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Estee Lauder Companies, Inc. (NYSE:EL)
Q3 2018 Earnings Conference Call
May 2, 2018, 9:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day everyone and welcome to the Estee Lauder Companies fiscal 2018 third quarter conference call. Today's call is being recorded and webcast. For opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Dennis D'Andrea. Please go ahead, sir.

Dennis D'Andrea -- Vice President of Investor Relations

Good morning, everyone.

On today's call are Fabrizio Freda, President and Chief Executive Officer, and Tracey Travis, Executive Vice President and Chief Financial Officer. As many of our remarks today contain forward-looking statements, let me refer you to our press release and reports filed with the FCC 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 chargers provision one-time impacts of the recently enacted U.S. tax law and other adjustments disclosed in our press release. You can find reconciliations between GAAP and non-GAAP figures in our press release and on the investors section of our website.

During our Q&A session we ask that you please limit yourself to one question so we can respond to all of you within the time schedule for this call. And I'll turn it over to Fabrizio now.

Fabrizio Freda -- President and Chief Executive Officer

Thank you Dennis and good morning everyone. Our excellent performance continues in our fiscal third quarter, building on the momentum we generated in the first half of the year. our strong growth was broad-based across all regions and product categories, which produced double-digit increases in both the top and the bottom lines. Sales rose 13% in constant currency, about double the robust pace of global prestige beauty. We gained share. We leveraged our highest sales into even greater product growth aided by [inaudible] [00:01:57], efficiencies, and lower tax rates. Our adjusted unit earning per share increased 17% in constant currency. We did better than expected results in confidence in the fourth quarter outlook, we are again racing our sales and EPS guidance for the fiscal year. We should make our performance one of our best in the last decade, even in the midst of high competitive environment. Our global success came from bringing our brands into high growth markets, channels, and retailers in attracting consumers with compelling innovations, high quality products, and social media activities. We have been able to devote increased investments to our digital activities as a result of our leading beauty forward initiative, which has freed up resources from other areas.

Today, all our brands are amplified in digital communications in aligning with inspiring interactions. We have range in year, our financial structure, to make this happen. In our results this quarter prove of our ability to capitalize on positive industry trends. Our winning strategy centers it on activating and accelerating multiple angles of growth. As our business flourished around the globe, we continue to support the momentum of our fastest growing brands, countries, and channels. They are gaining greater traction as we develop more growth engines in each area. We open new doors in consumer preferred channels and retailers and closed less successful ones. Our results reflect skilled execution, improved analytics, in our increasing ability to take advantage of opportunities quickly, effectively, and respond to trends faster.

Consumer interest in beauty and access to products is outstanding in established and emerging markets. This trend is evident in our third quarter results where literally all of our brands grew on a global basis. Many rose by double digits, led by our luxury tier skincare focused brands and the Estee Lauder brand. Many of our mid-sized brands have grown so strongly in recent years that they are now leader sin their respective categories in prestige beauty.

Jo Malone London, for example, is a top brand in high-end fragrances. La Mer is #1 in luxury skincare. Tom Ford is a leader in luxury makeup. And Aveda is highly ranked in natural prestige hair care. All these brands improved in the third quarter, farthest so they define their positions. Same to each of our largest brands: Estee Lauder, Clinique, and MAC, grew globally. Our established brands are winning because they are changing, innovating, and appealing to new and younger consumers. The most brilliant example of this transformation is our Estee Lauder brand. We intend to apply its playbook to other brands. Like many of our mid-sized brands, our big brands are also prestige beauty forerunners. Estee Lauder is a global leader in prestige skincare. Clinique is #1 in prestige beauty in the U.S. and MAC is top ranked in prestige makeup worldwide.

Estee Lauder was again a standout in our portfolio. Sales climbed strong double digits, reflecting the brand's strengths across skincare and makeup as well as in many markets and channels illustrating its increasing global activity. The brand's success stands from the high quality of its products customization to consumer needs by region. Strong repurchase rate, especially among its Europe products, and a focus on engaging consumers to digital and social media.

Clinique growth improved, led by gains in skincare, which rose in every region. The brand's makeup and fragrant business also increased, with particular strengths in European region.

MAC global sales increased the reflected strengths in Asia and travel retail. Several of MAC top global doors were in travel retail location in Asia, boosted in part by visitors to Korea for the winter Olympics.

Several factors drove our skincare acceleration. Asians are large users of skincare and our business in that region was robust. In addition, more millennials are purchasing skincare products and our innovation and hero products were well received, including newer ones like masks. This is a trend we anticipated, and therefore we are well positioned. Many of our brand's hero products continue driving our strong performance. Clinique's new Moisture Surge 72 hours Auto-Replenish Hydrator was first introduced in North America in December and the franchise nearly doubled there this quarter. In the past two months, the new moisturizer has been rolling out internationally and has helped lift the Clinique moisture surge franchise by over 50% fiscally to date. In Asia Pacific Clinique hero products comprise about one third of its sales, driven in part by strong moisture surge growth. Clinique is gaining share in moisturizers in many large markets, including the U.S., U.K., France, or Spain.

Estee Lauder launched last July of Advanced Night Repair Eye Concentrate Matrix has now solidly defined brand leadership in the eye treatment subcategory, which is a critical recruitment area in skincare. Our makeup shades were solid, but consumers' demand is leveling off after several years of exceptionally strong growth. Our top performers were Estee Lauder, MAC, and Tom Ford. These brands gained share globally in the GAAP, largely driven by Doublewear Foundation franchise. We are supporting Doublewear with a wider range of shades and forms, such as cushion compact, to address the needs of consumers worldwide.

MAC enjoyed growth internationally and has been well received as it enters new channels and retailers. It was our first brand to launch on ASOS in the U.K., an exciting online platform that is especially popular with millennials. MAC successfully reached new consumers. It's recent Nicopanda Collection, with the edgy fashion brand, has been a big hit. Two Faced global growth was mainly driven by success in specialty multi-doors in Europe and Asia and it has gained share internationally. The brand grew at a slower pace than in recent quarters because of tax comparison with the previous year is lower makeup category growth in the U.S. We expect to face also we return to significant growth in the U.S. next quarter with rollouts of new products and target standard consumer reach.

Turning to our geographies: Sales rose in about three-quarters of our markets. Asia Pacific was our strongest engine where nearly every country posted growth and most brands grew double digit. In china, we achieved another quarter of stellar double-digit growth, a gained share. Skincare, the predominant category, rose significantly, yet at the same time our makeup business doubled.

In France, was sharply higher. All major channels posted strong growth, driven by online and specialty multi-retailers, which more than doubled. Our investments in China are creating even greater awareness of our brands among Chinese consumers, especially as we intensify our social media campaigns. Through our own brand size and third party size, we can reach millions of consumers in more than 500 Chinese cities who desire our products but don't have access to a physical store. This is evident in our online sales, which are counted for nearly one-quarter of our Chinese business. Outside of travel retail, our strength in Europe, the Middle East, and Africa, was led by Italy where our local currency growth far upstaged the market. Across the region, several emerging markets, including Turkey, Central Europe, India, and Russia, posted double digit gains. The Middle East, however, continued to be challenged. In the U.S., our brands generated strongest stales online and specialty multi-retailers. But in total, our business declined slightly as a result of continued challenges in some brick-and-mortar department stores and freestanding stores. As the physical retailer scape continues to change, most recently with the unfortunate news of Bon-Ton's liquidation. Our business will be impacted in the short-term. Longer term, however, fewer stores should provide a healthier environment as sales continue to migrate to experiential retail and to online. We are working with retailers to strengthen our brand's assets on their websites where we're seeing good growth as well as the experience in brick-and-mortar stores to increase sales in both areas.

Looking at our business back channel, nearly all posted improved results. I will highlight two of our most vibrant. Travel retail generated momentum in every region due to increasing demand for our brands worldwide and our outstanding execution by our organization's teams. The channel has strong retail growth in Asia, double-digit gains in the U.S. and Canada, and retail sales in the European region outpace the local market. Our eight largest brands in the channel rose double digits at retail, as skincare accelerated sharply, reflecting positive global trends. Travel retail results are driven by our investments in key local markets that are fueling our commercial efforts in airport.

We launched our seasonal fragrance brands and Two Faced and Becca in more airports to meet growing consumer demand. We are seeing the clear success of our high-end trial strategy in the travel channel. Fragrances are an important category in travel retail. In our luxury fragrance portfolio is already a strong contingent. Most of our travel retail growth came from like door gains. Starting in June, there will be more than 30 new flights a week between China and Europe, which is expected to help increase passenger traffic. New [inaudible] [00:14:13] attract our online business, which once again climbed sharply. Sales grew double digits across all platforms, regions, and categories, even as our online business has become significantly larger, we are sustaining our momentum.

In Asia, our online sales doubled, led by Tmall in China. MAC's first super brand A on Tmall delivered terrific results. One of MAC's most popular products is lipstick and it sold approximately 180,000 [inaudible]. In March, we launched the [inaudible] on Tmall. Our eight brand on the platform we promise initial results. Our retail.com business grew double digits in every region. In the U.S. we have excellent retail sales on department store sites. Retail sales through macys.com grew 30% and the Estee Lauder brand is the #1 beauty brand there. Social media is becoming an integral part of our brand.com business by offering unique content and easy to use functionality, we are making them a competitive destination site and even more useful for consumers.

We launched seven more brands .com sites internationally including origin sites in France, Sweden, and Hong Kong. Our digital first mindset continues to influence everything we do. Our brands are finding new ways to engage consumers by using big data to inform trends pair with the right influences and create impactful content. To stay at the forefront, we are adding digital talent, leveraging new technology like augmented reality, monitor real time campaign analytics across all brands, and directing more advertising spending to search influences and mobile first videos. In the last call, we discussed our intent to enhance the company benefits and invest in our workforce to help attract and retain the best global employees.

As a first step, we are improving our family related benefits for our diverse employee base in the U.S. This includes a standard parental leave for all employees, irrespective of gender, and announces benefits around adoption child and held of care and enhanced flexibility when employees return to work. Our new policies are among the most comprehensive in the U.S. and underscore our commitment to family values and work/life balance. We plan to share additional benefit announcement in the coming months.

I will now to stand a moment discussing a situation, which we disclose in our press release this morning. We recently learned that some testing related to certain products as advertising claims, had been intentionally altered for some time by a small group of employees. We became aware of this when an employee brought this to our attention through our internal escalation process. This clearly does not meet our standards and we immediately launched a comprehensive review of our product advertising claim support, which is ongoing. It is not a safety issue. All of our products are completely safe, our ingredients remain of the highest quality, and consumer can continue to use the product they know and love with confidence. As we undertake this review, we expect that many of our claims will not change. But others will. Some changes may be minor. In others, could be more significant. And we will make any necessary changes as quickly as possible and bring this area up to our high standards. We have resolved this testing issue by now so that claims for new product launches will not be affected. We are investing and strengthening our talent, resources, and independent validation, to assure that this does not happen again. This matter does not reflect our strong commitment to our consumers or the integrity that is at the heart of our company. We are sorry, [inaudible] [00:19:19], and we take full responsibility for this matter while we continue to address this in a way that reflects our values and our high standards.

So we are proud of our many successes this fiscal year and confident about our future. We believe our broad brand portfolio, strong innovation, global reach, amazing people, greater China diversification, and agility to take advantage of new opportunities, position us well to continue outpacing the industry. Our focus on being financially disciplined will help us further fuel our move to [inaudible] of growth to continue our momentum. We are extremely pleased with our results and our track to deliver outstanding sales and earnings gains in fiscal year 2018. Now, I will turn the call over the Tracey.

Tracey Travis -- Executive Vice President and Chief Financial Officer

Thank you, Fabrizio, and good morning everyone. I remind you that my commentary excludes the impact of restructuring and other charges and adjustments primarily related to our leading beauty forward initiative and the new U.S. tax legislation. Net sales for the third quarter were $3.37 billion up 13% in constant currency compared to the prior year period. Once again, our performance was broad based across geographies and product categories with exceptional strength in the Asia/Pacific region, travel retail and online channels and in the skincare category. Our growth margin improved 40 basis points to 79.8% driven primarily by a favorable comparison to the inventory step up in the prior year period, post the acquisitions of Two Faced and Becca. Operating expenses of the percentage of sales were consistent year-over-year. Higher investments and advertising and promotion of 110 basis points and stock compensation expense of 50 basis points were all set primarily by lower selling cost. Operating income rose 21% and operating margin increased by 40 basis points to 17.4%. Our effective tax rate this quarter was 22.8% of 490 basis point improvement over the prior year quarter. This reduction was driven primarily by excess tax benefits on share-based compensation.

As a result, and as a reminder, provisional charges related to the recently enacted tax cuts and jobs act will be finalized within the allowable one-year measurement period. Diluted EPS rose 30% to $1.17 compared to the prior year, and for 17% in constant currency. Earnings for share for the quarter included approximately $0.11 of favorable currency translation. The higher than expected EPS primarily reflected better sales growth, a slightly lower tax rate, and more favorable currency translation. For the nine month year to date, we generated $1.93 billion in net cash flows from operating activities, a 54% increase over the prior year, due primarily to higher net income and improvements in certain working capital items. We invested $368 million in capital expenditures. We purchased 5.5 million shares for $676 million, nearly double what we spent last year, and paid $407 million in dividends.

Now let's turn to our outlook for the fourth quarter and for the full year. Global prestige beauty is a vibrant category that continues to grow. With the outstanding performance we've seen year to date, we are again raising our full year guidance as Fabrizio indicated. We expect continued strong execution to drive performance in our final quarter, although our fourth quarter comparison are the most difficult against the strong growth in the prior year quarter and we remain cautious on the brick-and-mortar retail environment in North America and the U.K. We anticipated some risk for bonds on our previous estimates and our current guidance reflects the new reality.

Furthermore, there continues to be a number of macro and geopolitical risks that could disrupt the positive trend we have seen. That said, we are raising our sales growth expectation for the fiscal 2018 full year to 11 to 12% in constant currency. This includes approximately two points of growth from the incremental sales from Two Faced and Becca in the first half of the year. Currency translation is expected to benefit reported sales growth by 4 percentage points reflecting weighted average rates of 1.20 for the euro, 1.35 for the pound, and 1.10 for the yen for the fiscal year. We're maintaining a degree of prudence in our outlook as we work through the review and retesting of some of our product advertising claims.

Nevertheless, we are raising our EPS expectations to range of $4.38 to $4.42 before restructuring and any other charges and adjustments. This includes approximately $0.22 of benefit from currency translation. It also includes an estimate for accelerated claims review and testing and consumer call center support, changes to some of our product communications as necessary, advisory fees and other cost related to the advertising claims review.in constant currency, we expect EPS to rise by 20-21%. For the fiscal 2018 fourth quarter, our sales are expected to rise by approximately 8-9% in constant currency. Currency translation is estimated to add approximately 4 percentage points. We expect to increase investment substantially behind advertising and promotion and select brand expansion, reflecting the increased flexibility we have from higher than expected sales growth, and our desire to support a strong start to fiscal 2019. EPS is forecast to be between $0.48 and $0.52 before restructuring charges. This includes an approximate $0.07 benefit from currency. With two months left in the fiscal year, we remain encouraged by the momentum and global prestige beauty and our ability to execute our strategies effectively to exceed that growth. Our outstanding organic sales increase reflects a thoughtful investment we have made in innovation, advertising and promotion, digital, and talent development. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Operator

The floor is now open for questions. If you have a question, you simply press the * key followed by the digit 1 on your touchtone telephone. Questions will be taken in the order in which they were received. To ensure everyone has the opportunity to ask a question, we will limit each person to one question. Time permitting, we will turn to you for additional questions. Just queue up again by pressing the * key and the digit 1. Our first question today comes from the line of Lauren Lieberman.

Lauren Lieberman -- Unknown Analyst

So you know, I guess for a couple years been interested in the question of the impact of channel mix on profitability and seeing that as a long term positive. My senses are leading beauty forward as still kind of a net investment mode but I still would've expected to see I guess better operating leverage this quarter just given the magnitude of the upside to topline. So I was curious if you can talk a little bit about why we didn't see that? Were there maybe some expenses counted for this quarter related to the advertising claims dynamic? You talked about wanting to start off '19 strongly if you're gonna be putting some money toward today more aggressively than you maybe initially planned before the topline came through as strongly as it did. Thanks.

Tracey Travis -- Executive Vice President and Chief Financial Officer

Thanks Lauren, so I'll start by answering that question. We have talked all year about our incremental investment in advertising and promotion. You're correct that leading beauty forward this year -- we did indicate that there would be some savings related to the program that we planned to reinvest in capabilities as it relates to digital marketing, reinvest in some of our analytical capabilities, which we've referred to earlier in the script, and other areas of capability for the future. That has been the result of some of the savings that we have generated from leading beauty forward. We've seen a big step up this year and again, mostly in this quarter and next quarter -- so the second half of the year. more investment and advertising and promotion than even in the first half of the year so that is also what you're seeing in the quarter and what you're also seeing in the full year guidance. And we have done a terrific job, as Fabrizio indicated, reallocating resources to invest in more advertising and promotion and other areas of investment -- like IT support for some of our consumer facing activities.

Fabrizio Freda -- President and Chief Executive Officer

I want to add: we are really in a transition period of using these resources to accelerate but mainly advertising and new capability like digital, data, analytics, ability to anticipate trends, new talent in these areas, improvement in retail, but the advertising piece frankly is very exciting. Yes, in these two quarters, quarter 3, quarter 4, we have a serious improvement of the investment in increase of investment. This is aiming at obviously preparing hopefully the continuation of a strong fiscal year '19, but is also the result of going from an era where certain brands were advertised and others were not, were mainly driven by the brick-and-mortar experience, to an era where every single brand will be leveraged by social media and in a way advertised. And in this transition we are putting more advertising funds in every single brand, also the brands in the past had not a lot of advertising. The result of this transition is frankly a very promising acceleration of topline that will be leverage. There will be leverage better over time.

Operator

Your next question comes from the line from Michael Benetti Credit Suisse.

Michael Benetti -- Credit Suisse -- Analyst

Hey guys, good morning, thanks for taking my question and congrats on a nice quarter.

Tracey, there's obviously a lot of inertia as you go through the margins and different reporting lines, and you spoke a little bit about advertising Fabrizio, but the 110 base point step up in this quarter, can you maybe help us think about the medium term a little bit as far as -- you said there's a leverage point on horizon but could you walk us through whether you guys feel like you're getting -- you're obviously landing it on the top line but as we think about the medium term and how was that 110 base point holdback in he quarter. Is the best strategy to keep spending that faster than revenue growth for the next year to keep playing offense? Or do you think in the next year we start to see a leverage point on that line?

Tracey Travis -- Executive Vice President and Chief Financial Officer

I think in the next year you will start to see that normalize more. One of the things that we have done this year -- we have such great momentum behind, terrific brand innovation, like what we're seeing in Estee Lauder and La Mer. Some of the expansion that we've done in our travel retail channel behind new brands and addition to the existing brands in the channel that we have taken the opportunity and we have some terrific social media programs as well. So this was the year really to invest behind to capitalize on that growth. We don't expect that we will see deleverage in advertising and promotion on a go forward basis.

Michael Benetti -- Credit Suisse -- Analyst

Okay, and then if I could just follow up quickly on the gross margin. Nice inflection in the quarter. I know you mentioned that there are some things in the compare on the inventory stuff up from Two Faced and Becca. I'd be interested in here and how you think about the puts and takes on that over the next couple quarters and maybe what we should think about by geography or product mix and whether we continue to see that kinda leverage flow through?

Tracey Travis -- Executive Vice President and Chief Financial Officer

Yeah, I mean, one of the reasons we saw deleverage in the first half of the year was because of the comparison year-over-year with the non-comp and the acquisitions and I think I did mention that we would see favorability in the second half of the year once our two acquisitions became part of our base. So it really -- our gross profit margin is very much dependent on our category mix and our channel mix and so the real measure if you will of margin that you should be focused on is the operating margin because mix does have a differential benefit on our gross profit margin mix but you could expect to see certainly some level of expansion and gross profit margin on a go forward basis, not perhaps what we saw in this quarter because of anniversaring the inventory step up but some benefit in gross profit margin given the near term programs that were expecting to launch.

Operator

Next question comes from the line of Linda Bolton Weiser, D.A. Davidson & Co.

Linda Bolton Weiser -- D.A. Davidson & Co. -- Analyst

Hi, so I was wondering if you could give a little more detail just on the margin performance in the Americas because the profit was down about over 50 million year-over-year I don't think that includes any charges in there. And you mentioned a comp issue, which I think you had referred to earlier, maybe you could quantify that. But also you mentioned investment in social media and digital I think. So I was curious about that in what areas -- are you putting more toward the smaller brands that you recently acquired or more toward some of the larger brands which seem to be slipping a bit in social media prominence? In particular, Glam Glow is quite lacking in prominence in social media compared to some of the other even smaller brands. So is that one of the areas receiving more investment? And then on the bigger brands, Bobbi Brown, Clinique, Smashbox, and Origins appear like they need a little more investment. So could you talk about the investment side and the comp issue there in the margins? Thanks.

Fabrizio Freda -- President and Chief Executive Officer

So Tracey will take the margin question. But on the advertising: basically, the answer is yes. The short answer is we are increasing social media activities on our big brands and on our mid-sized brands and on some of our new acquisitions particularly we are looking for accelerating in this area. You mentioned Glam Glow, which actually is a brand, which is doing very well behind these extra investments recently in the social media in the U.S. and in other areas of the world. So our intention is to do that. As I said before, our intention is to make sure that also the brand that is story telling is being driven more by in-store activation and innovation that get driven by investment in the social media arena. In order to do that well, we don't need only more money on the advertising line. The real big difference going from a brick-and-mortar brand to a social media driven brand is clarity assets and the amount of talent in communication, and that's the areas where in each one of the brands you mentioned we are making some excellent progress and we will continue. The way we produce creative assets, the way we expose consumer to our creative asset, the way we involve and engage consumer, in actually in some cases the generations of the assets, is really changing and that's very exciting, I feel we produce better results over time as well learn how to practice on every single brand this new reality. And finally, on margin, Tracey?

Tracey Travis -- Executive Vice President and Chief Financial Officer

On margin, a bit of it is a step up in advertising. You mentioned some of our newer, smaller brands, so we are investing more in advertising in Two Faced for instance -- and some of our other brands as well. We are investing a bit more in digital marketing as well in the U.S. I mentioned the change in accounting and stock based compensation, that is also impacting the American segment so that is also a margin drag, if you will, on the segment for the quarter.

Operator

Your next question comes from the line of Mark Astrachan from Stifel Nicolaus

Mark Astrachan -- Stifel Nicolaus -- Analyst

Thanks and good morning everybody. Probably a bit too early to talk about fiscal '19 expectations but I guess maybe looking at it through a different way. Any thoughts on what would impact global prestige beauty growth from current 6-7% levels and even up from the 4-5% that you were expecting back in August? And then, anything that you were seeing that potentially impacts your ability to continue growing ahead of the global market?

Fabrizio Freda -- President and Chief Executive Officer

So obviously today's not the day to speak about guidance for '19. To answer your question on the market is we believe that about 5% long term market growth potential is still the right estimate for the long term, meaning that year after year, the 4-5% average that we quoted in the past will likely continue to be the reality in term of what are the global forces that drive that. This is an extraordinary the 6-7% is up in fiscal year '18, we believe is an extraordinary strong year. The reason why it's extraordinary is a year where there is the combination of very positive factors. One is the consumption in china has jumped as we see in the market. The social media boom that in the past was mainly on the cap is coming through also in skincare. That's behind the sudden acceleration of skincare. The U.S. tax cut gives some push to the U.S. consumption, international passage of traffic for travel continues to increase. So the combination of factors of accelerating all together is there. We believe these accelerations started at the end of a fiscal obviously this somehow will normalize in the future and that's why we continue to believe that about 5% growth is the current long term estimate. As far as your second part of your question, we continue to believe that we will grow ahead of this 5% and we say that 6-8% is our long-term algorithm, we are continuing to be behind that. And in some years, like this one, we are growing double than the market because many of our activities are coming together in a brilliant way. So we are still confident our long term algorithm is pretty strong and pretty right.

Operator

Next question comes from the line of Steph Wissink from Jeffries.

Steph Wissink -- Jeffries -- Analyst

Hi, good morning everyone. Tracey, a question for you on the balance sheet. I'm wondering if you can talk about your comfort level with stretching the debt load -- what kind of leverage would you like to see over time in the model just thinking about your M&A capacity over the next couple of years? Thank you.

Tracey Travis -- Executive Vice President and Chief Financial Officer

Sure. We feel very comfortable where our balance sheet is. You all know we've been very prudent in terms of managing our balance sheet and biggest acquisition that we've done from an M&A standpoint was last year with Two Faced where we took on additional debt in order to fund that. We typically are in the 2-2.5 range in terms of leverage. That's a comfortable position for us to be, certainly to maintain our credit ratings. But we certainly have more capacity than that so we are not restrained at all from an M&A standpoint in terms of doing further acquisitions and given the strong free cash flow that we have, we certainly can fund all of the needs of the business. And certainly, we have our debt payments spread out in such a way that we can certainly manage the repayment of that with no problem whatsoever.

Operator

Your next question comes from the line of Jonathan Feeney from Consumer Edge Research.

Jonathan Feeney -- Consumer Edge Research -- Analyst

Good morning, thanks very much. Fabrizio, could you comment on maybe the economics equitality, particularly if I look at the Europe luxury business, or even the development of North America, it seems like a lot of the growth comes from -- I guess, maybe it's more simpler, how does the development of your lux portfolio relate to what's going on economically? What happens when the economy slows down, how has beauty changed in the past ten years or not changed that makes the economy drive that high into the business? Thank you.

Fabrizio Freda -- President and Chief Executive Officer

So obviously the global economy overall is stronger this year and this benefits our high end part of the portfolio. But what benefits even more our high end part of the portfolio is the growing consumption in Asia. Asia among the various region is the most oriented to the high end of our portfolios. So brands like Tom Ford or La Mer are doing very, very well there. The new high end fragrance portfolio that we have recently developed, which includes again Jo Malone, Tom Ford, Le Labo, those brands have huge potential in the region at the high end. And so we believe this will continue -- Asia economically is on a roll and we counter that in the past years, which is also the other part of your question. What happened is when there was an economic crisis or economic cycle, actually what suffered the most if the entry price point of the portfolio, not the high end. The high end part of the portfolio is the most resilient because even during economic health cycles the wealthier part of the population tends to be the one that suffered the least so that's the reality. So we believe that the fact that the high end of our portfolio is solid increasing and becoming bigger is actually an element that overtime will mitigate poor activity in our results.

Operator

Your next question comes from the line of Dara Mohsenian from Morgan Stanley.

Dara Mohsenian -- Morgan Stanley -- Analyst

Thanks and good morning guys. So Fabrizio, clearly you're delivering substantial upside to your long term topline algorithm this year. I was hoping you could just take a step back and discuss two of the key drivers behind that in terms of China and travel retail, you gave a bit of detail in your answer to Mark's question but: A. just to review what drove the greater than expected growth in those areas this year, B. have your long term expectations changed at all looking out over the next few years in those areas with the outperformance? And then C., is there risk you could see an abrupt deceleration in fiscal 2019 with the difficult comparisons, etc.?

Fabrizio Freda -- President and Chief Executive Officer

First of all, there are several factors, which are behind this acceleration. Let me mention at least some of which are among the most important. The first one is the fact that we are winning again over our big brands, and particularly our Estee Lauder brand, which is really growing at a strong double digit everywhere in the world. So this proves that the big brands -- when big brands make the necessary changes and speak the language of the new generations and tailor like this a lot of the brand is done by region their activity in a brilliant way. Big brands are still a stronger proposition than small brands because big brands have the tools in terms of money to spend, money to invest, huger talent, global reach, level off consumption, level of awareness with the consumers.

When you do the right thing, this becomes immediately impactful and I think the story behind our other brand shows that when we do good things they become fast, very fast, they're becoming tactful on the business. And that's very positive news for us and that's a big change. This is what was at a certain moment in economics mix capital years ago. The second -- and by the way this is sustainable, now our opinion actually could get better, stronger, with time. The second driver has been Asia, and in particular China.

Now in China, what's happening is very interesting, what's happening is that the social media reality is making the awareness of these beautiful brands innovation propositions idea in the conversation with a consumer is getting to a large majority of the population because social media is very popular. So the conversation goes on in 600 cities, 700 cities, but the physical distribution is actually today below the brand, which is the most distributed, is 117 cities. So there are hundreds of cities where there is awareness, there is demand, there is desire, and there is no physical distribution. And these hundreds of cities the people can buy it online or during their travel, their travel within China, or their travel outside of China. And that is a big implication of the great results we're seeing on Tmall, on our brands.com, in the travel within China of Chinese consumer and obviously in travel retail. This other thing, which is happening in China, which is sustainable, is China's been for years mainly driven by skincare. And this is continuing -- actually, it's accelerating. But importantly, is also driven by makeup [inaudible] [00:47:32] accelerations so our portfolio now pleasing China is leveraging its scale at full, while in the past was mainly a skincare discussion. That's another big change that's here to stay.

And finally, the quality of our execution. We have an extraordinary China team that's done an amazing job in China. And so the quality of our execution with our team in china is second to none and we believe this is a lot that is behind our success there. The other driver is travel retail. Travel retail is working -- we are today the market leader in the combination of skincare makeup that we call beauty and with the recent activation of the fragrance business, which is huge in travel retail, we chose an inch, meaning we are now the leaders in what we call the high luxury artisanal fragrance, which includes brands like Jo Malone, Tom Ford, or some of the new acquisition, and we have chosen really to leverage that piece of the fragrance market we believe that's where a lot of the future is. And we are making great roads there. So very solid. Our position is very solid. And we believe the trend of growth will continue to be there, so this is another strong driver. And yes, globally, is a good driver globally. Now the reason behind this driver is the many of the emerging market consumers -- well beyond Chinese, Russians, Brazilians, Middle Easterns, are among the biggest purchasers in travel retail so our investments on our brands in these market of origins of the travel is what really makes the difference.

And again, we have an amazing travel retail team that is learning better and better how to convert travelers into purchasers at the airport. And so this combination of investing in the market origins and learning how to convert in airport is really working for us and we believe we'll be another strong divest for the long term. So we feel comfortable that this will continue. Now, said this, you were asking about '19, '20, the future. Obviously, the base period has become stronger and stronger so we need to imagine even in this strong drivers, we imagine a certain normal relation of the trends. But even in think you have a normalization of the trends, we still believe there will be a lot of exciting growth opportunities.

Operator

Your next question comes from Wendy Nicholson from Citi Investment Research.

Wendy Nicholson -- Citi Investment Research -- Analyst

Hi, first thing on the product claims issue that you disclosed. It surprises me -- number one it just seems so un-Estee Lauder like. So does it reflect anything internally? Are you growing too fast? Do you feel like you've got the same level of control and corporate culture that you've always had? And what's the risk associated with that? I mean, I can't imagine consumers will care all that much but it's interesting to me that you called it out so specifically. So do you perceive any risk either in terms of your market share or sale trends or anything like that? Or any litigation associated with it? So that's question number one. And then question number two, I heard what you just said Fabrizio in terms of the Lauder brand and the investments you've made and how when you love a brand it grows, but I'm still just struck by the slow down in the U.S. market. With all the incremental distribution in Ulta, with the strength in online, your U.S. department store business is it down double digits? Is it down mid-single digits? It surprises me that that business isn't responding better to the stuff you're doing behind MAC and Clinique and Estee Lauder. So if you can just address the U.S. department store business and maybe your outlook for that going forward, that'd be great. Thanks.

Tracey Travis -- Executive Vice President and Chief Financial Officer

So Wendy let me start with your question on what we've included as it relates to the review of the product claim -- the advertising product claim issue in our estimates. So clearly, I said in my prepared remarks that we're being prudent in the full year estimate in the fourth quarter as we are doing a review of the situation and making sure that as we look at some of the claims on some of our products to the extent that we have to do retesting, we are in fact doing that retesting and we're doing it in an accelerated way. And so that certainly is incorporated into our Q4 expectations. There are some communication vehicles such as websites that have to change to the extent that we can't prove a claim and to your point, we don't know at this point that these are -- how many of the claims are impacted, we don't think there are that many, but we don't know. So we've prepared ourselves at least in the estimate to be able to address this entire situation as quickly as possible, and we have advisory fees, etc. We certainly do not have any costs in the estimate related to any legal activity from this as you indicated.

Fabrizio Freda -- President and Chief Executive Officer

So to continue on that on the first questions. Obviously you're right, this is definitely not typical of Estee Lauder and that's why as soon as we learned that we decided to act on it with first of all, maximum transparency and maximum speed. We have decided to analyze the situation, retest, and invest. Retesting everything. Everything we have to retest to validate our test, our advertising claims. And in the cases where there will be a minor change to do or a more serious change to do, we will do it immediately in transparency, communicating with our retailers, consumers, and everyone, and we'll take care of that. Second thing we have decided to do is to invest into improving our processes in that area first of all. And to be clear, as I said in my prepared remarks, we already fixed it so everything we are doing from now on is under control and we've invested in fixing it immediately.

Operator

Your next question comes from the line of Jason English from Goldman Sachs.

Jason English -- Goldman Sachs -- Analyst

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

Tracey Travis -- Executive Vice President and Chief Financial Officer

Jason, can you hold on a second? Fabrizio is still finishing his response to Wendy.

Jason English -- Goldman Sachs -- Analyst

Oh, sorry, yeah, I'll go mute.

Fabrizio Freda -- President and Chief Executive Officer

Sorry, I'll give you the word in a second, Jason. So we are addressing every other aspect in checking for quality in everything we do and we are further strengthening every one of our processes. So we are acting on it fast, transparently, and making sure the while work is happening is not in line with our standards. I want to make sure that our reaction to what happened is fully in line with our standards and with our integrity. That's what we've done. Now, the last part of your question here was the risks. As we say, we don't know yet how much of this will be dangerous -- as Tracey said, we have put all the input of our actions into our estimate in terms of the internal business in a broader sense, we don't know yet, but we will know soon and as we know we will decide if this is happening or not on our own results. On your other question, very fast, in all the United States -- the situation in the United States -- we are very successful in our new distribution. We continue to win online, as I explained in my prepared remarks, also in department stores we are doing fantastic in specialty multi. Our brands are growing there. The Estee Lauder brand, by the way, in the United States is very strong and growing all their own. But particularly, [inaudible] [00:56:14] brand exposure to the brick-and-mortar department store in percentage of the business is still so big that is very difficult to upset that decline with the growth of online and specialty for the time being. But this will change, it is changing, and things like the closure of Bon-Ton, we actually rate this change. Bon-Ton was more than $50 million in the past. These kind of changes are significant, we need to recall this business in the other channels. Jason, back to you.

Jason English -- Goldman Sachs -- Analyst

Are we good? Am I still here? Excellent, OK, thank you. I guess I want to come back to the question on global category growth. If we rewind the clock the last couple of years has been a lot of consternation around potential market fragmentation, the rise of indie brands, the shift to online, shift to especially multi where there's just clearly more brand assortment and more risk of brand fragmentation. But if we look at results from you, it was solid 13% LBMH perfume, cosmetics, and 17% L'Oreal lux 14%, PG's SK2 on fire also. Either your market growth rate -- either you're materially understating the market growth rate or in a much beady super cycle than the 6-7% range suggests. Or we're in a period where this fragmentation is gone entirely the other way and we're concentrating growth with the mega brands. Can you weigh in -- I mean clearly you have a view of which side we're at and that's a concentration of growth behind mega brands. if that's the case, what's driving it, where are the losers, what's causing this rise of indie brands to maybe stall out and go the other way?

Fabrizio Freda -- President and Chief Executive Officer

Jason, thank you for the question. I talked to that in the past, I don't know if you remember. But first of all, I believe we are in your7 second cant, the growth is 6-7%, that's what your monitor is publishing and that's what we believe is happening. But it's obviously very special goal. I don't know many other consumer markets, which are growing 6-7% so definitely we are in a booming of this industry. The fact that particularly luxury cosmetics are driving, which means the first thing that is happening is consumers are trading up over time so the growth of the luxury part is much stronger than the mass. Now this is true since 10 years by now and we are driving it. And the big companies that you mention including ourselves are all driving that [inaudible] [00:58:55] with good innovation, great service -- but what's happening particularly in this new world of social media consumers are interested not only in the product as a commodity but in the how to use the product in the service attached to it, in the creativity attached to it, in the case of makeup in the artistry that comes with it in the cases compare in the new learning and new habit to do what the previous generation didn't know how to do like the mask booming around the world. So there is a lot driven by novelty, and a lot driven by what the companies are doing in innovation, they're creating a market.

And then finally, there is all this growth in Asia and Asia consumers that are avid consumers of luxury beauty and they are now getting wealthier and so they have better access. And finally, it's the access. Luxury beauty is it a click or distance from any consumer around the world. In the past, people had to go to destination store, take the care, go there. So there is a reason why this market is growing strongly. Now why the big companies are growing so much better than the market, including Estee Lauder companies? Is because at the end what really makes the market growth is repurchase, is not trial. What is happening is the big competition of the many small brands is people try the product the first time because of the novelty but there is no consumer that buy the second time the product unless was happy with that product. So what we see in our brand that while our trial game has become more competitive and is in a way more expensive to do, the repurchase game is still driven by product quality. Our repurchase numbers are going up despite increased competition. So the big brands -- the successful brands where product quality, great performance in the long term are winning, are driving repurchase rates. And that's the reason why companies with strong brands, with strong research and development, with strong formulation capabilities, with strong product quality, have a chance to continue winning even in this more competitive environment in the future.

Operator

Your next question comes from the line of Bonnie Herzog from Wells Fargo.

Bonnie Herzog -- Wells Fargo -- Analyst

Thank you, good morning. I have a bit of a follow up question, the slow down in growth of your makeup artist brands. You've stepped up spending, so curious if you're starting to see a lift from the increased spend. For instance, did things improve for some of these brands by the end of the quarter and then into April? And then I have a question on skincare. It's very encouraging that you're seeing the pickup in demand among younger consumers that you mention, but curious to hear what your outlook is for this trend and how sustainable it is? And then finally, how do you think about the interplay of the two categories for this demographic and if you believe they can both accelerate -- or is there risk that it's just for makeup to skincare could become more pronounced? Thanks.

Tracey Travis -- Executive Vice President and Chief Financial Officer

So let me start with makeup. Just to remind you that in the first half of the year we had non-comp growth in our makeup category so Two Faced and Becca obviously were in our results this year and not in the results the prior year so in terms of what we're seeing now given some of the investments that we're making. We are very recently seeing a slight pickup in a couple of the makeup artist brands and we are very encouraged by the strategies and some of the product launches. In particular, Bobbi Brown with the new foundation launch, and other brands as well. So we are encouraged that we will see growth but clearly if you look just from a total category standpoint, skincare is growing faster than makeup. So not just for us. but certainly for the category globally and in different markets. And then in the interplay between skincare and makeup, Fabrizio?

Fabrizio Freda -- President and Chief Executive Officer

Yeah, the interplay is -- what happened in the last years, as you obviously have seen, is that the social media input in terms of the [inaudible] [01:03:31] social media communications, social media input started from makeup. And makeup has been driven and accelerated by this social media phenomena for a couple of years. Now, it's happening also on skincare. Still a lower level than makeup but it's starting to happen more intensely also skincare. That's what's behind the acceleration of skincare. And at the same time, some consumers start understanding that good skincare just to take care of the canvas before you put the makeup on your face is a great practice and make even your makeup work better. So skincare is not an alternative to makeup in my opinion, but it's just preparing the canvas in a completely different way. At the moment, social media start clarifying this opportunity particularly to young women. We see a boom of skincare. Interestingly, the boom of skincare, or the acceleration of skincare, is mainly about younger people, particularly in Asia. So it's not anti-aging which is accelerating, it's really the skincare for natural benefit for preparing the canvas. Skincare's a base to makeup, so the skincare, which is complimentary to great makeup, results.

Operator

The last question comes to us from Rupesh Parikh from Oppenheimer.

Rupesh Parikh -- Oppenheimer -- Analyst

Good morning, thanks for fitting me in. I just wanted to go back to your commentary on mid-tier department store challenges in the U.S. as you look at your remaining exposure there, how much would you say of your remaining base is still at risk? And as we look forward with the Bon-Ton headwind that appears to be going on right now and may I guess linger into next year, how do you think about recapture rates when these department stores close down?

Fabrizio Freda -- President and Chief Executive Officer

So we had a lot of closures of department stores in brick-and-mortar. Now we have some Macy's closures last year, we had Sears in Canada, we had Bon-Ton now. We assume that the reduction of number of stores in brick-and-mortar will continue. We believe this will be for us in the short term a negative impact, but in the long term this could be actually positive impact because the brick-and-mortar will need to improve the experiential part of retail which is here to stay and in my opinion is to be very successful over the medium long term. So we are working to improve the experiential quality of the strong brick-and-mortar in physical retail and at the same time we are focusing on leverage in the fast acceleration of online across every retailer partner and this is working. So what would be the input? As I said, depending by brand, from some of our brands we chart overexpose the two brick-and-mortar, department stores particularly. In the country, we expect that this transition will take some time, it's taking some time. Particularly in prices of closures, like the Bon-Ton situation now. With other brands, which are more thought with those specialty online the way they started, this will not be the case. And depending on how different brands will do the mix, we'll add an input. But as I said, I believe that we are in front in the future we are going to study, analyze, and then to restart growth also in the United States. The moment that balances by physical and online distribution and by destination store, experiential stores, will be adjusted. I personally believe this will be a very booming and interesting retailing market at the end of this transition.

Operator

That concludes today's question and answer session. If you were unable to join for the entire call, want to play it back, it'll be available by 1 p.m. Eastern Standard Time today through May 16th. To hear a recording of the call, please dial 855-859-2056, passcode #9948347. That concludes today's Estee Lauder conference call. I would like to thank you for your participation and wish you all a good day.

Duration: 68 minutes

Call participants:

Fabrizio Freda -- President and Chief Executive Officer

Dennis D'Andrea -- Vice President of Investor Relations

Tracey Travis -- Executive Vice President and Chief Financial Officer

Lauren Lieberman -- Unknown Analyst

Michael Benetti -- Credit Suisse -- Analyst

Mark Astrachan -- Stifel Nicolaus -- Analyst

Steph Wissink -- Jeffries -- Analyst

Dara Mohsenian -- Morgan Stanley -- Analyst

Wendy Nicholson -- Citi Investment Research -- Analyst

Jason English -- Goldman Sachs -- Analyst

Bonnie Herzog -- Wells Fargo -- Analyst

Rupesh Parikh -- Oppenheimer -- Analyst

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