Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2019
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-14064
The Estée Lauder Companies Inc.
(Exact name of registrant as specified in its charter)
Delaware(State or other jurisdiction of incorporation or organization)
11-2408943(I.R.S. Employer Identification No.)
767 Fifth Avenue, New York, New York(Address of principal executive offices)
10153(Zip Code)
212-572-4200
(Registrant’s telephone number, including area code)
Not Applicable
(Former name or former address, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A Common Stock, $.01 par value
EL
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ⌧
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ⌧
At January 30, 2020, 222,319,332 shares of the registrant’s Class A Common Stock, $.01 par value, and 137,220,914 shares of the registrant’s Class B Common Stock, $.01 par value, were outstanding.
THE ESTÉE LAUDER COMPANIES INC.
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Earnings —Three and Six Months Ended December 31, 2019 and 2018
2
Consolidated Statements of Comprehensive Income (Loss) —Three and Six Months Ended December 31, 2019 and 2018
3
Consolidated Balance Sheets —December 31, 2019 and June 30, 2019 (Audited)
4
Consolidated Statements of Cash Flows —Six Months Ended December 31, 2019 and 2018
5
Notes to Consolidated Financial Statements
6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
33
Item 3. Quantitative and Qualitative Disclosures About Market Risk
55
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
56
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
57
Signatures
58
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended
Six Months Ended
December 31
(In millions, except per share data)
2019
2018
Net sales
$
4,624
4,005
8,519
7,529
Cost of sales
1,041
910
1,949
1,733
Gross profit
3,583
3,095
6,570
5,796
Operating expenses
Selling, general and administrative
2,538
2,257
4,723
4,265
Restructuring and other charges
7
29
30
70
Goodwill impairment
511
20
Impairment of other intangible assets
266
18
Total operating expenses
3,322
2,324
5,530
4,373
Operating income
261
771
1,040
1,423
Interest expense
38
35
69
Interest income and investment income, net
13
12
27
Other components of net periodic benefit cost
1
—
Other income
576
Earnings before income taxes
811
748
1,571
1,381
Provision for income taxes
250
171
412
302
Net earnings
561
577
1,159
1,079
Net earnings attributable to noncontrolling interests
(4)
(7)
(6)
Net earnings attributable to The Estée Lauder Companies Inc.
557
573
1,152
1,073
Net earnings attributable to The Estée Lauder Companies Inc. per common share
Basic
1.55
1.58
3.19
2.94
Diluted
1.52
3.13
2.88
Weighted-average common shares outstanding
360.2
363.3
360.8
365.1
366.7
369.9
367.7
372.1
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In millions)
Other comprehensive income (loss):
Net unrealized investment gain
Net cash flow hedge gain (loss)
(22)
9
(24)
Amounts included in net periodic benefit cost
10
Translation adjustments
64
(38)
(15)
Benefit (provision) for deferred income taxes on components of other comprehensive income
(3)
Total other comprehensive income (loss)
Comprehensive income
618
555
1,082
Comprehensive income attributable to noncontrolling interests:
(5)
Comprehensive income attributable to The Estée Lauder Companies Inc.
615
552
1,146
1,077
CONSOLIDATED BALANCE SHEETS
June 30
(In millions, except share data)
ASSETS
Current assets
Cash and cash equivalents
3,596
2,987
Accounts receivable, net
2,225
1,831
Inventory and promotional merchandise
2,058
2,006
Prepaid expenses and other current assets
469
388
Total current assets
8,348
7,212
Property, plant and equipment, net
2,086
2,068
Other assets
Operating lease right-of-use assets
2,517
Goodwill
1,920
1,868
Other intangible assets, net
2,342
1,203
724
805
Total other assets
7,503
3,876
Total assets
17,937
13,156
LIABILITIES AND EQUITY
Current liabilities
Current debt
522
516
Accounts payable
1,137
1,490
Operating lease liabilities
369
Other accrued liabilities
2,925
2,599
Total current liabilities
4,953
4,605
Noncurrent liabilities
Long-term debt
4,662
2,896
Long-term operating lease liabilities
2,318
Other noncurrent liabilities
1,403
1,244
Total noncurrent liabilities
8,383
4,140
Contingencies
Equity
Common stock, $.01 par value; Class A shares authorized: 1,300,000,000 at December 31, 2019 and June 30, 2019; shares issued: 448,452,843 at December 31, 2019 and 443,685,124 at June 30, 2019; Class B shares authorized: 304,000,000 at December 31, 2019 and June 30, 2019; shares issued and outstanding: 137,220,914 at December 31, 2019 and 139,537,814 at June 30, 2019
Paid-in capital
4,615
4,403
Retained earnings
10,775
9,984
Accumulated other comprehensive loss
(569)
(563)
14,827
13,830
Less: Treasury stock, at cost; 226,278,070 Class A shares at December 31, 2019 and 222,120,630 Class A shares at June 30, 2019
(10,253)
(9,444)
Total stockholders’ equity – The Estée Lauder Companies Inc.
4,574
4,386
Noncontrolling interests
25
Total equity
4,601
4,411
Total liabilities and equity
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities
Adjustments to reconcile net earnings to net cash flows from operating activities:
Depreciation and amortization
287
269
Deferred income taxes
(46)
Non-cash stock-based compensation
139
131
Net loss on disposal of property, plant and equipment
Pension and post-retirement benefit expense
41
Pension and post-retirement benefit contributions
(33)
(12)
Goodwill and other intangible asset impairments
777
Changes in fair value of contingent consideration
(9)
Gain on previously held equity method investment
(553)
Other non-cash items
(10)
(13)
Changes in operating assets and liabilities:
Increase in accounts receivable, net
(347)
(343)
Decrease (increase) in inventory and promotional merchandise
31
(21)
Increase in other assets, net
(120)
(53)
Decrease in accounts payable
(375)
(174)
Increase in other accrued and noncurrent liabilities
252
387
Increase in operating lease assets and liabilities, net
Net cash flows provided by operating activities
1,255
1,273
Cash flows from investing activities
Capital expenditures
(291)
(292)
Payments for acquired businesses, net of cash acquired
(1,040)
Proceeds from the disposition of investments
271
Purchases of investments
(14)
Settlement of net investment hedges
Net cash flows used for investing activities
(1,350)
(35)
Cash flows from financing activities
Proceeds (repayments) of current debt, net
8
(169)
Proceeds from issuance of long-term debt, net
1,783
Debt issuance costs
Repayments and redemptions of long-term debt
(8)
Net proceeds from stock-based compensation transactions
71
59
Payments to acquire treasury stock
(813)
(1,126)
Payments of contingent consideration
Dividends paid to stockholders
(330)
(297)
Payments to noncontrolling interest holders for dividends
Net cash flows provided by (used for) financing activities
687
(1,536)
Effect of exchange rate changes on Cash and cash equivalents
17
Net increase (decrease) in Cash and cash equivalents
609
(305)
Cash and cash equivalents at beginning of period
2,181
Cash and cash equivalents at end of period
1,876
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of The Estée Lauder Companies Inc. and its subsidiaries (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated.
The unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments of a normal recurring nature considered necessary for a fair presentation have been included. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
Certain amounts in the consolidated financial statements of prior years have been reclassified to conform to current year presentation.
Management Estimates
The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses reported in those financial statements. Descriptions of the Company’s significant accounting policies are discussed in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019. Management evaluates the related estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, and makes adjustments when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from those estimates and assumptions. Significant changes, if any, in those estimates and assumptions resulting from continuing changes in the economic environment will be reflected in the consolidated financial statements in future periods.
Currency Translation and Transactions
All assets and liabilities of foreign subsidiaries and affiliates are translated at period-end rates of exchange, while revenue and expenses are translated at weighted-average rates of exchange for the period. Unrealized translation gains (losses), net of tax, reported as cumulative translation adjustments through other comprehensive income (loss) (“OCI”) attributable to The Estée Lauder Companies Inc. were $75 million and $(34) million, net of tax, during the three months ended December 31, 2019 and 2018, respectively, and $3 million and $(13) million, net of tax, during the six months ended December 31, 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. Beginning in 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 7 - 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 gains (losses) on foreign currency transactions of $27 million and $(7) million during the three months ended December 31, 2019 and 2018, respectively, and $24 million and $(21) million during the six months ended December 31, 2019 and 2018, respectively.
Concentration of Credit Risk
The Company is a worldwide manufacturer, marketer and distributor of skin care, makeup, fragrance and hair care products. The Company’s sales subject to credit risk are made primarily to department stores, perfumeries, specialty multi-brand retailers and retailers in its travel retail business. The Company grants credit to qualified customers and does not believe it is exposed significantly to any undue concentration of credit risk.
Inventory and Promotional Merchandise
Inventory and promotional merchandise consists of:
Raw materials
519
541
Work in process
237
268
Finished goods
1,101
981
Promotional merchandise
201
216
Property, Plant and Equipment
Assets (Useful Life)
Land
Buildings and improvements (10 to 40 years)
367
337
Machinery and equipment (3 to 10 years)
836
Computer hardware and software (4 to 10 years)
1,308
1,264
Furniture and fixtures (5 to 10 years)
117
116
Leasehold improvements
2,385
2,274
5,042
4,831
Less accumulated depreciation and amortization
(2,956)
(2,763)
The cost of assets related to projects in progress of $503 million and $474 million as of December 31, 2019 and June 30, 2019, respectively, is included in their respective asset categories above. Depreciation and amortization of property, plant and equipment was $127 million and $121 million during the three months ended December 31, 2019 and 2018, respectively, and $252 million and $237 million during the six months ended December 31, 2019 and 2018, respectively. Depreciation and amortization related to the Company’s manufacturing process is included in Cost of sales, and all other depreciation and amortization is included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings.
Income Taxes
The effective rate for income taxes was 30.8% and 22.9% for the three months ended December 31, 2019 and 2018, respectively, and 26.2% and 21.9% for the six months ended December 31, 2019 and 2018, respectively. The increase in the effective tax rate in both periods was primarily attributable to the impact of nondeductible goodwill impairment charges associated with the Company's Too Faced, BECCA and Smashbox reporting units and to a higher effective tax rate on the Company's foreign operations.
As of December 31, 2019 and June 30, 2019, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $67 million. The total amount of unrecognized tax benefits at December 31, 2019 that, if recognized, would affect the effective tax rate was $50 million. The total gross interest and penalties accrued related to unrecognized tax benefits during the three and six months ended December 31, 2019 in the accompanying consolidated statements of earnings was $1 million and $2 million, respectively. At December 31, 2019 and June 30, 2019, the total gross accrued interest and penalties in the accompanying consolidated balance sheets was $12 million. On the basis of the information available as of December 31, 2019, the Company does not expect significant changes to the total amount of unrecognized tax benefits within the next twelve months.
Other Accrued Liabilities
Other accrued liabilities consist of the following:
Advertising, merchandising and sampling
416
352
Employee compensation
437
574
Deferred revenue
378
314
Payroll and other taxes
325
221
Accrued general and administrative expenses
256
195
Other
1,113
943
Recently Adopted Accounting Standards
Leases (Accounting Standards Codification ("ASC") Topic 842 - Leases ("ASC 842"))
In February 2016, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance that requires lessees to account for most leases on their balance sheets with the liability being equal to the present value of the lease payments. The right-of-use asset is based on the lease liability adjusted for certain costs such as initial direct costs, prepaid lease payments and lease incentives received. Lease expense is recognized similar to previous accounting guidance with operating leases resulting in a straight-line expense, and finance leases resulting in a front-loaded expense similar to the previous accounting for capital leases.
In July 2018, the FASB amended this guidance to clarify certain narrow aspects of the new lease accounting standard that may have been incorrectly or inconsistently applied, and did not add new guidance. Also, in July 2018, the FASB issued authoritative guidance that allows companies to elect to adopt the new standard using a modified retrospective transition approach with a cumulative-effect adjustment to retained earnings in the period of adoption. Companies that elect the new adoption method were not required to restate the prior comparative periods in the financial statements.
Effective for the Company – Fiscal 2020 first quarter. An entity is permitted to apply the foregoing guidance using either of the modified retrospective transition approaches described in the standard, with certain practical expedients.
Impact on consolidated financial statements - On July 1, 2019, the Company adopted ASC 842, see Note 4 - 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.
In November 2019, the FASB issued authoritative guidance (Accounting Standards Update (“ASU”) 2019-11 - Codification Improvements to Topic 326, Financial Instruments – Credit Losses) that amends ASC Topic 326 to clarify, improve and amend certain aspects of this guidance, such as disclosures related to accrued interest receivables and the estimation of credit losses associated with financial assets secured by collateral.
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.
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.
Income Taxes (ASU 2019-12 – Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes)
In December 2019, the FASB issued authoritative guidance that simplifies the accounting for income taxes by removing certain exceptions and making simplifications in other areas.
Effective for the Company – Fiscal 2022 first quarter, with early adoption permitted in any interim period. If adopted early, the Company must adopt all the amendments in the same period. The amendments have differing adoption methods including retrospectively, prospectively and/or modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption, depending on the specific change.
Impact on consolidated financial statements – The Company is currently evaluating the impact of applying this guidance and believes that it has transactions that may fall under the scope.
No other recently issued accounting pronouncements are expected to have a material impact on the Company’s consolidated financial statements.
NOTE 2 –ACQUISITION OF BUSINESS
On December 18, 2019, the Company acquired the remaining 66.66% equity interest in Have&Be Co. Ltd. (“Have & Be”), the global skin care company behind Dr. Jart+ and men’s grooming brand Do The Right Thing, for $1,268 million in cash. This acquisition is expected to further strengthen the Company’s leadership position in skin care and expand its consumer reach in Asia/Pacific, North America, the United Kingdom and travel retail. We originally acquired a minority interest in Have & Be in December 2015, and that investment structure included a formula-based call option for the remaining equity interest. The original minority interest was accounted for as an equity method investment, which had a carrying value of $133 million at the acquisition date. The acquisition of the remaining equity interest in Have & Be was considered a step acquisition, whereby the Company remeasured the previously held equity method investment to its fair value of $682 million, resulting in the recognition of a gain of $549 million. The acquisition of the remaining equity interest also resulted in the recognition of a previously unrealized foreign currency gain of $4 million, which was reclassified from accumulated OCI. The total gain on the Company’s previously held equity method investment of $553 million is included in Other income in the accompanying consolidated statements of earnings for the three and six months ended December 31, 2019. The fair value of the previously held equity method investment was determined based upon a valuation of the acquired business, as of the date of acquisition, using an equal weighting of the income and market approaches, utilizing estimated cash flows and a terminal value, discounted at a rate of return that reflects the relative risk of the cash flows, as well as valuation multiples derived from comparable publicly traded companies. The accounting for the Have & Be business combination is provisional pending finalization of the Have & Be calendar 2019 audited financial statements, working capital adjustments, and allocation of the total consideration transferred.
The amount paid at closing was funded by cash on hand including the proceeds from the issuance of debt. In anticipation of the closing, the Company transferred cash to a foreign subsidiary for purposes of making the closing payment. As a result, the Company recognized a foreign currency gain of $23 million, which is also included in Other income in the accompanying consolidated statements of earnings for the three and six months ended December 31, 2019.
The Company recorded a preliminary allocation of the total consideration transferred, which includes the cash paid at closing and the fair value of its previously held equity method investment, to the tangible and identifiable intangible assets acquired and liabilities assumed based on their fair value at the acquisition date. The excess of the total consideration transferred over the fair value of the net tangible and intangible assets acquired was recorded as goodwill. The preliminary allocation of the total consideration transferred has been recorded as follows:
(In millions, unaudited)
Cash
228
Accounts receivable
48
Inventory
83
Other current assets
Property, plant and equipment
Right-of-use assets
Intangible assets
1,427
556
Other long-term assets
Total assets acquired
2,356
22
Lease liability
Total liabilities assumed
402
Total consideration transferred
1,954
The results of operations of Have & Be will be reported in future periods on a one-month lag to facilitate consolidated reporting. Accordingly, operating income for the three and six months ended December 31, 2019 does not include the results of operations of Have & Be since the date of acquisition, which were not material. Acquisition-related costs, which primarily include financial advisory, accounting and legal fees, in the amount of $6 million are included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings for the three and six months ended December 31, 2019. Pro forma results of operations reflecting the acquisition of Have & Be are not presented, as the impact on the Company’s consolidated financial results would not have been material.
NOTE 3 – GOODWILL AND OTHER INTANGIBLE ASSETS
As previously discussed in Note 2 – Acquisition of Business, in December 2019, the Company acquired Have & Be, which included the addition of goodwill of $556 million, amortizable intangible assets (customer lists) of $842 million with amortization periods of 7.5 years to 17.5 years, and non-amortizable intangible assets (trademarks) of $585 million. Goodwill associated with the acquisition is primarily attributable to the future revenue growth opportunities associated with additional share in the skin care category, as well as the value associated with assembled workforce. As such, the goodwill has been allocated to the Company’s skin care product category. The goodwill recorded in connection with this acquisition is not expected to be deductible for tax purposes. These amounts are provisional pending finalization of the Have & Be calendar 2019 audited financial statements, working capital adjustments, and allocation of the total consideration transferred.
During the six months ended December 31, 2019, the Company recognized $7 million of goodwill associated with the continuing earn-out obligations related to the acquisition of the Bobbi Brown brand.
The intangible assets acquired in connection with the acquisition of Have & Be are classified as level 3 in the fair value hierarchy. The estimate of the fair values of the acquired amortizable intangible assets were determined using a multi-period excess earnings income approach by discounting the incremental after-tax cash flows over multiple periods. Fair value was determined under this approach by estimating future cash flows over multiple periods, as well as a terminal value, and discounting such cash flows at a rate of return that reflects the relative risk of the cash flows. The estimate of the fair values of the acquired intangible assets not subject to amortization were determined using an income approach, specifically the relief-from-royalty method. This method assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to obtain the rights to use the comparable asset.
The following table presents goodwill by product category and the related change in the carrying amount:
Skin Care
Makeup
Fragrance
Hair Care
Total
Balance as of June 30, 2019
185
1,199
254
390
2,028
Accumulated impairments
(36)
(68)
(34)
(160)
149
1,131
232
356
Goodwill acquired during the period
563
Impairment charges
(511)
Translation adjustments, goodwill
(1)
Translation adjustments, accumulated impairments
(504)
52
Balance as of December 31, 2019
740
1,206
2,590
(579)
(670)
705
627
Other intangible assets consist of the following:
December 31, 2019
June 30, 2019
Gross
Total Net
Carrying
Accumulated
Book
Value
Amortization
Amortizable intangible assets:
Customer lists and other
1,524
389
1,135
684
315
License agreements
43
1,567
432
727
Non-amortizable intangible assets:
Trademarks
1,207
888
Total intangible assets
The aggregate amortization expense related to amortizable intangible assets was $11 million and $12 million for the three months ended December 31, 2019 and 2018, respectively, and was $22 million and $25 million for the six months ended December 31, 2019 and 2018, respectively. The estimated aggregate amortization expense for the remainder of fiscal 2020 and for each of the next four fiscal years is as follows:
Fiscal
2020
2021
2022
2023
2024
Estimated aggregate amortization expense
53
104
103
101
11
Impairment Testing During the Six Months Ended December 31, 2019
During December 2019, given the continuing declines in prestige makeup, generally in North America, and the ongoing competitive activity, the Company’s Too Faced, BECCA and Smashbox reporting units made revisions to their internal forecasts concurrent with the Company's brand strategy review process. The Company concluded that the changes in circumstances in these reporting units triggered the need for an interim impairment review of their respective trademarks and goodwill. These changes in circumstances were also an indicator that the carrying amounts of their respective long-lived assets, including customer lists, may not be recoverable. Accordingly, the Company performed interim impairment tests for the trademarks and recoverability tests for the long-lived assets as of December 31, 2019. The Company concluded that the carrying amounts of the long-lived assets were recoverable. The Company also concluded that the carrying values of the trademarks exceeded their estimated fair values, which were determined utilizing the relief-from-royalty method to determine discounted projected future cash flows, and recorded impairment charges. After adjusting the carrying value of the trademarks, the Company completed interim quantitative impairment tests for goodwill and recorded goodwill impairment charges for each of these reporting units. The fair value of each reporting unit was based upon an equal weighting of the income and market approaches, utilizing estimated cash flows and a terminal value, discounted at a rate of return that reflects the relative risk of the cash flows, as well as valuation multiples derived from comparable publicly traded companies that are applied to operating performance of the reporting unit. A summary of the impairment charges for the three and six months ended December 31, 2019 and the remaining trademark and goodwill carrying values as of December 31, 2019, for each reporting unit, are as follows:
Impairment Charge
Carrying Value
Reporting Unit:
Trademark
Too Faced
211
430
175
BECCA
65
63
Smashbox
46
26
264
The impairment charges were reflected in the makeup product category and in The Americas region.
Impairment Testing During the Six Months Ended December 31, 2018
During December 2018, the Company’s Smashbox reporting unit made revisions to its internal forecasts reflecting a slowdown of its makeup business driven by increased competitive activity and lower than expected growth in key retail channels for the brand. The Company concluded that these changes in circumstances in the Smashbox reporting unit triggered the need for an interim impairment review of its trademark and goodwill. Accordingly, the Company performed an interim impairment test as of December 31, 2018. The Company concluded that the carrying value of the Smashbox trademark exceeded its estimated fair value, which was determined utilizing a royalty rate to determine discounted projected future cash flows. As a result, the Company recognized an impairment charge of $18 million for the trademark. After adjusting the carrying value of the trademark, the Company completed an interim quantitative impairment test for goodwill and recorded a goodwill impairment charge related to the Smashbox reporting unit of $20 million. The Company compared the fair value of the Smashbox reporting unit with its carrying amount to calculate the impairment charge. The fair value of the reporting unit was based upon an equal weighting of the income and market approaches, utilizing estimated cash flows and a terminal value, discounted at a rate of return that reflects the relative risk of the cash flows, as well as valuation multiples derived from comparable publicly traded companies that are applied to operating performance of the reporting unit. These impairment charges were reflected in the makeup product category and in The Americas region.
NOTE 4 - 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 statements 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.
Upon the adoption of ASC 842, the Company made the following accounting policy elections:
As a result of the adoption of ASC 842, the Company recorded a cumulative adjustment of $29 million, net of tax, as a reduction to its fiscal 2020 opening balance of retained earnings, primarily to reflect the fair value of operating lease ROU assets that were impaired at, or prior to, the adoption date. In addition, the Company recognized operating lease ROU assets and liabilities of $2,598 million and $2,764 million, respectively, as of July 1, 2019. Finance lease ROU assets and liabilities are not material.
The Company has operating and finance leases primarily for real estate properties, including corporate offices, facilities to support the Company's manufacturing, assembly, research and development and distribution operations and retail stores, as well as information technology equipment, automobiles and office equipment, with remaining terms of approximately 1 year to 51 years. Some of the Company's lease contracts include options to extend the leases for up to 30 years, while others include options to terminate the leases within 34 years.
A summary of total lease costs and other information for the periods relating to the Company's finance and operating leases is as follows:
Total lease cost
Finance lease cost:
Amortization of right-of-use assets
Interest on lease liabilities
Operating lease cost
115
233
Short-term lease cost
15
Variable lease cost
49
92
176
346
Other information
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases
242
Financing cash flows from finance leases
Right-of-use assets obtained in exchange for new operating lease liabilities
110
Weighted-average remaining lease term – finance leases
years
Weighted-average remaining lease term – operating leases
Weighted-average discount rate – finance leases
2.7
%
Weighted-average discount rate – operating leases
2.5
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:
Operating Leases
Finance Leases
Remainder of fiscal 2020
219
Fiscal 2021
393
Fiscal 2022
347
Fiscal 2023
310
Fiscal 2024
286
Thereafter
1,559
Total future minimum lease payments
3,114
Less imputed interest
(427)
2,687
14
Operating lease and finance lease liabilities included in the consolidated balance sheet are as follows:
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 December 31, 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:
Payments Due in Fiscal Year(1)
Fiscal 2020
421
383
348
316
289
1,625
Total contractual obligations
3,382
As of December 31, 2019, the Company has additional operating lease obligations, relating primarily to facilities to support the Company’s manufacturing, research and development and distribution operations, as well as corporate offices, that have not yet commenced of $108 million. These leases will commence between fiscal 2020 and fiscal 2030 with lease terms of 1 year to 59 years.
NOTE 5 – CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER ACTIVITIES
In May 2016, the Company announced a multi-year initiative (“Leading Beauty Forward” or “LBF”) to build on its strengths and better leverage its cost structure to free resources for investment to continue its growth momentum. LBF is designed to enhance the Company’s go-to-market capabilities, reinforce its leadership in global prestige beauty and continue creating sustainable value. As of June 30, 2019, the Company concluded the approvals of all major initiatives under LBF related to the optimization of select corporate functions, supply chain activities, and corporate and regional market support structures, as well as the exit of underperforming businesses, and expects to substantially complete those initiatives through fiscal 2021. The approved restructuring and other charges expected to be incurred were:
Sales
Returns
Operating Expenses
(included in
Restructuring
Net Sales)
Cost of Sales
Charges
Total Charges Approved
Cumulative through December 31, 2019
88
507
358
967
Employee-
Asset-
Related
Contract
Other Exit
Costs
Terminations
Restructuring Charges Approved
461
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:
Total Charges
Cumulative through June 30, 2019
457
265
791
Six months ended December 31, 2019
458
294
829
Restructuring Charges
445
Changes in accrued restructuring charges for the six months ended December 31, 2019 were:
Balance at June 30, 2019
202
203
Cash payments
(52)
(2)
(54)
Balance at December 31, 2019
150
Accrued restructuring charges at December 31, 2019 are expected to result in cash expenditures funded from cash provided by operations of approximately $63 million, $62 million, $20 million and $5 million for the remainder of fiscal 2020 and for fiscal 2021, 2022 and 2023, respectively.
Additional information about LBF is included in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
NOTE 6 – DEBT
In November 2019, the Company completed a public offering of $500 million aggregate principal amount of its 2.000% Senior Notes due December 1, 2024 (the “2024 Senior Notes”), $650 million aggregate principal amount of its 2.375% Senior Notes due December 1, 2029 (the “2029 Senior Notes”) and $650 million aggregate principal amount of its 3.125% Senior Notes due December 1, 2049 (the “2049 Senior Notes”). The Company used proceeds from this offering for general corporate purposes, including to fund the acquisition of Have & Be, and intends to use a portion of the proceeds to refinance its $500 million aggregate principal amount of 1.80% Senior Notes due February 7, 2020 when they become due.
16
These recently issued notes are summarized as follows:
Unamortized
Debt
Semi-annual
Issuance
interest
Notes
Issue Date
Price
Yield
Discount
payments
($ in millions)
2024 Senior Notes
November 2019
99.421
2.122
June 1/December 1
2029 Senior Notes (1)
99.046
2.483
2049 Senior Notes
98.769
3.189
NOTE 7 – 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 are not 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.
The fair values of the Company’s derivative financial instruments included in the consolidated balance sheets are as follows:
Asset Derivatives
Liability Derivatives
Fair Value (1)
Balance Sheet
Location
Derivatives Designated as Hedging Instruments
Foreign currency cash flow hedges
23
Net investment hedges
19
Interest rate-related derivatives
Total Derivatives Designated as Hedging Instruments
Derivatives Not Designated as Hedging Instruments
Foreign currency forward contracts
Total Derivatives
50
32
The amounts of the gains and losses related to the Company’s derivative financial instruments designated as hedging instruments that are included in the assessment of effectiveness are as follows:
Amount of Gain or (Loss)
Recognized in OCI on
Reclassified from AOCI into
Derivatives
Location of Gain or
Earnings(1)
(Loss) Reclassified
from AOCI into
Earnings
Derivatives in Cash Flow Hedging Relationships:
(16)
Total derivatives
Derivatives in Net Investment Hedging Relationships(2):
Foreign currency forward contracts(3)
(37)
(39)
Amount of Gain or (Loss) Recognized in Earnings on
Derivatives (1)
Location of Gain or (Loss)
Recognized in Earnings on
Derivatives in Fair Value Hedging Relationships:
Interest rate swap contracts
Additional information regarding the cumulative amount of fair value hedging gain (loss) recognized in earnings for items designated and qualifying as hedged items in fair value hedges is as follows:
Cumulative Amount of Fair
Value Hedging Gain/(Loss)
Line Item in the Consolidated Balance Sheets in
Carrying Amount of the
Included in the Carrying Amount
Which the Hedged Item is Included
Hedged Liabilities
of the Hedged Liability
701
Total debt
951
Additional information regarding the effects of fair value and cash flow hedging relationships for derivatives designated and qualifying as hedging instruments is as follows:
Three Months Ended December 31
Interest
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
The effects of fair value and cash flow hedging relationships:
Gain (loss) on fair value hedge relationships – interest rate contracts:
Hedged item
Not applicable
Derivatives designated as hedging instruments
(11)
Gain (loss) on cash flow hedge relationships – foreign currency forward contracts:
Amount of gain reclassified from AOCI into earnings
Six Months Ended December 31
The amounts of the gains and losses related to the Company’s derivative financial instruments not designated as hedging instruments are presented as follows:
Derivatives Not Designated as Hedging Instruments:
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 December 2021. Hedge effectiveness of the foreign currency forward contracts is based on the forward method, which includes time value in the effectiveness assessment. At December 31, 2019, the Company had outstanding foreign currency forward contracts with a notional amount totaling $5,087 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 December 31, 2019, the Company’s foreign currency cash flow hedges were highly effective.
21
The estimated net gain on the Company’s derivative instruments designated as cash flow hedges as of December 31, 2019 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $6 million. The accumulated net gain on derivative instruments in AOCI was $5 million and $29 million as of December 31, 2019 and June 30, 2019, respectively.
Fair Value Hedges
The Company enters into interest rate derivative contracts to manage the exposure to interest rate fluctuations on its funded indebtedness. The Company has interest rate swap agreements, with notional amounts totaling $250 million, $450 million and $250 million to effectively convert the fixed rate interest on its 2020 Senior Notes, 2021 Senior Notes and 2022 Senior Notes, respectively, to variable interest rates based on three-month LIBOR plus a margin. These interest rate swap agreements are designated as fair value hedges of the related long-term debt, and the changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt.
Net Investment Hedges
The Company enters into foreign currency forward contracts, designated as net investment hedges, to hedge a portion of its net investment in certain foreign operations. The net gain or loss on these contracts is recorded within translation adjustments, as a component of AOCI on the Company's consolidated balance sheets. The purpose of the hedging activities is to minimize the effect of foreign exchange rate movements on the Company's net investment in these foreign operations. The net investment hedge contracts have varying maturities through the end of January 2020. Hedge effectiveness of the net investment hedge contracts is based on the spot method. At December 31, 2019, the Company had net investment hedges outstanding with a notional amount totaling $1,738 million.
Credit Risk
As a matter of policy, the Company enters into derivative contracts only with counterparties that have a long-term credit rating of at least A- or higher by at least two nationally recognized rating agencies. The counterparties to these contracts are major financial institutions. Exposure to credit risk in the event of nonperformance by any of the counterparties is limited to the gross fair value of contracts in asset positions, which totaled $50 million at December 31, 2019. To manage this risk, the Company has strict counterparty credit guidelines that are continually monitored. Accordingly, management believes risk of loss under these hedging contracts is remote.
NOTE 8 – 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.
The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2019:
Level 1
Level 2
Level 3
Assets:
47
Liabilities:
Contingent consideration
61
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:
36
68
The estimated fair values of the Company’s financial instruments are as follows:
Fair
Amount
Nonderivatives
Current and long-term debt
5,184
5,696
3,412
3,706
Additional purchase price payable
Foreign currency forward contracts – asset (liability), net
Interest rate-related derivatives – asset (liability), net
(23)
The following table presents the Company’s impairment charges for the three and six months ended December 31, 2019 for certain of its nonfinancial assets measured at fair value on a nonrecurring basis, classified as Level 3, due to a change in circumstances that triggered an interim impairment test:
Date of Fair Value
Measurement
Fair Value(1)
Other intangible assets, net (trademark)
676
The following table presents the Company’s impairment charges for the three and six months ended December 31, 2018 for certain of its nonfinancial assets measured at fair value on a nonrecurring basis, classified as Level 3, due to a change in circumstances that triggered an interim impairment test:
December 31, 2018
120
179
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.
Foreign currency forward contracts – The fair values of the Company’s foreign currency forward contracts were determined using an industry-standard valuation model, which is based on an income approach. The significant observable inputs to the model, such as swap yield curves and currency spot and forward rates, were obtained from an independent pricing service. To determine the fair value of contracts under the model, the difference between the contract price and the current forward rate was discounted using LIBOR for contracts with maturities up to 12 months, and swap yield curves for contracts with maturities greater than 12 months.
Interest rate contracts – The fair values of the Company’s interest rate contracts were determined using an industry-standard valuation model, which is based on the income approach. The significant observable inputs to the model, such as treasury yield curves, swap yield curves and LIBOR forward rates, were obtained from independent pricing services.
Current and long-term debt – The fair value of the Company’s debt was estimated based on the current rates offered to the Company for debt with the same remaining maturities. To a lesser extent, debt also includes finance lease obligations for which the carrying amount approximates the fair value. The Company’s debt is classified within Level 2 of the valuation hierarchy.
Additional purchase price payable – The Company’s additional purchase price payable represents fixed minimum additional purchase price that was discounted using the Company’s incremental borrowing rate, which was approximately 1%. The additional purchase price payable is classified within Level 2 of the valuation hierarchy.
24
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 December 31, 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.
Changes in the fair value of the contingent consideration obligations for the six months ended December 31, 2019 are included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings and were as follows:
Fair Value
Contingent consideration at June 30, 2019
Changes in fair value
Contingent consideration at December 31, 2019
NOTE 9 – 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 $35 million and $32 million as of December 31, 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:
361
Revenue recognized that was included in the deferred revenue balance at the beginning of the period
(243)
Revenue deferred during the period
307
425
Transaction Price Allocated to the Remaining Performance Obligations
At December 31, 2019, the combined estimated revenue expected to be recognized in the next twelve months related to performance obligations for customer loyalty programs, gift with purchase promotions, purchase with purchase promotions and gift card liabilities that are unsatisfied (or partially unsatisfied) is $378 million.
NOTE 10 – PENSION AND POST-RETIREMENT BENEFIT PLANS
The Company maintains pension plans covering substantially all of its full-time employees for its U.S. operations and a majority of its international operations. The Company also maintains post-retirement benefit plans that provide certain medical and dental benefits to eligible employees. Descriptions of these plans are included in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
The components of net periodic benefit cost for the three months ended December 31, 2019 and 2018 consisted of the following:
Other than
Pension Plans
U.S.
International
Post-retirement
Service cost
Interest cost
Expected return on plan assets
Amortization of:
Actuarial loss
Net periodic benefit cost
The components of net periodic benefit cost for the six months ended December 31, 2019 and 2018 consisted of the following:
(26)
During the six months ended December 31, 2019, the Company made contributions to its U.S. qualified defined benefit pension plan and international pension plans totaling $20 million and $6 million, respectively.
The amounts recognized in the consolidated balance sheets related to the Company’s pension and post-retirement benefit plans consist of the following:
123
105
(27)
(434)
(418)
Funded status
(338)
(340)
334
Net amount recognized
NOTE 11 – 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.
During the fiscal 2018 third quarter, the Company learned that some of its testing related to certain product advertising claims did not meet the Company’s standards, necessitating further validation. This review is ongoing, resulting in modifications to certain advertising claims. This is not a product safety issue and does not relate to the quality of the ingredients or the manufacturing of the Company’s products. Based on the Company’s review to date, it does not believe that this matter will be material to the Company, and no accrual has been recorded.
NOTE 12 – 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:
Compensation expense
73
Income tax benefit
Stock Options
During the six months ended December 31, 2019, the Company granted stock options in respect of approximately 1.3 million shares of Class A Common Stock with an exercise price per share of $199.24 and a weighted-average grant date fair value per share of $51.44. 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 six months ended December 31, 2019 was $144 million.
Restricted Stock Units
The Company granted RSUs in respect of approximately 0.8 million shares of Class A Common Stock during the six months ended December 31, 2019 with a weighted-average grant date fair value per share of $199.26 that, at the time of grant, were scheduled to vest as follows: 0.3 million in fiscal 2021, 0.3 million in fiscal 2022 and 0.2 million in fiscal 2023. Vesting of RSUs 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 six months ended December 31, 2019, the Company granted PSUs with a target payout of approximately 0.1 million shares of Class A Common Stock with a grant date fair value per share of $199.18, which will be settled in stock subject to the achievement of the Company’s net sales, diluted net earnings per common share and return on invested capital goals for the three fiscal years ending June 30, 2022, all subject to continued employment or the retirement of the grantees. For PSUs granted, no settlement will occur for results below the applicable minimum threshold. PSUs are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the PSUs and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant.
In September 2019, approximately 0.4 million shares of the Company’s Class A Common Stock were issued, and related accrued dividends were paid, relative to the target goals set at the time of the issuance, in settlement of 0.3 million PSUs which vested as of June 30, 2019.
NOTE 13 – 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:
Numerator:
Denominator:
Weighted-average common shares outstanding – Basic
Effect of dilutive stock options
4.7
4.6
4.8
Effect of PSUs
0.3
0.2
Effect of RSUs
1.5
1.7
1.9
Weighted-average common shares outstanding – Diluted
Net earnings attributable to The Estée Lauder Companies Inc. per common share:
As of December 31, 2019 and 2018, the number of shares of Class A Common Stock underlying options that were excluded in the computation of diluted EPS because their inclusion would be anti-dilutive was 1.3 million shares and 1.6 million shares, respectively. As of December 31, 2019 and 2018, 1.1 million shares of Class A Common Stock underlying PSUs have been excluded from the calculation of diluted EPS because the number of shares ultimately issued is contingent on the achievement of certain performance targets of the Company, as discussed in Note 12 – Stock Programs.
28
NOTE 14 – EQUITY
Total Stockholders’ Equity – The Estée Lauder Companies Inc.
Common stock, beginning of the period
Stock-based compensation
Common stock, end of the period
Paid-in capital, beginning of the period
4,514
4,065
3,972
Common stock dividends
100
97
210
190
Paid-in capital, end of the period
4,162
Retained earnings, beginning of the period
10,393
9,170
9,040
(175)
(157)
(332)
(298)
Cumulative effect of adoption of new accounting standards
(29)
(229)
Retained earnings, end of the period
9,586
Accumulated other comprehensive loss, beginning of the period
(627)
(409)
Other comprehensive income (loss)
Accumulated other comprehensive loss, end of the period
(430)
Treasury stock, beginning of the period
(9,756)
(8,426)
(7,896)
Acquisition of treasury stock
(426)
(531)
(703)
(1,033)
(71)
(61)
(106)
(89)
Treasury stock, end of the period
(9,018)
4,306
Noncontrolling interests, beginning of the period
Distribution to noncontrolling interest holders
Other comprehensive income
Noncontrolling interests, end of the period
4,333
Cash dividends declared per common share
.48
.43
.91
.81
The following is a summary of quarterly cash dividends declared per share on the Company’s Class A and Class B Common Stock during the six months ended December 31, 2019:
Date Declared
Record Date
Payable Date
Amount per Share
August 16, 2019
August 30, 2019
September 16, 2019
October 30, 2019
November 29, 2019
December 16, 2019
On February 5, 2020, a dividend was declared in the amount of $.48 per share on the Company’s Class A and Class B Common Stock. The dividend is payable in cash on March 16, 2020 to stockholders of record at the close of business on February 28, 2020.
Common Stock
During the six months ended December 31, 2019, the Company purchased approximately 4.3 million shares of its Class A Common Stock for $813 million.
During the six months ended December 31, 2019, approximately 2.3 million shares of the Company’s Class B Common Stock were converted into the same amount of shares of the Company’s Class A Common Stock.
Accumulated Other Comprehensive Income (Loss)
The following table represents changes in AOCI, net of tax, by component for the six months ended December 31, 2019:
Amounts
Net Cash
Included in Net
Flow Hedge
Periodic Benefit
Translation
Gain (Loss)
Cost
Adjustments
(253)
(331)
OCI before reclassifications
Amounts reclassified to Net earnings
Net current-period OCI
(18)
(246)
(326)
The following table represents the effects of reclassification adjustments from AOCI into net earnings for the three and six months ended December 31, 2019 and 2018:
Amount Reclassified from AOCI
Affected Line Item in
Consolidated
Statements of Earnings
Gain (Loss) on Cash Flow Hedges
Benefit (provision) for deferred taxes
Amounts Included in Net Periodic Benefit Cost
Amortization of actuarial loss
Earnings before income taxes (1)
Benefit for deferred taxes
Cumulative Translation Adjustments
Loss on liquidation of an investment in a foreign subsidiary
Total reclassification adjustments, net
NOTE 15 – STATEMENT OF CASH FLOWS
Supplemental cash flow information for the six months ended December 31, 2019 and 2018 is as follows:
Cash:
Cash paid during the period for interest
66
Cash paid during the period for income taxes
217
Non-cash investing and financing activities:
Capital lease, capitalized interest and asset retirement obligations incurred
Property, plant and equipment accrued but unpaid
NOTE 16 – SEGMENT DATA AND RELATED INFORMATION
Reportable operating segments include components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (the “Chief Executive”) in deciding how to allocate resources and in assessing performance. Although the Company operates in one business segment, beauty products, management also evaluates performance on a product category basis. Product category performance is measured based upon net sales before returns associated with restructuring and other activities, and earnings before income taxes, other components of net periodic benefit cost, interest expense, interest income and investment income, net, other income, 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, with a corresponding decrease in Europe, the Middle East & Africa, by $210 million and $411 million for the three and six months ended December 31, 2018, respectively, to conform with the current year methodology and presentation.
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. Other than the changes in total assets as a result of the acquisition discussed in Note 2 - Acquisition of Business, which impacted the Asia/Pacific region, and the goodwill and other intangible asset impairments discussed in Note 3 – Goodwill and Other Intangible Assets, which impacted The Americas region, 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.
PRODUCT CATEGORY DATA
Net sales:
2,205
1,732
4,047
3,218
1,660
1,560
3,103
2,966
581
537
1,043
1,009
162
154
298
297
39
Operating income (loss) before charges associated with restructuring and other activities:
772
565
1,404
1,031
(611)
138
(507)
299
84
163
274
806
1,078
1,505
Reconciliation:
Charges associated with restructuring and other activities
(82)
(70)
(69)
GEOGRAPHIC DATA(1)
The Americas
1,226
1,218
2,386
2,454
Europe, the Middle East & Africa
2,079
1,767
3,756
3,200
Asia/Pacific
1,319
1,020
2,377
1,875
Operating income (loss):
(529)
(354)
505
418
882
675
239
550
447
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 and six months ended December 31, 2019 and 2018, and reflects the basis of presentation described in Notes to Consolidated Financial Statements, Note 1 – Summary of Significant Accounting Policies for all periods presented. Products and services that do not meet our definition of skin care, makeup, fragrance and hair care have been included in the “other” category.
NET SALES
By Product Category:
By Region:
OPERATING INCOME (LOSS)
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, with a corresponding decrease in Europe, the Middle East & Africa by $210 million and $411 million for the three and six months ended December 31, 2018, respectively, to conform with the current year methodology and presentation.
The following table presents certain consolidated earnings data as a percentage of net sales:
100.0
22.5
22.7
22.9
23.0
77.5
77.3
77.1
77.0
Operating expenses:
54.9
56.4
55.4
56.6
0.1
0.7
0.4
0.9
11.0
0.5
6.0
5.8
3.1
71.8
58.0
64.9
58.1
5.6
19.3
12.2
18.9
0.8
12.5
6.8
17.5
18.7
18.4
18.3
5.4
4.3
4.0
12.1
14.4
13.6
14.3
(0.1)
12.0
13.5
Not adjusted for differences caused by rounding
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 47 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.
34
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.
During the second quarter of fiscal 2020, our global net sales momentum continued, fueled by our multiple engines of growth. Net sales grew across all regions and product categories. The 15% growth as compared to the prior-year period was led by our skin care product category and our Europe, the Middle East & Africa and Asia/Pacific regions. We continued to benefit from growth in global prestige skin care. The strong net sales growth in skin care reflected increases in every region, with contributions from Estée Lauder, La Mer, Origins and Clinique. We grew makeup category net sales in the quarter, led by M·A·C in Asia/Pacific, Estée Lauder and Bobbi Brown in Asia/Pacific and in our travel retail business and Tom Ford globally. 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 our travel retail business. The net sales growth for the period also reflected higher net sales from most developed markets across Europe, the Middle East & Africa as well as double-digit increases in Korea. In aggregate, emerging markets outside of China rose high single-digits. We believe that our success has been due, in part, to our sharp focus on key shopping events in the quarter (such as Singles’ Day and Christmas) as well as to our continued 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.
On December 18, 2019, we acquired the remaining equity interest in Have&Be Co. Ltd. (“Have & Be”), the global skin care company behind Dr. Jart+ and men’s grooming brand Do The Right Thing. We originally acquired a minority interest in Have & Be in December 2015. This acquisition is expected to further strengthen our leadership position in skin care and expand our consumer reach in Asia/Pacific, North America, the United Kingdom and travel retail. The results of operations of Have & Be will be reported in future periods on a one-month lag to facilitate consolidated reporting. Accordingly, operating income for the three and six months ended December 31, 2019 does not include the results of operations of Have & Be since the date of acquisition, which were not material.
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 continues to be 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 exit and transition 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 monitoring the potential impacts of the recent outbreak of the coronavirus on our global business. After experiencing continued strong momentum into January, we have seen a significant decline in air travel and consumer traffic in key shopping and tourist areas. Although it is difficult to anticipate the full impact of the coronavirus on our business, global travel retail, localities most affected by the virus outbreak and destination markets favored by tourists are expected to experience the greatest negative impact in the coming months followed by a gradual recovery later in the fiscal year. 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; global health issues 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 5 – 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.
Goodwill and Other Intangible Asset Impairments
During December 2019, given the continuing declines in prestige makeup, generally in North America, and the ongoing competitive activity, our Too Faced, BECCA and Smashbox reporting units made revisions to their internal forecasts concurrent with our brand strategy review process. We concluded that the changes in circumstances in these reporting units triggered the need for an interim impairment review of their respective trademarks and goodwill. These changes in circumstances were also an indicator that the carrying amounts of their respective long-lived assets, including customer lists, may not be recoverable. Accordingly, we performed interim impairment tests for the trademarks and recoverability tests for the long-lived assets as of December 31, 2019. We concluded that the carrying amounts of the long-lived assets were recoverable. We also concluded that the carrying values of the trademarks exceeded their estimated fair values, which were determined utilizing the relief-from-royalty method to determine discounted projected future cash flows, and recorded impairment charges. After adjusting the carrying value of the trademarks, we completed interim quantitative impairment tests for goodwill and recorded goodwill impairment charges for each of these reporting units. The fair value of each reporting unit was based upon an equal weighting of the income and market approaches, utilizing estimated cash flows and a terminal value, discounted at a rate of return that reflects the relative risk of the cash flows, as well as valuation multiples derived from comparable publicly traded companies that are applied to operating performance of the reporting unit. A summary of the impairment charges for the three and six months ended December 31, 2019 and the remaining trademark and goodwill carrying values as of December 31, 2019, for each reporting unit, are as follows:
The key assumptions used to determine the estimated fair value of the reporting units are primarily predicated on the success of future new product launches, the achievement of international distribution expansion plans, and the realization of cost reduction and other efficiency efforts. If such plans do not materialize, or if there are further challenges in the business environments in which these reporting units operate, resulting changes in the key assumptions could have negative impacts on the estimated fair values of the reporting units and it is possible we could recognize additional impairment charges in the future.
In addition, during December 2019, our GLAMGLOW reporting unit updated its projected operating results to reflect lower demand for its products, impacted by shifts in market trends and key customer performance in the core markets in which its products are sold and concurrent with our brand strategy review process. We concluded that these changes in circumstances in this reporting unit triggered the need for an interim impairment review of its trademark and goodwill. Based on the review, we concluded the fair value of the GLAMGLOW trademark exceeded its carrying value by approximately 12%. We completed an interim quantitative impairment test for goodwill and concluded the fair value of the GLAMGLOW goodwill exceeded its carrying value by approximately 5%. The fair value of the reporting unit was based upon an equal weighting of the income and market approaches, utilizing estimated cash flows and a terminal value, discounted at a rate of return that reflects the relative risk of the cash flows, as well as valuation multiples derived from comparable publicly traded companies that are applied to operating performance of the reporting unit. As of December 31, 2019, the carrying value of the GLAMGLOW trademark and goodwill was $63 million and $114 million, respectively. If this reporting unit is adversely affected by a softness in the retail environment for its products in the future, or if other business disruptions arise that cause a change to its long-term financial projections, there could be a negative effect on the fair value of the related trademark and goodwill, and it is possible we could recognize impairment charges in the future.
As Reported:
$ Change from prior-year period
619
990
% Change from prior-year period
Non-GAAP Financial Measure(1):
% Change from prior-year period in constant currency
For the three and six months ended December 31, 2019, reported net sales increased in all major product categories and grew predominantly in the Asia/Pacific and Europe, the Middle East & Africa geographic regions. Skin care net sales primarily benefited from higher sales of Estée Lauder, La Mer, Origins and Clinique products. The net sales increases from Estée Lauder and Tom Ford drove the increase in the makeup product category. Fragrance net sales primarily reflected higher net sales from Jo Malone London and Tom Ford. Each of our product categories benefited from targeted expanded consumer reach, new product offerings, and the continued success of certain hero franchises. Net sales increases in China and our travel retail business continued to drive growth internationally.
The total net sales increases were impacted by approximately $22 million and $62 million of unfavorable foreign currency translation for the three and six months ended December 31, 2019, respectively.
Product Categories
473
37
Reported skin care net sales increased in every region and reflected higher net sales from Estée Lauder, La Mer, Origins and Clinique, combined, of approximately $447 million and $805 million for the three and six months ended December 31, 2019, respectively. Net sales increased from Estée Lauder in both periods, led by our travel retail business and China, reflecting the continued success of existing product franchises, such as Advanced Night Repair, Perfectionist, Re-Nutriv, Revitalizing Supreme and Micro Essence, and new product launches, such as Advanced Night Repair Intense Reset Concentrate. The increase in net sales from La Mer in both periods reflected growth across all geographic regions, and benefited from existing products, such as The Treatment Lotion, and product relaunches, such as The Regenerating Serum, as well as targeted expanded consumer reach and stronger demand for holiday sets. Net sales from Origins in both periods reflected higher net sales of treatment lotions and moisturizers and, for the three months ended December 31, 2019, also reflected growth in all regions. The continued success of certain hero franchises, as well as strength from moisturizers and anti-aging products, contributed to the increase in net sales from Clinique in both periods.
The skin care net sales increases were impacted by approximately $10 million and $26 million of unfavorable foreign currency translation for the three and six months ended December 31, 2019, respectively.
137
Reported makeup net sales increased for the three months ended December 31, 2019, reflecting higher net sales from Estée Lauder, Tom Ford, Bobbi Brown and La Mer of approximately $101 million, combined. For the six months ended December 31, 2019, reported makeup net sales increased from these brands as well as from M·A·C by $166 million, combined. The higher net sales from Estée Lauder in both periods were primarily due to the success of our Double Wear franchise and Futurist line of products, which drove higher net sales in China and our travel retail business. The net sales increase from Tom Ford in both periods was primarily due to continued growth in Asia/Pacific, led by China and Japan, which resulted in higher net sales from third-party online malls, driven by Tmall, as well as the strength in lip and eye products, including the Lip Color and Eye Quad line of products, respectively, and targeted expanded consumer reach. Net sales from Bobbi Brown in both periods reflected higher net sales in Asia/Pacific, as well as our travel retail business, which benefited from existing products such as Intensive Skin Serum Foundation. The higher net sales in both periods from La Mer were primarily due to growth internationally, which benefited from successful holiday events and campaigns on Tmall, existing products, such as The Luminous Lifting Cushion Foundation, and targeted expanded consumer reach. Net sales increased from M·A·C for the six months ended December 31, 2019 reflecting higher net sales in Asia/Pacific primarily due to the growth from Tmall in China, targeted expanded consumer reach and the strength in lip and foundation products.
These increases were partially offset by lower net sales from BECCA and Smashbox, combined, of approximately $16 million for the three months ended December 31, 2019. For the six months ended December 31, 2019, the increases were partially offset by lower net sales from these brands, as well as from Too Faced and Clinique, of approximately $54 million, combined. The decreases in both periods reflected declines in North America, due to the general decline in prestige makeup and ongoing competitive activity. The lower net sales from BECCA also reflected a difficult comparison to certain prior-year launches.
The makeup net sales increases were impacted by approximately $10 million and $26 million of unfavorable foreign currency translation for the three and six months ended December 31, 2019, respectively.
44
Reported fragrance net sales increased, reflecting higher net sales from Jo Malone London and Tom Ford, combined, of approximately $40 million and $73 million for the three and six months ended December 31, 2019, respectively. In both periods, the net sales increase from Jo Malone London reflected growth across all geographic regions primarily due to the continued success of certain hero franchises, new product launches, such as Poppy & Barley, the stronger demand of holiday sets, and targeted expanded consumer reach. Net sales increased from Tom Ford in both periods across all geographic regions, which benefited from higher net sales from certain Private Blend franchises, new product launches, such as Métallique and Soleil Neige, and the stronger demand for holiday sets.
Partially offsetting these increases for the six months ended December 31, 2019 were lower net sales from certain of our designer fragrances and Estée Lauder of approximately $41 million, combined. Net sales declined from certain designer fragrances reflecting the decline in North America due, in part, to an unfavorable comparison to certain prior-year launches and declines for our products 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 and the United Kingdom.
The fragrance net sales increases were impacted by approximately $2 million and $9 million of unfavorable foreign currency translation for the three and six months ended December 31, 2019, respectively.
Reported hair care net sales increased for the three and six months ended December 31, 2019, primarily reflecting growth from Aveda. In both periods, the higher net sales from Aveda were primarily driven by new product launches, such as Nutriplenish and Full Spectrum Demi Plus, and the relaunch of Sap Moss, as well as the continued success of hero franchises such as the Damage Remedy line of products.
The growth in hair care net sales for the six months ended December 31, 2019 was mostly offset by lower net sales from Bumble and bumble due to the softness in North America, which impacted the salon and specialty-multi channels.
Geographic Regions
Reported net sales in The Americas for the three months ended December 31, 2019 increased due to higher net sales in the United States of approximately $10 million, reflecting higher net sales from Estée Lauder, Jo Malone London and Tom Ford, which drove the growth in the fragrance and skin care product categories. These increases more than offset the softness in North America for certain of our makeup products as previously discussed.
Reported net sales in The Americas for the six months ended December 31, 2019 decreased due to lower net sales in the United States of approximately $73 million, primarily from M·A·C, Too Faced and BECCA due 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 designer fragrances, Estée Lauder and BECCA.
The changes in net sales in The Americas were impacted by approximately $1 million and $5 million of favorable foreign currency translation for the three and six months ended December 31, 2019, respectively.
312
Reported net sales in Europe, the Middle East & Africa increased, primarily reflecting higher net sales from our travel retail business and, to a lesser extent, Russia of approximately $297 million and $533 million, combined, for the three and six months ended December 31, 2019, respectively. In both periods, net sales increased in our travel retail business across most brands, led by Estée Lauder, La Mer 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 The Regenerating Serum from La Mer. Also contributing to this increase was strategic investment spending to support both new and existing products. The higher net sales in Russia in both periods were primarily driven by Estée Lauder, Jo Malone London and Tom Ford, reflecting the success of hero franchises, such as Advance Night Repair from Estée Lauder, and new product launches, such as Poppy & Barley from Jo Malone London and Métallique and Soleil Neige from Tom Ford.
The net sales increases in Europe, the Middle East & Africa were impacted by approximately $12 million and $36 million of unfavorable foreign currency translation for the three and six months ended December 31, 2019, respectively.
40
502
Reported net sales in Asia/Pacific increased, reflecting higher net sales in China and Japan, combined, of approximately $308 million and $511 million for the three and six months ended December 31, 2019, respectively. In both periods, the higher net sales in China reflected double-digit growth from virtually every brand, led by Estée Lauder, La Mer, M·A·C and Tom Ford, continued growth in skin care and makeup, 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 every channel, led by online (due to the continued growth and successful holiday events and campaigns on Tmall), department stores, freestanding stores and specialty-multi. In both periods, the net sales growth in Japan reflected growth in virtually every brand, led by M·A·C and Jo Malone London, reflecting the success of certain hero franchises, new product launches and targeted expanded consumer reach, which contributed to growth in all major product categories and growth in virtually every channel.
These increases were partially offset by lower net sales in Hong Kong of approximately $33 million and $51 million for the three and six months ended December 31, 2019, respectively, due to the ongoing situation there that has continued to negatively impact traffic in downtown shops and the airport and has also led to intermittent store closures.
The net sales increases in Asia/Pacific were impacted by approximately $11 million and $31 million of unfavorable foreign currency translation for the three and six months ended December 31, 2019, respectively.
We strategically stagger our new product launches by geographic market, which may account for differences in regional sales growth.
GROSS MARGIN
Gross margin increased to 77.5% and 77.1% for the three and six months ended December 31, 2019, respectively, as compared with 77.3% and 77.0% in the prior-year periods.
Favorable (Unfavorable) Basis Points
Mix of business
Obsolescence charges
(25)
(40)
Manufacturing costs and other
The increase in gross margin for the three and six months ended December 31, 2019 reflected the favorable impact from our mix of business primarily due to favorable changes in strategic pricing and product category mix, as well as cost of promotional items as a percentage of net sales. Also reflected in the favorable impact from our mix of business for the three months ended December 31, 2019 was a favorable change from new product introductions and relaunches. Partially offsetting these favorable changes in both periods were higher costs from product sets included in mix of business, as well as unfavorable changes in manufacturing costs and other, including the impacts of incremental tariffs.
OPERATING EXPENSES
Operating expenses as a percentage of net sales increased to 71.8% and 64.9% for the three and six months ended December 31, 2019, respectively, as compared with 58.0% and 58.1% in the prior-year periods.
General and administrative expenses
(90)
Advertising, merchandising, sampling and product development
(30)
Selling
Store operating costs
Shipping
Foreign exchange transactions
Subtotal
130
60
(1,590)
(860)
(1,380)
(680)
For the three and six months ended December 31, 2019, the increases in operating expense margin were driven by the impact of goodwill and other intangible asset impairments. In addition, general and administrative expenses increased primarily due to professional service fees (including acquisition-related costs), enhanced capabilities in select corporate functions to support our strategic initiatives, and investments in information systems. These increases were partially offset by improvements from selling expenses primarily due to increased efficiencies in our sales operations and lower demonstration costs driven by changes in distribution channel mix.
OPERATING RESULTS
(510)
(383)
(66)
Operating margin
% Change in operating income from the prior-year period adjusting for the impact of charges associated with restructuring and other activities, goodwill and other intangible asset impairments and changes in fair value of contingent consideration
The reported operating margin for the three and six months ended December 31, 2019 decreased from the prior-year periods driven by the year-over-year impact of goodwill and other intangible asset impairments of $739 million, partially offset by improvements in gross margin and other operating expenses as a percentage of net sales 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.
42
207
373
Reported skin care operating income increased for the three and six months ended December 31, 2019, driven by higher results from Estée Lauder and La Mer, combined, of approximately $221 million and $438 million, respectively. The increases in operating income reflected higher net sales, partially offset by strategic investments in advertising and promotional activities and targeted expanded consumer reach.
These increases in the category were partially offset by higher operating expenses relating primarily to professional service fees (including acquisition-related costs), enhanced capabilities in select corporate functions to support our strategic initiatives, and investments in information systems. Also partially offsetting these increases were lower results from Clinique reflecting strategic investments in advertising and promotional activities due, in part, to support new product launches and continued net sales growth.
Operating income (loss)
(611
)
(507
(749
(806
(100
+)%
% Change in operating income from the prior-year period adjusting for the impact of goodwill and other intangible asset impairments
(6
)%
(20
Reported makeup operating results decreased for the three and six months ended December 31, 2019 driven by lower results from Too Faced, BECCA, M·A·C, and Smashbox, combined, of approximately $803 million and $838 million, respectively. The fiscal 2020 operating results from Too Faced, BECCA and Smashbox include $641 million, $68 million and $68 million of goodwill and other intangible asset impairments, respectively, and the fiscal 2019 operating results from Smashbox included $38 million of goodwill and other intangible asset impairments. The lower results in the category also reflected the net sales declines in North America as previously discussed and higher operating expenses relating primarily to professional service fees, enhanced capabilities in select corporate functions to support our strategic initiatives, and investments in information systems.
Partially offsetting the declines in both periods were higher results from Estée Lauder and Clinique, combined, of approximately $71 million. The higher results from Estée Lauder were primarily due to higher net sales, while the increases in operating income from Clinique reflected disciplined expense management. The operating income from both brands also benefited from selling efficiencies.
Reported fragrance operating income increased for the three months ended December 31, 2019, driven by higher results from Tom Ford and Estée Lauder, combined, of approximately $19 million, reflecting higher net sales, disciplined expense management, and selling efficiencies. Reported fragrance operating income increased for the six months ended December 31, 2019, driven by higher results from Jo Malone London and Tom Ford, combined, of approximately $37 million, reflecting higher net sales, partially offset by strategic investments in advertising and promotional activities due, in part, to support new product launches and continued net sales growth.
Partially offsetting the lower results for the three and six months ended December 31, 2019 were lower results from Clinique, reflecting lower net sales.
(17)
(20)
(59)
Reported hair care operating income for both periods decreased primarily due to lower results from Aveda, reflecting strategic investments in advertising and promotional activities to support new product launches and net sales growth. The lower results in the category also reflected higher operating expenses relating primarily to professional service fees, enhanced capabilities in select corporate functions to support our strategic initiatives, and investments in information systems.
(529
(354
(678
(737
% Change in operating income from the prior-year period adjusting for the impact of goodwill and other intangible asset impairments and changes in fair value of contingent consideration
Reported operating results in The Americas decreased for the three and six months ended December 31, 2019, primarily due to the year-over-year impact of goodwill and other intangible asset impairments of $739 million, as previously discussed, and higher expenses relating primarily to professional service fees, enhanced capabilities in select corporate functions to support our strategic initiatives, and investments in information systems.
Partially offsetting these decreases in both periods were higher intercompany royalty income, reflecting the value created in The Americas, given the growth of our travel retail business and, to a lesser extent, higher results from Estée Lauder due to an increase in net sales, disciplined expense management and selling efficiencies.
87
Reported operating income in Europe, the Middle East & Africa reflected higher results from our travel retail business and Russia, combined, of approximately $92 million and $202 million for the three and six months ended December 31, 2019, respectively, primarily due to higher net sales. The increases in net sales were partially offset by strategic investment spending in advertising and promotional activities to support the continued net sales growth and targeted expanded consumer reach.
Reported operating income increased in most markets in Asia/Pacific, led by higher results in China of approximately $68 million and $117 million for the three and six months ended December 31, 2019, respectively, driven by net sales growth. The net sales increases in China were 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 of approximately $21 million and $38 million for the three and six months ended December 31, 2019, respectively, caused by lower net sales, as previously noted, partially offset by disciplined expense management.
INTEREST AND INVESTMENT INCOME
Interest expense increased for both periods primarily due to the issuance of additional long-term debt in November 2019, partially offset by lower commercial paper. Interest income and investment income, net increased during the three months ended December 31, 2019, primarily due to overall higher cash balances.
45
OTHER INCOME
On December 18, 2019, we acquired the remaining equity interest in Have&Be Co. Ltd. (“Have & Be”), the global skin care company behind Dr. Jart+ and men’s grooming brand Do The Right Thing, for $1,268 million in cash. We originally acquired a minority interest in Have & Be in December 2015, which included a formula-based call option for the remaining equity interest. The original minority interest was accounted for as an equity method investment, which had a carrying value of $133 million at the acquisition date. The acquisition of the remaining equity interest in Have & Be was considered a step acquisition, whereby we remeasured the previously held equity method investment to its fair value of $682 million, resulting in the recognition of a gain of $549 million. The acquisition of the remaining equity interest also resulted in the recognition of a previously unrealized foreign currency gain of $4 million, which was reclassified from accumulated OCI. The total gain on our previously held equity method investment of $553 million is included in Other income in the accompanying consolidated statements of earnings for the three and six months ended December 31, 2019.
The amount paid at closing was funded by cash on hand including the proceeds from the issuance of debt. In anticipation of the closing, we transferred cash to a foreign subsidiary for purposes of making the closing payment. As a result, we recognized a foreign currency gain of $23 million, which is also included in Other income in the accompanying consolidated statements of earnings for the three and six months ended December 31, 2019. See Notes to Consolidated Financial Statements, Note 2 – Acquisition of Business for additional information.
PROVISION FOR INCOME TAXES
The provision for income taxes represents U.S. federal, foreign, state and local income taxes. The effective rate differs from the federal statutory rate primarily due to the effect of state and local income taxes, the tax impact of share-based compensation, the taxation of foreign income and income tax reserve adjustments, which represent changes in our net liability for unrecognized tax benefits including tax settlements and lapses of the applicable statutes of limitations. Our effective tax rate will change from quarter to quarter based on recurring and non-recurring factors including the geographical mix of earnings, enacted tax legislation, state and local income taxes, tax reserve adjustments, the tax impact of share-based compensation and the interaction of various global tax strategies. In addition, changes in judgment from the evaluation of new information resulting in the recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of change.
Effective rate for income taxes
30.8
26.2
21.9
Basis-point change from the prior-year period
790
The increase in the effective tax rate in both periods was primarily attributable to the impact of nondeductible goodwill impairment charges associated with our Too Faced, BECCA and Smashbox reporting units and a higher effective tax rate on our foreign operations.
NET EARNINGS ATTRIBUTABLE TO THE ESTÉE LAUDER COMPANIES INC.
($ in millions, except per share data)
79
Diluted net earnings per common share
% Change in diluted net earnings per common share from the prior-year period adjusting for the impact of charges associated with restructuring and other activities, goodwill and other intangible asset impairments, other income, changes in fair value of contingent consideration, the Transition Tax, the remeasurement of U.S. net deferred tax assets as of the TCJA enactment date and the establishment of a net deferred tax liability related to foreign withholding taxes on certain foreign earnings resulting from the TCJA
RECONCILIATIONS OF NON-GAAP FINANCIAL MEASURES
We use certain non-GAAP financial measures, among other financial measures, to evaluate our operating performance, which represent the manner in which we conduct and view our business. Management believes that excluding certain items that are not comparable from period to period, or do not reflect the Company’s underlying ongoing business, provides transparency for such items and helps investors and others compare and analyze our operating performance from period to period. In the future, we expect to incur charges or adjustments similar in nature to those presented below; however, the impact to the Company’s results in a given period may be highly variable and difficult to predict. Our non-GAAP financial measures may not be comparable to similarly titled measures used by, or determined in a manner consistent with, other companies. While we consider the non-GAAP measures useful in analyzing our results, they are not intended to replace, or act as a substitute for, any presentation included in the consolidated financial statements prepared in conformity with U.S. GAAP. The following tables present Net sales, Operating income and Diluted net earnings per common share adjusted to exclude the impact of charges associated with restructuring and other activities; goodwill and other intangible asset impairments; other income; the changes in the fair value of contingent consideration; the Transition Tax; the remeasurement of U.S. net deferred tax assets as of the TCJA enactment date; the establishment of a net deferred tax liability related to foreign withholding taxes on certain foreign earnings resulting from the TCJA; and the effects of foreign currency translation.
The following tables provide reconciliations between these non-GAAP financial measures and the most directly comparable U.S. GAAP measures.
% Change
in Constant
Variance
Change
Currency
Net sales, as reported
Returns associated with restructuring and other activities
Net sales, as adjusted
Operating income, as reported
739
Operating income, as adjusted
1,044
846
198
Diluted net earnings per common share, as reported
(.03)
.03
.08
(.05)
1.81
.09
1.72
(1.23)
(.02)
Remeasurement of U.S. net deferred tax assets as of the TCJA enactment date
.02
Diluted net earnings per common share, as adjusted
2.11
1.74
.37
82
(44)
1,848
1,534
.25
.18
(.09)
1.80
1.71
(1.22)
Transition Tax resulting from the TCJA
Net deferred tax liability related to foreign withholding taxes on certain foreign earnings resulting from the TCJA
3.78
3.15
.63
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.
The following tables reconcile the change in net sales by product category and geographic region, as reported, to the change in net sales excluding the effects of foreign currency translation:
As Reported
Three months
Impact of
Change,
ended
foreign
Variance,
in
December 31,
currency
in constant
as
constant
translation
reported
483
641
324
Six months
855
(28)
62
1,052
(73)
592
533
The following table reconciles the change in operating results by product category and geographic region, as reported, to the change in operating income excluding the impact of goodwill and other intangible asset impairments and changes in fair value of contingent consideration:
Add:
Changes in
and other
intangible
fair value of
asset
contingent
impairments
consideration
adjusted
204
(749)
+)
(532)
(66
(678)
86
376
(806)
(67)
(59
(14
(28
(737)
205
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
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 December 31, 2019, we had cash and cash equivalents of $3,596 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.
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 December 31, 2019 includes cash in offshore jurisdictions associated with our permanent reinvestment strategy. We do not believe that continuing to reinvest our foreign earnings impairs our ability to meet our domestic debt or working capital obligations. If these reinvested earnings were repatriated into the United States as dividends, we would be subject to state income taxes and applicable foreign taxes in certain jurisdictions.
The effects of inflation have not been significant to our overall operating results in recent years. Generally, we have been able to introduce new products at higher prices, increase prices and implement other operating efficiencies to sufficiently offset cost increases, which have been moderate.
Credit Ratings
Changes in our credit ratings will likely result in changes in our borrowing costs. Our credit ratings also impact the cost of our revolving credit facility. Downgrades in our credit ratings may reduce our ability to issue commercial paper and/or long-term debt and would likely increase the relative costs of borrowing. A credit rating is not a recommendation to buy, sell, or hold securities, is subject to revision or withdrawal at any time by the assigning rating organization, and should be evaluated independently of any other rating. As of January 30, 2020, our long-term debt is rated A+ with a stable outlook by Standard & Poor’s and A1 with a stable outlook by Moody’s.
51
At December 31, 2019, our outstanding borrowings were as follows:
Long-term
Current
Total Debt
3.125% Senior Notes, due December 1, 2049 (“2049 Senior Notes”) (1), (13)
635
4.15% Senior Notes, due March 15, 2047 (“2047 Senior Notes”) (2), (13)
494
4.375% Senior Notes, due June 15, 2045 (“2045 Senior Notes”) (3), (13)
455
3.70% Senior Notes, due August 15, 2042 (“2042 Senior Notes”) (4), (13)
247
6.00% Senior Notes, due May 15, 2037 (“2037 Senior Notes”) (5), (13)
5.75% Senior Notes, due October 15, 2033 (“2033 Senior Notes”) (6)
197
2.375% Senior Notes, due December 1, 2029 (“2029 Senior Notes”) (7), (13)
640
3.15% Senior Notes, due March 15, 2027 (“2027 Senior Notes”) (8), (13)
498
2.00% Senior Notes, due December 1, 2024 (“2024 Senior Notes”) (9), (13)
2.35% Senior Notes, due August 15, 2022 (“2022 Senior Notes”) (10), (13)
253
1.70% Senior Notes, due May 10, 2021 (“2021 Senior Notes”) (11), (13)
448
1.80% Senior Notes, due February 7, 2020 (“2020 Senior Notes”) (12), (13)
500
Other borrowings
Total debt as a percent of total capitalization (excluding noncontrolling interests) was 53% and 44% at December 31, 2019 and June 30, 2019, respectively.
Cash Flows
Net cash provided by operating activities
Net cash used for investing activities
Net cash provided by (used for) financing activities
The change in net cash flows from operations primarily reflected the unfavorable net change in working capital, in particular accounts payable due to the timing and level of payments, and higher cash paid for taxes primarily due to the increase in earnings before taxes, as well as the timing and level of payments, partially offset by higher earnings before taxes.
The change in net cash flows from investing activities primarily reflected cash paid in connection with the fiscal 2020 second quarter acquisition of Have & Be, as well as 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 proceeds from the November 2019 issuance of long-term debt, lower treasury stock purchases and changes in short-term debt reflecting the prior-year repayment of remaining commercial paper borrowings.
Dividends
For a summary of quarterly cash dividends declared per share on our Class A and Class B Common Stock during the six months ended December 31, 2019, see Notes to Consolidated Financial Statements, Note 14 — 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 11 — 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 7 — Derivative Financial Instruments.
Foreign Exchange Risk Management
For a discussion of foreign exchange risk management, see Notes to Consolidated Financial Statements, Note 7 — Derivative Financial Instruments (Cash Flow Hedges, Net Investment Hedges).
For a discussion of credit risk, see Notes to Consolidated Financial Statements, Note 7 — 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 $(238) million and $48 million as of December 31, 2019 and June 30, 2019, respectively. This potential change does not consider our underlying foreign currency exposures.
In addition, we enter into interest rate derivatives to manage the effects of interest rate movements on our aggregate liability portfolio, including future debt issuances. Based on a hypothetical 100 basis point increase in interest rates, the estimated fair value of our interest rate derivatives would decrease by approximately $12 million and $16 million as of December 31, 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:
54
We assume no responsibility to update forward-looking statements made herein or otherwise.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The information required by this item is set forth in Item 2 of this Quarterly Report on Form 10-Q under the caption Liquidity and Capital Resources - Market Risk and is incorporated herein by reference.
Item 4. Controls and Procedures.
Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 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 second quarter of fiscal 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s 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 11 — 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)
October 2019
1,578,918
189.34
1,173,751
36,114,378
710,271
188.23
35,404,107
December 2019
343,880
199.38
35,060,227
2,633,069
190.35
2,227,902
Subsequent to December 31, 2019 and as of January 30, 2020, we purchased approximately 0.2 million additional shares of our Class A Common Stock for $42 million pursuant to our share repurchase program.
Item 6. Exhibits.
ExhibitNumber
Description
4.1
Officers’ Certificate, dated November 21, 2019 defining certain terms of the 2.000% Senior Notes due 2024 (filed as Exhibit 4.1 to our Current Report on Form 8-K filed on November 21, 2019).*
4.2
Form of Global Note for the 2.000% Senior Notes due 2024 (included as Exhibit A in Exhibit 4.1 to our Current Report on Form 8-K filed on November 21, 2019) (filed as Exhibit 4.2 to our Current Report on Form 8-K filed on November 21, 2019).*
Officers’ Certificate, dated November 21, 2019 defining certain terms of the 2.375% Senior Notes due 2029 (filed as Exhibit 4.3 to our Current Report on Form 8-K filed on November 21, 2019).*
4.4
Form of Global Note for the 2.375% Senior Notes due 2029 (included as Exhibit A in Exhibit 4.3 to our Current Report on Form 8-K filed on November 21, 2019) (filed as Exhibit 4.4 to our Current Report on Form 8-K filed on November 21, 2019).*
4.5
Officers’ Certificate, dated November 21, 2019 defining certain terms of the 3.125% Senior Notes due 2049 (filed as Exhibit 4.5 to our Current Report on Form 8-K filed on November 21, 2019).*
Form of Global Note for the 3.125% Senior Notes due 2049 (included as Exhibit A in Exhibit 4.5 to our Current Report on Form 8-K filed on November 21, 2019) (filed as Exhibit 4.6 to our Current Report on Form 8-K filed on November 21, 2019).*
10.1
The Estée Lauder Companies Inc. Amended and Restated Fiscal 2002 Share Incentive Plan (filed as Exhibit 10.1 to our Current Report on Form 8-K filed on November 19, 2019). * †
31.1
Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CEO).
31.2
Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CFO).
32.1
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CEO). (furnished)
32.2
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CFO). (furnished)
101.1
The following materials from The Estée Lauder Companies Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 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
The cover page from The Estée Lauder Companies Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2019 is formatted in iXBRL
* Incorporated herein by reference.
† Exhibit is a management contract or compensatory plan or arrangement.
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.
Date: February 6, 2020
By:
/s/TRACEY T. TRAVIS
Tracey T. Travis
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)