Business context and reporting period
The Estée Lauder Companies Inc. filed this unaudited Form 10-Q for the three months ended September 30, 2018, its fiscal 2019 first quarter. The company sells prestige skin care, makeup, fragrance and hair care products in more than 150 countries and territories.
Financial performance
| Metric | Quarter ended Sept. 30, 2018 | Prior-year quarter |
|---|---|---|
| Net sales | $3.524 billion | $3.274 billion |
| Gross profit / margin | $2.701 billion / 76.6% | $2.563 billion / 78.3% |
| Operating income / margin | $652 million / 18.5% | $569 million / 17.4% |
| Net earnings attributable to Estée Lauder | $500 million | $427 million |
| Diluted EPS | $1.34 | $1.14 |
| Operating cash flow | $(119) million | $82 million |
Reported sales rose 8% (9% in constant currency); foreign currency translation reduced the increase by approximately $53 million. Skin care sales increased 17%, makeup 2%, hair care 5%, and fragrance declined 1%. By region, sales rose 14% in Europe, the Middle East & Africa and 24% in Asia/Pacific, but fell 7% in the Americas. Operating income increased 15%; adjusted for restructuring charges and contingent consideration fair-value changes, it grew 13% (15% in constant currency).
The reported gross margin declined 1.7 percentage points, chiefly reflecting the adoption of ASC 606 and hedge-accounting changes. Operating expense margin improved to 58.1% from 60.9%, supporting higher operating margin. The effective tax rate was 20.7%, down from 21.7%, primarily reflecting U.S. tax reform and favorable geographic earnings mix, partly offset by GILTI and other items.
Cash, debt and liquidity
Cash and cash equivalents were $1.443 billion at September 30, down from $2.181 billion at June 30; short-term investments were $550 million. Total debt was $3.544 billion, including $183 million current debt and $165 million of commercial paper at quarter-end. Debt was 45% of total capitalization, versus 43% at June 30. Management stated that cash, operating cash generation, investments, credit availability and capital-market access should be adequate for planned needs.
Operating cash flow turned negative from $82 million positive in the prior-year quarter, primarily because accounts receivable rose $546 million and accounts payable fell $262 million, reflecting shipment/collection and payment timing. Investing cash flow was $31 million positive; financing cash flow was $642 million negative, including $530 million of treasury-stock purchases and $141 million of dividends paid. Capital expenditures were $128 million.
Material changes, outlook and risks
- Revenue accounting: The company adopted ASC 606 using the modified retrospective method. It recorded a $229 million after-tax reduction to opening retained earnings. For the quarter, ASC 606 reduced reported sales by $67 million and operating income by $31 million. Its accounting changes affected reported comparisons, including promotional goods, loyalty obligations and product returns.
- Business drivers and pressures: Management cited growth in China, Hong Kong and travel retail, with strength in prestige skin care and selected brands. It flagged U.S. and U.K. store traffic and competitive pressures, currency and tourism exposure, macroeconomic uncertainty, Brexit, tariffs, geopolitical risks and possible effects on consumer demand.
- Restructuring: Leading Beauty Forward has estimated total charges of $900–$950 million before tax and expected annual net benefits of $350–$450 million before tax after full implementation. The company expects the program to be completed through fiscal 2021 and estimates a net workforce reduction of 1,800–2,000 positions.
- Tax and other items: The quarter included a provisional $10 million credit to the prior-year Transition Tax estimate and a $9 million foreign-withholding-tax charge. Further adjustments to remaining provisional tax amounts were expected in fiscal 2019’s second quarter. A review of testing supporting certain advertising claims remained ongoing; management said it was not a product-safety or product-quality issue, did not expect a material impact and recorded no accrual.
- Capital and subsequent events: In October, the company replaced its undrawn $1.5 billion revolving credit facility with a facility expiring in 2023, subject to possible extensions. On October 31, the board authorized repurchase of up to 40 million additional Class A shares. No specific near-term sales or earnings guidance is provided in the supplied filing text.
Important facts for investors to verify
- Assess the effect of ASC 606 and the new hedge-accounting presentation when comparing reported results with prior periods.
- Track whether receivables and payables normalize and operating cash flow recovers from the quarter’s working-capital outflow.
- Monitor the durability of China, Hong Kong and travel-retail growth against weakness in the Americas and selected makeup and fragrance brands.
- Evaluate restructuring execution, total charges and realization of the stated annual savings range.
- Review the final tax effects of the Tax Cuts and Jobs Act and any developments in the advertising-claims review.
- Consider debt, buybacks and liquidity alongside the company’s disclosed $3.32 billion of future minimum lease commitments at June 30, 2018; the filing expects the forthcoming lease standard to significantly affect the balance sheet.