EL - NYSE

Good day everyone and welcome to The Estée Lauder Companies' Fiscal 2025 Third Quarter Conference Call. Today's webcast is being recorded. For opening remarks and introductions, I would like to turn the call over to the Senior Vice President of Investor Relations, Ms. Rainey Mancini.

Thank you, Stéphane, and hello, everyone. Thank you for joining us today. We remain focused on long-term value creation and are determined to better position the company for sustainable long-term growth, margin improvement, and cash productivity. Encouragingly, we are starting to see progress on Beauty Reimagined priorities, reflected in the share gains in some key markets, gross margin expansion, CapEx optimization, and the execution on a PRGP restructuring program to become a leaner and more agile company. Looking at our third quarter results. Organic net sales declined 9% and was within the outlook range we gave in February. We delivered $0.65 EPS, exceeding our outlook and operating margin was 11.4%. Now, let me take a few moments to highlight the progress we have made across key areas, and then I'll walk you through our full year outlook. For results by product category and geographic region, please see a press release issued this morning. On the top line, we are encouraged by the share gains we saw in the U.S., China, and Japan this quarter, and we are committed to doing this more sustainably and broadly in more markets around the world. On margins, for the quarter, we again expanded our gross margin by 310 basis points compared to last year. This reflects net benefits from our PRGP and was driven by operational efficiencies, the reduction in excess, and obsolescence and benefits from our strategic pricing actions. Over the course of the fiscal year, we have pulled down production in response to a decline in sales volume. As a result, we triggered a requirement this quarter to recognize certain manufacturing costs in period rather than deferring them until the products are sold. You may recall that we took a similar in-period charge in Q3 of last year. The charge recognized last year was greater than the one we recognized this year, resulting in a year-over-year net favorable impact of 140 basis points. Moving to operating expenses. OpEx increased 580 basis points as a percent of sales during the quarter. This reflects continued investments to fuel growth in key areas of the business. This resulted in a 480 basis points increase in consumer-facing investments. With PRGP, we also made progress to reduce non-consumer-facing costs year-on-year, but this increased as a percent of sales due to our sales deleverage. Operating income decreased 27% to $403 million, our operating margin contracted 270 basis points to 11.4% compared to 14.1% last year. Our effective tax rate for the quarter was 30.8%, up from 30.5% last year. Diluted EPS declined to $0.65 or 33% from $0.97. Proceeding now to our PRGP restructuring program. As of March 31st, we have recorded $498 million of cumulative charges under the program, primarily in employee-related costs. On the overall PRGP, we are executing with excellence and are making solid progress on initiatives that targeted pressure points in our business. The plan's net benefits drove gross margin expansion every quarter. We are building momentum and driving progress to reduce non-consumer-facing costs through OpEx efficiencies and our restructuring program. And given the heightened macro and geopolitical volatility, we are exploring additional PRGP savings to help mitigate some potential risks. Moving now to our cash generation. For the nine months, we generated $671 million in net cash flow from operating activities compared to $1.471 billion last year. This decrease is due to the decrease in earnings adjusted for non-cash items, greater restructuring payments and an unfavorable change in operating assets and liabilities. This includes the fact that last year, we made a very significant year-on-year reduction in our inventory, which drove very strong CFFO in the base period. We invested $395 million in capital expenditures, down 44% compared to last year. The reduction was primarily driven by the prior year payments relating to the manufacturing facility in Japan. It also reflects a very strong focus on optimizing capital expenditures this year as we are determined to improve our free cash flow. Before I turn to outlook, let me first address uncertainty around evolving trade policies and tariffs that is adding volatility to an already complex global landscape. As you know, we have been investing in the regionalization of our supply chain for the last several years and we are using this new flexibility to help mitigate some of the impacts of the higher tariffs. To provide some context on our exposure. About 75% of what we sell in the U.S. is either sourced from our manufacturing plants in the U.S. and Canada or covered under existing trade agreements. Roughly 25% of what we sell in China is currently sourced from our manufacturing plants in the U.S., but we have strategies to potentially reduce that to below 10% including leveraging products made in our manufacturing plants in both Japan and Europe. Similarly, in EMEA, about a quarter is sourced from our manufacturing plants in the U.S. As Stéphane mentioned, our task force is closely tracking developments and evaluating a range of scenarios to help mitigate some of the impact of tariffs. Scenarios include optimizing a regionalized and third-party manufacturing networks, leveraging available trade programs, and executing further mitigation strategies over the next 12 months, including expanding our local sourcing. Based on what we know today and given our deferral period for certain manufacturing costs, we do not expect a material impact to fiscal 2025 profitability. However, unless meaningful resolution of trade negotiations is achieved, we do anticipate the high rate of tariffs to have a material impact in fiscal 2026. We are also exploring additional PRGP savings and strategic pricing to help further mitigate some of these impacts. We are working to give you a comprehensive update on our tariff mitigation plans during our August earnings call. Given that context, let me walk you through our specific outlook for the full year. We want to acknowledge the risks associated with the geopolitical landscape. Specifically tariffs and the uncertainty of their impact on consumer sentiment. If conditions worsen, particularly regarding Chinese consumer sentiment and the potential pressure on sales during the 6/18 midyear shopping festival, the negative impact on our financial performance could exceed what we have factored into our current assumptions. In that case, achieving the outlook we are providing today may not be possible. In February, we indicated that growth in our Travel Retail business would decline strong double-digits in the second half of the fiscal year. And that we would maintain appropriate trade inventory levels. Retail softness has persisted since then, and we expect a steeper decline in net sales in the fourth quarter compared to the 28% we saw in the third. However, despite this pressure, we continue to align shipments with demand and still expect to end the year at appropriate inventory levels. Our assumptions for the full year are total organic net sales to decrease in the range between 9% to 8% compared to last year. This reflects the continued softness in our global travel retail business, as well as ongoing pressure in Asia-Pacific, despite the recent improvements we saw in our Mainland China third quarter results. Currency translation is not expected to materially impact reported net sales. Gross margin of approximately 73.5%, an effective tax rate of 38% compared to 31% last year, and EPS of $1.30 on to $1.55. Currency translation is expected to dilute EPS by $0.03. In closing, we are proud of the meaningful progress we are making in executing our strategic priorities and remain confident in our Beauty Reimagined vision to restore sustainable sales growth and to achieve a solid double-digit adjusted operating margin over the next few years. To our talented employees around the world, thank you for your leadership and dedication. Together, we are better positioned to become the best consumer-centric company and a leaner, more agile business. That concludes our prepared remarks. I'll now turn it over to the operator to begin the Q&A session.

The floor is now open for questions. [Operator Instructions] Our first question today comes from Steve Powers with Deutsche Bank. Please go ahead.

Good morning Stéphane. I think this question is probably targeted for Akhil, but maybe for both of you. Just picking up on the commentary late in your comments that you were targeting trade inventories exiting fiscal 2025 to more or less aligned with consumer takeaway. That's obviously been an ongoing project, and it's become increasingly difficult. So, can you talk about whether you expect that to be true kind of across all categories and geographies or whether you see outliers? And then also kind of frame the risks around that outlook. You mentioned the June, the 6/18 variable, but just in general, your level of confidence that you can actually achieve that alignment exiting the fiscal year? Thank you.

Very good. Thank you, both. Appreciate it.

And your next question comes from Bonnie Herzog with Goldman Sachs. Please go ahead.

And your next question comes from Lauren Lieberman with Barclays. Please go ahead.

And your next question comes from Filippo Falorni with Citi. Please go ahead.

Yes, thank you, Stéphane. So Filippo, hello there. And two things, right? We are really leveraging this to fuel Beauty Reimagined, which is the growth agenda and solid double-digit margin. So, we are really thinking all of those things in those terms. Gross margin, we have already seen progress, and we believe there is more room to go there and that's our goal. Based on the zero waste that Stéphane talked about and what we have already demonstrated this year. Then, of course, the next big area is everything else other than COGS, which is OpEx, which you can do the math that if we are at about 8% [ph] margin with 73% gross margin, we do have a significant amount of OpEx where the optimization is being worked on. The reason you are not seeing enough movement there because even though we are dropping the dollars year-on-year, we are seeing sales deleverage. And as Stéphane pointed out, that as we return to growth, barring some of the tariff context we talked, we should start to see with dollars already dropping on those OpEx, a significant movement on OpEx margins. So, with the program touching all the way from discounts, just as a reminder, on the sales, gross margin and operational excellence, which we are driving, which you have seen the results. And all employee cost, we had we had doubled the restructuring. So, communicated extra restructuring of benefits of $350 million to $500 million when we communicated to you last time and significant work on procurement for non-employee costs. So between all of that, we are committed to our solid double-digit margin progression. And as you can see, there is room in both in gross margin and OpEx. And with a little bit of sales growth that we see, we should start to see this work translate into -- in that direction in a very meaningful way.

And your next question comes from Peter Grom with UBS. Please go ahead.

Yes. Absolutely. So, hi there Peter. So, overall, just to start from the top, right? Markets are growing ex-TR, our retail is growing ex-TR, and we are starting to grow share. So, that augurs well for the top line that Stéphane talked about. And we are definitely basing some of the last periods of very difficult or comparatives. From a tariff perspective, of course, the biggest watch out is for everybody. It's not -- we are not unique in that. It's consumer sentiment, consumer sentiment in U.S., consumer sentiment in China, which is hard to predict. But what we are seeing is that our brands are continuing to be very strong. They are some of the most desirable brands in both -- in China and around the world. So, we feel good in terms of -- and frankly, the talk has been more positive and more constructive even on the tariff area and those negotiations. So that gives us confidence. On cost side of tariffs, at these high rates for any company doing any cross-border business, the impacts are not going to be small, and we did say in our prepared comments that they can be material. However, we are looking are looking at three big things, and I'll just -- I think it's important to reiterate what Stéphane just said. We at, one, making sure that the flow of goods is in the most least tariff lanes, and we have the capability to do that. Second, we are looking at pricing opportunities. We do have opportunities there. And while being very surgical and keeping consumer confidence in mind, we will take action on that, but we will do that if it's necessary. And that's not counted yet. Thirdly, we are looking at more PRGP opportunities as well as because as we have executed well so far on -- this is a new muscle organization has built and Stéphane is driving this across the whole company internally and externally with other partners. So, we see more opportunities to do things there. as we build this new muscle which we have really progressed on in last year. So, those would be some of the things we are looking at and some guardrails around how we will navigate.

And your next question comes from Dara Mohsenian with Morgan Stanley. Please go ahead.

We have time for one more question, and it will come from Bryan Spillane with Bank of America. Please go ahead.

Thank you, Bryan. That's a great question, and Stéphane really covered it well. I wanted to give you just a few points to close it out. We -- Stéphane and I, as we are as we are making -- meeting our people around the world, we are very clear. It's growth, margin, cash and growth being a very large part of the driver of TSR. I think if you look under the hood, we explained today, are starting to see already the green shoots of growth. Our business in China grew. We starting to see share growth in in places where we haven't seen share growth. So, we are starting to already tap into what's possible terms of growing the company, which is why it gives us the confidence that barring the things we talked about external, we are poised to grow. Secondly, from the cost standpoint, our work has been massive. We outexecuted the PRGP program we put for ourselves. It's, of course, not visible because of some of the deleverage we saw in travel retail this year, but a of lot that is getting cycled out. Thirdly, Stéphane is fundamentally changing how we work. If you walk the hallways of a company and you look across and especially the announcement on very clear delineation between brand, region, and functions, that frees up resources because the way we work. So, there is opportunity to drive margins and fuel the business, but be very effective in this new way of speed, agility and clear empowerment and accountability. And then thirdly, as we work to find the best processes with our external partners that we are discussing and Stéphane shared that on shared services, et cetera. there is a significant opportunity to improve our work in processes. So, there is opportunity on the cost side, and we are starting to see growth come through and our hierarchy of value creation is very clear, it's gross, margin, cash. So, you will see us invest without any apology when the idea is right and drive that ROI. So, hopefully, that gives you the clarity on the playbook we are following.