Business context and reporting period
The Estée Lauder Companies Inc. filed this Form 10-K for the fiscal year ended June 30, 2016, covering its global prestige beauty business across skin care, makeup, fragrance and hair care. The request metadata says “2015 Q4,” but the filing is an FY2016 annual report; it also presents unaudited FY2016 fourth-quarter results.
The company sells products in more than 150 countries and territories through department stores, specialty retailers, salons, freestanding stores, e-commerce and travel retail. Its portfolio includes Estée Lauder, Clinique, M·A·C, La Mer, Jo Malone London and other owned or licensed brands.
Financial performance and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Net sales | $11.262 billion | $10.780 billion |
| Gross profit / gross margin | $9.081 billion / 80.6% | $8.680 billion / 80.5% |
| Operating income / operating margin | $1.610 billion / 14.3% | $1.606 billion / 14.9% |
| Net earnings attributable to the company | $1.115 billion | $1.089 billion |
| Diluted EPS | $2.96 | $2.82 |
| Cash from operating activities | $1.789 billion | $1.943 billion |
- Reported sales grew 4%; management reported 7% growth in constant currency after adjusting for the prior-year accelerated orders associated with the SMI rollout. Makeup sales rose 9% as reported; skin care declined 1%. Europe, the Middle East and Africa grew 7%, while Asia/Pacific sales decreased less than 1%.
- Gross margin improved 10 basis points, while operating margin fell 60 basis points. FY2016 operating income included $134.7 million of restructuring charges. Excluding those charges and the prior-year SMI order-timing benefit, operating income increased 1% and operating margin declined 30 basis points, according to the company’s non-GAAP reconciliation.
- FY2016 net earnings rose 2% and diluted EPS rose 5% as reported. Adjusted diluted EPS, excluding specified restructuring, SMI timing and Venezuela items, increased 5% to $3.20.
- Cash and cash equivalents were $914.1 million; short- and long-term investments totaled $1.577 billion. Current assets were $4.225 billion and current liabilities $2.681 billion. The company said approximately $2.002 billion of cash and investments was held offshore under its permanent-reinvestment strategy.
- Total debt was $2.242 billion, up from $1.625 billion; debt was 39% of total capitalization, versus 31% a year earlier. The company issued $450 million of 1.70% notes due 2021 and an additional $150 million of 4.375% notes due 2045. It reported no commercial paper or revolving-facility borrowings at year-end; the $1 billion revolving facility expires in 2020.
- Investing cash outflow was $1.269 billion and financing cash outflow was $604.9 million. Capital expenditures were $525.3 million; operating cash flow less capital expenditures was approximately $1.263 billion, calculated from the reported figures.
- FY2016 dividends declared were $1.14 per share, versus $0.92 in FY2015. The company repurchased approximately 9.9 million shares under its program for $835 million.
For FY2016 Q4, the filing reports net sales of $2.646 billion, operating income of $143.7 million, net earnings attributable to the company of $93.5 million and diluted EPS of $0.25. Q4 included $101.0 million of restructuring charges.
Material changes versus the prior year
- Reported sales increased $481.9 million, but the comparison benefited from $178.3 million of accelerated orders recorded in FY2015’s first quarter after the SMI rollout was advanced into FY2014’s fourth quarter. Foreign-currency translation was a material headwind; management estimated a $134 million adverse impact on FY2016 operating results.
- Makeup was the main reported sales growth driver, supported by M·A·C, Smashbox, Tom Ford, Clinique and Estée Lauder. Luxury fragrance brands and recent acquisitions also contributed. Skin care weakness was concentrated in Estée Lauder and Clinique and was affected by Hong Kong softness and lower travel-retail sales.
- Cash from operations fell $154.6 million, with management citing order-timing and working-capital comparisons, shipment and collection timing, and higher payments associated with new retail locations. Debt increased following the bond issuance; investment balances also rose as the company expanded its cash-investment strategy.
- The company acquired By Kilian and purchased a minority interest in Have & Be Co., associated with Dr. Jart+ and Do The Right Thing.
Outlook, risks and unusual items
- Leading Beauty Forward: The multi-year restructuring and efficiency initiative is expected to generate $600 million–$700 million in pretax charges through completion, with annual pretax net benefits of $200 million–$300 million after full implementation. Initiatives are expected to be completed through FY2021; estimated workforce reduction is approximately 900–1,200 positions. Management expects to reinvest part of the savings in growth.
- FY2017 guidance: The filing refers to sales and EPS guidance for FY2017 and the quarter ending September 30, 2016, but the supplied filing text does not provide clear numerical guidance ranges.
- Management cited continued strength in the U.S. dollar, slow retail growth in Hong Kong, weaker department-store traffic and changing shopping preferences in the United States, as well as risks involving Brazil, the U.K.’s anticipated EU exit, Turkey, the Middle East and global security. Travel retail is exposed to changes in passenger traffic and traveler spending.
- Other stated risks include intense competition, changing consumer preferences, dependence on retailers (Macy’s represented 9% of FY2016 sales), foreign exchange, supplier and operational disruptions, cybersecurity and information-system risks, acquisitions, regulation and litigation. Management said current legal matters were not expected to have a material adverse effect, while noting outcomes are uncertain.
- Internal controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at June 30, 2016 because of a material weakness in IT general controls over user access and program change management during a service-provider transition. The auditor issued an adverse opinion on internal control effectiveness. The weakness had not resulted in identified financial-statement misstatements or a restatement; remediation was expected in FY2017, subject to testing.
- The independent auditor issued an unqualified opinion on the consolidated financial statements. The filing also notes pension expense is expected to rise by approximately $17 million in FY2017 from changes in key assumptions.
Important facts for investors to verify
- Whether underlying sales and operating performance sustain growth after separating currency effects, acquisition contributions and the SMI order-timing comparison.
- Execution, total costs, timing and realized annual savings from Leading Beauty Forward, including potential disruption from workforce and operating changes.
- Progress and independent validation of remediation of the material IT-control weakness, and any subsequent disclosures about financial reporting controls.
- Debt repayment and refinancing needs, interest expense, and the accessibility of offshore cash given potential tax costs on repatriation.
- Exposure to Hong Kong and travel retail weakness, foreign-exchange movements, retailer concentration and changes in consumer shopping channels.
- Numerical FY2017 guidance and subsequent updates; specific guidance ranges are not clear in the supplied filing text.