Estee Lauder Cos. Inc (EL) — Q3 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. Many of our remarks today include forward-looking statements, so please refer to our press release and our SEC filings for factors that could cause actual results to differ significantly from these statements. To facilitate our discussion on the underlying business, our commentary on financial results and expectations excludes restructuring and other charges and adjustments mentioned in our press release. Unless otherwise indicated, all growth numbers for net sales are in constant currency, and all organic net sales growth excludes the effects of acquisitions, divestitures, brand closures, and currency translation. Reconciliations between GAAP and non-GAAP measures are available in our press release and on the Investors section of our website. As a reminder, online sales refer to those made directly to consumers through our brand.com sites and third-party platforms. Now I'll turn the call over to Fabrizio.

Thank you, Rainey, and hello to everyone. I want to begin by expressing great sadness for our colleagues and all the people impacted by the invasion of Ukraine, who are experiencing a devastating humanitarian crisis. We continue to focus on our employee safety, and our dearest hope is for peace to prevail. In the third quarter of fiscal year 2022, we delivered organic sales growth of 9%, in line with our guidance despite the acceleration of temporary COVID-19 restrictions in China in March. We exercised cost discipline as volatility increased, and our adjusted operating margin expanded, leading to stronger-than-expected adjusted diluted earnings per share growth of 17%. Our multiple engines of growth strategy enabled us to amplify the engines of the moment amid an intensified macro environment, with sales rising organically across both brick-and-mortar and online. Every category grew organically, led by fragrances' outstanding performance. Eleven brands contributed double-digit organic sales growth and further demonstrated our diversified drivers. Consumer demand remains robust even in this inflationary environment. Our largest brands provided highly sought-after products; M-A-C, Estée Lauder, and Clinique each delivered double-digit growth in makeup, fueling the category renaissance while La Mer thrived in skin care. Four of our scaling brands resonated strongly with consumers as Jo Malone London, Tom Ford Beauty, Aveda, and Bobbi Brown each rose double digits. Among our developing brands, Le Labo, KILIAN PARIS, and Bumble and bumble each achieved outsized growth and showcased their promise. Our sales rose double digit organically in the Americas and EMEA. We capitalized on reopening to translate improving brick-and-mortar traffic trends into outstanding sales growth, owing to our high-touch services, breakthrough innovation, hero franchises, and operational excellence. Our freestanding stores delivered exceptional performance benefiting from fleet optimization and expanded omnichannel capabilities and complemented the strengths in specialty multi. We are managing the ongoing complexities from the invasion of Ukraine as well as the temporary COVID-driven restrictions in China, which impacted performance in Asia-Pacific in the quarter. In Mainland China, organic sales fell mid-single digits as 25% growth online was offset by a steep decline in brick-and-mortar. After a strong February in Mainland China, traffic slowed more sharply in March to pressure brick-and-mortar sales. Additionally, the distribution centers for our Mainland China business are in Shanghai and operated with limited capacity. Tourism to Hainan highland was also curtailed in March after a vibrant start of the quarter. There is no doubt that these current limitations in China will prove to be transitory, although there will be a far greater impact on our results in the fourth quarter than they were in the third quarter, as Tracey will discuss. Looking ahead, we are confident in the resilience of the Chinese consumers and the untapped opportunity driving our investments in the market. We expect a reacceleration of growth when this moment of COVID abates. Let me share the progress we made during the third quarter to drive these strong results and advance our long-term ambitions for our multiple engines of growth strategy. Innovation excelled to reach nearly 30% of sales. We continue to elevate our ability to leverage data analytics with our best-in-class creative talent and R&D to successfully anticipate scale and set trends. The breadth of our innovation wins was far-reaching and benefited every category in skincare. La Mer upgraded The Treatment Lotion sort as the brand doubled down on this coveted East-West product, increasing the skin recharging Miracle Broad and transitioning to a recyclable luxurious glass bottle that contains 20% post-consumer recycled content. In Asia-Pacific, consumers gravitated to the new serum strengths and anti-aging benefits, while in the Americas, educating on the benefits of hydration and energy proved impactful with consumers, demonstrating our expertise in serving multiple needs with one product and communicating with the appropriate local relevance. For makeup, M-A-C sought to grow its mascara base, especially across Gen Z, younger millennial, and multi-ethnic consumers and created Macstack Mascara. With breakthrough technology, it stacks and builds the last look. Macstack went viral on TikTok, having now amassed over 153 million views, and its sales far exceeded our expectations in the quarter. Tom Ford Beauty's new private blend rose fragrances feature locally relevant notes, where Rose De Chine features Chinese golden rose, and Rose D'Amalfi includes Italian bergamot. This launch drove exceptional results globally, including China, where the brand had a very successful Valentine's Day. Lastly, in hair care, Aveda launched botanical retail strengthening overnight serum, disrupting the category by creating our first overnight serum that builds new hair bonds while you sleep. The product addressed key consumer pain points with quick-absorbing technology by leveraging a serum-based formula. Encouragingly, the product quickly rose to being the top-selling product in freestanding stores and sold out on brand.com. We are excited to build upon this momentum as our new innovation center in Shanghai opens later this calendar year. This important investment in China will significantly increase our ability to serve the Chinese and Asian consumers with locally relevant and inspired innovation. Also, the new center will further enable our East-to-West innovation mindset, supporting the creation of more successes like La Mer's The Treatment Lotion. Looking at our growth engines by category, the strategic decision to pivot our fragrance portfolio to luxury and artisanal is benefiting both top-line growth and profitability. Fragrance performance in the third quarter was super, with sales increasing 31% organically. Impressively, sales exceeded the pre-pandemic third quarter of fiscal year 2019 by nearly 50% on a reported basis. Jo Malone London, Tom Ford Beauty, Le Labo, KILIAN PARIS, and Editions de Parfums Frederic Malle each delivered double-digit sales growth, and the Estée Lauder brand complemented these strengths with its well-received new luxury collection. As consumers around the world increasingly express their individuality with scent, these brands are delivering outstanding results with strong double-digit growth fiscal year-to-date in every region, driven by demand across channels from brick-and-mortar to online and travel retail. Our freestanding stores are driving omnichannel experiences, while the online businesses have been transformed during the pandemic. These fragrance brands are also contributing to our sustainability goals, with refillable packaging being a compelling element of the value proposition for Le Labo and KILIAN PARIS. We are also thrilled to announce that during the third quarter, Le Labo became BCR-certified, making it the first major fragrance brand and first within our company to receive this certification, indicating a high level of commitment to sustainability and impact. Turning to makeup, it was on this call a year ago that we introduced our expectation for a makeup renaissance, anticipating it would gradually evolve market by market as social and professional user educations began to resume. We envisioned the category would experience a recovery driven by both restocking as well as a renaissance rooted in a renewed passion for the joy and creativity of makeup after a difficult time. Even with the rise of the Delta and Omicron variants, the makeup renaissance has delivered very favorable trends and offers great promise for the future. As user education expanded in certain markets upon reopening in the third quarter, makeup once again delivered double-digit organic sales growth in the Americas and EMEA. M-A-C and Clinique's makeup sales growth accelerated sequentially, while Estée Lauder and La Mer businesses in the category are already ahead of pre-pandemic levels. While brands have been meticulous in executing their merchandising and innovation strategy for the renaissance, we invested to create the omni artist by meeting consumers in innovative ways across brick-and-mortar and online to educate and inspire new looks and offer the best in personalized high-touch services. M-A-C has been superb in this regard. So too has Bobbi Brown with events like live streams from the largest mall in Manchester, England, to group classes to domain in China, to one-to-one Zoom sessions in the U.S. Moving to hair care, Aveda and Bumble and bumble have reignited growth engines to contribute to the diversified category growth that we expected for fiscal year 2022. Impressively, even as these brands grew sales strongly double digits in brick-and-mortar or reopening during the third quarter, they also achieved mid-single-digit online growth. Lastly, while skincare was pressured by COVID restrictions in the East, there were still many bright spots. In the quarter, we continued to advance our strategies across many long-term growth drivers from luxury to prestige. La Mer performance was extraordinary, with sales rising strong double digits. As I discussed, it upgraded The Treatment Lotion sort, creating a high effect on the new hydrate infused emulsion, while its heroes were highly sought after. With desirable innovation and coveted icons, La Mer is welcoming new consumers, earning their trust and trading them up as its ultra Genaissance de la Mer franchise is booming. While our high-end prestige skincare thrives with La Mer and Estée Lauder Renotriv, Bobbi Brown is prospering in the heart of the category, thanks to its strategic focus on treasured heroes like vitamin-enriched face base. We are also laser-focused on entry-level prestige to reach new consumers, notably with DECIEM the ordinary as the brand amplifies its heroes to drive repeat with its ingredient-led regiment-based approach. After the quarter closed, DECIEM announced it will be refining its brand portfolio to focus resources on the compelling opportunity we foresee for The Ordinary and NIOD. During the quarter, we also improved upon the fundamentals of consumer acquisitions, engagement, and high-touch services, positioning us well to realize even greater success with trial and repeat. Our partnership with TikTok expanded, and we are piloting new innovations on the platform to be at the forefront of social commerce innovations. In the U.S., several of our brands launched storefronts on TikTok, similarly linking them to brand.com. Brands also expanded their capabilities with Instagram Shopping and launched category-powered lenses on Snapchat similarly linked to brand.com. Clinique realized favorable engagement trends on TikTok and Instagram, featuring its back-in-stock coveted Black Honey Lipstick, and strong recruitment growth with new advertising for lots of search features showcasing the made-for-social phase of adventure campaign. The Estée Lauder brand entered the metaverse as connecting with our consumer wherever they are is paramount, and we are excited to be testing and learning in this new ecosystem. Estée Lauder was the exclusive beauty brand partner of the Decentraland Metaverse Fashion Week, the first-ever large virtual fashion week in an unchanged metaverse. Around the world, our brands are increasingly leveraging new campaign management tools to tailor communication and drive repeat to both re-engage with consumers and foster relationships with new consumers. We are realizing increased reactivation and repeat purchase rates from the U.K. to France, Australia, and beyond. In closing, we delivered very strong performance amid the accelerating headwinds during the third quarter. We’ve also made excellent progress advancing the long-term drivers of our multiple engine of growth strategy. These results in this progress are due to the tremendous accomplishments of our employees around the world, to whom I extend my deepest thanks as they continue to manage complex situations with grace and ingenuity. Moreover, I'm incredibly inspired by our employees' compassion for each other. Last week marked the two-year anniversary of the ELC Cares Employee Relief Fund. The fund was created in response to employee increasing desire to support one another in times of need. Since inception, over $10 million has been distributed to employees globally from donations and company matches. Looking ahead, while we are lowering our expectation for the fourth quarter, given the impact of the temporary COVID-driven restrictions in China, we expect to deliver another record year in fiscal year 2022. We remain incredibly optimistic about the future of our business. This quarter proved the vibrancy of prestige beauty, its resiliency even in a difficult macro environment, and the strength of our trusted brands and product innovations as markets sequentially recover from the prolonged pandemic. I will now turn the call over to Tracey.

Thank you, Fabrizio, and hello, everyone. Our third quarter net sales grew 9% organically despite the increased complexity and volatility caused by the pandemic and the invasion of Ukraine. Growth was broad-based across categories and markets as most regions across the world continued to recover and grow, albeit at different rates. Sales in specialty-multi and freestanding retail stores led growth, and online sales rose mid-single digits. The inclusion of sales from the late May 2021 DECIEM investment added approximately 2 points to reported net sales growth, and currency was a headwind of approximately 1 point. From a geographic standpoint, organic net sales in our Europe, the Middle East, and Africa region rose 18%. Growth was realized across most markets, channels, and brands. Market growth was led by both the recovery in the largest Western markets as well as in key emerging markets like Turkey and India. All brick-and-mortar channels grew, led by double-digit growth in department stores, freestanding stores, and specialty-multi stores. Organic sales online declined when compared to the prior year quarter, where online sales benefited both from the pandemic-driven store closures and reduced store traffic. All product categories and most brands grew in the region, led by La Mer, Jo Malone London, and M-A-C. Our global travel retail business again grew double digits despite the challenges that arose during the quarter. Asia is the largest region for our travel retail business, and sales in the key markets of China and Korea were very robust at retail for most of the quarter. However, there was a precipitous decline in Chinese travel in March as restrictions to contain COVID were increased in China. We continue to see a sharp increase in travel retail sales outside of Asia as traffic increased throughout Europe and the Americas. Net sales in the Americas rose 11% organically, with all markets contributing to growth. All product categories grew, with particular strength in makeup and hair care. The two largest prestige makeup brands in the U.S., M-A-C and Clinique, outpaced overall category growth to gain share. Bobbi Brown and Tom Ford Beauty also gained share helping to further drive the makeup renaissance as more consumers continued their return to the workplace and resumed more social occasions. Our sales in specialty-multi and freestanding retail stores strongly outperformed this quarter as consumers return to stores for shopping and services. The inclusion of sales from DECIEM added approximately 3 points to growth, and favorable currency movement contributed 1 point to sales growth in the region. In our Asia-Pacific region, organic net sales fell 4%, driven entirely by Greater China. For the quarter, net sales in Mainland China declined mid-single digits. Following a strong Lunar New Year in February, sales declined in March as additional COVID restrictions impacted many cities, most notably Shanghai, where our distribution centers serving the entire country are located. The restriction sharply curtailed productivity at these facilities, affecting our ability to both receive products being shipped into the country and to fulfill demand across all channels of distribution. However, shipments should begin to normalize as restrictions ease. Net sales in Hong Kong also declined throughout the quarter as the city took increasing measures to contain the virus. Partially offsetting these decreases were strong net sales growth in most other markets, including Japan, Malaysia, Thailand, and Singapore. Online sales in Asia-Pacific grew strong double digits as we continue to expand our brand reach across new platforms. Our gross margin improved 70 basis points compared to last year. Strategic price increases of approximately 4% combined with favorable currency and reduced obsolescence contributed to the increase in gross margin as well as the favorable impact of anniversary last year's under absorption of manufacturing overhead. This more than offset the impact of increased inflationary pressures in our supply chain, mainly in logistics and materials as well as increasing start-up costs for our new plant in Japan. Operating expenses decreased 40 basis points as a percent of sales. Our leverage of general and administrative expenses was partially offset by increased shipping costs related to higher freight rates and more air shipments on increased sales volume. Additionally, as cities throughout China began tightening restrictions and traffic to Hainan slowed, we reduced certain expenses to correspond with slower retail traffic. Operating income rose 15% to $917 million, and our operating margin expanded 110 basis points to 21.6% in the quarter. Diluted EPS of $1.90 increased 17% compared to the prior year. During the quarter, we recorded $216 million of impairment to goodwill and other intangibles primarily related to Dr. Jart+, reflecting forecast for slower-than-expected growth in China and travel retail. We continue to believe in the growth potential of the brand, which has been impacted by the temporary COVID disruptions in Asia given its strong growth prior to the start of the pandemic as well as the growth seen in recovering markets. For the 9 months, we generated $1.97 billion in net cash flows from operating activities compared to $2.78 billion last year, which reflects investments in working capital to both support growth and mitigate some of the risk of supply chain disruptions as well as higher cash paid for taxes. This was partially offset by higher net income. We significantly increased our capital investment to $658 million to support the ongoing construction of our new manufacturing facility near Tokyo, investments in our innovation center in Shanghai, as well as investments in online and technology enhancements. And we returned $2.62 billion in cash to stockholders through a combination of share repurchases and dividends. Turning now to our outlook. As you have heard and are aware, there have been two significant headwinds that have emerged since we last gave guidance in early February; increased COVID-related restrictions in China also impacting Hainan and the invasion of Ukraine. Our current guidance for the balance of this year reflects continued momentum in the Americas and EMEA excluding travel retail as well as the continuation of lockdowns and corresponding distribution constraints in China through at least the first half of our fourth quarter. While we expect continued growth at retail in both Mainland China and Hainan, the severity of the distribution constraints we are experiencing are expected to result in a meaningful decline in net sales for these areas for the quarter. We are cautiously optimistic that we will be able to fulfill the majority of our orders in time for our planned 6.18 activities. The elimination of sales in Russia and Ukraine has reduced expected fourth quarter sales growth by approximately 120 basis points. At the same time, we delivered outstanding results for the first 9 months of the fiscal year, with greater diversification of our growth drivers. Our geographic diversity is a tremendous asset, and we expect our multiple engines of growth to continue, including the ongoing recovery of the Americas, Western Europe, and most markets in Asia. We expect to also deliver strong margin improvement for the year. The benefit of our strategic pricing actions this year, along with agility in our cost management, are helping to offset the initial effects of increasing inflation throughout this fiscal year. We plan to continue to invest in the recovery, support innovation and assuming current disruptions abate, fuel upcoming key shopping moments in the quarter, like 6.18 in China and Mother's Day. With these assumptions as our backdrop for the full fiscal year, organic net sales are now forecasted to grow 5% to 7%. This range excludes approximately 2 points from acquisitions, divestitures, and brand closures, primarily the inclusion of DECIEM, and currency is forecasted to be neutral. Diluted EPS is expected to range between $7.05 and $7.15 before restructuring and other charges. This includes approximately $0.05 of accretion from currency translation and $0.02 dilution from DECIEM. In constant currency, we expect EPS to rise by 8% to 10%. These expectations imply margin expansion of approximately 70 basis points, including dilution of 40 basis points from DECIEM this year. In closing, we managed extremely well through an increasingly complex environment in our third quarter, and these complexities are expected to meaningfully impact our fourth quarter. Despite this, we continue to expect to deliver a very strong year with above-average organic top-line growth, excellent margin expansion, and solid EPS growth. We are confident that we can continue to manage through the present temporary headwinds and be well prepared for accelerated momentum when the pandemic effects ease. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Tracey, for retail, just hoping to get a little bit more visibility, if you will, to like the on-the-ground inventory dynamic in China currently and how you're thinking about that, I guess, for the first half of the quarter. So if I were to go on any of the e-commerce sites or to a store, what do I see now? Am I able to place an order online? Or does it say out of stock? If I go to a store, is there inventory? Because I'm trying to piece together the comment, Tracey, that you saw by 6.18 you'd be caught up, but knowing that Shanghai is the way kind of in and out, and you're assuming that's constrained for the first half of the quarter? I'm just trying to put those pieces together for that fourth-quarter outlook.

It really depends on the specific product. We have experienced supply chain disruptions over the past few weeks. While we do have inventory available for trade, we have encountered challenges shipping products to consumers. In some instances, shipping is taking longer than usual, and in other cases, we have been unable to ship at all. From what we are hearing, the market may reopen around mid-May, but this is still uncertain. We have had to make our assumptions for the fourth quarter based on the expectation that things will start to improve by mid-May, followed by a catch-up period. We do have products ready in and around China for June 18, but the challenge lies in getting them to our distribution center and then ensuring they reach customers in time.

I'm sure there will be more questions about China, but I wanted to focus on the Americas. Growth there was strong, as you mentioned, but it fell slightly short of our expectations. On a three-year basis, local currency growth is averaging negative 3% compared to pre-pandemic levels, indicating a slowdown and a reversal from the first half of the fiscal year. This negative 3% CAGR includes DECIEM. I would like more insight on how you perceive the recovery in the Americas, what may have led to the changes in multi-year growth from the first half to the third quarter, and how to consider the progression for the remainder of the calendar year.

Yes, sure. No, actually, we believe our North America business is accelerating and is in very good trend. Obviously, the sales by quarter may vary for a serious reasons, including the presence of holidays or presence of specific brands, innovations, et cetera. But in general, we had a plus 24% in the last 12 months and plus 10% in quarter three. If you see in that quarter three, Clinique is ranking number one overall brand, M-A-C number one in makeup, Bobbi Brown, Tom Ford, M-A-C, The Ordinary, they're all growing share. We are executing well the strategy of better covering all U.S. multi-ethnic consumer groups. We have improved our distribution mix, which now is more focused on high-growth, high-profit areas in general, particularly we have improved our online penetration during COVID, and we are maintaining it now. We have reestablished strong brick-and-mortar productivity, which was heavily hit by COVID, also closing 40 freestanding stores and exiting a number of department stores. We are rolling out successfully the Ulta Target, the Sephora called new doors, which are proving to reach new consumers. We have a stronger M-A-C and Clinique performance business, which in North America are, frankly, the two key brands that are driving the overall size of the growth. We have some strong innovation successes in quarter three. For example, Macstack, which we had mentioned in the prepared remarks, which is so far an extraordinary success. And I would underline, we are in a market where prestige has been recovering at a much faster pace than mass, which is exactly proving also that we are back into sourcing from mass new consumers, particularly with our entry prestige pricing brands like M-A-C, like Clinique, like The Ordinary. We also added with DECIEM acquisitions the Ordinary Brand, which is number four in prestige U.S. brands already in skin care, which is an extraordinary position and ranking first in units in many of the retail partners where they're sold. And on top of that, speaking about distribution, one-third of our North America business now is in the direct-to-consumer model with freestanding store brand.com and certain online activity that gives us a lot more data, consumer data and understanding of the consumer than we ever had in the past. So it's been years of reshaping our North America business in a condition that we believe today is strong and is much more stronger platform for continued growth and continued market share development of most of our brands in the future as well. So we are very positive about our North America trend and also very proud of today having a strong and motivated team, which is in action and is driving the business forward.

For retail, I wanted to get maybe an assessment on M-A-C in the U.S. because, I guess, prior to the pandemic, the brand was under a lot of pressure. It seems like things are looking better now, but I didn't know if that's a function of just improved mobility and a makeup category lift overall or if there's an improvement in the underlying fundamentals of that brand. If you could just help kind of frame the situation for us, that would be helpful.

Yes. I think M-A-C is really in a strong recovery trend and is, first of all, the makeup category in general, as I explained during the prepared remarks, is in what we call the renaissance, meaning the user education of makeup is coming back, with people going back to the office, going back to restaurants, parties, and vacations — all what we have seen gradually coming back with the COVID retreating at least up to a certain extent. This is working. With the user education coming back, the entire category is flourishing again. Plus, as I mentioned, it's important that makeup is also linked to mood, meaning the joy of interpreting personalities and expressing oneself. So a positive sense of recovery from COVID has been developed in the last several months, and this has benefited the category. M-A-C is the market leader in the prestige segment in quarter three. So obviously, it's benefiting from the overall category recovery. Second, the brand has now a better mix in distribution and has made important distribution choices so it's reaching consumers better, refocusing on multi-ethnic consumers who have always been at the core of this brand and has extraordinary new creative power to convey the M-A-C values to consumers in new fresh ways. Innovation is back, meaning not only innovation in taste, style, and looks, which have always been the core of the brand, but also innovation in R&D, new ideas of performance like Macstack, which is frankly, a technical product innovation that builds on an idea that's so close to the core of M-A-C, which is makeup artistry — the ability to build mascara on your lashes in different stacks, allowing for different makeup interpretations based on how much or how long and which locations. That customization in mascara is a big deal. The consumer is responding quickly, and it is already a leading mascara in North America and in any other market where it has been so far launched. So M-A-C is in a strong recovery trend, and we are very proud of the work of our team there.

So just returning to China, a, just short-term detail-wise, it sounds like, hopefully, some of the supply chain restrictions could open up in mid-May. But if that's not the case, can you just discuss contingency plans in a bit more detail that Tracey touched on? Are you comfortable you can meet demand for the June holidays if the Shanghai restrictions continue? Is it more top-line risk or more a question of profitability if you have to reconfigure the supply chain to get product there? And then just be longer term, Fabrizio, assuming your supply chain issues do end up being outsized versus the peer set, it sounds like maybe that's the case based on some of the competitor commentary so far, but obviously, it's an issue across the board. Just any implications to your retailer relationships in China or longer-term share and how you think about that?

Yes, Dara, so I'll start. There are two things going on in the fourth quarter that are impacting us. Given the pandemic management in China right now, there is also a slowdown in traffic to Hainan. So travel retail is being impacted as well in the fourth quarter, specifically Hainan along with China. As you saw in the third quarter when traffic slowed in our distribution and online, we pulled back on expenses, and we would be prepared to do the same in the fourth quarter if our assumptions change. The other thing that we are looking to do is have a temporary distribution center outside of the area that is most affected, and hopefully, we'll mitigate some of the pressure on our Shanghai campus. So those are a couple of the things that we're planning to do as our plan B, if you will, if the market does not open up in the middle of May. But we are encouraged by some recent signs that we've seen in terms of, or heard in terms of some of the cases coming down. But it's quite volatile, Dara, so this is the best estimate that we have at this time of the situation and what we could deliver in Q4.

Yes. And on your question on retailer relationships, we are in China for the long term and completely dedicated to continuing to develop the market and serve our partners there. We are going to open soon our R&D center in China, which is a very big event and a very important manifestation of our long-term determination to continue to be locally relevant and serving the specific needs of this market. And obviously, we are going to do as soon as the COVID restrictions will allow us to proceed. So, and the other thing I want to clarify that the China consumer demand underlying this moment of COVID restrictions is strong. Now it comes really from a multichannel online where it's more than 50% of the mainland sales. We grew double digits in quarter three despite what Tracey explained regarding our inability to ship existing orders in the last 15 days of March. That's the key point. We couldn't ship orders that we had in our hands, both from retailers and consumers online. And so obviously, that's temporary and this has happened in the past, in the United States, in Europe during pandemic lockdowns. So we know how this works and how this happens and we also know how to rebound when this finishes because it's not about consumer demand. It's about access to consumers that has changed dramatically in a very short period of time. But online was very strong, had a very strong February. And despite that, we grew market share in quarter three online, which is a store despite the inability to serve consumers in the second half of March. Hainan was strong until mid-March, but then Hainan had a very strong decline in traffic. We estimate 60% to 70% in the second half of March. And in April, we saw an 80% traffic reduction in Hainan. So that's what is reflected in our quarter four. But also, we have seen historically that the bounce back can be very strong because when these restrictions finish, people travel domestically very fast and very happily. So the confidence in Hainan's future is unchanged, actually increased, given the incredible development of the place and the confidence in online is very strong also because together with the continuous success with Tmall, we are also now expanding and having good expansion online with JD, along with digital marketing with TikTok activations. There are so many other things that are in the making. Brick-and-mortar was the most impacted during the restrictions. And that’s so as of mid-March and the entire month of April was really impacted in certain areas where there were restrictions. It was not everywhere but was definitely in Shanghai, where we have a lot, as we discussed, the distribution center. So I also want to clarify that the long-term fundamentals of global prestige beauty in China and in travel retail China remain very, very good. Actually, I personally have never been more enthusiastic about the opportunity. When the market rebounds, it should be much more profitable as we've seen in the U.S. because the market will rebound in travel retail and online and more productive brick-and-mortar and a more productive fragrance business than in any other region of the world because it's high-end fragrance is a much bigger percentage of the total development of the category. Also, we continue to invest in China, as Tracey has clarified. And obviously, we will tailor the investment to the level of access to consumers that the restrictions will permit, but we will invest in the growth in the innovation center. There will be more brands in China coming to additional cities coverage as soon as the permissions the restrictions will allow. I spoke already about the strongest plans with our partner Tmall and further diversification of the coverage in the country. The category growth expansion beyond skin care, makeup, fragrances are coming up strongly. The supply chain that needs to be further diversified Tracey has alluded to, but we had already planned for fiscal year 2023 and 2024 to have more regional distribution centers that we will deploy, but in the meantime, we'll look for certain temporary activity. Hainan expansion is also a story. There are new mega counters getting expanded in Hainan as we speak, not only for us but also for competition, but they are extraordinarily new opportunities that we are making temporary. Obviously, at this moment, as I said, there is little traffic. But in the, for example, in the July-September period, there will be more new counters expanded. The expectation for 6.18, assuming that the logistics can be resolved, is pretty strong. And also, I want to underline that we hear there will be more economic stimulus ahead in the country that will further develop consumption in the next 12 to 18 months. So I just want to underline, I hope it was clear that we are really trying to be as prudent and objective as possible in reflecting the COVID restrictions. But we remain absolutely determined to continue to build our China and China TR businesses.

Fabrizio, you mentioned that you're comfortable when to fulfill when you're able to. So I was hoping to see what was the impact in volumes of orders that were made online in China for your organic growth. And also just a clarification on Tracey's comments on the pricing front with, I think, a 400 basis point impact of pricing in the quarter. So I was hoping to hear what is the rollover impact on the carryover into the fourth quarter and the mix impact. I'm assuming the mix was a negative given that you're selling less — on a relative basis, you're growing less in skincare. Hope you'll share all of those.

So let me start, Andrea, with the pricing. My 400 basis points really was for the second half of the year. We started the year taking 3.5% of pricing increase. And typically, we take most of our pricing increases at the beginning of our fiscal year. We did take a second price increase in January. So the impact year-over-year for our second half is 4% pricing relative to the prior year. And we expect to, in our upcoming, the beginning of our upcoming fiscal year in July, take additional pricing. So, and that pricing is strategic between levels within the tiers of our categories. Skincare or higher-priced skincare might take higher price increases; our lower-priced skincare would take lower price increases. It's very much dependent on the market, the currency, the inflation; there's a very sophisticated model that we use to determine pricing for our various brands. So yes, we will have lower skincare sales in the fourth quarter. But on average, the pricing increases that we've taken will still be around 4%, and we do expect that they would cover the inflation that we are experiencing at the moment.

And answering the first part of your question, which is how much we could not ship. Frankly, I cannot distinguish the online versus the brick-and-mortar. But I can tell you that as of March 15, when we couldn't ship orders for 15 days, the orders we had in our hands that we did not ship at that moment were 2.5 points of growth for the entire quarter, which is a substantial amount of shipments. And then in April and the beginning of May, we also had limited capacity shipments. And also importantly, in the quarter three numbers that you see, the impact of the pandemic was mainly reflected in the Mainland China impact, while travel retail had a very strong quarter despite less traffic in the second part of March. So somehow, we ended up with higher stocks in our assumptions. And then in the quarter four expectation, there is a bigger proportion of the impact of the reduced traffic in Hainan than there is, frankly, an impact in China. And so that's also maybe gives you a bit more light on our assumptions in this very difficult situation, frankly, to interpret at a detailed level given the very high volatility.

Fabrizio, you mentioned in the prepared remarks or maybe in the Q&A, just maybe an expectation that there could be some stimulus in China. And I guess one of the questions we've got this morning was whether or not any of the softness that you've seen in China is all connected to the consumer feeling the impact of the economy slowing or recession risk. So can you just touch on that a little bit just in terms of whether or not you've seen any sort of impact on demand or any consumer behavior patterns based on the economy slowing in China?

No. So far, we are not seeing any impact in this area, also because — not only because, as I said, the demand remains robust, and you can look at the demand in China in this moment since when global COVID started mainly since when Chinese started traveling internationally less. You need to look at the brick-and-mortar in China, the online in China, and Hainan. The combination of these three has been very strong even if you look at our quarter three and you put together the results in alongside the results in Mainland China online, as I said before, we were growing market share and growing double digits even with the pandemic's negative impact reflected in the second half of March. When you look only at Mainland China or only at Hainan in certain moments without, you may see different patterns by channel, but the total Chinese consumption has been very, very solid for us, for the industry, for competition in general. The other important thing to clarify is that this is not changing also in the composition. For example, the most important segment in this moment in the China demand is high-end luxury brands. So both in our portfolio, brands like La Mer and Tom Ford, or in our competitive portfolio, or within our portfolio, brands like Estée Lauder, the performance of Renotriv, which is the high-end part of the brand. So everywhere, the high luxury part is doing better in growth than any other part. This doesn't suggest that the consumers are worried about the economy. This suggests the consumers are actually looking for high performance and strong experiences more and more in this moment. That said, there is obviously a lower economic expectation at this moment, but there is also a lot of trust in the possibility of economic stimulus and in the possibilities of restarting stronger economic development. So I believe that the consumer sentiment is still overall solid.

Kind of expanding on that last question on consumer sentiment more broadly. How have the recent developments macro-wise affected or changed your viewpoint or impacted your viewpoint on the resiliency of prestige beauty as a category more broadly geographically both here in the U.S. and in EMEA and in APAC? We've seen these consumer-centric numbers start to get a little bit depressed over the past few weeks. So just wondering how you're viewing the resiliency of prestige beauty in these market dynamics.

Yes. No. I have to say that we see the consumer sentiment at different levels of development by region. So first of all, in the U.S., the consumer sentiment is solid. And in the U.S., it is very interesting. You can also read the results by channel and see that prestige continues to grow and to accelerate in the post-COVID environment, at least from a consumer sentiment standpoint. The consumer sentiment has been much stronger in prestige segments than in mass segments. Both are growing, but prestige is growing much more. And this is a sign that consumers feel confident going for quality, for performance, for experience, and for what they feel connected to. They are increasingly engaged in the pleasure of pampering themselves. This is a positive consumer sentiment overall. It does not mean trust in the long-term economy, but positive in what drives beauty is a positive consumer sentiment reflected by the interest in dedicating to oneself. The interest in self-care is emerging, which is overall positive amid these difficult periods rather than being driven solely by economic trends. The consumer sentiment is what is pushing prestige beauty globally. This consumer sentiment is sometimes even stronger during high-stress periods because there is a greater need for pampering. So it is strong in the U.S., solid in China, better in many other markets like Japan, U.K., and in markets across Asia, like Korea and Singapore, which are all recovering from tough COVID periods. The only region where consumer sentiment appears to be declining is Europe, and it’s not solely economic results. In Europe, consumer sentiment has been complicated by the ongoing war in Ukraine. The war has created bad feelings among people, contributing to a mixed consumer sentiment at this moment in Europe. However, this turmoil does not affect business similarly, as the prestige beauty sector remains solid despite societal concerns. This indicates the consumer sentiment is generally strong, with even greater interest in purchasing based on individual needs.

And the only thing I would add to that is even as we've commented, the fragrance category during this time has picked up, so to Fabrizio's point in terms of self-pampering and prestige hair care. So we're actually seeing an acceleration in some categories of prestige during this time, particularly in the markets that are in recovery. So this really is a temporary situation that we're experiencing now and into the fourth quarter. Our team on the ground in China has been working diligently to try to get product to consumers, respecting obviously, the restrictions that are in place and staying healthy. And we are incredibly thankful to them for all of the things that they're doing to make sure that they can, as best they can under these circumstances, meet the demand of our consumers in China, who really are looking for our products, and we'll get them as soon as we can get them to them.

As you think about the categories of makeup and skincare, what are you looking at for skincare going forward as makeup is recovering so strongly in terms of new product releases? And then any expansion of what you're seeing at the new Ulta and Target relationships and your product expansion there?

Yes, sure. Skincare will continue to develop. Actually, one of the key things happening is the skinification of many categories, including hair care. The skincare key trends are increasing. What's happening in a very broad sense on top of anti-aging, which remains very important, particularly with the growth of the more mature consumer segment in numbers and interest in the category, is that skincare is entering categories of instant benefits that in the past were primarily associated with makeup. Today, skincare is about anti-aging but also about instant benefits. For instant benefits, I mean luminosity, even skin tone, and brightness — there are many different benefits that today are linked to how the skin looks daily, rather than only over time. The category is larger, offering more usage occasions and reasons for use. The industry is providing amazing technology with great progress in this area. In the long term, we have a very positive view on skincare. Skincare is particularly strong in Asia and, specifically, in China. So, at a time of restrictions like we are witnessing now, you will see less strong growth in skincare, but this is again temporary as we have explained concerning the overall situation. The long-term skincare trend remains robust. In terms of the situation with Target and Kohl’s — yes, Target, Ulta, and Kohl’s Sephora stores, we are pretty happy about the initial results there. These accounted for only 3 points of growth at present, but it has primarily benefitted consumer accessibility, bringing new customers. A lot of this is extra and provides us the ability to reach new consumers, and our brands are performing very well in those spaces with these consumers. So this is also a good trend moving us in the right direction, but it's only the beginning of the journey.