UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
----------------------
FORM 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of the
-
Securities Exchange Act of 1934
For the quarterly period ended December 31, 2004
OR
_ Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
Commission file number: 1-14064
The 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. Yes X No
- -
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
- -
At January 25, 2005, 134,194,796 shares of the registrant's Class A Common
Stock, $.01 par value, and 91,112,901 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 and Six Months Ended December 31, 2004 and 2003...........2
Consolidated Balance Sheets --
December 31, 2004 and June 30, 2004.............................3
Consolidated Statements of Cash Flows --
Six Months Ended December 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..................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........25
Item 4. Controls and Procedures..............................................25
Part II. Other Information
Item 1. Legal Proceedings....................................................26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........27
Item 4. Submission of Matters to a Vote of Security Holders..................27
Item 6. Exhibits.............................................................27
Signatures ...............................................................28
THE ESTEE LAUDER COMPANIES INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Six Months Ended
December 31 December 31
-------------------- ---------------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions, except per share data)
Net Sales........................................................ $ 1,750.3 $ 1,619.1 $ 3,254.4 $ 2,965.7
Cost of sales.................................................... 448.0 412.7 859.3 776.8
--------- --------- --------- ---------
Gross Profit..................................................... 1,302.3 1,206.4 2,395.1 2,188.9
--------- --------- --------- ---------
Operating expenses:
Selling, general and administrative........................... 1,071.8 980.3 2,009.3 1,828.8
Related party royalties....................................... - 7.1 - 11.4
--------- --------- --------- ---------
1,071.8 987.4 2,009.3 1,840.2
--------- --------- --------- ---------
Operating Income................................................. 230.5 219.0 385.8 348.7
Interest expense, net............................................ 3.3 7.2 7.4 14.9
--------- --------- --------- ---------
Earnings before Income Taxes, Minority Interest
and Discontinued Operations..................................... 227.2 211.8 378.4 333.8
Provision for income taxes....................................... 85.5 80.7 141.5 124.8
Minority interest, net of tax.................................... (3.4) (4.8) (3.6) (5.0)
--------- --------- --------- ---------
Net Earnings from Continuing Operations.......................... 138.3 126.3 233.3 204.0
Discontinued operations, net of tax.............................. - (30.6) - (31.3)
--------- --------- --------- ---------
Net Earnings .................................................... $ 138.3 $ 95.7 $ 233.3 $ 172.7
========= ========= ========= =========
Basic net earnings per common share:
Net earnings from continuing operations..................... $ .61 $ .55 $ 1.03 $ .89
Discontinued operations, net of tax......................... - (.13) - (.13)
--------- --------- --------- ---------
Net earnings................................................ $ .61 $ .42 $ 1.03 $ .76
========= ========= ========= =========
Diluted net earnings per common share:
Net earnings from continuing operations..................... $ .60 $ .54 $ 1.01 $ .88
Discontinued operations, net of tax......................... - (.13) - (.13)
--------- --------- --------- ---------
Net earnings................................................ $ .60 $ .41 $ 1.01 $ .75
========= ========= ========= =========
Weighted average common shares outstanding:
Basic....................................................... 225.6 228.6 226.4 228.3
Diluted..................................................... 229.2 231.6 230.2 231.1
Cash dividends declared per common share......................... $ .40 $ .30 $ .40 $ .30
See notes to consolidated financial statements.
2
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED BALANCE SHEETS
December 31 June 30
2004 2004
---- ----
(Unaudited)
(In millions)
ASSETS
Current Assets
Cash and cash equivalents............................................................... $ 577.9 $ 611.6
Accounts receivable, net................................................................ 844.4 664.9
Inventory and promotional merchandise, net.............................................. 699.1 653.5
Prepaid expenses and other current assets............................................... 283.1 269.2
-------- --------
Total current assets............................................................... 2,404.5 2,199.2
-------- --------
Property, Plant and Equipment, net...................................................... 683.1 647.0
-------- --------
Other Assets
Investments, at cost or market value.................................................... 12.9 12.6
Goodwill, net .......................................................................... 684.2 672.3
Other intangible assets, net............................................................ 73.1 71.9
Other assets, net....................................................................... 97.0 105.1
-------- --------
Total other assets................................................................. 867.2 861.9
-------- --------
Total assets.............................................................. $3,954.8 $3,708.1
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt......................................................................... $ 80.4 $ 73.8
Accounts payable........................................................................ 293.6 267.3
Accrued income taxes.................................................................... 127.9 109.4
Other accrued liabilities............................................................... 963.7 871.5
-------- --------
Total current liabilities.......................................................... 1,465.6 1,322.0
-------- --------
Noncurrent Liabilities
Long-term debt.......................................................................... 472.8 461.5
Other noncurrent liabilities............................................................ 198.4 175.6
-------- --------
Total noncurrent liabilities....................................................... 671.2 637.1
-------- --------
Minority Interest....................................................................... 16.7 15.5
-------- --------
Stockholders' Equity
Common stock, $.01 par value; 650,000,000 shares Class A authorized; shares
issued: 154,858,139 at December 31, 2004 and 150,969,807 at June 30, 2004;
240,000,000 shares Class B authorized; shares issued and outstanding:
91,112,901 at December 31, 2004 and 93,012,901 at June 30, 2004...................... 2.5 2.4
Paid-in capital......................................................................... 424.9 382.3
Retained earnings....................................................................... 2,030.4 1,887.2
Accumulated other comprehensive income.................................................. 80.1 10.5
-------- --------
2,537.9 2,282.4
Less: Treasury stock, at cost; 20,703,660 Class A shares at December 31, 2004
and 16,455,660 Class A shares at June 30, 2004....................................... (736.6) (548.9)
-------- --------
Total stockholders' equity......................................................... 1,801.3 1,733.5
-------- --------
Total liabilities and stockholders' equity................................ $3,954.8 $3,708.1
======== ========
See notes to consolidated financial statements.
3
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
December 31
-----------------------
2004 2003
---- ----
(In millions)
Cash Flows from Operating Activities
Net earnings............................................................................... $ 233.3 $ 172.7
Adjustments to reconcile net earnings to net cash flows provided by
operating activities from continuing operations:
Depreciation and amortization.......................................................... 94.5 91.8
Deferred income taxes.................................................................. 22.1 (0.3)
Minority interest, net of tax.......................................................... 3.6 5.0
Non-cash stock compensation............................................................ (1.3) 3.1
Discontinued operations, net of tax.................................................... - 31.3
Other non-cash items................................................................... 0.5 0.4
Changes in operating assets and liabilities:
Increase in accounts receivable, net................................................... (128.6) (103.5)
(Increase) decrease in inventory and promotional merchandise, net...................... (15.1) 38.8
Increase in other assets, net.......................................................... (6.4) (16.2)
Increase (decrease) in accounts payable................................................ 9.3 (6.4)
Increase in accrued income taxes....................................................... 34.3 18.5
Increase in other accrued liabilities.................................................. 47.4 126.2
Increase in other noncurrent liabilities............................................... 4.8 20.8
-------- --------
Net cash flows provided by operating activities of continuing operations............. 298.4 382.2
-------- --------
Cash Flows from Investing Activities
Capital expenditures....................................................................... (103.8) (87.7)
Acquisition of businesses, net of cash acquired............................................ (4.6) (3.7)
Purchases of long-term investments......................................................... (0.3) (0.1)
-------- --------
Net cash flows used for investing activities of continuing operations................ (108.7) (91.5)
-------- --------
Cash Flows from Financing Activities
Increase (decrease) in short-term debt, net................................................ 5.6 (2.1)
Proceeds from the issuance of long-term debt, net.......................................... - 195.5
Proceeds from the net settlement of treasury rate lock agreements.......................... - 15.0
Repayments of long-term debt............................................................... - (2.0)
Net proceeds from employee stock transactions.............................................. 41.7 23.8
Payments to acquire treasury stock......................................................... (187.7) (19.6)
Dividends paid to stockholders............................................................. (90.1) -
Distributions made to minority holders..................................................... (3.0) (2.8)
-------- --------
Net cash flows provided by (used for) financing activities of continuing operations.. (233.5) 207.8
-------- --------
Effect of Exchange Rate Changes on Cash and Cash Equivalents.................................. 10.5 6.9
-------- --------
Cash Flows Provided by (Used for) Discontinued Operations..................................... (0.4) 0.4
-------- --------
Net Increase (Decrease) in Cash and Cash Equivalents....................................... (33.7) 505.8
Cash and Cash Equivalents at Beginning of Period........................................... 611.6 364.1
-------- --------
Cash and Cash Equivalents at End of Period................................................. $ 577.9 $ 869.9
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest .............................................................................. $ 10.6 $ 17.6
========= ========
Income taxes........................................................................... $ 85.1 $ 87.7
========= ========
Non-cash items:
Estimated tax benefit from exercise of stock options................................... $ 18.4 $ 10.2
========= ========
Liability associated with acquisition of business...................................... $ 7.7 $ -
========= ========
See notes to consolidated financial statements.
4
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 operating results of its
reporting unit that sold jane brand products, which have been reflected as
discontinued operations for the three and six-month periods ended December 31,
2003. All significant intercompany balances and transactions have been
eliminated.
The consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by U.S. 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, 2004.
Net Earnings Per Common Share
For the three and six-month periods ended December 31, 2004 and 2003, net
earnings per common share ("basic EPS") is computed by dividing net earnings by
the weighted average number of common shares outstanding and contingently
issuable shares (which satisfy certain conditions). Net earnings per common
share assuming dilution ("diluted EPS") is computed by reflecting potential
dilution from 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 Six Months Ended
December 31 December 31
-------------------- --------------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions, except per share data)
Numerator:
Net earnings from continuing operations............................... $ 138.3 $ 126.3 $ 233.3 $ 204.0
Discontinued operations, net of tax................................... - (30.6) - (31.3)
--------- --------- --------- ---------
Net earnings.......................................................... $ 138.3 $ 95.7 $ 233.3 $ 172.7
========= ========= ========= =========
Denominator:
Weighted average common shares outstanding - Basic.................... 225.6 228.6 226.4 228.3
Effect of dilutive securities: Stock options.......................... 3.6 3.0 3.8 2.8
--------- --------- --------- ---------
Weighted average common shares outstanding - Diluted.................. 229.2 231.6 230.2 231.1
========= ========= ========= =========
Basic net earnings per common share:
Net earnings from continuing operations............................... $ .61 $ .55 $ 1.03 $ .89
Discontinued operations, net of tax................................... - (.13) - (.13)
--------- --------- --------- ---------
Net earnings.......................................................... $ .61 $ .42 $ 1.03 $ .76
========= ========= ========= =========
Diluted net earnings per common share:
Net earnings from continuing operations............................... $ .60 $ .54 $ 1.01 $ .88
Discontinued operations, net of tax................................... - (.13) - (.13)
--------- --------- --------- ---------
Net earnings.......................................................... $ .60 $ .41 $ 1.01 $ .75
========= ========= ========= =========
5
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2004 and 2003, outstanding options to purchase 6.8 million
and 11.3 million shares, respectively, of Class A 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 and their
inclusion would be anti-dilutive.
Stock-Based Compensation
As of December 31, 2004, the Company had established a number of share incentive
programs as discussed in more detail in the Company's Annual Report on Form 10-K
for the year ended June 30, 2004. The Company applies the intrinsic value method
as outlined in Accounting Principles Board Opinion ("APB") 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
on options granted to employees. Statement of Financial Accounting Standard
("SFAS") No. 123, "Accounting for Stock-Based Compensation," ("SFAS No. 123")
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 pro forma charge for
compensation cost related to stock options granted is recognized over the
service period. The service period represents the period of time between the
date of grant and the date each option becomes exercisable without consideration
of acceleration provisions (e.g., retirement, change of control, etc.). The
following table illustrates the effect on net earnings per common share as if
the fair value method had been applied to all outstanding awards in each period
presented.
Three Months Ended Six Months Ended
December 31 December 31
-------------------- --------------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions, except per share data)
Net earnings, as reported............................................. $ 138.3 $ 95.7 $ 233.3 $ 172.7
Deduct: Total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects................................... (6.8) (8.9) (13.5) (17.2)
--------- --------- --------- ---------
Pro forma net earnings................................................ $ 131.5 $ 86.8 $ 219.8 $ 155.5
========= ========= ========= =========
Earnings per common share:
Net earnings per common share - Basic, as reported................. $ .61 $ .42 $ 1.03 $ .76
========= ========= ========= =========
Net earnings per common share - Basic, pro forma................... $ .58 $ .38 $ .97 $ .68
========= ========= ========= =========
Net earnings per common share - Diluted, as reported............... $ .60 $ .41 $ 1.01 $ .75
========= ========= ========= =========
Net earnings per common share - Diluted, pro forma................. $ .57 $ .37 $ .95 $ .67
========= ========= ========= =========
On August 27, 2004, stock units in respect of 365,580 shares of Class A Common
Stock were converted into a cash equivalent amount of $16.1 million, which was
paid in December 2004.
Accounts Receivable
Accounts receivable is stated net of the allowance for doubtful accounts and
customer deductions of $35.0 million and $30.1 million as of December 31, 2004
and June 30, 2004, respectively.
6
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventory and Promotional Merchandise
Inventory and promotional merchandise only includes inventory considered
saleable or usable in future periods, and is stated at the lower of cost or
fair-market value, with cost being determined on the first-in, first-out method.
Cost components include raw materials, componentry, direct labor and overhead
(e.g., indirect labor, utilities, depreciation, purchasing, receiving,
inspection and warehousing) as well as inbound freight. Promotional merchandise
is charged to expense at the time the merchandise is shipped to the Company's
customers.
December 31 June 30
2004 2004
---- ----
(Unaudited)
(In millions)
Inventory and promotional merchandise consists of:
Raw materials......................................... $ 163.1 $ 148.1
Work in process....................................... 35.6 36.5
Finished goods........................................ 345.2 317.7
Promotional merchandise............................... 155.2 151.2
-------- --------
$ 699.1 $ 653.5
======== ========
Property, Plant and Equipment
Property, plant and equipment, including leasehold and other improvements that
extend an asset's useful life or productive capabilities, 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. Leasehold improvements are amortized
on a straight-line basis over the shorter of the lives of the respective leases
or the expected useful life of those improvements.
December 31 June 30
2004 2004
---- ----
(Unaudited)
Asset (Useful Life) (In millions)
------------------
Land ................................................... $ 13.9 $ 13.6
Buildings and improvements (10 to 40 years)............. 171.0 160.9
Machinery and equipment (3 to 10 years)................. 728.9 661.1
Furniture and fixtures (5 to 10 years).................. 108.1 101.9
Leasehold improvements.................................. 683.4 630.3
-------- --------
1,705.3 1,567.8
Less accumulated depreciation and amortization.......... 1,022.2 920.8
-------- --------
$ 683.1 $ 647.0
======== ========
Depreciation and amortization of property, plant and equipment was $44.9 million
and $43.5 million during the three months ended December 31, 2004 and 2003,
respectively, and $89.1 million and $84.5 million during the six months ended
December 31, 2004 and 2003, respectively. Depreciation and amortization related
to our manufacturing process is included in cost of sales and all other
depreciation and amortization is included in selling, general and administrative
expenses in the accompanying consolidated statements of earnings.
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 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, 2004.
7
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of net periodic benefit cost for the three months ended December
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, net............................... $ 4.8 $ 4.2 $ 2.9 $ 2.6 $ 0.8 $ 0.7
Interest cost................................... 5.3 5.0 2.5 2.1 1.0 0.9
Expected return on plan assets.................. (6.0) (5.2) (2.8) (2.5) - -
Amortization of:
Transition asset............................. - - - 0.1 - -
Prior service cost........................... 0.1 0.1 0.1 0.1 - -
Actuarial loss............................... 1.2 1.6 1.0 0.8 - -
-------- -------- -------- -------- -------- --------
Net periodic benefit cost....................... $ 5.4 $ 5.7 $ 3.7 $ 3.2 $ 1.8 $ 1.6
======== ======== ======== ======== ======== ========
The components of net periodic benefit cost for the six months ended December
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, net............................... $ 9.7 $ 8.5 $ 5.7 $ 5.1 $ 1.6 $ 1.4
Interest cost................................... 10.6 10.0 4.9 4.0 2.0 1.8
Expected return on plan assets.................. (12.0) (10.3) (5.5) (4.8) - -
Amortization of:
Transition asset............................. - - - 0.1 - -
Prior service cost........................... 0.2 0.2 0.1 0.2 - -
Actuarial loss............................... 2.3 3.1 2.0 1.6 - -
-------- -------- -------- -------- -------- --------
Net periodic benefit cost....................... $ 10.8 $ 11.5 $ 7.2 $ 6.2 $ 3.6 $ 3.2
======== ======== ======== ======== ======== ========
The Company previously disclosed in its consolidated financial statements for
the fiscal year ended June 30, 2004 that it expected to contribute $25.0 million
and $18.0 million to the U.S. and international pension plans, respectively,
during the fiscal year ending June 30, 2005. As of December 31, 2004, the
expected contribution for U.S. pension plans for the fiscal year ending June 30,
2005 has not materially changed and the expected contributions for the
international pension plans are expected to decrease $1.0 million for a total of
$17.0 million for the fiscal year ending June 30, 2005.
Management Estimates
The preparation of financial statements in conformity with U.S. 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 judgments 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, 2004.
8
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recently Issued Accounting Standards
On December 21, 2004, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position No. FAS 109-1, "Application of FASB Statement No. 109,
Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004" ("FSP No.
109-1"), and FASB Staff Position No. FAS 109-2, "Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004" ("FSP No. 109-2"). These staff positions provide
accounting guidance on how companies should account for the effects of the
American Jobs Creation Act of 2004 ("AJCA") that was signed into law on October
22, 2004. FSP No. 109-1 states that the tax relief (special tax deduction for
domestic manufacturing) from this legislation should be accounted for as a
"special deduction" instead of a tax rate reduction. FSP No. 109-2 gives a
company additional time to evaluate the effects of the legislation on any plan
for reinvestment or repatriation of foreign earnings for purposes of applying
FASB Statement No. 109. The Company is investigating the repatriation provision
to determine whether it might repatriate extraordinary dividends, as defined in
the AJCA, of up to $500 million during fiscal 2005 or fiscal 2006. The Company
is currently evaluating all available U.S. Treasury guidance, as well as
awaiting anticipated further guidance. The Company expects to complete this
evaluation within a reasonable amount of time after additional guidance is
published. The Company estimates the potential income tax effect of any such
repatriation would be to record a tax liability based on the effective 5.25%
rate provided by the AJCA. The actual income tax impact to the Company will
become determinable once further technical guidance has been issued.
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment" ("SFAS
No. 123(R)"). This statement replaces SFAS No. 123, "Accounting for Stock-Based
Compensation" and supersedes APB No. 25, "Accounting for Stock Issued to
Employees." SFAS 123(R) requires all stock-based compensation to be recognized
as an expense in the financial statements and that such cost be measured
according to the fair value of stock options. SFAS 123(R) will be effective for
quarterly periods beginning after June 15, 2005, which is the Company's first
quarter of fiscal 2006. While the Company currently provides the pro forma
disclosures required by SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," on a quarterly basis (see "Note 1 - Stock-Based
Compensation"), it is currently evaluating the impact this statement will have
on its consolidated financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment
of ARB No. 43, Chapter 4" ("SFAS No. 151"). SFAS No. 151 requires all companies
to recognize a current-period charge for abnormal amounts of idle facility
expense, freight, handling costs and wasted materials. This statement also
requires that the allocation of fixed production overhead to the costs of
conversion be based on the normal capacity of the production facilities. SFAS
No. 151 will be effective for fiscal years beginning after June 15, 2005. The
Company is currently evaluating the effect that this statement will have on its
consolidated financial statements.
On May 19, 2004, the FASB issued FASB Staff Position No. FAS 106-2, "Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003" ("FSP No. 106-2"), in response to a
new law regarding prescription drug benefits under Medicare ("Medicare Part D")
and 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. FSP No. 106-2
is effective for financial statements of companies for the first interim or
annual period beginning after June 15, 2004. The Company adopted FSP No. 106-2
in the first quarter of fiscal 2005 and recognized the impact of the new law
under Medicare Part D, which was not material to the Company's results of
operations, cash flows or financial condition.
9
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 -- 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 Six Months Ended
December 31 December 31
-------------------- ----------------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions)
Net earnings..................................................... $ 138.3 $ 95.7 $ 233.3 $ 172.7
--------- --------- --------- ---------
Other comprehensive income (loss):
Net unrealized investment gain.............................. 0.3 - - -
Net derivative instruments gain (loss)...................... (5.6) (2.2) (6.7) 5.3
Net minimum pension liability adjustments................... - - - 0.5
Translation adjustments..................................... 68.0 52.1 76.3 37.2
--------- --------- --------- ---------
Other comprehensive income.................................. 62.7 49.9 69.6 43.0
--------- --------- --------- ---------
Comprehensive income............................................. $ 201.0 $ 145.6 $ 302.9 $ 215.7
========= ========= ========= =========
The accumulated net gain (loss) on derivative instruments consists of the
following:
Three Months Ended Six Months Ended
December 31 December 31
-------------------- ---------------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions)
OCI - derivative instruments, beginning of period................ $ 9.1 $ 6.0 $ 10.2 $ (1.5)
--------- --------- --------- ---------
Gain (loss) on derivative instruments....................... (12.5) (10.7) (13.8) 0.5
Reclassification to earnings of net loss during the
period...................................................... 4.0 7.4 3.7 8.7
Provision for deferred income taxes......................... 2.9 1.1 3.4 (3.9)
--------- --------- --------- ---------
Net derivative instruments gain (loss)...................... (5.6) (2.2) (6.7) 5.3
--------- --------- --------- ---------
OCI - derivative instruments, end of period...................... $ 3.5 $ 3.8 $ 3.5 $ 3.8
========= ========= ========= =========
Of the $3.5 million, net of tax, derivative instrument gain recorded in OCI at
the end of the current period, $9.0 million, net of tax, related to the gain on
the settlement of the treasury rate lock agreements upon issuance of the 5.75%
Senior Notes in September 2003, which will be reclassified to earnings as an
offset to interest expense over the life of the debt. This was offset by a $5.5
million loss, net of tax, related to forward and option contracts which the
Company will reclassify to earnings during the next six months.
At the end of the prior-year period, the $3.8 million, net of tax, derivative
instrument gain recorded in OCI included $9.1 million, net of tax, related to
the gain on the settlement of the treasury rate 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. This was offset by a $5.3 million
loss, net of tax, related to forward and option contracts which the Company
reclassified to earnings during the fiscal year ended June 30, 2004.
10
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 -- Acquisition of Business
In July 2004, the Company acquired a majority equity interest in its former
distributor in Portugal. The initial payment, paid at closing, was funded by
cash provided by operations and did not have a material effect on the Company's
results of operations or financial condition. Additionally, the Company incurred
$8.5 million of short-term and long-term obligations (at the exchange rate at
December 31, 2004) associated with the acquisition, $3.1 million of which (at
the exchange rate at December 31, 2004) was classified as debt at December 31,
2004, payable semi-annually through February 2008 at a variable interest rate.
Note 4 -- 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 does
business in one operating 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 the Company's
reportable segment are substantially the same as those for the consolidated
financial statements, as described in the segment data and related information
footnote included in the Company's Annual Report on Form 10-K for the year ended
June 30, 2004. The assets and liabilities of the Company are managed centrally
and are reported internally in the same manner as the consolidated financial
statements; thus, no additional information is produced for the Chief Executive
or included herein. There has been no significant variance in the total or
long-lived asset value associated with the Company's segment data since June 30,
2004.
Three Months Ended Six Months Ended
December 31 December 31
------------------- ------------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In millions)
SEGMENT DATA
Net Sales:
Skin Care........................................................ $ 617.4 $ 572.1 $ 1,141.7 $ 1,035.0
Makeup........................................................... 592.4 527.1 1,191.9 1,016.1
Fragrance........................................................ 458.6 446.4 770.3 777.5
Hair Care........................................................ 71.6 63.0 134.7 117.8
Other............................................................ 10.3 10.5 15.8 19.3
--------- --------- --------- ---------
$ 1,750.3 $ 1,619.1 $ 3,254.4 $ 2,965.7
========= ========= ========= =========
Operating Income:
Skin Care........................................................ $ 120.9 $ 118.2 $ 185.7 $ 157.8
Makeup........................................................... 72.4 64.5 137.2 110.0
Fragrance........................................................ 27.2 27.1 49.5 66.3
Hair Care........................................................ 9.3 8.8 12.1 13.5
Other............................................................ 0.7 0.4 1.3 1.1
--------- --------- --------- ---------
230.5 219.0 385.8 348.7
Reconciliation:
Interest expense, net......................................... 3.3 7.2 7.4 14.9
--------- --------- --------- ---------
Earnings before income taxes, minority interest and
discontinued operations....................................... $ 227.2 $ 211.8 $ 378.4 $ 333.8
========= ========= ========= =========
REGIONAL DATA
Net Sales:
The Americas..................................................... $ 877.7 $ 804.7 $ 1,765.9 $ 1,656.2
Europe, the Middle East & Africa................................. 628.9 586.7 1,052.7 914.5
Asia/Pacific..................................................... 243.7 227.7 435.8 395.0
--------- --------- --------- ---------
$ 1,750.3 $ 1,619.1 $ 3,254.4 $ 2,965.7
========= ========= ========= =========
Operating Income:
The Americas..................................................... $ 83.2 $ 59.4 $ 190.3 $ 178.5
Europe, the Middle East & Africa................................. 117.4 128.8 159.3 136.5
Asia/Pacific..................................................... 29.9 30.8 36.2 33.7
--------- --------- --------- ---------
$ 230.5 $ 219.0 $ 385.8 $ 348.7
========= ========= ========= =========
11
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 six months ended December 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 Six Months Ended
December 31 December 31
-------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Net Sales
By Region:
The Americas............................................... $ 877.7 $ 804.7 $ 1,765.9 $ 1,656.2
Europe, the Middle East & Africa........................... 628.9 586.7 1,052.7 914.5
Asia/Pacific............................................... 243.7 227.7 435.8 395.0
--------- --------- --------- ---------
$ 1,750.3 $ 1,619.1 $ 3,254.4 $ 2,965.7
========= ========= ========= =========
By Product Category:
Skin Care.................................................. $ 617.4 $ 572.1 $ 1,141.7 $ 1,035.0
Makeup..................................................... 592.4 527.1 1,191.9 1,016.1
Fragrance.................................................. 458.6 446.4 770.3 777.5
Hair Care.................................................. 71.6 63.0 134.7 117.8
Other...................................................... 10.3 10.5 15.8 19.3
--------- --------- --------- ---------
$ 1,750.3 $ 1,619.1 $ 3,254.4 $ 2,965.7
========= ========= ========= =========
Operating Income
By Region:
The Americas............................................... $ 83.2 $ 59.4 $ 190.3 $ 178.5
Europe, the Middle East & Africa........................... 117.4 128.8 159.3 136.5
Asia/Pacific............................................... 29.9 30.8 36.2 33.7
--------- --------- --------- ---------
$ 230.5 $ 219.0 $ 385.8 $ 348.7
========= ========= ========= =========
By Product Category:
Skin Care.................................................. $ 120.9 $ 118.2 $ 185.7 $ 157.8
Makeup..................................................... 72.4 64.5 137.2 110.0
Fragrance.................................................. 27.2 27.1 49.5 66.3
Hair Care.................................................. 9.3 8.8 12.1 13.5
Other...................................................... 0.7 0.4 1.3 1.1
--------- --------- --------- ---------
$ 230.5 $ 219.0 $ 385.8 $ 348.7
========= ========= ========= =========
12
THE ESTEE LAUDER COMPANIES INC.
The following table presents certain consolidated earnings data as a percentage
of net sales:
Three Months Ended Six Months Ended
December 31 December 31
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net sales........................................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales.................................................... 25.6 25.5 26.4 26.2
----- ----- ----- -----
Gross profit..................................................... 74.4 74.5 73.6 73.8
----- ----- ----- -----
Operating expenses
Selling, general and administrative........................... 61.2 60.6 61.7 61.6
Related party royalties....................................... - 0.4 - 0.4
----- ----- ----- -----
61.2 61.0 61.7 62.0
----- ----- ----- -----
Operating income................................................. 13.2 13.5 11.9 11.8
Interest expense, net............................................ 0.2 0.4 0.3 0.5
----- ----- ----- -----
Earnings before income taxes, minority interest and discontinued
operations.................................................... 13.0 13.1 11.6 11.3
Provision for income taxes....................................... 4.9 5.0 4.3 4.2
Minority interest, net of tax.................................... (0.2) (0.2) (0.1) (0.2)
----- ----- ----- -----
Net earnings from continuing operations.......................... 7.9 7.8 7.2 6.9
Discontinued operations, net of tax.............................. - (1.9) - (1.1)
----- ----- ----- -----
Net earnings..................................................... 7.9% 5.9% 7.2% 5.8%
===== ===== ===== =====
Second Quarter Fiscal 2005 as Compared with Second Quarter Fiscal 2004
Net Sales
Net sales increased 8% or $131.2 million to $1,750.3 million reflecting growth
in all major product categories and geographic regions. Product category
increases were led by strong domestic sales of makeup and skin care products as
a result of certain new and recent product launches. Excluding the impact of
foreign currency translation, net sales increased 5%.
Product Categories
In order to meet the demands of consumers, we continually introduce new
products, support new and established products through advertising, sampling and
merchandising and phase out existing products that no longer meet the needs of
our consumers. The economics of developing, producing and launching these new
products influence our sales and operating performance each period.
Skin Care
Net sales of skin care products increased 8% or $45.3 million to $617.4 million,
led by new and recently launched products. Approximately $22 million of the
increase was attributable to Future Perfect Anti-Wrinkle Radiance Creme SPF 15
and Nutritious Vita-Mineral Energy Lotion by Estee Lauder and Superdefense
Triple Action Moisturizers SPF 25 by Clinique. Also contributing to sales growth
was approximately $14 million of Lifting Face Serum and The Concentrate by La
Mer and products in the 3-Step Skin Care System and Advanced Stop Signs Eye
Cream SPF 15 by Clinique. Partially offsetting these increases was a decrease of
approximately $7 million in sales of Idealist Micro-D Deep Thermal Refinisher
and the LightSource line of products by Estee Lauder. Excluding the impact of
foreign currency translation, skin care net sales increased 4%.
13
THE ESTEE LAUDER COMPANIES INC.
Makeup
Makeup net sales increased 12% or $65.3 million to $592.4 million, led by strong
net sales of our makeup artist lines, which accounted for approximately $39
million of the increase. Our makeup artist lines benefited from new points of
distribution both domestically and internationally and the success of recent
product launches. In addition, approximately $23 million of the increase in
sales was attributable to the recent launches of Superbalanced Compact Makeup
SPF 20, certain new and existing Colour Surge products from Clinique, Pure Color
Eyeliner from Estee Lauder and the current period inclusion of sales from
certain BeautyBank brands. Also contributing to sales growth were Perfectly Real
Makeup from Clinique and Electric Intense LipCreme and Lash XL Maximum Length
Mascara by Estee Lauder of approximately $17 million, collectively. Partially
offsetting these increases was a decrease of approximately $14 million of sales
of Ideal Matte Refinishing Makeup SPF 8 and certain Pure Color Lip products by
Estee Lauder and High Impact Mascara by Clinique. Excluding the impact of
foreign currency translation, makeup net sales increased 10%.
Fragrance
Net sales of fragrance products increased 3% or $12.2 million to $458.6 million,
primarily due to the recent launches of True Star from Tommy Hilfiger, DKNY Be
Delicious and Lauder Beyond Paradise Men from Estee Lauder of approximately $41
million, collectively. Partially offsetting these increases was a decrease in
sales of approximately $28 million of Aramis Life, Tommy Girl from Tommy
Hilfiger and the remaining products in the Aramis line. Excluding the impact of
foreign currency translation, fragrance net sales decreased 1%.
Hair Care
Hair care net sales increased 14% to $71.6 million. This increase was due to
sales growth from Aveda and Bumble and bumble products and services. Aveda sales
increased as a result of new professional color products, the recent
introduction of Air Control and Pure Abundance hair care products and the recent
launch of Aveda's online business. Bumble and bumble benefited from increases in
sales from their hair treatment line and new points of distribution. These
factors accounted for the majority of the $8.6 million increase. Excluding the
impact of foreign currency translation, hair care net sales increased 12%.
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 $73.0 million to $877.7 million. This
increase was due to growth in net sales from our makeup artist brands in North
America, certain new and recently launched products from all product categories,
higher net sales in Canada and the current-period inclusion of net sales of
BeautyBank products.
In Europe, the Middle East & Africa, net sales increased 7% or $42.2 million to
$628.9 million, primarily reflecting higher net sales in the United Kingdom,
France, Portugal and Germany of approximately $39 million, collectively, where
we benefited from the effect of favorable foreign currency exchange rates to the
U.S. dollar. Excluding this benefit, we had a difficult comparison to the
prior-year quarter in continental Europe. In the prior-year quarter, we
experienced a recovery of net sales which had fallen in the first quarter of
fiscal 2004 due to adverse weather conditions; lower sales orders resulting from
a change in fiscal year of one key customer; and the renegotiation of certain
trading terms with another. On a local currency basis, net sales in Europe, the
Middle East & Africa decreased slightly.
Net sales in Asia/Pacific increased 7% or $16.0 million to $243.7 million. This
increase reflected higher net sales of approximately $17 million in Taiwan,
China, Hong Kong and Australia, partially offset by decreases in Japan and Korea
of approximately $3 million. Excluding the impact of foreign currency
translation, Asia/Pacific net sales increased 4%.
We strategically stagger our new product launches by geographic market, which
may account for differences in regional sales growth.
Cost of Sales
Cost of sales as a percentage of total net sales increased to 25.6% as compared
with 25.5% in the prior-year quarter. Cost of sales as a percentage of net sales
reflected an unfavorable net change in the mix of our business within geographic
regions and product categories, as discussed above, of approximately 50 basis
points. Partially offsetting these changes were net favorable changes in
production and supply chain efforts of approximately 40 basis points, primarily
driven by favorable material sourcing.
14
THE ESTEE LAUDER COMPANIES INC.
Since certain promotional activities are a component of sales or cost of sales
and the timing and level of promotions vary with our promotional calendar, we
have experienced, and expect to continue to experience, fluctuations in the cost
of sales percentage. In addition, future cost of sales mix may be impacted by
the inclusion of new brands which have margin and product cost structures
different from those of our existing brands.
Operating Expenses
Operating expenses increased to 61.2% of net sales as compared with 61.0% of net
sales in the prior-year quarter. Collectively, our planned shift of spending
closer to the holiday season partially offset by our ongoing cost containment
efforts to maintain expenses in line with our business needs increased operating
expenses as a percentage of net sales by approximately 60 basis points as
compared with the prior-year quarter. Partially offsetting this net increase, we
realized a benefit of approximately 40 basis points from the elimination of
royalty payments made to Mrs. Estee Lauder. We will continue to realize a
period-to-period benefit from the elimination of these royalty payments through
the remainder of fiscal 2005.
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.
Operating Results
Based on the growth of net sales offset by increases in our cost of sales and
operating expense margins as previously discussed, operating income increased 5%
or $11.5 million to $230.5 million as compared with the prior-year quarter.
Operating margins were 13.2% of net sales in the current-year quarter as
compared with 13.5% in the prior-year quarter.
Product Categories
Operating income increased 12% or $7.9 million in makeup and 2% or $2.7 million
in skin care reflecting net sales growth from certain new and recently launched
products. Hair care operating income increased 6% primarily due to improved
results internationally, partially offset by an increase in operating expenses
related to the growth of our business in the United States. Operating income
remained relatively flat in fragrances as a result of the continued softness in
this product category, coupled with ongoing development costs for future
fragrances and brands, as well as sustained support spending related to existing
products.
Geographic Regions
Operating income in the Americas increased 40% or $23.8 million to $83.2
million. This increase reflects strong sales during the holiday season,
primarily due to the new and recent launches of certain makeup and skin care
products. Profitability in this region in the current-year quarter reflects more
normalized levels following a decrease in the prior-year quarter.
In Europe, the Middle East & Africa, operating income decreased 9% or $11.4
million to $117.4 million primarily due to lower results from our travel retail
and distributor businesses, and in Italy of approximately $10 million,
collectively. In continental Europe, the results reflect a difficult comparison
to the prior-year quarter. In the prior-year quarter, we experienced a recovery
of net sales which had fallen in the first quarter of fiscal 2004 due to adverse
weather conditions; lower sales orders resulting from a change in fiscal year of
one key customer; and the renegotiation of certain trading terms with another.
In Asia/Pacific, operating income decreased 3% or $0.9 million to $29.9 million.
This decrease reflects lower results from China, where we continue to invest in
new brand expansion and business opportunities, and in Korea of approximately $5
million, collectively, partially offset by an increase in operating income of
approximately $4 million in Taiwan and Hong Kong, collectively.
15
THE ESTEE LAUDER COMPANIES INC.
Interest Expense, Net
Net interest expense was $3.3 million as compared with $7.2 million in the
prior-year period. The decrease in net interest expense was due primarily to a
$4.1 million decrease in preferred stock dividends as a result of the redemption
of $291.6 million aggregate principal amount of Cumulative Redeemable Preferred
Stock due 2015 on June 10, 2004 and the reduction in the dividend rate of the
remaining $68.4 million of the 2015 Preferred Stock.
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
December 31, 2004 was 37.6% as compared with 38.1% 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 decrease in the effective tax rate was attributable to the reduction in the
amount of nondeductible preferred stock dividends of approximately 100 basis
points, partially offset by the anticipated full-year mix of global earnings
impact of approximately 50 basis points.
The American Jobs Creation Act of 2004 ("AJCA") was enacted in October 2004. It
includes a special one-time dividends received deduction on the repatriation of
certain foreign earnings to a U.S. taxpayer (the "repatriation provision"),
provided certain criteria are met. We are investigating the repatriation
provision to determine whether we might repatriate extraordinary dividends, as
defined in the AJCA, of up to $500 million during fiscal 2005 or fiscal 2006. We
are currently evaluating all available U.S. Treasury guidance, as well as
awaiting anticipated further guidance. We expect to complete this evaluation
within a reasonable amount of time after additional guidance is published. We
estimate the potential income tax effect of any such repatriation would be to
record a tax liability based on the effective 5.25% rate provided by the AJCA.
The actual income tax impact to us will become determinable once further
technical guidance has been issued.
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
decisions were made, circumstances warranted that we conduct an assessment of
the tangible and intangible assets of this 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. Accordingly, we
recorded an after-tax charge to discontinued operations of $30.6 million for the
three months ended December 31, 2003. The charge represents the impairment of
goodwill in the amount of $26.4 million, the reduction in value of other
tangible assets held for sale of $1.2 million, net of tax, and the operating
loss of $3.0 million, net of tax, for the three month period ended December 31,
2003. Included in the operating loss of the period were additional costs
associated with the sale and discontinuation of the business.
Six Months Fiscal 2005 as Compared with Six Months Fiscal 2004
Net Sales
Net sales increased 10% or $288.7 million to $3,254.4 million primarily
reflecting growth in the makeup and skin care product categories and growth in
all geographic regions, led by Europe, the Middle East & Africa. Fragrance net
sales declined primarily due to the soft fragrance business in the United States
coupled with a lower volume of shipments related to new product launches in the
current period compared with launches from the comparable prior-year period.
Excluding the impact of foreign currency translation, net sales increased 7%.
Product Categories
In order to meet the demands of consumers, we continually introduce new
products, support new and established products through advertising, sampling and
merchandising and phase out existing products that no longer meet the needs of
our consumers. The economics of developing, producing and launching these new
products influence our sales and operating performance each period.
16
THE ESTEE LAUDER COMPANIES INC.
Skin Care
Net sales of skin care products increased 10% or $106.7 million to $1,141.7
million. Approximately $51 million of this increase in sales was related to the
introduction of Future Perfect Anti-Wrinkle Radiance Creme SPF 15 and Nutritious
Vita-Mineral Energy Lotion by Estee Lauder, new launches of Superdefense Triple
Action Moisturizers SPF 25 and certain Repairwear products by Clinique and to
the introduction of certain BeautyBank brands. Strong sales of Lifting Face
Serum and The Concentrate by La Mer, Hydra Complete Multi-Level Moisture Creme
by Estee Lauder and Advanced Stop Signs Eye Cream SPF 15 by Clinique accounted
for approximately $25 million of the increase. Partially offsetting these
increases was a decrease of approximately $17 million in sales of Idealist
Micro-D Deep Thermal Refinisher and the LightSource line of products by Estee
Lauder. Excluding the impact of foreign currency translation, skin care net
sales increased 7%.
Makeup
Makeup net sales increased 17% or $175.8 million to $1,191.9 million, partially
due to strong net sales of our makeup artist lines, which accounted for
approximately $84 million of the increase. Our makeup artist lines benefited
from new points of distribution both domestically and internationally and the
success of recent product launches. In addition, approximately $60 million of
the increase in sales was attributable to the recent launches of Superbalanced
Compact Makeup SPF 20, Colour Surge Eye Shadow, the Colour Surge Lip Lacquer
line of products and Cream Shaper for Lips from Clinique, Pure Color Eyeliner by
Estee Lauder and the current period inclusion of net sales from certain
BeautyBank brands. Also contributing to sales growth were strong sales of Lash
XL Maximum Length Mascara and Electric Intense LipCreme by Estee Lauder and
Perfectly Real Makeup and certain Colour Surge lip products from Clinique of
approximately $46 million, collectively. Partially offsetting these increases
was a decrease of approximately $31 million of sales of the Glosswear line of
products and Clarifying Powder Makeup by Clinique and Ideal Matte Refinishing
Makeup SPF 8 and Pure Color Lip Vinyl by Estee Lauder. Excluding the impact of
foreign currency translation, makeup net sales increased 15%.
Fragrance
Net sales of fragrance products decreased 1% or $7.2 million to $770.3 million.
Net sales for this product category decreased mainly due to the soft fragrance
business in the United States as well as difficult comparisons with the volume
of product launches in the prior-year period. Fragrance sales reflected a
decrease of approximately $79 million of Aramis Life, Clinique Simply and Estee
Lauder Beyond Paradise, which were launched in the prior-year period, Tommy and
Tommy Girl products from Tommy Hilfiger and the remaining products in the Aramis
line. Partially offsetting these decreases were sales from the recent launches
of True Star from Tommy Hilfiger, DKNY Be Delicious and Lauder Beyond Paradise
Men from Estee Lauder for a total of approximately $75 million. Excluding the
impact of foreign currency translation, fragrance net sales decreased 4%.
Hair Care
Hair care net sales increased 14% to $134.7 million. This $16.9 million increase
was due to sales growth from Aveda and Bumble and bumble products. Aveda net
sales increased as a result of sales of new professional color products and the
introduction of Air Control and Pure Abundance hair care products, while Bumble
and bumble benefited from recent launches in their hair treatment line of
products and the addition of new points of distribution. 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 7% or $109.7 million to $1,765.9 million.
Approximately $81 million of this increase was due to our makeup artist brands
in North America, the inclusion of BeautyBank products and higher net sales in
Canada. This increase was partially offset by a decrease in our fragrance
business of approximately $25 million.
In Europe, the Middle East & Africa, net sales increased 15% or $138.2 million
to $1,052.7 million primarily due to higher net sales in the United Kingdom, our
travel retail business, Spain, France, South Africa and Germany of approximately
$103 million, collectively. 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 7%.
Net sales in Asia/Pacific increased 10% or $40.8 million to $435.8 million. This
increase reflected higher net sales of approximately $32 million in China,
Taiwan, Australia and Hong Kong, partially offset by lower sales in Korea of
approximately $1 million. Excluding the impact of foreign currency translation,
Asia/Pacific net sales increased 6%.
We strategically stagger our new product launches by geographic market, which
may account for differences in regional sales growth.
17
THE ESTEE LAUDER COMPANIES INC.
Cost of Sales
Cost of sales as a percentage of total net sales increased to 26.4% from 26.2%.
Cost of sales as a percentage of net sales primarily reflected an unfavorable
net change in the mix of our business within our geographic regions and product
categories, as discussed above, of approximately 40 basis points. Partially
offsetting these changes were favorable net changes in production and supply
chain efforts of approximately 20 basis points, primarily driven by favorable
material sourcing.
During the current period, the higher price of oil did not have a material
impact on our cost of raw materials and componentry. Sustained oil price
increases could result in higher costs, however, we believe this will not have a
material adverse effect on our cost of sales margin in the near future.
Since certain promotional activities are a component of sales or cost of sales
and the timing and level of promotions vary with our promotional calendar, we
have experienced, and expect to continue to experience, fluctuations in the cost
of sales percentage. In addition, future cost of sales mix may be impacted by
the inclusion of new brands which have margin and product cost structures
different from those of our existing brands.
Operating Expenses
Operating expenses decreased to 61.7% of net sales as compared with 62.0% of net
sales in the prior year. Collectively, our planned increase in spending,
partially offset by our ongoing cost containment efforts to maintain expenses in
line with our business needs, increased operating expenses as a percentage of
net sales by approximately 10 basis points as compared with the prior-year
period. We also realized a benefit of approximately 40 basis points from the
elimination of royalty payments made to Mrs. Estee Lauder. We will continue to
realize a period-to-period benefit from the elimination of these royalty
payments through the remainder of fiscal 2005.
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.
Operating Results
Based on the growth of net sales, increase in our cost of sales margin and
improvement in our operating expense margin as previously discussed, operating
income increased 11% or $37.1 million to $385.8 million as compared with the
prior-year period. Operating margins were 11.9% of net sales in the current
period as compared with 11.8% in the prior-year period.
Product Categories
Operating income increased 18% or $27.9 million in skin care and 25% or $27.2
million in makeup reflecting overall sales growth and recently launched
products. Operating results decreased 25% or $16.8 million in fragrance,
reflecting the continued softness in this product category in the Americas
region, coupled with ongoing development costs for future fragrances and brands,
as well as sustained support spending related to existing products. Hair care
operating results decreased 10% or $1.4 million primarily reflecting an increase
in operating expenses related to the growth of our business in the United
States.
Geographic Regions
Operating income in the Americas increased 7% or $11.8 million to $190.3
million. The current-period increase reflects strong sales during the holiday
season, primarily due to the new and recent launches of certain makeup and skin
care products.
In Europe, the Middle East & Africa, operating income increased 17% or $22.8
million to $159.3 million primarily due to improved results from the United
Kingdom, South Africa, Switzerland and Italy of approximately $20 million,
partially offset by lower results in Russia of approximately $2 million.
In Asia/Pacific, operating income increased 7% or $2.5 million to $36.2 million.
This increase reflects improved results in Hong Kong, Taiwan, Australia and
Malaysia of approximately $8 million, collectively, partially offset by a
decrease in operating income in China, where we continue to invest in new brand
expansion and business opportunities, and in Korea of approximately $7 million,
collectively.
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THE ESTEE LAUDER COMPANIES INC.
Interest Expense, Net
Net interest expense was $7.4 million as compared with $14.9 million in the
prior-year period. The decrease in net interest expense was due primarily to a
$9.8 million decrease in preferred stock dividends as a result of the redemption
of $291.6 million aggregate principal amount of 2015 Preferred Stock on June 10,
2004 and the reduction in the dividend rate of the remaining $68.4 million of
2015 Preferred Stock. This improvement was partially offset by an increase in
interest expense as a result of higher debt balances and, to a lesser extent,
higher interest rates.
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 six months ended
December 30, 2004 and 2003 was 37.4%. These rates differ from statutory rates
due to the effect of state and local taxes, tax rates in foreign jurisdictions
and certain nondeductible expenses. In comparing the significant components that
affect the effective tax rate for the six months ended December 30, 2004 and
2003, the anticipated full-year mix of global earnings added approximately 100
basis points which was offset by the reduction in the amount of nondeductible
preferred stock dividends of approximately 100 basis points.
The AJCA was enacted in October 2004. It includes a special one-time dividends
received deduction on the repatriation of certain foreign earnings to a U.S.
taxpayer (the "repatriation provision"), provided certain criteria are met. We
are investigating the repatriation provision to determine whether we might
repatriate extraordinary dividends, as defined in the AJCA, of up to $500
million during fiscal 2005 or fiscal 2006. We are currently evaluating all
available U.S. Treasury guidance, as well as awaiting anticipated further
guidance. We expect to complete this evaluation within a reasonable amount of
time after additional guidance is published. We estimate the potential income
tax effect of any such repatriation would be to record a tax liability based on
the effective 5.25% rate provided by the AJCA. The actual income tax impact to
us will become determinable once further technical guidance has been issued.
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
decisions were made, circumstances warranted that we conduct an assessment of
the tangible and intangible assets of this 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. Accordingly, we
recorded an after-tax charge to discontinued operations of $31.3 million for the
six months ended December 31, 2003. The charge represents the impairment of
goodwill in the amount of $26.4 million, the reduction in value of other
tangible assets held for sale of $1.2 million, net of tax, and the operating
loss of $3.7 million, net of tax, for the six month period ended December 31,
2003. Included in the operating loss of the period were additional costs
associated with the sale and discontinuation of the business.
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, borrowings from the issuance
of long-term debt and committed and uncommitted credit lines provided by banks
in the United States and abroad. At December 31, 2004, we had cash and cash
equivalents of $577.9 million compared with $611.6 million at June 30, 2004.
At December 31, 2004, our outstanding borrowings of $553.2 million included: (i)
$244.7 million of 6% Senior Notes due January 2012 consisting of $250.0 million
principal, unamortized debt discount of $0.8 million and a $4.5 million
adjustment to reflect the fair value of an outstanding interest rate swap; (ii)
$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; (iii) $68.4
million of Cumulative Redeemable Preferred Stock, which shares have a mandatory
redemption date of June 30, 2015; (iv) a 3.0 billion Japanese yen term loan
(approximately $28.7 million at the exchange rate at December 31, 2004), which
is due in March 2006; (v) a 2.3 million Euro note (approximately $3.1 million at
the exchange rate at December 31, 2004) payable semi-annually through February
2008 at a variable interest rate; and (vi) $11.0 million of other short-term
borrowings.
19
THE ESTEE LAUDER COMPANIES INC.
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 stable outlook by Standard & Poor's and A1 with a stable outlook by
Moody's. At December 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 December 31,
2004, we had an unused $400.0 million revolving credit facility, expiring on
June 28, 2006, and $147.0 million in additional uncommitted credit facilities,
of which $11.0 million was used.
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.
Total debt as a percent of total capitalization was 23% at December 31, 2004 and
24% at June 30, 2004.
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 from continuing operations was $298.4
million during the six months ended December 31, 2004 as compared with $382.2
million in the prior-year period. The reduction in cash flows provided by
operating activities primarily reflected changes in other accrued liabilities,
inventory and accounts receivable, net. The change in other accrued liabilities
in the current period compared to the prior-year period was primarily due to
significant deferred compensation and supplemental pension payments made to
retired executives. The increase in inventory was primarily due to the timing of
promotional shipments compared with the prior year, a general increase in
inventory levels to accommodate increased sales, particularly for our new
brands, such as BeautyBank, and for certain new international activities.
Increased accounts receivable levels reflect a seasonal increase in the quarter
corresponding to increased holiday shipments. These reductions in cash flows
provided by operating activities as compared with the prior-year period were
partially offset by increased net earnings.
Net cash used for investing activities was $108.7 million during the six months
ended December 31, 2004 compared with $91.5 million in the prior-year period.
For both periods the use of cash primarily reflects capital expenditures, which
were higher during the current period.
Net cash used for financing activities was $233.5 million during the six months
ended December 31, 2004 compared to net cash provided by financing activities of
$207.8 million in the prior-year period. During the current period, the use of
cash primarily reflects the acquisition of treasury stock and the payment of the
common stock dividends. In the prior-year period, the source of cash was
primarily related to the transactions associated with the issuance of long-term
debt, which was partially reduced by the acquisition of treasury stock.
Dividends
On November 3, 2004, the Board of Directors declared an annual dividend of $.40
per share, or $90.1 million, on our Class A and Class B Common Stock, which was
paid on December 28, 2004 to stockholders of record at the close of business on
December 10, 2004. The annual common stock dividend declared during the period
ended December 31, 2003 was $.30 per share, or $68.5 million, but such dividend
was not paid until the third quarter of fiscal 2004. Dividends declared on the
cumulative redeemable preferred stock were $0.3 million and $10.1 million for
the six months ended December 31, 2004 and 2003, respectively. These dividends
have been characterized as interest expense in the accompanying consolidated
statements of earnings for the six months ended December 31, 2004 and 2003.
20
THE ESTEE LAUDER COMPANIES INC.
Share Repurchase Program
We are authorized by the Board of Directors to repurchase up to 28.0 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 December
31, 2004, the cumulative total of acquired shares pursuant to the authorization
was 20.9 million, reducing the remaining authorized share repurchase balance to
7.1 million. During the first six months of fiscal 2005, we purchased
approximately 4.2 million shares for $187.7 million as outlined in the following
table:
Total Number of Maximum Number
Shares Purchased as of 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 2004 - - - 11,327,900
August 2004 1,275,700 $43.03 1,275,700 10,052,200
September 2004 750,000 44.61 750,000 9,302,200
October 2004 - - - 9,302,200
November 2004 2,222,300 44.71 2,222,300 7,079,900
December 2004 - - - 7,079,900
--------- ---------
Year-to-date 4,248,000 44.19 4,248,000
========= =========
(1) The publicly announced repurchase program was last increased by 10.0
million shares on May 11, 2004. The initial program covering the repurchase
of 8.0 million shares was announced in September 1998 and increased by 10.0
million shares on October 30, 2002.
Commitments and Contingencies
There have been no significant changes to our commitments and contingencies as
discussed in our Annual Report on Form 10-K for the year ended June 30, 2004.
Contractual Obligations
There have been no significant changes to our contractual obligations as
discussed in our Annual Report on Form 10-K for the year ended June 30, 2004.
Business Acquisitions
In July 2004, we acquired a majority equity interest in our former distributor
in Portugal. The initial payment, paid at closing, was funded by cash provided
by operations and did not have a material effect on our results of operations or
financial condition. Additionally, we incurred $8.5 million of short-term and
long-term obligations (at the exchange rate at December 31, 2004) associated
with the acquisition, $3.1 million of which (at the exchange rate at December
31, 2004) was classified as debt at December 31, 2004, payable semi-annually
through February 2008 at a variable interest rate.
Derivative Financial Instruments and Hedging Activities
There have been no significant changes to our derivative financial instruments
and hedging activities as discussed in our Annual Report on Form 10-K for the
year ended June 30, 2004.
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 and foreign currency
options entered into to hedge anticipated transactions have been designated as
cash-flow hedges. As of December 31, 2004, these cash-flow hedges were highly
effective, in all material respects.
21
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 November 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 December 31, 2004, we had foreign currency contracts in the form of
forward exchange contracts and option contracts in the amount of $516.2 million
and $33.3 million, respectively. The foreign currencies included in forward
exchange contracts (notional value stated in U.S. dollars) are principally the
British pound ($113.1 million), Euro ($110.0 million), Swiss franc ($98.9
million), Canadian dollar ($39.8 million), Japanese yen ($32.9 million) and
Australian dollar ($24.7 million). The foreign currencies included in the option
contracts (notional value stated in U.S. dollars) are principally the Euro
($16.0 million), Swiss franc ($6.6 million) and British pound ($5.5 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 December 31, 2004, the fair-value hedge was highly
effective, in all material respects.
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, 2004, our average value-at-risk, calculated
for the most recent twelve months, is $8.3 million related to our foreign
exchange contracts. As of December 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 $12.7 million. There have been no significant
changes in market risk since June 30, 2004 that would have a material effect on
our calculated value-at-risk exposure, as disclosed in our Annual Report on Form
10-K for the fiscal year ended June 30, 2004.
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 our Annual Report on Form 10-K for the fiscal year ended June
30, 2004, 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 U.S. generally accepted accounting principles. 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 and assumptions. 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, 2004, there have been no changes in our critical
accounting policies and no significant changes to the assumptions and estimates
related to them.
22
THE ESTEE LAUDER COMPANIES INC.
Recently Issued Accounting Standards
On December 21, 2004, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position No. FAS 109-1, "Application of FASB Statement No. 109,
Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004" ("FSP No.
109-1"), and FASB Staff Position No. FAS 109-2, "Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004" ("FSP No. 109-2"). These staff positions provide
accounting guidance on how companies should account for the effects of the
American Jobs Creation Act of 2004 that was signed into law on October 22, 2004.
FSP No. 109-1 states that the tax relief (special tax deduction for domestic
manufacturing) from this legislation should be accounted for as a "special
deduction" instead of a tax rate reduction. FSP No. 109-2 gives a company
additional time to evaluate the effects of the legislation on any plan for
reinvestment or repatriation of foreign earnings for purposes of applying FASB
Statement No. 109. We are investigating the repatriation provision to determine
whether it might repatriate extraordinary dividends, as defined in the AJCA, of
up to $500 million during fiscal 2005 or fiscal 2006. We are currently
evaluating all available U.S. Treasury guidance, as well as awaiting anticipated
further guidance. We expect to complete this evaluation within a reasonable
amount of time after additional guidance is published. We estimate the potential
income tax effect of any such repatriation would be to record a tax liability
based on the effective 5.25% rate provided by the AJCA. The actual income tax
impact to us will become determinable once further technical guidance has been
issued.
In December 2004, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)"). This statement
replaces SFAS No. 123, "Accounting for Stock-Based Compensation" and supersedes
APB No. 25, "Accounting for Stock Issued to Employees." SFAS 123(R) requires all
stock-based compensation to be recognized as an expense in the financial
statements and that such cost be measured according to the fair value of stock
options. SFAS 123(R) will be effective for quarterly periods beginning after
June 15, 2005, which is our first quarter of fiscal 2006. While we currently
provide the pro forma disclosures required by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," on a quarterly basis (see
"Note 1 - Stock-Based Compensation"), we are currently evaluating the impact
this statement will have on our consolidated financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment
of ARB No. 43, Chapter 4" ("SFAS No. 151"). SFAS No. 151 requires all companies
to recognize a current-period charge for abnormal amounts of idle facility
expense, freight, handling costs and wasted materials. This statement also
requires that the allocation of fixed production overhead to the costs of
conversion be based on the normal capacity of the production facilities. SFAS
No. 151 will be effective for fiscal years beginning after June 15, 2005. We are
currently evaluating the effect that this statement will have on our
consolidated financial statements.
On May 19, 2004, the FASB issued FASB Staff Position No. FAS 106-2, "Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003" ("FSP No. 106-2"), in response to a
new law regarding prescription drug benefits under Medicare ("Medicare Part D")
and 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. FSP No. 106-2
is effective for financial statements of companies for the first interim or
annual period beginning after June 15, 2004. We adopted FSP No. 106-2 in the
first quarter of fiscal 2005 and recognized the impact of the new law under
Medicare Part D, which was not material to our results of operations, cash flows
or financial condition.
23
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," "may," "could," "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, and any action
we may take as a result;
(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 or suppliers, the cost and
availability of capital, which we may need for new equipment,
facilities or acquisitions, the cost and availability of raw materials
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;
(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; and
24
THE ESTEE LAUDER COMPANIES INC.
(15) the impact of repatriating, or planning to repatriate, certain of
our foreign earnings to the United States in connection with The
American Jobs Creation Act of 2004.
We assume no responsibility to update forward-looking statements made herein or
otherwise.
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 Rules 13a-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
December 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 Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred
during the second quarter of fiscal 2005 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
25
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, which is still pending, and, if approved
by the Court, will result in the plaintiffs' claims being dismissed, with
prejudice, in their entirety in both the Federal and California actions. 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. At December 31, 2004, the remaining accrual balance was $21.0
million. 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 for all
the PRPs. In 2001, the State sued other PRPs (including Hickey's Carting, Inc.,
Dennis C. Hickey and Maria Hickey, collectively the "Hickey Parties"), in the
U.S. District Court for the Eastern District of New York to recover such costs
in connection with the site, and in September 2002, the Hickey Parties brought
contribution actions against the Company and other Blydenburgh PRPs. These
contribution actions seek to recover, among other things, any damages for which
the Hickey Parties are found liable in the State's lawsuit against them, and
related costs and expenses, including attorneys' fees. In June 2004, the State
added the Company and other PRPs as defendants in its pending case against the
Hickey Parties. The Company and certain other PRPs have engaged in settlement
discussions which to date have been unsuccessful. The Company has accrued an
amount which it believes would be necessary to resolve its share of this matter.
If settlement discussions are not successful, then the Company intends to
vigorously defend the pending claims. While no assurance can be given as to the
ultimate outcome, management believes that the resolution of the Blydenburgh
matters will not have a material adverse effect on the Company's consolidated
financial condition.
In December 2004, the Company and certain other PRPs settled with the State all
matters of liability in respect of the Huntington/East Northport landfill. In
reaching the settlement, there was no finding or admission of liability by the
Company. The amount paid by the Company in connection with the settlement was
not material to the Company's results of operations or 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 calendar
years ended December 31, 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. In
February 2004, the subsidiary filed an appeal of the finding in the report to
the Portuguese Secretary of State for Fiscal Matters. The appeal is still
pending. On December 20, 2004, the Company received a notice of assessment from
the Portuguese Tax Administration solely in respect of the calendar year ended
December 31, 2000. The assessment, which includes interest, amounted to
approximately 26 million Euros (approximately $35 million at the exchange rate
at December 31, 2004). The Company intends to oppose the assessment, in which
case it may be necessary to provide a form of financial guarantee. While no
assurance can be given as to the ultimate outcome in respect of the foregoing
assessment or any additional assessments that may be issued for subsequent
periods, management believes that the likelihood that the assessment or any
future assessments ultimately will be upheld is remote.
26
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
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 4. Submission of Matters to a Vote of Security Holders.
(a) The Annual Meeting of Stockholders of the Company was held on
November 5, 2004.
(b) The following directors were elected at the Annual Meeting of
Stockholders: Aerin Lauder, William P. Lauder, Richard D. Parsons
and Lynn Forester de Rothschild as Class II Directors for a term
expiring at the 2007 Annual Meeting. The Class III Directors, whose
terms expire at the 2005 Annual Meeting, are Charlene Barshefsky,
Leonard A. Lauder, Ronald S. Lauder and Marshall Rose. The Class I
Directors, whose terms expire at the 2006 Annual Meeting, are Rose
Marie Bravo, Mellody Hobson, Irvine O. Hockaday, Jr. and Barry S.
Sternlicht.
(c) (i) Each person elected as a director at the Annual Meeting
received the number of votes (shares of Class B Common Stock
are entitled to ten votes per share) indicated beside his or
her name:
Name Votes For Votes Withheld
---- --------- --------------
Aerin Lauder 990,693,139 47,909,532
William P. Lauder 996,874,617 41,728,054
Richard D. Parsons 990,812,725 47,789,946
Lynn Forester de Rothschild 1,033,493,509 5,109,162
(ii) 1,035,675,909 votes (shares of Class B Common Stock are
entitled to ten votes per share) were cast for and 2,030,604
votes were cast against the ratification of the appointment of
KPMG LLP as independent auditors of the Company for the 2005
fiscal year. There were 896,158 abstentions and no broker
nonvotes.
(d) Not applicable.
Item 6. Exhibits.
Exhibit
Number Description
------ -----------
10.1 Summary of Compensation for Non-Employee Directors (filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K on
December 17, 2004). *+
10.2 Amendment No. 6 to Stockholders' Agreement.
31.1 Certification pursuant to Rule 13a-14(a) (CEO).
31.2 Certification pursuant to Rule 13a-14(a) (CFO).
32.1 Certification pursuant to Rule 13a-14(b) and 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 Rule 13a-14(b) and 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (CFO). (furnished)
- -----------------
* Incorporated herein by reference.
+ Exhibit is a management contract or compensatory plan or arrangement.
27
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: January 27, 2005 By: /s/Richard W. Kunes
---------------------------
Richard W. Kunes
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
28
THE ESTEE LAUDER COMPANIES INC.
INDEX TO EXHIBITS
Exhibit
Number Description
------ -----------
10.1 Summary of Compensation for Non-Employee Directors (filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K on
December 17, 2004). *+
10.2 Amendment No. 6 to Stockholders' Agreement.
31.1 Certification pursuant to Rule 13a-14(a) (CEO).
31.2 Certification pursuant to Rule 13a-14(a) (CFO).
32.1 Certification pursuant to Rule 13a-14(b) and 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 Rule 13a-14(b) and 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (CFO). (furnished)
- -----------------
* Incorporated herein by reference.
+ Exhibit is a management contract or compensatory plan or arrangement.