The Estée Lauder Companies Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and six months ended December 31, 2012 (the second quarter and first half of fiscal 2013), compared with the corresponding periods of fiscal 2012. The company manufactures, markets and distributes prestige skin care, makeup, fragrance and hair care products in more than 150 countries and territories.
Financial performance
| Metric | Three months ended Dec. 31, 2012 | Six months ended Dec. 31, 2012 |
|---|---|---|
| Net sales | $2,933.0 million; up 7% year over year | $5,482.5 million; up 5% |
| Gross margin | 80.6%, versus 79.9% | 79.8%, versus 79.2% |
| Operating income and margin | $653.1 million; 22.3%, versus $597.0 million and 21.8% | $1,135.1 million; 20.7%, versus $1,027.0 million and 19.7% |
| Net earnings attributable to Estée Lauder | $447.5 million, up 13% | $747.0 million, up 11% |
| Diluted EPS | $1.13, versus $1.00 | $1.89, versus $1.70 |
| Operating cash flow | $655.1 million for the six months, versus $610.2 million | |
| Capital expenditures | $205.4 million for the six months, versus $181.5 million |
Six-month operating cash flow less capital expenditures was $449.7 million. Cash and cash equivalents were $1,323.6 million at December 31, 2012, compared with $1,347.7 million at June 30, 2012. Current assets were $4,341.0 million and current liabilities $2,052.2 million.
Total debt was $1,356.1 million, including $26.0 million current and $1,330.1 million long-term debt; debt as a share of total capitalization was 30%, down from 32% at June 30, 2012. The company reported no commercial paper or revolver borrowings at quarter-end and said it was in compliance with debt covenants. Six-month cash dividends paid were $279.5 million; treasury stock purchases were $326.5 million.
Material changes and drivers
- Sales increased across all regions and product categories. Skin care was the largest category, with quarterly sales of $1,279.9 million, up 10%; makeup rose 7%, fragrance 4% and hair care 9%.
- Reported second-quarter results benefited from approximately $94 million of retailer orders accelerated ahead of SAP implementation, compared with approximately $30 million accelerated in the prior-year quarter. Management estimated this timing difference created a difficult comparison of about $64 million in sales and $55 million in operating results. Excluding accelerated orders, quarterly sales growth was 5% and operating income growth, also excluding restructuring charges, was 2%. For the six months, sales growth excluding accelerated orders was 4% and operating results growth excluding accelerated orders and restructuring was 6%.
- Gross margin improvement reflected pricing, product mix, manufacturing efficiencies and, to a lesser extent, currency. Higher advertising, merchandising and sampling investment and increased technology costs partly offset expense leverage.
- Net interest expense declined, principally due to refinancing at lower rates. First-half earnings included a $19.1 million pre-tax debt-extinguishment charge after redemption of $230.1 million of 7.75% notes.
Outlook, risks and unusual items
- Management said it expected higher advertising, merchandising and sampling investment to continue through the rest of fiscal 2013. It anticipated improved travel-retail results later in the fiscal year, while noting slower exceptional growth and retailer destocking. No specific full-year sales or EPS guidance is provided in the supplied filing text.
- The company described economic weakness in parts of Southern Europe, Korea and Australia, competitive pressure in fragrance and Korea, and destocking by a Russian customer. Management warned prolonged or worsening economic uncertainty could hurt consumer confidence, demand and spending.
- The SAP-based Strategic Modernization Initiative is expected to reach most locations through 2014. Rollout-related order timing may cause sales and operating-result fluctuations; disruptions or delays are also identified as risks.
- The company closed its restructuring program to new initiatives and estimated total cumulative charges and implementation costs of $325–$350 million, substantially to be recorded through fiscal 2013. Estimated savings through fiscal 2013, including reductions relative to normalized spending, were $760–$785 million. Accrued restructuring costs of $46.3 million were expected to require cash payments over fiscal 2013–2015.
- A December 2012 amendment to the Rodan + Fields sale agreement generated $21.3 million of second-quarter other income and a $22.4 million note receivable, payable in installments through 2015. This is a non-recurring item affecting reported earnings.
- Management recorded out-of-period adjustments relating to prior fiscal years: a $5.9 million pre-tax earnings decrease in the first quarter and a $13.6 million pre-tax increase in the second quarter. The net six-month effect was a $7.7 million pre-tax earnings increase and $1.7 million net earnings increase; management said the adjustments were not material to the periods presented or previously issued statements.
- The former Darphin owner’s litigation remains on appeal. A Paris court had awarded €22.9 million plus interest; the company paid €25.3 million under the judgment and maintains an accrual below the award, based on its assessment of the probable appeal outcome. Oral arguments were scheduled for December 2013.
- Foreign-exchange exposure is managed with forward contracts; their notional amount was $2,016.6 million at December 31. Management said the hedges were highly effective in all material respects. The company also disclosed $74.6 million of gross unrecognized tax benefits and said $10–$15 million could decrease within 12 months.
Most important facts for investors to verify
- How much of sales and operating-income growth reflects underlying demand versus SAP-related order acceleration, and whether the shifted orders affect the following quarter as expected.
- Whether management’s travel-retail recovery expectations materialize and whether weakness in Europe, Korea and Australia persists.
- Progress and remaining costs of the restructuring program, including whether estimated savings are achieved without impairing growth.
- The sustainability of margins amid higher strategic spending, product-launch competition and currency movements.
- Cash conversion and working-capital trends, especially receivables, inventory and payment timing, alongside ongoing dividends and share repurchases.
- Developments in the Darphin appeal and global tax examinations; the filing states that management believes other current litigation is not expected to have a material adverse effect.