Estee Lauder Cos. Inc (EL) — Q2 2023 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 SEC filings for factors that could lead to different actual results. To help with the discussion about our core business, the commentary on our financial results and expectations excludes restructuring and other charges detailed in our press release. Unless otherwise indicated, all organic net sales growth also excludes impacts from acquisitions, divestitures, brand closures, and foreign currency translation. Reconciliations between GAAP and non-GAAP measures are available in our press release and on the Investors section of our website. Please note that references to online sales include sales 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. It is good to be with you today. Turning to results. For the second quarter of fiscal year 2023, organic sales fell 11%, which was within our outlook despite the incremental pressure from the resurgence of COVID-19 in China. Many developed and emerging markets globally outperformed our expectations to offset the COVID-related impacts of significantly reduced retail traffic as well as limited staffing in beauty advisers, in domestic China and Travel Retail in Hainan in November and December. Adjusted EPS fell 45%. While this deep decline was meaningfully better than our outlook, driven by both disciplined expense management and moderation of the stronger U.S. dollar. Importantly, we continue to prudently invest for growth, launching thoughtful innovation and increasing A&P as a percentage of sales. For fiscal year 2023, we are lowering our outlook for organic sales growth and adjusted diluted EPS primarily for two reasons. First, inventory levels in Hainan remain somewhat more elevated than we expected due to the disruptions in travel and in-store staffing levels in November and December. Second, the recently announced potential rollback of COVID-related supportive measures in Korea Duty Free is creating a near-term transitory pressure on our business with our courier duty-free retailers. In the third quarter, it is more than offsetting the initial positive impact from the resumption of international travel by Chinese consumers as well as favorable trends in our second quarter, including outstanding performance across many developed markets in Western Europe and Asia Pacific as well as many emerging markets globally and a better-than-expected currency environment. All told, our return to growth has shifted from the third quarter to the fourth quarter, which Tracey will discuss in greater detail. We remain focused on investing in our brands including for innovation, advertising, strategic entry into new countries and expanded consumer reach to fuel our multiple engines of growth strategy. Our growth engines in the second quarter were many among categories, regions, and channels, and we anticipate the gradual return of more growth engines across the second half of fiscal year 2023. Beginning with categories, Fragrance extended its long-running double-digit organic sales growth streak in the second quarter, rising 12%. We are inspired by the growth prospects still ahead for the luxury and artisanal segment of the category. As consumers seek unique, distinct, and long-lasting scents of the highest quality. Many of today’s consumers seek to build an occasion-based collection to express themselves differently across seasons, times of the day, or events. Our portfolios of Jo Malone London, Tom Ford Beauty, Le Labo, KILIAN PARIS, and Editions de Parfums Frederic Malle are ideally positioned for this accelerating fundamental shift. As demand increases globally, we are excited about our plans to bring these brands to new markets and channels in the coming quarters. Innovation will also continue to be a key growth pillar. For example, Tom Ford Beauty's outstanding launches in the first half will be followed by the cherry collection in the second half, building on the success of the regional hero last cherry. Makeup grew organically in the Americas as well as the domestic markets EMEA and across Southeast Asia in the second quarter. Our brands are indeed realizing the promise of the category as professional and personal use education drives point innovation, alluring marketing campaigns on new platforms, and artist collaborations. MAC was a standout success. The brand growth engines were many, freestanding doors excelled, welcoming consumers with expert services delivering double-digit organic sales growth globally. Across channels, blockbuster innovation, hero products, and holiday merchandise proved highly sought after. Clinique further fueled makeup across subcategories led by its brand, which has created a hero franchise with nearly lipstick in black honey. Estee Lauder Double Wear foundation had exceptional success with Its My Shade, My Story campaign in Western Europe. Virality on TikTok drove strong new consumer acquisition, and the franchise strengthened its #1 ranking for foundation with prestige beauty share gains. Looking ahead, we are excited for the launch of Estee Lauder Pure Color lipstick in the second half. The brand reinvented its iconic franchise to capitalize on lipstick revival and integrate skincare benefits for lips—designed to flatter all skin tones across matte, cream, and luster finishes. The line's packaging pays homage to the brand's original lipstick from the 1960s. In hair care, our brands extended the category’s organic sales growth streak to eight consecutive quarters. The launch last July in Mainland China will be complemented by the brand’s recent entry into Travel Retail in Hainan, as we continue to invest for the vibrant growth opportunity of prestige hair care with Chinese consumers. Moreover, Aveda became a certified B Corporation, joining Le Labo in our portfolio in achieving this important third-party validation as the brand deepened its decades-long commitment to social and environmental responsibility. Skincare organic sales fell sharply in the second quarter. There were a few headwinds with the most significant challenge being COVID-19 in travel retail in Asia and with the Chinese consumer, given the category's exposure. Amin, the top landscape for skincare, the ordinary was a striking success. Its organic sales growth accelerated from high single-digit in the first quarter to strong double digits in the second quarter. The brand's hero product excelled as did the blockbuster innovation of the multiple tail lash and brow serum, while The Ordinary also realized outstanding performance in the specialty multichannel again, gaining momentum from its exciting launch in India in the fourth quarter of last year. We are focused on returning skincare to growth globally with sequentially improving trends from the third quarter to the fourth quarter as the transitory pressure from travel retail abates. To that end, we have an incredibly rich innovation pipeline primed to launch. Here are a few among them. Already out from MAC is its new hyper-real franchise as the brand leverages its expertise to create an artist-approved skin care line of products which are purposely designed to perform alongside makeup. La Mer's revamped moisturizing soft cream arrived this month with powerful new clinical results to reverse and reveal visible signs of aging. Thereafter, Clinique will bring Moisture Surge 100 Hour Extended to market—extending its popular hero product to meet consumer desire for hydration and sun protection with a lightweight texture that has made it an icon. With these launches, we aim to reach new consumer demographics and tap into high-growth subsegments. Let me now turn to geographies. While the U.S. and domestic China were challenged in the second quarter with sales falling in the single digits organically in each market, we believe both will be growth engines in the second half. For the U.S., we are optimistic for a return to growth given sequentially improving monthly trends in each of organic sales and retail sales performance throughout the second quarter. Building on this momentum, the market is equipped with numerous growth drivers, including an exceptional innovation pipeline across brands, the rollout of new Clinique counters to select doors after a successful pilot of Clinique lab in select locations, and the launch of exclusive products by many brands in specialty multi. We are also progressively modernizing numerous freestanding stores as they are primed to be an important contributor to growth following the rationalization of the footprint. Moreover, our enhanced omnichannel capabilities are also primed to contribute to growth in the U.S. as consumers who engage with our brands online and in-store drive consistently higher value from upsell and cross-sell. This was especially true during holidays in the second quarter. For domestic China, we are confident in a vibrant recovery for our business following the relaxing of COVID restrictions as the economy is well-positioned to rebound and Chinese consumers are passionate about prestige beauty. We entered this phase with momentum having expanded our market share of prestige beauty in China during the second quarter, driven by gains in skincare, makeup, fragrance, and hair care, demonstrating the scalability of our aspirational brand portfolio and the excellent go-to-market strategies of our local team. While the third quarter is set to be more variable due to the high level of COVID cases, we now anticipate even stronger organic sales growth in the fourth quarter as recovery evolves. We expect online sales to continue their strengths and anticipate a gradual return to fuller brick-and-mortar traffic by the end of the fiscal year. Online organic sales rose in the single digits in the second quarter, fueled by many brands led by La Mer's double-digit growth. We achieved excellent results for Estee Lauder as the brand realized top ranks across platforms. Moreover, our retail sales growth in the online channel meaningfully outpaced the industry in the quarter for strong prestige beauty share gains. Beyond the U.S. and China, we realized outstanding organic sales growth in many large developed and emerging markets around the world. Our local team has been executing with excellence to deliver broad-based sales gains. Western Europe, led by the U.K., prospered, while Japan and Australia contributed strongly in Asia Pacific. India, Brazil, Turkey, and Malaysia are among the stars of our emerging markets with each posting strong double-digit organic sales growth, led by India, rising nearly 50%. We are very encouraged by the excellent performance we are delivering in emerging markets. As these emerging markets evolve in recovery from the pandemic, we foresee compelling long-term growth opportunities arising from the expanding middle class trading up to prestige beauty. We entered this important phase of recovery from a position of strength as we hold leading prestige beauty share in many of these markets. For example, in India, Mexico, and South Africa, we are the #1 ranked company in both prestige makeup and skincare, while we lead in prestige makeup in Malaysia, Thailand, and Turkey. Let me now turn to the strategic deal we announced in November to acquire Tom Ford. This transformational luxury acquisition will make Tom Ford an owned brand of Estee Lauder Companies, enabling us to manage the brand's intellectual property and equity while remaining true to our focus as a pure play in prestige beauty. We have also reached agreements with luxury companies, Zegna Group and Marcolin, to license the brand fashion and eyewear businesses, respectively. We first partnered with Tom Ford over 15 years ago, and his singular vision of modal luxury is beyond compare. Together, we have elevated Tom Ford Beauty into the top echelon of high-growth luxury beauty impressively. Tom Ford Beauty is expected to achieve $1 billion in net sales annually over the next couple of years, and we foresee promising profitable growth opportunities ahead. Before I close, I want to recognize the start of Black History Month in the U.S. and thank our employees for creating an engaging calendar of events for colleagues and consumers to celebrate and honor the Black experience while we continue to focus on accelerating our commitment to equity and the collective accomplishment of our equity goals year-round. In closing, while we are lowering our fiscal year 2023 outlook to reflect the additional transitory pressures affecting our Travel Retail business, we are encouraged by both the strong underlying trends in many other areas of our business and improving macro trends. Inflation has stabilized in many markets globally, the strength of the U.S. dollar has moderated, and the return to mobility domestically and international travel is happening earlier than expected. Moreover, in the first half of fiscal year 2023, we made exciting progress on several strategic initiatives to drive growth and resiliency in our business. We significantly strengthened our capabilities in innovation, manufacturing, and distribution, opened the China innovation labs, our first plant in Asia Pacific, and introduced our new distribution center in China, while we also expanded our brand portfolio with Tom Ford and Balmain Beauty. All told, we have great confidence that we will emerge from this volatile transitional year, even better positioned to realize the long-term growth opportunity of global prestige beauty. To our employees, our future is bright because of your creativity, passion, and wisdom. I extend my deepest gratitude for your significant contribution to our long-term success. And now I turn the call over to Tracey.

Thank you, Fabrizio, and hello, everyone. As Fabrizio mentioned, our business in the second quarter continued to be pressured by the external headwinds of COVID-related impacts, including the rising number of COVID cases in China, lower shipments of replenishment orders in the U.S., and the stronger U.S. dollar. Our second quarter organic net sales declined 11% and earnings per share decreased 49% to $1.54. Tighter expense management and a slightly improved currency impact contributed to our better-than-expected EPS results. From a geographic standpoint, organic net sales in the Americas declined 3%. We saw healthy demand for our holiday offerings as consumers gravitated towards our in-store and online promotions. However, we also experienced lower shipments of replenishment orders due to retailer inventory tightening as we anticipated, and a later improvement in retail trends post-Christmas. In Latin America, organic net sales rose in double digits, reflecting continued growth in nearly all markets, the ongoing recovery in makeup as consumers return to stores, and the strength of our fragrance portfolio. Organic net sales in our Europe, Middle East, and Africa region declined 17%, including the negative impact from foreign currency transactions and key international travel retail locations of 3%. The decline was driven by travel retail as expected, while growth from nearly every market in the rest of the region was strong. Our global travel retail sales were significantly pressured by the ongoing COVID-related impacts. Despite stores being opened throughout the quarter, travel to Hainan remained largely curtailed, and as a result, shipments of replenishment inventory remained low. Elsewhere, we experienced strong sales growth in Travel Retail, reflecting increased international tourism as travel restrictions in many countries lifted from the prior year. The ongoing pressures in Asia travel retail more than offset the growth we experienced in the rest of the EMEA region, including both developed and emerging markets such as the United Kingdom, France, India, and Turkey. We continue to see various stages of recovery across the region, which, coupled with the strong resumption of tourism, fueled brick-and-mortar growth during the quarter. Organic net sales in our Asia Pacific region fell 7%, primarily due to the ongoing COVID-related impacts in Greater China. This affected brick-and-mortar sales in Greater China and Dr. Jart Travel Retail in Korea. Online sales continued to grow in Mainland China, due in part to the expansion of our online presence with the recent launches on JD and Joyn, as well as solid performance during the 11.11 Shopping Festival. Most markets in the region continued to progress in recovery as the return of brick-and-mortar traffic led to high single-digit or double-digit growth in Japan, Australia, Malaysia, and the Philippines. From a category standpoint, fragrance continued to lead growth with organic net sales rising 12%. Strong holiday demand for our beautiful line of fragrances from Estee Lauder and double-digit growth from both La Mer and Tom Ford Beauty propelled the category's growth in every region during the quarter. Organic net sales in hair care rose 4% and declined 3% in makeup, the latter driven primarily by the COVID restrictions in China as solid performance from both MAC and Clinique contributed to growth in both the Americas and domestic markets in EMEA. Organic net sales in skin care declined 20%. This category continues to be the most affected by the COVID restrictions in China, particularly in Asia travel retail and Mainland China, where skin care accounts for a large majority of our business. Our gross margin declined by 430 basis points compared to last year. The positive impacts from strategic pricing in this quarter were more than offset by inflationary pressures on our supply chain, region and category mix, and higher costs due to promotional items. Operating expenses increased by 500 basis points as a percentage of sales, driven primarily by the reduction in sales. This also reflects our investments in areas such as advertising, promotional activities, and innovation, which increased by 150 basis points compared to last year. Operating income declined 46% to $768 million, and our operating margin contracted by 930 basis points to 16.6% in the quarter. During the quarter, we recorded $207 million of impairment charges related to three brands, primarily reflecting lower-than-expected growth in key geographic regions and channels due to the pressure on consumer demand from the impacts of COVID. Diluted EPS of $1.54 decreased 49% compared to last year. The impacts from foreign currency translation and foreign currency transactions in key travel retail locations negatively impacted diluted EPS by 5% and 4%, respectively. During the quarter, we generated $751 million in net cash flows from operating activities compared to $1.8 billion last year. The decline reflects lower net income and the negative impact from changes in working capital, primarily due to the timing of payments. We invested $419 million in capital expenditures and returned $708 million in cash to stockholders through both dividends and share repurchases. As we expected, our first-half performance was pressured by ongoing external headwinds. Let me now turn to our outlook for the remainder of fiscal 2023. For the second half of fiscal 2023, we are encouraged by the easing of COVID restrictions in China and the expected return of travelers throughout Asia and around the world once more stabilization occurs with outbound flights, visas, and COVID entry and testing requirements. In Hainan, we are starting to see increased positive signs already as traffic level declines have moderated in recent months. However, retailer inventory levels are still somewhat elevated, reflecting the impact of the lengthy store closures as well as the rapid reduction in traffic and in-store staffing levels in November and December. In Korea travel retail, an incremental headwind has emerged since we last provided our outlook in November. The recently announced potential rollback of COVID-related supportive measures in Korea Duty Free is creating near-term transitory pressure on our business with our Korean duty-free retailers, which is pressuring our third quarter outlook. We also expect more moderate net sales growth in the near term in our China business as the rise in COVID cases in November and December slowed expected brick-and-mortar retail traffic and social usage occasions, which continued in January during the pre-Lunar New Year shopping time frame. Collectively, we expect these impacts to create greater headwinds in the third quarter than we originally anticipated. As a result, we are updating our outlook to reflect a shift in the start of the travel retail recovery in Asia from the third to the fourth quarter of fiscal 2023 due to the normalization of inventory levels in Hainan, the uncertain pace of recovery of travel retail traffic in Korea, and a more moderate acceleration of growth in China. The momentum from our other developed and emerging markets in EMEA and Asia Pacific in the first half is expected to continue as those markets progressively evolve in recovery. We are also cautiously optimistic and expect our North America net sales performance to improve as our retail growth trend in the region has already increased, particularly in January. We have a supportive innovation pipeline planned for the second half, as Fabrizio mentioned. As it relates to our operating income, while these external headwinds have introduced a high level of volatility and had a meaningful impact on our financial results this fiscal year, we remain confident in the ongoing strength of prestige beauty, our business strategy, and our ability to reaccelerate long-term profitable growth. We, therefore, plan to sustain the strategic investments imperative to that growth, including innovation, advertising, and continued geographic expansion for many of our brands. These investments also support the continued strengthening of our multiple engines of growth as we invest in emerging markets and faster growth channels that are already progressing well in their recovery. As a result, we expect to see pressure on our operating income in the third quarter with an accelerated improvement in the fourth quarter as the sales recovery in travel retail, Mainland China, and skincare start to materialize more meaningfully. The negative impacts from foreign currency that we anticipated in our previous guidance have improved due to the recent weakening of the U.S. dollar. However, currency is still expected to have a meaningful drag on our reported sales and diluted EPS growth for the third quarter and full year. Our outlook is now based on December 30 spot rates of 1.067 for the euro, 1.207 for the pound, 6.964 for the Chinese yuan, and 12.63 for the Korean won. Based on this backdrop, our guidance is as follows: we expect organic sales for our third quarter to decline between 10% and 8%, primarily reflecting the pressures on our Travel Retail business that I mentioned previously. Currency translation is expected to be dilutive to reported net sales by 3 points, and the impact of certain foreign currency transactions in key international travel locations is not expected to be material. The impact of sales from certain designer fragrance license exits is expected to dilute reported growth by approximately 1 point. We expect third quarter adjusted EPS of $0.37 to $0.47 for a decline between 81% to 75%. Currency translation is expected to be dilutive to EPS by $0.04, such that constant currency adjusted EPS is expected to decline between 79% and 73%. This includes the negative impact from certain foreign currency transactions and key international travel retail locations of approximately 1 percentage point. For the full year, we now expect organic sales to be in the full range between down 2% to flat. Currency translation is expected to dilute reported sales growth for the full fiscal year by 4 percentage points, and we expect an additional 1 point of dilution from the impact of certain foreign currency transactions in key international travel retail locations. The impact of sales from certain designer fragrance license exits is expected to dilute reported growth by approximately 1 point. We expect full-year operating margin to be approximately 15.1%, a 460 basis point contraction from the prior year period, primarily due to the geographical and category mix of sales and foreign currency impacts, as well as the sustained investments to support recovery as previously mentioned. We now expect our full-year effective tax rate to be approximately 25.5%, reflecting in part the change in our estimated geographical mix of earnings. Diluted EPS is expected to range between $4.87 and $5.02 before restructuring and other charges. This includes approximately $0.29 of dilution from currency translation. In constant currency, we expect EPS to fall between 29% and 27%, which includes a negative impact from foreign currency transactions and key international travel retail locations of approximately 4 percentage points. Regarding the Tom Ford brand acquisition, we expect to complete this transaction in the fourth quarter and to fund it through a combination of cash, debt, and deferred payments. In anticipation of closing this transaction, in January, we increased our commercial paper program by $2 billion. We also estimate a slight EPS dilution to the full-year outlook that I just provided due to the final purchase accounting inclusive of transaction costs. While this year has undoubtedly been a perfect storm of unforeseen macro pressures on our business, and the transition to accelerated recovery has indeed been longer than we anticipated, we have navigated through the challenging environment and strengthened the company in the process, thanks to our amazing employees, our company values, and our multiple engines of growth strategy. We are encouraged by the many signs of improvement in the overall environment and the progress our incredible teams have made in preparing us for a strong recovery. Our fundamentals are solid and intact, reinforced by the actions we have taken over the past few years. From the acquisition of the majority interest in a brand in fiscal 2021 to the recent announcement of our agreement to acquire the Tom Ford brand and the Balmain license agreement, we are expanding our brand portfolio at both the entry-level and luxury levels of prestige beauty. We've taken strategic actions to enhance our go-to-market capabilities, supply chain agility, and local relevance through our new innovation, production, and distribution facilities in Asia. We've enhanced our digital marketing capabilities and continue to progress on our ESG initiatives. These actions and many more demonstrate that we remain confident in the long-term sustainable profitable growth of our business. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

I was hoping—and this is probably more for you, Tracey. If you could walk through with us how the length of the supply chain works for supplying both Hainan and Mainland China currently, knowing it's shifting. Because as we think through the change forecast in demand and knowing what I believe is a pretty lengthy supply chain, how you're managing production versus shipments and if that's sort of informing why there's so much visibility seemingly on Q4. And I guess we should see inventory spike up on your balance sheet in Q3. Is that right?

Yes. You're correct, Lauren, that we do expect that we will—two things. One, inventory levels are still coming down in Hainan. They are almost at the level that we would expect sales to accelerate. So yes, you should start to see an inventory build related to the shipments that we expect to see in Q4. In Korea, again, the pace is a little more uncertain given the transitory nature of what's going on right now. So we do anticipate, as I mentioned in the prepared remarks, that we will start to see the resumption of travel in Korea. And depending on the pace of that resumption, that will depend on the amount of shipments that we have in the quarter. But we have taken obviously an assumption there. We are sitting on a decent amount of inventory even in our own warehouses to supply the sales that we expect to see in the fourth quarter.

So just sort of extend that question a little bit, right? We have a lot of quarterly volatility in terms of Q3 versus Q4. Q2, there's a difference in shipments versus underlying retail sales. Obviously, COVID impacts in China. So it's hard to get a great underlying sense of retail sales here and how the business is doing. So a ratio, maybe you can just give us a little bit of an update on retail sales by region. I'm particularly interested in category growth and any macro impacts in the U.S. and Europe? And then how you're thinking about Asia Pacific and China versus the rest of the region. Let's so on near-term results here, but more how results came into the quarter versus what you originally expected and that might inform the revenue trajectory as you look out over the next couple of years and how you think about it? I think you touched on a lot of aspects of that, but it would be helpful to get a general overview.

Yes. No. Absolutely, with pleasure. Let me start with China, first of all. And so China, the results in the quarter were pretty good. We built significant market share. So the overall market in China was negative double digits. Our net sales were and our retail was negative single digits, and we built market share in every single category. So in most areas, we built market share in makeup, fragrance, and hair care in every aspect. Now this, for us, is a very important sign that our brands are really working, and the aspirational value of our brands remains very, very strong, which in the moment of reopening is a very strong position to be in. So excellent performance relatively to market. Though some of our brands were shining, La Mer in skin care was the brand that was gaining the best market share and for beauty in makeup, Jo Malone London in fragrance was really leading the share gain. The other important reading of China is that during 11/11, our net sales were up 10.9%, and our retail sales were up 11.9%, holding the #1 ranking across various categories and there was a lot of great success on the brand creative activity, live streaming on innovation. And so the way when consumers are back in this very difficult volatile period like a situation like 11.11, where there is obviously high traffic, our brands respond enormously. And obviously, when consumers are not back or don't travel, or our site is when we have seen some issues. So in total, China is developing the way we planned. And from a market share standpoint, recovering also, and is definitely going in the right direction. In terms of the future, the potential of China, we continue to see now the opening to create a gain traffic in Mainland, in brick-and-mortar, we see the continuation of the line success. And we see the—obviously, the reopening of Hainan. And so the Chinese consumer on all fronts. Also, we see the fact that the Chinese consumer is starting to travel internationally, and this will gradually increase as the governments will agree theses and models of growth. At this moment, there are parts of the world we already opened, others we will open soon. Japan will be in soon. Korea is the one where the agreement is not yet finalized, but we are optimistic that in the future, this will also be resolved. So that's another very important trend. This will have a positive impact, obviously, in our retail channel, but also in the countries of destination, as has always happened historically. In terms of categories in China, obviously, the most important thing is that as China accelerates on all fronts, skincare will accelerate for us. And so the acceleration of travel retail in Asia, the acceleration of international travel of Chinese consumers, will have a substantial improvement of our skincare trends that, in turn, will have a positive impact on our margin mix. This is obviously an important element of the program. Then for other regions of the world, as I commented in my prepared remarks, the situation has been very strong in Europe where we built market share in most of the European markets. Very strong in the rest of Asia, particularly strong gains in Japan and Australia, as I mentioned. And in Korea, excluding the travel retail impacts, that are particularly heavy on our brands, Korea is starting to progress very well. So good progress in all other regions. Then North America. Now in North America, we also continue to lose share in the quarter. Overall, we would like to accelerate our plan of share recovery. But the good news is there's been very strong progress in quarter two. Every single month, October, November and December, there was progress in top-line sales acceleration. First of all, in retail, the quarter in the U.S. ended up plus 2%, so on the positive. But December was plus 6.5%, 7%. So in line with our goals of acceleration. So we see the U.S. progressing. Now the next six months, there is an even stronger plan. In the U.S., we have a strong acceleration of innovation. I mentioned already some in the prepared remarks like Estee Lauder Patchology, La Mer, Clinique, HyperReal, and Marc Jacobs. We have some important distribution improvement. We are deploying more distribution of our high-end fragrances in Macy's, and the Ordinary is entering some doors and strands. We are deploying in Ulta and Sephora new, incremental distribution and incremental expansion of our key brands in these doors. And we are renovating 100 freestanding stores, opening eight new fresh stores, and continue to improve our omnichannel capabilities on all fronts. So we see an acceleration of our progress also in the U.S. So in summary, when I should add what Tracey also underlined, at the same time, we have improved our capability behind this program. Our digital marketing is strong. Our supply chain is shortened and faster. Obviously, we have made progress in our factory in Japan, opened our R&D center in China that will increase the amount of local relevant innovations in Asia in an important way in the next fiscal year—starting this fiscal year in a significant way. And we have opened a new distribution center in Switzerland, and on the service, obviously, China, within China, as we discussed also in the last call. So there are all these investments and progresses in capabilities that make us ready for the reacceleration in the future. In summary, this fiscal year has been a year where we really suffered due to the COVID lockdowns, particularly in Asia, and the high level of infections during the reopening and the impact of the strength of the U.S. dollar that was particularly big in our high profit, high-important channels like travel retail and China, travel retail. So it was really a perfect storm kind of situation. But all the rest, apart from these three areas, really progressed and in some cases, were very successful in gaining market share. So that's my overview. I hope to answer your question that having an overview of the situation. But I would say is very, very encouraging for the recovery period.

So Tracey, I wanted to ask about the implied outlook for organic revenue growth in the fourth quarter, which is quite strong and better than expected. And I know we're still a few months away from fiscal '24 here. But is the implied exit rate in the Q4 guidance a fair way to kind of think about the potential top-line recovery looking out to next year? Or are there kind of the timing-related impacts given what you're forecasting in Q3 that could be driving a stronger growth? So look, we expect a stronger fourth quarter than probably you anticipated and us as well, given a few months back. And part of that, as we said in our prepared remarks, is because of the shift of recovery expectation, certainly in terms of some of Travel Retail. I would just remind you that—and I know you're well aware of this—we're also anniversarying some pretty significant shutdowns from last year. So this volatility that we're speaking about actually started at the end of our fiscal 2022 in the fourth quarter. And we're coming up on the anniversary of that. So the numbers look particularly large from a growth standpoint because we are anniversarying some lockdowns in China and in travel retail in Hainan in particular, which was the start of some of the problems that we have anticipated on this call today. I think we are anticipating for fiscal '24—we're not giving fiscal '24 guidance right now. But given that in the fourth quarter, all markets are anticipated to be open and remain open and traveling will gradually resume, and again uncertain about the pace of that resumption, but we've certainly seen encouraging signs in many of our markets—that fiscal '24 will be a strong year for us. So I wouldn't take the Q4 implied growth and apply it to fiscal '24, Peter, if that's what you're getting at.

Tracey, maybe I could just dovetail on that a little bit. You told us a few quarters back that a 20% margin was a North Star. As you think out to next year and many of the moving parts of your business finally start to come back online, is there any—there may be some pull-forward revenue that leaks into the first half of the year. I don't know, obviously, you gave us the fourth quarter here. But as you look out to next year, is 20% an appropriate North Star for next year given the revenue drivers back online? And then I guess, Fabrizio, can you help us size the travel business a little better since it's such a big swing factor in the model here going forward? I think it was about 15% of sales pre-COVID, half of it China. You spoke a little bit about the shape of it at a conference in December that the pre-COVID Chinese business—the Chinese traveler was largely a Tier 1 international traveler. I think you said Hainan only has completely replaced that, but it's a different customer, maybe a lower-tier customer. Just because this moves the model around so much, can you help us just think about how big that business is today in the non-China markets, Hainan—and non-Hainan China to help us think about the model?

So let me just—and Fabrizio will pick up on your questions on Travel Retail. But Travel Retail actually was larger; you're remembering, Michael, that our online business was bigger during the pandemic. Travel Retail was more like 26% pre-pandemic. But in terms of the operating margin for fiscal '24, as you can imagine, with some of the more recent events, we are still going through what our expectations are for fiscal '24, and we'll certainly provide guidance as we normally do in the August timeframe. I think 20% is a little ambitious right now for fiscal '24 based on what we're seeing. But some of that has to do with how currency moves, which was my previous comment in terms of if you have projections on currency, let me know. But certainly, in terms of the business fundamentals, the growth, we would expect more margin expansion that is in our normal algorithm for fiscal '24 because of the recovery of volume. And obviously, when you're down in volume as we are this year, as much as we protect the strategic investments, but also make choiceful discretionary investments as well. Volume solves a lot of sins. And so we would expect more leverage on our expense base next year certainly than we are able to get this year, practically because of the volume trends and as well as the shocks in terms of those hits that occurred and how fast we can react to them. So again, we are expecting a certainly progressive fiscal '24. And with all of the things that we spoke about in the prepared remarks as it relates to the investments that we made that will come online, we'll have a new factory operational in Asia that will shorten our time to market, and we will have the new innovation center, which will start to contribute to the development of products for us in the future, et cetera. So all of those things that we said in the prepared marks should also support the acceleration of growth in fiscal '24. Now for your travel—or more on your travel retail question, I'll turn it to Fabrizio.

Yes. Thank you, Tracey. Also, I want to add on the margin thing that the first step of normalization of our margin that Tracey is describing on top of volume will also depend on which volume. Because if you assume that the normalization of business would be in travel retail in China, then you are assuming that the normalization will be in skincare that tends to be higher margin. So there will be a moment of recovery and normalization. And then from there, we will restart our normal algorithm. And we will see how the normalization trends evolve and how long they will take. But that will be the way we will move back. In terms of the travel retail question, let’s clarify the dynamics of travel retail. The dynamics will be, first of all, Hainan is now established. And yes, I said that when the international travel of Chinese consumers will restart, Hainan will not be cannibalized in a big way as it is now a well-established vacation place for Chinese that does not require a passport. Keep in mind that at least before COVID, I do not have the latest information, but previously, less than 20% of Chinese had a passport. So there is 80% of Chinese that will go to Hainan and they will not travel internationally in this model. So Hainan will continue and will continue to develop. The addition will be the international travelers, which is coming back in an important way. And then, obviously, Korea and the rest of Asia. So Korea has always been a very big business. But as you know, Hong Kong and Macau and Japan were all very important travel retail businesses that now will improve. There will be different levels of growth in all of this. Now in terms of categories, because of the prevalence of the Chinese consumer, travel retail and skin care is a very important category. So the travel retail acceleration in the future will carry skincare, which will be beneficial for our profitability. The last point I want to make is that the travel retail is driven by increased traffic and conversion. The numbers available before COVID indicated that conversion was between 10% and 15%, and we know also that when there is retail like in China and Korea and the consumers can buy online before they go to the airport, this conversion number increased. The amount of conversion of travelers is increasing, and the comeback of Chinese consumers in international travel is very good news because the Chinese consumer used to have much more purchase per person than the average travelers from different regions. The increase in the mix of Chinese travelers is also very good news for global travel retail. So in the post-COVID world, when we will really be post-COVID, I think we are going to see some years of exciting opportunity globally in travel retail development.

Yes, I wanted to ask about the sustainability of growth in some of these categories, which benefited from reopening like fragrances and makeup and expectations for skincare improvement. It sounds like you’re obviously talking to improving skincare trends globally, obviously, China as well. And then I wanted to ask the same question around China. Should we expect a similar reopening trajectory? Or are you expecting a similar trajectory in China that we’ve seen around the rest of the world in terms of growth and in terms of the categories which benefit?

So the reopening of China is significant. Today, the level of sales online is the highest percentage in the world. So to be clear, the reopening of China will primarily impact the reopening of brick-and-mortar, which will impact 50% of the business in China. Obviously, during the period where the level of infections in China was super high, around 80% of families had somebody with the virus, so the implications were normal. In this period, we also saw reduced consumption. Everything, including online, reduced interest in makeup and other categories. But that’s temporary, obviously. Your question is more about what happens when everything normalizes. The only thing I want to clarify is that it has to be regular—not only the ability to purchase in stores but also to be free of COVID for consumption to come back. When people will be free of COVID as a disease, we will see traffic increasing dramatically, and we will see a continuous acceleration, a gradual continuous accumulation of online sales, which is already very strong. There are many new platforms online that are being opened in China, which are promising. Our success on JD has been very strong. It’s one of the reasons behind our market share growth during events like 11.11 and June 18. In summary, there are many good potential levers of growth that will be activated by the comeback of consumers. Skin care will be the biggest beneficiary for the simple reason that it is the biggest category in China's beauty market. Fragrance is also on a roll in China, expected to grow with the reopening, developing in the high-end segment. Makeup, which has been most affected by COVID, will also see resurgence when the situation normalizes. Lastly, we have launched data in China for a sustainable luxury haircare segment that is beginning to develop, which is also exciting for our future opportunities.

And in terms of fragrance, we will continue to expand our fragrance portfolio. We’re certainly seeing a pickup and expecting a pickup in travel retail as it relates to fragrance, and fragrance is still a growing category in Asia. So certainly, during the recovery, we expect that fragrance trends will persist.