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ESTEE LAUDER COMPANIES INC - Quarter Report: 2019 September (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to

Commission file number 1-14064

The Estée Lauder Companies Inc.

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)

11-2408943
(I.R.S. Employer Identification No.)

767 Fifth Avenue, New York, New York
(Address of principal executive offices)

10153
(Zip Code)

212-572-4200

(Registrant’s telephone number, including area code)

Not Applicable

(Former name or former address, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Class A Common Stock, $.01 par value

EL

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer 

Accelerated filer

Non-accelerated filer   

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes No

At October 24, 2019, 222,550,639 shares of the registrant’s Class A Common Stock, $.01 par value, and 137,262,914 shares of the registrant’s Class B Common Stock, $.01 par value, were outstanding.

Table of Contents

THE ESTÉE LAUDER COMPANIES INC.

INDEX

Page

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

Consolidated Statements of Earnings —
Three Months Ended September 30, 2019 and 2018

2

Consolidated Statements of Comprehensive Income (Loss) —
Three Months Ended September 30, 2019 and 2018

3

Consolidated Balance Sheets —
September 30, 2019 and June 30, 2019 (Audited)

4

Consolidated Statements of Cash Flows —
Three Months Ended September 30, 2019 and 2018

5

Notes to Consolidated Financial Statements

6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

28

Item 3. Quantitative and Qualitative Disclosures About Market Risk

46

Item 4. Controls and Procedures

46

Part II. Other Information

Item 1. Legal Proceedings

46

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

46

Item 6. Exhibits

47

Signatures

48

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

Three Months Ended

September 30

(In millions, except per share data)

    

2019

    

2018

 

Net sales

$

3,895

 

$

3,524

Cost of sales

 

908

 

823

Gross profit

 

2,987

 

2,701

Operating expenses

Selling, general and administrative

 

2,185

 

2,008

Restructuring and other charges

23

41

Total operating expenses

2,208

2,049

Operating income

 

779

 

652

Interest expense

 

32

 

34

Interest income and investment income, net

14

15

Other components of net periodic benefit cost

1

Earnings before income taxes

 

760

 

633

Provision for income taxes

 

162

 

131

Net earnings

 

598

 

502

Net earnings attributable to noncontrolling interests

 

(3)

 

(2)

Net earnings attributable to The Estée Lauder Companies Inc.

$

595

 

$

500

Net earnings attributable to The Estée Lauder Companies Inc. per common share

Basic

$

1.65

 

$

1.36

Diluted

$

1.61

$

1.34

Weighted-average common shares outstanding

Basic

 

361.4

 

366.8

Diluted

 

368.6

 

374.4

See notes to consolidated financial statements.

2

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THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

Three Months Ended

September 30

(In millions)

    

2019

    

2018

Net earnings

 

$

598

 

$

502

Other comprehensive income (loss):

Net unrealized investment gain

 

 

2

Net cash flow hedge loss

 

(2)

 

Amounts included in net periodic benefit cost

 

5

 

3

Translation adjustments

 

(70)

 

23

Benefit (provision) for deferred income taxes on components of other comprehensive income

 

3

 

(3)

Total other comprehensive income (loss)

 

(64)

 

25

Comprehensive income

 

534

 

527

Comprehensive income attributable to noncontrolling interests:

Net earnings

 

(3)

(2)

Comprehensive income attributable to The Estée Lauder Companies Inc.

 

$

531

 

$

525

See notes to consolidated financial statements.

3

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THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED BALANCE SHEETS

September 30

June 30

(In millions, except share data)

    

2019

    

2019

 

(Unaudited)

ASSETS

Current assets

Cash and cash equivalents

 

$

2,259

 

$

2,987

Accounts receivable, net

 

2,294

 

1,831

Inventory and promotional merchandise

 

2,055

 

2,006

Prepaid expenses and other current assets

 

414

 

388

Total current assets

 

7,022

 

7,212

Property, plant and equipment, net

 

2,018

 

2,068

Other assets

Operating lease right-of-use assets

2,516

Goodwill

 

1,868

 

1,868

Other intangible assets, net

 

1,191

 

1,203

Other assets

 

816

 

805

Total other assets

 

6,391

 

3,876

Total assets

 

$

15,431

 

$

13,156

LIABILITIES AND EQUITY

Current liabilities

Current debt

 

$

520

 

$

516

Accounts payable

 

1,071

 

1,490

Operating lease liabilities

346

Other accrued liabilities

 

2,653

 

2,599

Total current liabilities

 

4,590

 

4,605

Noncurrent liabilities

Long-term debt

 

2,895

 

2,896

Long-term operating lease liabilities

2,335

Other noncurrent liabilities

 

1,053

 

1,244

Total noncurrent liabilities

 

6,283

 

4,140

Contingencies

Equity

Common stock, $.01 par value; Class A shares authorized: 1,300,000,000 at September 30, 2019 and June 30, 2019; shares issued: 447,163,948 at September 30, 2019 and 443,685,124 at June 30, 2019; Class B shares authorized: 304,000,000 at September 30, 2019 and June 30, 2019; shares issued and outstanding: 137,262,914 at September 30, 2019 and 139,537,814 at June 30, 2019

 

6

 

6

Paid-in capital

 

4,514

 

4,403

Retained earnings

 

10,393

 

9,984

Accumulated other comprehensive loss

 

(627)

 

(563)

 

14,286

 

13,830

Less: Treasury stock, at cost; 223,724,519 Class A shares at September 30, 2019 and 222,120,630 Class A shares at June 30, 2019

 

(9,756)

 

(9,444)

Total stockholders’ equity – The Estée Lauder Companies Inc.

 

4,530

 

4,386

Noncontrolling interests

 

28

 

25

Total equity

 

4,558

 

4,411

Total liabilities and equity

 

$

15,431

 

$

13,156

See notes to consolidated financial statements.

4

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THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

Three Months Ended

September 30

(In millions)

    

2019

    

2018

 

Cash flows from operating activities

Net earnings

 

$

598

 

$

502

Adjustments to reconcile net earnings to net cash flows from operating activities:

Depreciation and amortization

 

143

 

132

Deferred income taxes

 

11

 

(9)

Non-cash stock-based compensation

 

56

 

58

Net loss on disposal of property, plant and equipment

 

2

 

3

Pension and post-retirement benefit expense

 

21

 

18

Pension and post-retirement benefit contributions

 

(9)

 

(6)

Changes in fair value of contingent consideration

(11)

Other non-cash items

(2)

(4)

Changes in operating assets and liabilities:

Increase in accounts receivable, net

 

(487)

 

(546)

Increase in inventory and promotional merchandise

 

(83)

 

(36)

Increase in other assets, net

 

(48)

 

(18)

Decrease in accounts payable

(400)

(262)

Increase in other accrued and noncurrent liabilities

 

31

 

60

Decrease in operating lease assets and liabilities, net

 

(3)

 

Net cash flows used for operating activities

 

(170)

 

(119)

Cash flows from investing activities

Capital expenditures

 

(125)

 

(128)

Proceeds from the disposition of investments

173

Purchases of investments

(5)

(14)

Settlement of net investment hedges, net

2

Net cash flows provided by (used for) investing activities

 

(128)

 

31

Cash flows from financing activities

Proceeds (repayments) of current debt, net

 

5

 

(3)

Repayments and redemptions of long-term debt

 

(5)

 

Net proceeds from stock-based compensation transactions

 

55

 

33

Payments to acquire treasury stock

 

(313)

 

(530)

Dividends paid to stockholders

 

(156)

 

(141)

Payments to noncontrolling interest holders for dividends

(2)

(1)

Net cash flows used for financing activities

 

(416)

 

(642)

Effect of exchange rate changes on Cash and cash equivalents

 

(14)

 

(8)

Net decrease in Cash and cash equivalents

 

(728)

 

(738)

Cash and cash equivalents at beginning of period

 

2,987

 

2,181

Cash and cash equivalents at end of period

 

$

2,259

 

$

1,443

See notes to consolidated financial statements.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements include the accounts of The Estée Lauder Companies Inc. and its subsidiaries (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated.

The unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments of a normal recurring nature considered necessary for a fair presentation have been included. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.

Certain amounts in the consolidated financial statements of prior years have been reclassified to conform to current year presentation.

Management Estimates

The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses reported in those financial statements. Descriptions of the Company’s significant accounting policies are discussed in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019. Management evaluates the related estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, and makes adjustments when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from those estimates and assumptions. Significant changes, if any, in those estimates and assumptions resulting from continuing changes in the economic environment will be reflected in the consolidated financial statements in future periods.

Currency Translation and Transactions

All assets and liabilities of foreign subsidiaries and affiliates are translated at period-end rates of exchange, while revenue and expenses are translated at weighted-average rates of exchange for the period. Unrealized translation gains (losses), net of tax, reported as cumulative translation adjustments through other comprehensive income (loss) (“OCI”) attributable to The Estée Lauder Companies Inc. were $(72) million and $21 million, net of tax, during the three months ended September 30, 2019 and 2018, respectively. For the Company’s subsidiaries operating in highly inflationary economies, the U.S. dollar is the functional currency. Remeasurement adjustments in financial statements in a highly inflationary economy and other transactional gains and losses are reflected in earnings. These subsidiaries are not material to the Company’s consolidated financial statements or liquidity.

The Company enters into foreign currency forward contracts and may enter into option contracts to hedge foreign currency transactions for periods consistent with its identified exposures. During the first quarter of fiscal 2020, the Company entered into foreign currency forward contracts to hedge a portion of its net investment in certain foreign operations, which are designated as net investment hedges. See Note 5 - Derivative Financial Instruments for further discussion. The Company categorizes these instruments as entered into for purposes other than trading.

The accompanying consolidated statements of earnings include net exchange losses on foreign currency transactions of $3 million and $14 million during the three months ended September 30, 2019 and 2018, respectively.

Concentration of Credit Risk

The Company is a worldwide manufacturer, marketer and distributor of skin care, makeup, fragrance and hair care products. The Company’s sales subject to credit risk are made primarily to department stores, perfumeries, specialty multi-brand retailers and retailers in its travel retail business. The Company grants credit to qualified customers and does not believe it is exposed significantly to any undue concentration of credit risk.

6

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Inventory and Promotional Merchandise

Inventory and promotional merchandise consists of:

September 30

June 30

(In millions)

    

2019

    

2019

 

Raw materials

 

$

510

 

$

541

Work in process

 

234

 

268

Finished goods

 

1,075

 

981

Promotional merchandise

 

236

 

216

 

$

2,055

 

$

2,006

Property, Plant and Equipment

September 30

June 30

(In millions)

    

2019

    

2019

 

Assets (Useful Life)

Land

 

$

29

 

$

29

Buildings and improvements (10 to 40 years)

 

341

 

337

Machinery and equipment (3 to 10 years)

 

815

 

811

Computer hardware and software (4 to 10 years)

 

1,265

 

1,264

Furniture and fixtures (5 to 10 years)

 

115

 

116

Leasehold improvements

 

2,279

 

2,274

 

4,844

 

4,831

Less accumulated depreciation and amortization

 

(2,826)

 

(2,763)

 

$

2,018

 

$

2,068

The cost of assets related to projects in progress of $469 million and $474 million as of September 30, 2019 and June 30, 2019, respectively, is included in their respective asset categories above. Depreciation and amortization of property, plant and equipment was $125 million and $116 million during the three months ended September 30, 2019 and 2018, respectively. Depreciation and amortization related to the Company’s manufacturing process is included in Cost of sales, and all other depreciation and amortization is included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings.

Income Taxes

The effective rate for income taxes was 21.3% and 20.7% for the three months ended September 30, 2019 and 2018, respectively. The increase in the effective tax rate of 60 basis points was primarily attributable to a higher effective tax rate on the Company’s foreign operations partially offset by a higher benefit related to share-based compensation awards.

As of September 30, 2019 and June 30, 2019, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $65 million and $67 million, respectively. The total amount of unrecognized tax benefits at September 30, 2019 that, if recognized, would affect the effective tax rate was $49 million. The total gross interest and penalties accrued related to unrecognized tax benefits during the three months ended September 30, 2019 in the accompanying consolidated statement of earnings was $1 million. The total gross accrued interest and penalties in each of the accompanying consolidated balance sheets at September 30, 2019 and June 30, 2019 was $12 million. On the basis of the information available as of September 30, 2019, the Company does not expect any significant changes to the total amount of unrecognized tax benefits within the next twelve months.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Other Accrued Liabilities

Other accrued liabilities consist of the following:

September 30

June 30

(In millions)

    

2019

    

2019

 

Advertising, merchandising and sampling

 

$

429

 

$

352

Employee compensation

 

381

 

574

Payroll and other taxes

 

263

 

221

Deferred revenue

345

314

Other

 

1,235

 

1,138

 

$

2,653

 

$

2,599

Recently Adopted Accounting Standards

Leases (Accounting Standards Codification ("ASC") Topic 842 - Leases ("ASC 842"))

In February 2016, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance that requires lessees to account for most leases on their balance sheets with the liability being equal to the present value of the lease payments. The right-of-use asset is based on the lease liability adjusted for certain costs such as initial direct costs, prepaid lease payments and lease incentives received. Lease expense is recognized similar to previous accounting guidance with operating leases resulting in a straight-line expense, and finance leases resulting in a front-loaded expense similar to the previous accounting for capital leases.

In July 2018, the FASB amended this guidance to clarify certain narrow aspects of the new lease accounting standard that may have been incorrectly or inconsistently applied, and did not add new guidance. Also, in July 2018, the FASB issued authoritative guidance that allows companies to elect to adopt the new standard using a modified retrospective transition approach with a cumulative-effect adjustment to retained earnings in the period of adoption. Companies that elect the new adoption method were not required to restate the prior comparative periods in the financial statements.

Effective for the Company – Fiscal 2020 first quarter. An entity is permitted to apply the foregoing guidance using either of the modified retrospective transition approaches described in the standard, with certain practical expedients.

Impact on consolidated financial statements - On July 1, 2019, the Company adopted ASC 842, see Note 3 - Leases for further discussion.

Recently Issued Accounting Standards

Measurement of Credit Losses on Financial Instruments (ASC Topic 326 - Financial Instruments - Credit Losses)

In June 2016, the FASB issued authoritative guidance that requires companies to utilize an impairment model for most financial assets measured at amortized cost and certain other financial instruments, which include trade and other receivables, loans and held-to-maturity debt securities, to record an allowance for credit risk based on expected losses rather than incurred losses. In addition, this guidance changes the recognition method for credit losses on available-for-sale debt securities, which can occur as a result of market and credit risk, and requires additional disclosures. In general, modified retrospective adoption will be required for all outstanding instruments that fall under this guidance.

Effective for the Company - Fiscal 2021 first quarter.

Impact on consolidated financial statements – The Company is currently evaluating the impact of applying this guidance on its financial instruments, such as accounts receivable. While the Company’s evaluation is ongoing, the adoption of this standard is not expected to have a material impact on its consolidated financial statements.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Goodwill and Other – Internal-Use Software (ASU 2018-15 - Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract)

In August 2018, the FASB issued authoritative guidance that permits companies to capitalize the costs incurred for setting up business systems that operate on cloud technology. The new guidance aligns the requirement for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance does not affect the accounting for the service element of a hosting arrangement that is a service contract. Capitalized costs associated with a hosting arrangement that is a service contract must be amortized over the term of the hosting arrangement to the same line item in the income statement as the expense for fees for the hosting arrangement.

Effective for the Company Fiscal 2021 first quarter, with early adoption permitted in any interim period. This guidance can be adopted either:

retrospectively; or
prospectively to all implementation costs incurred after the date of adoption.

Impact on consolidated financial statements – The Company is currently evaluating the impact of applying this guidance to its business systems that operate on cloud technology. While the Company’s evaluation is ongoing, the adoption of this standard is not expected to have a material impact on its consolidated financial statements.

No other recently issued accounting pronouncements are expected to have a material impact on the Company’s consolidated financial statements.

NOTE 2 – GOODWILL AND OTHER INTANGIBLE ASSETS

The following table presents goodwill by product category and the related change in the carrying amount:

(In millions)

    

Skin Care

    

Makeup

    

Fragrance

    

Hair Care

    

Total

 

Balance as of June 30, 2019

Goodwill

 

$

185

 

$

1,199

 

$

254

 

$

390

 

$

2,028

Accumulated impairments

 

(36)

 

(68)

 

(22)

 

(34)

 

(160)

 

149

 

1,131

 

232

 

356

 

1,868

Goodwill acquired during the period

 

3

3

Translation adjustments, goodwill

(1)

(3)

(4)

Translation adjustments, accumulated impairments

 

1

1

 

3

(3)

Balance as of September 30, 2019

Goodwill

 

184

1,202

251

390

2,027

Accumulated impairments

 

(35)

(68)

(22)

(34)

(159)

 

$

149

 

$

1,134

 

$

229

 

$

356

 

$

1,868

Other intangible assets consist of the following:

September 30, 2019

June 30, 2019

Gross

Total Net

Gross

Total Net

Carrying

Accumulated

Book 

Carrying

Accumulated

Book

(In millions)

    

Value

    

Amortization

    

Value

    

Value

    

Amortization

    

Value

 

Amortizable intangible assets:

Customer lists and other

 

$

682

 

$

378

 

$

304

 

$

684

 

$

369

 

$

315

License agreements

 

43

 

43

 

 

43

 

43

 

 

$

725

 

$

421

 

304

 

$

727

 

$

412

 

315

Non-amortizable intangible assets:

Trademarks

 

887

 

888

Total intangible assets

 

$

1,191

 

$

1,203

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The aggregate amortization expense related to amortizable intangible assets was $11 million and $13 million for the three months ended September 30, 2019 and 2018, respectively. The estimated aggregate amortization expense for the remainder of fiscal 2020 and for each of the next four fiscal years is as follows:

Fiscal

(In millions)

    

2020

    

2021

    

2022

    

2023

    

2024

 

Estimated aggregate amortization expense

 

$

33

 

$

43

 

$

42

 

$

42

 

$

40

NOTE 3 - LEASES

During the first quarter of fiscal 2020, the Company adopted ASC 842 using the modified retrospective transition approach permitted under the new standard for leases that existed at July 1, 2019 and, accordingly, the prior comparative periods were not restated. Under this method, the Company was required to assess the remaining future payments of existing leases as of July 1, 2019. Additionally, as of the date of adoption, the Company elected the package of practical expedients that did not require the Company to assess whether expired or existing contracts contain leases as defined in ASC 842, did not require reassessment of the lease classification (i.e. operating lease vs. finance lease) for expired or existing leases, and did not require a change to the accounting for previously capitalized initial direct costs.

The adoption of this standard impacted the Company's consolidated balance sheet due to the recognition of right-of-use ("ROU") assets and associated lease liabilities related to operating leases as compared to the previous accounting. The accounting for finance leases under ASC 842 is consistent with the prior accounting for capital leases. The impact of the adoption of this standard on the Company's consolidated statement of earnings and consolidated statement of cash flows was not material.

Per the guidance of ASC 842, a contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset. The Company recognizes a lease liability and a related ROU asset at the commencement date for leases on its consolidated balance sheet, excluding short-term leases as noted below. The lease liability is equal to the present value of unpaid lease payments over the remaining lease term. The Company's lease term at the commencement date may reflect options to extend or terminate the lease when it is reasonably certain that such options will be exercised. To determine the present value of the lease liability, the Company uses an incremental borrowing rate, which is defined as the rate of interest that the Company would have to pay to borrow (on a collateralized basis over a similar term) an amount equal to the lease payments in similar economic environments. The ROU asset is based on the corresponding lease liability adjusted for certain costs such as initial direct costs, prepaid lease payments and lease incentives received. Both operating and finance lease ROU assets are reviewed for impairment, consistent with other long-lived assets, whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. After an ROU asset is impaired, any remaining balance of the ROU asset is amortized on a straight-line basis over the shorter of the remaining lease term or the estimated useful life.

After the lease commencement date, the Company evaluates lease modifications, if any, that could result in a change in the accounting for leases. For a lease modification, an evaluation is performed to determine if it should be treated as either a separate lease or a change in the accounting of an existing lease. In addition, significant changes in events or circumstances within the Company's control are assessed to determine whether a change in the accounting for leases is required.

Certain of the Company's leases provide for variable lease payments for the right to use an underlying asset that vary due to changes in facts and circumstances occurring after the commencement date, other than the passage of time. Variable lease payments that are dependent on an index or rate (e.g., Consumer Price Index) are included in the initial measurement of the lease liability, the initial measurement of the ROU asset, and the lease classification test based on the index or rate as of the commencement date. Any changes from the commencement date estimation of the index- and rate-based variable payments are expensed as incurred in the period of the change. Variable lease payments that are not known at the commencement date and are determinable based on the performance or use of the underlying asset, are not included in the initial measurement of the lease liability or the ROU asset, but instead are expensed as incurred. The Company's variable lease payments primarily include rents based on a percentage of sales in excess of stipulated levels, common area maintenance based on the percentage of the total square footage leased by the Company, as well as costs relating to embedded leases, such as third-party manufacturing agreements.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Upon the adoption of ASC 842, the Company made the following accounting policy elections:

Certain of the Company’s contracts contain lease components as well as non-lease components, such as an agreement to purchase services. Unless an accounting policy is elected to the contrary, the contract consideration must be allocated to the separate lease and non-lease components in accordance with ASC 842. For purposes of allocating contract consideration, the Company elected not to separate the lease components from non-lease components for all asset classes. This was applied to all existing leases as of July 1, 2019 and will be applied to new leases on an on-going basis.
The Company elected not to apply the measurement and recognition requirements of ASC 842 to short-term leases (i.e. leases with a term of 12 months or less). Accordingly, short-term leases will not be recorded as ROU assets or lease liabilities on the Company’s consolidated balance sheets, and the related lease payments will be recognized in net earnings on a straight-line basis over the lease term.
For certain leases relating to automobiles, information technology equipment and office equipment, the Company elected to apply the guidance of ASC 842 utilizing a portfolio approach. Under this approach, the Company combined and accounted for leases (as a portfolio) with similar characteristics (e.g., lease term, discount rates, etc.) as a single lease, provided its application is not materially different when compared to the application at the individual lease level.

As a result of the adoption of ASC 842, the Company recorded a cumulative adjustment of $29 million, net of tax, as a reduction to its fiscal 2020 opening balance of retained earnings, primarily to reflect the fair value of operating lease ROU assets that were impaired at, or prior to, the adoption date. In addition, the Company recognized operating lease ROU assets and liabilities of $2,598 million and $2,764 million, respectively, as of July 1, 2019. Finance lease ROU assets and liabilities are not material.

The Company has operating and finance leases primarily for real estate properties, including corporate offices, facilities to support the Company's manufacturing, assembly, research and development and distribution operations and retail stores, as well as information technology equipment, automobiles and office equipment, with remaining terms of approximately 1 year to 50 years. Some of the Company's lease contracts include options to extend the leases for up to 30 years, while others include options to terminate the leases within 34 years.

A summary of total lease costs and other information for the period relating to the Company's finance and operating leases is as follows:

    

Three Months Ended

 

(In millions)

September 30, 2019

 

Total lease cost

 

  

Finance lease cost:

Amortization of right-of-use assets

$

3

Interest on lease liabilities

 

Operating lease cost

 

118

Short-term lease cost

 

6

Variable lease cost

 

43

Total

$

170

Other information

 

  

Cash paid for amounts included in the measurement of lease liabilities

 

Operating cash flows from operating leases

$

123

Financing cash flows from finance leases

$

5

Right-of-use assets obtained in exchange for new operating lease liabilities

$

48

Weighted-average remaining lease term – finance leases

 

6

years

Weighted-average remaining lease term – operating leases

 

11

years

Weighted-average discount rate – finance leases

 

2.7

%

Weighted-average discount rate – operating leases

 

2.5

%

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The total future minimum lease payments, over the remaining lease term, relating to the Company’s operating and finance leases for the remainder of fiscal 2020 and for each of the next four fiscal years and thereafter is as follows:

(In millions)

    

Operating Leases

    

Finance Leases

Remainder of fiscal 2020

$

285

$

9

Fiscal 2021

 

373

 

8

Fiscal 2022

 

331

 

3

Fiscal 2023

 

301

 

1

Fiscal 2024

 

286

 

Thereafter

 

1,542

 

Total future minimum lease payments

 

3,118

 

21

Less imputed interest

 

(437)

 

(1)

Total

$

2,681

$

20

Operating lease and finance lease liabilities included in the consolidated balance sheet are as follows:

September 30, 2019

(In millions)

    

Operating Leases

    

Finance Leases

Total current liabilities

$

346

$

11

Total noncurrent liabilities

 

2,335

 

9

Total

$

2,681

$

20

The ROU assets and lease liabilities related to finance leases are included in Other assets and in Current debt and Long-term debt, respectively, in the accompanying consolidated balance sheet as of September 30, 2019.

The following table summarizes scheduled maturities of the Company’s contractual obligations relating to operating leases for which cash flows are fixed and determinable as of June 30, 2019:

(In millions)

    

Payments Due in Fiscal Year(1)

Fiscal 2020

$

421

Fiscal 2021

 

383

Fiscal 2022

 

348

Fiscal 2023

 

316

Fiscal 2024

 

289

Thereafter

 

1,625

Total contractual obligations

$

3,382

(1)Minimum operating lease commitments only include base rent. Certain leases provide for contingent rents that are not measurable at inception and primarily include rents based on a percentage of sales in excess of stipulated levels, as well as common area maintenance. These amounts are excluded from minimum operating lease commitments and are included in the determination of total rent expense when it is probable that the expense has been incurred and the amount is reasonably measurable. Such amounts have not been material to total rent expense.

As of September 30, 2019, the Company has additional operating leases obligations, relating primarily to facilities to support the Company’s manufacturing and research and development operations, as well as corporate offices, that have not yet commenced of $98 million. These leases will commence between fiscal 2020 and fiscal 2025 with lease terms of 1 year to 20 years.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4 – CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER ACTIVITIES

In May 2016, the Company announced a multi-year initiative (“Leading Beauty Forward” or “LBF”) to build on its strengths and better leverage its cost structure to free resources for investment to continue its growth momentum. LBF is designed to enhance the Company’s go-to-market capabilities, reinforce its leadership in global prestige beauty and continue creating sustainable value. As of June 30, 2019, the Company concluded the approvals of all major initiatives under LBF related to the optimization of select corporate functions, supply chain activities, and corporate and regional market support structures, as well as the exit of underperforming businesses, and expects to substantially complete those initiatives through fiscal 2021. The approved restructuring and other charges expected to be incurred were:

Sales

Returns

Operating Expenses

(included in

Restructuring

Other

(In millions)

     

Net Sales)

    

Cost of Sales

    

Charges

    

Charges

    

Total

Total Charges Approved

Cumulative through September 30, 2019

$

14

$

88

$

507

$

358

$

967

Employee-

Asset-

Related

Related

Contract

Other Exit

(In millions)

    

Costs

    

 Costs

    

Terminations

    

Costs

    

Total

Restructuring Charges Approved

Cumulative through September 30, 2019

$

461

$

7

$

25

$

14

$

507

The Company records approved charges associated with restructuring and other activities once the relevant accounting criteria have been met. Total cumulative charges recorded associated with restructuring and other activities for LBF were:

Sales

 

Returns

Operating Expenses

 

(included in

Restructuring

Other

 

(In millions)

     

Net Sales)

    

Cost of Sales

    

Charges

    

Charges

    

Total

Total Charges

Cumulative through June 30, 2019

$

14

$

55

$

457

$

265

$

791

Three months ended September 30, 2019

2

1

22

25

Cumulative through September 30, 2019

$

14

$

57

$

458

$

287

$

816

Employee-

Asset-

Related

Related

Contract

Other Exit

(In millions)

    

Costs

    

Costs

    

Terminations

    

Costs

    

Total

Restructuring Charges

Cumulative through June 30, 2019

$

445

$

4

$

3

$

5

$

457

Three months ended September 30, 2019

1

1

Cumulative through September 30, 2019

$

445

$

4

$

3

$

6

$

458

Changes in accrued restructuring charges for the three months ended September 30, 2019 were:

Employee-

Asset-

 

Related

 Related

Contract

Other Exit

(In millions)

    

Costs

    

Costs

    

Terminations

    

 Costs

    

Total

 

Balance at June 30, 2019

$

202

$

$

$

1

$

203

Charges

1

1

Cash payments

(29)

(1)

(30)

Balance at September 30, 2019

$

173

$

$

$

1

$

174

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Accrued restructuring charges at September 30, 2019 are expected to result in cash expenditures funded from cash provided by operations of approximately $108 million, $44 million, $19 million and $3 million for the remainder of fiscal 2020 and for fiscal 2021, 2022 and 2023, respectively.

Additional information about LBF is included in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.

NOTE 5 – DERIVATIVE FINANCIAL INSTRUMENTS

The Company addresses certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments. The Company enters into foreign currency forward contracts, and may enter into option contracts, to reduce the effects of fluctuating foreign currency exchange rates. In addition, the Company enters into interest rate derivatives to manage the effects of interest rate movements on the Company’s aggregate liability portfolio, including potential future debt issuances. During the first quarter of fiscal 2020, the Company entered into foreign currency forward contracts to hedge a portion of its net investment in certain foreign operations, which are designated as net investment hedges. The Company entered into the net investment hedges to offset the risk of changes in the U.S. dollar value of the Company's investment in these foreign operations due to fluctuating foreign exchange rates. Time value is excluded from the effectiveness assessment and is recognized under a systematic and rational method over the life of the hedging instrument in Selling, general and administrative expenses. The net gain or loss on net investment hedges is recorded within translation adjustments, as a component of accumulated OCI (“AOCI”) on the Company’s consolidated balance sheets, until the sale or substantially complete liquidation of the underlying assets of the Company's investment. The Company also enters into foreign currency forward contracts, and may use option contracts, not designated as hedging instruments, to mitigate the change in fair value of specific assets and liabilities on the balance sheet. The Company does not utilize derivative financial instruments for trading or speculative purposes. Costs associated with entering into derivative financial instruments have not been material to the Company’s consolidated financial results.

For each derivative contract entered into, where the Company looks to obtain hedge accounting treatment, the Company formally and contemporaneously documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking the hedge transaction, the nature of the risk being hedged, and how the hedging instruments’ effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively. This process includes linking all derivatives to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. At inception, the Company evaluates the effectiveness of hedge relationships quantitatively, and has elected to perform, after initial evaluation, qualitative effectiveness assessments of certain hedge relationships to support an ongoing expectation of high effectiveness, if effectiveness testing is required. If based on the qualitative assessment, it is determined that a derivative has ceased to be a highly effective hedge, the Company will perform a quantitative assessment to determine whether to discontinue hedge accounting with respect to that derivative prospectively.

14

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The fair values of the Company’s derivative financial instruments included in the consolidated balance sheets are as follows:

Asset Derivatives

Liability Derivatives

Fair Value (1)

Fair Value (1)

Balance Sheet

September 30

June 30

Balance Sheet

September 30

June 30

(In millions)

    

Location

    

2019

    

2019

    

Location

    

2019

    

2019

Derivatives Designated as Hedging Instruments

Foreign currency cash flow hedges

Prepaid expenses and other current assets

 

$

39

$

23

 

Other accrued liabilities

 

$

2

 

$

4

Net investment hedges

Prepaid expenses and other current assets

3

Other accrued liabilities

1

Interest rate-related derivatives

Prepaid expenses and other current assets

4

3

Other accrued liabilities

39

26

Total Derivatives Designated as Hedging Instruments

46

26

42

30

Derivatives Not Designated as Hedging Instruments

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

4

 

4

 

Other accrued liabilities

 

6

 

2

Total Derivatives

 

$

50

$

30

 

$

48

 

$

32

(1)See Note 6 – Fair Value Measurements for further information about how the fair value of derivative assets and liabilities are determined.

15

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The amounts of the gains and losses related to the Company’s derivative financial instruments designated as hedging instruments that are included in the assessment of effectiveness are as follows:

Amount of Gain or (Loss)

Amount of Gain or (Loss)

Recognized in OCI on

Reclassified from AOCI into

Derivatives

Location of Gain or

Earnings(1)

Three Months Ended

(Loss) Reclassified

Three Months Ended

September 30

from AOCI into

September 30

(In millions)

    

2019

    

2018

    

Earnings 

    

2019

    

2018

Derivatives in Cash Flow Hedging Relationships:

Foreign currency forward contracts

 

$

25

 

$

3

 

Net sales

 

$

13

 

$

3

Interest rate-related derivatives

(14)

Interest expense

11

3

Total derivatives

$

13

$

3

Derivatives in Net Investment Hedging Relationships(2):

Foreign currency forward contracts(3)

3

Total derivatives

 

$

14

 

$

3

 

(1)The amount reclassified into earnings as a result of the discontinuance of cash flow hedges because probable forecasted transactions will no longer occur by the end of the original time period was not material.
(2)During the three months ended September 30, 2019, the gain recognized in earnings from net investment hedges related to the amount excluded from effectiveness testing was $12 million.
(3)Included within translation adjustments, as a component of AOCI on the Company’s consolidated balance sheets.

Amount of Gain or (Loss) Recognized in Earnings on

    

    

Derivatives (1)

Location of Gain or (Loss)

Three Months Ended

Recognized in Earnings on

September 30

(In millions)

Derivatives

2019

    

2018

Derivatives in Fair Value Hedging Relationships:

Interest rate swap contracts

 

Interest expense

 

$

2

 

$

(2)

(1)Changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt.

Additional information regarding the cumulative amount of fair value hedging adjustments for items designated and qualifying as hedged items in fair value hedges is as follows:

Amount of Gain or (Loss)

(In millions)

Recognized in Earnings on Derivatives

Cumulative Amount of Fair

Value Hedging Adjustments

Line Item in the Consolidated Balance Sheets in

Carrying Amount of the

Included in the Carrying Amount

Which the Hedged Item is Included

Hedged Assets (Liabilities)

of the Hedged Asset (Liability)

    

September 30, 2019

    

September 30, 2019

Current debt

$

250

$

Long-term debt

701

3

Total debt

$

951

$

3

16

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Additional information regarding the effects of fair value and cash flow hedging relationships for derivatives designated and qualifying as hedging instruments is as follows:

Three Months Ended September 30

2019

 

2018

    

    

Interest

    

    

Interest

(In millions)

Net Sales

expense

Net Sales

expense

Total amounts of income and expense line items presented in the consolidated statements of earnings in which the effects of fair value and cash flow hedges are recorded

$

3,895

$

32

$

3,524

$

34

The effects of fair value and cash flow hedging relationships:

 

  

 

  

 

  

 

  

Gain (loss) on fair value hedge relationships – interest rate contracts:

 

  

 

  

 

  

 

  

Hedged item

 

Not applicable

 

2

 

Not applicable

 

(2)

Derivatives designated as hedging instruments

 

Not applicable

 

(2)

 

Not applicable

 

2

Gain (loss) on cash flow hedge relationships – foreign currency forward contracts:

Amount of gain reclassified from AOCI into earnings

13

Not applicable

3

Not applicable

The amounts of the gains and losses related to the Company’s derivative financial instruments not designated as hedging instruments are presented as follows:

Amount of Gain or (Loss)

Recognized in Earnings on

Derivatives

Location of Gain or (Loss)

Three Months Ended

Recognized in Earnings on

September 30

(In millions)

    

Derivatives

    

2019

    

2018

Derivatives Not Designated as Hedging Instruments:

Foreign currency forward contracts

 

Selling, general and administrative

 

$

(27)

 

$

22

Cash Flow Hedges

The Company enters into foreign currency forward contracts, and may enter into foreign currency option contracts, to hedge anticipated transactions and receivables and payables denominated in foreign currencies, for periods consistent with the Company’s identified exposures. The purpose of the hedging activities is to minimize the effect of foreign exchange rate movements on the cash flows that the Company receives from foreign subsidiaries. The foreign currency forward contracts entered into to hedge anticipated transactions have been designated as cash flow hedges and have varying maturities through the end of September 2021. Hedge effectiveness of the foreign currency forward contracts is based on the forward method, which includes time value in the effectiveness assessment. At September 30, 2019, the Company had outstanding foreign currency forward contracts with a notional amount totaling $5,725 million.

The Company may enter into interest rate forward contracts to hedge anticipated issuance of debt for periods consistent with the Company’s identified exposures. The purpose of the hedging activities is to minimize the effect of interest rate movements on the cost of debt issuance.

For hedge contracts that are no longer deemed highly effective, hedge accounting is discontinued and gains and losses in AOCI are reclassified to sales when the underlying forecasted transaction occurs. If it is probable that the forecasted transaction will no longer occur, then any gains or losses in AOCI are reclassified to current-period sales. As of September 30, 2019, the Company’s foreign currency cash flow hedges were highly effective.

17

Table of Contents

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The estimated net gain on the Company’s derivative instruments designated as cash flow hedges as of September 30, 2019 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $24 million. The accumulated net gain on derivative instruments in AOCI was $27 million and $29 million as of September 30, 2019 and June 30, 2019, respectively.

Fair Value Hedges

The Company enters into interest rate derivative contracts to manage the exposure to interest rate fluctuations on its funded indebtedness. The Company has interest rate swap agreements, with notional amounts totaling $250 million, $450 million and $250 million to effectively convert the fixed rate interest on its 2020 Senior Notes, 2021 Senior Notes and 2022 Senior Notes, respectively, to variable interest rates based on three-month LIBOR plus a margin. These interest rate swap agreements are designated as fair value hedges of the related long-term debt, and the changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt.

Net Investment Hedges

The Company enters into foreign currency forward contracts, designated as net investment hedges, to hedge a portion of its net investment in certain foreign operations. The net gain or loss on these contracts is recorded within translation adjustments, as a component of AOCI on the Company's consolidated balance sheets. The purpose of the hedging activities is to minimize the effect of foreign exchange rate movements on the Company's net investment in these foreign operations. The net investment hedge contracts have varying maturities through the end of October 2019. Hedge effectiveness of the net investment hedge contracts is based on the spot method. At September 30, 2019, the Company had net investment hedges outstanding with a notional amount totaling $1,723 million.

Credit Risk

As a matter of policy, the Company enters into derivative contracts only with counterparties that have a long-term credit rating of at least A- or higher by at least two nationally recognized rating agencies. The counterparties to these contracts are major financial institutions. Exposure to credit risk in the event of nonperformance by any of the counterparties is limited to the gross fair value of contracts in asset positions, which totaled $50 million at September 30, 2019. To manage this risk, the Company has strict counterparty credit guidelines that are continually monitored. Accordingly, management believes risk of loss under these hedging contracts is remote.

NOTE 6 – FAIR VALUE MEASUREMENTS

The Company records certain of its financial assets and liabilities at fair value, which is defined as the price that would be received to sell an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date. The accounting for fair value measurements must be applied to nonfinancial assets and nonfinancial liabilities that require initial measurement or remeasurement at fair value, which principally consist of assets and liabilities acquired through business combinations and goodwill, indefinite-lived intangible assets and long-lived assets for the purposes of calculating potential impairment. The Company is required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are as follows:

Level 1: Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.

Level 2: Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation.

18

Table of Contents

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2019:

(In millions)

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets:

Foreign currency forward contracts

 

$

 

$

46

 

$

 

$

46

Interest rate-related derivatives

4

4

Total

 

$

 

$

50

 

$

 

$

50

Liabilities:

Foreign currency forward contracts

$

$

9

$

$

9

Interest rate-related derivatives

39

39

Contingent consideration

36

36

Total

 

$

$

48

$

36

 

$

84

The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2019:

(In millions)

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets:

Foreign currency forward contracts

 

$

 

$

27

 

$

 

$

27

Interest rate-related derivatives

3

3

Total

 

$

 

$

30

 

$

 

$

30

Liabilities:

Foreign currency forward contracts

 

$

 

$

6

 

$

 

$

6

Interest rate-related derivatives

26

26

Contingent consideration

36

36

Total

$

$

32

$

36

$

68

The estimated fair values of the Company’s financial instruments are as follows:

September 30

June 30

2019

2019

Carrying

Fair

Carrying

Fair

(In millions)

    

Amount

    

Value

    

Amount

    

Value

Nonderivatives

Cash and cash equivalents

 

$

2,259

 

$

2,259

 

$

2,987

 

$

2,987

Current and long-term debt

 

3,415

3,841

 

3,412

3,706

Additional purchase price payable

3

3

3

3

Contingent consideration

36

36

36

36

Derivatives

Foreign currency forward contracts – asset (liability), net

 

37

37

 

21

21

Interest rate-related derivatives – asset (liability), net

(35)

(35)

(23)

(23)

The following methods and assumptions were used to estimate the fair value of the Company’s financial instruments for which it is practicable to estimate that value:

Cash and cash equivalents – Cash and all highly-liquid securities with original maturities of three months or less are classified as cash and cash equivalents, primarily consisting of cash deposits in interest bearing accounts, time deposits and money market funds (classified within Level 1 of the valuation hierarchy). The carrying amount approximates fair value, primarily due to the short maturity of cash equivalent instruments.

19

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Foreign currency forward contracts The fair values of the Company’s foreign currency forward contracts were determined using an industry-standard valuation model, which is based on an income approach.  The significant observable inputs to the model, such as swap yield curves and currency spot and forward rates, were obtained from an independent pricing service.  To determine the fair value of contracts under the model, the difference between the contract price and the current forward rate was discounted using LIBOR for contracts with maturities up to 12 months, and swap yield curves for contracts with maturities greater than 12 months.

Interest rate contracts – The fair values of the Company’s interest rate contracts were determined using an industry-standard valuation model, which is based on the income approach. The significant observable inputs to the model, such as treasury yield curves, swap yield curves and LIBOR forward rates, were obtained from independent pricing services.

Current and long-term debt The fair value of the Company’s debt was estimated based on the current rates offered to the Company for debt with the same remaining maturities. To a lesser extent, debt also includes finance lease obligations for which the carrying amount approximates the fair value. The Company’s debt is classified within Level 2 of the valuation hierarchy.

Additional purchase price payable – The Company’s additional purchase price payable represents fixed minimum additional purchase price that was discounted using the Company’s incremental borrowing rate, which was approximately 1%. The additional purchase price payable is classified within Level 2 of the valuation hierarchy.

Contingent consideration – Contingent consideration obligations consist of potential obligations related to the Company’s acquisitions in previous years. The amounts to be paid under these obligations are contingent upon the achievement of stipulated financial targets by the business subsequent to acquisition. At September 30, 2019, the fair values of the contingent consideration related to certain acquisition earn-outs were based on the Company’s estimate of the applicable financial targets as per the terms of the agreements. Significant changes in the projected future operating results would result in a significantly higher or lower fair value measurement. As these are unobservable inputs, the Company’s contingent consideration is classified within Level 3 of the valuation hierarchy. There have been no changes in the fair value of contingent consideration obligations for the three months ended September 30, 2019.

NOTE 7 – REVENUE RECOGNITION

The Company's revenue recognition accounting policies are described in the notes to consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2019.

Accounts Receivable

Accounts receivable, net is stated net of the allowance for doubtful accounts and customer deductions totaling $30 million and $32 million as of September 30, 2019 and June 30, 2019, respectively. The allowance for doubtful accounts is based upon the evaluation of accounts receivable aging, specific exposures and historical trends. Payment terms are short-term in nature and are generally less than one year.

Deferred Revenue

Significant changes in deferred revenue during the period are as follows:

(In millions)

    

September 30, 2019

Balance at June 30, 2019

$

361

Revenue recognized that was included in the deferred revenue balance at the beginning of the period

 

(160)

Revenue deferred during the period

 

195

Other

(4)

Balance at September 30, 2019

$

392

Transaction Price Allocated to the Remaining Performance Obligations

At September 30, 2019, the combined estimated revenue expected to be recognized in the next twelve months related to performance obligations for customer loyalty programs, gift with purchase promotions, purchase with purchase promotions and gift card liabilities that are unsatisfied (or partially unsatisfied) is $345 million.

20

Table of Contents

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8 – PENSION AND POST-RETIREMENT BENEFIT PLANS

The Company maintains pension plans covering substantially all of its full-time employees for its U.S. operations and a majority of its international operations. The Company also maintains post-retirement benefit plans that provide certain medical and dental benefits to eligible employees. Descriptions of these plans are included in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.

The components of net periodic benefit cost for the three months ended September 30, 2019 and 2018 consisted of the following:

Other than

Pension Plans

Pension Plans

U.S.

International

Post-retirement

(In millions)

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

Service cost

 

$

10

 

$

9

 

$

9

 

$

8

 

$

1

 

$

1

Interest cost

 

8

 

9

 

3

 

3

 

2

 

2

Expected return on plan assets

 

(13)

 

(13)

 

(3)

 

(3)

 

(1)

 

(1)

Amortization of:

Actuarial loss

 

4

 

3

 

1

 

 

 

Net periodic benefit cost

 

$

9

 

$

8

 

$

10

 

$

8

 

$

2

 

$

2

During the three months ended September 30, 2019, the Company made contributions to its international pension plans totaling approximately $3 million.

The amounts recognized in the consolidated balance sheets related to the Company’s pension and post-retirement benefit plans consist of the following:

September 30

June 30

(In millions)

    

2019

    

2019

Other assets

 

$

101

 

$

105

Other accrued liabilities

 

(27)

 

(27)

Other noncurrent liabilities

 

(422)

 

(418)

Funded status

 

(348)

 

(340)

Accumulated other comprehensive loss

 

329

 

334

Net amount recognized

 

$

(19)

 

$

(6)

NOTE 9 – CONTINGENCIES

Legal Proceedings

The Company is involved, from time to time, in litigation and other legal proceedings incidental to its business. Management believes that the outcome of current litigation and legal proceedings will not have a material adverse effect upon the Company’s business, results of operations, financial condition or cash flows. However, management’s assessment of the Company’s current litigation and other legal proceedings could change in light of the discovery of facts with respect to legal actions or other proceedings pending against the Company not presently known to the Company or determinations by judges, juries or other finders of fact which are not in accord with management's evaluation of the possible liability or outcome of such litigation or proceedings. Reasonably possible losses in addition to the amounts accrued for such litigation and legal proceedings are not material to the Company’s consolidated financial statements.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Contingencies

During the fiscal 2018 third quarter, the Company learned that some of its testing related to certain product advertising claims did not meet the Company’s standards, necessitating further validation. This review is ongoing, resulting in modifications to certain advertising claims. This is not a product safety issue and does not relate to the quality of the ingredients or the manufacturing of the Company’s products. Based on the Company’s review to date, it does not believe that this matter will be material to the Company, and no accrual has been recorded.

NOTE 10 – STOCK PROGRAMS

Total net stock-based compensation expense is attributable to the granting of, and the remaining requisite service periods of stock options, restricted stock units (“RSUs”), performance share units (“PSUs”), long-term PSUs, and share units. Compensation expense attributable to net stock-based compensation is as follows:

Three Months Ended

September 30

(In millions)

    

2019

    

2018

Compensation expense

 

$

56

 

$

58

Income tax benefit

11

12

Stock Options

During the three months ended September 30, 2019, the Company granted stock options in respect of approximately 1.3 million shares of Class A Common Stock with an exercise price per share of $199.49 and a weighted-average grant date fair value per share of $51.42. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model. The aggregate intrinsic value of stock options exercised during the three months ended September 30, 2019 was $116 million.

Restricted Stock Units

The Company granted RSUs in respect of approximately 0.8 million shares of Class A Common Stock during the three months ended September 30, 2019 with a weighted-average grant date fair value per share of $199.54 that, at the time of grant, were scheduled to vest as follows: 0.3 million in fiscal 2021, 0.3 million in fiscal 2022 and 0.2 million in fiscal 2023. Vesting of RSUs granted is generally subject to the continued employment or the retirement of the grantees. The RSUs are accompanied by dividend equivalent rights, payable upon settlement of the RSUs either in cash or shares (based on the terms of the particular award) and, as such, were valued at the closing market price of the Company’s Class A Common Stock on the date of grant.

Performance Share Units

During the three months ended September 30, 2019, the Company granted PSUs with a target payout of approximately 0.1 million shares of Class A Common Stock with a grant date fair value per share of $199.49, which will be settled in stock subject to the achievement of the Company’s net sales, diluted net earnings per common share and return on invested capital goals for the three fiscal years ending June 30, 2022, all subject to continued employment or the retirement of the grantees. For PSUs granted, no settlement will occur for results below the applicable minimum threshold. PSUs are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the PSUs and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant.

In September 2019, approximately 0.4 million shares of the Company’s Class A Common Stock were issued, and related accrued dividends were paid, relative to the target goals set at the time of the issuance, in settlement of 0.3 million PSUs which vested as of June 30, 2019.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 – NET EARNINGS ATTRIBUTABLE TO THE ESTÉE LAUDER COMPANIES INC. PER COMMON SHARE

Net earnings attributable to The Estée Lauder Companies Inc. per common share (“basic EPS”) is computed by dividing net earnings attributable to The Estée Lauder Companies Inc. by the weighted-average number of common shares outstanding and contingently issuable shares (which satisfy certain conditions). Net earnings attributable to The Estée Lauder Companies Inc. per common share assuming dilution (“diluted EPS”) is computed by reflecting potential dilution from stock-based awards.

A reconciliation between the numerator and denominator of the basic and diluted EPS computations is as follows:

Three Months Ended

September 30

(In millions, except per share data)

    

2019

    

2018

Numerator:

Net earnings attributable to The Estée Lauder Companies Inc.

 

$

595

 

$

500

Denominator:

Weighted-average common shares outstanding – Basic

 

361.4

 

366.8

Effect of dilutive stock options

 

4.9

 

5.0

Effect of PSUs

0.3

0.4

Effect of RSUs

 

2.0

 

2.2

Weighted-average common shares outstanding – Diluted

 

368.6

 

374.4

Net earnings attributable to The Estée Lauder Companies Inc. per common share:

Basic

 

$

1.65

 

$

1.36

Diluted

$

1.61

$

1.34

As of September 30, 2019 and 2018, the number of shares of Class A Common Stock underlying options that were excluded in the computation of diluted EPS because their inclusion would be anti-dilutive was 1.3 million shares and 1.6 million shares, respectively. As of September 30, 2019 and 2018, 1.1 million shares of Class A Common Stock underlying PSUs have been excluded from the calculation of diluted EPS because the number of shares ultimately issued is contingent on the achievement of certain performance targets of the Company, as discussed in Note 10 – Stock Programs.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12 – EQUITY

Three Months Ended

September 30

(In millions)

    

2019

    

2018

Common stock, beginning of the period

$

6

$

6

Stock-based compensation

 

 

Common stock, end of the period

 

6

 

6

Paid-in capital, beginning of the period

 

4,403

 

3,972

Common stock dividends

 

1

 

1

Stock-based compensation

 

110

 

92

Paid-in capital, end of the period

 

4,514

 

4,065

Retained earnings, beginning of the period

 

9,984

 

9,040

Common stock dividends

 

(157)

 

(141)

Net earnings attributable to The Estée Lauder Companies Inc.

 

595

 

500

Cumulative effect of adoption of new accounting standards

 

(29)

 

(229)

Retained earnings, end of the period

 

10,393

 

9,170

Accumulated other comprehensive loss, beginning of the period

 

(563)

 

(434)

Other comprehensive income (loss)

 

(64)

 

25

Accumulated other comprehensive loss, end of the period

 

(627)

 

(409)

Treasury stock, beginning of the period

 

(9,444)

 

(7,896)

Acquisition of treasury stock

 

(277)

 

(502)

Stock-based compensation

 

(35)

 

(28)

Treasury stock, end of the period

 

(9,756)

 

(8,426)

Total stockholders’ equity – The Estée Lauder Companies Inc.

 

4,530

 

4,406

Noncontrolling interests, beginning of the period

 

25

 

22

Net earnings attributable to noncontrolling interests

 

3

 

2

Noncontrolling interests, end of the period

 

28

 

24

Total equity

$

4,558

$

4,430

Cash dividends declared per common share

$

.43

$

.38

The following is a summary of quarterly cash dividends declared per share on the Company’s Class A and Class B Common Stock during the three months ended September 30, 2019:

Date Declared

    

Record Date

    

Payable Date

    

Amount per Share

August 16, 2019

 

August 30, 2019

 

September 16, 2019

 

$

.43

On October 30, 2019, a dividend was declared in the amount of $.48 per share on the Company’s Class A and Class B Common Stock. The dividend is payable in cash on December 16, 2019 to stockholders of record at the close of business on November 29, 2019.

Common Stock

During the three months ended September 30, 2019, the Company purchased approximately 1.6 million shares of its Class A Common Stock for $313 million.

During the three months ended September 30, 2019, approximately 2.3 million shares of the Company’s Class B Common Stock were converted into the same amount of shares of the Company’s Class A Common Stock.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS