| SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | 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. See Income Taxes for additional discussion regarding tax legislation enacted by the U.S. government in December 2017, the impact of which may affect the estimates and assumptions used to determine the expected future tax consequences of events recognized in the Company’s consolidated financial statements. 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 $65 million and $67 million, net of tax, during the three months ended March 31, 2018 and 2017, respectively, and $149 million and $(53) million, net of tax, during the nine months ended March 31, 2018 and 2017, respectively.
The Company enters into foreign currency forward contracts and may enter into option contracts to hedge foreign currency transactions for periods consistent with its identified exposures. Accordingly, the Company categorizes these instruments as entered into for purposes other than trading.
The accompanying consolidated statements of earnings include net exchange gains (losses) on foreign currency transactions of $(26) million and $8 million during the three months ended March 31, 2018 and 2017, respectively, and $(61) million and $14 million during the nine months ended March 31, 2018 and 2017, respectively.
Accounts Receivable
Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions totaling $38 million and $30 million as of March 31, 2018 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 qualified customers and does not believe it is exposed significantly to any undue concentration of credit risk. The Company does not have any customers that represent 10% or greater of its consolidated net sales in each period presented. The Company’s largest customer sells products primarily in the United States and accounted for $188 million, or 11%, of the Company’s accounts receivable at March 31, 2018. This customer represented less than 10% of the Company’s accounts receivable at June 30, 2017.
Inventory and Promotional Merchandise
Inventory and promotional merchandise, net consists of:
March 31
June 30
(In millions)
2018
2017
Raw materials
$
$
Work in process
Finished goods
Promotional merchandise
$
$
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
March 31
June 30
(In millions)
2018
2017
Assets (Useful Life)
Land
$
$
Buildings and improvements (10 to 40 years)
Machinery and equipment (3 to 10 years)
Computer hardware and software (4 to 15 years)
Furniture and fixtures (5 to 10 years)
Leasehold improvements
Less accumulated depreciation and amortization
)
)
$
$
The cost of assets related to projects in progress of $206 million and $183 million as of March 31, 2018 and June 30, 2017, respectively, is included in their respective asset categories above. Depreciation and amortization of property, plant and equipment was $116 million and $106 million during the three months ended March 31, 2018 and 2017, respectively, and $342 million and $316 million during the nine months ended March 31, 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 in the current-year period. These impacts primarily consist of the following:
·
A reduction in the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018, which will result in a fiscal 2018 U.S. blended statutory income tax rate for the Company of 28%.
·
A one-time transitional repatriation tax on unremitted foreign earnings (“Transition Tax”), which may be paid over an eight-year period.
·
The remeasurement of U.S. net deferred tax assets as of the enactment date.
On December 22, 2017, the Securities and Exchange Commission (the “SEC”) staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to provide guidance that companies should apply each reporting period related to the income tax effects of the TCJA. SAB 118 provides that companies (i) should record the effects of the changes from the TCJA for which the accounting is complete (not provisional), (ii) should record provisional amounts for the effects of the changes from the TCJA for which the accounting is not complete, and for which reasonable estimates can be determined, in the period they are identified, and (iii) should not record provisional amounts if reasonable estimates cannot be made for the effects of the changes from the TCJA, and should continue to apply guidance based on the tax law in effect prior to the enactment on December 22, 2017. In addition, SAB 118 establishes a one-year measurement period (through December 22, 2018) where a provisional amount could be subject to adjustment, and requires certain qualitative and quantitative disclosures related to provisional amounts and accounting during the measurement period.
During the three months ended March 31, 2018, the Company changed its indefinite reinvestment assertion with respect to certain of its foreign earnings resulting in an adjustment to the provisional Transition Tax charge recorded in the fiscal 2018 second quarter. Accordingly, the Company recorded a provisional charge of $7 million and $332 million in the provision for income taxes for the three and nine months ended March 31, 2018, respectively. As of March 31, 2018, $30 million and $302 million of the provisional charges are included in Other accrued liabilities and Other noncurrent liabilities, respectively, in the accompanying consolidated balance sheet. Such charges remain provisional pending the finalization of earnings estimates of the Company’s foreign subsidiaries and any further changes to the Company’s indefinite reinvestment assertion on its applicable remaining foreign earnings.
During the three months ended March 31, 2018, the Company recorded an adjustment to its provisional charge recorded in the fiscal 2018 second quarter associated with the remeasurement of its net deferred tax assets resulting from the reduction in the U.S. corporate income tax rate. This adjustment was due to the revision of certain temporary differences. Accordingly, the Company recorded a provisional credit of $9 million for the three months ended March 31, 2018 and a provisional charge of $42 million for the nine months ended March 31, 2018 which adjusted net deferred taxes. Our net deferred tax assets are included in Other assets in the accompanying consolidated balance sheet as of March 31, 2018. The remeasurement of U.S. net deferred tax assets is provisional as the final remeasurement cannot be determined until the underlying temporary differences are known, rather than estimated.
In addition, as a result of the Transition Tax, the Company recorded a provisional charge of $18 million in the fiscal 2018 second quarter related to foreign withholding taxes for planned repatriation of certain foreign earnings. This net deferred tax liability is recorded as a reduction in net deferred tax assets which is included in Other assets in the accompanying consolidated balance sheet as of March 31, 2018. This charge remains provisional due to uncertainty at this time related to the U.S. tax treatment of such foreign withholding taxes.
The Company is continuing to analyze the impact of the TCJA. Adjustments to the provisional charges will be recorded as discrete items in the provision for income taxes in the period in which those adjustments become reasonably estimable and/or the accounting is complete. Such adjustments may result from, among other things, future guidance, interpretations and regulatory changes from the Internal Revenue Service, the SEC, the FASB and/or various tax jurisdictions. The Company will complete its analysis no later than December 22, 2018.
There are other potential impacts under the TCJA that are not effective for the Company until fiscal 2019. These primarily include a new minimum tax on global intangible low-taxed income (“GILTI”), the base erosion anti-abuse tax (“BEAT”) and the foreign derived intangibles income (“FDII”) provisions. The Company has not recorded any impact associated with these provisions at this time.
The effective rate for income taxes was 22.1% and 26.3% for the three months ended March 31, 2018 and 2017, respectively. This decrease reflected a favorable impact of excess tax benefits related to share-based compensation awards of approximately 400 basis points, and an adjustment to the remeasurement of U.S. net deferred tax assets resulting from the TCJA of approximately 190 basis points. Partially offsetting these decreases were an adjustment to the Transition Tax resulting from the TCJA of approximately 150 basis points and tax reserve adjustments of approximately 20 basis points.
The effective rate for income taxes was 46.0% and 27.2% for the nine months ended March 31, 2018 and 2017, respectively. This increase was primarily attributable to the Transition Tax of approximately 1,930 basis points, the remeasurement of U.S. net deferred tax assets of approximately 240 basis points, and the establishment of a net deferred tax liability related to certain foreign withholding taxes on planned repatriation of approximately 100 basis points, with each resulting from the enactment of the TCJA. Partially offsetting this increase was approximately 250 basis points due to a favorable impact of excess tax benefits related to share-based compensation awards, and approximately 140 basis points primarily reflecting a favorable geographic mix of earnings and a favorable impact of the reduced U.S. statutory tax rate.
As of March 31, 2018 and June 30, 2017, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $68 million at the end of each period. The total amount of unrecognized tax benefits at March 31, 2018 that, if recognized, would affect the effective tax rate was $48 million. The total gross accrued interest and penalty expense related to unrecognized tax benefits during the three months ended March 31, 2018 in the accompanying consolidated statement of earnings was $1 million. During the nine months ended March 31, 2018, the Company recognized a gross interest and penalty benefit of $1 million in the accompanying consolidated statement of earnings. The total gross accrued interest and penalties in the accompanying consolidated balance sheets at March 31, 2018 and June 30, 2017 was $11 million and $13 million, respectively. On the basis of the information available as of March 31, 2018, 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:
March 31
June 30
(In millions)
2018
2017
Advertising, merchandising and sampling
$
$
Employee compensation
Payroll and other taxes
Accrued income taxes
Other
$
$
Recently Adopted Accounting Standards
Accumulated Other Comprehensive Income
In February 2018, the FASB issued authoritative guidance that permits a reclassification of the stranded tax effects due to a change in the U.S. federal corporate income tax rate as a result of the TCJA from accumulated OCI (“AOCI”) to retained earnings. This guidance cannot be applied to stranded tax effects from changes previously recognized in AOCI unrelated to the TCJA. Furthermore, this accommodation to reclassify the stranded tax effects resulting from the TCJA does not change the underlying guidance requiring that the effect of a change in tax laws or rates be included in income from continuing operations for future tax rate changes.
Effective for the Company — Fiscal 2020 first quarter, with early adoption permitted. The guidance may be applied:
·
retrospectively for periods in which the income tax effects of the TCJA related to items remaining in AOCI are recognized; or
·
at the beginning of the period of adoption.
Impact on consolidated financial statements — The Company has elected to early adopt this guidance at the beginning of its fiscal 2018 third quarter. As a result, the Company reclassified $32 million in tax effects from AOCI to retained earnings as of January 1, 2018. It is the Company’s policy to use the portfolio approach to release income tax effects from AOCI. The Company may make further adjustments in subsequent periods if changes to the provisional amounts established as a result of the TCJA are recorded.
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 and nine months ended March 31, 2018, the Company recognized $19 million and $43 million, respectively, of excess tax benefits as a reduction to the provision for income taxes in its consolidated statements 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.
Recently Issued Accounting Standards
Hedge Accounting
In August 2017, the FASB issued authoritative guidance to simplify hedge accounting. The guidance includes the 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 expects to early adopt this guidance in the beginning of its fiscal 2019 first quarter and does not believe the adoption of this guidance will have a material impact on its 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 (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 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 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.
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, 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 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 SEC 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, and 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 using the modified retrospective adoption 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. The Company has assessed its third-party retailer arrangements and noted that upon adoption of the new revenue recognition standard, the Company will have a change in the classification of certain payments to customers as well as a change in the timing of certain accruals for variable consideration. 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 continuing to assess the impact that its 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. |
