The Estée Lauder Companies Inc. — Q1 FY2014 10-Q
Reporting period: Three months ended September 30, 2013, compared with the three months ended September 30, 2012. The company manufactures and sells prestige beauty products in more than 150 countries and territories.
Financial performance
| Metric | Q1 FY2014 | Q1 FY2013 |
|---|---|---|
| Net sales | $2,675.0 million | $2,549.5 million |
| Gross profit / margin | $2,130.9 million / 79.7% | $2,010.3 million / 78.9% |
| Operating income / margin | $449.5 million / 16.8% | $482.0 million / 18.9% |
| Net earnings attributable to Estée Lauder | $300.7 million | $299.5 million |
| Diluted EPS | $0.76 | $0.76 |
| Operating cash flow | $29.9 million | $(125.2) million |
- Sales grew 5% reported and 6% excluding foreign-exchange effects. Growth spanned all major product categories and regions.
- By category, sales were: skin care $1,171.0 million (+5%), makeup $1,001.0 million (+4%), fragrance $367.4 million (+6%), and hair care $124.8 million (+10%).
- By region, sales were: Americas $1,202.4 million (+2%), Europe, Middle East & Africa $891.2 million (+8%), and Asia/Pacific $581.4 million (+7%).
- Gross margin improved 0.8 percentage points, but operating margin fell 2.1 points as higher advertising, merchandising and sampling, general and administrative, retail expansion, and selling and shipping costs more than offset the gross-margin improvement.
- Net earnings attributable to the company rose less than 1%. The effective tax rate declined to 30.8% from 33.3%, primarily reflecting tax-reserve adjustments and a lower effective rate on foreign operations.
Liquidity, debt and cash flow
- Cash and cash equivalents were $1,322.2 million at September 30, down from $1,495.7 million at June 30, 2013. Total debt was $1,340.6 million; the company reported debt at 27% of total capitalization, down from 29% at June 30.
- Current assets were $4,632.4 million and current liabilities were $1,987.6 million. The company had no commercial paper outstanding and no borrowings under its $1.0 billion revolving credit facility, which expires in July 2015.
- Operating cash flow improved from a use of cash to positive $29.9 million, mainly due to shipment and collection timing for receivables and favorable accounts-payable timing. Investing activities used $94.9 million, including $85.7 million of capital expenditures; financing activities used $114.9 million.
- The company paid $69.8 million in dividends and repurchased $59.5 million of stock during the quarter. It declared a quarterly dividend of $0.18 per share during the quarter and subsequently declared $0.20 per share, payable in December 2013.
Material changes, outlook and risks
- Operating income declined 7%, despite sales growth. Higher strategic spending weighed on results, particularly in skin care and fragrance. Makeup operating income increased 3%; hair care and fragrance operating income declined 21% and 31%, respectively.
- Management’s strategy through fiscal 2016 emphasizes product innovation, skin care, luxury consumers, digital and online channels, travel retail, freestanding stores, and growth in emerging markets. The filing provides no specific full-year fiscal 2014 earnings or sales guidance.
- Management cited weakness in parts of Southern Europe and Korea, competitive pressure in Korea, near-term uncertainty in U.S. retail, and a potential slowing of China’s future growth. Prolonged or worsening economic uncertainty could reduce consumer confidence, demand and spending.
- The company expects the final major wave of its Strategic Modernization Initiative rollout in certain locations in July 2014. Some retailers may bring orders forward from fiscal 2015’s first quarter into fiscal 2014’s fourth quarter to build safety stock, potentially affecting shipment timing.
- Foreign-exchange exposure remains material: outstanding forward contracts had a notional value of $1,763.6 million. Management said the related cash-flow hedges were highly effective in all material respects. The company also identified risks involving competition, product launches, retailer concentration and working-capital practices, currency movements, supply and systems disruptions, and consumer-channel shifts.
- For the Darphin dispute, the former owner sought €60.0 million; a French commercial court awarded €22.9 million plus interest. The company appealed, has paid €25.3 million under the judgment, and holds a bank guarantee for repayment if the judgment is reversed. Oral arguments were scheduled for June 2014. Management maintained an accrual below the court award, based on its assessment of the likely appeal outcome.
- Unrecognized tax benefits were $63.5 million at September 30. The company said they could reasonably decrease by $10–$15 million within 12 months as tax examinations and controversies are resolved or statutes of limitations lapse.
- Management stated that current litigation is not expected to have a material adverse effect overall, while noting outcomes could differ from its assessments. The company reported compliance with debt covenants and effective disclosure controls.
Important facts for investors to verify
- Whether revenue growth and new-product contributions persist, particularly in skin care, makeup and travel retail.
- Whether increased brand investment translates into improved operating margins after the reported margin decline.
- The sustainability of operating cash flow, given the company’s explanation that the improvement was substantially driven by shipment, collection and payment timing.
- The effects of economic weakness, competition, foreign-exchange movements and the planned systems rollout on demand, shipments and costs.
- Developments in the Darphin appeal and tax matters, and any resulting changes to accruals or cash requirements.