Business context and reporting period
The Estée Lauder Companies Inc. manufactures and sells prestige beauty products across skin care, makeup, fragrance and hair care in more than 150 countries and territories. This unaudited Form 10-Q covers the fiscal quarter and six months ended December 31, 2013; comparisons are with the corresponding periods ended December 31, 2012. Amounts are in U.S. dollars.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $3,018.7 million, up 3% | $5,693.7 million, up 4% |
| Gross profit / margin | $2,437.1 million / 80.7% (prior 80.6%) | $4,568.0 million / 80.2% (prior 79.8%) |
| Operating income / margin | $656.3 million / 21.7% (prior 22.3%) | $1,105.8 million / 19.4% (prior 20.7%) |
| Net earnings attributable to Estée Lauder | $432.5 million, down 3% | $733.2 million, down 2% |
| Diluted EPS | $1.09 (prior $1.13) | $1.86 (prior $1.89) |
| Operating cash flow | Not separately presented for the quarter | $782.4 million (prior $655.1 million) |
Quarterly net sales growth was 4% excluding foreign currency effects; six-month growth was 5% on that basis. Quarterly diluted EPS fell 4%, and six-month diluted EPS fell 2%. Net interest expense declined to $12.4 million for the quarter and $25.9 million for the six months.
For the quarter, makeup sales rose 8% and fragrance 4%, while skin care declined 1%. By region, the Americas grew 5% and Europe, the Middle East and Africa (EMEA) 7%; Asia/Pacific declined 6%. For the six months, all major product categories grew; EMEA and the Americas led regional growth, while Asia/Pacific sales were nearly flat.
Cash, debt and liquidity
At December 31, 2013, cash and cash equivalents were $1,748.0 million, compared with $1,495.7 million at June 30, 2013. Current assets were $4,925.6 million and current liabilities $2,039.1 million. Total debt was $1,338.8 million, including $15.9 million current debt; debt as a share of total capitalization was 26%, down from 29% at June 30. The company had no commercial paper outstanding and no borrowings under its $1.0 billion revolving credit facility. It reported compliance with debt covenants.
Six-month operating cash flow was $782.4 million; investing cash outflow was $226.7 million, including $216.9 million of capital expenditures; financing cash outflow was $303.1 million. Cash increased by $252.3 million. Management said cash, operating cash generation, credit facilities and access to capital markets should be adequate for planned operations and obligations.
Material changes and unusual items
Comparisons are affected by approximately $94 million of retailer orders accelerated into the prior-year second quarter ahead of a Strategic Modernization Initiative (SMI) rollout; management estimated those orders contributed approximately $78 million to prior-year operating results. Excluding that timing effect, management reported second-quarter sales growth of 6% and operating income growth of 11%, excluding restructuring adjustments. For the six months, sales growth excluding accelerated orders was 6%; operating income growth was 3% excluding the order timing and restructuring effects.
Operating expenses rose as a percentage of sales, reflecting planned advertising and launch investment, foreign-exchange transaction effects, stock compensation and other costs. These pressures were partly offset by lower restructuring charges and improved gross margin. The prior-year comparison also included $21.3 million of other income in the quarter ($23.1 million for the six months), primarily from an amended Rodan + Fields sale agreement, and $19.1 million of debt-extinguishment expense in the prior-year six-month period.
Outlook, risks and contingencies
The filing provides strategic commentary, but no quantified full-year sales or earnings guidance. Management plans to continue investing in product innovation, digital capabilities, research and development, and retail experiences, and expects the final major SMI rollout wave in certain locations in July 2014. Retailers may accelerate orders into fiscal 2014’s fourth quarter ahead of that rollout, potentially affecting comparisons.
Management cited weakness in some European countries and Korea, competitive pressure in Korea, uncertainty in U.S. retail, unfavorable currencies in some emerging markets, slower near-term growth in China and Hong Kong, and Chinese government actions affecting travel and spending. Venezuela introduced a profit-margin cap in January 2014; the company was evaluating its impact. Venezuela represented less than 1% of six-month sales and about 2% of operating income; a hypothetical further 45% currency devaluation could produce an estimated $20 million after-tax remeasurement loss based on period-end net assets.
The company is appealing a French court judgment in the Darphin dispute. It had paid €25.3 million under the judgment and maintains an accrual it believes reflects the probable outcome; appeal arguments were scheduled for June 2014. Management stated that other current litigation was not expected to have a material adverse effect, while noting outcomes could differ from its assessment. The Spanish tax-deduction dispute was resolved against the company without a material financial-statement impact. Management also said a $5 million to $10 million decrease in unrecognized tax benefits was reasonably possible within 12 months.
Important facts for investors to verify
- Assess underlying growth and margins separately from the prior-year $94 million SMI-related order acceleration and its estimated $78 million operating-results effect.
- Track investment spending and operating-margin trends, particularly in skin care, fragrance and Asia/Pacific.
- Monitor China-related travel-retail demand, foreign exchange and the effects of Venezuela’s margin controls or any further devaluation.
- Review the Darphin appeal, tax exposures, and the timing and execution risks of the planned SMI rollout.
- Management reported effective disclosure controls as of December 31, 2013 and no material second-quarter change in internal control over financial reporting.