Good day, everyone and welcome to The Estée Lauder Company's Fiscal 2021 Third Quarter Conference Call. Today's call is being recorded and webcast. For opening remarks and introductions, I'd like to turn the call over to Senior Vice President of Investor Relations, Ms. Rainey Mancini. Please go ahead..

Hello. On today's call are Fabrizio Freda, President and Chief Executive Officer and Tracey Travis, Executive Vice President and Chief Financial Officer.

Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC, where you'll find factors that could cause actual results to differ materially from these forward-looking statements.

To facilitate the discussion of our underlying business, the commentary on our financial results and expectations is before restructuring and other charges and adjustments disclosed in our press release. Unless otherwise stated, all net sales growth numbers are in constant currency and all organic results exclude the impacts of acquisitions.

You can find reconciliations between GAAP and non-GAAP measures in our press release and on the Investors section of our website. As a reminder, references to online sales include sales we make directly to our consumers through our Brand.com site and through third-party platforms.

It also includes 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 we can respond to all of you within the time scheduled for this call. And now I'll turn the call over to Fabrizio..

Thank you, Rainey and hello, everyone. It's a pleasure to speak with you today. And I hope that you and your families are in good health. Our hearts are with those impacted by COVID-19, particularly in places like India and Brazil, that are experiencing severe resurgences.

We remain committed to doing what we can to support our employees and these communities. Our third quarter of the fiscal year 2021 marks the continuation of strong sequential sales growth improvements, despite the ongoing challenges from the pandemic.

We exceeded our sales and earnings growth expectation, even as several markets experienced increasing COVID-19 pressure throughout the quarter. Our multiple engines of growth strategy drove our success, empowered by the exceptional creativity and passion of our employees. We achieved these outstanding results while acting on our values.

First and foremost, we continued to invest in employees and consumer safety and well being during the health crisis.

We expanded our work for the environment from setting innovative new sustainability goals in travel retail to seeing a wind farm in Oklahoma became fully operational, which is our largest renewable energy concept to date, and a project we were proud to support.

We made progress on our racial equity commitments, and also outlined a new set of commitments for women advanced in gender equality, inclusive of achieving gender pay equity and globally increased representation of women from underrepresented groups.

In March, we launched our new Equity and Engagement Center of Excellence, to drive greater equity representation within our business and across the value chain.

We also launched the partnership with Howard University to support the success of its alumnae to our experiential learning, career coaching, professional training, and mentorship opportunities. While there was joy in this progress, there was also sorrow.

We stood with our employees, consumers and partners in denouncing the rise in acts of violence, hate and discrimination against the Asia and Pacific Islander community, and committed to donate to organizations that support justice and equal treatment from Asian community in the United States.

We keep our employees and communities top of mind through these challenging times. With that as our guiding principle, let me turn back to financial results. Constant currency sales rose 13%, representing a substantial acceleration of organic sales growth improvement.

We delivered strong performance despite increased COVID-19 hardship in Western Europe, Latin America and parts of North America during the quarter. Estée Lauder, La Mer, Jo Malone London, Clinique and Tone for Beauty lead the impressive performance of many brands.

Skin care and fragrance once again delivered superior sales growth, although they had the toughest comparison to the year-ago period.

In fact, our skin care category was nearly 30% larger on a reported basis this quarter than it was 2 years ago, owing to innovation in our powerful Hero franchises, strength across multiple subcategories and the addition of Dr Jart, but before the future inclusion updation.

In our fragrance category, it was 16% bigger than it was in fiscal year 2019 on a reported basis, driven by our strategic focus on the luxury and our seasonal segments. Both of these categories now have even greater scale to capture prestige beauty share as the recovery unfolds.

In the third quarter of fiscal year 2021, we focused our investment decisions on engines of growth and employed cost discipline in other areas, resulting in a near doubling of adjusted diluted earnings per share versus the prior year period.

While the complexities of the pandemic are ever present, adjusted operating margin nonetheless exceeded that of the third quarter of fiscal year '19. And adjusted diluted earnings per share was 5% higher. Throughout the pandemic, we have been steadfast in our commitment to the long-term, as we successfully navigate the short-term.

We continue to strategically invest to drive sustainable growth, including building an end-to-end Innovation Center in Shanghai, and state-of-the-art manufacturing facility near Tokyo. These are expected to open in calendar year 2022.

More recently, several of our brands decided to participate in the new partnership of Sephora with Kohl's recalls and Ulta beauty with Target, beginning in the second half of this calendar year. This new consumer coverage represents the promising evolution of the retail landscape both in store and online in the United States for prestige beauty.

We also agreed to increase our ownership in DECIEM, becoming majority investors with the path to full ownership in 3 years. DECIEM with its fast growing brand, the ordinary and new brands incubation capability aligns well with our multiple engines of growth strategy.

The ordinary further #diversifies our skin care growth engine by consumer segments, price point and geography with a superior online business. The brand has redefined entry prestige with an increased ingredient focused regimen based product portfolio that drives basket size.

The Ordinary has quickly established itself as a top 5 skin care brand in the U.S prestige beauty having improved its rank significantly over the last year. Sustainability is integral to DECIEM equity, products and retail practices, which will announce our sustainability brand portfolio and fuel the achievement of our ESG strategy and goals.

We look forward to continue the exciting journey with Nicola Kilner and her incredibly talented team to realize DECIEM global opportunity. In the third quarter, the Estée Lauder brands delivered stellar results led by strong double-digit growth in skin care, sequentially improving trends in makeup and the return to growth in fragrance.

The brand is driving a renewal in the skinification on makeup trend with a significant growth of its Futurist franchise and its new Beautiful Magnolia fragrance is off to a very promising start. The Estée Lauder skin care franchises performed exceptionally well led by Advanced Night Repair and its recently reformulated namesake serum.

Revitalizing Supreme also was a standout as the launch of Supreme Bright, proved highly sought. Supreme Bright is an amazing story of east to west success. With the product born in the brightening trend in Asia, and realizing global appeals for its uneven skin tone benefits.

Re-Nutriv, new eye serum surged and created a halo effect for the franchise phase in eye creams. La Mer performance was once again outstanding. The brand's worldwide success is multifaceted from both loyal and new consumers and with increase in demand from men who now represent more than 15% of sales in mainland China.

La Mer's iconic product, rich storytelling, and ideal merchandising, aligned to deliver the successful journey to renewal campaign for Chinese New Year as well the brand executed a superb global campaign focused on moisturizers.

The new Genaissance de La Mer, the concentrated night balm continue to spark consumer desires elevating the brand ultra luxury franchise. Clinique sales growth accelerated sequentially and rose in every region driven by its skin care portfolio.

From consumers' excellent response to the new Moisture Surge in the United States to even better Clinique interrupter fueling substantial growth in mainland China to in-demand Hero franchises like Dramatically Different Moisturizing, Clinique prospered.

Our luxury and our seasonal fragrances realized significant growth in the Americas and Asia Pacific. Like skin care, fragrance offer a means to express self care and that showed through the emotional comfort of scent. We are seeing strong repeat from the emerging category in Asia Pacific. While we continue to welcome new consumers in the region.

This trends in fragrance is driven by our strategic shift to the higher end is favorable to margin announcement in the category. Jo Malone London, Tom Ford Beauty, Kilian Paris, Le Labo and Frédéric Malle each grew double digits.

Innovation and Hero products work in harmony to fulfill consumer desires with newness from Jo Malone London and Tom Ford Beauty incredibly well received. Kilian Paris, virtual selling, which engaged founder Kilian Hennessy, influencers, and education ambassadors through live chat and shoppable live streams contributed to superb online growth.

Each region grew this quarter, led by Asia Pacific, which saw sales rise in every category and many countries contributed. Mainland China was exceptional, delivering sequentially accelerated double-digit sales growth with skin care and fragrance performing ahead of the previous quarter and makeup returning to growth at double digits.

Both brick-and-mortar and online thrived, driven by the strong equity of our brands, desirable innovation, high quality product leading to repeat purchase, competitive investment in advertising and investment in local talent and capabilities.

For the Chinese New Year, we met the consumer where she or he chose to shop, serving the local consumer as well, the travelling consumer in Hainan, both in-store and retail to tremendous success. Online continue to be a powerful growth engine. As global sales increased strong double digits in every region.

Sales of brand.com, third-party platforms and retail.com rose strong double digits, while sales of pure play grew triple-digit as we are building our consumer coverage with select pure play retailers. Our online channel is now nearly double the size it was two years ago.

Importantly, the media value of brand.com continue to rise as live chat, virtual try-on and live streaming led to increased traffic and time spent on our sites. EMEA online sales increased near triple digits, while Latin America's growth was also very high.

We adaptively met consumer demand in these regions, which were more pressure than others from temporary brick-and-mortar closures. In Asia Pacific and North America, where installed traffic is gradually improving in comparisons to the prior year are increasingly more difficult, online sales still grew double digits.

We are innovating in the high touch online consumer experience and harnessing our data to increase engagement and drive sales. Let me share two examples from EMEA.

In the United Kingdom, Clinique launched an integrated platform to deliver seamless end-to-end high touch virtual experiences with a personalized data led version of its Skin School on demand.

Clinique is providing consultants with data to unlock more sophisticated recommendation with a multitude of tools to ensure the consumer experience is customized based on preferences. Consultants can now enable co-browsing and the adding of friends to services.

This new platform, while still in its early days, is delivering above average conversion rates. La Mer enhanced its digital experiences with more expert classes and one-to-one consultations tailored to local consumers.

The brand expanded live chat to every market in the region with a standard hours and additional days leading to incredible growth in conversion. All told, La Mer saw its regional online mix of business surge. Our brands are investing for growth with social media platform.

Too Faced introduced a new virtual try-on lens on Snapchat to add to its growing portfolio of virtual try-on experiences. On TikTok, it launched a mini movie showcasing the transformative experience of Better Than Sex Mascara via its first world premiere on the platform. Dr.

Jart appears color correcting treatment, targets strong online sales in the United States for the brand amplified by social selling TikTok and influencer support. Looking ahead, we are preparing a renaissance in makeup.

And we anticipate that momentum will gradually build around the world, driven by local reopening and social and professional occasions. Our data and insights are driving new creativity to aspire consumers as they increase their occasion based makeup.

We are strategically well-positioned to grow our sales and capture prestige beauty share in makeup recovery with our Hero products, robust innovation pipeline, analytics engine driving aspirational intelligence, an enticing in-store and online activations centered on the omni-channel consumer.

Already in the third quarter newness from Clinique even better franchise in foundation and concealer was highly sought as we saw consumer restocking their core makeup products. Too Faced new Lip Plumper was a major hit. Hero products like Tom Ford Beauty eyeshadows, a mascara from Too Faced, the Bobbi Brown also performed very well.

MAC is launching a new mascara, and there is exciting innovation from many brands to come. In closing, we deliver outstanding performance despite the resurging impact of the pandemic in many countries. We lead with our values as we continue to priorities the safety and well-being of our employees and consumers.

We made progress on our environmental goals and acted on our social committed. We invested in accelerating drivers for sustainable growth, including innovation in China, manufacturing in Asia Pacific, global online and consumer analytics.

For the long-term, we are confident that our multiple engines of growth strategy will continue to create value for our stockholders. I want to say thank you to our employees who are integral to our success in making us a better company through this difficult moment.

We are beautifully positioned in prestige beauty to continue drive in recovery with the house of the most dedicated and talented employees. I will now turn the call over to Tracy..

Thank you, Fabrizio. I certainly echo that statement and look forward to the continued progression of our recovery. For our fiscal third quarter, net sales rose 13% as we left the onset of the COVID pandemic, and delivered exceptional growth in the Asia Pacific region and in the skin care and fragrance categories.

While our brick-and-mortar distribution continue to experience soft foot traffic, our online channel delivered strong growth across all formats and all regions. Conversely, the environments in Western Europe, Latin America and parts of North America were challenged throughout the quarter.

Our gross margin increased 90 basis points compared to the prior year quarter favorability and category and channel mix driven by skin care and online growth, as well as lower tester costs were partially offset by obsolescence, negative currency and COVID related under recovery of fixed cost primarily in our facilities that manufacture makeup products.

Operating expenses improved by 530 basis points compared to the prior year quarter, largely reflecting the improved sales leverage this year.

You will recall that when the pandemic struck in the prior year quarter, the sudden and dramatic drop in sales created expense deleverage that was difficult to fully offset despite the cost actions we took at that time.

This quarter, we benefited from both temporary and longer term cost savings, which is reflected in the substantially lower selling and store operating costs as a percent of sales continued to shift from brick-and-mortar to online as sales continued to shift from brick-and-mortar to online.

This was due in part to temporary store closures in response to a resurgence of the virus in certain EMEA and Latin American markets. We realize some subsidies and the extension of furlough benefits in some of the affected markets.

We've also prudently managed staffing levels in our stores, and new hires on our management teams, until we see the recovery gaining more consistent momentum. Advertising spending grew double digits, and was predominantly focused on digital spending.

We invested to support our online acceleration as well as our new product launches, a strong recovery in certain markets and key shopping moments such as Lunar New Year, Women's Day and Valentine's Day. As a result, our operating margin rose 620 basis points to 20.5%, which was 40 basis points above fiscal '19 level.

Our effective tax rate for the quarter came in at 20.7%. The lower tax rate for the quarter was primarily due to a lower rate on the company's foreign operations. Diluted EPS of $1.62 increased 92% compared to the prior year. EPS exceeded our expectations primarily due to the higher sales, continued cost management and a lower effective tax rate.

Our plans under the post-COVID business acceleration program are progressing.

Year-to-date, we have taken actions in three main areas to adjust our distribution footprint in Latin America and EMEA including travel retail, to exit global distribution of BECCA products, and to realign resources and capabilities, including employee related costs between our brick-and-mortar and online channels.

We are already beginning to realize the modest benefits from these actions. As the program continues, we expect to further rationalize our brick-and-mortar retail footprint, primarily in Western markets.

For the 9 months, we generated $2.78 billion in net cash flows from operating activities, which was substantially above the prior year, primarily due to higher net earnings as well as working capital improvements.

We invested $386 million in capital expenditures to support key investment areas like production and distribution capacity and technology, including our online business. Conversely, we spent far less on counters and stores.

We ended the period with approximately $6.4 billion in cash and cash equivalents, including cash from $600 million and senior notes issued in March to support the increased equity investment in DECIEM, once the deal was finalized.

We also reinstated our share buyback program in March and utilized $316 million of cash to repurchase our stock and we paid $561 million in dividends. After the end of the quarter, we used $450 million in cash to pay down debt maturing in the fourth quarter.

Given our strong cash generation this year, we still remain in a very strong position to pursue further growth opportunities after these actions. So now, let's turn to our outlook. We continue to be encouraged by the sequential improvement we have seen in our business throughout the fiscal year.

And we are optimistic that restrictions and hesitancy on travel and social activities will begin to ease in certain markets as vaccine coverage steadily increases.

In China, Australia, and Israel, which are at the leading edge of recovery, we are seeing higher makeup sales with usage occasions increasing as social and professional engagements gradually normalize. For example, sales in our freestanding stores in Israel have returned to pre-pandemic level and even lipstick sales are almost back to normal.

The upcoming addition of the DECIEM brands to our portfolio and the expansion of our business with Sephora and Ulta beauty in the U.S. represent additional growth drivers for us as we progress in recovery from the pandemic shock, giving us further cause for optimism.

We have led with our strengths, our values and our amazing team and have proactively addressed areas where which we could control while at the same time ensuring we are protecting our strategic growth areas.

As a result, in the context of a very challenging environment in fiscal 2021, we expect to end the year with sales growth of between 9% and 10% in constant currency. Currency translation is expected to add approximately 2 percentage points to reported growth, reflecting rates of 1.18 for the Euro, 1.33 for the pound and 6.64 for the Yuan.

6 months of incremental sales from the December 2019 acquisition of Dr. Jart, and approximately 1 month expected from DECIEM are contributing approximately 2 percentage points to our expectations of growth for the year.

Mindful of the more gradual resumption of traffic to our brick-and-mortar distribution, we kept tight control over costs this year to protect investments needed for long-term growth.

Some of the costs we cut temporarily will gradually return as more doors open, subsidies will correspondingly diminish and we plan to meaningfully ramp up advertising spending in our fourth quarter as consumers return to social and professional engagements.

That said, we expect to end this fiscal year with an operating margin of approximately 18.5%, an improvement of roughly 100 basis points above fiscal 2019. Full year EPS is expected to be between $6.05 and $6.15, before restructuring and other charges.

This reflects approximately $0.10 accretion from currency translation and $0.04 dilution from acquisitions. Our fourth quarter sales are expected to rise between 44% and 50% in constant currency. This reflects both the recovery in many parts of the world as well as an easier comparison against the prior year period most impacted by the pandemic.

Currency is expected to be accretive by approximately 4 percentage points and the addition of approximately 1 month of sales from DECIEM would contribute less than 2 percentage points to sales growth.

Fourth quarter EPS is expected to be between $0.38 and $0.48, reflecting the sales outlook and increased investments to support the ramp up of our innovate -- innovation and manufacturing capabilities in Asia.

Continued investment to drive our online business and the advertising and promotion to support recovery, with a resulting operating margin more typical of our pre-pandemic levels of mid to high single-digit in the quarter.

Currency is expected to add $0.02 to EPS, and the addition of DECIEM is immaterial for the quarter, given the short timeframe in purchase accounting. In closing, we are pleased with our performance in the third quarter in the context of a challenging macro backdrop.

Our skin care and fragrance brands have proven to be resilient during this time, as consumers shifted online and we enhanced the digital experience with increased services on our sites.

As we navigate through the final months of our fiscal year, we are investing in both the near-term recovery and the drivers of long-term sustainable growth that create value for our multiple stakeholders.

While it is difficult to predict the growth of global prestige beauty in the near-term, we are confident as we have demonstrated that we can nimbly allocate resources to continue to operate with agility and gain share as the recovery gives way to the new normal.

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

[Operator Instructions] Our first question comes from the line of Lauren Lieberman with Barclays..

Great, thanks. Good morning..

Good morning..

Good morning. I was hoping you could talk a little bit about Asia Pacific because as strong as trends are, on a 2-year basis, things were a little bit slower this quarter. I know the fiscal second quarter you have 11.11 that's probably a much bigger shopping holiday than Chinese New Year.

But from the aggregate level that we see in Asia, things were probably a little bit slower than people expected. So could you just give us a little bit more color there, describing maybe trends in China -- Mainland China, I should say versus whether it was Hong Kong, Japan, other areas where things might have slowed down.

And also any other thoughts on Hainan and the degree to which shopping there may be overlapping with things that purchases that used to happen in other Asian markets as Chinese were travelling more overseas are now maybe repatriating those purchases to Hainan? Thanks..

Yes, sure. Let me start and then Tracey will -- perspective. The -- first of all, we believe China is super strong. I mean, we have accelerated decisively. Our reported number is 63% growth, which is almost double last quarter. So China mainland is very, very strong. Now these numbers include Dr.

Jart which is a -- also a strong growing brand in Asia and now is part of our portfolio. So all good. Now, your question on Hainan, Hainan was also strong and continues to grow. And as we say, we really look and manage the Chinese consumer. So we sell to the Chinese consumers where they -- when they travel to Hainan we sell to them in their travel.

And when they are in their cities, we sell to them in their cities. The opportunity of continue serving the growing middle class and the multiple smaller cities which are becoming very important for consumption from which the demand is growing continuous.

And we are serving this multiple growth, meaning also there's more cities, the Tier 3, Tier 4 and the different consumer groups. We are serving these both in mainland and in Hainan when the travel in a very positive way. So China is very strong, and in our opinion will continue a very strong trend.

The other thing that we seen, which is important to us in China is the recovery of makeup, because China is ahead of other regions in the control of COVID and so in people going back with more confidence to shopping also in brick-and-mortar. And we see the positive impact on that -- on the cap, which I said in my prepared remarks grew double digits.

And this obviously is encouraging for what today recovery will represent also in the West as the brick-and-mortar sales go back into the new normal. The other part of your question was about Asia in total. And, yes, Hong Kong is obviously smaller than what used to be and the recovery is lower.

And so Hong Kong is getting better, but it's been resized at least for the time being to what used to be. So still is a drag versus the historical levels. And Japan was definitely hit by a new wave.

And there was new closures and a lot of government activity to limit shopping in brick-and-mortar any way to limit the social life activity, which means again, very big impact on makeup. And Korea, on the contrary, start the recovery, had a better quarter, and Australia had definitely a better quarter.

By the way Australia is another place where its visible the recovery of makeup because of the reopening of the brick-and-mortar and more social life. So Asia was a very mixed bag.

In summary, very strong China, very strong Hainan, a better Korea, a better Australia, New Zealand, and still very hard hit some of the emerging markets, Japan and Hong Kong..

And you covered it, Fabrizio..

Okay..

Your next question is from Erinn Murphy with Piper Sandler..

Great, thanks. Good morning. Fabrizio, I was hoping you could share a little bit more about the renaissance of makeup you spoke to in China in particular.

How is the consumer interacting with the category there? Are there new trends that they're starting to embrace? And then are they sticking with virtual try-on and some of the new ways of shopping like social selling or live streaming, and -- or do you anticipate testers or samples coming back? Just curious on some of the behavior behind that category there..

Well, first of all, what we see is that the recovery on makeup is particularly -- benefits particularly of the recovery of brick-and-mortar omni-channel shopping because people does like to interact with the products and like the experience of shopping together. And so this is really one driver.

And so in China, we see this getting stronger and as the recovery unleash. What we see in terms of product, that people -- and again, I speak about China where these active at all. Australia and Israel is another place where we see signs of what happens during the recovery. And the signs are consistent by the way.

And first of all, people go back to their core makeup also because they have not used it for some time and may not be fresh anymore in some cases. So, there is a lot of back to foundation, to lipstick, to mascaras that needs to be purchased back. And now depending which region of the world, a different proportion of these subcategories as you know.

But this is back to core. But there is also a huge interest in newness, is obviously that from an emotional standpoint people don't want to go back to the past. They want a new normal. They want to forget actually this very difficult year when they’re in a recovery mode and go back to a new future. So they look for newness, for novelty.

And that's why in our renaissance plan, we are both planning in every region of the world where and when this recovery will happen. We are ready to bring back our core and allow the consumer to reload what is their core habits, the core products.

And at the same time, an outstanding mix of new product innovation, breakthrough idea, fresh way to use makeup, new looks, and most importantly, looks which are consistent with the renaissance of the user educations because to be clear, makeup is not only about shopping -- emotional shopping.

It's about having the occasions in your social life, your professional life to use makeup. And so we are studying how those occasions come back and which kind of makeup core and newness is of interest for each occasions. And the occasion are different by region.

And so with this level of analytics, we are preparing what we call the renaissance, which is a comeback, that is very specific. And our ability today to manage these with precisions and avoid excessive pool show, avoiding the wrong subcategories focus. In other words, ensuring a good return of our investments during the recovery.

Our ability to do that has dramatically increased, thanks to analytics, which are not only giving us more data to understand what's happening but is giving us more data to anticipate what is going to happen, and that's what we are working on..

Great. Thank you..

Your next question is from Nik Modi with RBC Capital Markets..

Hi. Good morning, everyone..

Good morning..

Good morning. I wanted to ask about the recent new hire for the online President that you've brought in from the outside. I mean, obviously, the online business for you has done incredibly well over the last 10-plus years.

And so just wanted to get your thoughts on kind of what the priorities will be for new leadership, especially given that they do have outside perspective on both CPG and retail? Thanks..

Yes, sure. First of all, Gibu is now in -- since some months and is an exceptional new lead -- new hire and a leader, well integrated by now in our organization. He will bring our online business to next level. As you said, we have done well for many years, but he is here to bring it to a completely new level.

And so the priority is, first of all, to continue our growth and leverage this huge acceleration in every single channel, in brand.com, in third parties, in pure plays, in retail.com and in making sure that we have the circulation of the best practices around the world, that we learn from what's happening in every angle in -- of the world, both in our business and in what competition or retailers are doing, the third-party are doing.

But I would say the center of all this is to add more technology in order to make the consumer experience in each one of these touch points really, really high quality and even more competitive. So the focus is on taking the consumer experience to the next level.

You heard me speaking in the past about chats, virtual try-on, live streaming, and many other experiences that are possible but need to become better and better over time and surprise the consumer for positive.

And if we do that correctly, we will continue to drive traffic to our online because we will attract traffic, not only because of our great brands, of our great innovation, but also because of our outstanding services online and because of the experience online that will be frictionless.

And also, we will need to make sure that this happens in a very efficient way and in a way which is driven by technology and become consistent across the world so that we can scale it very fast every single time this is going to be needed.

And finally, we -- also, one of the priorities is to make digital advertising, and particularly, all the advertise linked to eCommerce more efficient and more effective. And with these to continue to push conversion that will be one of the key challenges and the key opportunities of the next year's in the world of online..

Your next question is from Dara Mohsenian with Morgan Stanley..

Hey, guys..

Hello..

Just given the unique nature of the COVID crisis, can you just give us a bit of an update on your expectations for the travel retail category going forward? How quickly do you think demand comes back? How do you manage the business for the pace of recovery, but also potential volatility? I just love a bit of an update there. Thanks..

Yes. Our -- again, Tracey, I will let you add any perspective. But anyway, our travel retail business is up. And so is -- I would say that the recovery will be in net extra versus what is already growth.

So what's happened in this field, as you all know, is that the domestic travel in general and particularly within China has been more than offsetting the lack of international travel all over the world and particularly in the west.

And so in this moment, we expect the strengths that today in travel retail, in domestic travel in China with Hainan and with new centers like Shenzhen, the Greater Bay and other opportunities which are emerging over time, we expect this to continue and to remain very, very solid.

But then at certain moment when international travel will be restated, then we expect international travel to bring net extra opportunities, particularly in the west where there will be obviously many more populations going back to travel.

And when this will happen, we envision travel retail to be even stronger than what used to be historically and definitely stronger than today which is mainly driven by only the domestic travel part. So strong reality today, a strong future for travel retail.

Now travel retail is about traffic, which what I was commenting on now, speaking about the future recovery in international travel. But it's also true about conversion, which is the percentage of travelers that buy something. So we have seen recently the conversion going up, driven by pretail. So the ability to buy online when you travel.

Now, pretail is accelerating in Asia, is a very -- it's already about one-third of the business in many parts of Asia and is not yet very present or very significant in the west. So we see in the future pretail to continue to grow and to be a significant part on travel retail.

And with the growth of pretail, we see the opportunity of increased growth or conversion. And in that sense, the -- these -- the traffic coming back plus conversion of travelers into buyers continue to progress, those two KPIs will represent a very solid future for travel retail..

And the only thing I would add, Dara, to what Fabrizio said, we are obviously watching traffic patterns and travel patterns pretty closely. Our travel retail team is -- so international travel is really projected at this point in time not to recover until perhaps even the second half of fiscal '20 -- our fiscal '22.

So again, we're watching it closely obviously. If it will recover sooner, the travel retail business internationally in terms of consumption would pick up correspondingly.

But in the meantime, the travel retail team has done a fantastic job of making sure that we are managing the Western travel retail markets prudently in terms of investments until we see the recovery of traffic and consumption in the Western markets.

And the only thing I -- the other thing I would say is that travel retail and online combined now are a little more than half of our total business. And so when you think about our growth momentum going forward and the recovery -- the strength that we see in online and the recovery of travel retail it bodes very well for our future growth..

Great. Thanks..

Your next question is from Jason English with Goldman Sachs..

Hey, good morning, folks. Thank you for slotting me in..

Good morning..

Good morning, Jason..

I guess I want to -- good morning. I want to come back to, I guess, the first question where growth was a bit slower than many of us expected. And one thing that surprised me was just the sequential drop.

I know that 2Q is always bigger than 3Q, but the drop down from 2Q to 3Q in terms of revenue was larger than is typical, pretty much across every region but especially Asia Pacific. So in fact one or two questions.

One, was last quarter maybe a bit inflated with some retailers once again stepping back into the market reloading inventory? Or are we seeing more of a setback? I mean, I know you talked about some markets tightening down, but generally from where we sit and look globally, it looks like the world is slowly reopening and obviously not all consistent -- consistently.

So help me contextualize around my head around why we would see the sequential debt?.

Yes. I mean, I will start, Jason. I think that what we're seeing more and more in the business particularly in Asia Pacific is more seasonality of the business. So Q2, as you indicate has become a very large quarter for us. It always was a large quarter with holiday.

But with the addition of 11.11 and tremendous growth of that holiday year-over-year, we're seeing a very large sales number in our second quarter. In the third quarter, as Fabrizio mentioned, China had a very strong third quarter. We did have some large markets in Asia that were a bit softer, Japan.

And I think through this pandemic, we are going to see ups and downs until things really more sustainably get back to normal when vaccine rates obviously accelerate a bit. So I would not read anything long-term into it other than this is still part of the pandemic in terms of seeing up and down performance in various markets.

Similarly in terms of EMEA as well, obviously, outside of travel retail, but the Western markets in EMEA were also quite challenged in the quarter as well. So that we expect to see until, again, we see more stabilization and normalization from the pandemic..

Yes. And so frankly, I just want to underline what Tracey said. I will read in this more of a strong Q2, particularly driven by an extraordinary 11.11 where some of our brands were topped in the 11.11 project and by the fact that holidays were a moment also in the West. They were pretty positive.

People were possible, they were allowed, went back to shopping, some brick-and-mortar were open. And then, maybe because these holidays where in some places were open to early, then there was a lot of closures immediately after that, Japan, U.K. Italy, part of North America, Canada.

So we've got an enormous amount of closures in the January, March period, in the West particularly, and Japan, obviously. And so that's the combination. The combination is the pandemic impact on brick-and-mortar.

Now, keep in mind that as you have seen in the results, we have extraordinary skin care and fragrance, and [indiscernible] brand is doing really strong. The question is the makeup recovery, and the makeup is very linked to the comeback of the brick-and-mortar experience.

So all the closures that happened actually after the holidays in many Western markets and in Japan did have an impact on makeup. And we have seen that. So I would not say there is any long-term sign in this Q3. Actually, it is an extraordinarily strong Q3. By the way, it was ahead of our guidance because we had seen that in our guidance.

We had seen these kinds of things that would have happened because of the closures. And so it was a very strong quarter and Q2 was just an extraordinary quarter.

But as Tracey said, Q2 will be pretty strong because in the future there will be always a combination of holidays and a strong peak of commercial activities like 11.11 and more that we create a high in terms of an absolute level of sales..

Operator, next question?.

Your next question is from Rupesh Parikh with Oppenheimer..

Good morning. Thanks for taking my question. So, Fabrizio, I guess getting going back to your comments of, skin care and fragrance have now exceeded FY '19 levels.

So I was curious, as you look at makeup going forward, do you see any structural impediments in your business to get back to where makeup was pre-pandemic from a sales perspective?.

No, no, I would definitely not. I think we are counting on it, again, as the COVID abates and the opening. As I've said before, I want to repeat that, makeup is about user education.

So -- and the user education on makeup at exactly the social and professional occasions that when there are closures or when the pandemic is very active and not there and so consumption goes down.

So we are really -- we don't see any reason why we would not go back to first stabilization and then growth in makeup when these social occasions come back and these professional occasion comebacks. Just want to take the opportunity to make the pictures.

Today, we have our current drivers, which are the Chinese consumer, the global online, and the skin care category and now the high-end fragrance category that will continue to drive. There is no discussion. These areas have been accelerated by COVID.

But in reality, their trends were strong already before, so COVID does accelerated, and we are really ready and as you see we are having great success on these drivers even in the middle of COVID. Now, there are new drivers that should be added to these drivers as COVID will abate.

Makeup usage, as I said, brick-and-mortar productivity in most markets, certain markets and consumer groups like U.S., U.K., Japan, continental Europe, emerging markets today are unfortunately really badly hit by COVID. We come back, and we gradually come back as the COVID improves.

Younger consumer consumption, which is especially linked to makeup will come back. And the TR [ph] outside of Hainan as we said before and pretail acceleration will come back. So there are all these new drivers that we need to accelerate in the next 18 months assuming that will be the pace of return from COVID gradually.

Then there are new strengths that we have built during COVID and we have invested in them. There is better innovation in Asia with the center in Shanghai and the quality of our innovation that is creating higher repeat process rates.

There is more skin care and more makeup skinification and we have more production capacity of high quality production capacity in our upcoming factory in Tokyo; better consumer understanding and better ability to anticipate trends driven by our investment in analytics; more resources for advertising, especially digital advertising, which is increasing; better high touch services online, as I explained before when there was a question on online; brand portfolio, which is becoming stronger with the acquisition of DECIEM and Dr.

Jart; a huge investment and acceleration in every ESG activity during COVID. And all of these combined is what I call the new strengths that we are bringing to the [indiscernible].

So the way we see it is that the current drivers will drive, the new drivers including makeup will come back and the new strengths that we have built in Estée Lauder Companies during this year will hit.

And that's why we really believe that this quarter is just the confirmation that we are creating a very solid long-term sustainable growth pattern for the company..

Okay, great..

And the only thing I would add to that is, just to underscore some of the investment in technology we've made for virtual try-on.

So when you think about those social and professional occasions coming back, whether someone wants to come in the store and try makeup or if they want to try it online, the engagement that we see online from some of the capabilities and features that we've added to online certainly bodes very well for when those occasions come back and the makeup category acceleration..

Okay, great. Thank you..

We have time for one more question. Your final question will come from Chris Carey with Wells Fargo..

Hi. Good morning, everyone. So I wonder if you can just provide some comments on how you're thinking about that operating margin for fiscal '21, which I think you said was 18.4%, but correct me if I got that wrong. I mean, you noted this quarter that they're temporary but also longer term cost saving is substantially lower.

Operating costs in store with the shift online, there are some subsidies in play, but you're also reallocating costs for the longer term for brick-and-mortar to online, channel mix is obviously going to be a dynamic going forward.

And I guess, underlying the question is that margins continue to come through at a much higher level, channel mix is clearly an element but there are some costs that have come out permanently but also costs that are going to be coming back into the base.

And so, I guess getting back to it, I wonder how you view this fiscal '21 target? Do you think that you can move up from there with all the initiatives that they have noted, or would you expect some sort of a step back as you weather some of these costs coming back into the base and channel mix evolving over the next year? Thanks so much..

Yes. So, Chris, as you know we typically give forward guidance for the upcoming fiscal year in August, which we will certainly do. I mean this has been an unusual year because of all of the things that you've mentioned.

We had part of the year where we had temporary salary reductions, we've had furloughs and we've also done a fantastic job, our teams have, in terms of managing costs. Some of those costs will come back next year and some of them won't.

Some of the door closures that we've permanently done, those costs and the remaining fleet of doors should be more productive as traffic continues to accelerate to brick-and-mortar, which is where we see the bulk of the recovery.

So given the cost actions that we've taken, given where we expect growth to come from next year disproportionately, we would expect continued margin progression. But we will be able to say more specifically what that will be in the August timeframe.

But as we've said for many years, our growth areas are all margin accretive when you think about travel retail, when you think about online when you think about the strength that we've had over multiple years in terms of skin care.

And as Fabrizio said, we expect skin care and fragrance to continue to grow and makeup will also grow more strongly certainly next year as those occasions come back. So we've got multiple engines, multiple ways to progress margin even as investments do come back for brick-and-mortar and in other areas.

We will, in the fourth quarter as you indicate, and as I said in my prepared remarks, so -- strongly invest as we normally do for a start of a strong fiscal year and we will invest more in advertising to support what we believe will be an acceleration. It's selectively in the markets that we think that it will happen in..

Thanks so much for the perspective..

That concludes today's question-and-answer session. I would like to turn it over to management for closing remarks..

Just thank everybody for obviously their interest in the company. And again, I think we want to thank all of our teams for the fantastic performance navigating through what has been a difficult year, but we are incredibly proud, as I mentioned and Fabrizio mentioned of our results.

And certainly, we look forward to closing the year strong with the guidance that we provided. So thank you, everyone..

Thank you. If you were unable to join the entire call, a playback will be available at 1 p.m. Eastern Time today through May 17. To hear recording of this call, please dial 1-855-859- 2056. The passcode number 5569398. That concludes today’s Estée Lauder conference call. I would like to thank you all for your participation and wish you a good day..