Estee Lauder Cos. Inc (EL) — Q3 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 Investor section of our 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 the call. And I'll turn it over to Fabrizio now.

Thank you, Dennis, and good morning, everyone. Our company delivered an excellent performance in the third quarter. Our business accelerated, driven by many brands, channels and markets that experienced strong momentum. In constant currency, our sales rose 9% and adjusted diluted earnings per share increased 28%, both of which exceeded our expectations. The outperformance was generated from stronger organic sales growth, largely in China in the travel retail channel; a better-than-expected performance of our newest brands, Too Faced and BECCA, as well as disciplined expense management. When fiscal 2017 began, we said our sales were expected to accelerate every quarter, culminating in a robust second half. As we look to the fourth quarter, our sales growth should increase further, enabling us to deliver our financial and sales target for the full year and position us for a strong start in fiscal year 2018. Our success this quarter came despite continued external macro headwinds in certain areas. In the U.S., foot traffic continued to decline in brick-and-mortar department stores, our largest domestic channel. And Macy's closed 68 stores, as expected. In certain other countries, we faced difficult economic or political climates, particularly in the Middle East, Turkey, and Latin America. And the continued strength of the dollar impacted our reported results. Globally, we encountered stiff competition from both established and upstart brands. The fact that we have achieved a strong performance against this backdrop speaks to our successful strategy, which is anchored by our increasingly diversified business model and multiple engines of growth. We also are benefiting from our choice to stay focused on a dynamic prestige industry that has been growing steadily for many years and continues to grow faster than many other household and personal care sectors. As global prestige beauty undergoes rapid change, we are embracing new opportunities, accelerating penetration of the fastest-growing channels, reallocating resources to the leading business drivers, and pivoting for the future in our industry. Consumers' appetite for beauty products is intensifying, particularly in the luxury arena and in makeup, which fuel outstanding growth in our high-end brands and continued double-digit growth in our makeup category. In addition, we enjoyed superb growth in the fastest-growing beauty channels, with travel retail, online, and specialty multi, each rising strong double-digits. By geography, we grew strong double digits in certain emerging markets, notably China. Altogether, we generated higher sales in every region and in our three largest product categories, fueled by an acceleration of our hero products, new product innovation, increased social media presence, new digital initiatives, and greater penetration in the fastest high-growth channels. At the same time, we continued investing in priority areas and capabilities and our Leading Beauty Forward initiative. Our diverse portfolio of brands continues to be a strategic advantage. We leveraged each brand in the most appropriate prestige distribution channels to target different consumer segments. This approach yielded outstanding results for our luxury brands including Tom Ford, La Mer, and Jo Malone. Each generated double-digit sales growth in constant currency in every region. La Mer's new hydrating serum and brightening mask were well received and benefit from an increase in travel from Chinese consumers around the world. The brand gained share in Asia-Pacific and maintained its leading position in luxury skin care there. Among our largest brands, Estée Lauder achieved solid growth globally for the second consecutive quarter, with higher sales in skin care, makeup, and fragrances. The brand was well positioned to capitalize on increased travel and consumption from Chinese consumers, which favorably impacted its business in travel retail, the UK, and Asian markets and lifted its skin care sales. Estée Lauder's makeup category excelled in Asia-Pacific with increases in face, lip, and eye products. The Estée Lauder brand continued to support its two key hero franchises, Advanced Night Repair and Double Wear, with new products combined with more effective marketing and communication. The investment paid off. The two highly desirable product lines reached a new consumer, posted positive growth in every region, and increased double digits for the fiscal year-to-date. Around the world, Double Wear is the best-selling prestige foundation in many markets such as the U.K. and attracts consumers across generations to the brand, including millennials. We have successfully created a new growth engine with our luxury and artisanal fragrance brands and they continued to advance strongly while at the same time improve the profitability of the entire fragrance category. Jo Malone and Tom Ford accelerated rapidly, particularly in travel retail, and we also see great potential for our newer fragrance brands, Le Labo, Frédéric Malle, and By Kilian. This is the first full quarter that reflected a contribution of our newest brands, Too Faced and BECCA, and their sales exceeded our expectations. We also started to extend their presence internationally. Adding these brands to our portfolio accelerated our penetration in both makeup and in the fast-growing specialty multi-channel and increases our reach with millennial consumers. Indeed, many of our brands are expanding in fast-growing channels to reach new consumers. Since today, they have wider choices of where to shop for prestige beauty products. In this regard, we are excited our M.A.C. brand will launch this month in Ulta Beauty, one of the fastest growing specialty multi-retailers in the United States. Ulta's consumers are devoted beauty enthusiasts and have been requesting the brand. M.A.C. will first be available on ulta.com starting next year, followed by about 25 stores beginning in June, with more than 100 doors planned by the end of December. The locations will feature dedicated M.A.C. makeup artists in a boutique-like setting, allowing M.A.C. to provide exceptional artistry services. Expanding into specialty multi globally is integral to M.A.C's strategy to grow its consumer base, continue to raise awareness, become more accessible, and drive incremental sales. Although M.A.C. is the number-one prestige makeup brand worldwide, it is in less than 3,000 doors, a fraction of the location of most of its direct competitors, in some cases, in even less than 15%. M.A.C. continues to make great inroads in specialty multi internationally. In Brazil, for example, M.A.C. is the leading brand on sephora.com and will open in some of the retailers' top brick-and-mortar stores this August. In Europe, M.A.C. is increasing consumer reach by opening more doors with Douglas as well as other specialty multi retailers including KICKS in Sweden. Our Estée Lauder brand launched in Ulta last fall in 30 doors and successfully tapped into a new audience. During the first three months, more than 40% of consumers who bought its products were new to the brand. And over 65% of the new makeup consumers were millennials. With strong sales results, Estée Lauder plans to roll out to more Ulta stores. Clinique's experience in Ulta has been terrific and it is building on its business there with more in-store boutiques. By the end of fiscal 2017, our three largest brands will have strategically expanded their consumer reach in the U.S. specialty multi-channel. Several of our other brands have achieved strong sales in the U.S. specialty multi, including GLAMGLOW, Smashbox, Tom Ford in Sephora, and Darphin in Bluemercury. During the quarter, we launched Jo Malone and La Mer into a few key Sephora doors, including its largest one that recently opened in Manhattan, and also on sephora.com. The initial response has been terrific. Both brands are recruiting new consumers from these efforts. Internationally, our business has also performed well in many specialty multi retailers, including Mecca, Boots, Douglas, and in Korea. More specialty multi retailers are entering Korea, and Clinique and Origins have expanded their consumer reach to some of these new locations. Clinique and M.A.C. launched in specialty multi in Thailand with fantastic results. We had outstanding results in travel retail, led by our business in Asia-Pacific. Our vibrant retail sales showed the strongest quarterly growth in over three years and far outpaced passenger traffic growth in the quarter. Sales increased in every product category. Makeup sales surged, led by M.A.C., Tom Ford, and several other brands. Higher skin care sales were driven by Estée Lauder and La Mer due to the greater number of Chinese and other Asian travelers. And in fragrance, which still leads total beauty sales in the channel, we achieved superior results and share growth, led by Jo Malone and Tom Ford. We believe there will be strong demand among consumers for our newer luxury and artisanal fragrance brands in travel retail as we roll them out, enabling us to further penetrate the channel's most important category. We also continue to expand the availability of our other brands that aren't widely distributed in travel retail, and brought more brands into more high potential airports. Our sales from our e-commerce channels continue to grow at an exceptional pace, up 30% globally, more than twice the growth of e-commerce in general. Sales rose double digits across brands, retailers, and third-party sites, and also grew double digits in every region, driven largely by increased traffic, order size, and conversion. Mobile-driven sales rose significantly and are now a larger portion of our total mix. We entered Hong Kong, a new market for our online business, with a brand size from GLAMGLOW. And in China, our online sales soared, led by our brands on Tmall. M.A.C. plans to launch on Tmall this quarter, which should provide more fuel for our China business and allow M.A.C. to reach new shoppers in smaller Chinese cities who don't have access to its products in brick-and-mortar stores. Globally, we continue to successfully launch additional brands online in more markets. Department stores are striving to provide consumers with strong experiences they can't get anywhere else. International department stores remain strong, particularly in Europe and China. We continue to work with our U.S. department stores to create in-store and omni-channel excitement and innovate with product, services, merchandising, and education. We are devoting additional resources to the top doors and promoting in-store events on retailers' websites where, as I just mentioned, our business has been brisk. Research shows that consumers who shop both in-store and online spend more than those who buy in just one channel. We are being proactive with department stores to design strategies to reinvigorate traffic, while addressing productivity challenges in brick-and-mortar. Now, let me turn to our recent and upcoming innovations. Across our brands, we are focused on the biggest global opportunities, which in Clinique's case means its core products, like moisturizers. Its initial launch of Fresh Pressed serum and cleanser with concentrate Vitamin C was a global hit that garnered terrific attention and demand, and validated the brand's strength to leverage the initial success with a more extensive rollout in the coming months. The serum is used with the brand's moisturizers, which increases their sales as well. Fresh Pressed helped drive improving retail trends for Clinique in China and travel retail. In another move to strengthen its position in moisturizers, Clinique just introduced a supercharged hydrating formula of Moisture Surge, developed from proprietary technology that is expected to elevate the best-selling franchise. Clinique marketing will focus on the instant benefits of Moisture Surge, which has been growing in most markets. Estée Lauder will begin introducing Advanced Night Repair Eye Concentrate Matrix in July. This product, which contains innovative technology based on scientific breakthrough research, repairs the visible signs of aging on eyes to make eyes look refreshed, and features a custom-designed massage applicator. It is one of the brand's highest scoring products in testing with consumers. For example, after four weeks of usage, almost 90% of women said their eyes looked more youthful. It will be supported by a 360-degree campaign based on strong insights from consumers around the world. In makeup, we are very excited about Estée Lauder Double Wear Cushion Compact for the Asian market, which will be supported by strong investment in China, and Pure Color Love lipstick, a global launch that is aimed at younger consumers. M•A•C new Next to Nothing sheer Face Color is a lightweight foundation that makes skin glow. It is being supported with a major social media campaign that is already helping fuel M•A•C sales this quarter. In fragrance, Jo Malone launched Star Magnolia cologne, which is expected to have wide appeal, and Tom Ford created SOLE DI POSITANO, which evokes the fragrant Italian coast. With the help of our Leading Beauty Forward initiative, we continue to reallocate resources faster and cut costs deeper, to invest in talent and capabilities that will drive our business in today's evolving beauty landscape. This includes social media, digital technologies, retail operations, and analytical expertise. To help leverage both new and existing brands, our brands continue to increase their social media activity and capabilities to engage consumers across numerous digital platforms using influencers, brand ambassadors, and other compelling voices and technologies. For example, Smashbox collaborated with a popular influencer to help promote its Cover Shot Eye Palette, and the collection became one of the brand's largest launches ever. And in China, the Estée Lauder brand significantly lifted its makeup sales by leveraging a combination of in-store and social media campaigns. This kind of digital content created by influencers and third parties is measured in terms of earned media value. In the third quarter, M•A•C remained the second-largest beauty brand among prestige and mass makeup players in earned media value in the U.S., as measured by Tribe Dynamics. M•A•C has improved its earned media value share in makeup in each of the last three quarters. Our brands are also creating inventive digital experiences for consumers. For example, a cutting-edge technology used by Estée Lauder and Smashbox lets consumers virtually apply different lipstick shades, either in real-time or in augmented reality. Our performance this quarter further demonstrated our company strategy, built on multiple engines of growth and leading to agile resource reallocation when needed, is sustainable and working. Our company has the most desirable portfolio of prestige brands in the industry. And we are committed to strategically deploy them across the fastest-growing channels and consumer segments around the world. Importantly, we have the highest quality workforce with extremely capable people committed to our company's success. At the same time, we are reducing costs, redesigning for better sales growth leverage, and reallocating our resources to make priority investments in the most attractive areas that are expected to drive our growth in both the fourth quarter and next year. As a successful high-growth company in a growing industry, we have continued to increase our global share in prestige beauty. And as we enter our fourth quarter, we are further building momentum to deliver another year of strong profitable growth. Now, I will turn the call over to Tracey.

Thank you, Fabrizio, and good morning, everyone. First, I will review our fiscal 2017 third quarter results, and then cover our expectations for the remainder of the fiscal year. As a reminder, my commentary excludes the impact of restructuring and other charges, which are disclosed in our press release this morning. Net sales for the third quarter were $2.86 billion, up 9% in constant currency compared to the prior year period. Incremental sales from our most recent acquisitions of Too Faced and BECCA contributed approximately four points of this growth. And the balance was driven by strong performance in several areas of our business, most notably travel retail, online, China, and our mid-sized and luxury brands. From a geographic perspective, every region grew sales, led by Europe, the Middle East, and Africa. Net sales rose 13% in constant currency in EMEA, led by a 30% increase in global travel retail. The substantial growth in travel retail was supported by an 8% increase in international passenger traffic, as well as further expansion of our makeup and fragrance brands in the best airports. Notably, our travel retail business in Hong Kong and Macau returned to strong growth in the quarter. We are closely monitoring the political tensions that have curtailed Chinese consumers traveling to South Korea, but we do expect the slowdown in this travel quarter to be offset by Chinese consumers traveling to other Asian destinations. The EMEA region also benefited from strong sales in Italy and the U.K., which rose high-single-digits while most other Western European markets grew mid-single digits. The region's major soft spot this quarter was the Middle East, where net sales fell again as distributors continue to align their inventory to much weaker retail traffic. This negative sales trend, however, did begin to ease this quarter and is expected to further improve in our fourth quarter as we anniversary the turndown. Excluding the Middle East, the total EMEA region grew 15%. Sales in the Asia-Pacific region grew 8% in constant currency. Growth was led by China where net sales rose more than 20%. Most of our brands grew double digits in China this quarter and our online business in China grew more than 70%. We also achieved solid sales growth in Taiwan and Malaysia, and both Japan and Australia rose low-single-digits while sales in Hong Kong continue to stabilize. Net sales in the Americas rose 5% in constant currency. Latin America sales grew 5%, led by strong growth in Mexico and Chile, while Brazil remained challenged. Sales in North America benefited from the addition of our newest brands, Too Faced and BECCA, as well as double-digit growth in both the online and specialty multi-channels. These increases were offset by continued declines in the brick-and-mortar business of department stores, as well as in freestanding stores. Our gross margin declined 160 basis points from the prior year period due primarily to adverse product mix, including the impact of the fiscal 2017 acquisitions and the associated inventory step-up related to purchase accounting. Obsolescence was also a slight contributor to the margin decline. Operating expenses as a percent of sales improved 370 basis points, primarily due to lower selling and promotion expenses that reflected our changing channel mix, along with prudent expense management in line with softer sales in U.S. department stores and freestanding stores. General and administrative expenses also declined, reflecting the benefits of our cost savings programs, equity income from our investment in Have & Be Company, and the deferral of some IT and R&D projects to the fourth quarter. As a result, operating income rose a strong 23%, and operating margin increased by 210 basis points. Net earnings rose 24% to $340 million, reflecting the operating income improvement and a lower effective tax rate, partially offset by higher net interest expense. Diluted EPS of $0.91 was 25% above the prior year, and grew 28% in constant currency. Earnings per share for the quarter included $0.02 of unfavorable currency translation and $0.02 of dilution from acquisitions. EPS was higher than anticipated due primarily to the margin-accretive sales beat coupled with disciplined expense management by our teams, and the deferral of some projects to the fourth quarter. With respect to cash flow and capital allocation, for the nine months, we generated $1.25 billion in net cash flows from operating activities, and we invested $316 million in capital projects and approximately $1.7 billion in acquisitions. In early February, we issued $1.5 billion of senior notes, which we used to repay outstanding commercial paper and to refinance $300 million in senior notes coming due on May 15. We also continued to return cash to shareholders utilizing $363 million to repurchase 4.2 million shares of our stock, and $361 million to pay dividends. Now turning to our outlook for the full year, we expect to end fiscal 2017 with sales growth of between 6% to 7% in constant currency, and that reflects approximately two points of incremental sales from the acquisitions of Too Faced and BECCA. Currency translation is expected to depress reported sales for the full fiscal year by nearly 2 percentage points, reflecting weighted average rates of $1.08 for the euro, $1.26 for the pound, and $1.09 for the yen. Diluted EPS is expected to range between $3.32 and $3.37 before restructuring charges, including approximately $0.13 of dilution from currency translation and $0.07 of dilution from the recent acquisitions. In constant currency, we expect EPS to rise by 8% to 9%. Our sales in the fourth quarter are expected to rise 9% to 10% in constant currency, demonstrating the sequential acceleration in sales growth that we have anticipated throughout the year. The strong fourth quarter increase is expected to come from approximately four points of incremental sales from Too Faced and BECCA, expanded consumer reach for several brands, particularly in Specialty Multi, online, and in our international freestanding stores. Further improvement in Hong Kong as sales are expected to return to positive growth as travel to the area picks up. An easier comparison in the Middle East, as we lap the period of soft retail sales and destocking, and continued momentum in China and other Asia-Pacific markets. We are also committed to continue to invest behind our strategic priorities. We do plan to invest increased spending in our fourth quarter behind new products and marketing activities, support for the roll-out of the new distribution, such as M·A·C and ULTA, and some projects in IT and R&D that were delayed from the third quarter. We expect fourth quarter EPS of between $0.35 and $0.40. This includes dilution of about $0.03 from currency and about $0.03 from acquisitions. We are successfully executing against our Leading Beauty Forward initiatives according to plan, as Fabrizio mentioned, and will continue to reallocate resources to strategic areas of importance. In closing, we are pleased with our third quarter and year-to-date results and are very proud that our organization continues to make great progress on achieving our long-term strategic objectives while pivoting and successfully reallocating resources when necessary towards the fastest growth areas of our business. In this dynamic, ever-changing global macro environment, our success is a true testament to the collective efforts of our dedicated employees around the world. And that includes our prepared remarks. We'll be happy to take your questions at this time.

Thanks for taking my question, and congrats on a great quarter. So my two questions are on BECCA and Too Faced. First, I wanted to get a sense of what type of growth rates you're currently seeing in those businesses? And then, it sounds like they're both trending above expectations, so just curious what's driving the above expectation performance so far? Thank you.

So the growth is very, very strong in these two brands. So, it's very strong double-digit growth in each one of the two brands and in every segment they're operating. And what is driving the success is actually same-door sales success, which is driven mainly by same-door sales and, for the moment, a very small initial distribution deployment. These two brands are really strong and consumer demand is exceptional. Their recent launches are among the most successful launches in the entire marketplace. And on top of that, for us, the great news is that they attract really new consumers that in the past we were attracting less, particularly Too Faced attracts more younger consumers in our portfolio, which is great extra business for the company overall. Importantly, they have dramatically increased our penetration in Specialty Multi in the U.S. And this will continue internationally, which is a very important objective because, as you all know, the Specialty Multi-Channel globally is one of the fastest growing channels in our sector.

Hi. Good morning, everyone. Thank you for taking my question. I just wanted to see if you can kind of elaborate more on basically the Clinique products into ULTA stores and how – I understand you've been there for five years, and how that learning can be applied to the M•A•C relationship? And along those lines, how you think about any cannibalization of the products within Specialty Multi against department stores. And second, if you could elaborate more on the fourth quarter guidance for margins, because it seems conservative against your beat of $0.21, and just a $0.03 increase over the low end of the guidance. So if you can give us what is your embedding in terms of investments? I understand from Tracey's comment that you had some R&D that might be pushed over to the fourth quarter. So if you could elaborate more on the investments? And again, congrats on the results.

Thank you. I'll start with answering the ULTA question. So Clinique is very successful in the ULTA channel. And what we have learned is that when Clinique is exposed with all the strengths of the core portfolio and the strengths of services to a growing traffic, the brand responds very, very well. Clinique is growing both makeup and skin care aggressively in every ULTA door in which the brand is deployed. In terms of what we can learn for M•A•C – by the way, as I said in my prepared remarks, we plan to gradually increase the number of Clinique doors in ULTA in agreement with our retail partner. As far as the learning for M•A•C, absolutely we have learned a lot for perfecting our upcoming M•A•C execution; also from the Clinique experience. In particular, we have learned the importance of the service aspect, of making sure that the brand is deployed with all the necessary SKU assortment and decorations of the SKUs to the consumer. It’s the concept of a curated assortment that really fits the consumer, which has been a big learning that will be absolutely applied to every one of our brands. The good news is that this is true for Clinique based on your question, but is true for every other one of our three big brands. Also, Lauder is the same. We really attract new consumers and a lot of millennial consumers. So the cannibalization is very, very limited. These consumers were not shopping in the brands before in a large majority, or they were lapsed brand users, because they were not anymore shopping in channels where the brands today are distributed. So the large majority of the business is net extra business. Tracey?

And in terms of the fourth quarter, as we mentioned in the prepared remarks, because we have some very strong launches coming up in the fourth quarter, we also have a fair amount of consumer reach expansion into Specialty Multi, as well as some of the opening of our freestanding stores and other points of distribution in the fourth quarter. And that's where the investment is coming in for the fourth quarter. When you look at our expense mix in the fourth quarter relative to last year, it's relatively comparable. And again, our motto certainly here has been to start strong and stay strong. So, a combination of very strong launch and distribution activity in the fourth quarter, and certainly supporting products to accelerate into fiscal 2018 is what the fourth quarter represents.

Hey, guys. Good morning. First, curious if you guys have detected any change in overall market growth for global prestige beauty from the 4% to 5% it was growing at earlier. And then secondly, a little bit more detail on the U.S. growth, with and without Too Faced and BECCA, and maybe what M•A•C did in North America this quarter? Thanks.

So on the total M•A•C growth, no. We're not seeing a big change. Overall, it's still between 4% and 5%; probably closer to 4% at this moment than to 5%, but still in the range. And – but what we have seen a change – we see a change continuously is where the growth is coming from. The growth is coming from – by category – is coming more from makeup than in the past, as you know. And by recently, in this quarter, the growth is again coming from Asia more than in the previous quarters. And then, certain emerging markets have been more challenged than in the past, like, I don't know, Brazil or Turkey, obviously, and a few others. And so, we see a variation where the growth comes from. But what is interesting is actually the total growth is still between 4% and 5%.

And as far as the North America performance this quarter. As we indicated, the brick-and-mortar channels were pretty challenged, particularly in the U.S., in the third quarter. Excluding Too Faced and BECCA, the North America segment was down in sales, and M•A•C was certainly a contributor to that performance. The M•A•C team is working very strongly in the U.S. to accelerate performance, both in the department store channel and certainly in their freestanding stores, and has some great programs coming up over the next couple of quarters.

Great. Thanks for taking my question. I guess I wanted to focus on the comment, Fabrizio, you made on the earned media value for M•A•C picking up in the third quarter. When you look back, what was driving that? Was it new product launches? Was it product placement with influencers? And then I guess just a housekeeping question in terms of the cadence of openings at ULTA. You talked about 25 in June and over 100 by year-end. Should we just kind of model the balance of that in the next quarter? Or how do we think about the next couple of quarters in the calendar year? Thanks.

So, let me start from this last question. You should not model it differently; it is 25 by June and then 100, and you can assume that the 100 will be equally split because it's a matter of capability opening. The opening will be more aggressive as of September, obviously, because of organization and capability things. But this is the total number that we're planning for at the moment. What was the? Ah, the earned media for...

Earned media for...

So what was driving the improvement of the earned media value of M•A•C is, first of all, the M•A•C activation of many more influencers. And the activation also of M•A•C makeup artists influenced themselves, which is a unique model created by the M•A•C brand. This means M•A•C is, obviously, activating external influencers, but also, many of the very valuable makeup artists of M•A•C influence themselves. And being enabled by a lot of great quality asset to support to do this job around the world, and particularly in the U.S. The other thing is, activity in this, is M•A•C is back launching hero products. And as you know, a lot of this media value is driven by exciting new products. For example, Next to Nothing launch, which I mentioned in my prepared remark, is an activity that is creating a lot of conversation in the social media arena, which is helping support the brand. We believe this strength will continue. The M•A•C brand is very active among the various changes they're leading in the U.S. market and internationally in increasing the numbers of hero products that will be passed of their deployed portfolio of innovation.

Hey. Good morning, guys. Thank you for slotting me in. I just want to turn to margins. Your guidance implies that EBIT margins are going to be down for the full year modestly. Another three years where you kind of fall short of your longer-term targets of 40 basis points to 50 basis points. Can we go through some of the drivers? Like, obviously some deleverage in freestanding stores, department stores, etc. Talk about the size of those, the path forward? And maybe put a little more teeth on this Leading Beauty Forward program to give us some context of the savings when they can flow? And what it means for margins on the forward? Is this sort of just the new reality that we should get acclimated to stagnant margins? Or is there a path to improve on the forward? Thank you.

Yeah. Thanks, Jason. With respect to our margins this year, and I think we had indicated this was the case last year as well. One of the things, as you all know, that we've been experiencing for the last three years is negative currency impact on our margins. So, in fact, if you look at the guidance that you're referring to, Jason, for this year, we have 80 basis points of improvement in margins. That is being offset by a combination of currency as well as our acquisitions. So we've had a bit of that experience over the last couple of years as we have done a fair number of acquisitions. But most importantly the currency drag on our margin. So, yes, we've had deleverage in freestanding stores and that's had an impact. We are offsetting much of that with some of the shifts that we are making in terms of expansion into specialty multi, and you'll certainly see more of that impact in fiscal 2018. As it relates to Leading Beauty Forward, when we announced the program about a year ago now, we indicated that the structure of the program is efficiency, effectiveness, and redesigning certain organizations to allow us to achieve greater leverage in the future, and leverage implies margin expansion. So, we've delivered 80 basis points of savings from just our cost savings programs this year. Leading Beauty Forward will take another chunk out of our cost base and also allow us to grow in a more leveraged fashion. We've got lots of great activity around Leading Beauty Forward. When we announced the program, and certainly still maintain this, we said that we would not see benefit this year. We will start to see some benefit next year, but it will not impact our margin guidance for next year. Then you'll start to see Leading Beauty Forward lead into our margin results over the following few years until it achieves its full potential and that full potential is $200 million to $300 million. We will invest a portion of that back, but a portion of that will also be dropped to the bottom line. So it is the reason that we have so much activity around Leading Beauty Forward and, as both Fabrizio and I mentioned, it is actually slightly ahead of plan in terms of some of the initiatives under the program as the organization really rallies behind this to not only create some of these leveraged structures from an organizational standpoint, but also build some of the capability for the future support of our strategic objectives.

Good morning. I have a couple of quick follow-on questions on M•A•C. First, I just wanted to clarify that it did improve sequentially in the U.S.? And then in ULTA, I imagine this will be incremental in the top line. But will it be a drag on your margins given some expected cannibalization of your more profitable M•A•C retail stores? I guess how do you balance that? And then I was curious about a potential halo effect that you might be seeing, broadly speaking, with your new innovation on some of your hero franchises or maybe as you further penetrate new channels, such as specialty multi with some of your big brands. I guess I'm curious if you're seeing any evidence that Estée Lauder customer baskets are increasing? Meaning that your customers are buying more of your portfolio brands and possibly spending more per transaction? Thanks.

So, let me start from this line. I think we said it in prepared remarks and everywhere we comment on this new distribution. The new distribution is bringing new customers. We have absolute evidence. That's why we have tested our way first with 30 doors, then in certain areas internationally the same. We have done this very gradually with a lot of attention. The large majority of consumers are new to the brands. This is true for new distribution, both online in specialty and this is true for a lot of our new innovations which are focused on segments where we have strategic opportunities or strategic gaps. That has actually been the big strength. The other information I have already shared but I want to further clarify is that the large majority of these new consumers are millennials. And that's true in all these things that we have. We have year-end data that supports all these learnings and then based on this data, we made decisions on distribution evolutions around the world.

In terms of M•A•C in the U.S., we think some up and down performance as it relates to M•A•C in the U.S. So the expectation, obviously, is in the fourth quarter and beyond, that the M•A•C performance, given certainly the expansion into specialty multi along with, as Fabrizio said, many of the programs that they're working on and the increase in some of the digital activity that they're doing, will start to gradually improve sales in the U.S. Also, as we said, M•A•C is quite strong other than a couple of pockets in international; quite strong in international, particularly in Asia. And again, in addition to some of the expansion into specialty multi that's being done here in the U.S. and the work that is going on to grow sales in the freestanding store and department store channel, they're also launching in Asia on Tmall. So we expect next year to be a strong year for M•A•C going forward.

In terms of the profit dilution of the new distribution, M•A•C is very dependent on traffic. If we create good sales per door, M•A•C is a profitable brand. Our priority is to stay focused on really making M•A•C a good brand with great sales per door in every single distribution channel and that will keep M•A•C as a very profitable brand. In terms of the overall dynamic, I want again to clarify the M•A•C exposure to the declining brick-and-mortar department store traffic is the key issue we are trying to solve. M•A•C has enormous demand and attention from consumers. It's a very desirable brand. Wherever M•A•C is exposed to traffic, it's performing well. That is the key issue we are trying to work on. As we said, we have many international pockets where M•A•C is booming. We need to address the U.S. issue as we have discussed. I hope you see many of the pivoting activities that we are doing to achieve this goal as fast as possible.

And the only thing I want to add to that is M•A•C is one of the strongest, if not the strongest, brand online in terms of growth.

Yes. Thanks and good morning, everybody. Wanted to go back to the overall category growth question and answer. So obviously, good quarter sequential improvement but still pretty decently below your larger peers in terms of absolute organic growth. So I guess I'm curious to what do you attribute this? How much is Americas? The M•A•C commentary that you've touched on, how much is Clinique as a brand that hasn't been touched on but seems like it declined in the quarter? And then how do you think about improving those trends relative to peers? Or do you think this sort of normalizes over time as overall growth moves back towards what you're calling 4% to 5% prestige beauty category growth? Thanks.

Our growth algorithm is 6% to 8% and we are obviously on this trend. The key point is this industry is not a zero-sum game. All the big companies are growing. And depending on the quarter and the year, some are growing a bit less or a bit more, but we all are growing. The key point is that there is strong category growth and there is space to grow for a lot of big companies. Believing that small brands are diluting the growth of big companies is clearly not demonstrated by the facts, because big companies are growing. They are growing their brands and enriching their portfolios. If certain smaller brands do very well, some of them get acquired by the big companies when they have the right rate of return. I believe actually this is an environment where many big companies can grow and can grow at the same time in this amazing part of the industry, which is prestige beauty. Now, what do I attribute in the short-term in the last six months, nine months? Our growth being below some of our competitors is frankly 80% U.S. department store traffic. We are the company which has the highest exposure in percentage of our business and in our big brands to U.S. department store traffic. That’s the big thing. Then there are many, many other areas of the world where frankly we are growing faster than many other companies. Lastly, we are building market share. So in a market where we continue to grow 4% to 5%, we continue to grow market share. This was evident also in the recent Unimonitor report for 2016 calendar and is obviously proven by these first quarter numbers where we are growing in constant currency 9% versus the market which is probably closer to 4%. So we keep growing market share. We keep growing well all over the world, and we do have an issue to solve - to address, which is that U.S. department store traffic - and we are pivoting to reinforce this channel and at the same time diversify our business in the needed way.

Great. Thanks. First, we obviously talked a fair bit about M•A•C in the U.S. and the increase in ULTA and Sephora, but one of the things I want to know is how much of their issue for M•A•C in the U.S. do you think is a function of more competition in the makeup category versus just its retail positioning, particularly with younger consumers that M•A•C has captured for so long? And then perhaps can you give a little bit more detail in terms of what other opportunities are there for other brands in terms of the specialty-multi distribution, not just the smaller faster growing brands but also the larger ones? And then following up on that, as more activity moves online into smaller format channels, what's the difference in terms of the purchasing patterns versus your traditional retailers? Obviously, the consumer is younger. They are clearly focused a little bit more on the smaller brands versus the larger brands, but what about product category, price points, and things like that? Thank you.

Okay. So let's start again. M•A•C is – there've been some research issued that M•A•C is the number one brand loved by teenagers in this market in the U.S. Recent research just confirmed this. All our consumer data shows that M•A•C is among the preferred brands among millennials and frankly, all generations. M•A•C is a business built to be very sensitive to traffic. That’s the key thing we need to do. The brand is in excellent shape, very desirable. As I said, there are markets around the world where the brand this quarter has been growing 40% or 45%, despite the competition being the same. So it's a very specific opportunity. That said, there is definitely a lot of new competition and every big brand has to face this new competition. On this, I would like to make an observation. What we see in the data is that this increasing competition, done by an ever-increasing number of brands, is increasing competition at the trial moment. We don't see increased competition in the area of loyalty and in the area of retention and repeat, which is where the profit is. Let me explain this. We have, for example, in all our big brands, take Estée Lauder with Advanced Night Repair and take M•A•C with Studio Fix, the big hero products in this moment are getting more success and increased repeat, despite the increased competition. What is tougher is to get the attention at the trial moment, because of the many small brands; there's more activity out there. However, I'd like you to think that the trial moment is not the profitable moment. Trial is an investment. Repeat is a profit. So at the end, the profitable brands are still the big brands with great hero products, great repeat, and not many small brands that generate a lot of noise on trial, because unless they get the repeat, they will not be sustainable. We are very focused on a sustainable, long-term profitability strategy for our brands, and that's the way we are addressing the issue at M•A•C and the opportunity for all our brands. The second question was specialty-multi, which is an opportunity for many of our brands, and I mentioned many of them in my prepared remarks exactly to give you maximum exposure to all the pivoting we're doing. To clarify one point: every brand has a unique distribution strategy in the Estée Lauder Company portfolio. We don’t do things by channel. We do things by brand. There are brands designed to win well in specialty, brands designed to be in multiple channels, and brands designed to be more exclusive in certain channel types. Our broad portfolio of brands gives us the possibility to play this growing multi-channel portfolio globally in an excellent strategic way. The last question was about online purchasing patterns. Yes, we see a very different pattern in purchases online. Purchases online tend to be younger and tend to be profitable, because consumers are very loyal when they get into it. There’s a lot of good repeat. The online sales allow us to reach consumers that sometimes we cannot reach with brick-and-mortar, especially in emerging markets. I just gave the good example of China, where a good launch of M•A•C in Tmall that will happen this quarter; we know by all our analysis that will expose millions of Chinese consumers in cities of Tier 3 or Tier 4 who today cannot buy the brand to be able to purchase the brand. This is true for many other brands in our portfolio and many of our online activities around the world.

Hey, guys. So, I wanted to look at your two heritage brands, Estée Lauder and Clinique, and Estée Lauder looks like it's clearly stabilizing here. There's another quarter of sales growth in both skin care and makeup globally. What are you learning from that? Because on the flipside, it looks like Clinique is still struggling a little bit, both in skin care and in color, not just in the U.S., but globally as well. So if you could help figure out what could happen to Clinique and how you're learning from Estée? You mentioned some innovation. Is that really going to be the turning point in Clinique? And then second thing, Tracey, maybe more for you, on just more quantification on the drivers you'd mentioned regarding SG&A coming down in the quarter. How much of it was a shift in IT spend from this quarter to next quarter? Was there ad spend shift perhaps versus how much was kind of permanent, in terms of actually the improved efficiencies from cost cutting or channel mix? Thanks, guys.

Okay. I'll start from the Lauder and Clinique question, and Tracey will take over. First of all, Lauder is growing, so it's not stabilized. Lauder has been growing in a very exciting way, in my opinion, this quarter. This is the second quarter in a row where the Lauder brand is growing globally. What is driving that is successful innovation that is hitting new consumers, combined with amazing work on relaunching hero products, and that's the key point. I mean, Double Wear is a fantastic foundation product that millions of consumers around the world love. But still, there are millions of consumers that never tried this product. The ability of the brand to continue to win with winning hero products is the key learning, and this is working very well. For example, we have learned that Double Wear in specialty multi attracts Millennials, despite being a foundation that's been around for many years, and being a fantastic product for many years, attracts new Millennials to the brand better than maybe specific Millennial launches targeted to Millennials. We are now ready to leverage these new discoveries on Lauder and continue the acceleration. The third thing helping the Lauder brand is that it is more positively exposed to the Chinese consumers and to the Asian dynamics than the Clinique brand. The Clinique brand in the country is more exposed to U.S. department stores than any other brand in our portfolio, together with M•A•C in the U.S. But globally, Clinique is more exposed in total. The key point is that Lauder has benefited from the comeback of growth in Asia and it being part of one of the brands driving the comeback of skin care in Asia. The learning for Clinique is the same: more hero products, more activity on innovation that builds not only specific new products but also existing hero products. The Fresh Pressed Vitamin C launch is an example of that. Vitamin C is a new product, but at the same time, creates a regimen with existing moisturizers of Clinique. We have tested these successfully in the last year. The art of learning for Clinique is that it also needs to accelerate the entrance in growing channels. Clinique is further accelerating the expansion in the successful specialty multi-channels where it is playing and online. We will continue to do that. Clinique is also working to further activate their makeup innovation and activities in fiscal year 2018 that should further boost the brand.

And in terms of the beat this quarter in the margin leverage that we had this quarter, I would say that about 65% of it is a combination of the sales beat as well as the mix of sales. So, favorable channel mix as well as category mix, as Fabrizio was just saying. We did see a pickup in our skin care category, and as you all know, that is our most profitable growth category from a margin standpoint. The balance of it was some shifts in terms of projects, and as well as advertising and promotion spend. So again, we mentioned there were some of the programs that are launching in Q4 that we are spending behind that were initially thought to launch in Q3. The Cushion Compact would be one of those for Estée Lauder in China, so we are spending behind that in Q4. So that's some of the shifts.