The Estée Lauder Companies Inc. — Form 10-Q Summary
Business context and reporting period: The company manufactures and sells prestige skin care, makeup, fragrance and hair care products in more than 150 countries. This unaudited filing covers the three months ended September 30, 2016 (fiscal 2017 first quarter); comparisons are with the quarter ended September 30, 2015.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $2.865 billion | $2.835 billion | +1% reported; +2% constant currency |
| Gross profit / margin | $2.269 billion / 79.2% | $2.258 billion / 79.6% | Margin down 40 basis points |
| Operating income / margin | $418 million / 14.6% | $453 million / 16.0% | Down 8%; margin down 140 basis points |
| Net earnings attributable to Estée Lauder | $294 million | $309 million | Down 5% |
| Diluted EPS | $0.79 | $0.82 | Down 3% |
| Operating cash flow | $(150) million | $8 million | Declined $158 million |
Excluding $31 million of restructuring-related charges, operating income was $449 million, down 1% reported and up 1% in constant currency; adjusted diluted EPS was $0.84, up 3% (5% in constant currency). These are non-GAAP measures. The effective tax rate fell to 26.6% from 29.2%, reflecting lower tax rates on foreign operations and reduced tax reserves. Cash dividends declared were $0.30 per share, compared with $0.24.
Balance sheet, liquidity and capital allocation
- At September 30, 2016, cash and cash equivalents were $664 million, short-term investments $525 million, and long-term investments $1.050 billion. Cash was down from $914 million at June 30, 2016.
- Total debt was $2.500 billion: $592 million current and $1.908 billion long-term. Debt to total capitalization was 41%, versus 39% at June 30, primarily due to commercial paper issuance.
- Operating cash outflow reflected payment timing for accounts payable and accrued liabilities, higher inventory and lower earnings, partly offset by accounts receivable timing. Investing cash outflow was $66 million; financing cash outflow was $36 million. The company repurchased $222 million of shares and paid $111 million in dividends.
- In October 2016, the company expanded its commercial paper program to $1.5 billion and replaced its undrawn $1.0 billion revolving facility with a $1.5 billion facility expiring in October 2021, subject to extension terms. Management said available cash, investments, operating cash generation and credit access should support planned needs.
Material changes and operating trends
- Sales increased in fragrance, makeup, hair care and most regions, but declined in skin care and the Americas. Fragrance sales rose 7% reported (10% constant currency), led by Jo Malone London, Le Labo and By Kilian. Americas sales fell 3% reported (2% constant currency); Asia/Pacific rose 7% reported (5% constant currency), and Europe, the Middle East and Africa rose 3% reported (7% constant currency).
- Operating results were pressured by restructuring charges, unfavorable currency effects, lower makeup results and higher stock-based compensation and store operating costs. Makeup operating income declined 21%, mainly due to M·A·C; skin care operating income increased 12%.
- Management attributed U.S. weakness to reduced mid-tier department-store traffic and lower tourism affecting certain M·A·C stores. It cited continued softness in Hong Kong, distributor inventory rebalancing in the Middle East, and currency and macroeconomic headwinds. Online, travel retail and specialty multi-brand retail were areas of opportunity.
Outlook, risks and unusual items
- Leading Beauty Forward: The multiyear restructuring initiative is expected to incur $600 million–$700 million in total pretax charges and generate $200 million–$300 million in annual pretax net benefits after full implementation. Initiatives are expected to be completed through fiscal 2021; the company estimated a net reduction of approximately 900–1,200 positions. It expects to reinvest part of the savings in growth.
- No specific near-term sales or earnings guidance is provided in the supplied filing text. Management described a long-term growth strategy focused on innovation, emerging markets, digital engagement, channel expansion and efficiency.
- Key disclosed risks include competition, changing shopping preferences, retailer traffic and inventory practices, foreign exchange, tourism, macroeconomic and geopolitical uncertainty, product-launch execution, and the ability to realize restructuring and technology-program benefits. A 10% hypothetical strengthening of the U.S. dollar would reduce the derivative portfolio’s fair value by an estimated $15 million; this sensitivity excludes underlying exposures.
- The company reported a material weakness in internal control over financial reporting involving user-access and program-change-management controls for certain IT systems. Disclosure controls were therefore not effective as of September 30, 2016. Remediation was ongoing, with completion expected in fiscal 2017, subject to successful operation and testing of controls.
- Management said current litigation and reasonably possible additional losses were not material. Unrecognized tax benefits were $83 million; $10 million–$15 million could decrease within 12 months. In October 2016, the company signed an agreement to acquire the BECCA makeup brand; the filing text provides no purchase price.
Important facts for investors to verify
- Whether sales and margin trends improve, particularly in the Americas, skin care and makeup, and how currency and retail traffic affect results.
- Actual restructuring charges, timing, workforce effects and realization of Leading Beauty Forward’s projected annual benefits.
- Operating cash flow and working-capital movements, including receivables, inventory and payment timing; the quarter produced $150 million of operating cash outflow.
- Commercial paper refinancing, upcoming debt maturities and the company’s liquidity needs for repurchases, dividends and planned investments.
- Progress in remediating the disclosed material weakness and whether controls are ultimately tested and deemed effective.