Business context and reporting period
The Estée Lauder Companies Inc. (NYSE: EL) manufactures and sells prestige skin care, makeup, fragrance and hair care products in approximately 150 countries and territories. This is the Form 10-K for the fiscal year ended June 30, 2019, not a standalone 2018 Q4 filing. Fiscal Q4 refers to the three months ended June 30, 2019.
Financial performance
| Metric | FY2019 | FY2018 |
|---|---|---|
| Net sales | $14.863 billion | $13.683 billion |
| Operating income | $2.313 billion | $2.055 billion |
| Operating margin | 15.6% | 15.0% |
| Net earnings attributable to the Company | $1.785 billion | $1.108 billion |
| Diluted EPS | $4.82 | $2.95 |
| Operating cash flow | $2.517 billion | $2.562 billion |
| Cash and cash equivalents at year-end | $2.987 billion | $2.181 billion |
| Total debt at year-end | $3.412 billion | $3.544 billion |
FY2019 reported sales rose 9%; constant-currency growth was 11%, with approximately $371 million of unfavorable currency translation. Gross margin declined to 77.2% from 79.2%, primarily reflecting the adoption of ASC 606 and hedge-accounting changes, which together reduced margin by about 195 basis points. Operating cash flow was slightly lower year over year. Capital expenditures were $744 million, up from $629 million.
Growth was led by skin care, up 17% reported (20% constant currency), and Asia/Pacific, up 21% reported (25% constant currency). Makeup sales rose 4% reported; fragrance declined 1%; hair care rose 2%. Sales in the Americas declined 5%, while Europe, the Middle East and Africa grew 15%.
Fiscal fourth quarter
Q4 FY2019 net sales were $3.590 billion, versus $3.295 billion in Q4 FY2018. Operating income was $216 million versus $278 million; net earnings attributable to the Company were $157 million versus $186 million; diluted EPS was $0.43 versus $0.49. Q4 FY2019 included $124 million of restructuring and other charges before tax and a $19 million favorable change in contingent consideration fair value.
Material changes and unusual items
- Net earnings increased 61% and diluted EPS increased 63%, but the comparison was materially affected by the prior year’s $450 million of net TCJA-related charges. The reported FY2019 effective tax rate was 22.2%, versus 43.6% in FY2018.
- FY2019 included a $71 million after-tax gain on liquidation of an investment in a foreign subsidiary; the underlying reported items were a $77 million foreign-currency gain and a $6 million securities-sale loss.
- FY2019 included $90 million of Smashbox goodwill and trademark impairment charges. Remaining Smashbox goodwill and trademark carrying values were $72 million and $55 million, respectively; management noted further impairment could occur if forecasts or business conditions weaken.
- Leading Beauty Forward charges were $241 million in FY2019. The company raised its estimated total program charges to $950–$990 million before tax and revised expected annual net benefits to $425–$475 million before tax after full implementation. Major initiatives were expected to be substantially completed through FY2021.
- ASC 606 adoption reduced FY2019 reported sales by $49 million and operating income by $21 million versus the prior accounting method; it also resulted in a $229 million after-tax reduction to opening retained earnings.
Liquidity, outlook and risks
Management said cash, operating cash generation, available credit and access to capital markets should be adequate for planned operations and commitments. The company had an undrawn $1.5 billion revolving credit facility and no commercial paper outstanding at June 30, 2019. Its $3.412 billion total debt included $516 million classified as current; a $499 million senior-note issue was due in February 2020. Cash included $1.765 billion held in offshore jurisdictions under the company’s permanent-reinvestment strategy.
Management cited strong demand in China and online and travel retail as growth drivers, while noting slower U.S. makeup growth, declining traffic at some U.S. and U.K. brick-and-mortar retailers, competitive pressures, foreign-exchange and tourism exposure, U.S.–China trade-policy uncertainty, Brexit, and macroeconomic and geopolitical risks. It also highlighted supplier, supply-chain, cybersecurity, product-claims, tax and impairment risks. The filing states that FY2020 and September 2019 sales and EPS guidance was provided, but the guidance ranges are not clear in the supplied filing text.
Contractual obligations totaled $13.649 billion, including $3.382 billion of operating lease commitments and $4.556 billion of unconditional purchase obligations. The company expected to adopt the new lease standard in FY2020 and anticipated a significant balance-sheet impact, but no material earnings or cash-flow impact. Management reported no material expected adverse effect from current litigation; a review of support for certain advertising claims was ongoing, and management said it was not a product-safety issue and was not expected to be material.
Key facts investors should verify
- Confirm FY2020 and near-term sales and EPS guidance ranges in the company’s earnings release or other filing; they are not stated clearly in this text.
- Assess underlying earnings growth separately from the prior-year TCJA tax charges, the FY2019 liquidation gain, restructuring costs, and impairments; compare reported and adjusted measures.
- Monitor skin care and China/online/travel-retail growth against continued weakness in U.S. makeup and the Americas region.
- Track gross-margin effects from accounting changes and whether restructuring savings reach management’s revised $425–$475 million annual target.
- Review the February 2020 note maturity, lease-related balance-sheet changes, and cash generation relative to dividends, repurchases and other contractual commitments.
- Evaluate Smashbox and other brand impairment assumptions, as well as trade, currency, retailer-traffic, travel, tax and supply-chain exposures.