Good day, everyone, and welcome to The Estee Lauder Companies Fiscal 2019 Second Quarter Conference Call. Today's call is being recorded and webcast. For opening remarks and introduction, I would now like to turn the call over to the Senior Vice President of Investor Relations, Ms. Rainey Mancini.

Good morning. 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 will 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, goodwill and other intangible asset impairments, changes in contingent consideration, the finalization of provisional charges related to the U.S. tax law enacted at the end of calendar 2017, and the new accounting standard for revenue recognition. All net sales growth numbers are in constant currency. You can find reconciliations between GAAP and non-GAAP figures in our press release and on the Investors section of our Web site. During the Q&A session, we ask that you please limit yourself to one question so we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio.

Thank you, Rainey. Good morning everyone. We delivered excellent results in our second quarter, as multiple engines of growth drove cost of currency double-digit gains in sales and earning per share, led by strong advances in our product categories, brands, countries, and channels. We strategically invested in the most promising opportunities and our rich digital content engaged consumers, attracting then to our high quality innovative products. Overall, net sales grew 11%, and therefore the first time exceeded $4 billion in a quarter. We achieved this milestone despite an extremely challenging and volatile environment, which included softness in two of our largest markets, the U.S. and the U.K. and global trade tensions. This is a testament to our strategic resource allocation, superb execution by our talented employees, and improved capabilities throughout the organization. We leveraged our strengths where we had the greatest growth opportunities, including China in travel retail. And we further broadened and diversified our growth engines with strong results in the rest of Asia and emerging markets, in our fast growing channels, and in most brands. The benefits from our leading Beauty Forward initiative allowed us to deliver savings and selectively increase our advertising spending, which in turn supported our strong top line growth and enabled us to leverage our cost structure. Diluted earnings per share rose 25%, more than twice our sales pace. Importantly, we accelerated our share growth in Global Prestige Beauty in the quarter, which confirmed that our strategy has enabled us to gain share profitability. With an outstanding first-half and ongoing confidence that we will continue to effectively execute our winning strategy, we are raising our sales and EPS guidance for the year. We now expect sales growth of 8% to 9%, and EPS gains of 14% to 16% for fiscal 2019. In the recent…

Thank you, Fabrizio, and good morning everyone. First I will review our fiscal 2019 second quarter financial results and then cover our expectations for the third quarter and for the full year. As a reminder my commentary today includes the adjustments that were mentioned at the beginning of the call by Rainey. All net sales growth numbers I will discuss are in constant currency and compatible accounting methods unless otherwise stated. Also as a reminder, we adopted the new accounting standard for revenue recognition ASC 606, this fiscal year on a modified retrospective basis. For the quarter, the impact decreased our sales growth by two percentage points, our operating profit growth by seven points and our diluted EPS by $0.11. And now for the quarter results, net sales for the second quarter rose 11% with broad based growth across most regions and product categories. From a geographic standpoint, our Asia Pacific region had robust net sales growth this quarter. Net sales overall rose 20% with many markets experiencing double digit increases. Sales in China and Hong Kong grew very strong double digit with most brands categories and channels contributing to growth. Our sales in department stores in China continue to grow strong double digits and other channels especially online rose even faster. We also achieved excellent mid-single digit sales growth in Japan and Korea, with growth across all channels including department stores specialty multi and online. And other markets such as Taiwan, Thailand, Malaysia and Indonesia also contributed to the region's growth with our sales in Australia declining slightly. Net sales in our Europe, the Middle East and Africa regions rose 16% driven by strong double digit increases in both our global travel retail sector and other emerging markets in the region. Double digit like door growth across most brands…

The floor is now open for questions. [Operator Instructions] Our first question today comes from the line of Olivia Tong with Bank of America.

Thanks. Good morning. I wanted to start on China, because the growth there obviously continues to be fairly impressive. First, if you could talk about the overall environment, because some of your luxury peers are also saying that they haven't seen a slowdown yet, but in terms of your outperformance, how much do you think has the environment has held up better than it appeared versus the actions you are taking, growing market share, positioning yourself in faster-growing channels, wanting more brands, more online initiatives, all these things. And can you give us a sense of where your comp growth is versus what's come from new brand launches into either the market or also online. Thanks.

Okay, so the environment of prestige beauty, I want to be clear, is strong. Actually, as we said in our prepared remarks, the prestige beauty market in the quarter has further accelerated growth. And our performance within that market is very, very strong because we continue to build market share even in an accelerating market. So, to answer directly your question, our program is working very well, and we are very satisfied, so there is a lot of our specific activity which is working, that's why we are growing market share. But the market also remains solid. This is the prestige beauty market; it's not necessarily the total economy, which is different, which shows that prestige beauty is particularly resilient in China versus the total market. And this comes from the passion of consumers for the category, for the growth of the middle class, and very importantly from the role of young people in the overall Chinese consumer base. China is a very special market where the young generation is consuming more than their parents in many areas, but particularly in prestige beauty, where the market share of prestige and luxury in the young generation is bigger than the market share in prestige and luxury in the more adult consumer, that's why prestige beauty in this moment is doing well and is also in general more resilient than other categories in China.

Your next question comes from Ali Dibadj with Bernstein Research.

Hey guys. So, wanted to better understand and maybe help quantify what is actually in the expectation or in your guidance particularly along three dimensions, one is North America. Can you talk a little bit about that by channel? It looked like specialty multi slowed a little bit. Want to get a sense of growth there by channel. Two, as again, just on China, Tracey, I think you mentioned quote unquote moderating -- solid but somewhat moderating in China. Just want to understand what you've put into your guidance there. And then anymore you can give us about the return on those investments you're making in the second-half, try to help us understand the expectations you're setting on guidance. Thank you.

Okay. So, I'll start in terms of the Americas in the second-half. In general, we are expecting slightly improved performance in the second-half from the America region and in particular in the U.S. for a couple of reasons. One, obviously, as we mentioned, we are not anniversarying the Bon-Ton shipments from the first-half of last year. So that will represent some improvement. At the same time, we're cognizant of the fact that January, as we mentioned in our prepared remarks, Ali, has been quite soft. And everything from weather related issues to obviously the government shutdown I think has impacted consumer sentiment in the U.S. in the third quarter. We also have very strong innovations that, as I mentioned, we are supporting globally, Clinique iD being one of them and really focused on our largest brands, some of which will be announced later. And that will, also, we expect those to do quite well, and we are investing incremental advertising in the second-half in North America behind those programs. So, from a channel standpoint we expect some improvement in department stores, some continued good performance in specialty multi in particular with the traction we've seen in Ulta and Shoppers Drug Market in Canada and a few others. And online, online continues to grow nicely across all of the channels of distribution, retailer.com as well as our own brand.com site. In terms of the return on the investments that we're seeing in the second-half, we obviously have a tremendous amount of experience, and Fabrizio suggested in his prepared remarks the improvements that we've made internally in terms of our data analytics, so we have lots of information to inform not only the new products that we're launching in the second half of the year, but how to communicate and what to invest behind in terms of marketing those products, and what generates the highest return. So that is a continual area of increasing improvement for us. And obviously, as we have seen in the first half we've showed that we actually had good return on the investments that we've made in that area.

Your next question comes from Wendy Nicholson with Citi.

Hi, good morning…

Good morning.

-- can you talk about the margin on the skin care? I mean, it's phenomenal, and I guess, if you can unpack that a little bit, is it more driven by channel, is there less promotion in that, is that a function of Leading Beauty Forward, is it the growth in China and you just have to spend less to support the brands there, just trying to get a sense for a 30% plus operating margin in skin care, how sustainable is that going to be going forward? Thank you.

So I'll start and Fabrizio may add to it, Wendy, but thanks for the question. So skin care grew at 22% in the quarter, and that's a combination of great innovation, the investment that we put behind skin care in all markets, but in particular where we saw the greatest momentum, which was in Asia, as well as in travel retail, and we saw the benefit from those results. So that really is the predominant driver of the better margin in skin care. Skin care is also benefiting from the investments in Leading Beauty Forward. Both in terms of lower cost as well as some of the investments we've made in digital and social capability internally that's allowed us to market these skin care products in a better way. So I mean those are all contributing factors to skin care.

Yes, and I'd just like to add that the profitability is also improving in skin care because of the strong growth is leveraging our cost base in an amazing way, and the strong growth is generated by our much more accurate ability via the use of data to identify target groups and ways to reach the target group be it a channel or an investment in advertising and digitalization. So then the new model we are developing, which is more data based is making the growth stronger and the stronger growth is leveraging our construction better. The other thing is -- the second point is a Leading Beauty Forward is really transforming our P&L structure and taking money from fixed costs to advertising. And within advertising and promotion to be clear, the entire increase is advertising. Promotions are flat despite our strong business growth. With that dynamic, advertising is much more flexible. Advertising is the resource that you can move from a working initiative, from taking down initiative, which is now working in very fast front in market which has a good momentum or out of a market that doesn't have a good momentum. So we have basically made our resources much easier to allocate with speed to the biggest opportunity around the globe. And this improved agility is increasing return of our resources and this is very evident in this moment particularly on skin care.

Your next question comes from Steve Powers with Deutsche Bank.

Yes. Hi, can you hear me okay?

Yes.

Okay, great, thanks. So I actually wanted to follow up on Fabrizio's comments there surrounding Leading Beauty Forward, both for an update on the benefits you're achieving as well as for more perspective on the cost of achieving them. I think if my math is correct and my records are correct, since the start of the year, you've raised your anticipated restructuring cost now by about 50% at the midpoint. So again, just hoping you could elaborate on what initiatives are driving that increase, what portion of those costs are cash, and whether we should view this as your point forward program costs and benefits or whether this is in effect an increase in the overall program both in terms of the cost to achieve, but also hopefully the benefits also, thanks?

Yes. So I'll start and then Fabrizio might add to this. We did raise the expected benefits as well as costs of the program at the beginning of the year. So we're now expecting the full program costs to be $900 million to $950 million and the benefits to be $350 million to $450 million, once the program is complete, the full annualized benefits from the program. So yes, you are seeing higher charges this year related to that increase. The increase is driven by adding more programs to Leading Beauty Forward. We launched it in 2016, this is the last year of charges for Leading Beauty Forward and then we realized the benefits from the ongoing programs execution. So, so that's the reason why you're seeing higher cost from the program. In terms of the elements of the program, we have a number of supply chain initiatives in the program to increase agility and reduce inventory levels and speed to market. we have supported an accelerated transformation in our digital and social capability through the Leading Beauty Forward initiative and have incurred restructuring charges related to that. We've established shared service operations in the organization and that has allowed us to leverage a growth, which you saw certainly this quarter in our sales much more effectively and flow more dollars to the bottom-line. We have investments and savings from our procurement programs and that has allowed us to achieve more savings in our indirect procurement spending, which we expect to continue going forward. So there are many different areas under Leading Beauty Forward that we've invested behind in the program over the last two and a half, almost three years now that we've been managing the program in order to drive the kinds of results that we're seeing now and expect to see in the future.

Your next question comes from Erinn Murphy with Piper Jaffray.

Great thanks. Good morning. I guess my question for retail is for you on the comments you made on pre-tail travel retail sales. It sounds like that's become more of a sizable portion of the overall business. Can you just share a little bit more about that? And how do you think about the expansion plan for pre-tail and then I guess any comments on what you're seeing from a customer base with Clinique iD if it's reactivating a lot of consumer bringing in a new customer? Thanks.

Yes, so pre-tail is as I explained in my prepared remarks is basically the possibility when you have a ticket, you're making a journey, you could instead of buy in the airport you could buy online before coming to the airport and then you will get the products at the airport in some cases on the share your airplane and that's today is mainly in Korea and I would say is only significant in Korea. So it's the beginning of the learning about this area but in Korea where this has started is becoming a significant part of the business. We believe it is a pretty good idea. First of all, it's a good service to the consumers that can decide to shop while traveling even without investing the time to go to the store, so it's a good convenience process for the consumer but interestingly as an impact in improving conversion because we know that you know, we estimate between 10% or 15% of the travelers by anything. Obviously, if you had the possibility more conveniently to buy yearly online and taking your time to choose this can increase the amount of conversion. So this can be overtime in other booster of the overall market potential in travel retail in our opinion because it can be conversion boosters over time, but to be very clear for the moment is a Korean mainly a Korean reality. Second question is a Clinique iD, we see very promising initial results from Clinique iD. The consumers are very interested, they are trying the product and by the way the advertising spending behind the brand is just starting and we will see more in the next months and the large majority actually will be in quarter four, so there is a lot of great programs that in the next six, eight months will then hopefully bring Clinique iD to the levels that we believe has the potential to go, as I explained in my initial comments is that the idea of personalization and is very much appreciated by the consumer and the personalization opportunity together with the high tax services the Clinique provides in every touch point with the consumer together with the data, the information that we have, what are the concerns that people have and our ability to focus the personalization on the most promising concerns that Clinique can address the combination of these factors we believe they are strong potential.

Thank you. Your next question comes from Nik Modi, RBC Capital Markets.

Yes, thanks. So just a quick housekeeping and then the real question just on the cash flow I see for the first-half of the year cash flow has been lagging operating profit quotes. So just wanted to get some context around that, and then the broader question is, when you really think about how much your channel mix has been diversifying. I'm just curious if you're finding opportunities on the sampling line. My understanding is that that's a decent size nugget in the P&L and so I'm just curious if you're finding opportunities to save money in that area? Thanks.

All right, Nick. So on the cash flow, as I mentioned in the prepared remarks that our cash flow was a bit less than last year, really primarily related to working capital, given the strong growth that that we've had two years running now, we certainly are staging quite a bit of inventory to support growth going forward. So, that combined with we had some very aggressive programs last year as it relates to payables. We're still seeing improvement and payables and receivables but less improvement than we saw last year which was as you recall a record year for us in terms of cash flow growth, so that's really what's happening in the cash flow so still quite strong as it relates to cash generation strong enough that that obviously we purchased a fair amount for own stock in the first half with the excess cash that we had.

Sampling?

Yes so sampling in terms of the channel mix and the samples with the growth of online that does require some sampling in certain markets, so certainly in venues in Asia and in the Tmall in particular it -- we do have a lot of samples in that venue, less, so in travel retail and in and a bit more mix in specialty multi but certainly as we see the shift out of department stores, I would say samples in general the cost has comedown but certain channels do require more samples than others but overall sample cost is coming down.

And the only thing I want to add is that we have done some great work in the cost per sample, but the idea is to invest more in more samples in the future because trial is when you have a high quality products with the kind of rapacious rate we have been able to create a early trial with the proper the sampling is a great opportunity and so we will continue to invest in the number of samples particularly on our new upcoming very promising innovations that we are reducing the cost per sample.

And are being more targeted in terms of the products that we're offering sample then.

.:

Yes, good morning. And just a quick follow-up on China and you emphasize prestige a number of times when describing the market conditions and do you think that they're the share gains of prestige versus other channels in China have increased, largely the mass market here. And then, just very quickly, no mention of France at all, am I right in thinking that for those no disruption from the yellow vest rights that we saw in Q4? Thanks.

So I'll take the second question. In terms of France, we did see growth in France, obviously, a bit slower given some of the protests, as you mentioned, but we did see growth in France. So I talked about Western Europe had mixed performance but France was one of the markets that actually did grow.

Yes, now France was good. Your first question on China, yes, well, what we mean is that again, the phenomenon of the young people in China and the middle class in general to trade that to high quality products is continuing and is actually accelerating, so our view of the market is that high quality is paying out and they trade that to quality is continuing even in a situation where there are more economical concerns than in the past.

Your next question comes from Dara Mohsenian with Morgan Stanley.

Hey, guys, so the comments on North America…

Hi, Dara.

Hey, how are you?

Good.

So the comments on North America were helpful in terms of the week holiday season and obviously the January issues but for retail, I was hoping for more of a longer term perspective sort of setting aside January and moving past that, do you think North America can get back to consistent growth going forward as you look out the next fiscal year and beyond, particularly with the growth in specialty and online and maybe just preempt tonight's speech a bit and give your own state of the union on North America and thoughts there and then also on the margin side obviously we've seen some large compression last few years, so can that reverse at some point going forward or do you expect to see continued investment there ? Thanks.

I'll start with the trend in North America. Absolutely, we believe we are on the process of turning around our North American business and we believe that we will go back to growth in North America and to put again more perspective on the last quarter and the quarter was pretty solid in November included and the December has been a very soft month and then as Tracey explained also the beginning of January continue that trend, we attribute at least part of that to the government shutdown to the overall consumer sentiment was not a easy moment to spend a lot of money in December. But our performance in November was very, very positive. So we -- when we look at the quarter results in the U.S., particularly the market was flat. Now, the market before was growing 5%, 7%. So all the difference that we see in our performance in the U.S. in the quarter is frankly, is the market is not what we are doing in the market for the long-term. So our agenda for the long-term is unchanged and what is it is first of all, we are investing more money, we will have more advertising power on the right priorities in the U.S. and we will see some of it taking place in the next six months, particularly in quarter four behind some great innovation that with the helpful data has been tailored to the American consumers even more than the past in many aspects. Our analytical efforts have also helping our U.S. team to have a much more granular analysis or what are the opportunities by group. For example, we are focusing our existing hero products more on the Hispanic target group where we didn't have sufficient market share as an example. And our…

Yes, they are and then on margin. Just a reminder that our America sector does include a portion of our corporate expenses, so in terms of what happened in the quarter, we the Smashbox impairment that we mentioned was charged against the Americas segment. The revenue recognition impact from a profit standpoint was $21 million as it just states in our press release. And then we had some of the investments that we made in IT and few other areas that also impacted the Americas segment. We certainly expect that when the Americas segment returns to growth that we will start to see the impact from a margin standpoint. And the Americas region itself is strong from a margin standpoint but because we have some of these other items in here, it does suppress as it always has some of the margin result and certainly as the sales growth has softened in the Americas we're seeing that impact in the quarterly results currently.

Your next question comes from Caroline Levy was Macquarie.

Thanks so much and good morning. I'm going to pivot back to China and just ask you for your perspective on the changes that might happen amongst Daigou, the resellers who buy in travel retail who I think are now required to have a tax ID to resell in China. So just to talk about whether you think there is an impact has been an impact, will be an impact and then you mentioned tariffs and we also know that there's some lower import taxes I believe in the beauty segment. So putting all these different things together, how do you think each of them play out?

Let me just comment on the Daigou phenomena. First of all, our travel retail business has not seen the impact from the stricter enforcement generally. So we don't see the impact so far. Is also important however to remember that we add Estee Lauder companies have a long standing policy, the limit, the numbers are products that is single consumer can buy at any country in our travel retail globally since ever. So we were never benefiting from lot of the guys do business because of our strict policies to avoid that any phenomenal ID's and obviously to limit any of these markets around the world. So this policy that is being restricting us in the past is turning probably to be an advantage today because we see less of the difference, that we believe would see less on the difference whatever will be the implication of these new legislation. Typically as far the moment we do not see any impacts. And the other important things is that we believe in general, the items of prestige beauty at the end affordable luxurious. So people can still buy even the new regulation something which is lower price and still makes purchase again within our policy. And so this will we continue being good more actionable on low cost items than on very expensive items. And so I believe there will be also these differentiating factors overtime. And then we continue to focus our efforts also on the drivers of our travel retail business for the long term independently from the Daigou issues. So continue to target get to the international passengers and to the rising middle class working when our corridor, we continue at really increase the distribution of our new brands, we continue the conversional travelers into shopper as I explained before also helped by the potential in the long term of the prepaid system. We continue to deliver more services in exclusivity through the channels also in terminal exclusive products. So all these great actions they we had do in the travel retail for the long term I believe as their potential to more than offset whatever would be the limitation of created by that by phenomenon. So that's the aspect of -- sorry, was it…

And then Caroline, as it relates to China as we mentioned any expected tear offs that have been discussed we've included within our guidance. So that's certainly in our second half expectations both as it relates to the margin and in expenses. And as it relates to the import duties, yes, certainly over the last few years now, there has been a steady increase in import duties and as we stated previously we have passed their savings on to consumers. We do believe that has stimulated some of the growth in China for sure, for all of the prestige beauty players who have who have done the same. And in addition to that with some of the tax cuts that Fabrizio mentioned in our prepared remarks and that are expected to benefit Chinese consumers this year income tax cuts. That also is another stimulus that we think will support continued growth in prestige beauty.

And the last thing I want to add is on travel retail particularly is that, the impact of our increased advertising investment in the key countries where the big populations that travel or origin is frankly the biggest driver for travel retail. The travel retail business is driven by our ability to create demand and aspiration for our brands and our great products in the country of origin of the travels. The travel retail business without these investments, without these great brands and great product obviously we will not flourish just because of whatever system and whatever promotion or whatever price or duty discounts. So the key idea is that what we are seeing in our travel retail business is also the results at the end of what we discussed before, meaning the Leading Beauty Forward system liberating more resources our ability to invest these resources in advertising, in the key markets and improved innovation programs that goes with it. All of this is the main driver for travel retail and we should not forget that.

And that's the main driver in China, we seen the same in Russia, Brazil and other markets that have large traveling consumers purchasing.

Your next question comes from Lauren Lieberman with Barclays.

Thanks, good morning. I just want to ask something about the Middle East. And so that a business it's you call that is very strong I know it's been super choppy to say the least given distributor route-to-markets. So if you could just kind of give us an update on any changes you've made in the route-to-market, anything you've been able to do or maybe not to kind of smooth out in a shipment versus demand and manage that business differently then maybe than the case in two years ago.

Yes, I do say what we have seen today is just the beginning of the plan we have to reinforce in the Middle East in many aspects because what we have seen today is more of really adjustment of the stock. If you remember when there was the biz slow down all of it sudden there were two high stocks in the market and when because of the sudden slowdown the stocks went very high, in the long chain that you just described that what happens is that people don't buy the new products first because they have stocks of the old products. In these low down even the ability to create more consumer interest, so we had been breaking these negative cycle and we have gone back to add more reasonable level of stocks which means more orders of the new and more ability to involve the consumers which is at the end what really counts on the power of our innovation and power of our brands. And doing that we have seen that an improvement off trends. So that's the current situation. In the future, we will make further improvements that we had brands that have very high potential they can be far the leverage we have regions with Middle East which has high potential they can be far the leverage of that and we have obviously get beat it to and there is more enough sizing on the new innovation. That to be clear this is not yet in the results we have published so far but has the potential to be in the next couple years in the Middle East.

Thanks so much.

You're welcome.

That concludes today's question-and-answer session. If you were unable to join for the entire call, a playback will be available at 1:00 PM Eastern Time today through February 19. To hear a recording of the call, please dial 855-859-2056, passcode is 8459666. That concludes today's Estee Lauder Conference Call. I would like to thank you all for your participation, and wish you all a good day.