Estee Lauder Cos. Inc (EL) — Q3 2021 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 our reports filed with the SEC, where you'll find factors that could cause actual results to differ materially from these forward-looking statements. To facilitate the discussion of our underlying business, the commentary on our financial results and expectations is before restructuring and other charges and adjustments disclosed in our press release. Unless otherwise stated, all net sales growth numbers are in constant currency and all organic results exclude the impacts of acquisitions. You can find reconciliations between GAAP and non-GAAP measures in our press release and on the Investors section of our website. As a reminder, references to online sales include sales we make directly to our consumers through our Brand.com site and through third-party platforms. It also includes estimated sales of our products through our retailers' websites. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Thank you, Rainey and hello, everyone. It's a pleasure to speak with you today. And I hope that you and your families are in good health. Our hearts are with those impacted by COVID-19, particularly in places like India and Brazil, that are experiencing severe resurgences. We remain committed to doing what we can to support our employees and these communities. Our third quarter of the fiscal year 2021 marks the continuation of strong sequential sales growth improvements, despite the ongoing challenges from the pandemic. We exceeded our sales and earnings growth expectations, even as several markets experienced increasing COVID-19 pressure throughout the quarter. Our multiple engines of growth strategy drove our success, empowered by the exceptional creativity and passion of our employees. We achieved these outstanding results while acting on our values. First and foremost, we continued to invest in employees and consumer safety and well-being during the health crisis. We expanded our work for the environment from setting innovative new sustainability goals in travel retail to seeing a wind farm in Oklahoma become fully operational, which is our largest renewable energy concept to date, and a project we were proud to support. We made progress on our racial equity commitments, and also outlined a new set of commitments for women to advance in gender equality, inclusive of achieving gender pay equity and globally increased representation of women from underrepresented groups. In March, we launched our new Equity and Engagement Center of Excellence, to drive greater equity representation within our business and across the value chain. We also launched the partnership with Howard University to support the success of its alumnae through experiential learning, career coaching, professional training, and mentorship opportunities. While there was joy in this progress, there was also sorrow. We stood with our employees, consumers and partners in denouncing the rise in acts of violence, hate and discrimination against the Asian and Pacific Islander community, and committed to donate to organizations that support justice and equal treatment for the Asian community in the United States. We keep our employees and communities top of mind through these challenging times. With that as our guiding principle, let me turn back to financial results. Constant currency sales rose 13%, representing a substantial acceleration of organic sales growth improvement. We delivered strong performance despite increased COVID-19 hardship in Western Europe, Latin America and parts of North America during the quarter. Estée Lauder, La Mer, Jo Malone London, Clinique and Tom Ford Beauty led the impressive performance of many brands. Skin care and fragrance once again delivered superior sales growth, although they had the toughest comparison to the year-ago period. In fact, our skin care category was nearly 30% larger on a reported basis this quarter than it was two years ago, owing to innovation in our powerful Hero franchises, strength across multiple subcategories and the addition of Dr. Jart, but before the future inclusion update. In our fragrance category, it was 16% bigger than it was in fiscal year 2019 on a reported basis, driven by our strategic focus on the luxury and our seasonal segments. Both of these categories now have even greater scale to capture prestige beauty share as the recovery unfolds. In the third quarter of fiscal year 2021, we focused our investment decisions on engines of growth and employed cost discipline in other areas, resulting in a near doubling of adjusted diluted earnings per share versus the prior year period. While the complexities of the pandemic are ever present, adjusted operating margin nonetheless exceeded that of the third quarter of fiscal year '19. And adjusted diluted earnings per share was 5% higher. Throughout the pandemic, we have been steadfast in our commitment to the long-term, as we successfully navigate the short-term. We continue to strategically invest to drive sustainable growth, including building an end-to-end Innovation Center in Shanghai, and a state-of-the-art manufacturing facility near Tokyo. These are expected to open in calendar year 2022. More recently, several of our brands decided to participate in the new partnerships of Sephora with Kohl's and Ulta Beauty with Target, beginning in the second half of this calendar year. This new consumer coverage represents the promising evolution of the retail landscape both in store and online in the United States for prestige beauty. We also agreed to increase our ownership in DECIEM, becoming majority investors with the path to full ownership in three years. DECIEM, with its fast-growing brand, The Ordinary and new brand incubation capability aligns well with our multiple engines of growth strategy. The Ordinary further diversifies our skin care growth engine by consumer segments, price point and geography with a superior online business. The brand has redefined entry prestige with an increased ingredient focused regimen-based product portfolio that drives basket size. The Ordinary has quickly established itself as a top five skin care brand in U.S. prestige beauty having improved its rank significantly over the last year. Sustainability is integral to DECIEM equity, products and retail practices, which will announce our sustainability brand portfolio and fuel the achievement of our ESG strategy and goals. We look forward to continuing the exciting journey with Nicola Kilner and her incredibly talented team to realize DECIEM's global opportunity. In the third quarter, the Estée Lauder brands delivered stellar results led by strong double-digit growth in skin care, sequentially improving trends in makeup and the return to growth in fragrance. The brand is driving a renewal in the skinification of makeup trend with a significant growth of its Futurist franchise and its new Beautiful Magnolia fragrance is off to a very promising start. The Estée Lauder skin care franchises performed exceptionally well led by Advanced Night Repair and its recently reformulated namesake serum. Revitalizing Supreme also was a standout as the launch of Supreme Bright proved highly sought. Supreme Bright is an amazing story of East to West success. With the product born in the brightening trend in Asia, and realizing global appeal for its uneven skin tone benefits. Re-Nutriv, new eye serum surged and created a halo effect for the franchise phase in eye creams. La Mer's performance was once again outstanding. The brand's worldwide success is multifaceted from both loyal and new consumers and with an increase in demand from men who now represent more than 15% of sales in mainland China. La Mer's iconic product, rich storytelling, and ideal merchandising, aligned to deliver the successful journey during the renewal campaign for Chinese New Year as well the brand executed a superb global campaign focused on moisturizers. The new Genaissance de La Mer, the concentrated night balm continues to spark consumer desires elevating the brand's ultra-luxury franchise. Clinique's sales growth accelerated sequentially and rose in every region driven by its skin care portfolio. From consumers' excellent response to the new Moisture Surge in the United States to even better Clinique interrupter fueling substantial growth in mainland China to in-demand Hero franchises like Dramatically Different Moisturizing, Clinique prospered. Our luxury and seasonal fragrances realized significant growth in the Americas and Asia Pacific. Like skin care, fragrance offers a means to express self-care and that showed through the emotional comfort of scent. We are seeing strong repeat from the emerging category in Asia Pacific. While we continue to welcome new consumers in the region. These trends in fragrance are driven by our strategic shift to the higher end, which is favorable to margin announcements in the category. Jo Malone London, Tom Ford Beauty, Kilian Paris, Le Labo and Frédéric Malle each grew double digits. Innovation and Hero products work in harmony to fulfill consumer desires with newness from Jo Malone London and Tom Ford Beauty incredibly well received. Kilian Paris, virtual selling, which engaged founder Kilian Hennessy, influencers, and education ambassadors through live chat and shoppable live streams contributed to superb online growth. Each region grew this quarter, led by Asia Pacific, which saw sales rise in every category and many countries contributed. Mainland China was exceptional, delivering sequentially accelerated double-digit sales growth with skin care and fragrance performing ahead of the previous quarter and makeup returning to growth at double digits. Both brick-and-mortar and online thrived, driven by the strong equity of our brands, desirable innovation, high-quality products leading to repeat purchases, competitive investment in advertising, and investment in local talent and capabilities. For the Chinese New Year, we met the consumer where they chose to shop, serving the local consumer as well as the traveling consumer in Hainan, both in-store and retail to tremendous success. Online continues to be a powerful growth engine. As global sales increased strong double digits in every region. Sales of brand.com, third-party platforms, and retail.com rose strong double digits, while sales of pure play grew triple digits as we are building our consumer coverage with select pure play retailers. Our online channel is now nearly double the size it was two years ago. Importantly, the media value of brand.com continues to rise as live chat, virtual try-on and live streaming led to increased traffic and time spent on our sites. EMEA online sales increased near triple digits, while Latin America's growth was also very high. We adaptively met consumer demand in these regions, which were more pressured than others from temporary brick-and-mortar closures. In Asia Pacific and North America, where installed traffic is gradually improving in comparisons to the prior year, are increasingly more difficult, online sales still grew double digits. We are innovating in the high-touch online consumer experience and harnessing our data to increase engagement and drive sales. Let me share two examples from EMEA. In the United Kingdom, Clinique launched an integrated platform to deliver seamless end-to-end high-touch virtual experiences with a personalized data-led version of its Skin School on demand. Clinique is providing consultants with data to unlock more sophisticated recommendations with a multitude of tools to ensure the consumer experience is customized based on preferences. Consultants can now enable co-browsing and the adding of friends to services. This new platform, while still in its early days, is delivering above-average conversion rates. La Mer enhanced its digital experiences with more expert classes and one-to-one consultations tailored to local consumers. The brand expanded live chat to every market in the region with standard hours and additional days leading to incredible growth in conversion. All told, La Mer saw its regional online mix of business surge. Our brands are investing for growth with social media platforms. Too Faced introduced a new virtual try-on lens on Snapchat to add to its growing portfolio of virtual try-on experiences. On TikTok, it launched a mini movie showcasing the transformative experience of Better Than Sex Mascara via its first world premiere on the platform. Dr. Jart appears color correcting treatment, targets strong online sales in the United States for the brand amplified by social selling, TikTok and influencer support. Looking ahead, we are preparing for a renaissance in makeup. And we anticipate that momentum will gradually build around the world, driven by local reopening and social and professional occasions. Our data and insights are driving new creativity to inspire consumers as they increase their occasion-based makeup. We are strategically well-positioned to grow our sales and capture prestige beauty share in makeup recovery with our Hero products, robust innovation pipeline, analytics engine driving aspirational intelligence, and enticing in-store and online activations centered on the omnichannel consumer. Already in the third quarter newness from Clinique's even better franchise in foundation and concealer was highly sought as we saw consumer restocking their core makeup products. Too Faced's new Lip Plumper was a major hit. Hero products like Tom Ford Beauty eyeshadows, mascara from Too Faced, and Bobbi Brown also performed very well. MAC is launching a new mascara, and there is exciting innovation from many brands to come. In closing, we delivered outstanding performance despite the resurging impact of the pandemic in many countries. We lead with our values as we continue to prioritize the safety and well-being of our employees and consumers. We made progress on our environmental goals and acted on our social commitments. We invested in accelerating drivers for sustainable growth, including innovation in China, manufacturing in Asia Pacific, global online and consumer analytics. For the long term, we are confident that our multiple engines of growth strategy will continue to create value for our stockholders. I want to say thank you to our employees who are integral to our success in making us a better company through this difficult moment. We are beautifully positioned in prestige beauty to continue driving recovery with the house of the most dedicated and talented employees. I will now turn the call over to Tracey.

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

Great, thanks. Good morning.

Good morning.

Good morning. I would like you to discuss the Asia Pacific region. Although the trends are strong on a two-year basis, this quarter showed some slowdown. I understand that during the fiscal second quarter, the 11.11 shopping event is likely a much more significant holiday compared to Chinese New Year. However, it seems the overall performance in Asia didn’t meet expectations. Could you provide more insights on the trends in Mainland China compared to Hong Kong, Japan, and other regions where there may have been a slowdown? Additionally, I would appreciate your thoughts on Hainan and whether shopping there is replacing purchases that would have occurred in other Asian markets as Chinese consumers are now making more purchases at home instead of traveling overseas. Thank you.

Yes, definitely. I'll begin and then Tracey can share her thoughts. First of all, we see China as extremely robust. Our reported growth stands at 63%, nearly doubling from last quarter. China Mainland is performing exceptionally well. This figure includes Dr. Jart, another strong brand in Asia that is now part of our portfolio. Regarding Hainan, it has also shown strength and continues to grow. We focus on catering to the Chinese consumer, whether they are traveling to Hainan or shopping in their own cities. There is a significant opportunity in serving the expanding middle class, particularly in smaller cities that are emerging as important consumption hubs with a consistently growing demand. We are addressing this growth in Tier 3 and Tier 4 cities, ensuring we reach various consumer groups both in the mainland and in Hainan during travel. Thus, we maintain a strong belief in China's positive trends moving forward. Another noteworthy aspect is the recovery of the makeup sector in China, which is ahead of other regions in controlling COVID-19. This has allowed people to return to shopping with greater confidence, particularly in physical stores. We’ve observed encouraging growth in makeup sales, which reflects potential recoveries in Western markets as brick-and-mortar sales stabilize in the new normal. As for the broader Asian market, Hong Kong remains smaller than its previous status and is recovering more slowly, still trailing historical levels. Japan has faced challenges with new COVID-19 waves, leading to renewed closures and restrictions on in-person shopping and social activities, thereby impacting makeup sales significantly. In contrast, Korea has initiated recovery and saw a better quarter, as did Australia, where the reopening of stores has stimulated more social interactions and a visible recovery in makeup sales. Overall, Asia presents a mixed picture: very strong performance in China and Hainan, improved results in Korea and Australia, while Japan and Hong Kong continue to struggle significantly.

And you covered it, Fabrizio.

Great, thanks. Good morning. Fabrizio, I was hoping you could share a little bit more about the renaissance of makeup you spoke to in China in particular. How is the consumer interacting with the category there? Are there new trends that they're starting to embrace? And then are they sticking with virtual try-on and some of the new ways of shopping like social selling or live streaming, or do you anticipate testers or samples coming back? Just curious on some of the behavior behind that category there.

We notice that the recovery in makeup is largely supported by the resurgence of brick-and-mortar shopping, as consumers enjoy interacting with products and the social experience of shopping together. This trend is particularly strong in China as recovery momentum builds. In terms of product preferences, particularly in China, we see people returning to their fundamental makeup items since they haven't used them for a while and may need replenishment. This leads to increased purchases of foundational products like lipstick and mascara. Different regions show varying demand for these categories, but overall, there is a significant interest in new products. Consumers are eager to embrace a "new normal" and move past the challenges of the previous year, seeking novelty in their makeup choices. To address this, we are strategically planning across different regions to align with the timing of this recovery. We aim to reintroduce core products while also offering innovative new items, new applications for makeup, and looks that align with the renewed focus on user education. Makeup is not just about shopping; it plays a role in consumers' social and professional lives, so we are analyzing how these occasions arise and what makeup products will appeal for each one, as they differ by region. Through this analytical approach, we are preparing for a tailored comeback, ensuring a precise management of investments without excessive focus on unproductive subcategories. Our enhanced ability to leverage analytics allows us to not only gather more insights into current trends but also to predict future behaviors, which is the focus of our ongoing work.

Great. Thank you.

Hi. Good morning, everyone.

Good morning.

I wanted to ask about the recent new hire for the online President that you've brought in from the outside. I mean, obviously, the online business for you has done incredibly well over the last 10-plus years. And so just wanted to get your thoughts on kind of what the priorities will be for new leadership, especially given that they do have outside perspective on both CPG and retail? Thanks.

Yes, of course. First of all, Gibu has been with us for several months now and is an exceptional new leader, well integrated into our organization. He will elevate our online business significantly. While we have performed well for many years, he is positioned to take it to a completely new level. The primary focus is to maintain our growth and capitalize on the substantial acceleration in every channel, including our website, third-party platforms, pure play sites, and retail. We need to ensure the circulation of best practices worldwide and learn from what is happening in every aspect of the business, including what our competitors and retailers are doing. Central to this effort is the addition of more technology to enhance the consumer experience at every touchpoint, making it high quality and increasingly competitive. Our goal is to elevate the consumer experience. I've previously mentioned innovations like chats, virtual try-ons, live streaming, and other potential experiences that must continually improve and pleasantly surprise consumers. If we execute this well, we will drive traffic to our online presence, not only through our excellent brands and innovations but also because of our exceptional online services and seamless experience. Additionally, we need to ensure that these improvements are implemented efficiently, supported by technology, and are consistent globally, allowing us to scale quickly as needed. Lastly, another priority is to enhance the efficiency and effectiveness of digital advertising, especially those linked to eCommerce, and to continue driving conversion, which will be a significant challenge and opportunity in the online space over the next year.

Hey, guys.

Hello.

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

Our travel retail business is seeing growth, particularly as domestic travel in China offsets the decline in international travel globally, especially in the west. We anticipate that the current strengths in travel retail, driven by domestic travel in regions like Hainan and emerging centers such as Shenzhen and the Greater Bay Area, will continue to be robust. When international travel resumes, we expect it to create additional opportunities, especially in the west where more travelers will begin to travel again. We believe that travel retail will emerge even stronger than historically, primarily focusing on current domestic travel. Travel retail relies heavily on traffic, which relates to the future recovery of international travel, as well as conversion, which is the percentage of travelers making purchases. We've noticed a recent increase in conversion rates, fueled by pretail, which allows customers to buy online while traveling. This trend is growing rapidly in Asia, now accounting for about one-third of business in various regions, though it remains less developed in the west. We foresee continued growth in pretail, significantly impacting travel retail. With the expansion of pretail, we expect to see enhanced growth in conversion rates, indicating a very positive outlook for the future of travel retail.

I would like to add that we are closely monitoring traffic and travel patterns. Currently, international travel is not expected to recover until possibly the second half of fiscal '22. We are keeping a close eye on this situation, as an earlier recovery would positively impact the international travel retail business. Meanwhile, our travel retail team has done an excellent job managing investments in the Western travel retail markets until we see improvements in traffic and consumption. Additionally, travel retail and online sales currently constitute over half of our total business. Considering our growth momentum and the anticipated recovery of both online and travel retail, we are optimistic about our future growth prospects.

Great. Thanks.

Hey, good morning, folks. Thank you for slotting me in.

Good morning.

Good morning. I want to return to the first question about the growth being slower than expected. What surprised me was the sequential drop in revenue. I understand that Q2 is usually stronger than Q3, but the decrease from Q2 to Q3 was more significant than usual across nearly all regions, particularly in Asia Pacific. I have a couple of questions: Was last quarter's performance perhaps inflated by some retailers re-entering the market and restocking inventory? Or are we experiencing a more noticeable setback? I know you've mentioned some markets tightening, but overall, it seems like the world is gradually reopening, though not uniformly. Please help me understand why we are seeing this sequential dip.

Yes. I mean, I will start, Jason. I think that what we're seeing more and more in the business particularly in Asia Pacific is more seasonality of the business. So Q2, as you indicate has become a very large quarter for us. It always was a large quarter with holiday. But with the addition of 11.11 and tremendous growth of that holiday year-over-year, we're seeing a very large sales number in our second quarter. In the third quarter, as Fabrizio mentioned, China had a very strong third quarter. We did have some large markets in Asia that were a bit softer, Japan. And I think through this pandemic, we are going to see ups and downs until things really more sustainably get back to normal when vaccine rates obviously accelerate a bit. So I would not read anything long-term into it other than this is still part of the pandemic in terms of seeing up and down performance in various markets. Similarly in terms of EMEA as well, obviously, outside of travel retail, but the Western markets in EMEA were also quite challenged in the quarter as well. So that we expect to see until, again, we see more stabilization and normalization from the pandemic.

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

Operator, next question?

Good morning. Thanks for taking my question. So, Fabrizio, I guess going back to your comments of skin care and fragrance have now exceeded FY '19 levels. So I was curious, as you look at makeup going forward, do you see any structural impediments in your business to get back to where makeup was pre-pandemic from a sales perspective?

No, I would definitely not say that. We are optimistic, again, as COVID subsides and as things start to open up. As I've mentioned before, makeup relies heavily on user education. The education about makeup is crucial during social and professional events that were affected by closures or high pandemic activity, leading to reduced consumption. We firmly believe there’s no reason we wouldn't return to stabilization and then growth in makeup as these social and professional occasions resume. It's important to highlight that our current drivers include the Chinese consumer, global online sales, the skincare category, and the high-end fragrance category, all of which will continue to propel our growth. These areas have seen a boost from COVID, but their growth was strong even before the pandemic, and we are experiencing significant success with these drivers despite COVID conditions. As we move forward, we anticipate new drivers emerging alongside the recovery from COVID, such as increased makeup usage, improved brick-and-mortar productivity in various markets like the U.S., U.K., Japan, continental Europe, and emerging markets that have been severely impacted by COVID. As the situation improves, we expect younger consumers, particularly those interested in makeup, to return to consumption, along with the recovery of TR outside of Hainan and the acceleration of pretail. Over the next 18 months, we see a pace of return from COVID that will require us to focus on these new drivers. We have also built new strengths during COVID, including enhanced innovation in Asia centered in Shanghai, leading to higher repeat purchase rates, increased skincare and makeup skinification, and expanded high-quality production capacity at our upcoming Tokyo factory. Additionally, our better understanding of consumer trends, driven by our investment in analytics, along with increased resources for advertising, especially digital, and improved online services will contribute to our success. Our brand portfolio has strengthened with the acquisition of DECIEM and Dr. Jart, and we've made significant investments in every ESG initiative during COVID. All these factors combined contribute to our new strengths. We believe that our current drivers will continue to perform well, new drivers including makeup will rebound, and the strengths we've developed will propel Estée Lauder Companies forward. Therefore, we see this quarter as a confirmation of the solid long-term sustainable growth path we are establishing for the company.

Okay, great.

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

Okay, great. Thank you.

Hi. Good morning, everyone. So I wonder if you can just provide some comments on how you're thinking about that operating margin for fiscal '21, which I think you said was 18.4%, but correct me if I got that wrong. I mean, you noted this quarter that they're temporary but also longer-term cost savings are substantially lower. Operating costs in the store with the shift online, there are some subsidies in play, but you're also reallocating costs for the longer term for brick-and-mortar to online, channel mix is obviously going to be a dynamic going forward. And I guess getting back to it, I wonder how you view this fiscal '21 target? Do you think that you can move up from there with all the initiatives that they have noted, or would you expect some sort of a step back as you weather some of these costs coming back into the base and channel mix evolving over the next year? Thanks so much.

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

Thanks so much for the perspective.

Just thank everybody for obviously their interest in the company. And again, I think we want to thank all of our teams for the fantastic performance navigating through what has been a difficult year, but we are incredibly proud, as I mentioned and Fabrizio mentioned of our results. And certainly, we look forward to closing the year strong with the guidance that we provided. So thank you, everyone.