Estee Lauder Cos. Inc (EL) — Q1 2017 Earnings Call Transcript

Good morning, everyone. 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. You can find reconciliations between GAAP and non-GAAP figures in our press release and on the Investors section of our website. During the Q&A section, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for the call. And I'll turn it over to Fabrizio now.

Thank you, Dennis, and good afternoon, everyone. In the first quarter of fiscal year 2017, sales grew in line with our forecast, and earnings per share growth exceeded our expectations, due to more prudent expense management as we navigated through some of the macro uncertainty in the quarter. Across our business, many brands, countries and channels achieved double-digit sales gains. Our strongest performance came from our small and midsize brands, particularly those in the luxury tier, many European markets, and the online, specialty multi, and travel retail channels. Yet, as we had anticipated, our strong gains were partially offset by challenging market and economic conditions in certain countries. In constant currency, our sales rose 2%, and adjusted EPS increased 5%. We manage our business with a full year perspective. So even though the first-quarter top-line growth is starting off at a slower than usual pace, we are confident in our ability to achieve the solid sales and earnings growth we forecasted for fiscal year 2017. Our first-quarter growth was slower primarily due to ongoing challenges in U.S. mid-tier department stores caused by lower traffic, the market slowdown in the Middle East, and difficult comparisons in France and Germany, as well as a continued negative trend in Hong Kong. All these challenges were anticipated, and plans are in place to gradually accelerate our sales growth quarter by quarter and position us to deliver our full fiscal year plan. Despite headwinds, we expect to continue in some areas but, sorry, despite headwinds that are expected to continue in some areas, we have plans to further leverage our stronger brands, channels, and countries. We have robust holiday programs and a strong innovation pipeline, exciting opportunities to reach new target consumers and geographies, especially with our fast-growing brands and compelling programs to better engage shoppers. By being well diversified and having multiple engines of growth, we are able to activate the drivers that we believe will fuel stronger sales. These are expected to include a number of international markets, the makeup and fragrance categories, and target distribution opportunities. We are reaffirming our previously stated goal of constant currency sales growth of 6% to 7% for fiscal year 2017. This will come from a combination of factors. Our organic growth is expected to accelerate, mainly in makeup and fragrance, fueled by strong innovation in the second half and supported by greater social media initiatives for improved consumer engagement. We should have easier comparisons in several markets since external events that impacted our results last year will be in our base. Also contributing to growth will be new points of distribution globally for our fast-growing high productivity brands, with a higher concentration coming in the second half, as well as planned price increases. Additionally, the planned acquisition of BECCA will provide incremental sales. As a result, we are also reaffirming our goal of adjusted constant currency EPS growth of 8% to 10% for the full year. In the past several months, we have continued to make excellent progress on our strategic objectives. We believe that the industry's strong growth in global makeup sales will continue, so we are focusing on building and strengthening our makeup portfolio. In the quarter, we achieved solid makeup growth in several brands. However, the total category was affected by declines in M•A•C in the United States, owing to fewer foreign tourists, particularly in New York City, and the lowered traffic in department stores. M•A•C is a powerful and authentic brand that speaks to all ages, races, and sexes. And we expect its U.S. business to deliver stronger results through the rest of the year. As of October, M•A•C U.S. sales started to improve, thanks to the launch of its successful Selena makeup collection and the new range of lipstick called Liptensity. The Selena collection was inspired by the late singer and her huge fan base and accounted for the highest online traffic in one day on the brand's site. M•A•C will bring back the Selena collection in January to meet continued demand. It has other exciting collaborations and plans including The Nutcracker themed holiday collection and compelling social media programs that will leverage M•A•C's rapidly expanding fan base, which now includes 16 million global Facebook fans and 12 million followers on Instagram. The brand also has an active presence on YouTube, Twitter, and other popular digital platforms by now. M•A•C's international business grew in line with the global prestige makeup sector, fueled by double-digit growth in most European and Asian markets. Internationally, we expect M•A•C to show double-digit growth in the fiscal year and gain market share driven by continued organic growth, a stronger innovation program, an expansion of social media, and new opportunities to reach target consumers that don't yet have access to the brand. Today, M•A•C is sold in a relatively small and select number of locations in each market, and there is an opportunity for us to further build its presence where it is underrepresented, primarily in Tier 2 and Tier 3 cities in the EMEA region and in China. M•A•C doors are among the most productive in the entire industry. Smashbox, our pure-play makeup brand, generated double-digit global growth for the quarter, and we expect to deliver strong double-digit increases for the fiscal year. The brand is focused on winning in the specialty multi and direct-to-consumer channels and recently redesigned its U.S. e-commerce site for greater consumer engagement. Our Tom Ford brand had an outstanding quarter with its makeup business nearly doubling, led by its popular new lipsticks. Makeup is expected to continue to be a major growth driver, and the brand should benefit from the upcoming color collection inspired by the designer's runway fashion. Fragrance represents the majority of this luxury brand's business and continues to generate strong momentum. La Mer, our luxury skincare brand, just launched its innovative skin color collection, which includes 15 shades of foundation, a growing sub-category, blast powder, and concealer. These products incorporate the brand's signature Miracle Broth and are expected to capitalize on growing demand for products that bridge skincare with makeup. The collection has increased traffic to the La Mer counters and websites, and the brand anticipates it will attract new consumers and provide incremental sales to its core products of moisturizers, eye creams, and serums. We are also building on our global leadership in prestige makeup. Two weeks ago, we agreed to acquire BECCA, a prestige makeup brand with a unique positioning that is complementary to our other makeup brands. BECCA's strengths are in foundations and complexion products, which are high loyalty areas. It has grown rapidly by offering a broad and balanced range of shades that appeal to multicultural consumers, along with a strong presence in fast-growing North America specialty multi-retailers. It is also active on social media and attracts a diverse and loyal fan base. We see a great opportunity to strategically expand the brand internationally as well as in travel retail and online, which are key growth areas for the company. Strong gains in fragrance this quarter were again led by our luxury brands, which are experiencing rapid global growth. Our newest fragrance brands are experienced and crafted to fit our authentic point of view, similar to our makeup artist brands, and are resonating strongly with new consumers. For example, we have continued to build out our seasonal Le Labo brand to reach more of its target consumers by opening select high-growth department store doors and freestanding stores globally. At the same time, the brand has had strong like-door growth, leading to exceptional sales increases. Jo Malone's superior growth was reinforced by its travel retail business, which benefits from increasing awareness of the brand in key local markets. Jo Malone is capitalizing on growth opportunities by opening new store formats in the travel retail channel. After many quarters of strong growth, Jo Malone rose three places in the rankings to become the third-largest women's prestige fragrance brand in the United States in the first quarter. This is especially noteworthy, given the brand's limited distribution in only 250 doors in the entire United States. Jo Malone is the second-largest prestige fragrance brand in its home market, the UK, and growing double digits. Yet, it has just one-tenth the number of points of sales compared to the market leader. We are anticipating that our high-end fragrances will perform well in the holiday season, with enticing gifts offering and new classic scents. We expect that momentum to carry into the second half of the fiscal year. In skincare, natural products are growing in popularity, and we are well positioned with our Aveda and Origins brands. Aveda's new Tulasara skincare line, which creates glowing skin inspired by an ancient healing art of India, led to the brand's robust skincare sales growth worldwide, exceeding its expectations. Aveda plans to broaden the franchise in the next few months with masks for the face and eyes centered on the theme of weddings. Origins has strengthened its leading position in facial masks, and its skincare sales climbed double digits in every region. This includes a new line of face and body masks, infused with tea, that provides immediate benefits and features desired by today’s consumers. Many of our brands are enhancing their distribution in the fastest-growing channels to reach target consumers where they're shopping today. Our brands continue to penetrate the specialty multi-channel globally. In the U.S., Clinique continued its rollout in ULTA. And in September, Estée Lauder introduced a greater selection of top-selling skincare and makeup products in 30 ULTA doors and on ulta.com. Clinique, Origins, and Bumble and bumble added locations in several stores inside JCPenney. Our brands are further penetrating the channels in foreign markets. For example, in Germany, GLAMGLOW successfully partnered with Douglas to target core consumers throughout all of its locations. Likewise, when Smashbox entered Finland this quarter, it reached its target consumer by launching in the specialty retailer KICKS. Our travel retail business was vibrant in the quarter, as our net sales growth far outpaced passenger traffic growth, despite some difficult markets including Hong Kong, Japan, and Latin America. Our smaller and midsized brands, as well as M•A•C, are in high demand in the channel. They all increased double digits at retail with very solid like-door growth as we continued to accelerate their rollout. Geographically, Asia-Pacific was the best performer in travel retail, and the makeup, fragrance, and hair care categories grew sharply. We expect to continue our strong sales increases in travel retail, fueled in part by passenger traffic growth, which is projected to rise during the next three quarters. Our online sales this quarter were once again very strong. Mobile continues to be the fastest-growing area in E&M commerce, a trend also reflected in our business. In the quarter, m-commerce represented 41% of our online global sales, up from 37% last year. And sales from mobile devices grew 23%. In the recent period, we opened approximately 100 new sites, mostly with international retailers. Looking at our heritage brands, Estée Lauder and Clinique have remained stable. Importantly, in the quarter, both brands grew in makeup globally. They have generated makeup growth for several quarters, and we expect each of them to accelerate their makeup business in the second half of the year. Estée Lauder's international makeup sales were vibrant, with a particularly strong performance in the UK following the Brexit vote. When a drop in the pound increased the wave of tourists, the brand sold especially well in department stores favored by foreign visitors, such as Harrods, where Estée Lauder retail sales grew by 20%. Estée Lauder's Double Wear Foundation was a strong seller worldwide, fueled by its innovative Cushion Stick applicator. In skincare, Estée Lauder had global success with Advanced Night Repair, another powerful growth engine for the brand. Estée Lauder continued to see strategic opportunities to accelerate its business this year by fueling these two core pillars with new products and compelling digital assets, as it targets a wider consumer base and increased penetration in higher growth channels. Clinique's business in North America increased in makeup and skincare, driven by higher sales in specialty multi retailers, online, and in select department stores. Clinique also had solid growth in makeup internationally with strong results for its new foundation called Superbalanced Silk Makeup. It has started a redesign of some counters and stores in the United States and Hong Kong. As a result, sales climbed in those locations. Clinique expects to broaden its reach in high-growth channels, particularly in North America, while working with department stores to increase traffic at counters and accelerate its growth. Improving productivity is a focus for our entire organization. Through Leading Beauty Forward, our multiyear initiative, we aim to increase our efficiency and reduce costs to achieve both leverage and reinvestment in growth drivers. Additionally, we will improve our speed to market and agility. We are making good progress. Much of the organizational design work and several projects are underway. In closing, we continue to deploy strategies to drive our sustainable and profitable long-term growth. Our diversified business is fueled by multiple engines of growth, and our financial agility enables us to quickly move resources to take advantage of changing consumer demand and new opportunities. This year, we will further accelerate our stronger growth engines, reinvigorate slower areas, and create more resources to invest in opportunities and capabilities as we adapt to the changing dynamics in prestige beauty. As we discussed in our August call, our sales profile this year is weighted to the second half and is rolling out as we had anticipated. We expect that fiscal year 2017 will be another successful year that will advance our financial performance and strengthen our leadership. Now, I will turn the call over to Tracey.

Thank you, Fabrizio, and good morning, everyone. First, I will review our fiscal 2017 first-quarter results, and then I will cover our expectations for the second quarter and the full year. As a reminder, my commentary excludes the impact of restructuring and other charges, primarily related to our Leading Beauty Forward program. Net sales for the first quarter were $2.87 billion, up 2% in constant currency compared to the prior year period. Incremental sales from By Kilian contributed approximately 20 basis points of this growth. From a geographic perspective, Europe, the Middle East, and Africa saw the fastest growth again this quarter. Net sales rose 7% in constant currency, with double-digit growth from the travel retail channel, developed markets like Italy and Spain, as well as most of the region's emerging markets. Sales in Germany and the UK were also solid. Last quarter, we called out two issues that we predicted would put some pressure on our first-quarter sales in EMEA. As we anticipated, sales in France declined due to a significant drop in tourism against a tough comparison with an exceptionally strong first quarter of last year. Net sales in the Middle East fell sharply as distributors in the area significantly rebalanced inventory levels to adjust to weaker retail traffic due primarily to the impact of lower oil prices on the overall macro environment. We do see some traveling luxury consumers from the Middle East taking advantage of the weaker pound and buying more in the UK. Excluding the Middle East, the EMEA region grew 10%. Sales in the Asia-Pacific region grew 5% in constant currency. Growth was led by Korea, which grew low double digits followed by strong growth in Australia, Taiwan, Thailand, and Japan. China grew in line with the overall region. Sales in Hong Kong continued to decline. Excluding Hong Kong, the region grew 7%. Net sales in the Americas declined 2% in constant currency. Latin America grew 15%, led by strong growth in Mexico while Brazil remains challenged. Canada rose low single digits and the U.S. declined mid-single digits. Our sales through both online and specialty multi channels again rose double digits. However, we saw continued declines in the brick-and-mortar business of mid-tier department stores, as well as tourist-driven freestanding stores. Additionally, the U.S. had a tough comparison to the prior year, which included some major new product launches in department stores. Net sales by product category were led by the 10% constant currency growth in fragrance for the quarter, reflecting the success of our strategy to focus on the higher margin, top-tier segment of the category. Jo Malone was once again the largest contributor to our overall fragrance growth. The launch of Basil & Neroli, strong comp door growth, and expanded consumer reach drove a strong double-digit increase in sales. By Kilian contributed incremental sales, adding about a point to the fragrance category growth, and Le Labo also grew rapidly. Makeup sales rose 1% in constant currency. Tom Ford delivered exceptional growth, nearly doubling its makeup business this quarter. Smashbox rose double digits, and Estée Lauder and Clinique innovation in makeup also drove the category as previously mentioned. And as Fabrizio discussed earlier, M•A•C continued its strong double-digit trends in most international markets. However, the brand's U.S. business continues to experience lower foot traffic and tourism in its core channels of distribution, constraining overall makeup growth in the quarter. Hair care sales increased 1% in constant currency, primarily due to growth from Bumble and bumble. Skincare sales grew less than 1% in constant currency. Double-digit growth, supported by strong innovation from La Mer, Origins, and Aveda, was mostly offset by lower sales from Estée Lauder, which had a major launch in the prior year period, and from Clinique, reflecting continued softness in Asia and in EMEA. Our gross margin declined 30 basis points from the prior year, due primarily to unfavorable currency and a slightly unfavorable product mix. Operating expenses as a percent of sales increased 10 basis points. Higher store operating costs and selling expenses associated with our retail store growth, along with the accounting for stock compensation expenses, were mostly offset by favorable currency transactions and a gain on the sale of a fixed asset as well as more prudent expense management. As a result, operating income fell 1% and operating margin decreased 30 basis points. Net earnings increased 2% to $314 million, reflecting a lower effective tax rate. Diluted EPS rose 3% to $0.84 or 5% in constant currency. Earnings per share for the quarter included $0.02 of unfavorable currency translation. EPS was higher than anticipated due primarily to more prudent expense management. As you are aware, we have seasonally higher working capital requirements in our fiscal first quarter as we build inventory to support the holiday selling period. During the quarter, we used $150 million in net cash flows from operating activities and we invested $85 million in capital projects. We used $222 million to repurchase 2.4 million shares of our stock and paid $111 million in dividends. We also announced this morning that our board approved a 13% increase in our quarterly dividend to $0.34 per share. Now, let's turn to our outlook for next quarter and for the full year. As Fabrizio mentioned, we continue to expect sales to grow 6% to 7% in constant currency for the fiscal 2017 year. This range includes the expected contribution from BECCA as we plan to close the transaction this quarter. On a preliminary basis, we estimate that BECCA could add approximately 30 basis points to sales growth and dilute EPS by $0.02 in fiscal 2017, which won't affect the range of our forecast. Currency translation is expected to depress sales by less than 1%, reflecting weighted average rates of $1.10 for the euro, 1.22 for the pound, and 105 for the yen for the fiscal year. Diluted EPS is expected to range between $3.38 and $3.44 before restructuring charges, including approximately $0.08 of dilution from currency translation. In constant currency, we expect our EPS to rise by 8% to 10%. For the fiscal 2017 second quarter, our sales are expected to rise by approximately 5% to 6% in constant currency, reflecting new product launches and holiday promotions as well as easier comparisons in the U.S. and France. The Middle East and Hong Kong are expected to continue to weigh on sales growth until the second half. Negative currency translation is estimated at approximately two percentage points. Our most recent acquisitions could add approximately 50 basis points to sales growth for the quarter. EPS is forecast between $1.10 and $1.15 before restructuring charges. This includes about $0.05 dilution from currency. The acceleration in EPS growth implied in the second half of the year is directly related to the sales growth trends. We are pleased with the performance we made on our strategic initiatives in the first quarter, and we remain focused on delivering another successful year, despite the volatile political, economic, and currency environment. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Hi, guys. The first question is more short-term. In your release, you changed the expected full year top line outperformance versus the category to more than 1% from 2% previously, along with the 4% to 5% beauty category growth. So given that commentary in Q1 came in at the low end of the range, Q2's still expected to be below the full-year FX-neutral sales growth rate. Should we expect the sales growth to be more at the low end of your 6% to 7% range now? Is that reasonable? And then the second question more longer-term is last quarter, you announced you were expanding more of your business into ULTA and Sephora. As we look out over the next few years, I was hoping you could discuss conceptually how much further distribution expansion you'd expect to see in non-traditional retailers versus your historical footprint and if bringing more brands into those retailers over time is part of your plans. Thanks.

So let me take the first half of that question in terms of the range. It's still pretty early in the year, which is the reason why we give a range for the full year. So at this point, we're not prepared to say that we're going to be at the low end of the range. And certainly, the second quarter is a big quarter for us. It's holiday. And obviously, the second half of the year is big for us for all the reasons that we spoke about in our prepared remarks. So at this time, it's still very much within the range.

Yeah. And the answer to the question about whether we will continue increasing our penetration in China is yes. That's part of our program. There are several winning channels around the world in this moment in the area of luxury and prestige. One is definitely specialty multi, and we will continue to increase not only distribution but success and continue to increase brands tailored to this channel in the future around the world. We will also continue to increase our penetration of the online channels. And we will continue to increase also our penetration of travel retail and distribution in these areas, among others.

Great. Thank you. Just following up on Dara's question, if you're not taking the high end off the table, then what are you seeing to make you confident that the second half can accelerate to essentially a double-digit pace in the second half in order to get to the high end of your outlook? But really what I wanted to ask more about was M•A•C because – what are you doing to remedy some of the things that are going on in the U.S.? I guess part of this is an appeal to tourists and less travel and the impact of that. But how much of this is just how much more competitive the makeup category has become, particularly with the younger consumers that M•A•C has captured for so long?

All right. So, Olivia, thanks for your questions. Let me start off with the expectations again for the second half. We talked a bit about the innovation that we're expecting in the second half. We talked about pricing, and we also talked about an acceleration of consumer coverage for many of our smaller brands. As you're aware, we most recently acquired a number of smaller brands that are in expansion mode, brands like Jo Malone and Tom Ford and others have quite a bit of expansion opportunity as well ahead of them. And so they are certainly much of that distribution growth is planned for the second half of the year. If you were to think about the second half in terms of the building blocks that we typically talk to you about for the full year, 2% is roughly – a little over 2% is roughly the pricing expectation that we expect to get in the second half of the year. New distribution would be about 3% to 4%, so a bit of a step-up versus the first half of the year. And then our existing and new business including our newer acquisitions are another 3% to 4%. So that's how we get to the numbers for the full year that we guided to in terms of 6% to 7%.

Yeah. And as far as M•A•C is concerned, as I said in my prepared remarks, M•A•C is still growing double digits in many of the global markets where there's equal new competition as there is in the U.S. And M•A•C internationally has been growing in line with the very fast-growing market, continuing to well compete with mass and all the mass brands, despite some of them now using prestige codes; they continue to grow on average less than the prestige brands. So M•A•C continues to be one of our most successful and fast-growing brands, and we will count on this for the future. In the U.S., there are specific two issues in the short term that we have already commented on, which is obviously M•A•C is very concentrated and focused on a high internal distribution presence in high tourist areas and in mid-tier department stores. The traffic in both of these areas has been significantly lower than in the past. And so M•A•C will need to react to that. The second is the programs. And you're right, there is new competition. There are some very successful brands; we have acquired one of them, BECCA, and there are many other successful brands, particularly in specialty multi, which are new competition among the millennial generation. M•A•C is stepping up their activity, their innovation, their collection, their social media, and their penetration of this new target group with new activity. That's why in our prepared remarks we brought up the example of the Selena collection and what's happening there when M•A•C speaks to this target group more directly. And we plan to do much more of this also in the second semester of the fiscal year. So net, we expect M•A•C to continue to be one of our strong growth brands in the long-term.

Great. Thanks. I actually want to take a step back and think about your long-term algorithm because within that algorithm, I know you've got objectives to grow the top line while also expanding operating margins and improving free cash flow. But it seems philosophically as though maintaining the top line at 6% plus really dominates the other two. And arguably, that's not wrong, assuming the 6% plus growth is there. But I guess as we hear questions today related to the top line, what would it take for you to see whether in your business or in your end markets where you'd say, you know what, we're going to throttle back just a bit on top line investment and seek to generate similar profits, maybe improve free cash flow by going more after margin? I guess my concern is that you've been growing 6%, 7%, 8% in a market growing 4% to 5% for a while. And clearly, that can't go on forever, at least not without significantly higher costs. And I think the market's concern is that's what we're starting to see this quarter. And to that point, if you do happen to trend short of 6% in fiscal 2017, I think the market's fear is that you'll continue to spend as if you were still growing at that level, leading ultimately to deleverage and EPS reductions. So can you just help frame for us how you're monitoring top line trends and give us confidence that if the revenue does start to fall short, that the flexibility you've been speaking of the past few quarters can be applied to cost management to better protect the bottom line and in the fact – even in the face of top line disappointment? Thanks.

Yes. I would like Tracey to add to this. But first of all, our long-term opportunity of growth remains between 6% and 8%. It could be 8% in some years, of course, there could be 6% in others, depending on the external situation and on our internal innovation program and priorities and spending, as you mentioned. So I still believe the range for the long-term is the right range. And we are moving into that and continue to use this range as an opportunity. The key areas of opportunity— we still continue to have pricing power. So as we say in our forecast, for example, in our 6% to 7% this year, which represents our long-term view, is two points coming from pricing, with 2.5% coming from distribution and 2.5% coming from organic growth. Our portfolio of brands, as Tracey explained before, still offer a lot of opportunities for more distribution with at least half of our brands being high growth, high productivity and not at all available to global consumers in many areas. This will continue to be true for many years to come. As an example, even our recent acquisition, BECCA, has enormous opportunities for going also international, online, in travel retail, and all these areas which will build value and today are not leveraged by a brand that is doing very well among its target group. We have plenty of examples of this in our portfolio. The 2.5% organic growth in a market that is growing 4% to 5% in prestige is frankly achievable if we get our plans together. We still believe that the 6% to 8% range is achievable, but it is also possible that in some years, it will be 6% and not 8%, as we have demonstrated in the past. In terms of your second question, which is about flexibility, this is actually the key point. Our financial flexibility is there, and we are regularly adjusting resources, not only due to the overall growth level but also to the different priorities that we have around the world and to reallocating resources to the winning areas. I believe this flexibility is one of our biggest strengths that we can exercise to continue to succeed. We are ready to do it, and we are prepared to do this, and our Leading Beauty Forward program, among other benefits, is also there to help us become stronger in our ability to do exactly that. To close on your question, yes, we are committed to adjust and adapt costs to the future sales growth opportunities that we will have. Tracey?

Yeah. Stephen, so the only thing I will add on to what Fabrizio has already said, some of the margin gains that we are achieving through our SMI program and other cost initiatives are in fact being offset by acquisition accounting and currency. So we are seeing almost an equal cost set in terms of some of the benefit that we're achieving from an organic growth standpoint with some of those factors. As I mentioned on our year-end call last year, the purchase accounting will bleed off over the next year or so, and you'll start to see some more of the margin flow through. One of the things that we also look at here is obviously EBITDA, given the fact that we have done several acquisitions in the last few years. And you certainly see more progression in terms of our EBITDA margin.

Thank you. Good morning. Again, my question is around margins, and just—in your 2% or 2% to 2.5% organic long-term growth, are you factoring in the likelihood of some years where two or three of your biggest brands are down in your biggest market, which is what we're seeing right now? And I think it would be helpful to understand why M•A•C in the U.S. should get back to growth, separate from innovation. But just given where travelers are going, you're benefiting in the UK. Is it realistic that M•A•C gets back to growth, based on everything you are seeing right now?

Yes, it is realistic that M•A•C gets back to growth. The point that I keep making is diversification. M•A•C is a big global brand. The U.S. is less than 30% of M•A•C volume. The rest of M•A•C growth around the world can be double digits, as it has been high single digits in the quarter we just closed, and is projected to be double digit. So a brand that has double-digit power really demonstrates an enormous amount of opportunity, including extra distribution opportunities internationally. The growth is strong and consistent in places like China, where M•A•C is really, really untapped. There are many examples like that. Each one of these brands has a very different mix in the portfolio. I don't think we are going to deploy every single brand and every single opportunity in terms of price and distribution and organic growth brand per brand. Therefore, I summarize with the one-third, one-third, one-third approach. Yes, we are not seeing the big brands have the role to drive the 6% to 8% on the high side. But they do have the role to drive growth. The other smaller brands in the portfolio are also growing double digits and that portfolio mix is what drives our long-term algorithm. And to clarify, we anticipate that M•A•C will indeed regain its growth in the U.S. market, continuing innovation and social media plans are part of this strategy.

That's right. We have stabilized the brands with consistent growth in the makeup part. However, the skin care segment has been slower than we wanted due to declining traffic in U.S. department stores and Hong Kong which contribute significantly to skincare sales.

Good morning.

Good morning, Bill.

Hey. Can you guys just bridge the gap for us between sort of the 7% to 8% makeup category growth and the 1% you reported? Because if I did the math – and I think Fabrizio just said that only 30% of M•A•C sales are in the U.S. So if you assume that international business grew 7%, in line with the makeup category, does that mean the U.S. was down 20%? So I was just sort of trying to figure out, like, what is the source of the volume or share losses? And how do you fix it?

Yeah. So I'll start. I think we talked about three markets that were softer than last year, some due to macro factors. The U.S. was obviously one of those. France, which had an exceptionally strong first quarter last year, is softer for obvious reasons this year and the Middle East. And those are big markets for M•A•C and for makeup in general, and certainly for M•A•C. We expect throughout the balance of the year that we won't be anniversarying some of the events, but in addition to that, we do expect a pickup in all of those markets throughout the course of the year.

I want to add that Hong Kong is also a decent makeup market. Brazil is a very big makeup market for us and has been declining. But there are other markets like China where, just to give you an example, M•A•C has been growing 20% or more. And there are other markets in the world where our makeup portfolio is growing at 30% to 40%. So it's not as simple as just one market explaining everything. The average of our international market has been doing well. But Middle East, Brazil, low base in France, and also Germany fall in my prepared remarks are other examples of markets that are driving down significant growth numbers but are offset by other phenomenon. In the U.S. specifically, the underperformance relates to M•A•C, while the rest of our portfolio in the U.S. has been performing well, meeting our expectations with significant growth from Lauder and Clinique makeup. We will improve the trend in M•A•C in the U.S. through accelerating our distribution in our makeup brands and activating organic growth with enhanced programs, particularly outstanding innovation and better social media plans.

Hi. Just housekeeping, specifically, can you give us the like-door growth in China in the quarter and the actual number for M•A•C? How much was M•A•C down in the U.S. and what was M•A•C's growth globally just for the quarter? And then my bigger sort of conceptual question. I get and I understand the opportunity for distribution expansion for so many of the brands in so many new markets. And I see why that will drive a third of your growth, and that's great. But my concern is that you are gaining more market share, it seems, through distribution expansion as opposed to with your own innovation. And I look at your two really big new products over the last year: New Dimensions and Estée Edit, which we heard about for several quarters before they were launched. They were supposed to be game-changers. New Dimensions was supposed to set off a whole new category. Estée Edit was supposed to revitalize the brand with millennials. And both of those brands have fallen well short of your expectations. And I know it may take time, and Estée Edit may be a slow build, and all that kind of stuff. But my bigger question, Fabrizio, and you even mentioned it at Barclays, that the company is changing its focus less from blockbuster home runs, successful new product innovations, and more smaller things. But I'm just wondering how big a change that is culturally. Does that change the cost to compete? Those kinds of things because that strikes me as a very, very different philosophy or approach to building your brands and launching new products than we've seen historically at the company. Thank you.

Yeah, you raise a lot of questions. So China, this was again a quarter where China retail touched double digits. We are very happy. China retail grew overall 10%. M•A•C in China grew outstandingly, and our same-door in China grew by 2%. And so that's the situation. We have good, interesting growth in China. By the way, this is also driven by our makeup brands significantly, with M•A•C being a strong driver of this growth. The second part of your question is around the innovation plan. Definitely, New Dimension was below our expectations. The launch of New Dimension last year fell in the first quarter; part of what we see in skincare this year is that we are anniversarying a base where New Dimension fell below our expectations, despite being a significant volume launch. The future of our innovation is changing, as I explained in the Barclays Conference and otherwise, meaning there is some very exciting innovation and less blockbusters. We believe this is more aligned with current consumer expectations where consumers want to try new products and have a variety of them. The model is not about a breakthrough model but considers a lot of advertising before the product is in stores, which is higher financial risk. Thus, the model where we use the innovation to attract new consumers and engage them, and then when we see success, accelerate success with leveraging it further from this current stage is a much more manageable, financially effective model. We will have a mix of some breakthrough technology innovation and some more commercial innovations, and the fact that many of our growth is coming from makeup without breakthrough is still part of our portfolio approach. Still last year, we increased the percentage of our sales growth coming from innovations from 20% in fiscal year 2015 to 24% in fiscal year 2016. Regarding the cost of innovation, I believe it's the opposite. The new improvement of our innovation program is decreasing the cost of innovation, because it’s decreasing the risk situation. It's decreasing the amount of upfront money spent on innovations that don't work and giving us a better agility to allocate tailored resources where consumers react positively to our innovation. Therefore, these factors are increasing the effectiveness and return on our innovation.

Yeah, thanks for the question. Fabrizio or Tracey, given the importance of the December quarter and the overall year, can you just maybe give us your overall macro undertones that you are kind of assuming in your forecast for the second quarter, just to kind of give us a feel on how much potential cushion or risk you are baking in, just given the environment right now?

So I'll start, Nik. It certainly is difficult to predict the environment, certainly most near-term here in the U.S. But at least the election uncertainty will be over next week, and we can move forward. I think that we are very pleased with the programs that we have to take advantage of the holiday season. M•A•C has an incredibly strong giftable program this year, and so we're very excited about that. Certainly, we expect that is going to drive a great amount of volume and sales for M•A•C. In terms of Jo Malone, many of our brands are fragrance brands. Obviously, we're well-positioned for the holiday. We are still mindful of the fact that there are many parts of the globe that are weak, and certainly Fabrizio talked about some of those—Hong Kong, the Middle East. We're not expecting a big pickup in those markets in the second quarter and the holiday season. We expect the UK to have a bit of a pickup certainly given the currency favorability there. We do expect that that will be the case. And we were actually in the UK last week and certainly saw quite a bit of traffic in the shops. So I would say it's a mixed bag. I think we're very in tune with what's happening around our globe and certainly our regional presidents are as we migrate into this holiday season. I think we feel we have an incredibly strong lineup across all of our brands including Estée Lauder and Clinique for holiday.

Yeah. The thing I want to leave you with regarding our assumptions is that we do not assume Hong Kong to go back to growth this fiscal year. We do not assume Middle East will go back to growth this fiscal year. We do not assume U.S. mid-tier department stores to improve significantly throughout the year. We assume they will not further deteriorate, but we do not assume big improvements. The rest is we assume that we will be able to reallocate resources depending on the volatility we see in the other areas of economic and political volatility around the world.

Thanks. Good morning.

Good morning.

The first—good morning. I just wanted to clarify, Fabrizio, what you just said about Hong Kong, Middle East, and U.S. department stores, that was—you are not expecting them to be positive for the fiscal year or for the calendar—for the second quarter?

We do not expect Hong Kong market to grow in the fiscal year and definitely not in the next three months. We don't expect the Middle East to be positive in the fiscal year and definitely not in the next three months. And I said we don't expect U.S. department stores to further deteriorate in traffic for the remaining fiscal year.

Yeah. Thanks and good morning, everybody. I'm wondering if you can comment on M•A•C growth excluding new distribution outside of the U.S. and how sustainable current double-digit growth is. And sort of broadly, we've estimated M•A•C has driven somewhere around 20%, 25% of company sales growth in recent years. So if it's slowing, and I get the comment about international being called 70% of brand volume, but how much can the company make up with acquisitions or other, assuming that the rest of the portfolio doesn't accelerate? And why or why not is this a good way to think about that?

The way to think about that is, as I said before, one-third of our sales will be growing single digits, one-third will be growing double digits, and one-third will be in the middle, as I said before. We manage the portfolio through different growth levers. So specifically to M•A•C, outside of the United States, M•A•C is relatively untapped in terms of price and distribution in many countries. Take countries like China where M•A•C has really enormous opportunities with a limited number of cities and markets yet to explore. There are many examples like that. Each of these brands differs significantly in terms of portfolio mix. I don't think we will deploy every brand and opportunity solely by price and distribution. That's why I summarize with a one-third, one-third, one-third approach. In the fragrance business, acquisitions have played a role in creating the engines of growth in this new high-end artisanal fragrance category where we want to lead and drive growth. I think this quarter has shown significant evidence of that potential long-term. In other categories, acquisitions will play a measurable role as they always have to fill strategic gaps or opportunities, and we will continue leveraging acquisitions and analyzing opportunities in the future for strategic gaps. We also have some minority investments around the world that could be significant long-term opportunities, like Dr. Jart+ in Korea, a rapidly growing brand where we have a minority investment that could also lead us toward full acquisition opportunities in the future. We are building distinct engines of growth to diversify our opportunities long-term. That is our key strategy, and I believe we are making great progress on it quarter by quarter.

The only thing I want to add to that is that internationally, outside of the markets that we've spoken about, M•A•C growth from a comparable store standpoint is strong and is expected to be strong throughout the balance of the year. The international M•A•C business is quite strong, as is the travel retail business. So I just want to caution you on concerns regarding the M•A•C growth globally.

Furthermore, the online business is also growing very well. The specific issue we have is with the U.S. distribution platform of M•A•C and the competition in the U.S. That is the challenge we're addressing and will continue to improve in the next few months.