The Estée Lauder Companies Inc. — Fiscal 2017 Second-Quarter Form 10-Q
Reporting period: Quarter and six months ended December 31, 2016. The company manufactures, markets and distributes prestige beauty products in more than 150 countries and territories. Results are unaudited and prepared under U.S. GAAP.
Financial performance
| Metric | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2016 |
|---|---|---|
| Net sales | $3.208 billion; +3% reported, +5% constant currency | $6.073 billion; +2% reported, +4% constant currency |
| Gross margin | 80.1%, versus 81.2% | 79.7%, versus 80.4% |
| Operating income / margin | $617 million / 19.2%; income down 2% | $1.035 billion / 17.0%; income down 4% |
| Net earnings attributable to the company | $428 million, versus $447 million | $722 million, versus $756 million |
| Diluted EPS | $1.15, versus $1.19 | $1.94, versus $2.00 |
For the six-month period, operating cash flow was $824 million, down from $962 million. Investing cash outflow was $1.727 billion, including $1.690 billion paid for acquired businesses; financing provided $1.270 billion, principally reflecting commercial paper issuance. Cash and cash equivalents were $1.262 billion at December 31, compared with $914 million at June 30.
Total debt was $4.033 billion, including $2.143 billion current debt and $1.890 billion long-term debt, versus $2.242 billion at June 30. Current debt included $1.821 billion of commercial paper and $303 million of senior notes due May 2017. The company had $413 million of short-term investments and $996 million of long-term investments. Current assets were $4.789 billion and current liabilities $4.458 billion. Debt was 52% of total capitalization, up from 39% at June 30.
Material changes and drivers
- Sales grew in all major product categories except hair care. Makeup and fragrance were notable growth contributors; hair care sales declined 8% in the quarter and 4% for six months.
- By region, quarterly sales increased in the Americas, EMEA and Asia/Pacific. Six-month sales declined 1% in the Americas but increased 3% in EMEA and 6% in Asia/Pacific. Travel retail and several luxury brands supported growth; U.S. department-store softness, Hong Kong weakness and unfavorable currency translation were headwinds.
- Reported operating results were pressured by lower gross margin, foreign exchange and higher restructuring charges. Excluding restructuring charges, operating income increased 1% for the quarter and was essentially flat for six months; constant-currency adjusted growth was 6% and 4%, respectively. These are non-GAAP measures.
- Interest expense rose to $22 million for the quarter and $43 million for six months, primarily due to higher short- and long-term debt.
Outlook, management commentary and risks
- The filing provides no specific near-term sales or EPS guidance. Management said liquidity from cash, operations, investments, credit facilities and capital markets should be adequate for planned operations, capital expenditures, acquisitions, dividends, repurchases and other obligations.
- The Leading Beauty Forward program is expected to generate $600–$700 million of pretax restructuring and other charges through its implementation, with annual pretax net benefits of $200–$300 million after full implementation; some savings are expected to be reinvested. The program is expected to be completed through fiscal 2021 and to reduce the workforce by approximately 900–1,200 positions.
- The company acquired Too Faced for approximately $1.484 billion on December 19, 2016 and acquired BECCA in November 2016. The purchase-price allocations remain provisional. Too Faced contributed approximately $13 million of sales and a $4 million after-tax loss, including acquisition-related costs, during the reported periods.
- Management cited competitive pressure, slow U.S. department-store traffic, a strong U.S. dollar and reduced tourist spending, Hong Kong retail softness, economic challenges in Brazil and the Middle East, Brexit uncertainty, and global security issues. It also noted risks from consumer and channel shifts, product launches, acquisitions, and currency and market volatility.
- Disclosure controls were not effective as of December 31 because of a previously reported material weakness in IT general controls over user access and program change management. Remediation was ongoing, with completion expected in fiscal 2017; management said the weakness would not be considered remediated until controls operated effectively for a sufficient period and testing confirmed this.
- Management said current litigation and reasonably possible additional losses were not material. The company reported $82 million of gross unrecognized tax benefits; it said $5–$10 million could decrease within 12 months from expected examinations or statute expirations.
Key facts for investors to verify
- Whether commercial paper maturing through March 2017, and the $303 million note due May 2017, are refinanced or repaid as intended.
- Progress, total costs and realized savings from Leading Beauty Forward against the stated estimates.
- Final acquisition valuations and the financial contribution and integration progress of Too Faced and BECCA.
- Remediation and testing of the IT-control material weakness, and any subsequent change in control effectiveness.
- Whether sales growth, margins and cash generation withstand currency, retail-traffic and consumer-spending pressures.