Estee Lauder Is Revising Claims, Retesting Products After Internal Breakdown
This article was originally published in The Rose Sheet
Executive Summary
Lauder says “a small group of employees” is responsible for intentionally altering testing behind product claims, misconduct alerted to management through the firm’s internal escalation process. Currently, the scope of the issue – and the potential impact on Lauder’s business – is unclear, but claims revisions of varying magnitude are expected as the company’s review progresses.
Estee Lauder Companies, Inc.’s impressive third-quarter results were overshadowed May 2 by its disclosure that a number of advertising claims may be unsupported and in need of changes – potentially “significant” revisions in some cases.
While the situation was brought to the firm’s attention by internal mechanisms rather than regulatory or legal devices, Lauder is being “prudent” about its fiscal 2018 full-year outlook as it conducts its review and implements fixes.
The company’s stock tumbled immediately following the announcement, but has recovered to large extent since, with some analysts seeing the scare-off as an overreaction and a prime buying opportunity for savvy investors.
Lauder first raised the claims issue in its third-quarter earnings release, casting it as a matter of testing that did not meet the firm’s standards and would require “further validation.” Associated advertising claims would be modified, it said.
“At this time, the Company does not know whether the results of this ongoing review will be material to the Company,” Lauder added.
CEO Fabrizio Freda provided additional detail during the firm’s same-day briefing with analysts.
“We recently learned that some testing related to certain products’ advertising claims had been intentionally altered for some time by a small group of employees,” he said.
The issue was alerted to management through Lauder’s internal escalation process, immediately triggering a comprehensive, ongoing review of the company’s product claims support, according to the exec.
“We expect that many of our claims will not change, but others will. Some changes may be minor, and others could be more significant,” Freda said.
Lauder has incorporated the costs of its corrective testing/claims work into its full-year forecast. “In terms of the impact on our business in a broader sense, we don’t know yet, but we will know soon,” Freda said.
The firm is racing to retest where appropriate to ensure that claims are properly substantiated. According to Executive VP and CFO Tracey Thomas Travis, the scope of the problem is not entirely clear at present.
“We don’t think that there are that many [unfounded claims], but we don’t know,” she said. At the same time, Lauder does expect that adjustments will be needed to some websites, among other materials, "to the extent that we can’t prove a claim.”
Analysts on the call seemed relatively unfazed by the news overall. Citigroup’s Wendy Nicholson was an exception.
“It surprises me,” she said, “it just seems so un-Estee Lauder-like.”
Nicholson questioned whether Lauder’s robust growth has affected its corporate culture and the level of control the firm has over its ranks. Finally, she asked about the prospect of litigation.
Freda agreed that the imbroglio is not typical of Lauder. “And that’s why, as soon as we learned that, we decided to act on it with, first of all, maximum transparency and maximum speed. … In the cases where there will be a minor change to do or a more serious change to do, we will do it immediately and transparently, communicating with our retailers, consumers and everyone,” he said.
To the litigation piece, Travis owned, “We certainly do not have any costs in the estimate related to any legal activity from this.”
Freda added, “In terms of the impact on our business in a broader sense, we don’t know yet, but we will know soon.”
A Lauder spokesperson told Rose Sheet May 16 that the firm’s review and claims modifications likely will take months to complete.
The firm is stressing in its communications that the testing/claims failure has no bearing on product safety or quality and that its internal processes for testing and claims validation have been reformed to prevent the issue’s recurrence.
“This matter does not reflect our strong commitment to our consumers or the integrity that is at the heart of our company. We are sorry this occurred, and we take full responsibility for this matter,” Freda said.
Despite the mess, Lauder raised its FY 2018 full-year sales and earnings projections after booking $3.37bn in third-quarter sales, an increase of 18% reported, or 13% in constant currency. (Also see "Lauder Rides Asia, Skin-Care Momentum In Q3; Sales Up 18%" - HBW Insight, 16 May, 2018.)
In his May 3 note to investors, Deusche Bank analyst Steve Powers attributed the initial market reaction to Lauder’s Q3 report to decelerating makeup growth, increasingly difficult comparisons going forward, and uncertainty around the testing/claims validation issue.
“We can see why the market may be jittery with respect to these issues, but in our opinion the market overreacted – creating the entry point we have been waiting for,” he says, adding, “Overall, EL is relatively well-protected from the structural issues facing the broader CPG industry.”