Business context and reporting period
The Estée Lauder Companies Inc. manufactures and sells prestige beauty products across skin care, makeup, fragrance and hair care. This unaudited Form 10-Q covers the three months ended September 30, 2015, the first quarter of fiscal 2016; comparisons are with the same period of fiscal 2015. Amounts are in millions of dollars except per-share data.
Financial performance
| Metric | Quarter ended Sep. 30, 2015 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $2,834.7 | $2,631.0 | +8% reported |
| Gross profit / margin | $2,257.5 / 79.6% | $2,094.4 / 79.6% | Margin unchanged |
| Operating income / margin | $453.2 / 16.0% | $348.0 / 13.2% | +30% reported |
| Net earnings attributable to Estée Lauder | $309.3 | $228.1 | +36% |
| Diluted EPS | $0.82 | $0.59 | +39% |
| Operating cash flow | $8.2 | $127.7 | Down $119.5 |
Reported results benefited materially from comparison with the prior-year quarter, when retailers advanced approximately $178 million of orders ahead of the company’s July 2014 Strategic Modernization Initiative (SMI) rollout. Excluding those orders and foreign-exchange effects, sales increased 8%, operating income increased 8%, and diluted EPS increased 16%. Excluding the accelerated orders, operating income declined 5% and operating margin fell approximately 90 basis points.
Foreign-currency translation reduced sales by approximately $198 million and operating income by approximately $60 million. The effective tax rate decreased to 29.2% from 31.5%, principally due to a lower rate on foreign operations. Selling, general and administrative expense was 63.6% of sales, versus 66.4%; management said this comparison was favorably affected by the prior-year order timing.
Sales mix and operating trends
Makeup sales rose 14% to $1,161.8 million and fragrance rose 9% to $412.9 million; skin care increased 2% to $1,108.8 million and hair care increased 5% to $134.3 million. Makeup and fragrance benefited from launches, brand growth and expanded distribution. After adjusting for currency and accelerated orders, skin care sales declined 1%, while makeup, fragrance and hair care increased 16%, 12% and 6%, respectively.
By region, reported sales increased 14% in the Americas and 8% in Europe, the Middle East and Africa, but declined 4% in Asia/Pacific. Adjusted for currency and prior-year order timing, sales grew 9% in the Americas and 11% in Europe, the Middle East and Africa; Asia/Pacific was approximately flat. China and Hong Kong faced a difficult retail environment and lower Chinese travel, while Korean travel-retail sales were affected by reduced travel amid MERS concerns.
Cash, liquidity and debt
At September 30, 2015, cash and cash equivalents were $408.5 million, short-term investments $670.8 million and long-term investments $710.1 million. Total debt was $2,066.2 million, including $422.0 million of commercial paper; debt to total capitalization rose to 37% from 31% at June 30, primarily due to commercial paper issuance. The company had no borrowings under its $1.0 billion revolving credit facility. Management said cash, operating cash flow, credit availability and market access should support planned operations and obligations.
Cash and cash equivalents fell $612.9 million during the quarter, mainly reflecting investment purchases under the company’s cash investment strategy. Investing cash outflow was $564.5 million, including $688.1 million of investment purchases and $89.9 million of capital expenditures. Operating cash flow was pressured by receivables growth and payment timing: accounts receivable increased $389.0 million and accounts payable decreased $100.8 million. Financing cash outflow was $44.0 million and included $387.0 million of treasury-stock purchases and $89.7 million of dividends, partly offset by commercial-paper proceeds.
Outlook, commentary and risks
The filing provides no specific numerical sales or earnings guidance. Management’s fiscal 2018 strategy emphasizes innovation, digital and omnichannel capabilities, emerging markets, store expansion, productivity and the SMI. It noted accelerated growth in prestige makeup, while describing slower prestige skin-care growth and continued department-store traffic weakness in some markets.
In October 2015, the company approved a technology-infrastructure transition to a primarily vendor-owned, pay-for-use model. It expects approximately $40–$50 million of restructuring and other charges, mainly non-cash asset write-offs, through calendar 2016, plus employee and implementation costs funded from operations. Management expects future efficiencies, lower technology costs and a positive return on investment; savings may be partly reinvested.
Key risks discussed include foreign-exchange movements, competitive pressure, weak retail conditions and department-store traffic, slower growth in China and Hong Kong, lower travel and spending by Russian and Brazilian travelers, and disruption to Korean travel retail. Management cautioned that prolonged or worsening economic uncertainty could weaken consumer confidence and demand. The company uses derivatives for hedging and states it does not use them for trading or speculation.
Management said current litigation and reasonably possible additional losses are not expected to be material. Unrecognized tax benefits were $78.1 million; the company did not expect significant changes to that balance within 12 months. The company is evaluating a revenue-recognition standard effective for it in fiscal 2019 and has not selected a transition method. Disclosure controls were judged effective as of September 30, 2015.
Most important facts for investors to verify
- Underlying performance: reported growth was substantially affected by the prior-year SMI order shift; compare results excluding that timing effect and currency translation.
- Cash conversion: operating cash flow fell to $8.2 million, with significant receivables and payables movements; assess subsequent collection and payment trends.
- Liquidity and refinancing: commercial paper outstanding was $422.0 million at quarter-end and $564.0 million on October 26, 2015; the company said it refinances maturities periodically.
- Regional exposure: monitor China, Hong Kong and travel-retail trends, along with foreign-exchange effects and travel-related risks.
- Technology transition: track the $40–$50 million expected charges, implementation costs and whether anticipated savings and returns materialize.