Estee Lauder Companies Inc

NYSE:EL

Earnings Call Transcript 2020-Q4

[Operator]

Good day, everyone, and welcome to The Estée Lauder Company's Fiscal 2020 Fourth Quarter and Full Year 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.

[Rainey Mancini, Senior Vice President of Investor Relations]

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 other 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. 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. For clarity, I would like to remind you that references to online sales include sales of our products from our online channel, including Brand.com and third party platforms, as well as estimated sales of our products through our retailer’s websites. During the Q&A session, we ask that you please limit yourself to one question so that we can respond to all of you within the time scheduled for this call.

And now I'll turn the call over to Fabrizio.

[Fabrizio Freda, President and Chief Executive Officer]

Thank you, Rainey and Hello, everyone. Fiscal Year 2020 was truly a year without parallel as we delivered one of our strongest first half on record and navigated with agility through a unprecedented pandemic in the second half. In both of these dramatically different halves, our employees lead with the extraordinary passion, creativity and resiliency. Our hearts continue to be with everyone impacted by COVID-19 and we remain focused on the safety and well being of our employees, their families and consumers.

The second half of our fiscal year also marked a period of profound paid, strategic events in the United States highlighted the systemic racial injustice that has plagued our society for far too long. In June, we announced a comprehensive set of commitments to act with urgency on achieving racial equity. We stand in solidarity with our black employees, black consumers and black communities and certainly know black lives matter. Among our many commitments, we are listening and learning to foster stronger internal culture and advocacy and inclusion. We are focusing on talent and opportunity to ensure that we are providing more equitable access to professional development and advancement for our black employees. We are ensuring that the end-to-end creative process accurately and consistently represents the black experience and engages black professionals.

We are investing for change through a three year $10 million pledge for the company, our brands, our foundation, employee matching gifts and the Lauder family to support nonprofits and are in the process of making the initial $5 million donation. Since announcing our commitments, we have held 30 town halls with our employees and began to identify gaps in our professional development and advancement opportunity for our existing black talent. We have also engaged a diversity focused recruitment firm and created new diversity recruitment resources. We have commitment to doing more as a live in our company and in our communities.

In the last few months, the company and our employees have also made donations and pledges to organization around the world to help limit the spread of COVID-19 and eased the related hardship phase by the communities in which we live and work. We made hand sanitizer for frontline workers, high risk individuals and our employees. The production continues in this date at our facilities in the United States, the United Kingdom, Belgium and Switzerland.

Our brands have found meaningful ways to offer support, and Aveda is a shining example, it’s initiative for salon owners and stylists serve to connect the educate, as well as to provide financial and business assistance. By offering a standard payments term, online sales, reopening toolkits and over 1,000 hours of virtual education, Aveda actively assisted its network during this challenging period of salon closures.

Turning now to the year's performance. In the first half of fiscal year 2020, sales rose 14% and adjusted EPS climbed to 20%. Our continued outperformance yielded strong global prestige due to share gains. In fact, our gains accelerated in calendar 2019. We were well on our way to a third fiscal year double digit sales and adjusted EPS growth. Despite extensive temporary store closures worldwide in the second half as COVID-19 pandemic took hold, sales fell only 20% and we were profitable as we quickly pivoted to online to capture consumption and adjust our cost structure.

Our multiple engines of growth strategy, which has powered our success for over decade, continues to be highly effectively. The company diversified prestige beauty portfolio give us many levers to drive the business. Our robust global skincare portfolio, vibrant online business, a broad exposure to Asia-Pacific are the engines of this moment. And then we enjoyed both strong and growing prestige beauty share and profitability. Across these engines, the Estée Lauder brand's performance was magnificent in fiscal year 2020, as it achieved its third consecutive year of double digit sales growth. Impressively, the brand hero franchises of Advanced Night Repair, Revitalizing Supreme, Perfectionist, Re-Nutriv and Micro Essence, all contributed meaningfully to growth.

For the fiscal year, skincare performed exceptionally well, Estée Lauder, La Mer, Tom Ford, Origins, Darphin and Le Labo drove growth organically, while the category also benefit from the acquisition of Dr. Jart. We delivered excellent performance across subcategories, owning to strong repeat purchase rates, data analytics driven marketing, new social selling strategies developed during COVID-19 and highly desirable innovation. Among the subcategories, demand for watery lotions is soaring as a hydrating step before serums and moisturizers in the new era of self care. Estée Lauder Macro Essence, La Mer, The Treatment Lotion, Origins, Dr. Weil Mega Mushroom Treatment Lotion, delivered outstanding growth for the fiscal year and we expect to continue our ability in this compelling subcategory.

Beyond watery lotions, our serums in high care subcategories are prospering. For serums, cherished heroes like Estée Lauder Advanced Night Repair and innovation from clinic even better line and Estée Lauder Perfectionist and the Re-Nutriv franchise bolstered growth in fiscal year 2020. La Mer new Eye Concentrate launched a few months ago has been highly sold as consumers are embracing its lighter texture and new claims. In EMEA, the product was the best seller on La Mer.com in the fourth quarter.

Trusted brands like Clinique, flourished online when brick and mortar closed. In the fourth quarter, Clinique US prestige beauty share rose on retailer.com solidifying its number one rank. Sales on Clinique.com were the largest across all our brand sites in the quarter, driven by heroes’ dramatically different moisturizing lotion and moisture surge. Clinique promise to deliver products that are simple, safe and effective for skin is resonating largely online.

Our online business surged worldwide in fiscal 2020. It delivered nearly triple digit organic sales growth in the fourth quarter, which is a testament to the capabilities and scale we had built, each our Brand.com, brand boutiques and platforms, such as Tmall and retailer.com doors, contributed meaningfully. On our brand sites, in particular, we deliver nearly 90% organic sales growth globally in the fourth quarter as we increased investments to offer the best high-touch services. We quickly evolved our live chat capability to offer detail.

We also announced our virtual try-on to include more categories. We rapidly deployed live streaming first in mainland China and then globally, engaging make up artists, as well as brand ambassadors for tutorials. Our live streams are shoppable, meaning that consumers can make purchases within the event. Across the brands, traffic grew significantly in the fourth quarter and conversion rates rose dramatically. Encouragingly, we saw strong growth in engagement and repeat purchase behaviors. both new and existing consumers shopped our brand sites more frequently, as for example, with Origins and Estée Lauder in the United States, reinforcing the great work we are doing to cultivate and retain consumer through this moment.

Consumer had discovered new shopping habits online that are enduring and this is true of all ages. Clinique’s live streaming series designed to both entertain and educate led consumer to return more frequently, spend four times longer on site and convert at far higher levels. The brand drew live streaming event with Clinique global ambassador, Emilia Clarke, surpassed the newly elevated conversion levels.

Bobbi Brown launched its artistry like never before program in May, offering consumers one-on-one and small group video consultations with national make up artists. These engaging sections range from 15 to 60 minutes with the 30 minute makeup bag makeover sessions is the most popular. Conversion rates are incredibly strong with the high level of units per transaction. Bobbi Brown continues to scale this program globally to meet the increasing demand. This is just one example of the many ways our brands are building community through this challenging moment, and we see this as an exciting evolution of the shopping experience for the future.

Aveda, which led our brands by first launching its ingredient glossary earlier in the year is seeing guests we engage with a glossary spend three times more time on avida.com than average. Rather acting on our commitment to ingredient transparency, Clinique, La Mer and Origins, launched the ingredient glossaries in the fourth quarter, and we have more to come in fiscal year 2021. We maintained our strategy focused on key online shopping events throughout the year.

Our advanced planning for these events delivered outstanding results. For the 618 midyear shopping festival, the Estée Lauder brand sales on Tmall tripled and its sales ranked second among all prestige beauty brands. Our Asia Pacific region delivered superior sales growth in fiscal year 2020. Every category in the region expanded, led by accelerating growth in skincare. Fragrance also accelerated as consumer desire in the region for our portfolio of luxury and artisanal fragrance build.

Mainland China performed exceptionally with its sales rising roughly 60% organically in the fourth quarter. Korea and several other markets also grew for the year and for quarter, driving prestige beauty share gains for both periods. In Mainland China, the premium and luxury segments of prestige skincare are booming. In fact, luxury is the primary growth driver for the total category.

For this, La Mer is ideally positioned with its heritage, iconic ingredients and superior quality. La Mer is helping to grow the category and the brand shares of prestige skincare is expanding significantly, which is the idea of combination. Desire for our luxury and artisanal fragrances is strong in the region, and we continue to see the growth. In the fourth quarter, we launched Kilian and Frédéric Malle in Mainland China with great initial interest from consumers. In Korea, our fragrance sales soared as Jo Malone London and Tom Ford, grew with our launches of Kilian and Le Labo were also highly sold, collectively driving prestige share gains in the category.

With air travels still largely curtailed, we are focused on meeting demand locally across the brick-and-mortar and online channels, as well as in localized destinations of travel retail. Hainan, in particular is prospering as tourists gradually resumes, which partially offset the decline of travel retail in the fourth quarter. As of July, duty-free shopping allowances in Hainan have increased more than three fold, which is further boosting consumption. We continue to strengthen our leadership in the travel retail channel.

Innovation is fundamental to our strategy. And even in this unique year, it once a year represented over 25% of sales. It will play a vital role in fiscal year 2021, powering the engines of the moment and the engines of the future. Already out these months are two big launches in skincare. La Mer launched its new concentrate as a potent barrier serum newly advanced with antioxidant power to be a double source of strength against environmental stressors and their aging effects.

Estée Lauder introduced the breakthrough new generation of its brand icon, Advanced Night Repair. This powerhouse serum still has all the benefits and texture loyal consumers know and love, and now feature innovative new technology. Tested on women of all skin tones, ethnicities, and ages, it now offer the fast growing highly desired benefits of firmness, pore minimization and eight hour antioxidant power on top of its existing wrinkle and uneven skin tone benefits to recruit a younger consumer, while retaining our loyal users globally. Its package is being modernized into a luxurious, recyclable glass bottle that supports our sustainability initiatives. We have excited launches to come from MAC and Clinique in makeup as we anticipate trends on the horizon. Our pipeline in fragrances and hair care is also robust with newness from Jo Malone London and Aveda, among others.

Looking ahead, we are confident that we can return to our long-term growth algorithm of 6% to 8% sales growth, 50 basis points of operating margin expansion and double digit earnings per share growth in constant currency after a period of normalization as the impacts of COVID-19 subside. Our citizenship and sustainability goals remains on track. We are also implementing sustainable office practices in mainland China and exploring green energy solutions there.

For fiscal year 2021, we are investing in several strategic priorities intended to drive our long-term sustainable growth. Among the priorities are enhancing manufacturing capabilities, expanding online fulfillment capabilities and further funding growth opportunity in Asia Pacific, including our new state-of-art innovation center in Shanghai.

While the world continues to confront many unknowns related to the pandemic, certain realities have emerged that have accelerated our strategy. As online has quickly grown, we need to more aggressively adjust our brick-and-mortar footprint and more closely align with how and where the consumer wants to shop. The post COVID business acceleration program we announced to-date is designed to rapidly relocate our resources, enabling us to invest in the greatest opportunities for long-term sustainable growth, like online, skincare, or China. Importantly, this program would also improve the productivity and sustainability of our brand building brick-and-mortar footprint and better position us to make it experiential and omnichannel. Tracey will discuss the program in more detail.

In closing, we confidentially bring the strength of the first half and the learnings from the second half with us into a new fiscal year. I want to thank all our employees for your exceptional contributions across the year and most especially the second half, you navigated through an unprecedented period with grace and made us a better company.

Now, I will turn the call over to Tracey.

[Tracey Travis]

Thank you, Fabrizio, and hello everyone. As Fabrizio said, fiscal 2020 was an extreme tale of two halves. At the end of December, we delivered our best half year performance on record. And by the time we closed the year on June 30th, COVID-19 had created the backdrop for our worst second half [performance].

Navigating through this year has certainly been one of the most significant challenges we have faced. Same time we are proud to recognize the incredible compassion and resilience of our employees who continue to support their communities and each other as they also work to both mitigate the business impact of COVID-19 and also drive the recovery of our growth. As a reminder, my commentary today is adjusted for the items that Rainey mentioned at the beginning of the call, and that sales growth numbers are in constant currency.

And now for the quarter results. Net sales for the fourth quarter fell 31%, as the majority of our brick and mortar distribution throughout the world was closed for much of the quarter. We rapidly accelerated programs to capture additional growth globally online, resulting in nearly double our online sales year-over-year. As a result, online sales including Retailer.com represented more than 40% of our total sales in the quarter. The December acquisition of Dr. Jart added approximately 3 points to net sales growth.

Regarding our regional performance, net sales in Asia-Pacific rose 16%, driven primarily by very strong double digit growth in skincare. Mainland China returned to previous levels of robust double digit growth as brick and mortar retail reopened and online more than doubled on strong 618 midyear shopping festival programs. Nearly every brand and channel rose strong double digits in China. Korea rose mid-single digits while other markets in the region have been slower to recover.

Net sales in our Europe, the Middle East and Africa regions fell 39% with all markets declining. Global travel retail, which is primarily reported in EMEA, was hard hit by the 97% drop in international passenger traffic but still managed to decline less than 30% for the quarter supported by strong local tourism within China. Net sales in the Americas declined 54%, reflecting a very difficult environment throughout the region.

From a category standpoint, skincare was the most resilient. Net sales grew 3%, driven by continued strong increases from the Estée Lauder and La Mer brands in Asia. Skincare sales also benefited from the acquisition of the Dr. Jart brand. Net sales in makeup fell 61%, reflecting the greatest impact of COVID-19 work from home and social distancing guidelines on consumer preferences, particularly in Western markets where makeup is the largest category.

Fragrance net sales declined 56%, reflecting the impact of store closures and a shift in consumer preferences from personal colognes to hand wash and home fragrances. Our hair care net sales fell 35%. Most stores and salons were shuttered during the quarter. Our gross margin decreased 840 basis points compared to the fourth quarter last year as we expected.

A number of factors contributed to the decline and most were triggered by the impact of COVID-19 on our sales and on our manufacturing locations. Increased obsolescence contributed more than half of the decline as demand for all products, particularly makeup was sharply curtailed by COVID-19. Inefficiencies caused by the temporary shutdown in some of our manufacturing locations and the implementation of social distancing measures reduced capacity and triggered a requirement to recognize these manufacturing costs in the current period rather than when the product is sold. This contributed approximately 210 basis points to the decline. The inventory step up related to the Dr. Jart acquisition increased tariffs and other supply chain impacts made up the remainder of the decline.

Operating expenses declined 22%, reflecting the $550 million in cost actions we implemented during the quarter. However, the sudden and dramatic sales decline and the gross margin impacts I just mentioned, resulted in a $228 million operating loss for the quarter. The diluted loss per share of $0.53, including $0.03 of unfavorable currency translation and $0.06 dilution from the acquisition of Dr. Jart.

Let me now discuss a few elements of our full year results. Net sales declined 3% in constant currency, reflecting the record performance in the first half, followed by the impact of COVID-19 on the second half. Our distribution mix shift continue to evolve, accelerated by COVID-19. Online sales growth accelerated during the year and continue to outpace other channels. Online, including retailer.com, represented 22% of our total sales during fiscal 2020, a 7 point increase compared to last year.

Travel retail delivered strong performance despite the sharp downturn in the second half, and grew high single digits for the year, ending fiscal 2020 at 25% of sales. Department stores globally, including their retailer.com business, represented 31% of fiscal 2020 sales. And North America department stores were 9% of our global sales mix. Our gross margin fell 220 basis points to 75.2%, driven largely by the factors I just described in the fourth quarter.

For the full year, the increase in obsolescence comprised about half of the decline. The COVID related manufacturing efficiencies were approximately 50 basis points, and the Dr. Jart acquisition increased tariffs and other supply chain impacts caused the remainder of the decrease. Operating expenses declined $240 million or 3% for the year, reflecting savings from Leading Beauty Forward and our ongoing costs initiatives, as well as the cost containment actions we took in response to COVID-19 in the second half of the fiscal year.

Our full year operating margin fell 280 basis points to 14.7%, primarily reflecting the gross margin decline, 40 basis points dilution from the inclusion of Dr. Jart and the deleveraging effect of lower sales. The capabilities we built during this time and the actions we took and are taking should help position us to emerge strongly when the recovery is in full swing.

Our effective tax rate for the year was 23.2%, an increase of 200 basis points over the prior year, primarily driven by the geographic mix of earnings. Net earnings declined 24% to $1.5 billion and diluted EPS fell 23% to $4.12. Earnings per share was negatively impacted by $0.04 from currency translation and $0.11 dilution from the acquisition of Dr. Jart.

We recorded $1.2 billion after tax or $3.31 per share of impairment charges, primarily related to our makeup brands that were initially challenged by a general slowdown in the overall makeup category and along with certain freestanding retail stores have been further challenged by the impact of COVID-19 on consumer demand.

In fiscal 2020, we recorded approximately $68 million after-tax, or $0.19 per share in restructuring and other charges for our Leading Beauty Forward initiative. We remain on track to substantially complete initiatives under the program by the end of fiscal 2021, and we continue to expect annual net benefits of approximately $475 million before taxes.

These charges were partially offset by the gain on our minority interest in Dr. Jart and favorable changes in the fair value of contingent consideration. As you have heard, COVID-19 has created a number of disruptions to our business, including accelerating changes in our distribution mix that had been expected to occur over a longer period of time. The post-COVID business acceleration program that we announced today reflects the need to accelerate additional organizational changes during fiscal 2021 to operate more effectively in the post-COVID reality.

We expect to close select department store counters and between 10% to 15% of freestanding retail stores, primarily in Europe and North America, while also further supporting the accelerating consumer shift to online shopping. This necessitates commensurate changes in our commercial organizations that will reduce the number of employees by a net range of 1,500 to 2,000, primarily point of sale and support personnel related to those retail locations.

While some positions will necessarily be eliminated, we also plan to increase investment in online talent and capabilities, including online consultation by sales associates. We also intend to reinvest a portion of the savings from the program to further build out our online technical capabilities, including accelerating omnichannel capabilities linked to our retail stores and to increase digital media to reach both new and existing consumers.

The program is beginning now and we expect to realize results fairly quickly, mostly in the coming two years. We expect to take charges of between $400 million and $500 million through fiscal 2022 and generate savings of $300 million to $400 million before tax by fiscal 2023, a portion of which will be reinvested to drive growth.

Moving on to cash flows. Cash generated from operations was slightly below last year at $2.3 billion, reflecting lower net sales, partially offset by call to actions and favorable working capital. We utilized $623 million for capital improvements, primarily supporting our ecommerce capabilities, supply chain improvements and information technology.

We eliminated or deferred approximately one third of our planned CapEx, mostly related to retail stores and office space upgrades. We also used $1.04 billion net of cash required to purchase the remaining ownership interest in Dr. Jart. During the year, we borrowed $2.7 billion net of repayments to both fund the acquisition of Dr. Jart and to provide liquidity and flexibility as the COVID-19 impact spread during the second half of the year.

We ended the year with $5 billion in cash and cash equivalents and $6.1 billion in short and long term debt. Even with these liquidity actions and with lower earnings, we returned $1.4 billion in cash to stockholders during the year via dividends and share repurchase activity. In August, we repaid the remaining outstanding $750 million drawn on our revolver.

In the near-term, while we are encouraged by the gradual reopening of markets around the world, it remains difficult to predict the duration of the pandemic, the timing and trajectory of the recovery and the corresponding impact on our business, even while online remains a significant bright spot. Where stores are open, we are seeing traffic return slowly. We are also mindful of the risk of the global recession and a likely slow recovery in employment, as some businesses in Western markets remain closed and many government support measures taper off.

Therefore, we are not providing explicit sales and EPS guidance for the full year. However, we can provide you with some underlying assumptions to help at least frame some of your expectations for the year. We do expect to see progressive quarterly sales and profit improvement as retail doors reopen and traffic and travel gradually resumes, assuming no significant second wave occurs. Given this expectation, for the first half of the fiscal year, comparisons to our record performance in the prior first half will be difficult with sales and profit below prior year levels.

While online is expected to perform strongly, the momentum for recovery in brick-and-mortar and travel retail will not be realized until later in the second half. Conversely, we expect sales and profit to grow significantly in the second half of the year against a period of considerable COVID impact, particularly in the fourth quarter. The inclusion of six months of incremental sales from the acquisition of Dr. Jart should add about 1 to 2 percentage points to sales growth for the fiscal year. Pricing is expected to add another 2 points of growth.

Our manufacturing capacity is back to near normal levels and we expect our gross margin to recover accordingly. We expect to realize the full benefit from Leading Beauty Forward in fiscal 2021, and we will continue to maintain some of the COVID-19 cost controls as we progress through the first half of the year. These savings are expected to give us the flexibility to invest more in digital marketing and advertising to support innovation, recruit new consumers and drive brand awareness, while also supporting our operating margin recovery.

Our full year effective tax rate is expected to be approximately 23% and net interest expense is expected to be approximately $170 million. Capital expenditures are planned at approximately $900 million as we continue to invest in additional manufacturing and distribution capacity, technology and data analytics, research capabilities and ecommerce to support future growth. And as you saw in press release today, we declared a quarterly dividend of $0.48 per share. We also expect to reinstate share repurchases sometime during the year as we gain comfort that the recovery is more sustained.

As we are all already halfway through our first quarter, we are more comfortable providing guidance for this quarter. At this time, we expect sales to decline 11% to 12% in constant currency. Sales declines peaked in April and have been gradually improving each month as retail markets around the world reopened for business. The incremental sales from Dr. Jart are expected to add about 2.5 points to growth and currency is expected to be dilutive by approximately 1 point.

We expect first quarter EPS of $0.80 to $0.85, reflecting the sales outlook, continued cost containment measures and investment in key growth areas like online, innovation and China. Currency is expect to dilute EPS by $0.01 and Dr. Jart is forecast to dilute EPS by $0.06. We look forward to leveraging the tremendous strengths of our business and driving a strong recovery in the new fiscal year as the market accommodates.

Protecting our agility to invest appropriately for both the near term recovery and the long-term opportunities inherent in global prestige beauty is paramount to the strategic actions we are taking to continue to support long-term sustainable growth. On behalf of Fabrizio and The Estée Lauder Company's leadership team, we give thanks to all of our employees around the world for their extraordinary efforts to manage during this unprecedented period.

That concludes our prepared remarks. We'll be happy to take your questions at this time.

[Operator]

The floor is now open for questions [Operator Instructions]. Our first question will come from the line of Erinn Murphy with Piper Sandler.

[Erinn Murphy, Piper Sandler]

I guess my question is for Fabrizio. You've had a lot of success in digital that was really expounded upon this quarter. Have you changed your views on how you view Amazon as a potential beauty partner? And then secondly, as stores are starting to reopen. Can you just talk about how consumers are interacting with stores? Thank you.

[Fabrizio Freda, President and Chief Executive Officer]

So, not yet. We have not changed our point of view at this point of time on Amazon. We see such a huge long-term sustainable evolution of our online that we want to focus on that. And specifically, I want to explain what's happening online. Our last quarter, our online business was growing at double digits and these included 90% growth on our brand.com. Great work on Retail.com in the 80% plus and also triple digit in our platforms are likely more. This increase, particularly the Brand.com and the platforms is increasing our direct to consumer business, which means increasing our data availability of consumers and increasing our ability to market these consumers.

The other thing we are seeing is a dramatic increase in consumer engagement in the world of online. And because of these better engagements, we are driving loyalty and repeat of our hero products like never before. And finally, we really see an increase of exclusivity, meaning the consumers that were really there are buying more exclusively our brands and our brands online. And we see the arrival of new consumers across all age groups, which was not the case in the past where the younger age group was ahead. And now we see really an increase across all ages group. This is a tremendous opportunity and we will stay focused on leveraging this opportunity in the future.

The other thing we are doing is investing in creating better omnichannel capability, which brings you -- bridge to your second part of the question, which is what we see in store. We see that brick-and-mortar stores are and will remain very important. But they will need to be linked more whenever possible in omnichannel ways to the online, the consumer expect the full experience and the brick-and-mortar store will need to become even more experiential to attract the right traffic on top of being omnichannel.

And so we expect brick-and-mortar to be very important, continue being brand building, but we need as we explained in the prepared remarks to rationalize it, because we need to increase productivity. We need to bring back the productivity level that have been diminished by the COVID situation. And bringing back the productivity will make the brick-and-mortar more sustainable for the long-term and we continue to be an essential part of brand building.

[Operator]

The next question will come from the line of Lauren Lieberman with Barclays.

[Lauren Lieberman, Barclays]

I was hoping we could talk a little bit about North America and sort of underlying brand’s performance and takeaway, if you will, there. So I think anything you could share I guess one in terms of brand.com performance and then two, the degree to which existing retail inventory, so retail inventory at department stores, as an example and specialty multi, which are redirected to fulfill online orders, such that maybe the shipment numbers that you're recording don't really give us like a full read of how the brands were actually performing during the quarter? Thanks.

[Fabrizio Freda, President and Chief Executive Officer]

Yes. So, first of all, your first part of the equation in North America our online business has been exceptionally strong, and our brand.com business has been really exceptionally strong. And the penetration of the online business has increased dramatically up to the 40% and so that’s changed. Now a lot of this will be sustainable for the reason I was explaining before. Meaning that retail.com is increasing and there are reason why it would be sustainable, the engagement of the consumers there is increasing.

Our brand.com increase in the 90% is sustainable, because we see it from the consumer engagement for the amount of time people spend on our brand.com just to give you a sense, a few data points that the virtual try on that we have added, or the chat with consultants that we have added, or the entertainment activities that we have added in the story explanation of innovation, all of these brought in some brands, and Estée Lauder as an example. We have consumer that spent 26 minutes of our site interacting with us. So we see real time of interaction, the time of engagement going-up.

So this is -- will make this very sustainable growth over the long-term. And joined with our new technologies will make it probably one of the best consumer experiences overtime in luxury consumer experience, full of experience and our omnichannel capabilities. So that's what's happened now. To be clear, this was in our plans. This was part of our compass. But the COVID-19 has anticipated these trends and the speed of marching of these trends of at least two three years that’s what we have seen.

Now, the impact of COVID-19 outbreak, however, is also expected to disrupt the brick and mortar in the near term, is in fact include the store closure in the parent stores, which are happening obviously in the quarter -- last quarter they were closed. In many, many cases, the closure directed by us will also be added in the future as we explained in the post COVID-19 acceleration program. And then we are conscious of the highest level of unemployment and that is affecting consumer sentiment, in total, in general. And we see also these affecting particularly for the time being the make up category.

We are managing through this, pivoting towards the online business as I explained, supporting also -- supported by our new understand -- granual understanding of consumer and the biggest availability to data that we can drive and in our post-COVID business acceleration program will, however, accelerate the increased productivity in our freestanding store, in our department stores and should work really to rapidly bring productivity back in the future.

Fewer brick and mortar location, which is what's happening there. Now in the short term but also will continue in the medium term will reduce our fixed cost and should have also making the region becoming more profitable with the different mix between online and brick and mortar.

[Tracey Travis]

And the only thing I'll add Lauren is the brand.com business in North America in the fourth quarter was up almost 70%, and represented about 60% of the mix of business. So it was a very strong performer, as you might well imagine and that to Fabrizio’s point was the case really across all of our markets.

[Operator]

Our next question will come from the line of Nik Modi with RBC Capital Markets.

[Nik Modi, RBC Capital Markets]

Just a quick clarification. Can you confirm that online margins are [accretive] to the corporate average level? Just clarification. And then Tracey, Fabrizio, I mean, how do we think about this post COVID plan and kind of what you're targeting for like online as a percentage of the overall 7 point increase is quite dramatic. I'm just curious how you're thinking about the evolution over the 24 month period over this program? Thanks.

[Fabrizio Freda, President and Chief Executive Officer]

I don't know. I can say our online margins are stronger than average. So the development of our online business is accretive to the business that is a fact. And how we are thinking of this? I mean, we are thinking of the continuous growth of the penetration of online in our business. I'm not going to give you a specific number, because there's a lot, has to be written in the future. But as a point of reference, we have today at the level of 40% in the most developed online markets in the world, US, UK, China, and other markets are growing tremendously from a much lower base than these three markets. But in every market, there is a tremendous growth. So the potential is very high. And we will learn more about what this specific landing point could be, but it’s going to be significantly higher than today.

[Tracey Travis]

So we finished the fiscal year ‘20 at at a 22% online mix, as we said in our prepared remarks. And we would expect online penetration to grow from there, even with the strong growth in the fourth quarter, obviously, with a lot of our brick-and-mortar closed during much of the quarter. We do still expect the higher penetration in fiscal '21 of online on top of what we saw in full year on fiscal '20 with a portion of our brick-and-mortar doors closed.

So to Fabrizio's point, the acceleration of online that we are prepared to continue to sustain with all of the programs that we implemented in Q4 and expect to continue along with other capabilities that we're adding in fiscal '21, should continue to sustain a lot of those consumers that perhaps discovered shopping online for the first time, or at least certainly was our record of them for the first time and they continued that practice.

[Operator]

Our next question will come from the line of Mark Astrachan with Stifel.

[Mark Astrachan, Stifel]

I wanted to ask, so your growth in calendar first half '20 was slightly above what estimated market share for prestige look like, at least estimated by one of your larger peers but also then slightly below the growth from that larger peer, which has been somewhat consistent in recent years. I guess, perhaps talk a bit about the dynamics of that and how you anticipate share trends to progress kind of through your fiscal '21, maybe segment geography and kind of what perhaps has driven some of that under performance like you anticipate for the future and kind of maybe, if we're all wrong, kind of looking at that point that out as well. Thank you.

[Fabrizio Freda, President and Chief Executive Officer]

I'm not sure I understood completely the way you frame the question. But basically, we are growing global market share and we are in prestige, our -- the global market leader. And the total market share is growing and is growing ahead of our competition in general a global level, because we are focusing on the area of fastest growth and most importantly, we are focusing on the areas of profitable, sustainable long-term growth. And because of this, the total is growth.

Now there are areas of the business where because of our historical business model, we are losing market share. In some cases also, we're losing more market share than some of our competitors and those are -- this is specific to the U.S., for example, is an example of this. But there are areas like China, travel retail, Asia, in general, where we are growing and we are growing very fast. So our strategy is not to add our multiple engines of growth to grow all at the same time at any cost. We are trying to put the resources. We have located resources, where there is the highest sustainability and better returns. And in that sense, we really look at the key measure of the global market share. And so that’s answer part of your question.

The other part of the equation, how we see this market share develop by quarter. As we explained in our prepared remarks, we see really a gradual improvement of our business quarter-by-quarter during fiscal year '21. We explained, which is our view of the first quarter, the second quarter will be better and the last semester will be really strong. And that's our view of the recovery and this is a reflection of the way the stores will reopen, COVID will hopefully be managed around the world and the market, particularly the consumer sentiment in different part of the world will be reestablished.

Where the consumer sentiment is reestablished? Where COVID has allowed the reopening in most of the channels like China, we are seeing tremendous business and tremendous share gain. So is also in the area of consumption in market share was the core of your question. We see a gradual acceleration and recovery over the years in the fourth quarter of fiscal year 2021. Tracey, maybe you want to add some perspective.

[Tracey Travis]

No. And obviously, we have not provided guidance for the year for obvious reasons, as we don't know how the recovery will progress or COVID-19 will impact global markets for the fiscal year. But as we think about the second half of the year, because I know we tried to provide you with as much as we were comfortable providing as it relates to the guidance. But if you think about the second half of the year comparable, assuming that there is a gradual recovery and there's no other shock to the system, very comparable to our fiscal 2019 EPS performance. So stronger sales growth, but comparable to our fiscal '19 EPS growth. And that's with obviously the tax rate and the interest expense call outs that I made.

[Operator]

Our next question will come from the line of Wendy Nicholson with Citi.

[Wendy Nicholson, Citi]

The first question is on the stores that you will keep open. Can you give us some sense of what that footprint will look like maybe by brand and by geography. And I know those stores, even though they’ve been, the ones that you're closing, they may have been unproductive, but they still have served as great ways to build customer relationships. And they're great branding vehicles and all that kind of good stuff. So how much of the savings from closing those stores do you intend to drop to the bottom line versus reinvest to offset the benefit of that branding presence, if you will, that you had historically? Thank you.

[Fabrizio Freda, President and Chief Executive Officer]

Let me start and then Tracey may add some. First of all, we are doing what the consumers are telling us they want. So we are following the consumer preferences evolution. And second, we are responding to the decisions of our retail partners, because to be clear there are retailers which are using the number of stores, there are retailers which are closing. And so first of all, we need to reflect what is the reality of the market. Second, we need to reflect what the consumer preferences are. And these will result in closing the stores, which are the least productive.

And so the stores that will remain, which is obviously the large majority, these stores would be more productive and will allow us to make these store experiential and in the appropriate cases also multichannel. And these will make these stores not only sustainable for the long-term but will make these stores brand building. While the non-productive stores, which are not working and there is no traffic, frankly, are losing their power of being branded business. But the large majority of the remaining brick and mortar will remain -- will be more productive and will be a fantastic brand building tool that will continue to create the relationships that we have experienced.

But the unproductive stores of the world are frankly not very productive relationship to date. And on the contrary, the online, new way to work and particularly the new way of the consumer to engage online, is becoming much more relationship building, much more brand building than ever before. And I think if I had to summarize what is in my opinion the biggest change of COVID-19 that made all the online channel, brand.com, platforms, pure plays, retailer.com, much more brand engaging and so much more fully luxury experiences, thanks to technology than ever before.

And so to last part of your question, the savings from these productivity improvement in brick and mortar will be in fact obviously, going to the bottom line but in fact will be invested and will be invested in making the remaining brick-and-mortar store and our online much more brand building, growing faster and continue to create outstanding relationship with our consumers. Now to underestimate the fact that a lot of the strong online growth is in brand.com and platforms. So where we have the data access will also give us much more information, data insights, to manage the consumers and the business better in the future.

[Tracey Travis]

And the only thing I'll add to that is most of our stores are profitable. We have had a portion of our stores as you have heard us talk about the mix shift we've experienced over the last few years. Some of our stores became more marginally profitable and obviously, COVID-19 accelerated some of them into a loss. As we think about recovery and what to expect in terms of brick-and-mortar recovery, those are stores that now we believe need to close. And as you all know, the deleverage related to some of the fixed costs of freestanding stores when they are not productive is burdensome. And certainly prevents us from being able to invest behind recruiting new consumers from a digital marketing perspective.

So those are the stores that we will be taking action on. They were -- on that marginal bubble to begin with and certainly has become loss making now that and we don't expect them to recover from loss making. As it relates to our mix of stores you can imagine as well, clearly, in the more mature markets, like North America and Europe, those are where the bulk of the stores are that we will be addressing. And with the challenges in the makeup category, a number of them are in the makeup area. But they're not just makeup, they do comprise some other locations as well, where mall productivity has declined and/or street productivity has declined but some are freestanding stores.

[Operator]

Our next question comes from the line of Steve Powers with Deutsche Bank.

[Steve Powers, Deutsche Bank]

So I guess as we met all of that together and fast forward to when your sales do recover to pre-COVID levels. Is it your expectation standing here today that the resulting profitability in margin against those sales will be higher than before just given the productivity and restructuring efforts, and the mix shifts that we're talking about the online and skincare? Or are there reasons to believe that that maybe delayed, given the growth reinvestments you just spoke about and maybe some residual weakness in higher margin channels like travel? I guess, little bit more color as to how you're thinking about all that?

[Tracey Travis]

So and obviously margin, we don't expect will recover this year. And certainly with the actions that we're taking, we would hope that we could recover back to fiscal ‘19 margins by next fiscal year. But that is just the pattern as we believe in fiscal ‘22 again, all things going smoothly, which has not been the case for last several years. But that in fiscal ‘22 assuming a normal year, we will be back to the margins that we had pre-COVID and would progress from there, as Fabrizio indicated in his prepared remarks, to back to our 6% to 8% top line growth and 50 basis points of margin expansion.

[Operator]

Our next question will come from the line of Rupesh Parikh with Oppenheimer.

[Rupesh Parikh, Oppenheimer]

So on the makeup category, I was curious just to get your perspective in terms of how you guys think the makeup recovery could take place from here? And then also, I guess related to that question. I know obsolescence related to makeup was a big headwind on the gross margin line in Q4. So I was just curious whether that headwind would continue into this fiscal year? Thank you.

[Tracey Travis]

So I'll answer the second portion of that question. We clearly adjusted our demand plans and our forecast to be more in line with the trends that we're seeing in makeup this year, even in the recovery. One of the things that we have seen during COVID-19, there has been even an acceleration from a penetration standpoint of interest in skincare and we certainly expect that to continue next year.

We have some great innovation programs behind our makeup brands as well. But we are adjusting our forecast to the level of consumption we expect coming out of fiscal ‘20 and the ramp up through fiscal fiscal ‘21. So we certainly don't expect to see the same level of obsolescence unless there is another complete shutdown of business, we don't expect to see the same level of obsolescence in fiscal ‘21. And then Fabrizio?

[Fabrizio Freda, President and Chief Executive Officer]

And to the question of when makeup recover. Absolutely, makeup is a category, is coming back. This is -- what we are seeing is the impact of what COVID has created on the consumer sentiment or consumer behaviors, is the result of wearing masks in many parts of the world, which has an impact of lipstick, the result of being in homes and having less interaction and less social interaction between people. And there is also frankly the stress that causes and the situation today in many parts of the world is creating that is conducive, it’d be less to the use of makeup that again is part of the joyful moments and individual moments, more than anything else.

And so we expect this to come back, and to come back now, this is now into point of views. From my point of view, the makeup cycle will come back very strongly as soon as consumer sentiment will be back and obviously will be back in the future. We'll see this category booming again and we'll be ready for that. That's exactly the essence of the multiple engines of growth that in this moment is skincare, and there is reason why is skincare. Somebody was asking me if the lipstick index is finished. You all remember the lipstick index concept was that beauty is a resilient category, both in situation of crisis like this one and in particular situation of recession risk, because they are affordable purchases for indulging and taking care of yourself. And consumer really love their routines.

Now this has remain exactly true also in this crisis. What has changed is the category, because of COVID is, lipstick was not the right category to indicate that but the resiliency of the overall beauty is still evident and is still vary from market. But the way I answer is the lipstick index has been substituted by the most rising index but the concept of index is still there. This is a very resilient category and makeup will come back when consumer sentiment will come back.

[Operator]

The next question will come from the line of Steph Wissink with Jefferies.

[Steph Wissink, Jefferies]

Our question relates to trial and discovery. I think, Tracey, you mentioned you have some new launches planned and also, Fabrizio, you talked about some of the emerging technologies, live streaming, virtual try-on that you're using in your online business. Can you talk a little bit about how you think about trial and discovery going forward, whether it's makeup or skincare, and then also just intertwining your comments on data, customer data and data access? Thank you.

[Fabrizio Freda, President and Chief Executive Officer]

First of all, trial and discovery is going very well. And what is evolving and continue to be very strong is obviously trial and discovery in store is always has always been the key point, and what is evolving in trial and discovery online. And the way this is happening is, first of all, we see and I said this before, we see consumer spending much more time. So the level of engagement, the level of relationship with our online sites is increasing. They spend time and they spend time to discover.

Now in terms of trial, we are making a very big new investments in sampling online. So you will go and buy online, for example, now at brand.com, your preferred hero products and then you will receive the samples of what our data suggests that you may like around that when you open your pack at home. And in this way, we see how we are driving trial.

We are driving discovery, frankly, stronger than what we've ever been able to do in stores, because the ability to know what people will like based on data together with the ability to interact with people with more time in the online relationship, and to shift to their home, their main purchases allow us to make them try a discover, everything else is just a matter of the techniques that we choose. So this is the moment where I believe trial and discovery can be further enhanced in the luxury business model that we are developing for our future.

[Operator]

The next question will come from Michael Binetti with Credit Suisse.

[Michael Binetti, Credit Suisse]

I would rather ask you a long-term question, but I want you to clarify one thing that Tracey mentioned. Tracey, I think you said the second half of the year earnings performance will be the same as fiscal second half of '19. And then I think later you said EPS growth would be comparable to fiscal '19. Maybe you could clarify that as I just look back at the model you did about $2.09 in EPS in the second half of '19? I think everybody is probably going to hook models to that comment. So it would help to get a little clarification there.

And then I guess, and I do hate to be near term, but it seems like in the first quarter guidance bakes in about 800 basis points of an operating margin contraction. I think you said the gross margin should start to improve. And obviously, with the factories open, you'll see less of the accounting drag there from idle factory overhead accruals. I know, the stores are reopening but the SG&A was down by $0.5 billion in the fourth quarter. It seems like it should still be meaningfully lower year-over-year, even if retail starts to come back online. So I just want to make sure I understand where the pressure is on the margin might be in the first quarter related to what you guided?

[Tracey Travis]

So let me start with -- again, reiterating the fact we are not giving guidance. So as we try to help you frame the your model for the year, given the fact we're not giving guidance. One of the things to think about as we believe that the second half of the year, we will still be recovering our sales growth but will be more normalized assuming no additional impacts from COVID-19. The way you could think about our second half EPS is similar to our adjusted fiscal '19 EPS in the second half. Again, with the ramp up and acceleration in sales that we expect to see. So that is a way to kind of think about the second half. But again, that depends obviously on a continuation of progress as it relates to the recovery.

As it relates to the first quarter, what we said in our prepared remarks is we do expect gross margin to recover. And so when you think about the margin for Q1, one of the things we are doing is investing in advertising. So even with sales down in the quarter, we have a launch of our -- one of our most popular products, Advanced Night Repair and that is, we are supporting with digital advertising, some of the online initiatives as well. We are supporting with additional advertising and other innovation as well. So that is a piece of what's driving some margin deleverage in the first quarter.

The other piece is higher shipping costs. So we are still catching up a bit from our plants starting up more slowly as it relates to social distancing, but now ramped up but really catching up on some of the shipping to replenish some of the product that was low on inventory in certain markets. So that is driving a piece of the margin. And then when you think about EPS, we obviously have higher net interest expense. So we have higher interest expense and we have lower interest income, given where rates are today. So the combination of that is also putting some pressure on our EPS in the first quarter. And then the last piece obviously, as I did quote the tax rate, which would be the tax rate we expect to see in the first quarter as well.

[Operator]

Our next question will come from the line of Andrea Teixeira with JPMorgan.

[Andrea Teixeira, JPMorgan]

Fabrizio, Tracey, can you help me understand the travel retail performance embedded in the first quarter guidance, now that you have more than half of your quarter through? And just a clarification on those puts and takes that Tracey you just described for the first quarter. So basically, your team is through a lot of the pressures that we saw in the quarter. So if you can help us understand the exit rates on some of these expenses that would great, but the travel would be my first -- my main question?

[Tracey Travis]

So, I'll start and then let Fabrizio share his perspective on travel retail. There are still travel restrictions. So travel retail is still largely closed in the first quarter. And again, we expect travel retail really to be the slowest to recover. Now again, we are seeing traffic locally in Asia, in particular in China and so that is continuing to pick up. And as Fabrizio addressed some event in his prepared remarks, but we do expect that travel retail will be the slowest to recover.

As it relates, again, to the to the first quarter. Relative to the fourth quarter, I guess we'll all add to what I’ve said just previously. We did have some furlough programs in the fourth quarter that also are not repeating in the first quarter. So that is another piece of why the expenses, if you're comparing the fourth quarter to the first quarter, might look a bit higher. So it's the advertising, it's the shipping cost. And we do have some of the furlough programs that we had in the fourth quarter that will not be repeating. Probably for -- when you look at the quarter, and more comparable quarter would be the third quarter of last year relative to our first quarter this year in terms of overall performance.

[Fabrizio Freda, President and Chief Executive Officer]

And what I will add on travel retail is that, first of all, in the long-term, we believe travel retail will continue to be a very exciting channel. And in this moment, the traffic is at very low. But for example, the conversion of travelers into buyers is increasing dramatically. The Asia is the biggest path to a travel retail globally. And the good news that Asia is going to recover faster than the West, the traveling traffic and the conversion driven by retail. So basically by travel retail online in Asia even stronger saying the rest of the world. So the good news that will overtime mitigate the current lack of traffic in travel retail is that the recovery is starting from Asia, Asia is the biggest and the most interesting travel retail segment.

The other important thing to say in travel retail is that in this moment, the number of travel retail also in the last quarter and minus 30% has been better than at least we were afraid of, because of the many closures around the world. And the reason why it's been better, there are some mitigating factors, which are very important. The most important mitigating factor is that -- has been the start of China local internal travel that in many cases is beautifully traveled, like in the Hainan Island And the extraordinary increase of what the Chinese are buying within their local duty free travel is mitigating the lack of very limited international travel.

But then you can expect for the long-term when the international travel will be reinstated, these local internal travel will not go away. And so there will be a stronger and even more exciting long term travel retail market to manage in which we are today the market leader. And so there is a lot of long term potential into that and I'm very exciting to see what's happening in Hainan, particularly for the future.

[Tracey Travis]

And the only thing I will add in terms of quarter four versus quarter one, obviously, being down 30% in sales in Q4 and progressing to down 11% to 12% in Q1. We are seeing obviously a pick up in our brick and mortar business. And so in July in fact, as Fabrizio indicated, we actually had positive sales growth. And that was related to some of the restocking that we saw in the trade for doors that had been closed and are now reopening. So we are seeing positive signs that we will expect to continue to see throughout the first half, even as brick and mortar recovers more slowly than obviously the strength we're seeing continue in online.

[Operator]

And we have time for one more question. The final question comes from the line of Olivia Tong with Bank of America.

[Olivia Tong, Bank of America]

First, just a follow-up. Did you just say that July was positive overall or specific to a channel? And then just generally speaking, I wanted to ask about the balance between containing costs and supporting the top line, because it's clear that your investments resonated in the top line in the last couple of years pre-pandemic. So as we think about the timing of you getting back on your long term algorithm clearly with a focus on efficiency. Can you talk about how the organization plans to balance achieving both of those things concurrently? Thanks.

[Tracey Travis]

So my comment on July was global and it was sales growth. And a lot of that being driven from North America actually in terms of some of the restocking within North America, and still seeing growth obviously in markets like China and Korea, the same markets that had momentum in the fourth quarter or more momentum. But every market is improving a bit as doors reopen and we start to see traffic flow back to stores. But July really was restocking from many of our retailers that had their doors closed, and we're sourcing some of their online sales from their brick and mortar doors.

[Fabrizio Freda, President and Chief Executive Officer]

In terms of -- so yes, July was positive to the company. But to speak about your second part of the question is the focus on the top line, and we intent to remain a high growth company. So we are really focused on growth but we are focused on profitable growth. And in the short term, we are -- we’ll remain focused cost containment to make sure that we preserve the resources to invest in growth. So the cost containment in our program is never shorter, is always designed to preserve and reallocate resources for investment in long term growth and obviously, to drive profitability at the right level.

So that's the way we think about it. And in our compass and our strategic process are very focused in identifying the key areas of growth and the key areas of sustainable profitable growth, and to invest in them over proportionally, and to continuously reallocate resources in these areas, that's what we're talking. And also our refractory program is also designed to give us the flexibility to continue doing that also in the COVID situation despite that we are paying a lot of attention to mitigate the short-term impact of lack of sales with a lot of good action of cost containment. We are really focused on recovery, that’s the key point, is recovery of our top-line that overtime gradually will bring back our profitability and our ability to continue to deliver the kind of EPS and double digit EPS growth that we want want to deliver in the long-term.

I'd also would like to close, if this is last question, saying in this COVID crisis, as we try to in every crisis, I truly believe, we are coming out as a better company. And yes, we're focused on the profitability side. This company can go back to being high growth and being high growth with strong profitability, but also is a better company in inclusion, in sustainability, in technology. And all of these together will make us also better employer and stronger loyalty, both of employees and of Europe. And I think that's very important value for the company we are, which our company -- very long-term focus. And I think this crisis has been managing in a way where we remain as long-term focused company and we’ll remain a better company, we’ll be a better company.

[Operator]

And that concludes today's question-and-answer session. If you were unable to join for the entire call, a play back will be available at 1:00 PM Eastern Time today through September 3rd. To hear a recording of the call, please call 855-859-2056, passcode 4170137. 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.