10-Q 1 a16-22889_110q.htm 10-Q

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 December 31, 2016

 

OR

 

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

 

For the transition period from              to

 

Commission file number: 1-14064

 

The Estée Lauder Companies Inc.

(Exact name of registrant as specified in its charter)

 

Delaware
(State or other jurisdiction of
incorporation or organization)

 

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

 

 

 

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

 

10153
(Zip Code)

 

212-572-4200

(Registrant’s telephone number, including area code)

 

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, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)

 

Smaller reporting company 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 January 26, 2017, 222,244,079 shares of the registrant’s Class A Common Stock, $.01 par value, and 144,161,737 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 Six Months Ended December 31, 2016 and 2015

 

2

 

 

 

Consolidated Statements of Comprehensive Income (Loss) — Three and Six Months Ended December 31, 2016 and 2015

 

3

 

 

 

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

 

4

 

 

 

Consolidated Statements of Cash Flows — Six Months Ended December 31, 2016 and 2015

 

5

 

 

 

Notes to Consolidated Financial Statements

 

6

 

 

 

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

 

29

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

50

 

 

 

Item 4. Controls and Procedures

 

50

 

 

 

Part II. Other Information

 

 

 

 

 

Item 1. Legal Proceedings

 

51

 

 

 

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

 

51

 

 

 

Item 6. Exhibits

 

52

 

 

 

Signatures

 

53

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

 

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

(In millions, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Net Sales

 

$

3,208

 

$

3,124

 

$

6,073

 

$

5,959

 

Cost of Sales

 

637

 

589

 

1,233

 

1,166

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

2,571

 

2,535

 

4,840

 

4,793

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

1,917

 

1,886

 

3,742

 

3,691

 

Restructuring and other charges

 

37

 

19

 

63

 

19

 

Total operating expenses

 

1,954

 

1,905

 

3,805

 

3,710

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

617

 

630

 

1,035

 

1,083

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

22

 

17

 

43

 

34

 

Interest income and investment income, net

 

5

 

3

 

11

 

6

 

Earnings before Income Taxes

 

600

 

616

 

1,003

 

1,055

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

170

 

167

 

277

 

295

 

Net Earnings

 

430

 

449

 

726

 

760

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to noncontrolling interests

 

(2

)

(2

)

(4

)

(4

)

Net Earnings Attributable to The Estée Lauder Companies Inc.

 

$

428

 

$

447

 

$

722

 

$

756

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Basic

 

$

1.17

 

$

1.21

 

$

1.97

 

$

2.04

 

Diluted

 

$

1.15

 

$

1.19

 

$

1.94

 

$

2.00

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

366.9

 

369.6

 

366.7

 

371.1

 

Diluted

 

372.6

 

376.0

 

372.9

 

377.5

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

.34

 

$

.30

 

$

.64

 

$

.54

 

 

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
December 31

 

Six Months Ended
December 31

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

430

 

$

449

 

$

726

 

$

760

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Net unrealized investment gain (loss)

 

(7

)

(4

)

(11

)

(3

)

Net derivative instrument gain (loss)

 

40

 

(7

)

34

 

4

 

Amounts included in net periodic benefit cost

 

8

 

6

 

16

 

13

 

Translation adjustments

 

(114

)

(43

)

(113

)

(123

)

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

 

(18

)

(1

)

(19

)

(8

)

Total other comprehensive income (loss)

 

(91

)

(49

)

(93

)

(117

)

Comprehensive income (loss)

 

339

 

400

 

633

 

643

 

 

 

 

 

 

 

 

 

 

 

Comprehensive (income) loss attributable to noncontrolling interests:

 

 

 

 

 

 

 

 

 

Net earnings

 

(2

)

(2

)

(4

)

(4

)

Translation adjustments

 

 

1

 

(1

)

1

 

 

 

(2

)

(1

)

(5

)

(3

)

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

 

$

337

 

$

399

 

$

628

 

$

640

 

 

See notes to consolidated financial statements.

 

3



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED BALANCE SHEETS

 

 

 

December 31

 

June 30

 

 

 

2016

 

2016

 

 

 

(Unaudited)

 

 

 

 

 

($ in millions)

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

1,262

 

$

914

 

Short-term investments

 

413

 

469

 

Accounts receivable, net

 

1,508

 

1,258

 

Inventory and promotional merchandise, net

 

1,278

 

1,264

 

Prepaid expenses and other current assets

 

328

 

320

 

Total current assets

 

4,789

 

4,225

 

 

 

 

 

 

 

Property, Plant and Equipment, net

 

1,563

 

1,583

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

Long-term investments

 

996

 

1,108

 

Goodwill

 

1,938

 

1,228

 

Other intangible assets, net

 

1,349

 

344

 

Other assets

 

577

 

735

 

Total other assets

 

4,860

 

3,415

 

Total assets

 

$

11,212

 

$

9,223

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Current debt

 

$

2,143

 

$

332

 

Accounts payable

 

617

 

717

 

Other accrued liabilities

 

1,698

 

1,632

 

Total current liabilities

 

4,458

 

2,681

 

 

 

 

 

 

 

Noncurrent Liabilities

 

 

 

 

 

Long-term debt

 

1,890

 

1,910

 

Other noncurrent liabilities

 

1,056

 

1,045

 

Total noncurrent liabilities

 

2,946

 

2,955

 

 

 

 

 

 

 

Contingencies (Note 10)

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

Common stock, $.01 par value; Class A shares authorized: 1,300,000,000 at December 31, 2016 and June 30, 2016; shares issued: 427,123,920 at December 31, 2016 and 424,109,008 at June 30, 2016; Class B shares authorized: 304,000,000 at December 31, 2016 and June 30, 2016; shares issued and outstanding: 144,161,737 at December 31, 2016 and 144,770,237 at June 30, 2016

 

6

 

6

 

Paid-in capital

 

3,349

 

3,161

 

Retained earnings

 

8,178

 

7,693

 

Accumulated other comprehensive loss

 

(639

)

(545

)

 

 

10,894

 

10,315

 

Less: Treasury stock, at cost; 205,150,411 Class A shares at December 31, 2016 and 201,119,435 Class A shares at June 30, 2016

 

(7,101

)

(6,743

)

Total stockholders’ equity — The Estée Lauder Companies Inc.

 

3,793

 

3,572

 

Noncontrolling interests

 

15

 

15

 

Total equity

 

3,808

 

3,587

 

Total liabilities and equity

 

$

11,212

 

$

9,223

 

 

See notes to consolidated financial statements.

 

4



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Six Months Ended
December 31

 

 

 

2016

 

2015

 

 

 

(In millions)

 

Cash Flows from Operating Activities

 

 

 

 

 

Net earnings

 

$

726

 

$

760

 

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

 

 

 

 

 

Depreciation and amortization

 

218

 

202

 

Deferred income taxes

 

(55

)

(32

)

Noncash stock-based compensation

 

134

 

111

 

Excess tax benefits from stock-based compensation arrangements

 

(14

)

(13

)

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

 

(7

)

6

 

Noncash restructuring and other charges

 

3

 

13

 

Pension and post-retirement benefit expense

 

39

 

35

 

Pension and post-retirement benefit contributions

 

(10

)

(12

)

Change in fair value of contingent consideration

 

4

 

8

 

Other noncash items

 

(8

)

 

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in accounts receivable, net

 

(243

)

(277

)

Decrease in inventory and promotional merchandise, net

 

78

 

102

 

Increase in other assets, net

 

(32

)

(33

)

Decrease in accounts payable

 

(143

)

(81

)

Increase in other accrued and noncurrent liabilities

 

134

 

173

 

Net cash flows provided by operating activities

 

824

 

962

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

Capital expenditures

 

(208

)

(223

)

Payments for acquired businesses, net of cash acquired

 

(1,690

)

(19

)

Proceeds from disposition of investments

 

637

 

558

 

Purchases of investments

 

(478

)

(960

)

Proceeds from sale of property, plant and equipment

 

12

 

 

Net cash flows used for investing activities

 

(1,727

)

(644

)

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

Proceeds of current debt, net

 

1,817

 

347

 

Repayments and redemptions of long-term debt

 

(3

)

(4

)

Net proceeds from stock-based compensation transactions

 

41

 

22

 

Excess tax benefits from stock-based compensation arrangements

 

14

 

13

 

Payments to acquire treasury stock

 

(363

)

(628

)

Dividends paid to stockholders

 

(236

)

(201

)

Payments to noncontrolling interest holders for dividends

 

 

(2

)

Net cash flows provided by (used for) financing activities

 

1,270

 

(453

)

 

 

 

 

 

 

Effect of Exchange Rate Changes on Cash and Cash Equivalents

 

(19

)

(18

)

Net Increase (decrease) in Cash and Cash Equivalents

 

348

 

(153

)

Cash and Cash Equivalents at Beginning of Period

 

914

 

1,021

 

Cash and Cash Equivalents at End of Period

 

$

1,262

 

$

868

 

 

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 $(120) million and $(45) million, net of tax, during the three months ended December 31, 2016 and 2015, respectively, and $(120) million and $(128) million, net of tax, during the six months ended December 31, 2016 and 2015, 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 $1 million and $10 million during the three months ended December 31, 2016 and 2015, respectively, and $6 million during the six months ended December 31, 2016 and 2015.

 

Accounts Receivable

 

Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions totaling $23 million and $24 million as of December 31, 2016 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 all 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 $226 million, or 7%, and $253 million, or 8%, of the Company’s consolidated net sales for the three months ended December 31, 2016 and 2015, respectively, and $533 million, or 9%, and $592 million, or 10%, of the Company’s consolidated net sales for the six months ended December 31, 2016 and 2015, respectively.  This customer accounted for $146 million, or 10%, and $164 million, or 13%, of the Company’s accounts receivable at December 31, 2016 and June 30, 2016, respectively.

 

Inventory and Promotional Merchandise

 

Inventory and promotional merchandise, net consists of:

 

 

 

December 31

 

June 30

 

(In millions)

 

2016

 

2016

 

Raw materials

 

$

275

 

$

306

 

Work in process

 

140

 

177

 

Finished goods

 

691

 

622

 

Promotional merchandise

 

172

 

159

 

 

 

$

1,278

 

$

1,264

 

 

Property, Plant and Equipment

 

 

 

December 31

 

June 30

 

(In millions)

 

2016

 

2016

 

Assets (Useful Life)

 

 

 

 

 

Land

 

$

28

 

$

15

 

Buildings and improvements (10 to 40 years)

 

183

 

187

 

Machinery and equipment (3 to 10 years)

 

679

 

680

 

Computer hardware and software (4 to 15 years)

 

1,082

 

1,041

 

Furniture and fixtures (5 to 10 years)

 

89

 

84

 

Leasehold improvements

 

1,820

 

1,789

 

 

 

3,881

 

3,796

 

Less accumulated depreciation and amortization

 

(2,318

)

(2,213

)

 

 

$

1,563

 

$

1,583

 

 

The cost of assets related to projects in progress of $267 million and $186 million as of December 31, 2016 and June 30, 2016, respectively, is included in their respective asset categories above.  Depreciation and amortization of property, plant and equipment was $108 million and $100 million during the three months ended December 31, 2016 and 2015, respectively, and $210 million and $195 million during the six months ended December 31, 2016 and 2015, 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:

 

 

 

December 31

 

June 30

 

(In millions)

 

2016

 

2016

 

Advertising, merchandising and sampling

 

$

341

 

$

283

 

Employee compensation

 

368

 

504

 

Payroll and other taxes

 

242

 

163

 

Other

 

747

 

682

 

 

 

$

1,698

 

$

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 28.3% and 27.2% for the three months ended December 31, 2016 and 2015, respectively, and 27.6% and 28.0% for the six months ended December 31, 2016 and 2015, respectively.

 

The increase in the effective tax rate for the three months ended December 31, 2016 was principally attributable to the prior-year period impact of the retroactive reinstatement of the U.S. federal research and development tax credit.  The decrease in the effective tax rate for the six months ended December 31, 2016 was principally attributable to a favorable geographical mix of earnings.

 

As of December 31, 2016 and June 30, 2016, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $82 million at the end of each respective period.  The total amount of unrecognized tax benefits at December 31, 2016 that, if recognized, would affect the effective tax rate was $55 million. The total gross interest and penalties accrued related to unrecognized tax benefits during the three and six months ended December 31, 2016 in the accompanying consolidated statements of earnings was de minimis and $1 million, respectively.  The total gross accrued interest and penalties in the accompanying consolidated balance sheets at December 31, 2016 and June 30, 2016 was $19 million and $18 million, respectively.  On the basis of the information available as of December 31, 2016, 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

 

Goodwill

 

In January 2017, the Financial Accounting Standards Board (“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.

 

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 — Currently evaluating the impact of applying this guidance.

 

8



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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 — Currently evaluating the impact of applying this guidance.

 

Compensation - Stock Compensation

 

In March 2016, as part of its simplification initiative, 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.

 

Impact on consolidated financial statements — Currently evaluating the impact of applying this guidance.

 

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.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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.

 

NOTE 2 — INVESTMENTS

 

Gains and losses recorded in accumulated OCI (“AOCI”) related to the Company’s available-for-sale investments as of December 31, 2016 were as follows:

 

(In millions)

 

Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

U.S. government and agency securities

 

$

431

 

$

1

 

$

(2

)

$

430

 

Foreign government and agency securities

 

88

 

 

(1

)

87

 

Corporate notes and bonds

 

510

 

 

(2

)

508

 

Time deposits

 

280

 

 

 

280

 

Other securities

 

28

 

 

 

28

 

Total

 

$

1,337

 

$

1

 

$

(5

)

$

1,333

 

 

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

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the Company’s available-for-sale securities by contractual maturity as of December 31, 2016:

 

(In millions)

 

Cost

 

Fair Value

 

Due within one year

 

$

413

 

$

413

 

Due after one through five years

 

924

 

920

 

 

 

$

1,337

 

$

1,333

 

 

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 December 31, 2016:

 

 

 

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

 

$

781

 

$

(5

)

$

14

 

$

 

 

Gross gains and losses realized on sales of investments included in the consolidated statements of earnings for the three and six months ended December 31, 2016 and 2015 were de minimis.

 

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 $151 million and $194 million for the three months ended December 31, 2016 and 2015, respectively, and $332 million and $389 million for the six months ended December 31, 2016 and 2015, respectively.

 

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.  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.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

For the three and six months ended December 31, 2016, the Company’s statements of earnings included approximately $13 million of net sales and $(4) million, net of tax, 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 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 six months ended December 31, 2016, 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 six months ended December 31, 2016, the Company recognized $6 million of goodwill associated with the continuing earn-out obligations related to the acquisition of the Bobbi Brown brand.

 

The intangible assets acquired in connection with the 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 by discounting the incremental after-tax cash flows over multiple periods.  Fair value was determined under this approach by estimating future cash flows over multiple periods, as well as a terminal value, and discounting such cash flows at a rate of return that reflects the relative risk of the cash flows.  The estimate of the fair values of 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

 

 

718

 

 

 

718

 

Translation adjustments

 

 

 

(7

)

(1

)

(8

)

 

 

 

718

 

(7

)

(1

)

710

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

183

 

1,178

 

248

 

391

 

2,000

 

Accumulated impairments

 

(28

)

 

 

(34

)

(62

)

 

 

$

155

 

$

1,178

 

$

248

 

$

357

 

$

1,938

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Other intangible assets consist of the following:

 

 

 

December 31, 2016

 

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

 

$

253

 

$

440

 

$

299

 

$

245

 

$

54

 

License agreements

 

43

 

43

 

 

43

 

43

 

 

 

 

$

736

 

$

296

 

440

 

$

342

 

$

288

 

54

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks and other

 

 

 

 

 

909

 

 

 

 

 

290

 

Total intangible assets

 

 

 

 

 

$

1,349

 

 

 

 

 

$

344

 

 

The aggregate amortization expense related to amortizable intangible assets was $5 million and $4 million for the three months ended December 31, 2016 and 2015, respectively, and was $9 million and $8 million for the six months ended December 31, 2016 and 2015, respectively.  The estimated aggregate amortization expense for the remainder of fiscal 2017 and for each of fiscal 2018 to 2021 is $26 million, $51 million, $51 million, $44 million and $43 million, respectively.

 

NOTE 5 — CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER ACTIVITIES

 

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 December 31, 2016, the Company expects that LBF will result in related restructuring and other charges totaling between $600 million and $700 million before taxes.

 

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, either through Company-owned or third-party service providers in existing or lower-cost locations.  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.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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 December 31, 2016 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

 

Six months ended December 31, 2016

 

 

2

 

33

 

25

 

60

 

Cumulative through December 31, 2016

 

$

4

 

$

30

 

$

120

 

$

96

 

$

250

 

 


(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 December 31, 2016 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

 

Six months ended December 31, 2016

 

30

 

1

 

 

2

 

33

 

Cumulative through December 31, 2016

 

$

105

 

$

4

 

$

5

 

$

6

 

$

120

 

 

Specific actions taken during the six months ended December 31, 2016 included:

 

·            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, as well as other charges primarily for recruitment and training related to the new capabilities.

 

·            Optimize Select Corporate Functions - The Company 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.

 

·            Optimize Supply Chain - The Company approved certain activities related to an initiative to generate distribution capabilities and efficiencies through a third-party service provider.  The Company also approved certain activities related to initiatives to enhance strategic sourcing capabilities for direct and indirect 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 PMO costs, professional fees and asset write-offs.  The Company also approved consulting fees for an initiative to improve the organizational design of manufacturing and engineering activities related to certain product lines.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Program-to-Date Restructuring and Other Charges

 

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

 

Six months ended December 31, 2016

 

2

 

7

 

29

 

34

 

72

 

Cumulative through December 31, 2016

 

$

3

 

$

7

 

$

104

 

$

39

 

$

153

 

 

Charges recorded during the six months ended December 31, 2016 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 the future structures, processes and technologies of certain corporate functions and, to a lesser extent, costs to establish and maintain the LBF Project Management Office.  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

 

Six months ended December 31, 2016

 

25

 

2

 

1

 

1

 

29

 

Charges recorded through December 31, 2016

 

$

99

 

$

3

 

$

1

 

$

1

 

$

104

 

 

Accrued restructuring charges from program inception through December 31, 2016 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

 

25

 

2

 

1

 

1

 

29

 

Cash payments

 

(16

)

 

(1

)

 

(17

)

Noncash asset write-offs

 

 

(2

)

 

 

(2

)

Translation adjustments

 

(2

)

 

 

 

(2

)

Balance at December 31, 2016

 

$

80

 

$

 

$

 

$

1

 

$

81

 

 

Accrued restructuring charges at December 31, 2016 are expected to result in cash expenditures funded from cash provided by operations of approximately $21 million, $41 million and $19 million in fiscal 2017, 2018 and 2019, respectively.

 

15



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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 — DEBT

 

As of December 31, 2016, the Company had $1.8 billion of commercial paper outstanding, maturing through March 2017, which the Company intends to refinance or repay as it matures.  Proceeds from the issuance of commercial paper were used to finance a portion of the purchase price related to the acquisition of Too Faced and for other general corporate purposes.  In November 2016, the Company increased the size of its commercial paper program to $3 billion (from $1.5 billion) under which it may issue commercial paper in the United States.

 

In November 2016, the Company entered into a senior unsecured credit agreement that provides for a 364 day revolving credit facility (the “364 Day Facility”) in the amount of $1.5 billion.  The Facility expires on November 13, 2017.  Interest rates on borrowings under the 364 Day Facility will be based on prevailing market interest rates in accordance with the agreement.  Costs incurred to establish the 364 Day Facility were de minimis and are being amortized over the term of the facility.  The 364 Day Facility has an annual fee of less than $1 million, payable quarterly, based on the Company’s current credit ratings.  The 364 Day 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.  The Company intends to use the 364 Day Facility, together with its New Facility (as defined below), for credit support for the Company’s commercial paper program and for general corporate purposes. At December 31, 2016, no borrowings were outstanding under the 364 Day Facility.

 

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 December 31, 2016, 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.

 

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.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

 

 

Fair Value (1)

 

 

 

Fair Value (1)

 

(In millions)

 

Balance Sheet
Location

 

December 31
2016

 

June 30
2016

 

Balance Sheet
Location

 

December 31
2016

 

June 30
2016

 

Derivatives Designated as Hedging Instruments 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

$

47

 

$

37

 

Other accrued liabilities

 

$

7

 

$

18

 

Interest rate-related derivatives

 

Prepaid expenses and other current assets

 

11

 

 

Not applicable

 

 

 

 

 

Interest rate swap contracts

 

Prepaid expenses and other current assets

 

1

 

18

 

Other accrued liabilities

 

5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives Designated as Hedging Instruments

 

 

 

59

 

55

 

 

 

12

 

18

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

9

 

11

 

Other accrued liabilities

 

4

 

8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives

 

 

 

$

68

 

$

66

 

 

 

$

16

 

$

26

 

 


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

 

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
December 31

 

from AOCI into

Earnings

 

Three Months Ended
December 31

 

(In millions)

 

2016

 

2015

 

(Effective Portion)

 

2016

 

2015

 

Derivatives in Cash Flow Hedging Relationships

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

45

 

$

11

 

Cost of sales

 

$

4

 

$

4

 

 

 

 

 

 

 

Selling, general and administrative

 

12

 

14

 

Interest rate-related derivatives

 

11

 

 

Not applicable

 

 

 

 

 

Total Derivatives

 

$

56

 

$

11

 

 

 

$

16

 

$

18

 

 


(1)   The amount of gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was de minimis and $1 million for the three months ended December 31, 2016 and 2015, respectively.  The amount of gain recognized in earnings related to the ineffective portion of the hedging relationships was de minimis for the three months ended December 31, 2016.  There was no gain (loss) recognized in earnings related to the ineffective portion of the hedging relationships for the three months ended December 31, 2015.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

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)

 

 

 

Six Months Ended
December 31

 

from AOCI into
Earnings

 

Six Months Ended
December 31

 

(In millions)

 

2016

 

2015

 

(Effective Portion)

 

2016

 

2015

 

Derivatives in Cash Flow Hedging Relationships

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

48

 

$

36

 

Cost of sales

 

$

6

 

$

7

 

 

 

 

 

 

 

Selling, general and administrative

 

19

 

24

 

Interest rate-related derivatives

 

11

 

 

Not applicable

 

 

 

 

 

Total Derivatives

 

$

59

 

$

36

 

 

 

$

25

 

$

31

 

 


(1) The amount of gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was $(1) million and $2 million for the six months ended December 31, 2016 and 2015, respectively.  The amount of gain recognized in earnings related to the ineffective portion of the hedging relationships was de minimis for the six months ended December 31, 2016 and 2015.

 

 

 

 

 

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

 

 

 

 

Location of Gain or (Loss)
Recognized in Earnings on

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

(In millions)

 

Derivatives

 

2016

 

2015

 

2016

 

2015

 

Derivatives in Fair Value Hedging Relationships

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts

 

Interest expense

 

$

(17

)

$

(2

)

$

(22

)

$

6

 

 


(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.

 

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
December 31

 

Six Months Ended
December 31

 

(In millions)

 

Derivatives

 

2016

 

2015

 

2016

 

2015

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Selling, general and administrative

 

$

4

 

$

(6

)

$

1

 

$

1

 

 

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 December 2018.  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.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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 December 31, 2016, the Company’s foreign currency cash-flow hedges were highly effective.

 

At December 31, 2016, the Company had foreign currency forward contracts in the amount of $3,016 million.  The foreign currencies included in foreign currency forward contracts (notional value stated in U.S. dollars) are principally the British pound ($477 million), Chinese yuan ($358 million), Hong Kong dollar ($351 million), Euro ($343 million), Swiss franc ($324 million), Australian dollar ($172 million) and Japanese yen ($130 million).

 

The estimated net gain on the Company’s derivative instruments designated as cash-flow hedges as of December 31, 2016 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $25 million.  The accumulated gain on derivative instruments in AOCI was $84 million and $50 million as of December 31, 2016 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 a notional amount totaling $450 million and $250 million to effectively convert the fixed rate interest on its 2021 and 2022 Senior Notes, respectively, to variable interest rates based on three-month LIBOR plus a margin.  These interest rate swap agreements are designated as fair-value hedges of the related long-term debt, and the changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt.

 

Credit Risk

 

As a matter of policy, the Company enters into derivative contracts only with counterparties that have a long-term credit rating of at least A- or higher by at least two nationally recognized rating agencies.  The counterparties to these contracts are major financial institutions.  Exposure to credit risk in the event of nonperformance by any of the counterparties is limited to the gross fair value of contracts in asset positions, which totaled $68 million at December 31, 2016.  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.

 

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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 December 31, 2016:

 

(In millions) 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

56

 

$

 

$

56

 

Interest rate-related derivatives

 

 

11

 

 

11

 

Interest rate swap contracts

 

 

1

 

 

1

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

430

 

 

430

 

Foreign government and agency securities

 

 

87

 

 

87

 

Corporate notes and bonds

 

 

508

 

 

508

 

Time deposits

 

 

280

 

 

280

 

Other securities

 

 

28

 

 

28

 

Total

 

$

 

$

1,401

 

$

 

$

1,401

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

11

 

$

 

$

11

 

Interest rate swap contracts

 

 

5

 

 

5

 

Contingent consideration

 

 

 

200

 

200

 

Total

 

$

 

$

16

 

$

200

 

$

216

 

 

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

 

 

20



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

 

 

December 31

 

June 30

 

 

 

2016

 

2016

 

(In millions)

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Nonderivatives

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,262

 

$

1,262

 

$

914

 

$

914

 

Available-for-sale securities

 

1,333

 

1,333

 

1,504

 

1,504

 

Current and long-term debt

 

4,033

 

4,120

 

2,242

 

2,482

 

Additional purchase price payable

 

37

 

37

 

37

 

37

 

Contingent consideration

 

200

 

200

 

196

 

196

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts - asset (liability), net

 

45

 

45

 

22

 

22

 

Interest rate-related derivatives - asset

 

11

 

11

 

 

 

Interest rate swap contracts - asset (liability), net

 

(4

)

(4

)

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 because of the short maturity of cash equivalent instruments.

 

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

 

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

 

Interest rate-related derivatives and swap contracts — The fair values of the Company’s interest rate-related derivatives and 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.

 

21



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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 that include, at December 31, 2016, the risk-adjusted projected future operating results of the acquired entity, a risk-adjusted discount rate ranging from 1.8% to 2.5%, a measure of revenue volatility ranging from 5.1% to 13.4%, an asset volatility ranging from 29.6% to 33.0% and a revenue/earnings before income tax, depreciation and amortization correlation factor of 80%.  Significant changes in the projected future operating results would result in a significantly higher or lower fair value measurement.  Changes to the discount rate, volatility 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 six months ended December 31, 2016 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

 

4

 

Contingent consideration at December 31, 2016

 

$

200

 

 

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 December 31, 2016 and 2015 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

Other than

 

 

 

Pension Plans

 

Pension Plans

 

 

 

U.S.

 

International

 

Post-retirement

 

(In millions)

 

2016

 

2015

 

2016

 

2015

 

2016

 

2015

 

Service cost

 

$

9

 

$

8

 

$

7

 

$

6

 

$

1

 

$

1

 

Interest cost

 

7

 

8

 

3

 

4

 

1

 

2

 

Expected return on plan assets

 

(13

)

(12

)

(4

)

(5

)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

 

 

1

 

 

 

 

Actuarial loss

 

4

 

3

 

2

 

3

 

1

 

 

Net periodic benefit cost

 

$

7

 

$

7

 

$

9

 

$

8

 

$

3

 

$

3

 

 

22



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The components of net periodic benefit cost for the six months ended December 31, 2016 and 2015 consisted of the following: