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As Of Filer Filing For·On·As Docs:Size Issuer Filing Agent 10/31/19 Estee Lauder Companies Inc 10-Q 9/30/19 88:12M Toppan Merrill/FA |
Document/Exhibit Description Pages Size
1: 10-Q Quarterly Report HTML 1.46M
2: EX-10.1 Material Contract HTML 74K
3: EX-10.2 Material Contract HTML 49K
4: EX-31.1 Certification -- §302 - SOA'02 HTML 32K
5: EX-31.2 Certification -- §302 - SOA'02 HTML 33K
6: EX-32.1 Certification -- §906 - SOA'02 HTML 28K
7: EX-32.2 Certification -- §906 - SOA'02 HTML 28K
30: R1 Document and Entity Information HTML 76K
58: R2 Consolidated Statements of Earnings HTML 93K
85: R3 Consolidated Statements of Comprehensive Income HTML 65K
(Loss)
39: R4 Consolidated Balance Sheets HTML 129K
29: R5 Consolidated Balance Sheets (Parenthetical) HTML 40K
57: R6 Consolidated Statements of Cash Flows HTML 114K
84: R7 Summary of Significant Accounting Policies HTML 107K
41: R8 Goodwill and Other Intangible Assets HTML 160K
26: R9 Leases HTML 98K
78: R10 Charges Associated With Restructuring and Other HTML 175K
Activities
53: R11 Derivative Financial Instruments HTML 246K
25: R12 Fair Value Measurements HTML 152K
36: R13 Revenue Recognition HTML 38K
77: R14 Pension and Post-Retirement Benefit Plans HTML 84K
52: R15 Contingencies HTML 31K
24: R16 Stock Programs HTML 41K
35: R17 Net Earnings Attributable to the Estee Lauder HTML 55K
Companies Inc. Per Common Share
79: R18 Equity HTML 169K
51: R19 Statement of Cash Flows HTML 45K
20: R20 Segment Data and Related Information HTML 94K
49: R21 Summary of Significant Accounting Policies HTML 136K
(Policies)
76: R22 Summary of Significant Accounting Policies HTML 87K
(Tables)
68: R23 Goodwill and Other Intangible Assets (Tables) HTML 164K
19: R24 Leases (Tables) HTML 104K
48: R25 Charges Associated With Restructuring and Other HTML 183K
Activities (Tables)
75: R26 Derivative Financial Instruments (Tables) HTML 239K
67: R27 Fair Value Measurements (Tables) HTML 144K
18: R28 Revenue Recognition (Tables) HTML 35K
50: R29 Pension and Post-Retirement Benefit Plans (Tables) HTML 85K
33: R30 Stock Programs (Tables) HTML 36K
21: R31 Net Earnings Attributable to the Estee Lauder HTML 53K
Companies Inc. Per Common Share (Tables)
54: R32 Equity (Tables) HTML 172K
81: R33 Statement of Cash Flows (Tables) HTML 44K
34: R34 Segment Data and Related Information (Tables) HTML 92K
22: R35 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - HTML 33K
Currency Translation and Transactions (Details)
55: R36 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - HTML 41K
Inventory and Promotional Merchandise (Details)
82: R37 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - HTML 69K
Property, Plant and Equipment (Details)
32: R38 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - HTML 39K
Income Taxes (Details)
23: R39 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Other HTML 44K
Accrued Liabilities (Details)
46: R40 GOODWILL AND OTHER INTANGIBLE ASSETS - Goodwill HTML 64K
(Details)
15: R41 GOODWILL AND OTHER INTANGIBLE ASSETS - Other HTML 66K
Intangible Assets (Details)
62: R42 LEASES - General (Details) HTML 64K
69: R43 LEASES - Total Lease Costs and Other Information HTML 58K
(Details)
47: R44 LEASES - Future Minimum Lease Payments (Details) HTML 62K
16: R45 LEASES - Operating Lease and Finance Lease HTML 40K
Liabilities included in the Consolidated Balance
Sheet (Details)
63: R46 LEASES - Maturities of Contractual Obligations HTML 47K
(Details)
70: R47 LEASES - Not Yet Commenced (Details) HTML 33K
45: R48 CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER HTML 47K
ACTIVITIES - Approved Restructuring Activities by
Major Cost Type (Details)
17: R49 CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER HTML 57K
ACTIVITIES - Cumulative Restructuring Charges by
Major Cost Type (Details)
31: R50 CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER HTML 52K
ACTIVITIES - Accrued Restructuring Charges
(Details)
40: R51 DERIVATIVE FINANCIAL INSTRUMENTS - Derivative HTML 58K
Instruments Included in the Consolidated Balance
Sheets (Details)
86: R52 DERIVATIVE FINANCIAL INSTRUMENTS - Gain (Loss) on HTML 86K
Derivative Financial Instruments (Details)
59: R53 DERIVATIVE FINANCIAL INSTRUMENTS - Cash Flow HTML 65K
Hedges, Fair Value Hedges, Credit Risk (Details)
28: R54 FAIR VALUE MEASUREMENTS - Hierarchy For Financial HTML 51K
Assets and Liabilities Measured at Fair Value on a
Recurring Basis (Details)
38: R55 FAIR VALUE MEASUREMENTS - Estimated Fair Values of HTML 76K
Financial Instruments (Details)
83: R56 Revenue Recognition (Details) HTML 42K
56: R57 Revenue Recognition - Transaction price allocated HTML 32K
to the remaining performance obligations (Details)
27: R58 PENSION AND POST-RETIREMENT BENEFIT PLANS - HTML 56K
Components of Net Periodic Benefit Cost (Details)
42: R59 PENSION AND POST-RETIREMENT BENEFIT PLANS - HTML 44K
Amounts Recognized in the Consolidated Balance
Sheets (Details)
72: R60 Contingencies (Details) HTML 28K
66: R61 STOCK PROGRAMS - Compensation Expense and Stock HTML 44K
Options (Details)
14: R62 STOCK PROGRAMS - Restricted Stock Units (Details) HTML 43K
44: R63 STOCK PROGRAMS - Performance Share Units (Details) HTML 43K
71: R64 NET EARNINGS ATTRIBUTABLE TO THE ESTEE LAUDER HTML 58K
COMPANIES INC. PER COMMON SHARE - Reconciliation
Between Numerator and Denominator of Basic and
Diluted EPS Computations (Details)
65: R65 NET EARNINGS ATTRIBUTABLE TO THE ESTEE LAUDER HTML 33K
COMPANIES INC. PER COMMON SHARE - Antidilutive
Securities Excluded from Computation of Earnings,
Per Share (Details)
13: R66 EQUITY - Equity Roll forward (Details) HTML 73K
43: R67 EQUITY - Class of Stock and Dividend Information HTML 49K
(Details)
73: R68 EQUITY - Changes in Accumulated Other HTML 52K
Comprehensive Income (Loss) (Details)
64: R69 EQUITY - Reclassification Adjustments From HTML 70K
Accumulated Other Comprehensive Income (Loss)
(Details)
61: R70 Statement of Cash Flows (Details) HTML 38K
88: R71 Segment Data and Related Information (Details) HTML 96K
60: XML IDEA XML File -- Filing Summary XML 161K
74: XML XBRL Instance -- el-20190930x10q815441_htm XML 3.54M
37: EXCEL IDEA Workbook of Financial Reports XLSX 91K
9: EX-101.CAL XBRL Calculations -- el-20190930_cal XML 256K
10: EX-101.DEF XBRL Definitions -- el-20190930_def XML 693K
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12: EX-101.PRE XBRL Presentations -- el-20190930_pre XML 1.13M
8: EX-101.SCH XBRL Schema -- el-20190930 XSD 162K
87: JSON XBRL Instance as JSON Data -- MetaLinks 407± 646K
80: ZIP XBRL Zipped Folder -- 0001104659-19-058209-xbrl Zip 304K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM i 10-Q
(Mark One)
| | |
| i ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | |
| For the quarterly period ended i September 30, 2019 | |
| | |
| or | |
| | |
| i ☐ | 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 i 1-14064 | |
The Estée Lauder Companies Inc.
(Exact name of registrant as specified in its charter)
i Delaware | i 11-2408943 |
| |
i 767 Fifth Avenue, i New York, i New
York | i 10153 |
i 212- i 572-4200
(Registrant’s telephone number, including area code)
Not Applicable
(Former name or former address, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Class A Common Stock, $.01 par value | EL | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. i Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). i Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
i Large accelerated filer ⌧ | Accelerated filer ◻ |
Non-accelerated filer ◻ | Smaller reporting company i ☐ |
| Emerging growth company i ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i ☐ No ⌧
At October 24, 2019, i 222,550,639 shares of the registrant’s Class A Common Stock, $.01 par value, and i 137,262,914 shares of the registrant’s Class B Common Stock, $.01 par value, were outstanding.
THE ESTÉE LAUDER COMPANIES INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
THE ESTÉE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
| | | | | | | |
| | Three Months Ended | | ||||
| | September 30 | | ||||
(In millions, except per share data) |
| 2019 |
| 2018 |
| ||
| | | | | | | |
Net sales | | $ | i 3,895 |
| $ | i 3,524 | |
Cost of sales | |
| i 908 | |
| i 823 | |
| | | | | | | |
Gross profit | |
| i 2,987 | |
| i 2,701 | |
| | | | | | | |
Operating expenses | | | | | | | |
Selling, general and administrative | |
| i 2,185 | |
| i 2,008 | |
Restructuring and other charges | | | i 23 | | | i 41 | |
Total operating expenses | | | i 2,208 | | | i 2,049 | |
| | | | | | | |
Operating income | |
| i 779 | |
| i 652 | |
| | | | | | | |
Interest expense | |
| i 32 | |
| i 34 | |
Interest income and investment income, net | | | i 14 | | | i 15 | |
Other components of net periodic benefit cost | | | i 1 | | | — | |
Earnings before income taxes | |
| i 760 | |
| i 633 | |
| | | | | | | |
Provision for income taxes | |
| i 162 | |
| i 131 | |
Net earnings | |
| i 598 | |
| i 502 | |
| | | | | | | |
Net earnings attributable to noncontrolling interests | |
| ( i 3) | |
| ( i 2) | |
Net earnings attributable to The Estée Lauder Companies Inc. | | $ | i 595 |
| $ | i 500 | |
| | | | | | | |
Net earnings attributable to The Estée Lauder Companies Inc. per common share | | | | | | | |
Basic | | $ | i 1.65 |
| $ | i 1.36 | |
Diluted | | $ | i 1.61 | | $ | i 1.34 | |
| | | | | | | |
Weighted-average common shares outstanding | | | | | | | |
Basic | |
| i 361.4 | |
| i 366.8 | |
Diluted | |
| i 368.6 | |
| i 374.4 | |
See notes to consolidated financial statements.
2
THE ESTÉE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
(In millions) |
| 2019 |
| 2018 | ||
| | | | | | |
Net earnings |
| $ | i 598 |
| $ | i 502 |
| | | | | | |
Other comprehensive income (loss): | | | | | | |
Net unrealized investment gain | |
| — | |
| i 2 |
Net cash flow hedge loss | |
| ( i 2) | |
| — |
Amounts included in net periodic benefit cost | |
| i 5 | |
| i 3 |
Translation adjustments | |
| ( i 70) | |
| i 23 |
Benefit (provision) for deferred income taxes on components of other comprehensive income | |
| i 3 | |
| ( i 3) |
Total other comprehensive income (loss) | |
| ( i 64) | |
| i 25 |
Comprehensive income | |
| i 534 | |
| i 527 |
| | | | | | |
Comprehensive income attributable to noncontrolling interests: | | | | | | |
Net earnings | |
| ( i 3) | | | ( i 2) |
Comprehensive income attributable to The Estée Lauder Companies Inc. |
| $ | i 531 |
| $ | i 525 |
See notes to consolidated financial statements.
3
THE ESTÉE LAUDER COMPANIES INC.
CONSOLIDATED BALANCE SHEETS
| | | | | | | |
| | September 30 | | June 30 | | ||
(In millions, except share data) |
| 2019 |
| 2019 |
| ||
| | (Unaudited) | | | | | |
ASSETS | | | | | | | |
Current assets | | | | | | | |
Cash and cash equivalents |
| $ | i 2,259 |
| $ | i 2,987 | |
Accounts receivable, net | |
| i 2,294 | |
| i 1,831 | |
Inventory and promotional merchandise | |
| i 2,055 | |
| i 2,006 | |
Prepaid expenses and other current assets | |
| i 414 | |
| i 388 | |
Total current assets | |
| i 7,022 | |
| i 7,212 | |
| | | | | | | |
Property, plant and equipment, net | |
| i 2,018 | |
| i 2,068 | |
| | | | | | | |
Other assets | | | | | | | |
Operating lease right-of-use assets | | | i 2,516 | | | — | |
Goodwill | |
| i 1,868 | |
| i 1,868 | |
Other intangible assets, net | |
| i 1,191 | |
| i 1,203 | |
Other assets | |
| i 816 | |
| i 805 | |
Total other assets | |
| i 6,391 | |
| i 3,876 | |
Total assets |
| $ | i 15,431 |
| $ | i 13,156 | |
| | | | | | | |
LIABILITIES AND EQUITY | | | | | | | |
Current liabilities | | | | | | | |
Current debt |
| $ | i 520 |
| $ | i 516 | |
Accounts payable | |
| i 1,071 | |
| i 1,490 | |
Operating lease liabilities | | | i 346 | | | — | |
Other accrued liabilities | |
| i 2,653 | |
| i 2,599 | |
Total current liabilities | |
| i 4,590 | |
| i 4,605 | |
| | | | | | | |
Noncurrent liabilities | | | | | | | |
Long-term debt | |
| i 2,895 | |
| i 2,896 | |
Long-term operating lease liabilities | | | i 2,335 | | | — | |
Other noncurrent liabilities | |
| i 1,053 | |
| i 1,244 | |
Total noncurrent liabilities | |
| i 6,283 | |
| i 4,140 | |
| | | | | | | |
Contingencies | | | | | | | |
| | | | | | | |
Equity | | | | | | | |
Common stock, $ i i .01 / par value; Class A shares authorized: i i 1,300,000,000 / at September 30, 2019 and June 30, 2019; shares issued: i 447,163,948 at September 30, 2019 and i 443,685,124 at June 30, 2019; Class B shares authorized: i i 304,000,000 / at September 30, 2019 and June 30, 2019; shares issued and outstanding: i 137,262,914 at September 30, 2019 and i 139,537,814 at June 30, 2019 | |
| i 6 | |
| i 6 | |
Paid-in capital | |
| i 4,514 | |
| i 4,403 | |
Retained earnings | |
| i 10,393 | |
| i 9,984 | |
Accumulated other comprehensive loss | |
| ( i 627) | |
| ( i 563) | |
| |
| i 14,286 | |
| i 13,830 | |
Less: Treasury stock, at cost; i 223,724,519 Class A shares at September 30, 2019 and i 222,120,630 Class A shares at June 30, 2019 | |
| ( i 9,756) | |
| ( i 9,444) | |
Total stockholders’ equity – The Estée Lauder Companies Inc. | |
| i 4,530 | |
| i 4,386 | |
Noncontrolling interests | |
| i 28 | |
| i 25 | |
Total equity | |
| i 4,558 | |
| i 4,411 | |
Total liabilities and equity |
| $ | i 15,431 |
| $ | i 13,156 | |
See notes to consolidated financial statements.
4
THE ESTÉE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| | | | | | | |
| | Three Months Ended | | ||||
| | September 30 | | ||||
(In millions) |
| 2019 |
| 2018 |
| ||
| | | | ||||
Cash flows from operating activities | | | | | | | |
Net earnings |
| $ | i 598 |
| $ | i 502 | |
Adjustments to reconcile net earnings to net cash flows from operating activities: | | | | | | | |
Depreciation and amortization | |
| i 143 | |
| i 132 | |
Deferred income taxes | |
| i 11 | |
| ( i 9) | |
Non-cash stock-based compensation | |
| i 56 | |
| i 58 | |
Net loss on disposal of property, plant and equipment | |
| i 2 | |
| i 3 | |
Pension and post-retirement benefit expense | |
| i 21 | |
| i 18 | |
Pension and post-retirement benefit contributions | |
| ( i 9) | |
| ( i 6) | |
Changes in fair value of contingent consideration | | | — | | | ( i 11) | |
Other non-cash items | | | ( i 2) | | | ( i 4) | |
Changes in operating assets and liabilities: | | | | | | | |
Increase in accounts receivable, net | |
| ( i 487) | |
| ( i 546) | |
Increase in inventory and promotional merchandise | |
| ( i 83) | |
| ( i 36) | |
Increase in other assets, net | |
| ( i 48) | |
| ( i 18) | |
Decrease in accounts payable | | | ( i 400) | | | ( i 262) | |
Increase in other accrued and noncurrent liabilities | |
| i 31 | |
| i 60 | |
Decrease in operating lease assets and liabilities, net | |
| ( i 3) | |
| — | |
Net cash flows used for operating activities | |
| ( i 170) | |
| ( i 119) | |
| | | | | | | |
Cash flows from investing activities | | | | | | | |
Capital expenditures | |
| ( i 125) | |
| ( i 128) | |
Proceeds from the disposition of investments | | | — | | | i 173 | |
Purchases of investments | | | ( i 5) | | | ( i 14) | |
Settlement of net investment hedges, net | | | i 2 | | | — | |
Net cash flows provided by (used for) investing activities | |
| ( i 128) | |
| i 31 | |
| | | | | | | |
Cash flows from financing activities | | | | | | | |
Proceeds (repayments) of current debt, net | |
| i 5 | |
| ( i 3) | |
Repayments and redemptions of long-term debt | |
| ( i 5) | |
| — | |
Net proceeds from stock-based compensation transactions | |
| i 55 | |
| i 33 | |
Payments to acquire treasury stock | |
| ( i 313) | |
| ( i 530) | |
Dividends paid to stockholders | |
| ( i 156) | |
| ( i 141) | |
Payments to noncontrolling interest holders for dividends | | | ( i 2) | | | ( i 1) | |
Net cash flows used for financing activities | |
| ( i 416) | |
| ( i 642) | |
| | | | | | | |
Effect of exchange rate changes on Cash and cash equivalents | |
| ( i 14) | |
| ( i 8) | |
Net decrease in Cash and cash equivalents | |
| ( i 728) | |
| ( i 738) | |
Cash and cash equivalents at beginning of period | |
| i 2,987 | |
| i 2,181 | |
Cash and cash equivalents at end of period |
| $ | i 2,259 |
| $ | i 1,443 | |
See notes to consolidated financial statements.
5
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
iBasis of Presentation
The accompanying consolidated financial statements include the accounts of The Estée Lauder Companies Inc. and its subsidiaries (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated.
The unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments of a normal recurring nature considered necessary for a fair presentation have been included. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
Certain amounts in the consolidated financial statements of prior years have been reclassified to conform to current year presentation.
iManagement Estimates
The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses reported in those financial statements. Descriptions of the Company’s significant accounting policies are discussed in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019. Management evaluates the related estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, and makes adjustments when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from those estimates and assumptions. Significant changes, if any, in those estimates and assumptions resulting from continuing changes in the economic environment will be reflected in the consolidated financial statements in future periods.
iCurrency 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 $( i 72) million and $ i 21 million, net of tax, during the three months ended September 30, 2019 and 2018, respectively. For the Company’s subsidiaries operating in highly inflationary economies, the U.S. dollar is the functional currency. Remeasurement adjustments in financial statements in a highly inflationary economy and other transactional gains and losses are reflected in earnings. These subsidiaries are not material to the Company’s consolidated financial statements or liquidity.
The Company enters into foreign currency forward contracts and may enter into option contracts to hedge foreign currency transactions for periods consistent with its identified exposures. During the first quarter of fiscal 2020, the Company entered into foreign currency forward contracts to hedge a portion of its net investment in certain foreign operations, which are designated as net investment hedges. See Note 5 - Derivative Financial Instruments for further discussion. The Company categorizes these instruments as entered into for purposes other than trading.
The accompanying consolidated statements of earnings include net exchange losses on foreign currency transactions of $ i 3 million and $ i 14 million during the three months ended September 30, 2019 and 2018, respectively.
/ iConcentration of Credit Risk
The Company is a worldwide manufacturer, marketer and distributor of skin care, makeup, fragrance and hair care products. The Company’s sales subject to credit risk are made primarily to department stores, perfumeries, specialty multi-brand retailers and retailers in its travel retail business. The Company grants credit to qualified customers and does not believe it is exposed significantly to any undue concentration of credit risk.
/6
Inventory and Promotional Merchandise
Inventory and promotional merchandise consists of:
i
| | | | | | | |
| | September 30 | | June 30 | | ||
(In millions) |
| 2019 |
| 2019 |
| ||
Raw materials |
| $ | i 510 |
| $ | i 541 | |
Work in process | |
| i 234 | |
| i 268 | |
Finished goods | |
| i 1,075 | |
| i 981 | |
Promotional merchandise | |
| i 236 | |
| i 216 | |
|
| $ | i 2,055 |
| $ | i 2,006 | |
/ iProperty, Plant and Equipment
i
| | | | | | | |
| | September 30 | | June 30 | | ||
(In millions) |
| 2019 |
| 2019 |
| ||
Assets (Useful Life) | | | | | | | |
Land |
| $ | i 29 |
| $ | i 29 | |
Buildings and improvements ( i 10 to i 40 years) | |
| i 341 | |
| i 337 | |
Machinery and equipment ( i 3 to i 10 years) | |
| i 815 | |
| i 811 | |
Computer hardware and software ( i 4 to i 10 years) | |
| i 1,265 | |
| i 1,264 | |
Furniture and fixtures ( i 5 to i 10 years) | |
| i 115 | |
| i 116 | |
Leasehold improvements | |
| i 2,279 | |
| i 2,274 | |
| |
| i 4,844 | |
| i 4,831 | |
Less accumulated depreciation and amortization | |
| ( i 2,826) | |
| ( i 2,763) | |
|
| $ | i 2,018 |
| $ | i 2,068 | |
/The cost of assets related to projects in progress of $ i 469 million and $ i 474 million as of September 30, 2019 and June 30, 2019, respectively, is included in their respective asset categories above. Depreciation and amortization of property, plant and equipment was $ i 125 million and $ i 116 million during the three months ended September 30, 2019 and 2018, respectively. Depreciation and amortization related to the Company’s manufacturing process is included in Cost of sales, and all other depreciation and amortization is included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings.
/
iIncome Taxes
The effective rate for income taxes was i 21.3% and i 20.7% for the three months ended September 30, 2019 and 2018, respectively. The increase in the effective tax rate of 60 basis points was primarily attributable to a higher effective tax rate on the Company’s foreign operations partially offset by a higher benefit related to share-based compensation awards.
As of September 30, 2019 and June 30, 2019, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $ i 65 million and $ i 67 million, respectively. The total amount of unrecognized tax benefits at September 30, 2019 that, if recognized, would affect the effective tax rate was $ i 49 million. The total gross interest and penalties accrued related to unrecognized tax benefits during the three months ended September 30, 2019 in the accompanying consolidated statement of earnings was $ i 1 million. The total gross accrued interest and penalties in each of the accompanying consolidated balance sheets at September 30, 2019 and June 30, 2019 was $ i i 12 / million. On the basis of the information available as of September 30, 2019, the Company does not expect any significant changes to the total amount of unrecognized tax benefits within the next twelve months.
/
7
Other Accrued Liabilities
Other accrued liabilities consist of the following:
i
| | | | | | | |
| | September 30 | | June 30 | | ||
(In millions) |
| 2019 |
| 2019 |
| ||
Advertising, merchandising and sampling |
| $ | i 429 |
| $ | i 352 | |
Employee compensation | |
| i 381 | |
| i 574 | |
Payroll and other taxes | |
| i 263 | |
| i 221 | |
Deferred revenue | | | i 345 | | | i 314 | |
Other | |
| i 1,235 | |
| i 1,138 | |
|
| $ | i 2,653 |
| $ | i 2,599 | |
/ iRecently Adopted Accounting Standards
Leases (Accounting Standards Codification ("ASC") Topic 842 - Leases ("ASC 842"))
In February 2016, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance that requires lessees to account for most leases on their balance sheets with the liability being equal to the present value of the lease payments. The right-of-use asset is based on the lease liability adjusted for certain costs such as initial direct costs, prepaid lease payments and lease incentives received. Lease expense is recognized similar to previous accounting guidance with operating leases resulting in a straight-line expense, and finance leases resulting in a front-loaded expense similar to the previous accounting for capital leases.
In July 2018, the FASB amended this guidance to clarify certain narrow aspects of the new lease accounting standard that may have been incorrectly or inconsistently applied, and did not add new guidance. Also, in July 2018, the FASB issued authoritative guidance that allows companies to elect to adopt the new standard using a modified retrospective transition approach with a cumulative-effect adjustment to retained earnings in the period of adoption. Companies that elect the new adoption method were not required to restate the prior comparative periods in the financial statements.
Effective for the Company – Fiscal 2020 first quarter. An entity is permitted to apply the foregoing guidance using either of the modified retrospective transition approaches described in the standard, with certain practical expedients.
Impact on consolidated financial statements - On July 1, 2019, the Company adopted ASC 842, see Note 3 - Leases for further discussion.
Recently Issued Accounting Standards
Measurement of Credit Losses on Financial Instruments (ASC Topic 326 - Financial Instruments - Credit Losses)
In June 2016, the FASB issued authoritative guidance that requires companies to utilize an impairment model for most financial assets measured at amortized cost and certain other financial instruments, which include trade and other receivables, loans and held-to-maturity debt securities, to record an allowance for credit risk based on expected losses rather than incurred losses. In addition, this guidance changes the recognition method for credit losses on available-for-sale debt securities, which can occur as a result of market and credit risk, and requires additional disclosures. In general, modified retrospective adoption will be required for all outstanding instruments that fall under this guidance.
Effective for the Company - Fiscal 2021 first quarter.
Impact on consolidated financial statements – The Company is currently evaluating the impact of applying this guidance on its financial instruments, such as accounts receivable. While the Company’s evaluation is ongoing, the adoption of this standard is not expected to have a material impact on its consolidated financial statements.
8
Goodwill and Other – Internal-Use Software (ASU 2018-15 - Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract)
In August 2018, the FASB issued authoritative guidance that permits companies to capitalize the costs incurred for setting up business systems that operate on cloud technology. The new guidance aligns the requirement for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance does not affect the accounting for the service element of a hosting arrangement that is a service contract. Capitalized costs associated with a hosting arrangement that is a service contract must be amortized over the term of the hosting arrangement to the same line item in the income statement as the expense for fees for the hosting arrangement.
Effective for the Company – Fiscal 2021 first quarter, with early adoption permitted in any interim period. This guidance can be adopted either:
| ● | retrospectively; or |
| ● | prospectively to all implementation costs incurred after the date of adoption. |
Impact on consolidated financial statements – The Company is currently evaluating the impact of applying this guidance to its business systems that operate on cloud technology. While the Company’s evaluation is ongoing, the adoption of this standard is not expected to have a material impact on its consolidated financial statements.
No other recently issued accounting pronouncements are expected to have a material impact on the Company’s consolidated financial statements.
iNOTE 2 – GOODWILL AND OTHER INTANGIBLE ASSETS
The following table presents goodwill by product category and the related change in the carrying amount:
i
| | | | | | | | | | | | | | | | |
(In millions) |
| Skin Care |
| Makeup |
| Fragrance |
| Hair Care |
| Total |
| |||||
Balance as of June 30, 2019 | | | | | | | | | | | | | | | | |
Goodwill |
| $ | i 185 |
| $ | i 1,199 |
| $ | i 254 |
| $ | i 390 |
| $ | i 2,028 | |
Accumulated impairments | |
| ( i 36) | |
| ( i 68) | |
| ( i 22) | |
| ( i 34) | |
| ( i 160) | |
| |
| i 149 | |
| i 1,131 | |
| i 232 | |
| i 356 | |
| i 1,868 | |
| | | | | | | | | | | | | | | | |
Goodwill acquired during the period | |
| — | | | i 3 | | | — | | | — | | | i 3 | |
Translation adjustments, goodwill | | | ( i 1) | | | — | | | ( i 3) | | | — | | | ( i 4) | |
Translation adjustments, accumulated impairments | |
| i 1 | | | — | | | — | | | — | | | i 1 | |
| |
| — | | | i 3 | | | ( i 3) | | | — | | | — | |
| | | | | | | | | | | | | | | | |
Balance as of September 30, 2019 | | | | | | | | | | | | | | | | |
Goodwill | |
| i 184 | | | i 1,202 | | | i 251 | | | i 390 | | | i 2,027 | |
Accumulated impairments | |
| ( i 35) | | | ( i 68) | | | ( i 22) | | | ( i 34) | | | ( i 159) | |
|
| $ | i 149 |
| $ | i 1,134 |
| $ | i 229 |
| $ | i 356 |
| $ | i 1,868 | |
Other intangible assets consist of the following:
i
| | | | | | | | | | | | | | | | | | | |
| | | | ||||||||||||||||
| | Gross | | | | | Total Net | | Gross | | | | | Total Net | | ||||
| | Carrying | | Accumulated | | Book | | Carrying | | Accumulated | | Book | | ||||||
(In millions) |
| Value |
| Amortization |
| Value |
| Value |
| Amortization |
| Value |
| ||||||
Amortizable intangible assets: | | | | | | | | | | | | | | | | | | | |
Customer lists and other |
| $ | i 682 |
| $ | i 378 |
| $ | i 304 |
| $ | i 684 |
| $ | i 369 |
| $ | i 315 | |
License agreements | |
| i 43 | |
| i 43 | |
| — | |
| i 43 | |
| i 43 | |
| — | |
|
| $ | i 725 |
| $ | i 421 | |
| i 304 |
| $ | i 727 |
| $ | i 412 | |
| i 315 | |
Non-amortizable intangible assets: | | | | | | | | | | | | | | | | | | | |
Trademarks | | | | | | | |
| i 887 | | | | | | | |
| i 888 | |
Total intangible assets | | | | | | |
| $ | i 1,191 | | | | | | |
| $ | i 1,203 | |
/9
The aggregate amortization expense related to amortizable intangible assets was $ i 11 million and $ i 13 million for the three months ended September 30, 2019 and 2018, respectively. The estimated aggregate amortization expense for the remainder of fiscal 2020 and for each of the next four fiscal years is as follows:
i
| | | | | | | | | | | | | | | | |
| | Fiscal | | |||||||||||||
(In millions) |
| 2020 |
| 2021 |
| 2022 |
| 2023 |
| 2024 |
| |||||
Estimated aggregate amortization expense |
| $ | i 33 |
| $ | i 43 |
| $ | i 42 |
| $ | i 42 |
| $ | i 40 | |
iNOTE 3 - LEASES
During the first quarter of fiscal 2020, the Company adopted ASC 842 using the modified retrospective transition approach permitted under the new standard for leases that existed at July 1, 2019 and, accordingly, the prior comparative periods were not restated. Under this method, the Company was required to assess the remaining future payments of existing leases as of July 1, 2019. Additionally, as of the date of adoption, the Company elected the package of practical expedients that did not require the Company to assess whether expired or existing contracts contain leases as defined in ASC 842, did not require reassessment of the lease classification (i.e. operating lease vs. finance lease) for expired or existing leases, and did not require a change to the accounting for previously capitalized initial direct costs.
The adoption of this standard impacted the Company's consolidated balance sheet due to the recognition of right-of-use ("ROU") assets and associated lease liabilities related to operating leases as compared to the previous accounting. The accounting for finance leases under ASC 842 is consistent with the prior accounting for capital leases. The impact of the adoption of this standard on the Company's consolidated statement of earnings and consolidated statement of cash flows was not material.
Per the guidance of ASC 842, a contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset. The Company recognizes a lease liability and a related ROU asset at the commencement date for leases on its consolidated balance sheet, excluding short-term leases as noted below. The lease liability is equal to the present value of unpaid lease payments over the remaining lease term. The Company's lease term at the commencement date may reflect options to extend or terminate the lease when it is reasonably certain that such options will be exercised. To determine the present value of the lease liability, the Company uses an incremental borrowing rate, which is defined as the rate of interest that the Company would have to pay to borrow (on a collateralized basis over a similar term) an amount equal to the lease payments in similar economic environments. The ROU asset is based on the corresponding lease liability adjusted for certain costs such as initial direct costs, prepaid lease payments and lease incentives received. Both operating and finance lease ROU assets are reviewed for impairment, consistent with other long-lived assets, whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. After an ROU asset is impaired, any remaining balance of the ROU asset is amortized on a straight-line basis over the shorter of the remaining lease term or the estimated useful life.
After the lease commencement date, the Company evaluates lease modifications, if any, that could result in a change in the accounting for leases. For a lease modification, an evaluation is performed to determine if it should be treated as either a separate lease or a change in the accounting of an existing lease. In addition, significant changes in events or circumstances within the Company's control are assessed to determine whether a change in the accounting for leases is required.
Certain of the Company's leases provide for variable lease payments for the right to use an underlying asset that vary due to changes in facts and circumstances occurring after the commencement date, other than the passage of time. Variable lease payments that are dependent on an index or rate (e.g., Consumer Price Index) are included in the initial measurement of the lease liability, the initial measurement of the ROU asset, and the lease classification test based on the index or rate as of the commencement date. Any changes from the commencement date estimation of the index- and rate-based variable payments are expensed as incurred in the period of the change. Variable lease payments that are not known at the commencement date and are determinable based on the performance or use of the underlying asset, are not included in the initial measurement of the lease liability or the ROU asset, but instead are expensed as incurred. The Company's variable lease payments primarily include rents based on a percentage of sales in excess of stipulated levels, common area maintenance based on the percentage of the total square footage leased by the Company, as well as costs relating to embedded leases, such as third-party manufacturing agreements.
10
Upon the adoption of ASC 842, the Company made the following accounting policy elections:
| ● | Certain of the Company’s contracts contain lease components as well as non-lease components, such as an agreement to purchase services. Unless an accounting policy is elected to the contrary, the contract consideration must be allocated to the separate lease and non-lease components in accordance with ASC 842. For purposes of allocating contract consideration, the Company elected not to separate the lease components from non-lease components for all asset classes. This was applied to all existing leases as of July 1, 2019 and will be applied to new leases on an on-going basis. |
| ● | The Company elected not to apply the measurement and recognition requirements of ASC 842 to short-term leases (i.e. leases with a term of 12 months or less). Accordingly, short-term leases will not be recorded as ROU assets or lease liabilities on the Company’s consolidated balance sheets, and the related lease payments will be recognized in net earnings on a straight-line basis over the lease term. |
| ● | For certain leases relating to automobiles, information technology equipment and office equipment, the Company elected to apply the guidance of ASC 842 utilizing a portfolio approach. Under this approach, the Company combined and accounted for leases (as a portfolio) with similar characteristics (e.g., lease term, discount rates, etc.) as a single lease, provided its application is not materially different when compared to the application at the individual lease level. |
As a result of the adoption of ASC 842, the Company recorded a cumulative adjustment of $ i 29 million, net of tax, as a reduction to its fiscal 2020 opening balance of retained earnings, primarily to reflect the fair value of operating lease ROU assets that were impaired at, or prior to, the adoption date. In addition, the Company recognized operating lease ROU assets and liabilities of $ i 2,598 million and $ i 2,764 million, respectively, as of July 1, 2019. Finance lease ROU assets and liabilities are not material.
The Company has operating and finance leases primarily for real estate properties, including corporate offices, facilities to support the Company's manufacturing, assembly, research and development and distribution operations and retail stores, as well as information technology equipment, automobiles and office equipment, with remaining terms of approximately i 1 year to i 50 years. Some of the Company's lease contracts include options to extend the leases for up to i 30 years, while others include options to terminate the leases within i 34 years.
A summary of total lease costs and other information for the period relating to the Company's finance and operating leases is as follows:
i
| | | | |
|
| Three Months Ended |
| |
(In millions) | |
| ||
Total lease cost |
| |
| |
Finance lease cost: | | | | |
Amortization of right-of-use assets | | $ | i 3 | |
Interest on lease liabilities | |
| — | |
Operating lease cost | |
| i 118 | |
Short-term lease cost | |
| i 6 | |
Variable lease cost | |
| i 43 | |
Total | | $ | i 170 | |
Other information | |
|
| |
Cash paid for amounts included in the measurement of lease liabilities | |
| | |
Operating cash flows from operating leases | | $ | i 123 | |
Financing cash flows from finance leases | | $ | i 5 | |
Right-of-use assets obtained in exchange for new operating lease liabilities | | $ | i 48 | |
Weighted-average remaining lease term – finance leases | |
| i 6 | years |
Weighted-average remaining lease term – operating leases | |
| i 11 | years |
Weighted-average discount rate – finance leases | |
| i 2.7 | % |
Weighted-average discount rate – operating leases | |
| i 2.5 | % |
11
The total future minimum lease payments, over the remaining lease term, relating to the Company’s operating and finance leases for the remainder of fiscal 2020 and for each of the next four fiscal years and thereafter is as follows:
i i
| | | | | | |
(In millions) |
| Operating Leases |
| Finance Leases | ||
Remainder of fiscal 2020 | | $ | i 285 | | $ | i 9 |
Fiscal 2021 | |
| i 373 | |
| i 8 |
Fiscal 2022 | |
| i 331 | |
| i 3 |
Fiscal 2023 | |
| i 301 | |
| i 1 |
Fiscal 2024 | |
| i 286 | |
| — |
Thereafter | |
| i 1,542 | |
| — |
Total future minimum lease payments | |
| i 3,118 | |
| i 21 |
Less imputed interest | |
| ( i 437) | |
| ( i 1) |
Total | | $ | i 2,681 | | $ | i 20 |
Operating lease and finance lease liabilities included in the consolidated balance sheet are as follows:
i
| | | | | | |
| | |||||
(In millions) |
| Operating Leases |
| Finance Leases | ||
Total current liabilities | | $ | i 346 | | $ | i 11 |
Total noncurrent liabilities | |
| i 2,335 | |
| i 9 |
Total | | $ | i 2,681 | | $ | i 20 |
The ROU assets and lease liabilities related to finance leases are included in Other assets and in Current debt and Long-term debt, respectively, in the accompanying consolidated balance sheet as of September 30, 2019.
The following table summarizes scheduled maturities of the Company’s contractual obligations relating to operating leases for which cash flows are fixed and determinable as of June 30, 2019:
i
| | | |
(In millions) |
| Payments Due in Fiscal Year(1) | |
Fiscal 2020 | | $ | i 421 |
Fiscal 2021 | |
| i 383 |
Fiscal 2022 | |
| i 348 |
Fiscal 2023 | |
| i 316 |
Fiscal 2024 | |
| i 289 |
Thereafter | |
| i 1,625 |
Total contractual obligations | | $ | i 3,382 |
| (1) | Minimum operating lease commitments only include base rent. Certain leases provide for contingent rents that are not measurable at inception and primarily include rents based on a percentage of sales in excess of stipulated levels, as well as common area maintenance. These amounts are excluded from minimum operating lease commitments and are included in the determination of total rent expense when it is probable that the expense has been incurred and the amount is reasonably measurable. Such amounts have not been material to total rent expense. |
As of September 30, 2019, the Company has additional operating leases obligations, relating primarily to facilities to support the Company’s manufacturing and research and development operations, as well as corporate offices, that have not yet commenced of $ i 98 million. These leases will commence between fiscal 2020 and fiscal 2025 with lease terms of i 1 year to i 20 years.
12
NOTE 4 – CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER ACTIVITIES
In May 2016, the Company announced a multi-year initiative (“Leading Beauty Forward” or “LBF”) to build on its strengths and better leverage its cost structure to free resources for investment to continue its growth momentum. LBF is designed to enhance the Company’s go-to-market capabilities, reinforce its leadership in global prestige beauty and continue creating sustainable value. As of June 30, 2019, the Company concluded the approvals of all major initiatives under LBF related to the optimization of select corporate functions, supply chain activities, and corporate and regional market support structures, as well as the exit of underperforming businesses, and expects to substantially complete those initiatives through fiscal 2021. The approved restructuring and other charges expected to be incurred were:
i
| | | | | | | | | | | | | | | |
| | Sales | | | | | | | | | | | | | |
| | Returns | | | | | Operating Expenses | | | | |||||
| | (included in | | | | | Restructuring | | Other | | | | |||
(In millions) |
| Net Sales) |
| Cost of Sales |
| Charges |
| Charges |
| Total | |||||
Total Charges Approved | | | | | | | | | | | | | | | |
Cumulative through September 30, 2019 | | $ | i 14 | | $ | i 88 | | $ | i 507 | | $ | i 358 | | $ | i 967 |
i
| | | | | | | | | | | | | | | |
| | Employee- | | Asset- | | | | | | | | | | ||
| | Related | | Related | | | Other Exit | | | | |||||
(In millions) |
| Costs |
| Costs |
| Terminations |
| Costs |
| Total | |||||
Restructuring Charges Approved | | | | | | | | | | | | | | | |
Cumulative through September 30, 2019 | | $ | i 461 | | $ | i 7 | | $ | i 25 | | $ | i 14 | | $ | i 507 |
The Company records approved charges associated with restructuring and other activities once the relevant accounting criteria have been met. Total cumulative charges recorded associated with restructuring and other activities for LBF were:
i
| | | | | | | | | | | | | | | | |
| | Sales | | | | | | | | |
| |||||
| | Returns | | | | | Operating Expenses | | | |
| |||||
| | (included in | | | | | Restructuring | | Other | | | |
| |||
(In millions) |
| Net Sales) |
| Cost of Sales |
| Charges |
| Charges |
| Total | | |||||
Total Charges | | | | | | | | | | | | | | | | |
Cumulative through June 30, 2019 | | $ | i 14 | | $ | i 55 | | $ | i 457 | | $ | i 265 | | $ | i 791 | |
Three months ended September 30, 2019 | | | — | | | i 2 | | | i 1 | | | i 22 | | | i 25 | |
Cumulative through September 30, 2019 | | $ | i 14 | | $ | i 57 | | $ | i 458 | | $ | i 287 | | $ | i 816 | |
| | | | | | | | | | | | | | | |
| | Employee- | | Asset- | | | | | | | | | | ||
| | Related | | Related | | | Other Exit | | | | |||||
(In millions) |
| Costs |
| Costs |
| Terminations |
| Costs |
| Total | |||||
Restructuring Charges | | | | | | | | | | | | | | | |
Cumulative through June 30, 2019 | | $ | i 445 | | $ | i 4 | | $ | i 3 | | $ | i 5 | | $ | i 457 |
Three months ended September 30, 2019 | | | — | | | — | | | — | | | i 1 | | | i 1 |
Cumulative through September 30, 2019 | | $ | i 445 | | $ | i 4 | | $ | i 3 | | $ | i 6 | | $ | i 458 |
Changes in accrued restructuring charges for the three months ended September 30, 2019 were:
i
| | | | | | | | | | | | | | | | |
| | Employee- | | Asset- | | | | | | | | |
| |||
| | Related | | Related | | | Other Exit | | | | | |||||
(In millions) |
| Costs |
| Costs |
| Terminations |
| Costs |
| Total |
| |||||
Balance at June 30, 2019 | | $ | i 202 | | $ | — | | $ | — | | $ | i 1 | | $ | i 203 | |
Charges | | | — | | | — | | | — | | | i 1 | | | i 1 | |
Cash payments | | | ( i 29) | | | — | | | — | | | ( i 1) | | | ( i 30) | |
Balance at September 30, 2019 | | $ | i 173 | | $ | — | | $ | — | | $ | i 1 | | $ | i 174 | |
/13
Accrued restructuring charges at September 30, 2019 are expected to result in cash expenditures funded from cash provided by operations of approximately $ i 108 million, $ i 44 million, $ i 19 million and $ i 3 million for the remainder of fiscal 2020 and for fiscal 2021, 2022 and 2023, respectively.
Additional information about LBF is included in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
iNOTE 5 – DERIVATIVE FINANCIAL INSTRUMENTS
The Company addresses certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments. The Company enters into foreign currency forward contracts, and may enter into option contracts, to reduce the effects of fluctuating foreign currency exchange rates. In addition, the Company enters into interest rate derivatives to manage the effects of interest rate movements on the Company’s aggregate liability portfolio, including potential future debt issuances. During the first quarter of fiscal 2020, the Company entered into foreign currency forward contracts to hedge a portion of its net investment in certain foreign operations, which are designated as net investment hedges. The Company entered into the net investment hedges to offset the risk of changes in the U.S. dollar value of the Company's investment in these foreign operations due to fluctuating foreign exchange rates. Time value is excluded from the effectiveness assessment and is recognized under a systematic and rational method over the life of the hedging instrument in Selling, general and administrative expenses. The net gain or loss on net investment hedges is recorded within translation adjustments, as a component of accumulated OCI (“AOCI”) on the Company’s consolidated balance sheets, until the sale or substantially complete liquidation of the underlying assets of the Company's investment. The Company also enters into foreign currency forward contracts, and may use option contracts, not designated as hedging instruments, to mitigate the change in fair value of specific assets and liabilities on the balance sheet. The Company does not utilize derivative financial instruments for trading or speculative purposes. Costs associated with entering into derivative financial instruments have not been material to the Company’s consolidated financial results.
For each derivative contract entered into, where the Company looks to obtain hedge accounting treatment, the Company formally and contemporaneously documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking the hedge transaction, the nature of the risk being hedged, and how the hedging instruments’ effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively. This process includes linking all derivatives to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. At inception, the Company evaluates the effectiveness of hedge relationships quantitatively, and has elected to perform, after initial evaluation, qualitative effectiveness assessments of certain hedge relationships to support an ongoing expectation of high effectiveness, if effectiveness testing is required. If based on the qualitative assessment, it is determined that a derivative has ceased to be a highly effective hedge, the Company will perform a quantitative assessment to determine whether to discontinue hedge accounting with respect to that derivative prospectively.
14
The fair values of the Company’s derivative financial instruments included in the consolidated balance sheets are as follows:
i
| | | | | | | | | | | | | | | | | |
| | Asset Derivatives | | Liability Derivatives | | ||||||||||||
| | | | Fair Value (1) | | | | Fair Value (1) | | ||||||||
| | Balance Sheet | | September 30 | | June 30 | | Balance Sheet | | September 30 | | June 30 | | ||||
(In millions) |
| Location |
| 2019 |
| 2019 |
| Location |
| 2019 |
| 2019 | | ||||
Derivatives Designated as Hedging Instruments | | | | | | | | | | | | | | | | | |
Foreign currency cash flow hedges | | Prepaid expenses and other current assets |
| $ | i 39 | | $ | i 23 |
| Other accrued liabilities |
| $ | i 2 |
| $ | i 4 | |
Net investment hedges | | Prepaid expenses and other current assets | | | i 3 | | | — | | Other accrued liabilities | | | i 1 | | | — | |
Interest rate-related derivatives | | Prepaid expenses and other current assets | | | i 4 | | | i 3 | | Other accrued liabilities | | | i 39 | | | i 26 | |
| | | | | | | | | | | | | | | | | |
Total Derivatives Designated as Hedging Instruments | | | | | i 46 | | | i 26 | | | | | i 42 | | | i 30 | |
| | | | | | | | | | | | | | | | | |
Derivatives Not Designated as Hedging Instruments | | | | | | | | | | | | | | | | | |
Foreign currency forward contracts |
| Prepaid expenses and other current assets | |
| i 4 | |
| i 4 |
| Other accrued liabilities | |
| i 6 | |
| i 2 | |
| | | | | | | | | | | | | | | | | |
Total Derivatives | | |
| $ | i 50 | | $ | i 30 | | |
| $ | i 48 |
| $ | i 32 | |
| (1) | See Note 6 – Fair Value Measurements for further information about how the fair value of derivative assets and liabilities are determined. |
15
The amounts of the gains and losses related to the Company’s derivative financial instruments designated as hedging instruments that are included in the assessment of effectiveness are as follows:
i
| | | | | | | | | | | | | | |
| | Amount of Gain or (Loss) | | | | Amount of Gain or (Loss) | ||||||||
| | Recognized in OCI on | | | | Reclassified from AOCI into | ||||||||
| | Derivatives | | Location of Gain or | | Earnings(1) | ||||||||
| | Three Months Ended | | (Loss) Reclassified | | Three Months Ended | ||||||||
| | September 30 | | from AOCI into | | September 30 | ||||||||
(In millions) |
| 2019 |
| 2018 |
| Earnings |
| 2019 |
| 2018 | ||||
Derivatives in Cash Flow Hedging Relationships: | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Foreign currency forward contracts |
| $ | i 25 |
| $ | i 3 |
| Net sales |
| $ | i 13 |
| $ | i 3 |
Interest rate-related derivatives | | | ( i 14) | | | — | | Interest expense | | | — | | | — |
| | | i 11 | | | i 3 | | Total derivatives | | $ | i 13 | | $ | i 3 |
Derivatives in Net Investment Hedging Relationships(2): | | | | | | | | | | | | | | |
Foreign currency forward contracts(3) | | | i 3 | | | — | | | | | | | | |
Total derivatives |
| $ | i 14 |
| $ | i 3 | | |
| | | | | |
| (1) | The amount reclassified into earnings as a result of the discontinuance of cash flow hedges because probable forecasted transactions will no longer occur by the end of the original time period was not material. |
| (2) | During the three months ended September 30, 2019, the gain recognized in earnings from net investment hedges related to the amount excluded from effectiveness testing was $ i 12 million. |
| (3) | Included within translation adjustments, as a component of AOCI on the Company’s consolidated balance sheets. |
| | | | | | | | |
| | | | Amount of Gain or (Loss) Recognized in Earnings on | ||||
|
| |
| Derivatives (1) | ||||
| | Location of Gain or (Loss) | | Three Months Ended | ||||
| | Recognized in Earnings on | | September 30 | ||||
(In millions) | | Derivatives | | 2019 |
| 2018 | ||
Derivatives in Fair Value Hedging Relationships: | | | | | | | | |
| | | | | | | | |
Interest rate swap contracts |
| Interest expense |
| $ | i 2 |
| $ | ( i 2) |
| (1) | Changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt. |
Additional information regarding the cumulative amount of fair value hedging adjustments for items designated and qualifying as hedged items in fair value hedges is as follows:
i
| | | | | | |
| | Amount of Gain or (Loss) | ||||
(In millions) | | Recognized in Earnings on Derivatives | ||||
| | | | | Cumulative Amount of Fair | |
| | | | | Value Hedging Adjustments | |
Line Item in the Consolidated Balance Sheets in | | Carrying Amount of the | | Included in the Carrying Amount | ||
Which the Hedged Item is Included | | Hedged Assets (Liabilities) | | of the Hedged Asset (Liability) | ||
|
|
| ||||
Current debt | | $ | i 250 | | $ | — |
Long-term debt | | | i 701 | | | i 3 |
Total debt | | $ | i 951 | | $ | i 3 |
16
Additional information regarding the effects of fair value and cash flow hedging relationships for derivatives designated and qualifying as hedging instruments is as follows:
i
| | | | | | | | | | | | |
| | Three Months Ended September 30 | ||||||||||
| | 2019 |
| 2018 | ||||||||
|
| |
| Interest |
| |
| Interest | ||||
(In millions) | | Net Sales | | expense | | Net Sales | | expense | ||||
Total amounts of income and expense line items presented in the consolidated statements of earnings in which the effects of fair value and cash flow hedges are recorded | | $ | i 3,895 | | $ | i 32 | | $ | i 3,524 | | $ | i 34 |
| | | | | | | | | | | | |
The effects of fair value and cash flow hedging relationships: | |
|
| |
|
| |
|
| |
|
|
Gain (loss) on fair value hedge relationships – interest rate contracts: | |
|
| |
|
| |
|
| |
|
|
Hedged item | |
| Not applicable | |
| i 2 | |
| Not applicable | |
| ( i 2) |
Derivatives designated as hedging instruments | |
| Not applicable | |
| ( i 2) | |
| Not applicable | |
| i 2 |
| | | | | | | | | | | | |
Gain (loss) on cash flow hedge relationships – foreign currency forward contracts: | | | | | | | | | | | | |
Amount of gain reclassified from AOCI into earnings | | | i 13 | | | Not applicable | | | i 3 | | | Not applicable |
| | | | | | | | | | | | |
The amounts of the gains and losses related to the Company’s derivative financial instruments not designated as hedging instruments are presented as follows:
i
| | | | | | | | | |
| | | | Amount of Gain or (Loss) | | ||||
| | | | Recognized in Earnings on | | ||||
| | | | Derivatives | | ||||
| | Location of Gain or (Loss) | | Three Months Ended | | ||||
| | Recognized in Earnings on | | September 30 | | ||||
(In millions) |
| Derivatives |
| 2019 |
| 2018 | | ||
Derivatives Not Designated as Hedging Instruments: | | | | | | | | | |
| | | | | | | | | |
Foreign currency forward contracts |
| Selling, general and administrative |
| $ | ( i 27) |
| $ | i 22 | |
Cash Flow Hedges
The Company enters into foreign currency forward contracts, and may enter into foreign currency option contracts, to hedge anticipated transactions and receivables and payables denominated in foreign currencies, for periods consistent with the Company’s identified exposures. The purpose of the hedging activities is to minimize the effect of foreign exchange rate movements on the cash flows that the Company receives from foreign subsidiaries. The foreign currency forward contracts entered into to hedge anticipated transactions have been designated as cash flow hedges and have varying maturities through the end of September 2021. Hedge effectiveness of the foreign currency forward contracts is based on the forward method, which includes time value in the effectiveness assessment. At September 30, 2019, the Company had outstanding foreign currency forward contracts with a notional amount totaling $ i 5,725 million.
The Company may enter into interest rate forward contracts to hedge anticipated issuance of debt for periods consistent with the Company’s identified exposures. The purpose of the hedging activities is to minimize the effect of interest rate movements on the cost of debt issuance.
For hedge contracts that are no longer deemed highly effective, hedge accounting is discontinued and gains and losses in AOCI are reclassified to sales when the underlying forecasted transaction occurs. If it is probable that the forecasted transaction will no longer occur, then any gains or losses in AOCI are reclassified to current-period sales. As of September 30, 2019, the Company’s foreign currency cash flow hedges were highly effective.
17
The estimated net gain on the Company’s derivative instruments designated as cash flow hedges as of September 30, 2019 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $ i 24 million. The accumulated net gain on derivative instruments in AOCI was $ i 27 million and $ i 29 million as of September 30, 2019 and June 30, 2019, respectively.
Fair Value Hedges
The Company enters into interest rate derivative contracts to manage the exposure to interest rate fluctuations on its funded indebtedness. The Company has interest rate swap agreements, with notional amounts totaling $ i 250 million, $ i 450 million and $ i 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 i three-month LIBOR plus a margin. These interest rate swap agreements are designated as fair value hedges of the related long-term debt, and the changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt.
Net Investment Hedges
The Company enters into foreign currency forward contracts, designated as net investment hedges, to hedge a portion of its net investment in certain foreign operations. The net gain or loss on these contracts is recorded within translation adjustments, as a component of AOCI on the Company's consolidated balance sheets. The purpose of the hedging activities is to minimize the effect of foreign exchange rate movements on the Company's net investment in these foreign operations. The net investment hedge contracts have varying maturities through the end of October 2019. Hedge effectiveness of the net investment hedge contracts is based on the spot method. At September 30, 2019, the Company had net investment hedges outstanding with a notional amount totaling $ i 1,723 million.
Credit Risk
As a matter of policy, the Company enters into derivative contracts only with counterparties that have a long-term credit rating of at least A- or higher by at least i 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 $ i 50 million at September 30, 2019. To manage this risk, the Company has strict counterparty credit guidelines that are continually monitored. Accordingly, management believes risk of loss under these hedging contracts is remote.
iNOTE 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.
i
/18
The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2019:
| | | | | | | | | | | | | |
(In millions) |
| Level 1 |
| Level 2 |
| Level 3 |
| Total | | ||||
Assets: | | | | | | | | | | | | | |
Foreign currency forward contracts |
| $ | — |
| $ | i 46 |
| $ | — |
| $ | i 46 | |
Interest rate-related derivatives | | | — | | | i 4 | | | — | | | i 4 | |
Total |
| $ | — |
| $ | i 50 |
| $ | — |
| $ | i 50 | |
| | | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | | |
Foreign currency forward contracts | | $ | — | | $ | i 9 | | $ | — | | $ | i 9 | |
Interest rate-related derivatives | | | — | | | i 39 | | | — | | | i 39 | |
Contingent consideration | | | — | | | — | | | i 36 | | | i 36 | |
Total |
| $ | — | | $ | i 48 | | $ | i 36 |
| $ | i 84 | |
The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2019:
| | | | | | | | | | | | | |
(In millions) |
| Level 1 |
| Level 2 |
| Level 3 |
| Total | | ||||
Assets: | | | | | | | | | | | | | |
Foreign currency forward contracts |
| $ | — |
| $ | i 27 |
| $ | — |
| $ | i 27 | |
Interest rate-related derivatives | | | — | | | i 3 | | | — | | | i 3 | |
Total |
| $ | — |
| $ | i 30 |
| $ | — |
| $ | i 30 | |
| | | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | | |
Foreign currency forward contracts |
| $ | — |
| $ | i 6 |
| $ | — |
| $ | i 6 | |
Interest rate-related derivatives | | | — | | | i 26 | | | — | | | i 26 | |
Contingent consideration | | | — | | | — | | | i 36 | | | i 36 | |
Total | | $ | — | | $ | i 32 | | $ | i 36 | | $ | i 68 | |
The estimated fair values of the Company’s financial instruments are as follows:
i
| | | | | | | | | | | | |
| | September 30 | | June 30 | ||||||||
| | 2019 | | 2019 | ||||||||
| | Carrying | | Fair | | Carrying | | Fair | ||||
(In millions) |
| Amount |
| Value |
| Amount |
| Value | ||||
Nonderivatives | | | | | | | | | | | | |
Cash and cash equivalents |
| $ | i 2,259 |
| $ | i 2,259 |
| $ | i 2,987 |
| $ | i 2,987 |
Current and long-term debt | |
| i 3,415 | | | i 3,841 | |
| i 3,412 | | | i 3,706 |
Additional purchase price payable | | | i 3 | | | i 3 | | | i 3 | | | i 3 |
Contingent consideration | | | i 36 | | | i 36 | | | i 36 | | | i 36 |
| | | | | | | | | | | | |
Derivatives | | | | | | | | | | | | |
Foreign currency forward contracts – asset (liability), net | |
| i 37 | | | i 37 | |
| i 21 | | | i 21 |
Interest rate-related derivatives – asset (liability), net | | | ( i 35) | | | ( i 35) | | | ( i 23) | | | ( i 23) |
The following methods and assumptions were used to estimate the fair value of the Company’s financial instruments for which it is practicable to estimate that value:
Cash and cash equivalents – Cash and all highly-liquid securities with original maturities of three months or less are classified as cash and cash equivalents, primarily consisting of cash deposits in interest bearing accounts, time deposits and money market funds (classified within Level 1 of the valuation hierarchy). The carrying amount approximates fair value, primarily due to the short maturity of cash equivalent instruments.
19
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 i 12 months, and swap yield curves for contracts with maturities greater than i 12 months.
Interest rate contracts – The fair values of the Company’s interest rate contracts were determined using an industry-standard valuation model, which is based on the income approach. The significant observable inputs to the model, such as treasury yield curves, swap yield curves and LIBOR forward rates, were obtained from independent pricing services.
Current and long-term debt – The fair value of the Company’s debt was estimated based on the current rates offered to the Company for debt with the same remaining maturities. To a lesser extent, debt also includes finance lease obligations for which the carrying amount approximates the fair value. The Company’s debt is classified within Level 2 of the valuation hierarchy.
Additional purchase price payable – The Company’s additional purchase price payable represents fixed minimum additional purchase price that was discounted using the Company’s incremental borrowing rate, which was approximately i 1%. The additional purchase price payable is classified within Level 2 of the valuation hierarchy.
Contingent consideration – Contingent consideration obligations consist of potential obligations related to the Company’s acquisitions in previous years. The amounts to be paid under these obligations are contingent upon the achievement of stipulated financial targets by the business subsequent to acquisition. At September 30, 2019, the fair values of the contingent consideration related to certain acquisition earn-outs were based on the Company’s estimate of the applicable financial targets as per the terms of the agreements. Significant changes in the projected future operating results would result in a significantly higher or lower fair value measurement. As these are unobservable inputs, the Company’s contingent consideration is classified within Level 3 of the valuation hierarchy. There have been i no changes in the fair value of contingent consideration obligations for the three months ended September 30, 2019.
iNOTE 7 – REVENUE RECOGNITION
The Company's revenue recognition accounting policies are described in the notes to consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
Accounts Receivable
Accounts receivable, net is stated net of the allowance for doubtful accounts and customer deductions totaling $ i 30 million and $ i 32 million as of September 30, 2019 and June 30, 2019, respectively. The allowance for doubtful accounts is based upon the evaluation of accounts receivable aging, specific exposures and historical trends. Payment terms are short-term in nature and are generally less than one year.
Deferred Revenue
Significant changes in deferred revenue during the period are as follows:
i
| | | |
(In millions) |
| ||
Balance at June 30, 2019 | | $ | i 361 |
Revenue recognized that was included in the deferred revenue balance at the beginning of the period | |
| ( i 160) |
Revenue deferred during the period | |
| i 195 |
Other | | | ( i 4) |
Balance at September 30, 2019 | | $ | i 392 |
Transaction Price Allocated to the Remaining Performance Obligations
At September 30, 2019, the combined estimated revenue expected to be recognized in the next i 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 $ i 345 million.
/20
NOTE 8 – PENSION AND POST-RETIREMENT BENEFIT PLANS
The Company maintains pension plans covering substantially all of its full-time employees for its U.S. operations and a majority of its international operations. The Company also maintains post-retirement benefit plans that provide certain medical and dental benefits to eligible employees. Descriptions of these plans are included in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
i
The components of net periodic benefit cost for the three months ended September 30, 2019 and 2018 consisted of the following:
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Other than | ||||
| | Pension Plans | | Pension Plans | ||||||||||||||
| | U.S. | | International | | Post-retirement | ||||||||||||
(In millions) |
| 2019 |
| 2018 |
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||||
Service cost |
| $ | i 10 |
| $ | i 9 |
| $ | i 9 |
| $ | i 8 |
| $ | i 1 |
| $ | i 1 |
Interest cost | |
| i 8 | |
| i 9 | |
| i 3 | |
| i 3 | |
| i 2 | |
| i 2 |
Expected return on plan assets | |
| ( i 13) | |
| ( i 13) | |
| ( i 3) | |
| ( i 3) | |
| ( i 1) | |
| ( i 1) |
Amortization of: | | | | | | | | | | | | | | | | | | |
Actuarial loss | |
| i 4 | |
| i 3 | |
| i 1 | |
| — | |
| — | |
| — |
Net periodic benefit cost |
| $ | i 9 |
| $ | i 8 |
| $ | i 10 |
| $ | i 8 |
| $ | i 2 |
| $ | i 2 |
/During the three months ended September 30, 2019, the Company made contributions to its international pension plans totaling approximately $ i 3 million.
The amounts recognized in the consolidated balance sheets related to the Company’s pension and post-retirement benefit plans consist of the following:
i
| | | | | | |
| | September 30 | | June 30 | ||
(In millions) |
| 2019 |
| 2019 | ||
Other assets |
| $ | i 101 |
| $ | i 105 |
Other accrued liabilities | |
| ( i 27) | |
| ( i 27) |
Other noncurrent liabilities | |
| ( i 422) | |
| ( i 418) |
Funded status | |
| ( i 348) | |
| ( i 340) |
Accumulated other comprehensive loss | |
| i 329 | |
| i 334 |
Net amount recognized |
| $ | ( i 19) |
| $ | ( i 6) |
/
iNOTE 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.
21
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 i no accrual has been recorded.
iNOTE 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:
i
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
(In millions) |
| 2019 |
| 2018 | ||
Compensation expense |
| $ | i 56 |
| $ | i 58 |
Income tax benefit | | | i 11 | | | i 12 |
/Stock Options
During the three months ended September 30, 2019, the Company granted stock options in respect of approximately i 1.3 million shares of Class A Common Stock with an exercise price per share of $ i 199.49 and a weighted-average grant date fair value per share of $ i 51.42. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model. The aggregate intrinsic value of stock options exercised during the three months ended September 30, 2019 was $ i 116 million.
Restricted Stock Units
The Company granted RSUs in respect of approximately i 0.8 million shares of Class A Common Stock during the three months ended September 30, 2019 with a weighted-average grant date fair value per share of $ i 199.54 that, at the time of grant, were scheduled to vest as follows: i 0.3 million in fiscal 2021, i 0.3 million in fiscal 2022 and i 0.2 million in fiscal 2023. Vesting of RSUs granted is generally subject to the continued employment or the retirement of the grantees. The RSUs are accompanied by dividend equivalent rights, payable upon settlement of the RSUs either in cash or shares (based on the terms of the particular award) and, as such, were valued at the closing market price of the Company’s Class A Common Stock on the date of grant.
Performance Share Units
During the three months ended September 30, 2019, the Company granted PSUs with a target payout of approximately i 0.1 million shares of Class A Common Stock with a grant date fair value per share of $ i 199.49, which will be settled in stock subject to the achievement of the Company’s net sales, diluted net earnings per common share and return on invested capital goals for the three fiscal years ending June 30, 2022, all subject to continued employment or the retirement of the grantees. For PSUs granted, no settlement will occur for results below the applicable minimum threshold. PSUs are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the PSUs and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant.
In September 2019, approximately i 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 i 0.3 million PSUs which vested as of June 30, 2019.
/
22
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:
i
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
(In millions, except per share data) |
| 2019 |
| 2018 | ||
Numerator: | | | | | | |
Net earnings attributable to The Estée Lauder Companies Inc. |
| $ | i 595 |
| $ | i 500 |
| | | | | | |
Denominator: | | | | | | |
Weighted-average common shares outstanding – Basic | |
| i 361.4 | |
| i 366.8 |
Effect of dilutive stock options | |
| i 4.9 | |
| i 5.0 |
Effect of PSUs | | | i 0.3 | | | i 0.4 |
Effect of RSUs | |
| i 2.0 | |
| i 2.2 |
Weighted-average common shares outstanding – Diluted | |
| i 368.6 | |
| i 374.4 |
| | | | | | |
Net earnings attributable to The Estée Lauder Companies Inc. per common share: | | | | | | |
Basic |
| $ | i 1.65 |
| $ | i 1.36 |
Diluted | | $ | i 1.61 | | $ | i 1.34 |
/As of September 30, 2019 and 2018, the number of shares of Class A Common Stock underlying options that were excluded in the computation of diluted EPS because their inclusion would be anti-dilutive was i 1.3 million shares and i 1.6 million shares, respectively. As of September 30, 2019 and 2018, i i 1.1 / million shares of Class A Common Stock underlying PSUs have been excluded from the calculation of diluted EPS because the number of shares ultimately issued is contingent on the achievement of certain performance targets of the Company, as discussed in Note 10 – Stock Programs.
/
23
NOTE 12 – EQUITY
i
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
(In millions) |
| 2019 |
| 2018 | ||
Common stock, beginning of the period | | $ | i 6 | | $ | i 6 |
Stock-based compensation | |
| — | |
| — |
Common stock, end of the period | |
| i 6 | |
| i 6 |
| | | | | | |
Paid-in capital, beginning of the period | |
| i 4,403 | |
| i 3,972 |
Common stock dividends | |
| i 1 | |
| i 1 |
Stock-based compensation | |
| i 110 | |
| i 92 |
Paid-in capital, end of the period | |
| i 4,514 | |
| i 4,065 |
| | | | | | |
Retained earnings, beginning of the period | |
| i 9,984 | |
| i 9,040 |
Common stock dividends | |
| ( i 157) | |
| ( i 141) |
Net earnings attributable to The Estée Lauder Companies Inc. | |
| i 595 | |
| i 500 |
Cumulative effect of adoption of new accounting standards | |
| ( i 29) | |
| ( i 229) |
Retained earnings, end of the period | |
| i 10,393 | |
| i 9,170 |
| | | | | | |
Accumulated other comprehensive loss, beginning of the period | |
| ( i 563) | |
| ( i 434) |
Other comprehensive income (loss) | |
| ( i 64) | |
| i 25 |
Accumulated other comprehensive loss, end of the period | |
| ( i 627) | |
| ( i 409) |
| | | | | | |
Treasury stock, beginning of the period | |
| ( i 9,444) | |
| ( i 7,896) |
Acquisition of treasury stock | |
| ( i 277) | |
| ( i 502) |
Stock-based compensation | |
| ( i 35) | |
| ( i 28) |
Treasury stock, end of the period | |
| ( i 9,756) | |
| ( i 8,426) |
| | | | | | |
Total stockholders’ equity – The Estée Lauder Companies Inc. | |
| i 4,530 | |
| i 4,406 |
| | | | | | |
Noncontrolling interests, beginning of the period | |
| i 25 | |
| i 22 |
Net earnings attributable to noncontrolling interests | |
| i 3 | |
| i 2 |
Noncontrolling interests, end of the period | |
| i 28 | |
| i 24 |
| | | | | | |
Total equity | | $ | i 4,558 | | $ | i 4,430 |
| | | | | | |
Cash dividends declared per common share | | $ | i .43 | | $ | i .38 |
/ iThe following is a summary of quarterly cash dividends declared per share on the Company’s Class A and Class B Common Stock during the three months ended September 30, 2019:
| | | | | | | | |
Date Declared |
| Record Date |
| Payable Date |
| Amount per Share | | |
|
|
| $ | i .43 | | |||
/On October 30, 2019, a dividend was declared in the amount of $ i .48 per share on the Company’s Class A and Class B Common Stock. The dividend is payable in cash on December 16, 2019 to stockholders of record at the close of business on November 29, 2019.
Common Stock
During the three months ended September 30, 2019, the Company purchased approximately i 1.6 million shares of its Class A Common Stock for $ i 313 million.
During the three months ended September 30, 2019, approximately i 2.3 million shares of the Company’s Class B Common Stock were converted into the same amount of shares of the Company’s Class A Common Stock.
/24
Accumulated Other Comprehensive Income (Loss)
The following table represents changes in AOCI, net of tax, by component for the three months ended September 30, 2019:
i
| | | | | | | | | | | | | |
| | | | | Amounts | | | | | | | | |
| | Net Cash | | Included in Net | | | | | | | | ||
| | Flow Hedge | | Periodic Benefit | | Translation | | | | | |||
(In millions) |
| Gain (Loss) |
| Cost |
| Adjustments |
| Total | | ||||
Balance at June 30, 2019 |
| $ | i 21 |
| $ | ( i 253) | | $ | ( i 331) |
| $ | ( i 563) | |
OCI before reclassifications | |
| i 8 | |
| — | |
| ( i 72) | (1) |
| ( i 64) | |
Amounts reclassified to Net earnings | | | ( i 10) | | | i 4 | | | i 6 | | | — | |
Net current-period OCI | |
| ( i 2) | |
| i 4 | |
| ( i 66) | |
| ( i 64) | |
Balance at September 30, 2019 |
| $ | i 19 |
| $ | ( i 249) | | $ | ( i 397) |
| $ | ( i 627) | |
| (1) | See Note 5 - Derivative Financial Instruments for gains (losses) relating to net investment hedges. |
/The following table represents the effects of reclassification adjustments from AOCI into net earnings for the three months ended September 30, 2019 and 2018:
i
| | | | | | | | |
| | Amount Reclassified from AOCI | | | ||||
| | Three Months Ended | | Affected Line Item in | ||||
| | September 30 | | Consolidated | ||||
(In millions) |
| 2019 |
| 2018 |
| Statements of Earnings | ||
Gain (Loss) on Cash Flow Hedges | | | | | | | | |
Foreign currency forward contracts |
| $ | i 13 |
| $ | i 3 | | Net sales |
Provision for deferred taxes | |
| ( i 3) | |
| ( i 1) | | Provision for income taxes |
|
| $ | i 10 |
| $ | ( i 2) | | Net earnings |
| | | | | | | | |
Amounts Included in Net Periodic Benefit Cost | | | | | | | | |
Amortization of prior service cost |
| $ | — |
| $ | — | | (1) |
Amortization of actuarial loss | |
| ( i 5) | |
| ( i 3) | | (1) |
| |
| ( i 5) | |
| ( i 3) | | Earnings before income taxes |
Benefit for deferred taxes | |
| i 1 | |
| i 1 | | Provision for income taxes |
|
| $ | ( i 4) |
| $ | ( i 2) | | Net earnings |
Cumulative Translation Adjustments | | | | | | | | |
Loss on liquidation of an investment in a foreign subsidiary | | | ( i 6) | | | — | | Restructuring and other charges |
Total reclassification adjustments, net |
| $ | — |
| $ | — | | Net earnings |
| (1) | See Note 8 – Pension and Post-Retirement Benefit Plans for additional information. |
iNOTE 13 – STATEMENT OF CASH FLOWS
iSupplemental cash flow information for the three months ended September 30, 2019 and 2018 is as follows:
| | | | | | | |
(In millions) |
| 2019 |
| 2018 | | ||
Cash: | | | | | | | |
Cash paid during the period for interest |
| $ | i 32 |
| $ | i 33 | |
Cash paid during the period for income taxes |
| $ | i 115 |
| $ | i 60 | |
| | | | | | | |
Non-cash investing and financing activities: | | | | | | | |
Capital lease, capitalized interest and asset retirement obligations incurred |
| $ | — |
| $ | i 6 | |
Property, plant and equipment accrued but unpaid |
| $ | i 50 |
| $ | i 43 | |
/
25
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 i 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, and charges associated with restructuring and other activities. 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.
During the fiscal 2020 first quarter, changes were made to reflect certain Leading Beauty Forward enhancements made to the capabilities and cost structure of the Company’s travel retail business, which are primarily centralized in The Americas region, and resulted in a change to the royalty structure of the travel retail business to reflect the value created in The Americas region. Accordingly, the fiscal 2019 operating income of The Americas was increased by $ i 201 million, with a corresponding decrease in Europe, the Middle East & Africa to conform with the current year presentation. The impact of such activities in the fiscal 2020 first quarter was comparable, so there was no material year-over-year change in operating results of either region attributable to such change.
/26
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, 2019. 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, 2019.
i
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
(In millions) |
| 2019 |
| 2018 | ||
PRODUCT CATEGORY DATA | | | | | | |
Net sales: | | | | | | |
Skin Care |
| $ | i 1,842 |
| $ | i 1,486 |
Makeup | |
| i 1,443 | |
| i 1,406 |
Fragrance | |
| i 462 | |
| i 472 |
Hair Care | |
| i 136 | |
| i 143 |
Other | | | i 12 | | | i 17 |
Net sales |
| $ | i 3,895 |
| $ | i 3,524 |
| | | | | | |
Operating income (loss) before charges associated with restructuring and other activities: | | | | | | |
Skin Care |
| $ | i 632 |
| $ | i 466 |
Makeup | |
| i 104 | |
| i 161 |
Fragrance | |
| i 66 | |
| i 55 |
Hair Care | |
| — | |
| i 14 |
Other | |
| i 2 | |
| i 3 |
| |
| i 804 | |
| i 699 |
Reconciliation: | | | | | | |
Charges associated with restructuring and other activities | | | ( i 25) | | | ( i 47) |
Interest expense | |
| ( i 32) | |
| ( i 34) |
Interest income and investment income, net | | | i 14 | | | i 15 |
Other components of net periodic benefit cost | | | ( i 1) | | | — |
Earnings before income taxes |
| $ | i 760 |
| $ | i 633 |
| | | | | | |
GEOGRAPHIC DATA(1) | | | | | | |
Net sales: | | | | | | |
The Americas |
| $ | i 1,160 |
| $ | i 1,236 |
Europe, the Middle East & Africa | |
| i 1,677 | |
| i 1,433 |
Asia/Pacific | | | i 1,058 | | | i 855 |
Net sales |
| $ | i 3,895 |
| $ | i 3,524 |
| | | | | | |
Operating income (loss): | | | | | | |
The Americas |
| $ | i 175 |
| $ | i 234 |
Europe, the Middle East & Africa | |
| i 377 | |
| i 257 |
Asia/Pacific | |
| i 252 | |
| i 208 |
| | | i 804 | | | i 699 |
Charges associated with restructuring and other activities | | | ( i 25) | | | ( i 47) |
Operating income | | $ | i 779 | | $ | i 652 |
| (1) | The net sales and operating income from the Company’s travel retail business are included in the Europe, the Middle East & Africa region. |
27
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 approximately 150 countries and territories. The following table is a comparative summary of operating results for the three months ended September 30, 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 and hair care have been included in the “other” category.
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
(In millions) |
| 2019 |
| 2018 | ||
NET SALES |
| |
|
| |
|
By Product Category: |
| |
|
| |
|
Skin Care | | $ | 1,842 | | $ | 1,486 |
Makeup | |
| 1,443 | |
| 1,406 |
Fragrance | |
| 462 | |
| 472 |
Hair Care | |
| 136 | |
| 143 |
Other | |
| 12 | |
| 17 |
| |
| | |
| |
Net sales | | $ | 3,895 | | $ | 3,524 |
| | | | | | |
By Region: | |
|
| |
|
|
The Americas | | $ | 1,160 | | $ | 1,236 |
Europe, the Middle East & Africa | |
| 1,677 | |
| 1,433 |
Asia/Pacific | |
| 1,058 | |
| 855 |
Net sales | | $ | 3,895 | | $ | 3,524 |
| | | | | | |
OPERATING INCOME (LOSS) | |
|
| |
|
|
By Product Category: | |
|
| |
|
|
Skin Care | | $ | 632 | | $ | 466 |
Makeup | |
| 104 | |
| 161 |
Fragrance | |
| 66 | |
| 55 |
Hair Care | |
| — | |
| 14 |
Other | |
| 2 | |
| 3 |
| |
| 804 | |
| 699 |
Charges associated with restructuring and other activities | |
| (25) | |
| (47) |
Operating income | | $ | 779 | | $ | 652 |
| | | | | | |
By Region: | |
|
| |
|
|
The Americas | | $ | 175 | | $ | 234 |
Europe, the Middle East & Africa | |
| 377 | |
| 257 |
Asia/Pacific | |
| 252 | |
| 208 |
| |
| 804 | |
| 699 |
Charges associated with restructuring and other activities | |
| (25) | |
| (47) |
Operating income | | $ | 779 | | $ | 652 |
During the fiscal 2020 first quarter, changes were made to reflect certain Leading Beauty Forward enhancements made to the capabilities and cost structure of our travel retail business, which are primarily centralized in The Americas region, and resulted in a change to the royalty structure of the travel retail business to reflect the value created in The Americas region. Accordingly, the fiscal 2019 operating income of The Americas was increased by $201 million, with a corresponding decrease in Europe, the Middle East & Africa to conform with the current year presentation. The impact of such activities in the fiscal 2020 first quarter was comparable, so there was no material year-over-year change in operating results of either region attributable to such change.
28
THE ESTÉE LAUDER COMPANIES INC.
The following table presents certain consolidated earnings data as a percentage of net sales:
| | | | | |
|
| Three Months Ended | | ||
|
| September 30 | | ||
|
| 2019 |
| 2018 | |
Net sales |
| 100.0 | % | 100.0 | % |
Cost of sales |
| 23.3 |
| 23.4 | |
Gross profit |
| 76.7 |
| 76.6 | |
| | | | | |
Operating expenses |
|
|
|
| |
Selling, general and administrative |
| 56.1 |
| 56.9 | |
Restructuring and other charges |
| 0.6 |
| 1.2 | |
Total operating expenses |
| 56.7 |
| 58.1 | |
| | | | | |
Operating income |
| 20.0 |
| 18.5 | |
Interest expense |
| 0.8 |
| 1.0 | |
Interest income and investment income, net |
| 0.3 |
| 0.4 | |
Other components of net periodic benefit cost |
| — |
| — | |
| | | | | |
Earnings before income taxes |
| 19.5 |
| 17.9 | |
Provision for income taxes |
| 4.1 |
| 3.7 | |
| | | | | |
Net earnings |
| 15.4 |
| 14.2 | |
Net earnings attributable to noncontrolling interests |
| 0.1 |
| — | |
| | | | | |
Net Earnings attributable to The Estée Lauder Companies Inc. |
| 15.3 | % | 14.2 | % |
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 39 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-period results using prior-year period weighted-average foreign currency exchange rates and adjusting for the period-over-period impact of foreign currency cash flow hedging activities.
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 25-27 of our Annual Report on Form 10-K for the year ended June 30, 2019, as well as below.
29
THE ESTÉE LAUDER COMPANIES INC.
During the first quarter of fiscal 2020, 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 product category and our international regions. We continued to benefit from growth in global prestige skin care. Estée Lauder, La Mer, Clinique and Origins contributed to the strong growth in skin care, and we grew skin care net sales in every region. We grew makeup category net sales in the quarter, led by M•A•C in Asia/Pacific and Latin America, Estée Lauder and La Mer in our travel retail business and Tom Ford in Asia/Pacific. This growth was partially offset by a decline in prestige makeup generally in North America, which impacted many of our brands.
Internationally, net sales grew in nearly every market, led by China and in our travel retail business. The net sales growth for the period also reflected higher net sales from developed markets across Europe, the Middle East & Africa as well as double-digit increases in Japan and Korea. In aggregate, emerging markets outside of China also rose double-digits. We believe that our success has been due, in part, to our focus on strengthening consumer engagement by leveraging digital marketing and enhancing our social media strategies and execution, as we continue to pivot towards areas of prestige beauty where we see the greatest opportunities.
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 the United Kingdom. Our business in Hong Kong was challenged, as the ongoing situation there has negatively impacted traffic in downtown shops and the airport and also led to intermittent store closures. We continue to monitor the geopolitical tensions between the United States and China and the uncertainties caused by the evolving trade policy dispute, which could increase our cost of sales and negatively impact our overall net sales, or otherwise have a material adverse effect on our business. We also continue to monitor 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 impacts 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 and Ermenegildo Zegna brand names, which we license from their respective owners.
Leading Beauty Forward
Information about our multi-year initiative, Leading Beauty Forward, is described in Notes to Consolidated Financial Statements, Note 4 – Charges Associated with Restructuring and Other Activities and in the Overview on page 26 of our Annual Report on Form 10-K for the year ended June 30, 2019.
30
THE ESTÉE LAUDER COMPANIES INC.
NET SALES
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net sales | | $ | 3,895 | | $ | 3,524 |
$ Change from prior-year period | |
| 371 | |
|
|
% Change from prior-year period | |
| 11 | % |
|
|
| | | | | | |
Non-GAAP Financial Measure(1): | |
|
| |
|
|
% Change from prior-year period in constant currency | |
| 12 | % |
|
|
(1) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 39 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.
Reported net sales increased, primarily reflecting higher net sales in the skin care category, as well as increased net sales in the Europe, the Middle East & Africa and Asia/Pacific geographic regions. Skin care net sales primarily benefited from higher net sales of Estée Lauder, La Mer and Clinique products. The international net sales increase was led by our travel retail business, with higher net sales across most brands, as well as in China.
The total net sales increase was impacted by approximately $40 million of unfavorable foreign currency translation.
Product Categories
Skin Care
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net sales | | $ | 1,842 | | $ | 1,486 |
$ Change from prior-year period | |
| 356 | |
|
|
% Change from prior-year period | |
| 24 | % |
|
|
| | | | | | |
Non-GAAP Financial Measure(1): | |
|
| |
|
|
% Change from prior-year period in constant currency | |
| 25 | % |
|
|
| (1) | See “Reconciliations of Non-GAAP Financial Measures” beginning on page 39 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures. |
Reported skin care net sales increased, primarily due to higher net sales from Estée Lauder, La Mer and Clinique of approximately $348 million, combined, reflecting higher net sales in each geographic region. The continued success of existing product franchises, such as Advanced Night Repair, Perfectionist and Micro Essence, combined with new product launches, such as Advanced Night Repair Intense Reset Concentrate, contributed to the increased net sales from Estée Lauder. The increase in net sales from La Mer benefited from existing products, such as The Treatment Lotion, and new product launches, such as The Regenerating Serum, as well as targeted expanded consumer reach. Net sales from Clinique increased primarily due to strength from moisturizers and the continued success of certain hero franchises.
The skin care net sales increase was impacted by approximately $16 million of unfavorable foreign currency translation.
31
THE ESTÉE LAUDER COMPANIES INC.
Makeup
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net sales | | $ | 1,443 | | $ | 1,406 |
$ Change from prior-year period | |
| 37 | |
|
|
% Change from prior-year period | |
| 3 | % |
|
|
| | | | | | |
Non-GAAP Financial Measure(1): | |
|
| |
|
|
% Change from prior-year period in constant currency | |
| 4 | % |
|
|
Reported makeup net sales increased, reflecting higher net sales from Estée Lauder, M•A•C and Tom Ford of approximately $58 million, combined. The increase in net sales from Estée Lauder primarily reflected continued strength of our Double Wear line of products. The higher net sales from M•A•C and Tom Ford reflected strong growth in Asia/Pacific, led by China and Japan, which resulted in higher net sales from third-party online malls and our travel retail business. Also contributing to the higher net sales from M•A•C were targeted expanded consumer reach and strength in lip and foundation products. The net sales from Tom Ford also benefited from the strength in lip and eye products, including Lip Color Classic and Eye Quad, respectively.
Partially offsetting these increases were approximately $32 million of lower net sales of Too Faced and BECCA products, combined. The decrease was due, in part, to the decline in prestige makeup generally in North America. The lower net sales from BECCA also reflected a difficult comparison to certain prior-year launches.
The makeup net sales increase was impacted by approximately $16 million of unfavorable foreign currency translation.
Fragrance
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net sales | | $ | 462 | | $ | 472 |
$ Change from prior-year period | |
| (10) | |
|
|
% Change from prior-year period | |
| (2) | % |
|
|
| | | | | | |
Non-GAAP Financial Measure(1): | |
|
| |
|
|
% Change from prior-year period in constant currency | |
| (1) | % |
|
|
Reported fragrance net sales reflected decreases from certain of our designer fragrances and Estée Lauder of approximately $40 million, combined. Net sales declined from certain designer fragrances primarily due, in part, to an unfavorable comparison to certain prior-year launches in North America and declines in the specialty-multi and department store channels. The net sales decline from Estée Lauder was primarily due to an unfavorable comparison to the prior-year launch of Beautiful Belle in North America.
Partially offsetting these decreases were approximately $33 million of higher net sales from Jo Malone London and Tom Ford, combined. The net sales increase from Jo Malone London reflected double-digit growth in Asia/Pacific, led by China and Japan, and from our travel retail business primarily due to the continued success of certain hero franchises, new product launches, such as Poppy & Barley, and targeted expanded consumer reach. Net sales increased from Tom Ford across all geographic regions, which benefited from higher net sales from certain Private Blend franchises, as well as new product launches such as Métallique.
The fragrance net sales decrease included approximately $7 million of unfavorable foreign currency translation.
32
THE ESTÉE LAUDER COMPANIES INC.
Hair Care
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net sales | | $ | 136 | | $ | 143 |
$ Change from prior-year period | |
| (7) | |
|
|
% Change from prior-year period | |
| (5) | % |
|
|
| | | | | | |
Non-GAAP Financial Measure(1): | |
|
| |
|
|
% Change from prior-year period in constant currency | |
| (4) | % |
|
|
Reported hair care net sales decreased, reflecting lower net sales from Bumble and bumble and Aveda. Net sales declined from Bumble and bumble due to the continued softness in North America, which impacted the salon and specialty-multi channels. The lower net sales from Aveda was primarily due to an unfavorable comparison to the prior-year launch of Cherry Almond Softening Shampoo and Conditioner.
Geographic Regions
The Americas
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net sales | | $ | 1,160 | | $ | 1,236 |
$ Change from prior-year period | |
| (76) | |
|
|
% Change from prior-year period | |
| (6) | % |
|
|
| | | | | | |
Non-GAAP Financial Measure(1): | |
|
| |
|
|
% Change from prior-year period in constant currency | |
| (6) | % |
|
|
Reported net sales in The Americas decreased, reflecting lower net sales in the United States of approximately $83 million, primarily from Too Faced, M•A•C and BECCA. The decrease was due, in part, to the decline in prestige makeup generally in North America. Also contributing to the decline was an unfavorable comparison to prior-year launch activity from certain of our designer fragrances and BECCA.
Partially offsetting these decreases were increased net sales from Latin America of approximately $11 million, reflecting higher net sales from M•A•C due, in part, to new lipstick and eyeshadow launches in Brazil.
The net sales decrease in The Americas included approximately $4 million of favorable foreign currency translation.
33
THE ESTÉE LAUDER COMPANIES INC.
Europe, the Middle East & Africa
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net sales | | $ | 1,677 | | $ | 1,433 |
$ Change from prior-year period | |
| 244 | |
|
|
% Change from prior-year period | |
| 17 | % |
|
|
| | | | | | |
Non-GAAP Financial Measure(1): | |
|
| |
|
|
% Change from prior-year period in constant currency | |
| 19 | % |
|
|
Reported net sales in Europe, the Middle East & Africa increased, primarily reflecting higher net sales from our travel retail business of approximately $230 million. Net sales increased in our travel retail business across most brands, led by Estée Lauder, La Mer, M•A•C, Tom Ford and Origins, driven, in part, by increased passenger traffic, as well as new product launches, including Estée Lauder’s Advanced Night Repair Intense Reset Concentrate and a new larger size of The Treatment Lotion from La Mer. Also contributing to this increase was strategic investment spend supporting both new and existing products.
The net sales increase in Europe, the Middle East & Africa was impacted by approximately $24 million of unfavorable foreign currency translation.
Asia/Pacific
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net sales | | $ | 1,058 | | $ | 855 |
$ Change from prior-year period | |
| 203 | |
|
|
% Change from prior-year period | |
| 24 | % |
|
|
| | | | | | |
Non-GAAP Financial Measure(1): | |
|
| |
|
|
% Change from prior-year period in constant currency | |
| 26 | % |
|
|
Reported net sales in Asia/Pacific increased, reflecting higher net sales in China, Japan and Korea of approximately $209 million, combined. The higher net sales in China, led by Estée Lauder, La Mer, M•A•C and Tom Ford, reflected continued growth in skin care and makeup, as well as targeted expanded consumer reach, and new product launches, such as Estée Lauder’s Advanced Night Repair Intense Reset Concentrate and a new larger size of The Treatment Lotion from La Mer. The net sales increase in China benefited virtually every channel, led by online (due to the continued growth on Tmall), department stores, freestanding stores and specialty-multi. The net sales growth in Japan was primarily driven by M•A•C, Estée Lauder, La Mer, Jo Malone London and Clinique, reflecting the success of certain hero franchises, new product launches, such as The Regenerating Serum from La Mer, and targeted expanded consumer reach, which contributed to double-digit growth in all major product categories and growth in virtually every channel. The business in Japan benefited from consumer buying in anticipation of a value-added tax increase. Net sales increased in Korea primarily due to higher net sales from Estée Lauder and Jo Malone London and benefited from growth in our online and specialty-multi channels.
These increases were partially offset by lower net sales in Hong Kong of approximately $18 million, primarily due to the ongoing situation there that has negatively impacted traffic in downtown shops and the airport and also led to intermittent store closures.
The net sales increase in Asia/Pacific was impacted by approximately $20 million of unfavorable foreign currency translation.
We strategically time our new product launches by geographic market, which may account for differences in regional sales growth.
34
THE ESTÉE LAUDER COMPANIES INC.
GROSS MARGIN
Gross margin increased to 76.7% for the three months ended September 30, 2019 as compared with 76.6% in the prior-year period.
| | |
Favorable (Unfavorable) Basis Points | ||
Three Months Ended September 30, 2019 | ||
Mix of business |
| 80 |
Obsolescence charges |
| (60) |
Manufacturing costs and other |
| (30) |
Subtotal | | (10) |
Charges associated with restructuring and other activities |
| 20 |
Total |
| 10 |
The favorable impact from our mix of business primarily reflected favorable changes in strategic pricing and product category mix (i.e. more growth in our higher margin skin care category), partially offset by the unfavorable impact from new product introductions.
OPERATING EXPENSES
Operating expenses as a percentage of net sales decreased to 56.7% for the three months ended September 30, 2019 as compared with 58.1% in the prior-year period.
| | |
Favorable (Unfavorable) Basis Points | ||
Three Months Ended September 30, 2019 | ||
General and administrative expenses |
| 20 |
Advertising, merchandising, sampling and product development |
| (60) |
Selling |
| 130 |
Stock-based compensation |
| 10 |
Store operating costs |
| 30 |
Foreign currency transactions |
| (10) |
Subtotal |
| 120 |
Charges associated with restructuring and other activities |
| 60 |
Changes in fair value of contingent consideration |
| (40) |
Total |
| 140 |
The improvement in operating expense margin reflected a favorable impact from selling expenses primarily due to increased efficiencies in our sales operations and lower demonstration costs driven by changes in distribution channel mix. This improvement was partially offset by an increase in advertising and promotional activities primarily due to increased spend to support digital advertising, social media, locally relevant promotions, new product launches and targeted expanded consumer reach.
35
THE ESTÉE LAUDER COMPANIES INC.
OPERATING RESULTS
| | | | | | | |
| | Three Months Ended |
| ||||
| | September 30 |
| ||||
($ in millions) |
| 2019 |
| 2018 |
| ||
As Reported: |
| |
|
| |
| |
Operating income | | $ | 779 | | $ | 652 | |
$ Change from prior-year period | |
| 127 | |
| | |
% Change from prior-year period | |
| 19 | % |
| | |
| | | | | | | |
Operating margin | |
| 20.0 | % |
| 18.5 | % |
| | | | | | | |
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 and changes in fair value of contingent consideration | |
| 17 | % |
|
| |
The increase in reported operating margin for the three months ended September 30, 2019 over the prior-year period was driven by improvements in net sales, operating expenses as a percentage of net sales and the increase in gross margin, as previously noted.
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.
Product Categories
Skin Care
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Operating income | | $ | 632 | | $ | 466 |
$ Change from prior-year period | |
| 166 | |
|
|
% Change from prior-year period | |
| 36 | % |
|
|
Reported skin care operating income increased, primarily from Estée Lauder and La Mer reflecting higher net sales , partially offset by strategic investments in advertising and promotional activities and targeted expanded consumer reach of approximately $217 million, combined.
These increases in the category were partially offset by higher operating expenses relating primarily to investments in information systems and enhanced capabilities in select corporate functions to support our strategic initiatives.
Makeup
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Operating income | | $ | 104 | | $ | 161 |
$ Change from prior-year period | |
| (57) | |
|
|
% Change from prior-year period | |
| (35) | % |
|
|
36
THE ESTÉE LAUDER COMPANIES INC.
Reported makeup operating income decreased as a result of lower results from Too Faced, Bobbi Brown, BECCA, Tom Ford, Estée Lauder and M•A•C of approximately $56 million, combined. The decline in operating income from Too Faced and BECCA was primarily due to lower net sales. Operating results from Bobbi Brown decreased, primarily due to an increase in advertising and promotional activities to support new product launches and digital advertising. The operating income from Tom Ford, Estée Lauder and M•A•C declined, as increases in net sales were more than offset by investment spending to support continued net sales growth.
Partially offsetting these decreases were increases in operating results from Smashbox and La Mer of approximately $15 million, combined. The increase in operating income from Smashbox reflected a decrease in cost of sales due to the timing of shipments of promotional items and lower amortization expense relating to an intangible asset that was fully amortized in fiscal 2019. Operating results from La Mer increased primarily due to the increase in net sales, partially offset by the increase in advertising and promotional activities to support digital advertising, social media and locally relevant promotions.
Fragrance
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Operating income | | $ | 66 | | $ | 55 |
$ Change from prior-year period | |
| 11 | |
|
|
% Change from prior-year period | |
| 20 | % |
|
|
Reported fragrance operating income increased, reflecting higher results from Jo Malone London and Tom Ford of approximately $26 million, combined, due to higher net sales. The lower results from Estée Lauder, Clinique and certain of our designer fragrances of approximately $15 million, combined, reflected decreases in cost of sales and operating expenses, which were more than offset by the declines in net sales. Operating income from Clinique declined due to lower net sales.
Hair Care
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Operating income | | $ | — | | $ | 14 |
$ Change from prior-year period | |
| (14) | |
|
|
% Change from prior-year period | |
| (100) | % |
|
|
Reported hair care operating income decreased, primarily reflecting lower results from Aveda and Bumble and bumble primarily due to the decreases in net sales.
Geographic Regions
The Americas
| | | | | | |
|
| Three Months Ended | ||||
|
| September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Operating income | | $ | 175 | | $ | 234 |
$ Change from prior-year period | |
| (59) | |
|
|
% Change from prior-year period | |
| (25) | % |
|
|
Reported operating income in The Americas decreased, primarily reflecting lower results in the United States of approximately $66 million, due to the decline in net sales. Partially offsetting this decrease were higher results from Latin America of approximately $13 million, primarily as a result of higher net sales.
37
THE ESTÉE LAUDER COMPANIES INC.
Europe, the Middle East & Africa
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Operating income | | $ | 377 | | $ | 257 |
$ Change from prior-year period | |
| 120 | |
|
|
% Change from prior-year period | |
| 47 | % |
|
|
In Europe, the Middle East & Africa, reported operating income increased, reflecting higher results from our travel retail business of approximately $109 million, primarily driven by the increase in net sales.
Asia/Pacific
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Operating income | | $ | 252 | | $ | 208 |
$ Change from prior-year period | |
| 44 | |
|
|
% Change from prior-year period | |
| 21 | % |
|
|
Reported operating income increased in Asia/Pacific, primarily reflecting higher results in China, Japan and Korea of approximately $58 million, combined, driven by net sales growth. The net sales increase in China was partially offset by an increase in advertising and promotional activities to support digital advertising, social media and targeted expanded consumer reach. The growth in operating income was offset by lower results in Hong Kong caused by lower net sales, as previously noted.
INTEREST AND INVESTMENT INCOME
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
(In millions) |
| 2019 |
| 2018 | ||
Interest expense | | $ | 32 | | $ | 34 |
Interest income and investment income, net | | $ | 14 | | $ | 15 |
Interest expense decreased as compared with the prior-year period, primarily due to lower average debt balances. Interest income and investment income, net decreased primarily due to the decrease in interest rates and lower cash and investment balances.
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.
| | | | | |
| | Three Months Ended |
| ||
| | September 30 |
| ||
|
| 2019 |
| 2018 |
|
Effective rate for income taxes |
| 21.3 | % | 20.7 | % |
Basis-point change from prior year |
| 60 |
|
| |
38
THE ESTÉE LAUDER COMPANIES INC.
The effective rate for income taxes was 21.3% and 20.7% for the three months ended September 30, 2019 and 2018, respectively. The increase in the effective tax rate of 60 basis points was primarily attributable to a higher effective tax rate on our foreign operations partially offset by a higher benefit related to share-based compensation awards.
NET EARNINGS ATTRIBUTABLE TO THE ESTÉE LAUDER COMPANIES INC.
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
($ in millions, except per share data) |
| 2019 |
| 2018 | ||
As Reported: |
| |
|
| |
|
Net earnings attributable to The Estée Lauder Companies Inc. | | $ | 595 | | $ | 500 |
$ Change from prior-year period | |
| 95 | |
|
|
% Change from prior-year period | |
| 19 | % |
|
|
Diluted net earnings per common share | | $ | 1.61 | | $ | 1.34 |
% Change from prior-year period | |
| 21 | % |
|
|
| | | | | | |
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, changes in fair value of contingent consideration, the Transition Tax, and the establishment of a net deferred tax liability related to foreign withholding taxes on certain foreign earnings resulting from the Tax Cuts and Jobs Act (“TCJA”) | |
| 19 | % |
|
|
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; the changes in the fair value of contingent consideration; the Transition Tax and 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.
39
THE ESTÉE LAUDER COMPANIES INC.
The tables provide reconciliations between these non-GAAP financial measures and the most directly comparable U.S. GAAP measures.
| | | | | | | | | | | | | | |
| | Three Months Ended | | | | | | | % Change |
| ||||
| | September 30 | | | | | % | | in Constant |
| ||||
($ in millions, except per share data) |
| 2019 |
| 2018 |
| Variance |
| Change |
| Currency |
| |||
Net sales, as reported | | $ | 3,895 | | $ | 3,524 | | $ | 371 |
| 11 | % | 12 | % |
Returns associated with restructuring and other activities | |
| — | |
| — | |
| — |
|
|
|
| |
Net sales, as adjusted | | $ | 3,895 | | $ | 3,524 | | $ | 371 |
| 11 | % | 12 | % |
| | | | | | | | | | | | | | |
Operating income, as reported | | $ | 779 | | $ | 652 | | $ | 127 |
| 19 | % | 20 | % |
Charges associated with restructuring and other activities | |
| 25 | |
| 47 | |
| (22) |
|
|
|
| |
Changes in fair value of contingent consideration | |
| — | |
| (11) | |
| 11 |
|
|
|
| |
Operating income, as adjusted | | $ | 804 | | $ | 688 | | $ | 116 |
| 17 | % | 17 | % |
Diluted net earnings per common share, as reported | | $ | 1.61 | | $ | 1.34 | | $ | .27 |
| 21 | % | 22 | % |
Charges associated with restructuring and other activities | |
| .06 | |
| .10 | |
| (.04) |
|
|
|
| |
Changes in fair value of contingent consideration | |
| — | |
| (.02) | |
| .02 |
|
|
|
| |
Transition Tax resulting from the TCJA | |
| — | |
| (.03) | |
| .03 |
|
|
|
| |
Net deferred tax liability related to foreign withholding taxes on certain foreign earnings resulting from the TCJA | |
| — | |
| .02 | |
| (.02) |
|
|
|
| |
Diluted net earnings per common share, as adjusted | | $ | 1.67 | | $ | 1.41 | | $ | .26 |
| 19 | % | 20 | % |
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.
40
THE ESTÉE LAUDER COMPANIES INC.
The following table reconciles 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 | | | | | | | | | | |
| |||||||
|
| | |
| | |
| | |
| | |
| | |
| |
| % |
|
| | Three months | | Three months | | | | | Impact of | | | | | % | | Change, |
| |||
| | ended | | ended | | | | | foreign | | Variance, | | Change, | | in |
| ||||
| | September 30, | | September 30, | | | | | currency | | in constant | | as | | constant |
| ||||
($ in millions) | | 2019 | | 2018 | | Variance | | translation | | currency | | reported | | currency |
| |||||
By Product Category: |
| |
|
| |
|
| |
|
| |
|
| |
|
|
|
|
| |
Skin Care | | $ | 1,842 | | $ | 1,486 | | $ | 356 | | $ | 16 | | $ | 372 |
| 24 | % | 25 | % |
Makeup | |
| 1,443 | |
| 1,406 | |
| 37 | |
| 16 | |
| 53 |
| 3 |
| 4 | |
Fragrance | |
| 462 | |
| 472 | |
| (10) | |
| 7 | |
| (3) |
| (2) |
| (1) | |
Hair Care | |
| 136 | |
| 143 | |
| (7) | |
| 1 | |
| (6) |
| (5) |
| (4) | |
Other | |
| 12 | |
| 17 | |
| (5) | |
| — | |
| (5) |
| (29) |
| (29) | |
| |
| 3,895 | |
| 3,524 | |
| 371 | |
| 40 | |
| 411 |
| 11 | | 12 | |
Returns associated with restructuring and other activities | |
| — | |
| — | |
| — | |
| — | |
| — |
| |
| | |
Total | | $ | 3,895 | | $ | 3,524 | | $ | 371 | | $ | 40 | | $ | 411 |
| 11 | % | 12 | % |
| | | | | | | | | | | | | | | | | | | | |
By Region: | |
|
| |
|
| |
|
| |
|
| |
|
|
|
|
|
| |
The Americas | | $ | 1,160 | | $ | 1,236 | | $ | (76) | | $ | (4) | | $ | (80) |
| (6) | % | (6) | % |
Europe, the Middle East & Africa | |
| 1,677 | |
| 1,433 | |
| 244 | |
| 24 | |
| 268 |
| 17 |
| 19 | |
Asia/Pacific | |
| 1,058 | |
| 855 | |
| 203 | |
| 20 | |
| 223 |
| 24 |
| 26 | |
| |
| 3,895 | |
| 3,524 | |
| 371 | |
| 40 | |
| 411 |
| 11 | | 12 | |
Returns associated with restructuring and other activities | |
| — | |
| — | |
| — | |
| — | |
| — |
| |
| | |
Total | | $ | 3,895 | | $ | 3,524 | | $ | 371 | | $ | 40 | | $ | 411 |
| 11 | % | 12 | % |
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 September 30, 2019, we had cash and cash equivalents of $2,259 million compared with $2,987 million at June 30, 2019. 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.
41
THE ESTÉE LAUDER COMPANIES INC.
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. As a result, we changed our indefinite reinvestment assertion related to certain foreign earnings, and we continue to analyze the indefinite reinvestment assertion on our remaining applicable foreign earnings. Our cash and cash equivalents balance at September 30, 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 October 24, 2019, our commercial paper is rated A-1 by Standard & Poor’s and P-1 by Moody’s, and our long-term debt is rated A+ with a stable outlook by Standard & Poor’s and A2 with a stable outlook by Moody’s.
Debt
At September 30, 2019, our outstanding borrowings were as follows:
| | | | | | | | | |
|
| Long-term |
| Current |
| | | ||
($ in millions) | | Debt | | 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) | |
| 253 | |
| — | |
| 253 |
1.70% Senior Notes, due May 10, 2021 (“2021 Senior Notes”) (8), (10) | |
| 448 | |
| — | |
| 448 |
1.80% Senior Notes, due February 7, 2020 (“2020 Senior Notes”) (9), (10) | |
| — | |
| 500 | |
| 500 |
Other borrowings | |
| 9 | |
| 20 | |
| 29 |
| | $ | 2,895 | | $ | 520 | | $ | 3,415 |
| (1) | Consists of $500 million principal, 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 $4 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 $1 million adjustment to reflect the fair value of interest rate swaps and debt issuance costs of $1 million. |
| (9) | Consists of $500 million principal |
| (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% and 44 % at September 30, 2019 and June 30, 2019, respectively.
42
THE ESTÉE LAUDER COMPANIES INC.
Cash Flows
| | | | | | |
| | Three Months Ended | ||||
| | September 30 | ||||
(In millions) |
| 2019 |
| 2018 | ||
Net cash used for operating activities | | $ | (170) | | $ | (119) |
Net cash provided by (used for) investing activities | | $ | (128) | | $ | 31 |
Net cash used for financing activities | | $ | (416) | | $ | (642) |
The change in net cash used for operating activities reflected an unfavorable net change in working capital, primarily accounts payable due to the timing and level of payments, partially offset by higher net earnings.
The change in net cash flows from investing activities primarily reflected lower proceeds from the sale of investments due to the prior-year liquidation of our foreign subsidiary that owned our available-for-sale securities.
The change in net cash flows from financing activities primarily reflected lower treasury stock purchases.
Dividends
For a summary of quarterly cash dividends declared per share on our Class A and Class B Common Stock during the three months ended September 30, 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, 2019.
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, 2019. 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 portfolio would have resulted in a net increase (decrease) in the fair value of our portfolio of approximately $(141) million and $48 million as of September 30, 2019 and June 30, 2019, respectively. This potential change does not consider our underlying foreign currency exposures.
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THE ESTÉE LAUDER COMPANIES INC.
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 increase (decrease) by approximately $33 million and $(16) million as of September 30, 2019 and June 30, 2019, 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.
OFF-BALANCE SHEET ARRANGEMENTS
We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities 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, 2019, 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, 2019, 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, other performance measures, 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; |
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THE ESTÉE LAUDER COMPANIES INC.
| (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 timing or 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; |
| (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, 2019. |
We assume no responsibility to update forward-looking statements made herein or otherwise.
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THE ESTÉE LAUDER COMPANIES INC.
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 September 30, 2019 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date.
As part of the Company’s review of internal control over financial reporting, we make changes to systems and processes to improve such controls and increase efficiencies, while ensuring that we maintain an effective internal control environment. 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 first quarter of fiscal 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. As of the beginning of fiscal 2020, we adopted FASB Accounting Standards Codification Topic 842 – Leases. We implemented lease accounting software to facilitate the calculations of the accounting entries and disclosures in accordance with the standard and implemented new business processes and internal controls related to the recognition, measurement and disclosure of our leases under the standard, none of which materially affected our internal control over financial reporting.
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:
| | | | | | | | | |
|
| |
| | |
| Total Number of |
| Maximum |
| | | | | | | Shares Purchased | | Number of Shares |
| | Total Number | | Average Price | | as Part of Publicly | | that May Yet Be | |
| | of Shares | | Paid Per | | Announced | | Purchased Under | |
Period | | Purchased(1) | | Share | | Program | | the Program(2) | |
July 2019 |
| 126,230 | | $ | 182.74 |
| 126,230 |
| 38,616,620 |
August 2019 |
| 508,491 | |
| 182.08 |
| 508,491 |
| 38,108,129 |
September 2019 |
| 1,002,411 | |
| 196.71 |
| 820,000 |
| 37,288,129 |
|
| 1,637,132 | |
| 191.09 |
| 1,454,721 | | |
| (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 Board of Directors last authorized an increase to the share repurchase program by 40.0 million shares on October 31, 2018. Our repurchase program does not have an expiration date. |
Subsequent to September 30, 2019 and as of October 24, 2019, we purchased approximately 1.0 million additional shares of our Class A Common Stock for $195 million pursuant to our share repurchase program.
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THE ESTÉE LAUDER COMPANIES INC.
Item 6. Exhibits.
| ||
Exhibit | | Description |
10.1 | | |
10.2 | | |
31.1 | | |
31.2 | | |
32.1 | | |
32.2 | | |
101.1 | | The following materials from The Estée Lauder Companies Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019 are formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) the Consolidated Statements of Earnings, (ii) the Consolidated Statements of Comprehensive Income (Loss), (iii) the Consolidated Balance Sheets, (iv) the Consolidated Statements of Cash Flows and (v) Notes to Consolidated Financial Statements |
104 | | The cover page from The Estée Lauder Companies Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019 is formatted in iXBRL |
† Exhibit is a management contract or compensatory plan or arrangement.
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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: October 31, 2019 | By: | |
| | |
| | Executive Vice President and Chief Financial Officer |
| | (Principal Financial and Accounting Officer) |
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| This ‘10-Q’ Filing | Date | Other Filings | ||
|---|---|---|---|---|
 | ||||
| 5/15/37 | ||||
| 10/15/33 | ||||
| 3/15/27 | ||||
| 8/15/22 | ||||
| 6/30/22 | ||||
| 5/10/21 | ||||
| 2/7/20 | 4, SC 13G/A | |||
| 12/16/19 | 4 | |||
| 11/29/19 | ||||
| Filed on: | 10/31/19 | 4, 8-K | ||
| 10/30/19 | 8-K | |||
| 10/24/19 | ||||
| For Period end: | 9/30/19 | |||
| 9/16/19 | 4 | |||
| 8/30/19 | 4 | |||
| 8/16/19 | 8-K | |||
| 7/1/19 | ||||
| 6/30/19 | 10-K | |||
| 10/31/18 | 10-Q, 4, 8-K | |||
| 9/30/18 | 10-Q | |||
| List all Filings | ||||
As Of Filer Filing For·On·As Docs:Size Issuer Filing Agent 8/18/23 Estee Lauder Companies Inc. 10-K 6/30/23 158:26M 8/24/22 Estee Lauder Companies Inc. 10-K 6/30/22 161:35M 8/27/21 Estee Lauder Companies Inc. 10-K 6/30/21 165:28M 8/28/20 Estee Lauder Companies Inc. 10-K 6/30/20 162:32M |