Estée Lauder Companies Inc. — Q2 FY2020 Form 10-Q
Reporting period: Three and six months ended December 31, 2019. Unaudited results are compared with the corresponding prior-year periods; amounts are in U.S. dollars unless noted.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $4.624 billion, +15% reported (+16% constant currency) | $8.519 billion, +13% reported (+14% constant currency) |
| Gross margin | 77.5%, versus 77.3% | 77.1%, versus 77.0% |
| Operating income / margin | $261 million / 5.6%, versus $771 million / 19.3% | $1.040 billion / 12.2%, versus $1.423 billion / 18.9% |
| Net earnings attributable to Estée Lauder | $557 million, down 3% | $1.152 billion, up 7% |
| Diluted EPS | $1.52, down 2% | $3.13, up 9% |
| Adjusted operating income and diluted EPS | Operating income $1.044 billion, +23%; EPS $2.11, +21% | Operating income $1.848 billion, +20%; EPS $3.78, +20% |
| Operating cash flow | $1.255 billion for six months, versus $1.273 billion |
Adjusted figures are non-GAAP measures that exclude specified items, including restructuring charges, impairments and other income; they are not substitutes for GAAP results. Gross margin improved modestly, supported by business mix, while obsolescence, manufacturing costs and tariffs partly offset the benefit.
Business drivers and changes versus prior year
- Q2 sales grew across all regions and product categories. Skin care led, up 27% for the quarter; makeup rose 6%, fragrance 8%, and hair care 5%.
- Asia/Pacific sales grew 29% and Europe, the Middle East & Africa grew 18% in Q2, led by China and travel retail. Americas sales increased 1% in Q2 but fell 3% for the six-month period.
- Prestige makeup weakness in North America and competitive pressure drove substantial impairment charges for Too Faced, BECCA and Smashbox: $511 million of goodwill and $266 million of trademarks. The charges reduced reported operating income by $739 million versus the prior-year period. Makeup category operating results were a loss of $611 million in Q2.
- Acquired the remaining interest in Have & Be, the owner of Dr. Jart+ and Do The Right Thing, on December 18 for $1.268 billion cash. The step acquisition generated a $553 million gain on the previously held investment and related currency reclassification; a further $23 million foreign-exchange gain contributed to total other income of $576 million. Have & Be’s post-acquisition results were not material to this quarter.
- Sales growth was partly offset by unfavorable currency translation of $22 million in Q2 and $62 million for six months. The six-month increase was concentrated in skin care, China and travel retail.
Liquidity, debt and cash flow
- Cash and cash equivalents were $3.596 billion at December 31, 2019, up from $2.987 billion at June 30, 2019. Current assets were $8.348 billion and current liabilities $4.953 billion.
- Total debt was $5.184 billion, versus $3.412 billion at June 30; debt was 53% of total capitalization, compared with 44%. The November issuance included $1.8 billion principal of senior notes due 2024, 2029 and 2049, partly to fund the acquisition and refinance $500 million of notes due February 2020.
- Six-month operating cash flow was $1.255 billion; investing cash outflow was $1.350 billion, including $1.040 billion paid for acquired businesses and $291 million of capital expenditures. Financing cash inflow was $687 million, including debt proceeds; the company repurchased $813 million of shares and paid $330 million in dividends.
- Management said cash, operating cash flow, credit availability and capital-market access should be adequate for planned operations and obligations. Long-term debt ratings were A+ and A1, both with stable outlooks, as of January 30, 2020.
Outlook, risks and other notable matters
- The filing provides no quantified full-year sales or earnings guidance. Management reported strong momentum into January, but said coronavirus-related declines in air travel and consumer traffic were already evident in key shopping and tourist areas. It expected the greatest near-term impact on travel retail, affected localities and tourist destinations, followed by a gradual recovery later in the fiscal year; the full impact was uncertain.
- Other cited risks include Hong Kong disruption and intermittent store closures, weaker retail traffic in the United States and United Kingdom, Brexit uncertainty, U.S.–China trade tensions and tariffs, foreign-exchange movements, competition, and changes in consumer shopping preferences. Management cautioned that prolonged or worsening conditions could harm demand and results.
- Further impairment charges remain possible if brand growth, distribution expansion or cost-reduction assumptions do not materialize. GLAMGLOW’s goodwill fair value exceeded carrying value by only approximately 5% at December 31.
- The company adopted lease accounting on July 1, 2019, recognizing $2.517 billion of operating-lease right-of-use assets at December 31; adoption’s earnings and cash-flow effects were not material. The existing Leading Beauty Forward program is expected to be substantially completed through fiscal 2021.
- Management said current litigation was not expected to have a material adverse effect and that reasonably possible losses beyond accruals were not material. A review of certain advertising-claim testing remained ongoing; management did not expect it to be material and recorded no accrual. Disclosure controls were deemed effective.
Investor verification points
- Review the reconciliation and assumptions behind adjusted results, particularly the $777 million impairment total and $576 million of other income.
- Track Have & Be’s finalized purchase-price allocation, integration and contribution to future results; the acquisition accounting was provisional.
- Assess whether the forecast recovery from coronavirus-related travel and traffic disruption occurred, especially in travel retail and Asia.
- Monitor makeup-brand performance and valuation headroom, including the risk of additional impairment charges.
- Evaluate post-acquisition leverage, refinancing of the 2020 notes, and cash generation after capital spending, dividends and share repurchases.