Business Context and Reporting Period
This Form 10-Q covers The Estée Lauder Companies Inc. for the quarterly period ended March 31, 2007 (Third Quarter of Fiscal 2007) and the nine months ended March 31, 2007. The Company manufactures, markets, and sells beauty products in skin care, makeup, fragrance, and hair care categories across over 130 countries. The reporting excludes the Stila brand, which was sold in April 2006 and is classified as discontinued operations.
Key Financial Metrics
| Metric (in millions) | 3 Months Ended Mar 31, 2007 | 3 Months Ended Mar 31, 2006 | 9 Months Ended Mar 31, 2007 | 9 Months Ended Mar 31, 2006 |
|---|---|---|---|---|
| Net Sales | $1,690.5 | $1,578.2 | $5,275.1 | $4,859.2 |
| Gross Profit | $1,264.5 | $1,166.7 | $3,922.0 | $3,569.7 |
| Operating Income | $156.7 | $116.3 | $589.0 | $472.1 |
| Net Earnings (Continuing Ops) | $93.8 | $63.2 | $360.3 | $275.4 |
| Diluted EPS (Continuing Ops) | $0.45 | $0.29 | $1.71 | $1.26 |
| Operating Cash Flow (9 Mo) | $450.6 (2007) vs $469.5 (2006) | |||
| Cash & Equivalents (Mar 31, 2007) | $202.0 | |||
| Total Debt (Mar 31, 2007) | $1,174.2 |
Margins (3 Months Ended Mar 31, 2007): Gross Margin was 74.8%; Operating Margin was 9.3%.
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 7% ($112.3M) for the quarter and 9% ($415.9M) for the nine months. Growth was driven by double-digit increases in Europe, Middle East & Africa (EMEA) and Asia/Pacific, offset by a 2% decline in the Americas due to retailer consolidation (Federated/May merger) and weakness at converted Macy's doors.
- Profitability: Operating income rose 35% for the quarter and 25% for the nine months. This improvement was aided by the absence of a $51.6M cost savings charge recorded in the prior year's quarter and improved gross margins (down to 25.2% of sales from 26.1%).
- Product Performance: Skin Care (+9%) and Makeup (+7%) sales grew, driven by new launches and international expansion. Fragrance sales declined 3% due to lower sales of legacy brands and difficult comparisons to prior-year launches. Hair Care sales surged 21% due to Aveda and Bumble and bumble growth.
- Discontinued Operations: The prior year included a $75.7M charge related to the sale of the Stila brand. The current period reflects only $0.3M of operating income from transitional services.
Guidance, Outlook, and Risks
- Share Repurchases: The Company executed an accelerated share repurchase program in March 2007, purchasing approximately 15.96 million shares for $750.0 million. As of March 31, 2007, 6.9 million shares remained available under the authorized program.
- Debt and Liquidity: Total debt increased to $1.17 billion, primarily due to commercial paper issued to fund share repurchases. In May 2007 (subsequent event), the Company issued $600 million in Senior Notes to refinance commercial paper. A new $750 million revolving credit facility was established in April 2007.
- Cost Savings: The cost savings initiative initiated in fiscal 2006 is substantially complete, with only $0.4M in additional charges incurred in the current nine-month period.
- Risks and Contingencies:
- Legal Proceedings: Ongoing litigation includes a consolidated class action regarding retail pricing (settlement pending appeal) and environmental liability regarding the Blydenburgh landfill. Management believes outcomes will not be materially adverse.
- Market Risks: Exposure to foreign currency fluctuations and interest rate changes is managed via hedging instruments. Retailer consolidation and competitive pressures in the U.S. remain key operational risks.
- Operational: Implementation of SAP systems at the Aveda manufacturing facility poses potential disruption risks.
Investor Verification Checklist
- U.S. Retailer Impact: Verify the extent of sales decline attributed to the Federated/May merger and the timeline for stabilization at converted Macy's locations.
- Debt Refinancing: Confirm the successful issuance of the $600 million Senior Notes in May 2007 and the reduction of commercial paper balances.
- Share Repurchase Settlement: Monitor the final settlement of the accelerated share repurchase program (expected by October 2007) to determine the final share count and price adjustment.
- Fragrance Category: Assess the sustainability of fragrance sales given the noted challenges in the U.S. market and reliance on international launches.
- Legal Accruals: Review the remaining accrual balance of $16.3 million for the retail pricing class action settlement and the status of the Blydenburgh landfill negotiations.