The Estée Lauder Companies Inc. — Form 10-Q
Business context and reporting period. The company manufactures, markets and distributes prestige beauty products across skin care, makeup, fragrance and hair care in more than 150 countries. This filing covers the quarter and nine months ended March 31, 2013 (fiscal 2013 third quarter), compared with the same periods in 2012. Dollar amounts are in millions except per-share data.
Financial performance
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $2,291.8 vs. $2,248.2; up 2% reported and 3% excluding currency | $7,774.3 vs. $7,462.4; up 4% reported and 5% excluding currency |
| Gross profit / gross margin | $1,848.7; 80.7% vs. 79.1% | $6,224.0; 80.1% vs. 79.2% |
| Operating income / margin | $245.1 vs. $211.5; 10.7% vs. 9.4% | $1,380.2 vs. $1,238.5; 17.8% vs. 16.6% |
| Net earnings attributable to the company | $178.8 vs. $130.4 | $925.8 vs. $805.7 |
| Diluted EPS | $0.45 vs. $0.33 | $2.35 vs. $2.03 |
| Operating cash flow | Not presented separately for the quarter | $934.2 vs. $869.7 |
Quarterly operating income rose 16%; management said it would have increased 22% excluding the effect of retailer order timing and restructuring-related returns and charges. Nine-month operating income increased 11%; excluding restructuring-related items, operating results increased 9%.
Liquidity, debt and capital allocation
- At March 31, 2013, cash and cash equivalents were $1,438.6, total debt was $1,349.2, and total equity was $3,206.8. Cash exceeded reported debt by approximately $89.4.
- Current assets were $4,286.2 and current liabilities $1,915.9. The company reported no commercial paper outstanding and no borrowings under its $1.0 billion revolving credit facility.
- Nine-month capital expenditures were $305.5. Cash used for financing was $536.5, including $363.2 of treasury-stock purchases and $349.3 of dividends paid; these outflows were partly offset by $498.7 of net long-term debt issuance proceeds.
- Total debt as a percentage of total capitalization, excluding noncontrolling interests, declined to 30% from 32% at June 30, 2012. The company said it was in compliance with debt covenants.
Material changes and drivers
- Quarterly sales growth was led by makeup; skin care sales were slightly lower. For the nine-month period, all major product categories grew, with skin care and makeup each increasing 5%.
- Quarterly results faced a difficult comparison from approximately $94 million of orders accelerated into fiscal Q2 2013 ahead of the Strategic Modernization Initiative (SMI), versus approximately $30 million accelerated into fiscal Q2 2012. Management estimated this timing created a $64 million quarterly sales comparison headwind and approximately $55 million of operating-results impact. Excluding accelerated orders, quarterly sales growth would have been 5%.
- Gross margin improved, reflecting manufacturing efficiencies, lower obsolescence charges, mix and pricing, and favorable exchange rates. Nine-month operating expense as a percentage of sales also improved, although the quarterly ratio edged higher.
- Cash from operations increased year over year, primarily with higher earnings and favorable receivables timing; increased capital spending and inventory for SMI partly offset the improvement.
- Long-term debt increased as the company issued $500 million of notes at 2.35% due 2022 and 3.70% due 2042, and used proceeds in part to redeem $230.1 million of 7.75% notes due 2013. The redemption generated a $19.1 million pretax extinguishment charge.
Outlook, commentary and risks
- Management did not provide a quantified full-year sales or earnings forecast in the supplied filing text. It expected improving travel-retail net sales growth to continue through the remainder of fiscal 2013 and expected SMI-related service issues to be resolved by fiscal year-end.
- The company deferred a previously scheduled January 2014 SMI implementation by six months after supply-planning implementation challenges caused some customer-service delays and product stockouts. Management said those issues had not materially affected the quarter’s results.
- The long-running cost-savings program was closed to new initiatives in fiscal Q2 2013. Estimated cumulative restructuring charges and implementation costs were revised to approximately $325–$350 million; substantially all were expected to be recorded through fiscal 2013. Management forecast approximately $785 million of savings through fiscal 2013, including savings relative to normalized spending, before strategic reinvestments.
- Management cited continued weakness in Southern Europe and Korea, competitive pressure in Korean prestige beauty, retailer destocking, foreign-exchange fluctuations and uncertain consumer demand as risks. It cautioned that worsening or prolonged economic conditions could adversely affect confidence, demand and spending.
- The February 2013 Venezuelan currency devaluation was not considered to have a significant effect on the reported period or expected ongoing sales and operating income.
- Unusual items include $23.1 million of nine-month other income, principally relating to an amended Rodan + Fields sale agreement, and $19.1 million of debt-extinguishment expense. The company also recorded out-of-period adjustments relating to fiscal 2008–2012; their net nine-month effect was a $7.7 million increase in pretax earnings and a $1.7 million increase in net earnings, with no diluted EPS change. Management said the adjustments were not material to the current or previously issued statements.
- A former Darphin owner’s litigation remains on appeal in France. A prior court awarded €22.9 million plus interest; the company has paid €25.3 million under the judgment, received a bank guarantee for repayment if reversed, and maintains an accrual below the award based on its assessment of the likely appeal outcome. Oral arguments were scheduled for December 2013.
- Management reported effective disclosure controls as of March 31, 2013. It noted Darphin trademark fair value had exceeded carrying value by less than 2% in its prior impairment test and said a more severe European downturn or other disruption could lead to future impairment.
Important facts for investors to verify
- How much of reported sales and earnings growth reflects underlying demand versus SMI-related order timing, and whether the expected resolution of implementation issues occurs as planned.
- Whether travel-retail growth continues and whether weakness in Southern Europe and Korea, retailer destocking and currency movements intensify.
- Progress against the remaining restructuring costs and the approximately $785 million savings estimate, including the effect of strategic reinvestment.
- Future cash conversion, working-capital needs, capital expenditures, repurchases and dividends relative to the company’s cash and debt position.
- Developments in the Darphin appeal and any change in the assumptions supporting the Darphin trademark valuation.