Business context and reporting period
The Estée Lauder Companies manufactures and sells prestige beauty products in more than 150 countries and territories. This Form 10-Q covers the fiscal third quarter and nine months ended March 31, 2017. The request metadata says “2016 Q3,” but the filing identifies the period as the quarter ended March 31, 2017.
Financial performance
Amounts below are in U.S. dollars; financial statement amounts are in millions except per-share data.
| Metric | Quarter ended Mar. 31, 2017 | Year-over-year | Nine months ended Mar. 31, 2017 | Year-over-year |
|---|---|---|---|---|
| Net sales | $2,857 | +8% (9% constant currency) | $8,930 | +4% (5% constant currency) |
| Gross margin | 79.3% | Down 1.7 percentage points | 79.6% | Down 1.0 percentage point |
| Operating income | $427 | +11% | $1,462 | Down $5 |
| Operating margin | 14.9% | Up 0.4 percentage point | 16.4% | Down 0.6 percentage point |
| Net earnings attributable to Estée Lauder | $298 | +12% | $1,020 | Down $1 |
| Diluted EPS | $0.80 | +13% | $2.74 | +1% |
Quarterly sales growth was broad-based except in hair care, led by makeup and fragrance. Nine-month sales rose in all regions; EMEA and Asia/Pacific operating income increased, while Americas operating income declined. Management attributed growth to brand performance, expanded consumer reach, online and travel-retail sales, and the Too Faced and BECCA acquisitions.
Operating cash flow for the nine months was $1,252, versus $1,316 a year earlier. Capital expenditures were $316. Investing cash outflow was $2,106, including $1,690 of net acquisition payments; financing provided $1,083, including $1,498 of net long-term debt proceeds. Cash and cash equivalents were $1,139 at March 31, up from $914 at June 30, 2016.
At March 31, current debt was $519 and long-term debt $3,377, for total debt of $3,896, versus $2,242 at June 30, 2016. Debt as a share of total capitalization rose to 49% from 39%. The company issued $1.5 billion of senior notes in February and had no borrowings under its $1.5 billion revolving credit facility. Management said cash, operating cash flow, investments, credit lines and capital-market access should support planned needs.
Material changes, outlook and risks
- Acquisitions: Too Faced was acquired for approximately $1.484 billion; BECCA was also acquired during the period. The acquisitions added substantial goodwill and intangible assets. Too Faced contributed approximately $87 million of quarterly sales and $100 million for the nine-month period.
- Margins and restructuring: Gross margin fell, reflecting business mix, obsolescence, currency, restructuring and acquisition-related costs, including a $10 million inventory step-up adjustment in the quarter. Leading Beauty Forward charges were $62 million for the quarter and $134 million for nine months. The company expects total pre-tax charges of $600–$700 million through fiscal 2021 and annual pre-tax net benefits of $200–$300 million after full implementation; a portion is expected to be reinvested in growth.
- Management commentary and risks: Management cited U.S. brick-and-mortar traffic declines, a strong dollar affecting tourism, competition, and economic and geopolitical uncertainty in certain markets. Other risks include consumer and channel shifts, retailer inventory management, foreign exchange, product launches, acquisitions and execution of restructuring and technology initiatives. No specific near-term earnings or sales guidance is provided in the supplied filing text.
- Controls: Disclosure controls were deemed ineffective at March 31 due to a previously reported material weakness in IT general controls over user access and program change management. Remediation was underway; management expected completion in fiscal 2017, subject to testing and validation.
- Contingencies: Management said current legal matters and reasonably possible additional losses were not material. Unrecognized tax benefits were $76 million; the company said $5–$10 million could decrease within 12 months.
Important facts for investors to verify
- How much reported growth reflects acquisitions and currency effects versus comparable underlying demand.
- Whether gross-margin pressure and Americas operating-income declines persist, and whether planned restructuring benefits are achieved after reinvestment.
- Integration, valuation and future performance of Too Faced and BECCA, including provisional purchase accounting and contingent obligations.
- Debt, interest expense and liquidity needs following the acquisition-related borrowing and note issuance.
- Whether the IT control material weakness is remediated and validated as planned.