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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 March 31, 2004
OR
Transition Report Pursuant to Section 13 or 15(d) of the Securities
- Exchange Act of 1934
Commission file number 1-14064
The Estee Lauder Companies Inc.
(Exact name of registrant as specified in its charter)
Delaware 11-2408943
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
767 Fifth Avenue, New York, New York 10153
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 212-572-4200
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.
X Yes No
- - -
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
X Yes No
- - -
At April 21, 2004, 121,753,886 shares of the registrant's Class A Common Stock,
$.01 par value, and 105,484,533 shares of the registrant's Class B Common Stock,
$.01 par value, were outstanding.
THE ESTEE LAUDER COMPANIES INC.
Index
Page
----
Part I. Financial Information
Item 1. Financial Statements..................................................2
Consolidated Statements of Earnings --
Three Months and Nine Months Ended March 31, 2004 and 2003......2
Consolidated Balance Sheets --
March 31, 2004 and June 30, 2003................................3
Consolidated Statements of Cash Flows --
Nine Months Ended March 31, 2004 and 2003.......................4
Notes to Consolidated Financial Statements...........................5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................14
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........27
Item 4. Controls and Procedures..............................................27
Part II. Other Information...................................................28
THE ESTEE LAUDER COMPANIES INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Nine Months Ended
March 31 March 31
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions, except per share data)
Net Sales........................................................ $ 1,421.6 $ 1,233.5 $ 4,387.3 $ 3,876.7
Cost of sales.................................................... 358.6 313.8 1,135.4 1,037.1
--------- --------- --------- ---------
Gross Profit..................................................... 1,063.0 919.7 3,251.9 2,839.6
--------- --------- --------- ---------
Operating expenses:
Selling, general and administrative........................... 887.9 786.0 2,716.7 2,408.7
Related party royalties....................................... 5.5 4.4 16.9 14.8
--------- --------- --------- ---------
893.4 790.4 2,733.6 2,423.5
--------- --------- --------- ---------
Operating Income................................................. 169.6 129.3 518.3 416.1
Interest expense, net............................................ 6.9 1.9 21.8 7.0
--------- --------- --------- ---------
Earnings before Income Taxes, Minority Interest
and Discontinued Operations..................................... 162.7 127.4 496.5 409.1
Provision for income taxes....................................... 60.9 41.3 185.7 136.0
Minority interest, net of tax.................................... (1.7) (1.1) (6.7) (3.9)
--------- --------- --------- ---------
Net Earnings from Continuing Operations.......................... 100.1 85.0 304.1 269.2
Discontinued operations, net of tax.............................. (1.8) (1.2) (33.1) (2.4)
--------- --------- --------- ---------
Net Earnings .................................................... 98.3 83.8 271.0 266.8
Preferred stock dividends........................................ - 5.9 - 17.6
--------- --------- --------- ---------
Net Earnings Attributable to Common Stock........................ $ 98.3 $ 77.9 $ 271.0 $ 249.2
========= ========= ========= =========
Basic net earnings per common share:
Net earnings attributable to common stock from
continuing operations...................................... $ .44 $ .34 $ 1.33 $ 1.08
Discontinued operations..................................... (.01) (.00) (.14) (.01)
--------- --------- --------- ---------
Net earnings attributable to common stock................... $ .43 $ .34 $ 1.19 $ 1.07
========= ========= ========= =========
Diluted net earnings per common share:
Net earnings attributable to common stock from
continuing operations...................................... $ .43 $ .34 $ 1.31 $ 1.07
Discontinued operations..................................... (.01) (.01) (.14) (.01)
--------- --------- --------- ---------
Net earnings attributable to common stock................... $ .42 $ .33 $ 1.17 $ 1.06
========= ========= ========= =========
Weighted average common shares outstanding:
Basic....................................................... 228.3 232.1 228.3 233.5
Diluted..................................................... 231.9 234.0 231.4 235.5
Cash dividends declared per common share......................... $ - $ - $ .30 $ .20
See notes to consolidated financial statements.
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED BALANCE SHEETS
March 31 June 30
2004 2003
---- ----
(Unaudited)
(In millions)
ASSETS
Current Assets
Cash and cash equivalents............................................................... $ 867.8 $ 364.1
Accounts receivable, net................................................................ 786.7 634.2
Inventory and promotional merchandise, net.............................................. 574.5 599.0
Prepaid expenses and other current assets............................................... 243.4 247.6
-------- --------
Total current assets............................................................... 2,472.4 1,844.9
-------- --------
Property, Plant and Equipment, net...................................................... 620.4 607.7
-------- --------
Other Assets
Investments, at cost or market value.................................................... 13.8 14.0
Deferred income taxes................................................................... 24.3 38.7
Goodwill, net........................................................................... 671.5 695.3
Other intangible assets, net............................................................ 65.6 65.4
Other assets, net....................................................................... 74.1 83.9
-------- --------
Total other assets................................................................. 849.3 897.3
-------- --------
Total assets.............................................................. $3,942.1 $3,349.9
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt......................................................................... $ 5.3 $ 7.8
Accounts payable........................................................................ 226.1 229.9
Accrued income taxes.................................................................... 129.5 111.9
Other accrued liabilities............................................................... 921.6 704.0
-------- --------
Total current liabilities.......................................................... 1,282.5 1,053.6
-------- --------
Noncurrent Liabilities
Long-term debt.......................................................................... 836.3 283.6
Other noncurrent liabilities............................................................ 164.3 216.8
-------- --------
Total noncurrent liabilities....................................................... 1,000.6 500.4
-------- --------
Cumulative Redeemable Preferred Stock, at redemption value.............................. - 360.0
-------- --------
Minority Interest....................................................................... 18.0 12.3
-------- --------
Stockholders' Equity
Common stock, $.01 par value; 650,000,000 shares Class A authorized; shares
issued: 137,810,112 at March 31, 2004 and 133,616,710 at June 30, 2003;
240,000,000 shares Class B authorized; shares issued and outstanding: 105,484,533
at March 31, 2004 and 107,462,533 at June 30, 2003................................... 2.4 2.4
Paid-in capital......................................................................... 356.9 293.7
Retained earnings....................................................................... 1,816.1 1,613.6
Accumulated other comprehensive loss.................................................... (3.1) (53.1)
-------- --------
2,172.3 1,856.6
Less: Treasury stock, at cost; 16,083,560 Class A shares at March 31, 2004
and 13,623,060 Class A shares at June 30, 2003....................................... (531.3) (433.0)
-------- --------
Total stockholders' equity......................................................... 1,641.0 1,423.6
-------- --------
Total liabilities and stockholders' equity................................ $3,942.1 $3,349.9
======== ========
See notes to consolidated financial statements.
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
March 31
------------------
2004 2003
---- ----
(In millions)
Cash Flows from Operating Activities
Net earnings............................................................................... $ 271.0 $ 266.8
Adjustments to reconcile net earnings to net cash flows provided by
operating activities from continuing operations:
Depreciation and amortization.......................................................... 139.2 127.8
Deferred income taxes.................................................................. 12.0 25.8
Minority interest...................................................................... 6.7 3.9
Non-cash stock compensation............................................................ 5.6 0.1
Discontinued operations................................................................ 33.1 -
Other.................................................................................. 0.8 -
Changes in operating assets and liabilities:
Increase in accounts receivable, net................................................... (128.9) (88.6)
Decrease in inventory and promotional merchandise, net................................. 39.6 23.0
(Increase) decrease in other assets, net............................................... 6.0 (8.9)
Decrease in accounts payable........................................................... (12.4) (36.6)
Increase in accrued income taxes....................................................... 32.3 6.7
Increase in other accrued liabilities.................................................. 127.2 125.7
Increase (decrease) in other noncurrent liabilities.................................... 18.5 (26.4)
--------- ---------
Net cash flows provided by operating activities of continuing operations............. 550.7 419.3
--------- ---------
Cash Flows from Investing Activities
Capital expenditures....................................................................... (130.9) (107.1)
Acquisition of businesses, net of cash acquired............................................ (3.9) (7.1)
Proceeds from divestitures................................................................. 3.0 -
Proceeds from the disposition of long-term investments..................................... - 4.0
Purchases of long-term investments......................................................... (0.1) -
--------- ---------
Net cash flows used for investing activities of continuing operations................ (131.9) (110.2)
--------- ---------
Cash Flows from Financing Activities
Increase (decrease) in short-term debt, net................................................ (2.0) 0.7
Proceeds from the issuance of long-term debt, net.......................................... 197.3 -
Debt issuance costs........................................................................ (1.8) -
Proceeds from the net settlement of treasury lock agreements............................... 15.0 -
Repayments of long-term debt............................................................... (2.1) (42.8)
Net proceeds from employee stock transactions.............................................. 43.7 2.0
Payments to acquire treasury stock......................................................... (98.3) (215.5)
Dividends paid to stockholders............................................................. (68.5) (75.9)
Distributions made to minority holders..................................................... (2.8) (3.4)
--------- ---------
Net cash flows provided by (used for) financing activities of continuing operations.. 80.5 (334.9)
--------- ---------
Effect of Exchange Rate Changes on Cash and Cash Equivalents.................................. 5.5 6.9
--------- ---------
Cash flows used for discontinued operations................................................... (1.1) -
--------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents....................................... 503.7 (18.9)
Cash and Cash Equivalents at Beginning of Period........................................... 364.1 546.9
--------- ---------
Cash and Cash Equivalents at End of Period................................................. $ 867.8 $ 528.0
========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest............................................................................... $ 25.9 $ 17.2
========= =========
Income taxes........................................................................... $ 134.6 $ 95.3
========= =========
Non-cash items:
Tax benefit from exercise of stock options............................................. $ 14.1 $ 0.5
========= =========
See notes to consolidated financial statements.
THE ESTEE 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
Estee Lauder Companies Inc. and its subsidiaries (collectively, the "Company")
as continuing operations with the exception of the results of its former
reporting unit that sold jane brand products which are reflected as discontinued
operations (see Note 5). All significant intercompany balances and transactions
have been eliminated.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles 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 generally accepted accounting principles for complete financial statements.
In the opinion of management all adjustments (consisting of normal recurring
accruals) 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 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, 2003.
Certain amounts in the consolidated financial statements of prior periods have
been reclassified to conform to current period presentation for comparative
purposes.
Net Earnings Per Common Share
For the three and nine month periods ended March 31, 2004, net earnings per
common share ("basic EPS") is computed by dividing net earnings, which includes
preferred stock dividends (see "Recently Issued Accounting Standards"), by the
weighted average number of common shares outstanding and contingently issuable
shares (which satisfy certain conditions). For the three and nine month periods
ended March 31, 2003, net earnings per common share ("basic EPS") is computed by
dividing net earnings, after deducting preferred stock dividends on the
Company's Cumulative Redeemable Preferred Stock, 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 the exercise
of stock options.
A reconciliation between the numerators and denominators of the basic and
diluted EPS computations is as follows:
Three Months Ended Nine Months Ended
March 31 March 31
------------------ ------------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions, except per share data)
Numerator:
Net earnings from continuing operations............................... $ 100.1 $ 85.0 $ 304.1 $ 269.2
Preferred stock dividends............................................. - 5.9 - 17.6
-------- -------- -------- --------
Net earnings attributable to common stock from continuing operations.. 100.1 79.1 304.1 251.6
Discontinued operations, net of tax................................... (1.8) (1.2) (33.1) (2.4)
-------- -------- -------- --------
Net earnings attributable to common stock............................. $ 98.3 $ 77.9 $ 271.0 $ 249.2
======== ======== ======== ========
Denominator:
Weighted average common shares outstanding - Basic.................... 228.3 232.1 228.3 233.5
Effect of dilutive securities: Stock options.......................... 3.6 1.9 3.1 2.0
-------- -------- -------- --------
Weighted average common shares outstanding - Diluted.................. 231.9 234.0 231.4 235.5
======== ======== ======== ========
Basic net earnings per common share:
Net earnings from continuing operations............................... $ .44 $ .34 $ 1.33 $ 1.08
Discontinued operations, net of tax................................... (.01) (.00) (.14) (.01)
-------- -------- -------- --------
Net earnings.......................................................... $ .43 $ .34 $ 1.19 $ 1.07
======== ======== ======== ========
Diluted net earnings per common share:
Net earnings from continuing operations............................... $ .43 $ .34 $ 1.31 $ 1.07
Discontinued operations, net of tax................................... (.01) (.01) (.14) (.01)
-------- -------- -------- --------
Net earnings.......................................................... $ .42 $ .33 $ 1.17 $ 1.06
======== ======== ======== ========
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of March 31, 2004 and 2003, outstanding options to purchase 9.4 million and
21.8 million shares, respectively, of common stock were not included in the
computation of diluted EPS because the exercise prices of those options were
greater than the average market price of the common stock during the applicable
periods.
Dividends
On November 5, 2003, the Board of Directors declared an annual dividend of $.30
per share on Class A and Class B Common Stock, payable on January 6, 2004 to
stockholders of record at the close of business on December 16, 2003. On October
30, 2002, the Board of Directors declared an annual dividend of $.20 per share,
payable on January 3, 2003 to stockholders of record at the close of business on
December 12, 2002. During the quarters ended March 31, 2004 and 2003, the
Company paid dividends of $68.5 million and $46.5 million, respectively.
Employee Stock-Based Compensation
As of March 31, 2004, the Company had established a number of share incentive
programs as discussed in more detail in our annual report on Form 10-K for the
year ended June 30, 2003. The Company applies the intrinsic value method as
outlined in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations in accounting for stock
options and share units granted under these programs. Under the intrinsic value
method, no compensation expense is recognized if the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of the grant. Accordingly, no compensation cost has been recognized.
Statement of Financial Accounting Standard ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," requires that the Company provide pro forma
information regarding net earnings and net earnings per common share as if
compensation cost for the Company's stock option programs had been determined in
accordance with the fair value method prescribed therein. The Company adopted
the disclosure portion of SFAS No. 148, "Accounting for Stock-Based Compensation
- - Transition and Disclosure" requiring quarterly SFAS No. 123 pro forma
disclosure. The following table illustrates the effect on net income and
earnings per share as if the fair value method had been applied to all
outstanding awards in each period presented.
Three Months Ended Nine Months Ended
March March
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions, except per share data)
Net earnings attributable to common stock, as reported................ $ 98.3 $ 77.9 $ 271.0 $ 249.2
Deduct: Total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects................................... (7.1) (6.1) (24.3) (16.9)
------ ------ ------- -------
Pro forma net earnings, attributable to common stock.................. $ 91.2 $ 71.8 $ 246.7 $ 232.3
====== ====== ======= =======
Earnings per common share:
Basic - as reported................................................ $ .43 $ .34 $ 1.19 $ 1.07
====== ====== ======= =======
Basic - pro forma.................................................. $ .40 $ .31 $ 1.08 $ .99
====== ====== ======= =======
Diluted - as reported.............................................. $ .42 $ .33 $ 1.17 $ 1.06
====== ====== ======= =======
Diluted - pro forma................................................ $ .39 $ .31 $ 1.06 $ .98
====== ====== ======= =======
Accounts Receivable
Accounts receivable is stated net of the allowance for doubtful accounts and
retail customer deductions of $30.2 million and $31.8 million as of March 31,
2004 and June 30, 2003, respectively.
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventory and Promotional Merchandise
Inventory and promotional merchandise only include inventory considered saleable
or usable in future periods, and are stated at the lower of cost or market, with
cost being determined on the first-in, first-out method. Promotional merchandise
is charged to expense at the time the merchandise is shipped to the Company's
customers.
March 31 June 30
2004 2003
---- ----
(Unaudited)
(In millions)
Inventory and promotional merchandise consists of:
Raw materials......................................... $ 96.9 $ 137.7
Work in process....................................... 28.6 34.1
Finished goods........................................ 328.6 296.6
Promotional merchandise............................... 120.4 130.6
-------- --------
$ 574.5 $ 599.0
======== ========
Property, Plant and Equipment
Property, plant and equipment are carried at cost less accumulated depreciation
and amortization. For financial statement purposes, depreciation is provided
principally on the straight-line method over the estimated useful lives of the
assets ranging from 3 to 40 years. Leasehold improvements are amortized on a
straight-line basis over the shorter of the lease term or the expected useful
life of those improvements.
March 31 June 30
2004 2003
---- ----
(Unaudited)
(In millions)
Land.................................................... $ 13.7 $ 13.5
Buildings and improvements.............................. 159.4 152.7
Machinery and equipment................................. 668.6 599.5
Furniture and fixtures.................................. 101.7 95.3
Leasehold improvements.................................. 602.0 538.1
--------- ---------
1,545.4 1,399.1
Less accumulated depreciation and amortization.......... 925.0 791.4
--------- ---------
$ 620.4 $ 607.7
========= =========
Depreciation and amortization of property, plant and equipment was $44.8 million
and $38.7 million during the three months ended March 31, 2004 and 2003,
respectively, and $129.3 million and $113.5 million during the nine months ended
March 31, 2004 and 2003, respectively.
Restructuring Accrual
During the nine-month period ended March 31, 2004, the Company paid $12.1
million against its restructuring accrual of which $9.7 million related to the
fiscal 2002 charges and $2.4 million related to the fiscal 2001 charges,
bringing the restructuring accrual balance at March 31, 2004 to $12.4 million.
Of the amount paid during the nine-month period ended March 31, 2004,
approximately $9.0 million related to severance payments. There have been no
material changes to the restructuring plans since June 30, 2003.
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pension and Postretirement 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 contributory postretirement
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, 2003.
The components of net periodic benefit cost for the three months ended March 31,
2004 and 2003 consisted of the following:
Other than
Pension Plans Pension Plans
------------------------------------------------- -----------------
U.S. International Postretirement
----------------------- --------------------- -----------------
2004 2003 2004 2003 2004 2003
-------- -------- ------- ------- ------- -------
(Unaudited)
(In millions)
Service cost.................................... $ 4.2 $ 3.8 $ 2.7 $ 2.1 $ 0.7 $ 0.5
Interest cost................................... 5.0 5.3 2.3 2.0 0.9 0.8
Expected return on plan assets.................. (5.2) (4.6) (2.6) (2.3) - -
Amortization of:
Transition (asset) obligation................ - (0.4) 0.1 0.1 - -
Prior service cost........................... 0.1 0.1 0.1 0.1 - -
Actuarial loss (gain)........................ 1.6 1.3 0.9 0.4 - -
Settlements and curtailments.................... - - - - - -
-------- -------- -------- -------- -------- --------
Net periodic benefit cost....................... $ 5.7 $ 5.5 $ 3.5 $ 2.4 $ 1.6 $ 1.3
======== ======== ======== ======== ======== ========
The components of net periodic benefit cost for the nine months ended March 31,
2004 and 2003 consisted of the following:
Other than
Pension Plans Pension Plans
------------------------------------------------- -----------------
U.S. International Postretirement
----------------------- --------------------- -----------------
2004 2003 2004 2003 2004 2003
-------- -------- ------- ------- ------- -------
(Unaudited)
(In millions)
Service cost.................................... $ 12.7 $ 11.3 $ 7.9 $ 6.4 $ 2.1 $ 1.7
Interest cost................................... 15.0 15.9 6.7 6.1 2.6 2.4
Expected return on plan assets.................. (15.5) (13.7) (7.6) (6.9) - -
Amortization of:
Transition (asset) obligation................ - (1.1) 0.3 0.2 - -
Prior service cost........................... 0.4 0.2 0.2 0.2 - -
Actuarial loss (gain)........................ 4.6 3.8 2.6 1.1 - (0.1)
Settlements and curtailments.................... - - - - - -
-------- -------- -------- -------- -------- --------
Net periodic benefit cost....................... $ 17.2 $ 16.4 $ 10.1 $ 7.1 $ 4.7 $ 4.0
======== ======== ======== ======== ======== ========
Management Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses
reported in those financial statements. These judgements can be subjective and
complex, and consequently actual results could differ from those estimates and
assumptions. The Company's most critical accounting policies relate to revenue
recognition; concentration of credit risk; inventory; pension and other
postretirement 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, 2003.
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recently Issued Accounting Standards
On January 12, 2004, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position No. FAS 106-1, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003," ("FSP No. 106-1") in response to a new law regarding prescription drug
benefits under Medicare ("Medicare Part D") as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that is at
least actuarially equivalent to Medicare Part D. Currently, SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions," ("SFAS
No. 106") requires that changes in relevant law be considered in current
measurement of postretirement benefit costs. However, certain accounting issues
related to the federal subsidy remain unclear and significant uncertainties may
exist which impair a plan sponsor's ability to evaluate the direct effects of
the new law and the ancillary effects on plan participants' behavior and
healthcare costs. Due to these uncertainties, FSP No. 106-1 provides plan
sponsors with an opportunity to elect to defer recognizing the effects of the
new law in the accounting for its retiree health care benefit plans under SFAS
No. 106 and to provide related disclosures until authoritative guidance on the
accounting for the federal subsidy is issued and clarification regarding other
uncertainties is resolved. The Company has elected to defer recognition while
evaluating the new law and the pending issuance of authoritative guidance and
their effect, if any, on the Company's results of operations, financial position
and financial statement disclosure. Therefore, any measures of the accumulated
postretirement benefit obligation or the net periodic postretirement benefit
cost do not reflect the effects of the new law and issued guidance could require
the Company to change previously reported information.
In December 2003, the FASB issued FASB Interpretation Number 46-R ("FIN 46-R"),
"Consolidation of Variable Interest Entities." FIN 46-R, which modifies certain
provisions and effective dates of FIN 46, sets forth criteria to be used in
determining whether an investment in a variable interest entity should be
consolidated. These provisions are based on the general premise that if a
company controls another entity through interests other than voting interests,
that company should consolidate the controlled entity. The Company has evaluated
whether the provisions of FIN 46-R are applicable to its investments, certain of
which are currently accounted for by the equity method, as well as other
arrangements, which may meet the criteria of the interpretation, and believes
that there are currently no material arrangements that meet the definition of a
variable interest entity which would require consolidation.
In December 2003, the FASB revised SFAS No. 132, "Employers' Disclosures about
Pensions and other Postretirement Benefits," ("SFAS No. 132") establishing
additional annual disclosures about plan assets, investment strategy,
measurement date, plan obligations and cash flows. In addition, the revised
standard established interim disclosure requirements related to the net periodic
benefit cost recognized and contributions paid or expected to be paid during the
current fiscal year. The new annual disclosures are effective for financial
statements of companies with fiscal years ending after December 15, 2003 and the
interim-period disclosures are effective for interim periods beginning after
December 15, 2003. The Company will adopt the annual disclosures for its fiscal
year ending June 30, 2004 and has adopted the interim disclosures for its fiscal
quarter ended March 31, 2004. The adoption of the revised SFAS No. 132 will have
no impact on the Company's results of operation or financial condition.
The Company has adopted SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity," ("SFAS No.
150"). SFAS No. 150 established standards for classifying and measuring certain
financial instruments with characteristics of both liabilities and equity. Among
other things, it specifically requires that mandatorily redeemable instruments,
such as redeemable preferred stock, be classified as a liability. Initial and
subsequent measurements of the instruments differ based on the characteristics
of each instrument and as provided for in the statement. Based on the provisions
of this statement, the Company has classified the Cumulative Redeemable
Preferred Stock as a liability and the related dividends thereon have been
characterized as interest expense. Restatement of financial statements for
earlier years presented was not permitted. The adoption of this statement has
resulted in the inclusion of the dividends on the preferred stock (equal to $4.3
million and $14.4 million, respectively, for the three and nine months ended
March 31, 2004) as interest expense. While the inclusion has impacted net
earnings, net earnings attributable to common stock and earnings per common
share were unaffected. Given that the dividends are not deductible for income
tax purposes, the inclusion of the preferred stock dividends as interest expense
has caused an increase in the effective tax rate. The adoption of SFAS No. 150
had no impact on the Company's financial condition.
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Long-Term Debt
At March 31, 2004, the Company's long-term debt of $836.3 million included:
(i) $360.0 million of Cumulative Redeemable Preferred Stock, which shares have a
mandatory redemption date of June 30, 2015 (see "Recently Issued Accounting
Standards"); (ii) $251.5 million of 6% Senior Notes due January 2012 consisting
of $250.0 million principal, unamortized debt discount of $0.9 million and a
$2.4 million adjustment to reflect the fair value of an outstanding interest
rate swap; (iii) $197.3 million of 5.75% Senior Notes due October 2033
consisting of $200.0 million principal and unamortized debt discount of $2.7
million; and (iv) a 3.0 billion yen term loan (approximately $27.5 million at
current exchange rates), which is due in March 2006.
On July 1, 2003, the Company adopted the provisions of SFAS No. 150 and,
accordingly, has classified the $360.0 million Cumulative Redeemable Preferred
Stock as long-term debt. This standard requires the classification of the
Cumulative Redeemable Preferred Stock as a liability without restatement, and,
as such, the Company did not restate the consolidated financial statements for
earlier periods presented.
In September 2003, the Company issued and sold $200.0 million of 5.75% Senior
Notes due October 2033 ("5.75% Senior Notes") in a public offering. The 5.75%
Senior Notes were priced at 98.645% with a yield of 5.846%. Interest payments,
which will commence on April 15, 2004, will be made semi-annually on April 15
and October 15 of each year. In May 2003, in anticipation of the issuance of the
5.75% Senior Notes, the Company entered into a series of treasury lock
agreements on a notional amount totaling $195.0 million at a weighted average
all-in rate of 4.53%. The treasury lock agreements were settled upon the
issuance of the new debt and the Company received a payment of $15.0 million
that will be amortized against interest expense over the life of the 5.75%
Senior Notes. As a result of the treasury lock agreements, debt discount and
debt issuance costs, the effective interest rate on the 5.75% Senior Notes will
be 5.395% over the life of the debt.
On December 31, 2003, the Company and the holders of the Cumulative Redeemable
Preferred Stock exchanged all of the outstanding shares of $6.50 Cumulative
Redeemable Preferred Stock due June 30, 2005 for a newly issued series of
Cumulative Redeemable Preferred Stock with a mandatory redemption date of June
30, 2015 ("2015 Preferred Stock"). Assuming no early redemption, dividends on
the 2015 Preferred Stock are payable at a rate per annum of 4.75%, payable
quarterly, until June 30, 2005, down from 6.5% during that period for the
original $6.50 Cumulative Redeemable Preferred Stock, and thereafter will be
payable at a rate set semi-annually and equal to the after-tax yield on six-
month U.S. Treasuries. The 2015 Preferred Stock may be put to the Company under
certain circumstances, and may be called for redemption by the Company under
certain similar circumstances; however, in each case the puts or calls may not
occur until after the passing of Mrs. Estee Lauder. For the shares held by one
holder (which holds $68.4 million of the principal amount of the shares of 2015
Preferred Stock after the exchange), the Company's call right will not be
exercisable until the thirteenth-month anniversary of Mrs. Lauder's passing.
However, if the Company calls and pays for the other shares of the 2015
Preferred Stock prior to June 30, 2005, then the dividend rate on the shares
held by that holder, or its transferees, will automatically change to the rate
based on six-month U.S. Treasuries upon Mrs. Lauder's passing even if prior to
June 30, 2005. This exchange transaction has been accounted for as a
modification of the terms of the Cumulative Redeemable Preferred Stock, and
accordingly, the effects of this transaction on the Company's operating results
have been limited to the prospective change in dividend rates described above.
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Comprehensive Income
The components of accumulated other comprehensive income ("OCI") included in the
accompanying consolidated balance sheets consist of net unrealized investment
gain (loss), net gain or (loss) on derivative instruments designated and
qualifying as cash-flow hedging instruments, net minimum pension liability
adjustments and cumulative translation adjustments as of the end of each period.
Comprehensive income and its components, net of tax, are as follows:
Three Months Ended Nine Months Ended
March 31 March 31
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions)
Net earnings..................................................... $ 98.3 $ 83.8 $ 271.0 $ 266.8
------- ------- ------- -------
Other comprehensive income (loss):
Net unrealized investment gain (loss)....................... 0.2 1.2 0.2 (0.3)
Net derivative instruments gain (loss)...................... 4.1 3.5 9.4 7.5
Net minimum pension liability adjustments................... - - 0.5 (0.3)
Translation adjustments..................................... 2.7 7.8 39.9 18.8
------- ------- ------- -------
Other comprehensive income (loss)........................... 7.0 12.5 50.0 25.7
------- ------- ------- -------
Comprehensive income............................................. $ 105.3 $ 96.3 $ 321.0 $ 292.5
======= ======= ======= =======
The accumulated net gain (loss) on derivative instruments consists of the
following:
Three Months Ended Nine Months Ended
March 31 March 31
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions)
OCI - derivative instruments, beginning of period................ $ 3.8 $ (5.1) $ (1.5) $ (9.1)
------- ------- ------- -------
Gain (loss) on derivative instruments....................... 0.2 2.2 0.7 2.5
Reclassification to earnings of net loss during the period.. 6.0 2.9 14.7 8.9
Provision for deferred income taxes......................... (2.1) (1.6) (6.0) (3.9)
------- ------- ------- -------
Net derivative instruments gain (loss)...................... 4.1 3.5 9.4 7.5
------- ------- ------- -------
OCI - derivative instruments, end of period...................... $ 7.9 $ (1.6) $ 7.9 $ (1.6)
======= ======= ======= =======
Of the $7.9 million, net of tax, derivative instrument gain recorded in OCI at
the end of the current-year period, $9.1 million, net of tax, related to the
proceeds from the settlement of the treasury lock agreements upon issuance of
the 5.75% Senior Notes which will be reclassified to earnings as an offset to
interest expense over the life of the debt and was offset by a $1.2 million
loss, net of tax, related to forward and option contracts which the Company will
reclassify to earnings during the next fifteen months. At the end of the prior-
year period the $1.6 million, net of tax, derivative instrument loss recorded in
OCI related to forward and option contracts.
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - Acquisition of Business
In July 2003, the Company acquired the Rodan & Fields skin care line. The
initial purchase price, paid at closing, was funded by cash provided by
operations, the payment of which did not have a material effect on the Company's
results of operations or consolidated financial condition. The Company may be
required to make additional payments between fiscal 2007 and 2011 based on
certain conditions. In addition, during the nine months ended March 31, 2004,
there was other minor acquisition activity. Pro forma results of operations, as
if such businesses had been acquired as of the beginning of the fiscal year,
have not been presented, as the impact on the Company's consolidated financial
results would not have been material.
Note 5 - Divestiture and Discontinued Operations
In February 2004, the Company sold the assets and operations of its reporting
unit that sold jane brand products. Prior to the sale of the business, in
December 2003, the Company committed to a plan to sell such assets and
operations. At the time the decision was made, circumstances warranted that the
Company conduct an assessment of the tangible and intangible assets of the jane
business. Based on this assessment, the Company determined that the carrying
amount of these assets as reflected on the Company's consolidated balance sheets
exceeded their estimated fair value. In accordance with the assessment and the
closing of the sale, the Company recorded an after-tax charge to discontinued
operations of $33.1 million for the nine months ended March 31, 2004. The charge
represents the impairment of goodwill in the amount of $26.4 million; the
reduction in value of other tangible assets in the amount of $1.3 million, net
of taxes; and the operating loss of $5.4 million, net of tax. Included in the
operating loss of the nine-month period were additional costs associated with
the sale and discontinuation of the business. For the three months ended March
31, 2004, the Company recorded $1.8 million, net of taxes, representing
additional costs associated with the sale and discontinuation of the business.
All consolidated statements of earnings information for prior periods has been
restated for comparative purposes, including the restatement of the makeup
product category and the Americas region data presented in Note 6. As of March
31, 2004, accrued liabilities related to the discontinued operations were $3.6
million.
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6 - 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 and
net interest expense. The accounting policies for each of the 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 June 30, 2003 annual report on Form 10-K. 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 each segment since June 30, 2003 other than the reduction of the assets
associated with the discontinuance and sale of our reporting unit which sold
jane products.
Three Months Ended Nine Months Ended
March 31 March 31
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions)
Product Category
Net Sales:
Skin Care........................................................ $ 559.1 $ 507.8 $ 1,594.1 $ 1,408.6
Makeup........................................................... 591.0 485.5 1,607.1 1,418.3
Fragrance........................................................ 203.4 181.6 980.9 864.4
Hair Care........................................................ 61.3 53.2 179.1 163.8
Other............................................................ 6.8 5.4 26.1 21.6
--------- --------- --------- ---------
$ 1,421.6 $ 1,233.5 $ 4,387.3 $ 3,876.7
========= ========= ========= =========
Operating Income:
Skin Care........................................................ $ 96.0 $ 74.4 $ 253.8 $ 204.8
Makeup........................................................... 96.1 61.0 206.1 158.5
Fragrance........................................................ (27.6) (7.6) 38.7 42.4
Hair Care........................................................ 3.3 1.8 16.8 10.4
Other............................................................ 1.8 (0.3) 2.9 -
--------- --------- --------- ---------
169.6 129.3 518.3 416.1
Reconciliation:
Interest expense, net......................................... 6.9 1.9 21.8 7.0
--------- --------- --------- ---------
Earnings before income taxes, minority interest and
discontinued operations....................................... $ 162.7 $ 127.4 $ 496.5 $ 409.1
========= ========= ========= =========
REGIONAL DATA
Net Sales:
The Americas..................................................... $ 783.1 $ 715.6 $ 2,439.3 $ 2,274.8
Europe, the Middle East & Africa................................. 453.1 361.5 1,367.6 1,104.0
Asia/Pacific..................................................... 185.4 156.4 580.4 497.9
--------- --------- --------- ---------
$ 1,421.6 $ 1,233.5 $ 4,387.3 $ 3,876.7
========= ========= ========= =========
Operating Income:
The Americas..................................................... $ 102.8 $ 78.4 $ 281.3 $ 216.8
Europe, the Middle East & Africa................................. 57.2 44.7 193.7 162.7
Asia/Pacific..................................................... 9.6 6.2 43.3 36.6
--------- --------- --------- ---------
$ 169.6 $ 129.3 $ 518.3 $ 416.1
========= ========= ========= =========
Note 7 - Subsequent Event
On April 24, 2004, Mrs. Estee Lauder passed away. At that time, the 2015
Preferred Stock, as described in Note 2 and included in our long-term debt as
of March 31, 2004, became current based upon the ability of the holders of the
2015 Preferred Stock to put the shares to the Company for redemption.
THE ESTEE 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
130 countries and territories. The following is a comparative summary of
operating results for the three and nine months ended March 31, 2004 and 2003,
and reflects the basis of presentation described in Note 1 to the consolidated
financial statements 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 Nine Months Ended
March 31 March 31
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Net Sales
By Region:
The Americas............................................... $ 783.1 $ 715.6 $ 2,439.3 $ 2,274.8
Europe, the Middle East & Africa........................... 453.1 361.5 1,367.6 1,104.0
Asia/Pacific............................................... 185.4 156.4 580.4 497.9
--------- --------- --------- ---------
$ 1,421.6 $ 1,233.5 $ 4,387.3 $ 3,876.7
========= ========= ========= =========
By Product Category:
Skin Care.................................................. $ 559.1 $ 507.8 $ 1,594.1 $ 1,408.6
Makeup..................................................... 591.0 485.5 1,607.1 1,418.3
Fragrance.................................................. 203.4 181.6 980.9 864.4
Hair Care.................................................. 61.3 53.2 179.1 163.8
Other...................................................... 6.8 5.4 26.1 21.6
--------- --------- --------- ---------
$ 1,421.6 $ 1,233.5 $ 4,387.3 $ 3,876.7
========= ========= ========= =========
Operating Income
By Region:
The Americas............................................... $ 102.8 $ 78.4 $ 281.3 $ 216.8
Europe, the Middle East & Africa........................... 57.2 44.7 193.7 162.7
Asia/Pacific............................................... 9.6 6.2 43.3 36.6
--------- --------- --------- ---------
$ 169.6 $ 129.3 $ 518.3 $ 416.1
========= ========= ========= =========
By Product Category:
Skin Care.................................................. $ 96.0 $ 74.4 $ 253.8 $ 204.8
Makeup..................................................... 96.1 61.0 206.1 158.5
Fragrance.................................................. (27.6) (7.6) 38.7 42.4
Hair Care.................................................. 3.3 1.8 16.8 10.4
Other...................................................... 1.8 (0.3) 2.9 -
--------- --------- --------- ---------
$ 169.6 $ 129.3 $ 518.3 $ 416.1
========= ========= ========= =========
THE ESTEE LAUDER COMPANIES INC.
The following table presents certain consolidated earnings data as a percentage
of net sales:
Three Months Ended Nine Months Ended
March 31 March 31
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net sales........................................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales.................................................... 25.2 25.4 25.9 26.8
----- ----- ----- -----
Gross profit..................................................... 74.8 74.6 74.1 73.2
----- ----- ----- -----
Operating expenses
Selling, general and administrative........................... 62.5 63.6 61.9 62.1
Related party royalties....................................... 0.4 0.5 0.4 0.4
----- ----- ----- -----
62.9 64.1 62.3 62.5
----- ----- ----- -----
Operating income................................................. 11.9 10.5 11.8 10.7
Interest expense, net............................................ 0.5 0.2 0.5 0.2
----- ----- ----- -----
Earnings before income taxes, minority interest and discontinued
operations.................................................... 11.4 10.3 11.3 10.5
Provision for income taxes....................................... 4.3 3.3 4.2 3.5
Minority interest, net of tax.................................... (0.1) (0.1) (0.2) (0.1)
----- ----- ----- -----
Net earnings from continuing operations.......................... 7.0 6.9 6.9 6.9
Discontinued operations.......................................... (0.1) (0.1) (0.7) (0.1)
----- ----- ----- -----
Net earnings..................................................... 6.9% 6.8% 6.2% 6.8%
===== ===== ===== =====
Third Quarter Fiscal 2004 as Compared with Third Quarter Fiscal 2003
Net Sales
Net sales increased 15% or $188.1 million to $1,421.6 million reflecting growth
in all product categories and all geographic regions. Product category increases
resulted from new and recent product launches and the addition of the Darphin
line of products, which was acquired during the fourth quarter of fiscal 2003.
Net sales results in Europe, the Middle East & Africa and Asia/Pacific grew
double digits in the current quarter and were positively impacted by the
weakening of the U.S. dollar. Excluding the impact of foreign currency
translation, net sales increased 10%.
Product Categories
Skin Care
Net sales of skin care products increased 10% or $51.3 million to $559.1 million
reflecting the addition of the Darphin line of products as well as growth in
developing brands, particularly outside the Americas. Increased net sales were
supported by new and recently launched products which include Hydra Complete
Multi-Level Moisture products and Idealist Micro-D Deep Thermal Refinisher by
Estee Lauder and Repairwear Day SPF 15 Intensive products and Pore Minimizer
products by Clinique. The increase was also supported by strong sales of Re-
Nutriv Intensive Lifting products by Estee Lauder. Partially offsetting these
increases were lower net sales of certain existing products such as
Perfectionist Correcting Serum for Lines/Wrinkles and Idealist Skin Refinisher
by Estee Lauder and Repairwear Intensive Night products by Clinique. Excluding
the impact of foreign currency translation, skin care net sales increased 4%.
THE ESTEE LAUDER COMPANIES INC.
Makeup
Makeup net sales increased 22% or $105.5 million to $591.0 million. Our makeup
artist lines, led by M.A.C and Bobbi Brown, experienced growth from existing and
new points of distribution. Current period product launches include Perfectly
Real Makeup by Clinique and Electric Intense LipCreme by Estee Lauder which
contributed to net sales growth. In addition, increased net sales also reflected
the recent launches of Ideal Matte Refinishing Makeup SPF 8, Pure Color Eye
Shadow Duo and Artist's Lip and Eye Pencils by Estee Lauder as well as High
Impact Mascara and the High Impact Eye Shadow collection by Clinique. Offsetting
these increases were lower net sales of certain existing products such as Colour
Surge Lipstick and Eye Defining Duo by Clinique as well as MagnaScopic Maximum
Volume Mascara, which experienced a successful launch during the prior-year
quarter, and So Ingenious Multi-Dimension Liquid Makeup and Loose Powder from
Estee Lauder. Excluding the impact of foreign currency translation, makeup net
sales increased 17%.
Fragrance
Net sales of fragrance products increased 12% or $21.8 million to $203.4 million
reflecting net sales growth outside the Americas, which was supported by
improved results from our travel retail business and the weakening of the U.S.
dollar. Recent launches of Estee Lauder Beyond Paradise, Clinique Simply, the
Tommy Jeans collection and Aramis Life also contributed to net sales
improvements. These net sales increases were partially offset by lower net sales
of Clinique Happy Heart, Beautiful and Intuition by Estee Lauder, Estee Lauder
pleasures, Estee Lauder pleasures intense and certain Tommy Hilfiger products.
Excluding the impact of foreign currency translation, fragrance net sales
increased 5%.
Hair Care
Hair care net sales increased 15% or $8.1 million to $61.3 million primarily
attributable to Aveda and Bumble and bumble both of which experienced growth
from existing and new points of distribution as well as the success of new and
existing products. Excluding the impact of foreign currency translation, hair
care net sales increased 13%.
The introduction of new products may have some cannibalizing effect on sales of
existing products, which we take into account in our business planning.
Geographic Regions
Net sales in the Americas increased 9% or $67.5 million to $783.1 million
reflecting an improving retail environment particularly in the latter portion of
the quarter, however, the domestic fragrance business continues to be
challenging. Other product categories contributed to growth in this region
supported by the success of new and recently launched products. This improvement
was led by the makeup category reflecting growth in our core brands and the
continued development of our makeup artist lines as well as growth from most of
our freestanding retail stores.
In Europe, the Middle East & Africa, net sales increased 25% or $91.6 million to
$453.1 million. We benefited from higher net sales in our travel retail
business, Spain, the United Kingdom and Germany, as well as from the addition of
Darphin and the effect of favorable foreign currency exchange rates to the U.S.
dollar. Excluding the impact of foreign currency translation, net sales in
Europe, the Middle East & Africa increased 12%.
Net sales in Asia/Pacific increased 19% or $29.0 million to $185.4 million. This
increase reflected higher net sales in Japan, Australia, China and the effect of
favorable foreign currency exchange rates to the U.S. dollar. Excluding the
impact of foreign currency translation, Asia/Pacific net sales increased 10%.
We strategically stagger our new product launches by geographic market, which
may contribute to differences in regional sales growth.
Cost of Sales
Cost of sales as a percentage of total net sales improved to 25.2% from 25.4%
reflecting production and supply chain efficiencies of approximately 60 basis
points and lower costs from promotional activities of approximately 30 basis
points. Substantially offsetting these improvements were changes in exchange
rates and the mix of products being sold as well as by increased travel retail
sales, which carry a higher cost of goods sold percentage. Travel retail has a
higher cost of goods sold percentage because of its heavy fragrance mix coupled
with its margin structure.
Since the cost of promotional activities is a component of 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.
THE ESTEE LAUDER COMPANIES INC.
Operating Expenses
Operating expenses decreased to 62.9% of net sales as compared with 64.1% of net
sales in the prior-year quarter. The decrease in operating expenses as a
percentage of net sales reflects the higher growth rate in net sales,
particularly in the travel retail business, cost containment efforts to maintain
expenses in line with our business needs and to a lesser extent a shift of
planned advertising production activities from the third quarter to the fourth
quarter. The decrease was partially offset by higher levels of advertising,
sampling and merchandising to support new and recently launched products,
operating expenses related to spending behind BeautyBank (our division dedicated
to developing new beauty brand concepts and business opportunities, including
the development of new brands for sale to Kohl's Department Stores) and the
higher operating costs associated with newly acquired brands.
Changes in advertising, sampling and merchandising spending result from the
type, timing and level of activities related to product launches and rollouts,
as well as the markets being emphasized.
On April 24, 2004, Mrs. Estee Lauder passed away. As a result, the royalty
payments made to her since 1969 in connection with our purchase of the "Estee
Lauder" trademark outside the United States ceased to accrue. The estimated
impact for the remainder of fiscal 2004 will be a reduction of operating
expenses of approximately $3.8 million, or $2.3 million after tax.
Operating Income
Operating income increased 31% or $40.3 million to $169.6 million as compared
with the prior-year quarter. Operating margins were 11.9% of net sales in the
current period as compared with 10.5% in the prior-year quarter. The increase in
operating margin reflects sales growth coupled with improvements in the
components of cost of sales and certain operating expenses.
Product Categories
Operating income increased 58% to $96.1 million in makeup, 29% to $96.0 million
in skin care and 83% to $3.3 million in hair care reflecting net sales growth
primarily from our developing brands as well as success of new and recently
launched products. Our operating loss in the fragrance category increased by
$20.0 million to $27.6 million. The fragrance category continues to be
challenged by a soft domestic fragrance market, while we have continued to
support our recent product launches as well as their international rollout and
incurred development costs for future fragrance launches.
Geographic Regions
Operating income in the Americas increased 31% or $24.4 million to $102.8
million primarily reflecting growth in our makeup category. In Europe, the
Middle East & Africa, operating income increased 28% or $12.5 million to $57.2
million primarily due to the significant increase in our travel retail business
and improvements in a number of markets led by Spain, Germany, Greece, Italy and
Switzerland. In Asia/Pacific, operating income increased 55% or $3.4 million to
$9.6 million reflecting improved results in Japan, Singapore, Hong Kong and
Thailand. At the same time, we continued to invest in the region to support new
brand expansion and business opportunities in developing markets such as China.
Interest Expense, Net
Net interest expense was $6.9 million as compared with $1.9 million in the
prior-year quarter. The increase in net interest expense was due primarily to
the inclusion of the preferred stock dividends of $4.3 million as interest
expense in the current period. This change in reporting resulted from a change
in accounting standards which prohibits us from restating the prior period
results (see "Recently Issued Accounting Standards"). To a lesser extent,
interest expense was also affected by higher average net borrowings partially
offset by a lower effective interest rate provided by the interest rate swap on
the 6% Senior Notes.
Provision for Income Taxes
The provision for income taxes represents Federal, foreign, state and local
income taxes. The effective rate for income taxes for the three months ended
March 2004 was 37.4% as compared with 32.4% in the prior-year quarter. These
rates differ from statutory rates due to the effect of state and local taxes,
tax rates in foreign jurisdictions and certain nondeductible expenses. The
increase in the effective income tax rate was attributable to the inclusion of
the preferred stock dividends as interest expense which are not deductible for
income tax purposes, the anticipated full-year mix of global earnings and to a
lesser extent the timing of tax planning initiatives. The prior-period rate
included benefits derived from certain favorable tax negotiations.
THE ESTEE LAUDER COMPANIES INC.
Discontinued Operations
In February 2004, we sold the assets and operations of our reporting unit that
sold jane brand products. During the third quarter, we recorded a loss of $1.8
million, net of tax, representing additional costs associated with the sale and
discontinuation of the business. All consolidated statements of earnings
information for prior periods has been restated for comparative purposes,
including the restatement of the makeup product category and the Americas region
data.
Nine Months Fiscal 2004 as compared with Nine Months Fiscal 2003
Net Sales
Net sales increased 13% or $510.6 million to $4,387.3 million reflecting growth
in all product categories and all geographic regions led by double digit growth
in Europe, the Middle East & Africa and the addition of the Darphin line of
products, which was acquired during the fourth quarter of fiscal 2003. Net sales
results in Europe, the Middle East & Africa and Asia/Pacific in the current
period benefited from the weakening of the U.S. dollar. Excluding the impact of
foreign currency translation, net sales increased 8%.
Product Categories
Skin Care
Net sales of skin care products increased 13% or $185.5 million to $1,594.1
million. This increase in net sales was primarily attributable to new and
recently launched products such as Idealist Micro-D Deep Thermal Refinisher and
Hydra Complete Multi-Level Moisture products by Estee Lauder and Pore Minimizer
products by Clinique. The increase was supported by strong sales of Re-Nutriv
Intensive Lifting products by Estee Lauder, and the Repairwear line of products
from Clinique and products in Clinique's 3-Step Skin Care System, as well as the
addition of the Darphin line of products. Partially offsetting these increases
were lower net sales of certain existing products such as Advanced Stop Signs by
Clinique and Idealist Skin Refinisher, Lightsource Age-Resisting Moisture Lotion
and Resilience Lift products by Estee Lauder. Excluding the impact of foreign
currency translation, skin care net sales increased 8%.
Makeup
Makeup net sales increased 13% or $188.8 million to $1,607.1 million. In
addition to strong sales of our M.A.C and Bobbi Brown makeup artist lines, the
increase in net sales reflected the current year launch of Perfectly Real Makeup
by Clinique and Ideal Matte Refinishing Makeup SPF 8 and Electric Intense
LipCreme by Estee Lauder. The increase in net sales also reflected the recent
launches of High Impact Mascara by Clinique and Artist's Lip and Eye Pencils,
Pure Color Lip Vinyl and Pure Color Eye Shadow Duo by Estee Lauder. Offsetting
these increases were lower net sales of certain existing products such as So
Ingenious Multi-Dimension Liquid Makeup and Loose Powder, Pure Color Lipstick
and Pure Color Velvet Lipstick and Nail Lacquer from Estee Lauder. Excluding the
impact of foreign currency translation, makeup net sales increased 9%.
Fragrance
Net sales of fragrance products increased 13% or $116.5 million to $980.9
million. The increase in net sales was primarily attributable to the current
year launches of Estee Lauder Beyond Paradise, Aramis Life, Clinique Simply
and the Tommy Jeans collection. The increase in net sales also benefited from
improved results from our travel retail business. These net sales increases were
partially offset by lower net sales of Estee Lauder pleasures, Beautiful and
Intuition by Estee Lauder, Clinique Happy and certain Tommy Hilfiger products.
Excluding the impact of foreign currency translation, fragrance net sales
increased 8%.
Hair Care
Hair care net sales increased 9% or $15.3 million to $179.1 million primarily
attributable to Aveda and Bumble and bumble. The increase from Aveda was due to
increased distribution and successful recent product launches. Bumble and bumble
experienced growth from existing and new points of distribution. Partially
offsetting these increases were lower net sales from Clinique's Simple Hair Care
System. Excluding the impact of foreign currency translation, hair care net
sales increased 7%.
The introduction of new products may have some cannibalizing effect on sales of
existing products, which we take into account in our business planning.
THE ESTEE LAUDER COMPANIES INC.
Geographic Regions
Net sales in the Americas increased 7% or $164.5 million to $2,439.3 million
primarily reflecting growth from our newer brands as well as the success of new
and recently launched products and an improving retail environment.
In Europe, the Middle East & Africa, net sales increased 24% or $263.6 million
to $1,367.6 million primarily reflecting higher net sales from our travel retail
business, the United Kingdom, Spain, South Africa, Germany and Greece as well as
from the addition of Darphin. We also benefited from the effect of favorable
foreign currency exchange rates to the U.S. dollar. Excluding the impact of
foreign currency translation, net sales in Europe, the Middle East & Africa
increased 12%.
Net sales in Asia/Pacific increased 17% or $82.5 million to $580.4 million. This
increase reflected higher net sales in Australia, Japan, Taiwan, Korea, and
China. Excluding the impact of foreign currency translation, net sales in Asia/
Pacific increased 9%.
We strategically stagger our new product launches by geographic market, which
may contribute to differences in regional sales growth.
Cost of Sales
Cost of sales as a percentage of total net sales improved to 25.9% from 26.8%
reflecting production and supply chain efficiencies and lower costs from
promotional activities of approximately 70 basis points each. Partially
offsetting these improvements were changes in exchange rates and the mix of
products being sold as well as by increased travel retail sales, which carry a
higher cost of goods sold percentage. Travel retail has a higher cost of goods
sold percentage because of its heavy fragrance mix coupled with its margin
structure.
Since the cost of promotional activities is a component of 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.
Operating Expenses
Operating expenses decreased to 62.3% of net sales as compared with 62.5% of net
sales in the prior-year period. The decrease in operating expenses as a
percentage of net sales reflects the higher growth rate in net sales,
particularly the newer brands and in the travel retail business. Partially
offsetting the favorability in the current period were higher levels of
advertising, sampling and merchandising to support new and recently launched
products, operating expenses related to spending behind BeautyBank, the higher
operating costs associated with newly acquired brands and expenses related to
compliance with new regulatory requirements (such as those arising under the
Sarbanes-Oxley Act of 2002).
Changes in advertising, sampling and merchandising spending result from the
type, timing and level of advertising, sampling and merchandising activities
related to product launches and rollouts, as well as the markets being
emphasized.
On April 24, 2004, Mrs. Estee Lauder passed away. As a result, the royalty
payments made to her since 1969 in connection with our purchase of the "Estee
Lauder" trademark outside the United States ceased to accrue. The estimated
impact for the remainder of fiscal 2004 will be a reduction of operating
expenses of approximately $3.8 million, or $2.3 million after tax.
Operating Income
Operating income increased 25% or $102.2 million to $518.3 million as compared
with the prior-year period. Operating margins were 11.8% of net sales in the
current period as compared with 10.7% in the prior-year period. The increase in
operating margin reflects sales growth coupled with the improvement in the
components of cost of sales as well as our continued control of non-business
building expenses.
Product Categories
Operating income increased 30% to $206.1 million in makeup, 24% to $253.8
million in skin care and 62% to $16.8 million in hair care reflecting overall
sales growth and new product introductions. Operating income decreased 9% to
$38.7 million in fragrance reflecting increased support spending related to new
product launch activities.
THE ESTEE LAUDER COMPANIES INC.
Geographic Regions
Operating income in the Americas increased 30% or $64.5 million to $281.3
million. Contributing to the increase were an improved retail environment,
strong product launches and growth from newer brands. In Europe, the Middle East
& Africa, operating income increased 19% or $31.0 million to $193.7 million
primarily due to the significantly increased results generated from our travel
retail business as well as improvements in the United Kingdom and Spain. In Asia
/Pacific, operating income increased 18% or $6.7 million to $43.3 million. This
increase reflects improved results in Taiwan, Japan and Australia.
Interest Expense, Net
Net interest expense was $21.8 million as compared with $7.0 million in the
prior-year period. The increase in net interest expense was due to the inclusion
of the preferred stock dividends of $14.4 million as interest expense in the
current period. This change in reporting resulted from a change in accounting
standards which prohibits us from restating the prior period results (see
"Recently Issued Accounting Standards"). To a lesser extent, interest expense
was also affected by higher average net borrowings offset by a lower effective
interest rate provided by the interest rate swap on the 6% Senior Notes.
Provision for Income Taxes
The provision for income taxes represents Federal, foreign, state and local
income taxes. The effective rate for income taxes for the nine months ended
March 2004 was 37.4% as compared with 33.2% in the prior-year period. These
rates differ from statutory rates due to the effect of state and local taxes,
tax rates in foreign jurisdictions and certain nondeductible expenses. The
increase in the effective income tax rate was attributable to the inclusion of
the preferred stock dividends as interest expense which are not deductible for
income tax purposes, the anticipated full-year mix of global earnings and to a
lesser extent the timing of tax planning initiatives. The prior-period rate
included benefits derived from certain favorable tax negotiations.
Discontinued Operations
In February 2004, we sold the assets and operations of our reporting unit that
sold jane brand products. Prior to the sale of the business, in December 2003,
we committed to a plan to sell such assets and operations. At the time such
decision was made, circumstances warranted that we conduct an assessment of the
tangible and intangible assets of the jane business. Based on this assessment,
we determined that the carrying amount of these assets as reflected on our
consolidated balance sheets exceeded their estimated fair value. In accordance
with the assessment and the closing of the sale, we recorded an after-tax charge
to discontinued operations of $33.1 million for the nine months ended March 31,
2004. The charge represents the impairment of goodwill in the amount of $26.4
million; the reduction in value of other tangible assets in the amount of $1.3
million, net of taxes; and the operating loss of $5.4 million, net of tax.
Included in the operating loss of the nine-month period were additional costs
associated with the sale and discontinuation of the business. All consolidated
statements of earnings information for prior periods has been restated for
comparative purposes, including the restatement of the makeup product category
and the Americas region data.
THE ESTEE LAUDER COMPANIES INC.
Financial Condition
Liquidity and Capital Resources
Our principal sources of funds historically have been cash flows from operations
and borrowings under our commercial paper program, proceeds from the issuance of
long-term debt and committed and uncommitted credit lines provided by banks in
the United States and abroad. At March 31, 2004, we had cash and cash
equivalents of $867.8 million compared with $364.1 million at June 30, 2003.
At March 31, 2004, our outstanding borrowings of $841.6 million included: (i)
$360.0 million of Cumulative Redeemable Preferred Stock, which shares have a
mandatory redemption date of June 30, 2015 (see "Recently Issued Accounting
Standards"), (ii) $251.5 million of 6% Senior Notes due January 2012 consisting
of $250.0 million principal, unamortized debt discount of $0.9 million and a
$2.4 million adjustment to reflect the fair value of an outstanding interest
rate swap; (iii) $197.3 million of 5.75% Senior Notes due October 2033
consisting of $200.0 million principal and unamortized debt discount of $2.7
million; (iv) a 3.0 billion yen term loan (approximately $27.5 million at
current exchange rates), which is due in March 2006; and (v) $5.3 million of
other short-term borrowings.
On December 31, 2003, we and the holders of the Cumulative Redeemable Preferred
Stock exchanged all of their outstanding shares of $6.50 Cumulative Redeemable
Preferred Stock due June 30, 2005 for a newly issued series of Cumulative
Redeemable Preferred Stock with a mandatory redemption date of June 30, 2015
("2015 Preferred Stock"). Assuming no early redemption, dividends on the 2015
Preferred Stock are payable at a rate per annum of 4.75%, payable quarterly,
until June 30, 2005, down from 6.5% during that period for the original $6.50
Cumulative Redeemable Preferred Stock, and thereafter will be payable at a rate
set semi-annually and equal to the after-tax yield on six-month U.S. Treasuries.
On April 24, 2004, Mrs. Estee Lauder passed away. As a result, the $360.0
million principal amount of the 2015 Preferred Stock may be put to us. If put to
us before June 30, 2005, we would have up to 120 days after the exercise date
of the put to pay for the shares. In addition, from and after April 24, 2004,
$291.6 million of the principal amount of the shares may be called for
redemption by us subject to thirty to sixty days prior written notice. Although
there can be no assurance, at this time, we expect that such shares will either
be put to us or, pending approval by our Board of Directors, that we will call
such shares during the quarter ending June 30, 2004. The remaining $68.4 million
of the principal amount of the shares may not be called for redemption by us
until May 24, 2005. If prior to June 30, 2005, any portion of the $291.6 million
principal amount of the shares is redeemed, then the dividend rate on the same
proportion of the remaining $68.4 million principal amount of the shares will
automatically change to the rate based on six-month U.S. Treasuries. The
benefits from the reduction of the dividend rate from 6.5% to 4.75% amount to
$1.6 million per quarter and, assuming the preferred stock remains outstanding
for the balance of fiscal 2004, we expect to save approximately $4.7 million in
preferred stock dividends for the full fiscal year. As discussed above, certain
additional savings may be realized if the redemption occurs prior to the end of
the current fiscal year.
In September 2003, we issued and sold $200.0 million of 5.75% Senior Notes due
October 2033 ("5.75% Senior Notes") in a public offering. The 5.75% Senior Notes
were priced at 98.645% with a yield of 5.846%. Interest payments, which
commenced April 15, 2004, will be made semi-annually on April 15 and October 15
of each year. In May 2003, in anticipation of the issuance of the 5.75% Senior
Notes, we entered into a series of treasury lock agreements on a notional amount
totaling $195.0 million at a weighted average all-in rate of 4.53%. The treasury
lock agreements were settled upon the issuance of the new debt and we received a
payment of $15.0 million that will be amortized against interest expense over
the life of the 5.75% Senior Notes. As a result of the treasury lock agreements,
the debt discount and debt issuance costs, our effective interest rate on the
5.75% Senior Notes will be 5.395% over the life of the debt. The net proceeds
from the sale of the 5.75% Senior Notes will be used for general corporate
purposes, including but not limited to the redemption of our outstanding
redeemable preferred stock. We issued these fixed-rate notes to lock in long-
term liquidity at historically low prevailing market rates and to mitigate
future interest rate volatility.
We have a $750.0 million commercial paper program under which we may issue
commercial paper in the United States. Our commercial paper is currently rated
A-1 by Standard & Poor's and P-1 by Moody's. Our long-term credit ratings are A+
with a negative outlook by Standard & Poor's and A1 with a stable outlook by
Moody's. At March 31, 2004, we had no commercial paper outstanding. We also have
an effective shelf registration statement covering the potential issuance of up
to an additional $300.0 million in debt securities. As of March 31, 2004,we had
an unused $400.0 million revolving credit facility, expiring on June 28, 2006,
and $172.8 million in additional uncommitted credit facilities.
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 the revolving credit facility.
THE ESTEE LAUDER COMPANIES INC.
Total debt as a percent of total capitalization was 34% at March 31, 2004 as
compared with 14% at June 30, 2003. This increase primarily reflects the
reclassification of the redeemable preferred stock to long-term debt as well as
the issuance of the 5.75% Senior Notes.
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.
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 and capital expenditures on both a near-term and long-term
basis.
Cash Flows
Net cash provided by operating activities was $550.7 million during the nine
months ended March 31, 2004 as compared with net cash provided by operating
activities of $419.3 million in the prior-year period, reflecting less of a
decline in accounts payable than in the prior-year period, higher levels of
accrued income taxes resulting from the anticipated full-year mix of global
earnings, decreased levels of inventory which were partially offset by increased
levels of accounts receivable. The decrease in inventory reflects our continued
efforts to reduce such levels and improve working capital. The increase in
accounts receivable levels reflects strong sales growth. Net cash used for
investing activities was $131.9 million during the nine months ended March 31,
2004, which primarily reflects capital expenditures. Net cash provided by
financing activities of $80.5 million primarily related to the issuance of the
5.75% Senior Notes partially offset by the acquisition of treasury stock and the
payment of the common stock dividends.
Dividends
On November 5, 2003, the Board of Directors declared an annual dividend of $.30
per share on our Class A and Class B Common Stock, payable on January 6, 2004 to
stockholders of record at the close of business on December 16, 2003. Common
Stock dividends paid during the fiscal years 2004 and 2003 were $68.5 million
and $46.5 million, respectively. Dividends declared on the Cumulative Redeemable
Preferred Stock for the nine months ended March 2004 and 2003 were $14.4 million
and $17.6 million, respectively. The decrease reflects an agreement to reduce
the dividend of the preferred stock made in connection with the exchange of the
preferred shares on December 31, 2003. The Cumulative Redeemable Preferred Stock
dividends declared for the nine months ended March 31, 2004 have been
characterized as interest expense (see "Recently Issued Accounting Standards").
Share Repurchase Program
We are authorized by the Board of Directors to repurchase up to 18.0 million
shares of Class A Common Stock in the open market or in privately negotiated
transactions, depending on market conditions and other factors. As of March 31,
2004, the cumulative total of acquired shares pursuant to the authorization was
16.3 million reducing the remaining authorized share repurchase balance to 1.7
million. During the first nine months of fiscal 2004, we purchased approximately
2.5 million shares for $98.3 million as outlined in the following table:
Total Number of Maximum Number of
Shares Purchased as Shares that May
Total Number of Average Price part of Publicly Yet Be Purchased
Period Shares Purchased Paid per Share Announced Program (1) Under the Program
------ ---------------- -------------- --------------------- -----------------
July 2003 0 0 0 4,160,500
August 2003 350,000 $33.60 350,000 3,810,500
September 2003 15,000 34.00 15,000 3,795,500
October 2003 0 0 0 3,795,500
November 2003 202,300 36.25 202,300 3,593,200
December 2003 0 0 0 3,593,200
January 2004 0 0 0 3,593,200
February 2004 1,378,300 41.20 1,378,300 2,214,900
March 2004 514,900 42.59 514,900 1,700,000
--------------- ---------------- --------------------
Year-to-date 2,460,500 $39.96 2,460,500
=============== ================ ====================
(1) The publicly announced repurchase program was last increased by 10 million
shares on October 30, 2002. The initial program covering the repurchase of
8 million shares was announced in September 1998.
THE ESTEE LAUDER COMPANIES INC.
Commitments and Contingencies
As of April 24, 2004, the $360.0 million of 2015 Preferred Stock may be put to
us. However, $291.6 million of the principal amount of the shares may be called
for redemption by us at any time, subject to the notification provisions, and
the remaining $68.4 million of the principal amount of the shares may not be
called for redemption by us until May 24, 2005. If shares of the 2015 Cumulative
Redeemable Preferred Stock are put to us, we would have up to 180 days after
notice to purchase such shares.
Certain of our business acquisition agreements include "earn-out" provisions.
These provisions generally require that we pay to the seller or sellers of the
business additional amounts based on the performance of the acquired business.
The payments typically are made after a certain period of time and our next
"earn-out" payment is expected to be made after the end of fiscal 2005. Since
the size of each payment depends upon performance of the acquired business, we
do not expect that such payments will have a material adverse impact on our
future results of operations or financial condition.
Contractual Obligations
In July 2003, we signed a new lease for our principal offices at the same
location. Our rental obligations under the new lease will commence in fiscal
2005 and expire in fiscal 2020. Obligations pursuant to the lease in fiscal
2005, 2006, 2007, 2008 and thereafter are $5.9 million, $23.6 million, $23.6
million, $24.1 million and $324.2 million, respectively. There have been no
other significant changes to our contractual obligations since June 30, 2003.
Business Acquisitions
During the first quarter of fiscal 2004, we acquired the Rodan & Fields skin
care line. The initial purchase price, paid at closing, was funded by cash
provided by operations, the payment of which did not have a material effect on
our results of operations or consolidated financial condition. We may make
additional payments between fiscal 2007 and 2011 based on certain conditions.
Derivative Financial Instruments and Hedging Activities
We address certain financial exposures through a controlled program of risk
management that includes the use of derivative financial instruments. We
primarily enter into foreign currency forward exchange contracts and foreign
currency options to reduce the effects of fluctuating foreign currency exchange
rates. We also enter into interest rate derivative contracts to manage the
effects of fluctuating interest rates. We categorize these instruments as
entered into for purposes other than trading.
For each derivative contract we enter into where we look to obtain special hedge
accounting treatment, we formally document the relationship between the hedging
instrument and hedged item, as well as its risk-management objective and
strategy for undertaking the hedge. This process includes linking all
derivatives that are designated as fair-value, cash-flow, or foreign-currency
hedges to specific assets and liabilities on the balance sheet or to specific
firm commitments or forecasted transactions. We also formally assess, both at
the hedge's inception and on an ongoing basis, whether the derivatives that are
used in hedging transactions are highly effective in offsetting changes in fair
values or cash flows of hedged items. If it is determined that a derivative is
not highly effective, then we will be required to discontinue hedge accounting
with respect to that derivative prospectively.
Foreign Exchange Risk Management
We enter into forward exchange contracts to hedge anticipated transactions as
well as receivables and payables denominated in foreign currencies for periods
consistent with our identified exposures. The purpose of the hedging activities
is to minimize the effect of foreign exchange rate movements on our costs and on
the cash flows that we receive from foreign subsidiaries. Almost all foreign
currency contracts are denominated in currencies of major industrial countries
and are with large financial institutions rated as strong investment grade by a
major rating agency. We also enter into foreign currency options to hedge
anticipated transactions where there is a high probability that anticipated
exposures will materialize. The forward exchange contracts have been designated
as cash-flow hedges. As of March 31, 2004, these cash-flow hedges were highly
effective, in all material respects.
THE ESTEE LAUDER COMPANIES INC.
As a matter of policy, we only enter into contracts with counterparties that
have at least an "A" (or equivalent) credit rating. The counterparties to these
contracts are major financial institutions. We do not have significant exposure
to any one counterparty. Our exposure to credit loss in the event of
nonperformance by any of the counterparties is limited to only the recognized,
but not realized, gains attributable to the contracts. Management believes risk
of loss under these hedging contracts is remote and in any event would not be
material to the consolidated financial results. The contracts have varying
maturities through the end of June 2005. Costs associated with entering into
such contracts have not been material to our consolidated financial results. We
do not utilize derivative financial instruments for trading or speculative
purposes. At March 31, 2004, we had foreign currency contracts in the form of
forward exchange contracts and option contracts in the amount of $606.6 million
and $98.9 million, respectively. The foreign currencies included in forward
exchange contracts (notional value stated in U.S. dollars) are principally the
Euro ($143.8 million), Swiss franc ($110.2 million), British pound ($77.2
million), Canadian dollar ($68.5 million), Japanese yen ($64.1 million) and
Australian dollar ($36.5 million). The foreign currencies included in the option
contracts (notional value stated in U.S. dollars) are principally the Euro
($34.1 million), British pound ($28.6 million) and Swiss franc ($19.0 million).
Interest Rate Risk Management
We enter into interest rate derivative contracts to manage the exposure to
fluctuations of interest rates on our funded indebtedness and anticipated
issuance of debt, as well as cash investments, for periods consistent with the
identified exposures. All interest rate derivative contracts are with large
financial institutions rated as strong investment grade by a major rating
agency.
We have an interest rate swap agreement with a notional amount of $250.0 million
to effectively convert fixed interest on the existing $250.0 million 6% Senior
Notes to variable interest rates based on LIBOR. We designated the swap as a
fair-value hedge. As of March 31, 2004, the fair-value hedge was highly
effective, in all material respects.
Additionally, in May 2003, in connection with the anticipated issuance of debt,
we entered into a series of treasury lock agreements on a notional amount
totaling $195.0 million at a weighted average all-in rate of 4.53%. These
treasury lock agreements were used to hedge the exposure to the rise in interest
rates prior to the September 2003 issuance of debt. The agreements were settled
upon the issuance of the $200.0 million of 5.75% Senior Notes and we realized a
gain in other comprehensive income of $15.0 million that will be amortized
against interest expense over the life of the 5.75% Senior Notes.
Market Risk
Using the value-at-risk model, as discussed in our annual report on Form 10-K
for the fiscal year ended June 30, 2003, our average value-at-risk, calculated
for the most recent twelve months, is $9.0 million related to our foreign
exchange contracts. As of March 31, 2004, our average value-at-risk related to
our interest rate contracts for the twelve month period for which these
contracts were outstanding was $14.4 million. There have been no significant
changes in market risk since June 30, 2003 that would have a material effect on
our calculated value-at-risk exposure, as disclosed in the annual report on Form
10-K for the fiscal year ended June 30, 2003.
Off-Balance Sheet Arrangements
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial condition or results
of operations.
Critical Accounting Policies
As disclosed in the annual report on Form 10-K for the fiscal year ended June
30, 2003, the discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in conformity with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses reported in those financial statements. These
judgments can be subjective and complex, and consequently actual results could
differ from those estimates. Our most critical accounting policies relate to
revenue recognition; concentration of credit risk; inventory; pension and other
postretirement benefit costs; goodwill and other intangible assets; income
taxes; and derivatives. Since June 30, 2003, there have been no changes in our
critical accounting policies and no significant changes to the assumptions and
estimates related to them.
THE ESTEE LAUDER COMPANIES INC.
Recently issued Accounting Standards
On January 12, 2004, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position No. FAS 106-1, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003," ("FSP No. 106-1") in response to a new law regarding prescription drug
benefits under Medicare ("Medicare Part D") as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that is at
least actuarially equivalent to Medicare Part D. Currently, Statement of
Financial Accounting Standard No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions,"("SFAS No. 106") requires that changes in relevant
law be considered in current measurement of postretirement benefit costs.
However, certain accounting issues related to the federal subsidy remain unclear
and significant uncertainties may exist which impair a plan sponsor's ability to
evaluate the direct effects of the new law and the ancillary effects on plan
participants' behavior and healthcare costs. Due to these uncertainties, FSP No.
106-1 provides plan sponsors with an opportunity to elect to defer recognizing
the effects of the new law in the accounting for its retiree health care benefit
plans under SFAS No.106 and to provide related disclosures until authoritative
guidance on the accounting for the federal subsidy is issued and clarification
regarding other uncertainties is resolved. We have elected to defer recognition
while evaluating the new law and the pending issuance of authoritative guidance
and their effect, if any, on our results of operations, financial position and
financial statement disclosure. Therefore, any measures of the accumulated
postretirement benefit obligation or the net periodic postretirement benefit
cost do not reflect the effects of the new law and issued guidance could require
us to change previously reported information.
In December 2003, the FASB issued FASB Interpretation Number 46-R ("FIN 46-R"),
"Consolidation of Variable Interest Entities." FIN 46-R, which modifies certain
provisions and effective dates of FIN 46, sets forth criteria to be used in
determining whether an investment in a variable interest entity should be
consolidated. These provisions are based on the general premise that if a
company controls another entity through interests other than voting interests,
that company should consolidate the controlled entity. We have evaluated whether
the provisions of FIN 46-R are applicable to our investments, certain of which
are currently accounted for by the equity method, as well as other arrangements,
which may meet the criteria of the interpretation, and believe that there are
currently no material arrangements that meet the definition of a variable
interest entity which would require consolidation.
In December 2003, the FASB revised Statement of Financial Accounting Standard
No. 132, "Employers' Disclosures about Pensions and other Postretirement
Benefits," ("SFAS No. 132") establishing additional annual disclosures about
plan assets, investment strategy, measurement date, plan obligations and cash
flows. In addition, the revised standard established interim disclosure
requirements related to the net periodic benefit cost recognized and
contributions paid or expected to be paid during the current fiscal year. The
new annual disclosures are effective for financial statements of companies with
fiscal years ending after December 15, 2003 and the interim-period disclosures
are effective for interim periods beginning after December 15, 2003. We will
adopt the annual disclosures for our fiscal year ending June 30, 2004 and have
adopted the interim disclosures for our fiscal quarter ended March 31, 2004. The
adoption of the revised SFAS No. 132 will have no impact on our results
of operation or financial condition.
We have adopted Statement of Financial Accounting Standard No. 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS No. 150"). SFAS No. 150 established standards for classifying and
measuring certain financial instruments with characteristics of both liabilities
and equity. Among other things, it specifically requires that mandatorily
redeemable instruments, such as redeemable preferred stock, be classified as a
liability. Initial and subsequent measurements of the instruments differ based
on the characteristics of each instrument and as provided for in the statement.
Based on the provisions of this statement, we have classified the Cumulative
Redeemable Preferred Stock as a liability and the related dividends thereon have
been characterized as interest expense. Restatement of financial statements for
earlier years presented was not permitted. The adoption of this statement has
resulted in the inclusion of the dividends on the preferred stock (equal to $4.3
million and $14.4 million, respectively, for the three and nine months ended
March 31, 2004) as interest expense. While the inclusion has impacted net
earnings, net earnings attributable to common stock and earnings per common
share were unaffected. Given that the dividends are not deductible for income
tax purposes, the inclusion of the preferred stock dividends as an interest
expense has caused an increase in our effective tax rate. The adoption of SFAS
No. 150 had no impact on our financial condition.
THE ESTEE LAUDER COMPANIES INC.
Forward-Looking Information
We and our representatives from time to time make written or oral forward-
looking statements, including statements contained in this and other filings
with the Securities and Exchange Commission, in our press releases and in our
reports to stockholders. The words and phrases "will likely result," "expect,"
"believe," "planned," "will," "will continue," "may," "could," "should,"
"anticipated," "estimate," "project" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements include, without
limitation, our expectations regarding sales, earnings or other future financial
performance and liquidity, product introductions, entry into new geographic
regions, information systems initiatives, new methods of sale and future
operations or operating results. Although we believe that our expectations are
based on reasonable assumptions within the bounds of our knowledge of our
business and operations, actual results may differ materially from our
expectations. Factors that could cause actual results to differ from
expectations include, without limitation:
(1) increased competitive activity from companies in the skin care,
makeup, fragrance and hair care businesses, some of which have greater
resources than we do;
(2) our ability to develop, produce and market new products on which
future operating results may depend;
(3) consolidations, restructurings, bankruptcies and reorganizations in
the retail industry causing a decrease in the number of stores that
sell our products, an increase in the ownership concentration within
the retail industry, ownership of retailers by our competitors and
ownership of competitors by our customers that are retailers;
(4) shifts in the preferences of consumers as to where and how they
shop for the types of products and services we sell;
(5) social, political and economic risks to our foreign or domestic
manufacturing, distribution and retail operations, including changes
in foreign investment and trade policies and regulations of the host
countries and of the United States;
(6) changes in the laws, regulations and policies that affect, or will
affect, our business, including changes in accounting standards, tax
laws and regulations, trade rules and customs regulations, and the
outcome and expense of legal or regulatory proceedings;
(7) foreign currency fluctuations affecting our results of operations
and the value of our foreign assets, the relative prices at which we
and our foreign competitors sell products in the same markets
and our operating and manufacturing costs outside of the United
States;
(8) changes in global or local economic conditions that could affect
consumer purchasing, the willingness of consumers to travel, the
financial strength of our customers, the cost and availability
of capital, which we may need for new equipment, facilities or
acquisitions, and the assumptions underlying our critical accounting
estimates;
(9) shipment delays, depletion of inventory and increased production
costs resulting from disruptions of operations at any of the
facilities which, due to consolidations in our manufacturing
operations, now manufacture nearly all of our supply of a particular
type of product (i.e. focus factories);
(10) real estate rates and availability, which may affect our ability
to increase the number of retail locations at which we sell our
products and the costs associated with our other facilities;
(11) changes in product mix to products which are less profitable;
(12) our ability to acquire or develop new information and distribution
technologies, on a timely basis and within our cost estimates;
(13) our ability to capitalize on opportunities for improved
efficiency, such as globalization, and to integrate acquired
businesses and realize value therefrom; and
(14) consequences attributable to the events that are currently taking
place in the Middle East, including further attacks, retaliation and
the threat of further attacks or retaliation.
We assume no responsibility to update forward-looking statements made herein or
otherwise.
THE ESTEE LAUDER COMPANIES INC.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is set forth in Item 2 of this Quarterly
Report on Form 10-Q under the caption "Liquidity and Capital Resources - Market
Risk" and is incorporated herein by reference.
Item 4. Controls and Procedures
Our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-
15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) are designed to ensure that information required to be disclosed in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission. The Chief Executive Officer and the
Chief Financial Officer, with assistance from other members of management, have
reviewed the effectiveness of our disclosure controls and procedures as of March
31, 2004 and, based on their evaluation, have concluded that the disclosure
controls and procedures were effective as of such date.
There has been no change in our internal control over financial reporting (as
defined in Rules13a-15(f) and 15d-15(f) of the Exchange Act) that occurred
during the third quarter of fiscal 2004 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in various routine legal proceedings incident to the ordinary
course of business. In management's opinion, the outcome of pending legal
proceedings, separately and in the aggregate, will not have a material adverse
effect on our business or consolidated financial condition.
In July 2003, we entered into a settlement agreement with the plaintiffs, the
other Manufacturer Defendants (as defined below) and the Department Store
Defendants (as defined below) in a consolidated class action lawsuit that had
been pending in the Superior Court of the State of California in Marin County
since 1998. In connection with the settlement, the case has been refiled in the
United States District Court for the Northern District of California on behalf
of a nationwide class of consumers of prestige cosmetics in the United States.
The settlement requires Court approval and, if approved by the Court, will
result in the plaintiffs' claims being dismissed, with prejudice, in their
entirety. There has been no finding or admission of any wrongdoing by the
Company in this lawsuit. We entered into the settlement agreement solely to
avoid protracted and costly litigation. In connection with the settlement
agreement, the defendants, including the Company, will provide consumers with
certain free products and pay the plaintiffs' attorneys' fees. To meet its
obligations under the settlement, the Company took a special pre-tax charge of
$22.0 million, or $13.5 million after-tax, equal to $.06 per diluted common
share in the fourth quarter of fiscal 2003. The charge did not have a material
adverse effect on the Company's consolidated financial condition. In the federal
action, the plaintiffs, purporting to represent a class of all U.S. residents
who purchased prestige cosmetics products at retail for personal use from eight
department stores groups that sold such products in the United States (the
"Department Store Defendants"), alleged that the Department Store Defendants,
the Company and eight other manufacturers of cosmetics (the "Manufacturer
Defendants") conspired to fix and maintain retail prices and to limit the supply
of prestige cosmetics products sold by the Department Store Defendants in
violation of state and federal laws. The plaintiffs sought, among other things,
treble damages, equitable relief, attorneys' fees, interest and costs.
In 1998, the Office of the Attorney General of the State of New York (the
"State") notified the Company and ten other entities that they are 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 estimates to be $16 million. While
the State has sued other PRPs in connection with the site (including Hickey's
Carting, Inc., Dennis C. Hickey and Maria Hickey, collectively the "Hickey
Parties"), the State has not sued the Company. The Company and certain other
PRPs are in discussions with the State regarding possible settlement of the
matter. On September 9, 2002, the Hickey Parties brought contribution actions
against the Company and other Blydenburgh PRPs in the State's lawsuit against
the Hickey Parties in the U.S. District Court for the Eastern District of New
York. These 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. The Company intends to
defend the contribution claim vigorously. While no assurance can be given as to
the ultimate outcome, management believes that the Blydenburgh matters will not
have a material adverse effect on the Company's consolidated financial
condition.
In 1998, the State notified the Company and fifteen other entities that they are
PRPs with respect to the Huntington/East Northport landfill. The cleanup costs
are estimated at $20 million. No litigation has commenced. The Company and other
PRPs are in discussions with the State regarding possible settlement of the
matter. While no assurance can be given as to the ultimate outcome, management
believes that the matter will not have a material adverse effect on the
Company's consolidated financial condition.
In January 2004, the Portuguese Tax Administration issued a report alleging that
our subsidiary had income subject to tax in Portugal for the three fiscal years
ended June 30, 2002. Our subsidiary has been operating in the Madeira Free Trade
Zone since 1989 under license from the Madeira Development Corporation and, in
accordance with such license and the laws of Portugal, the Company believes that
its income is not subject to Portuguese income tax. The subsidiary has filed an
appeal of the finding to the Portuguese Secretary of State for Fiscal Matters.
As of April 27, 2004, no formal tax assessment has been made. While no assurance
can be given as to the ultimate outcome, management believes that the matter
will not have a material adverse effect on the Company's consolidated financial
condition.
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
The information required by this item is set forth in Part I Item 2 of this
Quarterly Report on Form 10-Q under the caption "Liquidity and Capital Resources
- - Share Repurchase Program" and is incorporated herein by reference.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits --
Description
Exhibit -----------
Number
- ------
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(CEO).
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(CFO).
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 (CEO). (furnished)
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 (CFO). (furnished)
(b) Reports on Form 8-K --
On January 6, 2004, we filed a Current Report on Form 8-K. Pursuant to Item 5 of
Form 8-K, we announced that Fred H. Langhammer would be retiring as President
and Chief Executive Officer and as a director of the Company on June 30, 2004.
After such time, William P. Lauder will become Chief Executive Officer.
On January 29, 2004, we filed a Current Report on Form 8-K. Pursuant to Item 12
of Form 8-K, we reported our fiscal 2004 second-quarter results.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE ESTEE LAUDER COMPANIES INC.
Date: April 28, 2004 By: /s/Richard W. Kunes
----------------------------
Richard W. Kunes
Senior Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)