Business context and reporting period
The Estée Lauder Companies Inc. filed this unaudited Form 10-Q for the quarter ended December 31, 2014, the second quarter of fiscal 2015. It manufactures and sells skin care, makeup, fragrance and hair care products in more than 150 countries and territories. The filing compares the three- and six-month periods ended December 31, 2014 with the corresponding prior-year periods.
Financial performance and position
| Metric | Quarter ended Dec. 31, 2014 | Six months ended Dec. 31, 2014 |
|---|---|---|
| Net sales | $3,044.5 million; up 1% | $5,675.5 million; down less than 1% |
| Gross profit / margin | $2,471.4 million / 81.2% | $4,565.8 million / 80.4% |
| Operating income / margin | $632.8 million / 20.8% | $980.8 million / 17.3% |
| Net earnings attributable to Estée Lauder | $435.7 million | $663.8 million |
| Diluted EPS | $1.13 | $1.71 |
| Effective income tax rate | 29.6% | 30.3% |
For the quarter, attributable earnings increased 1% and diluted EPS rose 3% from $1.09. For the six months, attributable earnings fell 9% and diluted EPS fell 8% from $1.86. Quarterly gross margin improved from 80.7%, but operating margin declined from 21.7%, principally as operating expenses rose as a share of sales. For the six-month period, gross margin improved from 80.2%, while operating margin declined from 19.4%.
Six-month cash provided by operations was $993.7 million, compared with $782.4 million. Investing used $790.9 million, including purchases of investments and acquisition spending; financing used $568.1 million, including $478.6 million of treasury-stock purchases and $168.9 million of dividends paid. Cash and cash equivalents were $1,241.2 million at December 31, 2014, down from $1,629.1 million at June 30, 2014. Available-for-sale investments totaled $512.9 million.
Total debt was $1,389.2 million ($68.5 million current and $1,320.7 million long-term), versus $1,343.1 million at June 30, 2014. No borrowings were outstanding under the $1.0 billion revolving credit facility at quarter-end; $50.0 million of commercial paper was outstanding. Management said cash, operating cash flow, available credit and access to capital markets should support planned operations and obligations. Total debt was 27% of total capitalization, excluding noncontrolling interests.
Material changes versus the prior comparable period
- Quarterly reported sales edged higher; excluding currency translation, they increased 5%. Makeup sales rose 4% and skin care 1%, while fragrance declined 8%. Europe, the Middle East and Africa and the Americas grew; Asia/Pacific declined.
- For the six months, reported sales were nearly flat, while sales excluding currency translation increased 2%. Makeup and hair care grew; skin care and fragrance declined. The Americas and Asia/Pacific declined, while Europe, the Middle East and Africa grew.
- Retailers had moved approximately $178 million of orders into fiscal 2014’s fourth quarter ahead of the July 2014 Strategic Modernization Initiative rollout. Management estimates this timing reduced the current six-month comparison by $178 million in sales and $127 million in operating income. Excluding the accelerated orders, management reported adjusted sales growth of 3%, adjusted operating income growth of approximately 0%, and adjusted diluted EPS of $1.93, up 4%. These are company-defined non-GAAP measures.
- Quarterly operating expenses increased 1.3 percentage points as a share of sales, mainly from capability-building costs and store expansion, partly offset by lower advertising, merchandising and sampling as a share of sales. Over six months, higher general and administrative, selling and shipping, and store costs were major contributors to expense pressure.
- Foreign currency was a significant headwind to reported results. Six-month translation adjustments were a $234.6 million loss in other comprehensive income; management also cited U.S. dollar strength and weakness in currencies including the yen, ruble and Venezuelan bolívar.
Outlook, management commentary, risks and unusual items
The filing provides no specific numeric sales or earnings guidance. Management described a long-term strategy through fiscal 2017 focused on brand development, product innovation, digital and e-commerce, geographic and channel expansion, travel retail, productivity and selective acquisitions. It cited growth from makeup artist and luxury brands and online, specialty multi-brand and freestanding retail channels, while noting challenges among some heritage brands.
Management remained cautious about slower growth in Hong Kong and China, weaker spending by Chinese, Russian and Brazilian travelers, political instability in Hong Kong, increased sanctions in Russia, and unfavorable foreign exchange. It warned that worsening or prolonged economic uncertainty could weaken consumer confidence, demand and spending. Other disclosed risks include competition, retailer destocking and consolidation, product-launch execution, consumer and channel shifts, currency movements, acquisition integration, information-system implementation and supply-chain disruption.
Le Labo and RODIN olio lusso were acquired during the first half; their combined acquisition-date fair value, net of cash acquired, was approximately $146 million. The company also acquired Editions de Parfums Frederic Malle and GLAMGLOW in January 2015, after quarter-end; their combined acquisition-date fair value, net of cash acquired, was approximately $295 million. These acquisitions include future payments, some contingent on operating results. The company also changed its cash investment strategy and held $512.9 million of available-for-sale investments at December 31.
Management said current litigation is not expected to have a material adverse effect and reasonably possible additional losses are not material. Gross unrecognized tax benefits were $69.6 million; the company did not expect significant changes to that amount in the next 12 months. Disclosure controls were reported effective at December 31, 2014.
Important facts for investors to verify
- Assess the SMI accelerated-order adjustment and the company’s non-GAAP comparisons against reported results, including the extent to which the timing effect explains the six-month decline.
- Track sales, margins and profitability by product category and region, particularly heritage brands, fragrance, the Americas, Hong Kong and China.
- Separate underlying performance from foreign-exchange effects and monitor the impact of further currency movements on sales, earnings and accumulated other comprehensive income.
- Review acquisition integration, contingent consideration and the effect of the January 2015 acquisitions on future results and cash needs.
- Monitor operating-expense growth, cash conversion, investment purchases, share repurchases, dividends and debt levels against management’s liquidity assessment.