q1, one of the things we are doing is investing in advertising. So even with sales down in the quarter, we have a launch of our -- one of our most popular products, Advanced Night Repair and that is, we are supporting with digital advertising, some of the online initiatives as well. We are supporting with additional advertising and other innovation as well. So that is a piece of what's driving some margin deleverage in the first quarter. The other piece is higher shipping costs. So we are still catching up a bit from our plants starting up more slowly as it relates to social distancing, but now ramped up but really catching up on some of the shipping to replenish some of the product that was low on inventory in certain markets. So that is driving a piece of the margin. And then when you think about EPS, we obviously have higher net interest expense. So we have higher interest expense and we have lower interest income, given where rates are today. So the combination of that is also putting some pressure on our EPS in the first quarter. And then the last piece obviously, as I did quote the tax rate, which would be the tax rate we expect to see in the first quarter as well.

Andrea Teixeira:

Fabrizio, Tracey, can you help me understand the travel retail performance embedded in the first quarter guidance, now that you have more than half of your quarter through? And just a clarification on those puts and takes that Tracey you just described for the first quarter. So basically, your team is through a lot of the pressures that we saw in the quarter. So if you can help us understand the exit rates on some of these expenses that would great, but the travel would be my first -- my main question?

Fabrizio Freda:

And what I will add on travel retail is that, first of all, in the long-term, we believe travel retail will continue to be a very exciting channel. And in this moment, the traffic is at very low. But for example, the conversion of travelers into buyers is increasing dramatically. The Asia is the biggest path to a travel retail globally. And the good news that Asia is going to recover faster than the West, the traveling traffic and the conversion driven by retail. So basically by travel retail online in Asia even stronger saying the rest of the world. So the good news that will overtime mitigate the current lack of traffic in travel retail is that the recovery is starting from Asia, Asia is the biggest and the most interesting travel retail segment. The other important thing to say in travel retail is that in this moment, the number of travel retail also in the last quarter and minus 30% has been better than at least we were afraid of, because of the many closures around the world. And the reason why it's been better, there are some mitigating factors, which are very important. The most important mitigating factor is that -- has been the start of China local internal travel that in many cases is beautifully traveled, like in the Hainan Island And the extraordinary increase of what the Chinese are buying within their local duty free travel is mitigating the lack of very limited international travel. But then you can expect for the long-term when the international travel will be reinstated, these local internal travel will not go away. And so there will be a stronger and even more exciting long term travel retail market to manage in which we are today the market leader. And so there is a lot of long term potential into that and I'm very exciting to see what's happening in Hainan, particularly for the future.

Operator:

And we have time for one more question. The final question comes from the line of Olivia Tong with Bank of America.

Tracey Travis:

So my comment on July was global and it was sales growth. And a lot of that being driven from North America actually in terms of some of the restocking within North America, and still seeing growth obviously in markets like China and Korea, the same markets that had momentum in the fourth quarter or more momentum. But every market is improving a bit as doors reopen and we start to see traffic flow back to stores. But July really was restocking from many of our retailers that had their doors closed, and we're sourcing some of their online sales from their brick and mortar doors.

Operator:

And that concludes today's question-and-answer session. If you were unable to join for the entire call, a play back will be available at 1:00 PM Eastern Time today through September 3rd. To hear a recording of the call, please call 855-859-2056, passcode 4170137. 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.

Laraine Mancini:

Thank you. 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 other 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. All net sales growth numbers are in constant currency. You can find reconciliations between GAAP and non-GAAP figures on our press release and on the Investors section of our website. [Operator Instructions]. And now I'll turn the call over to Fabrizio.

Tracey Travis:

Thank you, Fabrizio, and hello, everyone. COVID-19 is certainly proving to be the most significant challenge we have faced as a public company, as much of our brick-and-mortar distribution globally has been deemed nonessential during the quarter by several jurisdictions and remains closed today. We continue to do our best to support our communities and our employees while also working to mitigate the business impact during this time. As a reminder, my commentary today is adjusted for the items that Rainey mentioned at the beginning of the call and net sales growth numbers are in constant currency. So looking at our third quarter results. Net sales fell 10%, driven by the rapidly evolving impacts from COVID-19 that occurred throughout the quarter. As the majority of our brick-and-mortar distribution throughout the world was closed as the quarter progressed, we quickly pivoted to drive sales online. Our online growth accelerated sharply at the end of March and continued to rise in April. Sales grew in travel retail from a strong January and February before travel restrictions were enacted and skincare remained our most resilient category. The Americas region and the makeup category suffered the biggest shortfalls. The December acquisition of Dr. Jart+ added approximately 2 points of net sales growth. Our gross margin decreased 320 basis points compared to the third quarter last year due to a combination of factors. In the first 7 months of our fiscal year, we saw outstanding growth in our skincare category, much of it in Asia and in travel retail. To meet what has now been our third year of double-digit demand for our products, we supplemented our internal manufacturing capacity with additional third-party suppliers, and we incurred increased air freight to support sales growth in areas distant from our manufacturing facilities. This resulted in higher supply chain costs in our third quarter. The impact of increased tariffs, higher obsolescence and promotional activity also contributed as well as the inventory step-up related to Dr. Jart+. Previous initiatives like Leading Beauty Forward, which is still projected to contribute approximately $425 million to $475 million in net savings by fiscal 2021, have put us on much stronger footing to weather normal economic downturns. However, the impact of COVID-19 has not been a normal downturn. The sudden and dramatic change in sales growth from the beginning of the third quarter to the end created a deleverage effect that could not be offset quickly enough by the significant cost actions we took, which totaled approximately $250 million. Therefore, operating expenses as a percentage of sales rose 250 basis points. As we told you last quarter, we expect to see a greater impact from our third quarter cost actions, including advertising and promotion reductions more aligned to sales performance, a hiring curtailment and the benefits of work from home, which yielded sharply reduced travel and meeting expense as well as consulting expenses in our fourth quarter. As it became apparent that store closures and social distancing measures would move beyond China to be adopted around the world, we implemented even more cost actions that will have a more meaningful impact on curtailment of expenses beginning in May. These primarily include furloughs and other leaves of absence as well as temporary reduction in compensation for management and board members. The capabilities we have built and the actions we are taking now enable us to manage through the situation today while funding targeted strategic investments going forward, which will position us well to emerge strongly when the recovery is more apparent. Our interest expense rose by $11 million to $28 million during the quarter, reflecting higher debt levels to finance the acquisition of Dr. Jart+. Our effective tax rate increased to 30.5% from 22.1% in last year's third quarter, primarily attributable to a higher effective rate on the company's foreign operations due to the mix of earnings. Adjusted diluted EPS of $0.85 fell 45% compared to the prior year. Currency diluted EPS by $0.01 and the acquisition of Dr. Jart+ diluted EPS by approximately $0.03. During the quarter, we recorded $346 million of impairment charges related to 4 brands and certain freestanding retail stores that have been further challenged by the impact of COVID-19 on consumer demand. We believe that our strong balance sheet and ample liquidity provide core competitive advantages for our company, demonstrating the importance of scale. These position us to not only manage through a crisis but to emerge from it stronger. During the quarter, we borrowed $1.3 billion under our $1.5 billion revolving credit facility and had $200 million of commercial paper outstanding, ending the quarter with nearly $5 billion in cash and cash equivalents. In April, we issued $700 million of 2.6% 10-year senior notes in order to further enhance our financial flexibility and liquidity and repaid the commercial paper with the remaining capacity under the revolving credit facility. We were able to do all of this while maintaining our strong single A credit rating. For the 9 months, we generated $1.95 billion in net cash flows from operating activities, an increase of 11% from the prior year. We invested $468 million in capital expenditures and $1.04 billion to acquire the remaining interest in Dr. Jart+. We also used $883 million to repurchase shares and $502 million to pay dividends. To further enhance near-term liquidity, we are focusing our capital investment on areas necessary for future growth and paring back in areas such as retail renovations and office improvements. We cut our planned capital expenditures by 1/3 and now expect to spend between $600 million and $650 million for the full year. Additionally, we have suspended share repurchases for the balance of this fiscal year and our quarterly dividend that would have been paid in June of 2020. All of these activities greatly enhance our ability to manage through the shutdown in brick-and-mortar for an extended period of time while we focus on stimulating greater consumption online. History has not provided any truly comparable recent events we can use as guidance concerning the effects of the global pandemic. The disruption to our business caused by COVID-19 has clearly been more widespread and more pronounced than we had expected it would be when we last spoke with you just a few months ago in February. We delivered remarkably strong double-digit growth in sales and adjusted EPS through January, but that was followed by the dramatic spread of the pandemic and the related door closings and curtailment of travel that we spoke about. Due to the fluidity of the situation, it is both complex and difficult to predict the duration or the timing and trajectory of the recovery and the corresponding impact on our business. At this point, in the fourth quarter, the majority of our distribution, with the exception of China and a few other markets, remains closed. And while we are encouraged by the weekly acceleration of our global online business, we do not have enough visibility into the progression of the rest of the business until more retail doors open in the coming months. And we do believe traffic could initially return at a slower pace as some consumers remain tentative until a treatment is developed. Therefore, given the level of uncertainty, we are not providing explicit sales and EPS guidance for the year. That said, there are a few guideposts that we can provide to you. The inclusion of 6 months of sales from the acquisition of Dr. Jart+ should add about 1 percentage point to sales growth for the year. It is expected to dilute EPS by about $0.14 due to purchase accounting. Currency translation is expected to negatively affect reported sales growth by 1 percentage point, reflecting weighted average rates of $1.11 for the euro, $1.26 for the pound and $7.03 for the won for the fiscal year. The related EPS dilution should be approximately $0.05. We are very encouraged as we see the beginnings of recovery in China and markets around the world begin to discuss gradually lifting retail and travel restrictions as the virus abates. We expect strong online acceleration to continue as underlying consumer demand is driving both replenishment and new customers online. However, unlike the third quarter where many of our global doors were opened until the last month of the quarter, we expect that most of our retail distribution will remain closed for much of the fourth quarter, and consumer traffic will likely recover slowly in brick-and-mortar. We expect greater sales and margin declines in the fourth quarter as a result. We estimate that global prestige beauty will decline double digits in the second half of our fiscal year. We are also mindful of the risk of a global recession and a slow recovery in employment impacting consumer sentiment and discretionary spending. Our gross margin in the fourth quarter will reflect the adverse conditions we have been experiencing in March and April. The sudden and dramatic change to our volume forecast is expected to trigger an accounting rule requiring us to recognize the impact of reduced manufacturing volumes on our standard costs. Our plants have been running at meaningfully reduced capacity, reflecting some temporary plant closures as well as reduced efficiencies to accommodate social distancing requirements, staggered shift changes and other changes necessary in this environment. We are also required to recognize expenses related to manufacturing employees who are not working. These expenses are now recognized in the current period instead of when the product is sold. The inclusion of Dr. Jart+, with the impact of the inventory step-up, will also pressure our gross margin. We expect our belt-tightening efforts to have a more pronounced impact in the fourth quarter to partially offset the negative impacts I've discussed. We are implementing some of the additional actions in May and expect to deliver fourth quarter savings of between $500 million and $600 million. Our full year effective tax rate is expected to be approximately for 24%. So those are some of the guideposts that we can provide to you for the year. We are committed to continue to take the appropriate actions to rationalize our cost base relative to the new normal and return as quickly as possible to both sales growth and margin expansion as the COVID-19 situation stabilizes during the course of fiscal 2021. We delivered tremendous sales and profit growth through the first half of the year as our business continued to benefit from the strategic actions we took over the past several years to position our company for sustainable, profitable growth. And while the unfortunate temporary shock of COVID-19 has made our outlook for the balance of this year uncertain, we have taken appropriate action to mitigate the effects of the pandemic while continuing to protect our business to be able to be well positioned for both the near-term recovery and the long-term opportunities inherent in global prestige beauty. On behalf of Fabrizio and the Estée Lauder Company's leadership team, we extend our immense gratitude to all of our employees around the world for their extraordinary efforts to manage during this unprecedented period. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Lauren Lieberman:

Great. I wanted first to talk about -- so many questions. So I wanted first to talk about -- I have so many questions. So I wanted first to talk about travel retail and just what your data and analytics have told you over time about the sales historically through that channel. How much of it is sort of impulse? How much of it is new consumers discovering your brands? How much of it is sales that would have or could happen elsewhere like a replenishment-type sale when someone travels? Because that could inform thinking about your ability to recapture some of that sales or what degree of that sales, even assuming global travel remains suppressed for a good amount of time.

Operator:

And our next question comes from Steve Powers from Deutsche Bank.