Business context and reporting period
The Estée Lauder Companies Inc. filed this unaudited Form 10-Q for the first quarter of fiscal 2018, the three months ended September 30, 2017. The company manufactures, markets and distributes prestige beauty products in more than 150 countries and territories. Comparisons are with the three months ended September 30, 2016, unless otherwise noted.
Financial performance and liquidity
- Revenue: Net sales rose 14% to $3.274 billion; management also reported 14% growth in constant currency. Makeup sales increased 18%, skin care 16%, fragrance 8%, and hair care was unchanged.
- Profit and margins: Gross profit was $2.563 billion; gross margin declined to 78.3% from 79.2%. Operating income increased 36% to $568 million, and operating margin rose to 17.3% from 14.6%. Net earnings attributable to Estee Lauder were $427 million, up 45%; diluted EPS was $1.14, up 44%. The effective tax rate fell to 21.7% from 26.6%.
- Cash flow: Operating cash flow was $93 million versus cash used of $150 million a year earlier. Investing activities provided $36 million versus $66 million used; financing activities provided $173 million versus $36 million used. Capital expenditures were $116 million, compared with $85 million. Cash and cash equivalents ended the quarter at $1.444 billion.
- Liquidity and debt: Current assets were $5.507 billion and current liabilities $3.142 billion. Cash plus short-term investments totaled $1.825 billion. Total debt was $3.935 billion, including $552 million current debt, versus $3.572 billion at June 30, 2017. Debt was 45% of total capitalization, unchanged from June 30. Commercial paper outstanding was $530 million at quarter-end and approximately $616 million on October 25.
- Shareholder returns: The company repurchased approximately 1.1 million Class A shares for $111 million and paid $126 million in dividends. The quarterly dividend declared was $0.34 per share; a subsequent $0.38 dividend was declared October 31.
Material changes versus the prior-year quarter
- Growth was broad-based by region: Europe, the Middle East and Africa sales rose 20%, Asia/Pacific 16%, and the Americas 8%. Travel retail and China were important growth drivers.
- Fiscal 2017 acquisitions Too Faced and BECCA contributed incremental sales, particularly to makeup and the Americas. In the Americas, U.S. sales excluding those acquisitions declined approximately $30 million.
- Gross margin fell 90 basis points, primarily reflecting acquired-business costs, including a $6 million Too Faced inventory step-up adjustment, and foreign exchange. Operating expense as a share of sales improved to 60.9% from 64.6%, supporting higher operating margin.
- Interest expense increased to $31 million from $21 million, which management attributed primarily to higher short- and long-term debt levels. Interest and investment income increased to $12 million from $6 million.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific full-year sales or earnings guidance. Management said cash, operating cash generation, investments, available credit and capital-market access should be adequate for planned operations and obligations.
- Leading Beauty Forward: The multi-year restructuring program is expected to incur $600–$700 million of pretax charges and generate $200–$300 million of annual pretax net benefits after full implementation, with some savings reinvested. Completion is expected through fiscal 2021; estimated net workforce reduction is 900–1,200 positions. Cumulative charges recorded through September 30 were $331 million; accrued restructuring charges were $143 million.
- Tax and other items: Adoption of share-based compensation accounting guidance reduced the quarter’s tax provision by $23 million (about 420 basis points); the change was applied prospectively. The reported earnings increase therefore includes a material tax benefit. The quarter also included $38 million of Leading Beauty Forward charges across cost of sales and operating expenses.
- Risks: Management cited U.S. brick-and-mortar traffic declines and changing shopping preferences, competition, foreign exchange and tourism exposure, and economic, political and geopolitical uncertainty, including conditions in Brazil and the Middle East and the U.K.’s anticipated EU exit. It also noted potential future impairment risk for Editions de Parfums Frédéric Malle goodwill and trademark if business conditions worsen.
- Contingencies and accounting: Management said current litigation was not expected to have a material adverse effect and reasonably possible additional losses were not material. The company expects the new lease standard to have a significant balance-sheet impact; it disclosed $2.427 billion of future minimum lease commitments at June 30, 2017.
Important facts for investors to verify
- How much of future earnings growth is supported by underlying sales and operating performance versus the $23 million share-based-compensation tax benefit and acquisition contributions.
- Whether gross-margin pressure from Too Faced, BECCA, foreign exchange and product mix persists, and whether expense savings are sustainable.
- Progress, remaining charges and realized savings under Leading Beauty Forward against management’s stated ranges and timeline.
- Working-capital and cash-flow trends, particularly receivables growth, capital spending and the increase in commercial paper and total debt.
- Exposure to U.S. retail weakness, travel retail and tourism, foreign exchange, and potential impairment of acquired or at-risk intangible assets.