Business context and reporting period
The filing is The Estée Lauder Companies Inc.’s unaudited Form 10-Q for the quarter ended March 31, 2018, the third quarter of fiscal 2018. The company sells skin care, makeup, fragrance and hair care products in more than 150 countries and territories. Comparisons below are with the prior-year period.
Financial performance
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $3.370 billion, up 18% reported and 13% in constant currency | $10.388 billion, up 16% reported and 13% in constant currency |
| Gross margin | 79.7%, versus 79.3% | 79.3%, versus 79.6% |
| Operating income / margin | $497 million / 14.7%, versus $427 million / 14.9% | $1.775 billion / 17.1%, versus $1.462 billion / 16.4% |
| Net earnings attributable to Estée Lauder | $372 million, versus $298 million | $922 million, versus $1.020 billion |
| Diluted EPS | $0.99, versus $0.80 | $2.45, versus $2.74 |
For the quarter, adjusted operating income rose 21% and adjusted diluted EPS rose 30%, excluding specified restructuring, contingent-consideration and tax items. For the nine months, those adjusted measures increased 24% and 31%, respectively. These are non-GAAP measures; the filing provides reconciliations.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $1.931 billion, up from $1.252 billion. The company attributed the increase partly to higher earnings before tax, accrued liabilities and favorable accounts-payable changes.
- Investing cash outflow was $155 million, compared with $2.106 billion, largely reflecting the prior-year acquisitions of Too Faced and BECCA. Current-period capital expenditures were $368 million.
- Financing cash outflow was $822 million; it included $676 million of treasury-stock purchases and $407 million of dividends paid.
- Cash and cash equivalents were $2.140 billion at March 31, 2018, versus $1.136 billion at June 30, 2017; short-term investments were $384 million. Total debt was $3.659 billion, including $296 million current and $3.363 billion long-term.
- Management said cash, operating cash flow, investments, available credit and market access should be adequate for planned operations and commitments. Debt was 44% of total capitalization, compared with 45% at June 30, 2017.
Material changes and management commentary
- Quarterly growth was led by skin care, up 31% reported, and Asia/Pacific, up 38%; makeup grew 9% and fragrance 14%. Nine-month sales rose in all major product categories and regions. Travel retail, China and Hong Kong, digital and online channels, and new product launches were important growth drivers.
- Makeup operating income fell 38% for the quarter and 9% for the nine months, reflecting weaker results at several brands and increased digital and social-media investment. The Americas operating income declined 62% for the quarter, while Europe/Middle East/Africa and Asia/Pacific increased.
- Quarterly operating margin eased despite higher gross margin, as restructuring charges and increased advertising and promotional spending weighed on results. Nine-month operating margin improved, supported by lower operating expenses as a share of sales.
- The fiscal 2018 nine-month effective tax rate was 46.0%, versus 27.2%, principally due to provisional Tax Cuts and Jobs Act (TCJA) items, including a $332 million transition-tax charge. The quarter’s effective tax rate was 22.1%, versus 26.3%. TCJA accounting remains provisional and may be adjusted during the measurement period ending December 22, 2018.
Outlook, risks and unusual items
- No specific near-term sales or earnings guidance is provided in the supplied filing text. Under its Leading Beauty Forward restructuring program, the company expects total pretax charges of $600–$700 million and annual pretax net benefits of $200–$300 million after full implementation; it expects to reinvest part of the savings. Initiatives are planned through fiscal 2019, with completion expected through fiscal 2021.
- Management cited competition, weaker U.S. brick-and-mortar traffic, foreign-exchange and tourism exposure, economic and political uncertainty, tariffs and other regulatory matters as risks. It also highlighted possible impairment risk for Editions de Parfums Frédéric Malle and for acquired Too Faced and BECCA if their outlooks weaken.
- The company is reviewing testing supporting certain product advertising claims; some claims will be modified. It said this is not a product-safety or product-quality issue, but the review is ongoing, potential materiality is unknown, and litigation or regulatory proceedings are possible. No accrual was recorded.
- Management said current litigation and reasonably possible additional losses were not material. The company also disclosed foreign-exchange and interest-rate exposures and uses derivatives for risk management, not trading.
Important facts for investors to verify
- Whether provisional TCJA tax charges and deferred-tax measurements change, and the resulting effect on future earnings and cash taxes.
- Whether strong growth in skin care, travel retail and Asia/Pacific is sustained, alongside continued weakness in U.S. retail traffic and selected makeup brands.
- Progress, remaining costs and realized savings from Leading Beauty Forward, including the extent to which savings are reinvested.
- Outcome and potential financial, legal or regulatory consequences of the advertising-claims review.
- Cash-flow quality, including the contribution from accrued liabilities and supplier payment terms, and the company’s debt, repurchases and dividend funding.