Business context and reporting period
The Estée Lauder Companies Inc. manufactures, markets and sells prestige beauty products across skin care, makeup, fragrance and hair care in more than 150 countries and territories. This unaudited Form 10-Q covers the quarter and six months ended December 31, 2017, the second quarter of fiscal 2018; comparisons are with the corresponding 2016 periods. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Quarter ended Dec. 31, 2017 | Six months ended Dec. 31, 2017 |
|---|---|---|
| Net sales | $3.744 billion; up 17% reported and 14% in constant currency | $7.018 billion; up 16% reported and 14% in constant currency |
| Gross profit / margin | $2.991 billion / 79.9%, versus 80.1% | $5.554 billion / 79.1%, versus 79.7% |
| Operating income / margin | $710 million / 19.0%, versus $617 million / 19.2% | $1.278 billion / 18.2%, versus $1.035 billion / 17.0% |
| Net earnings attributable to Estée Lauder | $123 million, versus $428 million | $550 million, versus $722 million |
| Diluted EPS | $0.33, versus $1.15 | $1.46, versus $1.94 |
| Operating cash flow | Not reported separately for the quarter | $1.450 billion, versus $824 million |
Reported earnings were heavily affected by provisional Tax Cuts and Jobs Act charges. The company recorded $325 million for the transition tax, $51 million for remeasurement of U.S. deferred tax assets and $18 million for foreign withholding taxes on planned repatriation. The resulting effective tax rates were 81.9% for the quarter and 55.2% for the six-month period. Excluding those tax items and specified restructuring and other items, diluted EPS was $1.52 for the quarter, up 25%, and $2.73 for six months, up 32%.
Six-month capital expenditures were $263 million, making operating cash flow less capital expenditures approximately $1.187 billion. Investing activities used $144 million; financing activities used $362 million. The operating cash flow increase reflected higher earnings before taxes and increased accrued liabilities, including tax-related accruals; the filing says the TCJA charges did not affect reported operating cash flow.
At December 31, 2017, cash and cash equivalents were $2.105 billion, short-term investments $394 million, current assets $5.975 billion and current liabilities $3.403 billion. Total debt was $3.787 billion ($413 million current and $3.374 billion long-term), compared with $3.572 billion at June 30, 2017. The company said debt was 45% of total capitalization at both dates. Interest expense rose to $32 million for the quarter and $63 million for six months, primarily due to higher short- and long-term debt.
Material changes and business drivers
- Sales increased across all major product categories and geographic regions. Skin care rose 20% in the quarter and 18% for six months; makeup rose 16% and 17%; fragrance rose 14% and 11%; hair care rose 5% and 3%.
- Asia/Pacific was the fastest-growing region, with sales up 33% for the quarter and 25% for six months. Growth in China and Hong Kong, travel retail, online sales and prestige brands were significant contributors. Europe, the Middle East and Africa sales rose 20% in both periods; the Americas rose 5% and 7%.
- Too Faced and BECCA, acquired in fiscal 2017, contributed incremental sales, particularly in makeup and the Americas, while also weighing on gross margin due to higher cost of sales. Foreign currency translation added to reported sales growth; constant-currency growth was 14% for both periods.
- Quarterly operating income rose 15%, but operating margin declined 0.2 percentage point, reflecting lower gross margin and higher restructuring and other charges. Six-month operating margin improved 1.2 percentage points, mainly from lower operating expenses as a share of sales.
- Six-month net earnings fell despite revenue and operating income growth, primarily because of the one-time tax charges. Adjusted diluted EPS increased, according to the company’s non-GAAP reconciliation.
Outlook, management commentary and risks
- The filing provides no specific near-term sales or EPS forecast. Management said it expected cash on hand, operating cash generation, investments, credit lines and market access to support planned operations, capital spending, acquisitions, dividends, repurchases and other obligations.
- The multi-year Leading Beauty Forward program is expected to generate $600 million to $700 million of pretax restructuring and other charges, with $400 million recorded cumulatively through December 31, 2017. The company expects $200 million to $300 million of annual pretax net benefits after full implementation, with some savings reinvested in growth. The program is expected to reduce the workforce by approximately 900 to 1,200 positions overall.
- Management cited strong global demand, including prestige skin care, China and travel retail, and growth from new products, digital engagement and online channels. Risks it highlighted include competition, softer U.S. brick-and-mortar retail traffic, foreign-exchange movements and effects on tourism, economic and political uncertainty, geopolitical tensions, Brexit-related uncertainty, and retailer inventory management.
- Goodwill and trademark impairment remains a risk for Editions de Parfums Frédéric Malle if retail weakness or other disruptions worsen. The company also warned that Too Faced and BECCA’s combined goodwill and indefinite-lived intangible assets were approximately $1.3 billion and their carrying values approximated fair values at the cited assessment date.
- The company is still evaluating the TCJA effects; the tax amounts recorded are provisional and may be adjusted during the measurement period through December 22, 2018. It had not recorded potential fiscal 2019 impacts from GILTI, BEAT and FDII provisions.
- Management reported no material expected adverse effect from current legal proceedings and no significant changes to commitments and contractual obligations since the 2017 annual report. Future minimum lease commitments were $2.427 billion at June 30, 2017; the company expects the forthcoming lease standard to significantly affect its balance sheet.
Most important facts for investors to verify
- Confirm the scale and eventual adjustment, if any, of the provisional $394 million of TCJA-related tax charges; distinguish GAAP earnings from the company’s non-GAAP adjusted EPS.
- Assess whether constant-currency sales growth and operating performance persist after accounting for acquisition contributions, currency effects and travel retail strength.
- Track gross-margin pressure from acquired brands, product mix and foreign exchange, alongside the realized costs, timing and net savings of Leading Beauty Forward.
- Monitor cash flow quality, including the contribution from higher accrued liabilities, and debt, commercial paper and liquidity needs. Commercial paper outstanding was approximately $499 million on January 26, 2018.
- Review impairment assumptions for acquired brands and the Frédéric Malle reporting unit, as well as the future balance-sheet effect of lease accounting and the final TCJA tax accounting.