Estee Lauder Cos. Inc (EL) — Q2 2019 Earnings Call Transcript

Good morning. On today's call are Fabrizio Freda, President and Chief Executive Officer; and Tracey Travis, Executive Vice President and Chief Financial Officer. Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC, where you will find factors that could cause actual results to differ materially from these forward-looking statements. To facilitate the discussion of our underlying business, the commentary on our financial results and expectations is before restructuring and other charges, goodwill and other intangible asset impairments, changes in contingent consideration, the finalization of provisional charges related to the U.S. tax law enacted at the end of calendar 2017, and the new accounting standard for revenue recognition. All net sales growth numbers are in constant currency. You can find reconciliations between GAAP and non-GAAP figures in our press release and on the Investors section of our website. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Thank you, Rainey. Good morning everyone. We delivered excellent results in our second quarter, as multiple engines of growth drove cost of currency double-digit gains in sales and earnings per share, led by strong advances in our product categories, brands, countries, and channels. We strategically invested in the most promising opportunities and our rich digital content engaged consumers, attracting them to our high-quality innovative products. Overall, net sales grew 11%, and therefore for the first time exceeded $4 billion in a quarter. We achieved this milestone despite an extremely challenging and volatile environment, which included softness in two of our largest markets, the U.S. and the U.K., and global trade tensions. This is a testament to our strategic resource allocation, superb execution by our talented employees, and improved capabilities throughout the organization. We leveraged our strengths where we had the greatest growth opportunities, including China in travel retail. And we further broadened and diversified our growth engines with strong results in the rest of Asia and emerging markets, in our fast-growing channels, and in most brands. The benefits from our leading Beauty Forward initiative allowed us to deliver savings and selectively increase our advertising spending, which in turn supported our strong top-line growth and enabled us to leverage our cost structure. Diluted earnings per share rose 25%, more than twice our sales pace. Importantly, we accelerated our share growth in Global Prestige Beauty in the quarter, which confirmed that our strategy has enabled us to gain share profitability. With an outstanding first half and ongoing confidence that we will continue to effectively execute our winning strategy, we are raising our sales and EPS guidance for the year. We now expect sales growth of 8% to 9%, and EPS gains of 14% to 16% for fiscal 2019. In the recent quarter, we benefited from many growth engines throughout our business, supported by strong product innovation and effective marketing which was informed by improved customer insights and data analytics. Our innovation program is getting stronger. We have developed more advanced data and are using it to focus on top priority areas and create highly desirable products. The proof is evident in sales from new launches. We have reached an all-time high of nearly 30% of our business. And we have become even more sophisticated marrying analytical insight with our innate creativity. We believe our innovation has the potential to reach new heights, also thanks to the improved speed to market. Over time, consumer demand for different kinds of beauty products fluctuates, and skincare is currently the fastest growing category globally. With agility we deployed more of our resources into this area. Our skincare sales grew sharply, while our makeup and hair care categories also posted healthy gains. Our luxury and artisanal fragrance brands were stars in the fragrance area, but the category declined slightly because of some designer fragrances. Estee Lauder Beautiful Belle was a popular new scent during the holiday gifting season. Three of our largest brands grew globally, validating consumer loyalty to powerful, authentic, well-established brands, especially when supported by compelling innovation and strong hero products. Momentum continued in our Estee Lauder brand, which climbed double-digit for the seventh consecutive quarter. The brand delivered double-digit increases in every region, and a stellar performance in both skincare and makeup, led by its hero franchises. MAC gains were led by a strong international showing, and it continued to pivot to fast-growing channels with great penetration online and in specialty multi. La Mer continued its superior results and gained share in every region in luxury skincare, fueled by growing consumer loyalty to its beloved products, and effective digital campaigns that recruited many new consumers. Clinique continued to make good progress. Although its overall results were impacted by the decline in North America brick-and-mortar department stores, including the closure of Bon Ton. Nonetheless, Clinique skincare sales rose globally on the strengths of several key franchises, and we are optimistic about its skincare growth in the coming quarters, reflecting expected strong performance from recently-launched innovations. Clinique's new hydrating jelly and its dramatically different moisturizer franchise achieved terrific results across the globe. The brand's new innovation, Clinique ID, is a breakthrough product lineup that is custom fit for consumer needs by offering 15 combinations of different moisturizers and treatments. It launched in the last week of the quarter, and is off to a very encouraging start, exceeding our expectations in many markets. Clinique ID has the potential to become one of our company's most exciting launches, and addresses consumers' growing desire for more personalization. Looking at other brands in our diverse portfolio, our comfort luxury brand resonated very well with consumers, and fragrance brands, Jo Malone London, Le Labo, Frederic Malle, and By Kilian achieved double-digit growth as they further expanded internationally, remaining highly ranked in the U.S. specialty multi-channel. A key strategy via our brand's success is creating a significant base of profitable repeat business from devoted consumers by attracting new users with compelling innovations in marketing, and then, the quality of our products turns them into lifelong fans. Many of our brands thrive in a broad range of markets with diverse consumer needs, showing the power of that global appeal layered with locally relevant insights. We have developed robust analytics, and are using the data to help inform our innovation and our communications. Together, with compelling storytelling, macro influencers, and digital advertising, we can now better engage consumers through our product offerings and marketing. Asia-Pacific continued strong growth at a double-digit rate. China led the advance, Hong Kong and Japan had solid gains, and our sales in Korea accelerated. Virtually every brand generated higher sales in the region both at net and retail boosted by hero products and successful locally relevant innovations. Luxury brands have been in high demand in China, and our sales mirrored that trend as they increased strongly. We continue to gain share as prestige beauty further accelerated in the market, and every brand category and major channel grew double-digits. Makeup has been gaining favor among Chinese consumers. It now represents nearly one-third of our mix of business there. Within prestige makeup, Estee Lauder, M·A·C, and Tom Ford were especially popular and gained significant market share. Online has been growing sharply for many quarters. It now accounts for more than one-third of our sales in China. We had superb results on Tmall, and with the growing interest in makeup, M·A·C was the number one prestige makeup brand on Tmall during the entire calendar 2018 and has become number two in prestige makeup in the total market. Demand for prestige beauty from Chinese consumers has remained strong, in spite of macro issues and potential risks to the economy, including higher tariffs and greater oversight on Chinese travelers who buy goods offshore for resale domestically. So far, we have not seen any impact and remain optimistic about the long-term health and resilience of prestige beauty in China. The industry will be driven by favorable demographics, and we are confident that the largest growing middle class in China will remain passionate about high-quality beauty products. We note also that other actions such as the announced tax cuts have the potential to sustain consumer consumption over the next few years. Beyond China, our success in Asia was widespread as we further diversified our growth engines in the region. Our strategy in Japan is to broaden our target consumer reach beyond our primary department store channel. We made excellent progress, further penetrating specialty multi and online and had rapid growth in those fast-growing channels. With strong fragrance growth in Korea, we gained share led by our high-end brands By Kilian, Tom Ford, and Germano. Our business advanced in the Europe, Middle East, and Africa region with good underlying momentum in most markets. We gained in the emerging markets with large improvements in the Middle East and delivered increases in the group of developed Western markets. Even though prestige beauty in North America was challenging during the last month of the holiday season, influenced by the government shutdown in a weak store market that impacted consumer sentiment. There were several bright spots in our business. Several brands expanded further in ULTA, where we have seen strong growth, including Estee Lauder, M·A·C, Clinique, and Bumble and Bumble. Many of our brands' holiday sets were popular, including Estee Lauder blockbuster, which sold through early on. We saw strong retail sales on department stores and specialty multi e-commerce sites as well on our own brand sites. Our global digital agenda is working well and is a key enabler of our company strategy. We continue to support our brands with social media programs, technology advances, and growing online initiatives. Across our e-commerce business, our orders, and conversion increased and the $125 million global visit to our brand sites during the quarter made them highly valuable media assets. Sales on our brand sites, retailer sites, and third-party sites all grew double-digits. Several brands had record-breaking days online during the holiday period in North America. For example, Estee Lauder and La Mer generated record sales on their sites on Black Friday and Clinique's Cyber Monday event was its largest ever. In China, single-day activations boosted many of our brands on Tmall. Sales on our brand stores on Tmall on that day in November rose nearly 80%, and Estee Lauder and M·A·C were among the top five performers in total prestige beauty. In Europe, we saw speed and strong demand for our products on third-party sites, including ASOS in the U.K. and Zalando in several markets in Europe. Our global travel retail business remained robust. Thirteen of our brands grew double-digits at retail; all categories grew, and light-door sales were strong. Our retail sales rose several times more than the pace of global passenger traffic growth, and we lifted our business with successful exclusive products. La Mer, for example, leveraged the opportunity to reach travelers who arrived in the U.K. or on new flights from China. As a result, the travel retail business in the U.K. skyrocketed. Traveling consumers are showing an increased interest in the convenience of ordering products online before departing on their trips. Our online travel retail business now accounts for a meaningful share of our business, where it is available, and is increasing conversion of travelers into buyers. In addition, we are working with travel retail partners to develop alternative online selling models for the channel. To build on these exciting opportunities, our brands are now developing digital campaigns specifically for travel retail. International passenger traffic is expected to continue to increase in the next two quarters, and we have plans to expand our brand presence in airports. For example, we plan to open more doors for our new artisanal fragrance brands in our new millennium focus on makeup brands like Too Faced. In closing, we are very pleased with our progress this quarter and in the first six months of our fiscal year. Many of our key brands in countries delivered terrific growth, China remained very strong. Middle East improvements were noted, and our momentum expanded in other emerging markets. Our two fastest growing channels, online and travel retail, kept up their rapid pace globally. Our innovations were highly successful and our hero franchises continued to support growth across the portfolio. We are proud of our financial results and share gains in global prestige beauty and are increasing our guidance even while recognizing certain geopolitical and economic risks in the short term. At the same time, I want to emphasize that historically, prestige beauty is less sensitive to economic downturns because it is affordable luxury driven by repeated repurchases and loyalty. Long term, our industry has strong fundamentals including favorable demographics that should drive solid growth for years to come. In the next two quarters, we plan to invest more behind our innovation to further build our share and fuel our innovation success. We expect to invest behind important new product launches such as Clinique's upcoming innovations in popular products. And we are robustly planning an advertising campaign for our dedicated products. We're also allocating additional resources to strengthen our capabilities throughout our business. Our strategy is to further build our global share and drive long-term profitable growth. We are very well positioned to succeed. Over the last few years, we have streamlined our organization to better capitalize on global opportunities. We have unleashed savings from Leading Beauty Forward and other programs that we plan to invest in the most exciting opportunities to strengthen our leadership and to continue driving profitability. We operate our business with a long-term view and are upbeat about our outlook. Thanks to our diverse brand portfolio, wide global reach, and talented employees who are successfully executing our winning strategy. We believe fiscal year 2019 would be another year of exciting sales gain and double-digit EPS growth. Now I will turn the call over to Tracey.

Thank you, Fabrizio, and good morning everyone. First, I will review our fiscal 2019 second-quarter financial results and then cover our expectations for the third quarter and for the full year. As a reminder, my commentary today includes the adjustments that were mentioned at the beginning of the call by Rainey. All net sales growth numbers I will discuss are in constant currency and compatible accounting methods unless otherwise stated. Also as a reminder, we adopted the new accounting standard for revenue recognition ASC 606 this fiscal year on a modified retrospective basis. For the quarter, the impact decreased our sales growth by two percentage points, our operating profit growth by seven points and our diluted EPS by $0.11. And now for the quarter results, net sales for the second quarter rose 11% with broad-based growth across most regions and product categories. From a geographic standpoint, our Asia Pacific region had robust net sales growth this quarter. Net sales overall rose 20% with many markets experiencing double-digit increases. Sales in China and Hong Kong grew very strong double-digit with most brand categories and channels contributing to growth. Our sales in department stores in China continued to grow strong double digits, and other channels, especially online, rose even faster. We also achieved excellent mid-single-digit sales growth in Japan and Korea, with growth across all channels including department stores, specialty multi, and online. Other markets such as Taiwan, Thailand, Malaysia, and Indonesia also contributed to the region's growth, while our sales in Australia declined slightly. Net sales in our Europe, the Middle East, and Africa regions rose 16% driven by strong double-digit increases in both our global travel retail sector and other emerging markets in the region. Double-digit like-for-like growth across most brands drove the majority of the increase in travel retail and expanded consumer reach for brands such as Jo Malone London, Tom Ford, and M.A.C. also contributed to growth. Outside of travel retail, the Middle East, Turkey, and Russia are emerging market growth in the EMEA region. Western European growth was mixed, with Greece and Italy particularly strong and Germany more challenged. Our UK business declined 2% as macro issues dampen consumer spending, including uncertainty over Brexit, with the greatest impact felt across brick-and-mortar distribution. The online business remained a brighter spot as consumers continued to shift their spending time online. In online, we had solid growth across most retailer and third-party sites. House of Fraser, one of our largest department store customers in the U.K., has been reorganizing under new ownership, and we therefore reestablished trading with them in November. Net sales in the Americas declined 3%. Excluding $22 million in prior year's sales to Bon Ton, the region's sales would have declined 1%. North America continues to achieve solid growth online with strength across both retailer and brand sites. While much of the brick-and-mortar sales in North America softened in December. Net sales in the specialty multi-channel continue to grow particularly at ULTA. Latin American sales were flat overall as growth in Mexico, Brazil, and Argentina was offset by a decline in Venezuela. Skincare again led product category growth this quarter. Net sales grew 22% with very strong global contributions from the Estee Lauder and La Mer brands. Both brands had successful new products as well as growth in existing franchises. Our Origins brand also delivered a terrific performance in Asia and travel retail reflecting increasing demand for the brands' key product line. Net sales in makeup grew 6% led by strong demand for Double Wear foundation in Asia and travel retail as well as the greater focus on makeup in our U.S. holiday offering. M.A.C and Tom Ford continue to resonate with Chinese consumers, and BECCA saw double-digit gains from its holiday program and other new products. Net sales of fragrances declined 1% as declines in designer and Estee Lauder fragrances offset gains in luxury and artisanal brands. Our hair care net sales rose 6% primarily driven by Aveda's recent launches and strong online sales. Our gross margins declined 250 basis points compared to the second quarter last year, due entirely to the impact of the new accounting standards which negatively impacted our gross margin by 240 basis points through the reclassification of samples, testers, and collateral to the cost of goods from operating expenses. Additionally, favorable mix impacts of 85 basis points were mostly offset by adverse foreign currency and obsolescence. Operating expenses as a percent of sales improved 280 basis points. Major drivers of the improvements include 180 basis points related to the new accounting standard for revenue recognition, 130 basis points from lower selling costs, and 90 basis points of savings in general and administrative costs. We reinvested 120 basis points more in advertising and marketing to drive the business and still realized expense rate improvement. Operating income rose 8%, and operating margin increased by 20 basis points. Excluding the impact of the new accounting standard, operating income rose 15% and operating margin increased 120 basis points. Diluted EPS of $1.74 increased 14% compared to the prior year and grew 18% in constant currency. Earnings per share for the quarter included $0.05 of unfavorable currency translation. Diluted EPS excluding the impact of the accounting change was $1.86, an increase of 22% compared to the prior year or 25% in constant currency. For the six months, we generated $1.27 billion in net cash flows from operating activities, which was slightly below the prior year due primarily to investments in inventory to support our international growth and some timing differences in payables and receivables. We invested $292 million in capital expenditures, and we returned significant cash to shareholders. We used $1.13 billion to repurchase 8.2 million shares of our stock, and we paid $297 million in dividends, essentially doubling the value of stockholder distributions this year compared to the first six months of last year. During December, we took impairment charges of $38 million for goodwill and other intangible assets related to the Smashbox brand. This action reflects the slowdown in the brand's makeup sales driven by increased competitive activity and slower-than-expected growth in key retail channels for the brand. The charges represent less than 20% of the carrying value of Smashbox's goodwill and other intangible assets. Now let's turn to our outlook for the third quarter and for the full fiscal year. We had an outstanding first half, which reinforces confidence in our full-year guidance. However, there are still a number of macro risks and opportunities encompassed in our outlook for the second half. These include uncertainties caused by political instability and soft economies in certain markets, including the U.K. and Europe with the Brexit deadline impending shortly, soft January retail trends in some areas of the U.S. also influenced by the government shutdown, solid but somewhat moderating growth in China in travel retail, and the impact of expected additional tariffs in China and comps in the U.S. easing as the impact of Bon Ton sales in the prior year declines in our second half. As Fabrizio mentioned, given the strong first half performance, we are raising our expectation for full-year net sales growth to 8% to 9% in constant currency, excluding the impact of the new accounting standard. Currency translation is expected to negatively affect reported sales growth by three percentage points, reflecting rates of 1.147 for the Euro, 1.283 for the Pound, and 6.874 for the Yuan for the full fiscal year. We now expect the impact of the new accounting standard to be immaterial to net sales growth for the full year. We are raising our EPS expectations to a range of $4.92 to $5, before restructuring and other charges. This reflects a slightly lower effective tax rate estimate of 22%, approximately $0.22 of dilution from currency translation, and $0.01 dilution from the new accounting standard. In constant currency, and with comparable accounting, we expect EPS to rise by 14% to 16%. For the third quarter, net sales are expected to increase by approximately 8% to 9% in constant currency, and using comparable accounting. Currency translation is expected to negatively impact growth by five percentage points, and the accounting change is forecasted to add two points to growth. Therefore, we expect reported net sales to grow between 5% and 6%. EPS is forecasted between $1.26 and $1.28, before restructuring charges. This includes approximately $0.09 of dilution from currency and $0.18 benefit from the new accounting standard. With a strong first half of fiscal year behind us, we are focused on investing further behind key launches, digital outreach, and brand expansion to support future growth in North America and continued strength in other markets. We have the flexibility to make these investments in our second half while delivering another successful full year of solid top-line growth, margin expansion, and double-digit EPS growth, as reflected in our increased guidance for the year. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Thanks. Good morning. I wanted to start on China, because the growth there obviously continues to be fairly impressive. First, if you could talk about the overall environment, because some of your luxury peers are also saying that they haven't seen a slowdown yet, but in terms of your outperformance, how much do you think the environment has held up better than it appeared versus the actions you are taking, growing market share, positioning yourself in faster-growing channels, wanting more brands, more online initiatives, all these things. And can you give us a sense of where your comp growth is versus what's come from new brand launches into either the market or also online. Thanks.

Okay, so the environment of prestige beauty, I want to be clear, is strong. Actually, as we said in our prepared remarks, the prestige beauty market in the quarter has further accelerated growth. And our performance within that market is very, very strong because we continue to build market share even in an accelerating market. So, to answer directly your question, our program is working very well, and we are very satisfied, so there is a lot of our specific activity which is working, that's why we are growing market share. But the market also remains solid. This is the prestige beauty market; it's not necessarily the total economy, which is different. Prestige beauty is particularly resilient in China versus the total market. And this comes from the passion of consumers for the category, for the growth of the middle class, and very importantly from the role of young people in the overall Chinese consumer base. China is a very special market where the young generation is consuming more than their parents in many areas, particularly in prestige beauty, where the market share of prestige and luxury in the young generation is bigger than the market share in prestige and luxury in the more adult consumer. That's why prestige beauty is doing well in this moment and is also, in general, more resilient than other categories in China.

Hey everyone. I wanted to clarify and quantify what's included in your guidance, particularly regarding three areas. First, can you provide some insights on North America by channel? It seems like specialty multi has slowed down a bit, and I'm interested in understanding the growth there by channel. Second, regarding China, Tracey, you mentioned that growth is solid but somewhat moderating. Could you elaborate on what you've factored into your guidance for China? Lastly, any additional information you can share about the return on investments you're making in the second half would be helpful for understanding your expectations on guidance. Thank you.

Okay. So, I'll start in terms of the Americas in the second half. In general, we are expecting slightly improved performance in the second half from the Americas region and in particular in the U.S. for a couple of reasons. One, obviously, as we mentioned, we are not anniversarying the Bon-Ton shipments from the first half of last year. So that will represent some improvement. At the same time, we're cognizant of the fact that January, as we mentioned in our prepared remarks, has been quite soft. And everything from weather-related issues to obviously the government shutdown I think has impacted consumer sentiment in the U.S. in the third quarter. We also have very strong innovations that, as I mentioned, we are supporting globally, Clinique ID being one of them and really focused on our largest brands, some of which will be announced later. And that will, also, we expect those to do quite well, and we are investing incremental advertising in the second half in North America behind those programs. So, from a channel standpoint we expect some improvement in department stores, some continued good performance in specialty multi in particular with the traction we've seen at Ulta and Shoppers Drug Market in Canada and a few others. Online continues to grow nicely across all of the channels of distribution, retailer.com as well as our own brand.com site. In terms of the return on the investments that we're seeing in the second half, we obviously have a tremendous amount of experience, and Fabrizio suggested in his prepared remarks the improvements that we've made internally in terms of our data analytics, so we have lots of information to inform not only the new products that we're launching in the second half of the year, but how to communicate and what to invest behind in terms of marketing those products, and what generates the highest return. So that is a continual area of increasing improvement for us. And obviously, as we have seen in the first half we've showed that we had good return on the investments that we've made in that area.

Hi, good morning…

Good morning.

Can you talk about the margin on the skincare? I mean, it's phenomenal, and I guess, if you can unpack that a little bit, is it more driven by channel, is there less promotion in that, is that a function of Leading Beauty Forward, is it the growth in China and you just have to spend less to support the brands there, just trying to get a sense for a 30% plus operating margin in skincare, how sustainable is that going forward? Thank you.

So I'll start and Fabrizio may add to it, Wendy, but thanks for the question. So skincare grew at 22% in the quarter, and that's a combination of great innovation, and the investment that we put behind skincare in all markets, but in particular where we saw the greatest momentum, which was in Asia, as well as in travel retail, and we saw the benefit from those results. So that really is the predominant driver of the better margin in skincare. Skincare is also benefiting from the investments in Leading Beauty Forward. Both in terms of lower costs as well as some of the investments we've made in digital and social capability internally that has allowed us to market these skincare products in a better way. So I mean those are all contributing factors to skincare.

Yes, I would like to add that profitability is improving in skincare due to strong growth that is effectively utilizing our cost base. This growth is driven by our enhanced ability to use data to identify target groups and the best ways to reach them, including channels and investments in advertising and digitalization. The new model we are developing, which is more data-driven, is strengthening our growth and helping us better leverage our cost structure. Additionally, Leading Beauty Forward is transforming our profit and loss structure by shifting funds from fixed costs to advertising. To clarify, the entire increase in advertising is not coupled with a rise in promotions, which remain steady despite our strong business growth. This flexibility in advertising allows us to quickly allocate resources to initiatives that are performing well or pull back from areas that are not doing as well. Overall, we have streamlined our resource allocation to seize the largest opportunities worldwide, and this agility is enhancing our returns, particularly in skincare.

Yes. Hi, can you hear me okay?

Yes.

Okay, great, thanks. So I actually wanted to follow up on Fabrizio's comments there surrounding Leading Beauty Forward, both for an update on the benefits you're achieving as well as for more perspective on the cost of achieving them. I think if my math is correct and my records are correct, since the start of the year, you've raised your anticipated restructuring cost now by about 50% at the midpoint. So again, just hoping you could elaborate on what initiatives are driving that increase, what portion of those costs are cash, and whether we should view this as your point forward program costs and benefits or whether this is in effect an increase in the overall program both in terms of the cost to achieve but also hopefully the benefits also, thanks?

Yes. So I'll start and then Fabrizio might add to this. We did raise the expected benefits as well as costs of the program at the beginning of the year. So we're now expecting the full program costs to be $900 million to $950 million and the benefits to be $350 million to $450 million, once the program is complete, the full annualized benefits from the program. So yes, you are seeing higher charges this year related to that increase. The increase is driven by adding more programs to Leading Beauty Forward. We launched it in 2016, this is the last year of charges for Leading Beauty Forward, and then we realized the benefits from the ongoing program's execution. So that's the reason why you're seeing higher cost from the program. In terms of the elements of the program, we have a number of supply chain initiatives in the program to increase agility and reduce inventory levels and speed to market. We have supported an accelerated transformation in our digital and social capability through the Leading Beauty Forward initiative and have incurred restructuring charges related to that. We've established shared service operations in the organization, and that has allowed us to leverage growth, which you saw certainly this quarter in our sales much more effectively and flow more dollars to the bottom line. We have investments and savings from our procurement programs, and that has allowed us to achieve more savings in our indirect procurement spending, which we expect to continue going forward. So there are many different areas under Leading Beauty Forward that we've invested behind in the program over the last two and a half, almost three years now that we've been managing the program in order to drive the kinds of results that we're seeing now and expect to see in the future.

Great, thanks. Good morning. I guess my question for retail is for you on the comments you made on pre-tail travel retail sales. It sounds like that's become more of a sizable portion of the overall business. Can you just share a little bit more about that? And how do you think about the expansion plan for pre-tail? Any comments on what you're seeing from a customer base with Clinique ID if it's reactivating a lot of consumer bringing in a new customer? Thanks.

Yes, so pre-tail is, as I explained in my prepared remarks, is basically the possibility when you have a ticket, you're making a journey. You could instead of buying in the airport, buy online before coming to the airport and then you will get the products at the airport in some cases on the same airplane. And that's today is mainly in Korea, and I would say is only significant in Korea. So it's the beginning of the learning about this area, but in Korea, where this has started, it's becoming a significant part of the business. We believe it is a pretty good idea. First of all, it's a good service to the consumers that can decide to shop while traveling even without investing the time to go to the store, so it's a good convenience process for the consumer. But interestingly, it impacts improving conversion because we estimate that between 10% to 15% of travelers buy anything. Obviously, if you had the possibility to conveniently buy online and take your time to choose, this can increase the amount of conversion. So this can be overtime in other booster of the overall market potential in travel retail, in our opinion because it can be conversion boosters overtime, but to be very clear, for the moment, it's mainly a Korean reality. Second question is Clinique iD; we see very promising initial results from Clinique iD. The consumers are very interested, they are trying the product and, by the way, the advertising spending behind the brand is just starting, and we will see more in the next months and the large majority, actually, will be in quarter four. So there is a lot of great programs in the next six, eight months will hopefully bring Clinique iD to the levels that we believe it has the potential to go. As I explained in my initial comments, the idea of personalization is very much appreciated by the consumer and the personalization opportunity together with the high touch services that Clinique provides in every touchpoint with the consumer, together with the data, the information that we have, regarding the concerns that people have, and our ability to focus the personalization on the most promising concerns that Clinique can address; the combination of these factors we believe shows strong potential.

Yes, thanks. So just a quick housekeeping and then the real question just on the cash flow. I see for the first half of the year cash flow has been lagging operating profit. Just wanted to get some context around that, and then the broader question is, when you really think about how much your channel mix has been diversifying. I'm just curious if you're finding opportunities on the sampling line. My understanding is that that's a decent size nugget in the P&L, and so I'm just curious if you're finding opportunities to save money in that area? Thanks.

All right, Nick. So on the cash flow, as I mentioned in the prepared remarks, our cash flow was a bit less than last year, really primarily related to working capital, given the strong growth that we've had two years running now. We certainly are staging quite a bit of inventory to support growth going forward. So that combined with we had some very aggressive programs last year as it relates to payables. We're still seeing improvement in payables and receivables but less improvement than we saw last year, which was, as you recall, a record year for us in terms of cash flow growth, so that's really what's happening in the cash flow. Still quite strong as it relates to cash generation, strong enough that we purchased a fair amount for our stock in the first half with the excess cash that we had.

Sampling?

Yes, so sampling in terms of the channel mix and the samples with the growth of online that does require some sampling in certain markets. So certainly in venues in Asia and in Tmall in particular, we do have a lot of samples in that venue, less so in travel retail and a bit more mixed in specialty multi, but certainly as we see the shift out of department stores, I would say samples, in general, the cost has come down but certain channels do require more samples than others but overall sample cost is coming down.

And the only thing I want to add is that we have done some great work in the cost per sample, but the idea is to invest more in more samples in the future because trial is when you have a high quality products with the kind of rapid growth we've been able to create through early trial, the proper sampling is a great opportunity, and so we will continue to invest in the number of samples, particularly on our new upcoming very promising innovations while we are reducing the cost per sample.

Yes, good morning. Just a quick follow-up on China. You emphasize prestige a number of times when describing the market conditions and do you think that the share gains of prestige versus other channels in China have increased, largely in the mass market here? And then, just very quickly, I note no mention of France at all, am I right in thinking that for those no disruption from the yellow vest riots that we saw in Q4? Thanks.

So I'll take the second question. In terms of France, we did see growth in France, obviously, a bit slower given some of the protests, as you mentioned, but we did see growth in France. So I talked about Western Europe had mixed performance but France was one of the markets that actually did grow.

Yes, now France was good. Your first question on China, yes, well, what we mean is that again, the phenomenon of the young people in China and the middle class in general to trade up to high-quality products is continuing and is actually accelerating, so our view of the market is that high quality is paying off and they trade up to quality continues even in a situation where there are more economic concerns than in the past.

Hey, guys, so the comments on North America…

Hi, Dara.

Hey, how are you?

Good.

So the comments on North America were helpful in terms of the weak holiday season and obviously the January issues but for retail, I was hoping for more of a longer term perspective sort of setting aside January and moving past that. Do you think North America can get back to consistent growth going forward as you look out the next fiscal year and beyond, particularly with the growth in specialty and online? And maybe just preempt tonight's speech a bit and give your own state of the union on North America and thoughts there? And then also on the margin side, obviously we've seen some large compression last few years, so can that reverse at some point going forward or do you expect to see continued investment there? Thanks.

I'll start with the trend in North America. Absolutely, we believe we are on the process of turning around our North American business and we believe that we will go back to growth in North America. To put perspective on the last quarter, the quarter was pretty solid in November, but December has been a very soft month. As Tracey explained, the beginning of January continued that trend; we attribute at least part of that to the government shutdown and overall consumer sentiment that was not an easy moment to spend a lot of money in December. But our performance in November was very, very positive. When we look at the quarter results in the U.S., particularly, the market was flat. Now, the market before was growing 5%, 7%. So all the difference that we see in our performance in the U.S. in the quarter is frankly attributed to the market, not what we are doing in the market for the long term. Our agenda for the long term is unchanged and what it is, is first of all, we are investing more money; we will have more advertising power on the right priorities in the U.S., and we will see some of it taking place in the next six months, particularly in quarter four behind some great innovations that, with the helpful data, has been tailored to the American consumers even more than in the past in many aspects. Our analytical efforts have also helped our U.S. team to have a much more granular analysis of what are the opportunities by group. For example, we are focusing our existing hero products more on the Hispanic target group where we didn't have sufficient market share as an example. Our field restructuring that will be fully in place by the end of this fiscal year will allow us to execute this part of the tailoring by American region and groups in a much more accurate way than we have ever been able to do in the past. And then, to your point, the expansion in the fast-growing channels is accelerating and we are going to be in a situation where the majority of our business will be in fast-growing channels as their percentage continues to increase. Obviously, this will help the people and I want to underline we are still working very collaboratively with our department store partners to restart growth, which we believe is absolutely a possibility also thanks to the very encouraging results that in e-commerce are happening with our department store partners. It's a combination of factors that we believe will bring the U.S. back to growth in the future, and then when this will start in fact we also depend from the overall market in the U.S. and how the overall market situation will evolve and how the overall consumer sentiment in the U.S. will evolve but for the long-term, we are absolutely focused on that. Margin?

Yes, they are; and then on margin. Just a reminder that our America sector does include a portion of our corporate expenses, so in terms of what happened in the quarter, we the Smashbox impairment that we mentioned was charged against the Americas segment. The revenue recognition impact from a profit standpoint was $21 million as it just states in our press release. And then we had some of the investments that we made in IT and a few other areas that also impacted the Americas segment. We certainly expect that when the Americas segment returns to growth that we will start to see the impact from a margin standpoint. The Americas region itself is strong from a margin standpoint, but because we have some of these other items in here, it does suppress, as it always has, some of the margin results, and certainly as the sales growth has softened in the Americas, we're seeing that impact in the quarterly results currently.

Thanks so much and good morning. I'm going to pivot back to China and just ask you for your perspective on the changes that might happen amongst Daigou, the resellers who buy in travel retail, who I think are now required to have a tax ID to resell in China. So just to talk about whether you think there is an impact has been an impact, will be an impact, and then you mentioned tariffs and we also know that there's some lower import taxes I believe in the beauty segment. So putting all these different things together, how do you think each of them play out?

Let me comment on the Daigou phenomenon. Our travel retail business hasn't felt the effects of the stricter enforcement so far. It's also important to note that at Estee Lauder Companies, we have a long-standing policy that limits the number of products a single consumer can purchase in any country in our travel retail globally. We have not gained much from the Daigou business due to our strict policies designed to prevent significant identification issues and to manage these markets worldwide. This policy, which previously restricted us, is now proving to be an advantage, leading to less variability. We anticipate less variability regardless of the implications of new legislation. Currently, we do not see any impacts. Additionally, we believe that prestige beauty items are ultimately affordable luxuries, so consumers can continue to make purchases within our policy, even with the new regulations, especially for lower-priced items rather than the more expensive ones. There will also be differing factors over time. We remain focused on the long-term drivers of our travel retail business, independent of Daigou concerns, by targeting international passengers and the rising middle class to enhance our corridor. We continue to increase the distribution of our new brands, converting travelers into shoppers, which is also supported by the potential long-term benefits of the prepaid system. We are enhancing our services and exclusivity through terminal exclusive products. All these initiatives in our travel retail business have the potential to more than compensate for any limitations caused by the Daigou phenomenon.

And that's the main driver in China. We've seen the same in Russia, Brazil, and other markets that have large traveling consumers purchasing.

Thanks so much. I just want to ask something about the Middle East. And so that a business you call that is very strong. I know it's been super choppy to say the least, given distributor route-to-markets. So if you could just kind of give us an update on any changes you've made in the route-to-market, anything you've been able to do or maybe not to kind of smooth out in a shipment versus demand and manage that business differently than maybe the case two years ago.

Yes, I do say what we have seen today is just the beginning of the plan we have to reinforce in the Middle East in many aspects because what we have seen today is more of really adjustment of the stock. If you remember when there was the biz slowdown, all of a sudden there were too high stocks in the market, and because of the sudden slowdown, the stocks went very high; in the long chain that you just described, what happens is that people don't buy the new products first because they have stocks of the old products. In this slowdown, we had to break this negative cycle, and we have gone back to add more reasonable levels of stocks which means more orders of the new and more ability to involve consumers which is at the end what really counts on the power of our innovation and power of our brands. By doing that we have seen an improvement of trends. So that's the current situation. In the future, we will make further improvements that we had brands that have very high potential. They can be far the leverage we have regions with the Middle East which has high potential; they can be far the leverage of that and we have obviously get to it, and there is more enough sizing on the new innovation. To be clear, this is not yet in the results we have published so far but has the potential to be in the next couple of years in the Middle East.