Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-1004

 


 

FORM 10-Q

 

(Mark One)-

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

 

For the quarterly period ended March 31, 2017

 

OR

 

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

 

For the transition period from               to

 

Commission file number: 1-14064

 

The Estée Lauder Companies Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

11-2408943

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

767 Fifth Avenue, New York, New York

 

10153

(Address of principal executive offices)

 

(Zip Code)

 

212-572-4200

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).  Yes x  No o

 

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

 

Large accelerated filer x

 

Accelerated filer o

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

Emerging growth company o

 

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

 

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

 

At April 26, 2017, 223,870,597 shares of the registrant’s Class A Common Stock, $.01 par value, and 143,961,737 shares of the registrant’s Class B Common Stock, $.01 par value, were outstanding.

 

 

 



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

INDEX

 

 

 

Page

Part I. Financial Information

 

 

 

 

 

Item 1. Financial Statements (Unaudited)

 

 

 

 

 

Consolidated Statements of Earnings —
Three and Nine Months Ended March 31, 2017 and 2016

 

2

 

 

 

Consolidated Statements of Comprehensive Income (Loss) —
Three and Nine Months Ended March 31, 2017 and 2016

 

3

 

 

 

Consolidated Balance Sheets —
March 31, 2017 and June 30, 2016 (Audited)

 

4

 

 

 

Consolidated Statements of Cash Flows —
Nine Months Ended March 31, 2017 and 2016

 

5

 

 

 

Notes to Consolidated Financial Statements

 

6

 

 

 

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

 

31

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

52

 

 

 

Item 4. Controls and Procedures

 

52

 

 

 

Part II. Other Information

 

 

 

 

 

Item 1. Legal Proceedings

 

53

 

 

 

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

 

53

 

 

 

Item 6. Exhibits

 

54

 

 

 

Signatures

 

55

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

 

 

2017

 

2016

 

2017

 

2016

 

 

 

(In millions, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Net Sales

 

$

2,857

 

$

2,657

 

$

8,930

 

$

8,616

 

Cost of Sales

 

591

 

504

 

1,824

 

1,670

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

2,266

 

2,153

 

7,106

 

6,946

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

1,780

 

1,754

 

5,522

 

5,445

 

Restructuring and other charges

 

59

 

15

 

122

 

34

 

Total operating expenses

 

1,839

 

1,769

 

5,644

 

5,479

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

427

 

384

 

1,462

 

1,467

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

28

 

18

 

71

 

52

 

Interest income and investment income, net

 

8

 

4

 

19

 

10

 

Earnings before Income Taxes

 

407

 

370

 

1,410

 

1,425

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

107

 

104

 

384

 

399

 

Net Earnings

 

300

 

266

 

1,026

 

1,026

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to noncontrolling interests

 

(2

)

(1

)

(6

)

(5

)

Net Earnings Attributable to The Estée Lauder Companies Inc.

 

$

298

 

$

265

 

$

1,020

 

$

1,021

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Basic

 

$

.81

 

$

.72

 

$

2.78

 

$

2.76

 

Diluted

 

$

.80

 

$

.71

 

$

2.74

 

$

2.71

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

367.0

 

369.1

 

366.8

 

370.4

 

Diluted

 

372.3

 

375.6

 

372.7

 

376.9

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

.34

 

$

.30

 

$

.98

 

$

.84

 

 

See notes to consolidated financial statements.

 

2



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

 

 

2017

 

2016

 

2017

 

2016

 

 

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

300

 

$

266

 

$

1,026

 

$

1,026

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Net unrealized investment gain (loss)

 

2

 

7

 

(9

)

3

 

Net derivative instrument gain (loss)

 

(51

)

(36

)

(17

)

(32

)

Amounts included in net periodic benefit cost

 

7

 

6

 

23

 

19

 

Translation adjustments

 

64

 

71

 

(49

)

(52

)

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

 

17

 

11

 

(2

)

4

 

Total other comprehensive income (loss)

 

39

 

59

 

(54

)

(58

)

Comprehensive income (loss)

 

339

 

325

 

972

 

968

 

 

 

 

 

 

 

 

 

 

 

Comprehensive (income) loss attributable to noncontrolling interests:

 

 

 

 

 

 

 

 

 

Net earnings

 

(2

)

(1

)

(6

)

(5

)

Translation adjustments

 

1

 

(1

)

 

 

 

 

(1

)

(2

)

(6

)

(5

)

Comprehensive income (loss) attributable to The Estée Lauder Companies Inc.

 

$

338

 

$

323

 

$

966

 

$

963

 

 

See notes to consolidated financial statements.

 

3



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED BALANCE SHEETS

 

 

 

March 31

 

June 30

 

 

 

2017

 

2016

 

 

 

(Unaudited)

 

 

 

 

 

($ in millions)

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

1,139

 

$

914

 

Short-term investments

 

701

 

469

 

Accounts receivable, net

 

1,528

 

1,258

 

Inventory and promotional merchandise, net

 

1,310

 

1,264

 

Prepaid expenses and other current assets

 

294

 

320

 

Total current assets

 

4,972

 

4,225

 

 

 

 

 

 

 

Property, Plant and Equipment, net

 

1,576

 

1,583

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

Long-term investments

 

993

 

1,108

 

Goodwill

 

1,942

 

1,228

 

Other intangible assets, net

 

1,337

 

344

 

Other assets

 

625

 

735

 

Total other assets

 

4,897

 

3,415

 

Total assets

 

$

11,445

 

$

9,223

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Current debt

 

$

519

 

$

332

 

Accounts payable

 

597

 

717

 

Other accrued liabilities

 

1,744

 

1,632

 

Total current liabilities

 

2,860

 

2,681

 

 

 

 

 

 

 

Noncurrent Liabilities

 

 

 

 

 

Long-term debt

 

3,377

 

1,910

 

Other noncurrent liabilities

 

1,073

 

1,045

 

Total noncurrent liabilities

 

4,450

 

2,955

 

 

 

 

 

 

 

Contingencies (Note 10)

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

Common stock, $.01 par value; Class A shares authorized: 1,300,000,000 at March 31, 2017 and June 30, 2016; shares issued: 428,868,500 at March 31, 2017 and 424,109,008 at June 30, 2016; Class B shares authorized: 304,000,000 at March 31, 2017 and June 30, 2016; shares issued and outstanding: 143,961,737 at March 31, 2017 and 144,770,237 at June 30, 2016

 

6

 

6

 

Paid-in capital

 

3,462

 

3,161

 

Retained earnings

 

8,350

 

7,693

 

Accumulated other comprehensive loss

 

(599

)

(545

)

 

 

11,219

 

10,315

 

Less: Treasury stock, at cost; 205,125,233 Class A shares at March 31, 2017 and 201,119,435 Class A shares at June 30, 2016

 

(7,100

)

(6,743

)

Total stockholders’ equity — The Estée Lauder Companies Inc.

 

4,119

 

3,572

 

Noncontrolling interests

 

16

 

15

 

Total equity

 

4,135

 

3,587

 

Total liabilities and equity

 

$

11,445

 

$

9,223

 

 

See notes to consolidated financial statements.

 

4



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

March 31

 

 

 

2017

 

2016

 

 

 

(In millions)

 

Cash Flows from Operating Activities

 

 

 

 

 

Net earnings

 

$

1,026

 

$

1,026

 

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

 

 

 

 

 

Depreciation and amortization

 

337

 

305

 

Deferred income taxes

 

(84

)

(51

)

Noncash stock-based compensation

 

175

 

147

 

Excess tax benefits from stock-based compensation arrangements

 

(37

)

(18

)

Net (gain) loss on disposal of property, plant and equipment

 

(4

)

10

 

Noncash restructuring and other charges

 

3

 

15

 

Pension and post-retirement benefit expense

 

59

 

53

 

Pension and post-retirement benefit contributions

 

(19

)

(19

)

Change in fair value of contingent consideration

 

1

 

16

 

Equity investment income

 

(17

)

(2

)

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in accounts receivable, net

 

(242

)

(251

)

Decrease in inventory and promotional merchandise, net

 

59

 

53

 

Increase in other assets, net

 

(30

)

(82

)

Decrease in accounts payable

 

(168

)

(46

)

Increase in other accrued and noncurrent liabilities

 

193

 

160

 

Net cash flows provided by operating activities

 

1,252

 

1,316

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

Capital expenditures

 

(316

)

(334

)

Payments for acquired businesses, net of cash acquired

 

(1,690

)

(101

)

Proceeds from disposition of investments

 

955

 

925

 

Purchases of investments

 

(1,067

)

(1,587

)

Proceeds from sale of property, plant and equipment

 

12

 

 

Net cash flows used for investing activities

 

(2,106

)

(1,097

)

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

Proceeds of current debt, net

 

194

 

286

 

Proceeds from issuance of long-term debt, net

 

1,498

 

 

Debt issuance costs

 

(10

)

 

Repayments and redemptions of long-term debt

 

(4

)

(6

)

Net proceeds from stock-based compensation transactions

 

94

 

55

 

Excess tax benefits from stock-based compensation arrangements

 

37

 

18

 

Payments to acquire treasury stock

 

(363

)

(703

)

Dividends paid to stockholders

 

(361

)

(312

)

Payments to noncontrolling interest holders for dividends

 

(2

)

(3

)

Net cash flows provided by (used for) financing activities

 

1,083

 

(665

)

 

 

 

 

 

 

Effect of Exchange Rate Changes on Cash and Cash Equivalents

 

(4

)

(19

)

Net Increase (Decrease) in Cash and Cash Equivalents

 

225

 

(465

)

Cash and Cash Equivalents at Beginning of Period

 

914

 

1,021

 

Cash and Cash Equivalents at End of Period

 

$

1,139

 

$

556

 

 

See notes to consolidated financial statements.

 

5



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

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

 

The unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  In the opinion of management, all adjustments of a normal recurring nature considered necessary for a fair presentation have been included.  The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year.  The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2016.

 

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.  Certain significant accounting policies that contain subjective management estimates and assumptions include those related to revenue recognition, inventory, pension and other post-retirement benefit costs, goodwill, other intangible assets and long-lived assets, and income taxes.  Descriptions of these 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, 2016.  Management evaluates its 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) reported as cumulative translation adjustments through other comprehensive income (loss) (“OCI”) attributable to The Estée Lauder Companies Inc. amounted to $67 million and $72 million, net of tax, during the three months ended March 31, 2017 and 2016, respectively, and $(53) million and $(57) million, net of tax, during the nine months ended March 31, 2017 and 2016, respectively.

 

The Company enters into foreign currency forward contracts and may enter into option contracts to hedge foreign currency transactions for periods consistent with its identified exposures.  Accordingly, the Company categorizes these instruments as entered into for purposes other than trading.

 

The accompanying consolidated statements of earnings include net exchange gains on foreign currency transactions of $8 million and $11 million during the three months ended March 31, 2017 and 2016, respectively, and $14 million and $16 million during the nine months ended March 31, 2017 and 2016, respectively.

 

Accounts Receivable

 

Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions totaling $23 million and $24 million as of March 31, 2017 and June 30, 2016, respectively.

 

Concentration of Credit Risk

 

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

 

6



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company’s largest customer sells products primarily within the United States and accounted for $230 million, or 8%, and $248 million, or 9%, of the Company’s consolidated net sales for the three months ended March 31, 2017 and 2016, respectively, and $763 million, or 9%, and $840 million, or 10%, of the Company’s consolidated net sales for the nine months ended March 31, 2017 and 2016, respectively.  This customer accounted for $205 million, or 13%, and $164 million, or 13%, of the Company’s accounts receivable at March 31, 2017 and June 30, 2016, respectively.

 

Inventory and Promotional Merchandise

 

Inventory and promotional merchandise, net consists of:

 

 

 

March 31

 

June 30

 

(In millions)

 

2017

 

2016

 

Raw materials

 

$

278

 

$

306

 

Work in process

 

157

 

177

 

Finished goods

 

727

 

622

 

Promotional merchandise

 

148

 

159

 

 

 

$

1,310

 

$

1,264

 

 

Property, Plant and Equipment

 

 

 

March 31

 

June 30

 

(In millions)

 

2017

 

2016

 

Assets (Useful Life)

 

 

 

 

 

Land

 

$

29

 

$

15

 

Buildings and improvements (10 to 40 years)

 

183

 

187

 

Machinery and equipment (3 to 10 years)

 

636

 

680

 

Computer hardware and software (4 to 15 years)

 

1,094

 

1,041

 

Furniture and fixtures (5 to 10 years)

 

92

 

84

 

Leasehold improvements

 

1,854

 

1,789

 

 

 

3,888

 

3,796

 

Less accumulated depreciation and amortization

 

(2,312

)

(2,213

)

 

 

$

1,576

 

$

1,583

 

 

The cost of assets related to projects in progress of $202 million and $186 million as of March 31, 2017 and June 30, 2016, respectively, is included in their respective asset categories above.  Depreciation and amortization of property, plant and equipment was $106 million and $100 million during the three months ended March 31, 2017 and 2016, respectively, and $316 million and $295 million during the nine months ended March 31, 2017 and 2016, 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.

 

Other Accrued Liabilities

 

Other accrued liabilities consist of the following:

 

 

 

March 31

 

June 30

 

(In millions)

 

2017

 

2016

 

Advertising, merchandising and sampling

 

$

315

 

$

283

 

Employee compensation

 

437

 

504

 

Payroll and other taxes

 

206

 

163

 

Other

 

786

 

682

 

 

 

$

1,744

 

$

1,632

 

 

7



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Income Taxes

 

The effective rate for income taxes was 26.3% and 28.0% for the three months ended March 31, 2017 and 2016, respectively, and 27.2% and 28.0% for the nine months ended March 31, 2017 and 2016, respectively.

 

The decrease in the effective tax rate for each of the three-month and nine-month periods ended March 31, 2017 was primarily attributable to income tax reserve adjustments.

 

As of March 31, 2017 and June 30, 2016, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $76 million and $82 million, respectively.  The total amount of unrecognized tax benefits at March 31, 2017 that, if recognized, would affect the effective tax rate was $49 million.  During the three months ended March 31, 2017, the Company recognized a gross interest and penalty benefit of $1 million in the accompanying consolidated statement of earnings.  There was a total gross accrued interest and penalty expense during the nine months ended March 31, 2017 that was de minimis.  The total gross accrued interest and penalties in the accompanying consolidated balance sheets at March 31, 2017 and June 30, 2016 totaled $18 million at the end of each respective period.  On the basis of the information available as of March 31, 2017, it is reasonably possible that the total amount of unrecognized tax benefits could decrease in a range of $5 million to $10 million within the next twelve months as a result of projected resolutions of global tax examinations and controversies and a potential lapse of the applicable statutes of limitations.

 

Recently Issued Accounting Standards

 

Pension-related Costs

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

 

Effective for the Company — Fiscal 2019 first quarter, with early adoption permitted as of the first interim period in fiscal 2018.  The guidance must be applied (a) retrospectively as it pertains to the income statement classification of the components of net periodic benefit cost and (b) prospectively as it pertains to future capitalization of service costs.

 

Impact on consolidated financial statements  The Company is currently evaluating the timing of adoption and impact of applying this guidance on its consolidated financial statements.

 

Goodwill

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

 

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

 

Impact on consolidated financial statements  The impact of applying this guidance will be evaluated by the Company for future interim and annual impairment tests.

 

8



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Income Taxes

In October 2016, the FASB issued authoritative guidance that changes the way companies account for income taxes relating to intra-entity transfers of assets other than inventory.  This new guidance requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory in the period in which the transfer takes place. Under current guidance, recognition of current and deferred income taxes of an intra-entity asset transfer is prohibited until the asset has been sold to an outside party.  This new guidance may affect consolidated earnings where the intra-entity transfer of an asset other than inventory occurs between entities in jurisdictions with different tax rates.  This guidance must be adopted using a modified retrospective approach with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption.

 

Effective for the Company — Fiscal 2019 first quarter, with early adoption permitted.

 

Impact on consolidated financial statements — The Company is currently evaluating the impact of applying this guidance.

 

Measurement of Credit Losses on Financial Instruments

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

 

Effective for the Company — Fiscal 2021 first quarter.

 

Impact on consolidated financial statements — The Company is currently evaluating the impact of applying this guidance on its financial instruments, such as accounts receivable and short- and long-term investments.

 

Compensation - Stock Compensation

In March 2016, the FASB issued authoritative guidance that changes the way companies account for certain aspects of share-based payments to employees. This new guidance requires that all excess tax benefits and tax deficiencies related to share-based compensation awards be recorded as income tax expense or benefit in the income statement.  In addition, companies are required to treat the tax effects of exercised or vested awards as discrete items in the period that they occur.  This guidance also permits an employer to withhold up to the maximum statutory withholding rates in a jurisdiction without triggering liability classification, allows companies to elect to account for forfeitures as they occur, and provides requirements for the cash flow classification of cash paid by an employer when directly withholding shares for tax-withholding purposes and for the classification of excess tax benefits.  The new guidance prescribes different transition methods for the various provisions.

 

Effective for the Company — Fiscal 2018 first quarter, with early adoption permitted.

 

Impact on consolidated financial statements — The Company will adopt this guidance in its fiscal 2018 first quarter.  For the fiscal years ended June 30, 2016 and 2015, the Company recognized $22 million and $47 million of excess tax benefits, respectively, directly in its consolidated statements of equity. These amounts may or may not be representative of future amounts to be recognized in the income statement upon the adoption of this new standard, as the impact of the adoption will be primarily dependent on the timing and intrinsic value of stock-based compensation awards, employee exercise behavior and applicable tax rates.

 

Leases

In February 2016, the FASB issued authoritative guidance that requires lessees to account for most leases on their balance sheets with the liability being equal to the present value of the lease payments.  The right-of-use asset will be based on the lease liability adjusted for certain costs such as direct costs.  Lease expense will be recognized similar to current accounting guidance with operating leases resulting in a straight-line expense, and financing leases resulting in a front-loaded expense similar to the current accounting for capital leases.  This guidance must be adopted using a modified retrospective transition approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, and provides for certain practical expedients.

 

Effective for the Company — Fiscal 2020 first quarter, with early adoption permitted.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Impact on consolidated financial statements — The Company currently has an implementation team in place that is performing a comprehensive evaluation of the impact of the adoption of this guidance.  While the Company has not completed its evaluation, it believes the adoption of this standard will have a significant impact on its Consolidated Balance Sheets.

 

Revenue from Contracts with Customers

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Impact on consolidated financial statements — The Company will apply all of this new guidance when they become effective in fiscal 2019 and has not yet selected a transition method.  The Company currently has an implementation team in place that is performing a comprehensive evaluation of the impact of adoption and assessing the impact on third-party customer arrangements and the Company’s customer loyalty programs.

 

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

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 — INVESTMENTS

 

Gains and losses recorded in accumulated OCI (“AOCI”) related to the Company’s available-for-sale investments as of March 31, 2017 were as follows:

 

(In millions) 

 

Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

U.S. government and agency securities

 

$

452

 

$

2

 

$

(2

)

$

452

 

Foreign government and agency securities

 

103

 

 

(1

)

102

 

Corporate notes and bonds

 

506

 

 

(2

)

504

 

Time deposits

 

520

 

 

 

520

 

Other securities

 

26

 

1

 

 

27

 

Total

 

$

1,607

 

$

3

 

$

(5

)

$

1,605

 

 

Gains and losses recorded in AOCI related to the Company’s available-for-sale investments as of June 30, 2016 were as follows:

 

(In millions) 

 

Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

U.S. government and agency securities

 

$

560

 

$

3

 

$

 

$

563

 

Foreign government and agency securities

 

61

 

 

 

61

 

Corporate notes and bonds

 

454

 

3

 

 

457

 

Time deposits

 

390

 

 

 

390

 

Other securities

 

32

 

1

 

 

33

 

Total

 

$

1,497

 

$

7

 

$

 

$

1,504

 

 

The following table presents the Company’s available-for-sale securities by contractual maturity as of March 31, 2017:

 

(In millions)

 

Cost

 

Fair Value

 

Due within one year

 

$

701

 

$

701

 

Due after one through five years

 

906

 

904

 

 

 

$

1,607

 

$

1,605

 

 

The following table presents the fair market value of the Company’s investments with gross unrealized losses that are not deemed to be other-than temporarily impaired as of March 31, 2017:

 

 

 

In a Loss Position for Less Than 12
Months

 

In a Loss Position for More Than 12
Months

 

(In millions)

 

Fair Value

 

Gross
Unrealized
Losses

 

Fair Value

 

Gross
Unrealized
Losses

 

Available-for-sale securities

 

$

702

 

$

(5

)

$

5

 

$

 

 

There were no gross gains or losses realized on sales of investments included in the consolidated statements of earnings for the three and nine months ended March 31, 2017 and 2016.

 

The Company utilizes the first-in, first-out method to determine the cost of the security sold.  Sales proceeds from investments classified as available-for-sale were $200 million and $120 million for the three months ended March 31, 2017 and 2016, respectively, and $532 million and $502 million for the nine months ended March 31, 2017 and 2016, respectively.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 3 — ACQUISITION OF BUSINESSES

 

On December 19, 2016, the Company acquired 100% of Too Faced, a makeup brand, for approximately $1.5 billion.  This acquisition is expected to complement the Company’s distribution in the specialty-multi channel.  The amount paid at closing was funded by cash on hand including the proceeds from the issuance of commercial paper.  In February 2017, the Company issued long-term debt to refinance a portion of the outstanding commercial paper.  See Note 6 — Debt.   The purchase price recorded is provisional pending final working capital adjustments and completion of the final valuation.  The results of operations of Too Faced are included in the Company’s consolidated financial statements commencing on the acquisition date.

 

The Company has recorded an allocation of the purchase price to the Company’s tangible and identifiable intangible assets acquired and liabilities assumed based on their fair value at the acquisition date.  The excess of the purchase price over the fair value of the net tangible and intangible assets was recorded as goodwill, which includes value associated with assembled workforce.  The calculation of purchase price and purchase price allocation is as follows:

 

(In millions, unaudited)

 

 

 

Cash

 

$

28

 

Accounts receivable(1)

 

40

 

Inventory

 

105

 

Other current assets

 

3

 

Property, plant and equipment

 

8

 

Intangible assets

 

858

 

Goodwill

 

613

 

Total assets acquired

 

1,655

 

 

 

 

 

Accounts payable

 

56

 

Other accrued liabilities

 

15

 

Deferred income taxes

 

100

 

Total liabilities assumed

 

171

 

Total purchase price

 

$

1,484

 

 


(1)       Represents the gross amount of trade receivables of $44 million, net of estimated customer deductions of $4 million.

 

For the three and nine months ended March 31, 2017, the Company’s statements of earnings included approximately $87 million and $100 million, respectively, of net sales and $(5) million and $(10) million, net of tax, respectively, of net earnings (loss), inclusive of acquisition-related costs, related to Too Faced.  Acquisition-related costs, which primarily include financial advisory, accounting and legal fees, in the amount of $9 million for the nine months ended March 31, 2017 are included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings.

 

On November 14, 2016, the Company also acquired 100% of BECCA, a makeup brand.  Pro forma results of operations reflecting the Too Faced and BECCA acquisitions have not been presented, as the impact on the Company’s consolidated financial results would not have been material.

 

NOTE 4 — GOODWILL AND OTHER INTANGIBLE ASSETS

 

As previously discussed in Note 3 — Acquisition of Businesses, during the nine months ended March 31, 2017, the Company acquired Too Faced and BECCA, which included the addition of goodwill of $712 million, amortizable intangible assets of $394 million (with a weighted-average amortization period of approximately 10 years) and non-amortizable intangible assets of $623 million.  Goodwill associated with the acquisitions is primarily attributable to the future revenue growth opportunities associated with additional share in the makeup category.  As such, the goodwill has been allocated to the Company’s makeup product category.  Approximately $265 million of goodwill recorded in connection with certain of these acquisitions is expected to be deductible for tax purposes.  These amounts are provisional pending final working capital adjustments and completion of the final valuations.  During the nine months ended March 31, 2017, the Company recognized $8 million of goodwill associated with the continuing earn-out obligations related to the acquisition of the Bobbi Brown brand.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The intangible assets acquired in connection with the acquisitions of Too Faced and BECCA are classified as Level 3 in the fair value hierarchy.  The estimate of the fair values of acquired amortizable intangible assets was determined using a multi-period excess earnings income approach.  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 acquired intangible assets not subject to amortization was 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:

 

(In millions)

 

Skin Care

 

Makeup

 

Fragrance

 

Hair Care

 

Total

 

Balance as of June 30, 2016

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

184

 

$

460

 

$

255

 

$

393

 

$

1,292

 

Accumulated impairments

 

(29

)

 

 

(35

)

(64

)

 

 

155

 

460

 

255

 

358

 

1,228

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill acquired during the period

 

 

720

 

 

 

720

 

Translation adjustments

 

 

 

(6

)

 

(6

)

 

 

 

720

 

(6

)

 

714

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of March 31, 2017

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

183

 

1,180

 

249

 

392

 

2,004

 

Accumulated impairments

 

(28

)

 

 

(34

)

(62

)

 

 

$

155

 

$

1,180

 

$

249

 

$

358

 

$

1,942

 

 

Other intangible assets consist of the following:

 

 

 

March 31, 2017

 

June 30, 2016

 

(In millions)

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Total Net
Book
Value

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Total Net
Book
Value

 

Amortizable intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer lists and other

 

$

693

 

$

266

 

$

427

 

$

299

 

$

245

 

$

54

 

License agreements

 

43

 

43

 

 

43

 

43

 

 

 

 

$

736

 

$

309

 

427

 

$

342

 

$

288

 

54

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks and other

 

 

 

 

 

910

 

 

 

 

 

290

 

Total intangible assets

 

 

 

 

 

$

1,337

 

 

 

 

 

$

344

 

 

The aggregate amortization expense related to amortizable intangible assets was $13 million and $4 million for the three months ended March 31, 2017 and 2016, respectively, and was $22 million and $12 million for the nine months ended March 31, 2017 and 2016, respectively.  The estimated aggregate amortization expense for the remainder of fiscal 2017 and for each of fiscal 2018 to 2021 is $13 million, $51 million, $51 million, $44 million and $43 million, respectively.

 

NOTE 5 — CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER ACTIVITIES

 

Leading Beauty Forward

 

Background

 

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.

 

The Company plans to approve specific initiatives under LBF through fiscal 2019 related to the optimization of select corporate functions, supply chain activities, and corporate and regional market support structures, as well as the exit of underperforming businesses, and expects to complete those initiatives through fiscal 2021.  Inclusive of charges recorded from inception through March 31, 2017, the Company expects that LBF will result in related restructuring and other charges totaling between $600 million and $700 million before taxes.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Restructuring actions to be taken over the duration of LBF involve the redesigning, resizing and reorganization of select corporate functions and go-to-market structures to improve effectiveness and create cost efficiencies in support of increased investment in growth drivers.  As the Company continues to grow, it is important to more efficiently support its diverse portfolio of brands, channels and geographies in the rapidly evolving prestige beauty environment.  The initiatives being evaluated include the creation of a shared-services structure in existing or lower-cost locations, either using Company resources or through external service providers.  The Company also believes that decision-making in key areas of innovation, marketing and digital communications should be moved closer to the consumer to increase speed and local relevance.

 

In connection with LBF, at this time, the Company estimates a net reduction over the duration of LBF in the range of approximately 900 to 1,200 positions globally, which is about 2.5% of its current workforce. This reduction takes into account the elimination of some positions, retraining and redeployment of certain employees and investment in new positions in key areas.

 

Program-to-Date Approvals

 

Of the $600 million to $700 million restructuring and other charges expected to be incurred, total cumulative charges approved by the Company through March 31, 2017 were:

 

 

 

Sales

 

 

 

 

 

 

 

 

 

 

 

Returns

 

 

 

Operating Expenses

 

 

 

(In millions)

 

(included in
Net Sales)

 

Cost of Sales

 

Restructuring
Charges

 

Other
Charges

 

Total

 

Approval Period

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2016

 

$

4

 

$

28

(1)

$

87

 

$

71

(1)

$

190

 

Nine months ended March 31, 2017

 

11

 

6

 

78

 

77

 

172

 

Cumulative through March 31, 2017

 

$

15

 

$

34

 

$

165

 

$

148

 

$

362

 

 


(1)       Reflects approximately $25 million of supply chain consulting and professional services expected to be recognized in Cost of Sales, which were previously classified under Operating Expenses.

 

Included in the above table, cumulative restructuring initiatives approved by the Company through March 31, 2017 by major cost type were:

 

(In millions)

 

Employee-
Related
Costs

 

Asset-
Related
Costs

 

Contract
Terminations

 

Other Exit
Costs

 

Total

 

Approval Period

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2016

 

$

75

 

$

3

 

$

5

 

$

4

 

$

87

 

Nine months ended March 31, 2017

 

75

 

1

 

 

2

 

78

 

Cumulative through March 31, 2017

 

$

150

 

$

4

 

$

5

 

$

6

 

$

165

 

 

Specific actions taken during the nine months ended March 31, 2017 included:

 

·            Optimize Select Corporate Functions - The Company continued to approve initiatives to realign and optimize its organization to better leverage scale, improve productivity, reduce complexity and achieve cost savings across various functions, including research and development, global information systems and legal.  These actions will result in a net reduction of the workforce, which includes position eliminations, the re-leveling of certain positions and an investment in new capabilities.  The Company also approved consulting and other professional services related to the design of future structures, processes and technologies of certain corporate functions and, to a lesser extent, costs for training and recruitment related to new capabilities.  The Company also approved other charges to support the LBF Project Management Office (“PMO”).  The approved charges primarily consist of internal costs for employees dedicated solely to project management activities, with a focus on project integration, program communications and change management.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The future design of certain corporate functions includes the creation of a shared-services structure, either using Company resources or through external service providers.  As part of the future service delivery model in the finance organization, the Company approved the initial phase to transition select transactional activities to an external service provider, which is expected to result in other charges for implementation, project and consulting costs.

 

·            Optimize Corporate and Region Market Support Structures - The Company continued to approve initiatives to enhance its go-to-market support structures and achieve synergies across certain geographic regions, brands and channels.  These initiatives are primarily intended to shift certain areas of focus from traditional to social and digital marketing strategies to provide enhanced consumer experience, as well as to support expanded omnichannel opportunities.  These actions will result in a net reduction of the workforce, which includes position eliminations, the re-leveling of certain positions and an investment in new capabilities.  The Company also approved consulting and other professional services related to the design of future structures, processes and technologies and, to a lesser extent, other costs for recruitment and training related to new capabilities. In addition, the Company approved initiatives to enhance consumer engagement strategies across certain channels in Europe, which is expected to result in product returns.

 

·            Optimize Supply Chain - The Company approved certain activities related to an initiative to generate distribution capabilities and efficiencies through an external service provider.  The Company also approved certain activities related to initiatives to enhance strategic sourcing capabilities for direct procurement activities.  Collectively, these actions will result in a net reduction of the workforce, which includes position eliminations, the re-leveling of certain positions and an investment in new capabilities.  To enable the implementation of these initiatives, other charges were approved for LBF PMO costs, professional fees and asset write-offs.  The Company also continued to approve certain activities related to initiatives to redesign transportation management activities, to enhance its Quality Assurance organization, and to improve the organizational design of manufacturing and engineering activities related to certain product lines.  To enable the implementation of these initiatives, other charges were approved for consulting fees and, to a lesser extent, project management costs.

 

Program-to-Date Restructuring and Other Charges

 

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

 

 

 

Sales

 

 

 

 

 

 

 

 

 

 

 

Returns

 

 

 

Operating Expenses

 

 

 

(In millions)

 

(included in
Net Sales)

 

Cost of Sales

 

Restructuring
Charges

 

Other
Charges

 

Total

 

Fiscal 2016

 

$

1

 

$

 

$

75

 

$

5

 

$

81

 

Nine months ended March 31, 2017

 

2

 

10

 

70

 

52

 

134

 

Cumulative through March 31, 2017

 

$

3

 

$

10

 

$

145

 

$

57

 

$

215

 

 

Charges recorded during the nine months ended March 31, 2017 included returns (and the related cost of sales) and inventory write-offs related to the exit of certain businesses in select markets and channels of distribution.  Cost of sales also included consulting and professional services incurred, primarily related to the design of supply chain planning activities.  Other charges associated with LBF initiatives primarily reflected consulting and other professional services related to the design of future structures, processes and technologies of certain corporate functions and go-to-market activities and, to a lesser extent, costs to establish and maintain the LBF PMO.  Other charges are included in Restructuring and other charges in the accompanying consolidated statements of earnings.

 

Included in the above table, aggregate restructuring charges by major cost type were:

 

(In millions)

 

Employee-
Related
Costs

 

Asset-
Related
Costs

 

Contract
Terminations

 

Other Exit
Costs

 

Total

 

Fiscal 2016

 

$

74

 

$

1

 

$

 

$

 

$

75

 

Nine months ended March 31, 2017

 

66

 

2

 

2

 

 

70

 

Charges recorded through March 31, 2017

 

$

140

 

$

3

 

$

2

 

$

 

$

145

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Accrued restructuring charges from program inception through March 31, 2017 were:

 

(In millions)

 

Employee-
Related
Costs

 

Asset-
Related
Costs

 

Contract
Terminations

 

Other Exit
Costs

 

Total

 

Charges

 

$

74

 

$

1

 

$

 

$

 

$

75

 

Noncash asset write-offs

 

 

(1

)

 

 

(1

)

Translation adjustments

 

(1

)

 

 

 

(1

)

Balance at June 30, 2016

 

73

 

 

 

 

73

 

 

 

 

 

 

 

 

 

 

 

 

 

Charges

 

66

 

2

 

2

 

 

70

 

Cash payments

 

(24

)

 

(1

)

 

(25

)

Noncash asset write-offs

 

 

(2

)

 

 

(2

)

Translation and other adjustments

 

(2

)

 

 

 

(2

)

Balance at March 31, 2017

 

$

113

 

$

 

$

1

 

$

 

$

114

 

 

Restructuring charges for employee-related costs in fiscal 2017 are net of adjustments to the accrual estimate for certain employees who either resigned or transferred to other existing positions within the Company.  Accrued restructuring charges at March 31, 2017 are expected to result in cash expenditures funded from cash provided by operations of approximately $23 million, $57 million, $32 million and $2 million in fiscal 2017, 2018, 2019 and 2020, respectively.

 

Global Technology Infrastructure

 

In October 2015, the Company approved plans to transform and modernize its global technology infrastructure (“GTI”) to fundamentally change the way the Company delivers information technology services internally (such initiative, the “GTI Restructuring”).  As part of the GTI Restructuring, the Company transitioned its GTI from Company-owned assets to a primarily vendor-owned, cloud-based model where the Company pays for services as they are used.  The Company incurred restructuring charges of $12 million and $29 million for the three and nine months ended March 31, 2016, respectively, reflecting contract terminations, asset write-offs and employee-related costs.  Other charges in connection with the implementation of this initiative were $3 million and $5 million for the three and nine months ended March 31, 2016, respectively, primarily related to consulting services.  These charges are included in Restructuring and other charges in the accompanying consolidated statements of earnings.  The implementation of the GTI Restructuring was substantially completed during fiscal 2016.

 

NOTE 6 — DEBT

 

In February 2017, the Company completed a public offering of $500 million aggregate principal amount of its 1.80% Senior Notes due February 7, 2020 (the “2020 Senior Notes”), $500 million aggregate principal amount of its 3.15% Senior Notes due March 15, 2027 (the “2027 Senior Notes”) and $500 million aggregate principal amount of its 4.15% Senior Notes due March 15, 2047 (the “2047 Senior Notes”). The Company used proceeds from this offering for general corporate purposes, including to repay outstanding commercial paper as it matured and to refinance its $300 million aggregate principal amount of 5.55% Senior Notes due May 15, 2017 when it becomes due.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

These recently issued notes are summarized as follows:

 

Notes

 

Issue Date

 

Price

 

Yield

 

Unamortized
Debt
(Discount)
Premium

 

Interest rate
swap
adjustments

 

Debt Issuance
Costs

 

Semi-annual interest
payments

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2020 Senior Notes

 

February 2017

 

99.986

%

1.805

%

$

 

$

(1

)

$

2

 

February 7/August 7

 

2027 Senior Notes (1)

 

February 2017

 

99.963

 

3.154

 

 

N/A

 

3

 

March 15/September 15

 

2047 Senior Notes (2)

 

February 2017

 

99.739

 

4.165

 

(2

)

N/A

 

5

 

March 15/September 15

 

 


(1)                In November 2016, in anticipation of the issuance of the 2027 Senior Notes, the Company entered into a series of treasury lock agreements on a notional amount totaling $450 million at a weighted-average all-in rate of 2.37%.  The treasury lock agreements were settled upon the issuance of the new debt, and the Company recognized a gain in OCI of $2 million that is being amortized to interest expense over the life of the 2027 Senior Notes.  As a result of the treasury lock agreements, the debt discount and debt issuance costs, the effective interest rate on the 2027 Senior Notes will be 3.18% over the life of the debt.

(2)                In November 2016, in anticipation of the issuance of the 2047 Senior Notes, the Company entered into a series of treasury lock agreements on a notional amount totaling $350 million at a weighted-average all-in rate of 3.01%.  The treasury lock agreements were settled upon the issuance of the new debt, and the Company recognized a gain in OCI of $3 million that is being amortized to interest expense over the life of the 2047 Senior Notes.  As a result of the treasury lock agreements, the debt discount and debt issuance costs, the effective interest rate on the 2047 Senior Notes will be 4.17% over the life of the debt.

 

In February 2017, the Company decreased the size of its commercial paper program, under which it may issue commercial paper in the United States, to $1.5 billion. The commercial paper program had previously been increased to $3 billion in November 2016 to finance the Company’s second quarter acquisitions.  As of March 31, 2017, the Company had $195 million of commercial paper outstanding that matured through April 2017, which the Company refinanced as it matured.

 

In February 2017, the Company terminated its undrawn $1.5 billion senior unsecured credit agreement, which was entered into November 2016 and provided a 364 day revolving credit facility for the Company’s general corporate purposes.

 

In October 2016, the Company replaced its undrawn $1.0 billion unsecured revolving credit facility that was set to expire on July 15, 2020 (the “Prior Facility”) with a new $1.5 billion senior unsecured revolving credit facility that expires on October 3, 2021, unless extended for up to two additional years in accordance with the terms set forth in the agreement (the “New Facility”).  The New Facility may be used for general corporate purposes.  Up to the equivalent of $500 million of the New Facility is available for multi-currency loans.  Interest rates on borrowings under the New Facility will be based on prevailing market interest rates in accordance with the agreement.  The Company incurred costs of approximately $1 million to establish the New Facility, which will be amortized over the term of the facility.  The New Facility has an annual fee of approximately $1 million, payable quarterly, based on the Company’s current credit ratings.  The New Facility contains a cross-default provision whereby a failure to pay other material financial obligations in excess of $175 million (after grace periods and absent a waiver from the lenders) would result in an event of default and the acceleration of the maturity of any outstanding debt under this facility.  At March 31, 2017, no borrowings were outstanding under the New Facility.

 

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.  The Company also enters into foreign currency forward contracts and may use option contracts, not designated as hedging instruments, to mitigate the change in fair value of specific assets and liabilities on the balance sheet.  The Company does not utilize derivative financial instruments for trading or speculative purposes.  Costs associated with entering into derivative financial instruments have not been material to the Company’s consolidated financial results.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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, how the hedging instruments’ effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively, and a description of the method of measuring ineffectiveness.  This process includes linking all derivatives to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions.  The Company also formally assesses, both at the inception of the hedges and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.  If it is determined that a derivative is not highly effective, or that it has ceased to be a highly effective hedge, the Company will be required to discontinue hedge accounting with respect to that derivative prospectively.

 

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

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

 

 

Fair Value (1)

 

 

 

Fair Value (1)

 

(In millions)

 

Balance Sheet
Location

 

March 31
2017

 

June 30
2016

 

Balance Sheet
Location

 

March 31
2017

 

June 30
2016

 

Derivatives Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

$

27

 

$

37

 

Other accrued liabilities

 

$

30

 

$

18

 

Interest rate swap contracts

 

Prepaid expenses and other current assets

 

 

18

 

Other accrued liabilities

 

7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives Designated as Hedging Instruments

 

 

 

27

 

55

 

 

 

37

 

18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

4

 

11

 

Other accrued liabilities

 

10

 

8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives

 

 

 

$

31

 

$

66

 

 

 

$

47

 

$

26

 

 


(1) See Note 8 — Fair Value Measurements for further information about how the fair value of derivative assets and liabilities are determined.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The amounts of the gains and losses related to the Company’s derivative financial instruments designated as hedging instruments are presented as follows:

 

 

 

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

 

Location of Gain or
(Loss) Reclassified

 

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

 

 

 

Three Months Ended
March 31

 

from AOCI into
Earnings

 

Three Months Ended
March 31

 

(In millions)

 

2017

 

2016

 

(Effective Portion)

 

2017

 

2016

 

Derivatives in Cash Flow Hedging Relationships

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

(35

)

$

(16

)

Cost of sales

 

$

2

 

$

6

 

 

 

 

 

 

 

Selling, general and administrative

 

7

 

14

 

Interest rate-related derivatives

 

(6

)

 

Interest expense

 

1

 

 

Total Derivatives

 

$

(41

)

$

(16

)

 

 

$

10

 

$

20

 

 


(1)    The amount of gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was $2 million and $(3) million for the three months ended March 31, 2017 and 2016, respectively.  There was no gain (loss) recognized in earnings related to the ineffective portion of the hedging relationships for the three months ended March 31, 2017 and March 31, 2016.

 

 

 

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

 

Location of Gain or
(Loss) Reclassified

 

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

 

 

 

Nine Months Ended
March 31

 

from AOCI into
Earnings

 

Nine Months Ended
March 31

 

(In millions)

 

2017

 

2016

 

(Effective Portion)

 

2017

 

2016

 

Derivatives in Cash Flow Hedging Relationships

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

13

 

$

20

 

Cost of sales

 

$

8

 

$

13

 

 

 

 

 

 

 

Selling, general and administrative

 

26

 

38

 

Interest rate-related derivatives

 

5

 

 

Interest Expense

 

1

 

1

 

Total Derivatives

 

$

18

 

$

20

 

 

 

$

35

 

$

52

 

 


(1)    The amount of gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was de minimis and $(2) million for the nine months ended March 31, 2017 and 2016, respectively.  The amount of gain recognized in earnings related to the ineffective portion of the hedging relationships was de minimis for the nine months ended March 31, 2017 and 2016.

 

 

 

 

 

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

 

 

 

Location of Gain or (Loss)
Recognized in Earnings on

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

Derivatives

 

2017

 

2016

 

2017

 

2016

 

Derivatives in Fair Value Hedging Relationships

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts

 

Interest expense

 

$

(3

)

$

7

 

$

(25

)

$

13

 

 


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

 

19



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

 

 

 

 

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

 

 

 

Location of Gain or (Loss)
Recognized in Earnings on

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

Derivatives

 

2017

 

2016

 

2017

 

2016

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Selling, general and administrative

 

$

(11

)

$

20

 

$

(10

)

$

21

 

 

Cash-Flow Hedges

 

The Company enters into foreign currency forward contracts to hedge anticipated transactions, as well as 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 costs and on the cash flows that the Company receives from foreign subsidiaries.  The majority of foreign currency forward contracts are denominated in currencies of major industrial countries.  The Company may also enter into foreign currency option contracts to hedge anticipated transactions where there is a high probability that anticipated exposures will materialize.  The foreign currency forward contracts entered into to hedge anticipated transactions have been designated as cash-flow hedges and have varying maturities through the end of March 2019.  Hedge effectiveness of foreign currency forward contracts is based on a hypothetical derivative methodology and excludes the portion of fair value attributable to the spot-forward difference which is recorded in current-period earnings.  Hedge effectiveness of foreign currency option contracts is based on a dollar offset methodology.

 

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.

 

The ineffective portion of both foreign currency forward and interest rate derivatives is recorded in current-period earnings.  For hedge contracts that are no longer deemed highly effective, hedge accounting is discontinued and gains and losses in AOCI are reclassified to earnings 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 earnings.  As of March 31, 2017, the Company’s foreign currency cash-flow hedges were highly effective.

 

At March 31, 2017, the Company had foreign currency forward contracts in the amount of $3,175 million.  The foreign currencies included in foreign currency forward contracts (notional value stated in U.S. dollars) are principally the British pound ($565 million), Swiss franc ($397 million), Hong Kong dollar ($364 million), Chinese yuan ($328 million), Euro ($305 million), Australian dollar ($196 million) and Taiwan dollar ($138 million).

 

The estimated net gain on the Company’s derivative instruments designated as cash-flow hedges as of March 31, 2017 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $4 million.  The accumulated gain on derivative instruments in AOCI was $33 million and $50 million as of March 31, 2017 and June 30, 2016, 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, 1.70% Senior Notes due May 10, 2021 and 2.35% Senior Notes due August 15, 2022, 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.

 

20



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Credit Risk

 

As a matter of policy, the Company enters into derivative contracts only with counterparties that have a long-term credit rating of at least A- or higher by at least two nationally recognized rating agencies.  The counterparties to these contracts are major financial institutions.  Exposure to credit risk in the event of nonperformance by any of the counterparties is limited to the gross fair value of contracts in asset positions, which totaled $31 million at March 31, 2017.  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 March 31, 2017:

 

(In millions)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

31

 

$

 

$

31

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

452

 

 

452

 

Foreign government and agency securities

 

 

102

 

 

102

 

Corporate notes and bonds

 

 

504

 

 

504

 

Time deposits

 

 

520

 

 

520

 

Other securities

 

 

27

 

 

27

 

Total

 

$

 

$

1,636

 

$

 

$

1,636

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

40

 

$

 

$

40

 

Interest rate swap contracts

 

 

7

 

 

7

 

Contingent consideration

 

 

 

197

 

197

 

Total

 

$

 

$

47

 

$

197

 

$

244

 

 

21



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2016:

 

(In millions) 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

48

 

$

 

$

48

 

Interest rate swap contracts

 

 

18

 

 

18

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

563

 

 

563

 

Foreign government and agency securities

 

 

61

 

 

61

 

Corporate notes and bonds

 

 

457

 

 

457

 

Time deposits

 

 

390

 

 

390

 

Other securities

 

 

33

 

 

33

 

Total

 

$

 

$

1,570

 

$

 

$

1,570

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

26

 

$

 

$

26

 

Contingent consideration

 

 

 

196

 

196

 

Total

 

$

 

$

26

 

$

196

 

$

222

 

 

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

 

 

 

March 31

 

June 30

 

 

 

2017

 

2016

 

(In millions)

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Nonderivatives

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,139

 

$

1,139

 

$

914

 

$

914

 

Available-for-sale securities

 

1,605

 

1,605

 

1,504

 

1,504

 

Current and long-term debt

 

3,896

 

4,007

 

2,242

 

2,482

 

Additional purchase price payable

 

37

 

37

 

37

 

37

 

Contingent consideration

 

197

 

197

 

196

 

196

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts — asset (liability), net

 

(9

)

(9

)

22

 

22

 

Interest rate swap contracts — asset (liability), net

 

(7

)

(7

)

18

 

18

 

 

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, money market funds and time deposits. The carrying amount approximates fair value primarily due to the short maturity of cash equivalent instruments.

 

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

 

22



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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

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

 

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

 

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

 

Contingent consideration — Contingent consideration obligations consist of potential obligations related to the Company’s acquisitions in previous years. The amounts to be paid under these obligations are contingent upon the achievement of stipulated financial targets by the business subsequent to acquisition. The fair values of the contingent consideration related to certain acquisition earn-outs were estimated using a probability-weighted discount model that considers the achievement of the conditions upon which the respective contingent obligation is dependent (“Monte Carlo Method”).

 

The Monte Carlo Method has various inputs into the valuation model, in addition to the risk-adjusted projected future operating results of the acquired entities, which include the following ranges at March 31, 2017:

 

Risk-adjusted discount rate

 

1.5% to 2.4%

Revenue volatility

 

3.5% to 8.3%

Asset volatility

 

21.7% to 26.5%

Revenue/earnings before income tax, depreciation and amortization (“EBITDA”) correlation factor

 

80%

Revenue discount rates

 

2.9% to 4.9%

EBITDA discount rates

 

11.1% to 11.9%

 

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

 

Changes in the fair value of the contingent consideration obligations for the nine months ended March 31, 2017 are included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings and were as follows:

 

(In millions)

 

Fair Value

 

Contingent consideration at June 30, 2016

 

$

196

 

Change in fair value

 

1

 

Contingent consideration at March 31, 2017

 

$

197

 

 

23



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 9 — 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 which provide certain medical and dental benefits to eligible employees.  Descriptions of these plans 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, 2016.

 

The components of net periodic benefit cost for the three months ended March 31, 2017 and 2016 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

Other than

 

 

 

Pension Plans

 

Pension Plans

 

 

 

U.S.

 

International

 

Post-retirement

 

(In millions)

 

2017

 

2016

 

2017

 

2016

 

2017

 

2016

 

Service cost

 

$

9

 

$

8

 

$

7

 

$

6

 

$

 

$

1

 

Interest cost

 

8

 

8

 

3

 

4

 

2

 

2

 

Expected return on plan assets

 

(13

)

(12

)

(4

)

(5

)

 

(1

)

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

 

1

 

 

 

 

 

Actuarial loss

 

4

 

2

 

3

 

3

 

 

 

Special termination benefits

 

 

 

1

 

 

 

 

Net periodic benefit cost

 

$

8

 

$

7

 

$

10

 

$

8

 

$

2

 

$

2

 

 

The components of net periodic benefit cost for the nine months ended March 31, 2017 and 2016 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

Other than

 

 

 

Pension Plans

 

Pension Plans

 

 

 

U.S.

 

International

 

Post-retirement

 

(In millions)

 

2017

 

2016

 

2017

 

2016

 

2017

 

2016

 

Service cost

 

$

27

 

$

24

 

$

21

 

$

18

 

$

2

 

$

3

 

Interest cost

 

23

 

24

 

9

 

12

 

5

 

6

 

Expected return on plan assets

 

(39

)

(36

)

(12

)

(15

)

(1

)

(2

)

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

1

 

1

 

1

 

1

 

 

 

Actuarial loss

 

12

 

8

 

8

 

9

 

1

 

 

Special termination benefits

 

 

 

1

 

 

 

 

Net periodic benefit cost

 

$

24

 

$

21

 

$

28

 

$

25

 

$

7

 

$

7

 

 

During the nine months ended March 31, 2017, the Company made contributions to its international pension plans totaling approximately $9 million.

 

24



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

 

 

March 31

 

June 30

 

(In millions)

 

2017

 

2016

 

Other assets

 

$

75

 

$

79

 

Other accrued liabilities

 

(27

)

(27

)

Other noncurrent liabilities

 

(443

)

(429

)

Funded status

 

(395

)

(377

)

Accumulated other comprehensive loss

 

400

 

427

 

Net amount recognized

 

$

5

 

$

50

 

 

NOTE 10 — 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 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 litigation and other legal proceedings are not material to the Company’s consolidated financial statements.

 

NOTE 11 — 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”), PSUs based on total stockholder return (“TSR”), long-term PSUs, and share units.  Compensation expense attributable to net stock-based compensation is as follows:

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2017

 

2016

 

2017

 

2016

 

Compensation expense

 

$

41

 

$

36

 

$

175

 

$

147

 

Income tax benefit

 

14

 

12

 

58

 

48

 

 

Stock Options

 

During the nine months ended March 31, 2017, the Company granted approximately 2.5 million stock options with a weighted-average exercise price per share of $89.24 and a weighted-average grant date fair value per share of $22.79. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model.  The aggregate intrinsic value of stock options exercised during the three and nine months ended March 31, 2017 was $45 million and $116 million, respectively.

 

Restricted Stock Units

 

The Company granted approximately 1.6 million RSUs during the nine months ended March 31, 2017 with a weighted-average grant date fair value per share of $88.54 which, at the time of grant, were scheduled to vest as follows: 0.5 million in fiscal 2018, 0.5 million in fiscal 2019, 0.5 million in fiscal 2020 and 0.1 million in fiscal 2022.  Vesting of RSUs granted is generally subject to the continued employment of the grantees.  RSUs are accompanied by dividend equivalent rights, payable upon settlement 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.

 

25



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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Performance Share Units

 

In September 2016, the Company granted PSUs with a target payout of approximately 0.3 million shares with a weighted-average grant date fair value per share of $89.47, 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, 2019.  In January 2017, the Company granted PSUs with a target payout of approximately 0.3 million shares with a weighted-average grant date fair value per share of $80.79, which will be settled in stock subject to the achievement of certain net sales and net operating profit goals of a subsidiary of the Company for the fiscal year ending June 30, 2020.  In January 2017, the Company granted PSUs with a target payout of approximately 0.2 million shares with a weighted-average grant date fair value per share of $80.79, which will be settled in stock subject to the achievement of certain net sales and net operating profit goals of a subsidiary of the Company for the fiscal year ending June 30, 2022.  For PSU grants, no settlement will occur for results below the applicable minimum threshold.  Vesting of PSUs is generally subject to continued employment of the grantees. PSUs are accompanied by dividend equivalent rights that will be payable in cash upon settlement.

 

In September 2016, approximately 0.3 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, 2016.

 

Performance Share Units Based on Total Stockholder Return

 

In September 2016, 49,882 shares of the Company’s Class A Common Stock were issued, and related dividends paid, in accordance with the terms of the grant, related to the performance period ended June 30, 2016.

 

NOTE 12 — NET EARNINGS ATTRIBUTABLE TO THE ESTÉE LAUDER COMPANIES INC. PER COMMON SHARE

 

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

 

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

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions, except per share data)

 

2017

 

2016

 

2017

 

2016

 

Numerator:

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Estée Lauder Companies Inc.

 

$

298

 

$

265

 

$

1,020

 

$

1,021

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding — Basic

 

367.0

 

369.1

 

366.8

 

370.4

 

Effect of dilutive stock options

 

3.5

 

4.5

 

3.8

 

4.4

 

Effect of PSUs

 

0.2

 

 

0.2

 

 

Effect of RSUs

 

1.6

 

1.9

 

1.9

 

2.0

 

Effect of PSUs based on TSR

 

 

0.1

 

 

0.1

 

Weighted-average common shares outstanding — Diluted

 

372.3

 

375.6

 

372.7

 

376.9

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Basic

 

$

0.81

 

$

0.72

 

$

2.78

 

$

2.76

 

Diluted

 

0.80

 

0.71

 

2.74

 

2.71

 

 

26



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of March 31, 2017 and 2016, outstanding options to purchase 2.5 million and 0.2 million shares, respectively, of Class A Common Stock were not included in the computation of diluted EPS because their inclusion would be anti-dilutive.  As of March 31, 2017 and 2016, 1.3 million and 0.8 million shares, respectively, of Class A Common Stock underlying PSUs have been excluded from the calculation of diluted EPS because the number of shares ultimately issued is contingent on the achievement of certain performance targets of the Company, as discussed in Note 11 — Stock Programs.

 

NOTE 13 — EQUITY

 

 

 

Total Stockholders’ Equity — The Estée Lauder Companies Inc.

 

 

 

Non-

 

 

 

(In millions)

 

Common
Stock

 

Paid-in
Capital

 

Retained
Earnings

 

AOCI

 

Treasury
Stock

 

Total

 

controlling
Interests

 

Total
Equity

 

Balance at June 30, 2016

 

$

6

 

$

3,161

 

$

7,693

 

$

(545

)

$

(6,743

)

$

3,572

 

$

15

 

$

3,587

 

Net earnings

 

 

 

1,020

 

 

 

1,020

 

6

 

1,026

 

Common stock dividends

 

 

2

 

(363

)

 

 

(361

)

(5

)

(366

)

Other comprehensive income (loss)

 

 

 

 

(54

)

 

(54

)

 

(54

)

Acquisition of treasury stock

 

 

 

 

 

(307

)

(307

)

 

(307

)

Stock-based compensation

 

 

299

 

 

 

(50

)

249

 

 

249

 

Balance at March 31, 2017

 

$

6

 

$

3,462

 

$

8,350

 

$

(599

)

$

(7,100

)

$

4,119

 

$

16

 

$

4,135

 

 

The following is a summary of quarterly cash dividends declared per share on the Company’s Class A and Class B Common Stock during the nine months ended March 31, 2017:

 

Date Declared

 

Record Date

 

Payable Date

 

Amount per Share

August 18, 2016

 

August 31, 2016

 

September 15, 2016

 

$

.30

November 1, 2016

 

November 30, 2016

 

December 15, 2016

 

$

.34

February 1, 2017

 

February 28, 2017

 

March 15, 2017

 

$

.34

 

On May 2, 2017, a dividend was declared in the amount of $.34 per share on the Company’s Class A and Class B Common Stock.  The dividend is payable in cash on June 15, 2017 to stockholders of record at the close of business on May 31, 2017.

 

Common Stock

 

During the nine months ended March 31, 2017, the Company purchased approximately 4.2 million shares of its Class A Common Stock for $363 million.

 

During the nine months ended March 31, 2017, approximately 0.8 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 nine months ended March 31, 2017:

 

(In millions)

 

Net
Unrealized
Investment
Gain (Loss)

 

Net
Derivative
Instrument
Gain (Loss)

 

Amounts
Included in
Net Periodic
Benefit Cost

 

Translation
Adjustments

 

Total

 

Balance at June 30, 2016

 

$

7

 

$

32

 

$

(285

)

$

(299

)

$

(545

)

OCI before reclassifications

 

(9

)

12

 

3

(1)

(53

)

(47

)

Amounts reclassified from AOCI

 

 

(23

)

16

 

 

(7

)

Net current-period OCI

 

(9

)

(11

)

19

 

(53

)

(54

)

Balance at March 31, 2017

 

$

(2

)

$

21

 

$

(266

)

$

(352

)

$

(599

)

 


(1) Includes foreign currency translation gains of $4 million.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table represents the effects of reclassification adjustments from AOCI into net earnings for the three and nine months ended March 31, 2017 and 2016:

 

 

 

Amount Reclassified from AOCI

 

 

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

Affected Line Item in
Consolidated

 

(In millions)

 

2017

 

2016

 

2017

 

2016

 

Statement of Earnings

 

Gain (Loss) on Investments

 

 

 

 

 

 

 

 

 

 

 

Gain (loss) on investments

 

$

(1

)

$

 

$

 

$

 

Interest income and investment income, net

 

Benefit (provision) for deferred taxes

 

 

 

 

 

Provision for income taxes

 

 

 

$

(1

)

$

 

$

 

$

 

Net earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (Loss) on Cash-Flow Hedges

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

2

 

$

6

 

$

8

 

$

13

 

Cost of sales

 

Foreign currency forward contracts

 

7

 

14

 

26

 

38

 

Selling, general and administrative

 

Interest rate-related derivatives

 

1

 

 

1

 

1

 

Interest expense

 

 

 

10

 

20

 

35

 

52

 

Earnings before income taxes

 

Benefit (provision) for deferred taxes

 

(3

)

(7

)

(12

)

(18

)

Provision for income taxes

 

 

 

$

7

 

$

13

 

$

23

 

$

34

 

Net earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts Included in Net Periodic Benefit Cost

 

 

 

 

 

 

 

 

 

Amortization of prior service cost

 

$

 

$

(1

)

$

(2

)

$

(2

)

(1)

 

Amortization of actuarial loss

 

(7

)

(5

)

(21

)

(17

)

(1)

 

 

 

(7

)

(6

)

(23

)

(19

)

Earnings before income taxes

 

Benefit (provision) for deferred taxes

 

2

 

2

 

7

 

5

 

Provision for income taxes

 

 

 

$

(5

)

$

(4

)

$

(16

)

$

(14

)

Net earnings

 

Total reclassification adjustments, net

 

$

1

 

$

9

 

$

7

 

$

20

 

Net earnings

 

 


(1) See Note 9 — Pension and Post-Retirement Benefit Plans for additional information.

 

28



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 14 — STATEMENT OF CASH FLOWS

 

Supplemental cash flow information for the nine months ended March 31, 2017 and 2016 is as follows:

 

(In millions)

 

2017

 

2016

 

Cash:

 

 

 

 

 

Cash paid during the period for interest

 

$

58

 

$

47

 

Cash paid during the period for income taxes

 

$

324

 

$

349

 

 

 

 

 

 

 

Noncash investing and financing activities:

 

 

 

 

 

Capital lease and asset retirement obligations incurred

 

$

10

 

$

23

 

Noncash purchases (sales) of short- and long-term investments, net

 

$

1

 

$

2

 

Property, plant and equipment accrued but unpaid

 

$

26

 

$

22

 

 

NOTE 15 — 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 and earnings before income taxes, interest expense and interest income and investment income, net.  Returns and charges associated with restructuring and other activities are not allocated to 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, and to transform and modernize the Company’s global technology infrastructure.

 

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, 2016.  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 increase in total assets as a result of the acquisitions discussed in Note 3 - Acquisition of Businesses, which primarily 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, 2016.

 

29



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2017

 

2016

 

2017

 

2016

 

PRODUCT CATEGORY DATA

 

 

 

 

 

 

 

 

 

Net Sales:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

1,105

 

$

1,073

 

$

3,455

 

$

3,414

 

Makeup

 

1,271

 

1,161

 

3,743

 

3,574

 

Fragrance

 

336

 

276

 

1,275

 

1,159

 

Hair Care

 

126

 

128

 

399

 

411

 

Other

 

19

 

19

 

60

 

58

 

 

 

2,857

 

2,657

 

8,932

 

8,616

 

Returns associated with restructuring and other activities

 

 

 

(2

)

 

Net Sales

 

$

2,857

 

$

2,657

 

$

8,930

 

$

8,616

 

 

 

 

 

 

 

 

 

 

 

Operating Income (Loss) before charges associated with restructuring and other activities:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

265

 

$

202

 

$

828

 

$

701

 

Makeup

 

192

 

192

 

562

 

642

 

Fragrance

 

16

 

(6

)

157

 

114

 

Hair Care

 

12

 

10

 

38

 

36

 

Other

 

4

 

1

 

11

 

8

 

 

 

489

 

399

 

1,596

 

1,501

 

Reconciliation:

 

 

 

 

 

 

 

 

 

Charges associated with restructuring and other activities

 

(62

)

(15

)

(134

)

(34

)

Interest expense

 

(28

)

(18

)

(71

)

(52

)

Interest income and investment income, net

 

8

 

4

 

19

 

10

 

Earnings before income taxes

 

$

407

 

$

370

 

$

1,410

 

$

1,425

 

 

 

 

 

 

 

 

 

 

 

GEOGRAPHIC DATA

 

 

 

 

 

 

 

 

 

Net Sales:

 

 

 

 

 

 

 

 

 

The Americas

 

$

1,171

 

$

1,112

 

$

3,646

 

$

3,607

 

Europe, the Middle East & Africa

 

1,126

 

1,023

 

3,477

 

3,308

 

Asia/Pacific

 

560

 

522

 

1,809

 

1,701

 

 

 

2,857

 

2,657

 

8,932

 

8,616

 

Returns associated with restructuring and other activities

 

 

 

(2

)

 

Net Sales

 

$

2,857

 

$

2,657

 

$

8,930

 

$

8,616

 

 

 

 

 

 

 

 

 

 

 

Operating Income (Loss):

 

 

 

 

 

 

 

 

 

The Americas

 

$

87

 

$

112

 

$

236

 

$

310

 

Europe, the Middle East & Africa

 

288

 

212

 

956

 

843

 

Asia/Pacific

 

114

 

75

 

404

 

348

 

 

 

489

 

399

 

1,596

 

1,501

 

Charges associated with restructuring and other activities

 

(62

)

(15

)

(134

)

(34

)

Operating Income

 

$

427

 

$

384

 

$

1,462

 

$

1,467

 

 

30



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

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

 

RESULTS OF OPERATIONS

 

We manufacture, market and sell beauty products including those in the skin care, makeup, fragrance and hair care categories, which are distributed in over 150 countries and territories.  The following table is a comparative summary of operating results for the three and nine months ended March 31, 2017 and 2016, and reflects the basis of presentation described in Note 1 of Notes to Consolidated Financial Statements — Summary of Significant Accounting Policies for all periods presented.  Products and services that do not meet our definition of skin care, makeup, fragrance or hair care have been included in the “other” category.

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2017

 

2016

 

2017

 

2016

 

NET SALES

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

The Americas

 

$

1,171

 

$

1,112

 

$

3,646

 

$

3,607

 

Europe, the Middle East & Africa

 

1,126

 

1,023

 

3,477

 

3,308

 

Asia/Pacific

 

560

 

522

 

1,809

 

1,701

 

 

 

2,857

 

2,657

 

8,932

 

8,616

 

Returns associated with restructuring and other activities

 

 

 

(2

)

 

Net Sales

 

$

2,857

 

$

2,657

 

$

8,930

 

$

8,616

 

 

 

 

 

 

 

 

 

 

 

By Product Category:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

1,105

 

$

1,073

 

$

3,455

 

$

3,414

 

Makeup

 

1,271

 

1,161

 

3,743

 

3,574

 

Fragrance

 

336

 

276

 

1,275

 

1,159

 

Hair Care

 

126

 

128

 

399

 

411

 

Other

 

19

 

19

 

60

 

58

 

 

 

2,857

 

2,657

 

8,932

 

8,616

 

Returns associated with restructuring and other activities

 

 

 

(2

)

 

Net Sales

 

$

2,857

 

$

2,657

 

$

8,930

 

$

8,616

 

 

 

 

 

 

 

 

 

 

 

OPERATING INCOME (LOSS)

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

The Americas

 

$

87

 

$

112

 

$

236

 

$

310

 

Europe, the Middle East & Africa

 

288

 

212

 

956

 

843

 

Asia/Pacific

 

114

 

75

 

404

 

348

 

 

 

489

 

399

 

1,596

 

1,501

 

Charges associated with restructuring and other activities

 

(62

)

(15

)

(134

)

(34

)

Operating Income

 

$

427

 

$

384

 

$

1,462

 

$

1,467

 

 

 

 

 

 

 

 

 

 

 

By Product Category:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

265

 

$

202

 

$

828

 

$

701

 

Makeup

 

192

 

192

 

562

 

642

 

Fragrance

 

16

 

(6

)

157

 

114

 

Hair Care

 

12

 

10

 

38

 

36

 

Other

 

4

 

1

 

11

 

8

 

 

 

489

 

399

 

1,596

 

1,501

 

Charges associated with restructuring and other activities

 

(62

)

(15

)

(134

)

(34

)

Operating Income

 

$

427

 

$

384

 

$

1,462

 

$

1,467

 

 

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

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

 

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of sales

 

20.7

 

19.0

 

20.4

 

19.4

 

Gross profit

 

79.3

 

81.0

 

79.6

 

80.6

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

62.3

 

66.0

 

61.8

 

63.2

 

Restructuring and other charges

 

2.1

 

0.5

 

1.4

 

0.4

 

Total operating expenses

 

64.4

 

66.5

 

63.2

 

63.6

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

14.9

 

14.5

 

16.4

 

17.0

 

Interest expense

 

1.0

 

0.7

 

0.8

 

0.6

 

Interest income and investment income, net

 

0.3

 

0.1

 

0.2

 

0.1

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

14.2

 

13.9

 

15.8

 

16.5

 

Provision for income taxes

 

3.7

 

3.9

 

4.3

 

4.6

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

10.5

 

10.0

 

11.5

 

11.9

 

Net earnings attributable to noncontrolling interests

 

(0.1

)

 

(0.1

)

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Estée Lauder Companies Inc.

 

10.4

%

10.0

%

11.4

%

11.9

%

 

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

 

Non-GAAP Financial Measures

 

We use certain non-GAAP financial measures, among other financial measures, to evaluate our operating performance, which represent the manner in which we conduct and view our business.  Management believes that excluding certain items that are not comparable from period to period helps investors and others compare operating performance between two 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 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

We operate on a global basis, with the majority of our net sales generated outside the United States.  Accordingly, fluctuations in foreign currency exchange rates can affect our results of operations.  Therefore, we present certain net sales, operating results and diluted net earnings per common share information excluding the effect of foreign currency rate fluctuations to provide a framework for assessing the performance of our underlying business outside the United States.  Constant currency information compares results between periods as if exchange rates had remained constant period-over-period.  We calculate constant currency information by translating current year results using prior year weighted-average foreign currency exchange rates.

 

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Overview

 

We believe the best way to continue to increase stockholder value is to provide superior products and services in the most efficient and profitable manner while recognizing consumers’ changing behaviors and shopping preferences.  We are guided by our long-term strategy through fiscal 2019, which has numerous initiatives across geographic regions, product categories, brands, channels of distribution and functions that are designed to grow our sales, provide cost efficiencies, leverage our strengths and make us more productive and profitable.  We plan to continue building upon and leveraging our history of outstanding creativity, innovation, entrepreneurship, high quality products and services, and engaging communications while investing for long-term sustainable growth.  Our Quarterly Report on Form 10-Q for the quarter ended December 31, 2016 (specifically, the Overview on pages 31-33), as well as the discussion below, describes elements of our strategy.

 

Our balanced, diverse and highly desirable brand portfolio positions us well to capitalize on opportunities in fast growing and profitable areas of prestige beauty.  We believe that our range of prestige product offerings allows us to increase our share of a consumer’s beauty routine and source consumers from brands sold in mass distribution.  To complement our existing business, we are continuously looking to acquire brands that we believe have significant sales growth potential and may provide unique opportunities for profitable growth in the future.  During our fiscal 2017 second quarter, we further expanded our makeup brand portfolio with the acquisitions of Too Faced and BECCA.  Both of these brands are primarily distributed in the fast growth specialty-multi and online channels.  They are expected to help us reach new consumers, to increase our sales in these channels and to continue generating strong profitable growth.

 

We approach distribution strategically by brand.  Our brands are at different stages of development, and we seek to optimize distribution in both channels and geographies, matching each brand with appropriate opportunities while maintaining high productivity per door.  For example, MžAžC products will become available for the first time on Ulta Beauty’s website beginning in May 2017 and in select Ulta locations starting in June 2017.  Ulta Beauty is a leading specialty-multi retailer in the United States.

 

While our business is performing well overall, we continue to be faced with strong competition globally and economic challenges in certain countries.  In particular, we are cautious of the continued decline in retail traffic primarily related to brick-and-mortar stores in the United States as a result of the impact of shifts in consumer preferences as to where and how they shop for our products.  We are also cautious of the continued strength of the U.S. dollar in relation to most currencies and its impact on tourism, which has particularly impacted certain tourist-driven stores in the United States.  Additionally, we continue to monitor the effects of the macroeconomic environments in certain countries such as Brazil and in the Middle East, the United Kingdom’s anticipated exit from the European Union, geopolitical tensions and global security issues.

 

We believe we can, to some extent, offset the impact of these challenges by accelerating areas of strength and by utilizing the various growth drivers among our brands, channels and markets.  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 ongoing consumer confidence, demand and spending and, as a result, on our business.  We will continue to monitor these and other risks that may affect our business.

 

As referenced by the Company, our heritage brands are Estée Lauder, Clinique and Origins. Our makeup artist brands are MžAžC and Bobbi Brown, and our luxury brands are La Mer, Jo Malone London, Tom Ford, 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, Ermenegildo Zegna and Tory Burch licenses.

 

Leading Beauty Forward

 

In May 2016, we announced a multi-year initiative (“Leading Beauty Forward”) to build on our strengths and better leverage our cost structure to free resources for investment to continue our growth momentum.  Leading Beauty Forward is designed to enhance our go-to-market capabilities, reinforce our leadership in global prestige beauty and continue creating sustainable value.  We plan to approve specific initiatives under Leading Beauty Forward through fiscal 2019 related to the optimization of select corporate functions, supply chain activities, and corporate and regional market support structures, as well as the exit of underperforming businesses, and expect to complete those initiatives through fiscal 2021.  Inclusive of charges recorded from inception through March 31, 2017, we expect that Leading Beauty Forward will result in related restructuring and other charges totaling between $600 million and $700 million, before taxes, consisting of employee-related costs, asset write-offs and other costs to implement these initiatives.  After its full implementation, we expect Leading Beauty Forward to yield annual net benefits, primarily in Selling, general and administrative expenses, of between $200 million and $300 million, before taxes.  We expect to reinvest a portion behind future growth initiatives.  For additional information about Leading Beauty Forward, see Notes to Consolidated Financial Statements, Note 5 — Charges Associated with Restructuring and Other Activities.

 

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Global Technology Infrastructure

 

In October 2015, we approved plans to transform and modernize our global technology infrastructure (“GTI”) to fundamentally change the way we deliver information technology services internally (such initiative, the “GTI Restructuring”).  As part of the GTI Restructuring, we transitioned our GTI from Company-owned assets to a primarily vendor-owned, cloud-based model where we pay for services as they are used.  We incurred restructuring and other charges of $15 million and $34 million for the three and nine months ended March 31, 2016, respectively, reflecting contract terminations, asset write-offs, employee-related costs and, to a lesser extent, consulting services.  These charges are included in Restructuring and other charges in the accompanying consolidated statements of earnings.  The implementation of the GTI Restructuring was substantially completed during fiscal 2016.

 

NET SALES

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Net Sales

 

$

2,857

 

$

2,657

 

$

8,930

 

$

8,616

 

$ Change from prior-year period

 

200

 

 

 

314

 

 

 

% Change from prior-year period

 

8

%

 

 

4

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

9

%

 

 

5

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

For the three and nine months ended March 31, 2017, reported net sales grew in each major product category except hair care, and grew in each geographic region.  Skin care net sales benefited from increased sales of certain products, particularly from La Mer.  Incremental net sales from our fiscal 2017 second quarter acquisitions of Too Faced and BECCA, as well as net sales increases from Tom Ford, Estée Lauder and Smashbox, drove growth in the makeup product category.  Our fragrance category primarily benefited from net sales increases from Jo Malone London.  Increased sales from our other acquisitions during the past two fiscal years also contributed to growth in our skin care and fragrance categories.  The net sales decrease in our hair care category primarily reflected a difficult comparison with the prior-year period that featured greater launch activity.  Each of our product categories benefited from targeted expanded consumer reach, new product offerings and growth from emerging markets.  We strategically stagger our new product launches by geographic market, which may account for differences in regional sales growth.

 

Returns associated with restructuring and other activities are not allocated to our product categories or geographic regions because they result from activities that are deemed a Company-wide initiative to redesign, resize and reorganize select corporate functions and go-to-market structures.  Accordingly, the following discussions of Net Sales by Product Categories and Geographic Regions exclude the impact of returns associated with restructuring and other activities, which were de minimis for the three months ended March 31, 2017, and were $2 million for the nine months ended March 31, 2017.

 

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Product Categories

 

Skin Care

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Net Sales

 

$

1,105

 

$

1,073

 

$

3,455

 

$

3,414

 

$ Change from prior-year period

 

32

 

 

 

41

 

 

 

% Change from prior-year period

 

3

%

 

 

1

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

4

%

 

 

2

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

The reported skin care net sales increase for the three months ended March 31, 2017 reflected higher net sales from La Mer, Estée Lauder and GLAMGLOW of approximately $53 million, combined, partially offset by lower net sales from Clinique and MžAžC of approximately $24 million, combined.  The net sales increase for the nine months ended March 31, 2017 reflected higher net sales from La Mer, GLAMGLOW and Aveda of approximately $104 million, combined, partially offset by lower net sales from Clinique and MžAžC of approximately $72 million, combined.

 

For the three and nine months ended March 31, 2017, higher net sales from La Mer were primarily due to targeted expanded consumer reach in the Americas region and in our travel retail business, and the increase in net sales from GLAMGLOW reflected incremental sales from new launches such as Plumprageous and targeted expanded consumer reach.  Higher net sales from Estée Lauder for the three months ended March 31, 2017 were partially due to net sales growth in our travel retail business and China resulting from higher net sales of the Advanced Night Repair and Revitalizing Supreme lines of products.  Net sales growth from Aveda for the nine months ended March 31, 2017 was due to the introduction of the Tulasara line of skin care products.

 

The lower net sales of Clinique products for the three and nine months ended March 31, 2017 reflected higher net sales in the Americas, despite slower retail traffic in brick-and-mortar stores in the United States, which were more than offset by lower net sales in other regions.  The lower net sales from MžAžC for the three and nine months ended March 31, 2017 were impacted by slower retail traffic in brick-and-mortar stores in the United States reflecting the impact of shifts in consumer preferences as to where and how they shop.

 

The net sales increase for skin care was adversely affected by approximately $9 million and $42 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2017, respectively.

 

Makeup

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Net Sales

 

$

1,271

 

$

1,161

 

$

3,743

 

$

3,574

 

$ Change from prior-year period

 

110

 

 

 

169

 

 

 

% Change from prior-year period

 

9

%

 

 

5

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

11

%

 

 

6

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

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Incremental net sales from our fiscal 2017 second quarter acquisitions, as well as higher net sales from Tom Ford and Estée Lauder contributed approximately $152 million and $235 million of net sales to the makeup product category for the three and nine months ended March 31, 2017, respectively.  Increased net sales from Tom Ford were driven by higher sales of lipstick and eyeshadow products, such as the Tom Ford Soleil Color Collection.  Increased net sales of Estée Lauder products were due, in part, to higher sales from the Double Wear line of products and Pure Color Envy franchise.  In Asia/Pacific, Estée Lauder makeup product net sales benefited from social media activities, while in the United Kingdom, Estée Lauder makeup product net sales reflected the continued success of the Victoria Beckham collection.

 

Partially offsetting these increases were approximately $52 million and $92 million of lower net sales of Clinique and MžAžC products for the three and nine months ended March 31, 2017, respectively, primarily reflecting slower retail traffic in brick-and-mortar stores in the United States.  Partially offsetting these lower net sales from MžAžC was the net sales growth of the makeup category in Asia/Pacific and in our travel retail business.

 

The net sales increase for makeup was adversely affected by approximately $17 million and $58 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2017, respectively.

 

Fragrance

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Net Sales

 

$

336

 

$

276

 

$

1,275

 

$

1,159

 

$ Change from prior-year period

 

60

 

 

 

116

 

 

 

% Change from prior-year period

 

22

%

 

 

10

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

24

%

 

 

14

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Approximately $52 million and $129 million of the reported fragrance net sales increase for the three and nine months ended March 31, 2017, respectively, was due to higher net sales from most of our luxury brands, as well as incremental net sales from By Kilian.  The higher net sales from Jo Malone London were, in part, due to targeted expanded consumer reach in the travel retail, department store and freestanding store channels.  Increased net sales from Tom Ford reflected, in part, the continued success and growth of existing fragrances such as the Signature Franchise, as well as new product launches such as the Les Extraits Verts collection.

 

Partially offsetting the increases for the nine months ended March 31, 2017 was approximately $23 million of lower net sales of certain Estée Lauder and designer fragrances.  The lower net sales of certain Estée Lauder fragrances were partially due to a strategic decision to expand the qualifying purchase for the brand’s holiday blockbuster promotion beyond fragrances. Lower net sales from certain designer fragrances reflected the expiration of our license agreement with Coach.

 

The net sales increase for fragrance was adversely affected by approximately $6 million and $41 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2017, respectively.

 

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Hair Care

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Net Sales

 

$

126

 

$

128

 

$

399

 

$

411

 

$ Change from prior-year period

 

(2

)

 

 

(12

)

 

 

% Change from prior-year period

 

(2

)%

 

 

(3

)%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

(1

)%

 

 

(2

)%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

The lower net sales for the three and nine months ended March 31, 2017 primarily reflected a difficult comparison with the prior-year period that featured greater launch activity.

 

Geographic Regions

 

The Americas

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Net Sales

 

$

1,171

 

$

1,112

 

$

3,646

 

$

3,607

 

$ Change from prior-year period

 

59

 

 

 

39

 

 

 

% Change from prior-year period

 

5

%

 

 

1

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

5

%

 

 

1

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Net sales in the Americas reflected incremental sales, primarily in the United States, from our recent acquisitions of By Kilian, BECCA and Too Faced of approximately $109 million and $132 million for the three and nine months ended March 31, 2017, respectively.  Net sales growth in our online and specialty-multi channels, as well as from certain of our brands, including Tom Ford, Smashbox, La Mer and Jo Malone London, also contributed to the higher net sales in the region.  Higher net sales in Brazil, Chile and Canada contributed an additional increase of approximately $16 million, combined, for the nine months ended March 31, 2017.  The increases were partially offset by lower net sales in the United States of approximately $57 million and $112 million for the three and nine months ended March 31, 2017, respectively, attributable to slower retail traffic in brick-and-mortar stores that particularly impacted MAC and certain of our other brands.  This slower retail traffic reflected the impact of shifts in consumer preferences as to where and how they shop, as well as declines in tourism attributable, in part, to the strong U.S. dollar in relation to most currencies.

 

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Europe, the Middle East & Africa

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Net Sales

 

$

1,126

 

$

1,023

 

$

3,477

 

$

3,308

 

$ Change from prior-year period

 

103

 

 

 

169

 

 

 

% Change from prior-year period

 

10

%

 

 

5

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

13

%

 

 

10

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

Net sales for the three months ended March 31, 2017 reflected higher net sales from our travel retail business and in Russia of approximately $113 million, combined.  These increases were partially offset by lower net sales in the United Kingdom and the Middle East of approximately $19 million, combined.  The net sales increase for the nine months ended March 31, 2017 reflected higher net sales from our travel retail business and in Russia and Italy of approximately $262 million, combined.  These increases were partially offset by lower net sales in the United Kingdom and the Middle East of approximately $136 million, combined.  Excluding the impact of foreign currency translation, net sales in the United Kingdom increased in both periods primarily driven by higher net sales from La Mer, Jo Malone London and Tom Ford, reflecting an increase in tourism, as well as increased net sales from Estée Lauder partially due to the Victoria Beckham collection.  The lower net sales in the Middle East for both periods were primarily driven by the impact of the macroeconomic environment on consumer purchases and the associated rebalancing of inventory levels by certain of our distributors.

 

The net sales growth in our travel retail business for the three and nine months ended March 31, 2017 reflected higher net sales from Tom Ford, Jo Malone London, MžAžC and La Mer, driven, in part, by targeted expanded consumer reach and new product offerings.  The higher net sales for both periods in Russia were primarily driven by increased net sales from Estée Lauder, Clinique and Bobbi Brown, reflecting successful marketing and promotional activities supporting new and existing products.  Russia also benefited from incremental sales from the fiscal 2016 acquisition of By Kilian and the introduction of GLAMGLOW to the market during the current-year periods.  The higher net sales in Italy for the nine months ended March 31, 2017 were primarily driven by MžAžC and La Mer.

 

Net sales in Europe, the Middle East & Africa were adversely affected by approximately $32 million and $152 million of unfavorable foreign currency translation for the three and nine months ended March 31, 2017, respectively, which primarily impacted the United Kingdom.

 

Asia/Pacific

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Net Sales

 

$

560

 

$

522

 

$

1,809

 

$

1,701

 

$ Change from prior-year period

 

38

 

 

 

108

 

 

 

% Change from prior-year period

 

7

%

 

 

6

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change from prior-year period in constant currency

 

8

%

 

 

6

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

Net sales for the three months ended March 31, 2017 reflected higher sales in China, Taiwan and Japan of approximately $37 million, combined.  The net sales increase for the nine months ended March 31, 2017 reflected higher net sales in Japan, China and Korea of approximately $91 million, combined.  These increases were partially offset by lower net sales of approximately $1 million and $13 million in Hong Kong for the three and nine months ended March 31, 2017, respectively.

 

For both periods, the higher net sales in China reflected an increase in online sales primarily driven by marketing and promotional events, as well as targeted expanded consumer reach across all our brands.  The net sales increase for both periods in Japan was primarily due to higher net sales from Tom Ford and MžAžC, particularly of lip products, as well as Jo Malone London, which benefited from an increase in tourist traffic.

 

The higher net sales in Taiwan for the three months ended March 31, 2017 were primarily driven by MžAžC and Jo Malone London, as well as incremental net sales as a result of the introduction of GLAMGLOW to the market during the current year period. The net sales growth in Korea for the nine months ended March 31, 2017 reflected higher net sales from MžAžC, partially due to the expansion of its online presence, La Mer, which benefited from the introduction of new products, and Jo Malone London and Tom Ford resulting from targeted expanded consumer reach.

 

The lower net sales in Hong Kong for the nine months ended March 31, 2017 were primarily driven by the continued decrease in traveling Chinese consumers and changes in their spending patterns, which particularly impacted the Estée Lauder and Clinique brands and, to a lesser extent, La Mer.

 

GROSS MARGIN

 

Gross margin decreased to 79.3% for the three months ended March 31, 2017 as compared with 81.0% in the prior-year period, and decreased to 79.6% for the nine months ended March 31, 2017 as compared with 80.6% in the prior-year period.  Favorable (unfavorable) basis point changes for the three and nine months ended March 31, 2017 as compared with the prior-year periods are as follows:

 

 

 

March 31, 2017

 

 

 

Three Months Ended

 

Nine Months Ended

 

Mix of business

 

(40

)

(45

)

Obsolescence charges

 

(25

)

(30

)

Foreign exchange transactions

 

(5

)

(30

)

Manufacturing costs and other

 

20

 

40

 

Fiscal 2017 acquisitions

 

(110

)

(25

)

Subtotal

 

(160

)

(90

)

Charges associated with restructuring and other activities

 

(10

)

(10

)

Total

 

(170

)

(100

)

 

The unfavorable impact of acquisitions for the three and nine months ended March 31, 2017 was primarily due to a higher cost of sales related to our fiscal 2017 acquisitions, which includes an inventory step-up adjustment of $10 million, or approximately 35 basis points, for the three months ended March 31, 2017.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

OPERATING EXPENSES

 

Operating expenses as a percentage of net sales decreased to 64.4% for the three months ended March 31, 2017 as compared with 66.5% in the prior-year period, and decreased to 63.2% for the nine months ended March 31, 2017 as compared with 63.6% in the prior-year period.  Favorable (unfavorable) basis point changes for the three and nine months ended March 31, 2017 as compared with the prior-year periods are as follows:

 

 

 

March 31, 2017

 

 

 

Three Months Ended

 

Nine Months Ended

 

General and administrative expenses

 

130

 

90

 

Advertising, merchandising and sampling

 

100

 

60

 

Product development

 

30

 

20

 

Selling

 

140

 

40

 

Shipping

 

(20

)

(20

)

Store operating costs

 

 

(30

)

Stock-based compensation

 

(10

)

(30

)

Foreign exchange transactions

 

(20

)

 

Gain on sale of property, plant and equipment

 

 

10

 

Other

 

20

 

 

Subtotal

 

370

 

140

 

Charges associated with restructuring and other activities

 

(160

)

(100

)

Total

 

210

 

40

 

 

As a percentage of net sales, operating expenses improved as compared with the prior-year periods, reflecting disciplined expense management in indirect procurement, advertising and promotion, and selling activities, as well as a decrease in discretionary expenses.  The favorable impact of general and administrative expenses for the three months ended March 31, 2017 also reflected adjustments related to acquisitions and equity investment income.  Advertising, merchandising and sampling expenses were favorable for the three months ended March 31, 2017, primarily reflecting a shift from traditional advertising to digital advertising that carries a lower media cost.  Selling expenses were favorable for the three months ended March 31, 2017, reflecting lower demonstration costs, partially due to distribution channel mix.

 

OPERATING RESULTS

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

As Reported:

 

 

 

 

 

 

 

 

 

Operating Income

 

$

427

 

$

384

 

$

1,462

 

$

1,467

 

$ Change from prior-year period

 

43

 

 

 

(5

)

 

 

% Change from prior-year period

 

11

%

 

 

Less than 1

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% Change in operating income from the prior-year period adjusting for the impact of charges associated with restructuring and other activities

 

23

%

 

 

6

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

The overall operating results and operating margin for the three and nine months ended March 31, 2017 were impacted by unfavorable foreign currency translation of $10 million and $50 million, respectively, which primarily impacted Europe, the Middle East & Africa, the Americas and the makeup product category.  In addition, the operating results include the impact of charges associated with restructuring and other activities of $62 million and $15 million for the three months ended March 31, 2017 and 2016, respectively, and $134 million and $34 million for the nine months ended March 31, 2017 and 2016, respectively.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

For the three months ended March 31, 2017, operating margin increased 40 basis points from 14.5% in fiscal 2016 to 14.9% in fiscal 2017, reflecting the lower operating expense margin, partially offset by the decrease in gross margin, as previously noted.  The change in operating margin was unfavorably impacted by foreign currency translation and charges associated with restructuring and other activities of approximately 20 basis points and 170 basis points, respectively.  Adjusting for these items, operating margin for the three months ended March 31, 2017 would have increased by approximately 230 basis points.

 

For the nine months ended March 31, 2017, operating margin decreased 60 basis points from 17.0% in fiscal 2016 to 16.4% in fiscal 2017, reflecting the decrease in gross margin, partially offset by the lower operating expense margin, as previously noted.  The change in operating margin was unfavorably impacted by foreign currency translation and charges associated with restructuring and other activities of approximately 30 basis points and 110 basis points, respectively.  Adjusting for these items, operating margin for the nine months ended March 31, 2017 would have increased approximately 80 basis points.

 

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 and to transform and modernize the Company’s global technology infrastructure.  Accordingly, the following discussions of Operating Income by Product Categories and Geographic Regions exclude the impact of charges associated with restructuring and other activities.

 

Product Categories

 

Skin Care

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

$

265

 

$

202

 

$

828

 

$

701

 

$ Change from prior-year period

 

63

 

 

 

127

 

 

 

% Change from prior-year period

 

31

%

 

 

18

%

 

 

 

Skin care operating income increased for the three and nine months ended March 31, 2017, reflecting higher results from Estée Lauder and La Mer, partially offset by lower results from MžAžC.  The increase in operating income from La Mer and Estée Lauder reflected higher net sales.  The higher results from Estée Lauder also reflected a favorable comparison to the higher level of support spending in the prior-year periods.  The lower results from MžAžC reflected lower net sales.

 

Makeup

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

$

192

 

$

192

 

$

562

 

$

642

 

$ Change from prior-year period

 

 

 

 

(80

)

 

 

% Change from prior-year period

 

%

 

 

(12

)%

 

 

 

Makeup operating income was flat for the three months ended March 31, 2017, reflecting higher results from Tom Ford, Estée Lauder and Bobbi Brown, attributable to higher net sales.  These increases were offset by lower results from MžAžC and Clinique primarily due to a decrease in net sales.

 

Makeup operating income decreased for the nine months ended March 31, 2017, reflecting lower results from MžAžC and Clinique primarily due to a decrease in net sales, as well as transaction costs related to our fiscal 2017 acquisitions.  Partially offsetting this decrease were higher results from Tom Ford, Estée Lauder and Bobbi Brown, reflecting higher net sales.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

Fragrance

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

$

16

 

$

(6

)

$

157

 

$

114

 

$ Change from prior-year period

 

22

 

 

 

43

 

 

 

% Change from prior-year period

 

More than 100

%

 

 

38

%

 

 

 

Fragrance operating income increased for the three and nine months ended March 31, 2017, reflecting higher results from Jo Malone London, and certain designer fragrances, as well as a decrease in the fair value of contingent consideration related to acquisitions.  The higher results from Jo Malone London reflected higher net sales.  The higher results from certain of our designer fragrances for the three months ended March 31, 2017 reflected higher net sales and lower selling costs due to lower commission expense associated with the change in distribution channel mix, partially offset by increased investment spending behind existing and new products such as Tory Burch Love Relentlessly.  The higher results from certain of our designer fragrances for the nine months ended March 31, 2017 reflected a favorable comparison to the higher level of support spending behind new and existing products in the prior-year period.

 

Hair Care

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
 March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

$

12

 

$

10

 

$

38

 

$

36

 

$ Change from prior-year period

 

2

 

 

 

2

 

 

 

% Change from prior-year period

 

20

%

 

 

6

%

 

 

 

Hair care operating income increased for the three and nine months ended March 31, 2017, primarily reflecting higher results from Bumble and bumble due to effective cost containment.

 

Geographic Regions

 

Americas

 

 

 

Three Months Ended

March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

$

87

 

$

112

 

$

236

 

$

310

 

$ Change from prior-year period

 

(25

)

 

 

(74

)

 

 

% Change from prior-year period

 

(22

)%

 

 

(24

)%

 

 

 

Operating income in the Americas decreased for the three and nine months ended March 31, 2017, primarily reflecting lower results from MžAžC due to a decrease in net sales.  Also contributing to this decrease were higher promotional expenses related to targeted expanded consumer reach.  The decrease for the nine months ended March 31, 2017 also reflected transaction costs related to our fiscal 2017 acquisitions. Partially offsetting the decreases for both periods was disciplined expense management by certain of our heritage brands.

 

Europe, the Middle East & Africa

 

 

 

Three Months Ended
March 31

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

$

288

 

$

212

 

$

956

 

$

843

 

$ Change from prior-year period

 

76

 

 

 

113

 

 

 

% Change from prior-year period

 

36

%

 

 

13

%

 

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

The increase in operating income for the three months ended March 31, 2017 was primarily attributable to higher results from our travel retail business and the United Kingdom of approximately $83 million, combined, primarily reflecting higher net sales.  These higher results were partially offset by lower results in Central Europe and South Africa of approximately $5 million, combined, reflecting higher spending on marketing, advertising and promotion behind new and existing products, as well as increased selling costs related to targeted expanded consumer reach.

 

The increase in operating income for the nine months ended March 31, 2017 was primarily attributable to higher results from our travel retail business and Switzerland of approximately $163 million, combined.  The higher results in our travel retail business reflected higher net sales.  The increased operating income in Switzerland was primarily due to a gain in the fiscal 2017 first quarter on the sale of property, plant and equipment.  These higher results were partially offset by lower results in the Middle East, South Africa and France of approximately $58 million, combined.  The lower results in the Middle East reflected lower net sales.  The lower results in South Africa and France reflected higher spending on marketing, advertising and promotion behind new and existing products, as well as increased selling costs.

 

Asia/Pacific

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions)

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

$

114

 

$

75

 

$

404

 

$

348

 

$ Change from prior-year period

 

39

 

 

 

56

 

 

 

% Change from prior-year period

 

52

%

 

 

16

%

 

 

 

The increase in operating income during the three months ended March 31, 2017 primarily reflected higher results in China and Singapore of approximately $39 million, combined, primarily driven by net sales growth.

 

The increase in operating income during the nine months ended March 31, 2017 primarily reflected higher results in China and Japan of approximately $57 million, combined, driven by net sales growth.  These higher results were partially offset by lower results in Hong Kong and Indonesia of approximately $10 million, combined, primarily driven by lower net sales.

 

INTEREST AND INVESTMENT INCOME

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

(In millions)

 

2017

 

2016

 

2017

 

2016

 

Interest expense

 

$

28

 

$

18

 

$

71

 

$

52

 

Interest income and investment income, net

 

$

8

 

$

4

 

$

19

 

$

10

 

 

Interest expense increased for the three and nine months ended March 31, 2017 as compared with the prior-year periods, primarily due to higher short- and long-term debt levels.  Interest and investment income, net increased for the three and nine months ended March 31, 2017, primarily due to higher cash and long-term investment balances, as well as from an increase in interest rates.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

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 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, but not limited to, the geographical mix of earnings, enacted tax legislation, state and local income taxes, tax reserve adjustments, the ultimate disposition of deferred tax assets relating to stock-based compensation and the interaction of various global tax strategies.  In addition, changes in judgment from the evaluation of new information resulting in the recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of change.

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

 

 

2017

 

2016

 

2017

 

2016

 

Effective rate for income taxes

 

26.3

%

28.0

%

27.2

%

28.0

%

Basis-point change from the prior-year period

 

(170

)

 

 

(80

)

 

 

 

The decrease in the effective tax rate for the three and nine months ended March 31, 2017 was primarily attributable to income tax reserve adjustments.

 

NET EARNINGS ATTRIBUTABLE TO THE ESTÉE LAUDER COMPANIES INC.

 

 

 

Three Months Ended
March 31

 

Nine Months Ended
March 31

 

($ in millions, except per share data)

 

2017

 

2016

 

2017

 

2016

 

As Reported:

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Estée Lauder Companies Inc.

 

$

298

 

$

265

 

$

1,020

 

$

1,021

 

$ Change from prior-year period

 

33

 

 

 

(1

)

 

 

% Change from prior-year period

 

12

%

 

 

Less than 1

%

 

 

Diluted net earnings per common share

 

$

.80

 

.71

 

$

2.74

 

2.71

 

% Change from prior-year period

 

13

%

 

 

1

%

 

 

 

 

 

 

 

 

 

 

 

 

Non-GAAP Financial Measure (a):

 

 

 

 

 

 

 

 

 

% 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

 

25

%

 

 

7

%

 

 

 


(a) See “Reconciliations of Non-GAAP Financial Measures” beginning on page 45 for reconciliations between non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

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 helps investors and others compare operating performance between two 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.  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 and the effects of foreign currency translation.  The tables provide reconciliations between these non-GAAP financial measures and the most directly comparable U.S. GAAP measures.

 

 

 

Three Months Ended
March 31

 

 

 

%

 

% Change
in
Constant

 

($ in millions, except per share data)

 

2017

 

2016

 

Variance

 

Change

 

Currency

 

Net Sales, as reported

 

$

2,857

 

$

2,657

 

$

200

 

8

%

9

%

Returns associated with restructuring and other activities

 

 

 

 

 

 

 

 

Net Sales, as adjusted

 

$

2,857

 

$

2,657

 

$

200

 

8

%

9

%

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income, as reported

 

$

427

 

$

384

 

$

43

 

11

%

14

%

Charges associated with restructuring and other activities

 

62

 

15

 

47

 

 

 

 

 

Operating Income, as adjusted

 

$

489

 

$

399

 

$

90

 

23

%

25

%

 

 

 

 

 

 

 

 

 

 

 

 

Diluted net earnings per common share, as reported

 

$

.80

 

$

.71

 

$

.09

 

13

%

16

%

Charges associated with restructuring and other activities

 

.11

 

.02

 

.09

 

 

 

 

 

Diluted net earnings per common share, as adjusted

 

$

.91

 

$

.73

 

$

.18

 

25

%

28

%

 

 

 

Nine Months Ended
March 31

 

 

 

%

 

% Change
in
Constant

 

($ in millions, except per share data)

 

2017

 

2016

 

Variance

 

Change

 

Currency

 

Net Sales, as reported

 

$

8,930

 

$

8,616

 

$

314

 

4

%

5

%

Returns associated with restructuring and other activities

 

2

 

 

2

 

 

 

 

 

Net Sales, as adjusted

 

$

8,932

 

$

8,616

 

$

316

 

4

%

5

%

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income, as reported

 

$

1,462

 

$

1,467

 

$

(5

)

%

3

%

Charges associated with restructuring and other activities

 

134

 

34

 

100

 

 

 

 

 

Operating Income, as adjusted

 

$

1,596

 

$

1,501

 

$

95

 

6

%

10

%

 

 

 

 

 

 

 

 

 

 

 

 

Diluted net earnings per common share, as reported

 

$

2.74

 

$

2.71

 

$

.03

 

1

%

5

%

Charges associated with restructuring and other activities

 

.24

 

.06

 

.17

 

 

 

 

 

Diluted net earnings per common share, as adjusted (1)

 

$

2.97

 

$

2.77

 

$

.20

 

7

%

11

%

 


(1) Not adjusted for differences caused by rounding

 

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THE ESTÉE LAUDER COMPANIES INC.

 

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

 

 

 

As Reported

 

 

 

 

 

 

 

 

 

(In millions)

 

Three
Months
Ended
March 31,
2017

 

Three
Months
Ended
March 31,
2016

 

Variance

 

Add:
Impact of
foreign
currency
translation

 

Variance,
as
adjusted

 

%
Change,
as
reported

 

%
Change,
as
adjusted

 

Product Category:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Skin Care

 

$

1,105

 

$

1,073

 

$

32

 

$

9

 

$

41

 

3

%

4

%

Makeup

 

1,271

 

1,161

 

110

 

17

 

127

 

9

 

11

 

Fragrance

 

336

 

276

 

60

 

6

 

66

 

22

 

24

 

Hair Care

 

126

 

128

 

(2

)

1

 

(1

)

(2

)

(1

)

Other

 

19

 

19

 

 

(2

)

(2

)

 

(11

)

Total

 

$

2,857

 

$

2,657

 

$

200

 

$

31

 

$

231

 

8

%

9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Region:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Americas

 

$

1,171

 

$

1,112

 

$

59

 

$

(4

)

$

55

 

5

%

5

%

Europe, the Middle East & Africa

 

1,126

 

1,023

 

103

 

32

 

135

 

10

 

13

 

Asia/Pacific

 

560

 

522

 

38

 

3

 

41

 

7

 

8

 

Total

 

$

2,857

 

$

2,657

 

$

200

 

$

31

 

$

231

 

8

%

9

%

 

 

 

As Reported

 

 

 

 

 

 

 

 

 

(In millions)

 

Nine
Months
Ended
March 31,
2017

 

Nine
Months
Ended
March 31,
2016

 

Variance

 

Add:
Impact of
foreign
currency
translation

 

Variance,
as
adjusted

 

%
Change,
as
reported

 

%
Change,
as
adjusted

 

Product Category:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Skin Care

 

$

3,455

 

$

3,414

 

$

41

 

$

42

 

$

83

 

1

%

2

%

Makeup

 

3,743

 

3,574

 

169

 

58

 

227

 

5

 

6

 

Fragrance

 

1,275

 

1,159

 

116

 

41

 

157

 

10

 

14

 

Hair Care

 

399

 

411

 

(12

)

3

 

(9

)

(3

)

(2

)

Other

 

60

 

58

 

2

 

 

2

 

3

 

3

 

Total

 

$

8,932

 

$

8,616

 

$

316

 

$

144

 

$

460

 

4

%

5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Region:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Americas

 

$

3,646

 

$

3,607

 

$

39

 

$

1

 

$

40

 

1

%

1

%

Europe, the Middle East & Africa

 

3,477

 

3,308

 

169

 

152

 

321

 

5

 

10

 

Asia/Pacific

 

1,809

 

1,701

 

108

 

(9

)

99

 

6

 

6

 

Total

 

$

8,932

 

$

8,616

 

$

316

 

$

144

 

$

460

 

4

%

5

%

 

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THE ESTÉE LAUDER COMPANIES INC.

 

FINANCIAL CONDITION

 

LIQUIDITY AND CAPITAL RESOURCES

 

Overview

 

Our principal sources of funds historically have been cash flows from operations, borrowings pursuant to our commercial paper program, borrowings from the issuance of long-term debt and committed and uncommitted credit lines provided by banks and other lenders in the United States and abroad.  At March 31, 2017, we had cash and cash equivalents of $1,139 million compared with $914 million at June 30, 2016.  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 systems enhancements, capital expenditures, acquisitions, dividends, stock repurchases, restructuring initiatives, commitments and other contractual obligations on both a near-term and long-term basis.  Our cash and cash equivalents and short- and long-term investment balances at March 31, 2017 include cash and short- and long-term investments in offshore jurisdictions associated with our permanent reinvestment strategy.  We do not believe that the indefinite reinvestment of these funds offshore impairs our ability to meet our domestic debt or working capital obligations.  If these indefinitely reinvested earnings were repatriated into the United States as dividends, we would be subject to additional taxes.

 

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 as discussed below.  Downgrades in our credit ratings may reduce our ability to issue commercial paper and/or long-term debt and would likely increase the relative costs of borrowing.  A credit rating is not a recommendation to buy, sell, or hold securities, is subject to revision or withdrawal at any time by the assigning rating organization, and should be evaluated independently of any other rating.  As of April 26, 2017, our commercial paper is rated A-1 by Standard & Poor’s and P-1 by Moody’s, and our long-term debt is rated A+ with a stable outlook by Standard & Poor’s and A2 with a stable outlook by Moody’s.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

Debt

 

At March 31, 2017, our outstanding borrowings were as follows:

 

($ in millions)

 

Long-term
Debt

 

Current
Debt

 

Total Debt

 

4.15% Senior Notes, due March 15, 2047 (“2047 Senior Notes”) (1), (11)

 

$

493

 

$

 

$

493

 

4.375% Senior Notes, due June 15, 2045 (“2045 Senior Notes”) (2), (11)

 

455

 

 

455

 

3.70% Senior Notes, due August 15, 2042 (“2042 Senior Notes”) (3), (11)

 

247

 

 

247

 

6.00% Senior Notes, due May 15, 2037 (“2037 Senior Notes”) (4), (11)

 

293

 

 

293

 

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

 

197

 

 

197

 

3.15% Senior Notes, due March 15, 2027 (“2027 Senior Notes”) (6), (11)

 

497

 

 

497

 

2.35% Senior Notes, due August 15, 2022 (“2022 Senior Notes”) (7), (11)

 

250

 

 

250

 

1.70% Senior Notes, due May 10, 2021 (“2021 Senior Notes”) (8), (11)

 

442

 

 

442

 

1.80% Senior Notes, due February 7, 2020 (“2020 Senior Notes”) (9), (11)

 

497

 

 

497

 

5.55% Senior Notes, due May 15, 2017 (“2017 Senior Notes”) (10), (11)

 

 

301

 

301

 

Commercial paper that matures through April 2017 (0.82% average interest rate)

 

 

195

 

195

 

Other borrowings

 

6

 

23

 

29

 

 

 

$

3,377

 

$

519

 

$

3,896

 

 


(1)             Consists of $500 million principal, net unamortized debt discount of $2 million and debt issuance costs of $5 million.

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

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

(4)             Consists of $300 million principal, unamortized debt discount of $3 million and debt issuance costs of $4 million.

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

(6)             Consists of $500 million principal and debt issuance costs of $3 million.

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

(8)             Consists of $450 million principal, a $6 million adjustment to reflect the fair value of interest rate swaps and debt issuance costs of $2 million.

(9)             Consists of $500 million principal, a $1 million adjustment to reflect the fair value of interest rate swaps and debt issuance costs of $2 million.

(10)        Consists of $300 million principal and a $1 million adjustment to reflect the termination value of interest rate swaps.

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

 

In February 2017, we decreased the size of our commercial paper program, under which we may issue commercial paper in the United States, to $1.5 billion.  This commercial paper program had previously been increased to $3 million in November 2016 to finance our second quarter acquisitions.  In February 2017, we issued long-term debt to refinance a portion of the outstanding commercial paper.   At April 26, 2017, we had $258 million of commercial paper outstanding, which we may refinance or repay as it matures.

 

For further discussion of debt, see Notes to Consolidated Financial Statements, Note 6 — Debt.

 

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Total debt as a percent of total capitalization (excluding noncontrolling interests) increased to 49% at March 31, 2017 from 39% at June 30, 2016, primarily due to the issuance of the 2020 Senior Notes, 2027 Senior Notes and 2047 Senior Notes.

 

Cash Flows

 

 

 

Nine Months Ended March 31

 

(In millions)

 

2017

 

2016

 

Net cash provided by operating activities

 

$

1,252

 

$

1,316

 

Net cash used for investing activities

 

$

(2,106

)

$

(1,097

)

Net cash provided by (used for) financing activities

 

$

1,083

 

$

(665

)

 

The decrease in net cash provided by operating activities reflected an unfavorable change in accounts payable, primarily due to the timing of payments.  This decrease was partially offset by lower long-term payments related to new freestanding retail store locations, including cash payments made to former tenants to acquire the rights under commercial property leases.  Also offsetting this decrease was an increase in accrued liabilities reflecting higher restructuring costs.

 

The increase in net cash used for investing activities primarily reflected cash paid in connection with the fiscal 2017 second quarter acquisitions of Too Faced and BECCA, partially offset by lower net purchases of investments in connection with our cash investment strategy.

 

The increase in net cash provided by financing activities reflected the issuance of 2020 Senior Notes, 2027 Senior Notes and 2047 Senior Notes.  The increase also reflected lower treasury stock purchases, partially offset by higher dividend payments.

 

Dividends

 

For a summary of quarterly cash dividends declared per share on our Class A and Class B Common Stock during the nine months ended March 31, 2017, see Notes to Consolidated Financial Statements, Note 13 — 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, 2016.

 

Commitments, Contractual Obligations and Contingencies

 

Other than the issuance of our 2020 Senior Notes, 2027 Senior Notes and 2047 Senior Notes as disclosed in Notes to Consolidated Financial Statements, Note 6 — Debt, 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, 2016.  For a discussion of contingencies, see Notes to Consolidated Financial Statements, Note 10 — 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).

 

Credit Risk

 

For a discussion of credit risk, see Notes to Consolidated Financial Statements, Note 7 — Derivative Financial Instruments (Credit Risk).

 

Market Risk

 

During the first quarter of fiscal 2017, we changed our market risk assessment model from a value-at-risk model to a sensitivity based model. This sensitivity analysis utilizes hypothetical changes in currency exchange rates and interest rates at the end of the reporting period to express the potential future losses for an instrument or portfolio from adverse changes in market factors.  We believe this model provides greater insight into the impact of market risk exposures on our derivative instruments.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

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% weakening of the U.S. dollar against the foreign exchange rates for the currencies in our portfolio would have resulted in a net decrease in the fair value of our portfolio of approximately $12 million and $22 million as of March 31, 2017 and June 30, 2016, 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 $38 million and $15 million as of March 31, 2017 and June 30, 2016, 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, other than operating leases, that would be expected to have a material current or future effect upon our financial condition or results of operations.

 

CRITICAL ACCOUNTING POLICIES

 

As disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016, 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 reported amounts of assets, liabilities, revenues and expenses reported in those financial statements.  These judgments can be subjective and complex, and consequently, actual results could differ from those estimates and assumptions.  Our most critical accounting policies relate to revenue recognition, inventory, pension and other post-retirement benefit costs, goodwill, other intangible assets and long-lived assets, and income taxes.  Since June 30, 2016, 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.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING INFORMATION

 

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

 

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

 

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

 

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

 

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

 

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

 

(6) shifts in the preferences of consumers as to where and how they shop for the types of products and services we sell;

 

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

 

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

 

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

 

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

 

(11) shipment delays, commodity pricing, depletion of inventory and increased production costs resulting from disruptions of operations at any of the facilities that manufacture nearly all of our supply of a particular type of product (i.e. focus factories) or at our distribution or inventory centers, including disruptions that may be caused by the implementation of information technology initiatives, or by restructurings;

 

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THE ESTÉE LAUDER COMPANIES INC.

 

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

 

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

 

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

 

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

 

(16) consequences attributable to local or international conflicts around the world, as well as from any terrorist attack, retaliation or similar threats;

 

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

 

(18) additional factors as described in our filings with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the fiscal year ended June 30, 2016.

 

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.

 

(a)   Evaluation of Disclosure 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 (“SEC”) 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 (“CEO”) and the Chief Financial Officer (“CFO”), with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of March 31, 2017 and, based on their evaluation, have concluded that the disclosure controls and procedures were not effective as of such date due to the material weakness in internal control over financial reporting that was disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016.

 

(b)   Internal Control over Financial Reporting

 

As disclosed in Part II. Item 9A. Controls and Procedures in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016, during the fourth quarter of fiscal 2016, we identified a material weakness in internal control over financial reporting related to ineffective general information technology controls in the areas of user access and program change management over certain technology systems that are relevant to our financial reporting processes and system of internal control over financial reporting.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

Management believes that our consolidated financial statements included in this Form 10-Q have been prepared in accordance with generally accepted accounting principles.  Our CEO and CFO have certified that, based on such officer’s knowledge, the financial statements and other financial information included in this Form 10-Q fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this Form 10-Q.  In addition, we continue to implement the remediation plan described below for the material weakness disclosed in Part II. Item 9A. Controls and Procedures in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016.

 

(c)    Changes in Internal Controls over Financial Reporting

 

Except for changes in connection with our implementation of the remediation plan described below, there have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the third quarter of fiscal 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

(d)   Remediation Plan

 

Management is continuing to implement the remediation plan disclosed in Part II. Item 9A. Controls and Procedures in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016 to ensure that control deficiencies contributing to the material weakness are remediated such that these controls will operate effectively.

 

Actions taken under the remediation plan have included enhancing the design of existing controls and establishing new controls.  We believe the improvements we expect to achieve as a result of the remediation plan will effectively remediate the material weakness.  However, the material weakness will not be considered remediated until the remediated controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.  We expect that the remediation of this material weakness will be completed in fiscal 2017.

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

For a discussion of legal proceedings, see Notes to Consolidated Financial Statements, Note 10 — Contingencies.

 

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

 

Share Repurchase Program

 

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

 

Period

 

Total Number
of Shares
Purchased

 

Average Price
Paid Per
Share

 

Total Number of
Shares Purchased
as Part of Publicly
Announced
Program

 

Maximum Number
of Shares that May
Yet Be Purchased
Under the
Program
(1)

 

January 2017

 

348

(2)

$

80.61

 

 

14,959,413

 

February 2017

 

 

 

 

14,959,413

 

March 2017

 

 

 

 

14,959,413

 

 

 

348

 

80.61

 

 

 

 

 


(1)             The current repurchase program for up to 40.0 million shares was authorized by the Board of Directors on November 1, 2012.  Our repurchase program does not have an expiration date.

(2)             Reflects shares that were repurchased by the Company in connection with shares withheld to satisfy tax obligations upon the vesting of stock-based compensation.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

Item 6. Exhibits.

 

Exhibit
Number

 

Description

31.1

 

Certification pursuant to Rule 13a-14(a) (CEO).

31.2

 

Certification pursuant to Rule 13a-14(a) (CFO).

32.1

 

Certification pursuant to Rule 13a-14(b) and 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 Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CFO). (furnished)

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

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SIGNATURES

 

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

 

 

 

 

THE ESTÉE LAUDER COMPANIES INC.

 

 

 

 

 

 

 

 

Date: May 3, 2017

 

By:

/s/TRACEY T. TRAVIS

 

 

 

Tracey T. Travis

 

 

 

Executive Vice President

 

 

 

and Chief Financial Officer

 

 

 

(Principal Financial and

 

 

 

Accounting Officer)

 

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THE ESTÉE LAUDER COMPANIES INC.

 

INDEX TO EXHIBITS

 

Exhibit
Number

 

Description

31.1

 

Certification pursuant to Rule 13a-14(a) (CEO).

31.2

 

Certification pursuant to Rule 13a-14(a) (CFO).

32.1

 

Certification pursuant to Rule 13a-14(b) and 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 Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CFO). (furnished)

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

56