Estee Lauder Cos. Inc (EL) — Q4 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. Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC, where you'll find factors that could cause actual results to differ materially from these forward-looking statements. To facilitate the discussion of our underlying business, the commentary on our financial results and expectations is before restructuring and other charges and adjustments disclosed in our press release. Unless otherwise stated, all organic net sales growth also excludes the non-comparable impacts of acquisitions, divestitures, brand closures, and the impact of foreign currency translation. You can find reconciliations between GAAP and non-GAAP measures in our press release and on the Investors section of our website. As a reminder, references to online sales include sales we make directly to our consumers through brand.com sites and through third-party platforms. It also includes estimated sales of our products through our retailers' websites. During the Q&A session, we ask that you please limit yourselves to one question, so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Thank you, Rainey, and hello to everyone. We appreciate you joining us to discuss our fiscal year 2023 results and outlook. Let me begin with the fourth quarter. We delivered an organic sales increase of 4%, achieving a return to growth for the quarter as expected. Momentum continued in the markets of EMEA and Latin America and accelerated in Asia Pacific, where organic sales growth improved from 7% in the third quarter to 36% in the fourth quarter, led by mainland China and Hong Kong SAR. Looking at the full year, while demand for our business is still strong with retail sales rising mid-single digit globally, organic sales declined 6%. We delivered impressive double-digit growth in the markets of EMEA and returned to growth in Asia Pacific, while the Americas held steady. These gains across the markets of EMEA and Asia Pacific were more than offset by Asia travel retail, given the prolonged and complex recovery from the pandemic, as we have discussed in our previous earnings calls. Indeed, our global travel retail business decreased 34% organically in fiscal year 2023, solely driven by Asia travel retail. Our travel retail business in EMEA and the Americas soared, and our investment in activation and in-store beauty advisors drove strong performance as passenger traffic increased. The rest of our business in total rose 5% organically as growth accelerated from 10% in the third quarter to 17% in the fourth quarter. The challenges in Asia travel retail disproportionately pressured skin care, which is our highest margin category. Compounding matters, the leverage was pronounced as the lower level of sales coincided with the elevated strategic investment in manufacturing and R&D capabilities, as well as information technology for our online business and to support our expanding supply chain globally. All told, our adjusted operating margin contracted meaningfully in fiscal year 2023 to 11.4%, modestly better than we expected in the revised outlook we offered in May. During fiscal year 2023, we continued to make progress on our sustainability goals and commitments. For our packaging goals, for instance, we have now advanced from 51% of our packaging being recyclable, refillable, reusable, recycled, or recoverable in fiscal year '19 to over 70% in fiscal year 2023. As well, we are on track to maintain our status of 100% renewable electricity and Scope 1 and Scope 2 carbon neutrality. We are proud to have been recognized for our continued commitment to disclose our environmental impact as reflected in our climate, water, and forest disclosure scores for 2022. Most notably, we achieved an A minus for our climate change disclosures, and we earned a place in the prestigious A List for water, improving our score over 2021. Looking ahead, for Asia travel retail, the pressure in Hainan intensified over the course of the fourth quarter. In May and June, retail sales trends deteriorated and turned steeply negative, following the enforcement actions to control the illegal activity. The implication of these actions are favorable for sustainable long-term growth but certainly create significant short-term headwinds through the transition. As we embark on fiscal year 2024, we have four strategic imperatives: drive momentum where our business is performing well; reaccelerate growth in the United States; capture demand for the returning individual travel in Asia travel retail; and begin to rebuild our profitability. For fiscal year 2024, we expect to return to full-year organic sales growth and margin expansion with organic sales rising 6% to 8% and adjusted operating margin improving sequentially throughout the year. Our fiscal year 2024 action plan, where we expect to again increase our investment in advertising as a percentage of sales, will also set the stage for a stronger fiscal year 2025 acceleration. One of our greatest strengths to leverage in our return to top and bottom line growth is our diverse portfolio of nearly 25 brands. Sitting at the top are our $4 billion-plus brands of Clinique, Estée Lauder, La Mer, and M.A.C, each a winner in its own right. M.A.C, the world's biggest prestige makeup brand, was our best-performing brand across the entire portfolio in fiscal year 2023. Its unrivaled artistry, hero products, strong earned media value ranking, and breakthrough innovation of the Hyper Real franchise in skincare drove excellent results. For fiscal year 2024, the brand is on the cusp of a big launch in makeup as M.A.C aims to extend its winning streak in innovation. Indeed, all our billion-dollar-plus brands have exciting newness ahead in both product and commercial innovation as they leverage their brand equity, scale, and omnichannel beauty advisors. Clinique, the number one prestige skincare brand in the U.S., pioneered dermatologist-developed products when it was founded in 1968. The brand is deepening its connections with dermatologists, adding powerful, instant, and dermatologist-level claims, doubling down on its unique safety philosophy and activating more dermatologist education on TikTok. And later this month, Clinique will elevate its equity in aging with the breakthrough launch of Smart Clinical Repair Lifting Face and Neck Cream, a new dermatologist-tested formula. Estée Lauder, among the biggest prestige brands globally, is extending its world-renowned Advanced Night Repair franchise with the launch of Rescue Solution for sensitive skin, and the brand's luxury-oriented Re-Nutriv franchise has a rich innovation program across makeup and skincare. La Mer, the global leader in luxury skincare, grew double-digit in Asia Pacific in fiscal year 2023 and aims to accelerate its growth with the upcoming launch of the Lifting Firming Serum. This launch capitalizes on La Mer's successfully upgraded moisturizer soft cream, as both bring advanced benefits in anti-aging efficacy. Moreover, La Mer is introducing new regimens focused on the power of its iconic Miracle Broth to capitalize on the trend of night regimens. In fiscal year 2024, this esteemed tier of billion-dollar-plus brands is set to expand its brand count by 50%, as we expect Jo Malone London and TOM FORD to cross the sales threshold. These two brands have excelled over the last decade and are ideally positioned for the next decade given their positioning in the fast-growing segment of luxury and artisanal fragrance. For TOM FORD, which optimized luxury glamour, fiscal year 2023 was monumental. We are thrilled to have acquired the brand after having collaborated to create TOM FORD for over 15 years. This acquisition is a central building block to realize our aspirations in high-growth luxury beauty. Moreover, the brand's sales rose strong double-digits organically in fragrance for the fiscal year. The breadth of this performance was stunning as over 30 markets grew double digits. The strengths of its hero products and innovation proved a powerful combination with new and existing consumers. And TOM FORD Enticing Cafe Rose launched to begin fiscal year 2024. In makeup, TOM FORD delivered double-digit organic sales growth in Asia Pacific and the markets in EMEA, driven by excellent performance in lips. Among our other scaling brands or those with sales between $500 million and $1 billion, we are encouraged by their progress in fiscal year 2023. For Bobbi Brown Cosmetics, the brand continued to complement its expanding makeup business with strong growth in skincare, while Aveda executed on its global ambition with a successful launch in mainland China. The Ordinary graduated into our tier of scale brands as double-digit sales growth propelled it well above $500 million. The brand's list of achievements for the year is long, indeed, from success in its hero product to a step change in the contribution to sales from innovation to doubling its TikTok followers, to strong share gains in prestige skincare in the U.S. and Western Europe, The Ordinary proved its high-performance ingredient-led products are well-loved. And we believe it is just getting started in realizing its global potential. Looking across our developing brands, in which we strategically invest to realize the scale brands of the future, Le Labo, KILIAN PARIS, and Editions de Parfums, Frederic Malle each achieved double-digit organic sales growth in fiscal year 2023 to continue their winning streaks. Impressively, over the last five years, these three brands have delivered over 30% compound annual growth, demonstrating brand-building acumen. At this time next year, we will be on the verge of launching Balmain Beauty with the namesake luxury fashion house. Our collaboration with Balmain has been exceptional and we cannot wait to introduce this new luxury beauty brand to the world. For our brand portfolio, we have positioned ourselves to take advantage of the efficiencies and effectiveness that will be enabled by generative AI. Furthermore, creating high-quality, high-performing products is in our DNA. Innovation has long served as a catalyst for growth, once again represented over 25% of our sales in fiscal year 2023. We have a rich pipeline of newness slated for fiscal year 2024, and it gets even bigger and stronger in fiscal year 2025 with more breakthrough innovation and expansion into widespread opportunities. Over the last few years, aligned with our innovation strategy, we have significantly increased the breadth, depth, and diversity of our clinical studies for new and legacy products across categories to deliver impactful claims. This work, combined with our newly opened China Innovation Labs in Shanghai, equips us with even greater capabilities to drive growth with consumers locally and around the world. For skincare, we have also significantly increased our scientific credentialing, demonstrated by an 85% increase in scientific advisory board members and third-party dermatologists and academic partners in the last two years. Last month at the World Congress of Dermatology in Singapore, we presented several studies for Clinique, Estée Lauder, and La Mer. This was a milestone moment for Estée Lauder's Re-Nutriv franchise as our scientists unveiled our newness Breath Rule Longevity Age Reversal research on a global stage. Re-Nutriv has continued to be a pioneer in this frontier of skin biology and will extend upon the recent success of Ultimate Diamond Transformative Brilliance Serum with compelling innovation this fiscal year. As we rebuild from the challenges of fiscal year 2023, we expect to leverage and stand upon these trends as we drive resilient growth. The opportunities ahead of us are significant as over 900 million people are expected to enter the middle class through 2030 and drive consumption as they seek the high-quality, strong efficacy, and joy the prestige beauty affords. Our company has great confidence in the long-term development of China, and we are proud of the very strong business we have built, led by our exceptional local team. The Chinese consumers continue to be the unrivaled number one growth drivers of our industry throughout the decade. We are pleased to have returned to organic sales growth in mainland China in fiscal year 2023, and to have expanded our prestige beauty share as the market gradually evolves in its recovery from the pandemic. Impressively, mainland China's fourth quarter organic sales were up double digits compared to both one and two years ago, and we further expanded our prestige beauty share in the quarter. We made significant long-term investments in the market across fiscal year 2023. Beyond the opening of the China innovation lab in Shanghai and a new distribution center in Guangzhou, we launched Aveda to start the year and Le Labo to end the year. Aveda quickly captured up the ranks of prestige hair care, driven in part by its focus on the skinification of hair and high-performance product for scalp care. Le Labo's initial freestanding store in Shanghai redefines experiential shopping, which makes it no surprise that it was the brand's top-performing store in the world in the month of June. We also invested in the vibrant opportunity in both brick-and-mortar and online, opening in seven new cities, expanding our online reach with Douyin, and creating exceptional live streaming content which, as you know, is a game changer to excel in the market. Our online ecosystem continues to move from strength to strength across social and commerce, encompassing Timo, JD, WeChat, Red, and Douyin, among others, driving our share gains for the fiscal quarter and year. Online in Mainland China performed exceptionally well every month in the fourth quarter to realize over 60% organic sales growth and expanded online prestige beauty share by 2 points, owing to innovation, gifting campaigns, and excellent execution. We capped the quarter's success on 6/18, where our brand strength was broad-based. Estée Lauder ranked number one in store live streaming prestige beauty on both Timo and Douyin, La Mer ranked number one in luxury beauty on Timo for the third consecutive year, and Jo Malone London took the top spot on Timo and JD for luxury fragrances. From an organizational standpoint, mainland China and China travel retail have enhanced their capabilities for local coordination of go-to-market strategies and plans to maximize long-term value and support brand equity. The expected growth of the middle class around the world is an exciting implication for our business, given also our vibrant emerging market portfolio. Indeed, in fiscal year 2023, our emerging markets delivered organic sales growth of 20% led by India, Brazil, Turkey, and Thailand. India grew nearly 50% for the year, driven by excellent performance from our long-standing brands in the market and the very successful launch of The Ordinary. In North America, we are focused on reaccelerating growth to better capture prestige beauty opportunities in the region. Our multi-faceted strategy plan includes launching a robust innovation pipeline, increasing engagement by brands on TikTok, accentuating our strength in luxury and artisanal fragrance and high-performance, ingredient-led skincare, and expanding brand reach in specialty multi, among other initiatives. We are excited to extend our reach online as The Ordinary and Estée Lauder are soon to launch on TikTok Shop. Let me now turn to our profitability. We have identified four building blocks to progressively expand adjusted operating margin over the next few years. First, we are focused on optimizing mix by elevating luxury across brands, driven by consumer preferences, and expanding our direct-to-consumer ecosystem across brick-and-mortar and online. Second, we see many opportunities to maximize value through better price realization and accretive innovation. Third, we intend to increasingly leverage the strategic investments we have made over the last few years, most notably our new manufacturing facility in Japan and expanded online capabilities. Last, we believe we can unlock meaningful cost efficiencies in our value chain as we complete the rollout and adoption of our new integrated business planning process across global operations and use generative AI to drive efficiencies. In closing, while we had a challenging year, we remain confident in our long-term strategy to realize the promising growth opportunity in global prestige beauty with our diversified portfolio brands, robust research and development capability, and global reach. We are encouraged by the fundamental strength of our business in the markets of EMEA, Asia Pacific, Latin America, and are focused on our plans to recover growth in Asia travel retail and North America. For fiscal year 2024, we believe we are well positioned to return to organic sales growth and improve profitability. To our employees, you are the heart and soul of our beautiful company, and I extend my deepest gratitude for your exceptional contribution and dedication. And now, I will turn the call over to Tracey.

Thank you, Fabrizio, and hello, everyone. While we certainly had many successes this past fiscal year, as you just heard, we are not satisfied with our fiscal 2023 financial results and are executing on our strategy to progressively rebuild the margin-accretive areas of our business over the next few years and leverage the investments we have made in manufacturing, distribution, and technology capabilities. I will further address our plans when I discuss our fiscal 2024 outlook, but first, I will cover the fiscal 2023 fourth quarter and full year results. Our fourth quarter organic net sales increased 4% and earnings per share was $0.07. From a geographic standpoint, organic net sales grew in nearly all markets in both Asia Pacific and EMEA. This strong performance was partially offset by the ongoing challenges in our Asia travel retail business as we expected. Organic net sales in Asia Pacific rose 36%, reflecting double-digit growth in most markets, led by Mainland China and Hong Kong SAR, as they continue to progress in recovery with fewer COVID-related restrictions compared to the prior year. They also benefited from our successful brand innovations, new product launches, consumer activation, and targeted reach. In Mainland China, online realized over 30% organic growth and achieved approximately 60% penetration of sales in the quarter. In EMEA, organic net sales decreased 15%. The growth in nearly all markets and channels of distribution was more than offset by the performance of our Asia travel retail business. In Hainan, retail sales declined more than we expected in the quarter for the reasons Fabrizio mentioned. Excluding our travel retail business, net sales in both Makeup and Fragrance rose double digits in the region, benefiting from our strategic investments in advertising and promotional activities and the reestablishment of services in our stores. Organic net sales in the Americas were flat compared to last year. The strong double-digit increase in Latin America driven by the re-acceleration of Makeup growth in Brazil and Mexico was offset by the decline in the United States due to the slower-than-expected pace of improvement in retail sales of several of our brands. Standout performance from The Ordinary continues to be a bright spot in the region for many reasons that Fabrizio mentioned earlier. From a product category perspective, Makeup organic net sales increased 13%, reflecting growth in each region led by Asia Pacific as recovery continued and usage occasions increased. M.A.C, Estée Lauder, and TOM FORD drove growth, benefiting from investments in brand activations and increases in in-store staffing, the continued success of hero products, as well as new product launches. Fragrance organic net sales rose 12%, led by Le Labo and TOM FORD. Strong double-digit growth from Le Labo reflected increases in every region, momentum from our city exclusive special collection, as well as growth from both existing and new points of distribution, including its expansion into Mainland China. The increase from TOM FORD was fueled by strategic investments in advertising and promotional activities to support key shopping moments and brand activations. Organic net sales increased 6% in Hair Care and declined 3% in Skin Care. The pressures in our Asia travel retail business drove the Skin Care decline and were largely offset by the exceptional growth in the Asia/Pacific region. La Mer and Estée Lauder declined, while The Ordinary, Bobbi Brown, and M.A.C grew. M.A.C's growth was driven by the launch of the Hyper Real line of skincare products. Our gross margin declined 330 basis points compared to last year. This decline primarily reflects the under absorption of overhead in our plants due to the pull down of production throughout the year given our elevated inventory levels, as well as increased obsolescence charges. Operating expenses increased 70 basis points as a percent of sales, driven largely by the increase in advertising and promotional activities to support commercial activations in the quarter. Operating income declined 66% to $71 million, and our operating margin contracted 380 basis points to 2% in the quarter. Our effective tax rate for the quarter was a negative 17.9% compared to 14.2% last year due to a true-up in the quarter to reflect the final effective tax rate for the fiscal 2023 full year. Diluted EPS of $0.07 decreased 82% compared to last year. The impact from foreign currency translation and foreign currency transactions in key travel retail locations negatively impacted EPS by 7% and 9%, respectively. As we discussed in May, we completed the acquisition of the TOM FORD brand and the related intellectual property on April 28, paying approximately $2.3 billion. As a result of this acquisition, we entered into arrangements to license the TOM FORD trademark for eyewear to Marcolin and fashion to Zegna, which were the brand's prior licensees, creating a new revenue stream for the company. This acquisition had a dilutive impact on EPS of $0.01, including interest expense on our debt financing and reflecting savings from royalties we no longer have to pay. Shifting now to our full year results. This has certainly been a more volatile year than we anticipated. The challenges to our business in Asia travel retail and the United States, as well as in the first half in Mainland China were partially offset by the progression of recovery everywhere else. In Mainland China, we continue to gain share in all major product categories, demonstrating the strong demand for our products, although we remain conscious of the evolving economic conditions. Overall, our investments in brand activations, increased in-store staffing, distribution expansion, and online capabilities aided in the acceleration of recovery of sales which largely occurred in brick-and-mortar channels, excluding travel retail. Net sales growth was strong in brick-and-mortar, particularly in our freestanding stores and with our specialty multi-retailers. Global travel retail represented 20% of our reported sales in fiscal 2023, and online net sales, which were flat, represented 29% of our reported sales. Organic net sales fell 6%, primarily reflecting the challenges in our Asia travel retail business, which drove declines in our EMEA region of 16% and in Skin Care of 14%. Nearly all other domestic markets in EMEA grew double digits. In Asia Pacific, net sales rose 4% as markets continued to progress in recovery throughout the year and benefited from investments in advertising, promotional activities, innovation, and distribution expansion. Net sales in the Americas was flat compared to last year. Regarding categories, Fragrance net sales increased 14%, rising double digits in every geographic region and benefiting from the continued strength of hero products, successful innovation, and distribution expansion, while Skin Care was more challenged in Asia travel retail and North America. Net sales grew 6% in Hair Care and was flat in Makeup. Our gross margin declined 440 basis points compared to last year, largely due to the slower-than-expected recovery in Asia travel retail. This includes higher obsolescence charges, under absorption of overhead in our plants due to the pull-down of production throughout the year, given our higher inventory levels and less favorable category mix from our Skin Care mix. Operating expenses increased 390 basis points to 59.9% of sales, driven primarily by the decline in sales. Despite the pressures to sales, we sustained our investments to support markets where recovery was evident, including in areas such as advertising, promotion, innovation, and selling, which collectively increased by 280 basis points as a percent of sales. Operating income declined 48% to $1.8 billion from $3.5 billion last year, and our operating margin contracted 830 basis points to 11.4% for the full year. In spite of the challenges that materially impacted our top-line growth, we continued certain of our strategic investments important to support recovery and drive long-term sales growth and profitability. Our effective tax rate for the year was 26.5% compared to 21.3% last year, primarily reflecting the change in our geographical mix of earnings. Net sales declined 53% to $1.2 billion, and diluted EPS of $3.46 decreased 52% compared to last year, including the dilutive impacts from foreign currency translation and foreign currency transactions in key travel retail locations of 4% each. The acquisition of the TOM FORD brand was dilutive to EPS by $0.01. Now turning to our cash flows for the fiscal year. We generated $1.7 billion in net cash flows from operating activities compared to $3 billion last year. The decrease reflects lower net income, partially offset by lower working capital. We invested $1 billion in capital expenditures for supply chain enhancements, including our new manufacturing facility in Japan, consumer-facing capital, such as distribution expansion, investments in existing counters, and online capabilities. We returned $1.2 billion in cash to stockholders through both dividends and share repurchases. Beginning in December of 2022, we suspended the repurchase of shares given the increase in debt due to the TOM FORD acquisition. Before I turn to our outlook for the full year, I want to take a moment to first address the recent cybersecurity incident we disclosed in July, involving an unauthorized third-party that gained access to some of our systems. After becoming aware of the incident, we proactively took down some of our systems. We began bringing our systems back online within days, which limited the incident's impact on the company's operations. Based on the information available to date, we believe the incident is contained. So now, let's turn to our outlook. This past year has undoubtedly been difficult, largely given the challenges we faced from increased market volatility in certain markets and the corresponding impact on our business. As we work to return to net sales growth in fiscal 2024, and over the next few years, progressively rebuild our operating margin, we remain focused on the transition of key areas of our business that have been disproportionately impacted by a slower pace of recovery while also continuing to support growth in those areas where the recovery is more advanced. Over the next few years, mainland China and our travel retail business are expected to remain key drivers of our long-term profitable growth, and we anticipate continued growth with other areas of our business, including emerging markets globally, our more mature markets in the West, and our direct-to-consumer channels globally. Assuming an eventual return to global prestige growth of 4% to 5%, we expect to return to more consistent compounded annual sales growth within our 6% to 8% long-term growth algorithm. Restoration of our operating margin is a top priority, though margin recovery will not happen in one year. We do, however, expect to progressively drive margin expansion as we return to profitable growth in Skin Care, improved Makeup margins, and continue to drive our momentum in Fragrance, particularly our high-end artisanal fragrance brands. In addition, we plan to expand our gross margins through continuing to leverage our prestige pricing power, inclusive of driving additional accretive and compelling innovation, and improvements in operational efficiencies including enhanced supply-demand planning and inventory optimization to reduce excess inventory and discount. We will begin to leverage the further regionalization of our manufacturing and distribution network in Asia to create greater inventory agility as demand fluctuates. Overall, beginning in fiscal 2024, we expect to recapture lost operating margin at an accelerated pace by delivering annual margin expansion that is faster than our pre-pandemic historical average. This acceleration is expected to become more evident after the first quarter of fiscal 2024. So turning to fiscal 2024, we expect to continue to deliver net sales gains in the areas that performed well in 2023, including Asia Pacific, our Western and emerging European markets, and Latin America, as they continue to progress in recovery from the pandemic, and benefit from the strategic actions we are taking to accelerate growth, including targeted consumer activation, compelling innovation and distribution enhancements that we drove throughout the pandemic period. We are, however, mindful of the macroeconomic headwinds that have emerged in the Chinese economy. This has also resulted in our Asia travel retail business taking a bit longer than we originally anticipated to return to growth as travel and conversion remain pressured, which has been exacerbated by the sudden reduction of sales to non-travelers relative to the return of individual travelers in Korea and in Hainan. Correspondingly, inventory levels in the trade in Asia travel retail have improved at a slower pace. This will create greater pressure on our first half as we expect to continue to adjust our shipments and increase our retail activation but also should yield sequential quarterly improvements throughout the year in both sales and margin. With that backdrop in mind, and using June 30 spot rates of $1.087 for the euro, $1.261 for the pound, $7.253 for the Chinese yuan, and $13.21 for the Korean won, the full fiscal year organic net sales are forecasted to grow 6% to 8%. Royalty revenue from the acquisition of the TOM FORD brand is not expected to be material to net sales growth and will be excluded from organic net sales until the fourth quarter. The cybersecurity incident is also not expected to have a material impact on net sales. Currency translation is expected to dilute reported sales growth for the full fiscal year by 1 percentage point. We take the majority of our pricing actions at the beginning of our fiscal year. Our strategic price increases, including new products are expected to add approximately 5 points of growth. We expect the net benefits from strategic pricing, discount reductions, and lower obsolescence to drive gross margin expansion for the full year, partially offset by manufacturing under absorption. We are aligning our production volumes to address a more variable demand environment with the intent to carry less inventory in our system and in the trade, while we continue to regionalize our supply base in Asia. However, we expect the lower mix of net sales from the highly margin-accretive areas of our business, including Asia travel retail and Skin Care, and the under-absorption of overhead to result in margin contraction in the first half of the year. This is expected to be more than offset by gross margin expansion in the second half of the year, given the greater mix of our travel retail business and Skin Care and less obsolescence charges compared to last year. Our full year operating margin is forecasted to be approximately 12% to 12.5%, a 60 to 110 basis point expansion from fiscal 2023. In fiscal 2024, we anticipate sequential margin expansion throughout the year driven by improvements in gross margin while also maintaining go-to-market initiatives where appropriate. We expect our full year effective tax rate to be approximately 27%. Diluted EPS is expected to range between $3.50 and $3.75 before restructuring and other charges. The cybersecurity incident is expected to be approximately $0.07 dilutive to EPS. Our EPS range also includes approximately $0.11 of dilution from currency translation. In constant currency, we expect EPS to grow by approximately 4% to 12%. Net cash flows from operating activities are forecasted between $1.7 billion and $1.8 billion. Capital expenditures are planned at approximately 6% of forecasted net sales as we expect to fund new distribution and online capabilities, further enhance our manufacturing and distribution network, including the completion of our first manufacturing facility in Asia located in Japan to support the development of our Asia Pacific region. We also plan to continue investing in information technology to support our business. Our fiscal 2024 outlook also assumes flat quarterly dividend and the continued suspension of our share repurchases as we focus on deleveraging after the TOM FORD acquisition and prepare for the payment to purchase the remaining outstanding equity interest in DECIEM anticipated in May of 2024. For our first quarter, we currently expect organic net sales to fall 12% to 10%. The cybersecurity incident is not expected to have a material impact on net sales. At this time, we expect first quarter diluted EPS of negative $0.31 to negative $0.21 before restructuring and other charges. The cybersecurity incident is expected to be approximately $0.07 dilutive to EPS. This also includes approximately $0.02 of dilution from currency translation. In constant currency, we expect EPS of negative $0.29 to negative $0.19. I would like to close by thanking our employees for their dedication and focus during what turned out to be a challenging year. While we are not satisfied with our performance overall, we are certainly pleased by the results we were able to deliver in many recovering markets and brands. For fiscal 2024, we believe we have the right plans to navigate the environment as we gradually return to our historical cadence of long-term progressive and sustainable sales and profit growth, fueled by our highly desirable brand portfolio and our incredibly talented employees. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Yes. Hi. Good morning and thank you. I'd love it if you could address two topics, maybe one for you, Tracey, one for you, Fabrizio. First for Tracey, just appreciate your commentary at the end there, but just maybe a little bit more detail, if you could expand on the assumptions embedded in the 1Q step back and declines juxtaposed against what looks like a pretty rapid return to basically double-digit organic growth over the remainder of the year? Just a little more color there, and I'm assuming a lot of the variability focused on Hainan, so maybe some expansion there? And then Fabrizio, I know the company had a leadership offsite in June. I'd love your perspective on how recent changes in the operating environment impacted points of emphasis of that meeting? And how the related discussion may have informed your 2024 outlook? Thank you very much.

Hi, Steve. I'll address your question about the pace of the year. You're correct that there is significant variability. If we look back at the first and second quarters of last year, we faced some disruptions in Hainan, but we still managed to conduct business there and in Korea. Consequently, our travel retail mix was higher during the first half of last year, alongside the recovery we observed in the EMEA and Americas regions at the airports. In the second half of the year, we encountered challenges, particularly in Korea and the issues Fabrizio mentioned related to Hainan in the fourth quarter. This year, we are experiencing a reverse of those impacts as we compare our performance. Due to events in May and June in Hainan, we are witnessing a decrease in traffic and conversion rates there compared to last year, affecting our first quarter as we saw higher traffic and conversions previously. We expect a gradual improvement in the second quarter as we see the effects of the downturn that started to show in those areas last year. Additionally, we are addressing the softness from the second half of fiscal 2023 as we move into fiscal 2024. Therefore, we anticipate that travel retail will progressively improve in the third and fourth quarters compared to this past year. Part of this improvement is due to our destocking efforts. In Hainan, the unexpected change in Daigou has slowed retail traffic more than we anticipated, prompting us to adjust our shipment expectations for both the first quarter and slightly into the second quarter. I hope this provides clarity on what we are experiencing and the reasons behind the significant margin differences. Travel Retail benefits from our investments in markets like China, Korea, Japan, and across EMEA, which is why it remains a high-margin channel for us. Fabrizio?

Yes, on our leadership meeting in June, we looked at the strategy and the strategy of the future. And so what Tracey and I have presented in our prepared remarks are the results of also this work of reconfirming the strategy for 2024 for the next three years. And so, what are the key takeaways was your question. It's that, first of all, the market of global prestige beauty continues to be very attractive and will continue to be more and more attractive in the future. And our strategy is, as I explained in the prepared remarks, is now focused on continue building on our strengths and continue building the areas where we are really delivering great results and supporting this growth. At the same time, continue reinforcing the health of our brands and the innovation of our brands and refocusing resources and activities in all these areas. And then fix the travel retail issue, including a much better coordination between our travel retail organization in China and China region organization in mainland, and the plans for the North America acceleration, and to continue winning emerging markets. By the way, in the last quarter, we're astonishing with a 38% growth. And so, deploying the resources, the capabilities, and the skills to continue doing this in the key emerging markets, I have to say, the excitement in India is particularly high. And so, in summary, the leadership of the company has agreed and allocated resources and skills on the key components of the strategy for the next three years, which is to leverage the growth of the market and obviously, continue to build our strengths, fix our issues, and most importantly, support the profit recovery plan that again, we explained in the prepared remarks, in every single aspect of the accelerated pace of profit recovery, as Tracey just explained.

Hi, guys. So two-part question on my end that I think builds on that answer, Fabrizio. Some fairly unique circumstances in the past year, both externally and internally that caused weaker results than you originally expected. That's uncharacteristic versus a longer-term track record. So just wanted to get your perspective on, A, if you think you have good visibility on this fiscal 2024 earnings guidance? How much investment are you assuming incrementally to drive a recovery post 2024? And then B, perhaps, Tracey, you gave us some detail on margin expectations. But how should we think about sort of the ability to get back to peak historical margins at some point over the next few years? And how quickly we might see margin recovery relative to this 2024 base just as we think about those four building blocks you mentioned from here? Thanks.

Yes. Regarding our earnings guidance, Tracey and I have provided this guidance and we are confident in our business projections at this time. However, I must emphasize that external volatility remains significant, especially in the Chinese market and in the transition within the travel retail sector from Daigou to regular travelers, as well as the shift to group travel. These transitions are currently challenging. The overall economic recovery post-pandemic, particularly in China, will also influence our assumptions and guidance. We have made an effort to detail these assumptions in our press release. Internally, we are optimistic about our plans and the trends that are currently yielding positive results. The main concern is how quickly we can address the ongoing issues. Nevertheless, the strengths of our current trends are relatively straightforward to project. Overall, we trust our guidance, but there will be volatility to navigate moving forward, and we will be monitoring these developments closely. Tracey?

We are encouraged by the signs of recovery we are witnessing, particularly with the return of travelers. In fiscal 2024, we are taking steps to significantly reduce production to align our inventory levels, which will enhance our margins. I mentioned in my prepared remarks that we anticipate a recovery in gross margins from these actions. As the situation stabilizes and more travelers return to travel retail, we maintain confidence in our previously established strategy. Before the pandemic, we were making progress towards achieving 20% operating margins, and we believe that once conditions normalize, we can reach that target again. While I cannot provide a specific timeline, I have indicated that we plan to accelerate margin growth beyond our historical guidance of a 50 basis point improvement over the next few years. This reflects our intention to catch up on margin progression, supported by our strategies. Our organization is committed to returning to margins that better reflect our growth potential without compromising our brands or the recovering markets. We aim to balance careful investments that assist in recovery with the long-term growth strategy of 6% to 8% top line growth and margin expansion. While I understand your desire for a specific year and number, we hope to provide more clarity as the environment stabilizes. For now, we assure you that we are focused on accelerating our margin progression significantly beyond historical levels.

Hi. Good morning, everyone.

Good morning.

I have a quick follow-up and a geographic question. Regarding the China travel retail inventory situation, Fabrizio, you mentioned there will be increased collaboration between your teams in mainland China and travel retail. How confident are you that the necessary investments to clear inventory won’t negatively affect brand equity and health? I’m trying to understand the actions you might take to clear inventory given the volatile consumption trends you mentioned. Additionally, you noted impressive growth in India but some struggles in North America. How do you see the non-Asia markets evolving over the next 12 months or longer, especially in relation to these emerging high-growth markets? Thank you.

Yes. Regarding the travel retail situation, we've enhanced collaboration between the local and travel retail teams to improve decision-making and prioritize efforts that create value and develop brand equity in a more coordinated manner. We've also gathered better analytics to grasp channel dynamics, pricing differences, and various influencing factors. This has laid the groundwork for more comprehensive and timely information for informed decision-making, significantly reducing the risk of uncoordinated actions in the future. About brand health, it's very strong with Chinese consumers, as evidenced by our results in China. We've seen a 36% growth in the business for the April to June quarter, with online market share increasing by 2 points. External research confirms our brands rank highly in desirability. The efforts of our team in Mainland China have positively impacted brand equity and health. We are concentrating on selling through our inventory, especially following the weaker performance in Hainan during May and June, which affected the first quarter trend. We're committed to retail activities that enhance sell-through, and our team is aligned and well-resourced to tackle these challenges. In other markets, excluding Asia's travel retail, we've seen growth of 17% in the last quarter, one of our highest rates, even with North America being flat. Our strengths come from four major brands, each over $1 billion, with two more expected by 2024's end. By then, we anticipate reaching six $1 billion brands, reinforcing our scale and global reach. Our innovation pipeline remains robust at 25% even in this challenging year, with promising innovations lined up for 2024 and 2025. Execution in regions that are recovering faster from the pandemic has improved significantly, and we expect this momentum to continue into 2024. In the U.S., where improvement is necessary, the team has a clear action plan focused on four key areas. These include an extensive pipeline of new products launching in 2024, increased engagement on platforms like TikTok, strategic pricing to enhance value, and ongoing recruitment for mass-market activities supported by aligned retailers. Our brands M·A·C, Clinique, and The Ordinary play crucial roles, especially in North America, with exciting plans for each. The luxury fragrance segment shows substantial potential, having demonstrated double-digit growth over the last ten quarters, with opportunities for further expansion in the North American market.

Thank you, operator. Good morning, everyone. I have a question that you've mentioned a few times in your prepared remarks and the press release. What is happening in Hainan concerning the Daigou and reseller market? Looking ahead, do you expect travel retail in Hainan to primarily focus on individual sales, with the Daigou segment becoming significantly smaller or possibly no longer a factor? If that is the case, how will this affect your strategy for operating in China? Where do you plan to recover those sales if your presence with Daigou diminishes?

I'll start by addressing your question. We don't have control over it. We sell to our travel retail operators, so the dynamics of who is buying in Hainan depend on our retail partners. Currently, we are experiencing some adjustments due to the timing of when regular travelers and individual travelers return to Hainan, alongside some changes in enforcement and regulations in China. This disconnect in timing is affecting our sales, especially as we are reducing our inventory levels in Hainan. These factors are having a significant impact. However, we believe that travelers will eventually return to Hainan and enjoy the excellent shopping experience available there. We have no concerns about the growth of travel retail with traveling consumers. It's primarily a timing issue for us right now, and I wanted to emphasize that. This timing issue is creating a notable short-term, temporary impact for us. Yet, we remain confident in our strategy to continue growing travel retail globally, particularly in all of our markets in Asia.

Yes. I want to emphasize that we clearly see evidence that when regulations and retailers concentrate on individual travelers and when traffic from these travelers significantly increases, the business results are remarkable. Our travel retail business in EMEA is currently thriving, showing growth of about 36% to 40%, and the same is happening in the Americas. We expect to see similar growth in APAC, including Japan and Australia. Wherever there is a resurgence of travel post-COVID, there is exciting business growth. For instance, the groups have been allowed to travel in Thailand, leading to a boost in sales. It's important to note that while this is still below the levels seen in 2019, there is a clear trend of recovery. In our view, the travel retail channel has strong long-term potential. Selling to traveling consumers during their journey is a lucrative and valuable business. The disruptions we faced during the pandemic have been temporary and will eventually stabilize, as Tracey mentioned. This is our expectation and belief.

Thank you, good morning. I wanted to discuss the Japan manufacturing facility and the overall supply chain in Asia. Can you provide some insight into the timeline for completion? Specifically, will Japan be able to meet all the demand from China by the end of the calendar year? It would be helpful to understand the scale needed to get operations running and the impact on the supply chain length and visibility. In a volatile environment, managing timely recovery in Hainan and understanding traveler patterns in Korea and beyond is crucial. We need agility in this aspect, and it seems a local supply chain could be beneficial, but we lack clarity on when it will fully transition to that. Any information you can share would be appreciated. Thank you.

Thank you, Lauren. This year's capital expenditure includes completing our factory. We have conducted some preproduction runs in fiscal 2023, and the factory will supply some volume for the region in fiscal 2024. We have detailed plans, primarily focusing on Skin Care and some foundation products to be made at the facility. The ramp-up will be gradual, particularly for Skin Care. Our priority is to finish the plant first. Additionally, we have established a new temporary distribution center in China and plan to expand our distribution network there as well. I anticipate it will take a couple of years to fully operationalize the entire Asia supply chain at full capacity. However, as we gradually increase production over the upcoming year or two, we expect to enhance our agility by shifting production to those areas. Currently, we are working on contracting some of our production due to disruptions we have faced. You are correct that in the long term, this will enhance our agility. We are also implementing various measures to improve our responsiveness, including technology investments designed to better forecast demand in a fluctuating environment. While no forecasting tool could have predicted last year's challenges, we believe that empowering our inventory and supply planning through technology will lead to better agility moving forward. We are undertaking substantial efforts to improve our situation as we navigate through these significant disruptions we are currently addressing.

And I would just want to add a bit more color to the concept that Tracey just underlined on the fact that despite this will take a couple of years to ramp up to get to the full leveraging, the benefits on agility will come as we go earlier. And the reason for that is that the agility is particularly needed on what we call the hero SKUs. So the high-volume and the high-volume SKUs, the ones which can benefit more from speed to market, forecasting decisions which are closer to the moment where the market happens, the ability to produce depending on the trends. And so we will gradually ramp up, but we will ramp up first the SKUs and the brands that have the biggest need to create agility in Asia. And over time, then this will become our, as Tracey described, ongoing in a couple of years, we will have the full agility of the system implemented.