Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-1004

 


 

FORM 10-Q

 

(Mark One)

x

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

 

 

 

 

 

For the quarterly period ended December 31, 2008

 

 

 

 

 

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)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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

 

Large accelerated filer x

Accelerated filero

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

Smaller reporting companyo

 

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

 

At January 29, 2009, 118,623,473 shares of the registrant’s Class A Common Stock, $.01 par value, and 78,067,261 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

 

 

 

 

 

Consolidated Statements of Earnings —
Three and Six Months Ended December 31, 2008 and 2007

2

 

 

 

 

Consolidated Balance Sheets —
December 31, 2008 and June 30, 2008

3

 

 

 

 

Consolidated Statements of Cash Flows —
Six Months Ended December 31, 2008 and 2007

4

 

 

 

 

Notes to Consolidated Financial Statements

5

 

 

 

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

19

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

35

 

 

 

Item 4. Controls and Procedures

35

 

 

 

Part II. Other Information

 

 

 

 

Item 1. Legal Proceedings

35

 

 

 

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

36

 

 

 

Item 4. Submission of Matters to a Vote of Security Holders

37

 

 

 

Item 6. Exhibits

37

 

 

 

Signatures

38

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

 

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(In millions, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Net Sales

 

$

2,041.0

 

$

2,308.8

 

$

3,944.5

 

$

4,018.9

 

Cost of Sales

 

508.0

 

578.5

 

1,008.1

 

1,034.3

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

1,533.0

 

1,730.3

 

2,936.4

 

2,984.6

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

1,262.4

 

1,359.9

 

2,573.2

 

2,536.0

 

Special charges

 

0.3

 

(0.1

)

0.4

 

0.2

 

 

 

1,262.7

 

1,359.8

 

2,573.6

 

2,536.2

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

270.3

 

370.5

 

362.8

 

448.4

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

19.6

 

18.3

 

34.9

 

36.7

 

Earnings before Income Taxes and Minority Interest

 

250.7

 

352.2

 

327.9

 

411.7

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

89.4

 

122.9

 

117.0

 

144.0

 

Minority interest, net of tax

 

(3.3

)

(4.9

)

(1.8

)

(4.2

)

Net Earnings

 

$

158.0

 

$

224.4

 

$

209.1

 

$

263.5

 

 

 

 

 

 

 

 

 

 

 

Net earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

.80

 

$

1.16

 

$

1.07

 

$

1.36

 

Diluted

 

.80

 

1.14

 

1.06

 

1.34

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

196.6

 

193.3

 

195.9

 

193.7

 

Diluted

 

197.5

 

196.5

 

198.1

 

196.8

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per share

 

$

.55

 

$

.55

 

$

.55

 

$

.55

 

 

See notes to consolidated financial statements.

 

2



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED BALANCE SHEETS

 

 

 

December 31
2008

 

June 30
2008

 

 

 

(Unaudited)

 

 

 

 

 

($ in millions)

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

728.9

 

$

401.7

 

Accounts receivable, net

 

1,033.6

 

1,038.8

 

Inventory and promotional merchandise, net

 

896.6

 

987.2

 

Prepaid expenses and other current assets

 

420.7

 

359.5

 

Total current assets

 

3,079.8

 

2,787.2

 

 

 

 

 

 

 

Property, Plant and Equipment, net

 

1,030.9

 

1,043.1

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

Investments, at cost or market value

 

21.3

 

24.1

 

Goodwill

 

746.9

 

708.9

 

Other intangible assets, net

 

180.5

 

191.9

 

Other assets

 

262.6

 

256.0

 

Total other assets

 

1,211.3

 

1,180.9

 

Total assets

 

$

5,322.0

 

$

5,011.2

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Short-term debt

 

$

248.7

 

$

118.7

 

Accounts payable

 

310.3

 

361.7

 

Accrued income taxes

 

68.3

 

151.2

 

Other accrued liabilities

 

1,054.2

 

1,067.6

 

Total current liabilities

 

1,681.5

 

1,699.2

 

 

 

 

 

 

 

Noncurrent Liabilities

 

 

 

 

 

Long-term debt

 

1,406.4

 

1,078.2

 

Other noncurrent liabilities

 

554.9

 

554.0

 

Total noncurrent liabilities

 

1,961.3

 

1,632.2

 

 

 

 

 

 

 

Contingencies (Note 6)

 

 

 

 

 

 

 

 

 

 

 

Minority Interest

 

25.6

 

26.6

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

Common stock, $.01 par value; 650,000,000 shares Class A authorized; shares issued: 183,917,950 at December 31, 2008 and 180,754,534 at June 30, 2008; 240,000,000 shares Class B authorized; shares issued and outstanding: 78,067,261 at December 31, 2008 and June 30, 2008

 

2.6

 

2.6

 

Paid-in capital

 

1,126.3

 

979.0

 

Retained earnings

 

3,185.7

 

3,085.1

 

Accumulated other comprehensive income (loss)

 

(74.8

)

110.8

 

 

 

4,239.8

 

4,177.5

 

Less: Treasury stock, at cost; 65,294,477 Class A shares at December 31, 2008 and 63,914,699 Class A shares at June 30, 2008

 

(2,586.2

)

(2,524.3

)

Total stockholders’ equity

 

1,653.6

 

1,653.2

 

Total liabilities and stockholders’ equity

 

$

5,322.0

 

$

5,011.2

 

 

See notes to consolidated financial statements.

 

3



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Six Months Ended
December 31

 

 

 

2008

 

2007

 

 

 

(In millions)

 

 

 

 

 

 

 

Cash Flows from Operating Activities

 

 

 

 

 

Net earnings

 

$

209.1

 

$

263.5

 

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

 

 

 

 

 

Depreciation and amortization

 

125.9

 

121.9

 

Deferred income taxes

 

(2.1

)

(8.3

)

Minority interest, net of tax

 

1.8

 

4.2

 

Non-cash stock-based compensation

 

32.1

 

33.2

 

Excess tax benefits from stock-based compensation arrangements

 

(1.4

)

(0.4

)

Loss on disposal of property, plant and equipment

 

4.0

 

3.8

 

Other non-cash items

 

0.9

 

0.3

 

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in accounts receivable, net

 

(88.9

)

(201.5

)

Decrease (increase) in inventory and promotional merchandise, net

 

14.7

 

(8.0

)

Increase in other assets, net

 

(67.9

)

(24.7

)

Increase (decrease) in accounts payable

 

(30.5

)

12.3

 

Increase (decrease) in accrued income taxes

 

(20.5

)

50.4

 

Increase in other liabilities

 

39.5

 

115.2

 

Net cash flows provided by operating activities

 

216.7

 

361.9

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

Capital expenditures

 

(157.5

)

(160.4

)

Acquisition of businesses and other intangible assets, net of cash acquired

 

(63.8

)

(116.0

)

Proceeds from the disposition of long-term investments

 

0.8

 

 

Purchases of long-term investments

 

(0.4

)

(0.4

)

Net cash flows used for investing activities

 

(220.9

)

(276.8

)

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

Increase in short-term debt, net

 

121.8

 

138.1

 

Proceeds from issuance of long-term debt, net

 

297.7

 

 

Repayments and redemptions of long-term debt

 

(7.6

)

(2.4

)

Net proceeds from stock-based compensation transactions

 

109.5

 

26.1

 

Excess tax benefits from stock-based compensation arrangements

 

1.4

 

0.4

 

Payments to acquire treasury stock

 

(62.6

)

(80.1

)

Dividends paid to stockholders

 

(108.4

)

(106.6

)

Net cash flows provided by (used for) financing activities

 

351.8

 

(24.5

)

 

 

 

 

 

 

Effect of Exchange Rate Changes on Cash and Cash Equivalents

 

(20.4

)

5.2

 

 

 

 

 

 

 

Net Increase in Cash and Cash Equivalents

 

327.2

 

65.8

 

Cash and Cash Equivalents at Beginning of Period

 

401.7

 

253.7

 

Cash and Cash Equivalents at End of Period

 

$

728.9

 

$

319.5

 

 

See notes to consolidated financial statements.

 

4



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 consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“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 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.  For further information, refer to the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.

 

Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform to current period presentation for comparative purposes.

 

Management Estimates

 

The preparation of financial statements and related disclosures in conformity with 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.  Actual results could differ from those estimates and assumptions.  The Company’s most significant accounting policies relate to revenue recognition, concentration of credit risk, inventory, pension and other post-retirement benefit costs, goodwill and other intangible assets, income taxes and derivatives.  Descriptions of these policies are discussed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.

 

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 or losses are reported as cumulative translation adjustments through other comprehensive income.  Such adjustments amounted to $124.7 million of unrealized translation losses and $17.4 million of unrealized translation gains during the three months ended December 31, 2008 and 2007, respectively, and $208.7 million of unrealized translation losses and $47.8 million of unrealized translation gains during the six months ended December 31, 2008 and 2007, respectively.  The accompanying consolidated statements of earnings include net exchange (losses) gains on foreign currency transactions of $(6.2) million and $0.6 million during the three months ended December 31, 2008 and 2007, respectively, and $(26.2) million and $1.6 million during the six months ended December 31, 2008 and 2007, respectively.

 

Accounts Receivable

 

Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions of $32.7 million and $26.3 million as of December 31, 2008 and June 30, 2008, respectively.

 

5



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Inventory and Promotional Merchandise

 

The components of inventory and promotional merchandise, net were as follows:

 

 

 

December 31
2008

 

June 30
2008

 

 

 

(Unaudited)

 

 

 

 

 

(In millions)

 

 

 

 

 

 

 

Raw materials

 

$

208.3

 

$

205.4

 

Work in process

 

40.2

 

56.8

 

Finished goods

 

447.5

 

494.7

 

Promotional merchandise

 

200.6

 

230.3

 

 

 

$

896.6

 

$

987.2

 

 

Property, Plant and Equipment

 

Property, plant and equipment consists of:

 

 

 

December 31
2008

 

June 30
2008

 

 

 

(Unaudited)

 

 

 

 

 

(In millions)

 

Assets (Useful Life)

 

 

 

 

 

Land

 

$

14.4

 

$

14.9

 

Buildings and improvements (10 to 40 years)

 

177.7

 

183.5

 

Machinery and equipment (3 to 10 years)

 

1,023.7

 

1,008.9

 

Furniture and fixtures (5 to 10 years)

 

91.8

 

95.6

 

Leasehold improvements

 

1,095.0

 

1,090.7

 

 

 

2,402.6

 

2,393.6

 

Less accumulated depreciation and amortization

 

1,371.7

 

1,350.5

 

 

 

$

1,030.9

 

$

1,043.1

 

 

The cost of assets related to projects in progress of $140.5 million and $129.0 million as of December 31, 2008 and June 30, 2008, respectively, is included in their respective asset categories in the table above.  Depreciation and amortization of property, plant and equipment was $60.0 million and $57.4 million during the three months ended December 31, 2008 and 2007, respectively, and $119.3 million and $111.4 million during the six months ended December 31, 2008 and 2007, respectively.

 

Income Taxes

 

As of December 31, 2008 and June 30, 2008, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $198.0 million and $199.0 million, respectively.  The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $116.5 million.  The total interest and penalties accrued related to unrecognized tax benefits during the three and six months ended December 31, 2008 in the accompanying consolidated statements of earnings was $2.7 million and $5.4 million, respectively.  The total gross accrued interest and penalties in the accompanying consolidated balance sheets at December 31, 2008 and June 30, 2008 was $56.2 million and $54.0 million, respectively.  On the basis of the information available as of December 31, 2008, it is reasonably possible that a reduction in a range of $30 million to $60 million of unrecognized tax benefits may occur within 12 months as a result of projected resolutions of global tax examinations and controversies.

 

6



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Recently Adopted Accounting Standards

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”), to clarify the definition of fair value, establish a framework for measuring fair value and expand the disclosures on fair value measurements.  SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price).  SFAS No. 157 also stipulates that, as a market-based measurement, fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability, and establishes a fair value hierarchy that distinguishes between (a) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (b) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).

 

In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13.”  This FSP amends SFAS No. 157 to exclude certain leasing transactions accounted for under previously existing accounting guidance.  However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination, regardless of whether those assets and liabilities are related to leases.

 

In February 2008, the FASB issued FSP No. FAS 157-2, “Effective Date for FASB Statement No. 157” (“FSP No. FAS 157-2”).  This FSP permits the delayed application of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, as defined in this FSP, except for those that are recognized or disclosed at fair value in the financial statements at least annually, until the beginning of the Company’s fiscal 2010.  As of July 1, 2008, the Company adopted SFAS No. 157 (see Note 4), with the exception of its application to nonfinancial assets and nonfinancial liabilities, which the Company will defer in accordance with FSP No. FAS 157-2.  The Company is currently evaluating the impact of adopting SFAS No. 157 at the beginning of fiscal 2010 for such nonfinancial assets and nonfinancial liabilities on its consolidated financial statements.

 

In October 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP No. FAS 157-3”), which clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.  The FSP is effective upon issuance, including prior periods for which financial statements have not been issued.  Revisions resulting from a change in the valuation technique or its application should be accounted for as a change in accounting estimate following the guidance in SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”).  However, the disclosure provisions in SFAS No. 154 for a change in accounting estimate are not required for revisions resulting from a change in valuation technique or its application.  The Company adopted SFAS No. 157 beginning in its fiscal 2009 first quarter.  As part of this adoption, the Company evaluated the fair value measurements of its financial assets and liabilities and determined that these instruments are valued in active markets.  As such, the guidance in this FSP did not impact the Company’s consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), to permit all entities to choose to elect, at specified election dates, to measure eligible financial instruments at fair value.  An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date, and recognize upfront costs and fees related to those items in earnings as incurred and not deferred.  SFAS No. 159 became effective for the Company as of July 1, 2008.  As the Company did not elect the fair value option for its financial instruments (other than those already measured at fair value in accordance with SFAS No. 157), the adoption of this standard did not have an impact on its consolidated financial statements.

 

7



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Recently Issued Accounting Standards

 

In December 2008, the FASB issued FSP No. FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP No. FAS 132(R)-1”) to require employers to provide additional disclosures about plan assets of a defined benefit pension or other post-retirement plan.  These disclosures should principally include information detailing investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets and an understanding of significant concentrations of risk within plan assets.  The disclosures required by this FSP shall be provided for fiscal years ending after December 15, 2009 (or the Company’s fiscal 2010, the anticipated period of adoption).  Upon initial application, the provisions of this FSP are not required for earlier periods that are presented for comparative purposes.  Earlier application of the provisions of this FSP is permitted.

 

In November 2008, the FASB ratified the consensus reached on Emerging Issues Task Force (“EITF”) Issue No. 08-7, “Accounting for Defensive Intangible Assets” (“EITF No. 08-7”).  Defensive intangible assets are assets acquired in a business combination that the acquirer (a) does not intend to use or (b) intends to use in a way other than the assets’ highest and best use as determined by an evaluation of market participant assumptions.  While defensive intangible assets are not being actively used, they are likely contributing to an increase in the value of other assets owned by the acquiring entity.  EITF No. 08-7 will require defensive intangible assets to be accounted for as separate units of accounting at the time of acquisition and the useful life of such assets would be based on the period over which the assets will directly or indirectly affect the entity’s cash flows.  This Issue would be applied prospectively for defensive intangible assets acquired on or after the beginning of the Company’s fiscal 2010, in order to coincide with the effective date of SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”).

 

In November 2008, the FASB ratified the consensus reached on EITF Issue No. 08-6, “Accounting for Equity Method Investment Considerations” (“EITF No. 08-6”). EITF No. 08-6 addresses questions about the potential effect of SFAS No. 141(R) and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51” (“SFAS No. 160”) on equity-method accounting.  The primary issues include how the initial carrying value of an equity method investment should be determined, how to account for any subsequent purchases and sales of additional ownership interests, and whether the investor must separately assess its underlying share of the investee’s indefinite-lived intangible assets for impairment.  The effective date of EITF No. 08-6 coincides with that of SFAS No. 141(R) and SFAS No. 160 and is to be applied on a prospective basis beginning in the Company’s fiscal 2010.  Early adoption is not permitted for entities that previously adopted an alternate accounting policy.

 

In April 2008, the FASB issued FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. FAS 142-3”).  This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”).  This FSP also adds certain disclosures to those already prescribed in SFAS No. 142.  FSP No. FAS 142-3 becomes effective for fiscal years, and interim periods within those fiscal years, beginning in the Company’s fiscal 2010.  The guidance for determining useful lives must be applied prospectively to intangible assets acquired after the effective date.  The disclosure requirements must be applied prospectively to all intangible assets recognized as of the effective date.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“SFAS No. 161”).  SFAS No. 161 requires companies to provide qualitative disclosures about their objectives and strategies for using derivative instruments, quantitative disclosures of the fair values and gains and losses of these derivative instruments in a tabular format, as well as more information about liquidity by requiring disclosure of a derivative contract’s credit-risk-related contingent features.  SFAS No. 161 also requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments.  The Company is currently evaluating the disclosure requirements of SFAS No. 161.  The adoption of this disclosure-only standard will not have an impact on the Company’s consolidated financial results.  SFAS No. 161 becomes effective for the March 31, 2009 interim reporting period.

 

8



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In December 2007, the FASB issued SFAS No. 141(R).  SFAS No. 141(R) replaces SFAS No. 141, “Business Combinations,” however, it retains the fundamental requirements of the former Statement that the acquisition method of accounting (previously referred to as the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination.  SFAS No. 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control.  Among other requirements, SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at their acquisition-date fair values, with limited exceptions; acquisition-related costs generally will be expensed as incurred.  SFAS No. 141(R) requires certain financial statement disclosures to enable users to evaluate and understand the nature and financial effects of the business combination.  SFAS No. 141(R) must be applied prospectively to business combinations that are consummated on or after July 1, 2009.

 

In December 2007, the FASB issued SFAS No. 160 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.  Among other requirements, SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is to be reported as a separate component of equity in the consolidated financial statements.  SFAS No. 160 also requires consolidated net income to include the amounts attributable to both the parent and the noncontrolling interest and to disclose those amounts on the face of the consolidated statement of income.  SFAS No. 160 must be applied prospectively for fiscal years, and interim periods within those fiscal years, beginning in the Company’s fiscal 2010, except for the presentation and disclosure requirements, which will be applied retrospectively for all periods presented.

 

In December 2007, the FASB ratified the consensus reached on EITF Issue No. 07-1, “Collaborative Arrangements,” (“EITF No. 07-1”).  This Issue addresses accounting for collaborative arrangement activities that are conducted without the creation of a separate legal entity for the arrangement.  Revenues and costs incurred with third parties in connection with the collaborative arrangement should be presented gross or net by the collaborators pursuant to the guidance in EITF Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” and other applicable accounting literature.  Payments to or from collaborators should be presented in the income statement based on the nature of the arrangement, the nature of the company’s business and whether the payments are within the scope of other accounting literature.  Other detailed information related to the collaborative arrangement is also required to be disclosed.  The requirements under this Issue must be applied to collaborative arrangements in existence at the beginning of the Company’s fiscal 2010 using a modified version of retrospective application.  The Company is currently not a party to significant collaborative arrangement activities, as defined by EITF No. 07-1.

 

NOTE 2 — ACQUISITION OF BUSINESSES

 

During the first quarter of fiscal 2009, the Company acquired Applied Genetics Incorporated Dermatics, a manufacturer of cosmetics ingredients.  The purchase price, paid at closing, was funded by cash provided by operations.  In addition, the Company acquired businesses engaged in the wholesale distribution and retail sale of Aveda products.  These activities were predominantly related to the Company’s skin care and hair care businesses and resulted in increases to goodwill of $48.6 million and other intangible assets of $5.6 million as of December 31, 2008, pending final valuation.

 

The aggregate purchase price for these transactions, which includes acquisition costs, was $57.7 million at December 31, 2008.  The results of operations for each of the acquired businesses are included in the accompanying consolidated financial statements commencing with its date of original acquisition.  Pro forma results of operations as if each of such businesses had been acquired as of the beginning of the year of acquisition and as of the prior-year period have not been presented as the impact on the Company’s consolidated financial results would not have been material.

 

NOTE 3 — DEBT

 

In November 2008, the Company issued and sold $300.0 million of 7.75% Senior Notes due November 1, 2013 (“7.75% Senior Notes due 2013”) in a public offering.  The 7.75% Senior Notes due 2013 were priced at 99.932% with a yield of 7.767%.  Interest payments are required to be made semi-annually on May 1 and November 1, commencing May 1, 2009.  The net proceeds of this offering were used to repay then-outstanding commercial paper balances upon their maturity.

 

9



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4 — FAIR VALUE MEASUREMENTS

 

The Company adopted the provisions of SFAS No. 157 for financial assets and liabilities as of July 1, 2008.  The adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated financial statements.  SFAS No. 157 defines fair value 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.  SFAS No. 157 also establishes a fair value hierarchy which requires the entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

SFAS No. 157 describes three levels of inputs that may be used to measure fair value:

 

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 instruments valuation.

 

The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2008:

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets

 

Significant Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

 

 

(Unaudited) (In millions)

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Foreign currency forward and option contracts

 

$

 

$

33.3

 

$

 

$

33.3

 

Interest rate swap contracts

 

 

41.8

 

 

41.8

 

Available-for-sale securities

 

13.8

 

 

 

13.8

 

Total

 

13.8

 

75.1

 

 

88.9

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

 

$

15.9

 

$

 

$

15.9

 

 

Foreign Currency Forward and Option Contracts - The fair values of the Company’s foreign currency forward and option contracts were valued using pricing models, with all significant inputs derived from or corroborated by observable market data such as yield curves, currency spot and forward rates and currency volatilities.

 

Interest Rate Swap Contracts - The fair values of the Company’s outstanding interest rate swap contracts were determined based on non-binding offers from the counterparties that are corroborated by observable market data.

 

Available-For-Sale Securities - Available-for-sale securities are generally comprised of mutual funds and are valued using quoted market prices on an active exchange.

 

All derivative instruments are recognized in prepaid expenses and other current assets or in other accrued liabilities in the accompanying consolidated balance sheets.  Available-for-sale securities are included in investments in the accompanying consolidated balance sheets.

 

10



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 — PENSION AND POST-RETIREMENT BENEFIT PLANS

 

The Company maintains pension plans covering substantially all of its full-time employees for its U.S. operations and a majority of its international operations.  The Company also maintains a domestic post-retirement benefit plan which provides certain medical and dental benefits to eligible employees.  Descriptions of these plans are discussed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.

 

The components of net periodic benefit cost for the three months ended December 31, 2008 and 2007 consisted of the following:

 

 

 

 

 

Other than

 

 

 

Pension Plans

 

Pension Plans

 

(Unaudited)

 

U.S.

 

International

 

Post-retirement

 

(In millions)

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

5.2

 

$

4.9

 

$

3.9

 

$

4.1

 

$

0.9

 

$

1.1

 

Interest cost

 

7.0

 

6.6

 

4.3

 

3.7

 

1.9

 

1.6

 

Expected return on plan assets

 

(8.3

)

(7.9

)

(4.5

)

(3.8

)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

0.2

 

0.2

 

0.6

 

0.1

 

 

 

Actuarial loss

 

0.4

 

0.4

 

0.2

 

1.5

 

0.3

 

0.1

 

Net periodic benefit cost

 

$

4.5

 

$

4.2

 

$

4.5

 

$

5.6

 

$

3.1

 

$

2.8

 

 

The components of net periodic benefit cost for the six months ended December 31, 2008 and 2007 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

Other than

 

 

Pension Plans

 

Pension Plans

 

(Unaudited)

 

U.S.

 

International

 

Post-retirement

 

(In millions)

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

10.5

 

$

9.9

 

$

8.4

 

$

8.0

 

$

1.9

 

$

2.1

 

Interest cost

 

14.0

 

13.1

 

9.4

 

7.2

 

3.7

 

3.2

 

Expected return on plan assets

 

(16.7

)

(15.9

)

(9.7

)

(7.4

)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

0.3

 

0.3

 

1.2

 

0.1

 

 

 

Actuarial loss

 

0.9

 

0.9

 

0.3

 

3.0

 

0.3

 

0.2

 

Net periodic benefit cost

 

$

9.0

 

$

8.3

 

$

9.6

 

$

10.9

 

$

5.9

 

$

5.5

 

 

The Company previously disclosed in its consolidated financial statements for the fiscal year ended June 30, 2008 that it expected to make cash contributions totaling approximately $15 million to its trust based, noncontributory qualified defined benefit pension plan (“U.S. Qualified Plan”) and approximately $46 million to its international defined benefit pension plans during the fiscal year ending June 30, 2009.  During the six months ended December 31, 2008, the Company made $7.0 million of discretionary contributions to the U.S. Qualified Plan and does not currently anticipate further discretionary contributions for the remainder of the fiscal year.  In addition, as of December 31, 2008, the expected contributions to the international defined benefit pension plans are currently anticipated to be approximately $44 million for the fiscal year ending June 30, 2009.

 

11



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 — CONTINGENCIES

 

Legal Proceedings

 

The Company is involved, from time to time, in litigation and other legal proceedings incidental to its business.  Management believes that the outcome of current litigation and legal proceedings will not have a material adverse effect upon the Company’s results of operations or financial condition.  However, management’s assessment of the Company’s current litigation and other legal proceedings could change in light of the discovery of facts with respect to legal actions or other proceedings pending against the Company not presently known to the Company or determinations by judges, juries or other finders of fact which are not in accord with management’s evaluation of the possible liability or outcome of such litigation or proceedings.

 

In 1999, the Office of the Attorney General of the State of New York (the “State”) notified the Company and ten other entities that they had been identified as potentially responsible parties (“PRPs”) with respect to the Blydenburgh landfill in Islip, New York.  Each PRP may be jointly and severally liable for the costs of investigation and cleanup, which the State estimated in 2006 to be approximately $19.7 million for all PRPs.  In 2001, the State sued other PRPs (including Hickey’s Carting, Inc., Dennis C. Hickey and Maria Hickey, collectively the “Hickey Parties”), in the U.S. District Court for the Eastern District of New York to recover such costs in connection with the site, and in September 2002, the Hickey Parties brought contribution actions against the Company and other Blydenburgh PRPs.  These contribution actions seek to recover, among other things, any damages for which the Hickey Parties are found liable in the State’s lawsuit against them, and related costs and expenses, including attorneys’ fees.  In June 2004, the State added the Company and other PRPs as defendants in its pending case against the Hickey Parties.  In April 2006, the Company and other defendants added numerous other parties to the case as third-party defendants.  The Company and certain other PRPs have engaged in settlement discussions which to date have been unsuccessful.  Settlement negotiations with the new third-party defendants, the State, the Company and other defendants began in July 2006.  The Company has accrued an amount which it believes would be necessary to resolve its share of this matter.  If settlement discussions are not successful, the Company intends to vigorously defend the pending claims.  While no assurance can be given as to the ultimate outcome, management believes that the resolution of the Blydenburgh matters will not have a material adverse effect on the Company’s consolidated financial condition.

 

NOTE 7 — COMMON STOCK

 

During the six months ended December 31, 2008, the Company purchased approximately 1.4 million shares of its Class A Common Stock for $62.6 million.

 

NOTE 8 — STOCK PROGRAMS

 

As of December 31, 2008, the Company has two active equity compensation plans which include the Amended and Restated Fiscal 2002 Share Incentive Plan and the Non-Employee Director Share Incentive Plan (collectively, the “Plans”).  These Plans currently provide for the issuance of 24,342,700 shares of Class A Common Stock, which consist of shares originally provided for and shares transferred to the Plans from other inactive plans and employment agreements, to be granted in the form of stock-based awards to key employees, consultants and non-employee directors of the Company.  As of December 31, 2008, approximately 4,832,700 shares of Class A Common Stock were reserved and available to be granted pursuant to these Plans.  The Company may satisfy the obligation of its stock-based compensation awards with either new or treasury shares.  The Company’s equity compensation awards outstanding at December 31, 2008 include stock options, performance share units (“PSU”), restricted stock units (“RSU”) and share units.

 

Total net stock-based compensation expense is attributable to the granting of, and the remaining requisite service periods of, stock options, PSUs, RSUs and share units.  Compensation expense attributable to net stock-based compensation during the three months ended December 31, 2008 and 2007 was $9.5 million and $14.3 million, respectively.  Compensation expense attributable to net stock-based compensation during the six months ended December 31, 2008 and 2007 was $32.1 million and $33.2 million, respectively.  As of December 31, 2008, the total unrecognized compensation cost related to nonvested stock-based awards was $56.0 million and the related weighted-average period over which it is expected to be recognized is approximately 2.1 years.

 

12



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Stock Options

 

A summary of the Company’s stock option programs as of December 31, 2008 and changes during the six-month period then ended, is presented below:

 

(Unaudited) (Shares in thousands)

 

Shares

 

Weighted-
Average
Exercise
Price Per

Share

 

Aggregate 
Intrinsic
Value
(1)
(in millions)

 

Weighted-
Average
Contractual Life
Remaining in
Years

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2008

 

20,307.2

 

$

42.53

 

 

 

 

 

Granted at fair value

 

1,789.9

 

52.35

 

 

 

 

 

Exercised

 

(2,627.2

)

41.69

 

 

 

 

 

Expired

 

(68.9

)

46.05

 

 

 

 

 

Forfeited

 

(34.4

)

42.75

 

 

 

 

 

Outstanding at December 31, 2008

 

19,366.6

 

43.54

 

$

0.3

 

4.2

 

 

 

 

 

 

 

 

 

 

 

Exercisable at December 31, 2008

 

14,605.9

 

43.08

 

$

0.3

 

2.8

 

 


(1) The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option.

 

The exercise period for all stock options generally may not exceed ten years from the date of grant.  Stock option grants to individuals generally become exercisable in three substantively equal tranches over a service period of up to four years.  The Company attributes the value of option awards on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards.

 

The per-share weighted-average grant date fair value of stock options granted during the three months ended December 31, 2008 and 2007 was $11.46 and $15.54, respectively.  The per-share weighted-average grant date fair value of stock options granted during the six months ended December 31, 2008 and 2007 was $17.47 and $14.37, respectively.  The total intrinsic value of stock options exercised during the three months ended December 31, 2008 was de minimis.  The total intrinsic value of stock options exercised during the three months ended December 31, 2007 was $6.4 million.  The total intrinsic value of stock options exercised during the six months ended December 31, 2008 and 2007 was $24.7 million and $7.1 million, respectively.

 

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Three Months Ended
December 31

 

(Unaudited)

 

2008

 

2007

 

Weighted-average expected stock-price volatility

 

28%

 

24%

 

Weighted-average expected option life

 

8 years

 

9 years

 

Average risk-free interest rate

 

3.5%

 

4.6%

 

Average dividend yield

 

1.2%

 

1.2%

 

 

 

 

Six Months Ended
December 31

 

(Unaudited)

 

2008

 

2007

 

Weighted-average expected stock-price volatility

 

28%

 

24%

 

Weighted-average expected option life

 

8 years

 

8 years

 

Average risk-free interest rate

 

3.4%

 

4.5%

 

Average dividend yield

 

1.2%

 

1.2%

 

 

13



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Performance Share Units

 

During the six months ended December 31, 2008, the Company granted 131,000 PSUs, which will be settled in stock subject to the achievement of the Company’s net sales and net earnings per share goals for the three years ending June 30, 2011 and subject to the continued employment of the grantees.  Settlement will be made pursuant to a range of opportunities relative to the net sales and diluted net earnings per common share targets of the Company and, as such, the compensation cost of the PSU is subject to adjustment based upon the attainability of these target goals.  No settlement will occur for results below the applicable minimum threshold and additional shares shall be issued if performance exceeds the targeted performance goals.  PSUs are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the PSU.  These awards are subject to the provisions of the agreement under which the PSUs are granted.  The PSUs were valued at the closing market value of the Company’s Class A Common Stock on the date of grant and generally vest at the end of the performance period.  In September 2008, 78,400 shares of the Company’s Class A Common Stock were issued and related accrued dividends were paid, relative to the target goals set at the time of issuance, in settlement of 96,600 PSUs which vested as of June 30, 2008.

 

The following is a summary of the status of the Company’s PSUs as of December 31, 2008 and activity during the six months then ended:

 

 

 

 

 

Weighted-Average

 

 

 

 

 

Grant Date

 

(Unaudited) (Shares in thousands)

 

Shares

 

Fair Value Per
Share

 

Nonvested at June 30, 2008

 

189.3

 

$

41.05

 

Granted

 

131.0

 

52.83

 

Vested

 

 

 

Forfeited

 

 

 

Nonvested at December 31, 2008

 

320.3

 

45.87

 

 

Restricted Stock Units

 

The Company granted approximately 617,200 RSUs during the six months ended December 31, 2008.  At the time of grant, 343,500 were scheduled to vest on November 2, 2009, 178,700 on November 1, 2010 and 95,000 on October 31, 2011, all subject to the continued employment or retirement of the grantees.  Certain RSUs granted in fiscal 2009 are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the RSU and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant.  Other RSUs granted in fiscal 2009 are not accompanied by dividend equivalent rights and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant less the discounted present value of the dividends expected to be paid on the shares during the vesting period.

 

The following is a summary of the status of the Company’s RSUs as of December 31, 2008 and activity during the six months then ended:

 

 

 

 

 

Weighted-Average

 

 

 

 

 

Grant Date

 

(Unaudited) (Shares in thousands)

 

Shares

 

Fair Value Per
Share

 

Nonvested at June 30, 2008

 

814.0

 

$

40.85

 

Granted

 

617.2

 

52.19

 

Vested

 

(479.3

)

40.72

 

Forfeited

 

(20.6

)

44.05

 

Nonvested at December 31, 2008

 

931.3

 

48.36

 

 

14



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Share Units

 

The Company grants share units to certain non-employee directors under the Non-Employee Director Share Incentive Plan.  The share units are convertible into shares of Class A Common Stock as provided for in that plan.  Share units are accompanied by dividend equivalent rights that are converted to additional share units when such dividends are declared.  The following is a summary of the status of the Company’s share units as of December 31, 2008 and activity during the six months then ended:

 

 

 

 

 

Weighted-Average

 

 

 

 

 

Grant Date

 

(Unaudited) (Shares in thousands)

 

Shares

 

Fair Value Per
Share

 

Outstanding at June 30, 2008

 

18.1

 

$

39.21

 

Granted

 

4.1

 

33.62

 

Dividend equivalents

 

0.4

 

30.25

 

Converted

 

 

 

Outstanding at December 31, 2008

 

22.6

 

38.02

 

 

Cash Units

 

Certain non-employee directors defer cash compensation in the form of cash payout share units, which are not subject to the Plans.  These share units are classified as liabilities and, as such, their fair value is adjusted to reflect the current market value of the Company’s Class A Common Stock.  The Company recorded a $1.0 million reduction in compensation expense and $0.2 million as compensation expense to reflect additional deferrals and the change in the market value for the three months ended December 31, 2008 and 2007, respectively.  The Company recorded a $0.7 million reduction in compensation expense and $0.2 million as compensation expense to reflect additional deferrals and the change in the market value for the six months ended December 31, 2008 and 2007, respectively.

 

NOTE 9 — NET EARNINGS PER COMMON SHARE

 

Net earnings per common share (“basic EPS”) is computed by dividing net earnings by the weighted average number of common shares outstanding and contingently issuable shares (which satisfy certain conditions).  Net earnings per common share assuming dilution (“diluted EPS”) is computed by reflecting potential dilution from stock-based awards.

 

A reconciliation between the numerators and denominators of the basic and diluted EPS computations is as follows:

 

 

 

Three Months
Ended
December 31

 

Six Months
Ended
December 31

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

(In millions, except per share data)

 

Numerator:

 

 

 

 

 

 

 

 

 

Net earnings

 

$

158.0

 

$

224.4

 

$

209.1

 

$

263.5

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — Basic

 

196.6

 

193.3

 

195.9

 

193.7

 

Effect of dilutive stock options

 

0.4

 

2.7

 

1.6

 

2.6

 

Effect of restricted stock units

 

0.5

 

0.5

 

0.6

 

0.5

 

Weighted average common shares outstanding — Diluted

 

197.5

 

196.5

 

198.1

 

196.8

 

 

 

 

 

 

 

 

 

 

 

Net earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

.80

 

$

1.16

 

$

1.07

 

$

1.36

 

Diluted

 

.80

 

1.14

 

1.06

 

1.34

 

 

15



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of December 31, 2008 and 2007, outstanding options to purchase 16.7 million and 10.1 million shares, respectively, of Class A Common Stock were not included in the computation of diluted EPS because their inclusion would be anti-dilutive.  As of December 31, 2008 and 2007, 0.3 million of PSUs have been excluded from the calculation of diluted EPS because the number of shares ultimately issued is contingent on the achievement of certain performance targets of the Company, as discussed in Note 8.

 

NOTE 10 — COMPREHENSIVE INCOME (LOSS)

 

The components of accumulated other comprehensive income (“AOCI”) included in the accompanying consolidated balance sheets consist of net unrealized investment gain (loss), net gain (loss) on derivative instruments designated and qualifying as cash-flow hedging instruments, net actuarial gain (loss) and prior service costs or credits associated with pension and other post-retirement benefits, and cumulative translation adjustments as of the end of each period.

 

Comprehensive income (loss) and its components, net of tax, are as follows:

 

 

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

(In millions)

 

Net earnings

 

$

158.0

 

$

224.4

 

$

209.1

 

$

263.5

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Net unrealized investment gain (loss)

 

(0.5

)

(0.1

)

(0.6

)

(0.3

)

Net derivative instruments gain (loss)

 

2.0

 

 

10.7

 

(0.9

)

Amounts included in net periodic benefit cost, net

 

8.1

 

1.7

 

13.0

 

3.3

 

Translation adjustments

 

(124.7

)

17.4

 

(208.7

)

47.8

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

(115.1

)

19.0

 

(185.6

)

49.9

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

42.9

 

$

243.4

 

$

23.5

 

$

313.4

 

 

The accumulated net gain (loss) on derivative instruments, net of tax, consists of the following:

 

 

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

(In millions)

 

 

 

 

 

 

 

 

 

 

 

AOCI-derivative instruments, beginning of period

 

$

16.6

 

$

7.3

 

$

7.9

 

$

8.2

 

Gain (loss) on derivative instruments

 

14.0

 

(0.6

)

27.1

 

(2.0

)

Reclassification to earnings of net (gain) loss during the period

 

(10.9

)

0.6

 

(10.6

)

0.6

 

Adjustment for deferred income taxes

 

(1.1

)

 

(5.8

)

0.5

 

 

 

 

 

 

 

 

 

 

 

Net derivative instruments gain (loss)

 

2.0

 

 

10.7

 

(0.9

)

 

 

 

 

 

 

 

 

 

 

AOCI-derivative instruments, end of period

 

$

18.6

 

$

7.3

 

$

18.6

 

$

7.3

 

 

16



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Of the $18.6 million, net of tax, derivative instrument gain recorded in AOCI at December 31, 2008, $8.8 million, net of tax, related to the October 2003 gain from the settlement of the treasury lock agreements upon the issuance of the Company’s 5.75% Senior Notes due October 2033, which will be reclassified to earnings as an offset to interest expense over the life of the debt.  Also included in the net derivative instrument gain recorded in AOCI was $10.4 million in gains, net of tax, related to foreign currency forward and option contracts, which the Company will reclassify to earnings during the next six months.  Partially offsetting these gains was $0.6 million, net of tax, related to a loss from the settlement of a series of forward-starting interest rate swap agreements upon the issuance of the Company’s 6.00% Senior Notes due May 2037, which will be reclassified to earnings as an addition to interest expense over the life of the debt.

 

At the end of the prior period, the $7.3 million, net of tax, derivative instrument gain recorded in AOCI included $9.0 million, net of tax, related to the October 2003 gain from the settlement of the treasury lock agreements upon the issuance of the Company’s 5.75% Senior Notes due October 2033, which will be reclassified to earnings as an offset to interest expense over the life of the debt.  Partially offsetting this gain was $0.6 million, net of tax, related to a loss from the settlement of a series of forward-starting interest rate swap agreements upon the issuance of the Company’s 6.00% Senior Notes due May 2037, which will be reclassified to earnings as an addition to interest expense over the life of the debt.  Also partially offsetting the net derivative instrument gain recorded in AOCI was $1.1 million in losses, net of tax, related to foreign currency forward contracts, which were subsequently reclassified to earnings.

 

NOTE 11 – STATEMENT OF CASH FLOWS

 

Supplemental cash flow information for the six months ended December 31, 2008 and 2007 were as follows:

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

(In millions)

 

Cash

 

 

 

 

 

Cash paid during the period for interest

 

$

35.4

 

$

39.8

 

Cash paid during the period for income taxes

 

$

127.1

 

$

104.9

 

 

 

 

 

 

 

Non-cash investing and financing activities

 

 

 

 

 

Long-term debt issued upon acquisition of business

 

$

 

$

23.9

 

Liabilities incurred for acquisitions

 

$

3.1

 

$

5.3

 

Incremental tax benefit from the exercise of stock options

 

$

(7.8

)

$

(2.3

)

Capital lease obligations incurred

 

$

15.1

 

$

0.4

 

Interest rate swap derivative mark to market

 

$

30.9

 

$

19.6

 

 

NOTE 12 – SEGMENT DATA AND RELATED INFORMATION

 

Reportable operating segments include components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (the “Chief Executive”) in deciding how to allocate resources and in assessing performance.  Although the Company operates in one business segment, beauty products, management also evaluates performance on a product category basis.  Performance is measured based upon net sales and operating income.  Operating income represents earnings before income taxes, minority interest and net interest expense.  The accounting policies for the Company’s reportable segments are substantially the same as those for the consolidated financial statements, as described in the segment data and related information footnote included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.  The assets and liabilities of the Company are managed centrally and are reported internally in the same manner as the consolidated financial statements; thus, no additional information is produced for the Chief Executive or included herein.  There has been no significant variance in the total or long-lived asset value associated with the Company’s segment data since June 30, 2008.

 

17



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(Unaudited)
(In millions)

 

 

 

 

 

 

 

 

 

 

 

PRODUCT CATEGORY DATA

 

 

 

 

 

 

 

 

 

Net Sales:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

772.4

 

$

831.2

 

$

1,489.2

 

$

1,450.7

 

Makeup

 

728.3

 

827.3

 

1,471.2

 

1,490.4

 

Fragrance

 

415.0

 

520.5

 

742.8

 

833.5

 

Hair Care

 

108.5

 

110.4

 

207.3

 

213.0

 

Other

 

16.8

 

19.4

 

34.0

 

31.3

 

 

 

$

2,041.0

 

$

2,308.8

 

$

3,944.5

 

$

4,018.9

 

Operating Income (Loss):

 

 

 

 

 

 

 

 

 

Skin Care

 

$

136.9

 

$

166.5

 

$

180.4

 

$

202.3

 

Makeup

 

108.2

 

149.4

 

162.6

 

190.5

 

Fragrance

 

13.5

 

48.1

 

8.0

 

43.1

 

Hair Care

 

14.4

 

6.4

 

13.4

 

13.8

 

Other

 

(2.4

)

 

(1.2

)

(1.1

)

Special charges

 

(0.3

)

0.1

 

(0.4

)

(0.2

)

 

 

270.3

 

370.5

 

362.8

 

448.4

 

Reconciliation:

 

 

 

 

 

 

 

 

 

Interest expense, net

 

19.6

 

18.3

 

34.9

 

36.7

 

Earnings before income taxes and minority interest

 

$

250.7

 

$

352.2

 

$

327.9

 

$

411.7

 

 

 

 

 

 

 

 

 

 

 

GEOGRAPHIC DATA

 

 

 

 

 

 

 

 

 

Net Sales:

 

 

 

 

 

 

 

 

 

The Americas

 

$

903.8

 

$

1,028.2

 

$

1,842.8

 

$

1,927.1

 

Europe, the Middle East & Africa

 

762.3

 

933.2

 

1,403.8

 

1,484.4

 

Asia/Pacific

 

374.9

 

347.4

 

697.9

 

607.4

 

 

 

$

2,041.0

 

$

2,308.8

 

$

3,944.5

 

$

4,018.9

 

Operating Income (Loss):

 

 

 

 

 

 

 

 

 

The Americas

 

$

54.4

 

$

91.0

 

$

110.9

 

$

143.4

 

Europe, the Middle East & Africa

 

129.6

 

207.0

 

137.2

 

216.0

 

Asia/Pacific

 

86.6

 

72.4

 

115.1

 

89.2

 

Special charges

 

(0.3

)

0.1

 

(0.4

)

(0.2

)

 

 

$

270.3

 

$

370.5

 

$

362.8

 

$

448.4

 

 

NOTE 13 – SUBSEQUENT EVENT

 

Subsequent to December 31, 2008, the Company announced that it will implement cost savings programs, including a number of initiatives to resize and reorganize the Company to achieve long-term profitable growth.  The Company anticipates this multi-faceted initiative to result in related one-time restructuring and other special charges between $350 million and $450 million as it is rolled out over the next few fiscal years.

 

18



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

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

 

RESULTS OF OPERATIONS

 

We manufacture, market and sell beauty products including those in the skin care, makeup, fragrance and hair care categories which are distributed in over 140 countries and territories.  The following is a comparative summary of operating results for the three and six months ended December 31, 2008 and 2007, and reflects the basis of presentation described in Note 1 of Notes to Consolidated Financial Statements – Summary of Significant Accounting Policies for all periods presented.  Sales of products and services that do not meet our definition of skin care, makeup, fragrance or hair care have been included in the “other” category.

 

 

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(In millions)

 

NET SALES

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

The Americas

 

$

903.8

 

$

1,028.2

 

$

1,842.8

 

$

1,927.1

 

Europe, the Middle East & Africa

 

762.3

 

933.2

 

1,403.8

 

1,484.4

 

Asia/Pacific

 

374.9

 

347.4

 

697.9

 

607.4

 

 

 

$

2,041.0

 

$

2,308.8

 

$

3,944.5

 

$

4,018.9

 

 

 

 

 

 

 

 

 

 

 

By Product Category:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

772.4

 

$

831.2

 

$

1,489.2

 

$

1,450.7

 

Makeup

 

728.3

 

827.3

 

1,471.2

 

1,490.4

 

Fragrance

 

415.0

 

520.5

 

742.8

 

833.5

 

Hair Care

 

108.5

 

110.4

 

207.3

 

213.0

 

Other

 

16.8

 

19.4

 

34.0

 

31.3

 

 

 

$

2,041.0

 

$

2,308.8

 

$

3,944.5

 

$

4,018.9

 

 

 

 

 

 

 

 

 

 

 

OPERATING INCOME (LOSS)

 

 

 

 

 

 

 

 

 

By Region:

 

 

 

 

 

 

 

 

 

The Americas

 

$

54.4

 

$

91.0

 

$

110.9

 

$

143.4

 

Europe, the Middle East & Africa

 

129.6

 

207.0

 

137.2

 

216.0

 

Asia/Pacific

 

86.6

 

72.4

 

115.1

 

89.2

 

Special charges

 

(0.3

)

0.1

 

(0.4

)

(0.2

)

 

 

$

270.3

 

$

370.5

 

$

362.8

 

$

448.4

 

 

 

 

 

 

 

 

 

 

 

By Product Category:

 

 

 

 

 

 

 

 

 

Skin Care

 

$

136.9

 

$

166.5

 

$

180.4

 

$

202.3

 

Makeup

 

108.2

 

149.4

 

162.6

 

190.5

 

Fragrance

 

13.5

 

48.1

 

8.0

 

43.1

 

Hair Care

 

14.4

 

6.4

 

13.4

 

13.8

 

Other

 

(2.4

)

 

(1.2

)

(1.1

)

Special charges

 

(0.3

)

0.1

 

(0.4

)

(0.2

)

 

 

$

270.3

 

$

370.5

 

$

362.8

 

$

448.4

 

 

19



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

The following table presents certain consolidated earnings data as a percentage of net sales:

 

 

 

Three Months Ended
December 31

 

Six Months Ended
December 31

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of sales

 

24.9

 

25.1

 

25.6

 

25.7

 

Gross profit

 

75.1

 

74.9

 

74.4

 

74.3

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

61.9

 

58.9

 

65.2

 

63.1

 

Special charges

 

0.0

 

(0.0

)

0.0

 

0.0

 

 

 

61.9

 

58.9

 

65.2

 

63.1

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

13.2

 

16.0

 

9.2

 

11.2

 

Interest expense, net

 

0.9

 

0.8

 

0.9

 

0.9

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes and minority interest

 

12.3

 

15.2

 

8.3

 

10.3

 

Provision for income taxes

 

4.4

 

5.3

 

3.0

 

3.6

 

Minority interest, net of tax

 

(0.2

)

(0.2

)

(0.0

)

(0.1

)

 

 

 

 

 

 

 

 

 

 

Net earnings

 

7.7

%

9.7

%

5.3

%

6.6

%

 

In order to meet the demands of consumers, we continually introduce new products, support new and established products through advertising, merchandising and sampling and phase out existing products that no longer meet the needs of our consumers.  The economics of developing, producing, launching and supporting products influence our sales and operating performance each period.  The introduction of new products may have some cannibalizing effect on sales of existing products, which we take into account in our business planning.

 

Overview

 

The recent economic challenges and uncertainties in a number of countries where we do business, including the United States, have had a significant impact on our business during our fiscal second quarter.  This financial crisis is global in scale and has negatively affected consumer demand, which is having an adverse impact on our customers that are retailers as well as on our own retail stores.  These events have led to significant retailer destocking as well as changes in their ordering patterns for the products that we sell.  As a result, the 2008 holiday period was challenging for us on multiple levels.

 

In the Americas region, the U.S. department store channel experienced a very soft retail environment, which deteriorated beyond our expectations.  While our business suffered from lower store traffic and destocking, we were also faced with competitive pressures as retailers offered significant markdowns on other fashion and luxury items.  Despite these challenges, we believe that we gained share in the beauty business at U.S. department stores with the help of positive consumer response to new product offerings and gift sets, particularly in the skin care category.  Net sales results in alternative channels were generally mixed.  Trends at our freestanding retail stores followed those in department stores while sales of our products online continued to grow.

 

Global economic uncertainty has also impacted our business in Europe, the Middle East & Africa.  Net sales in many of our key markets declined during the quarter.  Our business was also impacted by retailer destocking and tighter working capital management.  Sales and profits in our travel retail business fell sharply due to a slowdown in passenger traffic, retailer destocking and the impact of weaker currencies.

 

20



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

At this time, our business in the Asia/Pacific region has been least affected by the global financial crisis, with net sales rising double digits in several countries, although growth in the region has slowed overall, including Japan, our largest market there.  The success in this region has resulted in net sales growth in our skin care category for the six months ended December 31, 2008.  In addition, net sales in China grew as we continue our expansion in this emerging market.  There are, however, some areas of concern.  In Korea, the weakness of the Korean won has put pressure on our reported sales in that country.  The global financial crisis had a greater impact on our businesses in Australia and New Zealand than the rest of the region.

 

In addition to the ongoing global financial crisis, our business has been negatively impacted by changes in foreign currency exchange rates caused by the dramatic strengthening of the U.S. dollar during our fiscal second quarter.  If the current exchange rates persist or the U.S. dollar continues to strengthen, there will be a continuing adverse impact on our results for the full fiscal year.

 

We are reviewing our plans and taking actions to mitigate the impact of these conditions.  Our cost-containment plans that we implemented throughout the Company during the first fiscal quarter will continue for the remainder of the fiscal year.  In addition, we announced that we will implement cost savings programs, including a number of initiatives to resize and reorganize the Company to achieve long-term profitable growth.  We anticipate this multi-faceted initiative to result in related one-time restructuring and other special charges between $350 million and $450 million as it is rolled out over the next few fiscal years.  As part of our strategy, we plan to continue to make investments behind fast-growing markets and channels to grow market share.  Skin care, which is our most profitable category, will be a priority for our strategic, innovative and support spending.  While our business strategies are designed to strengthen the Company over the long-term, we believe the uncertainty about future market conditions, consumer spending patterns and the financial strength of some of our retail customers, coupled with retailer destocking, will continue to negatively affect our net sales and operating results.

 

Second Quarter Fiscal 2009 as Compared with Second Quarter Fiscal 2008

 

NET SALES

 

Net sales decreased 12%, or $267.8 million, to $2,041.0 million, reflecting declines in each of our product categories.  Geographically, net sales decreases in Europe, the Middle East & Africa and the Americas were partially offset by modest growth in Asia/Pacific.  Excluding the impact of foreign currency translation, net sales decreased 6%.

 

Product Categories

 

Skin Care

Net sales of skin care products decreased 7%, or $58.8 million, to $772.4 million, primarily reflecting declines in net sales from our core brands.  Despite the difficult economic environment, we continued to enhance select product lines to address the needs of our consumers.  Our efforts have resonated well, as the recent launches of Perfectionist [CP+] Wrinkle Lifting Serum and the new Time Zone line of moisturizing products from Estée Lauder and Superdefense SPF 25 Age Defense Moisturizer and Moisture Surge Extended Thirst Relief from Clinique contributed incremental sales of approximately $56 million, combined.  While these new product launches contributed favorably to the category, they were partially offset by lower sales from other existing products in the Perfectionist line from Estée Lauder and the Moisture Surge and Superdefense lines from Clinique.  Net sales of most other product lines in this category also experienced declines, particularly in Europe, the Middle East & Africa and the Americas, partially offset by modest growth in Asia/Pacific.  Excluding the impact of foreign currency translation, skin care net sales were flat as compared with the prior-year period.

 

Makeup

Makeup net sales decreased 12%, or $99.0 million, to $728.3 million, primarily reflecting lower net sales from our core brands of approximately $84 million.  We also experienced lower net sales from our makeup artist brands, particularly driven by declines in the Americas.  These declines were mitigated in part by recent product launches and incremental net sales from new international points of distribution.  Excluding the impact of foreign currency translation, makeup net sales decreased 6%.

 

21



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

Fragrance

Net sales of fragrance products decreased 20%, or $105.5 million, to $415.0 million.  This decline was largely due to lower sales of designer fragrances, of which approximately $59 million was attributable to DKNY Be Delicious, Sean John Unforgivable, DKNY Red Delicious Women, Sean John Unforgivable Woman and certain Tommy Hilfiger fragrances.  Also contributing to the decrease were lower sales of certain Estée Lauder fragrances, as well as various Clinique fragrances, of approximately $52 million, combined.  The recent launches of Estée Lauder Sensuous and Hilfiger Men partially offset these declines by collectively contributing sales of approximately $30 million to the category.  Excluding the impact of foreign currency translation, fragrance net sales decreased 14%.

 

Hair Care

Hair care net sales decreased 2%, or $1.9 million, to $108.5 million.  Net sales declined primarily as a result of the conclusion of a hotel amenities program in the third quarter of fiscal 2008 and, to a lesser extent, a softer salon retail environment in the United States.  These declines were partially offset by incremental sales from new products, such as Dry Remedy Shampoo and Conditioner from Aveda, an increase in points of distribution and the acquisition of an independent distributor in Australia.  Excluding the impact of foreign currency translation, hair care net sales increased 2%.

 

Geographic Regions

Net sales in the Americas decreased 12%, or $124.4 million, to $903.8 million.  Lower net sales in the United States from our core brands and our makeup artist brands contributed approximately $109 million to the decrease.  Net sales declines in Canada and Latin America of approximately $13 million added to the decrease and were adversely impacted by the strengthening of the U.S. dollar.  Economic conditions in this region, particularly in the department store channel, as well as competitive pressures, have negatively impacted our businesses.  Ongoing challenges faced by certain of our department store customers in the United States may continue to affect our net sales for the short and long term.  Excluding the impact of foreign currency translation, net sales in the Americas decreased 10%.

 

In Europe, the Middle East & Africa, net sales decreased 18%, or $170.9 million, to $762.3 million.  Net sales decreases of approximately $134 million were driven by the United Kingdom, our travel retail business, France, Spain and Italy.  These performances reflected retailer destocking and tighter working capital management by certain key retailers.  Net sales in our travel retail business also declined due to a significant slowdown in passenger traffic and the impact of weaker currencies in certain key markets.  Excluding the impact of foreign currency translation, net sales in Europe, the Middle East & Africa decreased 7%.

 

Net sales in Asia/Pacific increased 8%, or $27.5 million, to $374.9 million, reflecting growth from most countries in the region.  This increase reflected higher net sales of approximately $40 million in Japan, China and Hong Kong.  Partially offsetting these increases were lower net sales of approximately $18 million combined in Australia and Korea.  Australia was the only affiliate in this region to experience a local currency sales decline and Korea’s decline reflected the stronger U.S. dollar against the Korean won.  Despite the overall net sales increase in this region, growth has been tempered by a softening retail environment, which we believe will continue and may worsen.  Excluding the impact of foreign currency translation, Asia/Pacific net sales increased 13%.

 

We believe the economic conditions that are currently having a negative impact on the global economy will likely have an adverse impact on our future financial performance.  We cannot predict with certainty the magnitude or duration of the impact or how it will vary across each of our geographic regions.

 

We strategically stagger our new product launches by geographic market, which may account for differences in regional sales growth.

 

COST OF SALES

 

Cost of sales as a percentage of total net sales improved to 24.9% as compared with 25.1% in the prior-year period.  Cost of sales as a percentage of net sales reflected a favorable change in manufacturing variances of approximately 50 basis points as well as a positive effect of exchange rates of approximately 10 basis points.  Partially offsetting these improvements was an increase in obsolescence charges of approximately 40 basis points.

 

22



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

Since certain promotional activities are a component of sales or cost of sales and the timing and level of promotions vary with our promotional calendar, we have experienced, and expect to continue to experience, fluctuations in the cost of sales percentage.  In addition, future cost of sales mix may be impacted by the inclusion of new brands which have margin and product cost structures different from those of our existing brands.

 

OPERATING EXPENSES

 

Operating expenses increased to 61.9% of net sales as compared with 58.9% of net sales in the prior-year period.  In line with our contingency plans and in light of the current economic conditions, we continued to apply various cost-containment measures to maintain expenses in line with our business needs.  While the implementation of these initiatives helped reduce total operating expenses as compared with the prior-year period, the dramatic and greater-than-expected decline in net sales during the current-year quarter ultimately had a negative impact on operating expense margin.  Exacerbating the net sales impact on operating expense margin were net losses from foreign exchange transactions.

 

Changes in advertising, merchandising and sampling spending result from the type, timing and level of activities related to product launches and rollouts, as well as the markets being emphasized.

 

OPERATING RESULTS

 

Operating income decreased 27%, or $100.2 million, to $270.3 million as compared with the prior-year period.  Operating margin decreased to 13.2% of net sales as compared with 16.0% in the prior-year period, reflecting the increase in our operating expense margin, partially offset by the improvement in our gross margin as previously discussed.  The ongoing economic challenges and uncertainties will likely adversely impact our operating results.

 

Product Categories

Fragrance operating income declined 72%, or $34.6 million, to $13.5 million, primarily reflecting lower net sales of designer fragrance products and certain fragrances from our core brands, partially offset by a reduction in selling, advertising, merchandising and sampling spending.  Makeup operating income decreased 28%, or $41.2 million, to $108.2 million, primarily reflecting lower results from certain of our core brands and from our makeup artist brands.  Skin care operating income decreased 18%, or $29.6 million, to $136.9 million, primarily reflecting lower results from certain of our core brands.  Hair care operating income increased over 100%, or $8.0 million, to $14.4 million, primarily reflecting a favorable comparison to the prior-year period when we made investments in new points of distribution and recorded higher intangible asset amortization resulting from the acquisition of the Ojon brand, partially offset by the current-year period decline in net sales as previously discussed.

 

Geographic Regions

Operating income in the Americas decreased 40%, or $36.6 million, to $54.4 million.  This decline primarily reflected lower sales experienced by the majority of our businesses in the region due to current economic conditions and competitive pressures, partially offset by cost containment and contingency plan efforts.

 

In Europe, the Middle East & Africa, operating income decreased 37%, or $77.4 million, to $129.6 million.  This decrease reflected lower results of approximately $66 million in the United Kingdom, our travel retail business, France, Russia, the Balkans and Italy.

 

In Asia/Pacific, operating income increased 20%, or $14.2 million, to $86.6 million, primarily reflecting improved results in Japan, China, Hong Kong and Taiwan of approximately $16 million, collectively.  Partially offsetting these improvements were lower results in Australia of approximately $5 million.

 

INTEREST EXPENSE, NET

 

Net interest expense was $19.6 million as compared with $18.3 million in the prior-year period.  This increase primarily resulted from higher average debt balances which include an additional $300.0 million of senior notes issued during the current-year period, partially offset by lower average interest rates on borrowings.

 

23



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

PROVISION FOR INCOME TAXES

 

The provision for income taxes represents Federal, foreign, state and local income taxes.  The effective rate differs from statutory rates due to the effect of state and local income taxes, tax rates in foreign jurisdictions and certain nondeductible expenses.  Our effective tax rate will change from quarter to quarter based on recurring and non-recurring factors including, but not limited to, the geographical mix of earnings, enacted tax legislation, state and local income taxes, tax audit settlements and the interaction of various global tax strategies.  In addition, changes in judgment from the evaluation of new information resulting in the recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of the change.

 

The effective rate for income taxes for the three months ended December 31, 2008 was 35.7% as compared with 34.9% in the prior-year period.  The increase in the effective income tax rate of 80 basis points was primarily attributable to the tax impact of our foreign operations.

 

Six Months Fiscal 2009 as Compared with Six Months Fiscal 2008

 

NET SALES

 

Net sales decreased 2%, or $74.4 million, to $3,944.5 million.  This decrease reflected lower net sales in the fragrance, hair care and makeup product categories, partially offset by higher net sales in skin care.  Geographically, net sales declines in Europe, the Middle East & Africa and the Americas were partially offset by double-digit growth in Asia/Pacific, particularly in the skin care category.  Current economic conditions have caused a slowdown in net sales growth in the Asia/Pacific region and decreases in net sales in the other two regions.  Such conditions are expected to continue for the remainder of the fiscal year.  Excluding the impact of foreign currency translation, net sales increased 1%.

 

Product Categories

 

Skin Care

Net sales of skin care products increased 3%, or $38.5 million, to $1,489.2 million.  The recent launches of Perfectionist [CP+] Wrinkle Lifting Serum and Cyber White EX from Estée Lauder and Superdefense SPF 25 Age Defense Moisturizer and Moisture Surge Extended Thirst Relief from Clinique contributed incremental sales of approximately $112 million, combined.  These sales were partially offset by approximately $77 million of lower sales from other existing products in the Perfectionist line from Estée Lauder and the Moisture Surge, Superdefense and Repairwear lines from Clinique.  Excluding the impact of foreign currency translation, skin care net sales increased 6%.

 

Makeup

Makeup net sales decreased 1%, or $19.2 million, to $1,471.2 million, primarily reflecting lower net sales from our core brands.  These declines were mitigated by the recent launches of High Impact Lip Colour SPF 15 and reformulated Superfit Makeup from Clinique, as well as Estée Lauder Signature Blush, which contributed incremental sales of approximately $54 million, combined.  In addition, international net sales increases from our makeup artist brands offset net sales decreases in the United States, resulting in slight growth during the current-year period.  Excluding the impact of foreign currency translation, makeup net sales increased 1%.

 

Fragrance

Net sales of fragrance products decreased 11%, or $90.7 million, to $742.8 million.  This decline was largely due to lower sales of designer fragrances, of which approximately $91 million was attributable to Sean John Unforgivable, DKNY Be Delicious, DKNY Red Delicious Women, Donna Karan Cashmere Mist, Sean John Unforgivable Woman and certain Tommy Hilfiger fragrances.  Also contributing to the decrease were lower sales of certain Estée Lauder fragrances and various Clinique fragrances of approximately $64 million, combined.  The recent launches of Estée Lauder Sensuous and Hilfiger Men, as well as increased sales of DKNY Delicious Night, partially offset these declines by collectively contributing approximately $72 million to the category.  Excluding the impact of foreign currency translation, fragrance net sales decreased 8%.

 

24



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

Hair Care

Hair care net sales decreased 3%, or $5.7 million, to $207.3 million.  Net sales declined primarily as a result of the conclusion of a hotel amenities program in the third quarter of fiscal 2008 and, to a lesser extent, a softer salon retail environment in the United States.  These declines were partially offset by incremental sales from new products, such as Dry Remedy Shampoo and Conditioner from Aveda, an increase in points of distribution and the acquisition of an independent distributor in Australia.  Excluding the impact of foreign currency translation, hair care net sales decreased 1%.

 

Geographic Regions

Net sales in the Americas decreased 4%, or $84.3 million, to $1,842.8 million.  Lower net sales from our core brands, as well as our makeup artist brands, in the United States contributed approximately $91 million to the decrease.  Net sales declines in Canada of approximately $6 million were offset by growth in Latin America.  Economic conditions in this region, particularly in the department store channel, as well as competitive pressures, have negatively impacted our businesses.  Ongoing challenges faced by certain of our department store customers in the United States may continue to affect our net sales for the short and long term.  The impact of foreign currency translation on net sales in the Americas was de minimis.

 

In Europe, the Middle East & Africa, net sales decreased 5%, or $80.6 million, to $1,403.8 million.  This decrease reflected lower net sales in the United Kingdom, Spain, France and South Africa of approximately $88 million, combined.  Partially offsetting these declines were net sales increases of approximately $15 million in the Middle East and Russia, which benefited from our continuing expansion in these markets.  Excluding the impact of foreign currency translation, net sales in Europe, the Middle East & Africa were flat as compared with the prior-year period.

 

Net sales in Asia/Pacific increased 15%, or $90.5 million, to $697.9 million.  This increase reflected higher net sales of approximately $77 million in China, Japan and Hong Kong.  Partially offsetting these increases were lower net sales of approximately $4 million in Australia and New Zealand.  Australia was the only affiliate in this region to have a local currency sales decline.  Excluding the impact of foreign currency translation, Asia/Pacific net sales increased 17%.

 

We believe the economic conditions that are currently having a negative impact on the global economy will likely have an adverse impact on our future financial performance.  We cannot predict with certainty the magnitude or duration of the impact or how it will vary across each of our geographic regions.

 

We strategically stagger our new product launches by geographic market, which may account for differences in regional sales growth.

 

COST OF SALES

 

Cost of sales as a percentage of total net sales improved to 25.6% as compared with 25.7% in the prior-year period.  Cost of sales as a percentage of net sales reflected favorable changes in manufacturing variances and the mix of our business of approximately 20 basis points, each, as well as a decrease in the level and timing of promotional activities and a positive effect of exchange rates of approximately 10 basis points, each.  Partially offsetting these improvements was an increase in obsolescence charges of approximately 50 basis points.

 

Since certain promotional activities are a component of sales or cost of sales and the timing and level of promotions vary with our promotional calendar, we have experienced, and expect to continue to experience, fluctuations in the cost of sales percentage.  In addition, future cost of sales mix may be impacted by the inclusion of new brands which have margin and product cost structures different from those of our existing brands.

 

OPERATING EXPENSES

 

Operating expenses increased to 65.2% of net sales as compared with 63.1% of net sales in the prior-year period.  In line with our contingency plans and in light of the current economic conditions, we continued to apply various cost-containment measures to maintain expenses in line with our business needs.  While the implementation of these initiatives helped reduce overall selling, advertising, merchandising and sampling costs during the current-year period, the dramatic and greater-than-expected decline in net sales during our fiscal second quarter ultimately had a negative impact on our overall operating expense margin.  Exacerbating the net sales impact on operating expense margin were net losses from foreign exchange transactions.

 

Changes in advertising, merchandising and sampling spending result from the type, timing and level of activities related to product launches and rollouts, as well as the markets being emphasized.

 

25



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

OPERATING RESULTS

 

Operating income decreased 19%, or $85.6 million, to $362.8 million as compared with the prior-year period.  Operating margin decreased to 9.2% of net sales as compared with 11.2% in the prior-year period, reflecting the increase in our operating expense margin, partially offset by the improvement in our gross margin as previously discussed.  The ongoing economic challenges and uncertainties will likely adversely impact our operating results.

 

Product Categories

Fragrance operating income declined 81%, or $35.1 million, to $8.0 million, primarily reflecting the decline in net sales of designer fragrance products and other fragrances from certain of our core brands.  Makeup operating income decreased 15%, or $27.9 million, to $162.6 million, primarily reflecting lower global results from certain of our core brands and from our makeup artist brands, particularly in the United States.  Skin care operating income decreased 11%, or $21.9 million, to $180.4 million, reflecting lower than anticipated net sales coupled with charges related to inventory obsolescence.  Hair care operating income decreased 3%, or $0.4 million, to $13.4 million, primarily reflecting a decrease in net sales as previously discussed.

 

Geographic Regions

Operating income in the Americas declined 23%, or $32.5 million, to $110.9 million, reflecting a decrease in net sales due to current economic conditions and competitive pressures partially offset by cost containment and contingency plan efforts.

 

In Europe, the Middle East & Africa, operating income decreased 37%, or $78.8 million, to $137.2 million primarily due to lower results of approximately $72 million in the United Kingdom, Russia, our travel retail business, France, the Balkans and Spain.  Partially offsetting these decreases were higher results in the Middle East and Germany of approximately $4 million.

 

In Asia/Pacific, operating income increased 29%, or $25.9 million, to $115.1 million.  Most of our affiliates in this region experienced an increase despite the recent softening in certain economic environments.  Approximately $26 million of this increase was generated in Japan, China, Hong Kong and Korea.  These increases were partially offset by lower results in Australia and New Zealand of approximately $4 million, combined.

 

INTEREST EXPENSE, NET

 

Net interest expense was $34.9 million as compared with $36.7 million in the prior-year period.  This change primarily resulted from lower average interest rates on borrowings, partially offset by higher average debt balances which include an additional $300.0 million of senior notes issued in the current-year period.

 

PROVISION FOR INCOME TAXES

 

The provision for income taxes represents Federal, foreign, state and local income taxes.  The effective rate differs from statutory rates due to the effect of state and local income taxes, tax rates in foreign jurisdictions and certain nondeductible expenses.  Our effective tax rate will change from quarter to quarter based on recurring and non-recurring factors including, but not limited to, the geographical mix of earnings, enacted tax legislation, state and local income taxes, tax audit settlements and the interaction of various global tax strategies.  In addition, changes in judgment from the evaluation of new information resulting in the recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of the change.

 

The effective rate for income taxes for the six months ended December 31, 2008 was 35.7% as compared with 35.0% in the prior-year period.  The increase in the effective income tax rate of 70 basis points was primarily attributable to the tax impact of our foreign operations.

 

26



Table of Contents

 

THE ESTÉE LAUDER COMPANIES INC.

 

FINANCIAL CONDITION

 

LIQUIDITY AND CAPITAL RESOURCES

 

Overview

Our principal sources of funds historically have been cash flows from operations, borrowings pursuant to our commercial paper program, borrowings from the issuance of long-term debt and committed and uncommitted credit lines provided by banks and other lenders in the United States and abroad.  At December 31, 2008, we had cash and cash equivalents of $728.9 million compared with $401.7 million at June 30, 2008.

 

Our business is seasonal in nature and, accordingly, our working capital needs vary.  From time to time, we may enter into investing and financing transactions that require additional funding.  To the extent that these needs exceed cash from operations, we could, subject to market conditions, issue commercial paper, issue long-term debt securities or borrow under our revolving credit facilities.

 

During fiscal 2009, we have been able to issue commercial paper in amounts and with terms that we deem acceptable.  We do not anticipate protracted difficulties in securing this form of working capital financing.  However, in order to maintain sufficient cash reserves over a longer period of time, in light of the current macroeconomic conditions, and the real or perceived lack of available credit, we issued $300.0 million of 7.75% Senior Notes due November 1, 2013 during the second quarter of fiscal 2009.  The net proceeds were used to repay then-outstanding commercial paper balances upon their maturity.

 

Based on past performance and current expectations, we believe that cash on hand, cash generated from operations, available credit lines and access to credit markets will be adequate to support currently planned business operations, information systems enhancements, capital expenditures, potential stock repurchases, commitments and other contractual obligations on both a near-term and long-term basis.

 

The effects of inflation have not been significant to our overall operating results in recent years.  Generally, we have been able to introduce new products at higher selling prices or increase selling prices sufficiently to offset cost increases, which have been moderate.

 

Debt

At December 31, 2008, our outstanding borrowings were as follows:

 

 

 

Long-term
Debt

 

Short-term
Debt

 

Total Debt

 

 

 

(In millions)

 

 

 

 

 

 

 

 

 

6.00% Senior Notes, due May 15, 2037 (1)

 

$

296.2

 

$

 

$

296.2

 

5.75% Senior Notes, due October 15, 2033 (2)

 

197.5

 

 

197.5

 

5.55% Senior Notes, due May 15, 2017 (3)

 

341.4

 

 

341.4

 

7.75% Senior Notes, due November 1, 2013 <