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

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)-

 

x      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2019

 

OR

 

o         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)

 

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 x No o

 

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 x  No o

 

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 x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

 

Emerging growth company o

 

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. o

 

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

 

At April 24, 2019, 219,271,734 shares of the registrant’s Class A Common Stock, $.01 par value, and 142,600,834 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 and Nine Months Ended March 31, 2019 and 2018

2

 

 

 

 

Consolidated Statements of Comprehensive Income (Loss) —
Three and Nine Months Ended March 31, 2019 and 2018

3

 

 

 

 

Consolidated Balance Sheets —
March 31, 2019 and June 30, 2018 (Audited)

4

 

 

 

 

Consolidated Statements of Cash Flows —
Nine Months Ended March 31, 2019 and 2018

5

 

 

 

 

Notes to Consolidated Financial Statements

6

 

 

 

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

36

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

59

 

 

Item 4. Controls and Procedures

59

 

 

Part II. Other Information

 

 

 

Item 1. Legal Proceedings

60

 

 

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

60

 

 

Item 6. Exhibits

60

 

 

Signatures

61

 


Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions, except per share data)

 

2019

 

2018

 

2019

 

2018

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

3,744

 

$

3,370

 

$

11,273

 

$

10,388

 

Cost of sales

 

819

 

683

 

2,552

 

2,147

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

2,925

 

2,687

 

8,721

 

8,241

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

2,170

 

2,092

 

6,435

 

6,266

 

Restructuring and other charges

 

29

 

97

 

99

 

198

 

Goodwill impairment

 

48

 

 

68

 

 

Impairment of other intangible assets

 

4

 

 

22

 

 

Total operating expenses

 

2,251

 

2,189

 

6,624

 

6,464

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

674

 

498

 

2,097

 

1,777

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

32

 

33

 

101

 

96

 

Interest income and investment income, net

 

15

 

16

 

42

 

40

 

Other components of net periodic benefit cost

 

1

 

1

 

1

 

2

 

Other income, net

 

71

 

 

71

 

 

Earnings before income taxes

 

727

 

480

 

2,108

 

1,719

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

170

 

106

 

472

 

790

 

Net earnings

 

557

 

374

 

1,636

 

929

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to noncontrolling interests

 

(2

)

(2

)

(8

)

(7

)

Net earnings attributable to The Estée Lauder Companies Inc.

 

$

555

 

$

372

 

$

1,628

 

$

922

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Basic

 

$

1.53

 

$

1.01

 

$

4.47

 

$

2.50

 

Diluted

 

$

1.51

 

$

.99

 

$

4.39

 

$

2.45

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

361.9

 

367.9

 

364.0

 

368.3

 

Diluted

 

368.3

 

375.7

 

370.9

 

375.7

 

 

See notes to consolidated financial statements.

 

2


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

2019

 

2018

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

557

 

$

374

 

$

1,636

 

$

929

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Net unrealized investment gain (loss)

 

9

 

(6

)

14

 

(13

)

Net derivative instrument gain (loss)

 

(7

)

(14

)

2

 

(19

)

Amounts included in net periodic benefit cost

 

3

 

5

 

10

 

15

 

Translation adjustments

 

(72

)

72

 

(87

)

154

 

Provision for deferred income taxes on components of other comprehensive income

 

(1

)

(4

)

(4

)

(6

)

Total other comprehensive income (loss)

 

(68

)

53

 

(65

)

131

 

Comprehensive income

 

489

 

427

 

1,571

 

1,060

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income attributable to noncontrolling interests:

 

 

 

 

 

 

 

 

 

Net earnings

 

(2

)

(2

)

(8

)

(7

)

Translation adjustments

 

 

 

1

 

(1

)

 

 

(2

)

(2

)

(7

)

(8

)

Comprehensive income attributable to The Estée Lauder Companies Inc.

 

$

487

 

$

425

 

$

1,564

 

$

1,052

 

 

See notes to consolidated financial statements.

 

3


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED BALANCE SHEETS

 

 

 

March 31

 

June 30

 

(In millions, except share data)

 

2019

 

2018

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

2,902

 

$

2,181

 

Short-term investments

 

 

534

 

Accounts receivable, net

 

2,036

 

1,487

 

Inventory and promotional merchandise, net

 

1,814

 

1,618

 

Prepaid expenses and other current assets

 

408

 

348

 

Total current assets

 

7,160

 

6,168

 

 

 

 

 

 

 

Property, plant and equipment, net

 

1,891

 

1,823

 

 

 

 

 

 

 

Other assets

 

 

 

 

 

Long-term investments

 

173

 

843

 

Goodwill

 

1,865

 

1,926

 

Other intangible assets, net

 

1,215

 

1,276

 

Other assets

 

627

 

531

 

Total other assets

 

3,880

 

4,576

 

Total assets

 

$

12,931

 

$

12,567

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current debt

 

$

516

 

$

183

 

Accounts payable

 

1,068

 

1,182

 

Other accrued liabilities

 

2,647

 

1,945

 

Total current liabilities

 

4,231

 

3,310

 

 

 

 

 

 

 

Noncurrent liabilities

 

 

 

 

 

Long-term debt

 

2,883

 

3,361

 

Other noncurrent liabilities

 

1,200

 

1,186

 

Total noncurrent liabilities

 

4,083

 

4,547

 

 

 

 

 

 

 

Contingencies

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

Common stock, $.01 par value; Class A shares authorized: 1,300,000,000 at March 31, 2019 and June 30, 2018; shares issued: 440,045,095 at March 31, 2019 and 435,413,976 at June 30, 2018; Class B shares authorized: 304,000,000 at March 31, 2019 and June 30, 2018; shares issued and outstanding: 142,600,834 at March 31, 2019 and 143,051,679 at June 30, 2018

 

6

 

6

 

Paid-in capital

 

4,331

 

3,972

 

Retained earnings

 

9,984

 

9,040

 

Accumulated other comprehensive loss

 

(498

)

(434

)

 

 

13,823

 

12,584

 

Less: Treasury stock, at cost; 220,872,840 Class A shares at March 31, 2019 and 211,320,208 Class A shares at June 30, 2018

 

(9,235

)

(7,896

)

Total stockholders’ equity — The Estée Lauder Companies Inc.

 

4,588

 

4,688

 

Noncontrolling interests

 

29

 

22

 

Total equity

 

4,617

 

4,710

 

Total liabilities and equity

 

$

12,931

 

$

12,567

 

 

See notes to consolidated financial statements.

 

4


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net earnings

 

$

1,636

 

$

929

 

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

 

 

 

 

 

Depreciation and amortization

 

404

 

389

 

Deferred income taxes

 

(46

)

84

 

Non-cash stock-based compensation

 

201

 

196

 

Net loss on disposal of property, plant and equipment

 

6

 

12

 

Non-cash restructuring and other charges

 

 

1

 

Pension and post-retirement benefit expense

 

53

 

54

 

Pension and post-retirement benefit contributions

 

(23

)

(65

)

Goodwill and other intangible assets impairments

 

90

 

 

Changes in fair value of contingent consideration

 

(18

)

(6

)

Gain on liquidation of an investment in a foreign subsidiary, net

 

(71

)

 

Other non-cash items

 

(17

)

(13

)

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in accounts receivable, net

 

(377

)

(325

)

Increase in inventory and promotional merchandise, net

 

(184

)

 

Increase in other assets, net

 

(73

)

(10

)

Increase (decrease) in accounts payable

 

(105

)

20

 

Increase in other accrued and noncurrent liabilities

 

280

 

654

 

Net cash flows provided by operating activities

 

1,756

 

1,920

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Capital expenditures

 

(441

)

(368

)

Proceeds from the disposition of investments

 

1,229

 

716

 

Purchases of investments

 

(14

)

(492

)

Net cash flows provided by (used for) investing activities

 

774

 

(144

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Proceeds (repayments) of current debt, net

 

(167

)

106

 

Repayments and redemptions of long-term debt

 

(1

)

(1

)

Net proceeds from stock-based compensation transactions

 

154

 

157

 

Payments to acquire treasury stock

 

(1,344

)

(676

)

Dividends paid to stockholders

 

(453

)

(407

)

Payments to noncontrolling interest holders for dividends

 

(3

)

(1

)

Net cash flows used for financing activities

 

(1,814

)

(822

)

 

 

 

 

 

 

Effect of exchange rate changes on Cash and cash equivalents

 

5

 

50

 

Net increase in Cash and cash equivalents

 

721

 

1,004

 

Cash and cash equivalents at beginning of period

 

2,181

 

1,136

 

Cash and cash equivalents at end of period

 

$

2,902

 

$

2,140

 

 

See notes to consolidated financial statements.

 

5


Table of Contents

 

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, 2018.

 

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, 2018.  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 $2 million and $65 million, net of tax, during the three months ended March 31, 2019 and 2018, respectively, and $(11) million and $149 million, net of tax, during the nine months ended March 31, 2019 and 2018, respectively.  The Company had an investment in a foreign subsidiary that owned the Company’s available-for-sale securities.  During the three months ended March 31, 2019, the Company sold its available-for-sale securities, which liquidated this investment in the foreign subsidiary.  As a result, the Company recorded a realized foreign currency gain on liquidation of $77 million and a gross loss on the sale of available-for-sale securities of $6 million, both of which were reclassified from accumulated OCI (“AOCI”) to Other income, net in the accompanying consolidated statement of earnings.  See Note 2 — Investments for additional information.  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.  Accordingly, the Company categorizes these instruments as entered into for purposes other than trading.

 

The accompanying consolidated statements of earnings include net exchange gains (losses) on foreign currency transactions of $73 million and $(26) million during the three months ended March 31, 2019 and 2018, respectively, and $52 million and $(61) million during the nine months ended March 31, 2019 and 2018, respectively.

 

6


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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.

 

Inventory and Promotional Merchandise

 

Inventory and promotional merchandise, net consists of:

 

 

 

March 31

 

June 30

 

(In millions)

 

2019

 

2018

 

Raw materials

 

$

501

 

$

432

 

Work in process

 

218

 

222

 

Finished goods

 

931

 

798

 

Promotional merchandise

 

164

 

166

 

 

 

$

1,814

 

$

1,618

 

 

Property, Plant and Equipment

 

 

 

March 31

 

June 30

 

(In millions)

 

2019

 

2018

 

Assets (Useful Life)

 

 

 

 

 

Land

 

$

29

 

$

30

 

Buildings and improvements (10 to 40 years)

 

285

 

237

 

Machinery and equipment (3 to 10 years)

 

764

 

719

 

Computer hardware and software (4 to 10 years)

 

1,217

 

1,193

 

Furniture and fixtures (5 to 10 years)

 

122

 

104

 

Leasehold improvements

 

2,251

 

2,152

 

 

 

4,668

 

4,435

 

Less accumulated depreciation and amortization

 

(2,777

)

(2,612

)

 

 

$

1,891

 

$

1,823

 

 

The cost of assets related to projects in progress of $388 million and $300 million as of March 31, 2019 and June 30, 2018, respectively, is included in their respective asset categories above.  Depreciation and amortization of property, plant and equipment was $121 million and $116 million during the three months ended March 31, 2019 and 2018, respectively, and $358 million and $342 million during the nine months ended March 31, 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

 

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “TCJA”).  The TCJA includes broad and complex changes to the U.S. tax code that impacted the Company’s accounting and reporting for income taxes.  The impacts under the TCJA in the prior fiscal year primarily consisted of the following:

 

·                  A reduction in the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018, which resulted in a fiscal 2018 U.S. blended statutory income tax rate for the Company of 28.1%.

·                  A one-time mandatory deemed repatriation tax on unremitted foreign earnings (the “Transition Tax”), which the Company elected to pay over an eight-year period.

·                  A remeasurement of U.S. net deferred tax assets.

·                  The recognition of foreign withholding taxes in connection with the reversal of the Company’s indefinite reinvestment assertion related to certain foreign earnings.

 

7


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Staff Accounting Bulletin No. 118 (“SAB 118”) established a one-year measurement period (effective December 22, 2017), whereby provisional amounts recorded for effects of the changes from the TCJA could be subject to adjustment.  The one-year measurement period expired on December 22, 2018 and, therefore, the accounting to record the effects of the changes from the TCJA was required to be completed during the three months ended December 31, 2018.

 

For the year ended June 30, 2018, the Company recorded the following provisional charges related to the TCJA:

 

·                  $351 million associated with the Transition Tax.

·                  $53 million in connection with the remeasurement of U.S. net deferred tax assets resulting from the statutory tax rate reduction.

·                  $46 million related to foreign withholding taxes associated with the reversal of its indefinite reinvestment assertion related to certain foreign earnings.

 

During the six months ended December 31, 2018, the Company recorded a credit of $12 million to adjust its fiscal 2018 provisional charge associated with the Transition Tax and reflected certain technical interpretations related to the Transition Tax computation.  The final cumulative charge related to this matter is $339 million.  The charges related to the Transition Tax are primarily included in Other noncurrent liabilities in the accompanying consolidated balance sheet as of March 31, 2019.

 

During the three months ended December 31, 2018, the Company recorded an increase of $8 million to its provisional charge recorded in fiscal 2018 associated with the remeasurement of its net deferred tax assets resulting from the reduction in the U.S. corporate income tax rate.  This adjustment was due to the revision of certain temporary differences.  The final cumulative charge related to this matter is $61 million.

 

In addition, the Company recorded a charge of $9 million for the three months ended September 30, 2018 related to foreign withholding taxes recorded in fiscal 2018 in connection with the reversal of its indefinite reinvestment assertion related to certain foreign earnings.  This charge reflected the Company’s interpretation of recently issued guidance from the U.S. government, and the accounting for this item pursuant to SAB 118 was considered complete as of September 30, 2018.  The final cumulative charge related to this matter is $55 million.

 

Although the accounting related to the income tax effects of the TCJA is complete pursuant to SAB 118, certain technical aspects of the TCJA remain subject to varying degrees of uncertainty as additional technical guidance and clarification from the U.S. government is expected to be issued over an extended period.  Receipt of additional guidance and clarification from the U.S. government may result in material changes to the provision for income taxes.  To the extent applicable, the Company would recognize such adjustments in the provision for income taxes in the period that additional guidance and clarification is received.

 

Provisions under the TCJA that became effective for the Company in the current fiscal year include a further reduction in the U.S. statutory rate to 21%, a new minimum tax on global intangible low-taxed income (“GILTI”), a base erosion anti-abuse tax, a foreign derived intangible income deduction and changes to IRC Section 162(m) related to the deductibility of executive compensation.

 

For more information about the TCJA and the related impact on the Company, see Note 8 — Income Taxes in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.

 

The effective rate for income taxes was 23.4% and 22.1% for the three months ended March 31, 2019 and 2018, respectively.  This increase was primarily attributable to the goodwill impairment related to Smashbox, with no associated tax benefit, partially offset by a slightly lower effective tax rate on the Company’s foreign operations due to a favorable geographic mix of earnings, partially offset by the impact of GILTI.  See Note 3 — Goodwill and Other Intangible Assets for additional information relating to the Smashbox impairments.

 

The effective rate for income taxes was 22.4% and 46.0% for the nine months ended March 31, 2019 and 2018, respectively.  The decrease in the effective tax rate was primarily attributable to the provisional charges related to the TCJA that were recorded in the nine months ended March 31, 2018.  Also contributing to the lower effective tax rate was the impact of the lower U.S. statutory tax rate and a lower effective tax rate on our foreign operations due to a favorable geographic mix of earnings, partially offset by the impact of GILTI and the goodwill impairment related to Smashbox.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of March 31, 2019 and June 30, 2018, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $68 million and $60 million, respectively.  The total amount of unrecognized tax benefits at March 31, 2019 that, if recognized, would affect the effective tax rate was $47 million.  The total gross interest and penalties accrued related to unrecognized tax benefits during the three and nine months ended March 31, 2019 in the accompanying consolidated statements of earnings was $1 million and $4 million, respectively.  The total gross accrued interest and penalties in the accompanying consolidated balance sheets at March 31, 2019 and June 30, 2018 was $13 million and $9 million, respectively.  On the basis of the information available as of March 31, 2019, the Company does not expect significant changes to the total amount of unrecognized tax benefits within the next twelve months.

 

Other Accrued Liabilities

 

Other accrued liabilities consist of the following:

 

 

 

March 31

 

June 30

 

(In millions)

 

2019

 

2018

 

Advertising, merchandising and sampling

 

$

413

 

$

348

 

Employee compensation

 

500

 

579

 

Deferred revenue

 

299

 

33

 

Sales return accrual

 

209

 

 

Payroll and other taxes

 

235

 

190

 

Accrued income taxes

 

228

 

90

 

Other

 

763

 

705

 

 

 

$

2,647

 

$

1,945

 

 

Debt

 

In October 2018, the Company replaced its undrawn $1.5 billion senior unsecured revolving credit facility that was set to expire in October 2021 with a new $1.5 billion senior unsecured revolving credit facility (the “New Facility”).  The New Facility expires on October 26, 2023 unless extended for up to two additional years in accordance with the terms set forth in the agreement.  Up to the equivalent of $500 million of the New Facility is available for multi-currency loans.  Interest rates on borrowings under the New Facility will be based on prevailing market interest rates in accordance with the agreement.  The costs incurred to establish the New Facility were not material.  The New Facility has an annual fee of approximately $1 million, payable quarterly, based on the Company’s current credit ratings.  The New Facility contains a cross-default provision whereby a failure to pay other material financial obligations in excess of $175 million (after grace periods and absent a waiver from the lenders) would result in an event of default and the acceleration of the maturity of any outstanding debt under this facility.

 

Recently Adopted Accounting Standards

 

Hedge Accounting

In August 2017, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance to simplify hedge accounting.  The guidance includes provisions that:

 

·                  enable entities to better portray their risk management activities within the financial statements;

·                  expand an entity’s ability to hedge nonfinancial and financial risk components;

·                  reduce complexity in fair value hedges of interest rate risk;

·                  eliminate the requirement to separately measure and disclose hedge ineffectiveness;

·                  require the entire change in fair value of a hedging instrument to be presented in the same income statement line as the hedged item;

·                  ease certain documentation and assessment requirements;

·                  modify the accounting for components excluded from the assessment of hedge effectiveness; and

·                  require revised tabular footnote disclosure.

 

The guidance also provides transition relief to make it easier for entities to apply certain amendments to existing hedges (including fair value hedges) where the hedge documentation is required to be modified.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Effective for the Company Fiscal 2020 first quarter, with early adoption permitted in any interim period.  The guidance must be applied:

 

·                  using the modified retrospective approach for cash flow and net investment hedge relationships that exist on the date of adoption; and

·                  prospectively for the presentation and disclosure requirements.

 

Impact on consolidated financial statements The Company has early adopted this guidance effective as of its fiscal 2019 first quarter, and no cumulative adjustment to retained earnings was required.  Upon adoption, all derivative gains and losses will be recognized in the same income statement line as the hedged items which, for all foreign currency cash flow hedges, is in Net sales.  There is no change to the interest expense classification of gains and losses from interest rate swap fair value hedges.  The amended presentation and disclosure requirements are being applied prospectively.  See Note 5 — Derivative Financial Instruments for further information.

 

Pension-related Costs

In March 2017, the FASB issued authoritative guidance that amends how companies present net periodic benefit cost in the income statement and balance sheet relating to defined benefit pension and/or other postretirement benefit plans.  Within the income statement, the new guidance requires companies to report the service cost component within operating expenses and report the other components of net periodic benefit cost below operating income.  In addition, within the balance sheet, the guidance changes the components of the pension cost eligible for capitalization to the service cost component only (e.g., as a cost of internally manufactured inventory or a self-constructed asset).

 

Effective for the Company — Fiscal 2019 first quarter.  The guidance must be applied:

 

·                  retrospectively as it pertains to the income statement classification of the components of net periodic benefit cost; and

·                  prospectively as it pertains to future capitalization of service costs.

 

Impact on consolidated financial statements  The Company adopted this guidance when it became effective, and although certain components of pension expense are being reclassified out of operating income, this did not have a material impact on reported operating income.  The Company elected the practical expedient which permits the use of amounts previously disclosed in its pension and post-retirement plan footnote as the basis for estimating the amounts necessary to retrospectively restate the prior-year period consolidated statements of earnings.

 

Revenue from Contracts with Customers

In May 2014, the FASB issued authoritative guidance, Accounting Standards Codification Topic 606 — Revenue from Contracts with Customers (“ASC 606”), that defines how companies should report revenues from contracts with customers.  The standard requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  It provides companies with a single comprehensive five-step principles-based model to use in accounting for revenue and supersedes prior revenue recognition requirements, including most industry-specific and transaction-specific revenue guidance.

 

In March 2016, the FASB issued authoritative guidance that amended the principal versus agent guidance in its new revenue recognition standard.  These amendments do not change the key aspects of the principal versus agent guidance, including the definition that an entity is a principal if it controls the good or service prior to it being transferred to a customer, but the amendments clarify the implementation guidance related to the considerations that must be made during the contract evaluation process.

 

In April 2016, the FASB issued authoritative guidance that amended the new standard to clarify the guidance on identifying performance obligations and accounting for licenses of intellectual property.

 

In May 2016, the FASB issued authoritative guidance that clarified certain terms, guidance and disclosure requirements during the transition period related to completed contracts and contract modifications.  In addition, the FASB provided clarification on the concept of collectability, the calculation of the fair value of noncash consideration and the presentation of sales and other similar taxes.

 

In May 2016, the FASB issued authoritative guidance to reflect the Securities and Exchange Commission Staff’s rescission of its prior comments that covered, among other things, accounting for shipping and handling costs and accounting for consideration given by a vendor to a customer.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In December 2016, the FASB issued authoritative guidance that amends various aspects of the new standard to clarify certain terms, guidance and disclosure requirements.  In particular, the guidance addresses disclosure requirements for remaining performance obligations, impairment testing for contract costs and accrual of advertising costs, as well as clarifies several examples.

 

Effective for the Company — Fiscal 2019 first quarter.  An entity is permitted to apply the foregoing guidance retrospectively to all prior periods presented, with certain practical expedients, or apply the requirements in the year of adoption, through a cumulative adjustment.

 

Impact on consolidated financial statements — On July 1, 2018, the Company adopted ASC 606, see Note 7 — Revenue Recognition for further discussion.

 

Goodwill

In January 2017, the FASB issued authoritative guidance that simplifies the subsequent measurement of goodwill by eliminating the second step from the quantitative goodwill impairment test.  The single quantitative step test requires companies to compare the fair value of a reporting unit with its carrying amount and record an impairment charge for the amount that the carrying amount exceeds the fair value, up to the total amount of goodwill allocated to that reporting unit.  The Company will continue to have the option of first performing a qualitative assessment to determine whether it is necessary to perform the quantitative goodwill impairment test.

 

Effective for the Company — Fiscal 2021 first quarter, with early adoption permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.

 

Impact on consolidated financial statements  The Company early adopted this guidance effective as of its fiscal 2019 second quarter and applied the new guidance in its quantitative goodwill impairment test related to the Smashbox reporting unit.  See Note 3 — Goodwill and Other Intangible Assets for further information.

 

Recently Issued Accounting Standards

 

Measurement of Credit Losses on Financial Instruments

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 and short- and long-term investments.

 

Leases

In February 2016, the 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 will be based on the lease liability adjusted for certain costs such as initial direct costs, prepaid lease payments and lease incentives received.  Lease expense will be recognized similar to current accounting guidance with operating leases resulting in a straight-line expense, and finance leases resulting in a front-loaded expense similar to the current 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 does 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 will not be required to restate the prior comparative periods in the financial statements.

 

Effective for the Company — Fiscal 2020 first quarter, with early adoption permitted using either of the modified retrospective transition approaches described in the standard, with certain practical expedients.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Impact on consolidated financial statements — The Company currently has an implementation team in place that is performing a comprehensive evaluation of the impact of the adoption of this guidance, which includes assessing the Company’s lease portfolio, implementing a new system to meet reporting requirements, and assessing the impact to business processes and internal controls over financial reporting and the related disclosure requirements.  While the Company’s evaluation is ongoing, it believes the adoption of this standard will have a significant impact on its consolidated balance sheets, but will not have a material impact to its consolidated statements of earnings, earnings per share amounts and consolidated statements of cash flowsAs disclosed in Note 14 — Commitments and Contingencies in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018, the Company had $3,320 million in future minimum lease commitments as of June 30, 2018.  Upon adoption, the Company’s lease liability will generally be based on the present value of such payments and the related right-of-use asset will generally be based on the lease liability, adjusted for initial direct costs, prepaid lease payments, lease incentives received and deferred rent.  The Company plans to adopt the new standard when it becomes effective in the fiscal 2020 first quarter using the modified retrospective transition approach for leases that exist in the period of adoption and will not restate the prior comparative periods.  Under this method, the Company is required to assess the remaining future payments and lease terms of existing leases as of the beginning of the fiscal 2020 first quarter, but is not required to assess leases that expire prior to fiscal 2020.  Additionally, as of the date of adoption, the Company expects to elect the package of practical expedients that does not require the Company to 1) assess whether expired or existing contracts contain leases, 2) reassess the lease classification (i.e. operating lease vs. finance lease) for expired or existing leases and 3) change the accounting for initial direct costs.

 

Goodwill and Other — Internal-Use Software

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.

 

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

 

NOTE 2 — INVESTMENTS

 

Beginning in the first quarter of fiscal 2019, the Company accounts for its cost method investments at cost, less impairment, plus/minus subsequent observable price changes, and will be required to perform an assessment each quarter to determine whether or not a triggering event has occurred that results in changes in fair value.  These investments were not material to the Company’s consolidated financial statements as of March 31, 2019.

 

During the three months ended March 31, 2019, the Company sold its available-for-sale securities, which liquidated its investment in the foreign subsidiary that owned those securities, and realized a gross loss of $6 million and a foreign currency gain of $77 million, both of which are reflected in Other income, net in the accompanying consolidated statement of earnings.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Gains and losses recorded in AOCI related to the Company’s available-for-sale investments as of June 30, 2018 were as follows:

 

(In millions) 

 

Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

U.S. government and agency securities

 

$

427

 

$

 

$

(5

)

$

422

 

Foreign government and agency securities

 

114

 

 

(2

)

112

 

Corporate notes and bonds

 

479

 

 

(7

)

472

 

Time deposits

 

200

 

 

 

200

 

Other securities

 

16

 

 

 

16

 

Total

 

$

1,236

 

$

 

$

(14

)

$

1,222

 

 

The Company utilizes the first-in, first-out method to determine the cost of the security sold.  Sales proceeds from investments classified as available-for-sale were $910 million and $21 million for the three months ended March 31, 2019 and 2018, respectively, and were $933 million and $317 million for the nine months ended March 31, 2019 and 2018, respectively.

 

NOTE 3 — GOODWILL AND OTHER INTANGIBLE ASSETS

 

Impairment Testing During the Nine Months Ended March 31, 2019

 

During December 2018, the Smashbox reporting unit made revisions to its internal forecasts reflecting a slowdown of its makeup business driven by increased competitive activity and lower than expected growth in key retail channels for the brand.  The Company concluded that these changes in circumstances in the Smashbox reporting unit triggered the need for an interim impairment review of its trademark and goodwill.  Accordingly, the Company performed an interim impairment test as of December 31, 2018.  The Company concluded that the carrying value of the Smashbox trademark exceeded its estimated fair value, which was determined utilizing a royalty rate to determine discounted projected future cash flows.  As a result, the Company recognized an impairment charge of $18 million for the trademark during the three months ended December 31, 2018.  After adjusting the carrying value of the trademark, the Company completed an interim quantitative impairment test for goodwill and recorded a goodwill impairment charge related to the Smashbox reporting unit of $20 million during the three months ended December 31, 2018.

 

During March 2019, the Smashbox reporting unit made additional revisions to its internal forecasts reflecting the continued slowdown of its makeup business driven by ongoing competitive activity and lower than expected growth in key retail channels for the brand.  The Company concluded that these changes in circumstances in the Smashbox reporting unit triggered the need for an interim impairment review of its trademark and goodwill.  Accordingly, the Company performed an interim impairment test as of March 31, 2019.  The Company concluded that the carrying value of the Smashbox trademark exceeded its estimated fair value, which was determined utilizing a royalty rate to determine discounted projected future cash flows.  As a result, the Company recognized an impairment charge of $4 million for the trademark during the three months ended March 31, 2019.  After adjusting the carrying value of the trademark, the Company completed an interim quantitative impairment test for goodwill and recorded a goodwill impairment charge related to the Smashbox reporting unit of $48 million during the three months ended March 31, 2019.  The cumulative impairment charges for the trademark and goodwill during the nine months ended March 31, 2019 were $22 million and $68 million, respectively.

 

In the second quarter of fiscal 2019, the Company early adopted the FASB’s authoritative guidance that eliminated the second step from the quantitative goodwill impairment test.  In accordance with this guidance, the Company compared the fair value of the Smashbox reporting unit with its carrying amount to calculate the impairment charge.  The fair values of the reporting unit as of December 31, 2018 and March 31, 2019 were based upon an equal weighting of the income and market approaches, utilizing estimated cash flows and a terminal value, discounted at a rate of return that reflects the relative risk of the cash flows, as well as valuation multiples derived from comparable publicly traded companies that are applied to operating performance of the reporting unit.  These impairment charges were reflected in the makeup product category and in the Americas region.  As of March 31, 2019, the remaining carrying values of the goodwill and trademark related to the Smashbox reporting unit were $72 million and $55 million, respectively.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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, 2018

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

185

 

$

1,186

 

$

256

 

$

391

 

$

2,018

 

Accumulated impairments

 

(36

)

 

(22

)

(34

)

(92

)

 

 

149

 

1,186

 

234

 

357

 

1,926

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill acquired during the period

 

 

10

 

 

 

10

 

Impairment charges

 

 

(68

)

 

 

(68

)

Translation adjustments, goodwill

 

(1

)

 

(2

)

(1

)

(4

)

Translation adjustments, accumulated impairments

 

1

 

 

 

 

1

 

 

 

 

(58

)

(2

)

(1

)

(61

)

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

184

 

1,196

 

254

 

390

 

2,024

 

Accumulated impairments

 

(35

)

(68

)

(22

)

(34

)

(159

)

 

 

$

149

 

$

1,128

 

$

232

 

$

356

 

$

1,865

 

 

Other intangible assets consist of the following:

 

 

 

March 31, 2019

 

June 30, 2018

 

(In millions)

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Total Net
Book
Value

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Total Net
Book
Value

 

Amortizable intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer lists and other

 

$

696

 

$

369

 

$

327

 

$

697

 

$

332

 

$

365

 

License agreements

 

43

 

43

 

 

43

 

43

 

 

 

 

$

739

 

$

412

 

327

 

$

740

 

$

375

 

365

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks and other

 

 

 

 

 

888

 

 

 

 

 

911

 

Total intangible assets

 

 

 

 

 

$

1,215

 

 

 

 

 

$

1,276

 

 

The aggregate amortization expense related to amortizable intangible assets was $13 million for the three months ended March 31, 2019 and 2018 and was $38 million for the nine months ended March 31, 2019 and 2018.  The estimated aggregate amortization expense for the remainder of fiscal 2019 and for each of the next four fiscal years is as follows:

 

 

 

Fiscal

 

(In millions)

 

2019

 

2020

 

2021

 

2022

 

2023

 

Estimated aggregate amortization expense

 

$

13

 

$

44

 

$

43

 

$

42

 

$

42

 

 

NOTE 4 — CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER ACTIVITIES

 

In May 2016, the Company announced a multi-year initiative (“Leading Beauty Forward,” “LBF” or the “Program”) 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.  The Company plans to approve specific initiatives under LBF through fiscal 2019 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 complete those initiatives through fiscal 2021.  Inclusive of approvals from inception through March 31, 2019, the Company estimates that LBF may result in related restructuring and other charges totaling between $900 million and $950 million, before taxes.  In connection with LBF, at this time, the Company estimates a net reduction over the duration of LBF in the range of 1,800 to 2,000 positions globally.  This reduction takes into account the elimination of certain positions, inclusive of positions that are unfilled, as well as retraining and redeployment of certain employees and investment in new positions in key areas.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Program-to-Date Approvals

Of the $900 million to $950 million restructuring and other charges expected to be incurred, total cumulative charges approved by the Company through March 31, 2019, some of which were recorded from Program inception through March 31, 2019, were:

 

 

 

Sales
Returns

 

 

 

Operating Expenses

 

 

 

(In millions)

 

(included in
Net Sales)

 

Cost of Sales

 

Restructuring
Charges

 

Other
Charges

 

Total

 

Approval Period

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2016

 

$

4

 

$

28

 

$

87

 

$

71

 

$

190

 

Fiscal 2017

 

11

 

10

 

132

 

118

 

271

 

Fiscal 2018

 

 

24

 

166

 

68

 

258

 

Nine months ended March 31, 2019

 

 

23

 

34

 

44

 

101

 

Adjustments through March 31, 2019

 

(1

)

(2

)

(52

)

(3

)

(58

)

Cumulative through March 31, 2019

 

$

14

 

$

83

 

$

367

 

$

298

 

$

762

 

 

Included in the above table, cumulative restructuring initiatives approved by the Company through March 31, 2019 by major cost type were:

 

(In millions)

 

Employee-
Related
Costs

 

Asset-
Related
Costs

 

Contract
Terminations

 

Other Exit
Costs

 

Total

 

Approval Period

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2016

 

$

75

 

$

3

 

$

5

 

$

4

 

$

87

 

Fiscal 2017

 

126

 

1

 

 

5

 

132

 

Fiscal 2018

 

161

 

 

1

 

4

 

166

 

Nine months ended March 31, 2019

 

32

 

1

 

 

1

 

34

 

Adjustments through March 31, 2019

 

(47

)

 

(3

)

(2

)

(52

)

Cumulative through March 31, 2019

 

$

347

 

$

5

 

$

3

 

$

12

 

$

367

 

 

During the nine months ended March 31, 2019, the Company continued to approve initiatives to optimize select corporate functions and enhance its go-to-market support structures.  These actions will result in a net reduction of the workforce, which includes position eliminations, the re-leveling of certain positions and an investment in new capabilities.  The Company also approved consulting and other professional services primarily related to the implementation and integration of new processes and technologies, temporary labor backfill and recruitment related to the new capabilities.  The Company continued to approve implementation costs, temporary labor backfill and consulting fees for an initiative related to supply chain planning activities, as well as employee-related costs to enable the investment in new capabilities to improve engineering processes related to certain product lines.  In addition, the Company approved other charges to support the LBF Project Management Office, consisting of internal and external resources that are intended to further drive project integration, organizational design capabilities and change management throughout the organization.

 

As initiatives under LBF progress through implementation, the Company has identified certain costs that were approved but will not be incurred.  These costs, reflected as adjustments to the cumulative approved restructuring and other charges presented above, were primarily related to estimated employee-related costs for certain employees who either resigned or transferred to other existing positions within the Company.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Program-to-Date Restructuring and Other Charges

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

 

 

 

(In millions)

 

(included in
Net Sales)

 

Cost of Sales

 

Restructuring
Charges

 

Other
Charges

 

Total

 

Fiscal 2016

 

$

1

 

$

 

$

75

 

$

5

 

$

81

 

Fiscal 2017

 

2

 

15

 

122

 

73

 

212

 

Fiscal 2018

 

8

 

18

 

127

 

104

 

257

 

Nine months ended March 31, 2019

 

2

 

16

 

31

 

68

 

117

 

Cumulative through March 31, 2019

 

$

13

 

$

49

 

$

355

 

$

250

 

$

667

 

 

The major cost types related to the cumulative restructuring charges set forth above were:

 

(In millions)

 

Employee-
Related
Costs

 

Asset-
Related
Costs

 

Contract
Terminations

 

Other Exit
Costs

 

Total

 

Fiscal 2016

 

$

74

 

$

1

 

$

 

$

 

$

75

 

Fiscal 2017

 

116

 

2

 

2

 

2

 

122

 

Fiscal 2018

 

124

 

1

 

1

 

1

 

127

 

Nine months ended March 31, 2019

 

30

 

 

 

1

 

31

 

Cumulative through March 31, 2019

 

$

344

 

$

4

 

$

3

 

$

4

 

$

355

 

 

Accrued restructuring charges from Program inception through March 31, 2019 were:

 

(In millions)

 

Employee-
Related
Costs

 

Asset-
Related
Costs

 

Contract
Terminations

 

Other Exit
Costs

 

Total

 

Charges

 

$

74

 

$

1

 

$

 

$

 

$

75

 

Noncash asset write-offs

 

 

(1

)

 

 

(1

)

Translation adjustments

 

(1

)

 

 

 

(1

)

Balance at June 30, 2016

 

73

 

 

 

 

73

 

 

 

 

 

 

 

 

 

 

 

 

 

Charges

 

116

 

2

 

2

 

2

 

122

 

Cash payments

 

(39

)

 

(2

)

(2

)

(43

)

Noncash asset write-offs

 

 

(2

)

 

 

(2

)

Balance at June 30, 2017

 

150

 

 

 

 

150

 

 

 

 

 

 

 

 

 

 

 

 

 

Charges

 

124

 

1

 

1

 

1

 

127

 

Cash payments

 

(92

)

 

 

(1

)

(93

)

Noncash asset write-offs

 

 

(1

)

 

 

(1

)

Translation adjustments

 

(2

)

 

 

 

(2

)

Balance at June 30, 2018

 

180

 

 

1

 

 

181

 

 

 

 

 

 

 

 

 

 

 

 

 

Charges

 

30

 

 

 

1

 

31

 

Cash payments

 

(77

)

 

(1

)

(2

)

(80

)

Noncash asset write-offs

 

 

 

 

 

 

Translation and other adjustments

 

(2

)

 

 

 

(2

)

Balance at March 31, 2019

 

$

131

 

$

 

$

 

$

(1

)

$

130

 

 

16


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Restructuring charges for employee-related costs are net of adjustments to the accrual estimate for certain employees who either resigned or transferred to other existing positions within the Company.  Accrued restructuring charges at March 31, 2019 are expected to result in cash expenditures funded from cash provided by operations of approximately $57 million, $54 million, $16 million, $2 million and $1 million for the remainder of fiscal 2019 and for fiscal 2020, 2021, 2022 and 2023, respectively.

 

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.  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 or not to discontinue hedge accounting with respect to that derivative prospectively.

 

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

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

 

 

 

Fair Value (1)

 

 

 

 

Fair Value (1)

 

(In millions)

 

Balance Sheet
Location

 

March 31
2019

 

June 30
2018

 

Balance Sheet
Location

 

March 31
2019

 

June 30
2018

 

Derivatives Designated as Hedging Instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

$

28

 

$

30

 

Other accrued liabilities

 

$

5

 

$

5

 

Interest rate swap contracts

 

Prepaid expenses and other current assets

 

 

 

Other accrued liabilities

 

9

 

26

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives Designated as Hedging Instruments

 

 

 

28

 

30

 

 

 

14

 

31

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives Not Designated as Hedging Instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

3

 

3

 

Other accrued liabilities

 

4

 

8

 

Total derivatives

 

 

 

$

31

 

$

33

 

 

 

$

18

 

$

39

 

 


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

 

17


Table of Contents

 

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 presented as follows:

 

 

 

Amount of Gain or (Loss)
Recognized in OCI on
Derivatives

 

Location of Gain or

 

Amount of Gain or (Loss)
Reclassified from AOCI into
Earnings
(1)

 

 

 

Three Months Ended
March 31

 

(Loss) Reclassified
from AOCI into

 

Three Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

Earnings

 

2019

 

2018(2)

 

Derivatives in Cash Flow Hedging Relationships:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

2

 

$

(32

)

Net sales

 

$

8

 

$

 

 

 

 

 

 

 

Cost of sales

 

 

(8

)

 

 

 

 

 

 

Selling, general and administrative

 

 

(10

)

Interest rate-related derivatives

 

 

 

Interest expense

 

1

 

 

Total derivatives

 

$

2

 

$

(32

)

 

 

$

9

 

$

(18

)

 


(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)   The gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was not material.

 

 

 

Amount of Gain or (Loss)
Recognized in OCI on
Derivatives

 

Location of Gain or

 

Amount of Gain or (Loss)
Reclassified from AOCI into
Earnings
(1)

 

 

 

Nine Months Ended
March 31

 

(Loss) Reclassified
from AOCI into

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

Earnings

 

2019

 

2018(2)

 

Derivatives in Cash Flow Hedging Relationships:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

18

 

$

(59

)

Net sales

 

$

15

 

$

 

 

 

 

 

 

 

Cost of sales

 

 

(20

)

 

 

 

 

 

 

Selling, general and administrative

 

 

(21

)

Interest rate-related derivatives

 

 

 

Interest expense

 

1

 

1

 

Total derivatives

 

$

18

 

$

(59

)

 

 

$

16

 

$

(40

)

 


(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)   The gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was not material.

 

 

 

 

 

Amount of Gain or (Loss)
Recognized in Earnings on Derivatives 
(1)

 

 

 

Location of Gain or (Loss)
Recognized in Earnings on

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

Derivatives

 

2019

 

2018

 

2019

 

2018

 

Derivatives in Fair Value Hedging Relationships:

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts

 

Interest expense

 

$

8

 

$

(11

)

$

17

 

$

(23

)

 


(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.

 

18


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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:

 

(In millions)

 

Amount of Gain or (Loss)
Recognized in Earnings on Derivatives 

 

Line Item in the Consolidated Balance Sheets in

 

Carrying Amount of the
Hedged Assets (Liabilities) 

 

Cumulative Amount of Fair
Value Hedging Adjustments
Included in the Carrying
Amount of the Hedged
Assets (Liabilities)

 

Which the Hedged Item is Included

 

March 31, 2019

 

March 31, 2019

 

Current debt

 

$

(248

)

$

(2

)

Long-term debt

 

(690

)

(7

)

Total debt

 

$

(938

)

$

(9

)

 

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
March 31, 2019

 

Nine Months Ended
March 31, 2019

 

(In millions)

 

Net Sales

 

Interest
expense

 

Net Sales

 

Interest
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

 

$

3,744

 

$

32

 

$

11,273

 

$

101

 

 

 

 

 

 

 

 

 

 

 

The effects of fair value and cash flow hedging relationships:

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Hedged item

 

Not applicable

 

8

 

Not applicable

 

17

 

Derivatives designated as hedging instruments

 

Not applicable

 

(8

)

Not applicable

 

(17

)

 

 

 

 

 

 

 

 

 

 

Gain (loss) on cash flow hedge relationships — interest rate contracts:

 

 

 

 

 

 

 

 

 

Amount of gain reclassified from AOCI into earnings

 

Not applicable

 

1

 

Not applicable

 

1

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Amount of gain reclassified from AOCI into earnings

 

8

 

Not applicable

 

15

 

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)
Recognized in Earnings on

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

Derivatives

 

2019

 

2018

 

2019

 

2018

 

Derivatives Not Designated as Hedging Instruments:

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Selling, general and administrative

 

$

(12

)

$

10

 

$

(2

)

$

5

 

 

19


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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 March 2021.  Hedge effectiveness of the foreign currency forward contracts is based on the forward method, which includes time value in the effectiveness assessment.  At March 31, 2019, the Company had foreign currency forward contracts with a notional amount totaling $4,526 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 net 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 net sales.  As of March 31, 2019, the Company’s foreign currency cash flow hedges were highly effective.

 

The estimated net gain on the Company’s derivative instruments designated as cash flow hedges as of March 31, 2019 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $17 million.  The accumulated net gain on derivative instruments in AOCI was $55 million and $53 million as of March 31, 2019 and June 30, 2018, 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.

 

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 $31 million at March 31, 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.

 

20


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 March 31, 2019:

 

(In millions)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

31

 

$

 

$

31

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

9

 

$

 

$

9

 

Interest rate swap contracts

 

 

9

 

 

9

 

Contingent consideration

 

 

 

78

 

78

 

Total

 

$

 

$

18

 

$

78

 

$

96

 

 

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, 2018:

 

(In millions)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

33

 

$

 

$

33

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

422

 

 

422

 

Foreign government and agency securities

 

 

112

 

 

112

 

Corporate notes and bonds

 

 

472

 

 

472

 

Time deposits

 

 

200

 

 

200

 

Other securities

 

 

16

 

 

16

 

Total

 

$

 

$

1,255

 

$

 

$

1,255

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

13

 

$

 

$

13

 

Interest rate swap contracts

 

 

26

 

 

26

 

Contingent consideration

 

 

 

96

 

96

 

Total

 

$

 

$

39

 

$

96

 

$

135

 

 

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

 

 

 

March 31

 

June 30

 

 

 

2019

 

2018

 

(In millions)

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Nonderivatives

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

2,902

 

$

2,902

 

$

2,181

 

$

2,181

 

Available-for-sale securities

 

 

 

1,222

 

1,222

 

Current and long-term debt

 

3,399

 

3,604

 

3,544

 

3,667

 

Additional purchase price payable

 

3

 

3

 

3

 

3

 

Contingent consideration

 

78

 

78

 

96

 

96

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts — asset (liability), net

 

22

 

22

 

20

 

20

 

Interest rate swap contracts — asset (liability), net

 

(9

)

(9

)

(26

)

(26

)

 

21


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the Company’s impairment charges for the nine months ended March 31, 2019 for certain of its nonfinancial assets measured at fair value on a nonrecurring basis, classified as Level 3, due to a change in circumstances that triggered an interim impairment test:

 

(In millions)

 

Impairment
charges

 

Date of Fair Value Measurement

 

Fair Value(1)

 

 

 

 

 

 

 

 

 

Goodwill

 

$

68

 

March 31, 2019

 

$

72

 

Other intangible assets, net (trademark)

 

22

 

March 31, 2019

 

55

 

Total

 

$

90

 

 

 

$

127

 

 


(1)   See Note 3 — Goodwill and Other Intangible Assets for discussion of the valuation techniques used to measure fair value, the description of the inputs and information used to develop those inputs.

 

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.

 

Available-for-sale securities — Available-for-sale securities are classified within Level 2 of the valuation hierarchy and are valued using third-party pricing services, and for time deposits, the carrying amount approximates fair value.  To determine fair value, the pricing services use market prices or prices derived from other observable market inputs such as benchmark curves, credit spreads, broker/dealer quotes, and other industry and economic factors.

 

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 swap contracts — The fair values of the Company’s interest rate swap 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 capital 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.  The fair values of the contingent consideration related to certain acquisition earn-outs were estimated using a probability-weighted discount model that considers the achievement of the conditions upon which the respective contingent obligation is dependent (“Monte Carlo Method”).

 

22


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Monte Carlo Method has various inputs into the valuation model, in addition to the risk-adjusted projected future operating results of the acquired entities, which include the following ranges at March 31, 2019:

 

Risk-adjusted discount rate

 

2.7

%

Revenue volatility

 

5.9% to 6.0

%

Asset volatility

 

25.5

%

Revenue and earnings before income tax, depreciation and amortization correlation coefficient factor

 

70.0

%

Revenue discount rates

 

4.7% to 4.9

%

Earnings before income tax, depreciation and amortization discount rate

 

13.3

%

 

Significant changes in the projected future operating results would result in a significantly higher or lower fair value measurement.  Changes to the discount rates, volatilities or correlation factors would have a lesser effect.  The implied rates are deemed to be unobservable inputs and, as such, the Company’s contingent consideration is classified within Level 3 of the valuation hierarchy.

 

Changes in the fair value of the contingent consideration obligations for the nine months ended March 31, 2019 are included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings and were as follows:

 

(In millions)

 

Fair Value

 

Contingent consideration at June 30, 2018

 

$

96

 

Changes in fair value

 

(18

)

Contingent consideration at March 31, 2019

 

$

78

 

 

NOTE 7 — REVENUE RECOGNITION

 

During the first quarter of fiscal 2019, the Company adopted the new revenue accounting standard, ASC 606, under the modified retrospective method to all contracts as of the date of adoption.  Under this method, the consolidated financial statements for the period beginning July 1, 2018 are presented under the new revenue accounting standard, while the prior-year periods reflect the revenue accounting standards in effect during those periods.  The following discussion is based on the Company’s accounting policies under the new standard; for a discussion of the Company’s prior accounting for revenue and a reconciliation of the impact of the change in accounting standard on the Company’s consolidated financial statements, see below Changes in Accounting Policies.  The Company also adopted the policy election to exclude from the transaction price all amounts collected from customers for sales and other taxes.  For revenue disaggregated by product category and geographic region, see Note 14 — Segment Data and Related Information.

 

Performance Obligations

The Company recognizes revenue at a point in time when it satisfies a performance obligation by transferring control over a product and other promised goods and services to a customer.

 

The Company sells wholesale to customers in distribution channels that include department stores, travel retail, specialty multi-brand retailers, perfumeries, salons/spas and through various online sites operated by authorized retailers.  The primary performance obligation related to these channels of distribution is product sales where revenue is recognized as control of the product transfers to the customer.  In the Americas region, revenue is generally recognized at the time the product is made available and provided to the customer’s carrier at the Company’s location and in the Europe, the Middle East & Africa and Asia/Pacific regions, revenue is generally recognized based upon the customer’s receipt.

 

The Company also sells direct to consumers at Company-operated freestanding stores and online through Company-owned and operated e-commerce and m-commerce sites and through third-party online platforms.  At Company-operated freestanding stores, revenue is recognized when control of the product is transferred at the point of sale.  Revenue from online sales is recognized when control of the product is transferred, generally based upon the consumer’s receipt.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In connection with the sale of product, the Company may provide other promised goods and services that are deemed to be performance obligations.  These are comprised of customer loyalty program obligations, gift with purchase and purchase with purchase promotions, gift cards and other promotional goods including samples and testers.

 

The Company offers a number of different loyalty programs to its customers across regions, brands and distribution channels including points-based programs, tier-based programs and recycling programs.  Revenue is allocated between the saleable product revenue and the material right loyalty obligations based on relative standalone selling prices when the consumer purchases the products that are earning them the right to the future benefits.  Deferred revenue related to the Company’s loyalty programs is estimated based on the standalone selling price and is adjusted for an estimated breakage factor.  Standalone selling price is determined primarily using the observable market price of the good or service benefit if it is sold by the Company or a cost plus margin approach for goods/services not directly sold by the Company.  Breakage rates consider historical patterns of redemption and/or expiration.  Revenue is recognized when the benefits are redeemed or expire.

 

The Company provides gift with purchase promotional products to certain customers generally without additional charge and also provides purchase with purchase promotional products to certain customers at a discount in relation to prices charged for saleable product.  Revenue is allocated between saleable product, gift with purchase product and purchase with purchase product based on the estimated relative standalone selling prices.  Revenue is deferred and ultimately recognized based on the timing differences, if any, between when control of promotional goods and control of the related saleable products transfer to the Company’s customer (e.g., a third-party retailer), which is calculated based on the weighted-average number of days between promotional periods.  The estimated standalone selling price allocated to promotional goods is based on a cost plus margin approach.

 

In situations where promotional products are provided by the Company to its customers at the same time as the related saleable product, such as shipments of samples and testers, the cost of these promotional products are recognized as a cost of sales at the same time as the related revenue is recognized and no deferral of revenue is required.

 

The Company also offers gift cards through Company-operated freestanding stores and Company-owned websites.  The related deferred revenue is estimated based on expected breakage that considers historical patterns of redemption taking into consideration escheatment laws as applicable.

 

Product Returns, Sales Incentives and Other Forms of Variable Consideration

In measuring revenue and determining the consideration the Company is entitled to as part of a contract with a customer, the Company takes into account the related elements of variable consideration.  Such elements of variable consideration include product returns and sales incentives, such as volume rebates and discounts, markdowns, margin adjustments and early-payment discounts.  We also enter into arrangements containing other forms of variable consideration, including certain demonstration arrangements, for which the Company does not receive a distinct good or service or for which the Company cannot reasonably estimate the fair value of the good or service.  For these types of arrangements, the adjustments to revenue are recorded at the later of when (i) the Company recognizes revenue for the transfer of the related goods or services to the customer, or (ii) the Company pays, or promises to pay, the consideration.

 

For the sale of goods with a right of return, the Company only recognizes revenue for the consideration it expects to be entitled to (considering the products to be returned) and records a sales return accrual within Other accrued liabilities for the amount it expects to credit back its customers.  In addition, the Company recognizes an asset included in Inventory and promotional merchandise, net and a corresponding adjustment to Cost of sales for the right to recover goods from customers associated with the estimated returns.

 

The sales return accrual and corresponding asset include estimates that directly impact reported net sales.  These estimates are calculated based on a history of actual returns, estimated future returns and information provided by retailers regarding their inventory levels.  Consideration of these factors results in an estimate for anticipated sales returns that reflects increases or decreases related to seasonal fluctuations.  In addition, as necessary, sales return accruals and the related assets may be established for significant future known or anticipated events.  The types of known or anticipated events that are considered, and will continue to be considered, include the financial condition of the Company’s customers, store closings by retailers, changes in the retail environment and the Company’s decision to continue to support new and existing products.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company estimates sales incentives and other variable consideration using the most likely amount method and records reserves within Other accrued liabilities when control of the related product is transferred to the customer.  Under this method, certain forms of variable consideration are based on expected sell-through results, which requires subjective estimates.  These estimates are supported by historical results as well as specific facts and circumstances related to the current period.

 

The Company also enters into transactions and makes payments to certain of its customers related to demonstration, advertising and counter construction, some of which involve cooperative relationships with customers.  These activities may be arranged either with unrelated third parties or in conjunction with the customer.  To the extent the Company receives a distinct good or service in exchange for consideration and the fair value of the benefit can be reasonably estimated, the Company’s share of the counter depreciation and the other costs of these transactions (regardless of to whom they were paid) are reflected in Selling, general and administrative expenses in the accompanying consolidated statements of earnings.

 

Accounts Receivable

Accounts receivable, net is stated net of the allowance for doubtful accounts and customer deductions totaling $31 million and $29 million as of March 31, 2019 and June 30, 2018, 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.  As a result of the adoption of ASC 606, amounts relating to the Company’s sales return accrual are recorded within Other accrued liabilities and the corresponding return asset is recorded in Inventory and promotional merchandise, net, and are no longer included as a reduction to Accounts receivable, net.  The Company applied the practical expedient available under ASC 606 to disregard determining significant financing components if the good/service is transferred and payment is received within one year.

 

Deferred Revenue

Significant changes in deferred revenue during the nine months ended March 31, 2019 are as follows:

 

(In millions)

 

 

 

Balance at July 1, 2018

 

$

380

 

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

 

(296

)

Revenue deferred during the period

 

272

 

Other

 

(2

)

Balance at March 31, 2019

 

$

354

 

 

Transaction Price Allocated to the Remaining Performance Obligations

At March 31, 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 $299 million.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Changes in Accounting Policies

As a result of the adoption of ASC 606, the Company has changed its accounting policies for revenue recognition as follows:

 

·                  For products sold that qualify for customer loyalty program awards, the Company defers a portion of revenue related to the product sales.  Previously, the Company recognized revenue in full for product sales and accrued for the expected amounts of loyalty awards to be provided under the incremental cost approach.

·                  A portion of revenue is deferred for shipments of saleable products with separate performance obligations to provide gift with purchase and purchase with purchase promotional products, and is recognized as control is transferred to a customer.  Previously, the Company recognized revenue for saleable products and purchase with purchase products based upon invoice prices charged to customers and included the cost of gift with purchase products and/or purchase with purchase products in Cost of sales when risks and rewards of ownership transferred to the Company’s customer (i.e. a third-party retailer).

·                  The cost of certain promotional products, including samples and testers, are classified within Cost of sales.  Such costs were previously accounted for as a component of Selling, general and administrative expenses.

·                  In conjunction with the adoption of ASC 606, the Company reassessed its contracts under the variable consideration guidance, including the payments to customer guidance, and as a result certain reclassifications were made related to timing and classification of certain net demonstration payments to and from customers.

·                  For product returns, the Company established a sales return accrual and a corresponding asset for the right to recover goods in Other accrued liabilities and Inventory and promotional merchandise, net, respectively, while previously the net liability for product returns was recorded as a reduction of Accounts receivable, net.

 

As a result of the change in accounting policies noted above, the Company recorded a cumulative adjustment of $229 million, net of tax, as a reduction to its fiscal 2019 opening balance of retained earnings.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables summarize the impacts of the adoption of ASC 606 on the Company’s consolidated financial statements as of and for the three and nine months ended March 31, 2019:

 

Consolidated Statements of Earnings

 

 

 

Three Months Ended March 31, 2019

 

Nine Months Ended March 31, 2019

 

(In millions, except per share data)

 

As
Reported

 

Impact

 

Prior to the
adoption of
ASC 606

 

As
Reported

 

Impact

 

Prior to the
adoption of
ASC 606

 

Net sales

 

$

3,744

 

$

(106

)

$

3,638

 

$

11,273

 

$

28

 

$

11,301

 

Cost of sales

 

819

 

(67

)

752

 

2,552

 

(219

)

2,333

 

Gross profit

 

2,925

 

(39

)

2,886

 

8,721

 

247

 

8,968

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

2,170

 

87

 

2,257

 

6,435

 

288

 

6,723

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

674

 

(126

)

548

 

2,097

 

(41

)

2,056

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

170

 

(28

)

142

 

472

 

(9

)

463

 

Net earnings attributable to The Estée Lauder Companies Inc.

 

555

 

(98

)

457

 

1,628

 

(32

)

1,596

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.53

 

$

(.27

)

$

1.26

 

$

4.47

 

$

(.09

)

$

4.38

 

Diluted

 

$

1.51

 

$

(.27

)

$

1.24

 

$

4.39

 

$

(.09

)

$

4.30

 

 

Consolidated Balance Sheet

 

 

 

March 31, 2019

 

(In millions)

 

As
Reported

 

Impact

 

Prior to the
adoption of
ASC 606

 

Accounts receivable, net

 

$

2,036

 

$

(211

)

$

1,825

 

Inventory and promotional merchandise, net

 

1,814

 

(26

)

1,788

 

Other assets

 

627

 

(60

)

567

 

Total assets

 

12,931

 

(297

)

12,634

 

 

 

 

 

 

 

 

 

Other accrued liabilities

 

2,647

 

(438

)

2,209

 

Other noncurrent liabilities

 

1,200

 

(55

)

1,145

 

Total liabilities

 

8,314

 

(493

)

7,821

 

 

 

 

 

 

 

 

 

Retained earnings

 

9,984

 

197

 

10,181

 

Accumulated other comprehensive loss

 

(498

)

(1

)

(499

)

Total stockholders’ equity — The Estée Lauder Companies Inc.

 

4,588

 

196

 

4,784

 

 

Consolidated Statement of Cash Flows

 

 

 

Nine Months Ended March 31, 2019

 

(In millions)

 

As
Reported

 

Impact

 

Prior to the
adoption of
ASC 606

 

Net earnings

 

$

1,636

 

$

(32

)

$

1,604

 

 

 

 

 

 

 

 

 

Changes in operating assets and liabilities

 

 

 

 

 

 

 

Increase in accounts receivable, net

 

(377

)

13

 

(364

)

Increase in inventory and promotional merchandise, net

 

(184

)

(1

)

(185

)

Increase in other assets, net

 

(73

)

(9

)

(82

)

Increase in other accrued and noncurrent liabilities

 

280

 

29

 

309

 

Net cash flows provided by operating activities

 

1,756

 

 

1,756

 

 

27


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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, 2018.

 

The components of net periodic benefit cost for the three months ended March 31, 2019 and 2018 consisted of the following:

 

 

 

Pension Plans

 

Other than
Pension Plans

 

 

 

U.S.

 

International

 

Post-retirement

 

(In millions)

 

2019

 

2018

 

2019

 

2018

 

2019

 

2018

 

Service cost

 

$

10

 

$

10

 

$

8

 

$

7

 

$

1

 

$

1

 

Interest cost

 

10

 

9

 

3

 

3

 

2

 

2

 

Expected return on plan assets

 

(15

)

(13

)

(3

)

(4

)

(1

)

(1

)

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

 

 

 

 

 

 

Actuarial loss

 

3

 

3

 

 

2

 

 

 

Net periodic benefit cost

 

$

8

 

$

9

 

$

8

 

$

8

 

$

2

 

$

2

 

 

The components of net periodic benefit cost for the nine months ended March 31, 2019 and 2018 consisted of the following:

 

 

 

Pension Plans

 

Other than
Pension Plans

 

 

 

U.S.

 

International

 

 

 

Post-retirement

 

(In millions)

 

2019

 

2018

 

2019

 

2018

 

2019

 

2018

 

Service cost

 

$

28

 

$

28

 

$

23

 

$

22

 

$

2

 

$

2

 

Interest cost

 

28

 

25

 

9

 

9

 

6

 

5

 

Expected return on plan assets

 

(41

)

(39

)

(10

)

(11

)

(2

)

(2

)

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

 

 

 

 

 

1

 

Actuarial loss

 

8

 

10

 

2

 

4

 

 

 

Net periodic benefit cost

 

$

23

 

$

24

 

$

24

 

$

24

 

$

6

 

$

6

 

 

During the nine months ended March 31, 2019, the Company made contributions to its international pension plans totaling $10 million.

 

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

 

 

 

March 31

 

June 30

 

(In millions)

 

2019

 

2018

 

Other assets

 

$

173

 

$

181

 

Other accrued liabilities

 

(27

)

(27

)

Other noncurrent liabilities

 

(384

)

(375

)

Funded status

 

(238

)

(221

)

Accumulated other comprehensive loss

 

223

 

234

 

Net amount recognized

 

$

(15

)

$

13

 

 

28


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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.

 

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
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

2019

 

2018

 

Compensation expense

 

$

70

 

$

64

 

$

201

 

$

196

 

Income tax benefit

 

$

13

 

$

13

 

$

38

 

$

41

 

 

Stock Options

 

During the nine months ended March 31, 2019, the Company granted stock options in respect of approximately 1.7 million shares of Class A Common Stock with an exercise price per share of $138.23 and a weighted-average grant date fair value per share of $38.62.  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 nine months ended March 31, 2019 was $215 million.

 

Restricted Stock Units

 

The Company granted RSUs in respect of approximately 1.2 million shares of Class A Common Stock during the nine months ended March 31, 2019 with a weighted-average grant date fair value per share of $139.48 that, at the time of grant, were scheduled to vest as follows: 0.4 million in fiscal 2020, 0.4 million in fiscal 2021 and 0.4 million in fiscal 2022.  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.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Performance Share Units

 

During the nine months ended March 31, 2019, the Company granted PSUs with a target payout of approximately 0.2 million shares of Class A Common Stock with a grant date fair value per share of $138.15, 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, 2021, all subject to continued employment or the retirement of the grantees.  In February 2019, the Company granted PSUs with a target payout of approximately 0.1 million shares with a weighted-average grant date fair value per share of $156.53, which will be settled in stock subject to the achievement of certain net sales and net operating profit goals of certain subsidiaries of the Company for the fiscal year ending June 30, 2022.  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 2018, 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, 2018.

 

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
March 31

 

Nine Months Ended
March 31

 

(In millions, except per share data)

 

2019

 

2018

 

2019

 

2018

 

Numerator:

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Estée Lauder Companies Inc.

 

$

555

 

$

372

 

$

1,628

 

$

922

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding — Basic

 

361.9

 

367.9

 

364.0

 

368.3

 

Effect of dilutive stock options

 

4.6

 

5.6

 

4.8

 

5.1

 

Effect of PSUs

 

0.3

 

0.3

 

0.3

 

0.2

 

Effect of RSUs

 

1.5

 

1.9

 

1.8

 

2.1

 

Weighted-average common shares outstanding — Diluted

 

368.3

 

375.7

 

370.9

 

375.7

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Basic

 

$

1.53

 

$

1.01

 

$

4.47

 

$

2.50

 

Diluted

 

$

1.51

 

$

.99

 

$

4.39

 

$

2.45

 

 

As of March 31, 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 1.6 million shares and de minimis, respectively.  As of March 31, 2019 and 2018, 1.3 million shares and 1.2 million shares, respectively, 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.

 

30


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 12 — EQUITY

 

Total Stockholders’ Equity — The Estée Lauder Companies Inc.

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

2019

 

2018

 

Common stock, beginning of the period

 

$

6

 

$

6

 

$

6

 

$

6

 

Stock-based compensation

 

 

 

 

 

Common stock, end of the period

 

6

 

6

 

6

 

6

 

 

 

 

 

 

 

 

 

 

 

Paid-in capital, beginning of the period

 

4,162

 

3,773

 

3,972

 

3,559

 

Common stock dividends

 

 

 

 

2

 

Stock-based compensation

 

169

 

138

 

359

 

350

 

Paid-in capital, end of the period

 

4,331

 

3,911

 

4,331

 

3,911

 

 

 

 

 

 

 

 

 

 

 

Retained earnings, beginning of the period

 

9,586

 

8,733

 

9,040

 

8,452

 

Common stock dividends

 

(157

)

(141

)

(455

)

(410

)

Net earnings attributable to The Estée Lauder Companies Inc.

 

555

 

372

 

1,628

 

922

 

Reclassification from accumulated other comprehensive loss as a result of the adoption of a new accounting standard

 

 

32

 

 

32

 

Cumulative effect of adoption of ASC 606

 

 

 

(229

)

 

Retained earnings, end of the period

 

9,984

 

8,996

 

9,984

 

8,996

 

 

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive loss, beginning of the period

 

(430

)

(407

)

(434

)

(484

)

Reclassification to retained earnings as a result of the adoption of a new accounting standard

 

 

(32

)

 

(32

)

Other comprehensive income (loss)

 

(68

)

53

 

(64

)

130

 

Accumulated other comprehensive loss, end of the period

 

(498

)

(386

)

(498

)

(386

)

 

 

 

 

 

 

 

 

 

 

Treasury stock, beginning of the period

 

(9,018

)

(7,540

)

(7,896

)

(7,149

)

Acquisition of treasury stock

 

(215

)

(275

)

(1,248

)

(605

)

Stock-based compensation

 

(2

)

(1

)

(91

)

(62

)

Treasury stock, end of the period

 

(9,235

)

(7,816

)

(9,235

)

(7,816

)

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity — The Estée Lauder Companies Inc.

 

4,588

 

4,711

 

4,588

 

4,711

 

 

 

 

 

 

 

 

 

 

 

Noncontrolling interests, beginning of the period

 

27

 

24

 

22

 

18

 

Net earnings attributable to noncontrolling interests

 

2

 

2

 

8

 

7

 

Other comprehensive income

 

 

 

(1

)

1

 

Noncontrolling interests, end of the period

 

29

 

26

 

29

 

26

 

 

 

 

 

 

 

 

 

 

 

Total equity

 

$

4,617

 

$

4,737

 

$

4,617

 

$

4,737

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

.43

 

$

.38

 

$

1.24

 

$

1.10

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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 nine months ended March 31, 2019:

 

Date Declared

 

Record Date

 

Payable Date

 

Amount per Share

 

August 17, 2018

 

August 31, 2018

 

September 17, 2018

 

$

.38

 

October 30, 2018

 

November 30, 2018

 

December 17, 2018

 

$

.43

 

February 4, 2019

 

February 28, 2019

 

March 15, 2019

 

$

.43

 

 

On April 30, 2019, a dividend was declared in the amount of $.43 per share on the Company’s Class A and Class B Common Stock.  The dividend is payable in cash on June 17, 2019 to stockholders of record at the close of business on May 31, 2019.

 

Common Stock

 

During the nine months ended March 31, 2019, the Company purchased approximately 9.7 million shares of its Class A Common Stock for $1,344 million.

 

On October 31, 2018, the Company’s Board of Directors authorized the repurchase of up to another 40.0 million shares of the Company’s Class A Common Stock.

 

During the nine months ended March 31, 2019, approximately 0.5 million shares of the Company’s Class B Common Stock were converted into the same number of shares of the Company’s Class A Common Stock.

 

Accumulated Other Comprehensive Income (Loss)

 

The following table represents changes in AOCI, net of tax, by component for the nine months ended March 31, 2019:

 

(In millions)

 

Net
Unrealized
Investment
Gain (Loss)

 

Net
Derivative
Instrument
Gain (Loss)

 

Amounts
Included in Net
Periodic Benefit
Cost

 

Translation
Adjustments

 

Total

 

Balance at June 30, 2018

 

$

(14

)

$

39

 

$

(175

)

$

(284

)

$

(434

)

OCI before reclassifications

 

8

 

14

 

1

(1)

(11

)

12

 

Amounts reclassified to Net earnings

 

6

 

(12

)

7

 

(77

)

(76

)

Net current-period OCI

 

14

 

2

 

8

 

(88

)

(64

)

Balance at March 31, 2019

 

$

 

$

41

 

$

(167

)

$

(372

)

$

(498

)

 


(1) Consists of foreign currency translation gains.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table represents the effects of reclassification adjustments from AOCI into net earnings for the three and nine months ended March 31, 2019 and 2018:

 

 

 

Amount Reclassified from AOCI

 

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

Affected Line Item in
Consolidated

(In millions)

 

2019

 

2018

 

2019

 

2018

 

Statements of Earnings

Gain (Loss) on Investments

 

 

 

 

 

 

 

 

 

 

Gain (loss) on investments

 

$

(6

)

$

 

$

(6

)

$

 

Other income, net

Benefit (provision) for deferred taxes

 

 

 

 

 

Provision for income taxes

 

 

$

(6

)

$

 

$

(6

)

$

 

Net earnings

 

 

 

 

 

 

 

 

 

 

 

Gain (Loss) on Cash Flow Hedges

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

8

 

$

 

$

15

 

$

 

Net sales

Foreign currency forward contracts

 

 

(8

)

 

(20

)

Cost of sales

Foreign currency forward contracts

 

 

(10

)

 

(21

)

Selling, general and administrative

Interest rate-related derivatives

 

1

 

 

1

 

1

 

Interest expense

 

 

9

 

(18

)

16

 

(40

)

Earnings before income taxes

Benefit (provision) for deferred taxes

 

(2

)

6

 

(4

)

13

 

Provision for income taxes

 

 

$

7

 

$

(12

)

$

12

 

$

(27

)

Net earnings

 

 

 

 

 

 

 

 

 

 

 

Amounts Included in Net Periodic Benefit Cost

 

 

 

 

 

 

 

 

 

 

Amortization of prior service cost

 

$

 

$

 

$

 

$

(1

)(1)

 

Amortization of actuarial loss

 

(3

)

(5

)

(10

)

(14

)(1)

 

 

 

(3

)

(5

)

(10

)

(15

)

Earnings before income taxes

Benefit for deferred taxes

 

1

 

 

3

 

3

 

Provision for income taxes

 

 

$

(2

)

$

(5

)

$

(7

)

$

(12

)

Net earnings

 

 

 

 

 

 

 

 

 

 

 

Cumulative Translation Adjustments

 

 

 

 

 

 

 

 

 

 

Gain on liquidation of an investment in a foreign subsidiary

 

$

77

 

$

 

$

77

 

$

 

Other income, net

Total reclassification adjustments, net

 

$

76

 

$

(17

)

$

76

 

$

(39

)

Net earnings

 


(1) See Note 8 — Pension and Post-Retirement Benefit Plans for additional information.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 13 — STATEMENT OF CASH FLOWS

 

Supplemental cash flow information for the nine months ended March 31, 2019 and 2018 is as follows:

 

(In millions)

 

2019

 

2018

 

Cash:

 

 

 

 

 

Cash paid during the period for interest

 

$

99

 

$

97

 

Cash paid during the period for income taxes

 

$

400

 

$

283

 

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

 

Capital lease and asset retirement obligations incurred

 

$

8

 

$

4

 

Property, plant and equipment accrued but unpaid

 

$

39

 

$

32

 

 

NOTE 14 — SEGMENT DATA AND RELATED INFORMATION

 

Reportable operating segments include components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (the “Chief Executive”) in deciding how to allocate resources and in assessing performance.  Although the Company operates in one business segment, beauty products, management also evaluates performance on a product category basis.  Product category performance is measured based upon net sales before returns associated with restructuring and other activities, and earnings before income taxes, other components of net periodic benefit cost, interest expense, interest income and investment income, net, charges associated with restructuring and other activities and other income, net.  Returns and charges associated with restructuring and other activities are not allocated to the product categories because they result from activities that are deemed a Company-wide initiative to redesign, resize and reorganize select corporate functions and go-to-market structures.

 

The accounting policies for the Company’s reportable segments are substantially the same as those for the consolidated financial statements, as 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, 2018.  The assets and liabilities of the Company are managed centrally and are reported internally in the same manner as the consolidated financial statements; thus, no additional information is produced for the Chief Executive or included herein.  There has been no significant variance in the total or long-lived asset values associated with the Company’s segment data since June 30, 2018.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

2019

 

2018

 

PRODUCT CATEGORY DATA

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

1,744

 

$

1,447

 

$

4,962

 

$

4,216

 

Makeup

 

1,461

 

1,388

 

4,427

 

4,275

 

Fragrance

 

392

 

382

 

1,401

 

1,423

 

Hair Care

 

136

 

139

 

433

 

419

 

Other

 

13

 

14

 

52

 

55

 

 

 

3,746

 

3,370

 

11,275

 

10,388

 

Returns associated with restructuring and other activities

 

(2

)

 

(2

)

 

Net sales

 

$

3,744

 

$

3,370

 

$

11,273

 

$

10,388

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss) before charges associated with restructuring and other activities:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

593

 

$

441

 

$

1,624

 

$

1,221

 

Makeup

 

99

 

119

 

398

 

514

 

Fragrance

 

17

 

23

 

156

 

195

 

Hair Care

 

(2

)

13

 

27

 

45

 

Other

 

2

 

2

 

9

 

9

 

 

 

709

 

598

 

2,214

 

1,984

 

Reconciliation:

 

 

 

 

 

 

 

 

 

Charges associated with restructuring and other activities

 

(35

)

(100

)

(117

)

(207

)

Interest expense

 

(32

)

(33

)

(101

)

(96

)

Interest income and investment income, net

 

15

 

16

 

42

 

40

 

Other components of net periodic benefit cost

 

(1

)

(1

)

(1

)

(2

)

Other income, net

 

71

 

 

71

 

 

Earnings before income taxes

 

$

727

 

$

480

 

$

2,108

 

$

1,719

 

 

 

 

 

 

 

 

 

 

 

GEOGRAPHIC DATA(1)

 

 

 

 

 

 

 

 

 

Net sales:

 

 

 

 

 

 

 

 

 

The Americas

 

$

1,155

 

$

1,181

 

$

3,609

 

$

3,818

 

Europe, the Middle East & Africa

 

1,625

 

1,416

 

4,825

 

4,236

 

Asia/Pacific

 

966

 

773

 

2,841

 

2,334

 

 

 

3,746

 

3,370

 

11,275

 

10,388

 

Returns associated with restructuring and other activities

 

(2

)

 

(2

)

 

Net sales

 

$

3,744

 

$

3,370

 

$

11,273

 

$

10,388

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

The Americas

 

$

(29

)

$

33

 

$

(57

)

$

231

 

Europe, the Middle East & Africa

 

494

 

386

 

1,580

 

1,196

 

Asia/Pacific

 

244

 

179

 

691

 

557

 

 

 

709

 

598

 

2,214

 

1,984

 

Charges associated with restructuring and other activities

 

(35

)

(100

)

(117

)

(207

)

Operating income

 

$

674

 

$

498

 

$

2,097

 

$

1,777

 

 


(1) The net sales from the Company’s travel retail business are included in the Europe, the Middle East & Africa region.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

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

 

RESULTS OF OPERATIONS

 

We manufacture, market and sell beauty products including those in the skin care, makeup, fragrance and hair care categories, which are distributed in over 150 countries and territories.  The following table is a comparative summary of operating results for the three and nine months ended March 31, 2019 and 2018, and reflects the basis of presentation described in Notes to Consolidated Financial Statements, Note 1 — Summary of Significant Accounting Policies for all periods presented.  Products and services that do not meet our definition of skin care, makeup, fragrance or hair care have been included in the “other” category.

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

2019

 

2018

 

NET SALES

 

 

 

 

 

 

 

 

 

By Product Category:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

1,744

 

$

1,447

 

$

4,962

 

$

4,216

 

Makeup

 

1,461

 

1,388

 

4,427

 

4,275

 

Fragrance

 

392

 

382

 

1,401

 

1,423

 

Hair Care

 

136

 

139

 

433

 

419

 

Other

 

13

 

14

 

52

 

55

 

 

 

3,746

 

3,370

 

11,275

 

10,388

 

Returns associated with restructuring and other activities

 

(2

)

 

(2

)

 

Net sales

 

$

3,744

 

$

3,370

 

$

11,273

 

$

10,388

 

 

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

The Americas

 

$

1,155

 

$

1,181

 

$

3,609

 

$

3,818

 

Europe, the Middle East & Africa

 

1,625

 

1,416

 

4,825

 

4,236

 

Asia/Pacific

 

966

 

773

 

2,841

 

2,334

 

 

 

3,746

 

3,370

 

11,275

 

10,388

 

Returns associated with restructuring and other activities

 

(2

)

 

(2

)

 

Net sales

 

$

3,744

 

$

3,370

 

$

11,273

 

$

10,388

 

 

 

 

 

 

 

 

 

 

 

OPERATING INCOME (LOSS)

 

 

 

 

 

 

 

 

 

By Product Category:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

593

 

$

441

 

$

1,624

 

$

1,221

 

Makeup

 

99

 

119

 

398

 

514

 

Fragrance

 

17

 

23

 

156

 

195

 

Hair Care

 

(2

)

13

 

27

 

45

 

Other

 

2

 

2

 

9

 

9

 

 

 

709

 

598

 

2,214

 

1,984

 

Charges associated with restructuring and other activities

 

(35

)

(100

)

(117

)

(207

)

Operating income

 

$

674

 

$

498

 

$

2,097

 

$

1,777

 

 

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

The Americas

 

$

(29

)

$

33

 

$

(57

)

$

231

 

Europe, the Middle East & Africa

 

494

 

386

 

1,580

 

1,196

 

Asia/Pacific

 

244

 

179

 

691

 

557

 

 

 

709

 

598

 

2,214

 

1,984

 

Charges associated with restructuring and other activities

 

(35

)

(100

)

(117

)

(207

)

Operating income

 

$

674

 

$

498

 

$

2,097

 

$

1,777

 

 

36


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THE ESTÉE LAUDER COMPANIES INC.

 

The following table presents certain consolidated earnings data as a percentage of net sales:

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

 

 

2019

 

2018

 

2019

 

2018

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of sales

 

21.9

 

20.3

 

22.6

 

20.7

 

Gross profit

 

78.1

 

79.7

 

77.4

 

79.3

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

58.0

 

62.1

 

57.1

 

60.3

 

Restructuring and other charges

 

0.8

 

2.9

 

0.9

 

1.9

 

Goodwill impairment

 

1.3

 

 

0.6

 

 

Impairment of other intangible assets

 

0.1

 

 

0.2

 

 

Total operating expenses

 

60.1

 

65.0

 

58.8

 

62.2

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

18.0

 

14.8

 

18.6

 

17.1

 

Interest expense

 

0.9

 

1.0

 

0.9

 

1.0

 

Interest income and investment income, net

 

0.4

 

0.5

 

0.4

 

0.4

 

Other components of net periodic benefit cost

 

 

 

 

 

Other income, net

 

1.9

 

 

0.6

 

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

19.4

 

14.2

 

18.7

 

16.5

 

Provision for income taxes

 

4.5

 

3.1

 

4.2

 

7.6

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

14.9

 

11.1

 

14.5

 

8.9

 

Net earnings attributable to noncontrolling interests

 

(0.1

)

(0.1

)

(0.1

)

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Estée Lauder Companies Inc.

 

14.8

%

11.0

%

14.4

%

8.9

%

 


Not adjusted for differences caused by rounding

 

In order to meet the demands of consumers, we continually introduce new products, support new and established products through advertising, merchandising and sampling and phase out existing products that no longer meet the needs of our consumers or our objectives.  The economics of developing, producing, launching, supporting and discontinuing products impact our sales and operating performance each period.  The introduction of new products may have some cannibalizing effect on sales of existing products, which we take into account in our business planning.

 

Non-GAAP Financial Measures

 

We use certain non-GAAP financial measures, among other financial measures, to evaluate our operating performance, which represent the manner in which we conduct and view our business.  Management believes that excluding certain items that are not comparable from period to period helps investors and others compare operating performance between periods.  While we consider the non-GAAP measures useful in analyzing our results, they are not intended to replace, or act as a substitute for, any presentation included in the consolidated financial statements prepared in conformity with U.S. GAAP.  See Reconciliations of Non-GAAP Financial Measures beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

We operate on a global basis, with the majority of our net sales generated outside the United States.  Accordingly, fluctuations in foreign currency exchange rates can affect our results of operations.  Therefore, we present certain net sales, operating results and diluted net earnings per common share information excluding the effect of foreign currency rate fluctuations to provide a framework for assessing the performance of our underlying business outside the United States.  Constant currency information compares results between periods as if exchange rates had remained constant period-over-period.  We calculate constant currency information by translating current year results using prior year weighted-average foreign currency exchange rates.  Beginning in fiscal 2019, the Company adopted a new accounting standard related to hedging that resulted in gains/losses on our foreign currency cash flow hedging activities to now be reflected in Net sales, where in prior periods they were reflected in Cost of sales and Selling, general and administrative expenses, see Notes to Consolidated Financial Statements, Note 5 — Derivative Financial Instruments.  To better assess our performance in a constant currency environment, beginning in fiscal 2019 we are excluding the impact of these hedging activities in our constant currency calculations.

 

37


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THE ESTÉE LAUDER COMPANIES INC.

 

Overview

 

We believe that the best way to increase stockholder value is to continue providing superior products and services in the most efficient and effective manner while recognizing consumers’ changing behaviors and shopping preferences.  Accordingly, our long-term strategy has numerous initiatives across geographic regions, product categories, brands, channels of distribution and functions designed to grow our sales, provide cost efficiencies, leverage our strengths and make us more productive and profitable.  We plan to build upon and leverage our history of outstanding creativity and innovation, high quality products and services, and engaging communications while investing for long-term sustainable growth.  Elements of our strategy are described in the Overview on pages 23-25 of our Annual Report on Form 10-K for the year ended June 30, 2018, as well as below.

 

During the third quarter of fiscal 2019, our global net sales momentum continued, fueled by our multiple engines of growth.  Net sales grew 11% as compared with the prior-year period, led by our skin care and makeup product categories.  Estée Lauder, La Mer and Origins continued to drive growth in skin care, with net sales from Estée Lauder and La Mer growing double digits.  The higher net sales from Tom Ford, Estée Lauder and La Mer drove the makeup category growth.  Internationally, our net sales grew in many markets, particularly in Asia/Pacific, led by China and Hong Kong, while our travel retail business continued to generate double-digit net sales increases.  We believe that our success has been due, in part, to our focus on innovation and our hero product strategy supported by targeted consumer engagement leveraging digital marketing and social media.

 

While our business is performing well overall, we continue to face strong competition globally and economic challenges in certain countries.  We are cautious of the continued decline in retail traffic primarily related to certain brick-and-mortar stores in the United States and the United Kingdom.  This is due to the impact of shifts in consumer preferences as to where and how they shop, as well as adverse macroeconomic conditions in those countries.  We continue monitoring the potential implications of the ongoing economic and political uncertainties stemming from the United Kingdom’s anticipated exit from the European Union (i.e. Brexit) and continue developing our risk mitigation strategies to address such uncertainties.  These strategies include changes related to regulatory and legislative compliance, assessing alternatives to supply chain routing, revising customer arrangements and analyzing inventory levels.  We are also cautious of foreign currency movements, including their impact on tourism.  Additionally, we continue to monitor the effects of the global macroeconomic environment; social and political issues; regulatory matters, including the imposition of tariffs; geopolitical tensions; and global security issues.

 

We believe we can, to some extent, offset the impact of these challenges by continually developing and pursuing a diversified strategy with multiple engines of growth and accelerating areas of strength among our geographic regions, product categories, brands and channels of distribution.  However, if economic conditions or the degree of uncertainty or volatility worsen, or the adverse conditions previously described are further prolonged, there could be a negative effect on consumer confidence, demand, spending and willingness or ability to travel and, as a result, on our business.  We will continue to monitor these and other risks that may affect our business.

 

Our “heritage brands” are Estée Lauder, Clinique and Origins.  Our “makeup artist brands” are M·A·C and Bobbi Brown.  Our “luxury brands” are La Mer, Jo Malone London, Tom Ford, AERIN, RODIN olio lusso, Le Labo, Editions de Parfums Frédéric Malle and By Kilian.  Our “designer fragrances” are sold under the Tommy Hilfiger, Donna Karan New York, DKNY, Michael Kors, Kiton, Ermenegildo Zegna and Tory Burch brand names, which we license from their respective owners.

 

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Leading Beauty Forward

 

In May 2016, we announced a multi-year initiative (“Leading Beauty Forward,” or the “Program”) to build on our strengths and better leverage our cost structure to free resources for investment to continue our growth momentum.  Leading Beauty Forward is designed to enhance our go-to-market capabilities, reinforce our leadership in global prestige beauty and continue creating sustainable value.  We plan to approve specific initiatives under Leading Beauty Forward through fiscal 2019 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 expect to complete those initiatives through fiscal 2021.  Inclusive of approvals from inception through December 31, 2018, we estimate that Leading Beauty Forward may result in related restructuring and other charges totaling between $900 million and $950 million, before taxes, consisting of employee-related costs, asset write-offs and other costs to implement these initiatives.  After its full implementation, we expect Leading Beauty Forward to yield annual net benefits, primarily in Selling, general and administrative expenses, of between $350 million and $450 million, before taxes.  These savings can be used to improve margin, mitigate risk and invest in future growth initiatives.  For additional information about restructuring and other charges, see Notes to Consolidated Financial Statements, Note 4 — Charges Associated with Restructuring and Other Activities.

 

Goodwill and Other Intangible Asset Impairments

 

During December 2018, our Smashbox reporting unit made revisions to its internal forecasts reflecting a slowdown of its makeup business driven by increased competitive activity and lower than expected growth in key retail channels for the brand.  We concluded that these changes in circumstances in the Smashbox reporting unit triggered the need for an interim impairment review of its trademark and goodwill.  Accordingly, we performed an interim impairment test as of December 31, 2018.  We concluded that the carrying value of the Smashbox trademark exceeded its estimated fair value, which was determined utilizing a royalty rate to determine discounted projected future cash flows.  As a result, we recognized an impairment charge of $18 million for the trademark during the three months ended December 31, 2018.  After adjusting the carrying value of the trademark, we completed an interim quantitative impairment test for goodwill and recorded a goodwill impairment charge related to the Smashbox reporting unit of $20 million during the three months ended December 31, 2018.

 

During March 2019, our Smashbox reporting unit made additional revisions to its internal forecasts reflecting the continued slowdown of its makeup business driven by ongoing competitive activity and lower than expected growth in key retail channels for the brand.  We concluded that these changes in circumstances in the Smashbox reporting unit triggered the need for an interim impairment review of its trademark and goodwill.  Accordingly, we performed an interim impairment test as of March 31, 2019.  We concluded that the carrying value of the Smashbox trademark exceeded its estimated fair value, which was determined utilizing a royalty rate to determine discounted projected future cash flows.  As a result, we recognized an impairment charge of $4 million for the trademark during the three months ended March 31, 2019.  After adjusting the carrying value of the trademark, we completed an interim quantitative impairment test for goodwill and recorded a goodwill impairment charge related to the Smashbox reporting unit of $48 million during the three months ended March 31, 2019.  The cumulative impairment charges for the trademark and goodwill during the nine months ended March 31, 2019 were $22 million and $68 million, respectively.

 

The fair values of the reporting unit as of December 31, 2018 and March 31, 2019 were based upon an equal weighting of the income and market approaches, utilizing estimated cash flows and a terminal value, discounted at a rate of return that reflects the relative risk of the cash flows, as well as valuation multiples derived from comparable publicly traded companies that are applied to operating performance of the reporting unit.  These impairment charges were reflected in the makeup product category and in the Americas region.  The key assumptions used to determine the estimated fair value of the reporting unit are predicated on the success of future new product launches, the achievement of international distribution expansion plans, and the realization of cost reduction and other efficiency efforts.  If such plans do not materialize, or if there are further challenges in the business environment in which this reporting unit operates, a resulting change in the key assumptions could have a negative impact on the estimated fair value of the reporting unit and it is possible we could recognize an additional impairment charge.  As of March 31, 2019, the remaining carrying values of the goodwill and trademark related to the Smashbox reporting unit were $72 million and $55 million, respectively.

 

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NET SALES

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net sales

 

$

3,744

 

$

3,370

 

$

11,273

 

$

10,388

 

$ Change from prior-year period

 

374

 

 

 

885

 

 

 

% Change from prior-year period

 

11

%

 

 

9

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

15

%

 

 

11

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

For the three and nine months ended March 31, 2019, reported net sales increased in the skin care and makeup product categories and grew in Europe, the Middle East & Africa and Asia/Pacific.  Skin care net sales primarily benefited from higher sales of Estée Lauder and La Mer products.  Net sales increases from Tom Ford, Estée Lauder, La Mer and M·A·C drove the increase in the makeup product category.  Each of our product categories benefited from targeted expanded consumer reach, new product offerings, and the continued success of certain hero franchises.  Net sales increases in China and Hong Kong continued to drive growth internationally, which contributed to the growth in our online channel (primarily third-party online platforms), while the growth in our travel retail business continued to benefit from the increase in international passenger traffic, particularly by Chinese travelers.

 

Returns associated with restructuring and other activities are not allocated to our product categories or geographic regions because they result from activities that are deemed a Company-wide initiative to redesign, resize and reorganize select corporate functions and go-to-market structures.  Accordingly, the following discussions of Net sales by Product Categories and Geographic Regions exclude the impact of returns associated with restructuring and other activities.

 

During the first quarter of fiscal 2019, we adopted Financial Accounting Standards Board Accounting Standards Codification Topic 606 — Revenue from Contracts with Customers (“ASC 606”).  The adoption of ASC 606 resulted in the deferral of a portion of product sales primarily related to future obligations (i) to provide gift with purchase and purchase with purchase promotional products and (ii) to satisfy customer loyalty program reward obligations, as well as the timing and classification of certain net demonstration payments to and from customers.  The collective impact of the adoption of ASC 606 increased (reduced) reported net sales for the three and nine months ended March 31, 2019 by $106 million and $(28) million, respectively.  For further information, see Notes to Consolidated Financial Statements, Note 7 — Revenue Recognition.

 

Product Categories

The change in net sales in each product category for the three and nine months ended March 31, 2019 included the impact of the adoption of ASC 606, which resulted in an increase (reduction) to net sales, as follows:

 

 

 

March 31, 2019

 

(In millions)

 

Three Months Ended

 

Nine Months Ended

 

Skin Care

 

$

56

 

$

(32

)

Makeup

 

41

 

10

 

Fragrance

 

9

 

(9

)

Hair Care

 

(1

)

 

Other

 

1

 

3

 

Total

 

$

106

 

$

(28

)

 

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Skin Care

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net sales

 

$

1,744

 

$

1,447

 

$

4,962

 

$

4,216

 

$ Change from prior-year period

 

297

 

 

 

746

 

 

 

% Change from prior-year period

 

21

%

 

 

18

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

25

%

 

 

20

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Reported skin care net sales increased, reflecting higher net sales from Estée Lauder and La Mer, combined, of approximately $234 million and $693 million for the three and nine months ended March 31, 2019, respectively.  Net sales increased from Estée Lauder, led by China and Hong Kong, reflecting the continued strength of existing product franchises, such as Advanced Night Repair, Nutritious, Perfectionist, Micro Essence and Revitalizing Supreme, and new product launches, such as Advanced Night Repair Eye Supercharged Complex, which drove growth in most channels of distribution, primarily our travel retail, online and department store channels.  The increase in net sales from La Mer reflected growth from most markets, led by China and Hong Kong, and benefited from the strength in eye products, other existing products, such as The Treatment Lotion, and targeted expanded consumer reach.  Also contributing to the growth of La Mer were the increase in Chinese travelers, which led to the brand’s growth in travel retail and department stores, and higher net sales in our online channel in China (primarily third-party online platforms).

 

The skin care net sales increases were impacted by approximately $63 million and $117 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2019, respectively.

 

Makeup

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net sales

 

$

1,461

 

$

1,388

 

$

4,427

 

$

4,275

 

$ Change from prior-year period

 

73

 

 

 

152

 

 

 

% Change from prior-year period

 

5

%

 

 

4

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

10

%

 

 

6

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

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Reported makeup net sales increased, reflecting higher net sales from Tom Ford, Estée Lauder, La Mer and M·A·C, combined, of approximately $59 million and $255 million for the three and nine months ended March 31, 2019, respectively, as well as the impacts of ASC 606 noted above.  The net sales increase in both periods from Tom Ford was driven by higher net sales of lipstick and eyeshadow products in Asia/Pacific, in particular China, and our travel retail business, as well as targeted expanded consumer reach.  The higher net sales from Estée Lauder were primarily due to the success of our Double Wear franchise, Futurist Aqua Brilliance and the Pure Color line of products, which drove higher net sales in China, Hong Kong and Korea, as well as in travel retail.  The increase in net sales from La Mer reflected double-digit growth in both periods and benefitted from new products, such as The Luminous Lifting Cushion Foundation, and targeted expanded consumer reach.  The net sales increases in China, as well as the increase in Chinese travelers, also contributed to the growth of La Mer, and led to the brand’s growth in travel retail.  The net sales increase from M·A·C in both periods was driven primarily by our Asia/Pacific region, led by China and Hong Kong, as well as the Middle East.  The higher net sales in Asia/Pacific was primarily due to targeted expanded consumer reach and the strength of lip products in China, including the success of the Strike of Kings collection. The increase in the Middle East reflected a favorable comparison to the prior year due to the rebalancing of inventory.  The increase for M·A·C also reflected higher net sales in our travel retail business, online third-party platforms and the specialty-multi channel.  Partially offsetting these increases for the brand were lower net sales from the United Kingdom due to overall softness in the makeup category there, continued competitive pressures and adverse macroeconomic conditions, as well as continued declines in the United States primarily due to slower traffic in certain department stores and freestanding stores.

 

These increases were partially offset by lower net sales from Clinique and Smashbox, combined, of approximately $39 million and $138 million for the three and nine months ended March 31, 2019, respectively.  The decline in net sales from Clinique reflected the negative impact of the liquidation and closure of a certain North American retailer, as well as overall softness in the makeup category and adverse macroeconomic conditions in the United Kingdom.  The lower net sales from Smashbox reflected the continued slowdown of its makeup business driven by ongoing competitive activity and lower growth in key retail channels for the brand.

 

The makeup net sales increases were impacted by approximately $60 million and $125 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2019, respectively.

 

Fragrance

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net sales

 

$

392

 

$

382

 

$

1,401

 

$

1,423

 

$ Change from prior-year period

 

10

 

 

 

(22

)

 

 

% Change from prior-year period

 

3

%

 

 

(2

)%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

7

%

 

 

1

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Reported fragrance net sales increased for the three months ended March 31, 2019, reflecting higher net sales from Estée Lauder, Jo Malone London, Tom Ford and Le Labo, combined, of approximately $23 million, mostly offset by lower net sales from certain of our designer fragrances.  For the nine months ended March 31, 2019, reported fragrance net sales decreased primarily due to lower net sales from certain of our designer fragrances and Estée Lauder, combined, of approximately $87 million, partially offset by higher net sales from Jo Malone London, Le Labo and Tom Ford, combined, of approximately $60 million.  The change in net sales from Estée Lauder in both periods was primarily due to the change in the mix of products included in the brand’s holiday blockbuster promotion.  The increase in net sales from Jo Malone London for both periods was driven primarily by growth from our Asia/Pacific region, led by China, due to targeted expanded consumer reach.  Net sales increased from Tom Ford in both periods, primarily reflecting higher net sales from the Private Blend franchise, particularly Soleil Blanc and Oud Wood, and targeted expanded consumer reach.  Net sales increased from Le Labo due to the success of existing products and targeted expanded consumer reach globally, which led to strong growth of the brand in our department store and freestanding store channels.

 

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The lower net sales from certain of our designer fragrances for both periods was primarily due to an unfavorable comparison to the prior-year launch of Michael Kors Sexy Ruby in North America, as well as the challenging retail environment in the United Kingdom.

 

The changes in fragrance net sales were impacted by approximately $18 million and $39 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2019, respectively.

 

Hair Care

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net sales

 

$

136

 

$

139

 

$

433

 

$

419

 

$ Change from prior-year period

 

(3

)

 

 

14

 

 

 

% Change from prior-year period

 

(2

)%

 

 

3

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

1

%

 

 

5

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Reported hair care net sales decreased for the three months ended March 31, 2019, primarily reflecting lower net sales from Bumble and bumble primarily due to the softness in the salon channel in North America.

 

Reported hair care net sales increased for the nine months ended March 31, 2019, primarily reflecting growth from Aveda, partially offset by lower net sales from Bumble and bumble due to the softness in the salon channel in North America.  The higher net sales from Aveda, particularly in our online channel, was primarily driven by the launch of Cherry Almond Softening Shampoo and Conditioner and continued success of certain hero franchises, such as the Rosemary Mint and Shampure lines of products.

 

Geographic Regions

The change in net sales in each geographic region for the three and nine months ended March 31, 2019 included the impact of the adoption of ASC 606, which resulted in an increase (reduction) to net sales, as follows:

 

 

 

March 31, 2019

 

(In millions)

 

Three Months Ended

 

Nine Months Ended

 

The Americas

 

$

54

 

$

(45

)

Europe, the Middle East & Africa

 

21

 

25

 

Asia/Pacific

 

31

 

(8

)

Total

 

$

106

 

$

(28

)

 

The Americas

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net sales

 

$

1,155

 

$

1,181

 

$

3,609

 

$

3,818

 

$ Change from prior-year period

 

(26

)

 

 

(209

)

 

 

% Change from prior-year period

 

(2

)%

 

 

(5

)%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

(2

)%

 

 

(5

)%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

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Reported net sales in The Americas for the three and nine months ended March 31, 2019 decreased due to lower net sales in the United States of approximately $12 million and $160 million, respectively.  The lower net sales for the three and nine months ended March 31, 2019 were driven primarily by lower net sales from M·A·C, Smashbox and Clinique.  The net sales decreases from M·A·C were primarily due to the continued traffic declines in department stores and freestanding stores.  The lower net sales from Smashbox reflected the continued slowdown of its makeup business driven by ongoing competitive activity and lower growth in key retail channels for the brand.  The lower net sales from Clinique were negatively impacted by the liquidation and closure of a certain North American retailer.  In addition, net sales in Latin America and Canada, combined, decreased approximately $14 million and $49 million for the three and nine months ended March 31, 2019, respectively, primarily due to lower net sales in both periods from M·A·C and Clinique, particularly in department stores and freestanding stores.

 

The net sales decreases in The Americas included approximately $6 million and $24 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2019, respectively.

 

Europe, the Middle East & Africa

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net sales

 

$

1,625

 

$

1,416

 

$

4,825

 

$

4,236

 

$ Change from prior-year period

 

209

 

 

 

589

 

 

 

% Change from prior-year period

 

15

%

 

 

14

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

22

%

 

 

18

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Reported net sales in Europe, the Middle East & Africa increased due to higher net sales from our travel retail business for the three and nine months ended March 31, 2019, respectively.  Net sales increased in our travel retail business, reflecting strong growth across most brands, led by Estée Lauder, La Mer, M·A·C and Tom Ford, driven, in part, by an increase in international passenger traffic, particularly by Chinese travelers, as well as strategic investment spend supporting both new and existing products, such as the La Mer Arrive Hydrated Campaign.  Also contributing to the increase were targeted expanded consumer reach and new product offerings, such as Estée Lauder’s Advanced Night Repair Eye Supercharged Complex.

 

Partially offsetting the net sales increases were lower net sales in certain Western European markets, primarily reflecting challenging environments in France, Benelux and Germany, as well as lower net sales in the United Kingdom, primarily driven by competitive pressures and adverse macroeconomic conditions. These decreases were approximately $42 million and $93 million, combined, for the three and nine months ended March 31, 2019, respectively.

 

The net sales increases in Europe, the Middle East & Africa included approximately $97 million and $175 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2019, respectively.

 

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Asia/Pacific

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net sales

 

$

966

 

$

773

 

$

2,841

 

$

2,334

 

$ Change from prior-year period

 

193

 

 

 

507

 

 

 

% Change from prior-year period

 

25

%

 

 

22

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

31

%

 

 

26

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Reported net sales in Asia/Pacific increased, reflecting higher net sales in China and Hong Kong, combined, of approximately $164 million and $451 million for the three and nine months ended March 31, 2019, respectively.  In both periods, the higher net sales in China, led by Estée Lauder, La Mer and M·A·C, reflected continued growth from the strong demand for skin care and makeup products that benefitted virtually every channel, particularly online (primarily third-party online platforms), department stores, freestanding stores and specialty-multi.  The net sales growth in Hong Kong in both periods, also led by Estée Lauder, La Mer and M·A·C, reflected a strong retail environment due to increased tourism, particularly from Chinese travelers, targeted expanded consumer reach and the continued success of certain hero franchises.

 

The net sales increases in Asia/Pacific included approximately $43 million and $89 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2019, respectively.

 

We strategically time our new product launches by geographic market, which may account for differences in regional sales growth.

 

GROSS MARGIN

 

Gross margin decreased to 78.1% for the three months ended March 31, 2019 as compared with 79.7% in the prior-year period, and decreased to 77.4% for the nine months ended March 31, 2019 as compared with 79.3% in the prior-year period.

 

 

 

Favorable (Unfavorable) Basis Points

 

 

 

March 31, 2019

 

 

 

Three Months Ended

 

Nine Months Ended

 

Foreign exchange transactions

 

(40

)

(30

)

Mix of business

 

70

 

85

 

Obsolescence charges

 

(65

)

(40

)

Manufacturing costs and other

 

(10

)

(15

)

Adoption of new accounting standards (ASC 606 and hedge accounting)

 

(115

)

(190

)

Total

 

(160

)

(190

)

 

The decrease in gross margin for the three and nine months ended March 31, 2019 primarily reflected the net impact of the adoption of recently issued accounting standards.  For more information see Notes to Consolidated Financial Statements, Note 5 — Derivative Financial Instruments and Note 7 — Revenue Recognition.  The favorable impact from our mix of business primarily reflected favorable changes in the shipments of promotional items, strategic pricing and product category mix, partially offset by the unfavorable impact from new product introductions.

 

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OPERATING EXPENSES

 

Operating expenses as a percentage of net sales decreased to 60.1% for the three months ended March 31, 2019 as compared with 65.0% in the prior-year period, and decreased to 58.8% for the nine months ended March 31, 2019 as compared with 62.2% in the prior-year period.

 

 

 

Favorable (Unfavorable) Basis Points

 

 

 

March 31, 2019

 

 

 

Three Months Ended

 

Nine Months Ended

 

General and administrative expenses

 

(90

)

 

Advertising, merchandising, sampling and product development

 

(70

)

(110

)

Selling

 

190

 

150

 

Adoption of new accounting standard (ASC 606)

 

390

 

260

 

Stock-based compensation

 

 

10

 

Store operating costs

 

10

 

10

 

Foreign exchange transactions

 

(20

)

 

Subtotal

 

410

 

320

 

Charges associated with restructuring and other activities

 

210

 

100

 

Goodwill and other intangible asset impairments

 

(130

)

(80

)

Total

 

490

 

340

 

 

For the three and nine months ended March 31, 2019, the improvements in operating expense margin reflected favorable impacts from the adoption of ASC 606 and selling expenses, primarily in North America due to lower demonstration costs, partially driven by changes in distribution channel mix, as well as efficiencies in our sales operations.  These improvements were offset by increases in advertising and promotional activities primarily due to increased spend to support digital advertising and social media (including costs associated with influencers), locally relevant promotions, new product launches, and targeted expanded consumer reach.  For the three months ended March 31, 2019, the improvements were offset by increases in general and administrative expenses due, in part, to the investment in information systems and enhanced capabilities in select corporate functions to support our strategic initiatives.

 

OPERATING RESULTS

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating income

 

$

674

 

$

498

 

$

2,097

 

$

1,777

 

$ Change from prior-year period

 

176

 

 

 

320

 

 

 

% Change from prior-year period

 

35

%

 

 

18

%

 

 

 

 

 

 

 

 

 

 

 

 

Operating margin

 

18.0

%

14.8

%

18.6

%

17.1

%

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change in operating income from the prior-year period adjusting for the impact of charges associated with restructuring and other activities, goodwill and other intangible asset impairments and changes in fair value of contingent consideration

 

28

%

 

 

16

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

The reported operating margin for the three and nine months ended March 31, 2019 increased from the prior-year periods driven by improvements in net sales, operating expenses as a percentage of net sales and lower charges associated with restructuring and other activities, partially offset by the lower gross margin, as previously noted.  Partially offsetting the increase in operating margin for the three and nine months ended March 31, 2019 was the unfavorable impact of goodwill and other intangible asset impairments.

 

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Charges associated with restructuring and other activities are not allocated to our product categories or geographic regions because they result from activities that are deemed a Company-wide initiative to redesign, resize and reorganize select corporate functions and go-to-market structures.  Accordingly, the following discussions of Operating income by Product Categories and Geographic Regions exclude the impact of charges associated with restructuring and other activities.

 

The adoption of ASC 606, as discussed above, increased operating income for the three and nine months ended March 31, 2019 by $126 million and $41 million, respectively.

 

Product Categories

The change in operating income in each product category for the three and nine months ended March 31, 2019 included the impact of the adoption of ASC 606, which resulted in an increase (reduction) to operating income, as follows:

 

 

 

March 31, 2019

 

(In millions)

 

Three Months Ended

 

Nine Months Ended

 

Skin Care

 

$

68

 

$

10

 

Makeup

 

45

 

23

 

Fragrance

 

13

 

5

 

Hair Care

 

(1

)

 

Other

 

1

 

3

 

Total

 

$

126

 

$

41

 

 

Skin Care

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating income

 

$

593

 

$

441

 

$

1,624

 

$

1,221

 

$ Change from prior-year period

 

152

 

 

 

403

 

 

 

% Change from prior-year period

 

34

%

 

 

33

%

 

 

 

Reported skin care operating income increased in both periods, primarily from Estée Lauder and La Mer, due to higher net sales.  Partially offsetting these increases were higher advertising and promotional activities primarily due to increased spend to support digital advertising and social media (including costs associated with influencers), locally relevant promotions, new product launches and targeted expanded consumer reach.

 

Makeup

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating income

 

$

99

 

$

119

 

$

398

 

$

514

 

$ Change from prior-year period

 

(20

)

 

 

(116

)

 

 

% Change from prior-year period

 

(17

)%

 

 

(23

)%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change in operating income from the prior-year period adjusting for the impact of goodwill and other intangible asset impairments

 

27

%

 

 

(5

)%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

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Reported makeup operating income decreased for the three months ended March 31, 2019, driven by lower results from Smashbox and BECCA, combined, of $83 million.  The lower results from Smashbox reflected the decline in net sales, as well as $52 million of goodwill and other intangible asset impairments.  The decrease in operating income from BECCA was primarily due to higher advertising and promotional activities to support new product launches and higher selling expenses.  Partially offsetting these decreases were higher results from Clinique, M·A·C and Tom Ford, combined, of approximately $39 million.  The higher results from Clinique were driven primarily by lower advertising and promotional activities, which were shifted to support new product launches and other events in the skin care category, and lower selling expenses, primarily in North America, driven by greater selling efficiencies and lower demonstration costs due, in part, to changes in distribution channel mix. The increase in operating income from M·A·C was primarily due to higher net sales, lower advertising and promotional activities and disciplined expense management.  The higher results from Tom Ford were driven primarily by the increase in net sales.

 

Reported makeup operating income decreased for the nine months ended March 31, 2019, driven by lower results from Smashbox and Too Faced, combined, of approximately $164 million. The lower results from Smashbox for the nine months ended March 31, 2019 reflected the decline in net sales, as well as $90 million of goodwill and other intangible asset impairments.  The lower results from Too Faced reflected lower net sales and higher investment spending behind new and existing products, as well as targeted expanded consumer reach. Partially offsetting these decreases were higher results from Estée Lauder primarily due to higher net sales and greater selling efficiencies.

 

Fragrance

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating income

 

$

17

 

$

23

 

$

156

 

$

195

 

$ Change from prior-year period

 

(6

)

 

 

(39

)

 

 

% Change from prior-year period

 

(26

)%

 

 

(20

)%

 

 

 

Reported fragrance operating income decreased for the three months ended March 31, 2019, driven by lower results from certain of our designer fragrances due to lower net sales, partially offset by disciplined expense management and selling efficiencies in North America.

 

Reported fragrance operating income decreased for the nine months ended March 31, 2019, driven by lower results from Jo Malone London and certain of our designer fragrances, combined, of approximately $33 million.  The increase from Jo Malone London net sales was more than offset by higher operating expenses due, in part, to increases in advertising and promotional activities, as well as store operating costs related to targeted expanded consumer reach. The lower results from certain of our designer fragrances reflected lower net sales, partially offset by disciplined expense management and selling efficiencies in North America.

 

Hair Care

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating income

 

$

(2

)

$

13

 

$

27

 

$

45

 

$ Change from prior-year period

 

(15

)

 

 

(18

)

 

 

% Change from prior-year period

 

(100

+)%

 

 

(40

)%

 

 

 

Reported hair care operating income for both periods decreased due to lower results from Bumble and bumble and Aveda.  The lower results from Bumble and bumble reflected lower net sales.  The decreases in operating income from Aveda were primarily due to increases in cost of sales; advertising and promotion expenses due to spending to support the brand’s social media and digital campaign activity, new product launches and digital advertising; and shipping expenses due to the net sales increases in our online channel.

 

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Geographic Regions

The change in operating income in each geographic region for the three and nine months ended March 31, 2019 included the impact of the adoption of ASC 606, which resulted in an increase (reduction) to operating income, as follows:

 

 

 

March 31, 2019

 

(In millions)

 

Three Months Ended

 

Nine Months Ended

 

The Americas

 

$

78

 

$

34

 

Europe, the Middle East & Africa

 

19

 

20

 

Asia/Pacific

 

29

 

(13

)

Total

 

$

126

 

$

41

 

 

The Americas

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating income

 

$

(29

)

$

33

 

$

(57

)

$

231

 

$ Change from prior-year period

 

(62

)

 

 

(288

)

 

 

% Change from prior-year period

 

(100

+)%

 

 

(100

+)%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change in operating income from the prior-year period adjusting for the impact of goodwill and other intangible asset impairments and changes in fair value of contingent consideration

 

(41

)%

 

 

(92

)%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 51 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Reported operating income in The Americas decreased for the three and nine months ended March 31, 2019, primarily due to lower net sales in the region, the goodwill and other intangible asset impairments related to Smashbox and investments in information systems and enhanced capabilities in select corporate functions to support our strategic initiatives. This was partially offset by lower selling expenses due to lower demonstration costs, partially driven by changes in distribution channel mix, as well as efficiencies in our sales operations.

 

Europe, the Middle East & Africa

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating income

 

$

494

 

$

386

 

$

1,580

 

$

1,196

 

$ Change from prior-year period

 

108

 

 

 

384

 

 

 

% Change from prior-year period

 

28

%

 

 

32

%

 

 

 

Reported operating income in Europe, the Middle East & Africa increased for the three and nine months ended March 31, 2019 due to higher results from our travel retail business, reflecting the increase in net sales.  The higher results in both periods were partially offset by lower results in the United Kingdom of approximately $3 million and $30 million, respectively, due to the decrease in net sales.

 

Asia/Pacific

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating income

 

$

244

 

$

179

 

$

691

 

$

557

 

$ Change from prior-year period

 

65

 

 

 

134

 

 

 

% Change from prior-year period

 

36

%

 

 

24

%

 

 

 

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Reported operating income increased in Asia/Pacific, reflecting higher results in China, Hong Kong and Korea, combined, of approximately $50 million and $114 million for the three and nine months ended March 31, 2019, respectively, driven by net sales growth.

 

INTEREST AND INVESTMENT INCOME

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

2019

 

2018

 

Interest expense

 

$

32

 

$

33

 

$

101

 

$

96

 

Interest income and investment income, net

 

$

15

 

$

16

 

$

42

 

$

40

 

 

Interest expense decreased during the three months ended March 31, 2019 due to lower commercial paper borrowings, and increased for the nine months ended March 31, 2019 primarily due to increases in interest rates.

 

Interest income and investment income, net decreased during the three months ended March 31, 2019 primarily due to lower cash and investment balances, as well as lower interest rates, and increased during the nine months ended March 31, 2019, primarily due to higher investment balances and increases in interest rates.

 

OTHER INCOME, NET

 

The Tax Cuts and Jobs Act (the “TCJA”), which was enacted on December 22, 2017, presented us with opportunities to manage cash and investments more efficiently on a global basis.  Accordingly, during the three months ended March 31, 2019, as part of the assessment of those opportunities, we sold our available-for-sale securities, which liquidated our investment in the foreign subsidiary that owned those securities.  As a result, we recorded a realized net gain on the liquidation of our investment in a foreign subsidiary of $71 million, which is reflected in Other income, net.  See Notes to Consolidated Financial Statements, Note 1 — Summary of Significant Accounting Policies — Currency Translation for further information.

 

PROVISION FOR INCOME TAXES

 

The provision for income taxes represents U.S. federal, foreign, state and local income taxes.  The effective rate differs from the federal statutory rate primarily due to the effect of state and local income taxes, the tax impact of share-based compensation, the taxation of foreign income and income tax reserve adjustments, which represent changes in our net liability for unrecognized tax benefits including tax settlements and lapses of the applicable statutes of limitations.  Our effective tax rate will change from quarter to quarter based on recurring and non-recurring factors including the geographical mix of earnings, enacted tax legislation, state and local income taxes, tax reserve adjustments, the tax impact of share-based compensation and the interaction of various global tax strategies.  In addition, changes in judgment from the evaluation of new information resulting in the recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of change.

 

The TCJA includes broad and complex changes to the U.S. tax code that impacted our accounting and reporting for income taxes.  For further discussion related to the TCJA, see Notes to Consolidated Financial Statements, Note 1 — Summary of Significant Accounting Policies — Income Taxes.

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

 

 

2019

 

2018

 

2019

 

2018

 

Effective rate for income taxes

 

23.4

%

22.1

%

22.4

%

46.0

%

Basis-point change from the prior-year period

 

130

 

 

 

(2,360

)

 

 

 

The effective rate for income taxes was 23.4% and 22.1% for the three months ended March 31, 2019 and 2018, respectively. This increase was primarily attributable to the goodwill impairment related to Smashbox, with no associated tax benefit, partially offset by a slightly lower effective tax rate on our foreign operations due to a favorable geographic mix of earnings, partially offset by the impact of GILTI.

 

The effective rate for income taxes was 22.4% and 46.0% for the nine months ended March 31, 2019 and 2018, respectively.  The decrease in the effective tax rate was primarily attributable to the provisional charges related to the TCJA that were recorded in the nine months ended March 31, 2018.  Also contributing to the lower effective tax rate was the impact of the lower U.S. statutory tax rate and a lower effective tax rate on our foreign operations due to a favorable geographic mix of earnings, partially offset by the impact of GILTI and the goodwill impairment related to Smashbox.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NET EARNINGS ATTRIBUTABLE TO THE ESTÉE LAUDER COMPANIES INC.

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions, except per share data)

 

2019

 

2018

 

2019

 

2018

 

As Reported:

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Estée Lauder Companies Inc.

 

$

555

 

$

372

 

$

1,628

 

$

922

 

$ Change from prior-year period

 

183

 

 

 

706

 

 

 

% Change from prior-year period

 

49

%

 

 

77

%

 

 

Diluted net earnings per common share

 

$

1.51

 

$

.99

 

$

4.39

 

$

2.45

 

% Change from prior-year period

 

52

%

 

 

79

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure(1):

 

 

 

 

 

 

 

 

 

% Change in diluted net earnings per common share from the prior-year period adjusting for the impact of charges associated with restructuring and other activities, goodwill and other intangible asset impairments, changes in fair value of contingent consideration, the gain on liquidation of an investment in a foreign subsidiary, net, the Transition Tax, the remeasurement of U.S. net deferred tax assets as of the TCJA enactment date and the establishment of a net deferred tax liability related to foreign withholding taxes on certain foreign earnings resulting from the TCJA

 

33

%

 

 

20

%

 

 

 


(1) See “Reconciliations of Non-GAAP Financial Measures” below for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

RECONCILIATIONS OF NON-GAAP FINANCIAL MEASURES

 

We use certain non-GAAP financial measures, among other financial measures, to evaluate our operating performance, which represent the manner in which we conduct and view our business.  Management believes that excluding certain items that are not comparable from period to period, or do not reflect the Company’s underlying ongoing business, provides transparency for such items and helps investors and others compare and analyze our operating performance from period to period.  In the future, we expect to incur charges or adjustments similar in nature to those presented below; however, the impact to the Company’s results in a given period may be highly variable and difficult to predict.  Our non-GAAP financial measures may not be comparable to similarly titled measures used by, or determined in a manner consistent with, other companies.  While we consider the non-GAAP measures useful in analyzing our results, they are not intended to replace, or act as a substitute for, any presentation included in the consolidated financial statements prepared in conformity with U.S. GAAP.  The following tables present Net sales, Operating income and Diluted net earnings per common share adjusted to exclude the impact of charges associated with restructuring and other activities; goodwill and other intangible asset impairments; the changes in the fair value of contingent consideration; the gain on liquidation of an investment in a foreign subsidiary, net; the Transition Tax; the remeasurement of U.S. net deferred tax assets as of the TCJA enactment date; the establishment of a net deferred tax liability related to foreign withholding taxes on certain foreign earnings resulting from the TCJA; and the effects of foreign currency translation.

 

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The tables provide reconciliations between these non-GAAP financial measures and the most directly comparable U.S. GAAP measures.  Certain information in the prior-year periods has been restated to conform to current period presentation.

 

 

 

Three Months Ended
March 31

 

 

 

%

 

% Change
in Constant

 

($ in millions, except per share data)

 

2019

 

2018

 

Variance

 

Change

 

Currency

 

Net sales, as reported

 

$

3,744

 

$

3,370

 

$

374

 

11

%

15

%

Returns associated with restructuring and other activities

 

2

 

 

2

 

 

 

 

 

Net sales, as adjusted

 

$

3,746

 

$

3,370

 

$

376

 

11

%

15

%

 

 

 

 

 

 

 

 

 

 

 

 

Operating income, as reported

 

$

674

 

$

498

 

$

176

 

35

%

44

%

Charges associated with restructuring and other activities

 

35

 

100

 

(65

)

 

 

 

 

Goodwill and other intangible asset impairments

 

52

 

 

52

 

 

 

 

 

Changes in fair value of contingent consideration

 

(9

)

(9

)

 

 

 

 

 

Operating income, as adjusted

 

$

752

 

$

589

 

$

163

 

28

%

35

%

Diluted net earnings per common share, as reported

 

$

1.51

 

$

.99

 

$

0.52

 

52

%

62

%

Charges associated with restructuring and other activities

 

.07

 

.20

 

(.13

)

 

 

 

 

Gain on liquidation of an investment in a foreign subsidiary, net

 

(.15

)

 

(.15

)

 

 

 

 

Goodwill and other intangible asset impairments

 

.14

 

 

.14

 

 

 

 

 

Changes in fair value of contingent consideration

 

(.02

)

(.02

)

 

 

 

 

 

Transition Tax resulting from the TCJA

 

 

.02

 

(.02

)

 

 

 

 

Remeasurement of U.S. net deferred tax assets as of the TCJA enactment date

 

 

(.02

)

.02

 

 

 

 

 

Diluted net earnings per common share, as adjusted

 

$

1.55

 

$

1.17

 

$

.38

 

33

%

40

%

 

 

 

Nine Months Ended
March 31

 

 

 

%

 

% Change
in Constant

 

($ in millions, except per share data)

 

2019

 

2018

 

Variance

 

Change

 

Currency

 

Net sales, as reported

 

$

11,273

 

$

10,388

 

$

885

 

9

%

11

%

Returns associated with restructuring and other activities

 

2

 

 

2

 

 

 

 

 

Net sales, as adjusted

 

$

11,275

 

$

10,388

 

$

887

 

9

%

11

%

Operating income, as reported

 

$

2,097

 

$

1,777

 

$

320

 

18

%

23

%

Charges associated with restructuring and other activities

 

117

 

207

 

(90

)

 

 

 

 

Goodwill and other intangible asset impairments

 

90

 

 

90

 

 

 

 

 

Changes in fair value of contingent consideration

 

(18

)

(6

)

(12

)

 

 

 

 

Operating income, as adjusted

 

$

2,286

 

$

1,978

 

$

308

 

16

%

20

%

Diluted net earnings per common share, as reported

 

$

4.39

 

$

2.45

 

$

1.94

 

79

%

86

%

Charges associated with restructuring and other activities

 

.26

 

.42

 

(.16

)

 

 

 

 

Gain on liquidation of an investment in a foreign subsidiary, net

 

(.15

)

 

(.15

)

 

 

 

 

Goodwill and other intangible asset impairments

 

.23

 

 

.23

 

 

 

 

 

Changes in fair value of contingent consideration

 

(.04

)

(.01

)

(.03

)

 

 

 

 

Transition Tax resulting from the TCJA

 

(.03

)

.88

 

(.91

)

 

 

 

 

Remeasurement of U.S. net deferred tax assets as of the TCJA enactment date

 

.02

 

.11

 

(.09

)

 

 

 

 

Net deferred tax liability related to foreign withholding taxes on certain foreign earnings resulting from the TCJA

 

.02

 

.05

 

(.03

)

 

 

 

 

Diluted net earnings per common share, as adjusted

 

$

4.70

 

$

3.90

 

$

.80

 

20

%

25

%

 

As diluted net earnings per common share, as adjusted, is used as a measure of the Company’s performance, we consider the impact of current and deferred income taxes when calculating the per-share impact of each of the reconciling items.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

The following tables reconcile the change in net sales by product category and geographic region, as reported, to the change in net sales excluding the effects of foreign currency translation:

 

 

 

As Reported

 

 

 

 

 

 

 

 

 

($ in millions)

 

Three months
ended
March 31,
2019

 

Three months
ended
March 31,
2018

 

Variance

 

Impact of
foreign
currency
translation

 

Variance,
in constant
currency

 

%
Change,
as
reported

 

%
Change,
in
constant
currency

 

By Product Category:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Skin Care

 

$

1,744

 

$

1,447

 

$

297

 

$

63

 

$

360

 

21

%

25

%

Makeup

 

1,461

 

1,388

 

73

 

60

 

133

 

5

 

10

 

Fragrance

 

392

 

382

 

10

 

18

 

28

 

3

 

7

 

Hair Care

 

136

 

139

 

(3

)

4

 

1

 

(2

)

1

 

Other

 

13

 

14

 

(1

)

1

 

 

(7

)

 

 

 

3,746

 

3,370

 

376

 

146

 

522

 

11

%

15

%

Returns associated with restructuring and other activities

 

(2

)

 

(2

)

 

(2

)

 

 

 

 

Total

 

$

3,744

 

$

3,370

 

$

374

 

$

146

 

$

520

 

11

%

15

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Americas

 

$

1,155

 

$

1,181

 

$

(26

)

$

6

 

$

(20

)

(2

)%

(2

)%

Europe, the Middle East & Africa

 

1,625

 

1,416

 

209

 

97

 

306

 

15

 

22

 

Asia/Pacific

 

966

 

773

 

193

 

43

 

236

 

25

 

31

 

 

 

3,746

 

3,370

 

376

 

146

 

522

 

11

%

15

%

Returns associated with restructuring and other activities

 

(2

)

 

(2

)

 

(2

)

 

 

 

 

Total

 

$

3,744

 

$

3,370

 

$

374

 

$

146

 

$

520

 

11

%

15

%

 

 

 

As Reported

 

 

 

 

 

 

 

 

 

($ in millions)

 

Nine months
ended
March 31,
2019

 

Nine months
ended
March 31,
2018

 

Variance

 

Impact of
foreign
currency
translation

 

Variance,
in constant
currency

 

%
Change,
as
reported

 

%
Change,
in
constant
currency

 

By Product Category:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Skin Care

 

$

4,962

 

$

4,216

 

$

746

 

$

117

 

$

863

 

18

%

20

%

Makeup

 

4,427

 

4,275

 

152

 

125

 

277

 

4

 

6

 

Fragrance

 

1,401

 

1,423

 

(22

)

39

 

17

 

(2

)

1

 

Hair Care

 

433

 

419

 

14

 

6

 

20

 

3

 

5

 

Other

 

52

 

55

 

(3

)

1

 

(2

)

(5

)

(4

)

 

 

11,275

 

10,388

 

887

 

288

 

1,175

 

9

%

11

%

Returns associated with restructuring and other activities

 

(2

)

 

(2

)

 

(2

)

 

 

 

 

Total

 

$

11,273

 

$

10,388

 

$

885

 

$

288

 

$

1,173

 

9

%

11

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Americas

 

$

3,609

 

$

3,818

 

$

(209

)

$

24

 

$

(185

)

(5

)%

(5

)%

Europe, the Middle East & Africa

 

4,825

 

4,236

 

589

 

175

 

764

 

14

 

18

 

Asia/Pacific

 

2,841

 

2,334

 

507

 

89

 

596

 

22

 

26

 

 

 

11,275

 

10,388

 

887

 

288

 

1,175

 

9

%

11

%

Returns associated with restructuring and other activities

 

(2

)

 

(2

)

 

(2

)

 

 

 

 

Total

 

$

11,273

 

$

10,388

 

$

885

 

$

288

 

$

1,173

 

9

%

11

%

 

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THE ESTÉE LAUDER COMPANIES INC.

 

The following table reconciles the change in operating income by product category and geographic region, as reported, to the change in operating income excluding the impact of goodwill and other intangible asset impairments and changes in fair value of contingent consideration:

 

 

 

As Reported

 

Add:

 

 

 

 

 

 

 

 

 

($ in millions)

 

Three
months
ended
March 31,
2019

 

Three
months
ended
March 31,
2018

 

Variance

 

Goodwill
and other
intangible
asset
impairments

 

Add:
Changes in
fair value of
contingent
consideration

 

Variance,
as
adjusted

 

%
Change,
as
reported

 

%
Change,
as
adjusted

 

By Product Category:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Skin Care

 

$

593

 

$

441

 

$

152

 

$

 

$

(3

)

$

149

 

34

%

34

%

Makeup

 

99

 

119

 

(20

)

52

 

 

32

 

(17

)

27

 

Fragrance

 

17

 

23

 

(6

)

 

3

 

(3

)

(26

)

(17

)

Hair Care

 

(2

)

13

 

(15

)

 

 

(15

)

(100

+)

(100

+)

Other

 

2

 

2

 

 

 

 

 

 

 

 

 

709

 

598

 

111

 

$

52

 

$

 

$

163

 

19

%

28

%

Charges associated with restructuring and other activities

 

(35

)

(100

)

65

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

674

 

$

498

 

$

176

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Americas

 

$

(29

)

$

33

 

$

(62

)

$

52

 

$

(1

)

$

(11

)

(100

+)%

(41

)%

Europe, the Middle East & Africa

 

494

 

386

 

108

 

 

1

 

109

 

28

 

28

 

Asia/Pacific

 

244

 

179

 

65

 

 

 

65

 

36

 

36

 

 

 

709

 

598

 

111

 

$

52

 

$

 

$

163

 

19

%

28

%

Charges associated with restructuring and other activities

 

(35

)

(100

)

65

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

674

 

$

498

 

$

176

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As Reported

 

Add:

 

 

 

 

 

 

 

 

 

($ in millions)

 

Nine months
ended
March 31,
2019

 

Nine months
ended
March 31,
2018

 

Variance

 

Goodwill
and other
intangible
asset
impairments

 

Add:
Changes in
fair value of
contingent
consideration

 

Variance,
as
adjusted

 

%
Change,
as
reported

 

%
Change,
as
adjusted

 

By Product Category:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Skin Care

 

$

1,624

 

$

1,221

 

$

403

 

$

 

$

(11

)

$

392

 

33

%

32

%

Makeup

 

398

 

514

 

(116

)

90

 

 

(26

)

(23

)

(5

)

Fragrance

 

156

 

195

 

(39

)

 

(1

)

(40

)

(20

)

(21

)

Hair Care

 

27

 

45

 

(18

)

 

 

(18

)

(40

)

(40

)

Other

 

9

 

9

 

 

 

 

 

 

 

 

 

2,214

 

1,984

 

230

 

$

90

 

$

(12

)

$

308

 

12

%

16

%

Charges associated with restructuring and other activities

 

(117

)

(207

)

90

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

2,097

 

$

1,777

 

$

320

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Americas

 

$

(57

)

$

231

 

$

(288

)

$

90

 

$

(9

)

$

(207

)

(100

+)%

(92

)%

Europe, the Middle East & Africa

 

1,580

 

1,196

 

384

 

 

(3

)

381

 

32

 

32

 

Asia/Pacific

 

691

 

557

 

134

 

 

 

134

 

24

 

24

 

 

 

2,214

 

1,984

 

230

 

$

90

 

$

(12

)

$

308

 

12

%

16

%

Charges associated with restructuring and other activities

 

(117

)

(207

)

90

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

2,097

 

$

1,777

 

$

320

 

 

 

 

 

 

 

 

 

 

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

FINANCIAL CONDITION

 

LIQUIDITY AND CAPITAL RESOURCES

 

Overview

Our principal sources of funds historically have been cash flows from operations, borrowings pursuant to our commercial paper program, borrowings from the issuance of long-term debt and committed and uncommitted credit lines provided by banks and other lenders in the United States and abroad.  At March 31, 2019, we had cash and cash equivalents of $2,902 million compared with $2,181 million at June 30, 2018.  Our cash and cash equivalents are maintained at a number of financial institutions.  To mitigate the risk of uninsured balances, we select financial institutions based on their credit ratings and financial strength, and we perform ongoing evaluations of these institutions to limit our concentration risk exposure.

 

Our business is seasonal in nature and, accordingly, our working capital needs vary.  From time to time, we may enter into investing and financing transactions that require additional funding.  To the extent that these needs exceed cash from operations, we could, subject to market conditions, issue commercial paper, issue long-term debt securities or borrow under our revolving credit facilities.

 

Based on past performance and current expectations, we believe that cash on hand, cash generated from operations, available-for-sale securities, available credit lines and access to credit markets will be adequate to support currently planned business operations, information technology enhancements, capital expenditures, acquisitions, dividends, stock repurchases, restructuring initiatives, commitments and other contractual obligations on both a near-term and long-term basis.

 

The TCJA resulted in the Transition Tax on unrepatriated earnings of our foreign subsidiaries and changed the tax law in ways that present opportunities to repatriate cash without additional U.S. federal income tax.  During fiscal 2018, we changed our indefinite reinvestment assertion related to certain foreign earnings and continue to analyze the indefinite reinvestment assertion on our remaining applicable foreign earnings.  Our cash and cash equivalents balance at March 31, 2019 includes cash in offshore jurisdictions associated with our permanent reinvestment strategy.  We do not believe that continuing to reinvest our foreign earnings impairs our ability to meet our domestic debt or working capital obligations.  If these reinvested earnings were repatriated into the United States as dividends, we would be subject to state income taxes and applicable foreign taxes in certain jurisdictions.

 

The effects of inflation have not been significant to our overall operating results in recent years.  Generally, we have been able to introduce new products at higher prices, increase prices and implement other operating efficiencies to sufficiently offset cost increases, which have been moderate.

 

Credit Ratings

Changes in our credit ratings will likely result in changes in our borrowing costs.  Our credit ratings also impact the cost of our revolving credit facility.  Downgrades in our credit ratings may reduce our ability to issue commercial paper and/or long-term debt and would likely increase the relative costs of borrowing.  A credit rating is not a recommendation to buy, sell, or hold securities, is subject to revision or withdrawal at any time by the assigning rating organization, and should be evaluated independently of any other rating.  As of April 24, 2019, our long-term debt is rated A+ with a stable outlook by Standard & Poor’s and A2 with a stable outlook by Moody’s.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

Debt

 

At March 31, 2019, our outstanding borrowings were as follows:

 

(In millions)

 

Long-term
Debt

 

Current
Debt

 

Total Debt

 

4.15% Senior Notes, due March 15, 2047 (“2047 Senior Notes”) (1), (10)

 

$

494

 

$

 

$

494

 

4.375% Senior Notes, due June 15, 2045 (“2045 Senior Notes”) (2), (10)

 

455

 

 

455

 

3.70% Senior Notes, due August 15, 2042 (“2042 Senior Notes”) (3), (10)

 

247

 

 

247

 

6.00% Senior Notes, due May 15, 2037 (“2037 Senior Notes”) (4), (10)

 

294

 

 

294

 

5.75% Senior Notes, due October 15, 2033 (“2033 Senior Notes”) (5)

 

197

 

 

197

 

3.15% Senior Notes, due March 15, 2027 (“2027 Senior Notes”) (6), (10)

 

498

 

 

498

 

2.35% Senior Notes, due August 15, 2022 (“2022 Senior Notes”) (7), (10)

 

248

 

 

248

 

1.70% Senior Notes, due May 10, 2021 (“2021 Senior Notes”) (8), (10)

 

442

 

 

442

 

1.80% Senior Notes, due February 7, 2020 (“2020 Senior Notes”) (9), (10)

 

 

498

 

498

 

Other borrowings

 

8

 

18

 

26

 

 

 

$

2,883

 

$

516

 

$

3,399

 

 


(1)

 

Consists of $500 million principal, net unamortized debt discount of $1 million and debt issuance costs of $5 million.

(2)

 

Consists of $450 million principal, net unamortized debt premium of $10 million and debt issuance costs of $5 million.

(3)

 

Consists of $250 million principal, unamortized debt discount of $1 million and debt issuance costs of $2 million.

(4)

 

Consists of $300 million principal, unamortized debt discount of $3 million and debt issuance costs of $3 million.

(5)

 

Consists of $200 million principal, unamortized debt discount of $2 million and debt issuance costs of $1 million.

(6)

 

Consists of $500 million principal and debt issuance costs of $2 million.

(7)

 

Consists of $250 million principal, a $1 million adjustment to reflect the fair value of interest rate swaps and debt issuance costs of $1 million.

(8)

 

Consists of $450 million principal, a $7 million adjustment to reflect the fair value of interest rate swaps and debt issuance costs of $1 million.

(9)

 

Consists of $500 million principal, a $1 million adjustment to reflect the fair value of interest rate swaps and debt issuance costs of $1 million.

(10)

 

The Senior Notes contain certain customary incurrence—based covenants, including limitations on indebtedness secured by liens.

 

Total debt as a percent of total capitalization (excluding noncontrolling interests) was 43% at March 31, 2019 and June 30, 2018.

 

Cash Flows

 

 

 

Nine Months Ended
March 31

 

(In millions)

 

2019

 

2018

 

Net cash provided by operating activities

 

$

1,756

 

$

1,920

 

Net cash provided by (used for) investing activities

 

$

774

 

$

(144

)

Net cash used for financing activities

 

$

1,814

 

$

822

 

 

The change in net cash flows from operating activities primarily reflected higher international inventory levels to support our forecasted sales activity, an unfavorable change in accounts payable due to the timing and level of payments and an increase in accounts receivable, reflecting the timing of shipments and collections.  These changes were partially offset by higher earnings before taxes.

 

The change in net cash flows from investing activities primarily reflected higher proceeds and lower purchases of investments, primarily due to the liquidation of our foreign subsidiary that owned our available-for-sale securities.

 

The change in net cash flows from financing activities primarily reflected higher treasury stock purchases and dividend payments in the current year, as well as changes in short-term debt reflecting the repayment of remaining commercial paper borrowings.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

Dividends

For a summary of quarterly cash dividends declared per share on our Class A and Class B Common Stock during the nine months ended March 31, 2019, see Notes to Consolidated Financial Statements, Note 12 — Equity.

 

Pension and Post-retirement Plan Funding

There have been no significant changes to our pension and post-retirement funding as discussed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.

 

Commitments, Contractual Obligations and Contingencies

There have been no significant changes to our commitments and contractual obligations as discussed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.  For a discussion of contingencies, see Notes to Consolidated Financial Statements, Note 9 — Contingencies.

 

Derivative Financial Instruments and Hedging Activities

For a discussion of our derivative financial instruments and hedging activities, see Notes to Consolidated Financial Statements, Note 5 — Derivative Financial Instruments.

 

Foreign Exchange Risk Management

For a discussion of foreign exchange risk management, see Notes to Consolidated Financial Statements, Note 5 — Derivative Financial Instruments (Cash Flow Hedges).

 

Credit Risk

For a discussion of credit risk, see Notes to Consolidated Financial Statements, Note 5 — Derivative Financial Instruments (Credit Risk).

 

Market Risk

We address certain financial exposures through a controlled program of market risk management that includes the use of foreign currency forward contracts to reduce the effects of fluctuating foreign currency exchange rates and to mitigate the change in fair value of specific assets and liabilities on the balance sheet.  To perform a sensitivity analysis of our foreign currency forward contracts, we assess the change in fair values from the impact of hypothetical changes in foreign currency exchange rates.  A hypothetical 10% strengthening of the U.S. dollar against the foreign exchange rates for the currencies in our foreign exchange derivatives portfolio would have resulted in a net increase of approximately $47 million in the fair value of our portfolio as of March 31, 2019, but would have resulted in a net decrease of approximately $10 million in the fair value of our portfolio as of June 30, 2018.  This potential change does not consider our underlying foreign currency exposures.

 

In addition, we enter into interest rate derivatives to manage the effects of interest rate movements on our aggregate liability portfolio, including future debt issuances.  Based on a hypothetical 100 basis point increase in interest rates, the estimated fair value of our interest rate derivatives would decrease by approximately $18 million and $24 million as of March 31, 2019 and June 30, 2018, respectively.

 

Our sensitivity analysis represents an estimate of reasonably possible net losses that would be recognized on our portfolio of derivative financial instruments assuming hypothetical movements in future market rates and is not necessarily indicative of actual results, which may or may not occur.  It does not represent the maximum possible loss or any expected loss that may occur, since actual future gains and losses will differ from those estimated, based upon actual fluctuations in market rates, operating exposures, and the timing thereof, and changes in our portfolio of derivative financial instruments during the year.  We believe, however, that any such loss incurred would be offset by the effects of market rate movements on the respective underlying transactions for which the derivative financial instrument was intended.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities, other than operating leases, that would be expected to have a material current or future effect upon our financial condition or results of operations.

 

CRITICAL ACCOUNTING POLICIES

 

As disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018, the discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in conformity with U.S. generally accepted accounting principles.  The preparation of these financial statements requires us to make estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported in those financial statements.  These estimates and assumptions can be subjective and complex, and consequently, actual results could differ from those estimates.  Our most critical accounting policies relate to goodwill, other intangible assets and long-lived assets and income taxes.  Since June 30, 2018, there have been no significant changes to the assumptions and estimates related to our critical accounting policies.

 

RECENTLY ISSUED ACCOUNTING STANDARDS

 

For a discussion regarding the impact of accounting standards that were recently issued but not yet effective, on the Company’s consolidated financial statements, see Notes to Consolidated Financial Statements, Note 1 — Summary of Significant Accounting Policies.

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING INFORMATION

 

We and our representatives from time to time make written or oral forward-looking statements, including in this and other filings with the Securities and Exchange Commission, in our press releases and in our reports to stockholders, which may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements may address our expectations regarding sales, earnings or other future financial performance and liquidity, product introductions, entry into new geographic regions, information technology initiatives, new methods of sale, our long-term strategy, restructuring and other charges and resulting cost savings, and future operations or operating results.  These statements may contain words like “expect,” “will,” “will likely result,” “would,” “believe,” “estimate,” “planned,” “plans,” “intends,” “may,” “should,” “could,” “anticipate,” “estimate,” “project,” “projected,” “forecast,” and “forecasted” or similar expressions.  Although we believe that our expectations are based on reasonable assumptions within the bounds of our knowledge of our business and operations, actual results may differ materially from our expectations.  Factors that could cause actual results to differ from expectations include, without limitation:

 

(1) increased competitive activity from companies in the skin care, makeup, fragrance and hair care businesses;

 

(2) our ability to develop, produce and market new products on which future operating results may depend and to successfully address challenges in our business;

 

(3) consolidations, restructurings, bankruptcies and reorganizations in the retail industry causing a decrease in the number of stores that sell our products, an increase in the ownership concentration within the retail industry, ownership of retailers by our competitors or ownership of competitors by our customers that are retailers and our inability to collect receivables;

 

(4) destocking and tighter working capital management by retailers;

 

(5) the success, or changes in timing or scope, of new product launches and the success, or changes in the timing or the scope, of advertising, sampling and merchandising programs;

 

(6) shifts in the preferences of consumers as to where and how they shop;

 

(7) social, political and economic risks to our foreign or domestic manufacturing, distribution and retail operations, including changes in foreign investment and trade policies and regulations of the host countries and of the United States;

 

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(8) changes in the laws, regulations and policies (including the interpretations and enforcement thereof) that affect, or will affect, our business, including those relating to our products or distribution networks, changes in accounting standards, tax laws and regulations, environmental or climate change laws, regulations or accords, trade rules and customs regulations, and the outcome and expense of legal or regulatory proceedings, and any action we may take as a result;

 

(9) foreign currency fluctuations affecting our results of operations and the value of our foreign assets, the relative prices at which we and our foreign competitors sell products in the same markets and our operating and manufacturing costs outside of the United States;

 

(10) changes in global or local conditions, including those due to the volatility in the global credit and equity markets, natural or man-made disasters, real or perceived epidemics, or energy costs, that could affect consumer purchasing, the willingness or ability of consumers to travel and/or purchase our products while traveling, the financial strength of our customers, suppliers or other contract counterparties, our operations, the cost and availability of capital which we may need for new equipment, facilities or acquisitions, the returns that we are able to generate on our pension assets and the resulting impact on funding obligations, the cost and availability of raw materials and the assumptions underlying our critical accounting estimates;

 

(11) shipment delays, commodity pricing, depletion of inventory and increased production costs resulting from disruptions of operations at any of the facilities that manufacture our products or at our distribution or inventory centers, including disruptions that may be caused by the implementation of information technology initiatives, or by restructurings;

 

(12) real estate rates and availability, which may affect our ability to increase or maintain the number of retail locations at which we sell our products and the costs associated with our other facilities;

 

(13) changes in product mix to products which are less profitable;

 

(14) our ability to acquire, develop or implement new information and distribution technologies and initiatives on a timely basis and within our cost estimates and our ability to maintain continuous operations of such systems and the security of data and other information that may be stored in such systems or other systems or media;

 

(15) our ability to capitalize on opportunities for improved efficiency, such as publicly-announced strategies and restructuring and cost-savings initiatives, and to integrate acquired businesses and realize value therefrom;

 

(16) consequences attributable to local or international conflicts around the world, as well as from any terrorist action, retaliation and the threat of further action or retaliation;

 

(17) the timing and impact of acquisitions, investments and divestitures; and

 

(18) additional factors as described in our filings with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the fiscal year ended June 30, 2018.

 

We assume no responsibility to update forward-looking statements made herein or otherwise.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

The information required by this item is set forth in Item 2 of this Quarterly Report on Form 10-Q under the caption Liquidity and Capital Resources - Market Risk and is incorporated herein by reference.

 

Item 4. Controls and Procedures.

 

Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure.  The Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of March 31, 2019 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date.

 

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the third quarter of fiscal 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

For a discussion of legal proceedings, see Notes to Consolidated Financial Statements, Note 9 — Contingencies.

 

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

 

Share Repurchase Program

 

We are authorized by the Board of Directors to repurchase shares of our Class A Common Stock in the open market or in privately negotiated transactions, depending on market conditions and other factors.  The following table provides information relating to our repurchase of Class A Common Stock during the referenced periods:

 

Period

 

Total Number
of Shares
Purchased
(1)

 

Average Price
Paid Per
Share

 

Total Number of
Shares Purchased
 as Part of Publicly
Announced
Program

 

Maximum
Number of Shares
that May Yet Be
Purchased Under
the Program
(2)

 

January 2019

 

896,918

 

$

127.45

 

867,172

 

40,677,208

 

February 2019

 

281,068

 

155.24

 

281,068

 

40,396,140

 

March 2019

 

388,213

 

158.26

 

387,488

 

40,008,652

 

 

 

1,566,199

 

140.08

 

1,535,728

 

 

 

 


(1)   Includes shares that were repurchased by the Company to satisfy tax withholding obligations upon the payout of certain stock-based compensation arrangements.

(2)   The current repurchase program for up to 80.0 million shares was authorized by the Board of Directors on November 1, 2012 and on October 31, 2018.  Our repurchase program does not have an expiration date.

 

Item 6. Exhibits.

 

Exhibit
Number

 

Description

10.1

 

First Amendment to the April 6, 2011 License Agreement, dated January 22, 2019, by and among Aerin LLC, Aerin Lauder Zinterhofer and Estee Lauder Inc.

10.2

 

Second Amendment to the April 6, 2011 License Agreement, dated February 22, 2019, by and among Aerin LLC, Aerin Lauder Zinterhofer and Estee Lauder Inc.

31.1

 

Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CEO).

31.2

 

Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CFO).

32.1

 

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CEO). (furnished)

32.2

 

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CFO). (furnished)

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

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Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

THE ESTÉE LAUDER COMPANIES INC.

 

 

 

 

 

 

Date: May 1, 2019

By:

/s/TRACEY T. TRAVIS

 

 

Tracey T. Travis

 

 

Executive Vice President and Chief Financial Officer

 

 

(Principal Financial and Accounting Officer)

 

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