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 Form 10-Q covers the quarter and nine months ended March 31, 2019, the third quarter of fiscal 2019; this differs from the “2018 Q3” period in the request metadata. Amounts below are in U.S. dollars unless stated otherwise.
Financial performance and position
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $3.744 billion, up 11% reported and 15% in constant currency | $11.273 billion, up 9% reported and 11% in constant currency |
| Gross profit / gross margin | $2.925 billion / 78.1%, versus 79.7% | $8.721 billion / 77.4%, versus 79.3% |
| Operating income / margin | $674 million / 18.0%, versus $498 million / 14.8% | $2.097 billion / 18.6%, versus $1.777 billion / 17.1% |
| Net earnings attributable to Estée Lauder | $555 million, versus $372 million | $1.628 billion, versus $922 million |
| Diluted EPS | $1.51, versus $0.99 | $4.39, versus $2.45 |
| Operating cash flow | Not separately presented for the quarter | $1.756 billion, versus $1.920 billion |
For the nine months, capital expenditures were $441 million; cash from investing was $774 million, including investment-sale proceeds; and financing used $1.814 billion, principally reflecting $1.344 billion of treasury-stock purchases and $453 million of dividends. Cash and cash equivalents were $2.902 billion at March 31, 2019, up from $2.181 billion at June 30, 2018.
Total debt was $3.399 billion ($516 million current and $2.883 billion long-term), compared with $3.544 billion at June 30, 2018. Debt was 43% of total capitalization at both dates. Current assets were $7.160 billion and current liabilities $4.231 billion. The company reported a $1.5 billion undrawn revolving credit facility, expiring in 2023 unless extended.
Material changes versus the prior comparable period
- Growth was strongest in skin care: quarterly sales rose 21%, led by Estée Lauder and La Mer. Asia/Pacific sales increased 25% and EMEA increased 15%; Americas sales declined 2%. Makeup sales rose 5% in the quarter, but makeup operating income and fragrance and hair-care operating income were lower.
- Gross margin declined 1.6 percentage points in the quarter and 1.9 points for nine months. Management cited the adoption of ASC 606 and hedge-accounting guidance as the largest combined adverse factors, along with foreign exchange and obsolescence charges; favorable business mix partly offset these effects.
- Operating margin improved despite lower gross margin, reflecting stronger sales, lower restructuring charges and improved operating-expense leverage. The results include $90 million of goodwill and intangible-asset impairments for the nine-month period, primarily related to Smashbox.
- Comparability is affected by ASC 606, adopted July 1, 2018 using the modified retrospective method; prior-year periods were not restated. The standard reduced opening retained earnings by $229 million, net of tax. It increased quarterly 2019 net sales by $106 million and operating income by $126 million; for the nine months it reduced net sales by $28 million and increased operating income by $41 million.
- Quarterly earnings included $71 million of net other income from liquidating a foreign subsidiary that held available-for-sale securities, including a $77 million foreign-currency gain and a $6 million securities loss. This is an unusual, nonrecurring item.
Outlook, commentary, risks and contingencies
Management said global sales momentum continued, citing innovation, hero products, digital and social-media marketing, growth in China and Hong Kong, and double-digit travel-retail growth. It provided no specific near-term sales or earnings guidance in the supplied filing text.
The Leading Beauty Forward program is expected to generate $900–$950 million of total pretax restructuring and other charges, with annual pretax net benefits of $350–$450 million after full implementation. Through March 31, cumulative charges recorded were $667 million; management expects to complete initiatives through fiscal 2021. Estimated workforce reduction is 1,800–2,000 positions globally.
Management highlighted intense competition, weaker retail traffic in parts of the U.S. and U.K., macroeconomic and political uncertainty, Brexit, currency movements, tourism, tariffs and geopolitical risks. Smashbox’s continuing sales slowdown and competitive pressure prompted impairment charges; further impairment is possible if forecasts or operating assumptions weaken. Management expects the upcoming lease-accounting standard to significantly increase reported balance-sheet assets and liabilities, without a material effect on earnings, EPS or cash flows.
The company said current litigation is not expected to have a material adverse effect and reasonably possible losses beyond recorded accruals are not material. It is reviewing substantiation for certain advertising claims; it stated this is not a product-safety or product-quality issue, expects no material impact based on its review to date, and recorded no accrual. Management said liquidity and available funding are adequate for currently planned operations and commitments.
Important facts for investors to verify
- Assess underlying growth and margins separately from ASC 606 and hedge-accounting presentation effects; prior-year figures were not restated.
- Review whether growth in China, Hong Kong and travel retail can offset weakness in the Americas and challenged makeup brands, particularly Smashbox.
- Track future impairment risk and the assumptions supporting Smashbox’s remaining goodwill and trademark values.
- Compare Leading Beauty Forward’s remaining costs, timing and realized savings with management’s estimates.
- Monitor operating cash conversion, working-capital investment, capital spending, share repurchases and debt maturities.
- Consider the one-time $71 million other-income gain and the prior-year TCJA tax charges when comparing reported earnings and tax rates.