10-Q 1 a18-30065_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

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, 2018

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes 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 ¨

Non-accelerated filer  ¨

 

Smaller reporting company ¨

 

 

Emerging growth company ¨

 

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

 

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

 

At October 24, 2018, 219,899,308 shares of the registrant’s Class A Common Stock, $.01 par value, and 142,953,234 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, 2018 and 2017

2

 

 

Consolidated Statements of Comprehensive Income (Loss) — Three Months Ended September 30, 2018 and 2017

3

 

 

Consolidated Balance Sheets — September 30, 2018 and June 30, 2018 (Audited)

4

 

 

Consolidated Statements of Cash Flows — Three Months Ended September 30, 2018 and 2017

5

 

 

Notes to Consolidated Financial Statements

6

 

 

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

35

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

54

 

 

Item 4. Controls and Procedures

54

 

 

Part II. Other Information

 

 

 

Item 1. Legal Proceedings

54

 

 

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

54

 

 

Item 6. Exhibits

55

 

 

Signatures

56

 


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)

 

2018

 

2017

 

 

 

 

 

 

 

Net Sales

 

$

3,524

 

$

3,274

 

Cost of Sales

 

823

 

711

 

 

 

 

 

 

 

Gross Profit

 

2,701

 

2,563

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

Selling, general and administrative

 

2,008

 

1,960

 

Restructuring and other charges

 

41

 

34

 

Total operating expenses

 

2,049

 

1,994

 

 

 

 

 

 

 

Operating Income

 

652

 

569

 

 

 

 

 

 

 

Interest expense

 

34

 

31

 

Interest income and investment income, net

 

15

 

12

 

Other components of net periodic benefit cost

 

 

1

 

Earnings before Income Taxes

 

633

 

549

 

 

 

 

 

 

 

Provision for income taxes

 

131

 

119

 

Net Earnings

 

502

 

430

 

 

 

 

 

 

 

Net earnings attributable to noncontrolling interests

 

(2

)

(3

)

Net Earnings Attributable to The Estée Lauder Companies Inc.

 

$

500

 

$

427

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic

 

$

1.36

 

$

1.16

 

Diluted

 

$

1.34

 

$

1.14

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

Basic

 

366.8

 

368.4

 

Diluted

 

374.4

 

375.4

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

.38

 

$

.34

 

 

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)

 

2018

 

2017

 

 

 

 

 

 

 

Net Earnings

 

$

502

 

$

430

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

Net unrealized investment gain (loss)

 

2

 

(1

)

Net derivative instrument loss

 

 

(9

)

Amounts included in net periodic benefit cost

 

3

 

5

 

Translation adjustments

 

23

 

54

 

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

 

(3

)

1

 

Total other comprehensive income

 

25

 

50

 

Comprehensive income

 

527

 

480

 

 

 

 

 

 

 

Comprehensive income attributable to noncontrolling interests:

 

 

 

 

 

Net earnings

 

(2

)

(3

)

Translation adjustments

 

 

(1

)

 

 

(2

)

(4

)

Comprehensive income attributable to The Estée Lauder Companies Inc.

 

$

525

 

$

476

 

 

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)

 

2018

 

2018

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

1,443

 

$

2,181

 

Short-term investments

 

550

 

534

 

Accounts receivable, net

 

2,214

 

1,487

 

Inventory and promotional merchandise, net

 

1,681

 

1,618

 

Prepaid expenses and other current assets

 

361

 

348

 

Total current assets

 

6,249

 

6,168

 

 

 

 

 

 

 

Property, Plant and Equipment, net

 

1,838

 

1,823

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

Long-term investments

 

661

 

843

 

Goodwill

 

1,929

 

1,926

 

Other intangible assets, net

 

1,264

 

1,276

 

Other assets

 

602

 

531

 

Total other assets

 

4,456

 

4,576

 

Total assets

 

$

12,543

 

$

12,567

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Current debt

 

$

183

 

$

183

 

Accounts payable

 

913

 

1,182

 

Other accrued liabilities

 

2,467

 

1,945

 

Total current liabilities

 

3,563

 

3,310

 

 

 

 

 

 

 

Noncurrent Liabilities

 

 

 

 

 

Long-term debt

 

3,361

 

3,361

 

Other noncurrent liabilities

 

1,189

 

1,186

 

Total noncurrent liabilities

 

4,550

 

4,547

 

 

 

 

 

 

 

Contingencies

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

Common stock, $.01 par value; Class A shares authorized: 1,300,000,000 at September 30, 2018 and June 30, 2018; shares issued: 436,602,595 at September 30, 2018 and 435,413,976 at June 30, 2018; Class B shares authorized: 304,000,000 at September 30, 2018 and June 30, 2018; shares issued and outstanding: 142,953,234 at September 30, 2018 and 143,051,679 at June 30, 2018

 

6

 

6

 

Paid-in capital

 

4,065

 

3,972

 

Retained earnings

 

9,170

 

9,040

 

Accumulated other comprehensive loss

 

(409

)

(434

)

 

 

12,832

 

12,584

 

Less: Treasury stock, at cost; 215,110,711 Class A shares at September 30, 2018 and 211,320,208 Class A shares at June 30, 2018

 

(8,426

)

(7,896

)

Total stockholders’ equity — The Estée Lauder Companies Inc.

 

4,406

 

4,688

 

Noncontrolling interests

 

24

 

22

 

Total equity

 

4,430

 

4,710

 

Total liabilities and equity

 

$

12,543

 

$

12,567

 

 

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)

 

2018

 

2017

 

 

 

 

 

 

 

Cash Flows from Operating Activities

 

 

 

 

 

Net earnings

 

$

502

 

$

430

 

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

 

 

 

 

 

Depreciation and amortization

 

132

 

127

 

Deferred income taxes

 

(9

)

(3

)

Non-cash stock-based compensation

 

58

 

57

 

Net loss on disposal of property, plant and equipment

 

3

 

3

 

Pension and post-retirement benefit expense

 

18

 

18

 

Pension and post-retirement benefit contributions

 

(6

)

(8

)

Changes in fair value of contingent consideration

 

(11

)

1

 

Other non-cash items

 

(4

)

(3

)

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in accounts receivable, net

 

(546

)

(390

)

Increase in inventory and promotional merchandise, net

 

(36

)

(16

)

Decrease (increase) in other assets, net

 

(18

)

2

 

Decrease in accounts payable

 

(262

)

(166

)

Increase in other accrued and noncurrent liabilities

 

60

 

30

 

Net cash flows provided by (used for) operating activities

 

(119

)

82

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

Capital expenditures

 

(128

)

(116

)

Proceeds from the disposition of investments

 

173

 

311

 

Purchases of investments

 

(14

)

(148

)

Net cash flows provided by investing activities

 

31

 

47

 

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

Proceeds (repayments) of current debt, net

 

(3

)

362

 

Net proceeds from stock-based compensation transactions

 

33

 

48

 

Payments to acquire treasury stock

 

(530

)

(111

)

Dividends paid to stockholders

 

(141

)

(126

)

Payments to noncontrolling interest holders for dividends

 

(1

)

 

Net cash flows provided by (used for) financing activities

 

(642

)

173

 

 

 

 

 

 

 

Effect of Exchange Rate Changes on Cash and Cash Equivalents

 

(8

)

6

 

Net Increase (Decrease) in Cash and Cash Equivalents

 

(738

)

308

 

Cash and Cash Equivalents at Beginning of Period

 

2,181

 

1,136

 

Cash and Cash Equivalents at End of Period

 

$

1,443

 

$

1,444

 

 

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, 2018.

 

Certain amounts in the consolidated financial statements of prior years have been reclassified to conform to current year presentation.

 

Management Estimates

 

The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses reported in those financial statements.  Descriptions of the Company’s significant accounting policies are discussed in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.  Management evaluates the related estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, and makes adjustments when facts and circumstances dictate.  As future events and their effects cannot be determined with precision, actual results could differ significantly from those estimates and assumptions.  Significant changes, if any, in those estimates and assumptions resulting from continuing changes in the economic environment will be reflected in the consolidated financial statements in future periods.

 

Currency Translation and Transactions

 

All assets and liabilities of foreign subsidiaries and affiliates are translated at period-end rates of exchange, while revenue and expenses are translated at weighted-average rates of exchange for the period.  Unrealized translation gains, net of tax, reported as cumulative translation adjustments through other comprehensive income (loss) (“OCI”) attributable to The Estée Lauder Companies Inc. were $21 million and $54 million, net of tax, during the three months ended September 30, 2018 and 2017, respectively.  For the Company’s subsidiaries operating in highly inflationary economies, the U.S. dollar is the functional currency.  Remeasurement adjustments in financial statements in a highly inflationary economy and other transactional gains and losses are reflected in earnings.  These subsidiaries are not material to the Company’s consolidated financial statements or liquidity.

 

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

 

The accompanying consolidated statements of earnings include net exchange losses on foreign currency transactions of $14 million and $18 million during the three months ended September 30, 2018 and 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 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

 

Inventory and Promotional Merchandise

 

Inventory and promotional merchandise, net consists of:

 

 

 

September 30

 

June 30

 

(In millions)

 

2018

 

2018

 

Raw materials

 

$

423

 

$

432

 

Work in process

 

197

 

222

 

Finished goods

 

857

 

798

 

Promotional merchandise

 

204

 

166

 

 

 

$

1,681

 

$

1,618

 

 

Property, Plant and Equipment

 

 

 

September 30

 

June 30

 

(In millions)

 

2018

 

2018

 

Assets (Useful Life)

 

 

 

 

 

Land

 

$

30

 

$

30

 

Buildings and improvements (10 to 40 years)

 

248

 

237

 

Machinery and equipment (3 to 10 years)

 

739

 

719

 

Computer hardware and software (4 to 10 years)

 

1,218

 

1,193

 

Furniture and fixtures (5 to 10 years)

 

114

 

104

 

Leasehold improvements

 

2,179

 

2,152

 

 

 

4,528

 

4,435

 

Less accumulated depreciation and amortization

 

(2,690

)

(2,612

)

 

 

$

1,838

 

$

1,823

 

 

The cost of assets related to projects in progress of $311 million and $300 million as of September 30, 2018 and June 30, 2018, respectively, is included in their respective asset categories above.  Depreciation and amortization of property, plant and equipment was $116 million and $112 million during the three months ended September 30, 2018 and 2017, 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

 

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “TCJA”).  The TCJA includes broad and complex changes to the U.S. tax code that impacted the Company’s accounting and reporting for income taxes.  The impacts under the TCJA in the prior fiscal year primarily consisted of the following:

 

·                  A reduction in the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018, which resulted in a fiscal 2018 U.S. blended statutory income tax rate for the Company of 28.1%.

·                  A one-time mandatory deemed repatriation tax on unremitted foreign earnings (the “Transition Tax”), which the Company elected to pay over an eight-year period.

·                  A remeasurement of U.S. net deferred tax assets.

·                  The recognition of foreign withholding taxes in connection with the reversal of the Company’s indefinite reinvestment assertion related to certain foreign earnings.

 

7


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

For the year ended June 30, 2018, the Company recorded the following provisional charges related to the TCJA:

 

·                  $351 million associated with the Transition Tax.

·                  $53 million in connection with the remeasurement of U.S. net deferred tax assets resulting from the statutory tax rate reduction.

·                  $46 million related to foreign withholding taxes associated with the reversal of its indefinite reinvestment assertion related to certain foreign earnings.

 

During the three months ended September 30, 2018, the Company recorded a provisional credit of $10 million to adjust its fiscal 2018 provisional charge associated with the Transition Tax, reflecting certain technical interpretations related to the Transition Tax computation.  Such charges remain provisional pending the finalization of earnings estimates of the Company’s foreign subsidiaries.  Further, certain technical aspects of the Transition Tax remain subject to varying degrees of uncertainty, and the Company has therefore made interpretations of the enacted legislation in its provisional income tax computations based upon the best available guidance while it awaits expected further technical guidance and clarification from the U.S. government.  As of September 30, 2018, the provisional charges related to the Transition Tax are primarily included in Other noncurrent liabilities in the accompanying consolidated balance sheet.

 

In addition, the Company recorded a charge of $9 million for the three months ended September 30, 2018 related to foreign withholding taxes recorded in fiscal 2018 in connection with the reversal of its indefinite reinvestment assertion related to certain foreign earnings.  This charge reflects the Company’s interpretation of recently issued guidance from the U.S. government, and the accounting for this item is considered complete as of September 30, 2018.  The final charge related to foreign withholding taxes associated with the Company’s reversal of its indefinite reinvestment assertion for certain foreign earnings as a result of the TCJA is $55 million.

 

Provisions under the TCJA that became effective for the Company in the current fiscal year include a further reduction in the U.S. statutory rate to 21%, a new minimum tax on global intangible low-taxed income (“GILTI”), a base erosion anti-abuse tax, a foreign derived intangible income deduction and changes to IRC Section 162(m) related to the deductibility of executive compensation.

 

The Company is continuing to analyze the impact of the TCJA.  Adjustments to remaining provisional charges will be recorded as discrete items in the provision for income taxes in the fiscal 2019 second quarter.  Such adjustments may result from, among other things, future guidance, interpretations and regulatory changes from the Internal Revenue Service, the Securities and Exchange Commission, the Financial Accounting Standards Board (the “FASB”) and/or various state and local tax jurisdictions.

 

For more information about the TCJA and the related impact on the Company, see Note 8 — Income Taxes in the notes to consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.

 

The effective rate for income taxes was 20.7% and 21.7% for the three months ended September 30, 2018 and 2017, respectively.  The decrease in the effective tax rate of 100 basis points was primarily attributable to the impact of the lower U.S. statutory tax rate as a result of the TCJA, as well as a lower effective tax rate on our foreign operations due to a favorable geographic mix of earnings partially offset by the impact of GILTI.  This decrease in the effective tax rate was partially offset by a lower benefit related to share-based compensation awards and the net impact of income tax reserve adjustments.

 

As of September 30, 2018 and June 30, 2018, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $65 million and $60 million, respectively.  The total amount of unrecognized tax benefits at September 30, 2018 that, if recognized, would affect the effective tax rate was $45 million.  The total gross interest and penalties accrued related to unrecognized tax benefits during the three months ended September 30, 2018 in the accompanying consolidated statement of earnings was $2 million.  The total gross accrued interest and penalties in the accompanying consolidated balance sheets at September 30, 2018 and June 30, 2018 was $11 million and $9 million, respectively.  On the basis of the information available as of September 30, 2018, the Company does not expect any significant changes to the total amount of unrecognized tax benefits within the next twelve months.

 

8


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Other Accrued Liabilities

 

Other accrued liabilities consist of the following:

 

 

 

September 30

 

June 30

 

(In millions)

 

2018

 

2018

 

Advertising, merchandising and sampling

 

$

375

 

$

348

 

Employee compensation

 

379

 

579

 

Deferred revenue

 

371

 

33

 

Sales return accrual

 

201

 

 

Payroll and other taxes

 

214

 

190

 

Accrued income taxes

 

195

 

90

 

Other

 

732

 

705

 

 

 

$

2,467

 

$

1,945

 

 

Recently Adopted Accounting Standards

 

Hedge Accounting

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

 

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

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

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

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

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

·                  ease certain documentation and assessment requirements;

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

·                  require 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 guidance must be applied:

 

·                  using the modified retrospective approach for cash flow and net investment hedge relationships that exist on the date of adoption; and

·                  prospectively for the presentation and disclosure requirements.

 

Impact on consolidated financial statements The Company has early adopted this guidance effective as of its fiscal 2019 first quarter and no cumulative adjustment to retained earnings was required.  Upon adoption, all derivative gains and losses will be recognized in the same income statement line as the hedged items which, for all foreign currency cash flow hedges, is in Net Sales.  There is no change to the interest expense classification of gains and losses from interest rate swap fair value hedges.  The amended presentation and disclosure requirements are being applied prospectively.  See Note 5 — Derivative Financial Instruments for further information.

 

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Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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.  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.  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 adopted this guidance when it became effective, and although certain components of pension expense are being reclassified out of operating income, this did not have a material impact on reported operating income.  The Company elected the practical expedient which permits the use of amounts previously disclosed in its pension and post-retirement plan footnote as the basis for estimating the amounts necessary to retrospectively restate the prior-year period consolidated statement of earnings.

 

Revenue from Contracts with Customers

In May 2014, the FASB issued authoritative guidance, Accounting Standards Codification Topic 606 — Revenue from Contracts with Customers (“ASC 606”), 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 prior 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.

 

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 first quarter.  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.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Impact on consolidated financial statements — On July 1, 2018, the Company adopted ASC 606, see Note 7 — Revenue Recognition for further discussion.

 

Recently Issued Accounting Standards

 

Goodwill

In January 2017, the FASB issued authoritative guidance that 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 will continue to assess the impact of adopting this guidance on future interim and annual impairment tests through the effective date.

 

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 guidance changes the recognition method for credit losses on available-for-sale debt securities, which can occur as a result of market and credit risk, and requires additional disclosures.  In general, modified retrospective adoption will be required for all outstanding instruments that fall under this guidance.

 

Effective for the Company — Fiscal 2021 first quarter.

 

Impact on consolidated financial statements — The Company is currently evaluating the impact of applying this guidance on its financial instruments, such as accounts receivable 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 finance leases resulting in a front-loaded expense similar to the current accounting for capital leases.

 

In July 2018, the FASB amended this guidance to clarify certain narrow aspects of the new lease accounting standard that may have been incorrectly or inconsistently applied, and does not add new guidance.  Also in July 2018, the FASB issued authoritative guidance that allows companies to elect to adopt the new standard using a modified retrospective transition approach with a cumulative-effect adjustment to retained earnings in the period of adoption.  Companies that elect the new adoption method will not be required to restate the prior comparative periods in the financial statements.

 

Effective for the Company — Fiscal 2020 first quarter, with early adoption permitted using either of the modified retrospective transition approaches described in the standard, with certain practical expedients.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Impact on consolidated financial statements — The Company currently has an implementation team in place that is performing a comprehensive evaluation of the impact of the adoption of this guidance, which includes assessing the Company’s lease portfolio, potential implementation of new systems to meet reporting requirements, the impact to business processes and internal controls over financial reporting and the related disclosure requirements.  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 14 — 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, 2018, the Company had $3,320 million in future minimum lease commitments as of June 30, 2018.  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.  The Company plans to adopt the new standard when it becomes effective in the fiscal 2020 first quarter using the modified retrospective transition approach for leases that exist in the period of adoption and will not restate the prior comparative periods.

 

Goodwill and Other — Internal-Use Software

In August 2018, the FASB issued authoritative guidance that permits companies to capitalize the costs incurred for setting up business systems that operate on cloud technology.  The new guidance aligns the requirement for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software.  The guidance does not affect the accounting for the service element of a hosting arrangement that is a service contract.  Capitalized costs associated with a hosting arrangement that is a service contract must be amortized over the term of the hosting arrangement to the same line item in the income statement as the expense for fees for the hosting arrangement.

 

Effective for the Company Fiscal 2021 first quarter, with early adoption permitted in any interim period.  This guidance can be adopted either:

 

·                  retrospectively; or

·                  prospectively to all implementation costs incurred after the date of adoption.

 

Impact on consolidated financial statements The Company is currently evaluating the impact of applying this guidance to its business systems that operate on cloud technology.

 

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

 

NOTE 2 — INVESTMENTS

 

Beginning in the first quarter of fiscal 2019, the Company will account for its cost method investments at cost, less impairment, plus/minus subsequent observable price changes, and will be required to perform an assessment each quarter to determine whether or not a triggering event has occurred that results in changes in fair value.  These investments were not material to the Company’s consolidated financial statements as of September 30, 2018.

 

Gains and losses recorded in accumulated OCI (“AOCI”) related to the Company’s available-for-sale investments as of September 30, 2018 were as follows:

 

(In millions) 

 

Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

U.S. government and agency securities

 

$

426

 

$

 

$

(4

)

$

422

 

Foreign government and agency securities

 

101

 

 

(2

)

99

 

Corporate notes and bonds

 

470

 

 

(6

)

464

 

Time deposits

 

50

 

 

 

50

 

Other securities

 

15

 

 

 

15

 

Total

 

$

1,062

 

$

 

$

(12

)

$

1,050

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Gains and losses recorded in AOCI related to the Company’s available-for-sale investments as of June 30, 2018 were as follows:

 

(In millions) 

 

Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

U.S. government and agency securities

 

$

427

 

$

 

$

(5

)

$

422

 

Foreign government and agency securities

 

114

 

 

(2

)

112

 

Corporate notes and bonds

 

479

 

 

(7

)

472

 

Time deposits

 

200

 

 

 

200

 

Other securities

 

16

 

 

 

16

 

Total

 

$

1,236

 

$

 

$

(14

)

$

1,222

 

 

The following table presents the Company’s available-for-sale securities by contractual maturity as of September 30, 2018:

 

(In millions)

 

Cost

 

Fair Value

 

Due within one year

 

$

554

 

$

550

 

Due after one through five years

 

509

 

500

 

 

 

$

1,063

 

$

1,050

 

 

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, 2018:

 

 

 

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

 

$

372

 

$

(5

)

$

599

 

$

(8

)

 

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 $12 million and $130 million for the three months ended September 30, 2018 and 2017, 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, 2018

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

185

 

$

1,186

 

$

256

 

$

391

 

$

2,018

 

Accumulated impairments

 

(36

)

 

(22

)

(34

)

(92

)

 

 

149

 

1,186

 

234

 

357

 

1,926

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill acquired during the period

 

 

3

 

 

 

3

 

Translation adjustments, goodwill

 

 

 

 

1

 

1

 

Translation adjustments, accumulated impairments

 

 

 

 

(1

)

(1

)

 

 

 

3

 

 

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

185

 

1,189

 

256

 

392

 

2,022

 

Accumulated impairments

 

(36

)

 

(22

)

(35

)

(93

)

 

 

$

149

 

$

1,189

 

$

234

 

$

357

 

$

1,929

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Other intangible assets consist of the following:

 

 

 

September 30, 2018

 

June 30, 2018

 

(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

 

$

344

 

$

353

 

$

697

 

$

332

 

$

365

 

License agreements

 

43

 

43

 

 

43

 

43

 

 

 

 

$

740

 

$

387

 

353

 

$

740

 

$

375

 

365

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks and other

 

 

 

 

 

911

 

 

 

 

 

911

 

Total intangible assets

 

 

 

 

 

$

1,264

 

 

 

 

 

$

1,276

 

 

The aggregate amortization expense related to amortizable intangible assets was $13 million for each of the three months ended September 30, 2018 and 2017.  The estimated aggregate amortization expense for the remainder of fiscal 2019 and for each of the next four fiscal years is as follows:

 

 

 

Fiscal

 

(In millions)

 

2019

 

2020

 

2021

 

2022

 

2023

 

Estimated aggregate amortization expense

 

$

38

 

$

44

 

$

43

 

$

42

 

$

42

 

 

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 approvals from inception through September 30, 2018, the Company estimates that LBF may result in related restructuring and other charges totaling between $900 million and $950 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 1,800 to 2,000 positions globally.  This reduction takes into account the elimination of certain positions, inclusive of positions that are unfilled, as well as retraining and redeployment of certain employees and investment in new positions in key areas.

 

Program-to-Date Approvals

Of the $900 million to $950 million restructuring and other charges expected to be incurred, total cumulative charges approved by the Company through September 30, 2018, some of which were recorded from Program inception through September 30, 2018, 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

 

$

87

 

$

71

 

$

190

 

Fiscal 2017

 

11

 

10

 

132

 

118

 

271

 

Fiscal 2018

 

 

24

 

166

 

68

 

258

 

Three months ended September 30, 2018

 

 

9

 

15

 

22

 

46

 

Adjustments through September 30, 2018

 

(1

)

(1

)

(43

)

(1

)

(46

)

Cumulative through September 30, 2018

 

$

14

 

$

70

 

$

357

 

$

278

 

$

719

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Included in the above table, cumulative restructuring initiatives approved by the Company through September 30, 2018 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

 

Fiscal 2018

 

161

 

 

1

 

4

 

166

 

Three months ended September 30, 2018

 

15

 

 

 

 

15

 

Adjustments through September 30, 2018

 

(42

)

 

(1

)

 

(43

)

Cumulative through September 30, 2018

 

$

335

 

$

4

 

$

5

 

$

13

 

$

357

 

 

During the three months ended September 30, 2018, 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, temporary labor backfill and recruitment related to the new capabilities.  The Company also continued to approve implementation costs, temporary labor backfill and consulting fees for an initiative related to supply chain planning activities.  In addition, the Company approved other charges to support the LBF Project Management Office, consisting of internal and external resources, which are intended to further drive project integration, organizational design capabilities and change management throughout the organization.

 

As initiatives under LBF progress through implementation, the Company has identified certain costs that were approved but will not be incurred.  These costs, reflected as adjustments to the cumulative approved restructuring and other charges presented above, were primarily related to estimated employee-related costs for certain employees who either resigned or transferred to other existing positions within the Company.

 

Program-to-Date Restructuring and Other Charges

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

 

 

 

Sales
Returns

 

 

 

Operating Expenses

 

 

 

(In millions)

 

(included in
Net Sales)

 

Cost of Sales

 

Restructuring
Charges

 

Other
Charges

 

Total

 

Fiscal 2016

 

$

1

 

$

 

$

75

 

$

5

 

$

81

 

Fiscal 2017

 

2

 

15

 

122

 

73

 

212

 

Fiscal 2018

 

8

 

18

 

127

 

104

 

257

 

Three months ended September 30, 2018

 

 

6

 

15

 

26

 

47

 

Cumulative through September 30, 2018

 

$

11

 

$

39

 

$

339

 

$

208

 

$

597

 

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

Fiscal 2018

 

124

 

1

 

1

 

1

 

127

 

Three months ended September 30, 2018

 

14

 

 

 

1

 

15

 

Cumulative through September 30, 2018

 

$

328

 

$

4

 

$

3

 

$

4

 

$

339

 

 

Accrued restructuring charges from Program inception through September 30, 2018 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

 

124

 

1

 

1

 

1

 

127

 

Cash payments

 

(92

)

 

 

(1

)

(93

)

Noncash asset write-offs

 

 

(1

)

 

 

(1

)

Translation adjustments

 

(2

)

 

 

 

(2

)

Balance at June 30, 2018

 

180

 

 

1

 

 

181

 

 

 

 

 

 

 

 

 

 

 

 

 

Charges

 

14

 

 

 

1

 

15

 

Cash payments

 

(33

)

 

(1

)

(1

)

(35

)

Noncash asset write-offs

 

 

 

 

 

 

Balance at September 30, 2018

 

$

161

 

$

 

$

 

$

 

$

161

 

 

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, 2018 are expected to result in cash expenditures funded from cash provided by operations of approximately $111 million, $40 million, $9 million and $1 million for the remainder of fiscal 2019 and for fiscal 2020, 2021 and 2022, respectively.

 

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.

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

For each derivative contract entered into, where the Company looks to obtain hedge accounting treatment, the Company formally and contemporaneously documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking the hedge transaction, the nature of the risk being hedged, and how the hedging instruments’ effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively.  This process includes linking all derivatives to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions.  At inception, the Company evaluates the effectiveness of hedge relationships quantitatively, and has elected to perform, after initial evaluation, qualitative effectiveness assessments of certain hedge relationships to support an ongoing expectation of high effectiveness, if effectiveness testing is required.  If, based on the qualitative assessment, it is determined that a derivative has ceased to be a highly effective hedge, the Company will perform a quantitative assessment to determine whether or not to discontinue hedge accounting with respect to that derivative prospectively.

 

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

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

 

 

Fair Value (1)

 

 

 

Fair Value (1)

 

(In millions)

 

Balance Sheet
Location

 

September 30
2018

 

June 30
2018

 

Balance Sheet
Location

 

September 30
2018

 

June 30
2018

 

Derivatives Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

$

28

 

$

30

 

Other accrued liabilities

 

$

5

 

$

5

 

Interest rate swap contracts

 

Prepaid expenses and other current assets

 

 

 

Other accrued liabilities

 

28

 

26

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives Designated as Hedging Instruments

 

 

 

28

 

30

 

 

 

33

 

31

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Prepaid expenses and other current assets

 

3

 

3

 

Other accrued liabilities

 

13

 

8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives

 

 

 

$

31

 

$

33

 

 

 

$

46

 

$

39

 

 


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

 

17


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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 that are included in the assessment of effectiveness are presented as follows:

 

 

 

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

 

Location of Gain or

 

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

 

 

 

Three Months Ended
September 30

 

(Loss) Reclassified
from AOCI into

 

Three Months Ended
September 30

 

(In millions)

 

2018

 

2017

 

Earnings

 

2018

 

2017(2)

 

Derivatives in Cash Flow Hedging Relationships:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

3

 

$

(18

)

Net Sales

 

$

3

 

$

 

 

 

 

 

 

 

Cost of Sales

 

 

(5

)

 

 

 

 

 

 

Selling, general and administrative

 

 

(4

)

Interest rate-related derivatives

 

 

 

Interest expense

 

 

 

Total derivatives

 

$

3

 

$

(18

)

 

 

$

3

 

$

(9

)

 


(1) The amount reclassified into earnings as a result of the discontinuance of cash flow hedges because probable forecasted transactions will no longer occur by the end of the original time period was not material.

(2) The gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was not material.

 

 

 

 

 

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

 

2018

 

2017

 

Derivatives in Fair Value Hedging Relationships:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts

 

Interest expense

 

$

(2

)

$

(2

)

 


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

 

Additional information regarding the cumulative amount of fair value hedging adjustments for items designated and qualifying as hedged items in fair value hedges is as follows:

 

 

 

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

 

 

 

 

 

Cumulative Amount of Fair

 

 

 

 

 

Value Hedging Adjustments

 

(In millions)

 

Carrying Amount of the

 

Included in the Carrying Amount

 

Line Item in the Consolidated Balance Sheets in

 

Hedged Assets (Liabilities)

 

of the Hedged Asset (Liability)

 

Which the Hedged Item is Included

 

September 30, 2018

 

September 30, 2018

 

Long-term debt

 

$

(921

)

$

(28

)

 

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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Additional information regarding the effects of fair value and cash flow hedging relationships for derivatives designated and qualifying as hedging instruments is as follows:

 

 

 

September 30, 2018

 

(In millions)

 

Net Sales

 

Interest expense

 

Total amounts of income and expense line items presented in the consolidated statement of earnings in which the effects of fair value and cash flow hedges are recorded

 

$

3,524

 

$

34

 

 

 

 

 

 

 

The effects of fair value and cash flow hedging relationships:

 

 

 

 

 

Gain (loss) on fair value hedge relationships — interest rate contracts:

 

 

 

 

 

Hedged item

 

Not applicable

 

(2

)

Derivatives designated as hedging instruments

 

Not applicable

 

2

 

 

 

 

 

 

 

Gain (loss) on cash flow hedge relationships — foreign currency forward contracts:

 

 

 

 

 

Amount of gain reclassified from AOCI into earnings

 

3

 

Not applicable

 

 

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

 

 

 

 

 

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

 

 

 

Location of Gain or (Loss)

 

Three Months Ended

 

 

 

Recognized in Earnings on

 

September 30

 

(In millions)

 

Derivatives

 

2018

 

2017

 

Derivatives Not Designated as Hedging Instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Selling, general and administrative

 

$

22

 

$

(4

)

 

Cash Flow Hedges

 

The Company enters into foreign currency forward contracts, and may enter into foreign currency option 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 the cash flows that the Company receives from foreign subsidiaries.  The foreign currency forward contracts entered into to hedge anticipated transactions have been designated as cash flow hedges and have varying maturities through the end of June 2020.  Hedge effectiveness of the foreign currency forward contracts is based on the forward method, which includes time value in the effectiveness assessment.  At September 30, 2018, the Company had foreign currency forward contracts with a notional amount totaling $3,000 million.

 

The Company may enter into interest rate forward contracts to hedge anticipated issuance of debt for periods consistent with the Company’s identified exposures.  The purpose of the hedging activities is to minimize the effect of interest rate movements on the cost of debt issuance.

 

For hedge contracts that are no longer deemed highly effective, hedge accounting is discontinued and gains and losses in AOCI are reclassified to net sales when the underlying forecasted transaction occurs.  If it is probable that the forecasted transaction will no longer occur, then any gains or losses in AOCI are reclassified to current-period net sales.  As of September 30, 2018, the Company’s foreign currency cash flow hedges were highly effective.

 

19


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THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The estimated net gain on the Company’s derivative instruments designated as cash flow hedges as of September 30, 2018 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $15 million.  The accumulated net gain on derivative instruments in AOCI was $53 million as of September 30, 2018 and June 30, 2018.

 

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 $31 million at September 30, 2018.  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 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.

 

20


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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 September 30, 2018:

 

(In millions) 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

31

 

$

 

$

31

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

422

 

 

422

 

Foreign government and agency securities

 

 

99

 

 

99

 

Corporate notes and bonds

 

 

464

 

 

464

 

Time deposits

 

 

50

 

 

50

 

Other securities

 

 

15

 

 

15

 

Total

 

$

 

$

1,081

 

$

 

$

1,081

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

18

 

$

 

$

18

 

Interest rate swap contracts

 

 

28

 

 

28

 

Contingent consideration

 

 

 

85

 

85

 

Total

 

$

 

$

46

 

$

85

 

$

131

 

 

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, 2018:

 

(In millions) 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

33

 

$

 

$

33

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

422

 

 

422

 

Foreign government and agency securities

 

 

112

 

 

112

 

Corporate notes and bonds

 

 

472

 

 

472

 

Time deposits

 

 

200

 

 

200

 

Other securities

 

 

16

 

 

16

 

Total

 

$

 

$

1,255

 

$

 

$

1,255

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

13

 

$

 

$

13

 

Interest rate swap contracts

 

 

26

 

 

26

 

Contingent consideration

 

 

 

96

 

96

 

Total

 

$

 

$

39

 

$

96

 

$

135

 

 

21


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:

 

 

 

September 30

 

June 30

 

 

 

2018

 

2018

 

(In millions)

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Nonderivatives

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,443

 

$

1,443

 

$

2,181

 

$

2,181

 

Available-for-sale securities

 

1,050

 

1,050

 

1,222

 

1,222

 

Current and long-term debt

 

3,544

 

3,637

 

3,544

 

3,667

 

Additional purchase price payable

 

3

 

3

 

3

 

3

 

Contingent consideration

 

85

 

85

 

96

 

96

 

 

 

 

 

 

 

 

 

 

 

Derivatives

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts — asset (liability), net

 

13

 

13

 

20

 

20

 

Interest rate swap contracts — asset (liability), net

 

(28

)

(28

)

(26

)

(26

)

 

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.

 

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”).

 

22


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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, 2018:

 

Risk-adjusted discount rate

 

2.7% to 3.3

%

Revenue volatility

 

4.9% to 5.0

%

Asset volatility

 

21.9

%

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

 

75.0

%

Revenue discount rates

 

4.8% to 5.2

%

Earnings before income tax, depreciation and amortization discount rate

 

13.1

%

 

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, 2018 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, 2018

 

$

96

 

Changes in fair value

 

(11

)

Contingent consideration at September 30, 2018

 

$

85

 

 

NOTE 7 — REVENUE RECOGNITION

 

During the first quarter of fiscal 2019, the Company adopted the new revenue accounting standard, ASC 606, under the modified retrospective method to all contracts as of the date of adoption.  Under this method, the consolidated financial statements for the period beginning July 1, 2018 are presented under the new revenue accounting standard, while the prior-year period reflects the revenue accounting standards in effect during that period.  The following discussion is based on the Company’s accounting policies under the new standard; for a discussion of the Company’s prior accounting for revenue and a reconciliation of the impact of the change in accounting standard on the Company’s consolidated financial statements, see below Changes in Accounting Policy.  The Company also adopted the policy election to exclude from the transaction price all amounts collected from customers for sales and other taxes.  For revenue disaggregated by product category and geographic region, see Note 14 — Segment Data and Related Information.

 

Performance Obligations

The Company recognizes revenue at a point in time when it satisfies a performance obligation by transferring control over a product and other promised goods and services to a customer.

 

The Company sells wholesale to customers in distribution channels that include department stores, travel retail, specialty multi-brand retailers, perfumeries and salons/spas.  The primary performance obligation related to these channels of distribution is product sales where revenue is recognized as control of the product transfers to the customer.  In the Americas region, revenue is generally recognized at the time the product is made available and provided to the customer’s carrier at the Company’s location and in the Europe, the Middle East & Africa and Asia/Pacific regions, revenue is generally recognized based upon the customer’s receipt.

 

23


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company also sells direct to consumers at Company-operated freestanding stores and online through Company-owned and operated e-commerce and m-commerce sites, through various sites operated by authorized retailers and through third-party online platforms.  At Company-operated freestanding stores, revenue is recognized when control of the product is transferred at the point of sale.  Revenue from online sales is recognized when control of the product is transferred, generally based upon the consumer’s receipt.

 

In connection with the sale of product, the Company may provide other promised goods and services that are deemed to be performance obligations.  These are comprised of customer loyalty program obligations, gift with purchase and purchase with purchase promotions, gift cards and other promotional goods including samples and testers.

 

The Company offers a number of different loyalty programs to its customers across regions, brands and distribution channels including points-based programs, tier-based programs and recycling programs.  Revenue is allocated between the saleable product revenue and the material right loyalty obligations based on relative standalone selling prices when the consumer purchases the products that are earning them the right to the future benefits.  Deferred revenue related to the Company’s loyalty programs is estimated based on the standalone selling price and is adjusted for an estimated breakage factor.  Standalone selling price is determined primarily using the observable market price of the good or service benefit if it is sold by the Company or a cost plus margin approach for goods/services not directly sold by the Company.  Breakage rates consider historical patterns of redemption and/or expiration.  Revenue is recognized when the benefits are redeemed or expire.

 

The Company provides gift with purchase promotional products to certain customers generally without additional charge and also provides purchase with purchase promotional products to certain customers at a discount in relation to prices charged for saleable product.  Revenue is allocated between saleable product, gift with purchase product and purchase with purchase product based on the estimated relative standalone selling prices.  Revenue is deferred and ultimately recognized based on the timing differences, if any, between when control of promotional goods and control of the related saleable products transfer to the Company’s customer (e.g. a third-party retailer), which is calculated based on the weighted-average number of days between promotional periods.  The estimated standalone selling price allocated to promotional goods is based on a cost plus margin approach.

 

In situations where promotional products are provided by the Company to its customers at the same time as the related saleable product, such as shipments of samples and testers, the cost of these promotional products are recognized as a cost of sales at the same time as the related revenue is recognized and no deferral of revenue is required.

 

The Company also offers gift cards through Company-operated freestanding stores and Company-owned websites.  The related deferred revenue is estimated based on expected breakage that considers historical patterns of redemption taking into consideration escheatment laws as applicable.

 

Product Returns, Sales Incentives and Other Forms of Variable Consideration

In measuring revenue and determining the consideration the Company is entitled to as part of a contract with a customer, the Company takes into account the related elements of variable consideration.  Such elements of variable consideration include, but are not limited to, product returns and sales incentives, such as volume rebates and discounts, markdowns, margin adjustments and early-payment discounts.  We also enter into arrangements containing other forms of variable consideration, including certain demonstration arrangements, for which the Company does not receive a distinct good or service or for which the Company cannot reasonably estimate the fair value of the good or service.  For these types of arrangements, the adjustments to revenue are recorded at the later of when (i) the Company recognizes revenue for the transfer of the related goods or services to the customer, or (ii) the Company pays, or promises to pay, the consideration.

 

For the sale of goods with a right of return, the Company only recognizes revenue for the consideration it expects to be entitled to (considering the products to be returned) and records a sales return accrual within Other accrued liabilities for the amount it expects to credit back its customers.  In addition, the Company recognizes an asset included in Inventory and promotional merchandise, net and a corresponding adjustment to Cost of Sales for the right to recover goods from customers associated with the estimated returns.

 

24


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The sales return accrual and corresponding asset include estimates that directly impact reported net sales.  These estimates are calculated based on a history of actual returns, estimated future returns and information provided by retailers regarding their inventory levels.  Consideration of these factors results in an estimate for anticipated sales returns that reflects increases or decreases related to seasonal fluctuations.  In addition, as necessary, sales return accruals and the related assets may be established for significant future known or anticipated events.  The types of known or anticipated events that are considered, and will continue to be considered, include, but are not limited to, the financial condition of the Company’s customers, store closings by retailers, changes in the retail environment and the Company’s decision to continue to support new and existing products.

 

The Company estimates sales incentives and other variable consideration using the most likely amount method and records reserves within Other accrued liabilities when control of the related product is transferred to the customer.  Under this method, certain forms of variable consideration are based on expected sell-through results, which requires subjective estimates.  These estimates are supported by historical results as well as specific facts and circumstances related to the current period.

 

The Company also enters into transactions and makes payments to certain of its customers related to demonstration, advertising and counter construction, some of which involve cooperative relationships with customers.  These activities may be arranged either with unrelated third parties or in conjunction with the customer.  To the extent the Company receives a distinct good or service in exchange for consideration and the fair value of the benefit can be reasonably estimated, the Company’s share of the counter depreciation and the other costs of these transactions (regardless of to whom they were paid) are reflected in Selling, general and administrative expenses in the accompanying consolidated statements of earnings.

 

Accounts Receivable

Accounts receivable, net is stated net of the allowance for doubtful accounts and customer deductions totaling $36 million and $29 million as of September 30, 2018 and June 30, 2018, respectively.  The allowance for doubtful accounts is based upon the evaluation of accounts receivable aging, specific exposures and historical trends.  Payment terms are short-term in nature and are generally less than one year.  As a result of the adoption of ASC 606, amounts relating to the Company’s sales return accrual are recorded within Other accrued liabilities and the corresponding return asset is recorded in Inventory and promotional merchandise, net, and are no longer included as a reduction to Accounts receivable, net.  The Company applied the practical expedient available under ASC 606 to disregard determining significant financing components if the good/service is transferred and payment is received within one year.

 

Deferred Revenue

Significant changes in deferred revenue during the period are as follows:

 

(In millions)

 

September 30, 2018

 

Balance at July 1, 2018

 

$

380

 

Revenue recognized that was included in the deferred revenue balance at the beginning of the period

 

(184

)

Revenue deferred during the period

 

225

 

Balance at September 30, 2018

 

$

421

 

 

Transaction Price Allocated to the Remaining Performance Obligations

 

At September 30, 2018, the combined estimated revenue expected to be recognized in the next twelve months related to performance obligations for customer loyalty programs, gift with purchase promotions, purchase with purchase promotions and gift card liabilities that are unsatisfied (or partially unsatisfied) is $371 million.

 

25


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Changes in Accounting Policies

As a result of the adoption of ASC 606, the Company has changed its accounting policy for revenue recognition as follows:

 

·                  For products sold that qualify for customer loyalty program awards, the Company defers a portion of revenue related to the product sales.  Previously, the Company recognized revenue in full for product sales and accrued for the expected amounts of loyalty awards to be provided under the incremental cost approach.

·                  A portion of revenue is deferred for shipments of saleable products with separate performance obligations to provide gift with purchase and purchase with purchase promotional products, and is recognized as control is transferred to a customer.  Previously, the Company recognized revenue for saleable products and purchase with purchase products based upon invoice prices charged to customers and included the cost of gift with purchase products and/or purchase with purchase products in Cost of Sales when risks and rewards of ownership transferred to the Company’s customer (i.e. a third-party retailer).

·                  The cost of certain promotional products, including samples and testers, are classified within Cost of Sales.  Such costs were previously accounted for as a component of Selling, general and administrative expenses.

·                  In conjunction with the adoption of ASC 606, the Company reassessed its contracts under the variable consideration guidance, including the payments to customer guidance, and as a result certain reclassifications were made related to timing and classification of certain net demonstration payments to and from customers.

·                  For product returns, the Company established a sales return accrual and a corresponding asset for the right to recover goods in Other accrued liabilities and Inventory and promotional merchandise, net, respectively, while previously the net liability for product returns was recorded as a reduction of Accounts receivable, net.

 

As a result of the accounting policy changes noted above, the Company recorded a cumulative adjustment of $229 million, net of tax, as a reduction to its fiscal 2019 opening balance of retained earnings.

 

26


Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables summarize the impacts of the adoption of ASC 606 on the Company’s consolidated financial statements as of and for the three months ended September 30, 2018:

 

Consolidated statement of earnings

 

 

 

Three Months Ended September 30, 2018

 

 

 

 

 

 

 

Prior to the

 

 

 

 

 

 

 

adoption of

 

(In millions, except per share data)

 

As Reported

 

Adjustments

 

ASC 606

 

Net Sales

 

$

3,524

 

$

67

 

$

3,591

 

Cost of Sales

 

823

 

(66

)

757

 

Gross Profit

 

2,701

 

133

 

2,834

 

Selling, general and administrative

 

2,008

 

102

 

2,110