Business Context and Reporting Period
The Estee Lauder Companies Inc. filed this Form 8-K on October 25, 2006, to report financial results for the fiscal quarter ended September 30, 2006 (Fiscal 2007 Q1). The Company is a leading manufacturer and marketer of skin care, makeup, fragrance, and hair care products sold in over 130 countries.
Key Financial Metrics
| Metric | Q1 2006 | Q1 2005 | Change |
|---|---|---|---|
| Net Sales | $1,593.5 million | $1,497.1 million | +6.4% |
| Gross Profit | $1,165.4 million | $1,077.6 million | +8.1% |
| Gross Margin | 73.1% | 72.0% | +110 bps |
| Operating Income | $99.9 million | $105.1 million | -4.9% |
| Operating Margin | 6.2% | 7.0% | -80 bps |
| Net Earnings (Continuing Ops) | $58.0 million | $61.8 million | -6.1% |
| Diluted EPS (Continuing Ops) | $0.27 | $0.28 | -3.6% |
| Net Earnings (Total) | $58.3 million | $58.5 million | -0.3% |
| Diluted EPS (Total) | $0.27 | $0.26 | +3.8% |
| Operating Cash Flow | ($70.1) million | ($61.6) million | Usage increased |
| Short-term Debt | $204.4 million | $253.6 million (Sep 2005) | Decreased |
| Long-term Debt | $438.6 million | $444.9 million (Sep 2005) | Decreased |
Liquidity: Cash and cash equivalents stood at $180.7 million as of September 30, 2006, down from $368.6 million at the end of the prior fiscal year (June 30, 2006). The decrease was driven by share repurchases ($110.5 million), capital expenditures ($67.3 million), and seasonal working capital increases.
Material Changes vs. Prior Period
- Sales Growth: Net sales increased 6.4% reported (5.4% in constant currency). Growth was driven by Skin Care (+8.3%), Makeup (+6.9%), and Hair Care (+17.0%). Fragrance sales declined 1.3%.
- Profitability Pressure: Despite sales growth, operating income declined 4.9% due to increased selling, general, and administrative expenses (up 9.6%) and special charges of $0.5 million related to a cost savings initiative.
- Category Performance: Makeup operating income dropped 17.5% due to campaign costs (Viva Glam) and an employment settlement charge. Skin Care operating income rose 10.6%.
- Geographic Trends: The Americas grew 2.2% but faced headwinds from the Federated/May merger reducing store doors. Europe, Middle East & Africa grew 13.0%, and Asia/Pacific grew 11.3%.
- Dividend: The Board declared a quarterly dividend of $0.50 per share, a 25% increase from the previous annual rate of $0.40.
Guidance, Outlook, and Risks
Management Commentary
CEO William P. Lauder stated the Company invested in fast-moving businesses to accelerate momentum while controlling costs elsewhere. Management expressed confidence in meeting the fiscal 2007 objective of $2.00 to $2.10 diluted earnings per share.
Guidance (Fiscal 2007)
- Q2 Outlook: Net sales expected to grow 6-8% in constant currency. Diluted EPS from continuing operations projected at $0.73 to $0.78.
- Full Year Outlook: Net sales expected to grow 5-7% in constant currency. Diluted EPS from continuing operations projected at $2.00 to $2.10.
- Cost Savings: The Company expects to deliver approximately $30 million in incremental savings under its cost savings initiative.
Risks and Contingencies
- Retail Consolidation: The merger of Federated and May Department Stores resulted in fewer doors, adversely impacting sales in the Americas.
- Lord & Taylor: The guidance includes $50 million of net sales and $0.06 EPS related to the Lord & Taylor business (recently sold by Federated). Future store closures in this chain could reduce fiscal 2007 results.
- Foreign Currency: Fluctuations impact reported results; a 1% benefit is expected for the full year.
- Discontinued Operations: The Stila brand was sold in April 2006; results are now reported as discontinued operations.
Investor Verification Checklist
- Verify the impact of the Federated/May merger on future department store distribution and sales volume.
- Monitor the Lord & Taylor store closure timeline and its potential negative impact on the full-year EPS guidance.
- Assess the sustainability of the 25% dividend increase given the decline in operating income and cash flow usage.
- Review the execution of the $30 million cost savings initiative to offset rising operating expenses.
- Track the performance of the Makeup category, specifically the return on investment for the Viva Glam campaigns and the resolution of the employment matter.