Estee Lauder Cos. Inc (EL) — Q4 2020 Earnings Call Transcript

Hello. On today's call are Fabrizio Freda, President and Chief Executive Officer and Tracey Travis, Executive Vice President and Chief Financial Officer. Since many of our remarks today contain forward-looking statements, let me refer you to our press release and other reports filed with the SEC, where you'll find factors that could cause actual results to differ materially from these forward-looking statements. To facilitate the discussion of our underlying business, the commentary on our financial results and expectations is before restructuring and other charges and adjustments disclosed in our press release. All net sales growth numbers are in constant currency. You can find reconciliations between GAAP and non-GAAP figures in our press release and on the Investors section of our website. For clarity, I would like to remind you that references to online sales include sales of our products from our online channel, including Brand.com and third party platforms, as well as estimated sales of our products through our retailers’ websites. During the Q&A session, we ask that you please limit yourself to one question so that we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Thank you, Rainey, and hello, everyone. Fiscal Year 2020 was truly a year without parallel as we delivered one of our strongest first halves on record and navigated with agility through an unprecedented pandemic in the second half. In both of these dramatically different halves, our employees led with extraordinary passion, creativity, and resiliency. Our hearts continue to be with everyone impacted by COVID-19, and we remain focused on the safety and well-being of our employees, their families, and consumers. The second half of our fiscal year also marked a period of profound pain, strategic events in the United States highlighted the systemic racial injustice that has plagued our society for far too long. In June, we announced a comprehensive set of commitments to act with urgency on achieving racial equity. We stand in solidarity with our black employees, black consumers, and black communities and certainly know black lives matter. Among our many commitments, we are listening and learning to foster stronger internal culture and advocacy and inclusion. We are focusing on talent and opportunity to ensure that we are providing more equitable access to professional development and advancement for our black employees. We are ensuring that the end-to-end creative process accurately and consistently represents the black experience and engages black professionals. We are investing for change through a three-year $10 million pledge for the company, our brands, our foundation, employee matching gifts, and the Lauder family to support nonprofits and are in the process of making the initial $5 million donation. Since announcing our commitments, we have held 30 town halls with our employees and began to identify gaps in our professional development and advancement opportunities for our existing black talent. We have also engaged a diversity-focused recruitment firm and created new diversity recruitment resources. We are committed to doing more as a leader in our company and in our communities. In the last few months, the company and our employees have also made donations and pledges to organizations around the world to help limit the spread of COVID-19 and ease the related hardship faced by the communities in which we live and work. We made hand sanitizer for frontline workers, high-risk individuals, and our employees. The production continues at our facilities in the United States, the United Kingdom, Belgium, and Switzerland. Our brands have found meaningful ways to offer support, and Aveda is a shining example; its initiative for salon owners and stylists serves to connect, educate, and provide financial and business assistance. By offering standard payments terms, online sales, reopening toolkits, and over 1,000 hours of virtual education, Aveda actively assisted its network during this challenging period of salon closures. Turning now to the year's performance. In the first half of fiscal year 2020, sales rose 14%, and adjusted EPS climbed to 20%. Our continued outperformance yielded strong global prestige beauty share gains. In fact, our gains accelerated in calendar 2019. We were well on our way to a third fiscal year of double-digit sales and adjusted EPS growth. Despite extensive temporary store closures worldwide in the second half as the COVID-19 pandemic took hold, sales fell only 20%, and we were profitable as we quickly pivoted online to capture consumption and adjusted our cost structure. Our multiple engines of growth strategy, which has powered our success for over a decade, continues to be highly effective. The company diversified prestige beauty portfolio gives us many levers to drive the business. Our robust global skincare portfolio, vibrant online business, and broad exposure to Asia-Pacific are the engines of this moment. And we enjoyed both strong and growing prestige beauty share and profitability. Across these engines, the Estée Lauder brand's performance was magnificent in fiscal year 2020, as it achieved its third consecutive year of double-digit sales growth. Impressively, the brand hero franchises of Advanced Night Repair, Revitalizing Supreme, Perfectionist, Re-Nutriv, and Micro Essence all contributed meaningfully to growth. For the fiscal year, skincare performed exceptionally well; Estée Lauder, La Mer, Tom Ford, Origins, Darphin, and Le Labo drove growth organically, while the category also benefitted from the acquisition of Dr. Jart. We delivered excellent performance across subcategories, owing to strong repeat purchase rates, data analytics-driven marketing, new social selling strategies developed during COVID-19, and highly desirable innovation. Among the subcategories, demand for watery lotions is soaring as a hydrating step before serums and moisturizers in the new era of self-care. Estée Lauder Macro Essence, La Mer, The Treatment Lotion, and Origins, Dr. Weil Mega Mushroom Treatment Lotion delivered outstanding growth for the fiscal year, and we expect to continue our ability in this compelling subcategory. Beyond watery lotions, our serums in high-care subcategories are prospering. For serums, cherished heroes like Estée Lauder Advanced Night Repair and innovation from Clinique's Even Better line and Estée Lauder Perfectionist and the Re-Nutriv franchise bolstered growth in fiscal year 2020. La Mer's new Eye Concentrate, launched a few months ago, has been highly sought after as consumers are embracing its lighter texture and new claims. In EMEA, the product was the best seller on La Mer.com in the fourth quarter. Trusted brands like Clinique flourished online when brick-and-mortar closed. In the fourth quarter, Clinique's US prestige beauty share rose on retailer.com, solidifying its number one rank. Sales on Clinique.com were the largest across all our brand sites in the quarter, driven by heroes like Dramatically Different Moisturizing Lotion and Moisture Surge. Clinique's promise to deliver products that are simple, safe, and effective for skin is resonating largely online. Our online business surged worldwide in fiscal 2020. It delivered nearly triple-digit organic sales growth in the fourth quarter, which is a testament to the capabilities and scale we had built. Each of our Brand.com, brand boutiques, and platforms, such as Tmall and retailer.com doors, contributed meaningfully. On our brand sites, in particular, we delivered nearly 90% organic sales growth globally in the fourth quarter as we increased investments to offer the best high-touch services. We quickly evolved our live chat capability to offer detailed support. We also announced our virtual try-on to include more categories. We rapidly deployed live streaming first in mainland China and then globally, engaging makeup artists, as well as brand ambassadors for tutorials. Our live streams are shoppable, meaning that consumers can make purchases within the event. Across the brands, traffic grew significantly in the fourth quarter, and conversion rates rose dramatically. Encouragingly, we saw strong growth in engagement and repeat purchase behaviors. Both new and existing consumers shopped our brand sites more frequently, as exemplified by Origins and Estée Lauder in the United States, reinforcing the great work we are doing to cultivate and retain consumers through this moment. Consumers have discovered new shopping habits online that are enduring, and this is true across all ages. Clinique’s live streaming series, designed to both entertain and educate, led consumers to return more frequently, spend four times longer on site, and convert at far higher levels. The brand's live streaming event with Clinique global ambassador Emilia Clarke surpassed the newly elevated conversion levels. Bobbi Brown launched its Artistry Like Never Before program in May, offering consumers one-on-one and small group video consultations with national makeup artists. These engaging sessions range from 15 to 60 minutes, with the 30-minute makeup bag makeover sessions being the most popular. Conversion rates are incredibly strong, with a high level of units per transaction. Bobbi Brown continues to scale this program globally to meet the increasing demand. This is just one example of the many ways our brands are building community through this challenging moment, and we see this as an exciting evolution of the shopping experience for the future. Aveda, which led our brands by first launching its ingredient glossary earlier in the year, is seeing guests who engage with the glossary spend three times more time on aveda.com than average. Reacting to our commitment to ingredient transparency, Clinique, La Mer, and Origins launched their ingredient glossaries in the fourth quarter, and we have more to come in fiscal year 2021. We maintained our strategy focused on key online shopping events throughout the year. Our advanced planning for these events delivered outstanding results. For the 618 midyear shopping festival, the Estée Lauder brand's sales on Tmall tripled, and its sales ranked second among all prestige beauty brands. Our Asia Pacific region delivered superior sales growth in fiscal year 2020. Every category in the region expanded, led by accelerating growth in skincare. Fragrance also accelerated as consumer demand in the region for our portfolio of luxury and artisanal fragrances built. Mainland China performed exceptionally, with its sales rising roughly 60% organically in the fourth quarter. Korea and several other markets also grew for the year and for the quarter, driving prestige beauty share gains for both periods. In Mainland China, the premium and luxury segments of prestige skincare are booming. In fact, luxury is the primary growth driver for the total category. For this, La Mer is ideally positioned with its heritage, iconic ingredients, and superior quality. La Mer is helping to grow the category, and the brand's share of prestige skincare is expanding significantly, which is the ideal combination. Desire for our luxury and artisanal fragrances is strong in the region, and we continue to see growth. In the fourth quarter, we launched Kilian and Frédéric Malle in Mainland China with great initial interest from consumers. In Korea, our fragrance sales soared as Jo Malone London and Tom Ford grew, with our launches of Kilian and Le Labo also highly sold, collectively driving prestige share gains in the category. With air travel still largely curtailed, we are focused on meeting demand locally across the brick-and-mortar and online channels, as well as in localized destinations of travel retail. Hainan, in particular, is prospering as tourists gradually resume travel, which partially offsets the decline in travel retail in the fourth quarter. As of July, duty-free shopping allowances in Hainan have increased more than threefold, which is further boosting consumption. We continue to strengthen our leadership in the travel retail channel. Innovation is fundamental to our strategy, and even in this unique year, it represented over 25% of sales. It will play a vital role in fiscal year 2021, powering the engines of the present and the engines of the future. Coming up in these months are two big launches in skincare. La Mer launched its new Concentrate as a potent barrier serum, newly advanced with antioxidant power to serve as a double source of strength against environmental stressors and their aging effects. Estée Lauder introduced the breakthrough new generation of its brand icon, Advanced Night Repair. This powerhouse serum still has all the benefits and texture loyal consumers know and love, and now features innovative new technology. Tested on women of all skin tones, ethnicities, and ages, it now offers the fast-growing, highly desired benefits of firmness, pore minimization, and eight-hour antioxidant power on top of its existing wrinkle and uneven skin tone benefits. Its package is being modernized into a luxurious, recyclable glass bottle that supports our sustainability initiatives. We have exciting launches to come from MAC and Clinique in makeup as we anticipate trends on the horizon. Our pipeline in fragrances and hair care is also robust, with newness from Jo Malone London and Aveda, among others. Looking ahead, we are confident that we can return to our long-term growth algorithm of 6% to 8% sales growth, 50 basis points of operating margin expansion, and double-digit earnings per share growth in constant currency after a period of normalization as the impacts of COVID-19 subside. Our citizenship and sustainability goals remain on track. We are also implementing sustainable office practices in Mainland China and exploring green energy solutions there. For fiscal year 2021, we are investing in several strategic priorities intended to drive our long-term sustainable growth. Among the priorities are enhancing manufacturing capabilities, expanding online fulfillment capabilities, and further funding growth opportunities in Asia Pacific, including our new state-of-the-art innovation center in Shanghai. While the world continues to confront many unknowns related to the pandemic, certain realities have emerged that have accelerated our strategy. As online sales quickly grew, we need to more aggressively adjust our brick-and-mortar footprint and more closely align with how and where consumers want to shop. The post-COVID business acceleration program we announced is designed to rapidly relocate our resources, enabling us to invest in the greatest opportunities for long-term sustainable growth, such as online, skincare, and China. Importantly, this program would also improve the productivity and sustainability of our brand-building brick-and-mortar footprint and better position us to make it experiential and omnichannel. Tracey will discuss the program in more detail. In closing, we confidently bring the strength of the first half and the learnings from the second half with us into a new fiscal year. I want to thank all our employees for their exceptional contributions across the year and most especially during the second half; you navigated through an unprecedented period with grace and made us a better company. Now, I will turn the call over to Tracey.

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

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

So, not yet. We have not changed our point of view at this point in time on Amazon. We see such a huge long-term sustainable evolution of our online that we want to focus on that. And specifically, I want to explain what's happening online. Our last quarter, our online business was growing at double digits, and this included 90% growth on our brand.com. Great work on Retail.com came in at 80% plus and also triple digits on our platforms. This increase, particularly the Brand.com and the platforms, is increasing our direct-to-consumer business, which means increasing our data availability of consumers and increasing our ability to market these consumers. The other thing we are seeing is a dramatic increase in consumer engagement in the world of online. Because of these better engagements, we are driving loyalty and repeat purchases of our hero products like never before. And finally, we really see an increase in exclusivity, meaning the consumers that are really there are buying more exclusively our brands and our brands online. We see the arrival of new consumers across all age groups, which was not the case in the past where the younger age group was ahead. Now we see a real increase across all age groups. This is a tremendous opportunity and we will stay focused on leveraging this opportunity in the future. The other thing we are doing is investing in creating better omnichannel capability, which bridges to your second part of the question, which is what we see in stores. We see that brick-and-mortar stores are and will remain very important. But they will need to be linked more whenever possible in omnichannel ways to the online. The consumer expects the full experience and the brick-and-mortar store will need to become even more experiential to attract the right traffic on top of being omnichannel. We expect brick-and-mortar to be very important, continue being brand-building, but we need, as we explained in the prepared remarks, to rationalize it because we need to increase productivity. We need to bring back the productivity level that has been diminished by the COVID situation. Bringing back productivity will make the brick-and-mortar more sustainable for the long term, and it will continue to be an essential part of brand building.

I was hoping we could talk a little bit about North America and sort of underlying brand performance and takeaway, if you will, there. So I think anything you could share I guess one in terms of brand.com performance and then two, the degree to which existing retail inventory, so retail inventory at department stores, as an example, is redirected to fulfill online orders, such that maybe the shipment numbers that you're recording don't really give us like a full read of how the brands were actually performing during the quarter? Thanks.

Yes. So, first of all, your first part of the question: In North America, our online business has been exceptionally strong, and our brand.com business has been really exceptional. The penetration of the online business has increased dramatically to about 40%, and that's changed. Now a lot of this will be sustainable for the reasons I was explaining before. Meaning that Retail.com is increasing, and there are reasons why it would be sustainable; the engagement of the consumers there is increasing. Our brand.com increase of 90% is sustainable because we are seeing it from the consumer engagement; for the amount of time people spend on our brand.com, just to give you a sense, a few data points: the virtual try-on that we have added, or the chat with consultants that we have added, or the entertainment activities that we have added in the story explanation of innovation, all of these brought in some brands, including Estée Lauder, as an example. We have consumers that spend 26 minutes on our site interacting with us. So we see real-time interaction; the time of engagement is going up. This will make this very sustainable growth over the long-term. Joined with our new technologies, we will likely create one of the best consumer experiences over time in luxury consumer experiences, full of engagement and our omnichannel capabilities. That's what's happening now. To be clear, this was in our plans. This was part of our compass. But COVID-19 has accelerated these trends, and the speed of these trends has moved forward by at least two to three years. That’s what we have seen. Now, the impact of the COVID-19 outbreak, however, is also expected to disrupt the brick-and-mortar in the near term, and it includes the store closures in department stores, which are happening obviously in the last quarter. The highest level of unemployment is affecting consumer sentiment, particularly for the time being in the makeup category. We are managing through this, pivoting towards the online business as I explained, supported by our new understanding and granular understanding of consumer behavior and the growing availability of data drives us in our post-COVID business acceleration program, which will work to rapidly bring back productivity in our freestanding stores and in our department stores, to reactivate productivity levels in the future. Fewer brick-and-mortar locations, which is what's happening there. Now, in the short term, but also will continue in the medium term, will reduce our fixed costs and should also make the region more profitable with the different mix between online and brick-and-mortar.

And the only thing I'll add, Lauren, is the brand.com business in North America in the fourth quarter was up almost 70% and represented about 60% of the mix of business. So it was a very strong performer, as you might well imagine, and that to Fabrizio’s point was the case really across all of our markets.

Just a quick clarification. Can you confirm that online margins are accretive to the corporate average level? Just a clarification. And then Tracey, Fabrizio, how do we think about this post-COVID plan and kind of what you're targeting for online as a percentage of the overall? That 7-point increase is quite dramatic; I'm just curious how you're thinking about the evolution over the 24-month period over this program? Thanks.

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

So we finished the fiscal year '20 at a 22% online mix, as we said in our prepared remarks. We would expect online penetration to grow from there, even with the strong growth in the fourth quarter, obviously with a lot of our brick-and-mortar closed during much of the quarter. We do still expect the higher penetration in fiscal '21 of online on top of what we saw in the full year of fiscal '20 with a portion of our brick-and-mortar doors closed. So to Fabrizio's point, the acceleration of online that we are prepared to continue to sustain with all of the programs that we implemented in Q4 and expect to continue along with other capabilities we are adding in fiscal '21 should continue to sustain a lot of those consumers that perhaps discovered shopping online for the first time or at least certainly was our record of them for the first time and they continued that practice.

I wanted to ask, so your growth in calendar first half '20 was slightly above what estimated market share for prestige looked like, at least estimated by one of your larger peers, but also then slightly below the growth from that larger peer, which has been somewhat consistent in recent years. I guess, perhaps talk a bit about the dynamics of that and how you anticipate share trends to progress through your fiscal '21, maybe segment geography and what perhaps has driven some of that underperformance. Like you anticipate for the future, and kind of maybe, if we're all wrong, kind of pointing that out as well. Thank you.

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

No, and obviously, we have not provided guidance for the year for obvious reasons, as we don't know how the recovery will progress or how COVID-19 will impact global markets for the fiscal year. But as we think about the second half of the year, because I know we tried to provide you with as much as we were comfortable providing as it relates to the guidance, if you think about the second half of the year comparable, assuming that there is a gradual recovery and there's no other shock to the system, very comparable to our fiscal 2019 EPS performance. So stronger sales growth, but comparable to our fiscal '19 EPS growth. And that's with obviously the tax rate and the interest expense call-outs that I made.

The first question is on the stores that you will keep open. Can you give us some sense of what that footprint will look like, maybe by brand and by geography? And I know those stores, even though they’ve been, the ones that you're closing, they may have been unproductive, but they still have served as great ways to build customer relationships. And they're great branding vehicles and all that kind of good stuff. So how much of the savings from closing those stores do you intend to drop to the bottom line versus reinvest to offset the benefit of that branding presence, if you will, that you had historically? Thank you.

Let me begin and then Tracey might want to add some thoughts. Firstly, we are aligning ourselves with what consumers are telling us they want, adapting to the evolution of their preferences. Additionally, we are responding to the actions of our retail partners, as some are reducing their number of stores or closing them entirely. It is essential for us to reflect the market's realities and consumer preferences, which will lead us to close the least productive stores. The majority of the stores that will remain will be more productive, allowing us to transform them into experiential spaces and, when appropriate, multichannel operations. This will ensure that these stores are sustainable over the long term and serve as effective brand builders. In contrast, the non-productive stores, which lack traffic and are not functioning well, are diminishing in their capacity to contribute to brand building. Most of the remaining brick-and-mortar locations will be more productive and will serve as excellent tools for building our brand and maintaining the relationships we have cultivated. However, the unproductive locations do not foster productive relationships at this time. The positive aspect is that our online growth, particularly through Brand.com and other platforms, is becoming increasingly focused on relationship and brand building. In response to your final question, the savings generated from improvements in brick-and-mortar productivity will benefit the bottom line but will also be reinvested to enhance both our remaining physical stores and online presence, helping to foster stronger brand-building efforts and deeper relationships with consumers. Moreover, leveraging our data access will provide us with valuable insights to better manage consumer interactions and our business in the future.

And the only thing I'll add is that most of our stores are profitable. We have had a portion of our stores, as you have heard us talk about, the mix shift we have experienced over the last few years. Some of our stores became more marginally profitable and have obviously become loss-making as a result of COVID-19. As we think about recovery and what to expect in terms of brick-and-mortar recovery, those are stores that now we believe need to close. As you all know, the deleverage related to some of the fixed costs of freestanding stores when they are not productive is burdensome and certainly prevents us from being able to invest behind recruiting new consumers from a digital marketing perspective. Those are the stores that we will be taking action on. They were on that marginal bubble to begin with and certainly have become loss-making now that and we don't expect them to recover from loss-making. As it relates to our mix of stores, you can imagine that in the more mature markets, like North America and Europe, those are where the bulk of the stores are that we will be addressing. With the challenges in the makeup category, a number of them are in the makeup area, but they're not just makeup; they do comprise some other locations as well, where mall productivity has declined and street productivity has declined, but some are freestanding stores.

So I guess as we met all of that together and fast-forward to when your sales do recover to pre-COVID levels. Is it your expectation standing here today that the resulting profitability and margin against those sales will be higher than before, just given the productivity and restructuring efforts and the mix shifts that we're talking about, the online and skincare? Or are there reasons to believe that that may be delayed, given the growth reinvestments you just spoke about and maybe some residual weakness in higher margin channels like travel? I guess, a little bit more color as to how you're thinking about all that?

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

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

So I'll answer the second portion of that question. We clearly adjusted our demand plans and our forecast to be more in line with the trends that we're seeing in makeup this year, even in the recovery. One of the things that we have seen during COVID-19 is there has been even an acceleration from a penetration standpoint of interest in skincare, and we certainly expect that to continue next year. We have some great innovation programs behind our makeup brands as well. But we are adjusting our forecast to the level of consumption we expect coming out of fiscal '20 and the ramp-up through fiscal '21. So we certainly don't expect to see the same level of obsolescence unless there is another complete shutdown of business. We don’t expect to see the same level of obsolescence in fiscal '21.

And to the question of when makeup recovers; absolutely, makeup is a category coming back. What we are seeing is the impact of what COVID has created on consumer sentiment and consumer behaviors — wearing masks in many parts of the world affects lipstick; being in homes and having less interaction and less social interaction between people; and there is also frankly the stress that many are experiencing in many parts of the world. So we expect this to come back. This is a matter of two points of view. From my point of view, the makeup cycle will come back very strongly as soon as consumer sentiment improves, and we expect to see this category booming again, and we will be ready for that. That’s exactly the essence of multiple engines of growth; in this moment, it is skincare, and there is a reason skincare is so popular. Somebody was asking me if the lipstick index is finished. You all remember the lipstick index concept, where beauty is a resilient category, both in situations of crisis like this one and in particular situations of recession risk because they are affordable purchases for indulging and taking care of yourself. Consumers really love their routines. Now, this has remained exactly true also in this crisis. What has changed is the category. Because of COVID, lipstick was not the right category to indicate that, which proves the resiliency of overall beauty is evident and still varies from market. The way I answer is the lipstick index has been substituted by the more rapidly growing index, but the concept of index is still there. This is a very resilient category, and makeup will come back when consumer sentiment returns.

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

First of all, trial and discovery is going very well. What is evolving and continues to be very strong is obviously trial and discovery in-store is always the key point, but what is evolving in trial and discovery online. The way this is happening is, first of all, we are seeing consumers spend much more time. So the level of engagement, the level of relationship with our online sites is increasing. They spend time and they are discovering. Now in terms of trial, we are making very big new investments in sampling online. So you can go and purchase online, for example, on brand.com, your preferred hero products, and then you will receive samples of what our data suggests that you may like around that when you open your pack at home. In this way, we see how we are driving trial. We are driving discovery, frankly stronger than what we've ever been able to do in stores because of our ability to know what people will like based on data and our ability to interact with people more meaningfully in their online relationships. This is the moment where I believe trial and discovery can be further enhanced in the luxury business model that we are developing for our future.

I would rather ask you a long-term question, but I want you to clarify one thing that Tracey mentioned. Tracey, I think you said the second half of the year earnings performance will be the same as fiscal second half of '19. Then I think later you said EPS growth would be comparable to fiscal '19. Maybe you could clarify that as I just look back at the model you did about $2.09 in EPS in the second half of '19? I think everybody is probably going to hook models to that comment. So it would help to get a little clarification there. I guess, and I do hate to be near-term, but it seems like in the first quarter guidance bakes in about 800 basis points of an operating margin contraction. I think you said the gross margin should start to improve. Obviously, with the factories open, you'll see less of the accounting drag there from idle factory overhead accruals. I know the stores are reopening, but the SG&A was down by $0.5 billion in the fourth quarter. It seems like it should still be meaningfully lower year-over-year, even if retail starts to come back online. So I just want to make sure I understand where the pressure is on the margin that might be in the first quarter related to what you guided?

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

Fabrizio, Tracey, can you help me understand the travel retail performance in the first quarter guidance now that more than half of the quarter has passed? I would like clarification on the factors influencing the first quarter that Tracey just described. It seems that your team has navigated many of the pressures experienced in the quarter. If you could provide insights into the exit rates related to some of these expenses, that would be helpful, but my main question focuses on travel.

So, I'll start and then let Fabrizio share his perspective on travel retail. There are still travel restrictions. So travel retail is still largely closed in the first quarter, and again, we expect travel retail really to be the slowest to recover. Now, again, we are seeing traffic locally in Asia, in particular in China, and that is continuing to pick up. As Fabrizio addressed some event in his prepared remarks, we do expect travel retail to be the slowest to recover. As it relates, again, to the first quarter. Relative to the fourth quarter, I guess I would add what I’ve said just previously; we did have some furlough programs in the fourth quarter that also are not repeating in the first quarter. So that is another piece of why the expenses, if you're comparing the fourth quarter to the first quarter, might look a bit higher. It’s advertising, shipping costs, and we do have some of the furlough programs that we had in the fourth quarter that will not be repeating. Probably for — when you look at the quarter, a more comparable quarter would be the third quarter of last year relative to our first quarter of this year in terms of overall performance.

What I will add on travel retail is that, first of all, in the long-term, we believe travel retail will continue to be a very exciting channel. In this moment, the traffic is at very low levels. But for example, the conversion of travelers into buyers is increasing dramatically. Asia is the biggest path to travel retail globally, and the good news is Asia is going to recover faster than the West, the traveling traffic, and the conversion driven by retail. The good news that is happening is that travel retail's sales in the last quarter, which amounted to minus 30%, have been better than what we feared, particularly due to the many closures around the world. The primary mitigating factor is that internal travel in China is positively affecting retail. The extraordinary increase of what the Chinese are buying within their local duty-free travel is helping mitigate the lack of very limited international travel. When international travel will resume, this local internal travel will not go away, making for a stronger and even more exciting long-term travel retail market to manage; we are currently the market leader. There is a lot of long-term potential for that, and I'm very excited to see what's happening in Hainan for the future.

The last piece of your question, in terms of quarter four versus quarter one, clearly we were down 30% in sales in Q4 and progressing to down 11% to 12% in Q1. We are seeing a pickup in our brick-and-mortar business. In July, in fact, as Fabrizio indicated, we actually had positive sales growth. This was related to some of the restocking that we saw in the trade for doors that had been closed and are now reopening. We are seeing positive signs that we will expect to continue to see throughout the first half, even as brick-and-mortar recovers more slowly than obviously the strength we are still seeing online.

First, just a follow-up. Did you just say that July was positive overall or specific to a channel? And then just generally speaking, I wanted to ask about the balance between containing costs and supporting the top line, because it's clear that your investments resonated in the top line in the last couple of years pre-pandemic. As we think about the timing of you getting back on your long term algorithm clearly with a focus on efficiency. Can you talk about how the organization plans to balance achieving both of those things concurrently? Thanks.

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

In terms of balancing the top line and the bottom line; we intend to remain a high-growth company. We are really focused on growth, but we are also focused on profitable growth. In the short term, we are going to maintain focus on cost containment to make sure that we preserve resources to invest in growth. The cost containment in our program is never shorter; it is always designed to preserve and reallocate resources for investment in long-term growth and to drive profitability at the right level. That’s the way we think about it. In our compass and our strategic process, we are very focused on identifying the key areas of growth and the key areas of sustainable profits, and we are investing in them disproportionately and continuously reallocating resources in those areas. That’s what we talk about. I would also like to close, if this is the last question, saying that in this COVID crisis, as we try to do in every crisis, I truly believe we are coming out as a better company. Yes, we are focused on profitability, but this company can go back to being high growth and strong profitability, and we will be a better company in inclusion, sustainability, and technology. All of these together will make us also a better employer and stronger in loyalty, both to employees and consumers. I think that’s a very important value for the company we are, which has a very long-term focus. I think this crisis has been managed in a way where we remain a long-term-focused company and, post-crisis, we’ll be a better company.