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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 March 31, 2005
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 April 26, 2005, 134,714,378 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.
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THE ESTEE LAUDER COMPANIES INC.
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Earnings --
Three and Nine Months Ended March 31, 2005 and 2004 2
Consolidated Balance Sheets --
March 31, 2005 and June 30, 2004 3
Consolidated Statements of Cash Flows --
Nine Months Ended March 31, 2005 and 2004 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Item 4. Controls and Procedures 26
Part II. Other Information
Item 1. Legal Proceedings 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
Item 6. Exhibits 29
Signatures 30
THE ESTEE LAUDER COMPANIES INC.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Nine Months Ended
March 31 March 31
-------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- ----------
(In millions, except per share data)
Net Sales $ 1,538.2 $ 1,421.6 $ 4,792.6 $ 4,387.3
Cost of Sales 386.5 358.6 1,245.8 1,135.4
----------- ----------- ----------- ----------
Gross Profit 1,151.7 1,063.0 3,546.8 3,251.9
----------- ----------- ----------- ----------
Operating expenses:
Selling, general and administrative 975.3 887.9 2,984.6 2,716.7
Related party royalties -- 5.5 -- 16.9
----------- ----------- ----------- ----------
975.3 893.4 2,984.6 2,733.6
----------- ----------- ----------- ----------
Operating Income 176.4 169.6 562.2 518.3
Interest expense, net 3.3 6.9 10.7 21.8
----------- ----------- ----------- ----------
Earnings before Income Taxes, Minority
Interest and Discontinued Operations 173.1 162.7 551.5 496.5
Provision for income taxes 64.7 60.9 206.2 185.7
Minority interest, net of tax (2.2) (1.7) (5.8) (6.7)
----------- ----------- ----------- ----------
Net Earnings from Continuing Operations 106.2 100.1 339.5 304.1
Discontinued operations, net of tax -- (1.8) -- (33.1)
----------- ----------- ----------- ----------
Net Earnings $ 106.2 $ 98.3 $ 339.5 $ 271.0
=========== =========== =========== ==========
Basic net earnings per common share:
Net earnings from continuing operations $ .47 $ .44 $ 1.50 $ 1.33
Discontinued operations, net of tax -- (.01) -- (.14)
----------- ----------- ----------- ----------
Net earnings $ .47 $ .43 $ 1.50 $ 1.19
=========== =========== =========== ==========
Diluted net earnings per common share:
Net earnings from continuing operations $ .46 $ .43 $ 1.48 $ 1.31
Discontinued operations, net of tax -- (.01) -- (.14)
----------- ----------- ----------- ----------
Net earnings $ .46 $ .42 $ 1.48 $ 1.17
=========== =========== =========== ==========
Weighted average common shares outstanding:
Basic 225.5 228.3 226.1 228.3
Diluted 228.7 231.9 229.7 231.4
Cash dividends declared per common share $ -- $ -- $ .40 $ .30
See notes to consolidated financial statements.
2
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED BALANCE SHEETS
March 31 June 30
2005 2004
-------------- --------------
(Unaudited)
(In millions)
ASSETS
Current Assets
Cash and cash equivalents $ 518.0 $ 611.6
Accounts receivable, net 921.5 664.9
Inventory and promotional merchandise, net 723.3 653.5
Prepaid expenses and other current assets 267.1 269.2
-------------- --------------
Total current assets 2,429.9 2,199.2
-------------- --------------
Property, Plant and Equipment, net 690.4 647.0
-------------- --------------
Other Assets
Investments, at cost or market value 12.7 12.6
Goodwill, net 684.5 672.3
Other intangible assets, net 72.1 71.9
Other assets, net 94.6 105.1
-------------- --------------
Total other assets 863.9 861.9
-------------- --------------
Total assets $ 3,984.2 $ 3,708.1
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt $ 113.8 $ 73.8
Accounts payable 251.0 267.3
Accrued income taxes 120.7 109.4
Other accrued liabilities 918.2 871.5
-------------- --------------
Total current liabilities 1,403.7 1,322.0
-------------- --------------
Noncurrent Liabilities
Long-term debt 441.8 461.5
Other noncurrent liabilities 206.4 175.6
-------------- --------------
Total noncurrent liabilities 648.2 637.1
-------------- --------------
Minority Interest 18.5 15.5
-------------- --------------
Stockholders' Equity
Common Stock, $.01 par value; 650,000,000 shares Class A authorized; shares issued:
156,050,339 at March 31, 2005 and 150,969,807 at June 30, 2004; 240,000,000
shares Class B authorized; shares issued and outstanding: 91,112,901 at March 31,
2005 and 93,012,901 at June 30, 2004 2.5 2.4
Paid-in capital 465.3 382.3
Retained earnings 2,136.6 1,887.2
Accumulated other comprehensive income 75.4 10.5
-------------- --------------
2,679.8 2,282.4
Less: Treasury stock, at cost; 21,378,660 Class A shares at
March 31, 2005 and 16,455,660 Class A shares at June 30, 2004 (766.0) (548.9)
-------------- --------------
Total stockholders' equity 1,913.8 1,733.5
-------------- --------------
Total liabilities and stockholders' equity $ 3,984.2 $ 3,708.1
============== ==============
See notes to consolidated financial statements.
3
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
March 31
---------------------------------------
2005 2004
-------------- --------------
(In millions)
Cash Flows from Operating Activities
Net earnings $ 339.5 $ 271.0
Adjustments to reconcile net earnings to net cash flows provided by operating
activities from continuing operations:
Depreciation and amortization 144.0 139.2
Deferred income taxes 36.1 12.0
Minority interest, net of tax 5.8 6.7
Non-cash stock compensation (1.2) 5.6
Discontinued operations, net of tax -- 33.1
Other non-cash items 0.9 0.8
Changes in operating assets and liabilities
Increase in accounts receivable, net (215.2) (128.9)
(Increase) decrease in inventory and promotional merchandise, net (41.2) 39.6
Decrease in other assets, net 1.2 6.0
Decrease in accounts payable (31.7) (12.4)
Increase in accrued income taxes 37.1 32.3
Increase in other accrued liabilities 6.9 127.2
Increase in other noncurrent liabilities 5.2 18.5
-------------- --------------
Net cash flows provided by operating activities of continuing operations 287.4 550.7
-------------- --------------
Cash Flows from Investing Activities
Capital expenditures (154.2) (130.9)
Acquisition of businesses, net of cash acquired (6.9) (3.9)
Proceeds from divestitures -- 3.0
Purchases of long-term investments (0.3) (0.1)
-------------- --------------
Net cash flows used for investing activities of continuing operations (161.4) (131.9)
-------------- --------------
Cash Flows from Financing Activities
Increase (decrease) in short-term debt, net 8.3 (2.0)
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 (0.7) (2.1)
Net proceeds from employee stock transactions 74.4 43.7
Payments to acquire treasury stock (217.1) (98.3)
Dividends paid to stockholders (90.1) (68.5)
Distributions made to minority holders (3.2) (2.8)
-------------- --------------
Net cash flows (provided by) used for financing activities
of continuing operations (228.4) 80.5
-------------- --------------
Effect of Exchange Rate Changes on Cash and Cash Equivalents 9.7 5.5
-------------- --------------
Cash Flows used for Discontinued Operations (0.9) (1.1)
-------------- --------------
Net Increase (Decrease) in Cash and Cash Equivalents (93.6) 503.7
Cash and Cash Equivalents at Beginning of Period 611.6 364.1
-------------- --------------
Cash and Cash Equivalents at End of Period $ 518.0 $ 867.8
============== ==============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 16.1 $ 25.9
============== ==============
Income taxes $ 127.4 $ 134.6
============== ==============
Non-cash items:
Estimated tax benefit from exercise of stock options $ 26.0 $ 14.1
============== ==============
Liability associated with acquisition of business $ 5.6 $ --
============== ==============
Capital lease obligations $ 6.9 $ --
============== ==============
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 nine-month periods ended March 31,
2004. 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.
Certain amounts in the consolidated financial statements of prior periods have
been reclassified to conform to current period presentation for comparative
purposes.
Net Earnings Per Common Share
For the three and nine-month periods ended March 31, 2005 and 2004, 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 Nine Months Ended
March 31 March 31
--------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
(Unaudited)
(In millions, except per share data)
Numerator:
Net earnings from continuing operations $ 106.2 $ 100.1 $ 339.5 $ 304.1
Discontinued operations, net of tax -- (1.8) -- (33.1)
--------- --------- --------- ---------
Net earnings $ 106.2 $ 98.3 $ 339.5 $ 271.0
========= ========= ========= =========
Denominator:
Weighted average common shares outstanding - Basic 225.5 228.3 226.1 228.3
Effect of dilutive securities: Stock options 3.2 3.6 3.6 3.1
--------- --------- --------- ---------
Weighted average common shares outstanding - Diluted 228.7 231.9 229.7 231.4
========= ========= ========= =========
Basic net earnings per common share:
Net earnings from continuing operations $ .47 $ .44 $ 1.50 $ 1.33
Discontinued operations, net of tax -- (.01) -- (.14)
--------- --------- --------- ---------
Net earnings $ .47 $ .43 $ 1.50 $ 1.19
========= ========= ========= =========
Diluted net earnings per common share:
Net earnings from continuing operations $ .46 $ .43 $ 1.48 $ 1.31
Discontinued operations, net of tax -- (.01) -- (.14)
--------- --------- --------- ---------
Net earnings $ .46 $ .42 $ 1.48 $ 1.17
========= ========= ========= =========
5
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of March 31, 2005 and 2004, outstanding options to purchase 6.7 million and
9.4 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 March 31, 2005, 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 Nine Months Ended
March 31 March 31
--------------------------- ------------------------
2005 2004 2005 2004
----------- ------------ ----------- -----------
(Unaudited)
(In millions, except per share data)
Net earnings, as reported $ 106.2 $ 98.3 $ 339.5 $ 271.0
Deduct: Total stock-based employee compensation expense
determined under fair value method for all awards, net of
related tax effects. (4.7) (7.1) (18.2) (24.3)
----------- ------------ ----------- -----------
Pro forma net earnings $ 101.5 $ 91.2 $ 321.3 $ 246.7
=========== ============ =========== ===========
Earnings per common share:
Net earnings per common share - Basic, as reported $ .47 $ .43 $ 1.50 $ 1.19
=========== ============ =========== ===========
Net earnings per common share - Basic, pro forma $ .45 $ .40 $ 1.42 $ 1.08
=========== ============ =========== ===========
Net earnings per common share - Diluted, as reported $ .46 $ .42 $ 1.48 $ 1.17
=========== ============ =========== ===========
Net earnings per common share - Diluted, pro forma $ .44 $ .39 $ 1.39 $ 1.06
=========== ============ =========== ===========
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 $32.9 million and $30.1 million as of March 31, 2005 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.
March 31 June 30
2005 2004
----------- ------------
(Unaudited)
(In millions)
Inventory and promotional merchandise consists of:
Raw materials $ 141.4 $ 148.1
Work in process 31.4 36.5
Finished goods 404.6 317.7
Promotional merchandise 145.9 151.2
----------- ------------
$ 723.3 $ 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.
March 31 June 30
2005 2004
----------- ------------
(Unaudited)
(In millions)
Assets (Useful Life)
Land $ 13.9 $ 13.6
Buildings and improvements (10 to 40 years) 171.6 160.9
Machinery and equipment (3 to 10 years) 746.6 661.1
Furniture and fixtures (5 to 10 years) 111.4 101.9
Leasehold improvements 705.0 630.3
----------- ------------
1,748.5 1,567.8
Less accumulated depreciation and amortization 1,058.1 920.8
----------- ------------
$ 690.4 $ 647.0
=========== ============
Depreciation and amortization of property, plant and equipment was $47.3 million
and $44.8 million during the three months ended March 31, 2005 and 2004,
respectively, and $136.4 million and $129.3 million during the nine months ended
March 31, 2005 and 2004, 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.
7
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Operating Leases
In connection with a February 7, 2005 letter from the Office of the Chief
Accountant of the Securities and Exchange Commission to the American Institute
of Certified Public Accountants expressing its views of existing accounting
literature related to lease accounting, the Company has completed a review of
its lease accounting policies. Generally, leasing is not a significant portion
of the Company's business and it has determined that any changes to its previous
practices would not result in a material impact on its results of operations and
statements of financial position and cash flows for the current period or any
individual prior year. Accordingly, the Company's consolidated financial
statements for prior periods will not be restated.
Currently, the Company recognizes rent expense from operating leases with
periods of free and scheduled rent increases on a straight-line basis over the
applicable lease term. The Company considers lease renewals in the useful life
of its leasehold improvements when such renewals are reasonably assured. From
time to time, the Company may receive capital improvement funding from its
lessors. These amounts are recorded as deferred liabilities and amortized over
the remaining lease term as a reduction of rent expense.
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.
The components of net periodic benefit cost for the three months ended March 31,
2005 and 2004 consisted of the following:
Other than
Pension Plans Pension Plans
------------------------------------------------------------- --------------------------
U.S. International Postretirement
--------------------------- ---------------------------- --------------------------
2005 2004 2005 2004 2005 2004
----------- ----------- ----------- ----------- ----------- -----------
(Unaudited)
(In millions)
Service cost, net $ 4.8 $ 4.2 $ 2.8 $ 2.7 $ 0.8 $ 0.7
Interest cost 5.3 5.0 2.5 2.3 1.0 0.9
Expected return on plan assets (6.0) (5.2) (2.9) (2.6) -- --
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 0.9 -- --
----------- ----------- ----------- ----------- ----------- -----------
Net periodic benefit cost $ 5.4 $ 5.7 $ 3.5 $ 3.5 $ 1.8 $ 1.6
=========== =========== =========== =========== =========== ===========
8
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of net periodic benefit cost for the nine months ended March 31,
2005 and 2004 consisted of the following:
Other than
Pension Plans Pension Plans
-------------------------------------------------------------- -----------------------------
U.S. International Postretirement
---------------------------- ---------------------------- -----------------------------
2005 2004 2005 2004 2005 2004
----------- ----------- ----------- ----------- ----------- -----------
(Unaudited)
(In millions)
Service cost, net $ 14.5 $ 12.7 $ 8.5 $ 7.9 $ 2.4 $ 2.1
Interest cost 15.9 15.0 7.4 6.7 3.0 2.6
Expected return on plan assets (18.1) (15.5) (8.4) (7.6) -- --
Amortization of:
Transition asset -- -- -- 0.3 -- --
Prior service cost 0.4 0.4 0.2 0.2 -- --
Actuarial loss 3.4 4.6 3.0 2.6 -- --
----------- ----------- ----------- ----------- ----------- -----------
Net periodic benefit cost $ 16.1 $ 17.2 $ 10.7 $ 10.1 $ 5.4 $ 4.7
=========== =========== =========== =========== =========== ===========
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 March 31, 2005, the expected
contributions for U.S. pension plans for the fiscal year ending June 30, 2005
have been decreased by approximately $18.0 million, for a total of $7.0 million,
and the expected contributions for the international pension plans are expected
to increase $2.8 million for a total of $20.8 million.
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.
9
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. The special deduction for
domestic manufacturing becomes effective for the Company in the first quarter of
fiscal 2006. The Company believes this legislation and the provisions of FSP No.
109-1 will not have a significant impact on its effective tax rate. 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. While it is anticipated that this liability will
increase the overall effective rate for income taxes, the actual tax rate impact
will only 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
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 March 2005, Staff
Accounting Bulletin No. 107 ("SAB No. 107") was issued to provide guidance from
the Securities and Exchange Commission to simplify some of the implementation
challenges of SFAS No. 123(R) as this statement relates to the valuation of
share-based payment arrangements for public companies. The Company will apply
the principles of SAB No. 107 in conjunction with its adoption of SFAS 123(R).
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 believes the adoption of this statement will not have a material impact
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.
10
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 Nine Months Ended
March 31 March 31
-------------------------- ------------------------
2005 2004 2005 2004
---- ---- ---- ----
(Unaudited)
(In millions)
Net earnings $ 106.2 $ 98.3 $ 339.5 $ 271.0
---------- ---------- ---------- --------
Other comprehensive income (loss):
Net unrealized investment gain 0.2 0.2 0.2 0.2
Net derivative instruments gain (loss) 3.3 4.1 (3.4) 9.4
Net minimum pension liability adjustments -- -- -- 0.5
Translation adjustments (8.2) 2.7 68.1 39.9
---------- ---------- ---------- --------
Other comprehensive income (loss) (4.7) 7.0 64.9 50.0
---------- ---------- ---------- --------
Comprehensive income $ 101.5 $ 105.3 $ 404.4 $ 321.0
========== ========== ========== ========
The accumulated net gain (loss) on derivative instruments consists of the
following:
Three Months Ended Nine Months Ended
March 31 March 31
------------------------- -----------------------
2005 2004 2005 2004
---- ---- ---- ----
(Unaudited)
(In millions)
OCI-derivative instruments, beginning of period $ 3.5 $ 3.8 $ 10.2 $ (1.5)
---------- ----------- ---------- --------
Gain (loss) on derivative instruments 0.2 0.2 (13.6) 0.7
Reclassification to earnings of net loss during 4.9 6.0 8.6 14.7
the period
(Provision) benefit for deferred income taxes (1.8) (2.1) 1.6 (6.0)
---------- ----------- ---------- --------
Net derivative instruments gain (loss) 3.3 4.1 (3.4) 9.4
---------- ----------- ---------- --------
OCI-derivative instruments, end of period $ 6.8 $ 7.9 $ 6.8 $ 7.9
========== =========== ========== ========
Of the $6.8 million, net of tax, derivative instrument gain recorded in OCI at
the end of the current period, $8.9 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 $2.1
million loss, net of tax, related to forward and option contracts which the
Company will reclassify to earnings during the next fifteen months.
At the end of the prior-year period, the $7.9 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 $1.2 million
loss, net of tax, related to forward and option contracts which the Company is
reclassifying to earnings through the fiscal year ending June 30, 2005.
11
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 aggregate payments made through March 31, 2005 to
acquire the distributor were funded by cash provided by operations and did not
have a material effect on the Company's results of operations or financial
condition. In addition, the Company incurred debt and other long-term
obligations of 4.6 million Euros associated with the acquisition (approximately
$5.6 million at acquisition date exchange rates). The debt incurred is 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 Nine Months Ended
March 31 March 31
-------------------------- -------------------------
2005 2004 2005 2004
---- ---- ---- ----
(Unaudited)
(In millions)
SEGMENT DATA
Net Sales:
Skin Care $ 608.2 $ 559.1 $ 1,749.9 $ 1,594.1
Makeup 628.2 591.0 1,820.1 1,607.1
Fragrance 228.7 203.4 999.0 980.9
Hair Care 67.3 61.3 202.0 179.1
Other 5.8 6.8 21.6 26.1
---------- ---------- ---------- ---------
$ 1,538.2 $ 1,421.6 $ 4,792.6 $ 4,387.3
========== ========== ========== =========
Operating Income:
Skin Care $ 89.3 $ 96.0 $ 275.0 $ 253.8
Makeup 90.1 96.1 227.3 206.1
Fragrance (9.2) (27.6) 40.3 38.7
Hair Care 5.6 3.3 17.7 16.8
Other 0.6 1.8 1.9 2.9
---------- ---------- ---------- ---------
176.4 169.6 562.2 518.3
Reconciliation:
Interest expense, net 3.3 6.9 10.7 21.8
---------- ---------- ---------- ---------
Earnings before income taxes, minority
interest and discontinued operations $ 173.1 $ 162.7 $ 551.5 $ 496.5
========== ========== ========== =========
REGIONAL DATA
Net Sales:
The Americas $ 844.6 $ 783.1 $ 2,610.5 $ 2,439.3
Europe, the Middle East & Africa 496.2 453.1 1,548.9 1,367.6
Asia/Pacific 197.4 185.4 633.2 580.4
---------- ---------- ---------- ---------
$ 1,538.2 $ 1,421.6 $ 4,792.6 $ 4,387.3
========== ========== ========== =========
Operating Income:
The Americas $ 112.5 $ 102.8 $ 302.8 $ 281.3
Europe, the Middle East & Africa 53.1 57.2 212.4 193.7
Asia/Pacific 10.8 9.6 47.0 43.3
---------- ---------- ---------- ---------
$ 176.4 $ 169.6 $ 562.2 $ 518.3
========== ========== ========== =========
12
THE ESTEE LAUDER COMPANIES INC.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
We manufacture, market and sell beauty products including those in the skin
care, makeup, fragrance and hair care categories which are distributed in over
130 countries and territories. The following is a comparative summary of
operating results for the three and nine months ended March 31, 2005 and 2004,
and reflects the basis of presentation described in Note 1 to the consolidated
financial statements for all periods presented. Sales of products and services
that do not meet our definition of skin care, makeup, fragrance or hair care
have been included in the "other" category.
Three Months Ended Nine Months Ended
March 31 March 31
---------------------------- ---------------------------
2005 2004 2005 2004
---- ---- ---- ----
(In millions)
Net Sales
By Region:
The Americas $ 844.6 $ 783.1 $ 2,610.5 $ 2,439.3
Europe, the Middle East & Africa 496.2 453.1 1,548.9 1,367.6
Asia/Pacific 197.4 185.4 633.2 580.4
----------- ---------- ---------- ------------
$ 1,538.2 $ 1,421.6 $ 4,792.6 $ 4,387.3
=========== ========== ========== ============
By Product Category:
Skin Care $ 608.2 $ 559.1 $ 1,749.9 $ 1,594.1
Makeup 628.2 591.0 1,820.1 1,607.1
Fragrance 228.7 203.4 999.0 980.9
Hair Care 67.3 61.3 202.0 179.1
Other 5.8 6.8 21.6 26.1
----------- ---------- ---------- ------------
$ 1,538.2 $ 1,421.6 $ 4,792.6 $ 4,387.3
=========== ========== ========== ============
OPERATING INCOME
By Region:
The Americas $ 112.5 $ 102.8 $ 302.8 $ 281.3
Europe, the Middle East & Africa 53.1 57.2 212.4 193.7
Asia/Pacific 10.8 9.6 47.0 43.3
----------- ---------- ---------- ------------
$ 176.4 $ 169.6 $ 562.2 $ 518.3
=========== ========== ========== ============
By Product Category:
Skin Care $ 89.3 $ 96.0 $ 275.0 $ 253.8
Makeup 90.1 96.1 227.3 206.1
Fragrance (9.2) (27.6) 40.3 38.7
Hair Care 5.6 3.3 17.7 16.8
Other 0.6 1.8 1.9 2.9
----------- ---------- ---------- ------------
$ 176.4 $ 169.6 $ 562.2 $ 518.3
=========== ========== ========== ============
13
THE ESTEE LAUDER COMPANIES INC.
The following table presents certain consolidated earnings data as a percentage
of net sales:
Three Months Ended Nine Months Ended
March 31 March 31
------------------------ ------------------------
2005 2004 2005 2004
---- ---- ---- ----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 25.1 25.2 26.0 25.9
-------- --------- --------- --------
Gross profit 74.9 74.8 74.0 74.1
-------- --------- --------- --------
Operating expenses:
Selling, general and administrative 63.4 62.5 62.3 61.9
Related party royalties -- 0.4 -- 0.4
-------- --------- --------- --------
63.4 62.9 62.3 62.3
-------- --------- --------- --------
Operating income 11.5 11.9 11.7 11.8
Interest expense, net 0.2 0.5 0.2 0.5
-------- --------- --------- --------
Earnings before income taxes, minority interest and
discontinued operations 11.3 11.4 11.5 11.3
Provision for income taxes 4.2 4.3 4.3 4.2
Minority interest, net of tax (0.2) (0.1) (0.1) (0.2)
-------- --------- --------- --------
Net earnings from continuing operations 6.9 7.0 7.1 6.9
Discontinued operations, net of tax -- (0.1) -- (0.7)
-------- --------- --------- --------
Net earnings 6.9% 6.9% 7.1% 6.2%
======== ========= ========= ========
Third Quarter Fiscal 2005 as Compared with Third Quarter Fiscal 2004
NET SALES
Net sales increased 8% or $116.6 million to $1,538.2 million due to growth in
all major product categories and geographic regions. Product category increases
were led by strong fragrance sales in the Americas as well as increased global
sales of makeup and skin care products. In each case, the increases reflected
new and recent product launches. Excluding the impact of foreign currency
translation, net sales increased 6%.
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 9% or $49.1 million to $608.2 million,
led by new and recently launched products. Increases amounting to approximately
$60 million were attributable to Superdefense Triple Action Moisturizers SPF 25
by Clinique, certain new launches in the Perfectionist and Re-Nutriv lines of
products and Future Perfect Anti-Wrinkle Radiance Creme SPF 15 by Estee Lauder
and The Lifting Face Serum & The Lifting Intensifier by La Mer. Partially
offsetting these increases was a decrease of approximately $17 million in sales
of Hydra Complete Multi-Level Moisture Creme, Perfectionist Correcting Serum for
Lines/Wrinkles and Body Performance Anti-cellulite Visible Contouring Serum by
Estee Lauder. Excluding the impact of foreign currency translation, skin care
net sales increased 6%.
14
THE ESTEE LAUDER COMPANIES INC.
MAKEUP
Makeup net sales increased 6% or $37.2 million to $628.2 million. Increases of
approximately $41 million were attributable to the recent launches of Tender
Blush, Ideal Matte Refinishing Makeup SPF 12 and AeroMatte Ultralucent Pressed
Powder by Estee Lauder, Superbalanced Compact Makeup SPF 20 and Colour Surge Eye
Shadow from Clinique and the current period inclusion of sales from American
Beauty and Flirt!, which are the two BeautyBank brands with makeup lines. Strong
sales from M.A.C.'s Small Eye Shadow, Lustreglass and Studio Fix products also
contributed approximately $15 million to the increase. Partially offsetting
these increases was a decrease of approximately $25 million of sales of the High
Impact Mascara and High Impact Eye Shadow collections and Perfectly Real Makeup
from Clinique and Electric Intense LipCreme and Pure Colour Eye Shadow by Estee
Lauder. Excluding the impact of foreign currency translation, makeup net sales
increased 5%.
FRAGRANCE
Net sales of fragrance products increased 12% or $25.3 million to $228.7
million, primarily due to the recent launches of DKNY Be Delicious and Be
Delicious Men, True Star from Tommy Hilfiger, Happy To Be from Clinique, Donald
Trump, The Fragrance and Lauder Beyond Paradise Men from Estee Lauder.
Collectively, these launches generated sales of approximately $55 million, which
was partially offset by a decrease in sales of approximately $31 million of
Beyond Paradise from Estee Lauder, Simply from Clinique and Tommy Jeans from
Tommy Hilfiger. Excluding the impact of foreign currency translation, fragrance
net sales increased 11%.
HAIR CARE
Hair care net sales increased 10% or $6.0 million to $67.3 million. This
increase was due to sales growth from Aveda and Bumble and bumble products and
services. Aveda sales increased as a result of ongoing demand for professional
color products and the recent introduction of Air Control and Pure Abundance
hair care products. Bumble and bumble benefited from increases in sales from its
hair and scalp treatment line and new points of distribution. Excluding the
impact of foreign currency translation, hair care net sales increased 9%.
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 8% or $61.5 million to $844.6 million. This
increase was due to net sales from new and recently launched fragrance products,
the current-period inclusion of net sales of BeautyBank products, an overall
increase in sales from our makeup artist lines and higher net sales in Canada.
In Europe, the Middle East & Africa, net sales increased 10% or $43.1 million to
$496.2 million, primarily reflecting higher net sales in our travel retail
business, Spain, the United Kingdom, Russia, South Africa and Benelux of
approximately $42 million, collectively. Partially offsetting these increases
were lower sales in France and Italy of approximately $5 million, combined. On a
local currency basis, net sales in Europe, the Middle East & Africa increased
6%.
Net sales in Asia/Pacific increased 6% or $12.0 million to $197.4 million. This
increase reflected higher net sales of approximately $16 million in China,
Korea, Hong Kong and Australia, partially offset by decreases in Japan and
Taiwan of approximately $5 million. Excluding the impact of foreign currency
translation, Asia/Pacific net sales increased 2%.
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 decreased to 25.1% as compared
with 25.2% in the prior-year quarter. Cost of sales as a percentage of net sales
reflected favorable net changes in production and supply chain efforts of
approximately 50 basis points, primarily driven by favorable material sourcing.
These net changes were partially offset by an increase in obsolescence charges
proportionate to the change in inventory levels of approximately 30 basis
points.
15
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 63.4% of net sales as compared with 62.9% of net
sales in the prior-year quarter. Contributing to this increase were our planned
levels of spending due to launch activity, as well as a slight shift in our
business activity to the third quarter from the fourth quarter resulting from
the early Easter holiday. These increases were partially offset by our ongoing
cost containment efforts to maintain expenses in line with our business needs.
Additionally, in the prior-year quarter, we experienced a greater increase in
net sales which contributed favorably to that period's operating expense margin.
The collective increase in operating expense margin of approximately 90 basis
points was partially offset by the 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, which ceased to accrue in April 2004.
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 and the decrease in our cost of sales, offset
by the increase in our operating expense margin as previously discussed,
operating income increased 4% or $6.8 million to $176.4 million as compared with
the prior-year quarter. Operating margins were 11.5% of net sales in the
current-year quarter as compared with 11.9% in the prior-year quarter.
PRODUCT CATEGORIES
Operating results improved 67% or $18.4 million in fragrance reflecting net
sales from new and recently launched products as well as the strategic
redeployment of advertising, merchandising and sampling to new and recently
launched products in our skin care and makeup categories. Accordingly, operating
income decreased 7% or $6.7 million in skin care and 6% or $6.0 million in
makeup. To a lesser extent, these decreases also include a shift from the second
quarter into the third quarter of costs related to certain gift-with-purchase
programs. Hair care operating income increased 70% or $2.3 million reflecting
improved results internationally, partially offset by an increase in operating
expenses related to the growth of our business in the United States.
GEOGRAPHIC REGIONS
Operating income in the Americas increased 9% or $9.7 million to $112.5 million,
primarily reflecting an improved performance in our fragrance product category,
partially offset by lower results in our makeup and skin care product categories
reflecting our emphasis on advertising and promotional spending behind new and
recently launched products.
In Europe, the Middle East & Africa, operating income decreased 7% or $4.1
million to $53.1 million primarily due to lower results in the United Kingdom,
France and Italy of approximately $8 million, collectively. Improved results in
Spain and South Africa of approximately $6 million partially offset those
decreases.
In Asia/Pacific, operating income increased 13% or $1.2 million to $10.8
million. This increase reflects higher results of approximately $6 million in
Korea, Thailand, Australia and Taiwan, partially offset by lower results from
Japan and Hong Kong of approximately $5 million.
16
THE ESTEE LAUDER COMPANIES INC.
INTEREST EXPENSE, NET
Net interest expense was $3.3 million as compared with $6.9 million in the
prior-year period. The decrease in net interest expense was due primarily to a
$4.0 million decrease in preferred stock dividends as a result of the redemption
of $291.6 million aggregate principal amount of the 2015 Preferred Stock on June
10, 2004 and the reduction in the dividend rate on 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
March 31, 2005 and 2004 was 37.4%. The effective rate differs from statutory
rates due to the effect of state and local taxes, tax rates in foreign
jurisdictions and certain nondeductible expenses. While there was no change in
the overall effective rate between the two periods, the effective tax rate for
the three months ended March 31, 2005 included an extra 100 basis points
attributable to the anticipated full-year mix of global earnings, which was
offset by the reduction in the amount of nondeductible preferred stock dividends
of approximately 100 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.
While it is anticipated that this liability will increase the overall effective
rate for income taxes, the actual tax rate impact will only 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. During the prior-year quarter, we recorded a loss of
$1.8 million, net of tax, which represented additional costs associated with the
sale and discontinuation of the business.
Nine Months Fiscal 2005 as Compared with Nine Months Fiscal 2004
NET SALES
Net sales increased 9% or $405.3 million to $4,792.6 million reflecting growth
in all major product categories, led by makeup and skin care, and growth in all
geographic regions, led by Europe, the Middle East & Africa. Excluding the
impact of foreign currency translation, net sales increased 6%.
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.
17
THE ESTEE LAUDER COMPANIES INC.
SKIN CARE
Net sales of skin care products increased 10% or $155.8 million to $1,749.9
million. Approximately $121 million of this increase in sales was related to the
introduction of Future Perfect Anti-Wrinkle Radiance Creme SPF 15 and new
launches in the Perfectionist and Re-Nutriv product lines 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 The Lifting Face Serum & The Lifting Intensifier by La
Mer and products in Clinique's 3-Step Skin Care System contributed approximately
$25 million to the sales increase, combined. Partially offsetting these
increases was a decrease of approximately $30 million in sales of Idealist
Micro-D Deep Thermal Refinisher, the LightSource line of products and
Perfectionist Correcting Serum for Lines/Wrinkles by Estee Lauder. Excluding the
impact of foreign currency translation, skin care net sales increased 7%.
MAKEUP
Makeup net sales increased 13% or $213.0 million to $1,820.1 million, partially
due to strong net sales of our makeup artist lines, which accounted for
approximately $114 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 $106 million of
the increase in sales was attributable to the recent launches of Superbalanced
Compact Makeup SPF 20, Colour Surge Eye Shadow, Colour Surge Soft Shimmer and
the Colour Surge Lip Lacquer line of products from Clinique, Tender Blush,
AeroMatte Ultralucent Pressed Powder, Pure Color Eyeliner and Pure Color Lip
Tint by Estee Lauder and the current period inclusion of net sales from American
Beauty and Flirt!, which are the two BeautyBank brands with makeup lines. Also
contributing to sales growth were increased sales of Lash XL Maximum Length
Mascara and Pure Pops Brush-on Color by Estee Lauder and Perfectly Real Makeup
and Colour Surge Bare Brilliance from Clinique of approximately $38 million,
collectively. Partially offsetting these increases was a decrease of
approximately $42 million of sales of the Glosswear line of products and the
High Impact Mascara and High Impact Eye Shadow collections by Clinique as well
as Pure Color Lip Vinyl and Ideal Matte Refinishing Makeup SPF 8 by Estee
Lauder. Excluding the impact of foreign currency translation, makeup net sales
increased 11%.
FRAGRANCE
Net sales of fragrance products increased 2% or $18.1 million to $999.0 million.
The increase is due to approximately $138 million in sales generated by the
recent launches of True Star from Tommy Hilfiger, DKNY Be Delicious and Be
Delicious Men, Lauder Beyond Paradise Men from Estee Lauder, Happy To Be from
Clinique and Donald Trump, the Fragrance. Partially offsetting the new product
sales were decreases in sales of approximately $74 million of Aramis Life, Estee
Lauder Beyond Paradise and Clinique Simply, which were launched in the
prior-year period, and decreases in sales of approximately $50 million of Tommy,
Tommy Jeans and Tommy Girl products from Tommy Hilfiger and Lauder Intuition Men
from Estee Lauder. Excluding the impact of foreign currency translation,
fragrance net sales decreased 1%.
HAIR CARE
Hair care net sales increased 13% to $202.0 million. This $22.9 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 its hair and scalp treatment line
of products and the addition of new points of distribution. 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 7% or $171.2 million to $2,610.5 million.
Our makeup artist brands in North America contributed approximately $65 million
to the increase. In addition, higher net sales in Canada, higher sales from our
hair care brands and the inclusion of BeautyBank products contributed
approximately $75 million, collectively.
In Europe, the Middle East & Africa, net sales increased 13% or $181.3 million
to $1,548.9 million primarily due to higher net sales in the United Kingdom, our
travel retail business, Spain, South Africa, Germany and Portugal of
approximately $138 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%.
18
THE ESTEE LAUDER COMPANIES INC.
Net sales in Asia/Pacific increased 9% or $52.8 million to $633.2 million. This
increase reflected higher net sales of approximately $44 million in China, Hong
Kong, Australia and Taiwan, partially offset by lower sales in Japan of
approximately $1 million. Excluding the impact of foreign currency translation,
Asia/Pacific net sales increased 5%.
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 26.0% from 25.9%
reflecting unfavorable changes in exchange rates of approximately 10 basis
points and the net change in the mix of our business within our geographic
regions and product categories, as discussed above, of approximately 30 basis
points. Partially offsetting these changes were favorable net changes in
production and supply chain efforts of approximately 30 basis points, primarily
driven by favorable material sourcing.
The higher price of oil is beginning to impact our cost of raw materials and
componentry, 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 as a percentage of net sales were 62.3% and remained
unchanged compared with the prior year. Our planned increase in advertising,
merchandising and sampling for spring launches over the prior year of
approximately 90 basis points was partially offset by our ongoing cost
containment efforts to maintain expenses in line with our business needs of
approximately 50 basis points. 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, which ceased to accrue in April 2004.
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 our
constant operating expense margin as previously discussed, operating income
increased 9% or $43.9 million to $562.2 million as compared with the prior-year
period. Operating margins were 11.7% of net sales in the current period as
compared with 11.8% in the prior-year period.
PRODUCT CATEGORIES
Operating income increased 10% or $21.2 million in makeup and 8% or $21.2
million in skin care reflecting overall sales growth and sales of recently
launched products. Operating results also increased 4% or $1.6 million in
fragrance reflecting sales growth resulting from new and recently launched
products. While we experienced significantly improved results in the fiscal 2005
third quarter due to these new launches, the fragrance business in the Americas
continues to be soft. Hair care operating results increased 5% or $0.9 million
reflecting the growth in net sales as previously discussed, partially offset by
an increase in operating expenses related to the growth of our business in the
United States.
GEOGRAPHIC REGIONS
Operating income in the Americas increased 8% or $21.5 million to $302.8
million. The current-period increase reflects strong sales in all of our product
categories due to new and recently launched products as well as continued growth
from our makeup artist brands.
19
THE ESTEE LAUDER COMPANIES INC.
In Europe, the Middle East & Africa, operating income increased 10% or $18.7
million to $212.4 million primarily due to improved results from the United
Kingdom, South Africa, Spain and Switzerland of approximately $21 million,
collectively, partially offset by lower results in Russia of approximately $3
million.
In Asia/Pacific, operating income increased 9% or $3.7 million to $47.0 million.
This increase reflects improved results in Taiwan, Australia, Hong Kong and
Thailand of approximately $10 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 Japan of approximately $8 million,
collectively.
INTEREST EXPENSE, NET
Net interest expense was $10.7 million as compared with $21.8 million in the
prior-year period. The decrease in net interest expense was due primarily to a
$13.8 million decrease in preferred stock dividends as a result of the
redemption of $291.6 million aggregate principal amount of the 2015 Preferred
Stock on June 10, 2004 and the reduction in the dividend rate on the remaining
$68.4 million of the 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 nine months ended
March 31, 2005 and 2004 was 37.4%. The effective rate differs from statutory
rates due to the effect of state and local taxes, tax rates in foreign
jurisdictions and certain nondeductible expenses. While there was no change in
the overall effective rate between the two periods, the effective tax rate for
the nine months ended March 31, 2005 included an extra 100 basis points
attributable to the anticipated full-year mix of global earnings, 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. While it is anticipated that this
liability will increase the overall effective rate for income taxes, the actual
tax rate impact 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, we committed, in
December 2003, 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 $33.1 million for the
nine months ended March 31, 2004. The charge represents the impairment of
goodwill in the amount of $26.4 million, the reduction in value of other
tangible assets of $1.3 million, net of tax, and the operating loss of $5.4
million, net of tax, for the nine month period ended March 31, 2004. Included in
the operating loss of the period were additional costs associated with the sale
and discontinuation of the business.
20
THE ESTEE LAUDER COMPANIES INC.
FINANCIAL CONDITION
- -------------------
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of funds historically have been cash flows from operations
and borrowings under our commercial paper program, borrowings from the issuance
of long-term debt and committed and uncommitted credit lines provided by banks
in the United States and abroad. At March 31, 2005, we had cash and cash
equivalents of $518.0 million compared with $611.6 million at June 30, 2004.
At March 31, 2005, our outstanding borrowings of $555.6 million included: (i)
$238.4 million of 6% Senior Notes due January 2012 consisting of $250.0 million
principal, unamortized debt discount of $0.8 million and a $10.8 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 2015 Preferred Stock, which shares have a mandatory redemption date
of June 30, 2015; (iv) a 3.0 billion Japanese yen term loan (approximately $28.5
million at the exchange rate at March 31, 2005), which is due in March 2006; (v)
a 1.8 million Euro note (approximately $2.4 million at the exchange rate at
March 31, 2005) payable semi-annually through February 2008 at a variable
interest rate; (vi) $6.9 million of capital lease obligations; and (vii) $13.7
million of other short-term borrowings.
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 March 31, 2005, we had no commercial paper outstanding. We also have
an effective shelf registration statement covering the potential issuance of up
to an additional $300.0 million in debt securities. As of March 31, 2005, we had
an unused $400.0 million revolving credit facility, expiring on June 28, 2006,
and $146.1 million in additional uncommitted credit facilities, of which $13.7
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 March 31, 2005 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 $287.4
million during the nine months ended March 31, 2005 as compared with $550.7
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
reflects significant deferred compensation and supplemental pension payments
made to retired executives. The increase in inventory was primarily due to
actual and anticipated sales levels, the building of safety stock in our new
distribution center in Europe and, to a lesser extent, the inclusion of new
points of distribution such as BeautyBank and new affiliate activities.
Increased accounts receivable levels reflect overall sales growth in the current
period and the timing of our receipt of customer payments, which occurred in the
beginning of the fiscal 2005 fourth quarter. 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 $161.4 million during the nine months
ended March 31, 2005 compared with $131.9 million in the prior-year period. For
both periods the use of cash primarily reflected capital expenditures, which
were higher during the current period.
21
THE ESTEE LAUDER COMPANIES INC.
Net cash used for financing activities was $228.4 million during the nine months
ended March 31, 2005 compared to net cash provided by financing activities of
$80.5 million in the prior-year period. This change from the prior-year period
primarily reflected an increase in the acquisition of treasury stock and an
increase in the annual common stock dividend paid to stockholders, partially
offset by an increase in proceeds from the exercise of employee stock options.
Additionally, $210.5 million of proceeds were received in the prior-year period
from transactions associated with the issuance of long-term debt.
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. On November 5, 2003, the Board of Directors declared an
annual dividend of $.30 per share on our Class A and Class B Common Stock, which
was paid on January 6, 2004 to stockholders of record at the close of business
on December 16, 2003. Dividends declared on the cumulative redeemable preferred
stock were $0.6 million and $14.4 million for the nine months ended March 31,
2005 and 2004, respectively. The preferred stock dividends have been
characterized as interest expense in the accompanying consolidated statements of
earnings for the nine months ended March 31, 2005 and 2004.
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 March 31,
2005, the cumulative total of acquired shares pursuant to the authorization was
21.6 million, reducing the remaining authorized share repurchase balance to 6.4
million. During the first nine months of fiscal 2005, we purchased approximately
4.9 million shares for $217.1 million as outlined in the following table:
Total Number of Shares Maximum Number of
Purchased as Part of Shares that May Yet Be
Total Number of Shares Average Price Paid Publicly Announced Purchased Under the
Period Purchased Per Share Program(1) 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
January 2005 - - - 7,079,900
February 2005 675,000 43.58 675,000 6,404,900
March 2005 - - - 6,404,900
----------------------- -------------------------
Year-to-date 4,923,000 44.11 4,923,000
======================= =========================
(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 aggregate payments made through March 31, 2005 to acquire the
distributor were funded by cash provided by operations and did not have a
material effect on our results of operations or financial condition. In
addition, we incurred debt and other long-term obligations of 4.6 million Euros
associated with the acquisition (approximately $5.6 million at acquisition date
exchange rates). The debt incurred is payable semi-annually through February
2008 at a variable interest rate.
22
THE ESTEE LAUDER COMPANIES INC.
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 March 31, 2005, these cash-flow hedges were highly
effective, in all material respects.
As a matter of policy, we only enter into contracts with counterparties that
have at least an "A" (or equivalent) credit rating. The counterparties to these
contracts are major financial institutions. We do not have significant exposure
to any one counterparty. Our exposure to credit loss in the event of
nonperformance by any of the counterparties is limited to only the recognized,
but not realized, gains attributable to the contracts. Management believes risk
of loss under these hedging contracts is remote and in any event would not be
material to the consolidated financial results. The contracts have varying
maturities through the end of June 2006. Costs associated with entering into
such contracts have not been material to our consolidated financial results. We
do not utilize derivative financial instruments for trading or speculative
purposes. At March 31, 2005, we had foreign currency contracts in the form of
forward exchange contracts and option contracts in the amount of $819.8 million
and $136.2 million, respectively. The foreign currencies included in forward
exchange contracts (notional value stated in U.S. dollars) are principally the
Euro ($177.9 million), Swiss franc ($145.6 million), British pound ($132.7
million), Canadian dollar ($91.5 million), Australian dollar ($56.4 million) and
Japanese yen ($47.5 million). The foreign currencies included in the option
contracts (notional value stated in U.S. dollars) are principally the Japanese
yen ($33.6 million), South Korean won ($26.3 million), Euro ($25.7 million) and
Swiss franc ($25.3 million).
INTEREST RATE RISK MANAGEMENT
We enter into interest rate derivative contracts to manage the exposure to
fluctuations of interest rates on our funded indebtedness and anticipated
issuance of debt, as well as cash investments, for periods consistent with the
identified exposures. All interest rate derivative contracts are with large
financial institutions rated as strong investment grade by a major rating
agency.
We have an interest rate swap agreement with a notional amount of $250.0 million
to effectively convert fixed interest on the existing $250.0 million 6% Senior
Notes to variable interest rates based on LIBOR. We designated the swap as a
fair-value hedge. As of March 31, 2005, 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 $8.8 million related to our foreign
exchange contracts. As of March 31, 2005, our average value-at-risk related to
our interest rate contracts for the twelve month period for which these
contracts were outstanding was $11.9 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.
23
THE ESTEE LAUDER COMPANIES INC.
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.
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. The special deduction for domestic
manufacturing becomes effective for us in the first quarter of fiscal 2006. We
believe this legislation and the provisions of FSP No. 109-1 will not have a
significant impact on our effective tax rate. 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. While it is anticipated
that this liability will increase the overall effective rate for income taxes,
the actual tax rate impact will only 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
Accounting Principles Board Opinion 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 is measured
according to the fair value of stock options. SFAS 123(R) will be effective for
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 March 2005, Staff Accounting
Bulletin No. 107 ("SAB No. 107") was issued to provide guidance from the
Securities and Exchange Commission to simplify some of the implementation
challenges of SFAS No. 123(R) as this statement relates to the valuation of
share-based payment arrangements for public companies. We will apply the
principles of SAB No. 107 in conjunction with our adoption of SFAS 123(R).
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
believe the adoption of this statement will not have a material impact on our
consolidated financial statements.
24
THE ESTEE LAUDER COMPANIES INC.
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.
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 conditions that could affect consumer
purchasing, the willingness of consumers to travel, the financial
strength of our customers or suppliers, our operations, 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);
25
THE ESTEE LAUDER COMPANIES INC.
(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
(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 March
31, 2005 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 third quarter of fiscal 2005 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
26
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are involved in various routine legal proceedings incident to our 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.
On March 30, 2005, the United States District Court for the Northern District of
California entered a Final Judgment approving the settlement agreement we
entered into in July 2003 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. The time to appeal that
judgment has not yet expired. Assuming no appeal, the Final Judgment will result
in the plaintiffs' claims being dismissed, with prejudice, in their entirety in
both the Federal and California actions. There was no finding or admission of
any wrongdoing by the Company or any other defendant 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 March 31, 2005, 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 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 subsidiary 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 $34 million at the exchange rate
at March 31, 2005). At the end of March 2005, the subsidiary filed an opposition
to the assessment. Despite filing the opposition, the Portuguese Tax
Administration could seek to collect on the assessment, in which case it may be
necessary for us 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.
27
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
In December 2004, a plaintiff purporting to represent a nationwide class brought
an action in the Superior Court of California for the County of San Diego. The
complaint, as amended, names two of our subsidiaries and approximately 25 other
defendants, including manufacturers and retailers. The plaintiff is seeking
injunctive relief, restitution, and general, special and punitive damages for
alleged violations of the California Unfair Competition Law, the California
False Advertising Law, and for negligent and intentional misrepresentation. The
purported class includes individuals "who have purchased skin care products from
defendants that have been falsely advertised to have an 'anti-aging' or youth
inducing benefit or effect." We intend to defend ourselves vigorously. While no
assurance can be given as to the ultimate outcome, management believes that the
resolution of this lawsuit will not have a material adverse effect on the
Company's consolidated financial condition.
28
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 6. EXHIBITS.
Exhibit
Number Description
------ -----------
10.1 Summary of Grant of Additional Target Bonus Opportunities to
Daniel J. Brestle, Patrick Bousquet-Chavanne and Philip
Shearer Reflecting Changes in Responsibilities (filed as
Item 1.01 to the Company's Current Report on Form 8-K on
February 10, 2005). *+
10.2 Employment Agreement with Daniel J. Brestle (filed as
Exhibit 10.2 to the Company's Current Report on Form 8-K/A
on February 10, 2005). *+
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.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE ESTEE LAUDER COMPANIES INC.
Date: April 28, 2005 By: /s/ RICHARD W. KUNES
-----------------------------
Richard W. Kunes
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
30
THE ESTEE LAUDER COMPANIES INC.
INDEX TO EXHIBITS
Exhibit
Number Description
------ -----------
10.1 Summary of Grant of Additional Target Bonus Opportunities to
Daniel J. Brestle, Patrick Bousquet-Chavanne and Philip
Shearer Reflecting Changes in Responsibilities (filed as
Item 1.01 to the Company's Current Report on Form 8-K on
February 10, 2005). *+
10.2 Employment Agreement with Daniel J. Brestle (filed as
Exhibit 10.2 to the Company's Current Report on Form 8-K/A
on February 10, 2005). *+
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.