10-Q 1 a17-21413_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 September 30, 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
(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, 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  (Do not check if a smaller reporting company)

Smaller reporting company o

 

Emerging growth company o

 

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

 

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

 

At October 25, 2017, 224,817,594 shares of the registrant’s Class A Common Stock, $.01 par value, and 143,419,528 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 Months Ended September 30, 2017 and 2016

2

 

 

 

 

Consolidated Statements of Comprehensive Income (Loss) — Three Months Ended September 30, 2017 and 2016

3

 

 

 

 

Consolidated Balance Sheets — September 30, 2017 and June 30, 2017 (Audited)

4

 

 

 

 

Consolidated Statements of Cash Flows — Three Months Ended September 30, 2017 and 2016

5

 

 

 

 

Notes to Consolidated Financial Statements

6

 

 

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

27

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

44

 

 

Item 4. Controls and Procedures

45

 

 

Part II. Other Information

 

 

 

Item 1. Legal Proceedings

45

 

 

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

45

 

 

Item 6. Exhibits

46

 

 

Signatures

47

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

 

 

Three Months Ended
September 30

 

(In millions, except per share data)

 

2017

 

2016

 

 

 

 

 

 

 

Net Sales

 

$

3,274

 

$

2,865

 

Cost of Sales

 

711

 

596

 

 

 

 

 

 

 

Gross Profit

 

2,563

 

2,269

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

Selling, general and administrative

 

1,961

 

1,825

 

Restructuring and other charges

 

34

 

26

 

Total operating expenses

 

1,995

 

1,851

 

 

 

 

 

 

 

Operating Income

 

568

 

418

 

 

 

 

 

 

 

Interest expense

 

31

 

21

 

Interest income and investment income, net

 

12

 

6

 

Earnings before Income Taxes

 

549

 

403

 

 

 

 

 

 

 

Provision for income taxes

 

119

 

107

 

Net Earnings

 

430

 

296

 

 

 

 

 

 

 

Net earnings attributable to noncontrolling interests

 

(3

)

(2

)

Net Earnings Attributable to The Estée Lauder Companies Inc.

 

$

427

 

$

294

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic

 

$

1.16

 

$

.80

 

Diluted

 

$

1.14

 

$

.79

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

Basic

 

368.4

 

366.4

 

Diluted

 

375.4

 

373.3

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

.34

 

$

.30

 

 

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
September 30

 

(In millions)

 

2017

 

2016

 

 

 

 

 

 

 

Net earnings

 

$

430

 

$

296

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

Net unrealized investment loss

 

(1

)

(4

)

Net derivative instrument loss

 

(9

)

(6

)

Amounts included in net periodic benefit cost

 

5

 

8

 

Translation adjustments

 

54

 

1

 

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

 

1

 

(1

)

Total other comprehensive income (loss)

 

50

 

(2

)

Comprehensive income

 

480

 

294

 

 

 

 

 

 

 

Comprehensive income attributable to noncontrolling interests:

 

 

 

 

 

Net earnings

 

(3

)

(2

)

Translation adjustments

 

(1

)

(1

)

 

 

(4

)

(3

)

Comprehensive income attributable to The Estée Lauder Companies Inc.

 

$

476

 

$

291

 

 

See notes to consolidated financial statements.

 

3



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED BALANCE SHEETS

 

 

 

September 30

 

June 30

 

(In millions, except share data)

 

2017

 

2017

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

1,444

 

$

1,136

 

Short-term investments

 

381

 

605

 

Accounts receivable, net

 

1,799

 

1,395

 

Inventory and promotional merchandise, net

 

1,518

 

1,479

 

Prepaid expenses and other current assets

 

365

 

349

 

Total current assets

 

5,507

 

4,964

 

 

 

 

 

 

 

Property, Plant and Equipment, net

 

1,695

 

1,671

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

Long-term investments

 

1,087

 

1,026

 

Goodwill

 

1,921

 

1,916

 

Other intangible assets, net

 

1,316

 

1,327

 

Other assets

 

676

 

664

 

Total other assets

 

5,000

 

4,933

 

Total assets

 

$

12,202

 

$

11,568

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Current debt

 

$

552

 

$

189

 

Accounts payable

 

679

 

835

 

Other accrued liabilities

 

1,911

 

1,799

 

Total current liabilities

 

3,142

 

2,823

 

 

 

 

 

 

 

Noncurrent Liabilities

 

 

 

 

 

Long-term debt

 

3,383

 

3,383

 

Other noncurrent liabilities

 

924

 

960

 

Total noncurrent liabilities

 

4,307

 

4,343

 

 

 

 

 

 

 

Contingencies

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

Common stock, $.01 par value; Class A shares authorized: 1,300,000,000 at September 30, 2017 and June 30, 2017; shares issued: 431,707,987 at September 30, 2017 and 429,968,260 at June 30, 2017; Class B shares authorized: 304,000,000 at September 30, 2017 and June 30, 2017; shares issued and outstanding: 143,419,528 at September 30, 2017 and 143,762,288 at June 30, 2017

 

6

 

6

 

Paid-in capital

 

3,665

 

3,559

 

Retained earnings

 

8,752

 

8,452

 

Accumulated other comprehensive loss

 

(435

)

(484

)

 

 

11,988

 

11,533

 

Less: Treasury stock, at cost; 206,604,964 Class A shares at September 30, 2017 and 205,627,082 Class A shares at June 30, 2017

 

(7,257

)

(7,149

)

Total stockholders’ equity — The Estée Lauder Companies Inc.

 

4,731

 

4,384

 

Noncontrolling interests

 

22

 

18

 

Total equity

 

4,753

 

4,402

 

Total liabilities and equity

 

$

12,202

 

$

11,568

 

 

See notes to consolidated financial statements.

 

4



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Three Months Ended
September 30

 

(In millions)

 

2017

 

2016

 

 

 

 

 

 

 

Cash Flows from Operating Activities

 

 

 

 

 

Net earnings

 

$

430

 

$

296

 

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

 

 

 

 

 

Depreciation and amortization

 

127

 

106

 

Deferred income taxes

 

(3

)

(32

)

Non-cash stock-based compensation

 

57

 

88

 

Excess tax benefits from stock-based compensation arrangements

 

 

(10

)

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

 

3

 

(7

)

Non-cash restructuring and other charges

 

 

1

 

Pension and post-retirement benefit expense

 

18

 

20

 

Pension and post-retirement benefit contributions

 

(8

)

(4

)

Changes in fair value of contingent consideration

 

1

 

4

 

Other non-cash items

 

(3

)

(4

)

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in accounts receivable, net

 

(390

)

(365

)

Increase in inventory and promotional merchandise, net

 

(16

)

(31

)

Decrease in other assets, net

 

13

 

4

 

Decrease in accounts payable

 

(166

)

(170

)

Increase (decrease) in other accrued and noncurrent liabilities

 

30

 

(46

)

Net cash flows provided by (used for) operating activities

 

93

 

(150

)

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

Capital expenditures

 

(116

)

(85

)

Payments for acquired businesses, net of cash acquired

 

(11

)

(10

)

Proceeds from the disposition of investments

 

311

 

365

 

Purchases of investments

 

(148

)

(348

)

Proceeds from sale of property, plant and equipment

 

 

12

 

Net cash flows provided by (used for) investing activities

 

36

 

(66

)

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

Proceeds of current debt, net

 

362

 

263

 

Repayments and redemptions of long-term debt

 

 

(2

)

Net proceeds from stock-based compensation transactions

 

48

 

26

 

Excess tax benefits from stock-based compensation arrangements

 

 

10

 

Payments to acquire treasury stock

 

(111

)

(222

)

Dividends paid to stockholders

 

(126

)

(111

)

Net cash flows provided by (used for) financing activities

 

173

 

(36

)

 

 

 

 

 

 

Effect of Exchange Rate Changes on Cash and Cash Equivalents

 

6

 

2

 

Net Increase (Decrease) in Cash and Cash Equivalents

 

308

 

(250

)

Cash and Cash Equivalents at Beginning of Period

 

1,136

 

914

 

Cash and Cash Equivalents at End of Period

 

$

1,444

 

$

664

 

 

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, 2017.

 

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, 2017.  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), net of tax, reported as cumulative translation adjustments through other comprehensive income (loss) (“OCI”) attributable to The Estée Lauder Companies Inc. were $54 million during the three months ended September 30, 2017 and de minimis for the three months ended September 30, 2016.

 

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

 

The accompanying consolidated statements of earnings include net exchange gains (losses) on foreign currency transactions of $(18) million and $5 million during the three months ended September 30, 2017 and 2016, respectively.

 

Accounts Receivable

 

Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions totaling $31 million and $30 million as of September 30, 2017 and June 30, 2017, 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 $275 million, or 8%, and $307 million, or 11%, of the Company’s consolidated net sales for the three months ended September 30, 2017 and 2016, respectively.  This customer accounted for $219 million, or 12%, and $112 million, or 8%, of the Company’s accounts receivable at September 30, 2017 and June 30, 2017, respectively.

 

Inventory and Promotional Merchandise

 

Inventory and promotional merchandise, net consists of:

 

 

 

September 30

 

June 30

 

(In millions)

 

2017

 

2017

 

Raw materials

 

$

312

 

$

334

 

Work in process

 

164

 

194

 

Finished goods

 

834

 

762

 

Promotional merchandise

 

208

 

189

 

 

 

$

1,518

 

$

1,479

 

 

During the first quarter of fiscal 2018, the Company adopted new accounting guidance issued by the Financial Accounting Standards Board (“FASB”) that simplifies the subsequent measurement of inventory by requiring inventory to be measured at the lower of cost or net realizable value instead of lower of cost or market value. Net realizable value is defined as the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation.  The adoption of this guidance did not have an impact on the Company’s measurement of inventory and promotional merchandise.

 

Property, Plant and Equipment

 

 

 

September 30

 

June 30

 

(In millions)

 

2017

 

2017

 

Assets (Useful Life)

 

 

 

 

 

Land

 

$

30

 

$

30

 

Buildings and improvements (10 to 40 years)

 

195

 

192

 

Machinery and equipment (3 to 10 years)

 

688

 

668

 

Computer hardware and software (4 to 15 years)

 

1,135

 

1,115

 

Furniture and fixtures (5 to 10 years)

 

101

 

96

 

Leasehold improvements

 

2,003

 

1,918

 

 

 

4,152

 

4,019

 

Less accumulated depreciation and amortization

 

(2,457

)

(2,348

)

 

 

$

1,695

 

$

1,671

 

 

The cost of assets related to projects in progress of $177 million and $183 million as of September 30, 2017 and June 30, 2017, respectively, is included in their respective asset categories above.  Depreciation and amortization of property, plant and equipment was $112 million and $102 million during the three months ended September 30, 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.

 

Income Taxes

 

The effective rate for income taxes was 21.7% and 26.6% for the three months ended September 30, 2017 and 2016, respectively.  The decrease in the effective tax rate was primarily attributable to the favorable impact of the adoption of new accounting guidance issued by the FASB related to share-based compensation awards. The impact of the new guidance resulted in a $23 million benefit to the Company’s income tax provision (approximately 420 basis points). For further discussion of the adoption, see Recently Adopted Accounting Standards below.

 

7



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of September 30, 2017 and June 30, 2017, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $63 million and $68 million, respectively.  The total amount of unrecognized tax benefits at September 30, 2017 that, if recognized, would affect the effective tax rate was $39 million. During the three months ended September 30, 2017, the Company recognized a gross interest and penalty benefit of $3 million in the accompanying consolidated statement of earnings.  The total gross accrued interest and penalties in the accompanying consolidated balance sheets at September 30, 2017 and June 30, 2017 was $10 million and $13 million, respectively.  On the basis of the information available as of September 30, 2017, the Company does not expect any significant changes to the total amount of unrecognized tax benefits within the next twelve months.

 

Other Accrued Liabilities

 

Other accrued liabilities consist of the following:

 

 

 

September 30

 

June 30

 

(In millions)

 

2017

 

2017

 

Advertising, merchandising and sampling

 

$

389

 

$

319

 

Employee compensation

 

368

 

522

 

Payroll and other taxes

 

233

 

190

 

Other

 

921

 

768

 

 

 

$

1,911

 

$

1,799

 

 

Recently Adopted Accounting Standards

 

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.

 

Impact on consolidated financial statements — As a result of the adoption of this guidance, during the three months ended September 30, 2017, the Company recognized $23 million of excess tax benefits as a reduction to the provision for income taxes in its consolidated statement of earnings.  Additionally, upon adoption the Company has included these excess tax benefits in cash flows from operating activities in the net earnings caption and will continue to classify cash paid for withholding shares for tax-withholding purposes in cash flows from financing activities.  This guidance was applied prospectively and prior-year periods have not been adjusted for these changes.  The Company will also continue to accrue for estimated forfeitures each quarter. Finally, as the Company has no outstanding awards classified as a liability due to withholding excess taxes, there was no impact to the Company’s consolidated balance sheets related to the adoption of that portion of the guidance.

 

8



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Recently Issued Accounting Standards

 

Hedge Accounting

 

In August 2017, the FASB issued authoritative guidance to simplify hedge accounting.  The amended guidance includes the following provisions:

 

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

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

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

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

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

·                  eases certain documentation and assessment requirements;

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

·                  requires revised tabular footnote disclosure.

 

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

 

Effective for the Company  Fiscal 2020 first quarter, with early adoption permitted in any interim period.  The Company must adopt the guidance using the modified retrospective approach for cash flow and net investment hedge relationships that exist on the date of adoption and adopt prospectively for the presentation and disclosure requirements.

 

Impact on consolidated financial statements  The Company is currently evaluating the timing of adoption and impact of applying this new hedge accounting.

 

Pension-related Costs

 

In March 2017, the FASB issued authoritative guidance that amends how companies present net periodic benefit cost in the income statement and balance sheet relating to defined benefit pension and/or other postretirement benefit plans.  Within the income statement, the new guidance requires companies to report the service cost component within operating expenses and report the other components of net periodic benefit cost below operating income (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:

 

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

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

 

Impact on consolidated financial statements  The Company will adopt this guidance when it becomes effective and although certain components of pension expense will be reclassified out of operating income, the Company does not believe this will have a material impact on reported operating income.

 

Goodwill

 

In January 2017, the 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 Company did not elect to apply this guidance to its fiscal 2017 impairment testing and will continue to assess the impact of adopting it on future interim and annual impairment tests.

 

9



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

 

Leases

 

In February 2016, the FASB issued authoritative guidance that requires lessees to account for most leases on their balance sheets with the liability being equal to the present value of the lease payments.  The right-of-use asset will be based on the lease liability adjusted for certain costs such as 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 — 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.  As disclosed in Note 15 — Commitments and Contingencies in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2017, the Company had $2,427 million in future minimum lease commitments as of June 30, 2017.  Upon adoption, the Company’s lease liability will generally be based on the present value of such payments, and the related right-of use asset will generally be based on the lease liability, adjusted for initial direct costs.

 

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 its prior comments that covered, among other things, accounting for shipping and handling costs and accounting for consideration given by a vendor to a customer.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

Effective for the Company — Fiscal 2019, 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 it becomes effective in fiscal 2019 and has not yet selected a transition method.  Although the Company has not yet completed its evaluation, it has preliminarily determined that certain promotional goods, such as samples and testers, will be reclassified from Selling, general and administrative expenses to Cost of Sales in the consolidated financial statements upon adoption.  Additionally, the Company’s customer loyalty programs, which have historically been accounted for under the incremental cost approach, will be accounted for as a reduction of revenue based on the fair value of estimated future redemptions when the obligation is created (i.e. upon sale of the product to the consumer).  Furthermore, the Company is assessing the impact that these promotional goods and loyalty programs will have on the timing of revenue recognition upon adoption.

 

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 September 30, 2017 were as follows:

 

(In millions) 

 

Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

U.S. government and agency securities

 

$

445

 

$

 

$

(1

)

$

444

 

Foreign government and agency securities

 

109

 

 

 

109

 

Corporate notes and bonds

 

532

 

 

(1

)

531

 

Time deposits

 

230

 

 

 

230

 

Other securities

 

17

 

 

 

17

 

Total

 

$

1,333

 

$

 

$

(2

)

$

1,331

 

 

Gains and losses recorded in AOCI related to the Company’s available-for-sale investments as of June 30, 2017 were as follows:

 

(In millions) 

 

Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

U.S. government and agency securities

 

$

464

 

$

2

 

$

(2

)

$

464

 

Foreign government and agency securities

 

103

 

 

(1

)

102

 

Corporate notes and bonds

 

506

 

 

(1

)

505

 

Time deposits

 

410

 

 

 

410

 

Other securities

 

16

 

1

 

 

17

 

Total

 

$

1,499

 

$

3

 

$

(4

)

$

1,498

 

 

The following table presents the Company’s available-for-sale securities by contractual maturity as of September 30, 2017:

 

(In millions)

 

Cost

 

Fair Value

 

Due within one year

 

$

381

 

$

381

 

Due after one through five years

 

952

 

950

 

 

 

$

1,333

 

$

1,331

 

 

11



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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 September 30, 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

 

$

537

 

$

(2

)

$

176

 

$

(2

)

 

Gross gains and losses on sales of investments included in the consolidated statements of earnings were not material for all periods presented.

 

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 $130 million and $181 million for the three months ended September 30, 2017 and 2016, respectively.

 

NOTE 3 — GOODWILL AND OTHER INTANGIBLE ASSETS

 

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, 2017

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

184

 

$

1,176

 

$

255

 

$

393

 

$

2,008

 

Accumulated impairments

 

(35

)

 

(22

)

(35

)

(92

)

 

 

149

 

1,176

 

233

 

358

 

1,916

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill acquired during the period

 

 

3

 

 

 

3

 

Translation adjustments

 

 

 

2

 

 

2

 

 

 

 

3

 

2

 

 

5

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

185

 

1,179

 

258

 

394

 

2,016

 

Accumulated impairments

 

(36

)

 

(23

)

(36

)

(95

)

 

 

$

149

 

$

1,179

 

$

235

 

$

358

 

$

1,921

 

 

Other intangible assets consist of the following:

 

 

 

September 30, 2017

 

June 30, 2017

 

(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

 

$

697

 

$

293

 

$

404

 

$

696

 

$

279

 

$

417

 

License agreements

 

43

 

43

 

 

43

 

43

 

 

 

 

$

740

 

$

336

 

404

 

$

739

 

$

322

 

417

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks and other

 

 

 

 

 

912

 

 

 

 

 

910

 

Total intangible assets

 

 

 

 

 

$

1,316

 

 

 

 

 

$

1,327

 

 

The aggregate amortization expense related to amortizable intangible assets was $13 million and $4 million for the three months ended September 30, 2017 and 2016, respectively.  The estimated aggregate amortization expense for the remainder of fiscal 2018 and for each of fiscal 2019 to 2022 is $39 million, $51 million, $44 million, $43 million and $42 million, respectively.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4 — CHARGES ASSOCIATED WITH RESTRUCTURING AND OTHER ACTIVITIES

 

In May 2016, the Company announced a multi-year initiative (“Leading Beauty Forward,” “LBF” or the “Program”) to build on its strengths and better leverage its cost structure to free resources for investment to continue its growth momentum.  LBF is designed to enhance the Company’s go-to-market capabilities, reinforce its leadership in global prestige beauty and continue creating sustainable value.  The Company plans to approve specific initiatives under LBF through fiscal 2019 related to the optimization of select corporate functions, supply chain activities, and corporate and regional market support structures, as well as the exit of underperforming businesses, and expects to complete those initiatives through fiscal 2021.  Inclusive of charges recorded from inception through September 30, 2017, the Company expects that LBF will result in related restructuring and other charges totaling between $600 million and $700 million before taxes.  In connection with LBF, at this time, the Company estimates a net reduction over the duration of LBF in the range of 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 September 30, 2017, some of which were recorded during fiscal 2017 and 2016, were:

 

 

 

Sales
Returns

 

 

 

Operating Expenses

 

 

 

 

 

(included in

 

 

 

Restructuring

 

Other

 

 

 

(In millions)

 

Net Sales)

 

Cost of Sales

 

Charges

 

Charges

 

Total

 

Approval Period

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2016

 

$

4

 

$

28

 

$

87

 

$

71

 

$

190

 

Fiscal 2017

 

11

 

10

 

132

 

118

 

271

 

Three months ended September 30, 2017

 

 

 

28

 

9

 

37

 

Cumulative through September 30, 2017

 

$

15

 

$

38

 

$

247

 

$

198

 

$

498

 

 

Included in the above table, cumulative restructuring initiatives approved by the Company through September 30, 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

 

Fiscal 2017

 

126

 

1

 

 

5

 

132

 

Three months ended September 30, 2017

 

28

 

 

 

 

28

 

Cumulative through September 30, 2017

 

$

229

 

$

4

 

$

5

 

$

9

 

$

247

 

 

During the three months ended September 30, 2017, the Company continued to approve initiatives to enhance its go-to-market support structures and optimize select corporate functions.  These actions will result in a net reduction of the workforce, which includes position eliminations, the re-leveling of certain positions and an investment in new capabilities.  The Company also approved consulting and other professional services primarily related to the implementation and integration of new processes and technologies and, to a lesser extent, other costs for temporary labor backfill and recruitment related to the new capabilities.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Program-to-Date Restructuring and Other Charges

 

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

 

 

 

Sales
Returns

 

 

 

Operating Expenses

 

 

 

 

 

(included in

 

 

 

Restructuring

 

Other

 

 

 

(In millions)

 

Net Sales)

 

Cost of Sales

 

Charges

 

Charges

 

Total

 

Fiscal 2016

 

$

1

 

$

 

$

75

 

$

5

 

$

81

 

Fiscal 2017

 

2

 

15

 

122

 

73

 

212

 

Three months ended September 30, 2017

 

 

4

 

14

 

20

 

38

 

Cumulative through September 30, 2017

 

$

3

 

$

19

 

$

211

 

$

98

 

$

331

 

 

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

 

(In millions)

 

Employee-
Related
Costs

 

Asset-
Related
Costs

 

Contract
Terminations

 

Other Exit
Costs

 

Total

 

Fiscal 2016

 

$

74

 

$

1

 

$

 

$

 

$

75

 

Fiscal 2017

 

116

 

2

 

2

 

2

 

122

 

Three months ended September 30, 2017

 

13

 

 

 

1

 

14

 

Cumulative through September 30, 2017

 

$

203

 

$

3

 

$

2

 

$

3

 

$

211

 

 

Accrued restructuring charges from Program inception through September 30, 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

 

116

 

2

 

2

 

2

 

122

 

Cash payments

 

(39

)

 

(2

)

(2

)

(43

)

Noncash asset write-offs

 

 

(2

)

 

 

(2

)

Balance at June 30, 2017

 

150

 

 

 

 

150

 

 

 

 

 

 

 

 

 

 

 

 

 

Charges

 

13

 

 

 

1

 

14

 

Cash payments

 

(20

)

 

 

(1

)

(21

)

Balance at September 30, 2017

 

$

143

 

$

 

$

 

$

 

$

143

 

 

Restructuring charges for employee-related costs are net of adjustments to the accrual estimate for certain employees who either resigned or transferred to other existing positions within the Company.  Accrued restructuring charges at September 30, 2017 are expected to result in cash expenditures funded from cash provided by operations of approximately $77 million, $56 million and $10 million for the remainder of fiscal 2018 and for each of fiscal 2019 and 2020, respectively.

 

14



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 — DERIVATIVE FINANCIAL INSTRUMENTS

 

The Company addresses certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments.  The Company enters into foreign currency forward contracts and may enter into option contracts to reduce the effects of fluctuating foreign currency exchange rates. In addition, the Company enters into interest rate derivatives to manage the effects of interest rate movements on the Company’s aggregate liability portfolio, including potential future debt issuances.  The Company also enters into foreign currency forward contracts and may use option contracts, not designated as hedging instruments, to mitigate the change in fair value of specific assets and liabilities on the balance sheet.  The Company does not utilize derivative financial instruments for trading or speculative purposes.  Costs associated with entering into derivative financial instruments have not been material to the Company’s consolidated financial results.

 

For each derivative contract entered into where the Company looks to obtain hedge accounting treatment, the Company formally and contemporaneously documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking the hedge transaction, the nature of the risk being hedged, 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

 

 

 

Balance Sheet
Location

 

Fair Value (1)

 

Balance Sheet
Location

 

Fair Value (1)

 

(In millions)

 

 

 

September 30
2017

 

June 30
2017

 

 

 

September 30
2017

 

June 30
2017

 

Derivatives Designated
as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

$

5

 

$

7

 

Other accrued liabilities

 

$

50

 

$

44

 

Interest rate swap contracts

 

Prepaid expenses and other current assets

 

2

 

3

 

Other accrued liabilities

 

4

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives Designated as Hedging Instruments

 

 

 

7

 

10

 

 

 

54

 

47

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

3

 

3

 

Other accrued liabilities

 

2

 

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives

 

 

 

$

10

 

$

13

 

 

 

$

56

 

$

49

 

 


 

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

 

15



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
September 30

 

from AOCI into
Earnings

 

Three Months Ended
September 30

 

(In millions)

 

2017

 

2016

 

(Effective Portion)

 

2017

 

2016

 

Derivatives in Cash Flow Hedging Relationships:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

(18

)

$

3

 

Cost of sales

 

$

(5

)

$

2

 

 

 

 

 

 

 

Selling, general and administrative

 

(4

)

7

 

Interest rate-related derivatives

 

 

 

Interest expense

 

 

 

Total derivatives

 

$

(18

)

$

3

 

 

 

$

(9

)

$

9

 

 


(1) The gain (loss) recognized in earnings related to the amount excluded from effectiveness testing and the amount related to the ineffective portion of the hedging relationships was not material for all periods presented.

 

 

 

 

 

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

 

 

 

Location of Gain or (Loss)
Recognized in Earnings on

 

Three Months Ended
September 30

 

(In millions)

 

Derivatives

 

2017

 

2016

 

Derivatives in Fair Value Hedging Relationships:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts

 

Interest expense

 

$

(2

)

$

(4

)

 


(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
September 30

 

(In millions)

 

Derivatives

 

2017

 

2016

 

Derivatives Not Designated as Hedging Instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Selling, general and administrative

 

$

 

$

(2

)

 

16



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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 September 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 September 30, 2017, the Company’s foreign currency cash-flow hedges were highly effective.

 

At September 30, 2017, the Company had foreign currency forward contracts in the amount of $2,546 million.  The foreign currencies included in foreign currency forward contracts (notional value stated in U.S. dollars) are principally the Swiss franc ($370 million), Euro ($354 million), British pound ($350 million), Hong Kong dollar ($307 million), Chinese yuan ($136 million), Japanese yen ($134 million) and Canadian dollar ($132 million).

 

The estimated net loss on the Company’s derivative instruments designated as cash-flow hedges as of September 30, 2017 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $23 million.  The accumulated net loss on derivative instruments in AOCI was $13 million and $4 million as of September 30, 2017 and June 30, 2017, respectively.

 

Fair-Value Hedges

 

The Company enters into interest rate derivative contracts to manage the exposure to interest rate fluctuations on its funded indebtedness. The Company has interest rate swap agreements, with notional amounts totaling $250 million, $450 million and $250 million to effectively convert the fixed rate interest on its 2020 Senior Notes, 2021 Senior Notes and 2022 Senior Notes, respectively, to variable interest rates based on three-month LIBOR plus a margin.  These interest rate swap agreements are designated as fair-value hedges of the related long-term debt, and the changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt.

 

Credit Risk

 

As a matter of policy, the Company enters into derivative contracts only with counterparties that have a long-term credit rating of at least A- or higher by at least two nationally recognized rating agencies.  The counterparties to these contracts are major financial institutions.  Exposure to credit risk in the event of nonperformance by any of the counterparties is limited to the gross fair value of contracts in asset positions, which totaled $10 million at September 30, 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.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 — FAIR VALUE MEASUREMENTS

 

The Company records certain of its financial assets and liabilities at fair value, which is defined as the price that would be received to sell an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date.  The accounting for fair value measurements must be applied to nonfinancial assets and nonfinancial liabilities that require initial measurement or remeasurement at fair value, which principally consist of assets and liabilities acquired through business combinations and goodwill, indefinite-lived intangible assets and long-lived assets for the purposes of calculating potential impairment.  The Company is required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The three levels of inputs that may be used to measure fair value are as follows:

 

Level 1: Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.

 

Level 2: Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.  The inputs are unobservable in the market and significant to the instrument’s valuation.

 

The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2017:

 

(In millions)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

8

 

$

 

$

8

 

Interest rate swap contracts

 

 

2

 

 

2

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

444

 

 

444

 

Foreign government and agency securities

 

 

109

 

 

109

 

Corporate notes and bonds

 

 

531

 

 

531

 

Time deposits

 

 

230

 

 

230

 

Other securities

 

 

17

 

 

17

 

Total

 

$

 

$

1,341

 

$

 

$

1,341

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

52

 

$

 

$

52

 

Interest rate swap contracts

 

 

4

 

 

4

 

Contingent consideration

 

 

 

140

 

140

 

Total

 

$

 

$

56

 

$

140

 

$

196

 

 

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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 June 30, 2017:

 

(In millions)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

10

 

$

 

$

10

 

Interest rate swap contracts

 

 

3

 

 

3

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

464

 

 

464

 

Foreign government and agency securities

 

 

102

 

 

102

 

Corporate notes and bonds

 

 

505

 

 

505

 

Time deposits

 

 

410

 

 

410

 

Other securities

 

 

17

 

 

17

 

Total

 

$

 

$

1,511

 

$

 

$

1,511

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

46

 

$

 

$

46

 

Interest rate swap contracts

 

 

3

 

 

3

 

Contingent consideration

 

 

 

139

 

139

 

Total

 

$

 

$

49

 

$

139

 

$

188

 

 

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

 

 

 

September 30

 

June 30

 

 

 

2017

 

2017

 

(In millions)

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Nonderivatives

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,444

 

$

1,444

 

$

1,136

 

$

1,136

 

Available-for-sale securities

 

1,331

 

1,331

 

1,498

 

1,498

 

Current and long-term debt

 

3,935

 

4,145

 

3,572

 

3,759

 

Additional purchase price payable

 

38

 

38

 

38

 

38

 

Contingent consideration

 

140

 

140

 

139

 

139

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts — asset (liability), net

 

(44

)

(44

)

(36

)

(36

)

Interest rate swap contracts — asset (liability), net

 

(2

)

(2

)

 

 

 

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.

 

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Table of Contents

 

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 September 30, 2017:

 

Risk-adjusted discount rate

 

1.8% to 2.2%

Revenue volatility

 

3.5% to 7.9%

Asset volatility

 

20.9% to 25.4%

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

 

80%

Revenue discount rates

 

3.0% to 4.9%

Earnings before income tax, depreciation and amortization discount rates

 

11.9% to 13.2%

 

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 three months ended September 30, 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, 2017

 

$

139

 

Changes in fair value

 

1

 

Contingent consideration at September 30, 2017

 

$

140

 

 

20



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 7 — 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 included in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2017.

 

The components of net periodic benefit cost for the three months ended September 30, 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

 

$

9

 

$

7

 

$

7

 

$

1

 

$

1

 

Interest cost

 

8

 

8

 

3

 

3

 

2

 

2

 

Expected return on plan assets

 

(13

)

(13

)

(3

)

(4

)

(1

)

(1

)

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

 

1

 

 

 

 

 

Actuarial loss

 

4

 

4

 

1

 

3

 

 

 

Net periodic benefit cost

 

$

8

 

$

9

 

$

8

 

$

9

 

$

2

 

$

2

 

 

During the three months ended September 30, 2017, the Company made contributions to its international pension plans totaling approximately $4 million.

 

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

 

 

 

September 30

 

June 30

 

(In millions)

 

2017

 

2017

 

Other assets

 

$

100

 

$

100

 

Other accrued liabilities

 

(28

)

(28

)

Other noncurrent liabilities

 

(404

)

(397

)

Funded status

 

(332

)

(325

)

Accumulated other comprehensive loss

 

321

 

325

 

Net amount recognized

 

$

(11

)

$

 

 

NOTE 8 — 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.

 

21



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 9 — 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
September 30

 

(In millions)

 

2017

 

2016

 

Compensation expense

 

$

57

 

$

88

 

Income tax benefit

 

19

 

29

 

 

Beginning in September 2017, the equity award agreements for employee equity grants contain a new provision regarding award forfeiture, which requires the recording of stock-based compensation expense for retirement-eligible employees over the new requisite service period (six months) rather than at the date of grant.

 

Stock Options

 

During the three months ended September 30, 2017, the Company granted approximately 2.1 million stock options with an exercise price per share of $107.95 and a weighted-average grant date fair value per share of $27.66. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model.  The aggregate intrinsic value of stock options exercised during the three months ended September 30, 2017 was $82 million.

 

Restricted Stock Units

 

The Company granted approximately 1.2 million RSUs during the three months ended September 30, 2017 with a weighted-average grant date fair value per share of $107.93 which, at the time of grant, were scheduled to vest as follows: 0.4 million in fiscal 2019, 0.5 million in fiscal 2020 and 0.3 million in fiscal 2021.  Vesting of RSUs granted is generally subject to the continued employment or retirement of the grantees.  The RSUs are accompanied by dividend equivalent rights, payable upon settlement of the RSUs either in cash or shares (based on the terms of the particular award) and, as such, were valued at the closing market price of the Company’s Class A Common Stock on the date of grant.

 

Performance Share Units

 

During the three months ended September 30, 2017, the Company granted PSUs with a target payout of approximately 0.2 million shares with a grant date fair value per share of $107.95, 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, 2020, all subject to continued employment or retirement of the grantees. For PSUs granted, no settlement will occur for results below the applicable minimum threshold.  PSUs are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the PSUs and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant.

 

In September 2017, approximately 0.2 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, 2017.

 

Performance Share Units Based on Total Stockholder Return

 

In August 2017, 30,267 shares of the Company’s Class A Common Stock were issued, and related dividends were paid, in accordance with the terms of the grant related to the final performance period of the award, which ended June 30, 2017.

 

NOTE 10 — 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.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

 

 

Three Months Ended
September 30

 

(In millions, except per share data)

 

2017

 

2016

 

Numerator:

 

 

 

 

 

Net earnings attributable to The Estée Lauder Companies Inc.

 

$

427

 

$

294

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted-average common shares outstanding — Basic

 

368.4

 

366.4

 

Effect of dilutive stock options

 

4.5

 

4.5

 

Effect of PSUs

 

0.2

 

0.1

 

Effect of RSUs

 

2.3

 

2.3

 

Weighted-average common shares outstanding — Diluted

 

375.4

 

373.3

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic

 

$

1.16

 

$

.80

 

Diluted

 

1.14

 

.79

 

 

As of September 30, 2017 and 2016, outstanding options to purchase 2.1 million and 2.6 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 September 30, 2017 and 2016, 1.2 million shares 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 9 — Stock Programs.

 

NOTE 11 — 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, 2017

 

$

6

 

$

3,559

 

$

8,452

 

$

(484

)

$

(7,149

)

$

4,384

 

$

18

 

$

4,402

 

Net earnings

 

 

 

427

 

 

 

427

 

3

 

430

 

Common stock dividends

 

 

1

 

(127

)

 

 

(126

)

 

(126

)

Other comprehensive income

 

 

 

 

49

 

 

49

 

1

 

50

 

Acquisition of treasury stock

 

 

 

 

 

(98

)

(98

)

 

(98

)

Stock-based compensation

 

 

105

 

 

 

(10