Good day, everyone, and welcome to The Estée Lauder Companies Fiscal 2020 Second Quarter Conference Call. Today's call is being recorded and webcast. For opening remarks and introductions, I would 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 other 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 and adjustments disclosed in our press release. 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 website. During the Q&A session, we ask that you please limit 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 good morning to everyone. We delivered exceptional results in the second quarter, which I will elaborate on shortly. But first I want to acknowledge how concerned we are for all the people including our employee and consumers who are affected by the recent outbreak of the coronavirus in China and around the world. Our hearts go out to them and I will discuss what steps our company is taking to support them in a few minutes. In the second quarter, our prestige beauty portfolio resonated with consumers globally. Our successful strategy based on multiple engines of growth once again helped fuel our performance as we grew in all regions and all major categories. Skin care rose in every region as did fragrance and hair care while makeup grew internationally. The company generated 16% constant currency sales growth, the highest organic growth rate in 20 years in the seasonally largest quarter of our fiscal year allowing us to gain significant share in global prestige beauty. While our second quarter continues to be boosted by holiday, it now also includes another important event driver Singles Day. Our advanced planning for these events delivered strong growth across our business led by Asia/Pacific region, the global online and travel retail channels and the skincare and fragrance categories powered by the extraordinary performance of Estée Lauder, La Mer and our luxury and artisanal fragrance brands. With disciplined expense management, we leverage our sales growth into a 21% increase in adjusted diluted earnings per share. Our strong performance reflected smart and deliberate investments in the best opportunities worldwide including focused product innovations, increased advertising, enhanced digital marketing, better use of data analytics, a greater local relevance. We attracted a broader group of consumers and continued to build strong repeat rates for our…

Thank you, Fabrizio, and good morning, everyone. Certainly, our thoughts and best wishes are with everyone managing through a very difficult situation in China and globally. We are committed to supporting our employees and other stakeholders, while we also manage the business impact as best we can during this time. As a reminder, my commentary today is adjusted for the items that Rainey mentioned at the beginning of the call and net sales growth numbers are in constant currency. We acquired Have & Be the owner of the Dr. Jart+ brand towards the end of December. The results for the new brand will be recorded in future periods on a one month lag, so you can expect operating results from Dr. Jart+ to be reflected in our fiscal third quarter for the first time, including the impact of purchase accounting and the interest expense on the debt we issued largely to fund this acquisition. So starting with the quarter results. Net sales for the second quarter rose 16% driven by strong growth in our international regions and improvement in North America. Sales growth in Asia, travel retail and online continue to exceed our expectations. From a geographic standpoint, our Asia Pacific region net sales rose 30% with broad-based growth across the region. Sales in Greater China accelerated, rising very strong double-digits. Our sales in Mainland China continued to deliver broad-based growth across cities, brands, categories and channels and our brands saw record results on Singles Day. As expected, sales on Hong Kong declined more than 20%. Among developed markets in APAC, we again delivered double-digit sales growth in Korea this quarter. Our sales in Japan rose mid-single digits despite the October 1st, VAT increase last year that contributed to double-digit growth last quarter. And emerging markets in Southeast Asia grew…

The floor is now open for questions. [Operator Instructions] Our first question today comes from Dara Mohsenian with Morgan Stanley. Please go ahead.

Hi. Good morning, guys. So just was hoping for a bit more clarity on the Coronavirus and how you guys are thinking about the potential impact longer term. I guess what we've seen with past epidemics is usually beauty demands come back pretty quickly after a couple of quarters. I know there's not a lot of visibility here and the duration of illness is obviously still a big wildcard. But just to retail any initial thoughts or context on if you think this could be an issue that impairs longer-term growth as we look out over the next few years? You talked about a gradual recovery through fiscal year end. Should we expect things to sort of ramp-up pretty quickly after that? Or how are you thinking about it in terms of longevity of impact? Thanks.

So obviously, we don't know about the specific medical health recovery timing, which is the unknown at this point. But we are in agreement with your assumption, which is basically this will have an impact in the short term and definition of short term is what is unknown today. But then after this period, there will be a recovery and people will come gradually back to normal habits. And so, we do expect to recover our momentum at the end of the health crisis. And in terms of our assumption today are in line with what you said. We assume the two quarters to be affected by the impact and we expect a normalization in fiscal year '21. That's our assumption today. The other important thing is that, we are ready to stay close to the current mitigation of the issue and resolution of the health classes as we are doing, supporting our China team and all the activities that the government is putting in place in China today. And we also will stand ready to support the recovery when the recovery will be happening and to invest behind the recovery as required by the market opportunity, but most importantly, by the needs of rebuilding the right consumption of Chinese consumers in the name of the economical development of China.

Great. That’s helpful. Thank you.

The next question will come from Lauren Lieberman with Barclays. Please go ahead.

Great. Thanks. Good morning. I was hoping we'd talk actually a little bit about the Americas because the strength this quarter, the inflection was very notable. So I was wondering, if you could talk a bit more about how much you think this is tied to just being really proactive in promoting and getting behind I should say in fragrance and skin and holiday being the key to this. Or are you starting to see other lift that you think can carry through past holiday? And then in part with that of course we've had the news about incremental Macy's door closures this week. So, if you can just comment on the outlook for the rest of the year in the Americas. Thanks.

So, first of all, in -- as we said this quarter has contributed to the stabilization of our North America business and this has been in line with the strategy we communicated in Investor Day. And we remain committed and to continue the work of stabilization in the next months. So what happened this quarter is, first of all, we have used as anticipated much more granular insight in the market to activate our plans and much more local relevance in the activation. The other thing that happened, we have recognized the softness of the overall makeup market and that's why we have accelerated our activity in skin care and particularly fragrances during the holiday season that we have well fitting the situation and we got great results. So, we had -- if you want adjusted our engines of growth in a way that contributed to the good results. Our innovation pipeline as anticipated has been strong and the impact of innovation has improved. And so, all this have been a positive impact. We will continue to operate in that direction, but we do have still to be confront some of the headwinds. To be clear, the makeup softness, particularly the color makeup softness is continuing. As you mentioned, the closures of certain retailing stores where we do have high market share will continue although we completely share the Macy's strategy of focusing on the high-performance doors and/or gradually stopping the smaller and lower performance doors with -- as I said, we support the strategy, but obviously we will need to operate with the strategy with making sure that we retain the consumer -- the brands. And this will be difficult, but we will do our best to do that. So we need to take under account our extraordinary efforts to improve our model that are working, but also take under account there will continue to be headwinds. So our strategy remains at this point stabilization.

Great. And just as a follow-up, how are you thinking about the impact of Chinese travelers not really visiting the U.S. over the next several months just in terms of the outlook?

That's actually a good point. We assume that there will be obviously an important reduction of Chinese travelers not visiting the U.S. in the next at least two, three months and this will have a negative impact obviously on the sales to Chinese tourists. Frankly, in this moment we are assuming in our guidance also a slowdown on any travel population. To be clear in this moment because of the coronavirus global concern, tourists in general is being reduced temporary. So, we are taking this temporary assumption -- sorry the assumption of this temporary reduction under account in our guidance.

Okay. Great. Thanks, so much.

And I just want to add as it relates to our guidance. I mentioned the range of $1.82 to $1.91 which is within our press release. I think I mentioned a different number in our guidance for the second half.

The next question is from Michael Binetti with Credit Suisse. Please go ahead.

Hey guys. Thanks for taking our question and congrats on a really good quarter. So, I want to ask you on the Dr. Jart+ dilution. Could you walk us through how much the $0.18 -- we're trying to think forward I guess over the four quarters of integrating that business, how much of that is one-time in nature? And when do you see that starting to wear off or even possibly turn to an accretive position? And then I just -- I want to ask you as you think through the U.S. number a little bit, so do you think the retailers that you worked with on the holiday strategy to get more skin care and fragrance out there? They really seem to want to keep pushing on makeup even as the warning signs were showing up over the last year or two. Do you think they've gone through the psychological change yet that skin care is going to be the driver for the medium term? And are they accepting that they have to pull back more on makeup in a structural way? I guess are the gains you saw in skin care and fragrance, would you characterize those as sticky and shelf space gains that are going to remain dedicated to those categories as we look into calendar 2020?

Yes. So, starting with the Have & Be dilution, we obviously have the step-up in inventory which is one-time depends on how you're treating the interest expense which is also in that number. What I would say Michael is that we expect that Have & Be will be, if you think forward, relatively flat including purchase accounting. So, eliminating those onetime items next year and accretive the following year.

Okay.

The makeup question is the second question?

Yes.

Sorry could you repeat who was the subject to the makeup when you said they? I didn't understand.

Yes. Well, it sounds like it was a pretty meaningful acceleration. Obviously in North America or in America we can see your numbers. But it sounds like the number that you got from specialty-multi which was a great growth channel for you guys over the last few years, but slowed recently sounds like it improved a lot this quarter and it sounds like you worked with them on skin care. And I'm just wondering if you feel like that channel they feel like they've gone through the mental change of saying, look skin care is going to be the bigger driver and we're going to give them -- give that category more shelf space that sticks around calendar 2020.

I -- frankly, yes, I think everyone realizes the power of skin care in this moment and we are all working together to leverage the power of skin care also because skin care for instant results and skincare product combined with makeup is on a growth. So, there are -- yes you speak about shelf space which obviously is a bit more gradual in the way it changes. But definitely innovation programs are reflecting a lot of this. So, there is more activity, more social media, more advertising in skin care than before and this is a reflection on the results. By the way makeup is a big category. The makeup for face meaning foundation for example is still doing very, very well. The place which is softer is color. And importantly, what we are doing to contribute not only to leverage skincare fragrances better but to reinstate growth in makeup in the future is we have accelerated the innovation in the makeup category contributing to the future results of our retail partners also in this category. So, to be clear, we are not giving up at all on makeup. We are just accepting that in the short-term, we are focusing more on other category and innovating better in makeup to reactivate the consumer interest.

Thank you very much. Congrats on getting North America back to positive.

Thank you.

The next question will come from Erinn Murphy with Piper Sandler.

Great. Thanks. Good morning and let me add my congratulations. I guess my question is around Amazon. There's been some press out recently talking about them potentially evolving their model to launch some luxury brands, maybe using a concession model. If something like this was to play out, would you ever consider -- or reconsider, excuse me, Amazon as a channel for luxury beauty? And then just a follow-up on China. Can you share, Tracey, maybe what percent of physical doors have been shuttered? And are you seeing any major change in trend in the online business in China since the outbreak has escalated? Thank you.

Okay. On the first question is -- the answer is no. At this point, we are not considering Amazon, a channel for our luxury beauty products and we are focusing of our current channels and our current partners to build a continued stabilization in North America of our business. As far as the China question, is the number of physical doors, I'll let Tracey go with that.

Yes. So, as you can imagine it's quite fluid. And one of the things that we've seen is the Chinese New Year extended for many, many of our employees. Our stores have closed as malls have closed. So, very recently two-thirds of our department store doors were closed and the remaining doors were on reduced hours. Now that could change next week, so this is a very fluid situation.

And on the second part of the China question which is the online, absolutely the online channel is very strong in China and as we said in the second quarter. But in this moment also online is suffering because in this moment in the middle of the outbreak, the delivery system in homes and in the big distribution centers also people are now working like in this moment until February 10th, many people with non-essential activity in factories in other situation this is stopped. The same is for distribution centers the same for other activities. So online in -- at least in the short-term is having the same issues of brick-and-mortar. In terms of the role of online in the recovery in the future, we are optimistic that online will play a very strong role in the recovery when the recovery will happen.

Thank you for that context. All the best.

Thank you.

The next question will come from Steve Strycula with UBS. Please go ahead.

Hi. Good morning. So, first part of my question just wanted to follow-up on Erinn's question. Can you give us a little bit more texture as to how to disaggregate how Mainland China sales are performing versus the travel retail component of the business? Primarily it's how we think about modeling the back half of the year. One of those businesses is housed within the EMEA segment. The other business is clearly housing APAC. So just want to get a little bit more texture as to which ones being more impacted real time. And then Fabrizio, if you use history as a guide post here, how do we think about once the issue is call it "contained" what is like the recovery path off from that moment forward? Is it typically from what you've seen before three months, four months for travel retail to come back online from flights being booked? Any help would be appreciated. Thanks.

Yeah. So the short answer to the first question in this moment travel retail is the most impacted channel. Because if you think what -- just to give you the context of what's happening, you will probably know that more than 60 airlines just closed their flights. So in this moment the travel in and out of China is suspended in the large majority of cases. So there is lack of traffic for -- just in and out of China. Second, in general tourism in this moment is more prudent, because it's a global issue. The outbreak is a global concern. And so many people which are concerned to travel in this moment are reducing their choice or postponing some of the travel. And I'm speaking touristic travel. Then there is a third factor. Many companies have banned travel to any place -- to China, but also to any other place where there is the virus. And so business travel is being reduced not to count the many companies are reducing business travel for cost containment reasons. So in this moment, the amount of travel in airports is reduced and traffic is significantly reduced. So that's the biggest impact. The second biggest impact is obviously China Mainland itself and Hong Kong, which have reduced significance. So I would say the Greater China area, because of all the reasons that we have already discussed in the prepared remarks that I'm not going to repeat. But the most important thing is that keep in mind that until February 10 most of the cities are not even -- people are not back to work until at February children are not back to school. And people are requested rightly so not to get out of home for reasons, which are not essential and not…

The next question is from Andrea Teixeira with JPMorgan. Please go ahead.

Thank you. Good morning. And I just want to echo the congrats on your results.

Thank you.

So as a follow-up on the North America and the comments that you made for mix Fabrizio and obviously there was -- it's natural that in the holidays, it's more giftable skin care and fragrances. And you're also putting more -- I think prudently putting more marketing behind those lines. So do you think that innovation and momentum continue to build into the next few quarters? Or we maybe potentially have some seasonal positive impact of that into the second quarter? Thank you.

So I'll start and then Fabrizio can also add his comments. We are progressing towards stabilization in North America. And clearly, it was a strong holiday and strong second quarter for us in North America and in other parts of the globe. So our teams have worked awfully hard to make this holiday season a very good one and consumers responded and we're very happy about that. As we look at the back half of the year, Fabrizio touched on the fact that we do have tourists that we expect that that business to be a bit softer given the situation that we're managing through globally. And I would also say that North America is making progressive progress. However, I would not expect that the second quarter would necessarily be reflective of continued acceleration from there. But the North America team is executing against all of the strategies that were laid out last year and we're seeing some good outcomes from that. So what we told you last quarter was North America, we expect certainly to have better performance this year than we did last year in North America. So that is progression towards stabilization. Lauren asked earlier about the Macy's announcement. And clearly, as we've been saying for some time, we believe that brick-and-mortar needs to be taken out of North America. North America has been over retailed for some time. So we are very much aligned with what Macy's has announced in their Investor Day yesterday. The doors that actually would be closing in our fiscal year were already included in our guidance.

That's helpful.

The next question will come from Mark Astrachan with Stifel. Please go ahead.

Thanks, and good morning everybody. Just wondering if you could quantify the online percentage of sales from China. And related to that also if you could just quantify the impact benefit from e-commerce accelerating consumption the enhanced availability in China. In other words, previously consumers would have to visit cities selling the product and now you're up to 123. But e-commerce obviously makes the product available everywhere. So maybe if you could just talk a bit about, how you think about that dynamic as having helped past tense sales and how you think about that on a go-forward basis and maybe if you think about some of those Tier 3 to 5 cities, which didn't readily available -- have product readily available, but now people can order online. How do you think about that in terms of accelerating demand, maintaining that demand and kind of how it will impact future growth?

Yes. No, that's a very good question. As I commented a lot of times on the subject this is a very important phenomenon, because today we have physical distribution in China in 123 city with our most distributed brands which are Lauder and Clinique and much lower city coverage in the other brands, which are still on a growth trajectory. So it is a lot of physical distribution potential in the long-term still untapped. But at the same time, we know there is demand in China now in over 600 cities. So there are over 450 cities where there is strong demand and there is not yet physical distribution of prestige luxury and for sure prestige luxury of Estée Lauder brands. So this demand gets filled by online and get filled by -- when there's consumer travel also travel within China like in amazing 3-Tier markets like Hainan Island then where they can access the products or when they travel for internal business or vacation like go to Beijing or to Shanghai. So that's the situation. But online cover a lot these cities and that's why also is growing and is very strategic, because it give us access to these consumers in a very productive way. The other important positive consequence of this dynamic is that the brick-and-mortar can remain very productive. It can remain very focused where there is the right productivity and online can cover productively the rest. So this is a good phenomenon continue to grow. It is definitely one of the reason behind my comment that we are having better and better results also in the Tier 3 and Tier 4 cities also where physical distribution has not yet arrived. In terms of percentage of sales, China is the highest percentage of sales online versus other markets. It's on high side and it's continued to grow.

We have time for one more question and that question will come from Nik Modi with RBC Capital Markets.

Thanks. Thanks for the question. Good morning, everyone. I just wanted to follow-up on Mark's question Fabrizio. How much flexibility do you have to turn up the dial on really focusing on some of those lower tier cities that you just referenced? I'm just thinking about as kind of the year progresses and if you really wanted to turn up the dial to generate sales growth in some of these other tier cities. Do you have that kind of control in the near term? Or is it a much longer-term burn?

I mean, we have control of the online I mean with our partners like Tmall and obviously, our own online activity. But the – remember we – our way to build distribution and also to build coverage is – we are in luxury. And for us selective distribution, which means demand ahead of supply is very important. So we gradually build the demand. And the reason why today demand is growing so fast also in the city is social media. Because while in the past advertising was local, meaning advertising was focused in the cities where there was physical distribution. Social media by definition is national. So you are in a dynamic where demand is normally ahead of supply and that's the typical demand of the good luxury market and we are filling this demand gradually and making sure that we keep the concept of desirability and high quality and high quality also the experience that we give to our consumer in mind. So we are not selling products. We are selling quality and full experiences and we only do that when we can provide the best possible service to the consumer. So the short answer is gradually, but yes, we have the capability to dial up as the market opportunity reveals itself.

And just a quick follow-up. Of the 450 cities you cited in China's opportunity, how many do you believe Estée Lauder as a company has a very good handle on demand? And just a general consumer insights in those cities?

So I will not give you specific numbers but I can tell you that we have the consumer data, so we know the number of consumers that are buying from different cities. Even we use these data analytics to decide where to open physical distribution. So we use the demand and the elements of the strength of the demand from the cities also to judge our physical distribution strategy to make sure that we continue to provide better high-touch services to the consumer when the demand is sufficient to be productive and to offer the quality and the service that we need to offer. So it's a gradual development of quality service.

Very helpful. Thank you.

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 20. To hear a recording of the call please dial 855-859-2056, passcode 443-7719. That concludes today's Estée Lauder conference call. I would like to thank you all for your participation and wish you all a good day.