Estee Lauder Cos. Inc (EL) — Q2 2022 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 those 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 net sales growth excludes the non-comparable impacts of acquisitions, divestitures, brand closures and the impact of currency translation. 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 sites and through third-party platforms and 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 that we can respond to all of you within the time scheduled for this call. And now, I will turn the call over to Fabrizio.

Thank you, Rainey, and hello, everyone. It is good to be with you today as our hearts continue to be with those impacted by COVID-19 around the world. We achieved record sales and profitability in the second quarter of fiscal year 2022. Our multiple engines of growth strategy showcased the benefit of its diversification. Every category, region, and major channel expanded. We seized the favorable dynamics of skin care and fragrance in developed markets in the West, brick-and-mortar, and continued to prosper in the East with Chinese consumers as well as in global travel retail and global online. The flexibility we built into our business model over the last decade enables us to allocate resources to attractive growth opportunities and effectively manage the impacts of an increasing inflationary environment. Our advanced planning for key shopping moments like 11.11 and holidays allowed us to overcome supply chain obstacles. For our second quarter, reported net sales grew 14%. Organic net sales rose 11%. Adjusted operating margin expanded, and adjusted diluted earnings per share increased 15%. Today's results are all the more impressive compared to the pre-pandemic second quarter of fiscal year 2020 when we delivered record organic sales growth in our seasonally largest quarter. Despite the ensuing challenges of COVID-19, which escalated during the quarter with Omicron, we far exceeded the exceptional results of two years ago. Reported sales are 20% higher driven by organic sales growth and with every region now larger, and we are much more profitable. Our gains during the last two years reinforced our confidence in our ability to navigate the impacts of the prolonged pandemic. Moreover, our optimism in the opportunities of tomorrow remains incredibly strong, owing to the timeless desirability of our brands and our commitment during the pandemic to invest for the near- and long-term. Our brand portfolio of large, scaling, and developing brands served as a powerful catalyst for growth as consumers reward the quality of our trusted brands and hero products. In the second quarter, 11 brands achieved double-digit organic sales growth versus the prior year period. This broad-based trend is similar to the contribution in the first quarter despite a far tougher comparison. The momentum in our largest brands, Clinique, Estée Lauder, La Mer, and M·A·C continues as the hero franchises capitalize on innovation in product engagement and high-touch experiences and services to drive trial and repeat. La Mer and Clinique delivered standout results in skin care, while Estée Lauder and M·A·C drove a makeup renaissance. Our scaling and developing brands achieved excellent results. Jo Malone London and Tom Ford Beauty led fragrance and were among our top-performing brands, while Bobbi Brown grew strongly driven by skin care. Aveda and Bumble and bumble delivered accelerating sales growth in hair care as Too Faced and Smashbox rose double digits in makeup. Product innovation also served as a powerful catalyst for growth across our brand portfolio, contributing nearly 25% of sales. This level of contribution is notable in a quarter when holiday exclusives represent a larger mix of business and especially so in a challenged supply chain environment. La Mer, fueled by its iconic heroes on-trend holiday merchandising and highly sought new dehydrating infused emotion, led the Company's sales growth. The brand excelled in every region and across major channels, cheered by its loyal consumers and embraced by a new cohort of consumers, including more men. Clinique's skin care portfolio with its desirable innovation and hero franchises performed strongly. Its new Smart Clinical Retail Wrinkle Correcting Serum drove sales gains in North America, amplifying the brand's global momentum in the serum subcategory. Clinique Take The Day Off makeup remover saw a dramatic uptick in sales, evidence of makeup's emerging renaissance and the staying power of this crowd favorite skin care product, which is recruiting a new generation of consumers. For makeup, the Estée Lauder brand is a driving force in the category's emerging renaissance, with makeup sales for the brand already larger than two years ago. Estée Lauder Double Wear hero franchise delivered remarkable performance, while its Futurist foundation, which is an East to West product born of the skinification of the makeup trend, was very strong. Our fragrance portfolio continued to go from strength to strength, owing to the enduring sand-based ritual created in the pandemic and enhanced by innovation. Better online storytelling and expanded reach as consumers in the East embrace this category. Each of Jo Malone London, Tom Ford Beauty, Le Labo, Kilian Paris, and Frederic Malle delivered strong double-digit growth in every region, demonstrating the appeal of these brands around the world. Tom Ford Beauty exemplifies the benefits of a strategic focus on heroes and innovation. Its Ombre Leather Parfum had a halo effect on the Ombre Parfum such that sales for the franchise doubled. In the third quarter, the brand is leveraging its global appeal with the flare of local relevance in the fragrance launch of Tom Ford Trilogy. Our growth engines also continue to diversify by region as we anticipate. Developed markets in the West performed especially well. North America executed with excellence to capture brick-and-mortar reopening trends and deliver a strong holiday across channels. Festive seasonal exclusives, including the Estée Lauder blockbuster set and Aveda collaboration with Phillip Lim, proved highly sought. Indeed, our in-store and online activation and merchandising were incredibly successful, with brand.com posting a record Black Friday. Every category grew double digits organically in North America led by makeup where our brand paid trusted product with enticing innovation as social and professional user education increased. M·A·C, Bobbi Brown, and Too Faced produced engaging content and artist-led education to inspire consumers to seize the joy and creativity of the category. Mainland China delivered high single-digit organic sales growth, an impressive result given the regional restrictions in the quarter, the pressured brick-and-mortar, and makeup. Online sales rose double digits organically, even after having posted significant growth in the year-ago period. For 11.11 on Tmall, the Estée Lauder brand ranked number one flagship store in beauty for the second consecutive year, as La Mer flagship store topped luxury beauty once more and Jo Malone London again led in prestige fragrance. On JD, the Estée Lauder brand ranked number one flagship store in beauty in its first year. Skin care and fragrance grew double digits organically in Mainland China. Hero products and innovation excelled, driving new consumer acquisition and repeat purchases. Several brands expanded prestige beauty share in the quarter, including Estée Lauder, La Mer, and Dr. Jart+. Looking ahead, we are excited about the long-term growth opportunity in the vibrant Asia/Pacific region and, most notably, in China. We are a few months from opening our new innovation center in Shanghai. Our aspirations for it are bold as we aim to meet and exceed the desires of Chinese consumers. The center is designed to enable end-to-end innovation from concept, product packaging through development, scale-up, and commercialization. I am pleased to share that the build-out of our state-of-the-art manufacturing facility near Tokyo is also progressing very well, which is a testament to the amazing work of our global supply chain team amid the pandemic. Its first phase is complete, and we are on track to start limited production by the first quarter of fiscal year 2023. Our growth engines further diversified by channel as both online and brick-and-mortar prospered. Specialty-multi and department stores contributed meaningfully, and freestanding stores in the West performed very well on reopening. Traffic improved and complemented our strategic actions, including those under the post-COVID business acceleration program to benefit productivity in brick-and-mortar. This channel trends are encouraging for the long term, even if tempered in this moment by Omicron. We continued to expand our omnichannel capabilities in the quarter to give consumers flexible and convenient shopping options for greater certainty for fulfillment. Buy online, pickup in-store offerings in the United States for M·A·C, Aveda, Jo Malone London, and Le Labo are driving favorable average order value trends, and we are expanding the capability to more doors internationally, which holds great promise for the future. Our global online channel delivered excellent performance, with organic sales rising high single digit after having surged over 50% in the year-ago period. Each of brand.com, third-party platforms, pure play, and retail.com contributed to growth. The drivers included higher levels of engagement for virtual try-on tools for choosing shade and scent, and improved live streaming. Indeed, in North America, La Mer generated the most sales from a live stream to date in the quarter. Our brands are innovating in social commerce on Instagram, Snapchat, TikTok, and WeChat, among others. We gained momentum in this promising online ecosystem during the quarter. Too Faced leveraged an Instagram live shopping event to launch its new fragrance. Estée Lauder Double Wear followers on TikTok skyrocketed with its latest campaign, also driving brand awareness and affinity much higher. And Tom Ford Beauty creatively debuted its new flagship site on WeChat's mini program in China. Embedded with these outstanding results across categories, regions, and channels is the progress we are making in social impact and sustainability. Since we spoke with you in November, we are pleased to have received several external recognitions of our ESG efforts. We were named to Forbes inaugural list identifying the world's top female-friendly companies, leading the way to support women inside and outside the workforce. For the fifth year in a row, we were named to Bloomberg Gender Equality Index. We were included in the CDP's Climate A List for the second consecutive year, which is a tribute to our deep commitment to climate action and to the highest level of transparency around our environmental interests. Last, MSCI recognized our progress toward our 2025 ESG goal in its recent upgrade of the Company to an A rating. The Company, our brands, and our employees have a number of events and activations planned in honor of Black History Month, and we are continuing to focus on our racial equity commitments and the work of accomplishing our goals. As we embark on the second half of our fiscal year, our innovation pipeline is rich with newness, especially for sustainability. La Mer's newly advanced The Treatment Lotion, which will be launched in March, is a powerful upgrade inside and out, crafted using our unique green score methodology and housed in a new recyclable glass bottle made with 20% post-consumer recycled glass. This methodology, which was peer-reviewed in an academic journal, Green Chemistry, evaluates ingredients and formulas through the lenses of human health, ecosystem health, and the environment. This approach can be adopted, built upon, and scaled by others across our industry to further advance sustainability. Estée Lauder is launching an all-new Revitalizing Supreme moisturizer created with innovations in formula and ingredients in a new recyclable glass bottle. Smashbox is introducing a photo-finished silkscreen primer collection featuring vegan formulas with a skin defending complex and instant makeup benefits. Lastly, DECIEM and BECCA's brand, The Ordinary, is welcoming back salicylic acid 2% solution, boosting a waitlist of over 400,000 for the new formula. In closing, we delivered outstanding performance amid the accelerated volatility, variability, and supply chain challenges of the pandemic. This demonstrates that we have the competency to navigate complexity well. Our commitment to invest for the long term is of great importance in this moment as we benefit from the advancements we have made over the last few years in data analytics, technology, R&D, and supply chain. These announced capabilities, combined with our strong portfolio of desirable brands, exceptional talent, and more flexible resource allocation, are enabling us to realize the power of our multiple engines of growth strategy even in a difficult external environment. The grace, wisdom, and ingenuity of our employees in this still challenging moment knows no bounds. They are the embodiment of our company's strong culture, and to them, I extend my deepest gratitude. I will now turn the call over to Tracey.

Thank you, Fabrizio, and hello, everyone. As you just heard, our momentum continued in our second quarter, with net sales growing 11% organically and 14% in total, led by a continued overall progression and recovery despite the volatility inherent across markets with a prolonged pandemic. We had a solid holiday performance across all of our regions. The inclusion of sales from the May 2021 DECIEM investment added approximately three points to reported net sales growth, and the currency impact was neutral. From a geographic standpoint, organic net sales in the Americas rose 19% as holiday shoppers returned to brick-and-mortar retail where we had an exciting array of gifting products and holiday activations in store. And even with more consumers shopping in stores, organic sales online also grew solidly in the Americas, with online representing more than one-third of sales in the region. Every market in the region contributed to sales growth this quarter, and the inclusion of sales from DECIEM added approximately five points to the total reported sales growth in the region. In Europe, the Middle East, and Africa region, organic net sales rose 13%. Growth was diverse and broad-based, with global travel retail as well as every market contributing. All channels grew, led by double-digit growth across brick-and-mortar as recovery continued in both developed and emerging markets in the region. Despite a strong performance during key shopping moments, organic sales online declined slightly, primarily driven by the U.K., due to a tough comparison with the prior year, which was more severely impacted by brick-and-mortar lockdowns. The inclusion of sales from DECIEM added about three points to total reported sales growth in the region. Our global travel retail business grew low double digits. Travel restrictions have eased globally, and international passenger traffic continued to progressively improve, resulting in some stores reopening during the quarter, particularly in Europe and the Americas. Travel retail continues to be led by Asia/Pacific, where demand from Chinese consumers remained strong. In our Asia/Pacific region, organic net sales rose 5%. Most of the markets in the region grew, led by Mainland China and Australia, although we continue to see variability in COVID restrictions and retail traffic across markets. Sales grew across most major channels in the region, especially online, which benefited from the recent launch of three brands on JD.com. The inclusion of sales from DECIEM added approximately one point to total reported sales growth in the region. From a category standpoint, organic net sales of fragrances grew 30% with double-digit increases across all regions. Exceptional double-digit increases from Jo Malone London, Tom Ford Beauty, Le Labo, and Kilian Paris reflected strong performances from hero products, new product launches, and the continued growth of the Bath & Body and Home subcategories. Organic net sales in makeup rose 12% as consumers in the Americas and Europe responded to social media activation, holiday assortments, and trends. Estée Lauder foundations continue to resonate very strongly with consumers, especially those in the Double Wear and Futurist franchises. M·A·C continued to drive the makeup renaissance with engaging, interactive campaigns throughout the quarter, like the special M·A·C trend Halloween report and solid holiday collections. Too Faced, Tom Ford Beauty, Smashbox, and Bobbi Brown also contributed to growth in the category this quarter. Organic net sales in skin care grew 7%, reflecting double-digit increases from La Mer, Clinique, and Bobbi Brown. The inclusion of sales from DECIEM added four percentage points to reported growth. Our organic net sales in hair care rose 18%, as traffic in salons and stores improved, primarily in the Americas. Aveda's growth came mostly from holiday gifts and hero franchises, both in online and freestanding stores, while Bumble and bumble focused on recruiting new consumers in the specialty-multi channel. Our gross margin improved 20 basis points compared to last year. The benefits of strategic price increases and favorable currency more than offset the impact of higher makeup mix and lower gross margin on DECIEM products. Inflationary pressures in our supply chain are expected to begin to more prominently impact the cost of goods in our fiscal third quarter. Operating expenses decreased 140 basis points as a percent of sales. Our leverage of selling expense and general and administrative expense was partially offset by increases in advertising and shipping costs, the latter due to both inflation and our direct-to-consumer online growth. Operating income rose 22% to $1.44 billion, and our operating margin expanded 160 basis points to 25.9% in the quarter. Our tax rate at 21.4% continued at a more normal level this year versus the prior year, which was impacted by a one-time benefit associated with GILTI. Diluted EPS of $3.01 increased 15% compared to the prior year. For the six months, we generated $1.85 billion in net cash flows from operating activities compared to $1.98 billion last year, which reflects both a return to more normalized working capital needs as well as increased inventory to mitigate some of the risk of supply chain disruption given the ongoing global macro challenges. We significantly increased our capital investment to $459 million to support the construction of our new production facility near Tokyo as well as investments in our online business and other technology enhancements. And we returned $1.84 billion in cash to stockholders through a combination of share repurchases and dividends, with an increase in our dividend rate occurring in the second quarter. So turning now to our outlook, we delivered an exceptional first half characterized by strong and diversified double-digit organic sales growth and disciplined cost management in the context of intermittent COVID disruptions, including the rise of the Omicron variant, high inflation, and volatility. Looking ahead, we are raising guidance to reflect our expectation for a strong year despite the potential further spread of Omicron, supply chain challenges, and increased inflationary pressures. Inflation in transportation and procurement is expected to impact our cost of goods in the second half. However, the benefit of pricing and cost mitigation efforts are helping to offset some of the inflation impacts for the fiscal year. At this time, we expect pricing to add approximately 3.5 points of growth with the inclusion of the additional pricing actions we are taking during our second half. We are planning to support the continuation of the recovery with increased point-of-sale staffing as retail traffic continues to gradually improve. We are also planning to support key hero franchise launches in our third quarter from Estée Lauder, La Mer, and Origins with increased marketing and advertising support. This investment will increase costs towards the latter part of the third quarter with more of the benefit to be realized in the fourth quarter. For the full fiscal year, organic net sales are forecasted to grow 10% to 13%. Based on rates of 1.146 for the euro, 1.357 for the pound, and 6.399 for the Chinese yuan, we expect currency translation to be negligible for the full year. This range excludes approximately three points from acquisitions, divestitures, and brand closures, primarily the inclusion of DECIEM. Diluted EPS is expected to range between $7.43 and $7.58 before restructuring and other charges. This includes approximately $0.07 of accretion from currency translation and $0.03 of accretion from DECIEM. In constant currency, we expect EPS to rise by 14% to 17%. We expect organic sales for our third quarter to rise 8% to 10%. The net incremental sales from acquisitions, divestitures, and brand closures are expected to add about three points to reported growth, and currency is forecasted to be negative by about one point. We expect third quarter EPS of $1.55 to $1.65. Currency is expected to be $0.01 accretive to EPS, and the inclusion of DECIEM is not expected to be material. In closing, our results thus far clearly demonstrate the power of our diversified portfolio. Temporary softness in our Eastern markets driven by the pandemic was again offset by renewed growth in our Western markets. A resulting slight slowing of growth in skin care was offset by remarkable growth in fragrances. We continue to be choiceful about where we invest, and the flexibility we have built into our cost structure is helping us to mitigate some of the COVID-related disruptions and inflation while allowing us to continue to invest appropriately in our future growth. This agility, along with the resilience of our remarkable teams worldwide, gives us confidence that we can continue to manage through the temporary complexities caused by the prolonged pandemic by focusing clearly on our long-term strategy and executing against it with excellence. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

I would like to get an update on China. You mentioned the strong brand performance during the 11.11 holiday, but the category wasn't as strong in terms of growth compared to past years. Given the lockdown situation, can you provide insight on category growth in China for calendar Q4 and what you’re currently observing in calendar Q1? Also, could you discuss the long-term growth trajectory in China regarding per capita consumption development over time?

Yes. No. Sure. So we achieved a high single-digit growth in Mainland China this quarter, and where brick-and-mortar channels were impacted by COVID restrictions. However, our online, which was not impacted by closures, grew double digits in quarter two and represented more than half of our business in China. Additionally, our business in China travel retail grew rapidly as well as retail. So, we had four years of exceptional double-digit growth in China every quarter, and we expect this strong trend to have the potential to continue, frankly. And what you see in quarter two is just one specific segment, the brick-and-mortar, that affected by COVID restrictions went to single-digit growth, but the rest was all double-digit growth. So we remain absolutely excited by the potential of China. The long-term fundamentals that you were referring to in your question of the market remained really intact. The growing middle class continues to develop. The increasing per capita spending continues, at least in all the data we see on our products. And what the agility for us to serve the Chinese consumers wherever they buy, meaning online, travel retail, and brick-and-mortar, we are improving in all these elements. We are increasing the number of cities where we have brick-and-mortar. We are increasing the coverage online. You heard in the prepared remarks, our reference to JD and the incredible success in JD where Estée Lauder is already the number one shop there, and the travel retail, where we continue to be very strong. Super excited by Hainan and the huge quality expression of our brands that is happening there. So very strong Chinese consumer trends and looking great, great future.

I wanted to ask about the operating expense leverage we've seen so far this year. When I compare the first half of this year to pre-COVID levels, it's impressive what you have achieved. I understand there are factors like mix benefit, sales leverage, and cost savings, as well as costs that haven't fully returned to pre-pandemic levels. Can you help us understand how to think about operating leverage in the long term? Is there a way to distinguish between the benefits you've experienced this year that are likely to last and those that might return as we move back to a more normal environment?

Yes. Thanks, Peter. In terms of the operating leverage that we've seen thus far, it has been terrific, obviously, in the first half. One of the things to keep in mind is our launch cadence in terms of when we actually have big product launches does affect quarter-to-quarter performance. But we certainly have continued to see some of the benefits of costs not returning. But brick-and-mortar is picking up. And clearly, we're continuing to ramp up in the third and fourth quarters, our selling staff to support greater brick-and-mortar sales. So when you look at our full year, the overall margin expansion that is included in our guidance is around 90 basis points, well ahead of our guidance of 50 basis points a year from a long-term perspective. And that includes not only some of the costs not fully returning but also includes some of the incremental costs related to managing this pandemic, some of the safety procedures we've had in place, some of the additional testing that we have in place, et cetera, that we are incurring. But we certainly expect continued growth from our higher margin channels and categories in the future that will continue to benefit us going forward.

I wanted to chat a little bit about the Americas and growth that you've seen in particular in North America outside of kind of COVID-related recovery. And here, I'm thinking about some of the expanded distribution or consumer reach you described, particularly the expansion of Ulta and Sephora doors into significantly new locations. So curious kind of what you're seeing in terms of how your brands are performing generally in those locations and what you're seeing in terms of maybe new consumers coming into those franchises, again, as you think about that expanded consumer reach and your overall footprint broadening out?

So let me start from that. First of all, we see our brands doing well in these new distributions. And again, these new distributions, particularly the target Ulta and the cool Sephora you are referring to, were designed to get new consumers, particularly sourcing consumers from us. And we see this working, and our initial projections continue to be strong. However, I want to clarify that in quarter two, a very small percentage of our growth was coming from those already. It's just the beginning. So the larger majority of our growth in quarter two was coming from just other organic activities that we are doing in the region. For example, we are strengthening and diversifying our product categories. Again, the makeup renaissance is really getting into new user education. So there are some fundamentals, which are improving for the post-COVID landscape. Then we are gaining share in many categories, subcategories, for example, Tom Ford and Jo Malone were doing outstanding. The skin care gained share. The Ordinary is an important part of building our overall market share in the region. And the other thing I could mention is our innovation and our marketing progress has been super strong. The distribution choices that we have made have increased our abilities to source new consumers. But apart from the new brick-and-mortar choices, the online progress in North America is bringing a lot of new consumers, particularly consumers that before were not shopping online, and now they're shopping omnichannel. And that's why our omnichannel progress in North America is also playing a strong growth to support our growth now in the long term and continue sourcing new consumers. Finally, we are really executing with excellence. We are reinvesting rapidly in rebuilding the stores in their core way. We are investing in fact in improving our online execution, as we discussed in previous calls. This combination of investing, along with thanks to our restructuring program, we are increasing productivity to brick-and-mortar as brick-and-mortar continues, is making our ability to leverage the growth in North America much stronger than what it was before. That's why North America is not only successful, not only recovering strongly from COVID, but also becoming a powerful engine of growth for the long term in this strategy of multiple engines of growth.

My question is about EMEA excluding travel. Fabrizio, could you discuss that scenario? Unfortunately, Omicron was first observed in the U.K. How has Continental Europe been performing as you exit the quarter, especially the U.K.? Additionally, Tracey, I appreciate the explanation regarding the margin in the third quarter. You mentioned the timing of some hiring in brick-and-mortar and delays in market launches related to spending. Could you provide some insight into whether this timing is influencing the situation and if we can expect to see operating leverage, as you indicated, 90 basis points for the year as we move into the fourth quarter?

Yes. I'll start from EMEA ex-travel retail. EMEA, ex-travel retail was very strong, and we saw good progress in many markets. Also in EMEA, the big acceleration is coming from online across every single country. So, there is very exciting progress with all brands. Good progress in EMEA, there are emerging markets, which are doing very well, like India, the Middle East, and Russia. So, overall EMEA is again a strong engine of growth that is being built over this year, and now in the post-COVID acceleration is proving its role of building strong engines of growth, so all very strong. Tracey?

Yes. And in terms of the margin, we still, in the second quarter, did have quite a few open positions as it relates to our selling staff and certainly hope to be able to close that gap in the third and fourth quarters. The big difference in the second half of the year is we will be spending more advertising as a percent of sales in the second half of the year to support the launches that we mentioned in the prepared remarks. And that will certainly impact particularly in Q3 the margin, and we expect to see the benefit of that in Q4, but really beyond. I mean these are our largest skin care brands, particularly Estée Lauder and La Mer, and the hero franchise reformulations that we are doing on some of the products are really quite significant for us going forward. That should help the skin care category grow a bit. Skin care is largely affected by some of the shutdowns in high concentration skin care markets like the Asia/Pacific market. So certainly, as that market picks up, we expect that skin care will pick up as well. That, too, I would attribute to more of a temporary slowdown than anything else.

On the travel retail business, the low double-digit growth keeps the division expanding, which is great to see. You mentioned that the APAC region continues to drive growth, specifically with rapid expansion in China's travel retail sector. However, I'm trying to understand how the strong performance in China travel retail balances with the mention in the press release regarding restrictions affecting Hainan traffic. Could you elaborate on the strong growth from Chinese consumers in travel retail alongside the impact on Hainan travel? Additionally, I'd like to get your overall perspective on how this broader channel is developing in Asia. There's been a belief that Mainland China, Japan, and Korea can continue to achieve significant growth even as the travel retail business in China expands greatly, and I’m interested in your latest insights on that.

Well, let me start with your question on what we called out in terms of some of the disruptions that occurred in Hainan relative to the strong low double-digit growth that we had in travel retail. For the first quarter, actually, we had greater double-digit growth in travel retail. When you look at the first quarter versus the second quarter, while it was double-digit, it was a bit less than in the first quarter, and that was a direct impact from the restrictions that occurred within China that impacted Hainan. We don't expect that level in the balance of the year. So we do expect to see travel retail pick up in the balance of the year. Hainan continues to be a very strong driver of our travel retail business. It is incredibly luxurious, and I know Fabrizio likes to talk about Hainan, so I will let him expand on that as well. But we continue to expand our presence in Hainan and continue to see fantastic consumer receptivity to our brands in Hainan.

Yes. To speak to the travel retail trends. First of all, travel retail globally was strong and was accelerating versus the previous quarter. Yes, in Asia, there were some elements of acceleration. Yes, Hainan was very strong, as Tracey was saying, but I want also to underline that there was strong growth in EMEA and North America, as I think Tracey said during her prepared remarks as well, which was linked to more traffic during holidays in these regions despite the Omicron variant growth. Now this is a very important sign because the reactivity of travel retail sales to traffic increase is extraordinary. We have seen this in EMEA, for example, during the last quarter. The first good news is that where traffic increases, travel retail responds very, very fast. The other good news is what Tracey was speaking about the overall retail growth across some closures and restrictions. In Hainan, Hainan is becoming an extraordinary place, luxury, with amazing experiences. It's probably one of the channels around the world that is more equity building for the brand. So that's an important thing to underline. In Hainan, there are many new retailers opening, so in Hainan, there is more distribution being built in several retailers investing in the island. That's something that will generate and will continue to generate expansion growth over time.

And regarding your question on travel outside of China, once travel restrictions are lifted, we certainly expect people to start traveling back to Japan and Korea and Thailand and other travel destinations for vacation as well as for business. We certainly expect that those travel retail corridors will continue to recover similarly to what we've seen the start of in EMEA and the Americas, although traffic is still well behind, obviously, pre-pandemic levels. So, more growth to come as it relates to travel retail.

And maybe one thing on that, to add, Tracey, is the clarification when the growth of international travel will restart. This will be only moderately cannibalizing anything like Hainan or domestic travel because remember that the external travel is only for people with passports. A relatively small percentage of people in Asia have a passport to travel internationally. Hainan is domestic travel open to the population. So when international travel restarts, this will be almost all net extra.

Fabrizio, we've seen a lot of leadership changes in the past few months right at the top of the business with, I think, both Chris, Hope, and Cedric Prouve stepping down. I think you've also made some structural changes with, I think, joining our reporting straight to Peter at International rather than into Asia/Pacific, sort of elevating the importance of the Mainland China business. So just hoping that you can talk a little bit about some of the structural and leadership changes as well as maybe the culture of the business and how that's changed since 2009 in the context of how should we think about leadership transition risk and how that's evolving.

Yes, this is a great question, and I appreciate your understanding of our talented team. What you're witnessing is a reflection of our culture and some organizational changes that demonstrate the business's evolution, particularly with the elevation of China as an independent region due to its significance and the need for coordination with travel retail and other key parts of the Company, including online operations. This step is crucial for enhancing our collaboration with China and empowering our China team to receive support for growth. Essentially, the organization is strengthening our execution capabilities within China. Regarding changes in senior leadership, these are all part of well-planned retirement strategies. Our culture encourages leaders to communicate their plans in advance, ensuring we handle transitions in a professional manner. The good news is that we have strong succession plans in place, as most of the transitions have been prepared with individuals who have been trained for these roles. It highlights the effectiveness of our succession planning, which reflects our collaborative culture. We are increasingly united by our strategic goals and execution, creating a cohesive team environment. Our progress from 2009 to today has been steady, and I believe we are now a highly efficient organization at the top.

I wanted to ask you about brand support and promotion, especially considering the increasing competition costs, particularly around key events like 11.11 in China, as well as more promotions, deeper discounts, live streaming deals, and influencer costs. Can you discuss how the market is changing and your perspective on the investment needed to gain traction in Asia? Additionally, could you provide context for the Q3 guidance compared to the second half? The margin slowdown in Q3 is quite significant, but there seems to be a strong recovery anticipated in Q4. I understand being cautious, and you mentioned a slight increase in advertising, but it appears you are optimistic about the future. If you could share some further insights on this, I would greatly appreciate it. Thank you.

In terms of 11.11, it is becoming increasingly competitive. We have previously discussed our approach to promotions for this event, which largely includes samples, and there is growing media support for 11.11 as well. We see it as a significant opportunity to attract new consumers, and it ranks among the biggest events of the year for recruiting consumers that we retain over the years. Media costs and live streaming activities have definitely increased. We have adapted our strategies to ensure our brands perform well in this environment. It is a major planning event for us, and overall, we're satisfied with our brands' performance during 11.11. We have already begun planning for next year's event, highlighting the need for long-term preparation. Regarding the cadence of Q3 and Q4, we have talked about our focus on the entire year. While we may have large product launches in the first or third quarter, we are optimistic about the future. There is a rebalancing occurring between the third and fourth quarters. Additionally, our guidance for Q3 includes the ongoing impact of Omicron on brick-and-mortar sales, as well as weather-related challenges in New York. We are observing a slower recovery in the third quarter for brick-and-mortar compared to just a few months ago, so we are taking a cautious approach. I also mentioned rising shipping and supply chain costs. We have implemented price increases, with a 4% increase in the second half of the year compared to a 3% increase in the first half, leading to an average of 3.5%. We have the flexibility to adjust pricing further if necessary. The combination of pricing and cost savings enables us to invest in long-term sustainable growth initiatives, such as a new innovation center in Shanghai and a new plant in Japan, as well as other capabilities that Fabrizio discussed. This ultimately supports strong double-digit top-line growth and margin expansion of 90 basis points.

Yes. I want to emphasize what Tracey mentioned about the transition from quarter three to quarter four. We are setting up for the year ahead and are optimistic about it. Our fiscal year projections indicate a strong performance, especially in quarter four. During quarter three, we will have significant launches that will yield benefits in quarter four. This is crucial. The price increases we are implementing in January and February in certain areas, as Tracey noted, will primarily affect quarter four. This is part of our overall strategy. Ultimately, we are committed to delivering a robust year and a strong quarter four, and we have confidence in this outlook.

And because I know our brands are listening, we do have three big skin care launches in the third quarter, but we do have makeup, fragrance, and hair care launches as well that we are supporting.

I'm hoping I can sneak two in because I think what's kind of making folks nervous is the slowdown in travel retail. Can you just speak to your confidence? I mean, obviously, consumers are still managing to get their skin care products and their fragrance and whatnot. They're just shopping more online. Is there any concern that you have that sort of longer-term, travel retail is going to be less of a buoyant channel for you? Has there just been a shift in consumer behavior? How confident are you that when people start traveling again, that travel retail channel is going to really accelerate? And then I don't think you commented specifically, and it goes back to Dara's question, I think, on the China promotional environment. Again, that's something that we've heard from other players out there that maybe Estée in particular has been exceptionally promotional in China. Can you just comment on that and sort of give us your take on that?

Yes. First of all, we are not promotional in Mainland China. Actually, the majority of our activities are sampling rather than pricing promotions. If by promotional we mean that we have increased our sampling, our products that we give as gifts, that's our promotional model. Yes, we had promotional activities needed to succeed in 11.11 during the quarter. Our promotion is largely about sampling and creating trial opportunities, so it's expansive rather than pricing. The retailers do what they believe is right for them in a given environment. Your question about travel retail, I think I have extreme high expectations for the long-term quality of travel retail growth. This is an extremely promising channel. We have just seen the beginning of what will be a long-term powerful channel expansion for travel retail. Our confidence is because travel retail is driven by two elements: the amount of travelers and conversion rates. Currently, the conversion of travelers into shoppers in travel retail is extraordinary. We've seen great conversion of travelers into shoppers going from 10%, 15% into the 30%. The arrival of online in travel retail is a major driver. I believe it's just the beginning in other regions of the world. When international travel will restart, this will be almost net extra growth without cannibalism. Our marketing capabilities will also enhance our travel retail growth. We're confident about the travel retail channel.

Again, I think we feel very good. When you look at this quarter, the results we achieved, travel retail had a great quarter, as we said, low double-digit growth, but the overall company grew at 14%. The diversified engines of growth that we have really give us the flexibility to continue to deliver against our expectations and grow our consumers and grow our profits.