The Estée Lauder Companies Inc. — Form 10-Q
Reporting period: Quarter and six months ended December 31, 2010 (fiscal 2011). Comparisons are with the corresponding periods ended December 31, 2009. The company manufactures, markets, and distributes beauty products in more than 150 countries and territories.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $2,492.0 million, up 10% (11% constant currency) | $4,583.7 million, up 12% (13% constant currency) |
| Gross margin | 78.3%, versus 76.8% | 77.5%, versus 76.3% |
| Operating income and margin | $517.7 million; 20.8%, versus $399.6 million; 17.7% | $815.7 million; 17.8%, versus $620.0 million; 15.1% |
| Net earnings attributable to Estée Lauder | $343.9 million; diluted EPS $1.71, versus $256.2 million and $1.28 | $535.0 million; diluted EPS $2.67, versus $396.9 million and $1.99 |
| Net interest expense | $16.1 million, versus $19.9 million | $32.2 million, versus $39.5 million |
For the quarter, sales growth spanned all major product categories and regions. Skin care sales rose 14%, makeup 8%, fragrance 11%, and hair care 2%. For the six months, skin care rose 15%, makeup 9%, and fragrance 13%; hair care declined 1%. Europe, the Middle East and Africa and Asia/Pacific were important growth contributors. Management cited new product launches, travel retail, growth in China, favorable product mix, and cost savings.
Operating cash flow was $508.0 million for the six months, down from $616.9 million. Investing activities used $400.9 million, including $256.1 million for acquisitions and $144.8 million of capital expenditures. Financing activities used $199.4 million, including $173.0 million of treasury-stock purchases and $148.0 million of dividends. Cash declined to $1,043.1 million from $1,120.7 million at June 30, 2010.
At December 31, total debt was $1,231.1 million ($26.0 million current and $1,205.1 million long-term), approximately unchanged from $1,228.4 million at June 30. Debt was 34% of total capitalization, excluding noncontrolling interests, versus 39% at June 30. The $750 million revolving credit facility was undrawn; no commercial paper was outstanding. Management reported covenant compliance and a 14-to-1 interest coverage ratio under the revolving-credit agreement.
Material changes and notable items
- The July 1, 2010 acquisition of Smashbox added approximately $143.5 million of goodwill and intangible assets; acquisition-related cash outflow, net of cash acquired, was $256.1 million.
- Gross margin improved, primarily from product mix and manufacturing variances. Operating expense ratios also improved, reflecting cost containment and higher sales leverage, partly offset by greater advertising, merchandising, sampling, and stock-based compensation costs.
- Prior-year comparisons included $45.6 million of goodwill and intangible-asset impairment charges in the six-month period; there were no such charges in the current period. Restructuring-related charges were $19.3 million for the quarter versus $0.3 million, and $23.9 million for six months versus $42.6 million.
- Net income benefited from an $11 million, net-of-tax benefit related to completion of the IRS examination of fiscal 2006–2008; the quarter’s tax rate also benefited from reinstatement of the federal research and experimentation credit.
- The company terminated $250 million notional interest-rate swaps and received $47.4 million in settlement. The related debt fair-value adjustment will be amortized against interest expense over the remaining debt term.
Outlook, risks, and contingencies
No specific sales or earnings guidance for the full fiscal year is provided in the filing. Management said results exceeded expectations, but warned that global economic uncertainty remains. It expects restructuring and other program charges over the program’s life to total $350 million–$450 million before tax, and estimates savings of $625 million–$675 million through the program, including $560 million–$580 million through fiscal 2011. Management expects cash on hand, operating cash generation, credit facilities, and market access to support planned operations and commitments.
Management said it does not expect the unusually strong sales activity in EMEA tied partly to travel retail and customer purchases under its perfumery strategy to continue at the same level through the rest of the fiscal year. It also noted competitive pressures in fragrance, challenging economic conditions in some markets, foreign-exchange exposure, retailer destocking and credit risk, execution risks for product launches and acquisitions, and possible disruption from the SAP modernization and restructuring initiatives. Ojon goodwill and two trademarks had limited impairment headroom or fair values equal to carrying values; delays or underperformance in planned initiatives could lead to future impairment. Management believes current litigation is not expected to have a material adverse effect, while noting outcomes may differ from its assessment.
The largest customer represented 10% of quarterly sales and 12% of six-month sales. Management reported effective disclosure controls as of December 31, 2010 and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether sales growth, particularly in travel retail, China, and EMEA, is sustainable after the filing’s cautions about unusually strong activity.
- How much of earnings and margin improvement reflects recurring operations versus prior-year impairment comparisons, tax benefits, and restructuring effects.
- Whether operating cash flow recovers as receivables, inventory, and payment timing normalize, and how acquisition spending and shareholder returns affect cash.
- Progress against restructuring savings and charges, and the performance and integration of Smashbox.
- Ojon and trademark impairment assumptions, foreign-exchange exposure, and the effect of market and retail-channel risks.